Dolby Laboratories Inc (DLB) 2007 Q3 法說會逐字稿

Ladies and gentlemen. Thank you for standing by. Welcome to the Dolby Laboratories conference call discussing Fiscal Year third quarter 2007 results. During the presentation, all participants will be in a listen-only mode. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Kevin Yeaman, Chief Financial Officer for Dolby Laboratories. Please go ahead Mr. Yeaman.

Thank you, good afternoon. Welcome to Dolby Laboratories third quarter fiscal 2007 earnings conference call. Joining me today is Bill Jasper, Dolby Laboratories' President and CEO. In addition, Tim Partridge and Marty Jaffe are here to participate in today's Q&A. On this conference call, we will be making forward-looking statements that include projects of future operating results for our fiscal year ending September 28, 2007, market trends for the industry in which we compete and our expectations concerning how those trends will effect 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 and elsewhere 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. So with that introduction behind us, I will now turn the call over to Bill.

Thank you, Kevin. Good afternoon, everybody. The third quarter marked another solid period for Dolby. Revenue and net income were up 28% and 56% year-over-year, respectively. As we continue to extend the Dolby brand and technologies across new markets. Today, digital entertainment is delivered across a growing variety of entertainment platforms and electronics devices. With this, the number of market opportunities before Dolby is growing. We remain focused on our long term objective of being an essential element in the entertainment experience, whether through Digital Cinema, DVD, Broadcast, Gaming, PC or on-the-go. In today's call, I would like to discuss the progress made through the third quarter towards our long term objective. As well as the specific changes we are making in an effort to further improve our success.

First, we continue to position Dolby to benefit from a high definition upgrade cycle that is currently underway. In our broadcast market, a growing amount of high definition content, coupled with falling price points for digital televisions is helping to drive a TV upgrade cycle. This is a significant trend for Dolby because Dolby Digital is included in the ATSC Digital Tuner, which has been mandated in all integrated television shipments in the U.S. and mandated as the digital standard in North America and South Korea. Furthermore, the ATSC Digital Tuner has been adopted in the Digital Cable Set-Top Box standard in the United States. As a result, our penetration of the broadcast market has been increasing.

In the European broadcast market, we continue to make progress of becoming the de facto audio standard for HD Broadcast. The number of stations broadcasting in Dolby Digital in the European and Middle Eastern region is now over 170. In conjunction with this, Dolby Digital has been included in many HD Set-Top Boxes in order to play back HD content encoded in Dolby Surround sounds. Additionally, when television manufacturer is now incorporating Dolby Digital into its mid to high-end European digital television shipments. In addition to broadcast, we believe we remain well positioned for potential upgrade cycles in next generation DVD and gaming. With Dolby technologies including in Blu-Ray and HD DVD, as well as the PlayStation 3 and Xbox 360 game consoles, we are positioned to directly benefit from increased demand for next generation players. While it is too soon to predict the timing and magnitude of a potential HD upgrade cycle in DVD or Gaming, we're encouraged by recent price declines for next generation units and the demonstrated consumer interest for HD content in the broadcast market.

Secondly, we continue to position Dolby in the PC market as consumer increasingly turn their PC to access media and entertainment. Dolby technologies are included in two versions of Microsoft's new operating system Vista. Dolby Digital and Dolby Stereo Creator are included in the Home Premium and Ultimate Editions, which according to Microsoft's most recent earnings call have accounted for the majority of Vista shipments. In addition, the number of Dolby technologies included in certain PC Notebooks has expanded. For example, in the third quarter Acer Computer, one of the largest PC notebook manufacturers globally, announced it will include Dolby Home Theater across its entire line of Aspire Notebooks. Dolby Home Theater is a bundled technology offering under our PC entertainment experience initiative and contains Dolby Digital, Dolby Headphone and Dolby Virtual Speaker as part of the firmware representing an additional licensing opportunity for Dolby.

The Acer announcement represents a meaningful step forward for our PC Entertainment Experience Initiative because it brings Dolby Home Theater to notebooks priced below $1,000. Prior to Acer, other PC OEMs including (lenoble) and Toshiba begin shipping select notebook models containing Dolby Home Theater. In addition, Toshiba announced last week that it would extend Dolby Home Theater to some additional Qosmio Notebook models; as well as Dolby Sound Room to select models of its lower priced Satellite line notebooks.

Third, we continue to invest in and drive new innovations to enhance the imaging and audio experience beyond surround sound. In the motion picture industry, we are building on our strong presence as a primary provider of audio technologies by working closely with the industry to deliver imaging technologies; including Dolby 3D and Dolby Digital Cinema. Since demonstrating Dolby 3D at this year's show West Cinema Convention, we have made similar demonstrations at the European Cinema Conventions, Cine Expo. We continue to receive positive feedback from exhibitors and studios and expect to start selling systems for 3D movies in the fall. In our Digital Cinema Initiative, we now have over 440 Dolby Digital Cinema systems in use worldwide and have achieved significant success with our Digital Cinema Mastering Program.

In addition, we are extending our imaging initiative to the consumer market with our focus on enhancing LED backlit LCD displays using High Dynamic Range technology. This technology makes the whites whiter and darks darker, which dramatically enhances image quality. We expect to begin seeing some initial revenue from this technology in fiscal 2008.

On the audio side, we continue to make progress in our effort to deliver additional audio technologies across our markets. We've demonstrated Dolby Volume technology which enables listeners to stabilize volume levels across broadcast channels and content. So, that users aren't always reaching for the volume control. We expect some initial high-end AV receivers will begin shipping with Dolby Volume this Christmas and for initial high-end televisions to ship in 2008.

We continue to position Dolby for many opportunities, including the high definition upgrade cycle across Broadcast DVD and Gaming, the trend toward PC entertainment and the delivery of additional Dolby technologies across existing and newer markets. Dolby's unique position across the entertainment and technology industries is helping us to respond to opportunities created by the rapid growth in digital entertainment.

Looking forward, we are focused on executing our long term strategy of developing a strong presence both at the point of content creation and the professional community and at the point of playback in consumer electronics. In an effort to improve our ability to scale our organization and effectively apply our strategy across our markets, in the third quarter of fiscal year 2007, we decided to reorganize our business from two operating segments into a functional organizational model. In the new functional model, there will be a Products and Technology group headed by Tim Partridge and a Sales and Marketing group headed by Ramzi Haidamus.

The Products and Technology group will be responsible for research, engineering, product development, manufacturing and technology. By bringing these capabilities together, we believe we are in a better position to drive innovation and maintain our technology leadership. The Sales and Marketing group will be responsible for all sales, marketing, business development, field operations. We believe this will help enable us to drive growth by bringing in integrated customer based perspective to our innovation and technology development efforts. With that, I'll turn it over to Kevin.

Thank you, Bill. Moving to our financial results, revenue for the third quarter was $119.6 million up 28% year-over-year and was comprised of 79% licensing revenue and 21% product sales and services revenue. In the technology licensing segment, revenue increased 37% year-over-year and was down 11% sequentially. In the third quarter year-over-year technology licensing growth was driven primarily by growth from our personal computer and broadcast markets.

Our PC market experienced very strong year-over-year growth. Sequentially, growth was only slightly up, but when normalizing for last quarter's $7.7 million in PC related royalty payments for products shipped in prior quarters, it was very strong. In the third quarter, we began receiving royalty payments for the initial shipments of Microsoft Vista Home Premium and Ultimate editions which exceeded our expectations. More importantly, OEMs and consumers still find value including additional software DVD playback functionality from third party ISVs. This is highly effective in increasing our totally royalty rate per PC.

In our Broadcast market, we experience very strong year-over-year growth on strong demand for digital television and Set-Top boxes. Sequentially, broadcast was down from the second quarter, as our fiscal second quarter benefited from strong holiday related shipments. In our Consumer Electronics market, growth was moderate year-over-year, but sharply down sequentially following last quarter's strong performance from holiday related demand. Year-to-date, our CE market is tracking to our initial assumption for flat to slightly up growth in fiscal 2007 and appears to be approximating industry analysts estimates.

In the Products and Services segment, revenue for the third quarter was flat year-over-year and up 11% sequentially. Products revenue was down 9% year-over-year, as a result of particularly strong cinema product orders in the third quarter of last year when some exhibitors stocked up ahead of anticipated price increases. Services revenue was up 35% year-over-year on a strong volume of new films and demand for Digital Cinema related services.

Let me turn to the details of the P&L for the third quarter. Licensing gross margin was 91% or up 1% sequentially, 1 point sequentially. Products gross margin was 53% or up 3 points sequentially. While, services gross margin was 61% up to 2 points sequentially. Products gross margin increased on sequential sales growth for our higher margin cinema audio products. As we stated in our last earnings call, we are currently deferring revenue on a number of Dolby Digital Cinema systems until meeting certain contractual obligations.

Since our initial Digital Cinema systems carry a lower margin than our other professional products, product margins are expected to be lower in the period we recognize this deferred revenue. We do not expect to recognize this revenue in fiscal 2007 and would expect product margins to be roughly 50% through the fourth quarter. (SU&A) expense was 40% of revenue in the third quarter, up 7 points sequentially. Payroll expenses increased sequentially, partly because of increased headcount and partly because year-to-date financial performance has exceeded our expectations which has resulted in an increase in the company's annual bonus accrual.

In addition, we incurred various consulting related costs, in conjunction with consulting, audit and other services. R&D expense was 10% of revenue for the third quarter, up 2 points sequentially. The sequential increase in absolute dollars for R&D was the result of higher headcount; due in part from our recent acquisition of BrightSide Technologies.

Dolby's tax rate for the third quarter was 35%, compared to 37% in the second quarter; as we benefited from an increase in the amount of tax exempt interest and from discreet items in the quarter. We expect our tax rate for the fourth quarter of fiscal 2007 to be around 37%. Third quarter net income in 2007 was $29.7 million or $0.26 per diluted share. Compared to $19.1 million or $0.17 per diluted share for the third quarter of fiscal 2006.

Net income includes stock based compensation charges of $5.1 million for the third quarter of 2007 and $4.7 million for the third quarter a year ago. Turning to the balance sheet, we finished the quarter with approximately $617 million in cash, cash equivalents and marketable securities. From Operations, we had approximately $35 million of cash and cash equivalents during the quarter.

In addition, the balance sheet contains approximately $29 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 patent's license 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 the products and technologies for which we had historically been paying. In the third quarter of fiscal 2006, we notified the patented licensor that going forward, we intended to pay royalties only for products and technologies that we believe are covered by the patent's license under the license agreement. Subsequently, we have been paying the patent license or 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.

Turning to our outlook, we now expect fiscal 2007 revenue to be approximately $465 million to $475 million. We now expect net income for fiscal 2007 to be approximately $122 million to $127 million. Consequently, we now expect earnings per diluted share for the full fiscal year 2007 to be approximately $1.07 to $1.11 per share. While stock based compensation expense may vary based on factors such as stock price volatility. We now expect stock based compensation expense for the full year to be approximately $21 million.

We will offer fiscal 2008 guidance on our fourth quarter conference call. This concludes our prepared remarks. I would now like to turn it over to the operator for questions.

(OPERATOR INSTRUCTIONS) One moment for the first question and we'll take our first question from Ralph Schackart with William Blair.

Good afternoon, another strong quarter guys. Just two quick questions if I could. First, in the PC business sounds like there's some great strong secular momentum and you're seeing some increased royalty rates. Can you give us a little bit more color on the increasing royalty rates? Is that brush? Is that only within certain skus on the high end, etc? Could you give us a little bit more color on that please?

Yes, we did see great strength in our PC market. It's the primary reason for the increase in guidance; followed, to the lesser extent by the strength in Broadcast. We benefited from three trends in the PC market. One would be continued unit shipment increases in the PC space. But, notably it was the shipments of Home Premium. To answer your question specifically, we found that OEMs and consumers continued to see value in added DVD functionality, even when purchasing the Home Premium edition. Some examples include a number of OEMs have branded media players where with the push of a button you can boot up your PC to use the DVD functionality without having to boot up the entire PC system. So, we're obviously very pleased about that I said for the increase in guidance

Of course, it's a little early to try to extrapolate the first quarter of this experience too far into the future. We currently believe this dynamic will continue through the holiday season. We don't have a lot of visibility into what OEMs plans are beyond that.

Great, thanks Kevin. Then, one more if I could, on the SG&A line item you explained some of the uptake with payrolls and bonus and consulting and audit. How should we think about this from a modeling standpoint? Is this a rate we should think about going forward or will some of those consulting and audit engagements roll off on a go forward basis?

Well, Ralph, as you know, we have been saying that we would be increasing headcount, investing, in particular, in a number of sales and marketing programs. So, we have seen quite an increase in absolute dollars in SG&A throughout the year. While we expect it to rise, I would not expect it to rise in absolute dollars as significantly as it has been in the last couple of quarters. Part of that is is because some of the consulting fees and so forth were one time events.

Okay, great. Thank you.

Moving on, we'll take our next question from Steven Frankel with Canaccord Adams.

I wonder if you might give us some insight into your on-the-go strategy. You talked about that a little bit in the past, but can you give us an update on where you are?

You're talking basically the mobile market Steve. I assume. Steve?

Yes.

Well, we continue to pursue the mobile market. We have a strategy of trying to get our technologies out there in a couple different forms. Number one is taking the Audistry by Dolby technologies and presenting those to the mobile space. We've been engaging a number of customers we think that the Audistry technologies can gain some strength in that particular area. We're also looking at other areas such as Dolby Headphone.

So far, we're continuing to dialogue. We recently hired a Head of Mobile Marketing. We've been adding people in this area on the engineering front to ensure that we have the right technologies in order to take out to that market. So, we're continuing to pursue it. But as we've announced I believe in the previous quarter, we're looking at 2008 before we start to really see any benefits from that.

Where is that count today and where was it last quarter?

We are at about 950 employees at the end of the quarter. That's up from just under 900 last quarter and remember that the 950 now includes the acquisition of BrightSide.

Okay. Great, thank you very much.

You're welcome.

Next, we'll hear from Paul Coster with J.P. Morgan.

Thank you. We've seen unit shipments for the DVD category holding up quite strong based upon some results from Zoran recently. However, the market seems to be shifting in favor of emerging markets. Can you comment upon the appetite for surround sound technologies in emerging markets? I guess everyone is going to assume that you're not going to see much revenue from that business because it will be very cheap to channel DVDs. Any comments on that?

There is an issue that as people do expand overseas, they're probably going to go with the 2-channel rather than the 5.1. You have to be careful about some of the industry statistics out there and some of the comments because I know there were some forecasts which came out with some specific monthly figures which showed very, very good growth in this particular area. But, those are just points in time and you have to remember that we're tending to look at the overall market. We still expect that for the full year, we're looking at flat to slightly up in this market. We still see some growth, but the DVD market obviously is very, very dependent on future growth on the next generation. We are seeing a little bit of -- I think we see some consolidation in manufacturing and other territories. We believe that the DVD market long run will continue to grow, but not nearly compared with the other markets in which we're operating.

Perhaps you can comment on how, if at all, your acquisition philosophy and execution for that matter has changed since the last call. But, before you do that, on the last question can you just perhaps elaborate on the move to multi-channel in merging markets. Do you think that's something that the industry is starting to promote or is that some way off?

I think everybody continues to promote 5.1 channels to go along with the HD, the high-def experience. That's what we've really been seeing in Europe over the last year or so. As people have been moving to a high-def video world, they recognize that they want more channels on the audio side. So, that's why we've been having great success over there. I think that the long term, as people continue to recognize that they can get better quality out of high-def, they're going to want better sound to go with it. We hope that will eventually drive things to use of more 5.1.

Okay, on the acquisition front?

Our strategy hasn't changed Paul. Our strategy is to look for opportunities where it makes sense from a technological standpoint. This is what was so exciting about BrightSide. We saw with BrightSide acquisition some technology which we described as a wow factor when we saw it. It really made a difference to consumers who looked at televisions with the backlit LEDs. So, we will continue to look for acquisitions where we think that the technology will fit in with what we're doing both on the audio side, but more importantly on the video side as we continue to expand our market offerings.

So, there's no sort of change in the timeline or urgency anything of that nature?

Well, no. We're continuing to keep our eyes open and investigate opportunities. As we said, for a couple years, we're not going to go out and try to buy revenue. We're not going to try to buy net income. We will go out and look for technologies which are synergistic with what we're doing and will not hesitate to bring those in where it can promote our long term interests of better entertainment for the consumer.

Okay, thank you.

We'll hear next from Andrew Hargreaves with Pacific Crest Securities.

Did you guys see any impact from the cable card integration ban in the way of an inventory build? Or, do you think your numbers were affected by that in any way?

Could you repeat the first part of your question?

Just wondering if you saw an impact from the cable card integration ban. We had heard that there was a bit of a build in Set-Top boxes in front of that.

Nothing specific, Andy. Obviously, cable cards are out there. We've had very, very good success and growth in the broadcast market. I don't have statistics available in front of me that break it down by the traditional Set-Top box versus cable cards. We tend to look more overall at that whole market segment.

Okay. Similar to one of the earlier questions, on the notebook side, is there any difference in the mix of emerging to develop markets in that particular piece of the business versus your other business?

We rely on industry analysts stats for that metric, because we do not get -- our licensees do not report to us where the point of consumer is. But, having said that, it is our understanding that notebook shipments or PC unit shipments overall are growing faster in emerging markets than in developed markets. We continue to see strong unit growth. Obviously, this is a very strong market for us. I think it's clear that consumers are very much viewing their PC as a platform for entertainment and we're benefiting from that in a number of ways.

Thanks

We'll hear from Brian Thackray with Deutsche Bank.

Thanks. Can you hear me?

Yes.

First question, getting back to the royalty rates on the PC side of the business. Can you give a little bit more insight into maybe the difference between the royalty rates on your pure DVD offering and the royalty rate opportunity with the up sell as you go towards a Vista enabled computer. Then, also, when you look at an Acer type or a Toshiba type of deal, what the different royalty rate economics look like, when you get a sense for unit versus ASP impact?

So, in terms of -- let me separate the impact we're seeing of Vista and the Home Premium edition from the second part of your question which really goes toward or PC Entertainment Experience program to get into the firmware of the Media Centric notebooks. As it relates to the Home Premium edition, that includes DVD playback functionality, and what we're finding is that there is still demand for added features such as the branded media player I described earlier and higher end DVD players. So, there's a lot of people competing for people's attention for this entertainment functionality.

We're benefiting from all those people that are competing for that attention. People still have a demand for higher end DVD players. In terms of unit playback, typically what that means is somebody has more than one DVD software application on their PC and we're getting paid twice on those units. We don't have any specific information on what percentage of unit that's happening on. In terms of the PC Entertainment Experience and lines like Aspire and the Qosmio that have additionally entertainment functionality. That has not had a big impact on our revenue to date. It's something we see being more of a factor in 2008. Most major manufacturers now have a line of notebooks that are focused toward the Media Centric market. They don't make up a large percentage of the volumes today.

The ASP impact there is that we have more technology than those typically. So, in addition to just software DVD playback, you can get features such as Dolby Headphone, Virtual Surround and a number of other technologies that we offer.

Just a follow-up. Historically, you guys have been able to grow operating income at least twice as fast as revenue. It's true you've gone through a bit of an investment here SG&A and R&D. Do you think we're past the peak of that investment? Looking forward, we'll start to move back towards that historic relationship.

I don't want to give any -- we're not going to give any 2008 any beyond guidance today. I would just say that, as you pointed out, we have been investing in a number of opportunities in the video and the mobile space. We intend to continue to do so. Beyond that, I don't have any specific operating margin guidance.

Alright, thank you, gentlemen.

We'll move next to Daniel Ernst with Hudson Square Research.

Good evening, thanks for taking the call. Two questions, if I might. First, on the broadcast side, can you comment on where you are or what the mix might be between domestic broadcast, Comcast, DirecTV, etc. and international; where you have your west-best standard and more of an option. Can you give us a mix between broadcast in domestic, international? Second question, on the gross margin side, can you remind us of what you expect that the March impact is going to be once the DCI revenue recognition begins to kick back in? Thanks.

Sure. On your first question, I do not have the specific breakout of how much of our broadcast revenue comes from domestic versus international markets. In fact, we have a number of licensees that ship to both markets and so we don't really have that data. Our belief is that North America over the last few years has been the biggest driver as people move toward high definition TV and TVs with digital tuners, which are now required when there is a tuner. We are continuing to get traction in Europe which is in the relatively early stages. As to your second question, I'm sorry what was your question?

Digital Cinema.

Digital Cinema margins. Could you repeat the question?

There's two elements to that. One is that in the relatively near future, you'll begin to recognize some different revenue and that will be an upside to revenue, but will drag margins down. So, the specific impact?

Yes, that's right.

Then, there's the more general impact of what DCI margins look like.

We do have about just over $7 million of deferred revenue in this area to date. When we recognize that revenue, it's at lower margins in our other products. What we've said is that in the quarter that it comes into revenue, our product margin, specifically, could go into the 30% range. Beyond that, when we're into sort of a normal quarter-by-quarter without the deferred revenue coming in, we've in the past said that we'd expect our product margins to be somewhere in the 40s. Now of course given that licensing is 79% of our revenue this quarter and has ranged between 75% and 80% historically, it has a lesser impact on overall gross margins.

You expect the $7 million to be recognized in a single quarter or could it be recognized over two quarters and therefore the margin of impact might be different?

It could be over two quarters. In which case, the margin impact would be different.

Okay, thank you.

Next, we'll hear from Mike Olson with Piper Jaffray. Mr. Olson? (OPERATOR INSTRUCTIONS) Hearing no response, we will move on. (OPERATOR INSTRUCTIONS) We'll go to Alan Davis with DA Davidson.

Yes, hey just a follow-up here on the PC royalties. I know you don't like to give specific royalty amounts. But curious, maybe you could share kind of maybe the multiple of the opportunity? How much greater it is, for example, on a Home Premium laptop or PC with multiple DVD applications, playback applications and your full Entertainment Experience Suite versus a PC with Home Basic and just one DVD playback piece of software? Perhaps maybe you can give us the multiple of how much greater the revenue opportunity is on the former than the later.

In a case where a user has multiple DVD software applications, then we get paid on each software DVD application. There are people that have multiple software DVD applications. In terms of the PC Entertainment Experience, we have not shared any specific ASP information on that program.

Could you share with us an update of where you expect your fiscal 2007 guidance, where you expect PC royalties and broadcast royalties to come in as a percentage of your total CE royalties or total royalties?

As we look to 2007, we think that given the strength in PC this quarter, which we expect to continue through the end of the year, that market could end up being as large as our CE market this year; probably just over 35% each. The broadcast market has continued to go strong and could come in at over 15% this year.

Okay and where was PC last year as a percentage?

PC last year was at about 30%. Just under 30%.

Great, thank you guys.

As you look to next year, again, remember that once we have a couple of quarters of Vista behind us, the quarter-to-quarter growth rate will go back to being driven first and foremost by the PC unit growth in the industry. Then, we're also watching very closely this trend of people continuing to get additional DVD functionality when they buy the Home Premium edition and whether that continues and for how long. That's obviously a big factor. Then, we will continue to move forward with our PC Entertainment Experience initiative, where we have a number of design wins. Also, don't forget that we had about $8 million in back royalties in the PC segment in 2007, which we would not expect to recur in 2008.

Okay. One last follow-up, in the quarter you just reported for Vista related revenues, specific Vista related revenues, there was PC royalty upside. But, if you just isolate Vista as a percentage of that upside, can you characterize how big of a piece Vista was?

No, because then I'd be getting into revenue by licensee and I really can't do that.

Alright. Fair enough, thanks.

Now, we have Ralph Schackart with William Blair with a follow-up question.

Hi. One quick follow-up on the reorganization into a functional model. Can you give us a sense of the synergies you expect to get in terms on the revenue side by customer or by end market, perhaps be a little bit easier for you? Then, also too, just give us a sense on the cost of operating expense side if you expect any synergies there, thanks.

Sure, Ralph. We haven't quantified the synergies. We expect to see some good synergies in all of our segments. One of the probably most visible ones would be the broadcast area, where we've been operating in the broadcast market on the professional side and a separate group operating on the consumer side. So, by putting these together, we think it puts us in much better shape to address the broadcast chain of entertainment. To work to get content created and distributed and played back much more smoothly than we've done in the past. We see some synergies there, but we haven't quantified it yet where we're working on obviously our plans for this next year. We think that it's going to pay off in the long run.

As to the synergies on the cost side, we're combining forces. We're not laying anybody off as a result. We just see it more in the sense of getting people working along side each other. We've been out there talking to broadcast customers in the same space. So, if anything, we think we'll see some opportunities where we might be able to take some of these segment opportunities and take them even further. Maybe have even more marketing and sales people, in order to take advantage of our expertise in this area. So, we just think overall it makes a lot of sense to go to a functional organization not only in broadcast, but in other areas such as gaming, in CE. Pulling together a lot of our work in the cinema and as that ties in with the consumer space. We're pretty excited about the opportunity.

Thanks, Bill.

(OPERATOR INSTRUCTIONS) We'll hear next from Paul Coster with J.P. Morgan with another follow-up question.

Can you give us a little bit of commentary on the auto markets or something there at the moment?

I'm sorry the what markets Paul?

Automotive.

Oh, automotive.

Yes, sorry. Wrong language.

Automotive continues to be a small market. We continue to get design wins across a number of different manufacturers as well as OEM customers. We think that people are continuing to move toward wanting better and better entertainment in the car, on the go. As such, we see more and more DVD players going in. People taking more advantage of surround sound, PL2X going into cars. We think that PL2 -- we really think that people want to upgrade that experience. In terms of meaningful revenue numbers, it's still a very, very small percentage of what we're doing.

Is it growing reasonably rapidly?

It's growing.

The other thing is on this dispute over licensing royalties. Do you have a sense on when that might get resolved? If you can't tell us when, could you tell us what kind of process is involved to resolve this? Do you have to go to court eventually?

Well, I can't really go into the process, nor the timing Paul. We've disclosed the state of where we are and we're working it as quickly as we can to try to come to a resolution and that's as much as we can say at this point.

Okay, thank you.

We'll hear next from Michael Olson with Piper Jaffray.

Sorry about this, but I had to step away for a second. So, if this was already asked. Just one question on DCI compliance as it relates to Digital Cinema. Any update on that front? I think previously you'd talked about being able to start recognizing some of those deals in the first part of fiscal 2008 after getting DCI compliance in September.

Yes, Mike. This is Tim. We're still waiting for a number of things that are completely out of our control to happen. Essentially, there is a company that is looking at the whole test specification from DCI and writing it into a text spec that people could use. So, the expectation is that that work will be done in September. Theoretically, there would be a test procedure that could be used to qualify the DCI compliant equipment. Then, the next stage would be for a third party company to step into that role to do the qualification.

While there are rumors that that will take place, there's nothing that is very concrete right now. So, a lot of it will depend on that. The other thing that I've mentioned before that we're waiting for is that there are some parts of the DCI specification that need to be ratified and standardized by standards bodies such as FMPT. So, until that work is done, none of us can fully write the software that's required to implement that. We're waiting on that, as well as a procedure to actually test the equipment. Either of those, we're hopeful that they will happen in the earlier parts of 2008, but certainly they are beyond our control right now.

Just one question on the Vista side. Obviously, the Home Premium and Ultimate editions have been a benefit to Dolby. Have you considered that there might be a possibility that the Home Premium and Ultimate editions become less of a piece of the pie for Vista going forward? Any thoughts on impact if that occurs?

As I said earlier, we wouldn't want to extrapolate too far into the future based on just one quarter of Vista shipments. But, all the market data that we've seen is that consumers are attracted to the Premium edition and that's going well. But it's fairly early on the Enterprise edition. Probably, too early to conclude or draw any even initial conclusions about the mix of Ultimate and the Enterprise edition. Clearly, that is something that is one of the variables that goes into our growth rate for next year is whether the mix of Premium holds up to what the initial success has been.

As well as whether or not people continue to put in an ISV software solution on top of Vista.

Okay, nice work. Thank you.

We'll move now to Andrew Abrams with Avian Securities.

First, congratulations on the quarter. Second, just if you could give a little color on the increments that you're getting out of the ATSC tuner business and how that's changed over the last maybe quarter or two quarters since the mandate went through?

By increments, could you elaborate on what you mean by increments?

Just how much, if you can define how much incremental business has come out of that over the last two or three quarters considering where you were six or nine months ago.

Sure. Well, that is the primary driver. The ATSC tuners are one of primary drivers behind our broadcast market which we do breakout separately as a part of licensing revenue. It was just over 10% of our licensing revenue in 2006 and we're now expecting it to be over 15% in 2007. So, the primary driver of that has been the inclusion of ATSC tuners in digital televisions and Set-Top boxes. The other driver is the demand for premium audio services that are being offered by cable and satellite providers in Europe.

Have you seen any change in that ramp? Or has it been a fairly linear ramp over the last couple of quarters?

They said in my prepared remarks, we saw that our broadcast market was relatively flat from Q2 to Q3 and that's probably because our Q2 reflects the holiday quarter shipments. So, that's what we saw most recently. Overall, it's been a strong market for us and we continue to see growth in that market for us going into the next fiscal year.

Thank you.

This concludes the question and answer session. Mr. Jasper, I'll turn things back to you for any additional or closing remarks.

Thank you operator and thank you all for joining us. We are very pleased that we had a very, very reasonable quarter and we look forward to speaking to you after our year end this fall. Thank you very much.

That does conclude today's presentation. We do appreciate your participation and wish you all a great day.