Elena Carr - Director of Corporate Finance and Investor Relations Kevin Yeaman - President and Chief Executive Officer Lewis Chew - Executive Vice President and Chief Financial Officer.

Mike Olson - Piper Jaffray Steven Frankel - Dougherty & Co. Eric Wold - B. Riley Ralph Schackart - William Blair Jim Goss - Barrington Research.

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal second quarter results. During the presentation, all participants will be in a listen-only mode. Afterwards, you’ll be invited to participate in a question-and-answer session.

[Operator Instructions] As a reminder, this call is being recorded, Wednesday, April 27, 2016. 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 second quarter 2016 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 a section captioned Risk Factors as well as in our most recent 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 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 status sheet on the investor relations section of our Web site.

As to the content of this call, Lewis will begin with a recap of Dolby’s financial results and provide our fiscal 2016 outlook and Kevin will finish with a discussion of the business. So with that introduction behind us, I’ll now turn the call over to Lewis..

Thanks, Elena. Good afternoon, everyone. I’ll start off by reviewing our second quarter revenue along with some comments on the different market segments that we serve and then I’ll review the rest of the income statement for Q2 along with the balance sheet. And then I’ll wrap up my section with the outlook for the third quarter and for the full year.

Total company revenue in the second quarter was $274 million, of which licensing was $249 million and product and services were $25 million. Q2 licensing revenue in total was about $6 million higher than Q2 of last year.

Within licensing, for the company overall, the main reason for the sequential increase in licensing revenue in Q2 was seasonality, even though the growth percentage would vary by market segment. So I will focus my explanatory comments on the year-over-year changes within each of the various market segments.

Broadcast represented about 45% of total licensing in the second quarter. Revenues in this market were up sequentially by about 9%. Year-over-year, broadcast was up by about 10%, driven primarily by higher back payments and also from higher volume in set-top boxes.

PC revenues were about 16% of total licensing in the second quarter and PC licensing was up sequentially by about 26%. On a year-over-year basis, PC licensing was nearly the same as last year’s Q2. And in that case, market volume was down, but that was mostly offset by higher back payments.

Consumer electronics in the second quarter represented about 14% of total licensing and they were up about 25% sequentially. Year-over-year, consumer electronics were down about 7% due to lower unit volume in AVRs, Blu-rays and DVD players and also some lower back payments. And this was offset partially by higher volume in DMAs and sound bar.

Mobile devices represented approximately 11% of licensing revenue in the second quarter and they were up about 31% sequentially. On a year-over-year basis, mobile licensing was down about 2%, so we do expect an increase in mobile in the second half of the year. More on that when I provide the Q3 outlook.

Licensing revenues in other markets comprised about 14% of total licensing in Q2. They were up sequentially by approximately 25%. Year-over-year, other market licensing was down by about 3% due to lower gaming back payments, offset partially by higher revenues from automotive and from Dolby Cinema.

Product and services revenue was $25 million in Q2 compared to $29.7 million in Q1 and $28.6 million in Q2 of last year.

As we anticipated, we saw a sequential drop-off in Q2 product sales following a stronger-than-expected Q1 that benefited from exhibitors upgrading some of their cinemas to get ready for a holiday movie release slate that included Star Wars episode seven.

And the year-over-year decline is mainly due to trends in general for the cinema equipment industry as the multi-year conversion cycle from film to digital is largely complete. So let me now cover the rest of the income statement. Total gross margin in the second quarter was 91.1% on a GAAP basis and 92.1% on a non-GAAP basis.

Product gross margin on a GAAP basis was 30.3% in the second quarter compared to 23.3% in Q1. And product gross margin on a non-GAAP basis was 38.1% in the second quarter compared to 30.5% in Q1. The increase in product margin was driven by better results related to our warranty programs and also by lower manufacturing costs.

Operating expenses in the second quarter on a GAAP basis were $167.6 million compared to $171.9 million in the first quarter. And then, on a non-GAAP basis, operating expenses were $139 million in Q2 compared to $150.9 million in the first quarter.

So what that means is operating income in the second quarter was $82.3 million on a GAAP basis or 30% of revenue and $103.8 million on a non-GAAP basis or 37.8% of revenue.

The effective tax rate for the second quarter was 19.4% on a GAAP basis and 20.5% on a non-GAAP basis, reflecting discrete items including a net benefit from the completion of tax audits. Net income in the second quarter was $67.4 million on a GAAP basis or 24.6% of revenue and was $83.5 million on a non-GAAP basis or 30.4% of revenue.

Diluted earnings per share in the second quarter on a GAAP basis was $0.66 compared to $0.30 in the first quarter and $0.56 in Q2 of last year. On a non-GAAP basis, second quarter diluted earnings per share were $0.82 compared to $0.48 in Q1 and $0.72 in Q2 of last year.

During Q2, we generated about $90 million in cash from operations and ended the quarter with $894 million in cash and investments. We bought back about 975,000 shares of our common stock in Q2 and we had about $75 million of stock repurchase authorization remaining as we began the third quarter.

We also announced today a quarterly cash dividend of $0.12 per share payable on May 18, 2016 to shareholders of record on May 9, 2016. Well, that’s the Q2 results. I’d like to move on now to cover our forward outlook.

First of all, we are expecting our mobile revenues to be higher in the second half of this year compared to the second half of last year. And that’s going to help drive our total company revenue growth in the second half.

There are some timing nuances between Q3 and Q4 that are a little different from our historical patterns, so let me walk you through the details of what we are projecting. We estimate that our total revenue in Q3 will range from $260 million to $275 million.

Within that, we estimate that licensing revenue will range from $240 million to $250 million, while products and services revenue should range from $20 million to $25 million.

Because of the timing of certain revenue between Q3 and Q4, we estimate that mobile will rise to about 20% of licensing in Q3 and then returned to about 12% or 13% of licensing in Q4. I’m just going to reread that one just really quick.

Like I said, because of the timing of certain revenue between Q3 and Q4, we estimate that mobile will rise to be about 20% of licensing in Q3 and then return to about 12% or 13% of licensing in Q4.

The net effect of this is that, for the full year, mobile will have increased to be around 13% to 14% of our total licensing versus the 10% to 11% of licensing run rate that we were seeing in the first half of the year and we see this higher number as our new annual baseline going forward, all else held equal.

We also expect to see a Q3, Q4 rise and fall in the PC revenue percentage. However, unlike the comment I just made for mobile, we don’t expect a net increase in the PC annual baseline going forward. And for broadcast, we expect revenue to be seasonally down in Q3, which is typical for us.

Gross margin in the third quarter is projected to range from 89% to 90% on a GAAP basis and 90% to 91% on a non-GAAP basis. Operating expenses in the third quarter are projected to range from $172 million to $175 million on a GAAP basis and from $154 million to $157 million on a non-GAAP basis.

Other income in the third quarter is projected to be approximately $1 million and our effective tax quarter for the third quarter is estimated to be around 26% on both a GAAP and non-GAAP basis.

So based on the combination of the factors I just went over, diluted earnings per share in the third quarter are projected to range from $0.47 to $0.53 on a GAAP basis and from $0.62 to $0.68 on a non-GAAP basis. Well, that’s Q3.

So over the full fiscal year 2016, we are maintaining the same overall range of revenue that we provided last quarter from $1 billion to $1.03 billion for the year. Within that, licensing revenue for 2016 is estimated to range from $905 million to $925 million and products and services should range from $95 million to $105 million.

Full year operating expenses are now estimated to range from $610 million to $615 million on a non-GAAP basis and from $685 million to $690 million on a GAAP basis. Full year gross margins on a GAAP basis are projected to range from 89% to 90% and non-GAAP gross margins should be about a point higher.

And the effective tax rate for the year is now projected to range from 23% to 24%, which reflects the discrete tax benefits that we realized in Q2. So with that, I would now turn the call over to Kevin Yeaman.

Kevin?.

Dawn of Justice. We are excited about the opportunity to provide an awe-inspiring Dolby experience for millions of consumers around the world. Finally, let’s talk about Dolby Voice. We continue to work with BT to roll out the BT MeetMe with Dolby Voice service to large customers around the world. And last year, we added a second partner.

This quarter, I was headed to Enterprise Connect and I was struck by all of the emerging areas that could also benefit from Dolby Voice. There are opportunities beyond traditional audio conferencing in areas of unified communication and collaboration. And we look forward to expanding our roster of partners as we move forward. Let me wrap up.

So far this year, we’ve made great progress. We are expanding our leadership in audio – Dolby Audio is now part of Apple iOS – and we continue to broaden our presence in online content. We have great momentum in bringing new experiences to the market. More TVs are shipping with Dolby Vision.

We have new partners in China for Dolby Cinema and our rollout with AMC continues. And we are expanding the availability of Dolby Voice. All of this gives me confidence that we are doing what we need to do to drive near-term revenue and earnings growth and to get back to double-digit growth. I look forward to updating you next quarter.

And with that, I will turn it over to Q&A..

Thank you. [Operator Instructions]. Your first question comes from Mike Olson with Piper Jaffray. .

Hey, good afternoon. I had two questions for you. First on Dolby Cinema, what’s the timeframe on – I think you just mentioned 200 Dolby Cinemas being completed.

And I guess, do you see Dolby Cinema as a direct competitor to IMAX or are the theater owners making a decision between IMAX or Dolby Cinema in certain locations or how is that kind of playing out? And then the second question is, can you just talk about the revenue model around the inclusion of Dolby in iOS? Is that a licensing fee per device like we’ve seen historically or is it some sort of like blanket deal? And when do you start to first see revenue from that? Is that in the September quarter? Thanks..

Good. So let me take those in order. So as it relates to Dolby Cinema, AMC has publicly discussed its plans to have 50 Dolby Cinema at AMC locations by the end of this calendar year. So out of the more than 200, AMC is planning 100 in total and 50 of those by the end of this calendar year. Wanda, we signed up last quarter.

They are not talking publicly about the pace of their rollout plans, but we expect the first Dolby Cinema locations to come online relatively soon. So it’s a swift pace. And, of course, we continue to look to expand with new partners and new geographies. And what I would say about the PLF market is that it’s a large market, it’s a growing market.

Exhibitors around the world are recognizing that if they invest in the quality of the experience that consumers are willing to pay for that experience. It gets people back to the cinema because it emphasizes what’s great about the cinematic experience. And so, it is very common for Dolby Cinema to be in buildings where there are other PLF formats.

So it’s a big market. And we think this is a unique experience in its own right because the Dolby Vision experience and the Dolby Atmos experience combined into Dolby Cinema really is spectacular. And we’re hearing that from creatives, we’re hearing that from consumers and our exhibitor partners are recognizing that as well.

And finally, we’re thrilled that Dolby Audio is included in iOS. We’re not going to go into any specifics about the economic arrangements. All I’ll say is that that’s been – that, along with all of our news for the quarter, has been factored into our guidance.

And it certainly gives a boost to our mobile business, which was reflected in Lewis’ guidance. And I think it’s a reflection of a partnership that we’ve been engaged with over many years with Apple and they’re committed to providing amazing experiences to their consumers.

We’re committed to enabling amazing experiences and I think that this is a major step forward. And at the same time, I think we’re going to have a lot of great opportunities to work together in the future..

Great, thank you..

We’ll go next to Steven Frankel with Dougherty & Co..

Good afternoon, Kevin.

To follow up on that, why now with Apple? What do you think triggered them to do this today?.

Steve, it’s a great question. I guess what I would say again is that this is a relationship that has developed over many years and it’s not unusual for us in our relationships to start bringing Dolby Audio experience in one context or one use case and to expand over time.

And it really comes down to a matter of stacking up the priorities that our customers and partners have and I’m glad that this has risen to the top of the priority list for Apple. So like I said, it’s really not uncommon.

If you look at Dolby Digital Plus in mobile devices generally, it started several years ago with our streaming partners who wanted to make Dolby Digital Plus available for use on televisions. And then Netflix went from there to expanding it through availability on the Microsoft operating system and the PCs.

And it was really just in the last year that Netflix began making the Dolby Digital Plus screens available to Dolby Digital Plus enabled mobile devices. And so, we see this as a natural progression. And we’ve had that with Apple. And like I said, I think we have a long history together and I think a bright future together..

Another mobile question in general, not Apple specific necessarily, but we’re seeing this trend of elimination of the analog audio jack and going to a digital connection at a higher quality.

Does that open up an opportunity for you to sell more of your post-processing solutions into the mobile world?.

I guess, Steve, for starters, we see an opportunity to uplift the audio experience across all the ways people enjoy their entertainment content today. And I think that we are doing all the right things to be an important part of all the ways they are going to do it in the future.

And I think anything that moves in the direction of providing higher fidelity, higher-quality experiences validates that people do care about quality of experience. And as that raises up the priority order for them, that’s good for us. .

And if I can sneak one quick one in for Lewis, the back payments in the quarter, were they all within the normal band or might you call out one of the areas of having a larger-than-normal back payment this time?.

Yeah, we did not have anything particular that was larger than normal. I would say that, as I’ve said before, the company is now big enough that every quarter we’re going to have recoveries and back payments. At a high level, like I said, our sequential movement in revenue was primarily driven by seasonalities.

So I just try to point out in those segments where the year-over-year increase was affected by back payments, both up and down. But, no, we didn’t have a particularly large one to call out this quarter..

Great, thank you..

We’ll go next to Eric Wold with B. Riley. .

Thank you. Two questions. One, on Dolby Vision, I’m going to take a higher level, kind of get your views on Dolby Vision versus the standards that were laid out by the UHD Alliance. I know that VIZIO has come out publicly stating those standards aren’t high enough.

For VIZIO, you have been in discussions [indiscernible] get in a situation where there may be some consumer confusion out there in the market. .

So, first, I would say that we developed Dolby Vision over a number of years to be a robust, a comprehensive, all the way from creation to playback and mastered to the highest quality in terms of the HDR contrast telegramic [ph] capability. And so, we are confident in both the quality and the comprehensiveness of our solution.

At the same time, as you probably know, we’re a member of UHDA. And so our implementation supports Dolby Vision. It also supports other ways of receiving HDR content.

And the idea behind that is simply that we want to make it easy for display providers to make a decision to go forward with Dolby Vision and not have to worry about whether there are going to be other ways of getting HDR as well and we are confident that Dolby Vision delivers the experience and that – that’s why we’re seeing an increase in content and we believe that that’s what consumers are going to respond to and that’s what we’re seeing.

And like I said, the TVs we have in market – last quarter, when we spoke with you, we had a couple models in the market. Now, we have – have gone much deeper into the VIZIO line, the LG displays, the OLED and the Super UHD LED, those televisions are available in the market. They are getting tremendous views and we’re seeing more content.

And we’re excited about having the ability to offer [indiscernible]..

Perfect. And just one follow-up on operating expenses. It’s now kind of the second consecutive quarter in a row where you guys have notched down kind of annual operating expense guidance for this year. It’s a positive trend there.

Are you getting more comfortable these expenses are somewhat stabilizing around these levels? And as we think about Cinema starting to roll out, VIZIO gaining – Vision gaining traction out there with the manufacturers, maybe kind of coming to an end with some of the integration around Voice, I don’t know if there is specific guidance for next year, but as you kind of think high-level, is there anything that would move these expenses meaningfully higher or lower next year other than typical inflation of price [ph]? Could we see them actually come down next year or is this kind of a more comfortable base level you’d expect going forward?.

Eric, this is Lewis. As you said, we are not in a position to make a comment about next year. But for this year, I’ll say a couple of things about OpEx. One, we do have a number of important projects that we’re working on that are in the pipeline that we are, of course, fully funding.

And we made a commitment coming into this year that we would deliver a year – that it was very important for me and Kevin to deliver a year where we could grow revenue at or above the rate of OpEx. And so, we feel pretty good right now that we’re on track for that. And at the same time, we feel good that we are funding the R&D we need to fund.

I tend to think more of the OpEx, from a modeling standpoint, is how much of our activity should there be as a percent of revenue. I’ve talked about this before. Right now, we’re running R&D somewhere between 18% and 20% of revenue. I think that’s a healthy level to be. Selling and marketing is 24%, 25%.

When I look across [indiscernible] that seems like a comfortable level. And this year, we are actually expecting to have G&A be flat to slightly down. Going forward, I think that’s the way I would look at it. But right now, it’s not possible for us to make a specific comment about FY 2017 spending.

But you’re seeing some of our strategy play out this year in terms of OpEx relative to revenue..

Perfect. That’s helpful. Thank you..

Yeah. .

We’ll go next to Ralph Schackart with William Blair..

Hi, good afternoon. Two questions if I could.

First on mobile customers that have not adopted Dolby, Kevin, can you maybe give us some context or some color how those conversations may have changed now that Apple has adopted Dolby in its operating system? And then second, I know you’ve talked about a longer-term goal of getting back to 10% or double-digit growth top line, can you give us a sense, as you look at the product portfolio today, do you feel continued confidence in that double-digit growth rate or would you need to add more products to the portfolio to achieve that goal? Thank you..

Sure. So as it relates to mobile and the growth opportunities in front of us in mobile, there is no doubt that everybody takes notice when Apple places importance on something. And so, I think it’s a good endorsement.

And I think that it will continue to have this effect of growing the whole ecosystem because this has always, for us, been about building up an ecosystem and that means devices, that means content services. We have developer programs in place. And I’m really pleased with how that’s coming together.

And so, mobile continues to be one of the areas in our core business where we continue to see growth opportunities, which is a nice, I guess, transition into where is the growth going to come from. Mobile is an area. And our Audio business still has growth. Broadcast is an area that still has growth.

We are bringing the Dolby experience to new use cases and experiences, things like Dolby Atmos for sound bars, very early work in areas like virtual reality. And then I’m very pleased with the amount of momentum we have with each of our new initiatives since coming into the year.

And as you know, we came into the year looking to do at least $20 million from a combination of those new initiatives. I’m really pleased with the pace we’re on.

In terms of the ways that we’re getting that built validates that these are experiences – are as compelling as we believe they were and we’re getting that validation from partners and from consumers. And that’s what would have to happen to put us on a path for our growth aspirations in the coming years.

And so, I guess I would say that, yes, we expect to be able to return to double-digit growth. I believe that we have the right – we have the opportunity to do that with good, strong execution, continuing this momentum and continuing to deliver on these great experiences.

But at the same time, there is certainly no shortage of great ideas at this company. We’re really focused right now on bringing these partnerships and wins to life and broadening the availability of each of these experiences to consumers. I’m very confident that beyond that many opportunities will follow. .

Okay, thank you..

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

Thanks. You mentioned in terms of both mobile and PC having a rise and fall, but then mobile would stay at the higher level on an ongoing basis.

Can I presume that the Apple issue affected both of those categories? And why is it that the – after the substantial gain you had made in the third quarter in mobile, in particular, to get to that 20% of the mix, why would the fourth quarter gain not be something pretty substantial also? What are the dynamics there? How is it a one-time effect rather than sort of a continuing, ongoing year-over-year improvement?.

Hey, Jim. This is Lewis. I walked through that pretty deliberately. I think it’s a rare moment when I go back and reread something that I said. But the high-level reason is that it really is due to timing of our revenue payments. And as Kevin said, it’s not customary for us to get into details at the customer level.

So we tried to lay out as clearly for you what’s baked into our guidance. So we’re not going to drill down to the level of talking about custom arrangements per se. We are trying to give you enough clarity on the rise and fall that we expect in Q3, Q4 and what sort of survives that.

And I think, hopefully, you’ve got from that – my takeaway was that, exiting this year, we do see a noticeable rise in the base of our mobile revenue for the year compared to what we were running with, say, at the beginning of this year. So we don’t see that same effect in PC.

And when we report Q3 and Q4, then we’ll have actual numbers to talk about..

Okay.

And if you look at the, say, the Dolby Cinema at AMC Prime, a venture that you discussed, am I correct in understanding that there is somewhat of a – both a revenue and cost-sharing model such that it probably makes – it facilitates your entry into the theaters on that sort of basis and then some ongoing participation?.

Yeah. Just to refresh everyone, Jim, and yourself, the relationship, for example, with AMC is we contribute key technology and equipment that goes along with that. And in return for that, they contribute their site and other innovations they would do. And in return for that, we are given a share of the revenue that comes from that screen.

So, yes, we do make a contribution to that effort in the form of equipment and technology..

Okay.

And the last thing, can you talk at all about – maybe without very specific, but in terms of the royalties, video versus audio, the Dolby Vision as sort of in – I think of first initiative in that basis - can you talk about how you’re getting paid or some relative payments or any sort of guidance to help us understand the importance of that venture?.

Well, sure. I think Dolby Vision for consumers is a very similar model to our Audio business. Still early days, right? The first – the increase in shipments of televisions this quarter, so there is not a significant percentage of licensing revenue from those initiatives in our historical results.

We’re doing the right things to get that going over time. And so, I think that answers your question..

Okay. Well, thank you..

Operator?.

We have no further questions in the queue at this time. I’d like to turn the call back over to Kevin Yeaman with any additional or closing remarks. .

Right. Well, thanks, everyone, for joining us again today. Again, we will stay focused here on expanding our leadership in audio entertainment and bringing these new experiences to life.

I hope you get a chance this quarter, if you haven’t yet already, to go see a movie in Dolby Cinema, check out these Dolby Vision televisions and we look forward to talking to you next quarter. .

This does conclude today’s conference. We thank you for your dissipation. You may now disconnect..