Dolby Laboratories Inc (DLB) 2009 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fourth quarter and fiscal 2009 financial results. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. (Operator Instructions) As a reminder, this call is being recorded, Tuesday November 3rd, 2009.

I would now like to turn the conference call over to Alex Hughes, Director of Investor Relations for Dolby Laboratories. Please go ahead, sir.

Good afternoon. Welcome to Dolby Laboratories' fourth quarter and fiscal year 2009 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories' President and CEO, and Murray Demo, Executive Vice President and Chief Financial Officer. In addition, Ramzi Haidamus, Executive Vice President of Sales and Marketing, is 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 24th, 2010, market trends for the industries in which we compete and our expectations and beliefs concerning how those trends will affect our operating results, the capabilities and market acceptance of our products and technologies, and our strategic and operational plans and objectives. These statements are based on management's current expectations and assumptions and are subject to risks and uncertainties. Actual results may differ materially from these set forth in these statements. Important factors such as macro economic conditions could cause actual results to differ materially from those in our forward-looking statements. These factors are addressed in the earnings press release that we issued today and under the section captioned Risk Factors, and elsewhere in our most recently quarterly report on Form 10-Q, available at www.SEC.gov or on our website at www.dolby.com under the Investor Relations section. Dolby disclaims any obligation to update information contained in these forward-looking statements whether as a result of new information, future events or otherwise.

During this call we will discuss GAAP and non-GAAP financial measures. Reconciliations between the two are available in our Earnings Release and in the Dolby Laboratories Investor Relations data sheet on our Investor Relations section of our website. Call participants are advised that the audio of this conference call is being broadcast live over the Internet. It is also being recorded for playback purposes. An archive of the call will be made available on our website for approximately one year and is the property of Dolby. The audio and archive may not be recorded or otherwise reproduced or redistributed without prior written permission from Dolby.

As for the structure of this call, Kevin will begin with an overview of the business and Murray will follow with a recap of Dolby's financial results.

With that introduction behind us, I would like to turn the call over to Kevin.

Thanks, Alex. Good afternoon, everyone. I am pleased to report solid fourth quarter and fiscal year results. This was a challenging year for many in our industry but we held up strong. We grew fiscal year revenue 12% and delivered diluted earnings per share of $2.11. While our financial results, of course, benefited from the first half of fiscal 2009 where Q1 and Q2 were tied to fairly strong industry shipments in calendar year 2008, I believe these results speak to the strength of our business and the benefit of Dolby's high margin licensing model.

During the year we continued to benefit from the inclusion of our technology in a wide range of entertainment devices including certain SKUs of Microsoft Vista, from our strong position in the US digital TV standard and our continued progress in European broadcast. We also finished the fiscal year with improved diversification across our core licensing markets with our broadcast market surpassing consumer electronics as our second largest licensing market for the first time.

Over the years our success has come from growing the adoption of Dolby's technology in long-term product cycles such as DVD, digital television or personal computer. On today's call I would like to discuss our strategic focus and priorities to drive continued long-term success.

Our first point of focus is growing our core business which is our leading family of Surround Sound formats. Today, our Surround Sound formats enjoy a strong position across the cinema, personal computer, broadcast and consumer electronics markets, representing a large footprint of the overall entertainment ecosystem. We now have the opportunity to expand the adoption of our Surround Sound formats into new geographies with the global transition to digital television, into new channels of distribution such as mobile and online, and into new devices that playback content. We believe our large existing footprint in the entertainment ecosystem better positions us for success in each of these areas.

In fiscal 2009, the team executed well on a number of these fronts that can drive future results. Our broadcast team did an excellent job. In Europe, we saw a number of countries adopt our technologies in their high definition television standards including France, Italy, Spain, the Digital TV Group of the UK, as well as the European Broadcast Union. This should help drive our European TV attach rate higher. The PC team also had a great year with the adoption of Dolby Digital Plus in four SKUs of Windows 7. This is big win because it extends us from two to four SKUs of the Windows operating system and is a validation of our next generation format, Dolby Digital Plus. As a result, Dolby Digital Plus extends into the primary consumer and business SKUs of the world's leading operating system.

In our core business, we remain focused on driving the adoption of our Surround Sound formats in the mobile and online channels. Both online and mobile are becoming increasingly important within the entertainment ecosystem and we want to ensure that our technologies are a part of each. In the mobile market, the team made solid progress in fiscal 2009 with the signing of a master agreement for Dolby Mobile with NTT Docomo in Japan, and with a win into certain handset models from the world's third largest handset maker, LG. We believe our mobile technologies are being well received by the industry, and we remain focused on signing additional Tier 1 handset makers in fiscal 2010.

In online, we are focused on extending our technologies to this new channel of distribution. We believe this will help extend our technologies into next generation delivery platforms and into new categories of devices aimed at playing back online files such as netbooks. I believe our existing presence in the entertainment ecosystem both on the content side and device side positions us well. By leveraging both sides of the ecosystem, we believe we can drive success in this market. For example, as new online channels develop and deliver content to existing devices such as connected Blu-Ray players or televisions, many of these devices will already have our format for DVD or broadcast content. This gives us the opportunity to work with online providers to take advantage of the existing installed base of devices containing our technology. Furthermore, by increasing the adoption of our technologies in online channels of distribution, we better position our technology to become embedded in next generation devices that play back online content.

Quality audio remains an important entertainment element and it should be no different for the online and mobile channels. As people receive their entertainment from a broader array of services and on a greater variety of devices, they should expect to receive the Dolby experience throughout. A lot of work remains to make this a reality but the team is focused on this objective and making great progress on the ground.

Our second point of focus is to try to leverage the success in our core business to bring additional audio and video technologies to market. In the area of audio, this means bringing new sound innovations to market that complement our Surround Sound formats. This can be new audio innovations that further enhance the entertainment experience such as Dolby Volume or new sound innovations such as Dolby Axon, our Surround Sound voice solution for online gaming. In the area of video, this means developing and delivering new imaging technologies that deliver a more immersive video experience. Our plan is to pursue this initiative through an ecosystem approach where we work with content creators, delivery channels and device manufacturers to optimize the experience. While this is a nascent and long-term initiative, we are excited about the opportunities ahead.

As we aim to grow beyond our core business and deliver new technologies, it is critical that we stay relentlessly focused on three essential ingredients for our success. Innovation, the customer and execution. As an R&D company, innovation is critical to our future and we have to ensure that we are promoting it with the right level of funding, focus and discipline. As a result, we have clarified our research focus, increased R&D funding and improved the geographic diversification of our research centers to put us in touch with a broader range of idea centers.

We also need to be focused on our customers so we deliver customer relevant innovations. This means making sure that we are on top of our customers' needs, where they are heading and where we can deliver them the most value. Opening new offices near key customers is an important step in this approach but we must also ensure that these customers see us as value providers. We are seeing the benefit of this approach in our mobile market as licensees are working closely with our research teams to develop technologies that can help differentiate their handsets.

Finally, as we move into new opportunities, such as mobile, online and video, we must continue to up our level of execution. Our new markets are only moving faster compared to traditional ones, and it is critical that we get out front and stay out front of our customers. In short, we had a strong fiscal year both financially and on the ground. We have some great opportunities ahead and we are focused clearly on the things we need to do to drive continued success.

With that I'll turn it over to Murray.

Thanks, Kevin. I'd like to discuss Dolby's Q4 and full year fiscal 2009 financial performance, our fiscal 2010 outlook, some enhancements to our financial reporting as well as the new stock repurchase program.

Revenue for the fourth quarter was $163.9 million, flat year-over-year. For the full fiscal year, revenue was $719.5 million, up 12%. Licensing revenue for the fiscal fourth quarter was $138.6 million, up 1% year-over-year and down 2% sequentially. Licensing revenue declined sequentially due to prior period royalties of $21.6 million received in our fiscal third quarter from three licensees in our Consumer Electronics and other markets categories. These prior period royalties were discussed in our third quarter earnings call.

Turning to licensing revenue by market for our fourth quarter of fiscal 2009, revenue from our PC market declined 16% year-over-year due to lower PC shipments, and was essentially flat from the third quarter. Our PC market made up approximately 35% of licensing revenue in fiscal 2009, compared to approximately 40% in fiscal 2008. Our Consumer Electronics market grew 9% year-over-year, as revenue from Blu-Ray and home theater in a box more than offset weakness in DVD. Sequentially, Consumer Electronics revenue declined 10% as the fiscal third quarter benefited from the significant prior period royalties. Full year revenue from our Consumer Electronics market made up approximately 25% of licensing revenue in both fiscal 2009 and fiscal 2008.

Our broadcast market grew 29% year-over-year and 24% sequentially. A rising attach rate to European TV shipments which reached 74% in Q4 drove year-over-year and sequential growth. Sequential growth was also driven by a higher contribution of NTIA converter box revenue in the fourth quarter. Revenue from our broadcast market made up approximately 25% of licensing revenue in fiscal 2009, compared to just under 20% in fiscal 2008.

Our other markets category which includes mobile, gaming, automotive and via, declined 8% year-over-year and 31% sequentially. The year-over-year decline was led by lower gaming and automotive revenue, partly offset by higher mobile revenue. The sequential decline was driven primarily by a large prior period royalty payment received in the third quarter related to our mobile market. Fiscal fourth quarter product revenues were $20.2 million, up 9% year-over-year on higher revenue related to digital, cinema and 3D. Product revenue declined 7% sequentially on lower revenue from our digital, cinema and 3D systems. Fiscal fourth quarter services revenue was $5 million, down 26% year-over-year, and 31% sequentially, due to a promotional activity in our 3D initiative where certain expenditures of approximately $1.8 million were booked as an offset to service revenue.

Turning to margins. Total Company gross margin was 89.5% for the fiscal fourth quarter. Our licensing gross margin was 97.4% in the fiscal fourth quarter. Product gross margin was 48.4% in the fiscal fourth quarter, up 8.7 points sequentially. The product gross margin increase was primarily driven by continued manufacturing efficiencies and a lower mix of revenue related to our lower margin digital, cinema and 3D systems. Services gross margin was 35.6% in the fourth quarter, down 20 points sequentially due to lower revenue resulting from the contra revenue accounting for a 3D promotion described earlier.

Operating expenses were $81.4 million in the fourth quarter of fiscal 2009. This includes $6.3 million in stock-based compensation expense. Operating expense increased $8.3 million sequentially due to planned increases in headcount for R&D and sales and marketing in support of our growth initiatives, increases in advertising and promotion, as well as increased professional fees related to stocks and audit which tend to be higher in the fiscal fourth quarter.

Turning to tax. Our effective tax rate for the fourth quarter of fiscal 2009 was 33.5%. Fiscal fourth quarter net income was $44.3 million, or $0.38 per diluted share, compared to $48.6 million or $0.42 per diluted share for the fourth quarter of fiscal 2008. For the full year, net income was $243 million, or $2.11 per diluted share, compared to $199.5 million or $1.74 per diluted share for fiscal 2008. Net income includes stock-based compensation expenses, amortization of intangibles ant and restructuring charges. Total stock-based compensation expenses from cost of sales and operating expenses were $6.4 million, and $22.4 million for the fourth quarter and fiscal year 2009, respectively, compared to $5.5 million, and $22.7 million for the same periods last year. Total amortization of intangibles were $3.7 million, and $15.2 million for the fourth quarter and fiscal year 2009, respectively, compared to $3.1 million and $12.5 million for the same periods last year. Total restructuring charges were $0.8 million and $4.8 million for the fourth quarter and fiscal year 2009, respectively, compared to 0 restructuring charges in the same periods last year.

Moving over to balance sheet, Dolby finished the fourth quarter with $941 million in cash, cash equivalents and marketable securities. Cash flow from operations was $78 million in the fourth quarter, and $273 million for fiscal 2009.

Now I'd like to provide an update on several changes we have made to further enhance our financial reporting beginning in fiscal 2010. First, we will provide both sales and marketing and G&A expenses as separate operating expense line items on our income statement each quarter. Second, we will reclassify various facilities expenses between R&D, sales and marketing and G&A beginning in fiscal 2010. Third, we will report net income and earnings per share on both a GAAP and non-GAAP basis. Our non-GAAP results exclude stock-based compensation expenses, the amortization of acquisition intangibles, as well as restructuring charges and the related tax impacts. We believe our non-GAAP measure provides investors with an additional tool to evaluate Dolby's operating results and going forward we will provide targets and results on both a GAAP and non-GAAP basis. The appropriate Regulation G reconciliations are provided in our press release today as well as on our Investor Relations website and of course we will continue to provide reconciliations in the future.

We also will reclassify our compliance settlements with semiconductor companies otherwise known as implementation licensees. These settlements have historically been reported as a separate line item on our P&L as a reduction to operating expenses and will now be recorded as a reduction to sales and marketing expense line. Any total quarterly settlements of $1 million or more will be disclosed each quarter. For your reference, we have updated our Dolby Investor Relations data sheet on our Investor Relations website to reflect each of these reclassifications over the past eight quarters.

With that, I would like to turn to our fiscal 2010 outlook. For total revenue, we are targeting $720 million to $750 million. Specifically for licensing, we are targeting revenue of $600 million to $620 million due to anticipated growth in our broadcast and other markets categories, primarily mobile, as well as expected flat to nominal growth in our PC market. Our outlook for licensing revenue is based on the following fiscal 2010 assumptions. In our PC market, we are assuming PC shipments increase approximately 3% during the fiscal year. Please keep in mind that the combination of our fiscal year ending in September and our recording of PC shipment related revenue one quarter in arrears does not equal calendar year 2010, and the various PC unit shipment growth rates forecasted by many firms. Also, while we believe the inclusion of Dolby Digital Plus in certain consumer and business SKUs of Windows 7 represents a growth opportunity, we expect that in fiscal 2010 revenue received from the ramp of Windows 7 will be largely offset by reduced revenue from ISVs as some OEMs elect to drop these applications from certain PC models shipping with Windows 7 media center.

In our broadcast market, we are targeting worldwide TV unit growth in the low single digits, and a significant increase in our European TV attach rate as manufacturers standardize Dolby technologies into general European TV shipments. In our Consumer Electronics market we expect revenue to decline due to the large amount of back royalties received in the third quarter of fiscal 2009. We are also assuming the declines in DVD revenue will be largely offset by growth in Blu-Ray revenue in fiscal 2010.

Turning to products and services. We are targeting revenue of $120 million to $130 million. For overall gross margins, we are targeting approximately 88% on a GAAP basis and 89% on a non-GAAP basis. We do not anticipate any major changes in the various gross margins for licensing, product or services when compared to fiscal 2009.

Turning to operating expenses, we are targeting approximately $313 million to $324 million on a GAAP basis, and $280 million to $290 million on a non-GAAP basis. Included in these targets are continued investments in R&D and sales and marketing headcount, to support our long-term audio and video growth opportunities. Our overall G&A headcount is expected to be essentially flat in fiscal 2010 versus fiscal year end 2009. For tax, we are targeting a tax rate of approximately 35% on both a GAAP and non-GAAP basis. For diluted earnings per share, we are targeting a range of $1.85 to $1.96 on a GAAP basis and $2.07 to $2.20 on a non-GAAP basis.

When comparing our fiscal 2010 targets with our fiscal 2009 actual results, please keep in mind the following. In licensing, there were two discrete items that contributed approximately $32 million in royalties in fiscal 2009 that we are not targeting in fiscal 2010. They include $17 million in broadcast revenue related to NTIA converter boxes in support of the digital broadcast transition in the United States, as well as another $15 million in back royalty payments related to periods prior to fiscal 2009. Additionally, in terms of gross margin, we had a one-time gain of $20 million in Q1 fiscal 2009 on a GAAP basis resulting from an amendment to a license agreement with an unrelated patent licensor that benefited total gross margin. Lastly, as you know, we experienced a strong first half in fiscal 2009 given that we avoided much of the economic slowdown since we recognize royalty revenue on a one quarter lag from our licensee shipments and we have a September year end.

Finally, we are happy to report today that we announced a stock repurchase program. Our Board of Directors has authorized the Company to purchase up to 250 million of its Class A common stock. This ongoing repurchasing program is targeted offsetting dilution from our employee stock programs. We expect to commence repurchases this fiscal year, and our fiscal 2010 earnings per share targets include repurchases under this program. The timing of the repurchase and the number of shares repurchased will depend on a variety of factors including price, regulatory requirements and other market conditions. The Company may limit, distend or terminate the stock repurchase program any time without prior notice.

With that, I will turn the call over to the Operator for questions. Thank you.

Thank you, ladies and gentlemen. (Operator Instructions) Our first question comes from Ralph Schackart with William Blair.

Good afternoon, two questions, if I could. It wouldn't be a complete call if I didn't ask this question. Kevin or Murray, can you give us a sense on the PC attach rate, seems to be a big investor focus here. I know you talked about it on the call a little bit, Murray. If you could give us a sense on the Microsoft dynamic as it relates to ISVs as well as the PC-EE as well.

So Ralph, let me go through a number of assumptions. Obviously there's a lot of moving parts in terms of our PC market. Again, we are targeting flat to nominal PC market revenue growth in 2010 and some of our assumptions include that we're targeting approximately 3% PC unit growth in our fiscal year. Obviously, there's numbers that are larger on a calendar year. This would translate to numbers probably closer to 10% looking on a calendar year basis.

Secondly, when we look at the business ramp for PC, what we're seeing is is that it's quite low in the first quarter, our fiscal first quarter, building up in the second and third quarter and then spiking further up in the fourth quarter. So that's what we're assuming in our targets is that kind of a ramp.

In terms of ISV, in 2009 we had approximately $100 million associated with our ISV DVD player revenue and in 2010 we're assuming that $20 million of that will go away. And then one other piece of this that's important to know is that this is a complex agreement we have with Microsoft. It has many moving parts. Including we will see volumes with Win 7 that we have not seen before. And considering this significant increase in volume, as the volume ramps over time we expect to see some significant price discounts. So those are some of the key assumptions that we used to set our target of flat to nominal revenue growth in our PC market segment.

As it relates to guidance, Murray, I think you had discussed that the tail off in standard def will be offset or more than offset in Blu-Ray. I think prior quarters you've seen a higher attach rate of the multichannel Blu-Ray devices as they've been higher priced ASP units, but as we move down the curve and start to get to mass market pricing, particularly around the holiday season, how should we think about growth in that category as units ramp, and I'll make the leap of faith and assume we'll move down market in lower channel Blu-Ray devices.

Ralph, this is Ramzi. As you point out, the holiday season is gearing up to be one where we'll see higher volume of Blu-Ray sales. We're looking at ASPs of units, of actual Blu-Ray player units, of about $120 today, most likely around the $99 mark around the holiday, and probably a portion of that will include some two channel players as opposed to multichannel player. However, I will note that even today, with $120 player, we still see fully loaded seven channel players with Dolby Digital Plus and true HD, therefore preserving a good chunk of our ASP. Moving forward we do continue to see a significantly higher ASP on Blu-Ray than DVD but over the last 12 months we have noticed a small decrease in ASP based on those two channel players.

I was thinking one more for Kevin, he's quiet back there. Kevin, if you think about the business, Dolby's built a heck of a licensing model, largely predicated on standards. As the world seems to be moving a little bit faster to digital content where there are no standards at this point, how are you thinking about Dolby's position there and the longer term implications for the licensing model?

Like I said in the script, Ralph, we're really focused on execution and I think that we have some really strong data points of where we've done that over the last year or so. Remember that in Europe, we didn't start out with standards based wins, we started in Europe with winning one operator at a time. In the mobile market, we are winning directly with handset manufacturers and mobile operators. We don't have standards to rely on so far in that mobile space. So this is clearly how our future is going to look as we move into online distribution. If you look at that market, there's a number of different players in that market that are looking to be central to the story of how this content gets distributed. Many of them are very strong, existing relationships of ours today, and many of them are new potential customers to us. And we are out engaged with a broad range of players across those types of companies. And so I think that we've shown that we can execute in this way but clearly these markets move fast. We're focused on being much more engaged externally in the market and responding quicker.

That's helpful. Thanks, Kevin. Thanks.

Our next question comes from Mike Olson from Piper Jaffray.

Thanks. Good afternoon. Couple quick ones here. It looks like your revenue guidance at the midpoint is about 2% year-over-year and OpEx guidance is up 9% year-over-year. Can you talk about just why OpEx is expected to be up that much relative to revenue? You talked about some higher headcount for R&D and sales and marketing. Is there anything else in there that's causing the difference between revenue and expense growth rates?

Mike, this is Murray. I think one thing is important to note is that we had these prior period royalties in the third quarter of 2009. If you take those out of the 2009 year, our licensing growth is 7% to 10% which is much more consistent with our overall operating expense growth. We continue to see obviously numerous growth opportunities. We're going to continue to invest in R&D and sales and marketing and be very focused on managing our G&A expenses and that's the profile we see going forward.

I would just add to that that another way of slicing those numbers is that if you look at the first half of our fiscal 2010, we have relatively poor historical comps. By the second half of 2010, we see ourselves excluding those back royalties returning to double-digit growth. In the meantime, we continue to see a number of opportunities in broadcast, we continue to see a number of opportunities in mobile. We see opportunities in our more nascent initiatives. And we don't want to wait for good comps to invest in those opportunities. Those opportunities are happening now.

Okay. And then just on broadcast, obviously becoming more and more important here. How much closer do you think we are to an inflection point where the CE guys are just adding Dolby into every TV in Europe to avoid the logistical nightmare of sending TVs with Dolby included to countries where you're mandatend and non-Dolby TVs to countries where you're not?

We saw some significant progress toward that this quarter. We saw coming out of Q4, we saw an attach rate in Europe of about 74%. We believe that that's directly attributable to manufacturers consolidating their SKUs. We'll be watching the next couple of quarters really closely to make sure that holds up. If I step back from that a little bit, I think another way to look at this is if we reached a point now where we are on a very high percentage of digital TVs shipped around the world. But less than 50% of the TVs shipped around the world are digital. So what we're looking at is a long-term opportunity here as the world continues to transition from analog to digital. To make that happen, we have to do a couple of things here at Dolby. We have a high attach rate in Europe but we need to continue to support broadcasters, operators in countries that are still working to get that content live. By the way, these are people that tend to have a lot of influence in decisions like how they're going to distribute online and mobile content, in a lot of cases. And we need to do in Asia what we've done in Europe and North America and we continue to work on a number of countries getting channels on air in Asia.

Is that 74% attach rate apples-to-apples with 33% attach rate you were talking about maybe expecting to exit the year at?

It is. We saw very significant jump in the attach rate. We think it's because of the consolidation of the SKUs, and like I said, we'll be watching that closely the next couple of quarters but we are assuming that that continues.

Okay. Thanks.

Our next question comes from Ingrid Chung with Goldman Sachs.

Thanks. Good afternoon. First, it says in the press release that your main objective for the share repurchase is to offset dilution from your equity compensation program. Do you see it also as a vehicle to return capital to shareholders and how does the initiation of your stock repurchase program impact your appetite to do moderate-sized acquisitions in the future? And then I was just wondering if you could make a comment about your expectation for netbook attach rates. I think originally for fiscal 2009 you were expecting 20 million netbook sales. What's your expectation for fiscal 2010?

In terms of the stock buyback, the Board from time to time has continued to look at uses for our cash. They made the decision this quarter to initiate this program. It is a way to return value to our shareholders, so that is a focus on it. We believe that it still puts us in a very good position to do M&A activity, as appropriate. So we continue to generate a lot of cash and we're looking to return some of that to the shareholders through a program like this.

On the netbook question, we are looking at about a 5% to 10% attach rate and that's with different types of technologies and playback scenarios. One thing to keep in mind about netbooks is the ASP of the product is fairly low. Therefore, there's a question of how much these products can handle an operating system such as Windows 7 Premium with Media playback. So we're going to be watching this area very closely to see what the attach rate between the basic versus the premium and we'll revise accordingly as Windows 7 becomes more mature in the marketplace.

Okay. I was also wondering if you could give us an update on the number of 3D screens you've rolled out and have you assumed DCI peak gets funded in your guidance for next year.

To your first question, we have shipped about 1,900 3D systems worldwide to date. And as far as the funding, we are not assuming any funding this year and we're watching that very closely.

Okay. Great. Thank you.

Our next question comes from Brian Thackray with Deutsche Bank.

Hi, guys. Thanks for the time. Just to come back to the attach rates on the PC side, do you feel that the current attach rates are pretty much set in the Windows 7 PCs that are out there, or could PC OEMs decide to change or have not fully set that going forward? Should we feel comfortable with the attach rates that we see, that's pretty well set going forward?

I think so far, we've haven't seen a significant change in the market. We are assuming that over the course of the year, that we have about a 20% reduction in that revenue stream and so we're watching closely as the OEMs introduce their models for the holiday season here.

Okay. So is it fair to say that your guidance is a little bit more conservative than the current Windows 7 attach rate looks like?

I think if you were able to look at every PC on the market right now in real-time, then yes, I think that we do believe that people could continue to introduce changes as we go through the year. And of course at the beginning of the year here, we're looking at it from a consumer notebook perspective and as we go deeper into the year we start to see the effect of the business adoption.

Okay. And I think you guys mentioned as Win 7 on the enterprise side starts to ramp that there's significant volume discounts. Is that any different from what you saw in Vista? Could you just help us frame the Win 7 volume discounts versus Vista?

The difference is that since we're in both consumer business we expect much higher volumes and that's why, as you get into business adoption, we would expect that we would have significant discounts to ramp as we go into that cycle. But I do want to step back and point out how excited we are to be a part of the Windows 7 operating system. To have Dolby Digital Plus as the Surround Sound format that they've adopted is a significant win for us. And strategically we think is very significant that we will be on the majority of operating systems for the world's leading operating system provider. We view it as a long-term relationship and we think it puts us in good stead for the future.

Okay. Last question. If I'm looking at the numbers right and adjusting for the deferred revenue on the digital cinema side from '09, it looks like there's a nice step-up in 2010. Do you feel like we're starting to be at the inflection point there? Is there something else going on there, am I looking at those numbers the right way?

In terms of deferred revenue, we entered the year with around $25 million around deferred revenue, digital cinema. We essentially ended there. There is a little twist on this, obviously, because of the new accounting pronouncement around the combination of hardware and software. So the $25 million approximate number that we exit in '09, we'll get some of that in 2010, of course. And also, because of the change in the accounting pronouncement, we will see more revenue recognized up front on our digital cinema and less being deferred. So probably what we would expect to see is that deferred revenue in total would decline over 2010 because of this change in accounting. And this is the one that Apple and others, this has been very important to them and we would certainly benefit in terms of the timing at Dolby, as well, this year.

That's helpful. Thanks, guys.

Our next question comes from Andy Hargreaves with Pacific Crest.

Just want to ask a couple broad questions on online and then post processing. On the post processing side, there aren't any standards really, or I wouldn't expect standards in that market, so how does that change your approach and does it change what you expect to get in terms of attach rates and pricing?

I'm sorry, you're cutting in and out but is your question as it relates to the online adoption and the lack of standards bodies? Was that your question?

The first question is on post processing technologies and the lack of standards in that market versus the codec market, how does that change your approach and change what your expectations are?

On the post processing, essentially what Kevin mentioned earlier, and our activities in mobile and the broadcast operators. These are a customer by customer hard-fought and hard-won design wins by our sales teams. We're approaching this from the good old fashioned marketing and sales approach. There are no standards, as you point out, and therefore it's about showing the superiority of our solutions relative to the competition, showing the quality of our solutions as well as the brand that comes along with the solution. So the package overall seems to be a winning package relative to the competition out there. So you are correct, no standardization but fairly good progress overall.

My question online is not necessarily the lack of standards but who you're competing against. Is it open source codecs that you're competing against or is it still the proprietary competitors?

There's a few audio standards today that are being used to download content. One is MP3, in 3 another is WMA and of course there's our codecs which is Dolby Digital, Dolby Digital Plus and HE-AAC. Our goal is to push forward with the three latter ones with emphasis on Dolby Digital Plus and HE-AAC or Dolby Pulse, as we have rebranded it. So the competition out there today is MP3 and WMA.

Okay. And does the audio tag and HGML5 impact you guys at all?

Could you elaborate on that?

They're adding support for an audio tag. I'm not sure if it even affects you in the new HDML standards. It's being included in browsers and I didn't know if that had any impact.

No, not really. It does not.

Okay. Thanks.

Our next question comes from Paul Coster with JPMorgan.

Yes, just want to go back to the online question for a moment. So it seems that most devices that play back online content, at least video based content, will already support Dolby Digital technologies in some form or another, so I may be missing something here. What turf are you fighting for here?

As was mentioned previously, it's an open greenfield out there. So we do not take it for granted that people are going to use our technology. In addition, we are in a position that we believe Dolby Digital Plus is a superior technology to our older technology, Dolby Digital. And therefore, our primary effort is to show the benefits of Dolby Digital Plus, its low bit rate benefit over Dolby Digital as well as the competition out there which I mentioned earlier being WMA or MP3 in certain cases. Yes, in iTunes, Amazon, Dolby Digital is being used but we also see benefit from upgrading to Dolby Digital Plus in the future.

Could we also just talk about video compression technologies for a moment. Are you going to be in the codec business for video or not?

Look, we're at an early stage. We have a number of early stage technologies, one of them as you know is our high dynamic range technology. We've said that we would like to improve that experience with an end-to-end solution which would include the format for delivery of content. We have a professional 3D product which we are looking to see what solutions we could bring to the consumer 3D market, that could very well involve the delivery format. So it's early days, Paul. But we think we have good opportunities there.

Okay. Last question. The product gross margins increased pretty significantly, owing in part to mix. Is that gross margin sustainable into 2010?

If you look at 2010, what I said in my prepared remarks is the product margins for fiscal 2009 represent good numbers for 2010. In the quarter, we did well because of product mix and we did have some benefits on our manufacturing efficiencies which will carry on in 2010. But primarily Q4 was in a big way around the mix of products within our product revenue.

Okay. Thank you.

Our next question comes from John Bright with Avondale.

Good afternoon. This is Tom Casera for John Bright. First, I wanted to go back to the Windows 7 discussion. Go back to ISVs. You're talking about a 20% decline this year. I'm wondering if you really see that as a multi-year process or think most of that decline will be taking place this year, or is that number going to get a lot closer to zero over the next couple years? Any sort of long-term thinking on that one.

I think a couple of things. First of all, remember that not every ISV player in that number is being sold along with an operating system. There are a number of basic operating systems and others that have ISV players as their primary player. So that's not the majority of the revenue but that is one of the revenue line items. Secondly, I think we're still seeing that there are those that value the ISV player in addition to the operating system. But yes, over time I think we would expect for there to be continued adjustments in the market as we go through the Windows 7 adoption cycle. But we continue to believe that the answer is somewhere in the middle. It's not at either extreme.

So on the length of this, one metric for you to watch out for, all of us to watch out for, is how long will it take for the businesses and specifically the larger businesses to switch over to Windows 7. As you know, one of the primary drivers from ISV is the attach rate of IV players to Vista without a DVD player. As these businesses switch over to 7 with DVD players, there will be less need for that ISV so that's one metric to watch out for and it's our understanding that some larger businesses will take longer than the smaller businesses to switch.

Can you guys talk about what length of upgrade cycle are you really expecting for businesses? Can you give any more specificity there?

That's something to probably watch out as large companies announce their IT plans but we understand that for the larger companies, for banks, for governmental organizations, it's a multi-year process. It could be two, three years, in some cases, and that's where the larger ones. Mid-sized businesses maybe more on the two year time frame and small businesses probably the first year.

In my prepared remarks I also mentioned that in 2010 that we expect to see it moving up in Q2 and Q3 and then again spiking in Q4 and continuing to ramp beyond that. So we do assume that we'll get certainly some business ramp this year but it's a multi-year trend.

Okay. One other question on Windows 7. In terms of the volume discounts can you guys also talk about relative to Vista, I don't know if you could maybe just frame order of magnitude. How much lower could the pricing get in a best case adoption for Win 7? Could it be 10% lower, 30% lower, I don't know if you can frame that at all for us.

We really can't provide specifics in terms of the agreement that we have with our customers, in this case Microsoft. All that we're saying is that as the volumes ramp that discounts can become significant because of just the sheer size of those volumes. Beyond that, we're really not at liberty to go into details with our customer agreements.

Okay. If I can touch on one question on European TVs, and obviously that's a big number, 74% penetration, big jump there. It was already touched on. What I'm wondering, looking at the European market, looks like LCD TVs, that's a tens of millions of units kind of number. It seems to me based on that, your guys addressable market is much lower than that in terms of what actually has a digital tuner in it. Is that what's going on there?

There's a few dynamics going on. One is that, as Kevin mentioned earlier, it's true that our attach rate is high, but let's not forget that the number of televisions is higher, meaning that there's still quite a few televisions that are analog shipping into Europe. Our attach rate is one that goes along with the digital television. So at a high level, the way I would summarize the European situation is we still have a significant upside with the remainder of the head room as we go to ubiquitous adoption. The TAM is increasing overall in Europe, so we see a higher adoption of digital television. And stepping back a little bit, we're looking at a 50% attach to worldwide television. So we see the head room for the Company is significant as long-term opportunity for us.

Okay. But basically it sounds like in terms of the European TV market, if I put those numbers together, we're talking a low percentage that's actually addressable, talking less than 50%, maybe less than 25% today?

I don't have the numbers on the total televisions today sold in Europe. But we will track very closely with our current attach rate the digital television sales in Europe. So I do not have those numbers for you so the metric right now is we're tracking the digital television sales with tuners as opposed to total television.

Thank you.

(Operator Instructions) And we will go next to John Vinh with Collins Stewart.

Good afternoon. Thanks for taking my question. Follow-up questions on the online streaming question. We're starting to see a trend where many of these Blu-Ray players on the market have streaming capabilities into them. I was wondering if you could just give us a sense of maybe your kind of pipeline opportunities going forward. And going forward, are there opportunities for you to receive multiple royalty streams just as you did in PCs on a potential Blu-Ray player? Could we see a scenario where you receive Dolby Digital Plus royalties for the Blu-Ray player and also an additional royalty stream for additional codecs that are being used for online stream decoding?

I think our strategy is to make sure that we're relevant to any channel of entertainment content distribution so that however a particular device, and obviously these devices are built to receive content from multiple channels, that we're in a position to provide Surround Sound experience. Now, in many of these cases it could be that they are supporting multiple codecs of ours, for instance, Dolby Digital Plus as well as HE-AAC but we wouldn't expect to get two royalties from the same codec, if that's what you're asking.

Got it. And then also a follow-up question on packaged media, longer term view. Can you give us your longer term view of what the tail for DVD looks like? And then obviously related to that, what do you guys see in terms of the current ramp of Blu-Ray over the next several years related to that, as well?

I'm not sure I got the first part of your question. The second part was around Blu-Ray. We saw just over 10 million units reported to us in fiscal 2009 and we're expecting between 15 million and 20 million for fiscal 2010 and obviously we're closely watching this holiday season.

And then on DVD, how far out does the tail go for DVD? I think Netflix has said they see DVDs going out to 2030. What is your view over the longer term on what that tale is? Is it a long drawn out tail, or do you see a cliff maybe five, six years out? What do you see in terms of how that sunsets going forward?

We see a long, drawn out tail, mostly because we don't see anything radical replacing it. We believe that Blu-Ray is an upgraded experience but nothing as radical as having gone from VHS tape to DVD where it was a very clear cliff in terms of quality, et cetera. So we see this maintaining a long tail for quite a few years before it completely disappears.

Okay. And then last question from me. I know China has not always been a royalty paying type of country but obviously it seems like there's some opportunities there. Can you give us an update on what sort of opportunities are there in China going forward over the next several years that you're looking at?

We've had good success in China over the years. Some of our first wins for PC-EE were in China, with Minovo, our first wins with Dolby Axon, our surround gaming technology are in China. We are working broadcast. There are channels on air today with Dolby Digital although they haven't set any kind of a standard as of yet. So we see China as a big opportunity. It's been a big focus on Ramzi and his team, ramping up that team and getting in a position to drive our newer initiatives there.

Great. Thank you.

I would like to, Operator, come back on one question. I just want to clarify that European broadcast, it's a 74% attach rate to total televisions. And so we expect that to continue through the year which should represent very good growth over last year. And then to reiterate, we think that on a global basis, we are attached to most digital televisions but that digital televisions are still less than 50% of the market, and so we see a continued growth over the long term there as the world transitions to digital. Now I'll take the next question.

Thank you. Our next question comes from Brian Thackray with Deutsche Bank.

Just two quick follow-ups. One, do you guys have what the kind of 2009 GAAP EPS would look like if we stripped out all the one-time items just so we have an apples-to-apples comparison? A quick second one, in terms of seasonality, you went through a huge growth phase, then we hit a recession. Help us and remind us what your typical seasonality pattern looks like through the quarters.

Typically our first half of the year benefits more from the holiday season than the second two quarters of the year, and then in any given year, it depends on the individual product cycles that we're exposed to, whether, for instance, if an increasing percentage of TVs are adopting broadcast, that might override any kind of seasonality. But usually the holiday season will manifest itself in the first half of the year. Now, of course this year we have tougher comps in the first half of the year. And the other thing to remember of course is that as we move through the year the Windows 7 business adoption should begin to surface.

Yes. In terms of the GAAP EPS, we provided there was $32 million in the one-time items or this benefit that we got in 2009 in licensing that we're not getting in 2010. So if you tax effected that and divided by the share count you'd get the EPS for that. And then in terms of the benefit that we got in gross margin in the first quarter, the $20 million there again, tax effect that and use a share count and you'll be able to get to some EPS numbers so that you could do that comparison.

Okay. Thanks, guys.

(Operator Instructions) This concludes today's question-and-answer session. At this time, I would like to turn the conference back over to Kevin Yeaman for any additional comments.

Thanks everybody again for joining us today. Again, we're going to continue to focus on the opportunities we have in our core business. We have a number of opportunities. We've talked quite a bit about the broadcast opportunity. We're also very excited about our opportunity in mobile and the progress we made this year. We look forward to continued progress in coming quarters. And we're excited about our presence in the PC market. We're also going to be focused on driving new technologies and driving our technologies into new markets. So we look forward to keeping you apprised of our progress and thank you for joining.

That concludes today's conference. Thank you for your participation.