Dolby Laboratories Inc (DLB) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing third quarter fiscal 2010 financial results. (Operator instructions). As a reminder, this call is being recorded Thursday, July 29, 2010. I would now like to turn the conference call over to Alex Hughes, Senior Director of Investor Relations for Dolby.

Thanks, Ed. Good afternoon. Welcome to the Dolby Laboratories third quarter fiscal 2010 conference call. Joining me today are Kevin Yeaman, Dolby Laboratories President and CEO; Murray Demo, Executive Vice President and Chief Financial Officer; and Ramzi Haidamus, Executive Vice President of Sales and Marketing.

On this call conference call we will be making forward-looking statements that include projects of future operating results for our fiscal year ending September 24, 2010;market trends for the industries in which we compete, and our expectations and beliefs concerning how those trends will affect the 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 that are subject to risk and uncertainties.

Actual results may differ materially from these set forth in such statements. Important factors such as macroeconomic conditions could cause actual results to differ materially from those in the 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 the most recently quarterly report on Form 10-Q available at www.sec.gov or 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 a result of new information, future events or otherwise.

During this call we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available on 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 our call will be made available on the website for approximately one year and is the property of Dolby.

As for the structure of this call, Murray will begin with a recap of Dolby's financial results and provide an updated outlook, and Kevin will finish with our discussion of the business. So with that introduction, I will now turn the call over to Murray.

Thanks, Alex. Good afternoon, and thank you for joining the call. I'd like to discuss Dolby's fiscal third quarter 2010 financial performance and our outlook for the fiscal year. Revenue for the third quarter was $230.3 million, up 34% year over year and down 5% sequentially. Licensing revenue for the third quarter was $170.3 million, up 20% year over year and down 13% sequentially. The year over year increase was driven by our PC and broadcast markets, while the sequential decline was due to seasonality.

When reviewing our year over year performance for both consumer electronics and mobile, please keep in mind we recognized $21.6 million of back royalty payments from three licensees related to prior periods in Q3 fiscal 2009. The majority of the back royalty revenue in Q3 2009 was in consumer electronics.

Looking at licensing revenue by market for the third quarter of fiscal 2010, revenue from our PC market grew 40% year over year on strong PC shipments in the ramp of Windows 7,and declined 5%sequentially due to seasonality. Revenue from third-party ISV softwarewas nominally year over year and sequentially.

Our broadcast market grew 43% year over year, primarily on strong TV unit growth and increased TV attach rate in both Europe and Japan. Sequential our broadcast market declined 7% due to seasonality.

Our consumer electronics market declined 9% year over year and 21% sequentially. The year over year decline was due to recognition of back royalty payments in the third quarter of fiscal 2009. The sequential decline was due to seasonality.

Our other markets category, which includes mobile, gaming, automobile and Via declined 3% year over year and 29% sequentially. The year over year decline was due to the recognition of back royalty payments in the mobile category in the third quarter of fiscal 2009 . The sequential decline was due to seasonality.

Third quarter product revenues were $52.7 million, up 142% year over year and 32% sequentially on increased revenue, primarily from our digital cinema servers and 3D systems. Third quarter services revenue was $7.3 million, flat year over year and down 5% sequentially.

Turning to margins. In the third quarter, GAAP gross margin was 82.6% and 83.3% on a non-GAAP basis. Gross margins were down sequentially, due primarily to a $9.6 million noncash impairment charge taken in the third quarter for certain digital cinema systems provided under operating leases to exhibitors. These operating leases were initiated to encourage the motion picture industry to transition to digital cinema. We ceased entering into these operating leases in the fourth quarter of fiscal 2009. At the end of the third quarter, the remaining book value of these digital cinema systems is $7.1 million. This impairment charge reduced our gross margins in the third quarter by 4.2 points on both a GAAP and non-GAAP basis.

Our licensing gross margin was 97.8% in the third quarter on a GAAP basis and 98.6% on a non-GAAP basis. GAAP product gross margin was 55.7% in the third quarter and 56.1% on a non-GAAP basis. Product gross margins were up seven percentage points sequentially, due primarily to increased manufacturing efficiency and cost reductions. GAAP services gross margin was 53.3% in the third quarter, and non-GAAP services gross margin was 53.8% in the third quarter.

Third quarter GAAP operating expenses were $94.3million, up $12.6 million sequentially. Non-GAAP operating expenses were $84.1 million, up $10.6 million from the previous quarter. The sequential increase was primarily due to the recognition of compliant settlements of $7.2 million from licensees discussed last quarter, which lowered Q2 sales and marketing expense on both a GAAP and non-GAAP basis.

Total employee head count was 1,203, an increase of 33 employee from the previous quarter. The increase was in R&D and sales and marketing.

Third quarter operating income was $95.9 million on GAAP basis, or 41.7% of revenue, and $107.7 million on a non-GAAP basis, or 46.8% of revenue.

Turning to tax. Our effective tax rate for the third quarter was 35.1% on a GAAP basis and 35% on a non-GAAP basis.

Third quarter GAAP net income was $63.5 million, or $0.55 per diluted share, compared to $51.1 million,or $0.44 per diluted share for the third quarter of 2009. Third quarter non-GAAP net income was $71.1 million,or $0.62 per diluted share, compared to $57.5 million, or $0.50 per diluted share for the third quarter of 2009.

Moving over to the balance sheet. Dolby finished the third quarter with $1,046 million in cash, cash equivalents and marketable securities. Cash flow from operations was $75 million in the third quarter. In the third quarter, we repurchased 1.492 million shares at $94.5 million, or an average price of $63.35 per share.

With that, I would like to turn to our fiscal 2010 outlook. For total revenue, we are targeting $890 million to $905 million. Specifically for licensing, we are targeting revenue of $690 million to $700 million due primarily to growth in our PC and broadcast markets. Our outlook for licensing revenue is based on the following fiscal 2010 assumptions. In our PC market, we are assuming PC shipments increased between 15% and 17% for the first fiscal year. Please keep in mind that the combination of our fiscal year ending in September and our recording of PC shipment related revenue in one quarter in arrears does not equal calendar year 2010 in the various PC unit shipment growth rates forecasted by many firms. We now expect our ISV revenue to decline between $0 and $5 million in fiscal year 2010.

In our broadcast market, we are assuming worldwide TV unit growth between 15% and 17%. We expect the European TV attach rate to be approximately 85% in fiscal 2010. In our consumer electronics market, we now expect our year over year revenue growth rate to be at mid single digits, despite the significant back royalties received in the third quarter of 2009. We are assuming that growth in Blu-Ray revenue in fiscal 2010 will than offset declines in DVD revenue.

Turning to products and services. We are targeting revenue of $200 million to $205 million. For gross margins we are targeting approximately 85% on a GAAP basis and 86% on a non-GAAP basis.

Turning to operating expenses. We are targeting approximately $356 million to $362 million on a GAAP basis, and $317 million to $321 million on a non-GAAP basis. For tax, we are targeting a tax rate of approximately 35% on both the GAAP and non-GAAP basis.

For diluted earnings per share, we are targeting a range of $2.31 to $2.36 on a GAAP basis, and $2.57 to $2.63 on a non-GAAP basis.

For fiscal 2011 we'll provide targets in the fourth quarter earnings call. As you think of fiscal 2011 you should keep in mind that we will recognize approximately $28 million in deferred product revenue in fiscal 2010 from prior years that will not be repeated in fiscal 2011.

Finally, we are pleased to report today that our Board of Directors has authorized the Company to repurchase an additional $300 million in class-A common stock. This new repurchase authorization continues our ongoing program targeted at offsetting dilution from our employee stock programs. And with that I will turn the call over to

Thanks, Murray. Good afternoon, everyone. We had a solid third quarter. In addition to the strong financial results, I am pleased with the progress the team has made in the number of important areas. Such as growing the global reach of our technologies in the broadcast and PC markets; extending our formats into important new areas, such as online and mobile; and further penetrating the growing 3D opportunity. I'll give you a quick update on the progress in each of the areas before handing it over to Q&A.

In the third quarter, we continued to see the uptake of our technologies globally. In broadcast, our attach rate to televisions continued to increase in Europe and Japan. Furthermore, we continue to see the adoption of our technologies by commercial service providers in new countries such as China and India.

In India, leading satellite provider Airtel Digital TV announced it will adopt Dolby Digital Plus in the high-definition service, helping us to increase the amount of content in our format in this large and important region. In China, Best TV selected Dolby Digital Plus. This is in addition to the 11 Chinese stations already broadcasting in our formats for high-definition content.

In our PC market, we continue to see the growth of Dolby Digital Plus with the global ramp of Windows 7. In addition, we continue to make progress with our PC Entertainment Experience suite of technologies. We estimate that just under 35% of consumer notebook models now contain the PC Entertainment Experience, which enables a more immersive audio experience from a notebook PC, regardless of the audio source. We believe the value proposition is well suited for the new class of tablet PCs aimed at media consumption.

We also continued to make progress in both our mobile market and online initiative. In our mobile market, the team continued to execute well. We remained fully engaged across the mobile ecosystem with Dolby Digital Plus, Dolby Mobile and Dolby Pulse being well received. We believe we are well positioned with the three technologies, as they offer a strong value proposition around efficiency, compatibility and immersive audio, which are becoming increasingly important to handset providers and operators.

Turning to our online initiative, the team continues to work closely with many players throughout the online distribution community. We have made great progress working with important partners, and to date leading online providers such as VUDU, Amazon and Apple are using Dolby technologies in some or all of their content. Discussions with various online providers continues to go well.

Finally, in our cinema market we continue to experience strong demand for the Dolby 3D cinema system. We have shipped approximately 4,400 Dolby 3D systems to date and over 1,000 in the fiscal third quarter. To compliment 3D technology, we also recently released Dolby Surround 7.1, which enables content creators to add even more audio dimensions to the 3D experience. Recently Disney Pixar launched Toy Story 3 globally in Dolby Surround 7.1 and plans to do the same for upcoming releases.

In summary, we had a solid third quarter. We believe we remain well positioned across many of the marketing initiatives, including broadcast, PC, mobile, online and 3D cinema. In addition, we continue to experience growing adoption of our technologies internationally and in new markets. With that, I'll turn it over to Q&A.

Thank you very much. (Operator Instructions). I'll take our first question from John Vinh with Collins Stewart.

Thanks for taking my question. First ahousekeeping question. On the back royalties that you called out for last year, what roughly was the split between CE and other of the back royalty payments?

So, John, we didn't provide specific numbers a year ago on that, but what we will say on that is same as last year, which was the majority was in CE, and a much lesser amount was in mobile.

Great, thank you. On your licensing guidance for the full year, that implies that licensing revenues are slightly down on a sequential basis. Seasonally speaking, your fiscal Q4 is typically -- usually slightly up. Can you maybe talk about what the implications are of what your guidance is implying there?

So in terms of licensing, I wouldn't say that it's going to be -- it could be done sequentially on the low end of the range. It could be obviouslyhigher of the higher end of the range. It's -- what we see is a continuation of what we saw in the third quarter and in the fourth quarter with no real major moves.

Okay. And within that segmentare there certain segments that you see with higher probability of being sequentially down in certain segments that you would believe would be more likely sequentially up? Are there also some tough sequential comps that we should be aware of?

If you look at our overall guidance, we're at 20% licensing growth year over year for Q3, and our guidance is a range of 14% to 21% growth year over year for Q4. And we consider that to be pretty strong growth, and it's given by continued strength in PC and in broadcast.

Yes, so John, just again, yes, the range again, it's down to -- more towards flattish. We don't see major changes from segment to segment. Between Q3 and Q4.

Thank you. Moving on, I'll take a question from Ralph Schackart from William Blair.

Good afternoon. First I would just like to ask a Windows 7 question. Have you seen any of the Win 7 Enterprise SKUs starting to affect the FY 2010 numbers at this point?

Yes, we started to see traction on the business SKUs. Its has been growing each of the past quarters. We saw it move again this quarter, but there is still obviously a long ways to go.

Okay. One more and I'll turn its over. On the PC side, Murray, correct me if I'm wrong, it is 15% to 17%. Is that for a unit forecast aligned your fiscal year?

Yes, that's correct. That 15% to 17%i s a unit forecast aligning with our fiscal year, not calendar year 2010.

Thank you. Moving on, we'lltake a question from Stephane Fraenkel from Brigantine Advisors.

Good afternoon. Following up on Ralph's question of the Enterprise SKU, what has to get to happen to the tipping point that the royalty rate gets adjusted that you talked about when Win 7 launched?

As we said in the past, we -- once Enterprise fully kicks in as you're referring to, Steve, we do expect that higher volumes than we have in the past and significant price discounts. But I don't think I'd point to one tipping point. It's going to happen as the rollout occurs, and most of the Enterprise adoption we think is still ahead of us.

Okay. And on the PCEE data point that you gave out, that you're attached to 35% of the units. What was that six months ago?

I'm sorry, I don't have the comparable number for six months ago.

(Operator Instructions). We'll take our next question from Jim Goss from Barrington Research.

Hi. A couple quick things. One, are you seeing -- well, you made a comment that Blu-Ray is now offsetting declines with DVD. Are you seeing any impact in the PC disk drives with Blu-Ray? And if so, is that counted in the PC side or the consumer electronic side? And generally, if Blu-Ray is doing better, do you think that is a turning point for the consumer electronics categories so it might start to revive its share of the total licensing revenue?

Well, as Murray mentioned, the increase in Blu-Ray is compensating for the decrease in DVD at a high level. In terms of the attach rate to PC, we are seeing still a fairly single -- low single digit number. We estimate 5% of attach of Blu-Ray physical drive to PC's and notebooks. We do see a significant increase on the stand alone Blu-Ray players, so we have seen as you mentioned a significant increase here. We are looking at reports that show about an 80% increase in Blu-Ray in the CE segment as stand alone players. So we are seeing a healthy increase on the set-top box, a fairly flat to moderate increase in the PC . We don't have very much data at this point to see where the future will hold on Blu-Ray on PC, but we're really confident and pleased with the overall increase of Blu-Ray in the

Okay. Maybe one last thing. In the mobile area, is that starting to gain enough strength that it might break out as a 10% category that you'd report separately, or is that still a ways off?

We're not going to give any guidance today for 2011, but we are really pleased with our progress in the mobile area. We are now on over 50 products shipping between our relationships with NTT and LG. We're of course very much looking forward to their release of the M8 later this year, which includes Dolby Digital Plus, and our discussions across the industry to continue to go very well. We think that between the offerings we have, we can significantly improve the audio experience over any of these devices.

(Operator Instructions). And we'll take a question from Tom Kucera from Avondale Partners.

Thank you. I want to touch on the current quarter. Really, in terms of -- that was a strong growth number in PCs. Was Windows 7 really -- obviously there's growth in PC shipment, but was Windows 7 really the biggest driver there, and was PCEE? Is that becoming a meaningful contributor to that point, or is that still quite small?

Win 7 was a big driver in the quarter. And we also mentioned that ISV was up sequentially marginally. So Win 7 is a big driver. We continue to see some success in PCEE over time, but Win 7 is a big driver.

So PCEE is still pretty small?

It is relatively small related to Win 7. This is Ramzi. And just to add some more color on PCEE relative to the previous question, we don't have a six month number, but to date, we have over 160 design wins. And with -- we have three generations, and we continue to see an increase penetration with each generation. So this last generation presents the largest increase relative to the previous one, so we're pretty pleased with the penetration so far.

And moving on, a follow-up question from Ralph Schackart. One follow-up on the ISV. I think you reported today, Murray, that you'll be flat to down $5 million. Correct me if I'm wrong, but at the beginning of the year you were guiding for about down $20 million. Have you done anything active in the end market to manage that decline or I guess keep it flat, or was it just a conservative forecast when you started the year? Just maybe a little bit more color on that.

Yes, the first thing I would point out, Ralph, is that when we have different PC unit growth assumptions when we started the year. So actually had PC unit growth came in the way we had given our guidance at the beginning of the year, it would have been down about the amount that we expected. So the attach rate has come down, but the PC units are up, and of course, what we have shared with you are the gross revenue numbers.

Okay. Thanks, Kevin.

(Operator Instructions). And we'll move on with another follow-up from Stephen Frankel.

Can you give us an update on Dolby Volume? Is there anything new in product shipments or design wins there?

Sure. So the current volume is that we have 40 products in the market place, ranging from AVRs, set-top box, TV's, and as you know we -- that was the first version of Dolby Volume that came out. We just launched a new version, which you're seeing -- from which we are seeing great response from the marketplace. We're starting with the IT manufacturers, and we'll be rolling that out over the next few quarters into a much broader footprint on AVR's, set-top boxes and TV's. So as you can see, this is an increase from last quarter and last year, and we believe we're on the right path. The code that we have been talking about has been generally available.

Thanks.

And we'll take a question from David Joyce.

Thank you. I was wondering if you would provide more color on the digital cinema market. I think you did mention a number, and I just had missed it. The number of installs you had. When do you think this -- the net ads will be peaking or the conversions will be peaking globally? And how have revenues for system been [in the trench].

So we sold -- the number we cited in the script, which is what I think you were asking for, was we shipped over 1,000 3D systems during the quarter. And in terms of the adoption, we see a strong demand moving into next year, most industry estimates I have seen currently show some time -- through 2011 it should be strong. And you might hit peak adoption for the industry some time late 2011, early 2012. That obviously depends a lot on how exhibitors plans continue to progress. But that's kind of the sweet spot from the reports I've read.

Are you still seeing any studio industry on the financing assistance for these conversions?

Yes. The studio assisted organizations are still rolling forward. You've got DCIP, [Cinedyn, Arts Alliance]. They're all in the market continuing to fund systems.

Moving on, we'll take a question from [Eric Woodworth] with DSM Capital.

Thanks for the call. Just following up on the prior question. Are you experiencing any supply constraints in terms of supplying the digital cinema upgrades or the 3D implementations? Thanks.

We did note last quarter that we were experiencing supply constraints and therefore had been building backlog that we expected to clear by the end of this fiscal year. We're through that. We cleared it during the quarter. So that contributed to our really strong products quarter, and we aren't experiencing shipment delays today.

Great. Thank you

(Operator Instructions). We'll take a follow-up from Tom Kucera.

Thank you. I wanted to follow up with two other questions on PCs. First, there's an earlier question on Blu-RayPC drives. I'm wondering when you guys might think that 5% attach rate will pick up and what really needs to happen there? And second question, looks like there's been some indicators that PC shipments in this past quarter --June quarter, which you recognize in September -- kind of weighted towards the corporate side. I'm wondering if you see that? I think that might affect your revenues there.

Starting with the Blu-Ray question , as the consumer base starts to get exposed to Blu-Ray in home via the significant growth set-top Blu-Ray, there could be a spillover into demand on the laptop and PC. But that is somewhat of a guess on our side. We are not seeing strong double digit growth that we saw around this time during the DVD uptick. So apples to apples, the Blu-Ray uptick and PC attach is significantly lower than the DVD uptick at the same time, about 10 to 12 years ago.

So that could tell us one of many things. It could be that online is taking over the optical drive experience in the PC. Or it could be that the consumer hasn't had the full benefit of that experience in home to transfer and put demand on the set -- on the PC and laptop. So we're kind of waiting and monitoring this area. Obviously very interesting to us. As an example of that shift from optical to online, we for example will note that CyberLink announced the first online media player supporting [all the digital clock] with a new launch of PowerDVD 10. This is a Blu-Ray software player, which willplay online DVD. And to answer the second part of your question, I'll turn it over to

Can you repeat the second question, please.

The second question was it looks like there's only indicators that PC shipments were weighted towards the corporate rather than the consumer side in the June quarter, which ends up being your September quarter. And I'm just wonder if you're seeing that and how that might affect you.

Well, what we had said earlier is that we have seen an increase in the business adoption of Win 7, and we're seeing that come through. In terms of PC shipments in the enterprise versus the consumer, I think the external data would be what we looking at as well. But we are seeing increasing traction in the enterprise.

We'll take a follow-up from Jim Goss.

Thank you. I wanted to follow up a little bit more on the discussion that got underway about 3D. You know, with the RealD IPO, it's probably heightened some attention on the area. And my sense is your exposure is a lot more international than it is domestically. I'm wondering what your US share is, and which specific international markets you're involved in, and how big you think that growth potential could be in -- domestically and internationally for you

We -- the majority of our share is that the shipments that we described, both on a to-date basis, 4,400 systems, and during the quarter of just over 1,000. The majority of those are international. Much of the domestic market is tied up in the DCIP group of entities, and we're not a part of that DCIP rollout. Internationally, we've been very strong, and we are doing well across a number of regions. And we see a continued demand there and expect to continue to do well.

IMAX was highlighting China and Russia as areas they're going into heavily, and I'm wondering if that's a big opportunity for you, as well, since China in particular has some big growth ambitions in its theaters groups.

It is. We see both those countries as significant opportunities for us. We have presence in both countries and we continue to push our solutions -- the entire digital solutions, including 3D -- both in the regions.

And there are currently there are no further questions in the queue at this time. (Operator Instructions). All right, it appears we have no further questions at this time. I'd like to turn it back over to Mr. Kevin Yeaman for any additional or closing remarks.

Thank you for joining us today. We look forward to speaking with you throughout the quarter and at the end of next quarter.

Thank you very much, ladies and gentlemen, that does conclude today's conference.