Dolby Laboratories Inc (DLB) 2005 Q3 法說會逐字稿

Good day, and welcome to the Dolby Laboratories conference call discussing fiscal third quarter 2005 results. [OPERATOR INSTRUCTIONS] As a reminder, this call is being recorded Thursday, July 28, 2005. I would now like to turn the conference call over to Paula Dunn, Director of Corporate Communications for Dolby Laboratories. Please go ahead, Ms. Dunn.

Thank you. Good afternoon, everyone. Welcome to Dolby Laboratories’ third quarter fiscal 2005 earnings conference call. Joining me today are Bill Jasper, Dolby Laboratories’ President and CEO, and Marty Jaffe, Executive Vice President of Business and Finance. In addition to Bill and Marty, Ed Schummer, Dolby’s Senior Vice President and General Manager of the Consumer Licensing division, is here to participate in the Q&A later in today’s call. If you have not already received a copy of our press release with the results discussed here today, you can find it on our Website, www.Dolby.com under the Investor Relations section.

This conference call contains forward-looking statements within the meaning of Section 27(a) of the Securities Act of 1933 as amended and Section 21(e) of the Securities Exchange Act of 1934 as amended. These statements include statements relating to our future operating results, market trends for the industries in which we compete, the capabilities and market acceptance of our products and technologies, and our ability to compete successfully in our markets. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause results, whether specific to Dolby or related to the entertainment industries in general, to differ from those expressed or implied by these forward-looking statements. In evaluating these forward-looking statements, you should specifically consider various risk factors, including the risk factors detailed from time to time in Dolby’s Securities and Exchange Commission filings and reports and our quarterly report on form 10-Q filed with the SEC on May 13, 2005. Dolby disclaims any obligation to update information contained in these forward-looking statements, whether as a result of new information, future events, or otherwise. Now, I will turn the call over to Marty Jaffe. Please go ahead, Marty.

Thank you, Paula. As we did last quarter, before starting with an overview of the quarter, I’d like to review three very important aspects of our business that you should be aware of and take into account when analyzing our quarterly results and our guidance. Diversities is our inclusion of pro forma results. Second is the timing of our revenue recognition, which affects both fluctuations in our quarterly results and our ability to forecast future performance. The third is the absence of predictability in our quarters. As we said in previous quarters earnings calls, and as well as our IPO perspectives, we believe that pro forma financial results are meaningful to investors because they reflect the Company’s financial position on a going-forward basis subsequent to the completion of Ray Dolby’s contribution of intellectual property to the Company just prior to the IPO. This resulted in the elimination of royalty payments to Mr. Dolby as of February 16, 2005. The impact of this is largely seen in our gross margins as a reduction to our cost of licensing and, to a lesser extent, our cost of product sales. As detailed in our press release, we also provide results taking into account Ray Dolby’s contribution and excluding stock-based compensation.

The second aspect is the timing of our revenue recognition. We do not manufacture or sell the products that drive our licensing business. Rather, we license our technologies to consumer electronics manufacturers and software developers to use them in products. Our licensees are required to report to us between 30 and 60 days following the end of the quarter in which they ship their products. As a result, there is a time lag between when our licensees ship their products and when they report these shipments to us. Our licensee shipment reports are prerequisite for us recognizing licensing revenue related to those shipments, and since licensing comprises roughly three-quarters of our revenue, our overall revenue can fluctuate quarter to quarter as a result of the timing of our receipt of those royalty reports. In addition, it is not uncommon for royalty reports to include corrective, retroactive royalties that cover extended periods of time. For this reason, our quarterly results could vary from forecasts, and our guidance policy is to provide guidance for the full year only.

The third aspect of our business model that we want to continue to stress is the lack of the predictable quarterly pattern in our results. Our revenues are lumpy. Different quarters are higher in different years.

As for the structure of this call, Bill will begin with an overview of the Company’s accomplishments during the third quarter, and he will discuss how we are managing the business. Following Bill’s discussion, I will provide a detailed run-down of the third quarter financial results and discuss guidance. We will then open the call up for questions. At this point, I’d like to turn it over to Bill Jasper. Please go ahead.

Thank you, Marty. Thanks again to all of you for joining us today. At the outset, I would like to comment on some of the important developments during the quarter as well as some of the trends we are currently seeing in our business and the markets in which we operate. This quarter marked many major milestones for the Company, the industry and consumers worldwide.

The worldwide launch of Dolby Digital Cinema took place with the release of “Star Wars: Episode III - Revenge of the Sith.” As the final chapter to the “Star Wars” saga, this was the first publicly announced theatrical release to leverage Dolby’s Digital Cinema product offering. As the movie debuted, Dolby engineers traveled with Lucasfilm in the U.S. and throughout the world, installing Dolby Digital Cinema for key screenings and offering ongoing support and services. If you did not have a chance to see “Star Wars: Episode III” in Dolby Digital Cinema, it is just a matter of months until you can experience Dolby Digital Cinema in 100 top cinemas around the nation with the release of Disney’s “Chicken Little” in digital 3-D. At the end of the third quarter of fiscal 2005, Dolby and Disney jointly announced collaboration for the first studio-supported rollout of digital cinema, delivering once again on our longstanding commitment to provide moviegoers with the best entertainment experience possible and paving the way for large-scale digital cinema deployment in the future. This collaboration is the latest in the 30-year history of Dolby’s and Disney’s working relationship.

We learned this morning that Cinemeccanica, a leading manufacturer of cinema projectors and a longstanding Dolby distributor, has sold a number of Dolby Digital Cinema systems into two separate influential theater chains in Italy. We believe this display of confidence in our Dolby Digital Cinema system will help accelerate the rollout of digital cinema in Europe.

On the broadcasting front, we are seeing increased use of Dolby Digital 5.1 in TV broadcasting around the globe, including China and Europe. In China, we are honored that Dolby Digital has been chosen by Shanghai Media Entertainment Group to provide the first channel in China’s television broadcasting history to offer 5.1 programming. This move will mark a significant advancement in the quality of sound delivered by the Chinese television industry. Shanghai Media Entertainment Group’s movie channel was selected for the kickoff of its 5.1 broadcasting service due to the growing library of Dolby Digital 5.1 audio encoded films coming out of the Shanghai Film Studio, a premiere film studio in China. The Group has also successfully implemented regular broadcast of feature films in Dolby Digital 5.1 on its Orient Movie Channel, and plans to start broadcasting surround sound programming on other popular channels, including its sports and music channels.

In Europe, we have seen a steady stream of broadcasters adding 5.1 to new or existing services. For instance, Premier, the dominant pay TV broadcaster in Germany, launched video on demand services using Dolby Digital audio exclusively instead of simulcasting with standard MPEG audio. Additionally, M6, one of France’s leading broadcasters, also went on air with Dolby Digital 5.1 surround sound for programming on both its new digital terrestrial television network, as well as its network satellite service. The European Broadcasting Union, or EBU, which represents the main state broadcasters in Europe, has published a technical document that recommends inclusion of 5.1 audio decoding in new TV and set-top boxes that receive HDTV signals in Europe. Dolby Digital is the only 5.1 audio technology being broadcast in a European TV. The document further discussed Dolby Digital Plus as the most future proof option for audio on HDTV. While not a standard, it is a strong recommendation from a body that is highly respected by its members, and this recommendation could put a Dolby decoder in every European HD receiver as it is for HDTV in the United States.

Also, in the U.S., this week the ATSC announced that Dolby Digital Plus has been fully approved and published as an ATSC audio coding standard. We are pleased that the ATSC also just approved a modification to the ATSC DTV standard to specify Dolby Digital Plus for use with the new robust transmission mode of EVSB. This process began in 2002 when Dolby Laboratories responded to the ATSC’s search for advanced video and audio technology for the newly developed EVSD enhanced transmission technology. In the future, EVSD with Dolby Digital Plus will give digital broadcasters the ability to increase their reach to provide more reliable reception and to provide new services to indoor, portable and fringe area receivers.

For another example of the worldwide search for quality sound, the Israeli Satellite Channel, the DBD Box, part of the Yes TV Network, selected Dolby technologies and began airing films in Dolby Digital 5.1 audio. Since its launch five years ago, Yes has been broadcasting in Dolby Analog sound on all of its channels, but the DBD Box Channel is the first to bring Dolby Digital 5.1 surround sound to nearly a half million TV subscribers in Israel.

On the consumer front, Dolby feels that next-generation DVD players will become a reality, and Dolby’s technologies are already included in both the Blu-ray and HD DVD standards. In the PC arena, together with our PC motherboard licensees, we are making it possible for PC enthusiasts to build PCs with audio performance and surround capabilities typically found in consumer electronics. Three leading motherboard manufacturers, Abit, ASUSTeK and Gigabyte, launched motherboards built on the Intel Express Chipset with Intel High Definition Audio implementations that meet the Designed for Dolby Master Studio requirements. PCs build with Designed for Dolby Master Studio motherboards, quality components, and Dolby tested and approved software applications can deliver the most advanced set of Dolby audio presentation capabilities. Each of these motherboards features Dolby Digital EX, Dolby Digital Live, Dolby Pro Logic IIX, Dolby Headphone, and Dolby Virtual Speaker technologies, and all are now available for purchase by do-it-yourself PC enthusiasts.

Dolby has also seen industry momentum through its subsidiary of Via Licensing, which reached its third quarter of profitability this past quarter. Via’s profitability milestone was reached in Q1 of this fiscal year, six months ahead of its business plan. Via has made significant advancements in providing the industry with licensing programs. Most recently, Via announced the final licensing terms and availability of a joint license for the IEEE 802.11 standard, making Via the only company to run a joint patent licensing program for the most widely used wireless networking standard. Additionally, Via publicly announced licensing terms for the Digital Video Broadcasting Multimedia Home Platform, 1.0 standard, which is typically referred to as DVBMHP 1.0, the Cable Labs Open Cable Applications Platform standard, also referred to as OCAP 1.0, and the TV Anytime Phase I Interactive Television standard, referred to as TVA-1 standard. All three of these standards are related to interactive television applications, thereby widening Via’s market reach beyond audio and video.

During the third quarter of fiscal 2005, we have noted trends related to the markets in which we operate that we would like to share with you. On the consumer side, we are seeing a slowdown in the growth of traditional consumer DVD players reported by licensees and slower than anticipated adoption of recordable and next-generation DVD players. In addition, we have seen that some manufacturers are reducing the complexity of their low-end DVD players, which reduces the number of processors on which Dolby earns licensing revenue. The industry has also experienced a movement by discount retailers towards lower-end, Chinese-made DVD players, which we believe poses challenges in royalty collection.

On the professional side, the health of the cinema industry is a key driver for Dolby’s product sales and services revenue. Disappointing box office results, as well as changes in the industry, including recent restructuring and consolidations among U.S. cinema exhibitors, appear to have put some equipment purchasing decisions on hold. Even though we have seen the rollout of digital cinema initiatives, widespread adoption has yet to take hold. We expect these trends and their effect on the markets in which we operate to continue into fiscal 2006.

Here’s how we’re managing the business in light of these realities. First, our success is tied to understanding and meeting the needs of our customers and the markets we serve in the long term and developing new ingredient technologies to enhance the entertainment experience. Some examples include opportunities that are already burgeoning realities, such as broadcast, next-generation packaged media, headphone technology, security and others, as well as new and emerging opportunities, such as in digital cinema. Second, we continue to build closer working relationships through face-to-face consumer engagement, thereby enabling us to deliver better products to our customers and improve financial results to you.

All of us recognize that one of our key regions is China, which we consider both an opportunity and a challenge. In the last two quarters, we have seen more evidence of increased competition in China, forcing smaller DVD manufacturers out of business, resulting in a concentration of volume to a smaller number of key licensees. Although this leads to volume discounts, we may be able to benefit by focusing our relationship building, enforcement of IP licensing, and collection efforts on a more manageable number of Chinese manufacturers. In an effort to ensure that the Company is receiving property royalty payments, we are planning to begin a program to audit select licensees.

Now, I’ll turn the call back over to Marty to provide some more detailed information about our financial results for the third quarter 2005 and to share with you our guidance. Marty?

Thank you, Bill. To start off, I will provide a financial overview of the third quarter of 2005 and then discuss guidance for fiscal 2005.

Total revenue for the third quarter was $79.7 million, 5% higher than the third quarter of fiscal 2004 of $76.1 million. On a year-to-date basis, our revenue was up $28.9 million, or 13% over the same nine-month period last year, to $249 million. Our revenue mix for the quarter was 76% licensing and 24% product sales and production services. Key revenue drivers include, in the technology licensing segment, revenue increased by $5.3 million, or 10% from the third quarter of 2004. Declines in the traditional consumer DVD player market that Bill mentioned were more than offset by improved results from other categories of DVD, such as software DVD players and portable DVD players, as well as PC gaming and broadcast markets. The continued growth in royalties earned from software associated with DVD on personal computers and laptops, the advent of Sony PSP, and sales of set-top boxes all yielded positive year-over-year comparisons.

We also saw better results from Via, our wholly owned subsidiary through which we carry out our patent pool licensing activities. In the products and services segment, revenue for the third quarter declined by $1.7 million, or 8% from the comparable prior year period, caused by a slowdown in box office results and the impact of restructuring and consolidation in the cinema industry, both of which we believe have impacted product purchasing decisions. It should be noted that last year’s third quarter was particularly buoyant as the result of strong sales in the Korean market. The greatest area of strength in the third quarter of 2005 on the professional side was increased sales of equipment to enable broadcasting in 5.1 surround sound to broadcasters located outside of the U.S.

Third quarter net income was $14.8 million, or $0.13 per diluted share compared to $12 million, or $0.13 per diluted share for the third quarter of fiscal 2004. Per-share calculations are based on 112.8 million diluted shares in the third quarter of fiscal 2005 compared with 95.3 million diluted shares in the comparable year-ago quarter. The 18% increase in shares is principally attributable to the shares sold by the Company in its February 2005 IPO.

On a pro forma basis, which gets us back to Ray Dolby’s asset contribution in February 2005, third quarter net income in 2005 was $14.8 million, or $0.13 per diluted share, compared to $17.6 million, or $0.18 per diluted share, last year. Let me remind you that for the current quarter, pro forma and actual results were identical, as the royalty obligations to Ray Dolby terminated back in Q2 in conjunction with our IPO. We provide these pro forma results to offer relevant comparative information.

Net income also includes stock-based compensation charges of $3.2 million for the third quarter of 2005 and $2.3 million for the third quarter a year ago. Net income excluding both the Ray Dolby royalty obligations and stock-based compensation charges for the third quarter of fiscal 2005 was $18.4 million, or $0.16 per diluted share, compared to $19.7 million, or $0.21 per diluted share, for the third quarter last year.

Operating expenses were $40.3 million compared with $32.4 million in the third quarter of 2004, a 24% year-over-year increase and the primary factor for our decline in pro forma net income. It should be noted that Q3 of fiscal year 2004 included a $2 million settlement that reduced operating expenses. As noted in our prospectus and last quarter’s conference call, our general and administrative costs have increased as we have expanded our infrastructure to fulfill the requirements of being a public company.

Let me now turn to a discussion of the most significant variances in our operating expense categories. Compared to the third quarter of 2004, SG&A was $5.2 million higher, and R&D was $700,000 higher. The most significant variants include the following. Personnel related expenses were higher by $2.3 million. Of that, $900,000 was attributable to increases in stock-based compensation. The remaining increase was due primarily to an increase in head count and salary increases. As of July 1, 2005, we had 810 employees company wide compared to 726 a year ago. This additional head count was to support the development of new technologies capable of driving current and new growth opportunities as well as additions in finance and administrative staff, such as IT, legal and internal audit. Occupancy expenses also grew by $700,000 to accommodate this growth. Professional fees increase $700,000 related primarily to information technologies support costs, legal fees, including those associated with employee benefits matters, and insurance costs. While operating expenses were up year over year, it should be noted that our operating expenses for the third quarter of 2005 were $3.1 million lower than our operating expenses in the second quarter of 2005, primarily as the result of lower stock-based compensation expense on a sequential basis, reduced legal fees associated with ongoing litigation, and lower advertising and promotional costs.

Overall gross margin was 82% in the third quarter of 2005 compared to 69% in the third quarter of fiscal 2004. The increase in gross margin was primarily due to the asset contribution by Ray Dolby that occurred in February 2005, resulting in elimination [indiscernible] royalties for the remainder of the year. On a pro forma basis, which excludes these royalty obligations, gross margin for the third quarter of 2004 was also 82%. Licensing gross margins increased to 92% this year from 76% last year. Gross margin for product sales increased to 50% this year from 49% last year. Product services gross margin decreased to 59% this year from 63% last year. Excluding royalty obligations to Ray Dolby that were recognized in the third quarter of 2004, licensing pro forma gross margin increased to 92% this year from 91% last year. Pro forma gross margin for product sales declined to 50% this year from 54 last year, primarily as the result of product mix sold and lower sales volume over which to allocate relatively fixed overhead costs. Pro forma projected service gross margin is not affected by royalty obligations to Ray Dolby.

Interest income was $2.5 million compared to about $300,000 in the third quarter of 2004, due to our significantly higher cash balances of the result of the IPO. As of July 1, 2004, our cash balance was $361.6 million or $10.9 million higher than it was April 2005. Make sure I said July 1, 2005 there.

Our effective tax rate was 45% for the third quarter of 2005 compared to 40% for the comparable year-ago period, and the same on a pro forma basis. This rate was primarily affected by stock-based compensation and losses from foreign subsidiaries. The increases from the third quarter 2004 attributable to stock-based compensation was 3% and 1% from losses in foreign subsidiaries. Stock-based compensation recorded for incentive stock options is generally not deductible for tax purposes. Therefore, an increase in stock-based compensation expense generally increases our effective rate, as our pretax income decreases but our provision for income taxes remains relatively flat. The stock-based compensation expense had a 6% impact on our effective tax rate for the third quarter fiscal 2005.

Now we’ll discuss guidance. While we’ll be providing guidance for projected financial results for future periods on this call and future earnings calls, it is our policy not to provide any further guidance or updates on the Company’s financial performance during the quarter, including confirming guidance that was previously given, unless we do so in a press release, SEC filing, or other publicly available communication. We are not changing the guidance ranges for fiscal 2005, which we provided to you in our last earnings release and conference call.

For fiscal 2005, revenue is currently expected to be at the low end of our previously forecasted range of $335 million to $350 million. Net income for fiscal 2005 is still expected to be between $49 million and $55 million. Pro forma net income, which excludes the now terminated royalty obligations to Ray Dolby for fiscal 2005, is still expected to be between $60 million and $67 million. Earnings per diluted share for the full-year 2005 are still expected to be in the range of $0.45 to $0.51, and on a pro forma basis, between $0.55 and $0.62, based on 108 million diluted shares. We still expect stock-based compensation expense for the full year to be between $14 and $15 million. Net income for fiscal 2005, excluding both the Ray Dolby obligations that existed until February 2005 and stock-based compensation expense, is expected to be in the range of $73 to $80 million or between $0.67 and $0.74 per diluted share.

This concludes our prepared remarks. Before I turn the call over to the operator to start the Q&A, I would like to point out that I will be presenting at the Adams Harkness Conference in Boston next week on Thursday, August 4. A Webcast of the presentation will be available from our Investor Relations Website at www.dolby.com. I would now like to turn it over to the operator for questions. Please go ahead, operator.

[OPERATOR INSTRUCTIONS] Anthony Nodo [ph]; Goldman Sachs.

The first question I had was what type of progress are you making with the mobile handset manufacturers as it relates to their efforts to enter the digital music market and potentially having Dolby technology implemented into the handsets? The second question is it looks like your guidance implies that the final fiscal quarter would have 25% year-over-year growth relative to the trend that we’ve seen in the last couple of quarters. That would be a fairly significant acceleration. That’s at the low end of your guidance, which would imply about $86 million. Do you have visibility into that level of acceleration? Lastly, it seems like your licensing revenue is basically in line with where we expected it at about $61 million, and we had forecasted about an 8% year-over-year increase for flat sequential growth in DVD player shipments. Is that about the trend that you’re seeing in the marketplace? Thanks.

Okay, Anthony, it’s Ed. I’m going to take the first one on the cell phones. As you know, we are part of a consortium that licenses so-called AAC technology. There has been a lot of interest from the cell phone industry in that technology, and some preliminary experiments have been made by companies such as Nokia. You may have seen some of the add-on units that have been sold to the market. One of the biggest issues that I think is facing the industry in the choice for expanding the functionality of cell phones is battery life. You don’t want additional capability in terms of any entertainment experience to significantly reduce your battery life. There’s going to have to be some parallel developments going on before we’ll see significant increase there. But, rest assured that when the capability to provide additional functionality is there, Dolby will be there to participate in it. On the guidance, I’ll have to turn it over to Marty. I’m not sure.

Yes. I think we’ll stick with our $335 to $350 million revenue range, and I think I’d point out to you that as we’ve said in the past, patterns are relatively lumpy in our earnings. So, you really can’t rely on previous quarter patterns to necessarily derive the patterns you’re going to see in the following year. I think that’s enough said on the guidance there. Can you repeat your last question, Anthony?

Sure. My last question was you actually achieved your licensing revenue for the quarter at $61 million, and embedded in our licensing forecast was a forecast for DVD player shipments that you would have had licenses against of about 8% year over year and flat sequentially. I was just wondering if that’s what you actually saw. Thank you.

This is Bill. We’re not going to give any breakdowns, but as I said in my remarks, we have seen a continued growth in DVD, but the rate of growth has slowed down from what we’ve experienced in the past. We’re not going to be breaking down any percentages by any of the half dozen or so product categories within that licensing income number.

Steven Frankl [ph]; Adams Harkness.

Bill, again, looking at the drivers of your business and trying to get comfortable with the increase in the September quarter, have you seen the same type of slowdown in home theater in a box and receivers, or is that still a relatively stronger business for you?

Home theater box has been continuing to be a good driver. The automotive is picking up. The PC has been… Ed?

Yes. The PC business has been good, and broadcast is also good. What we see, Steven, is a shift in the product mix away from standalone standard DVD player only type products to products that are a little bit more comprehensive and have additional functionality - a shift to PVRs with built-in DVD players and things like that. There’s a lot more interest in those product categories.

And, what kind of assumptions are you making around adoption rates for the next-gen systems, given there’s not going to be a compromise now and there’s going to be two competing systems? Do you see any kind of meaningful volume out next year in these two new formats?

At this point, we’re not making any assumptions. There is still rumors flying around that some sort of compromise may happen. As you have read in the press yesterday and even today, there are still industry associations that are urging the inventors of both formats to come to some sort of agreement for a single standard. Everybody knows that a format war is deadly. At this point, we’re just saying we’ll support whatever format is successful out there.

Ralph Shackert [ph]; William Blair.

Just sticking with the DVD-only player market, how many more years do you think in the standard def cycle is this a growth category for your business - on an absolute basis?

It’s hard to predict. If I could predict the future, Ralph, I wouldn’t have to sit here working. I’d be retired somewhere. The question really is what will cause consumers to pick up high definition sources other than broadcast which is currently available? There are so many interacting aspects of that out there. First off is the availability and the cost of high definition displays. As we see that coming down -- Certainly in the broadcast products we’ve seen that pick up already. Whether that will then drive in return the demand for high definition players -- we think so, but it’s really anybody’s guess as to when the standard definition will fall by the wayside. One thing to consider is that everybody today -- This is a digital world. But, do you know that there are still significant numbers of cassette players sold around the planet? We would not have thought so, but yet we still get revenue from them. That’s as close as I can predict that.

Thanks. Hopefully this question doesn’t need the crystal ball. On a sequential basis, your OpEx is trending in a very positive direction. Marty, how should we think about that going forward, both sequentially and as we think about our ’06 forecast?

I think what we’ve talked about in the past is a lot of the increase in sheer dollars that we saw in the last year or year and a half were a lot of the buildup in infrastructure that we talked about to be a public company - things like our ERP system, our [SOX] expenses, adding a legal department, and internal audit, etcetera. We don’t see those same trends increasing in terms of the percentage growth rates in the future, so I think we’re pretty comfortable with the general range of percentages of SG&A and R&D as a percentage of revenue. I think we’ll start to see some improvements in our leverage as SG&A as a percentage of revenue will start to drop in the future. I think we’ll get some of the payback on some of this investment.

Great. Just a housekeeping item; how should we think about your share count for next quarter as well as for the fiscal year?

108 for the year.

And the other quarter?

You guys have a quarter? Same thing. About 115 for the quarter.

Paul Coster; JP Morgan.

A couple of very quick ones, and then one bigger one. The customer concentration and geographic concentration - could you share any information with us there, Marty?

Yes. No one single customer is over 10%. On a geographic basis, basically it’s safe to say it’s about one-quarter U.S. and about three-quarters rest of the world.

Can you give us any breakdown inside the rest of the world? Is China the largest country?

I don’t actually have the specific percentage, but it typically is Japan first and then followed by China.

Okay. The gross margins on the licensing side came in at 92%, I think you said. Can it get any better than that? That seems to me to be a record.

I think we’re at about the sweet spot here. There’s a slight difference in mix of products. A little bit of difference in mix of products could affect it, but I think that’s about it. Ed, would you agree?

Yes.

Okay, and, Bill, you managed this business for long term; we know that. Nonetheless, revenues are coming in a bit light and so, too, are earnings. How do you respond to that, or do you not?

We don’t really respond on a quarter-by-quarter basis. What our licensees report to us for the quarter is what they report to us. We don’t panic and say we’re going to cut expenses here or there in order to manage the bottom line. As we stressed for months now, we’re managing for the long term. We expect long-term growth, and we set our budgets and our plans for the years and stick to them. We can’t control what Sony or Matsushita or Pioneer or Chinese licensees report to us on a quarterly basis. The only thing we can do is to step up as we have indicated and start auditing some of our licensees to hopefully improve our collection efforts, primarily in the Chinese field. But, there’s not a whole lot we can do on a short-term basis. We’re, again, managing for the long term.

Ben Swinburn; Morgan Stanley.

The European digital tuner opportunity seems like a pretty large one. Can you sort of talk about what happens from here? Do you expect a standard to be chosen, or are we sort of going to have the recommendation and then it’s going to be done on a country-by-country or even a broadcaster-by-broadcaster basis? Most of these governments in Europe are sort of picking their date now for a forced conversion. I would expect a nice acceleration on the unit size.

As you know, so far, Europe has been dominated by MPEG. All the broadcasting that has been going on has been two-channel MPEG. Where people wanted to deliver multi-channel material, they have chosen Dolby Digital 5.1 to do that because there was no other solution available to them. They’re gaining experience with that now, and we don’t want to necessarily push for a standard that is written in anywhere. We’re very happy with a de facto standard if we can get there from here.

If I can go back again to the DVD question. Bill, you made some interesting comments about ’06. You kind of listed three issues on the DVD side. One was just sort of unit shortfall from what you were expecting; a mix issue when you get towards the -- lower end products have a little lower revenue yield for Dolby; and then the impact of China and big-box retailers buying from China. I know we can’t sort of quantify them, but maybe you could rank them as to what’s had the biggest impact on the results coming in a little lower than either what you thought or what your key customers thought so far? Then, your point on falling into ’06; specifically, what exactly is the weakness you expect to see in 2006, just to clarify?

We’re not going to break those down. They all our three factors, and as we indicated, we expect to see those carrying over into 2006. The general weakness in DVD might be as a result of the standards confusion that’s out there in terms of next generation, and it may be causing people to hold off on buying that second or third DVD player. That’s definitely a possibility. But, we definitely expect those three trends to continue into the start of the next fiscal year.

Okay. And, then lastly, and I’ll yield back to the call; the announcement with Disney on “Chicken Little” - I know we can’t talk about sort of the revenue opportunity here, but was this a standard-term, commercial agreement, or was this a get the equipment-out-there and then build a business model from there kind of an agreement?

Well, we were very careful in structuring the deal with Disney to make certain that it was something that we could carry over to other studios as well. We’ve been having those discussions with other studios. So, even though it is a beta test and the 100 systems out there are one-time, 3-D effort with Disney, we expect what we have put together to be a model which can be rolled out in the U.S. as well as in Europe and in other countries around the world. We’re using it as a basis for hopefully helping to kick start digital cinema for the industry as a whole.

Does that include Dolby as helping to finance that, or can you not be that specific?

Well, with the Disney deal, it’s a partnership between us and Disney, and we are putting a significant amount of money into it, as is Disney, and looking forward to other possible digital cinema initiatives out there. We are considering to what extent we’re going to participate on the financial side as well. Obviously, we’re in a position to do so, and we’re taking a hard look at some of these initiatives around the world.

Daniel Ernst; Hudson Square Research.

I have three questions, if I might. First, on the professional products side - down 12% year on year. You’re not giving the exact breakout. Is it relative of where the weakness was between, say, Hollywood and U.S. theaters and broadcasters? And, then on the consumer side, the DVD question aside, the results on HDTV and digital deployment by cable operators appears to be continuing probably ahead of expectations. All the U.S. side includes the Dolby D-code, so, our sense is still TV on the consumer side offsetting the DVD side. And, then the last question is on R&D down, both in dollar terms and as a percentage of revenues. I’m wondering what we should look at going forward?

I think we got that, Daniel, but you’re breaking up actually. I think we got at least the first two. On the professional side, as we indicated, we’re seen a decline in the sale of our traditional cinema processors offset by increased broadcast sales. But, we’re not going to break that split down anymore than that. As we referred to the consolidations and mergers taking place, primarily in the U.S., we think that is affecting, at least temporarily, some buying decisions and, hopefully, those will turn around here in the future. On the consumer front, Ed?

You were talking about the slowdown that we’ve seen in traditional DVD players being taken up potentially by broadcast product? Was that the way I understood the question? I think that’s what you were referring to.

Not in broadcast so much as digital cable, digital satellite.

It’s semantics. We refer to those products as broadcast products, even though they’re on the receiving end of it. So, yes. You’re right. Obviously, the recognition of digital television in the United States is on its march forward, and there is going to be a date at which point analog is going to be switched off is driving that segment of the market. We’re seeing continued strong growth in that. How this will be going forward in the future is hard to predict, but we think that the current penetration of digital television products throughout the U.S. demographic is still very, very low. We’ve got quite a bit of room to grow in that area.

Let me take the R&D question. On the R&D side, we’ve been running around 8% to 9% roughly of revenue over the last few years. I think that feels about right - somewhere in that range.

Mike Olson; Piper Jaffray.

Not to beat a dead horse here, but was the decline in traditional DVD players in the quarter more significant than what you had expected going into the quarter and was offset by greater than expected broadcast and PC, or was it just a more favorable mix on the PC and broadcast side and a dropoff in traditional DVD as you had expected?

Just a shift in mix a little bit quicker than we had expected. It wasn’t anything real significant. We knew it was coming at some point; it’s just a matter of timing.

Again, we’re not projecting those breakdowns on a quarterly basis. We sit back and say what do we expect to happen in the year, and that’s how we set our forecast and our expectations. But, from quarter to quarter, we don’t sit here and say, “Gee; next quarter we expect DVDs to go up 8% and PC to up 17% and broadcasts to go up 20%.” We don’t do that. What comes in from a licensee comes in.

Okay. I don’t want to put words in your mouth, but it sounds like it came in a little bit faster than what you had expected this quarter, and the other stuff was a little stronger?

Well, as we indicated, we saw an acceleration of some of these long-term trends that we thought might be happening out in the next year or two. We saw a little bit of that happening right now - again, perhaps because of this confusion over next-generation DVD.

Can you give us some more detail related to the slowdown in box office revenue and the repercussions of that? Are you seeing deals getting pushed out to next quarter or pushed out indefinitely or just less interest on new-deal pipeline? Any more details on that?

No. All we’re saying is that we’ve seen a slight slowdown in the sales of traditional cinema processors as a result of that. We still expect long term that retrofits and new construction will start again. You have to remember that the film industry is so dependent upon the box office. It’s been something like 21 out of the last 22 weeks -- I’m not sure of the exact numbers. But, there’s a significant percentage year-over-year comparison in the film industry where box office receipts haven’t held up to last year. The industry, rightly so, takes a step back and looks at their CapEx expenditure plans and adjusts those accordingly. They definitely aren’t seeing the box office results coming in. I think that’s what we’re seeing right now. The industry is in a temporary -- I don’t want to say hold mode, but they just aren’t expanding as fast if they would have been, and as a result of the mergers and consolidations, we’re not quite seeing the same level of retrofit that we might have seen had those mergers and consolidations not taken place.

Steven Frankl; Adams Harkness.

As part of your annual planning process, you sit down with customers and you come up with some kind of unit forecast. Is it your sense that when you get to the end of the year, you’re going to find that many of these customers came up short? And, does that impact how you might look at those same forecasts next year?

Are you talking, Steve, on the professional side or the consumer side?

On the consumer side; I’m sorry.

Steve, on the consumer side, we don’t really get detailed annual forecasts from our customers. We don’t insist on them. They sometimes have no way of predicting what their sales in particular product categories are going to be. We base our predictions on industry data that everybody has access to, and that’s what we use to build our long-term strategy on.

And a follow-up on the box office side. Is it your sense that not only is this impacting cinema processors, but it might slow down the production pipeline of green lighting new movies as well, which would impact your services business going forward?

No; I don’t think we’ve seen any of that, Steve, and I don’t think that’s traditionally happened. If anything, I think people might step up film production in order to try to get more hits out there. I don’t think that’s the case.

Ralph Shackert; William Blair.

Can you talk a little bit about your Virtual Headphone technology for the handset industry and when we think that might be a product that could get some traction? And, then, additionally, will that have to go through your Via licensing group, similar to the AAC technology?

Dolby Headphone, Ralph, is a technology that we own. Through the acquisition of Lake Technology where it came from, it is a technology that is marketed and sold under the Dolby brand name. We think that that will be one of the value-add technologies that we will be able to offer to many of our customers and inclusion in some of these product categories. One of the issues that has existed until not too very long ago is the issue of power consumption and DSD footprint and implementing that technology. A recent redesign of the basic structure of the algorithm has enabled a much, much smaller footprint and operation with fewer [myths] and fewer memory requirements, so we think the time is right to get it included in some of these portable applications that you’ve been addressing.

Paul Coster; JP Morgan.

As we see the products mix shift in the licensing area, or the drivers change, I should say, are we going to see the licensing per unit change dramatically, and, if so, how will it evolve?

I’m not sure that you’re going to see significant changes in per unit, Paul, because the range of products is still so wide that you have to see almost monumental shifts in the categories to see any significant change in the average per unit across the whole category.

Okay. The related question is that at one time a DVD player was $100 or more, and your licensing as a percentage of the bill of materials was so big. Now, obviously we’re seeing DVD players out there for less than $50, so as a percentage of bill of materials, it’s much higher. Are you therefore under pricing pressure from the OEMs?

Paul, are we -- think about all the other licensors of technology who want about $15 per player for that. What do you think they’re feeling? Yes.

I’m just wondering if it’s accelerating. I realize you’re under pressure, but is it changing dramatically?

We haven’t seen any dramatic changes.

[OPERATOR INSTRUCTIONS] Ben Swinburn; Morgan Stanley.

Ed, is there revenue coming in from the satellite radio unit sales in the quarter, and, if so, is that AAC so it’s running through Via as well?

Satellite radio units? I presume you’re referring to XM Radio or Sirius or one of those?

That’s right.

XM Radio is using AAC, and it is coming in through Via. Yes.

But not Sirius?

No Sirius to my knowledge.

Any indication from set-top box manufacturers maybe supplying the R box for IPTV? It’s more of a 2006 event that they will be incorporating Dolby technology at this point?

I can’t talk about it at this point.

Okay. I’ll try one more. On the Xbox 360, is there any comment you can make if Microsoft’s going to be entering in sort of the standard Dolby licensing structure?

All I can say about the Xbox 360 is that it will incorporate Dolby technology at this point.

We have no further questions at this time. I’d like to turn the call over to Mr. Jasper for any additional or closing remarks.

Thank you, operator. I’d like to thank all of you again for joining us on today’s call, and we look forward to your participating in our upcoming investor presentations and Webcasts and speaking to you throughout the next quarter. Operator, you may now conclude this teleconference.

Once again, ladies and gentlemen, that does conclude today’s call. We do appreciate your participation. You may now disconnect.