Dolby Laboratories Inc (DLB) 2007 Q2 法說會逐字稿

Ladies and gentlemen, please stand by. We are about to begin. Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal second quarter 2007 results. [OPERATOR INSTRUCTIONS]

I would now like to turn the conference over to Kevin Yeaman, Chief Financial Officer for Dolby Laboratories. Please go ahead, Mr. Yeaman.

Thank you. Good afternoon. Welcome to Dolby Laboratories second 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 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 28, 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 most recent quarterly report on Form 10Q 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. And so with that introduction behind us, I'll now turn the call over to Bill.

Thank you, Kevin and good afternoon everybody. I am pleased to report a very strong second quarter, with revenue of $129 million and net income of $39 million. We continue to benefit from the increased penetration of Dolby Technologies throughout our markets, resulting in improved diversification of our licensing revenue.

In today's call, I would like to update you on our progress towards Dolby's long-term objective of being an essential element in the best digital entertainment technologies, as well as the initiatives we are focused on to further capitalize on the expansion of digital entertainment.

In the next generation DVD and gaming markets, we believe that we are well positioned. In next generation DVD, Dolby Digital Plus and Dolby True HD are audio standards in the HD DVD format, while Dolby Digital is an audio standard in the Blu-ray format. In next generation gaming, the Sony PS3 contains Dolby Digital Live for gaming, Dolby Digital 5.1 for DVD playback and Dolby True HD for decoding of up to 7.1 channels in Blu-ray, while the Xbox 360 includes Dolby Digital for game play and movie playback.

Additionally, we continue to benefit from the transition to digital television by broadcasters around the world. The number of stations adopting Dolby Digital as their multi-channel audio format is expanding and we are focused on increasing the penetration of Dolby Digital in the growing digital TV and set top box markets.

In North America, we are benefiting from increased penetration of Dolby Digital in integrated televisions shipped throughout the United States. The FCC has mandated that as of March of this year, all integrated televisions must contain the ATSC digital tuner and Dolby Digital is the adopted standard in the ATSC tuner.

We are equally pleased with our progress in the European and Middle Eastern Region. In our second quarter, 158 channels in this region were broadcasting in Dolby Digital. As the number of European channels broadcasting in Dolby Digital grows, we are seeing some European television manufacturers integrating Dolby Digital into their digital television shipments. We are very encouraged by this development and believe this validates our long-term strategy of building on our work across the broadcast chain to increase adoption of our technologies.

At this year's National Association of Broadcaster's conference, we demonstrated an end-to-end solution for the emerging IPTV market using Dolby Digital Plus in standard hardware products.

In the personal computer market, we continue to work with leading PC suppliers and manufacturers to encourage integration of additional Dolby technologies into their products. Furthermore, in our second quarter, Microsoft began shipping the Vista operating system, including the Home Premium and Ultimate editions, which incorporate both Dolby Digital and Dolby Stereo Creator.

In addition, through our PC entertainment experience initiative, we continue to work with a number of PC OEMs including LG, [Winovo], Toshiba and [Jesus] to introduce media centric notebook models that contain the suite of Dolby technologies and deliver a home theater experience with consumer electronic quality.

In the motion picture industry, we continue our progress towards a DCI compliant digital cinema server and demonstrated imaging technologies that are designed to enhance the overall theatrical experience. The current number of Dolby Digital cinema systems in use worldwide is over 300. In the second quarter, we announced that industry leader Technicolor ordered 190 Dolby Digital cinema systems for their North American Beta Test and their Kinepolis deployment in Belgium. We also received orders from Japan and expanded our deployments with Mega Plex in [Malco]. And last week, we announced that our system has been recommended for FIPS Level 3 certification. This is further evidence of our commitment to meeting all the specifications requested by major studios.

In addition, at this year's ShoWest Cinema convention we demonstrated Dolby 3D Digital Cinema, which will offer exhibitors a flexible alternative for delivering a high-quality 3D experience to moviegoers.

As digital media proliferates across these multiple distribution platforms, consumers have more ways to enjoy entertainment content than ever before. They are seeking a more immersive entertainment experience across these platforms, as well as more control over content. With a focus on these trends, we are working to deliver additional audio technologies to the market, including Dolby Headphones, Dolby Virtual Speaker, Dolby Volume and Audistry by Dolby. We also continue to focus on improving the entertainment experience beyond sound. In addition to our digital cinema and 3D technologies, we recently closed the acquisition of BrightSide Technologies, which has technologies to deliver a more vibrant image through LED backlit LCD displays using high dynamic range technology.

In summary, we believe that we are well-positioned for the future. As Dolby technologies are becoming incorporated on a greater variety of consumer devices, we are focused on new trends in the entertainment experience and building on our brand, reputation and experience across the industry to generate additional long-term growth opportunities. With that, I will turn it over to Kevin.

Thank you, Bill.

Moving to our financial results, revenue for the second quarter was $129 million, up 23% year-over-year and was comprised of 83% licensing revenue and 17% product sales and service revenue.

In the technology licensing segment, revenue increased 28% year-over-year and 29% sequentially. This was due in part to $7.7 million in revenue relating to PC products shipped over the prior 10 quarters by an existing licensee. This revenue resulted from the resolution of certain contractual matters with this licensee in the second quarter, as we anticipated on last quarter's call.

Year-over-year in sequential technology licensing growth was driven primarily by growth from our broadcast and personal computer markets. Very strong year-over-year and sequential growth in the broadcast portion of our licensing business came from strong demand for digital televisions and set top boxes with Dolby Digital. We experienced strong year-over-year and sequential licensing growth from our PC market, even excluding the $7.7 million in royalties relating to products shipped in prior quarters. This growth was driven by sustained demand for notebook computers, which commonly include DVD playback software with Dolby Digital.

Our largest market, consumer electronics, was up sequentially but flat year-over-year. Our other markets were roughly flat year-over-year and were up modestly sequentially with gaming experiencing strong sequential growth.

In the products and services segment, revenue for the second quarter was roughly flat year-over-year and sequentially. Within our products revenue, we experienced strong year-over-year and sequential demand for broadcast-related products, while experiencing year-over-year weakness for traditional motion picture related products. Services revenue was up 18% year-over-year and roughly flat sequentially.

Let me turn to the details of the P&L for the second quarter.

Licensing gross margin was 90%, or down 1 point sequentially. Product gross margin was 50%, up 7 points sequentially while services gross margin was 59%, down 2 points sequentially. You may remember from our last earnings call that we expected product margins to be adversely impacted in the remainder of the year as we recognized deferred revenue on a number of digital cinema systems, which carry a lower margin than our traditional cinema products. Stronger than expected product margins in the second quarter was the result of a delay in recognition of deferred revenue related to these digital cinema products. We currently do not expect to recognize much of this deferred revenue in the remainder of the year.

SG&A expense was 33% of revenue in the second quarter, down 3 percentage points sequentially. While SG&A declined sequentially in percentage terms due to significantly higher second quarter revenue, it increased by approximately $5 million from the first quarter. The growth in absolute dollars resulted from an increase in payroll and tradeshow related expenditures driven by annual merit increases, higher headcount and costs related to the consumer electronics show in the second quarter.

R&D expense was 8% of revenue for the second quarter, or flat sequentially. The sequential increase in absolute dollars for R&D was a result of higher investment in certain digital cinema, imaging and broadcast related initiatives.

In the second half of fiscal 2007, we expect operating expenditures to run at a higher rate, while we continue to invest in growth opportunities, such as next generation broadcast platforms and imaging technologies, including IPTV, 3D digital cinema and the integration of BrightSide Technologies. In addition, we recognized $1.5 million in the second quarter as a gain on settlement in connection with the resolution of disputes with two implementation licensees, which we do not expect to recur.

Dolby's tax rate for the quarter was 37%, compared to 32% in the first quarter. Our tax rate increased sequentially because last quarter we benefited from a catch up in research and development tax credits and an increase in tax deductions related to disqualifying dispositions under our employee stock option plan. We expect our tax rate for the remaining quarters of fiscal 2007 to be around 38%.

Second quarter net income in 2007 was $39.1 million, or $0.34 per diluted share, compared to $28 million or $0.25 per diluted share for the second quarter of fiscal 2006. Net income also includes stock-based compensation charges of $4.8 million for the second quarter of 2007, compared to $5.1 million for the second quarter a year ago.

Turning to the balance sheet, Dolby finished the quarter with approximately $605 million in cash, cash equivalents and marketable securities. From operations, we added approximately $23 million of cash during the second quarter. In addition, the balance sheet contains approximately $24 million in accrued royalties related to the license of certain patents under a license agreement with an unrelated third party.

In the third quarter of fiscal 2006, we evaluated whether the patents licensed to us under the license agreement covered all of the products and technologies for which we had historically been paying royalties to the patent licensor. Based on our evaluation, we determined that under the license agreement, we may not owe royalties on all of the products and technologies for which we had historically been paying. In the third quarter of fiscal 2006, we notified the patent licensor that going forward we intended to pay royalties only for products and technologies that we believe are covered by the patents licensed under the license agreement; and subsequently, we have been paying the patent licensor royalties on this basis.

In the second quarter of fiscal 2007, the patent licensor informed us that it disagreed with our interpretation of the license agreement. While we are trying to resolve this matter with the patent licensor, there continues to be uncertainty regarding the outcome. As a result, we have continued to accrue royalty expense in a manner consistent with our historical payments.

Before I turn to our outlook, I would like to discuss how we are viewing our segments and markets in the remainder of the year. In our professional segment, we started the year expecting growth of at least 10% on increased revenue from digital cinema and broadcast related products. Since we currently do not expect to recognize deferred revenue from any of these digital cinema systems in the remainder of the year, we now expect our professional segment to be flat in fiscal 2007.

In our consumer segment, we had a strong first half of the year, as we benefited from multiple growth drivers. We expect revenue in the second half of the year to be lower than the first half, as the first half benefited from the holiday season for consumer electronics and from the additional $7.7 million in prior period revenue. We continue to expect year-over-year growth in the second half, led by our broadcast market, even though the fourth quarter of last year benefited from $6.7 million in prior period revenue. Starting the year, we expected our consumer segment to grow 5 to 15% in fiscal 2007. We now expect full year growth of 15 to 20%.

Turning to our outlook, we now expect fiscal 2007 revenue of between $435 million to $450 million. We now expect net income for fiscal 2007 to be $110 million to $115 million. Consequently, we now expect earnings per diluted share for the full fiscal year 2007 to be approximately $0.95 to $1.00. Our 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 between $20 million and $22 million.

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

Thank you, sir. [OPERATOR INSTRUCTIONS]

And for our first question, we go to Ralph Schackart with William Blair.

Good afternoon and congrats on another strong quarter. There's been some speculation that Wal-Mart might be putting in a large HD DVD central order in the market within Asian manufacturing. I'm just curious if you could provide some color on this discussion? And additionally, too, do you think that Wal-Mart, being as large as they are could potentially break the logjam for the format war?

Frankly, this is Ramzi, we really don't have the detailed information which you seem to have, Ralph, and frankly if we did, we wouldn't be able to discuss it, about any specific purchase by Wal-Mart.

Okay. Thanks. And then as you look out over the next sort of 12 to 18 months, can you size up for the market, if you could please, your three biggest opportunities, particularly on the licensing end, that could really drive the EPS power in your royalty base models?

Well, I think, Ralph, that consistent with our guidance for the rest of this year, if we extend that out for the 12 to 18 month timeframe, the biggest growth that we're seeing right now continues to be from the broadcast portion of our licensing revenue and from the PC portion of our licensing revenue.

On the broadcast side, we've been seeing growth that could lead to it being up to as much as 15% of our licensing revenue this year, up from just over 10% last year. So, we're seeing very strong growth. And on the PC side, obviously we continue to closely watch what the impact of Vista will be. We don't have any royalty reports yet. We'll get our first report this quarter, but early indications are that on the consumer side, that the adoption of the Premium edition has been quite strong and that on the enterprise business side, adoption of Vista in general has been slower than expected. And of that is -- that's all positive indicators for us.

Okay. Great. And just sort of follow up points at , Kevin. Your second half '07 being lower than your first half of '07, does that incorporate sort of a conservative stance potentially in the PC market with the roll out of Vista at all?

So, first of all, we have the $7.7 million of prior period royalties this quarter, which we don't expect to recur in the second half of the year. So, that's part of it. The other part of it is in our consumer electronics market, we would typically see lower revenues in the second half of the year than the first half. So, [PT] did not play heavily in our thinking, as far as that trend goes. Does that answer your question?

It does. Thank you.

And for our next question, we go to Steven Frankel with Canaccord Adams.

I wonder if you mind give us some detail on what's holding up revenue recognition on the digital cinema side?

Yes, I'll give a brief explanation and let Tim answer any further detail questions. But essentially as we discussed on the last conference call, we are committing to make each of these servers VCI compliant, which is a set of specs in the industry. And while we delivered the features that we think are most important today to exhibitors and studios, as evidenced by content being played on our machines. There are some updates to do, which we don't expect to happen until probably late in the fourth quarter, which would not give us much opportunity to get those units upgraded.

Okay. And what's happening with the transition to Dolby Digital Plus in Europe? Do you have a number of stations or systems that have done that so far?

We're making progress on both ends. We have demonstrated our first professional end quarter at NEB this year. That's good progress relative to where were before last year. On the licensing side of it, we have several licensees signed up for Dolby Digital Plus. We're not on air yet or on line, if you will, but I would say all the indictors are in place to get us going in our market.

Great. Thank you.

Sure.

And for our next question we go to Ingrid Chung with Goldman Sachs.

Good afternoon. Thanks. I just wanted to ask a question about DVD player sales. We keep track of CEA data on a monthly basis and it looks like it's been up double digits for the last year or so. So, I was just wondering why we didn't see that in your CE licensing this quarter? Maybe it's a domestic, international mix or something like that?

Yes. Well, I would first point out that -- well, a number of financial analysts have quoted some industry reports in their reports. Many have quoted the worldwide industry analyst data that showed that year-over-year worldwide DVD shipments were down in the fourth quarter, and a number of you have cited CEA data which shows a very strong first quarter.

The CEA data of course represents a portion of the U.S. and so, we're hesitant to extrapolate that to the rest of the U.S. and the rest of the world, but clearly it seems to be a positive indicator and would be more reflective of the coming quarter than the previous quarter.

Okay. Gotcha. And then my second question is, why do we see a material tick up in accounts receivables from the last quarter to this quarter? It doesn't seem to follow a pattern from a year ago.

Well, part of it is just it is following the increase in revenue generally.

Okay. Alrighty. Great. Thank you.

And for our next question we go to Paul Coster with J.P. Morgan.

Thank you. Kevin, what percentage of revenue came from international origins? And what, if any, effect did currency movements have on revenues or any?

Currency movements don't affect our revenues in any meaningful way because substantially all of our revenues are denominated in dollars. So, the primary impact is that we do have offices that operate in local currencies and that will affect our expenses. But nothing that I would point to that's significant. It was about 75% of our revenues that were international.

Okay. When you came out as a public company, at that time the seasonality was kind of obscured by very erratic recognition of licensing revenues. Things have changed a lot. You now are manifesting much more seasonality; much more predictable, I guess. What changed there?

Well, I would hesitate to call it 'predictable' in the sense that there still are a number of factors that can affect any given quarter's revenue. There still could be shipments that are occurring before the Christmas season, for instance. So, we don't know which quarter people are going to ship in. And while we see some seasonality -- we cited seasonality in our consumer electronics market specifically, we're not necessarily seeing the same seasonality in all of our markets.

Okay. And the last question then. Catch up payments, do you feel that there are many in the pipeline or are we starting to normalize the recognition of the licensing business out of Asia?

Well, the two specific cases that we've cited, one this quarter and one in the fourth quarter of last year, were unusual instances and that's why we highlighted them. In general, in any given quarter, there are payments that relate to prior periods and if there's anything out of the ordinary, we would highlight it. So, there's nothing I would call out at this time.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] We go next to Daniel Ernst with Hudson Square Research.

Yes. Thanks for taking the call. Two questions, if I might. First, can you just walk us a little bit through the cash flow here. It didn't seem to be quite as strong as earnings growth. Just reconcile that for me.

And then on the adoption of the Dolby ATSC tuner in the U.S. now on all TVs, is there an opportunity -- your guidance excluded for a little bit of non-seasonal bump in that line as TVs now shift into the U.S. market? Virtually all TVs will have that tuner mandate. Thanks.

So, on your first question, the primary difference between net income and our operating cash flow is the increase in receivables that we discussed earlier.

Yep.

And there was also an increase in tax receivables. So, those were the primary drivers.

And could you repeat the second question.

So, now that the March deadline has passed, all TVs sold into the U.S. market or at least labeled as a TV as opposed to a monitor have to have the HSD digital tuner and therefore have Dolby. So, now it's going to be 100% of TVs or new 100% of TVs in the March after period. So, you have an opportunity there to have a non-seasonal bump just from that up-tick in TVs that previously had not had to have that tuner in it?

Well, there is a ripple effect due to the March guidelines coming into effect. Obviously, not all the consumers rushed out to the get their TVs so we do expect that to continue and that's reflected in Bill and Kevin's comments about the continued strong growth in broadcast. So, I don't think it's really over in terms of the effect of that rule getting into place. I'm not sure if I'm answering your question.

Yes. It's just that we would not expect March and June quarters to be seasonally strong for televisions, but for you it's also -- it's not just the sales themselves but also now it's the adoption of that mandate within all TVs. So, the adjustable pie for you just has a stair step up in that non-seasonal period.

We really don't know. I mean, we obviously had a strong quarter in broadcast for sales around the Christmas season, which came in in the March quarter. But as to how that carried over into actual March sales which would be reported in June, it's really too early to tell. There are some analysts' reports out there saying that perhaps in certain side segments perhaps the growth wasn't as much as people thought for certain companies. But we really have no insight into that yet.

Okay. Fair enough. Thanks a lot.

[OPERATOR INSTRUCTIONS] We go next to Alan Davis with D.A. Davidson.

Yes, just a couple of questions here. I'm wondering if you can give us a little more detail in your consumer side of your business for DVD player royalties for this year. What kind of growth is built into those assumptions?

Well, for our consumer electronics market, which includes consumer DVD players, we came into the year guiding to flat. We saw some growth in the first half, so we see it flat to slightly up for the year. So, that's reflected in our increased licensing revenue guidance.

Okay. Great. And I wonder if it's possible to breakout in some sense, if not precisely the percent of revenues now coming from -- in the broadcast and the consumer side. You know, digital TVs and also set top boxes.

Last year we said that it was just over 10%. Based on the strong growth we're seeing this year, we think it could make out 15% in '07.

Both of those combined?

Our broadcast market, which includes digital TVs and set top boxes.

Okay. But not willing to break it out beyond that?

No.

Okay. All right. Well, thank you.

And with a follow-up question, we return to Ralph Schackart with William Blair.

Hi. Two quick follow ups. First, can you give us an update on the traction and the mobile handset markets? Or any design wins or products you have on the market? And then also, two, can you give us an update on the traction with Dolby Volume out in the market? Thanks.

Well, I go to your second question. Dolby Volume has been well received in both the receiver marketplace, as well as in the television. In fact, we've been pleasantly surprised by the strong interest on the receiver side. It remains to be seen which products are going to come to market first, is it the TV or their receivers. I think it's just a matter of manufacturers turning out the product. We do still expect some products towards the end of this calendar year or very early '08, as we discussed at CES. Overall, we're pretty pleased with the progress. We're holding off announcements at this time until the products are tested and certified.

To your question on mobile, our mobile strategy continues to be developed. As you know, we have showcased some early technologies at CES. We do have a pull phenomenon. We do have interests. We are still evaluating the overall strategy on mobile before we get into specifics. So, at this time we don't have an announcement to make on a Company basis.

Okay. Thanks.

And with another follow-up question, we return to Paul Coster with J.P. Morgan.

Paul Coster. Thank you. Should we assume that acquisitions going forward will be more focused on this video segment or is it inappropriate to make that conclusion at this stage?

I think it's inappropriate to make the conclusion, Paul. We obviously are looking at all segments of the business. Obviously, our first major acquisition since going public was in the imaging video area with BrightSide. As we look toward ourselves getting into this area, we recognize there are some other possibilities. So, we're taking a look at that. But we wouldn't want to limit ourselves strictly to the video side of the business if we see technologies which are going to compliment what we're doing in other areas.

Okay. Thank you.

We go next to [Eric Mintz] with Eagle Assets.

Congrats on another strong quarter, guys. Hey, I just wondered if you could kind of refresh the strategy, the go-to-market strategy for digital cinema and what you're thinking right now in terms of how you want to provide products and services into that market? If it's just going to be a server sale or if it's more of a soup to nuts offering, the exhibitors?

This is Tim Partridge. So, as Bill mentioned in the opening remarks, we're very pleased with some traction that we're seeing on the service side in this last quarter, having taken orders from Technicolor for 190 systems and also some orders into Japan. So clearly we're making progress on the service side alone.

We've also announced previously that we are doing the kind of soup to nuts, as you put it, with Malco and Mega Plex, two relatively small chains here in the U.S., and we have expanded that deployment a little bit this last quarter, as well.

And so, primarily it's those two approaches, but we are certainly pursuing more aggressively this direct sale of our technologies, i.e., the server in this market right now.

And obviously with the open standards you guys have communicated that pricing pressures will be prevalent. Is there any update on that? Do you feel like you're differentiated now with the 3D technology that you have? Or is there any update on what prices for these servers are going to go for?

Yes. Well, we think we are differentiated in a number of ways, not only with proprietor like 3D, but in the announcement with the FIPS. We're the only company to have announced that we've been recommended for FIPS certification, which is a clear requirement of the studios. And so, on the server itself, we expect to be able to command a premium because of our relationships and our name and standing in the industry. But as you say, additional technology such as 3D will also be differentiating features for us. We showed our 3D systems to over 500 people at ShoWest during the quarter and had very strong interest from the industry. They were very happy with what they saw and both from the quality of point of view, as well as just giving them an alternative to present 3D, which is clearly a very hot technology right now within Hollywood.

Great. Thanks a lot, guys.

We go next to Robert Adams with Montgomery & Company.

This is Eric Rasmussen for Rob. Thanks for taking the questions. I think we've exhausted a lot of my questions, but if we can just -- you talked about a lot of end markets that you guys are selling into and targeting and penetrating. But I'm not sure if I heard anything about the incline of payments systems. Can you just kind of refresh us or give us an update on that.

Our automotive strategy has changed a little bit. We have been concentrating on the tier one manufacturers of products and we have had better success than in the past in penetrating that market. It turns out going directly to the car manufacturers a bit slower and the leverage is lower, therefore our strategy of going after tier ones seems to be paying off. But again, even with a successful strategy on the table, the time to market -- and this market, as you know, is very slow -- from design win to car on the road could take up to five years. So, we're going to be waiting patiently, as usual for our long-term strategy to pay off in the market.

Great. I guess we should just continue to look for updates from you guys and not really expect much in the near term?

Correct.

That's a fair assessment. Yes.

Great. Thank you.

And with that, Ladies and Gentlemen, we have no further questions on our roster. Therefore, Mr. Jasper, I'll turn the conference back over to you for any closing remarks.

Thank you, operator and thank you all for participating. We thought we had a very good quarter and we look forward to talking to you again in about three months time. Thank you.

And ladies and gentlemen, this does conclude today's conference call. We do appreciate your participation and you may disconnect at this time.