Dolby Laboratories Inc (DLB) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal first quarter 2007 results. [ OPERATOR INSTRUCTIONS ] As a reminder, this call is being recorded Thursday, February 1, 2007. I would now like to turn the conference over to Mr. Kevin Yeaman, Chief Financial Officer for Dolby Laboratories. Please go ahead, Mr. Yeaman.

Good afternoon. Welcome to Dolby Laboratories' first quarter fiscal 2007 earnings conference call. Joining me today is Bill Jasper, Dolby Laboratories' 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 projections 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 that could cause the actual results to differ materially from those in the forward-looking statements include or are detailed under the section captioned "Risk Factors" in our most recent annual report on Form 10-K and any subsequently filed quarter reports 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.

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. So with that introduction behind us, I will now turn the call over to Bill.

Thank you, Kevin. Good afternoon, everybody. I'm very pleased to report a solid first quarter with net income of approximately $30 million, our revenue or over $104 million. The end of year 2007 was a solid proven business model, a globally recognized brand, a technology presence across diverse markets, and a focus on delivering new and compelling innovations throughout our markets.

Through our Professional division, we continue to execute on our strategy of working closely with content creators and studios and the preparation and delivery of Dolby enabled content to consumers. And in our Consumer division, the public experiences entertainment through a wider variety of mediums. Our objective is to continue to include Dolby technologies everywhere in order to deliver the best entertainment experience possible.

This year's International Consumer Electronics Show clearly illustrated the opportunities ahead. Today, I would like to discuss some of the key trends observed at CES and how we are positioning Dolby for each and then cover new innovations from Dolby.

First, as to CES, the High Definition rollout, including HD television and next-generation DVD, was a strong theme at CES. In the HD TV market, manufacturers continued to introduce new LCD and Plasma models at lower price points for consumers. According to industry research, prices of flat panel displays have been trending down by 25% per year which has increased the demand for these products. Many of these flat panel displays contain Dolby Digital in accordance with the ATFC digital turner standard mandated by the FCC.

On the content side, HD programming and content continues to grow benefiting Dolby in several areas. First through our professional division, we deliver the products and services to encode programming in Dolby Digital. Second, an increased supply of HD programming in North America positively effects the television upgrade cycle from which we are well positioned to benefit through the inclusion of Dolby Digital and the ATFC digital tuner standard. Third, a similar increase in HD programming in Europe is helping to drive the adoption of HD Set-top Boxes across Europe in which we believe Dolby Digital is becoming a fee facto standard.

In the next-generation DVD category, LG Electronics launched its hybrid player both Blu-ray and HD DVD discs. In addition, any other leading manufacturer has demonstrated their next-generation DVD offering. With Dolby Digital Plus and Dolby True HD mandated in the HD DVD format and with Dolby Digital mandated in the Blu-ray format, we believe we are well positioned for this market.

We also saw additional HD camcorders by Sony and Panasonic that contain Dolby Digital 5.1 Creator enabling users to record in Dolby Digital 5.1 sound while creating home studio content.

A second CES theme was the continued move by PC and gaming leaders to become the central media hub in the home. Microsoft showcased its Windows Vista Operating System which pointed to a greater emphasis on media center elements in its Ultimate and Home Premium additions. Both of these additions integrate Dolby Digital 5.1 decoding for DVD movies and digital television viewing and give people the ability to create DVDs with Dolby Digital soundtracks.

Sony demonstrated a new Vaio Media Center PC which included Microsoft's Windows Vista Home Premium addition featuring Dolby Digital technology. This PC also includes support of the playback of Blu-ray discs, a TV tuner with ATSC support, and the ability to create DVDs with Dolby Digital 5.1.

We saw a similar push from game console manufacturers. For example, Microsoft announced it would extend the media capability of the Xbox 360 by eventually including IPTV. Today, Dolby Digital is included in the Xbox 360 for game play and movie playback while Sony's PS3 contains Dolby Digital for gaming, Dolby Digital 5.1 for DVD playback, and Dolby True HD for decoding of up to 5.1 channels in Blu-ray.

Finally, portable entertainment remained a strong theme throughout CES as many companies looked at delivering audio and video to consumers on the go. In the Notebook PC market, leading manufacturers, including Toshiba, LG Electronics and [Linobo] demonstrated media centric PCs developed with the Dolby PC entertainment experience initiative. This initiative provides a suite of technologies enabling PCs to deliver a home theater experience with high fidelity quality. These PCs, in addition to featuring Dolby Digital, include Dolby Headphones, Dolby Virtual Speaker, Dolby Prologics II, and Dolby Digital [Eye].

In the handheld category, a number of manufacturers showcased new portable media players. Currently, our participation in the handheld category is limited, representing a new opportunity for Dolby. Today we received a portion of royalties from each I Pod through our Via subsidiary. Going forward, we remain focused on driving the adoption of additional Dolby technologies complimentary to the handheld form factor.

Turning to innovation, in addition to focusing on trends in HD, Media Center, and portable entertainment, we remain committed to delivering new innovations across our markets. We recently demonstrated Dolby Volume for wide acclaim across the consumer electronics industry. One of the first markets Dolby Volume will address is television where it can be included to eliminate the annoyance of inconsistent sound levels across broadcast, as well as, to deliver a robust and vibrant audio experience at a low volume. In addition to the television category, we believe Dolby Volume can provide a real benefit to consumers through its inclusion in AB receivers and other devices. We are working with licensees and hope to see initial televisions with AB receivers to include Dolby Volume in the market by the end of calendar year 2007 and the beginning of calendar year 2008 respectively.

In our Professional division, we continue to make progress on delivering Digital Cinema to the industry with over 280 Dolby Digital Cinema systems employed globally. In addition to currently shipping JPEG 2000 capable systems, we have upgraded almost all the installed base of Dolby Digital Cinema systems for the JPEG 2000 compliance.

Last time we spoke about the next enhancement to our Digital Cinema system, 3D. I am pleased to report that it is progressing well. And we have recently started demonstrating it to the film making community.

In professional broadcasts, 239 channels world wide, including 119 in Europe, are using Dolby Digital on air. Also in Europe, three IP TV service providers, Orange, British Telecomm, T-Mobile will be delivering content using Dolby Digital.

In summary, we are well positioned for the future. Dolby technologies are becoming incorporated in a greater variety of consumer devices. As we move forward, we remain focused on extending our core technologies across existing and new markets driving the adoption of new Dolby technologies and capitalizing on our brand, reputation, and experience across the industry to generate additional long-term growth opportunities. 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, will continue to be a key factor in driving our success.

I will now turn the call over to Kevin.

Thank you, Bill. Moving to our financial results, revenue for the first quarter was $104.4 million, up 15% year over year and up 2% sequentially. This was comprised of 79% licensing revenue and 21% product sales and services revenue. In the technology licensing segment, revenue increased 19% year over year and 2% sequentially. Keep in mind that last quarter included $6.7 million of back royalties. And you may remember that we estimated approximately $5 million which is still due from one licensee and the evolution of certain contractual matters. We expect to record revenue from this in our second fiscal quarter.

In the first quarter, year over year technology licensing growth was driven primarily by growth from our consumer electronics, personal computers, and broadcast markets. Year over year in sequential growth in the CE portion of our licensing business was the result of strong demand for standard DVD players and portable DVD players.

In our PC market, we experienced strong year over year licensing growth and on sustained demand for Notebook computers which commonly include DVD playback software with Dolby Digital. Sequentially, PC related licensing declined. This was mainly attributable to the $6.7 million payment we received in the fourth quarter for PC shipments in prior periods.

In our broadcast market, we experienced strong year over year and sequential licensing growth as we continued to benefit from transition from High Definition and Digital television in North America. In our other markets we experienced overall and year over year sequential growth lead by our gaming market.

In the Products and Services segment, revenue for the first quarter was flat year over year and lightly up sequentially with a year over year decline in Products related revenue offset by growth in Services.

Let me turn to the details of the P&L for the first quarter. Licensing gross margin was 91% or flat sequentially. Products gross margin was 43%, up 2 points sequentially while Services gross margin was 61%, up one point sequentially. In the first quarter, Products gross margin was negatively impacted by approximately four percentage points sequentially due to additional costs incurred to upgrade the installed base of Dolby Digital Cinema systems to JPEG 2000 capability. Currently, almost all Dolby Digital Cinema systems have been upgraded for JPEG 2000 capabilities. And we are continuing to upgrade systems for certain security features.

During the remainder of fiscal 2007, we expect to recognize revenue on a number of Digital Cinema systems that are currently deferred upon meeting certain contractual obligations. We expect that the recognition of these products will adversely impact our Product gross margins, because our initial Digital Cinema systems carry a lower margin than our other professional products.

SG&A expense was 36% of revenue in the first quarter, down 4 percentage points sequentially. The sequential decline is the result of higher expense recognized in the fourth quarter of fiscal 2006 associated with our 2006 annual bonus plan, as well as, consulting expenses related to our compliance with the internal control provisions of Sarbanes-Oxley.

R&D expense was 8% of revenue for the first quarter, down 2 percentage points sequentially due to higher expenses in the fourth quarter associated with our company annual bonus plan.

Dolby's tax rate for the quarter was 32% compared to 38% in the fourth quarter. The decline in our tax rate was due primarily to an increase in research and development tax credits resulting from a change in the tax law. This change reinstated the research and development tax credits for prior periods, periods prior to the first quarter of fiscal 2007. In addition in the first quarter of fiscal 2007, an increase in tax deductions related to disqualifying dispositions under our employee stock option plan further decreased our effective tax rate. We expect our tax rate for the remaining quarters of fiscal 2007 to run around 38%, excluding the effective of any further disqualifying dispositions.

First quarter net income in 2007 was $29.9 million, or $0.27 per diluted share, compared to $17.3 million or $0.16 per diluted share for the first quarter of fiscal 2006. Net income included stock-based compensation charges of $4.9 million for the first quarter of 2007 and $5.1 million for the first quarter a year ago.

Turning to the balance sheet, Dolby finished the quarter with approximately $575 million in cash, cash equivalents, and marketable securities. From operations, we added approximately $47 million of cash and cash equivalents during the first quarter. This was the result of net income of $29.9 million which included non cash expenses of $8.1 million and changes in the balance sheet.

Capital expenditures were $1.8 million in the first quarter. In addition, the balance sheet includes accrued royalty expenses of approximately $16 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 historical 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 and for the first quarter of fiscal 2007 but have accrued the royalty expense based on the historical method. As of today, we have not received a response from the licensor.

Turning to our outlook, we believe that our annual guidance for fiscal 2007 of revenue between $420 million to $450 million continues to be appropriate. We now expect net income for fiscal 2007 to be $100 million to $110 million. Consequently, we now expect earnings per share -- or diluted share -- for the full fiscal year 2007 to be $0.88 to $0.96

While stock-based compensation expense may vary based on factors such as stock price volatility; we continue to expect stock-based compensation expense for the full year to be $20 million to $22 million.

This concludes our prepared remarks. I would now like to turn it over to the operator for questions. Please go ahead, operator.

Thank you. [OPERATOR INSTRUCTIONS] One moment, please, for the first question. We'll go first to Benjamin Swinburne with Morgan Stanley.

Good afternoon. Can you guys hear me?

Yes, Ben.

Great. Thanks for taking the question. I'll ask two for now, one on the PC segment and maybe just sticking more on the big picture about Vista. Bill, you ran through some of the technology trends that you are seeing there. Did the attach rate in the quarter if you sort of pull the payment -- the one time payment, Kevin, that you got last quarter out -- were attach rates up or down or flattish in terms of the playback software sequentially. And as we look forward now that Vista is actually launched maybe Ramzi could walk us through a little bit how we should think about attach rates going forward if you could. I haven't got anymore visibility on that at this point.

And then second on Digital Cinema, you referenced in your 10-K some competitive disadvantages that you had in the market today relative to some of your competitors. And I was wondering if the JPEG 2000 upgrade was the issue you were referring to there and if that's now behind you. Thanks.

Okay. Well starting with PC, you know, Ben, it is difficult on a quarterly basis to get all of the data required to precisely measure the attach rate. But absent that $6.7 million payment, our PC licensing segment was relative, was just about flat sequentially. And I think based on the industry trends we saw for the relevant quarters, that wouldn't indicate any significant changes in attach rates. Does that answer the first part of the first part of your question?

Yes, definitely.

And then you said second part of your question concerned how we see Vista going forward. Is that right?

Yes, you made some comments over the last couple of quarters about just maybe the changing landscape there. Now that it is launched and maybe closer to having these out in the marketplace, any update?

Yes. We are pretty encouraged by the marketing push toward either the Ultimate of the Home Media edition. As you know, both of them have Dolby technology upon shipment, no need for the user to select, so that comes automatically along with the shipment. So the way we've been observing the marketing push from Microsoft seems to be heavily weighted towards those versions which is encouraging for us. Of course, it just started shipping a few days ago, so it's a little too early to tell. Moving forward, the projections and product mix seem to be leaning towards the multi-media versions. So things are looking up. It's difficult to tell until we start seeing the first reports from our licensee.

Great.

Hi, Ben. This is Tim. Yes, what we were referring to in terms of competitive disadvantages in Digital Cinema was that, as you know, we've been going through an upgrade process to bring all of our systems up to the level that is required by the studios. That has meant doing largely the JPEG. And that was a hardware upgrade, so that was the extra expense and we are almost there worldwide with all of our systems. We've completed that upgrade with all of our North American systems and then we've got the international ones to do. And the systems that we are actually selling today are JPEG compliant.

And then over and above JPEG as I've been saying, there's more than just that to the DTI system. And there are a number of other small software upgrades that we are currently doing. And we are almost through with that as well. And then as I've also mentioned in the past in terms of competition, there's a lot of price pressure in this market right now. Does that answer your question?

Yes, thank you.

Next, we'll go to Ralph Schackart with William Blair.

Good afternoon. Now that you've had some time to digest what you've learned from the consumer electronic show, can you give us some perspective whether you think one format will prevail or if the market will move to a dual format for this cycle and what sort of implications that would have on your business over the longer term?

We are definitely seeing a significant push in both camps but still around all geographies we haven't seen a let up in either camp. So I would qualify the war is still going on if you will. However, there are some indications that some parties are taking some activities to try to accelerate the resolution of the war. As you've probably heard, there's the -- and as Bill mentioned earlier -- the LG Duo player is one such scenario. It remains to be seen if the build of materials is a feasible solution for the marketplace to adopt to a two format player. Another potential solution has been with one of the content companies potentially offering a dual format disc which could play both. So we've seen some movement in order to get the two camps together, but so far we haven't seen a resolution yet.

Okay, thanks. And then in terms of the mounting cash on the balance sheet and clearly with the high margin business model generating a lot of free cash flow, can you give us some perspective strategically, your thoughts on the uses of cash.

We don't have any change in our position on that. We continue to look to grow in a number of areas, including video. It's an area that we've been focused on as we've discussed in the past. So we continue to look for opportunities to play our cash toward an initiative, but we don't have any plans to announce other than that.

I would just like to stress that, as Kevin said, video is a key area and we're looking very strongly and get our entry into that market and see some possibilities.

Great, thanks.

Next we'll go to Daniel Ernst with Hudson Square Research.

Yes, good evening. Thanks for taking the call. Two questions, if I might. First on the international broadcast, looking at the consumer side of that, the Set-top Boxes and [what to the extent of the] TV sets. Can you talk about what the growth of that has been year on year? And is that an area that's now a meaningful share of revenues and could maybe you break it out? And then secondly, your comments on the hoping and working on broadening your role in the handheld market. We saw so many neat demos at CES. Is that an opportunity that is within the median time frame, calendar '07? Or is that more of a calendar '08, '09 opportunity we might sort of break into that side of the market? Thanks.

I'm sorry could you repeat the beginning of the first part of your question, because I didn't catch it.

The first part of the question was on the international side of consumer broadcast, so Set-top Boxes and TV sets and international. In North America we know it's quite strong with the ATFC mandate, but internationally where your defacto standard on some networks. And you said over 100 channels, talk about is that now a meaningful share of revenue where you are in Set-top Boxes or TV sets internationally.

So we did see good growth in our broadcast licensing group both year over year and sequentially. Most of the data we have is from our licensees which can ship products to North America or internationally. So we don't have perfect data on penetration and look much -- we look to industry data on that which would indicate that Europe is still at an earlier stage than North America, but that we are beginning to get some penetration there. I don't know if you would add anything to that, Ramzi.

The largest sign, positive sign, I would say is what bill mentioned earlier in terms of the adoption of broadcasters in Europe specifically and elsewhere. We have a significant uptake on broadcasters having offered broadcasting in Dolby Digital. And to add to that, we have our IP TV push with Dolby Digital Plus. We show that we had a couple of showcases of Dolby Digital Set-top Boxes at CES which is the beginning of a new cycle for that technology.

Second question?

Second question was on your opportunity in the handheld market moving beyond the Via licensing on AAC using Dolby Headphone, other technologies or Dolby True [indiscernible] as you call it.

We do have a few initiatives in terms of pushing our technologies into the handheld market, as you said, Dolby Headphone which is very much appropriate to the movie playback. And as we see more and more phone/media players as we have observed in CES, those are a prime target for our Dolby Headphone technology when somebody is watching a movie or a short clip or even a short TV series that is broadcast in Dolby Surround Mode.

Another personalized audio technology we are pushing is Artistry. And to answer your question is yes, we are leaning at having some design wins in 2007. But to be clear, design win and revenue in our product lifecycle can be a bit far apart.

So just to summarize, maybe not until a calendar '08 where we see an expansion of the opportunity in the handheld side.

From a revenue perspective, correct.

Okay. Alright, thank you.

Next we will go to Ingrid Chung with Goldman Sachs.

Hi, good afternoon. Just a quick question, you had sited that consumer electronics was helped by growing DVD unit sales and that actually does follow what we've been seeing with CEA data. I was just wondering how you'd explain the accelerating growth in the U.S.

Well, we probably see the same data you do in that regard. We're -- you know that we came into the year building our guidance based on flat performance in our CE market, so we are pleased to see Q1 get out of the gate with some growth. But I don't know that we have any answers to what is causing that growth other than what you read in other reports.

Okay. Thanks. And also just a quick one, on SG&A it seemed like either your growth on SG&A line had come down quite a bit. And you had sited that part of it was due to bonus payments. Should we expect SG&A growth to accelerate throughout the rest of the year?

Well you think that as we think about spending for the rest of the year, I think about a couple of things. There are some things that tend to cause growth toward the latter part of the year, such as, our raise program. Our trade shows tend to be in the last three quarters of the year. The calendar fourth quarter is not a big trade show quarter for us. And that also we do have hiring plans. We do intent to continue to invest, as a said, in a number of our new initiatives and our sales and marketing abilities. And so we do have hiring plans for the rest of the year that would affect that SG&A line.

Okay, great. Thanks.

[Operator Instructions]. Next we will go to Sam Doctor with JP Morgan.

Thank you. This is Sam Doctor for Paul Coster. Couple of questions I had, first for is a [indiscernible] for Visual Cinema and how you see that [indiscernible] for the industry over the next year or two.

Yes, Sam. Well currently as Bill said, we've got about 280 systems out there. And I think if you look at various reports that are published worldwide, there are around about 3000 systems totally deployed. So that's where it is right now. There's certainly lots of talk about that deployment continuing over the next couple of years. We're very encouraged by exhibitors supporting us and several of them asking specifically for Dolby equipment from the various systems integrators that are moving ahead with that deployment, but difficult to actually put a number on it right now.

Okay. Secondly, I had a question on gaming and specifically on the HD DVD attachment for the Xbox 360, do the actually increase your gaming opportunity to get the price points for the 360 and then for the add-on? And then how is that performing in the market?

The HD DVD does constitute an additional royalty when purchased on top of the Xbox. In terms of the results on that, we don't have the data on that up sell from Microsoft yet.

That will be the quarter [indiscernible] gaming revenue though?

I'm sorry. I didn't quite catch that.

The HD DVD add on will be gamin and not CE revenue. Is that right?

Oh, how would we account for it you mean?

Yes.

Well that attachment can play movies and it could potentially play high defs and DVDs. In terms of how to account for it, I'll have Kevin answer that question.

Yes. In terms of how we break down our segment data for you, we would track that in our gaming segment.

Okay. and if you would give chance for one clarification, the 5 million in back licensing, did you collect that in the first quarter or is that the second quarter? I'm sorry, I missed that.

We did not collect it in the first quarter, and we are expecting to collect it in the second quarter.

Okay, great. Thank you.

Next we will go to Steve Lidberg from Pacific Crest Securities.

Good afternoon, this is David Niederman in for Steve. Couple of quick questions, first off, looking at the Apple TV device at Mac World, talking with people there, it looked like it was going to be two channel only. Are you in talks to make that to support multi-channel audio going forward?

We don't have any information on that now.

Okay, great. And looking at the video initiatives that you spoke about earlier, could you talk a little bit about how you view the competitive landscape for that with some pretty well established video coder providers out there? How do you see that shaking out in the midterm? Thank you.

Well overall, we think that we are well positioned to come up with some viable technology offerings in the video imaging space. We've obviously learned quite a bit from our work in Digital Cinema working on JPEG 2000, enhancements to JPEG 2000, working the area of 3D. It is a very competitive landscape, there's some big players out there.

On the other hand, we have quite a few years of experience in this regard. We brought in a company called Demographics about five years ago who are some very, very talented people in video signal processing. We've added to some people on the east coast, an office in Pennsylvania, some former people from the consumer electronics industry back there. And we think we have some very, very viable technology to take the market both in the professional field, as well as, the consumer field. I think this again ties back in with our contacts in the contents side in terms of our business model getting content created and then distributed and played back. And we think we can compete quite well in the imaging and video space moving forward.

I just want to go back to your question earlier about the Apple TV. The output is true that it is two channel, but to the extent that it's Dolby Surround Encoded as is the case with all of Apple's movies. Any consumer can connect that LTRT output to their surround sound system at home and enjoy 5.1 channel surround playback.

So do you receive a royalty on the devices when they will be sold?

The decoder is not in the device. The royalty will come from those receivers that are in the homes.

No, but we will receive, our Via subsidiary will receive a royalty on the AAC decoding in those once we start selling them this summer.

Great. Thank you.

[Operator Instructions]. It appears we have no further questions at this time. Mr. Yeaman, I'll turn things back to you for any closing comments, sir.

This is Bill. We want to thank everybody for joining us on today's call. We think we've had a very, very good quarter. We've had the great CES. We have great technology for the future. We're looking forward to finishing off fiscal year in the style to which, I think, our investors and the customers have come to expect. We are very, very happy with our results. And we look forward to talking to you next quarter. Thank you very much for joining us.

Thank you, Mr. Jasper. That does conclude today's conference call. Again, thank you all for your participation and have a great day.