Dolby Laboratories Inc (DLB) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal second quarter’s 2006 results. During the presentation, all participants will be a listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. At that time if you have a question, you will need to press the star one on your telephone. As a reminder this call is being recorded Thursday, April 27, 2006.

I will now like to turn the conference over to Paula Denn [ph], Director of Corporate Communications for Dolby Laboratories. Please go ahead, Ms. Denn.

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, Tim Partridge, Dolby Senior Vice President and General Manager of the Professional Division, is here to participate in today’s Q and 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 affordable entertainment device markets, 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 10Q 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 a 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 results on our web site at www.dolby.com under the investor relations sections for the most directly comparable actual financial measure and reconciliation.

As for the structure of this call, Bill will begin with a discussion of Dolby strategy in focus and Kevin will follow with a rundown of Dolby financial results. So with that introduction behind us, I’ll now turn the call over to Bill.

Thank you, Paula. Good afternoon, everybody. I’m 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 benefitted 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 new 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 [unintelligible] World Cup matches in Dolby Digital 5.1.

In April the [unintelligible] group launched its first HD station on satellite with Dolby Digital 5.1, so that any set-top box that deploys receiving an HD signal must contain a Dolby Digital decoder.

In our core DVD market, we will benefit from the shipment of both Blu-ray and HD-DVD players as Dolby technologies are mandated audio standards in both next-generation DVD formats. While we don’t expect either of these formats to have a meaningful impact on our fiscal 2006 results, we are encouraged by the fact that some initial HD-DVD players are arriving on the market, and by the announcement of Universal and Warner Studios that they are releasing movie titles on HD-DVD.

In gaming Sony plans to ship the PS3 with Blu-ray playback in November. To date, Dolby technologies are in the top gaming platforms including the PlayStation 2, Xbox and Xbox 360, and Nintendo game cube.

In the PC market, Dolby technologies are mandated in both next generation DVD formats and consequently Dolby will benefit from any PC shipping with Blu-ray or HD-DVD disc playback capabilities. In addition, we’re working with Intel to encourage OEMs developing new PCs featuring Intel Viv technology to also include the Dolby PC entertainment experience.

In the automotive market, Dolby benefits from the inclusion of DVD-based audio and video entertainment systems in certain models as well as from the implementation of Dolby Pro Logic 2 technology in the audio system. To date, Prologic 2 is in 43 models of automobiles.

In our professional division, we introduced the Dolby Lake Processor which combines Dolby N [ph] Lakes audio expertise to provide advanced loud speaker management and equalization functionality for live tour sound, fixed installations, or studio applications.

Second, we are focusing on opportunities to offer premium Dolby technologies in more consumer devices. Our Dolby headphone technology creates a simulated 5.1 Surround Sound effect with an ordinary pair of headphones. Dolby headphone compliments the use of entertainment devices such as portable DVD players or game consoles in public areas or shared spaces. Denon is now offering Dolby headphones and a new line of home theater systems. JVC has also begun offering a surround sound head phone adapter featuring our Dolby headphone technology.

In addition, Audistry by Dolby gives listeners the ability to personalize their audio and hear it the way they like it. We believe Audistry could suit the portable market as it can be used to enhance sound from digital media players, media capable mobile phones, and other entertainment devices providing an exceptional personal listening experience. This quarter Sharp announced three 2.1 home theater systems that include audio Audistry technology. These are available at retail in Japan and arriving soon in the U.S.

Third, we are focusing on longer-term opportunities in the mobile and digital cinema markets. In the mobile market, we believe our technology can enhance mobile entertainment devices by giving the listener a new way to enjoy a simulated 5.1 channel experience. We are positioning Dolby headphone and Audistry by Dolby for this emerging market.

Currently through our Via licensing subsidiary, we benefit from the growth in AAC-based music devices such as the Apple i-Pod and the Nokia N90 series of phones as we receive a portion of the royalties paid to the Via AAC patent pool.

In digital cinema we are extending Dolby beyond audio and into imaging with our Dolby Digital Cinema System. Currently approximately 150 screens are equipped with Dolby Digital Cinema Systems worldwide. These systems continue to provide valuable marketing momentum with studios and exhibitors. Major film releases that have played on a number of our systems, include Warner Brothers’ Harry Potter and the Goblet of Fire and V for Vendetta; Disney’s The Chronicles of Narnia, The Shaggy Dog and Chicken Little; Touchtone Pictures’ Casanova; Universal’s Inside Man and Paramount’s She’s the Man.

We continue to work in conjunction with the movie industry towards DCI capability. At Show West in March we demonstrated Dolby’s enhanced Digital Cinema System, which will give exhibitors the flexibility to support both JPEG 2000 and MPEG 2 file formats. In 2006 we will be working with exhibitors to upgrade existing Dolby Digital Cinema Systems to support JPEG 2000.

And yesterday we announced that Megaplex Theaters selected Dolby to outfit 20 of its screens throughout its chain of multiplexes in Utah with Dolby Digital Cinema Systems. This includes ten of our systems that will be installed in Megaplex’s new complex multiplex in Jordan, Utah, of which seven screens will be dedicated to digital cinema presentations only making it one of the first multi-screen installations of digital-cinema-only theaters.

As evidenced by this year’s Show West, the movie industry is making steady progress towards digital cinema. We have seen increased interest in digital cinema from the financing community and exhibitors were clearly more enthusiastic about the transition to digital cinema than in the past. While it is too soon to definitively say when digital cinema will take off given the industry bottlenecks and cost barriers that I’ve mentioned before, we believe its momentum is gaining.

And finally, in order to address these many opportunities, we are taking steps to improve our effectiveness and efficiency as an organization. Dolby’s strong history of technology and innovation has earned us the trust and confidence of the many licensees we work with today. Looking ahead, we have an opportunity to further build on this success by balancing our engineering strength with a more market-driven organization aimed at better anticipating licensee and consumer needs. We plan to hone our ability to understand the dynamic needs of our licensees and anticipate earlier the innovations and premiums technologies that will make their products better.

Some of the steps that we are taking in consumer licensing include: One, moving our sales and marketing teams closer to the customer; two, giving our regional offices more responsibility for local marketing and business development initiatives; and three, shifting more of our resources to a sales-based model that is focused on delivering Dolby’s premium technologies to market segments.

In summary, the quarter saw an increase in the adoption of our consumer entertainment technologies as well as in the momentum behind the rollout of digital cinema. As a company with an over 40-year history of working with the entire entertainment industry from studios, to exhibitors, to broadcasters, to consumer electronics manufacturers, we believe Dolby is uniquely positioned to benefit from the creation and playback of digital content. We’re focused on both near-term and long-term opportunities as we concentrate on our long-term objective of being an essential element in the best entertainment technologies.

With that, I’ll turn it over to Kevin, but before he starts, I just want to mention that if Kevin sounds a little slurred at times it’s because his wife just had their second baby in the last few hours and so he’s operating on very few hours’ sleep. But with that, go ahead, Kevin.

Thanks, Bill. In the second quarter revenue was approximately $105 million up 23% year over year, which consisted of 79% licensing revenue and 21% product sales and production services revenue. In the technology licensing segment revenue was $83 million, an increase of 29% year over year driven primarily by strength in our consumer electronics and PC markets. The CE portion of our licensing business benefitted from a strong holiday season for our licensees. Although we began the year expecting CE to be flat to slightly down, we now expect it to be flat to slightly up for the year. Having said that with the holiday season behind us, we would expect CE revenues to be substantially lower in the second half of the year as compared to the first.

In the PC market we saw strength on increased univolumes and expect this market to be flat to slightly down in the second half of the year as compared to the first. In our other markets, we saw good performance in gaining due to strong holiday demand for the PlayStation portable, PlayStation 2, as well as for available units of the Xbox 360 and in broadcast as a result of the continuing shift towards HD broadcast-related products.

In the products and services segment, revenue for the second quarter was up 6% year over year primarily on strong demand for professional broadcast products. Turning to the details of the P&L for the second quarter, licensing gross margin was 91% or up one point sequentially. Products gross margin was 56% up 35 points from the previous quarter, which included a $5.7 million charge reflected in cost of product sales for the funding of our digital cinema initiative.

Excluding this charge, product gross margins continue to run higher than in 2005 primarily due to higher production volumes associated with demand for broadcast products. Services gross margin was 60% up eight points from the previous quarter, which included a $700,000 charge reflected in costs and services last quarter for installation of equipment in our digital cinema initiative. Excluding this charge, services gross margin was slightly down.

SG&A expense was 37% of revenue in the second quarter down three points sequentially on higher Q2 revenue. R&D expense was 8% of revenue for the second quarter down one point sequentially on higher revenue. Dolby’s effective tax rate for the quarter was 38%. We now expect that the tax rate for the full year to be about 40% as we will begin shifting some of our cash into tax-free municipal securities. Net income for the quarter was $28 million or $0.25 per diluted share compared to $10.3 million or $0.10 per diluted share for the second quarter of fiscal year 2005. Per share calculations are based on $111.4 million diluted shares in the second quarter of fiscal 2006.

On a pro forma basis, which gives effect to Ray Dolby’s intellectual property contribution in February 2005, second quarter net income was also $28 million or $0.25 per diluted share compared to $14.9 million or $0.14 per diluted share in the second quarter of 2005. Net income also includes stock-based compensation charges of $1.5 million for the second quarter of 2006 compared to $5.3 million for the second quarter a year ago.

Turning to the balance sheet, Dolby finished the quarter with over $450 million in cash and equivalents. The growth in cash is primarily due to net income and strong collections by our Via subsidiary late in the quarter. We have previously discussed the fact that Via accounts receivable had been building the last few quarters and that most of the money Via collects is subsequently paid out to taxable members. As the collections occurred late in the quarter, the amount payable to these parties grew to about $30 million. A significant portion of this amount has been paid out in the early part of the third quarter. From operations, we added $41 million in cash during the second quarter and capital expenditures were $2 million.

Before I cover the guidance section of my presentation, an aspect of our business model that we want to continue to stress is the lack of a predictable quarterly pattern in our results. Our revenues are lumpy. Different quarters are higher in different years. Secondly, we license our technologies to consumer electronics manufacturers and software developers who use them in products. Our licensees are required to report to us between 30 and 60 days after the end of the quarter in which they ship their product. Since licensing royalties comprise 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 or retroactive royalties to cover extended periods of time. This could cause our results to vary from forecasts. We are pleased to see revenue up 16% through the first half of 2006 compared to the same period last year. We are also however cognizant of the effect of a particularly strong holiday season for our licensees on the CE portion of our business in the first half of the year and, therefore, would expect single-digit year-over-year revenue growth in the second half of the year.

Essentially, the year is playing out consistent with our initial guidance, except that we are expecting CE to be flat to slightly up rather than flat to slightly down. In light of this, we now expect fiscal 2006 revenue to come in between $350 and $365 million. Additionally, we expect fiscal year net income to come in between $65 and $72 million. We expect diluted earnings per share to be in the range of $0.58 to $0.64. While under FAS123R, stock-based compensation expense may vary based on factors such as stock price or volatility. We currently expect stock-based compensation expense for the full year to be between $19 million and $21 million. With that, I would like to turn the call over to the operator for the Q-and-A portion of our call.

[OPERATOR INSTRUCTIONS] Our first question will come from Ralph Schackart with William Blair.

Hello? Hello? Can you hear me?

Okay. Now we can.

Okay. Here we go. Perhaps can you give us a little bit more color on the underlying licensing growth, specifically within the PC HD-TV and DVD end market? I believe from the prepared remarks you had mentioned that PC essentially could be flattened down the back half of the year. Just curious what’s driving that.

So as we said on the call, PC was strong on the first half on strong univolumes. We’re expecting flat to slightly down. Basically, we’re expecting pretty similar unit volumes. There’s a lot of shifting between the OEM providers, which just gives us cause to be cautious in terms of who our licensees are, but we still see that as a good growth area going forward.

In terms of HD-DVD 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 HD may change that if at all. The other thing that drives our broadcast segment is set-top box sales and it’s our understanding that most of the cable manufacturers are looking at their major rollouts in ’07, so that looks good going forward.

Okay. And 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?

Yeah, Ralph. On the Chinese enforcement activities we’re really pleased with the results today. We’ve had we’ve started our audit programs. We’ve had some good success. We think the real measure of that is going to be to see how much more of the royalties we’re collecting from those under the lower-cost manufacturing regions compared to what our expectations were and everything else being equal. I think the other yeah, that’s probably good enough.

And any one-time royalties in the quarter?

Every quarter as part of our business on an ongoing basis there are always going to be catch-up payments, late payments, a lot of these things. It’s just a normal part of our business, so there’s nothing that we want to call out at this point in time that’s out of the normal.

Sounds like nothing material. Great. Thanks. Great quarter, guys.

Thank you.

We’ll take our next question from Steve Lidberg with Pacific Crest Securities.

-- was it in higher end home theater or I guess more traditional DVD players. And then with regards to digital cinema, the Utah installation, how is that being financed? Is this different than what we saw with your first relationship with Disney and the rollout of 100 screens? Thanks.

Steve, we missed about the first five seconds of the first part of your question. It didn’t come through.

Sure. Just with regards to the consumer electronics business where did you see strength? Was it in the higher end segment of home theater or more traditional standard volume DVD player growth?

We saw strength across the consumer electronics. Really it was it did pretty well across both of those product lines.

Yeah, we don’t really break it out. As to the digital cinema, Tim Partridge is with us, the head of the pro division. I’ll let him address Utah.

Yes, Steve, it is under a different arrangement to the other which will roll out and this will be treated as an operating lease, so it will be depreciated over time and the VBS coming in over time will offset that depreciation.

Thank you.

And once again, that is star one if you’d like to ask a question today. We will go next to Anthony Noto with Goldman Sachs.

Hi. This is actually Ingrid Jones-Fransinoto. Just again on DVD, just a little bit more color. I guess my question is specifically about the U.S. Do you see some stabilization in the U.S.? And was most of the growth in CE coming internationally?

Well, we don’t really break it out in terms of the markets. I mean, we’re just addressing the total market. We’ve never broken it out geographically, but as Kevin has said we did see higher than anticipated growth overall in that CE market on a worldwide basis.

Okay. And just as a follow-up quickly, what was in your other income item?

Mostly it’s interest income.

Okay. Great. Thanks.

We’ll take our next question from Daniel Ernst with Hudson Square Research.

Yes. Good afternoon. Thanks for taking the call and congrats on a great quarter. And Kevin, congrats on the new baby and can’t believe you’re on the call here. My wife would kill me. But that aside, two questions.

One, maybe you could just give us a little bit of a breakout here on what percentage of the licensing revenue came out of CE versus broadcast and other MPC. I think you’ve given us some ranges in the past. Maybe you could talk about deviations from those ranges, because obviously broadcast has been on a roll lately both domestically and abroad.

And then my follow-up question, I’ll just on the digital cinema side, what is the hurdle on getting to the DCI certification from here? Thanks.

Sure. So 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 our other markets, including broadcast, gaming, automotive were made up the balance and that 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’s pretty consistent with what we’ve seen, except that CE we know see CE classes being slightly up on the strong holiday season.

Within that, let me just clarify an earlier point, because I think misheard the question. The one underlying trend is from industry exports [ph]. We have seen from them that they’re expecting home theater box sales to be a little bit softer, but DVD sales and building home theaters in the broader sense, we have good business. So all toll, 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.

Tim, DCI?

Yes, 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 are published they had JPEG in it and we needed to engineer that into the product, so as you’ve seen we did do that and we demonstrated that at Show West, and we’ll be converting our theaters over to JPEG in the coming months.

And there are also some of the standards that were recommended by DCI in their publication, still need to be formalized by the standard body such as SMPTE, so that is ongoing work that will also come to completion in the next few months. And then finally, the industry needs some kind of compliance programs such so that all 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 standard. And that is also work that’s 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.

So then just to clarify, you don’t see yourself currently at a disadvantage to some competition? In particular Doremi has had some press out recently on a number of deployments [ph].

Yeah, there are a lot of people out there that are claiming DCI compliance, of course, but without a compliance agency it’s that can actually certify that, it’s difficult to know what is compliant and what isn’t. So we’re striving to get there, and hopefully they’ll at the same time they’ll be some way of proving compliance and no, the market is still rolling out very slowly, so we don’t see ourselves at a competitive disadvantage at this point.

Okay. Great. Thanks a lot.

Moving on, we will take our next question from Michael Kern with Canaccord Adams.

Hi, guys. Sorry I missed the answer on this, but with digital cinema on the Megaplex rollout that you have are you financing that or are they buying that outright?

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

Okay. Thank you very much for the clarification.

And once again, that is star one if you’d like to ask a question today. We will go next to Mark Anderson with Axio Capital.

Yes, I was hoping you could address the longer-term opportunities within the mobile space, I guess whether it’s in hand-helds or gaming devices, and how you see that potentially playing out and when we might see traction in that part of your business.

Well, as you well know, the mobile market is a huge market. We if you’re talking specifically mobile headphones, we do see some opportunities from technologies such as Dolby headphones 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, but it’s not something that happens overnight. There are cost issues in terms of the costs of implementing those technologies, royalty costs, et cetera, but we’re looking very hard at getting into that market.

In the AAC what are your splits on that right now within the JV?

Well, I’m not sure what you mean by JV. Our licensing subsidiary

Yeah, your licensing subsidiary rather.

Licensing subsidiary, which is Via.

Yeah.

Handles the MPEG licensing for AAC.

Right.

And as such, all the patent pool owners who have contributed patents to the pool share in the royalties that come in, make sure on the royalties after Via has taken a small administrative fee off the top.

And your share of the patent pool is roughly how much?

It’s in the neighborhood of 30 to 35%.

Okay. That’s great. That

That’s including our administrative that Via gets.

And your administrative fee is a percent of the total revenue or it’s just a basic sort of fee that’s

It’s a percentage of the pool.

Okay. Great. Thank you.

We’ll go next to Eric Smith [ph] with Eagle Assets.

Great quarter, guys.

Thank you.

The cash is obviously mounting here on the balance sheet. Anything interesting in the acquisition pipeline you want to allude to?

Just that we’re taking a hard look at potential acquisitions and a number of the areas which we see as being our future.

Okay. Previously you guys had indicated that digital cinema in Europe might get traction sooner than the U.S. Anything to speak of there?

Not really, Eric. Still lots of ongoing initiatives that we’re involved in on both sides of the pond and certainly actual rollouts, it’s happening right now here before it is in Europe.

Okay. Great. Thanks a lot, guys.

And 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.

Okay. Well, thank you everybody for participating. We appreciate your time and we look forward to speaking with you next quarter. Thanks for joining us today. Bye-bye.

And that does conclude today’s conference. Thank you for your participation. You may now disconnect.