Elena Carr - Dolby Laboratories, Inc. Lewis Chew - Dolby Laboratories, Inc. Kevin J. Yeaman - Dolby Laboratories, Inc..

Michael Olson - Piper Jaffray & Co. Steven Frankel - Dougherty & Co. LLC Paul J. Chung - JPMorgan Securities LLC Ralph E. Schackart - William Blair & Co. LLC Patrick Sholl - Barrington Research Associates, Inc..

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 will be invited to participate in a question-and-answer session.

As a reminder, this call is being recorded, Wednesday, April 26, 2017. I would now like to turn the conference call over to Ms. Elena Carr, Director of Corporate Finance and Investor Relations for Dolby Laboratories. Please go ahead, Elena..

Good afternoon. Welcome to Dolby Laboratories second quarter 2017 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 captioned Risk Factor as well as in 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 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 that's posted on the Investor Relations section of our website.

As for the content of this call, Lewis will begin with a recap of our fiscal results and provide our fiscal 2017 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..

We've got growth from new revenue initiatives such as Dolby Cinema, Dolby Voice and consumer imaging programs, along with higher revenue from Mobile. And this is partially offset by declines in PCs, DVD, Blu-ray and home theater equipment. Broadcast could be relatively flat this year.

We anticipate lower recoveries coming off a stronger than typical FY 2016, and these little recoveries are offsetting other growth drivers in Broadcast. Here's the rest of the full year outlook. Gross margin is expected to range from 88% to 89% on a GAAP basis and about a point higher on a non-GAAP basis.

Operating expenses are projected to range from $696 million to $706 million. Let me repeat that, $696 million to $706 million on a GAAP basis, and from $625 million to $635 million on non-GAAP basis. Non-operating income should be $7 million to $9 million on both a GAAP and non-GAAP basis.

And the effective tax rate is estimated to range from 24% to 25%. So, that's it for the numbers. I'll now turn it over to Kevin..

Thank you, Lewis, and good afternoon, everyone. We continued to gain momentum this quarter in bringing our new audiovisual experiences to market. We expanded our Dolby Cinema footprint and added Reel Cinemas as a partner in the Middle East.

We announced with LG the first smartphone with Dolby Vision, and we added two new Dolby Voice partners, West Unified Services and BlueJeans. We also continue to focus on expanding our leadership in audio entertainment solutions, and I'm going to start there. A big part of our success is our ability to evolve the Dolby Audio platform.

Even as Dolby Digital Plus adoption is growing across our major markets, AC-4, our next-generation audio technology, is gaining early traction. AC-4 is twice as efficient as Dolby Digital Plus and offers compelling new features. AC-4 is now included in both the ATSC 3.0 and the DVT, digital television standards.

And while implementation takes time, key partners like Samsung, LG, Sony and VIZIO have already announced the adoption of AC-4 in televisions. We continue to make good progress in expanding the presence of Dolby Atmos, our immersive audio experience.

In the cinema, Dolby Atmos is now installed or committed in nearly 2,800 screens with about 700 Dolby Atmos titles announced or released. Last quarter, the first Dolby Atmos TVs were announced by LG and Xiaomi, and a number of Dolby Atmos sound bars were also announced at CES. This quarter, we saw many of these products launched in the market.

There are now seven Dolby Atmos sound bars on the market, and we expect several more to launch in the near term. This quarter, Nokia announced its first smartphone with Dolby Atmos, the Nokia 6. Dolby Atmos can be found on a number of mobile devices from partners like Amazon, Lenovo and Nokia.

I'm excited to see continued expansion in the ways the consumers can experience Dolby Atmos at home, both simply and affordably. So, let me turn to our new initiatives, starting with Dolby Cinema.

We saw continued momentum in the adoption of Dolby Cinema, which combines the most powerful imaging and audio technologies to deliver the ultimate cinema experience. Our newest partner, Reel Cinemas, plans on opening multiple Dolby Cinema locations across its portfolio in the Middle East.

One of the first sites will be their flagship location at the Dubai Mall. Reel Cinemas joins a growing list of partners for Dolby Cinema, which includes AMC in the United States, Wanda and Jackie Chan in China, Cineplexx in Austria, and Vue in the Netherlands.

The number of Dolby Cinema locations has grown rapidly over the past year, as we now have over 90 Dolby Cinemas in operation, and this compares to about 20 a year ago. We expect to surpass 100 screens soon, and have over 140 by the end of the year. In total, we have over 325 Dolby Cinema locations open or committed around the world.

The content pipeline for Dolby Cinema continues to grow, with about 25 additional titles since I updated you last quarter. So, there are now 85 titles with Dolby Vision and Dolby Atmos announced or released. And recent releases include The Fate of the Furious and Beauty and the Beast.

The reception we are getting from the industry and consumers is outstanding, and we look forward to working with our partners to make the best moviegoing experience more broadly available. Let me turn to Dolby Vision. The first smartphone with Dolby Vision was announced in February at Mobile World Congress.

LG's flagship G6 features Dolby Vision and is available now with content support from our partners at Netflix and Amazon Video. This marks a key milestone toward expanding Dolby Vision beyond the living room.

Last quarter, we announced additional TV OEM partners at CES including Sony and Philips, and the first Dolby Vision UHD Blu-ray players from LG, Philips and Oppo. We expect our newest TV partners to start shipping soon, and Dolby Vision Blu-ray players will be on the market in the next few months.

LG's 2017 TV lineup that features both Dolby Vision and Dolby Atmos is now shipping globally. Our Dolby Vision ecosystem continues to grow, and we look forward to building on this momentum. Finally, let's talk about Dolby Voice, our audio technology which brings the feel of in-person meetings to audio and video conferencing.

In addition to going after the traditional audio conferencing market, we are increasing our presence in the growing video conferencing market. BlueJeans is our newest Dolby Voice partner. BlueJeans is a leading video meetings platform, and Dolby Voice will be integrated into both the BlueJeans Huddle and BlueJeans on-video offerings this spring.

Our integrated solutions with BlueJeans and Highfive positions Dolby Voice to provide great experiences in the huddle room, which is a rapidly growing market. Also this quarter, we announced and launched a partnership with West, the world's largest audio conferencing services provider.

West joins PGi and BT in making Dolby Voice available in audio conferencing services globally. Overall, we are significantly expanding the availability of Dolby Voice during 2017 and are focused on driving adoption of Dolby Voice and the Dolby Conference Phone. So, let me wrap up.

During the quarter, we continued to strengthen our leadership position in audio entertainment, and momentum is growing for the new experiences we have brought to market. We've added a new partner for Dolby Cinema, and now have over 90 locations open.

More Dolby Vision TVs have come to market, and the first smartphone with Dolby Vision has just been launched. And we are significantly expanding the availability of Dolby Voice by adding two new partners this quarter.

All of this creates opportunities for increased revenue growth and broadens the number of people that will enjoy Dolby audiovisual experiences. I look forward to updating you next quarter. And with that, we will turn it over to Q&A..

Thank you, ladies and gentlemen. To be fair to all participants, we ask that you limit yourself to one question and one 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. One moment, please, for the first question.

Your first question comes from Mike Olson with Piper Jaffray. Please go ahead..

Hey. Good afternoon. I had two questions, if I could. On Dolby Cinema, you've had a lot of success getting Dolby Cinema deals outside of the U.S. You talked about another one here today. And I realize you have AMC in the U.S., and that's an important and significant deal as well.

But would you say that you're having more success internationally as far as kind of convincing theater groups that this is going to be significantly incremental? And if so, why do you think that's the case? If not, that's okay, too..

Well, we are very pleased with our success internationally in adding another partner this quarter. We're also really pleased with our success in the U.S. And I mean, if you remember, when we first signed on with AMC, it was for 100 screens over seven years.

And we're now targeting together 100 screens by the end of calendar 2017 and 160 by the end of calendar 2018. So, our focus is on rolling those out, making them successful, and so far, the results are very positive..

All right. And then, on Dolby Voice, I think most investors put that as kind of a distant third as far as potential impact to the model over the long term compared to Dolby Vision and Cinema. Is that how you look at it internally? Or can Dolby Voice be a significant driver as well? Thanks..

Sure. No, internally, we see Dolby Voice as a contributor to our future revenue growth. Here's an example of us moving into a new group of customers in the communications market, and we're focused on expanding the availability of Dolby Voice. As a reminder, it's deeply integrated into the services that we partner with.

And then, once we do that, we have the opportunity to grow adoption of the service, sell-through the Dolby Conference Phone. One of the significant developments this quarter, which I mentioned, is the audio conferencing market. Of course, it's one that we have significantly increased our presence in with West, which is the largest provider.

This is a market where most every large company has a solution today, so the opportunity to sell the phone is about replacements and upgrading it based on the increased quality of our service, which is getting really good reviews.

The other significant development this quarter is that with BlueJeans and our existing partner, Highfive, that really expands our presence into the huddle room, which is a market that is experiencing a lot of growth, and we think that will grow significant in the future.

So, we're really excited about both the expanded presence and going more directly into the video conferencing huddle room context..

Our next question comes from Steven Frankel with Dougherty & Company. Please go ahead..

Good afternoon. I want to revisit the timing issue around license revenue a little bit. I mean, that's not something we typically see with Dolby.

Does this have to do with the recovery that just is coming in later? Or is this something in the traditional license business?.

Hey, Steve. This is Lewis.

Is there something more specific you're pointing to? Or do you want me to just comment on what I said about the quarter?.

Yeah.

Well, I just wanted to comment whether this was a recovery where the timing differed from your initial plan, or is this some kind of change in a customer relationship that affects the timing of rev rec?.

So, the timing of revenue things I've mentioned in my prepared remarks do not have to do with recoveries. They do have to do with the fundamental timing of when we would say historically we have seen that revenue versus this year.

So, it is true that last year we saw some revenues in Q2 that this year we'll effectively see in Q3, and it's not related to recoveries..

So, I guess I'll try to dig a little deeper. Is that because the customers' business seasonality has changed? Or something's changed like we experienced a quarter or two ago where the customer changed their payment terms from paying every quarter to paying semi-annually? I don't remember the exact details, but maybe help me....

Yeah. It's more related to contractual arrangements than it is related to the movement of the actual PC market if that answers your question..

Yeah..

And, Steve, in the big picture here, I mean, our guidance for the year holds. The first half of the year, we grew just about 4%, first half over first half. At the midpoint, we're growing about 6%, second half over second half.

And I guess in many ways the licensing business seems like a smooth business, but the reality, like everything else, it has – it can be lumpy. We've got a very diversified business, so it tends to even out. In this quarter, we just came up a hair shy of midpoint, but we are within our guidance, and we feel good about our guidance for the year..

Okay. Enough about that, but maybe I'll steal one more here.

And, Kevin, maybe you could address HDR10 Plus and how, if at all, does that impact the opportunity around Dolby Vision? And also on Vision, what needs to happen to start to see Vision in the live content environment as opposed to what we have today with movies and episodic television?.

Sure. So, Samsung's HDR10 Plus format brings metadata into play.

And, of course, we have been advocates for and have included metadata in our solutions since the very beginning and it's an important part of how we offer the highest quality, the most flexibility, and the ability to adapt in real-time to the capabilities of the device on which the consumer is enjoying this content.

Now, of course, the metadata itself is one piece of a much larger ecosystem that we brought together to be able to support an ecosystem that includes multiple manufacturers, multiple content providers, and that's why you have seen the momentum we've had over the last year. We had about 10 television partners. We now have our first smartphone partner.

And I think live television, a great example of another context that requires a lot of tools and support around the fundamental format. That scenario where we're absolutely doing the work with an aim of bringing Dolby Vision to live television. As a point of comparison, Dolby Atmos came out before Dolby Vision.

Last quarter, we announced that BT was going to begin broadcasting live Dolby Atmos to its football games, it's soccer games. And so that happened. They've already broadcast 40 matches in Dolby Atmos and they've already decided to expand to another use case, which is boxing. So, it's a natural – the point being that there's a natural migration.

We start with the pre-produced content, if you will, and then bring up the ecosystem for live content. And, yes, we are hard at work at that right now..

Okay. Great. Thank you..

Hey, Steve. This is Lewis again. You can't tell. I know I sound a lot like Kevin. I want to come back to your timing question because it occurred to me that I mentioned it twice in the call. So, the first thing I mentioned was the comment about not hitting midpoint for this quarter.

So, that related actually to some newer revenue streams that we're getting. That has nothing to do with last year. That revenue that we try to anticipate, whether it comes in Q2 or Q3, I don't particularly care.

But I made a comment in PC about it being down year-over-year because of timing and that was the specific question I was answering to you earlier, which is last year we had some PC revenue fall in Q2 which sort of will fall in Q3 this year. So, there's actually two things.

I just want to make sure not only for you, but for everyone listening on the call, that they're clear on that. That the first opening comment I made about not hitting midpoint was some newer revenue which we definitely see coming in in the first part of this Q3 already. So, it didn't bother me at all..

Okay. I do appreciate that clarification. Thank you..

No problem..

Your next question comes from Paul Chung with JPMorgan..

Hi. Thanks for taking my question. So, Lewis, you mentioned in the past, over 100 screens would provide better clarity on unit economics on Dolby Cinema.

And since we're almost there, can you share any details? And how do those economics differ domestically versus in China and internationally?.

Yes. So, we are getting closer to 100 screens. And I will live up to my commitment of providing more detail on this Cinema business. I'm not sure I said exactly when we got to 100 screens, but I am happy that our CEO said in his prepared comments that 100 is right around the corner. So, we are getting closer.

As you can imagine, Paul, one of the things that's – even at the 100 screens, it takes a while to get to the point where they're all generating a full year's worth of revenue, so maybe a little bit of patience.

For right now, all I can say is that we do plan to break some of that out when it gets more significant, and that we're making really good progress. And we are very encouraged by the economics on this business. But beyond that, I don't have a lot more detail to share with you right this moment, okay? Thanks..

Okay.

So, you can't mention domestic versus international at all?.

No. Let me make a general comment, not just for you, but for the whole audience. In general, I'd say that we have a business approach to this business that, similar to our other businesses, do not necessarily vary dramatically by region, but they can vary by customer.

So, like in any relationship, you can have a customer with higher volume and one with lower volume, and that may change some of the economics. That's normal business. But I would not say right now that there's necessarily a distinction per se between international versus domestic. I think we'll need more time to see whether or not that shakes out..

Okay. And then, on the Mobile segment, can you expand on the opportunity for Vision and Atmos in smartphones? And is there possible battery consumption benefits for Vision? And if so, do you expect more OEMs to adopt? Thank you..

Sure. So, as I said, we added another Dolby Atmos provider on the phone this quarter with Nokia. And we're really excited that LG is the first to adopt Dolby Vision on the smartphone. Hopefully, you've seen that they're running a national advertising campaign which includes Dolby Vision there.

And I've said that we believe that any entertainment screen can benefit from what we're doing with Dolby Vision, and so we're happy to have this first example of how great it can be.

To your question on battery consumption, it's true that an OEM can choose to avail themselves of this technology to max out the video quality, or they could choose to also have features that employ its power to also benefit power consumption.

And, actually, because of the way we implement – because of the way our Dolby Vision technology works, the power consumption is 10% lower than other – both HDR and SDR formats in the market..

Great. Thank you..

Yes..

Your next question comes from Ralph Schackart with William Blair..

Good afternoon. Kevin, last quarter I think you talked about being on roughly about a quarter or so of the ultra-high def TVs by the holiday season this year. Just curious if that's still sort of a good sort of framework to think about. And then.

maybe you could sort of give some thoughts in terms of how you see that penetration rate going forward, beyond the 2017 season..

So – sure. So, I actually sharpened my pencil after that question, Ralph, because I've come to learn that a lot of people have a lot of definitions of what premium means.

So, what we've honed in on, which is what we've found, at least frequently, and perhaps most often used in the market, is UH TVs over a $750 price point and, at that level, we actually think that we will exit the calendar year at around 50% of that premium TV market.

And beyond that, a real focus of ours, of course, is then moving from those premium televisions to the next lines. And it's obviously too early for me to speak to what any individual customer's plans might be, but that's our focus. That's what, of course, broadens the volume of televisions that we can make a difference to.

And then, of course, again with LG now offering a smartphone with Dolby Vision, we will, of course, continue to pursue use cases beyond the TV. And all of those are areas that we would expect ourselves to make progress on going into 2018..

Great. One more, if I could. Can you maybe just give us a sense of how you would frame the mobile device market? Just because you have LG today with Vision, clearly tremendous amount of unit volumes, but guessing that unit economics are lower than TVs, contrast by lower unit volumes and, by my estimate, much higher ASPs within the TV market..

Yeah. I mean, look, it's not dissimilar to what we would see in the audio space as far as that goes. You've got a billion-plus device market and hundreds of millions of (33:13) market. I think that the key to where we are right now is that we now have, in market, a smartphone available which shows how great Dolby Vision can be.

That also begins getting the ecosystem going because we already, on the day of launch, we have content partners who are sending Dolby Vision content to those smartphones. And so, I think, for now, we view it as a great progress that we've shown. We have the opportunity now to show the relevance to this use case.

And then, what I would expect in mobile devices is the same as what we're seeing in TVs and the same as we've seen with Dolby Atmos in mobile devices, which it will start in the high end, and we will, of course, then look to bring it more broadly..

Okay. Thanks for the update..

Your next question comes from James Goss with Barrington Research..

Hi. This is Pat Sholl, in for Jim Goss. Regarding Dolby Cinema, I was just wondering how – I guess, how nimble you guys are able to be with what film is showing on the screens? So, making sure that, I guess, the most optimal film is playing on a specific weekend. If you could speak to your relationships with the studios in that regard..

Sure. So, the exhibitor is – still retains the control over what is going to be shown when, but they do have a lot of flexibility as it relates to the Dolby Cinema proposition. First of all, as I said earlier, we added 25 titles. That's 85 so far since the....

Huge..

...in the beginning of the program. It was 9 out of the 10 top box office leaders last year. Just to be clear, we don't have any required minimum playing time or those kinds of things. So, they have flexibility and they're exercising it and they're getting a lot of value from that.

And so, it's very common that on a weekend you might see one movie playing at Dolby Cinema in the afternoon, a different one in the evening. And they can be very flexible about how they move those bookings around..

Okay. Thank you..

Our next question is a follow-up from Steven Frankel with Dougherty & Company..

Hi, Lewis. Could you remind me what CapEx is likely to be for the year for the core business? In other words, exclude Cinema.

Just what's the normal CapEx for the business today?.

Yeah, I'd say – this is similar to what I've said in the past when I've been asked this in broader forums, is that our typical maintenance capital per year is probably $30 million to $35 million a year. That's what we typically run.

And then, in the last couple of years, it's been kind of noisy because we've been doing some construction projects, but those are largely done. So, going forward, it's that maintenance capital and the Dolby Cinema initiative which consumes most of our capital expenditures today..

Great. Thank you..

Yes..

And it appears there are no further questions at this time. I would like to turn the conference back to Kevin Yeaman for any additional or closing remarks..

Great. Well, thank you. Thank you, all of us, for joining us today, and we look forward to keeping you posted on our progress. Thank you..