Dolby Laboratories Inc (DLB) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal fourth quarter 2006 results. [ OPERATOR INSTRUCTIONS ] As a reminder, this call is being recorded Thursday, November the 9th, 2006. I would now like to turn the conference over to Mr. Kevin Yeaman, Chief Financial Officer for Dolby Laboratories. Mr. Yeaman, please go ahead.

Thank you. Good afternoon, everybody. Welcome to Dolby Laboratories' fourth quarter fiscal 2006 earnings conference call. Joining me today is Bill Jasper, President and CEO. In addition, Tim Partridge, General Manager of Dolby's Professional Division, Ramzi Haidamus, General Manager of Dolby's Consumer Division, and Marty Jaffe, Executive Vice President of Business Affairs are here to participate in today's Q&A.

On this conference call, we will be making forward-looking statements that include projection of future operating results for our fiscal year ending September 28th, 2007, market trends for the industries in which we compete and our expectations concerning how those trends will affect our operating results, our ability to expand our presence in existing markets and to penetrate new markets, 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 annual report on Form 10-K and our most recent quarterly report on Form 10-Q available at www.SEC.gov or on our website at www.dolby.com under the Investor Relations section. 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 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 fourth quarter of fiscal 2006 results on 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 an overview of the quarter, and I will follow with a rundown of Dolby's financial results and fiscal 2007 guidance. So with the introduction behind us, I will now turn the call over to Bill.

Thank you, Kevin. Good afternoon, everybody. I'm very pleased to announce a strong fourth quarter and fiscal year. During the quarter, we made progress towards our long-term objective of being an essential element in the best entertainment technologies used by professionals and consumers, including in the following four important areas.

First, continue to transition to high definition by extending Dolby audio technologies across HD broadcasts and next-generation DVD. In the fourth quarter, the number of European channels broadcasting in Dolby Digital 5.1 passed 100, including 31 HD channels. The total number of channels outside the Americas using Dolby is now about 135. In fiscal 2006, the number of operators outside the Americas who chose Dolby Digital to enhance their broadcast services doubled. In addition, a growing number of semiconductor manufacturers are supporting Dolby's technologies and their integrated circuit offerings for HD. Conexant recently announced that its family of high definition set-top box decoders would support Dolby Digital Plus, joining past announcements from Broadcom, a leading semiconductor manufacturer, and MIPS Technology, a leading semiconductor IP licensor.

In the consumer electronics industry, Toshiba, Panasonic, and Sony each announced new high definition products that include premium Dolby technologies. Toshiba's new HD DVD models can decode up to 5.1 channels of Dolby TrueHD and Dolby Digital Plus, while the first Blu-Ray player from Panasonic offers support for 7.1 channels of Dolby TrueHD and decoding of 7.1 channels of Dolby Digital Plus. Two new Sony HD camcorders deliver Dolby HD Digital 5.1 encoding and decoding technologies.

Second, we added to the list of PC manufacturers offering a media-rich PC that includes the Dolby PC Entertainment Experience. Last month, LG announced a new notebook featuring support for Dolby home theater, which includes Dolby Digital, Dolby Digital Live, Pro Logic II, Dolby Headphone and Dolby Virtual Surround, as well as a Dolby button, making it easy to access these features.

Third, as game console manufacturers gear up for the holiday season, we extended Dolby technologies to next-generation game consoles. Dolby's PlayStation 3 will include Dolby Digital 5.1 for gaming and Dolby TrueHD for decoding up to 7.1 channels for Blu-Ray movie playback. Nintendo's Wii Console will offer Dolby Pro Logic II technology, which creates a surround sound effect from two-channel stereo content. Microsoft, in addition to including a Dolby Digital for both game play and video playback in the Xbox 360, is offering an external HD DVD drive beginning this month.

Fourth, we continue to work closely with exhibitors in their transition to digital cinema as it gains momentum. To date, we have over 230 Dolby Digital Cinema systems deployed worldwide. Three cinema exhibitors, Premiere Theaters, Malco Theaters, and Megaplex Theaters are creating all digital complexes using Dolby Digital Cinema systems exclusively. And we're pleased with the ongoing trials with various exhibitors of our JPEG 2000 digital cinema system.

In summary, as we look to 2007, we're well positioned for the future. Our synergistic business model of providing technologies and products to assist our customers at all levels of the entertainment chain to create, distribute, and playback content has been and will continue to be a key factor in helping drive our success. As we move forward, we remain focused on extending our core technologies across assisting and new markets, driving the adoption of new Dolby technologies, and capitalizing on our brand, reputation, and experience across the entertainment chain to generate additional long-term growth opportunities.

I'll now turn the call back to Kevin.

Thank you, Bill. Revenue for the fourth quarter was approximately $102 million, up 29% year over year. On a full-year basis, Dolby's revenue was $392 million, up 19% from fiscal year 2005. Revenue for the quarter was comprised of 79% licensing revenue and 21% product sales and production services revenue. Licensing revenue for the fourth quarter was $80.4 million, which is an increase of 37% year over year and 16% sequentially. This was due in part to $6.7 million in revenue relating to PC products shipped over the past six quarters. You may remember that last quarter we estimated that approximately $10 million was due from two licensees pending resolution of certain contractual matters that we did not include these amounts in our guidance. This $6.7 million represents the recognition of amounts due from one of these licensees.

Turning to our licensing markets, we experienced year-over-year growth in each of our markets during the fourth quarter. The Consumer Electronics, or CE portion of our licensing business, experienced growth on a year-over-year and sequential basis. This was primarily driven by standard DVD related products. Even with this stronger-than-expected growth, we continued to diversify our licensing stream across newer markets. For the year, CE made up about 45% of our licensing revenue, down from about 50% in fiscal 2005 and more than 60% in fiscal 2004. Our PC market made up about 30% of our licensing revenue in fiscal 2006. In the fourth quarter, we experienced strong year-over-year growth on robust shipments of brand-name notebooks. The $6.7 million in prior-quarter royalties drove sequential growth.

Our broadcast market made up just over 10% of our licensing revenue in fiscal 2006 and about 10% in fiscal 2005 and is comprised of revenue from televisions and set-top boxes. The primary growth driver in this market is a transition to high definition and digital television.

We continue to further diversified our revenue stream to through growth in our the markets, which include gaming, automotive, and our Via subsidiary.

Turning to our Products and Services segment, revenue for the fourth quarter was up 7% year over year and down 11% sequentially. The sequential decrease was due to a decline in traditional cinema related products after an exceptionally strong third quarter, during which exhibitors accelerated their purchase orders ahead of anticipated price increases. The year-over-year growth was due to an increase in production services revenue.

Let me turn to the details of the P&L for the quarter. Total gross margin was 82% for the quarter, up two points sequentially due to the increase in licensing revenue as a percentage of total revenue. Licensing gross margin of 91% for the fourth quarter was flat sequentially. Product gross margins declined to 41% for the quarter, down five points sequentially. The decline was due to lower production volumes as a result of reduced demand for traditional cinema products during the fourth quarter and to a lesser extent, the cost of upgrading previously deployed digital cinema units.

Services gross margin was 60% for the fourth quarter, up eight points sequentially as a result of higher revenue. SG&A expense was 40% of revenue in the fourth quarter, down 1 point sequentially. R&D was 10% of revenue for the fourth quarter, or flat sequentially. In the fourth quarter, we recorded a $3.6 million gain from settlement relating to an audit of a semiconductor manufacturer that embeds our technologies. We recorded the $3.6 million as a gain rather than revenue since we do not collect royalties from semiconductor manufacturers like we do from consumer electronics manufacturers.

Dolby's effective tax rate for the quarter was approximately 38%. Fourth quarter net income in 2006 was $25.2 million, or $0.22 per diluted share, compared to $16.8 million or $0.15 per diluted share for the fourth quarter of fiscal 2005. For the full year, net income was $89.5 million, or $0.80 per diluted share, compared to $52.3 million, or $0.50 per diluted share for fiscal 2005. Net income for fiscal 2005 on a pro forma basis, giving effect to Ray Dolby's intellectual property contribution in February 2005 as though it had occurred prior to commencement of fiscal 2005, was $63.4 million or $0.61 per share.

Net income also reflects stock-based compensation expense of $4.2 million for the fourth quarter of 2006 and $2.7 million for the fourth quarter a year ago. For the full fiscal year 2006, stock-based compensation expense was $19.1 million versus $14.2 million in 2005.

Turning to the balance sheet, Dolby finished the year with nearly $520 million in cash, cash equivalents, and marketable securities. From operations, we added approximately $46 million during the fourth quarter as a result of net income of $25.2 million and changes in the balance sheet. Capital expenditures were $2.3 million in the fourth quarter. In addition, the balance sheet includes accrued royalty expenses of approximately $10 million related to a patent license agreement. In the third quarter of fiscal 2006, we evaluated whether the payment of royalties under this patent license agreement, using the historically method of calculation, would constitute an overpayment and subsequently notified the licensor that we no longer intended to pay royalties using this method. We paid the third party licensor under a new methodology for the third and fourth quarters of fiscal 2006, but have accrued the royalty expense based on the historical method. As of today, we have not heard from the licensor.

With that, I will turn to fiscal 2007 guidance. I will start by sharing some high level assumptions we used in formulating our revenue guidance. We're assuming that our Products and Services segment will grow at least 10% on demand for digital cinema and broadcast products, as well as demand for our live sound products and production services. In our licensing segment, we're expecting growth of 5% to 15%. We're assuming that our CE market will be roughly flat and that growth comes from our PC, broadcast, and other markets on continued demand for notebooks, high definition and digital televisions and gaming consoles. Our guidance now includes the prior-quarter revenue expected from the resolution of contractual matters with the remaining licensee as described above.

So in total, fiscal 2007 revenue is expected to be $420 million to $450 million. Net income for fiscal 2007 is expected to be $95 million to $105 million. Earnings per diluted share for the full year 2007 are expected to be between $0.83 and $0.92. While under FAS 123R, stock-based compensation expense may vary based on factors such as stock price or volatility. We expect stock-based competition expense for the full year to be $20 million to $22 million. That concludes our prepared remarks. I would now like to turn it over to the operator for questions.

Thank you, sir. [ OPERATOR INSTRUCTIONS ] And we'll take our first question Ralph Shackart with William Blair.

Good afternoon. Great quarter, guys, and happy to see the outlook. You talked a little bit about extending the Dolby brand and technologies into new end markets and you talked a little bit in the past about mobile devices and handsets. Can you sort of give us a little color where you are in that stage and will that start to roll through the numbers in 2007?

Our initiatives continue to be the rollout of new technology to cover new geographies and new product types, as well as the markets that you referred to. So yes, we're still on track in a long-term strategy to have product placement in cellular technology, i.e. telephones, as well as well as portable music devices and portable music initiatives in general. And we have some evidence already of some wins, as you know, through our VL Subsidiary with our AAC technology in iPod. That's a great start for us but we do intend to take the Dolby technology into the next step over the next year or so.

OK, great, and then in terms of the PC market with the delay of Vista until late January, how much of your guidance did you take that into effect and can you see potential larger upside in the PC segment if there's a larger upgrade cycle after Vista? Thanks.

So in terms of that last question, the PC market is a pretty dynamic market for us. We don't see any big change from Vista affecting us in the '07 timeframe. Obviously, the January 30 projected release date would affect our last two fiscal quarters. Ramzi, do you want to add to that?

Yes. Basically, we did mention in the last quarter that there could potentially be some effect related to the dynamic changes in the operating system business. Since the Vista operating system was delayed, that effect will not be noticed in 0'7. You'll probably hear from us sometime toward the end of the year about this subject matter.

OK, great. Just one last one if I could. Kevin, could you give us the full year fiscal '06 CapEx please?

Yes, I didn't give that number but we would expect it to be similar to -- oh, I'm sorry, the '06 number?

Yes.

Yes, I'll have that for you in a moment. I think it's about $8 million.

Roughly? OK, that's good.

Yes, about 8 million.

OK, thank you.

And we'll take our next question from Daniel Ernst with Hudson Square Research.

Hi this is Michael Porter calling in for Daniel Ernst. We've heard that there will be dual format HD DVD Blu-Ray players coming to the market. We're wondering if you'd heard anything along those lines.

The last we've heard about this trend is that there were some contractual matters regarding some of the DVD formats themselves. In other words, the companies who wanted to build those players were under some contractual matters that either let them or did not let them add the other formats. Pending those resolutions, we don't foresee seeing a whole lot of those types of dual players in the next year, and as that changes contractually we might see that happening any time, because we believe that is probably one way to resolve the format war between these two formats.

Right. And one follow-up, if I may. To what extent does you fiscal year '07 guidance break into the next-gen DVD log jam?

We're not assuming much contribution from next-generation DVD in our 2007 time frame.

OK.

And as I said in the prepared remarks, overall, we're expecting to see the CE market roughly flat.

Thank you.

[ OPERATOR INSTRUCTIONS ] We'll move next to a question from Steven Frankel with Canaccord Adams.

Thank you. Let me just do two quick ones; one for Kevin, which is what was the cash flow from operations for the quarter and for the year? And then big picture, what's changed versus the last conference call? You guys had a fairly muted outlook and hinted at a muted outlook for fiscal '07 and now, even with the next-gen DVD sales not kicking in, you seem a little more bullish on business. What's changed?

OK, so on the first question, cash flow from operations for the quarter was about $46 million. Obviously net income was about $25 million and the rest was due to changes in the balance sheet. For the year it was about $130 million.

In terms of your question regarding guidance, as you know, we gave a preliminary outlook of mid to high single-digit growth on the last call and our guidance comes out to about 7 to 15% on this call. First of all, it was preliminary guidance so we've had a chance to spend more time looking through each of our markets. Obviously we had a good quarter in the fourth quarter and fortunately, we have diversified across quite a few markets, as you know, and therefore there are quite a lot of different growth drivers with a variety -- or a range of outcomes within each sector. Of course on '07 we referred to the PC market in particular as one that we were being cautious about, and while we still believe that's a dynamic market and there are some reasons to be cautious, we haven't seen any impact on our business as of yet and at least we're into fiscal '07 now. As I said, we see roughly flat for CE, we see good growth in broadcast and our other markets, and we see some good opportunities in the Products and Services market, as well, with digital cinema beginning to contribute this year and broadcast products are still doing well.

OK, and is your JPEG 2000 product in test or full release today?

The JPEG decoders have been out there in the market now for a few months. We kind of a still call it test. We're very happy with the JPEG itself, but there are a couple of other technologies that the studios have requested, so we're not in full production yet with our final version, which we believe will meet all the requirements, not only JPEG, of the studios, but that it will happen in the near future.

Great, thanks very much.

And we'll take our next question from Sam Doctor with JPMorgan Securities.

Thank you. A couple of questions, first on the gaming market, can you give us some sense of what your outlook is for next year and what do you think the impact would be of the Blu-Ray drive is the PS3 and the Xbox 360 HD DVD attachment? What does that do for your growth?

Well, we haven't broken out our growth outlook next year by market, but that falls into the category of our other markets in terms of our breakout of revenue and guidance, but we experienced good growth in the gaming market last year. On the release of the Xbox and a good Christmas season last year, and so we're, in our guidance, expecting good growth again this year given the expected release of the PlayStation 3 and the Christmas season.

So do you expect to accelerate from last year?

We haven't given specific guidance on that, but -- the question, Ramzi, is do we expect the accelerated growth was a result of the PS3?

We do see the PS3 making a significant contribution simply for the fact that there are so many technologies in that platform owned by the Company.

OK, and if I might ask one more question on the PC side. Your PC revenue has been growing really well for the last couple of years. How much headroom do think there is still left as your group begins to converge with the market growth for media centric PCs?

Well, geographically speaking, there's still quite a bit of the world which is growing at a significant rate. Whether it's Latin America, EMEA, Asia-Pacific, there's still a lot of growth opportunities for us there, so that's where we see the majority of the growth happening for us, whether it happens with the current operating systems out there or with Vista.

So what would your attach rate of your market share be for media centric PCs?

I'll give you a high-level view of the attach rate. Right now, as you know, most laptops, for example, ship with a very high attached great for DVD players. With Vista XP, as we said -- sorry, with the Microsoft Vista -- as we said last quarter, it's going to depend heavily on the marketed option of the mix between home basic version, home premium version, the ultimate version, and the corporate version. There seems to be some question as to the what that mix is going to be an our attach rate will be somewhat proportional to that option.

OK, great. Thank you.

And we'll take our next question from Steve Lidberg with Pacific Crest Securities.

Good afternoon, this is David Niederman in for Steve. Just a couple of quick questions. Can you give a little color on Via -- contribution from Via Licensing? Is it north of 5% yet? And also if you could provide a little color about broadcasting. What percentage of your licensing revenue is that at the moment? Thank you.

Yes, let me take the last question first. In 2006, broadcast revenue from our licensing segment made up about 12%. Broadcast products make up about 25% of our products revenue, so the broadcast market is a big market for Dolby. We have separately broken out CE, which is about 45, PC, which is about 30, and broadcast, and the remainder is made of gaming, automotive, and our Via subsidiary, which we have not broken out separately at this stage.

Great, thanks.

And we'll take our next question from Benjamin Swinburne with Morgan Stanley.

Thanks for taking the call. Good afternoon, guys. Ramzi, just a point of clarification. Are you saying that the attach rate from Vista -- or I guess in a Vista world when we get there -- could be lower than what you're seeing today globally in the PC market?

Yes, just to add some more color on my earlier statement, there's about four SKUs -- at least four SKUs, if not five -- that are coming out of Vista. What's going to be shipping in the premium version -- the home premium version as well as the ultimate version -- is Dolby technology, i.e. DVD playback. So with those, it's really automatic, it's embedded. And so we're kind of 100% attached there. So the question isn't so much how much Dolby technology will be within each SKU, the question is what percentage of the market will each of these SKUs take over? And that's the question mark that we have, as well of a lot of the analysts out there that have.

I see, okay. Thank you. And other point of clarification on the guidance, I think Kevin, you said it includes the catch-up payment that is remaining on the licensing side? Is that right?

That's right. Last quarter, remember, we said there were two licensees that we expected these payments from, but we couldn't predict at that time which year it was going to fit into so we didn't include it in our guidance. So now that one is in the numbers of for '06 and we expect the other one to come in '07, we've included it.

OK, and have you given order of magnitude? Is it a similar size?

We said 10 million over the two licensees, about the somewhere around 5 million.

This is Ramzi, I just want to add one more item. There is another attach opportunity to the Vista SKUs. In the Vista basic version, where there is no DVD player shipped automatically, there's always of course the opportunity, which the OEMs will have, as they have today, for the consumer to go ahead and purchase a DVD player as they're purchasing the laptop or the set-top box. That's yet another opportunity in the PC market for us to have an attach rate even in the basic version of -- basic and corporate version of Vista.

OK. And just looking back on guidance last year coming into '06 and how strong you guys finished up, I believe, as I went back in the transcripts, I think CE has come in ahead of where you thought it would, maybe six, nine months ago? First, is that correct? And second, maybe give us some color on what drove that? Was it just overall unit DVD player sales were better than you thought or more sort of a pricing -- better revenue per unit? Anything you can add there?

Well, first of all, it is true that we came into last year expecting CE to be flat to slightly down and we actually saw some growth and it was driven largely by DVD unit volume. The other area where we did well, relative to our guidance last year, is we had said flat to slightly up for the Products and Services segment. It was actually up about 9% so we're pleased with that.

In terms of new growth opportunities, we're looking at the Digital camcorders coming out having quite a large acceptance in the marketplace. These are camcorders with either two-channel or multi-channel recording and the growth rate on those have been quite pleasing to us.

OK, and my last question on the high-def TV side, I think we're going to be moving to a mandated tuner early next year. Can you guys talk about what that means for your business in terms of broadcast license side and how much of that impacts your guidance for next year? Or this year, I guess it would be?

Actually, I'll comment on the business and then I'll turn it over, in terms of guidance, to Kevin. The broadcast market indeed in the U.S., when it comes to the ATSC standard is mandated so we will see 100% attachment when it comes to ATSC compliance, in a set-top box or additional television or analog television, which has an ATSC tuner, so we're very pleased with that. And you are correct on the time frame.

OK.

As far as the guidance goes, we do expect that to be a high-growth portion of our broadcast licensing market, the North American market, where ATSC tuners are being delivered through the televisions and set-top boxes. Keep in mind that that's not the only thing that makes up our broadcast market. We have televisions and set-top boxes that are delivered around the world, including in North America, with other technologies, such as Virtual Speaker and Dolby Digital. And so that is also a good market for us. It doesn't have quite the same growth dynamic as the ATSC driver but it's a growth market.

Great, thanks. I won't hog the call. Sorry.

We'll take our next question from Alan Davis with D.A. Davidson.

Yes, good afternoon, gentlemen. Great quarter. Just a couple of questions. First off, just wondering if you can give this a little bit more color on the growth rate in terms of your content for PC. I don't know if you want to break it down into laptop and desktop, but just maybe over the last few quarters, your content per box, could you just give us a little more color on the growth rates in terms of content?

Can you explain what you mean by content on PCs?

All right, I'm sorry, the dollar content per PC. Kind of the opportunity that you've gotten today and obviously it's going forward, as well.

The first thing I would note is that a substantial majority of our revenues in the PC market today are driven by the sale of software DVD players. But we have announced a number of wins over the last several quarters in terms of more technologies in PCs that are targeted as multimedia platforms.

OK, can you give us an idea of kind of the upside there relative to today, maybe down the road in a year or so, what the upside is in terms of your content for PC?

We don't give out any ASPs broken down by category.

OK. And then a longer-term question, curious if you can give us a little more color on your opportunity in the smartphone or wireless handset market.

We have technologies that are currently being pushed out into the market, demonstrated in cell phones, such as the enhancement of the audio quality, such as a surround sound experience, even with two sets of headphones attached to a cell phone, so that a series of initiatives that we're pushing, which would be actually applicable not only in the cell phone market but as well as in the portable music and portable video market. That's an initiative that covers all three markets.

And just so everyone is clear, since there been a couple of questions now on this mobile space, that is not a factor in the 2007 guidance timeframe.

Thank you.

And just a reminder [ OPERATOR INSTRUCTIONS ] will go next to Eric Mintz with Eagle Asset Management.

Hey, congrats on a great quarter and year, guys. Very well done. I'm just curious what you're thinking on digital cinema in '07, what's baked into the guidance there?

Well, in terms of guidance, we said that we expected at least 10% growth in our Products and Services segments and digital cinema kicking in are one of the biggest factors in our growth expectations for Products and Services. But I'll turn it over to Tim in terms of some additional depth on that.

Yes, we hope we will see some activity on revenues sides from digital cinema finally next year. We've been, as I said earlier, we've been very pleased with the JPEG trials that we've been doing and I'm happy with it, but we're also incorporating some other technologies that the studios have requested. There've been some minor changes recently to the specs that we've had to go out there and incorporate and there'll probably be some more specifically related to 3D. So we want to make sure that we capture all these changes. You know, we've been encouraged in the marketplace by exhibitors support us and that they several of them have actually specifically requested Dolby equipment from the various systems integrators and we are working very closely with all those systems integrators to be able to supply products to those exhibitors and we expect to have the system that, as I said earlier, meets all the studios' requirements soon. In the near future here.

So if fiscal '07 is going to be the first year of that cycle, how many years do you think would be in that upgrade rollout for the industry?

That's real difficult to say. Whether you're talking U.S. or worldwide, for one thing. The suspicion is that the U.S. will happen pretty quickly and you hear anything from a four to a ten-year period. Worldwide, it's going to happen in small pockets around the world and probably somewhat slower than that.

OK. And then obviously, you're not assuming much in the way of next-gen DVD in fiscal '07, but that would also be another multi-year cycle that you guys are just on the cusp of, as well?

Had there not been a format war, as we commented in the last quarter, the up tick would be significantly faster. We believe that both technologies actually offer significant benefit over existing DVD format. What really is at stake here is does one format win over the other or is there a combined combo player which accelerates it? And if it does, we can see accelerated rates similar to what we've seen in a standard DVD.

OK. And then finally, just on the PC, when you guys gave the initial '07 read and you were a little cautious on PC, I think you highlighted one of the major PC OEM was allowing people to opt out of Dolby on the website when they were selected their features for their PC. Have you seen anything from that program, how that's going?

Sure, let me first clarify a little bit about our comment. The opt-out really wasn't so much about Dolby, the opt-out was about whether the purchaser did not want to have DVD playback at all, with all of its features. In other words, you would not be able to play a movie on the PC, and that of course can be used for corporate use or business use. So that was the comment about our technologies not being involved in those products. To the extent that that has happening, we have seen very little evidence. There is one or two OEMs which in select products, give you the opportunity to not purchase a DVD software player, but by and large, in other words, over 95% of what we've seen certainly does not show this trend.

OK, great. Thanks a lot, guys.

As you point out our guidance still reflects some caution in the PC market relative to the growth rate we've seen over the last couple of years, but certainly the change from our preliminary guidance to now does reflect a little bit of a broader range of outcomes in that PC space, given where we are now.

And we'll take our next question from Adam Rashid with Eminence Capital.

Hi, thanks. Can you talk about the CE market? You mentioned this year it was I think 45% of revenue -- of the licensing revenue -- so it seems like it was up maybe 10% . If you could just talk about kind of the puts and takes; how did it shake out between low-end units? High-end units? The amount of technologies incorporated on the players? Kind of standard DVD players versus some of the DVD recorders and how you expect that to play out next year, as well?

I'll give you a bit of an overview on the CE market. First, the receiver market has been somewhat flat. We do see an upgrade in the CE market worldwide as soon as our premium technologies hit the market and that would be Dolby Digital Plus, multi-channel decoding, and TrueHD multi-channel decoding. These products are in the pipeline and we will see those show up in this fiscal year so you'll see a little bit of a refresh in terms of product there.

On the home theater and the box market, it looks like there's quite a bit of competition in there. Some market manufacturers are pulling out of that market so there doesn't seem to be the big upward trend that the industry thought there might be. As we mentioned earlier, there is significant growth on the affordable digital camcorder market, so we're encouraged by seeing multi-channel camcorders take off, to our surprise, quicker than we thought we did. And finally, on HD DVD players, the comments are in line with what we mentioned earlier today. It's about the resolution of the format war, either by a combo player being introduced or one of the formats winning over the other.

And if I look at that CE piece that was 45%, can you maybe just provide me a rough estimate, how much was receivers? How much was home theater and box? How much was DVD players?

We don't break it down any further than that.

OK. Did each of those categories to grow in 2006?

I'm pausing because I'm not sure whether home theater in a box was up or not come up, but I think it's safe to say that the other areas were all up year over year. And so I would add, we have said that the majority of the CE space is made up of DVD players, whether they're standard DVD players or portable DVD players.

Right, okay. And then when you mentioned you thought it would be flat next year, where is the rate of change in each of those groups? Is it mostly in the DVDs?

Yes, our guidance of roughly flat for the year, basically what we're looking at is the potential for moderating demand for standard DVD players in advance of clarity around the next-gen HD formats and not much contribution from next-gen HD formats. You know, this is also a space where we've seen some volatility year to year. In '05 the space came in below what industry analyst estimates were tracking. In '06 we came in at about that rate. So there might be some timing here. The other factor I would introduce really to the CE space is that, as you know, over last year or so we've put quite a lot of effort into our compliance efforts and while I can't point to any data which says that's what's driving the CE result, we do hope that the results of our efforts would be that people would start reporting more and we might not be able to directly attribute it to our compliance efforts. So it's an unknown to us whether that is what's driving what we're seeing, but that's what we hope to see over the long term.

OK, and just a quick question, can you talk about that royalty accrual? You accrued for a higher rate in the fourth quarter than you actually paid? What was the difference and when could you actually hammer out that agreement?

We accrued $10 million over two quarters, that was the third and fourth quarter, and we continued to build our guidance based on the 91% licensing gross margins, and that's what we expect for the foreseeable future. And there's not much more we can say at this point about that.

Right, and what is the nature of the agreement?

It's a patent license agreement.

OK. And so you've accrued -- that 10 million is in excess of what you paid or is 10 million is the total accrual?

Well, 10 million is the total accrual, less any amounts that we paid.

OK. And my final question, so you now have over $500 million of cash and your business generates a lot of cash. Maybe can you just update us on what you plan to do with that cash?

Well, we are continuing to explore areas that would be synergistic with what we're doing. As we've talked in the past, we're branching into imaging and video. We're taking a hard look at these areas. We're [piecing] up our Research and Development. We're looking for areas where we can continue to expand the business and we are pursuing things very aggressively in that regard.

We'll go to a follow-up question now from Benjamin Swinburne with Morgan Stanley.

Thanks. On the products sales side, Tim and Kevin, it sounds like the revenue mix is going to shift a little bit in '07 versus '06 with a little bit of digital cinema and a little bit less cinema processor revenue. Any impact to gross margin in that segment this year, or '07 versus '06 that you could talk about?

Yes, just by way of leading into that, in '06, we saw about 75% from traditional cinema products. Most of the rest was related to broadcast products. And then our live some products actually were beginning to contribute, but that's a small amount. In '07 we see growth in broadcast, live sound again, and digital cinema kicking in. And yes, in the early stages of the digital cinema rollout, we do expect that there could be some pricing pressure and that could result in lower margins -- lower product margins. If you look at we've been averaging somewhere around 50%, we could see dip get into the 40s during this guidance time frame.

Is there any material difference, Kevin, between the tuner processor and broadcast margins?

I wouldn't expect any -- I wouldn't point to any changes that I expect in the overall product margins as the result of mix of traditional cinema versus broadcast, but digital cinema would have an impact.

OK, and then a follow-up for Tim. Can you give us an update on DCI, where we are on the standards process and where you think -- if you have any comments you want to make on how the business plan shakes out here in terms of virtual print fees or vendor financing? Are the exhibitors more interested in the U.S. and actually starting to pay for some of this stuff? Anything along those lines?

And as a follow-up, do you see -- to the extent your market share in the cinema processor world, especially in the U.S., is very high -- as we move into digital cinema, do you think your share numbers flip and does that impact the cinema processor sales in those theaters or do those work in concert?

Sure. Okay, in no specific order, the business plan seems to a shaken out pretty much here in the U.S. in that there are the three major deployment companies who have got business plans that presented them to the industry that seemed acceptable. One's moved ahead already, Technicolor is about to move ahead next year, and NCN sometime soon after that. So the business plan seems to be done here for the U.S. Yet needs to appear a business plan that works internationally. Along a similar line, if there is a business plan that funds the equipment from payments from the studios and the guys at the [VPS], then that yet has to be figured out internationally, because of the market dynamics are so much more dynamic international. So internationally, we have seen different approaches to financing, such as straight sales, straight purchases from exhibitors, and we expect to see that more so internationally than here in the U.S.

Regarding the DCI spec, as you know that was published last year, but as I said earlier, there have been some minor tweaks to that recently, which we've had to go back and upgrade all our systems that are out there. There just over 230 systems we have out there now that we need to try to keep up to spec, so we've upgraded those. We're in the process of updating them to JPEG, of course. We have about 60 JPEG systems out there right now and as I've said, that's going real well. And then there are a couple of other technologies that we need to get into a final system before we can do a final upgrade across all of the units and then get into real production. The specs, even though they came out of DCI, as I've said before, there's some of them still need to be standardized within the standards bodies, such as SMPTE, so we're working on that front with many others to actually get them written down as well. And some of the specific ones we're very interested in getting down quickly are obviously 3D standards. As we've seen, 3D has been very well accepted by the cinema-going public and Hollywood has a renewed interest in 3D, a number of films planned for the future, so Dolby announced a 3D initiative just a few months ago, and we hope to get into that business also.

In terms of the market share, it will be a long time, as I said before, before every theater in the world is a digital theater so that therefore there will still be a need for prints and wherever there are prints, there are needs for the Dolby technologies that are on those prints. Therefore, there'll still be a need for the audio processor. Over and above the Dolby technology, the proprietary technology is in there, there's always going to be a need for a central audio processor, so we certainly expect that market to continue. Whether our overall digital cinema market share will be the same as it has been traditionally, obviously we'll be trying to achieve that.

So just to clarify, if one of your competitors on the digital cinema side were to sell into a screen or into an entire theater, that doesn't necessarily mean they would then be ripping out the cinema processors you've got in there. Even if they were to get rid of the film, there would still be a role for Dolby there with someone else's product?

Absolutely. The cinema processor includes a number of technologies, none of which are included in the digital cinema equipment. It's all about taking the audio, processing the audio, routing it to the correct speakers, and all that will still be needed in additional cinema world.

Gotcha. Thank you, guys.

And there are no further questions. Mr. Jasper, I'll turn the conference back over to you for any closing comments.

Thank you very much. I'd like to thank everybody for joining us on today's call. We've had a great quarter and a great year and we look forward to speaking with you in the future. Thanks.

And that concludes today's conference call. Thank you, everyone, for joining us. You may now disconnect.