Dolby Laboratories Inc (DLB) 2010 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 year 2010 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 Thursday, November 4, 2010. I would now like to turn the conference call over to Alex Hughes, Senior Director of Investor Relations for Dolby Laboratories. Please go ahead, Mr. Hughes.

Thank you, Carla. Good afternoon, and welcome to Dolby Laboratories fourth quarter and year end fiscal 2010 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories President and CEO; Murray Demo, Executive Vice-President and Chief Financial Officer; and Randy Heineman, Executive Vice-President of Sales and Marketing.

On this conference call, we will be making forward-looking statements that include projections of future operating results for our fiscal year ending September 30, 2011, 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 that are subject to risks and uncertainties. Actual results may differ materially from those set forth in such statements. Important factors such as macro economic 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 our most recent 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. A reconciliation between the two is available on our earnings release and in the Dolby Laboratories investor relations data sheet on our investor relation 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. 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 a discussion of the business. So with that introduction behind us, I will now turn the call over to Murray.

Thanks, Alex. Good afternoon and thank you for joining the call. I would like to discuss Dolby's Q4 and full year fiscal 2010 financial performance and our outlook for fiscal 2011. Revenue for the fourth quarter was $227.8 million, up 39% year-over-year and down 1% sequentially. Licensing revenue for the fourth quarter was $178.4 million, up 29% year-over-year and up 5% sequentially. The year-over-year increase was driven by growth in our PC, broadcast, and our other markets category led by mobile.

Looking at licensing revenue by market for the fourth quarter of fiscal 2010, fourth quarter PC revenue increased 33% year-over-year on higher PC shipments and the ramp of Windows 7. And declined 5% sequentially on lower ISV revenue. For the full year our PC market made up 36% of licensing revenue in both fiscal 2009 and fiscal 2010. Included in this amount for fiscal 2010 was the decline of third-party ISV revenue of approximately $2 million from fiscal 2009. Fourth quarter broadcast revenue grew 33% year-over-year and 16% sequentially.

The year-over-year increase was driven by higher TV unit growth and increasing European attach rates and higher settop box unit growth. The sequential increase was primarily driven by growth from settop box. Full year revenue from our broadcast market made up 27% of licensing in fiscal 2010 compared to 25% in fiscal 2009. Fourth quarter revenue from our consumer electronics market declined 3% year-over-year and sequentially. Full year revenue from our consumer electronics market made up 22% of licensing revenue in fiscal 2010 compared to 24% in fiscal 2009.

For fiscal 2010 growth from Blu-ray revenue more than offset the decline in DVD revenue. Fourth quarter revenue from our other markets category which includes mobile, gaming, automotive and Via, increased 78% year-over-year and 27% sequentially. The year-over-year increase was led by growth in mobile as well as automotive and Via. The sequential increase was driven by mobile. Fourth quarter product revenues were $40.3 million, up 99% year-over-year and down 24% sequentially.

The year-over-year growth was driven by increased unit shipments in our digital cinema servers and 3D systems and from the change in revenue recognition accounting discussed in prior quarters. Fourth quarter services revenue was $9.1 million, up 81% year-over-year and 25% sequentially. The year-over-year increase was primarily due to a promotion in the prior year where certain expenditures of $1.8 million were recorded as contra service revenue.

Turning to margins. In the fourth quarter, GAAP gross margin was 88.4%, and 89.1% on a non-GAAP basis. Gross margins were up sequentially primarily due to a $9.6 million non cash impairment charge incurred in the third quarter of fiscal 2010. Our licensing gross margin was 97.6% in the fourth quarter on a GAAP basis and 98.4% on a non-GAAP basis. GAAP product gross margin was 53.7% in the fourth quarter and 54.2% on a non-GAAP basis. Both were down approximately two points sequentially.

GAAP services gross margin was 62.7% and non-GAAP services gross margin was 63% in the fourth quarter. Both were up approximately 9 points sequentially. Fourth quarter GAAP operating expenses were $104.3 million, up $10 million sequentially. The sequential GAAP (inaudible) expense increase was due to higher restructuring expense primarily related to the asset impairment of a UK building, higher G&A expenses due to investments in infrastructure and higher R&D expenses.

Non-GAAP operating expenses were $89.2 million, up $5.1 million from the previous quarter. The sequential non-GAAP increase was due to the increased investments in infrastructure and R&D. Total employee head count was 1,244 an increase of 41 employees from the previous quarter. The increase was in R&D and sales and marketing. Fourth quarter operating income was $97.2 million on a GAAP basis or 42.7% of revenue and $113.9 million on a non-GAAP basis or 50% of revenue.

Turning to tax. Our effective tax rate for the fourth quarter was 35.8% on a GAAP basis and 35% on a non-GAAP basis. The increase in the tax rate from the prior quarter on a GAAP basis is related to the UK building impairment and related minority interest accounting. Fourth quarter GAAP net income was $65 million or $0.57 per diluted share compared to $44.3 million or $0.38 per diluted share for the fourth quarter of 2009.

Fourth quarter non-GAAP net income was $74.9 million or $0.66 per diluted share compared to $50.6 million or $0.44 per diluted share for the fourth quarter of 2009. For the full year, GAAP net income was $283.4 million or $2.46 per diluted share compared to $243 million or $2.11 per diluted share for fiscal 2009. For the full year non-GAAP net income was $313.5 million, or $2.72 per diluted share compared to $254.5 million or $2.21 per diluted share for fiscal 2009.

Moving over to the balance sheet. Dolby finished the fourth quarter with $1,039,000,000 in cash, cash equivalents and marketable securities. Cash flow from operations was $68 million in the fourth quarter. In the fourth quarter, we repurchased 1,049,000 shares at a total cost of $63.7 million, or an average price of $60.73 per share.

Now, I would like to turn to our fiscal 2011 outlook. For total revenue we are targeting $950 million to $990 million. Specifically for licensing we are targeting revenue of $770 million to $800 million due primarily to growth in our broadcast and PC markets. Our outlook for licensing revenue is based on the following 2011 assumptions. In our broadcast market we are assuming worldwide TV unit growth between 3% and 5%. Our growth in the broadcast market also assumes higher global TV attach rates.

During fiscal 2010, our average global TV attach rate was slightly above 50% and we expect it to grow approximately 8 to 10 points in fiscal 2011. In our PC market we are assuming PC shipments increase between 9% and 11% for the fiscal year. Regarding ISV revenue, we expect ISV revenue to decline approximately $10 million to $15 million in fiscal 2011. In our consumer electronics market we are targeting essentially flat to mid single digit year-over-year revenue growth. We are assuming that we receive royalties on approximately 30 million to 35 million Blu-ray units.

Turning to products and services. We are targeting revenue of $180 million to $190 million. Please keep in mind that we recognized approximately $30 million in deferred product revenue in fiscal 2010 from prior years that will not be repeated in fiscal 2011. For gross margins, we are targeting approximately 88% on a GAAP basis and 89% on a non-GAAP basis.

Turning to operating expenses, we are targeting approximately $411 million to $423 million on a GAAP basis and $360 million to $370 million on a non-GAAP basis. Dolby's fiscal calendar experiences a 53rd week approximately every four years. Fiscal 2011 is a 53 week year and our first fiscal quarter will include an additional week of some operating expenses. We expect this extra week of operating expense to be approximately $5 million and is included in our fiscal 2011 operating expense targets.

For tax, we are targeting a tax rate of approximately 33% on both a GAAP and non-GAAP basis. The decline in the tax rates are related to the restructuring of our international operations. For share count, we are targeting approximately 114 million shares. And for diluted earnings per share we are targeting a range of $2.52 to $2.66 on a GAAP basis and $2.87 to $3.03 on a non-GAAP basis.

Before I turn the call over to Kevin, I would like to make a few comments on our fiscal 2011 quarterly financials. We are targeting Q1 to be our lowest revenue quarter due to higher PC channel inventory. Turning to operating expenses, we are targeting Q1 and Q2 to be higher than Q3 and Q4. The extra week in Q1 and various trade shows in Q2 contribute to the higher operating expenses. And with that, I will turn the call over to Kevin.

Thanks, Murray. Good afternoon, everyone. I'm very pleased with our fourth quarter and fiscal year performance. We entered fiscal 2010 focused on expanding the adoption of our audio technologies into new geographies with the global transition to digital television, into new channels of content distribution such as mobile online, and into the increasing number of devices that play back content.

On today's call, I will review our progress in each of these areas and discuss our priorities to drive long-term growth. In fiscal 2010, we continued to grow the adoption of our surround sound formats with the global transition to digital television. For full fiscal 2010 we estimate that our global attach rate to TV shipments increased 15 points year-over-year to just over 50%. We estimate our exit rate for the year was in the high 50s.

We finished the year with a high penetration rate in North America, Europe and Japan while continuing to position ourselves well in new geographies. In China, we ended the year with 13 channels on air in our format. In addition, Dolby Digital Plus was adopted by Best TV, the first provider of IPTV services in China. In India, satellite provider Airtel digital TV announced it will adopt Dolby Digital Plus in its high definition service.

We also added to our position in Europe with the largest pay TV operator in Spain, Dolces Cable adopting Dolby Digital Plus. Our success in broadcast has often started with premium broadcast operators enhancing their digital offerings with the highest quality audio. This increases the presence of our formats throughout the regional content ecosystem. This in turn positions us to provide value across more devices and more content providers in the region in order to provide the highest quality experience however and whenever consumers enjoy their entertainment content.

This also positions us well in other forms of content distribution. A second initiative that we made progress on in fiscal 2010 is the extension of our multi channel formats into the online and mobile channels of distribution. Our approach to online has been very similar to our approach to broadcast. We have focused on growing the presence of our format throughout the online ecosystem by helping individual content providers. Today, many leading content providers are adopting our formats.

Last month, Netflix announced that it selected Dolby Digital Plus to deliver 5.1 channel Surround Sound for TV shows and movies streamed instantly. The PlayStation 3 will be the first consumer electronics device to support 5.1 Channel Surround from Netflix with more devices to be added over time. In addition, Sonic Solutions announced that Dolby Digital Plus would be part of its Roxio Now platform. This platform has been selected by retailers such as Best Buy and Blockbuster to deliver movie content.

These wins come in addition to services such as Amazon, Apple TV and Voodoo which are already providing their content using our multi channel formats. In other areas of the online and mobile content community, a number of leading music providers including Rhapsody and Omnia adopted Dolby Media Generator, a set of encoding tools designed to help content creators improve the quality of their service. Rhapsody will encode over nine million music tracks using Dolby Digital Generator and Omnia, over six million.

In addition, a number of service providers on the NTT DOCOMO network in Japan such as Front Media, Phase Wonder Works and PacketVideo are using Dolby Media Generator to improve the quality of their content. The more we help to ensure the quality of content, the better we can provide value at the device level. In fiscal 2010, we also made progress extending our portfolio technologies to portable devices. Dolby Mobile is now on over 60 handset models including nearly 30 models from LG, over 20 models on the NTT DOCOMO network and four new models from HTC.

Dolby Digital Plus has been adopted on five handset models, including two from Nokia and three from Pantek. Dolby Technologies are now running on a number of mobile operating systems including Android, Symbian and Windows Mobile. In the area of notebook computers, our suite of post processing technologies is now on over 30% of consumer notebooks.

Turning to fiscal 2011 and beyond, we are focused on driving long-term growth by expanding our core business, extending further into new markets and investing in adjacent opportunities. Starting with our core business, we believe our PC, broadcast and CE markets provide a solid foundation for growth. In each of these markets, our technologies are included in many popular entertainment devices enabling us to benefit from underlying unit growth.

In addition to this underlying unit growth, we also have room to increase our presence in these markets. In our broadcast market, for example, we estimate that just over 50% of global TV shipments and just over 30% of global settop box shipments included our technologies in fiscal 2010. With 1.5 billion TV households worldwide, this is still a very large market opportunity.

Similarly, in our PC market with Dolby Digital Plus now included in the business editions of Windows 7, we remain well positioned for the consumer ramp to Windows 7 and the enterprise ramp. In our CE market we are well positioned to benefit from an upgrade cycle to Blu-ray as the price points in players drop and compelling new future sets increase consumer adoption. We receive a higher ASP from Blu-ray than we do from DVD.

We also remain focused on growing the adoption of our technologies and new devices. As consumers increasingly use their portable devices to play back entertainment content, we believe they will seek a higher quality entertainment experience as well as greater compatibility with their existing entertainment ecosystem. In order to meet these needs, we are providing solutions across the chain. I discussed earlier the progress we are making in increasing the amount of content being enhanced by Dolby Technologies in the online and mobile ecosystems.

This increases our value proposition at the device level where we offer decoding technologies such as Dolby Digital Plus. Dolby Digital Plus is highly suitable to an emerging class of handsets that serve as portable media centers. These devices enable consumers to acquire, capture and enjoy content in full Dolby Surround Sound whether they are in their home theater or on the go. It also increases our value proposition for our post processing technology such as Dolby Mobile. Dolby Mobile improves the immersive audio experience and is ideal for those consuming stereo based content directly from their phones even when that content is in non-Dolby format such as MP3.

It works even better when content has been encoded using our solutions such as Dolby Media Generator. Our conversations with the mobile ecosystem continue to go well around both of these technologies and in fiscal 2011 we expect to continue signing new customers and increasing our penetration. Our focus is on the smart phone and media enabled handset markets which we estimate to represent approximately 40% of mobile phone shipments and are the fastest growing categories. The same factors that are driving our success in the mobile handset market will drive our success in other portable device markets such as tablets.

Finally, to drive additional long-term growth we are investing in adjacent market opportunities such as video where we believe our position across the entertainment ecosystem positions us uniquely. We have already made progress with our portfolio of video products for the professional market. In Cinema, we have shipped approximately 6,300 Digital Cinema Servers and approximately 5,600 Digital 3D Systems to date and estimate that our market share is approximately 25% for Digital Cinema Servers and approximately 30% for 3D.

We believe the transition to Digital Cinema and 3D remains a compelling opportunity as only 25% of the global commercial screens have upgraded to Digital Cinema and only 15% to 3D. We also introduced additional video technologies for the professional content community. In October we launched the Dolby Professional Reference Monitor to industry-wide acclaim.

The ProMonitor is a new flat panel video display that enables content makers to view the full detail and true colors of their images with greater accuracy than available before. We are encouraged by the positive reaction we received from the professional video community and continue to make investments that we believe will build on this success.

In summary, we have had a great fiscal year. We have made excellent progress growing the adoption of our formats globally, extending our formats into new channels of distribution such as online and mobile and into new devices like multimedia handsets. As we look to the future, we are well positioned to continue to grow our core markets and to drive the adoption of our technologies into new markets.

And with that, Operator, we would like to open up the call for questions.

Thank you. (Operator Instructions). We will take our first question from Ralph Schackart with William Blair.

Good afternoon. First question for Murray. Murray, correct me if I'm wrong, when you entered the fiscal year you guided ISV down $20 million from memory and it ended the year only a couple million dollars down. Just curious what drove the outperformance from the initial outlook?

Well Ralph what drove that was the PC TAM ended up being higher for fiscal 2010 than what we anticipated at the outset of the year. So It's that increase that helped to offset the detach and so we ended up the year only down $2 million.

With the attach rate sort of in line with what you originally predicted obviously with the increased units?

Yes, that's correct. We were pretty close with that in terms of we did see detach and if the TAM had been what we had set at the outset of the year we would have been down around $20 million but because of the higher PC shipments it helped to offset the detach.

Great. And then, Kevin, you talked about attach rates for the HDTV sort of exiting around high 50%. Where do you think that could go long-term as you look over the horizon?

Well, I think over the long-term as I look over the horizon every region that I visit and the customers in those regions are focused on getting to digital TV so I think ultimately the world transitions to digital television and I think we are very well positioned to meet their audio needs. So I think there is a lot of room to -- we think it is an area of growth for us.

One more, if I could. In terms of the smart phone market, you talked about 40% of shipments. Will fiscal 2011 be a year where that category might be a little more noticeable in the financials where you will be able to speak to it a little bit more or do you think we still need another gestation year before that becomes measurable to the operating performance?

Well, again, we think this is one of our most attractive growth opportunities and we are pretty pleased with the amount of progress we made over the fiscal year both in terms of our inclusion in content, which is destined for these devices, and our ability to improve the devices themselves. I think that you will, you should expect to hear us continuing to spend more time articulating with you what is going on as we progress on mobile handsets and portable devices generally.

Okay. That's it for me. Thank you.

Moving on, we will now go to Michael Olson with Piper Jaffray.

Alright, thanks, good afternoon. A couple of quick ones here. With the recent Netflix and Sonic deals, how would you describe your position in internet delivered content and the resulting impact on devices that will consume that content? And given TVs and Blu-ray players and many other devices that stream content to a TV already include Dolby, how does that increase your addressable market? Is it primarily through mobile devices and international device penetration or does it also change the opportunity for devices in the home in the US market as well?

Well, I think, first of all, that part of our value proposition to service providers and consumers is that Dolby Digital Plus does have a wide presence across a number of devices that are already connected. So we are bringing we think additional value by making sure that you get the highest quality audio experience from your device regardless of the source of content.

Over the longer term as the newer sources of content perhaps become the more prevalent sources of content, if that is the way the world goes, well then I think it is another more value that we are offering from that device. And I think it also gives, increases the value proposition for devices that are being introduced that primarily are used for online content. We think that having more online content and mobile content that will work with Dolby Media Generator is giving us more opportunities to provide value to handsets and other portable devices.

Okay. And then as far as China, can you just give us the latest? You made some comments about being in the draft DTV specification but doesn't necessarily indicate that Dolby would be mandatory? Is that correct? And I guess what in general is the status in China and when do you expect that decisions there might be made?

The status is that we continue to work on, there is a lot of operators in China, a lot of regional governments in China are focused on getting digital on air now and we are helping them and that is why we have 13 channels on air and why the first IPTV service is using us. What you otherwise describe is accurate. We are in the draft standard and so that means just what it says, which is we are in the draft standard and we really don't have any -- we are not really able to provide any guidance on when that will go from draft to final. But in the meantime, we continue to work throughout China to support operators as they go digital.

Okay. Thanks very much.

Moving on, we will now hear from John Vinh with Collins Stewart.

Hi, thanks for taking my question. Just a follow-up to the last question. In terms of the China draft specification, can you clarify whether you are an optional specification or a mandated specification in the draft standard? And do you need to be a mandated specification for terrestrial in China to benefit (inaudible) for that market and broadcast?

We are -- in the draft, we are an optional standard and we do not need to be mandated. It is always beneficial to be mandated but we have shown in many markets that it doesn't -- we succeeded in many markets digital broadcast through de facto standards or just providing value on an operator by operator basis. We think we are pretty pleased with our position in China.

The one example to what Kevin is speaking to is the DVD standard in Europe where Dolby Digital and Dolby Digital Plus are optional and you can see us adopted at a fairly wide scale and that's the kind of approach we are taking in most of the standardization work worldwide. As long as we are an option, we are happy with that status.

Great. And then also you had mentioned in your prepared remarks you expect to see your digital attach rates and broadcast increase by 8 to 10 points in fiscal 2011. Geographically, can you maybe talk about where you expect those share gains to come from?

Well, it is mostly in emerging markets. As said in the prepared remarks, we have high attach rates in North America, Europe and now Japan, being driven by two things. At one level we are focused on region by region importing markets and the technologies they need as they move to digital broadcast and then from the manufacturer side you will remember that some manufacturers are moving to a single SKU which include our technologies in all digital televisions shipped around the world so that naturally increases our attach rates in those markets to the extent that those television providers are moving to single SKUs.

Great. Thanks very much, guys.

And now we go to Deutsche Bank's Brian Thackray.

Hi, thanks. First question for Murray. It looks like 2010 was a year of investment for you guys. As I look at your guidance for next year, on the cost side it looks like it is for the most part kind of steady at Q4 levels. Is that a fair way to think about that and to the extent we do get any incremental revenue above where you expect, how much of that should end up flowing to the bottom line?

In terms of the operating expenses, as I mentioned earlier, when you look at it by quarter in the first quarter we have this extra week. It is a 14th week, it's once every four years or so, it is about $5 million. So that is driving some of the increase. We also have the fact that we are seeing a negative foreign currency impact because many of our expenses now are increasingly more global as we -- of our global expansion and in many markets around the world and so that is affecting us as well by approximately $5 million at these current rates. But at the same time we will continue to invest in R&D and sales and marketing.

Those are very important operating expense areas for us and that is factored into our guidance. In terms of margin leverage from here, that is something that we would have to look at. Clearly, in R&D and some of our sales and marketing activity are focused on the long-term or mid-term opportunities and we would have to make some of those decisions where it makes sense to go ahead and have leverage in a particular quarter or continue to invest for future revenue growth.

Thanks. And question on the mobile market. Looks like you guys obviously have had some accelerating momentum there with HTC and some others. Are there specific applications that those handset manufacturers are embedding on those phones where there is a natural attach rate that you guys have on top? I'm trying to better understand what is driving the increased attach rates on these smart phones for you?

It is more than one factor, Brian. I can go through some of them. Obviously what historically has driven us, driven the decoders into some of these handsets is side loading based on the availability of files in Dolby format. However, moving to a place where downloading and purchase of content on a mobile phone is becoming more prevalent. Purchasing online through the phone or off air through the phone and playing a rich multimedia movie in your home theater is becoming something of a future trend.

That is why you see phones like the Nokia and coming with an HD line out that you can plug directly into your home theater. This is not one of a kind and we believe other companies will do the same and we believe Nokia will come out with additional SKUs that will do the same. In addition to side loading and purchasing movies and our content we are also seeing a large adoption of our Dolby Mobile Technology. The notion of improving the handset multimedia experience based on our post processing technology is also gaining momentum. So we add all of these together and we are really happy with the progress and the mobile experience, or the mobile progress of our adoption of the technology.

Great, thank you.

Moving on, we will open the floor up to Paul Coster with JPMorgan.

Yes, thank you. I just clearly went back and looked at your guidance 2006, 2009, 2010. In each case the initial guidance was in sort of the single digit revenue growth and then, of course, you posted double digit growth each year so one would think that you generally are quite conservative. Is that true this year as well or are you signaling something a bit more profound with this kind of mid single digit type growth that you are projecting? In other words, do you feel like we are sort of seeing a secular slowdown?

Well, Paul, I think, first of all, you need to look at the revenue guidance and break it down between what we are seeing in licensing versus products because remember products have been affected by that big amount of revenue, $30 million in revenue we got from a change in revenue recognition rules last year. So, otherwise, without that, it's up. And having included that, it's down for the year. But licensing revenue for 2011 we are guiding to 8% to 13% growth. We think that is good growth in what probably what would be described as a slow economic growth environment in North America and Europe and stronger growth outside of North America and Europe.

Sorry, Kevin. Did you say that as sort of a good long-term growth rate for that business?

I was really just responding to your allusion to prior years in the first instance. I guess what I would say is we come into each year giving our best estimate of what we think our range of revenue is going to be for the year. And you're right that we have historically ended up the year higher than that. I can point to the factors for any given year that did that. Last year, at this time, was one of the worst economic environments in decades and the PC growth was just much higher than anyone anticipated when we did guidance last year. That drove a lot of growth. The year before that we were expecting a much more rapid ISV attach rate and judging from the questions I was getting that is what a lot of people were expecting. And, of course, it's held in there much better than we thought. Perhaps it is a function of our position in the market that we tend to get pleasant surprises, but I can just tell you when we come into the year we are giving you our best estimate of what the growth is going to be and this year it is 18% to 13% growth on licensing and --

8% to 13%.

8% to 13%. What did I say?

18%.

Sorry, 8% to 13%.

And then in the US, the DTV upgrade cycle. When do you think that kicks in again?

The US digital TV upgrade cycle?

Yeah, because most people have obviously the HDTV upgrade took place last year, analog to digital conversion. Feels like we may have to wait awhile before we get another upgrade cycle. Maybe 3D. Maybe connected TVs. When do you think that might kick in, do you agree?

We do think the connected TV is a very value proposition to the consumer. As you know, we support the 3D initiative includes some questions about a number of titles out there to drive enough, to get the consumer to upgrade. Certainly the connected experience has shown a huge value in upgrading the TV to a connected TV, whether you're going after the Netflix experience or downloadable movies it is a whole different leveling. And we do see the connected TV as attractive enough along with the drop in ASP as you saw some of the promotions coming up this holiday season, some of these connected TVs are selling sub $500 at a very attractive price. I don't think we we're going to be waiting very long before we see people starting to replace their TVs that were bought two years ago.

Okay, thank you.

Now, we will go to Ingrid Chung with Goldman Sachs.

Thanks, good afternoon. So two quick questions. First, how much Windows 7 enterprise revenue are you seeing at this point and have you hit the inflection point where there are volume discounts? Secondly, why is the stock based compensation expense increasing by more than 60%?

Well, so Ingrid, let me just take both. On enterprise PC, I wouldn't say we have hit -- we have seen a steady increase. I would say compared to what we expected, say, a year ago the enterprise ramp is -- we still are very confident in the enterprise, the ultimate adoption of Windows 7 enterprise. Probably going a little slower than we initially expected. So by the end of the year we wouldn't expect it to be a full adoption yet. Maybe three quarters of business shipments. I wouldn't say we hit the inflection point at this point, but it has been steadily increasing.

In terms of stock-based compensation, what's happening is, obviously we have more employees so that is leading to more stock grants and the stock price has gone up. We are on a four year vesting schedule so the year it is falling off and now is fully vested was back in 2006 when we had fewer employees and the stock price was much lower. Those are the things that are driving the higher stock-based compensation in the new year.

Okay, great. Thank you.

Moving on, we will open the floor up to Dougherty Markets, Steve Frankle.

Good afternoon. Could we start with some thoughts on tablet computers. Are they an impediment to your penetration or are they a growth opportunity for your post processing business?

Well, we see tablets, we see entertainment, the proliferation of entertainment devices including tablets as a growth opportunity. We are focused on, my comments earlier today, on how we are focused on online and mobile content and portable devices, includes tablets. You will see Dolby Technologies on tablets in the future. And we will keep focusing on all devices that are used for entertainment. In the near term, as to the debate as to whether they are cannibalizing one thing or another, it seems pretty clear that they are cannibalizing some significant percentage of netbooks. Still a lot less clear on notebooks. And, of course, our RPC TAM is 9% to 11% and that would be net of whatever effect you see from that.

Okay. And could you give us an idea where your attach rate is in Europe and Japan today on the TV side?

We have very high attach in both markets, over 90%.

About approximately 90% attach rates.

Okay. And the increase in inventory in the September quarter, is that in preparation to ship a lot of Cinema Servers and 3D systems in the early part of fiscal 2011?

Well, what we had, if you recall at the end of the second quarter we were not able to make -- to meet the demand for all of the orders we had because we couldn't get some components. And so what we have done is we've tried to protect ourself a little more safety stock given what has happened over the last few quarters on the transition to digital and the 3D and that is what is driving the increase in inventory.

All right, thank you very much.

Moving on, we will hear from Tom Kucera with Avondale Partners.

Thank you. I want to start with kind of a mechanical question. A question was asked earlier about the Windows 7 enterprise ramp. And I'm wondering, you know, my understanding is I guess the vast majority of enterprise PCs shipping today that they go out with Windows XP are actually Windows 7 licenses that are then downgraded and I wonder if you can help me walk me through am I incorrect in that assumption or do you end up not being compensated for some of the downgrade PCs or how does that work?

We get paid based on units what it ships with, but I believe there is -- we -- our understanding is there are still a number of units shipping with, for instance, Vista being downgraded to XP.

Okay. And second question I wanted to ask was on settop boxes. I guess you talked more really about TVs than settop boxes. It was a strong quarter for settop boxes. I'm wondering what is driving that? Is that Asia, sort of HD settop boxes in Europe? Talk about your expectations there. You are about 30% penetration there, where do you expect that to move in FY 2011?

What drove the higher tasks was in North America and Europe. Are that is an important part of our growth story going forward and we would expect to see continued improvements in our attach rates.

The majority of the settop boxes, new settop boxes that are reaching developed markets such as Europe and US tend to be media rich settop boxes with multi channel and that is also driving some of that increase attach.

What would that -- I guess are there a lot of settop boxes for example in the US that are shipping today without multi channel, without Dolby Digital?

Not to my knowledge actually. In the US, all of the boxes will ship either with Dolby Digital or Dolby Digital Plus. but I was referring to the European increase, which as we said, in Europe it is an optional format and nevertheless we see ourself being in almost all settop boxes because of the competitive nature of the market wanting to be rich media, i.e, multi channel.

Alright. Thank you.

And now we will take a question from Wedbush Securities, Kerry Rice.

Thanks a lot. You kind of touched on this previously, but going back to the PC markets. You know, you indicated you thought PCs would grow. I think PC shipments 9% to 11% within the year. How do we think about it for the PC segment of your business because you have got kind of a slower consumer PC but some enterprise business ramping but then you have the Windows 7 adoption. Should we kind of expect you to be able to grow faster than kind of the shipment, PC shipments?

No, our -- when you look at our PC market, the revenue is driven by PC TAM, it is also driven by any detach that we have with our ISV revenue. What we look at is industry information, plus our own sort of analysis to come up with what we believe is the PC TAM growth for next year. And that is 9% to 11% and that is where our focus is.

Okay. So the demand, the demand for Win 7 wouldn't push you above that as people maybe adopt that for their older computers?

Well, we obviously need an attach rate to go with those PC shipments so that is also another important factor in it. Also, as I had said in the prepared remarks, that at the beginning of the quarter as we looked at our revenue trajectory over 2011 that in the first quarter we think it's going to be a little softer in PC given higher channel inventories and so that has been factored into the guidance that we have provided for the full year but also in terms of how we are signaling what Q1 would look like as you put your models together.

Great. And then on the digital television market, we have obviously seen some increase in inventory, you had mentioned that, but I think that is primarily what we are seeing in North America and potentially Europe. But you -- I guess from what you are seeing, are you seeing any kind of slowdown or inventory glut in the emerging markets at all or China?

For digital television?

Yes.

What we communicated today is around what we have seen in the PC channel really not -- we don't really have any specific remarks to make around digital television channel.

Okay. Thank you.

And now we will go to Pacific Crest, Andy Hargreaves.

Thanks. Just a clarification. When you guys are giving the global TV attach rates, is that attach rates to total TVs or attach rates to digital TVs?

Total TVs.

Total TVs. Can you give what you think your attach rate to digital TVs globally is?

We are -- well, we think we are on -- I don't have the specific number. We are on the majority of digital TVs around the world.

Okay. I'm guessing it is pretty darn high like close to 90 percentish. Would I be crazy to think stuff like that?

I think it is safe to say it is over 80%.

Okay. Can you just talk a bit about the settop box and mobile markets. And I understand kind of the push towards online video and establishing relationships with Netflix and those guys. From the settop box maker and from the handset OEM makers perspective, what is their decision on why to include a full CODEC rather than passing along the content and having the end device decode the audio?

The mobile device is the end device. And we are seeing the mobile device becoming the consumption device as well as the center and the hub of entertainment. There used to be a time when it used to be with a thing just used to carry data around with, but we are seeing consumers move around with movies on that device, consuming it on the go, capturing multi channel content on a mobile phone, using sophisticated microphones and playing back that content on that phone or connecting to the home computer to watch that content. So whether it is user generated content with our CODEC, i.e. captured and encoded with a content only device, or download a file, is a very valuable proposition here about a rich experience in multi channel as you can play back with Dolby headphone on that device or connect into your home theater and listen to it in true Surround Sound.

Okay. Then can you just confirm on those online service provider deals are there material economics from the service providers or is it just about proliferating the ecosystem?

It is typical of our standard model. We provide support and tools to broadcasters, online providers, et cetera, but the primary economics are around the device side.

Okay. Thanks.

(Operator Instructions). And now we will hear from Jim Goss with Barrington Research.

Hi. Wanted to ask about a couple of things. One, related to R&D. I was wondering about the intensity of that effort as you broaden your number of initiatives, does the percent dedicated to R&D rise over time? And is the focus more avenues or more specific dedication to the initiatives you have been developing?

Well, you are going to see R&D as a focused area for us. You are going to see R&D receive the largest allocation of our increase in operating expenses. And it is going be a combination of existing and new initiatives. You know, we are -- as we focus on content, whether you're talking about broadcast online mobile, we are doing that regionally. These content ecosystems are developing regionally. That not only requires coverage in those markets but these service providers have needs that are unique relative to other types of content providers and we have a number of research and development projects that are aimed at meeting those needs. At the same time, we do think that by being closely engaged in these markets we have the opportunity to recognize opportunities introducing technologies and invest in research and new technologies and we will continue to invest in those types of initiatives as well.

And when you get to areas like you talked over the last couple of quarters, say in France where the television settop boxes have created a big opportunity and as you have exploded the opportunity have probably run out of room to run in those areas, and do you look for other areas of the globe to try to extend that franchise, obviously you do but how easy is it or does it just sort of set you up for a little bit of a stall when you finally are successful in completing those rollouts?

I don't think that is how we characterized France. We wouldn't characterize it on a company wide basis as having fully penetrated a particular country. I think you are probably referring to the very high attach rate we have to digital televisions in France.

Right.

The fact that we are now on digital broadcast content we think actually is very beneficial as we pursue other forms of content and other types of devices and these regional and local content ecosystems. And keep in mind that often times in certain of these markets we are talking about the same organization that is trying to get from broadcast content provided to their customers to online content and mobile content. A lot of the same players and a lot of the same people and so by building the relationships on the broadcast side we've often put ourselves in a position where we are a trusted provider, puts us in a good position to start to move into some of the other areas.

So it basically embeds you as the de facto standard in that particular area and increases the likelihood of success in other areas that are related?

Well, I think broadcast is an example where we became a de facto standard in Europe. And I would say that the extension to other content areas might not be so strong as a de facto standard but it puts us in a position to have an opportunity to work with them as they try to bring quality content on new forms of distribution into new types of devices.

Okay. And one other thing. I was on the Time-Warner Cable call earlier today and there was some discussion about the notion of whether there needs to be settop boxes, maybe they would vanish over time as interconnected televisions, you know, maybe obviated the need for the settop boxes. And granted, this isn't going to be a one or two or three year process, but as the world moves to those sort of things do you get more opportunity or less opportunity as some of these devices converge?

Well, we see just at a high level, we see actually proliferation of devices. Instead of seeing a convergence of devices we are seeing a divergence and introduction of new devices. And it's actually amazing looking back a few years ago when there was that theory to today where you have the tablets and the smart phones and the settop boxes and the connected TVs and the multiple TVs in the home and each consumer owning multiple devices. We are going the opposite direction than what most consumers thought we would go.

Specifically to your question about TVs, in theory, yes, you could have a TV and no settop box. In practice, consumers want choice. They want to go one day with cable, the next day with satellite, another day off air. It is very difficult to provide a television that can do all of the above. You no longer have a choice as to what operator you want to go with and what service you get if you get it hard wired in your TV. A settop box provides you a choice. And as we have seen, whether it is Tivo or the other operator boxes, these settop boxes are becoming very competitive in and of themselves. They are offering online services, they are offering OTT services and they are becoming rich media boxes. So I don't believe those settop boxes (inaudible) are going to roll over and die. They are going to continue to add value to compete with the connected television.

All right. Thanks. Great answers. Appreciate it.

There appear to be no further questions, gentlemen. I will turn it back to you for any closing or additional remarks.

Well, thank you, everybody, for joining us. And we look forward to talking to you as we continue to make progress. Thank you.

Ladies and gentlemen, that does conclude our conference call for today. Again, thank you for your participation.