Elena Carr - Director of Corporate Finance and IR Lewis Chew - EVP and CFO Kevin Yeaman - President and CEO

Steven Frankel - Dougherty Mike Olson - Piper Jaffray Ralph Schakart - William Blair Paul Chung - JP Morgan Eric Wold - B. Riley Jim Goss - Barrington Research

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call discussing Fiscal Third Quarter 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 Wednesday, July 22, 2015. I would now like to turn the conference over to Elena Carr, Director of Corporate Finance and Investor Relations for Dolby Laboratories. Please go ahead, Elena.

Good afternoon. Welcome to the Dolby Laboratories' third quarter 2015 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories' President and CEO; and Lewis Chew, Executive Vice President and Chief Financial Officer. As a reminder, today’s discussion will include forward-looking statements. These statements are subject to risks and uncertainties that may cause actual results to differ materially from the statements made today. A discussion of some of these risks and uncertainties can be found in our earnings press release that we issued today under the section captioned Risk Factors, as well as on our most recent report on Form 10-Q. Dolby assumes no obligation and does not intend to update any forward-looking statements made during this call as a result of any new information or future events. During today’s call, we’ll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings press release and in the Dolby Laboratories' Investor Relations data sheet on the Investor Relations section of our website. As for the content of this call, Lewis will begin with a recap of Dolby’s financial results and provide our fiscal 2015 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 Lewis.

Thanks, Elena. So good afternoon everyone, and thank you for joining the call. Let’s go over the results for the quarter. In Q3 total company revenue was $231.7 million and within licensing revenue was $204.9 million and products and services revenues were $26.8 million. And here is more detail by major market. Broadcast represented about 46% of total licensing in the third quarter and revenues in this market were down sequentially by about 7% mainly because of seasonality and year-over-year Q3 broadcast licensing grew by about 7%. PC revenues represented about 18% of total licensing in the third quarter. PC licensing was down about 7% sequentially and about 4% year-over-year, both comparisons were impacted by declines in PC market volumes offset partially by back payments in Q3 of this year. Consumer electronics in Q3 comprised about 11% of total licensing. They were down about 40% sequentially due mainly to seasonality along with lower back payments and year-over-year consumer electronics were down about 20%, driven by lower volumes in a variety of products including ‎Blu-ray and DVD players and AVRs. Mobile devices represented about 13% of our licensing revenue in Q3 and they were down about 4% sequentially and up slightly year-over-year. Revenues in other markets were approximately 12% of total licensing in the third quarter. They were seasonally down by about 35% from the second quarter and were down by about 3% from last year’s third quarter. Products and services revenue was $26.8 million in Q3 compared to $28.6 million in Q2 and $17.7 million in Q3 of fiscal 2014. The increased over last year’s Q3 was due primarily to our acquisition of Doremi labs in Q1 of this year. Let’s move on to the rest of the income statement. Total gross margin in the third quarter was 89.3% on GAAP basis and 90.5% on the non-GAAP basis. Product gross margin on a GAAP basis was 11.4% in the third quarter compared to 20.6% in Q2 and 16.3% in last year’s third quarter. Product gross margin on a non-GAAP basis was 20.2% in the third quarter compared to 29.5% in Q2 and 23.4% in last year’s Q3. Margins were impacted by some excess inventory charges and higher manufacturing cost as our volumes are running lower than expected. Operating expenses in the third quarter on a GAAP basis were $161.9 million compared to $168.2 million in the second quarter. On a non-GAAP basis operating expenses were a $143.6 million in Q3 compared to $149.5 million in the second quarter. Our Q3 operating expenses were lower due impart to a credit from the favorable resolution of a software license dispute. Operating income in the third quarter was $44.9 million on a GAAP basis or 19.4% of revenue and $66 million on a non-GAAP basis or 28.5% of revenue. The effective tax rate for the quarter was 24.3% on both the GAAP and non-GAAP. And so net income in the third quarter was $35.5 million on a GAAP basis or 15.3% of revenue and was $51.4 million on a non-GAAP basis or 22.2% of revenue. Diluted earnings per share in the third quarter were $0.34 on a GAAP basis, compared to $0.56 in the second quarter and $0.38 in Q3 of last year. On a non-GAAP basis third quarter diluted earnings per share were $0.49, compared to $0.72 in Q2 and $0.52 in Q3 of last year. So that’s my review of the Q3 results. And before I move onto the outlook for Q4, I’d like to make a few comments about our cash and our capital allocation. We continue to generate strong cash flows from operations and our balance sheet is solid. I would say solid as a rock, but that sounds too much like a line from an old disco song. Our core business is strong, our growth initiatives look promising and we are investing healthy amounts in R&D and sales and marketing to develop our new offerings and bring them to market. We have a little over $1 billion in cash and investments at the end of Q3 and during the quarter we bought back about $16 million of our common stock, which is about what we’ve been doing in recent quarters. However, as I look forward we planned to increase our quarterly buyback activity and we currently have available $212 million of stock repurchase authorization from the Board. We’ll keep you posted on our activity in future conference calls. We also announced a cash dividend today of $0.10. This is the fourth quarterly dividend that we’ve declared since commencing the program and I want to reiterate that our expectation is to grow that dividend overtime. So now I’d like to cover the outlook for the final quarter of the fiscal year. We estimate that in Q4 total revenue will range from $230 million to $240 million. Within that we anticipate that licensing revenue will range from $200 million to $210 million, while products and services revenue would be about $30 million. If I combine this Q4 estimate with our year-to-date actuals, our full year revenue range is now $970 million to $980 million. And essentially we’ve narrowed our estimates to the lower end of our original full year range to reflect the signs of potential weakness in the economy that we could be seeing in the near-term. Incorporated into our Q4 estimate are the following factors. We anticipate that our PC licensing revenue Q4 will be down by about 10% to 15% year-over-year due to lower volume and mix. We also anticipate that mobile will continue to run at around 11% to 13% of our licensing similar to recent quarters. And in our broadcast area, we see a flattish trend next quarter due to softer consumer demand. Gross margin in the fourth quarter is estimated to range in the 89% to 90% on a GAAP basis and 90% to 91% on a non-GAAP basis. Operating expenses in the fourth quarter are projected to range from $167 million to $170 million on a GAAP basis and from $148 million to $151 million on a non-GAAP basis. Other income in the fourth quarter is projected to be approximately $1 million and our effective tax rate for the fourth quarter is estimated to be around 26% on both the GAAP and non-GAAP basis. Based on a combination of the factors I just went over. Diluted earnings per share in the fourth quarter are projected to range from $0.27 to $0.33 on a GAAP basis. And from $0.43 to $0.49 on a non-GAAP basis. Finishing up with the remainder of the full year estimates that incorporate the Q4 numbers I just went over, licensing revenue for the year will range from $865 million to $875 million. And products and services will be around $105 million. Full year operating expense will range from $658 million to $661 million on a GAAP basis and from $583 million to $586 million on a non-GAAP basis. Full year gross margins on a GAAP basis will range from 90% to 91% and non-GAAP margins should be about a point higher. And the effective tax rate for the year is projected to be around 25%. So now I’d like to turn the call over to Kevin Yeaman, Kevin?

Thank you, Lewis and good afternoon everyone. I will start off today with a few updates on our core business and then move on to how we are progressing on our new initiatives. As Lewis noted, we are seeing some signs of potential softness in consumer markets generally and at the same time our presence in our key markets remains strong. Broadcast grew 7% and mobile remained at 13% of licensing revenue. These are both areas where we continue to see growth opportunities in the future. This quarter, PC was also a little better than we had expected. On the subject of PC, we announced that we have renewed our agreement with Microsoft and we will be included in the Windows 10 operating system. What’s new is that for the first time Dolby Audio will be natively supported in Microsoft’s flagship browser, Microsoft Edge. Now you will be able to enjoy the Dolby experience when listening to content through the browser. This will enable us to reach more users and new types of content with the Dolby experience as the majority of users streaming video today are doing so through the browser. We’re excited to continue to work with Microsoft to bring high quality audio experience across the Windows ecosystem. Let’s turn to our new initiatives starting with Dolby Cinema. This quarter marked the debut of the full Dolby Cinema experience combined Dolby Vision with Dolby Atmos. Dolby Cinema has been met with spectacular audience and industry reactions. Jeffery Morison from CNets said that Tomorrow End in Dolby Cinema is the best picture I’ve seen in the theater calling it the most impressive all around movie presentation I’ve ever witnessed. And I can say that reaction is pretty representative of what we’ve heard pretty broadly from consumers and people across the industry. The first Dolby Cinema AMC prime location is opened on May 21st. There are currently five sites opened and they are at some of the highest grossing complexes in the U.S. We expect to have 10 by the end of this summer and eventually up to 100 across the country. To-date seven titles have been experienced at Dolby Cinema at AMC Prime including Tomorrow End, San Andreas and Inside Out. We have seen increasing studio support for content optimized for Dolby Cinema. Last quarter Disney and Pixar were the first studios to announce their commitment to create Dolby Vision theatrical titles for release in Dolby Cinema. Since then, I’m excited to share with you this, six additional studios have released or announced Dolby Vision theatrical titles including Warner Brothers, Sony, Paramount, Universal, 20th Century Box and Lions Gate. Upcoming titles include Mission Impossible Rogue Nation, Everest and the Hunger Game’s Martin Jay Part II. This quarter we also had a second location opened with JT Bioscope in the Netherlands and it really does look spectacular. We’re expanding our footprint in Europe as just yesterday we announced that we are partnering with Cineplex to open six Dolby cinema locations in Austria. Dolby Cinema is off to a great start and we will continue to work with our partners to deliver the ultimate Cinema experience. Last quarter we announced a significant milestone for Dolby Vision for the home as the first TV with Dolby Vision was announced by Vizio. The new Vizio reference series will feature Dolby Vision and is the most sophisticated and technologically advanced TV made by Vizio. We will continue to work with TV OEMs and silicon providers to bring more Dolby Vision televisions to the market. Let me turn to Dolby Atmos which continues to get broad adoption in the cinema and beyond. There are now over 1,200 streams committed globally and more than 300 titles released or announced in Dolby Atmos. We have a strong slate of upcoming titles including Pixels and Fantastic Four. Dolby Atmos for the home also continues to gain momentum. Dolby Atmos is now included in about 40 AVRs Home Theatre in a Box system from many of the leading providers. Dolby Atmos is also being included in speakers from 10 manufacturers with 15 models launched or announced. Furthermore, we are now seeing a broader adoption of Dolby Atmos in the home as it is being integrated at lower price point in both AVR and Home Theatre in a Box systems. Recently Onkyo announced an AVR retailing at $499 with Dolby Atmos. An increasing amount of content in Dolby Atmos for ‎Blu-ray has also been announced. We have partnered with HBO to release Game of Thrones in Dolby Atmos. We’re excited to work with HBO and the momentum we have around Dolby Atmos content for the home. Dolby Atmos continues to be adopted beyond the cinema and home theater as our immersive audio provides unparalleled richness and depth in an increasing number of applications. Dolby Atmos is currently incorporated on a number of mobile devices and we are seeing very compelling applications in virtual reality and in gaming as both of these experiences benefit from the placement of audio objects. Last quarter we discussed our partnership with Jaunt, a provider of virtual reality content who’s bringing Dolby Atmos in this new and growing experience. As it relates to gaming, I’m excited to share with you that Star Wars Battlefront from Electronic Arts will be the first Dolby Atmos gaming title for the PC and will be available in time for the holidays. Turning to Dolby Voice; our partnership with BT continues to gain traction as over 70 customers have signed up for the BT MeetMe with Dolby voice service up from 25 at the beginning of our fiscal year. The service is now globally available and is currently integrated into BT’s Cisco WebEx and Microsoft Lync services. More importantly a number of the largest customers are currently in implementation. Once these customers are fully deployed we are in a position to share minutes revenue and we have the opportunities to sell Dolby conference phones to complete the Dolby Voice experience. We feel good about the pipeline of customers implementing over the next six months and the opportunities beyond that. As I look at the strength of our core business across the diverse and increasing number of end markets combined with the increasing momentum we are seeing around the employment of Dolby Cinema and the implementation of the Dolby Voice service. I'm confident about the opportunity we have to deliver our sustainable long-term and double-digit growth. We still have a lot of work to do and I look forward to updating you again next quarter. With that I will turn it over to Q&A.

Thank you, ladies and gentlemen. [Operator Instructions]. And we will take our first question from Steven Frankel with Dougherty.

Hi, good afternoon. Kevin, maybe you could start by updating us on where the U.S. is in considering a next generation audio standard for broadcast?

Sure. So a lot of work going on in that area and of course we are very focused on that and on the one hand we’re engaged with the number of potential early adopters at the same time the ATSC I’m sure you are aware is in consideration of the - is considering the next generation codec. We’ve been highly engaged in that process, there was recently an event where we were showing them what we can do. We think we have a fantastic solution that both increases efficiency and also opens up possibilities for new and enhanced audio experiences. And so we feel good about where we are at this stage in the game I still think we’re still think we’re still ways off from any broad implementation, but I think it won’t be long before we potentially see some of the early adopters.

And so what’s the ATSC deadline? When are they going to decide and when might it be implemented?

I was catching up on that this morning and I don’t think we have a firm date from them. So what we know is that they have been highly engaged they are deep into the process. But I wish I had a specific date that would be great. But I really unfortunate I don’t have one.

Okay. And then for Lewis, there were two puts and takes in the quarter that seemed significant. So could you size the PC back payment because I thought PC was supposed to be down double-digits in the quarter? And then maybe give us a rough idea of the positive impact from that software settlement that reduced expenses.

Yeah, both were in the neighborhood of few million dollars.

So this big drop sequentially in R&D should we think about that as the new run rate or was there something else that went on in the quarter that pair that back?

Yeah, so the bulk of that shift was due to the software issue that you mention and usually we don’t climb into this level of detail. But from a quarter-on-quarter stand point we were accruing some amount last quarter and in this quarter we’ve resolved it. So there is a little bit of double win from those two and when I normalize it out, the R&D activity has continue to proceed as we expected. And on the PC side we don’t typically break out those numbers separately per se, it’s a single-digit number sort of mid-single digits millions of dollars.

Great, thank you.

We’ll go next to Mike Olson with Piper Jeffery.

Good afternoon. I asked a similar question last quarter regarding some of the new initiatives. But I am curious on the latest thinking around, which of those initiatives between Dolby Vision, Cinema and Voice that you feel could be kind of the first to provide a material revenue contribution. I know you’re working on integrating Vision on some TVs for later this year and you are already in five Dolby Cinemas out there it sounds like that’s going to ramp quickly. I would guess it’s one of those two maybe more so than Dolby Voice, but how would you characterize that?

Sure. So looking at the new initiatives overall I do see that portfolio being a factor in our growth rate for next year. In terms of time to revenue as you say, Dolby Cinema is now in the market. It went in May 21st was the first showing. So it was late in the quarter, but we’ll get reports this quarter and we’ll begin, that will begin contributing to revenue. And as I said we’re expecting to have 10 Dolby Cinema at AMC prime sites by the end of the summer. They’ve been a fantastic partner I am really happy with how that’s progressing. We’ve also got a couple in Europe now and more on the horizon. So Dolby Cinema should contributing to revenue next year and we’ll keep you updated that as we go into the next quarter. As it relates to Dolby Voice, as I said in my remarks, we’re really pleased with the number of customers that have signed up for the BT MeetMe with Dolby Service and notably a lot of the larger customers are moving into implementation now and are going online anytime between well now and at the end of the calendar year. So as you’ll recall that we earn revenue from ports which is the capacity to offer these services. And then a share on the Dolby Voice minutes revenue and the opportunity to sell our Dolby Conference phone. So it’s when these companies go live that does last to revenue streams kick in. And so I think the next six months will be an exciting period for us as we get these large accounts into implementation and begin to encourage usage and the use of the Dolby Conference Phone. And of course and so we do see that being something where we’ll begin to see some of that as we go into the next year. Dolby Vision as you noted Vizio will ship the first Dolby Vision Television and of course we have content that’s ready to go those devices we have distribution partners. And I think in terms of ramping the revenue, we’re looking at first shipments towards the end of ‘15. So that’s probably in terms of time, it's probably time to revenue it's kind of in that order. And I think that again as a portfolio I do see it being a factor in our growth rate next year.

Alright, thanks very much.

Go next to Ralph Schakart with William Blair.

Good afternoon. Two questions if I could. First, Lewis just question for you maybe it’s a point of clarification. When you talked about PCs and consumer electronics being soft due to overall sort of consumer weakness is that sort of more macro commentary or would you sort of also suggest that perhaps PC and CE are more of aging product category? And then second just on broadcast being up 7% year-over-year and I think account for flat growth it's kind of declined on year-over-year growth rate is that product category also sort of maturing or is it just a timing issue on that growth rate? Thanks.

Sure, first of all yes. Almost all the comments we’re making about softness relate more to the macro. The PC macro is pretty well known you’ve already had some pretty big players out there comment and what they’re seeing in the PC market there is well published data on TAMs. So what we’re adding onto that is just the data we see broadly in CE, TV set top boxes which does affect broadcast. Almost all of our tone here is about the macro environment which, as you know, we really don’t control in terms of our share of market and our activities internally that’s going fine but really it’s a macro comment. And in some cases there could be some timing and maturity so in PC space we’ve talked for a little while now about as the PC has evolved to more and more don’t have optical disk that can effect does in terms of mix of pricing. So I wouldn’t call that a macro issue per se is a more specific to Dolby. But this quarter we actually did a little better in PC because of some these back payments. But going forward what we’re projecting for Q4 is probably similar to what we’d thought a quarter ago.

And just to elaborate on that, Ralph we do continue to see growth opportunities in broadcast. So the reference to the flattish outlook in Q4 really reflects the industry estimates we’ve for softness in consumer demand going into Q4.

Okay, thank you.

We’ll take our next question from Paul Coster with J.P. Morgan.

Hi, this is Paul Chung on for Paul Coster. Thanks for taking my question. A couple of quick ones from me. So R&D levels remained at elevated levels at least on an absolute dollar basis even though they came down sequentially. What magnitude of decline do you think we should expect if any of these new initiatives do take off? I guess where I’m trying to get to is where you can think your run rate for R&D and overall OpEx is in the scenario you see in high single-digit, double-digit growth?

So maybe I could swipe that up even to overall OpEx.

Okay.

We’re going to a trend right now where three or four years ago the OpEx was growing call it 10% or 12% or more percent but here in this year it will be I think maybe at our peak maybe as much as 15%, 16%, in fact in 2012 OpEx on a non-GAAP basis grew 16%. This year it will grow closer to 8% and what Kevin and I committed to doing is two things getting the company to a point where we can drive double-digit long-term growth in revenue and also we feel like we already are leveling off to growth rate in OpEx. We really haven’t given any forward-looking comments beyond next quarter for R&D and as announced I don't think I can give you any specific number right now. I don’t think that will be appropriate. But overall we do feel like we have invested significantly in that relationship between our OpEx and revenue is now close to a point that’s close to our business model. Now that does not mean, I mean your question inferred that somehow we said we’re going to cut R&D expense next quarter I don’t think we said that at all. So I just want to make sure you didn’t somehow pickup something we said that we didn’t.

Got you. Also finally what’s your sweet spot for cash at above a $1 billion? I know you mentioned an increasing buybacks are expected, but what magnitude can we expect given the stock levels are? Thanks.

Yeah. I think the overall envelope that I highlighted in my comments is we currently already have $212 million of dry powder that’s been approved by the Board and in recent quarters most of our buyback has been to keep our outstanding share level and what we are signaling is that we expect to increase that level going forward and the envelope we are working within of course is $200 plus million and on top of that we also are signaling that we do expect to grow the dividend. In terms of an optimum number I don’t know that I can just give you one number right now. But we would expect to see that we will bring the cash balances down as a teeter totter to the increased buyback. So why we disagree that we’ll update on this topic every quarter.

Okay, thank you.

We’ll take our next question from Eric Wold with B. Riley.

Thank you and good afternoon. I know you are not kind of giving forward guidance beyond the Q4 guidance at this point. Just I’m thinking on a broader level to the original $970 million to $1 billion revenue guidance that was given for this year, which is now $970 million to $980 million, can you walk through the major drivers of that that brought that down from where you thought it would be originally and then of those drivers kind of looking forward where you see them maybe remaining as a continued risk or an opportunity to improve from there.

Yeah, thanks Eric. I’ll kick off the answer now and ask Kevin to add some color. So let me give you from a magnitude standpoint. If you look at the full year guidance we have brought down quite a bit on the product and services side and we’ve only just nudge down licensing this quarter because all through this year we’ve either on track or beating licensing and even the quarter we just reported, we were expecting 205 in licensing and we essentially got 205 and next quarter we’re bringing it down slightly and all of that is due to this macro comment that both Kevin and I commented on earlier. So we feel pretty good about the licensing and we had some expectations this year of our products and services, it’s going through a maturation phase we’ll make the best project we can and have adjusted. Going forward I actually think there is some good news coming eventually, because we’re going to see new products coming out of the merger between Dolby and Doremi. Also as Kevin mentioned on the Voice area as these customers start to implement and sort of utilizing BT MeetMe Dolby Voice we think that opens up an opportunity to increase product revenue there from the Dolby Conference Phone. But in terms of the year-on-year adjustment from the range of $970 million to $1 billion, now $970 million to $980 million a large chunk of that was just a decline in the product and services revenue and a little bit of an adjustment in the licensing for the current environment.

And just quick follow-up on that, how should we think about timing for the new products coming out on the Doremi side or I guess Doremi/Dolby side?

Yeah we’re still working on that for example just this quarter we released the new product that was in development at the time that we brought Doremi, it’s the next generation integrated product for the Cinema. And so I would say that we're high on track. In fact if anything that trend will be probably be detected more by industry trends in terms of when people start to do their refresh then necessarily our activity although there is obviously a matching up of those two things we have to be ready when they want it. So the timing I think the timing will probably sort of level out bottom out and start picking up hopefully sometime next year.

[Operator Instructions]. We’ll go to our next question with Jim Goss with Barrington Research.

Thanks. First I’d wonder about the other figure that tapped me a little bit was your licensing cost revenues were lower than they intended to be and I was wondering why and what that carryover into the fourth quarter? And I was also wondering about potential ASPs, and Windows 10 versus Windows 8 if you have a better situation than you did as you’re moving into that transition?

Yeah so let me first thing to comment on the licensing cost of goods sold, Jim. When the number is that small we’re going to have some fluctuations quarter-on-quarter. I think longer term we have been running in that kind of 98% gross margin for licensing give or take. So I would say quarter-on-quarter it’s going to move around we might have some timing issues on when we pay royalties on third party patents that we own. But I would say the model that we’ve been running if you just average over a number of quarters there is nothing significant that’s changed. And I am sorry what was the other half of your question?

Okay. See Windows 10 inclusion versus Windows 8. It seem like that was a struggle last time, this time it seems like a better situation and I was wondering do you have higher ASPs and does this a more optimistic environment there?

No I would say in general we would view the Windows 10 is being good because it continues the track that we’re currently on. And Kevin already said in his prepared comments that from organic business standpoint, it’s nice because it really expands the envelop of how people can enjoy content through Dolby both from an economic standpoint just think of it as a continuation of what we are doing now.

Alright thank you.

Okay, operator do we have any other questions?

There are no more questions at this time. So I'll turn the conference back to Kevin Yeaman for any closing remarks.

Okay. Well thank you everybody for joining us. And we look forward to updating you again next quarter. Thank you.

This concludes today’s conference. Thank you for your participation.