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

Mike Olson - Piper Jaffray Paul Coster - JPMorgan Steven Frankel - Dougherty & Company Ralph Schackart - William Blair Jim Goss - Barrington Research.

Presentation:.

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference call discussing fiscal year first quarter results. [Operator Instructions] As a reminder, this call is being recorded Wednesday, January 21st, 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 Dolby Laboratories' first 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 the earnings press release that we issued today under the section encaptioned Risk Factors, as well as in our most recent Form 10-K.

Dolby assumes no obligation and does not intend to update any forward-looking statements made during this call as a result of new information or future events. During today's call, we will 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 Web site.

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 and good afternoon everyone. And let’s start with first quarter revenue which came in at $234.2 million for the quarter. Within that total, licensing was $216.6 million and products and services were $17.6 million. The licensing revenue was above the high end of our projected range, while products and services fell short.

So let me review the revenue in more detail starting with our licensing which I’ll discuss by major markets. Broadcast represented about 41% of total licensing in the first quarter. Revenues in this market were down sequentially by about 9% driven by lower unit volume and less back payments.

Year-over-year Q1 broadcast licensing grew about 21% as the tax rate increased in both set-top boxes and TVs. PC revenues represented about 16% of total licensing in the first quarter. They were down about 12% sequentially and about 18% compared to last year’s first quarter.

Both of these declines were greater than the overall PC market mainly because of lower mix of optical disc enabled PC that were reported to us which affects the revenue per unit that you receive. Consumer electronic revenues in Q1 were about 15% of total licensing.

They were up about 11% sequentially driven by higher volume across a broad variety of home electronics. The year-over-year consumer electronics decreased about 21% due to lower back payments and lower volume on Blu-ray DVD and home theatre in a box.

Mobile devices represented about 16% of licensing revenue in Q1, they were up more than 40% sequentially and also up 11% year-over-year, as we benefited during the quarter from higher ATAC royalty screens due to timing under our contract with the licensee.

Now this level won’t repeat in Q2 and therefore we anticipate that mobile will drop back down to around 12% of our total licensing in the second quarter. Revenues in other markets represented approximately 12% of total licensing in the first quarter.

Revenues were up about 37% sequentially in Q1 and more than 40% year-over-year driven by higher revenues from gaming, Dolby Voice and automotive. Product and services revenue was 17.6 million in Q1 which was slightly below Q4 but down about $8 million year-over-year, this was lower than we had projected due to a combination of the following factors.

In early November we completed the acquisition of Doremi Labs and sales of Doremi products post acquisition were below the original estimates as we worked our way through the first couple months of transition. In addition, market demand was a little softer than expected which impacted Dolby mature products.

However sales of Dolby Atmos products were on track with our original projections. Total gross margin in the first quarter was 91.7% on a GAAP basis and 93.0% on a non-GAAP basis. Product gross margins on a GAAP basis was 5.1% in the first quarter compared to 25% in Q4 and 23.8% in last year’s first quarter.

And product gross margin on a non-GAAP basis was 17.2% in the first quarter compared to 31.9% in Q4 and 28.9% in last year’s Q1 and the decrease was primarily driven by excess in obsolete inventory charges.

Operating expenses in the first quarter on a GAAP basis were $161 million compared to $156.2 million in the fourth quarter and on a non-GAAP basis operating expenses were $141.7 million in Q1 compared to $138.4 million in Q4.

Operating income in the first quarter was $53.5 million on a GAAP basis or 22.9% revenue and $76.1 million on a non-GAAP basis or 32.5% revenue. The effective tax rate for the quarter was 22.8% on a GAAP basis and 23.1% on a non-GAAP basis.

Our Q1 taxes benefited from a retroactive reinstatement for the 2014 R&D tax credit that was signed in [indiscernible] during December. Net income in the first quarter was $41.4 million on a GAAP basis or 17.7% of revenue and was $58.5 million on a non-GAAP basis or 25% of revenue.

Diluted earnings per share in the first quarter were $0.40 on a GAAP basis compared to $0.44 in the fourth quarter and $0.43 in Q1 of last year and on a non-GAAP basis Q1 diluted earnings per share were $0.56 compared to $0.58 in Q4 and $0.59 in Q1 of last year.

Cash flow from operations was only a few millions, but that included about $68 million of minuses just from changes in receivables include liabilities, which was related mainly to timing issues specifically to Q1 and I don’t expect that every quarter, so we had some or all of that back to normalize that you get an operating cash flow that looks lot more typical for us.

During the quarter we repurchased about $17 million of our common stock and have $243 million of remaining stocks repurchase authorization and we also today declared a cash dividend of $0.10 per share similar to last quarter and this dividend will be paid on February 10, 2015 to shareholder record on February 2, 2015.

As of the end of Q1 we had $939 million in total cash and investments which includes cash and cash equivalents as well as both short and long-term marketable securities. So looking forward here’s the outlook for Q2 and the full year. In the second quarter we estimate that total revenue will range from $260 million to $270 million.

Within that we anticipate that licensing revenue will range from $230 million to $240 million and products and services revenue combined would be about $30 million. We anticipate that our PC licensing revenue will decrease by 15% to 20% from last year’s Q2, mainly because of lower mix.

And also worth mentioning in the broadcast category our second quarter revenue will be down year-over-year but only because of the $25 million back payments that we received last year in Q2 that won’t repeat this year. Excluding that item broadcast revenue should grow in Q2.

Gross margin in the second quarter is estimated to range from 90% to 91% and 91% to 92% on a non-GAAP basis. Operating expenses in the second quarter are projected to range from $171 million to $175 million on a GAAP basis and from a $152 million to $156 million on a non-GAAP basis.

Other income in the second quarter is expected to be approximately $1 million and our effective tax rate for the second quarter is estimated to range from 25% to 26% on both the GAAP and non-GAAP basis.

So based on the combination of the factors I just went over second quarter diluted earnings per share are projected to range from $0.45 to $0.51 on a GAAP basis and from $0.60 to $0.66 on a non-GAAP basis.

Moving on to the full year, we estimate that total revenue for fiscal 2015 will range from $970 million to $1 billion and within that we anticipate that licensing will range from $860 million to $880 million and products and services combined will range from $110 million to 120 million for the year.

Full year operating expenses are estimated to range from 664 million to 674 million on a GAAP basis and from 585 million to 595 million on a non-GAAP basis. We estimate that full year gross margins on a GAAP basis will range from 89% to 90% with non-GAAP gross margins roughly about a point higher.

Other income is estimated to be around $4 million for the year and the effective tax rate for the year is estimated to range from 24% to 26%.

So now, I’d like to turn the call over to Kevin Yeaman, Kevin?.

The Battle of the Five Armies, American Sniper and Unbroken, just last week all of three of these were nominated for academy awards in the sound categories. Within the cinema market we see the highest growth coming from the premium large format segment.

Exhibitors are making large investments in this space to create new and more exciting venues that will attract more moviegoers. In recognition of this, we introduced Dolby Cinema this quarter, a solution that uniquely incorporates our leading audio and imaging technologies. Dolby Cinema is a highly differentiated experience.

It combines Dolby Atmos thermos of audio, Dolby Vision laser projectors for an unparalleled visual experience as well as inspired design.

Through Dolby Cinema exhibitors are able to offer a unique premium experience, moviegoers experience the cinema the best way they can and Dolby is engaged with the content community to further develop the pipeline of content in Dolby Vision and Dolby Atmos.

In December, JT Bioscoop in the Netherlands opened the first Dolby Cinema with very positive reviews. We’ll keep you posted on future Dolby Cinema sites. Beyond bringing Dolby Vision to the big screen, we continue to make progress on bringing Dolby Vision to the home.

Dolby Vision is our end to end imaging solution, which gives creative teams, the freedom to use the full gamut of colors, brightness and contrast, resulting in an enhanced entertainment experience. We kicked off the high dynamic range conversation last year at CES with the announcement of Dolby Vision.

This year at CES, HDR demonstrations were seen everywhere as it appears that the market is now ready for Dolby Vision. What we are offering with Dolby Vision is a scalable, commercially available end to end solution from content creation through delivery and playback.

Another sign that the market is ready for HDR is the movement from the industry to create the UHD Alliance. Dolby is one of the founding members of the UHD Alliance and we’ll contribute to establishing standard to support innovation in video technologies, which will include HDR for broad adoption.

Warner Brothers has recently announced that they will be mastering titles in Dolby Vision. The first slate of titles will include recent blockbusters like Edge of Tomorrow, Into the Storm and the Lego Movie. At CES, Netflix announced plans to stream content in Dolby Vision in 2015.

We are well on our way to creating a strong pipeline of Dolby Vision content for the cinema and the home. We continue to expect the first TV using Dolby Vision to ship in the first half of calendar 2015. Lastly, let me touch on Dolby Voice.

This quarter we began shipping the Dolby Conference Phone which further extends the quality experience we can provide with our offering. So let me wrap up with a few reflections as we enter the new calendar year. As you know, we’ve gone through a cycle of R&D investment in order to fuel innovation and open up new areas for growth.

At the same time, we significantly expanded our presence in online, mobile and digital broadcast, offsetting secular declines in PC and optical disc and developing new ecosystems in which to deploy our new solutions.

These efforts have resulted in platforms for breakthrough audio, imaging and voice experiences, which has yielded offerings we discussed today; Dolby Atmos, Dolby Cinema, Dolby Voice and Dolby Vision.

In the year ahead, I expect our efforts to result in commercial wins, further giving you data points on our progress towards establishing a strong foundation for long term revenue growth. I look forward to keeping you updated throughout the year. Operator, we’re ready for questions..

Thank you [Operator Instructions]. And we’ll take our first question from Mike Olson with Piper Jaffray..

Good afternoon. Couple of questions, first of all, broadcast continues to be an area of strength.

Is that primarily due to international penetration in new markets with digital broadcast standards that include Dolby? And if that’s the case can you just talk about maybe where we are on that spectrum at this point for worldwide penetration?.

Yes, it is adoption in international markets, emerging markets, in particular, which is driving the growth in broadcast. We’re still, in terms of the roll out of digital broadcast and use of digital broadcast, still in the pretty early stages in markets like China and India and Africa. The areas I highlighted on the call.

Our catch rate is actually a little ahead of that adoption given some of the manufacturers that have gone through single SKU of Dolby Digital Plus around the world. But we still see a really good opportunity for growth in emerging markets over the coming years as they continue to roll out there.

And we continue to set our sights on new offerings for those markets as well..

Thanks. And then you talked a lot about Atmos Dolby Vision. I realize those could be for both home [indiscernible] Cinema but you also just talked about Dolby Cinema overall.

So between that and the Doremi acquisition would it be fair to suggest that the company is shifting focus to some degree back towards theatrical technologies maybe a slightly less emphasis on the in-home market?.

Well, we’ve always been focused first and foremost on delivering compelling experiences and working with the content community whether that’s theatrical, episodic television, sports and working beyond that.

We are looking to apply our science of sight and sound to deliver compelling experiences and our aim is to do that across all the channels and all the use cases through which customers enjoy that.

So, I wouldn’t say that this represents a change in focus at all, but I do think it is a result of the innovation that we've invested in the last several years. We have really unique and differentiated experience to offer to the theatrical industry.

At a time where exhibition is really investing in differentiated experiences, the premium large format market is an area where they are seeing some growth and seeing that when they invest in the experience that moviegoers respond and we’re seeing excitement from Hollywood and from content creators around the world with the opportunity to really extend their pallet with Dolby Vision and Dolby Atmos.

And of course at the same time we’re looking at developing that pipeline of content and bringing those experiences to the home with consumer Atmos for the home and Dolby Vision..

We will take our next question from Paul Coster with JP Morgan..

Thanks very much.

I’ve got three questions actually just wanted to sneak them in, first one, you talked about higher tax rate set-top box and TV, can you just also talk about the value of the attach per unit as you go into emerging markets? And are we including Dolby Vision in that number is it a material amount?.

Hey, Paul. This is Lewis. As you know, we don’t historically breakout ASPs but I would say as a general comment that the broad profile of our ASP doesn’t came dramatically before we talked about this quarter and none of that attach rate is Dolby Vision.

So, the ASP already are sort of mix to cost different customers in a region then there is no major shift this quarter..

Okay, Dolby Vision, my experience from CES is the product for CHC is the product that probably see on the shelves in the holiday season of the same year and although you’ve got a couple of Dolby Vision adopters out there, the mainstream high definition for 4K TVs which probably represent the next upgrade cycle in North America and Europe, don’t look -- are they going to be including Dolby Vision at least this year.

Am I correct in saying that and really when we think of Dolby Vision are we to think of it as a calendar year ’16 opportunity..

I think when I look at -- first of all, I think the prominence of HDR at CES really speaks to the market readiness for a high contrast wide color gamut solution like Dolby Vision and I think when I look at the on the content side of things we’re going to see OTT content available this year in Dolby Vision.

I think that whether we look at terrestrial broadcast, Pay TV operators Blu-ray all are in discussions who are involved in those discussions in collaborating with those industries as to the best way to deliver HDR content to the home.

And so I think that what you're seeing on the TV side is becoming clear that it's a worthwhile investment to start thinking about higher brightness, higher contrast television because the content is going to be coming.

I think by the time it all comes together on a broad scale, yes 2016 is probably a good way to think about it, we’re going to see in the first-half of this year you’ll see the first Dolby Vision TV and you will see content available for that TV..

Okay, last question.

You talked of this investment phase -- R&D phase that we've been through, and yet looking forward the pro forma operating expenses continue to escalate, shouldn’t we see a moderation moving forward?.

Well, the investment in R&D and also in sales and marketing as we bring these to market is we still continue to plan on investing in these opportunities.

What you should see is the early data point which shows this is leading to where we intended to lead, which is returning to sustainable long-term double-digit revenue growth that’s where we intend to be and we see signs that are investment in the last several years is poised to pay-off as we enter 2015 looking to build on the momentum we've gained in each of these new initiatives..

And we’ll take our next question from Steven Frankel with Dougherty & Company..

Good afternoon, Kevin. Let's start with Doremi.

So the weakness in the quarter is that the sign of market that’s close to saturation or perhaps just an integration/execution issues that got in the way of doing business?.

Yes I would say that a more minor element of that story was market driven. I would actually take that on our side that we optimistically felt like we’ve just hit the ground running at day one.

And as is always the case, when you close a deal mid-quarter there is some transition time, but we feel pretty good about understanding what that was and in fact one of the things we discovered was some of the Doremi customers were ordering product just slightly in advance to the close of the deal just in case there was any logistical transition issues.

And that affected the total amount of shipments we were able to make during the quarter, but yes I mean we feel very good about the Doremi product line.

And we are obviously once you do a deal like this going to look at rationalizing between the product lines, the ultimate premise of the deal was that we could uniquely offer combined integrated solutions that would be very desirable to our customer base and that’s what we’re going to push forward for..

And Kevin I know you love to do this, but maybe you could help us a little bit understand the business model for Dolby Cinema and in the U.S. the changes spend a lot of money building their own brand, do you think you end up co-branding in the U.S.

if you’re successful selling in here or do you subsume your name to an RPX or an ETX?.

So to answer the first part of your question, we see this -- this will be a revenue sharing model with exhibitors. And we do think that that the experience is very compelling and it will be going to be very attractive to North American exhibitors as well as exhibitors around the world.

We expect it to carry the Dolby Cinema brand and I think the extent to which how that interplays with any existing DLS brands, I think we have to -- I don’t want to speculate on that..

And we’ll take our next question from Ralph Schackart with William Blair..

Just looking at the licensing guide up for the year, just curious what the factors were behind that and was it mainly broadcast driven? And then maybe just sort of bolting on to that question, Lewis you called out Voice and the other category just curious is that sort of contributing on a measurable basis now to the financial results? Thanks..

Yes so in the quarter if I look at all of our different markets, the two that actually ended being on the positive side as I reported was broadcast and mobile and then on the minus IPC and net net what we’re seeing for the full year is that the net positive wins over the negative. Yes broadcast is clearly our most steady growing business right now.

We actually have a slight uptick in the year versus our original expectations on mobile.

And then second half, what was second half of your question again Ralph?.

On Voice, is that at a point now where -- yes..

Yes so Voice, we did see revenue in the other category this quarter and as I said probably before we’ll keep that in other until it becomes big enough to breakout similar to what we did with mobile when it got to a significant enough percentage we broke that out.

A chunk of that revenue came from contractual licensing arrangements we had with our customer and I think it will be further down the road when we see more revenue coming purely from the revenue share model that we have..

And we’ll take our next question from Jim Goss with Barrington Research..

I've got a few about Dolby Vision and the Dolby Cinema.

First, with Dolby Vision, does it complement or compete with 4K and 8K advancements and my understanding is its broader color pallets, more subtleties, so does it just basically make greater use of the greater resolution and that’s how this form works?.

It is complementary to resolution. It could be complementary to 2K, 4K, 8K. It’s not dependent on a particular display type. The way to think about it is that in for many years now the industry has been capturing more dynamic range, more contrast, wider color gamut, than consumers have been able to see on their displays at home or in the cinema.

And so most of that information the higher dynamic range was getting left on the cutting room floor to fit it into the formats for delivery that were developed in many cases decades ago. So what Dolby Vision does, is it allows one to master the content to take advantage of the full dynamic range of the color gamut.

It allows one to deliver that content through OTT, through broadcast, through the cinema delivery chain. And then it allows you to play it back on the other side, bring it to full life including for TV displays being able to do the display management, to take that signal and optimize it for the capabilities of that display.

I think it opens up a really exciting area of innovation for TVs because it is absolutely complementary to resolution, 3D, all the other features that we’ve talked about and we've been working on this for really over five years, probably about seven years now.

That’s when our team first really focused on the area of HDR and contrast as the dimension that could have the single biggest impact or the quality of viewing experience. And that’s what we are so far seeing in our interactions with the creative community and with the initial what we’re seeing on displays..

And would it incorporate or obviate the need for 3D? I know you’ve had a position in 3D; it’s really sort of taken a back seat I think lately. And once you got the settle that Dolby Vision can create, does it create the depth perception that you might need without going to 3D and therefore that would change that dynamic..

So it is as I said earlier; it is a complementary dimension to depth. I will say that when done really well with high contrast ratios and wider color gamuts you begin to proceed depth and it’s not 3D per se but the brain response to the higher contrast details and the higher color range by beginning to perceive more depth in the picture.

So that said, it’s complementary but I think that we believe that this is a real wow factor as people think about the next generation of theatrical and consumer delivered content..

Finally when you mentioned the rev share mode, do you envision the premium price for Dolby Vision enabled films or Dolby Cinema with that plus Atmos? Or do you think it just sort of works into the model over time and that you think the theatre owners would be happy enough to have this imaging that they would share some of the tech price..

Well we do see this as being an offering in what’s known as the premium large format market and that market is characterized by higher prices than your standard screens.

In the case where somebody is converting an existing PLF to a Dolby Cinema, I can’t really speculate on whether they would further increase the price or not, and I think in the case with our converting, creating a new PLF we would expect that would be at a premium price, that is part of the value proposition as to create a highly differentiated experience and that movie goers will take notice of and want to experience, want to come back to and creators are going to be excited about taking advantage of..

And we’ll take follow up question from Paul Coster with JPMorgan..

The guidance for the year and the quarter suggests to me that we’re seeing over the last few quarters the year-on-year revenue growth decline and the rate of growth decline. But it looks to me like the guidance sort of looks for a reacceleration in the second half of the fiscal year.

Is that correct? And if so what you think the drivers of that reacceleration are?.

I think that’s a fair question Paul, the level of precision you’re referring to is a little tricky, because the number didn’t move around that much. Our guidance that we’re giving this quarter for the full year the same as we gave last quarter recognizing of course that this quarter we fell off slightly shorter than that.

So I don’t know that there is a big change, I think I had an earlier question about what was causing us to feel more optimistic and what areas were going up and I said that broadcast continue to be a strong area, that mobile is a little bit stringer for us this year as we sit here right now than we thought at the beginning of last quarter.

It’s really hard for me to characterize anything as reacceleration, I do think as we work our way through the year, there is more opportunity for some of these things that we’ve already talked about that Kevin alluded to start showing revenue.

In fact I had that specific question on voice and it’s really hard for me right now to give a lot of specifics on voice because it is lumped into other. But clearly we see voice as being something going forward as fundamentally only a growth story. There is really nothing to come down from, it’s a secular positive in every shape for us.

And product is something right now that it’s a little bit lumpy, because we just acquired another company, we’re very optimistic going forward about what we can sell. But in the near-term here we’re actually throttled back a little bit for the year our product expectations until we work our way for the transition.

Maybe if we get further down into the year Paul, maybe easier for me to address that as we see more of the year play itself out..

[Operator Instructions]. Okay, thank you everybody for joining us today. As we said we’re excited as we move into calendar 2015 with the new offerings we’ve got, these new experiences which we look forward to sharing more with you about as we go throughout the year. Thank you for joining..

Ladies and gentlemen that does conclude today’s presentation. We appreciate everyone’s participation..