Dolby Laboratories Inc (DLB) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories' conference call discussing second-quarter fiscal 2011 financial results. During today's 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, May 5, 2011. I would now like to turn the conference over to Alex Hughes, Senior Director of Investor Relations for Dolby Laboratories. Please go ahead.

Good afternoon, and welcome to Dolby Laboratories' second-quarter fiscal 2011 earnings 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 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 these 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 these set forth in such statements. Important factors such as general economic, cinema, or PC market 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 orderly 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 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 being also recorded for playback purposes. An archive of the call will be made available on our website for approximately 1 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. And 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'd like to discuss Dolby's fiscal second-quarter financial performance and our outlook for fiscal 2011. Revenue for the second quarter was $250 million, up 3% both year over year and sequentially. Licensing revenue for the second quarter was $214.6 million, up 10% year over year and 14% sequentially. The year-over-year increase was driven primarily by our broadcast market, as well as our other markets category led by mobile and gaming.

Looking at licensing revenue by market for the second quarter of fiscal 2011, PC revenue declined 8% year over year, primarily due to lower revenue from ISV software, and increased 11% sequentially on shipments of Windows 7. Broadcast revenue increased 36% year over year, and 26% sequentially, primarily due to increases in both TV and set-top boxes. Revenue from our consumer electronics market decreased 3% year over year, and 6% sequentially, primarily on lower revenue from DVD. The sequential decline was also due to higher DVD back royalties in our first quarter of approximately $4.5 million, which we discussed on last quarter's call. Revenue from our other markets category, which includes mobile, gaming, automotive, and [via], increased 27% year over year and 29% sequentially. The year-over-year and sequential increases were driven primarily by mobile and gaming.

Second-quarter product revenues were $26.3 million, down 34% year over year and 43% sequentially. The year-over-year decline was primarily driven by lower sales of 3D systems, and the previously discussed change in revenue recognition accounting, which benefited Q2 fiscal 2010 by approximately $8 million. The sequential decline was driven primarily by lower shipments of 3D and digital cinema systems. The revenue shortfall was driven by increased competition and lower 3D system demand due to weak box office results. Second-quarter services revenue was $9.1 million, up 19% year over year, and 6% sequentially.

Turning to margins, GAAP gross margin was 88.6% in the second quarter, and 90.1% on a non-GAAP basis. Our licensing gross margin was 97.3% in the second quarter on a GAAP basis, and 98.7% on a non-GAAP basis. GAAP product gross margin was 24% in the second quarter, and 26.4% on a non-GAAP basis. Product margins declined primarily due to a $4.2 million in discrete charges in the quarter related to 3D inventory adjustments, a loss on the sale of certain digital cinema systems provided to exhibitors under operating leases, and royalty-related charges. GAAP services gross margin was 70.7%, and non-GAAP services gross margin was 71.2% in the second quarter.

Second-quarter GAAP operating expenses were $101.1 million, and non-GAAP operating expenses were $89.6 million. Both were slightly down sequentially. Total employee headcount was 1,291, an increase of 30 employees from the previous quarter. The increase was primarily in R&D, and sales and marketing. Second-quarter operating income was $120.5 million on a GAAP basis, or 48.2% of revenue, and $135.7 million on a non-GAAP basis, or 54.3% of revenue. Second-quarter other income was $2 million on both a GAAP and a non-GAAP basis.

Turning to tax, our effective tax rate for the second quarter was 32.7% on both a GAAP and a non-GAAP basis. Second-quarter GAAP net income was $82.1 million or $0.72 per diluted share, compared to $85.9 million or $0.74 per diluted share for the second quarter of 2010. Second-quarter non-GAAP net income was $92.2 million or $0.81 per diluted share, compared to $93.1 million or $0.80 per diluted share for the second quarter of 2010.

Moving over to the balance sheet, Dolby finished the second quarter with $1.134 billion in cash, cash equivalents, and marketable securities. Cash flow from operations was $100.9 million in the second quarter. In the second quarter, we repurchased approximately 547,000 shares at a total cost of approximately $29.2 million, or an average price of $53.30 per share.

Now I will turn to our fiscal-2011 outlook. For total revenue, we are now targeting a range of $905 million to $945 million. Specifically for licensing, we continue to target revenue of $750 million to $780 million. Our outlook for licensing revenue is based on the following fiscal-2011 assumptions. In our PC market, we are now assuming PC shipments are flat to up 5%, and we continue to assume that ISV revenue declines approximately $25 million to $30 million in fiscal 2011.

In our broadcast market, we are now assuming worldwide TV unit growth between 3% and 7%. In our consumer electronics market, we continue to assume flat to mid-single-digit year-over-year revenue growth. We are now assuming that we receive royalties on approximately 27 million to 30 million Blu-ray units.

Turning to products and services, we are now targeting revenue of $155 million to $165 million compared to our previous range of $180 million to $190 million. The reduced revenue range is due to greater competition in the 3D market, increased pricing pressure, and higher 3D inventory levels at 1 distributor.

In regards to the impact from the earthquake and tsunami in Japan, we have not identified any major negative variances to date, but continue to monitor the situation closely.

For gross margins, we continue to target approximately 88% on a GAAP basis, and 89% on a non-GAAP basis. For product margins, we're targeting a range of 38% to 39% on a GAAP basis, and 40% to 41% on a non-GAAP basis.

Turning to operating expenses, we are now targeting approximately $401 million to $413 million on a GAAP basis, compared to our previous range of $406 million to $418 million. And on a non-GAAP basis, we are now targeting approximately $350 million to $360 million, compared to our previous range of $355 million to $365 million. For other income, we are now targeting approximately $6 million to $7 million for fiscal 2011.

For tax, we expect the tax rate for each of the 2 remaining quarters in fiscal 2011 to be approximately 33% on both a GAAP and a non-GAAP basis. Taking into consideration our actual tax rates for Q1 and Q2, combined with our expected tax rates for the remainder of the year, we continue to target a full-year tax rate of approximately 30% on a GAAP basis, and 33% on a non-GAAP basis.

For diluted earnings per share, we are now targeting a range of $2.49 to $2.65 on a GAAP basis, and $2.75 to $2.91 on a non-GAAP basis. We are now targeting approximately 113 million diluted shares outstanding for fiscal 2011.

And with that, I will turn the call over to Kevin.

Thanks, Murray. Good afternoon, everyone. As Murray discussed, we achieved stronger-than-expected licensing growth in the second quarter, driven by broadcast, gaming, and mobile, while we saw softness in 3D product sales. I would like to now spend some time discussing our long-term growth opportunities. At Dolby, we are passionate about making the entertainment experience more real and more immersive across all forms of delivery and playback. This is where we focus our efforts, and where we see many exciting opportunities ahead.

In looking at these opportunities, we are building on a strong foundation. Our technologies are incorporated into a wide range of home entertainment products, including digital televisions, set-top boxes, Blu-ray players, audio/video receivers, gaming consoles, and personal computers. This positions us to benefit from any increase in consumer spending across these areas, and to extend our technologies further into new geographies and devices.

In our broadcast market, we expect the continued adoption of our technologies internationally as the world transitions to digital television. Today, we estimate just under 60% of televisions and 40% of set-top boxes incorporate our technologies. This means that much of the available global market is left to be captured, primarily in geographies such as Asia, Eastern Europe, and Latin America. In all 3 regions, we are making excellent progress.

In China, Dolby Digital Plus has been made an optional format in the draft national TV standard. We believe this will help in our effort to extend our technologies to TVs produced and sold within China, which totals over 30 million units per year. We've also seen a high percentage of the country's high-definition channels on air, using our technologies. We believe these are important steps in making us a key ingredient technology in the Chinese broadcast ecosystem.

We are also making great progress in India. While India is in its earlier development stage of digital TV standards, we have already begun the important work of growing the adoption of our technologies through individual satellite providers offering HD programming. Recently, Tata Sky adopted Dolby Digital Plus, joining operator Air Digital TV with HD channels on air in our format. In addition, we've assisted the country's leading provider of HD programming, Star TV, in enabling its production of content in full surround sound. This is a significant upgrade from the mono audio standard in India, and Star TV is featuring Dolby Surround Sound prominently in its national advertising campaign.

Turning to Russia, Eastern Europe, and Latin America, we continue to actively engage the respective ecosystems, and are making progress promoting the adoption of our audio formats.

In addition to our efforts in broadcast, we are focused on bringing a more immersive audio experience to content delivered online or over cellular networks, whether enjoyed in the living room, on the PC, or from a growing array of portable entertainment devices. Today, consumers who experience content this way are too often forced to sacrifice on quality while also running into challenges around compatibility. By the time content gets to a mobile device, audio quality is significantly degraded from what the content creator intended originally, especially when compared to the quality of cinema or high-definition TV.

In addition, consumers are now playing back content from a wide range of platforms and devices, which is leading to a multitude of formats. As portable devices become more interconnected with home theater devices, such as TVs and PCs, compatibility issues arise. Through our technologies, both of these challenges can be overcome. By incorporating our technologies, portable devices can support our popular format in the home theater environment, while delivering a much more immersive and cinematic experience on the go. There is no reason why consumers shouldn't expect to play back all of their files in any environment with the immersive experience they have come to expect from home theater.

To achieve this, we are taking a similar ecosystem approach to what we took in the home theater environment. We're making good progress in our work with content providers and distributors. To date, leading online movie content services Netflix, Voodoo, Apple, Amazon, and Rovie's RoxioNow platform, all use Dolby's multi-channel formats to deliver 5.1 surround sound. Leading music services, such as Rhapsody and Omnifone, have also adopted our encoding tools to help content creators improve the quality of their service. We continue to strengthen our presence across the ecosystem by working with content creators, mobile operators, and online service providers, and look forward to continued progress.

In the area of technology platform providers, we are a working with IC manufacturers and operating system providers to support our technologies and formats. To date, significant IC suppliers to the mobile industry are supporting our technologies, including Texas Instruments and Analog Devices. As more consumers play back movie files from their handsets, we are seeing increased interest from IC manufacturers and mobile operators to support our formats. Some IC manufacturers want to ensure their mobile chipsets can playback a Dolby-encoded file, while some mobile operators see an opportunity to increase differentiation and charge a premium through our technologies. Dolby formats have also been adopted in leading operating systems reportable PCs, including Windows 7 and Apple Leopard.

For manufacturers of portable entertainment devices, Dolby Digital Plus and our post-processing technology suite, such as Dolby Mobile and PCEE 4, combine to deliver an immersive audio experience. In the category of handsets, Dolby Mobile has been incorporated into over 100 models to date, and Dolby Digital Plus is now in 14 models.

We have also seen the first tablets to ship in the market with Dolby technologies. 16 tablet models now include our technologies, including 8 tablet models with Dolby Digital Plus running Windows 7. We are in discussions with a number of tablet providers, and we expect our technologies to continue to be adopted in new models from multiple OEMs on a variety of platforms.

With that, let me turn to our cinema market. Murray discussed the second-quarter challenges we saw in cinema, and how this affects our outlook for the year. While we were disappointed with the Q2 results, we remain focused on serving the market with our portfolio of products, including audio processors, cinema servers, and 3D systems, as the industry continues to transition to digital cinema and 3D over the next 1 to 2 years. We believe the cinema market remains an attractive one.

In addition to being a significant opportunity in itself, it fosters a set of important relationships, with content creators and distributors who influence the adoption of technologies and other channels of content delivery. Working in cinema also helps catalyze innovations in audio and imaging, which can potentially be extended to consumer markets. We continue to see opportunities beyond digital cinema and 3D, where we can continue to enhance the experience with our integrated audio and video expertise. We recently introduced Dolby 7.1 to complement the immersive 3D experience. Dolby 7.1 helps artists deliver a more compelling 3D experience, and we are now looking to introduce this to exhibitors around the world, as well as bring it to consumer platforms, such as Blu-ray.

In addition to continued releases in the US, we have seen the first 7.1 releases in India, China, Spain, and the UK. Building on our work in cinema, we are also working closely with many in the broadcast industry to enable the efficient delivery of a full-resolution 3D experience, and believe we are making good progress. Finally, our research in imaging has led to the introduction of the Dolby Professional Reference Monitor, which has been greeted with industry-wide acclaim. The pro monitor displays the full color and detail of content, enabling the artist to better calibrate the image's dynamic range and color gamut.

In summary, we continue to build our brand and credibility across the cinema and entertainment ecosystems. As we do so, we remain focused on leveraging our core business to drive the continued adoption of our technologies globally, and into new categories and portable entertainment devices.

Operator, we're ready for questions.

(Operator Instructions) Please be sure to identify yourself and your firm at the outset. To be fair to all participants, we ask that you limit yourself to 1 question and 1 follow-up question until all participants have had a chance in the first round. If time allows, we will then come back to answer any remaining questions. Our first question will come from John Vinh from Collins Stewart.

Hi, thanks for taking my question. First question is regarding licensing. I noticed that you had nudged down your underlying forecast for most of your segments with the exception of broadcast, but maintained your revenue guidance for the year. Can you talk about that, what is the offset there? Higher ASPs, or is broadcast making up the difference?

Hi, John. In terms of our licensing guidance for the year, we are maintaining at $750 million to $780 million. And while we are quite pleased with our performance in the second quarter, the weakness in PC units as it goes into the second half of the year is what is offsetting the over-performance in the second quarter. In terms of where we're seeing growth in the second quarter, it's coming primarily from mobile and from broadcast.

Okay. And then also, I noticed you had nudged down your forecast for Blu-ray slightly. Can you talk about that a little bit?

Yes, what happened there is, we're seeing a Blu-ray unit showing up in home theater in a box, and so that migration is leading to more revenue in home theater in a box, and we're seeing less on a stand-alone Blu-ray.

Okay, so even though units are down, the ASPs are higher for home theater in a box that's going to offset that?

We're seeing more revenue coming in home theater in the box because of Blu-ray, yes.

And then last question for me, and then I'll jump back in the queue, is on ISVs. How are you guys thinking about your ISV revenues longer term? Obviously, you have talked about $25 million to $30 million of headwinds this year. Do you expect that we start to stabilize as we get through that this year, or is this going to be a long-tailed wind down of ISV revenues over the longer term?

The ISV revenue this year has held consistent with the guidance we gave last quarter. As we look into future years, we do think that OEMs will continue to evaluate in which models to include ISV software. And so we do expect that it will continue to see some detach beyond this year. Of course, we haven't given any specific guidance beyond this year. And there's also some base level of ISV revenue that it stabilizes at. It's a little early for us to give guidance on that, but I would expect that we will continue to see people evaluating it as we go forward.

Thank you.

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

Thanks, good afternoon. You just walked through a bunch of potential growth drivers that could help to offset the challenges in the PC space, and which of those would you say you're most excited about, and which could have a material impact in the near term? In other words, does mobile, international, broadcast, and some of the other opportunities have the potential to be materially larger in the next several quarters?

So in the first case, I would say as it relates to the guidance in the second half of the year, when you think about the guidance, we had good strength in the second quarter, and that was driven by broadcast, mobile, and gaming. And when taken together with the weakness we see in PC unit volumes anticipated for the second half, we felt that we were still at a pretty good place with our range of guidance.

When we think about growth opportunities, both in the short and the long term, we continue to be excited about broadcast, as we've seen over many broadcast adoption cycles, we're doing the things that it takes to win in those markets. Those increases in attach rates don't tend to come nice and ratably, they tend to come in spurts. We see that we are doing all the right things in those markets, and so we look forward to that being a continued growth driver as we move forward.

Mobile is another. We see mobile grew nicely in Q2. We see it contributing to growth in the second half of the year, and we continue to be very optimistic about what that holds for our future with over 100 models in the market now with Dolby Mobile and 14 with Dolby Digital Plus, and also seeing the beginning of traction with tablets.

All right. Thanks very much.

Our next question comes from Ingrid Chung with Goldman Sachs.

Thanks, good afternoon. So first off, I was wondering how much of an impact do you think Japan is having for both demand and supply? And then secondly, in the past you have talked about 8 to 10 percentage points of increase in terms of attach rates for TVs previously. I was wondering if you're trending ahead of that, and how much of that increase is due to China? Thanks.

Ingrid, I will take on Japan, and I'll turn the attach rate on TVs to Kevin. In terms of Japan, clearly there is a great deal of uncertainty about what is going on in Japan, and we're monitoring the situation very closely. And there are 3 facets to that. First of all, we're looking at our own supply chain for the products that we ship, and we've not seen an impact in the supply chain for us.

The second area that we're looking at is the supply chain for our OEMs, and to date we haven't seen any material impacts, but there is a lot of uncertainty around that as we go into later in the year, and we will continue to monitor that as well. And then the third piece is the Japan domestic demand, and there again, we haven't seen any major variances to date, but it's something that we're continuing to monitor. And as we look at our guidance for the year, we've tried, because of the uncertainty in Japan, that's been factored into the guidance that we have in our revenue, especially in licensing of the $750 million to $780 million.

On the TV attach rate, yes, Ingrid, we're on track for about an 8 percentage point increase in the TV attach rate globally. That's really distributed across geographies, so we're still -- as I said, the reason we do all this work in market to work with operators, the really great progress we made with Star TV this quarter in India, to go from producing content in mono to producing it in full surround sound, and having that be something that they really use as a differentiator is to set the groundwork, and we know that over time, that can result in some good increases in attach rate. Right now, we're on track for what we set out at the beginning of the year, in terms of global TV attach rate, and that's what our guidance continues to assume.

And is China a portion of that?

China is a portion of that, again, we've seen, the increase we've seen this year has been relatively distributed across a number of markets, as opposed to say last year when we saw a really big inflection point in Europe, and that really was the major driver of the attach rate. This year, it's been distributed as we do a lot of groundwork in a lot of different geographies.

Okay, great. Thanks, Kevin and Murray.

We'll hear our next question from Steve Frankel with Dougherty.

Good afternoon. Going back to the Chinese TV situation, what's the timetable for that proposed spec to become more formalized?

That's a tough one for us to answer, Steve. In the industry, what we hear is that it's a current work item, and it could happen any time, but these things have a process to them, and we have no ability to predict when the government will finalize its standardization process. But in the meantime, we continue to have very good engagement with the providers that are looking to get high-definition content on the air today. We are their provider in the majority of cases, and we think that being included as an option in the draft standard has been instrumental to them feeling comfortable that they're on the right path.

Okay, and switching to the PC market, could you give us an update on penetration of PCEE? Are you losing landing slots to technologies like Beets, or do you feel like you're holding your own or gaining share?

This is Ramzi. We're pretty confident with the latest progress that our latest technology is doing. As you might know, we just launched PCEE 4, just this year at CES, and as of today we have 24 announced SKUs, just for PCEE 4 alone. Cumulatively, we are at about 311 SKUs with our PCEE technology. That gives you around 30% or so attach rate. So, we're pretty happy with the progress, and believe we have a superior technology, and we'll continue to be pretty optimistic about this technology.

Okay, and one last question on this 3D shipment. I understand from talking to customers in the industry, you've lost some market share, lost some customers to be installed. How many active units do you think you have in the field today, and did you ship any meaningful units in the quarter?

We did. Our shipments are now up to 7,800, up from 7,200, so we have 7,800 shipments to date. We think that the majority of those are in active use. But as we said, the weakness we saw in Q2, there is increased competition in the market. We are also affected by the weak box office, since we have a model where people pay up front for the installation, they tend to install in the week or 2 leading up to big titles, and there weren't as many of those in Q1 as there are expected through the rest of the year. And that also caused some of our -- one of our major channel partners are caught up in the same box office dynamics as we are, and one partner in particular, a larger partner of ours got some inventory in the channel as a result, and it's going to take us probably a couple of quarters to work through that.

But when I step back from all this, we're probably, if you believe that 50% of the screens worldwide will ultimately end up as 3D, we're probably about halfway through that deployment cycle as an industry. It's a discrete market for us, but it's one where we think, as I said, we've shipped about 7,800 screens, and we're going to keep fighting for each piece of business there. And we also see the cinema industry beginning to have the mind space to start thinking about what's next, beyond digital cinema and 3D, and we believe that having established ourselves as a video provider through our server and our 3D system, and of course, our recognized expertise in audio, that we have a lot to offer in terms of really thinking about the next generation experience, as people start to think about what's next.

Okay, that's all my questions for now, thank you.

And we will hear next from Paul Coster with JPMorgan.

Yes, thank you. It looks to me like your downward revision to EPS is about 10% versus the prior forecast, whereas the revenue has only come down by 3% or 4%, and yet the skew is more towards higher-margin licensing, which has been less affected by this downward revision. And so therefore, I'm not quite sure what's going on there. Is it that your product sales in the cinema side are attracting even lower margins than normal, and will continue to do so for the foreseeable future? Am I missing something?

No, Paul, I think that you're reading that right, and that is that it's in the product area that's driving the reductions in EPS. It's a combination of the revenue decline, and also, our margins are going down in the product area. It's a much more competitive market in the 3D space. We're going to be more aggressive on pricing to win business, and that's leading to lower margins, and that's coming down and affecting the EPS line.

Okay, thank you. And then on the 3D solutions side, it sounds like you have something new coming to market. One of the things that you've been criticized for is for having active eyewear, which is quite expensive, and I know you brought down the cost of the eyewear, but this next-generation solution, will it move to passive and thus address that particular issue?

In the professional space, our 3D solution has always been passive, Paul, so I'm not clear on --.

Oh, I'm sorry, then I misunderstood. I thought that the new 3D solution was for theaters, but it's going to be for the professional broadcast market, correct?

We do have a solution or a format that we're bringing into the broadcast and online market that's a competitive solution for high-definition, full-resolution 3D for the online as well as the television market, and that is something that can be used -- it can be used either in passive or in active eyewear.

Okay, good, thank you very much.

(Operator Instructions) We will hear next from Daniel Ernst from Hudson Square Research.

Yes, good evening. Thanks for taking my call. Looking at the tablet market, if we can kind of compare and contrast it to the risks we were facing a couple of years ago with the netbook market, which didn't really end up panning out. Would you put the tablet market in a similar area? But the follow-on to that would be, is it really just a question of market share, eg, Apple hasn't been much for adding additional technologies, and paying license fees. And so if they are the market, is there an opportunity for you on Apple tablets?

And then related to that, even just the other vendors gain share, that you've done well with so far getting on some early models, the comparison to the PC market would be, there is not an opportunity for ISV. So with netbooks, there was maybe an opportunity for multiple players, 1 in the operating system and 2 as an ISV, but on the tablet that probably doesn't exist?

So I'm trying to parse the number of questions that were embedded in that question.

It's really 1 question with some framing around what's the opportunity and risk within the tablet market?

Sure, so first of all, as it relates to the netbook market, we're off to a faster start with tablets than we were with netbooks, and that's because over the last couple of years, we've been doing a lot of work with portable devices, and how to improve the quality of the experience. And first and foremost, our success is being able to demonstrate that we can add value to that experience, and I believe we can do that. We've shown that we can do that, and that's why we've gone from not having any tablets in the market, to having about 16 with our technologies today.

Clearly, Apple is the dominant tablet provider in the space, and we do believe that we can significantly enhance the audio quality over that experience, and we engage with them. Obviously we need to convince them of that value. And I can't comment on the likelihood or timing of that, but we have a lot of confidence that we can improve the quality of the experience over any of these portable devices, wherever the content is coming from. Does that answer your question?

Yes, I think it does. It's a tough one to predict the future there, but that was good color. And then as a follow-up question looking at the internet video space, and obviously now that Netflix is delivering over 5.1, can you remind us what the economic model is, when a Netflix or a Voodoo is delivering the ability to have Dolby 5.1 or 7.1 or however that progresses, what the economic model to you is?

So in many of the cases, in most of the cases, it's much like our other markets where we do provide certain tools and services to content providers to get the content on air in our formats, and the content is destined for devices that support our formats, which is of course, where we collect royalties from those devices. In this case, they're oftentimes targeting devices where we're already included for other reasons, and so from the manufacturer perspective and the consumer perspective, it's just more value out of the technologies that are already on the device.

Now, I think part of what you're getting at is, a lot of times there are content providers that perhaps don't want to try to distinguish which devices have what, and we are exploring models that make sense in terms of a value proposition for those types of cloud service providers, and what the right economic model is. And I don't have any examples to cite today, but it's an area where we think we will be able to operate and create value.

Okay, thanks for the color.

We'll hear next from Tom Kucera with Avondale Partners.

Hi, thank you for taking my question. I wanted to start by just talking about the PC market. Is there any way you guys could maybe quantify what that reduction in PC shipments would mean to your licensing revenues, the year-to-year forecasting?

I don't think we're going to specifically quantify it, and there are a lot of factors, but I think, again, at the highest level, as Murray said, when we look at our annual guidance we had upside in Q2, and we have the downward pressure from PC unit shipments, the outlook being a little lower in the second half. And all-in-all, we think that the guidance, when we weigh those factors and all the other things that are going on, we think the guidance range is still a good one.

Okay, and maybe to slice that another way, because obviously, I think a lot of investors are paying close attention to those PC shipment numbers when they come out, and maybe you could talk about, when you receive that information, how do you guys react? And maybe what are some of the puts and takes you look at when you're modifying your forecast?

That's a good question. Look, the things to really focus on as it relates to our PC revenues are PC unit shipments, which of course, is where your question started. It's also really important to look at the mix between developed and emerging markets, largely because of the premium SKU and payment rate tends to be much better and developed than emerging markets. It's also very important to look at what's happening with ISV detach, and that's of course, something that we have provided guidance on, and we don't think that's changed significantly since the last time we talked.

So I guess one way to look at this, as compared to last quarter when we saw PC units coming down, and we adjusted our guidance, we had a number of factors, remember, that were coming into play. One was the reduction in unit guidance, the other was is that there was -- it was becoming apparent, the amount of the mix shift between developed and emerging markets. And the other was that we were, remember we saw an acceleration of the detach in ISV. In other words, our exit rate more or less, we still see the same and did see the same, but it was happening earlier in this year.

So last quarter, we had each one of those things being a factor as we looked at our guidance and what the right guidance level is. This quarter, the change since last quarter really is limited to that PC unit guidance. And so when we look at that, taken together with all of the factors that go into guidance, and as you know, there are a lot of factors that go into guidance, so it's hard to overweight any 1 specific factor. We think that the range is still a good range.

Great, and if I could touch on the mobile segment for a moment. First, maybe you can talk about how important DD Plus is right now to the revenue out-performance you're seeing there versus Dolby Mobile?

Are you talking specifically about our Q2 results, or looking forward?

A little of both.

A little of both. The Dolby Digital Plus handsets in the market tend to be the newer wins, so that hasn't been a big contributor to revenue yet. Dolby Mobile has been in the market longer and we continue to accumulate more handsets, so that has been a contributor to some of the growth we've seen in Q2 results. And together, when we look at mobile overall, Dolby Mobile and Dolby Digital Plus, we see it as one of the areas driving growth in the second half.

And just on DD Plus, how would you say this market and the mentality of OEMs has changed over the last 3 months? In terms, are you getting more wins and so on; what do you think is driving that?

We see multiple factors driving this. Clearly, mobile handset providers want to play in the multimedia playback environment. They realize that content is coming from several channels. You have the internet-available content, whether that's online, streaming, or ripped content. You have operator-driven content; and Dolby Digital or Dolby Digital Plus provides a common denominator, a single codec that allows you to provide low-bit rate, high-quality surround sound, and you don't need to stream another codec, you don't need to have a secondary technology. It is really the one solution that can allow multimedia handset manufacturers to play back all types of content, irrespective of the source. And right now, those number of sources are increasing over time, and so that is the primary pull, and we have seen that number increase over time.

Great, thank you.

(Operator Instructions) We will hear next from Andy Hargreaves from Pacific Crest Securities.

Just going back to the product gross margin, if we adjust for the write down in the quarter, it looks like you'd be a little bit higher than 41%. Is that a reasonable expectation going forward?

Andy, in terms of product gross margin, as I said in my comments at the outset regarding -- about the outlook going forward, we're looking for the full-year product margins in the 38% to 39% on a GAAP basis, and 40% to 41% on a non-GAAP basis, so if you look at the Q1 and the Q2 actuals, and then you look at this as for the full year, you'll be able to come out to what this leads to.

Okay, thank you, sorry, I missed that. And then just a clarification on your Blu-ray comment. So are you saying that you're lowering stand-alone units, but your expectation for Blu-ray drives I guess, and CE products is basically the same, it's just that what would have been stand-alone units are now home theater in a box unit, so you're not counting them in the 27 to 30?

That's correct, so the revenue has just transitioned from Blu-ray stand-alone to home theater in a box, and both in our CE segment, so that's why we continue to maintain the CE segment target for the year at the same levels of flat to mid-single digits.

Okay, and then last, just on the broadcast segment, so you've grown about 25% in revenue in the first couple quarters, but it's 3% TV growth, plus your 8% attach rate wouldn't get you that much. So are you expecting a big decline in your revenue growth rates in the second half, or is there some Dolby volume or HDR that's contributing to some of that growth there?

Well, I think if you look at the guidance range, I think the growth rate equates to flat to 8% growth in the second half, which is less than what we saw in the first half, so I think that's a long way of saying, it sounds like you're looking at it right. And again, when we look at our license, we give annual licensing guidance, we saw better-than-expected growth in the second quarter. Remember, we anticipated that our second quarter might actually be our lowest growth rate quarter. Clearly that didn't turn out to be the case with strength in broadcast and mobile and gaming. And in the second half, we do see some weakness in the PC unit shipments, and when you net it all out, we still think we have a good guidance range.

Okay, and then last real quick. The DSOs have pushed out, is there any concern about quality or collectibility there?

No, we don't have any concerns on the collectibility side.

Okay, thanks.

And our next question will come from Kerry Rice with Wedbush Securities.

Thanks a lot. Just a couple questions. Tablets, you mentioned that you're on 16 tablets, are those all shipping today, and if they are, how do we think about maybe the revenue contribution in the second half, or does it actually fall, maybe, we should think about in the holiday time frame when that would actually be more of a material contributor?

And then back to the PCs, I know last quarter the enterprise was pretty strong, which offset some of the detach of the ISV. How was enterprise editions for Windows 7 going? And then based upon your earlier comments about the emerging markets versus developed, are we to take that because we're seeing some or more growth in the emerging markets, that is actually part of the slowdown in the PC units versus developed?

So why don't I let Murray start with how the tablets are factored into our guidance, and then we can take your question on the PC units.

In terms of tablets, as Kevin mentioned, we are quite pleased with the adoption of our technologies on tablets, but it's still early days and we are not factoring a lot in our guidance for this year, it's more of a 2012 and beyond revenue opportunity.

Okay.

And Ramzi, I don't know if you want to add any comments on what we're seeing in terms of engagement. We have a lot of engagement, looking to have more models really throughout the year, and this will all really build to contribute to our 2012.

We're looking at some good early signs. Of course, the earlier signs tend to be the chip manufacturers releasing ICVs with Dolby Digital Plus on established system-on-a-chip units that are appropriate for tablets and phones, and that's what we're seeing. That's the good early sign, and we're also seeing some adoption by companies globally on the tablet side for either Dolby Digital Plus and Dolby Mobile. And what Murray just described is very early signs of a trend towards these products becoming the hub of multimedia consumption. And finally, we're also looking at content providers, whether they be broadcasters or online services looking at providing rich content into those devices to be played back in high definition and surround sound.

You also asked a question about the PC unit, the mix between developed and emerging, that is one of the factors that affects our growth, our revenue growth, relative to the PC unit growth. And I think the way to think about it is that I think everybody came into the year expecting better performance in the emerging markets than the developed markets. I think leading up to our call last quarter, we recognized that that was even more of a -- that the market information was indicating even more of a shift, so that contributed to our change in guidance last quarter. So far, it continues to be weighted toward emerging markets, but it's consistent with what we were looking at when we established our range last quarter. Does that answer the question on the PC units?

Yes, and then on the enterprise side?

Oh yes, on the enterprise side. So we continue to see the strength in business PC shipments. We think that businesses are well into their hardware refresh cycle as it relates to Windows 7, and so that's one of the things that -- we had 11% sequential PC growth in the second quarter. And so we are seeing that, and most of what we've heard indicates that -- and of course, we don't get any reports on this from businesses, but we expect they are about halfway through their refresh cycle. And that's roughly what we've heard.

It's Murray, just one thing I was just going to say also on the tablets. As these things roll out, again, remember that our Q4 revenue is shipments that occur between April and June. So that's why, again, as you look out to when the revenue would come in for tablets, we have this 1-quarter lag in terms of when we report revenue relative to when they ship. So that transition has to be considered as you look at 2011 and 2012.

Okay. I just wanted to ask 1 quick on the enterprise. Last quarter, you had indicated that enterprise pretty much offset the decline in ISV revenue. Is that the right way to think about it for Q2? Is it surpassed that, so you're getting a little bit of a benefit now, or how do we think about enterprise as a contributor?

I don't remember that answer, or what timeframe we were referring to, but I think the way to think about it is this. You want to look at, for our revenue, it's driven by PC unit growth. And if you want to break that down further, it's the strength of the hardware refresh cycle and consumer demand. And then, again, as we've talked about, look at the mix between developed and emerging markets. And then, whatever happens with ISV is another factor, and of course, the trend this year has been to offset the growth coming from those other areas, partially or otherwise.

Okay, thank you.

We will hear our next question from Jim Goss with Barrington Research.

I just wanted to ask a little bit more about your 3D goals and targets. Do you view the opportunity to be greater in the US markets or the international markets? I know Real-D has a strong presence with the major players domestically. Does that block you out a little bit, or are there other opportunities that you think can take you here, and then how does it work internationally?

Most of our 3D business has been internationally. And we continue to see that that's where the opportunity is, and we're getting focused on the markets where they're still in the early to middle stages of their roll out, and focusing our efforts there, and that's where we would expect to have the best opportunity in the future.

Okay, and so you're going to focus pretty much all of your attention there it sounds like --?

Most of our attention has been focused on the international markets. As you have said, a lot of the large screens are already under contract in North America, and they continue to systematically go through their roll out as we understand it and we will -- so we do have business in North America, don't get me wrong, but the bulk of our business does come from international, so that's where most of our resources are deployed.

It sounds, looking at tablets and mobile devices, you're grouping this as a combined category, they have a lot of commonality. Is that fair to think of that as almost a single category for you?

We look at them as entertainment devices, and our focus is on making sure that we're enabling content providers. And that content could be going to a tablet, it could be going to a mobile phone, it could be going to a PC, or it could be going to a television. So to us, it's really about making sure that we're doing everything it takes to ensure the best experience on a device. So at that level, we have a great position obviously in the PC market, and we have been very focused on tablet and mobile discrete markets.

I think if you look across the industry, the OEMs that serve those markets, the operating systems that serve those markets, some people might look at it more like a PC, probably more people look more mobile. We're not so focused on where to categorize it, we're looking at it as an entertainment device, and making sure that we can improve the experience as much as possible.

And finally, to the extent that Apple, I think, tends to have its own franchise, is Dolby a differentiating factor for the competing devices and that's where you'll be positioned?

Well, I think it's fair to say there's a lot of people entering the market looking to differentiate themselves in any way they can, and any time people are looking to differentiate in audio quality, that's an area where we want to help them. Again, we think we can bring a lot of value to improving the audio experience across any device over any type of content, Apple being no exception, and we're going to continue to work across the market to demonstrate that value.

Okay, thanks.

This does conclude today's question-and-answer portion. I would now like to turn the conference back over to Kevin Yeaman for any additional or closing remarks.

I want to thank everybody for joining today, and we look forward to seeing many of you at the upcoming investor conferences this quarter. Thank you.

And once again, ladies and gentlemen, this does conclude today's conference call. We thank you all for your participation.