Dolby Laboratories F3Q07 (Qtr End 6/29/07 ) Earnings Call Transcript

| About: Dolby Laboratories, (DLB)
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Dolby Laboratories, Inc. (NYSE:DLB)

F3Q07 Earnings Call

August 1, 2007 5:00 pm ET

Executives

Kevin Yeaman - CFO

Bill Jasper - President and CEO

Tim Partridge - SVP and General Manager of the Professional Division

Marty Jaffe - EVP of Business Affairs

Analysts

Ralph Schackart - William Blair

Steven Frankel - Canaccord Adams

Paul Coster - J.P. Morgan

Andy Hargreaves - Pacific Crest Securities

Brian Thackray - Deutsche Bank

Daniel Ernst - Hudson Square Research

Alan Davis - D.A. Davidson

Mike Olson - Piper Jaffray

Andrew Abrams - Avian Securities

Presentation

Operator

Welcome to the Dolby Laboratories Conference Call discussing Fiscal Third Quarter 2007 Results. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in the question-and-answer session. (Operator Instructions). As a reminder, this call is being recorded, Wednesday, August 1, 2007.

I would now like to turn the conference call over to Kevin Yeaman, Chief Financial Officer for Dolby Laboratories. Please go ahead, Mr. Yeaman.

Kevin Yeaman

Thank you. Good afternoon. Welcome to Dolby Laboratories third quarter fiscal 2007 Earnings Call. Joining me today is Bill Jasper, Dolby Laboratories President and CEO. In addition, Tim Partridge and Marty Jaffe are here to participate in today's Q&A.

On this conference call, we will be making forward-looking statements that include projections of future operating results for our fiscal year ending September 28, 2007, market trends for the industries in which we compete, and our expectations concerning how those trends will affect our operating results; our ability to expand our presence in existing markets and to penetrate new markets; the capabilities and market acceptance of our products and technologies; and our strategic and operational plan.

Important factors could cause actual results to differ materially from those in the forward-looking statements, these factors are detailed under the section captioned Risk Factors and elsewhere in our most recent quarterly report on Form 10-Q available at www.sec.gov or on our website at www.dolby.com under the Investor Relations section. Dolby disclaims any obligation to update information contained in these forward-looking statements, whether as a result of new information, future events or otherwise.

As for the structure of this call, Bill will begin with an overview of the quarter and I will follow with a rundown on Dolby's financial results. So with that introduction behind us, I will now turn the call over to Bill.

Bill Jasper

Thank you, Kevin. Good afternoon, everybody. The third quarter marked another solid period for Dolby. Revenue and net income were up 28% and 56% year-over-year respectively as we continue to extend the Dolby brand and technologies across new markets.

Today digital entertainment has delivered across the growing variety of entertainment platforms and electronics devices and with this the number of market opportunities before Dolby is growing. We remain focused on our long-term objective of being an essential element in the entertainment experience, whether through digital cinema, DVD, broadcast, gaming, PC or on the go.

In today's call, I would like to discuss the progress made through the third quarter towards our long-term objective as well as the specific changes we are making in an effort to further improve our success.

First we continue to position Dolby to benefit from a high definition upgrade cycle that is currently underway and our broadcast market growing amount of high definition content coupled with selling price points for digital televisions is helping to drive a TV upgrade cycle. This is a significant trend for Dolby because Dolby Digital is included in the ATSC digital tuner, which has been mandated in all integrated television shipments in the U.S. and mandated as the digital standard in North America and South Korea.

Furthermore the ATSC digital tuner has been adopted in the digital cable set-top box standard in the United States. As a result, our penetration of the broadcast market has been increasing. In the European broadcast market, we continue to make progress towards our goal of becoming the de facto audio standard for HD broadcast.

The number of stations broadcasting in Dolby Digital in the European and Middle Eastern region is now over 170. In conjunction with this, Dolby Digital has been included in many HD set-top boxes in order to playback the HD content encoded in Dolby surround sound. Additionally, one television manufacturer is now incorporating Dolby Digital into its mid to high end European digital television shipments.

Envision the broadcast, we believe, we remain well positioned for potential upgrade cycles in next-generation DVD and gaming. With Dolby technologies included in Blu-ray and HD DVD as well as the play station III and Xbox 360 game consoles, we are positioned to directly benefit from increased demand for next-generation players.

While it is too soon to predict the timing and magnitude of a potential HD upgrade cycle in the DVD or gaming, we are encouraged by recent price declines for next-generation unit and our demonstrated consumer interest for HD content in the broadcast market. Secondly, we continue to position Dolby in the PC market, as consumers increasingly turn to their PC to access media and entrainment.

Dolby technologies are included in two versions of Microsoft's new operating system Vista, Dolby Digital and Dolby Stereo Creator are included in the home premium an ultimate additions, which according to Microsoft's most recent earnings call that accounted for the majority of Vista shipments.

In addition the number of Dolby technologies included in certain PC notebooks has expanded. For example in the third quarter, Acer Computer one of the largest PC notebook manufacturers globally announced that will include Dolby Home Theater across its entire line of Aspire Notebooks.

Dolby Home Theater is a bundle technology offering under our PC entertainment experienced initiative and contains Dolby Digital, Dolby Headphone, and Dolby Virtual Speaker, as part of the filmware representing an additional licensing opportunity for Dolby.

The Acer announcement represents a meaningful step forward for our PC entertainment experienced initiative, because it brings Dolby Home Theater to notebooks price below $1000. Prior to Acer other PC OEMs including Lenovo and Toshiba began shipping select notebook models containing Dolby Home Theater. In addition, Toshiba announced last week that it would extend Dolby Home Theater to some additional Qosmio Notebook models as well as Dolby Sound Room to select models of its lower priced Satellite line notebooks.

Third, we continue to invest and drive new innovations to enhance the imaging and audio experience beyond surround sound. In the motion picture industry, we are building on our strong presence of the primary provider of audio technologies by working closely with the industry to deliver imaging technologies including Dolby 3D and Dolby Digital Cinema.

Since demonstrating Dolby 3D this year at ShoWest Cinema Convention we have made similar demonstrations at the European Cinema Convention CineExpo. We continue to receive positive feedback from exhibiters and studios and expect to start selling systems for 3D movies in the fall.

In our Digital Cinema initiative, we now have over 440 Dolby Digital Cinema systems in use worldwide, and have achieved significant success with our digital cinema mastering program. In addition we are extending our imaging initiative to the consumer market with our focus on enhancing LED backlit LCD displays using high dynamic range technology. This technology makes the whites whiter and darks darker, which dramatically enhances image quality. We expect to begin seeing some initial revenue from this technology in fiscal 2008.

On the audio side, we continue to make progress in our effort to deliver additional audio technologies across our markets. We have demonstrated Dolby Volume technology, which enables listeners to stabilize volume levels across broadcast channels and content. So the users are always reaching for the volume control. We expect some initial high-end AV receivers will begin shipping with Dolby Volume this Christmas and for initial high-end televisions to ship in 2008.

We continue to position Dolby for many opportunities, including the high definition upgrade cycle across broadcast, DVD, and gaming. The trend toward PC entertainment and the delivery of additional Dolby technologies across existing and newer markets. Dolby's unique position across the entertainment and technology industries is helping us to respond to opportunities created by the rapid growth in digital entertainment.

Looking forward, we are focused on executing our long-term strategy of developing a strong presence both at the point of content creation in the professional community and at the point of playback and consumer electronics.

In an effort to improve our ability to scale our organization and effectively apply our strategy across our markets in the third quarter of fiscal 2007, we decided to reorganize our business from two operating segments in to a functional organizational model.

In the new functional model there will be a Products and Technology Group headed by Tim Partridge and a Sales and Marketing Group headed by Ramzi Haidamus. The products and technology group will be responsible more for research, engineering, product development, manufacturing and technology. By bringing these capabilities together we believe we are in a better position to drive innovation and maintain our technology leadership.

The sales and marketing group will be responsible for all sales, marketing business development and field operations. We believe this will help enable us to drive growth by bringing into integrated customer base respective to our innovation and technology development efforts.

With that, I will turn it over to Kevin.

Kevin Yeaman

Thank you, Bill. Moving to our financial results, revenue for the third quarter was $119.6 million, up 28% year-over-year and was comprised of 79% licensing revenue, and 21% product sales and services revenue. In the technology licensing segment, revenue increased 37% year-over-year and was down 11% sequentially.

In the third quarter, year-over-year technology licensing growth was driven primarily by growth from our personal computer and broadcast markets. Our PC market experienced very strong year-over-year growth. Sequentially growth was only slightly up, but we are normalizing for last quarter of $7.7 million in PC related royalty payments for products shipped in prior quarters, it was very strong.

In the third quarter, we began receiving royalty payments for the initial shipments of Microsoft Vista Home Premium and Ultimate editions, which exceeded our expectations. More importantly, OEMs and consumers still find value including additional software DVD playback functionality from third party ISVs. This is having the new effect of increasing our total royalty rate for PC.

In our broadcast market, we experienced very strong year-over-year growth and strong demand for digital television and set-top boxes. Sequentially, broadcast was down in the second quarter as our fiscal second quarter benefited from strong holiday related shipments.

In our consumer electronics market, growth was moderate year-over-year, but sharply down sequentially following last quarter's strong performance from holiday related demand. Year-to-date, our CE market is tracking to our initial assumption for flat to slightly up growth in fiscal 2007, and appears to be approximating industry analyst estimates.

In the Products and Services segment, revenue for the third quarter was flat year-over-year and up 11% sequentially. Products revenue was down 9% year-over-year, as a result of particularly strong cinema product orders in the third quarter of last year, when some exhibitor's startup ahead of anticipated price increases. Services revenue was up 35% year-over-year on a strong volume of new films and demand for digital cinema related services.

Let me turn to the details of the P&L for the third quarter. Licensing gross margin was 91% or up 1 point sequentially. Products gross margin was 53% or up 3 point sequentially. Our Services gross margin was 61% up 2 point sequentially. Products gross margin increased on sequential sales growth for our higher margin cinema audio products.

As we stated in our last earnings call, we are currently deferring revenue on a number of Dolby Digital Cinema systems and permitting certain contractual obligations. Since our initial Digital Cinema systems carry a lower margin than our other professional products, product margins are expected to be lower in the period, we recognized this deferred revenue. We do not expect to recognize this revenue in fiscal 2007, and would expect the products margin to be roughly 50% through the fourth quarter.

SG&A expense was 40% of revenue in the third quarter up 7 points sequentially. Payroll expenses increased sequentially partly because of increased headcount, and partly because year-to-date financial performance has exceeded our expectations, which have resulted in an increase in the company's annual bonus accrual. In addition, we incurred various consulting related costs in conjunction with consulting audit and other services.

R&D expense was 10% of revenue for the third quarter up 2 points sequentially. The sequential increase in absolute dollars for R&D was the result of higher headcount due in part from our recent acquisition of BrightSide Technologies.

Dolby tax rate for the third quarter was 35% compared to 37% in the second quarter, as we benefited from an increase in the amount of tax exempt interest and some discreet items in the quarter. We expect our tax rate for the fourth quarter of fiscal 2007 to be around 37%.

Third quarter, net income in 2007 was 29.7 million or $0.26 per diluted share compared to $19.1 million or $0.17 per diluted share for the third quarter of fiscal 2006. Net income includes stock based compensation charges of $5.1 million for the third quarter of 2007 and 4.7 million for the third quarter a year ago.

Turning to the balance sheet. We finish the quarter with approximately $617 million in cash, cash equivalents and marketable securities. From operations, we added approximately $35 million of cash, and cash equivalents during the quarter. In addition the balance sheet contains approximately $29 million in accrued royalties related to the license of certain patents under the license agreement with an unrelated third-party.

In the third quarter of fiscal 2006, we evaluated whether the patents is licensed to us under the license agreement covered all the products and technologies for which we had historically have been paying royalties to the patent licensor. Based on our evaluation, we determined that under the license agreement we may not owe royalties, and all the products and technologies for which we had historically have been paying.

In the third quarter of fiscal 2006, we notified the patent licensor that going forward we intended to pay royalties only for products and technologies that we believe are covered by the patents licensed under the license agreement, and subsequently we have been paying the patent licensor royalties on this basis.

In the second quarter of fiscal 2007, the patent licensor informed us that it disagreed with our interpretation of the license agreement. While we are trying to resolve this matter with the patent licensor, there continues to be uncertainty regarding the outcome. As a result, we continue to accrue royalty expense in a manner consistent with our historical payments.

Turning to our outlook, we now expect fiscal 2007 revenue to be approximately $465 million to $475 million. We now expect net income for fiscal 2007 to be approximately $122 million to $127 million. And consequently, we now expect earnings per diluted share for the full fiscal year 2007 to be approximately $0.07 to $0.11 per share.

Our stock-based compensation expense may vary based on factors such as stock price volatility. We now expect stock-based compensation expense for the full year to be approximately $21 million. We will offer fiscal 2008 guidance on our fourth quarter conference call.

This concludes our prepared remarks. I would now like to turn it over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And we will take our first question from Ralph Schackart with William Blair.

Ralph Schackart - William Blair

Good afternoon, another strong quarter guys. Just two quick questions if I could. First in the PC business it sounds like there is some great strong cycle of momentum and you are seeing some increasing royalty rate. Can you sort of give us a little bit more color on the increasing royalty rate, is that broad brochure that only within certain skews on the high end et cetera, so give us a little bit more color on that, please.

Kevin Yeaman

Sure. Yes, we did see great strengths in our PC market. It's the primary reason for the increase in guidance followed to a lesser extent by the strength in broadcast. We benefited from three trends in the PC market. One would be continued unit shipment increases in the PC space, but notably it was the shipments at Home Premium. And to add to your question specifically, we found that OEMs and consumers continue to see value in added DVD functionality even when purchasing the Home Premium edition.

Some examples include a number of OEMs have branded media players, where with a push of a button, you can boot-up your PC to use the DVD functionality without having to boot- up the entire PC system. So, we are obviously very pleased about that. It's the primary reason I already said for the increase in guidance. Of course, its a little early to try to extrapolate the first quarter of this experience, too far into the future. We currently believe this dynamic will continues through the holiday seasons. We don't have a lot of visibility into what OEMs plans are beyond that.

Ralph Schackart - William Blair

Okay. Thanks, Kevin. And then one more, if I could on the SG&A line items. You explained some of the uptick with payrolls and bonus and consulting an audit. How should we think about this from modeling standpoint at this array, we should think about going forward or some of those consulting and auditing engagements roll off on a go forward basis.

Kevin Yeaman

Well, Ralph as you know, we have been saying that we would be increasing headcount investing in particular the number of sales and marketing programs. So, we have seen quite an increase in absolute dollars and SG&A throughout the year. While we expect it to rise, I would not expect it to rise in absolute dollars, that significantly has been the last couple of quarters, and part of that is because some of the consulting fees and so forth were one time fees.

Ralph Schackart - William Blair

Okay, great. Thank you.

Operator

And moving on we'll take our next question from Steven Frankel with Canaccord Adams.

Steven Frankel - Canaccord Adams

I wonder, if you might give us some insight into your on the go strategy. You talked about that a little bit in the past, but can you give us an update on where you are?

Bill Jasper

You are talking basically the mobile market Steve right? I assume. Steve?

Steven Frankel - Canaccord Adams

Yes.

Bill Jasper

Well, we continue to pursue the mobile market. We've a strategy of trying to getting our technologies out there and a couple of different forms number one is taking the Audistry by Dolby technologies and presenting those to the mobile space. We've been engaging a number of customers.

We think that the Audistry technologies can gain some strength in that particular area. We will also look at other areas such as Dolby Headphone. So far, we're continuing to dialogue. We recently hired head of mobile marketing. We've been adding people on this area on the engineering front to ensure that we've the right technologies in order to take that to that market. And so, we're continuing to pursue it. But as we've announced on the previous quarter, we're looking at 2008 before we started to really see any benefits from that.

Steven Frankel - Canaccord Adams

Okay. And where is the headcount today, and where was it last quarter?

Kevin Yeaman

We're at about 950 employees at the end of the quarter that's up from just under 900 last quarter and remember that the 950 now includes the acquisition of BrightSide.

Steven Frankel - Canaccord Adams

Okay, great. Thank you very much.

Bill Jasper

You are welcome.

Operator

Next we'll hear from Paul Coster with J.P. Morgan.

Paul Coster - J.P. Morgan

Thank you. We've seen the unit shipments for the DVD category holding up quite strong based upon some results from Zoran recently, however the market seems to be shifting in favor of emerging markets. Can you comment upon the appetite for surround sound technologies in emerging markets? I guess if ones going to assume that you are not going to see much revenue from that business because it will be very cheap 2 channel DVD is there any comments on that?

Kevin Yeaman

Yeah. There is an issue that, as people do expand overseas are probably going to go with the 2 channel rather than the 5.1. And you've to be careful about some of the industry statistics out there, and some of the comments because I know, there was some forecast which came out with some specific monthly figures, which showed very, very good growth in this particular area.

But those are just applying sometime, and you've to remember that we are standing to look at the overall market, we still except it for the full year. We are looking at flat to slightly up in this market. We still see some growth. But the DVD market obviously is very, very dependent on future growth from the next-generation. We're seeing a little bit of acoustic season consolidation and manufacturing in other territories. But we believe that the DVD market long run will continue to grow, but not nearly compared with the other markets in which we are operating.

Paul Coster - J.P. Morgan

Right. Perhaps you can comment on how, if its how your acquisition philosophy and execution for that matter has changed since last call. But before you do that just can you, on the last question, can you just perhaps elaborate on the move to multi-channel in emerging market, do you think that something is that the CE industry is starting to promote or is that still somewhere else?

Bill Jasper

Well, I think everybody continues to promote 5.1 channels to go along with the HD, the high-def experience. That's what we really have been seeing in Europe over the last year or so. As people there moving to a high-def video world they recognized that they want more channels on the audio side. So that's what we've been having great success over there. And I think there is a long-term is people continue to recognize that they can get better quality on a high-def, they are going to work with better sound and with it and that's we hope will eventually drive things to more use of more 5.1

Paul Coster - J.P. Morgan

Okay on the acquisition front?

Bill Jasper

We are not, our strategy hasn't changed Paul. Our strategy is to look for opportunities that make sense from the technological standpoint, this is what is so exciting about BrightSide. We saw with BrightSide acquisitions some technology, which we described is a wild factor, when we saw it really made a difference to consumers, who look the televisions with the backlit LEDs. And so we will continue to look for acquisitions where we think that the technology will fit in with what we are doing both on audio side, but more importantly on the video side as we continue to expand our market offerings.

Paul Coster - J.P. Morgan

So there is no actual change in the timeline or urgency or anything in that nature?

Bill Jasper

No. We are continuing to keep our eyes open and investigate opportunities. As we said for couple of years, we are not going to go up and try to buy revenue. We are not going to try to buy net income. We will go up and look for technologies, which are synergistic that what we're doing. And we will not hesitate to bring those end work and promote our long-term interest to better entertainment for the consumer.

Paul Coster - J.P. Morgan

Okay. Thank you.

Operator

And we will hear next from Andy Hargreaves with Pacific Crest Securities.

Andy Hargreaves - Pacific Crest Securities

Hi. Did you guys see any impact from the cable card integration band in the way of an inventory build or do you see the numbers were affected by that in anyway?

Kevin Yeaman

Could you repeat the first part of your question?

Andy Hargreaves - Pacific Crest Securities

Yeah, just wondering if you saw an impact from the cable card integration band, we had heard that there was a bit of a field in set-top boxes in front of that. I am wondering.

Bill Jasper

Yeah, nothing specific, Andy obviously cable cards are out there. We've had very, very good success and growth in the broadcast market. I don't have statistics available in front of me that break it down by set-top box traditional set-top box versus cable cards, but we attend to more, look more overall at that whole market segment.

Andy Hargreaves - Pacific Crest Securities

Okay. And then on similar to the one of the other questions, on the notebook side is there any difference in the mix of emerging to developed markets in that particular keep the business versus your other businesses?

Kevin Yeaman

Well, we rely on industry analyst doubts for that metric, because we do not get, all licensees do not report to us, where the point of consumer is. But having said that, it is our understanding that notebook shipments or PC unit shipments overall are growing faster in emerging markets than in developed markets. But we continue to see strong unit growth and obviously is a very strong market for us. I think it's clear that consumers are very much viewing their PC as a platform for entertainment and we are benefiting from that .

Andy Hargreaves - Pacific Crest Securities

Thanks.

Operator

We hear from Brian Thackray with Deutsche Bank, next.

Brian Thackray - Deutsche Bank

Thanks gentlemen. Can you hear me?

Bill Jasper

Yes.

Brian Thackray Deutsche Bank

The first question getting back to the royalty rates on the PC side of business. Can you give a little bit more insight into, really the difference between the royalty rates on your peer DVD offering, and then more of the royalty rate opportunity up sell as you go towards, existed enabled computer? And then also, when you look at or say an Acer type or a Toshiba type house deal, what the different royalty rate economics looks like and get the sense for unit versus ASP impact?

Kevin Yeaman

So in terms of, let me separate the impact we're seeing of Vista in the Home Premium edition from the second part of your question, which really goes toward our PC entrainment experience program to get into the filmware of the media-centric notebooks. As it relates to the Home Premium edition that includes DVD playback functionality and what we're finding is that there is still demand for added features such as the branded media Partridge described earlier and higher end DVD players. So, lot of people competing for people retention for this entrainment functionality, and we are benefiting from all those people that are competing for that retention. People still have a demand for higher end DVD players.

So, in terms of unit playback, typically what that means somebody has more than one DVD software application on their PC, and we are getting paid twice on those units. We don't have any specific information on what percentage of unit that's happening on. In terms of the PC Entertainment Experience and aligns like the Aspire and the Qosmio that have additional entertainment functionality, that is, has not had a big impact on our revenue to-date. It's something we see being one of the factor in 2008. Most major manufacturers now have aligned notebooks that are focused towards the media-centric market.

But they don't make up a large percentage of the volumes today. The ASP impact there is that we've more technologies in those typically. So, in addition to just offer DVD playback, you can get features such as Dolby Headphone, Virtual Surround, and a number of other technologies that we offer.

Brian Thackray - Deutsche Bank

And just a quick follow-up, historically you guys have been able to grow operating income at least twice as fast as revenue, probably you gone through a bit of an investment here with SG&A and R&D. Do you think we'll pass the peak of that investment, as looking forward talking of factors that historic relationship?

Kevin Yeaman

I don't want to give, we're not going to give any 2008 and beyond guidance today. I would just say that we as you pointed out, we've been investing in a number of opportunities in the video and the mobile space. We intend to continue to do so. Beyond that I don't have any specific operating margin guidance.

Brian Thackray - Deutsche Bank

Thank you, gentlemen.

Operator

And we'll move next to Daniel Ernst with Hudson Square Research.

Daniel Ernst - Hudson Square Research

Good evening. Thanks for taking the call. Two questions if I may, first on the broadcast side, can you comment on where you are or what the mix might be between domestic broadcast, Comcast, DIRECTV et cetera, and international, where you have standards and more of an option. Can you give us some extreme broadcast in domestic and international? And then second question on the gross margin side, can you remind us of what do you expect that the margin impact going to be. What's the DCI revenue recognition begins to recycle? Thanks.

Kevin Yeaman

Sure. So, on your first question, I do not have the specific breakout of how much of our broadcast revenue comes from domestic versus international markets and in fact we have a number of licensees to ship to both markets until we all really have the data. Our belief is that North America over the last few three years has been the biggest driver as people move toward high definition TV and TVs with digital tuners, which are now required, when there is a tuner, but we are continuing to get attraction in Europe, which is in the relatively early stages. As to your second, I am sorry what is your second question?

Daniel Ernst - Hudson Square Research

Digital cinema.

Kevin Yeaman

Digital cinema margins, so we, could you just repeat the question?

Daniel Ernst - Hudson Square Research

There is two elements that one is that in the relatively near future, you will begin to recognize deferred revenue and that will be an upside revenue, but won't drive margins down into that specific impact one of the more general impact of what DCI margins look like?

Kevin Yeaman

Yeah, so we do have about just over $7 million of deferred revenue in this area today. When we recognize that revenue it's a lower margins than our other products, what we've said is that, in the quarter that it comes into revenue, our products margin specifically could go into the 30% range.

Beyond that when we are into sort of a normal quarter-by-quarter without the deferred revenue coming in. We've in the past said, that we do expect our product margins to be somewhere in the 40% in the 40s. Now of course, given the licensing is 79% of our revenue this quarter and is range between 75% and 80% historically, it has lesser impact on overall gross margins.

Daniel Ernst - Hudson Square Research

And you expect that 7 million to be recognized in a single quarter or could it be recognized over two quarters for the margin impact maybe different?

Kevin Yeaman

It could be over two quarters, in which case the margin impact would be different.

Daniel Ernst - Hudson Square Research

Okay. Thank you.

Operator

The next we will hear from Mike Olson with Piper Jaffray. Mr. Olson? (Operator Instructions). Hearing no response, we will move on. (Operator Instructions). And we will go to Alan Davis with D.A. Davidson.

Alan Davis - D.A. Davidson

Yeah. Hey, just a follow up here on the PC royalties. I know you don't like to give specific royalty amount, but curious maybe you could share with us, kind of maybe the multiple of the opportunity, how much greater it is? For example, on a Home Premium Laptop or PC with multiple DVD applications, playback applications and your full suite of entertainment experience suite versus a PC with home-based, I think just one DVD playback piece of software. What maybe perhaps you can give us the multiple how much greater the revenue opportunity is on the format in the latter?

Bill Jasper

So in case where, a user has multiple DVD software applications and then we get paid on each software DVD application. There are people that have multiple software DVD applications. In terms of the PC entertainment experience, we have not shared any specific ASP information on that program.

Alan Davis - D.A. Davidson

Okay. Could you share us with an update of what you expect for inside your fiscal '07 guidance? What you expect PC royalties and broadcast royalty to come in as the percentage of your total CE royalties or total royalties?

Bill Jasper

Yeah. So, as we look to '07, we think that given the strength in PC this quarter, and which we expect to continue through the end of the year that market can end up being as large as our CE market this year probably just over 35% each. The broadcast market as continued to grow strong, and it's remain at over 15% this year.

Alan Davis - D.A. Davidson

Okay. And where was the PC last year, as the percentage?

Bill Jasper

PC last year was at about 30%, just under 30%.

Alan Davis - D.A. Davidson

Great. Think you guys.

Bill Jasper

So, as you look to next year again remember that once we've a couple of quarters just behind us that quarter-to-quarter growth rate will go back being driven first and foremost by the PC unit growth in the industry. And then we're also watching very closely this trend as people continuing to get additional DVD functionality when they buy the Home Premium edition, and whether that continues and for how long, that's obviously a big factor.

And then we'll continue to move forward with our PC Entertainment Experience initiative, where we've a number of design wins. And also don't forget that we had about $8 million in back royalties in the PC segment in '07 which we would not expect to incur in 2008.

Alan Davis - D.A. Davidson

Okay. And one more last follow-up on in the quarter you just reported for Vista related revenues specific Vista related revenues obviously there is PC upside royalty, that's just isolated Vista as a percentage of that outside. Can you characterize how Vista was?

Bill Jasper

No, because they will be getting the revenue by licensee, and I really can't do that.

Alan Davis - D.A. Davidson

All right, fair enough. Thanks.

Operator

And we have Ralph Schackart with William Blair with a follow-up question.

Ralph Schackart - William Blair

Hi, one quick follow-up on the re-organization to a functional model. Can you give us a sense of the synergies do you expect to get in terms of on the revenue side by customer or by end market perhaps it would be a little bit easier for you? And then also just give us a sense on the cost operating expense side, if you expect any synergies there? Thanks.

Kevin Yeaman

Sure Ralph. We haven't quantified the synergies. We expect to see some good synergies coming in all of our segments. One of the probably most visible ones would be that the broadcast area, where we've been operating in the broadcast market on the professional side, and the separate group operating on the consumer side. And so putting these together, we think, it puts us in much better shape to address the broadcast chain of entertainment to work to get content creative and distribute, and playback much more smoothly then we've been in the past.

So, we've see some synergies there. But we haven't quantified it. We're working on obviously the plans for this next year, and we think that it's going to be payoff in the long run. As to the synergies on the cost side, we are combining forces. We're not modeling anybody office result. We just see it more on the sense of getting people working along side each other. They have been out there talking to broadcast customers in the same space.

So, if anything we think we'll see some opportunities where we might be able to take some of these segment opportunities, and take them even further and maybe add even more marketing sales people in order to take advantage of our expertise in this area. So, we just think overall it makes a lot of sense to go from a, to a functional organization modeling as broadcast, but in other areas such as gaming and CD following the exhibitor, lot of our work in the cinema, and as that ties in with the consumer space. So, we are pretty excited about the opportunity.

Ralph Schackart - William Blair

Okay, thanks.

Operator

(Operator Instructions). And will hear next from Paul Coster with J.P. Morgan with another follow up question.

Paul Coster - J.P. Morgan

Can you give us little bit of commentary on the auto markets or something there at the moment?

Kevin Yeaman

I am sorry world markets for automotive?

Bill Jasper

For automotive.

Paul Coster - J.P. Morgan

Sorry a wrong language.

Kevin Yeaman

It seems to be with a right language. Automotive continues to be a small market we continue to get the design wins for us on number of different manufactures as well as OEM customers. We think that people are continuing to move to wanting better and better entrainment in the car on the go and as such we see more and more DVD players going in, people taking more advantage of surround sound or PL2x going in the cars. So we think that PL2 that we really think that people who want to upgrade that experience but in terms of meaningful revenue numbers is still a very, very strong percentage of what we are doing.

Paul Coster - J.P. Morgan

Is it growing recently, rapidly?

Kevin Yeaman

It is growing.

Paul Coster - J.P. Morgan

Okay and then you feel on this dispute over licensing royalties. Do you have a sense on when that might get resolved or if you come to us when just what kind of process is involved to, resulted if just had to go the core eventually?

Kevin Yeaman

But I can't really go into the process and nor the timing talk, we've disclosed the, the state of where we are and we’re working as quickly as we can try to control our solution and that is as much as we can say at this point.

Paul Coster - J.P. Morgan

Okay. Thank you.

Operator

And we'll have next from Mike Olson with Piper Jaffray.

Mike Olson - Piper Jaffray

Hey, sorry about this, perhaps just wait for second, this was already asked. But just one question on DCI complaints as it relates to digital cinema, any update on that front I think previously you have talked about been able to start to recognize some of those deals in first part of fiscal '08 after getting DCI complaints in September?

Tim Partridge

Yes, Mike, this is Tim. We're still waiting for a number of things that completely out of our control, so is that happen, essentially there is a company and that is looking at the whole test specification from DCI, I'm writing that into a text script that people could use, so the expectation is that that work will be done in September, so the periodically would be a text procedure that could be used to fully for DCI complaint experiments, but in the next stage would for a third party company to step into that role to do the qualification and while there are rumors when that will take place, as of now, nothing that is very concrete right now.

So, lot of that would depend on that and the thing that I mention before that we're waiting for is that there are some parts of the DCI specification that need to be verified and standardized by standard bodies such as SMPTE. So until that work is done none others can fully write the software is required to implement that. So we're waiting on that, as well as, a procedure actually test equipment and as if those we are hopeful that they will happens in the earlier parts of '08, but certainly they are under our control right now.

Mike Olson - Piper Jaffray

Okay. And then just one question on the Vista side, obviously, either Home Premium and Ultimate Editions have been a benefit to Dolby? Have you considered that there might be possibly that the Home Premium and Ultimate Editions become less of a piece of the pie for Vista going forward? And just any thoughts on impact, if that occurs?

Kevin Yeaman

Well, yes. As I said earlier, we wouldn't want to extrapolate too far into the future based on just one quarter of Vista shipments. But all the market data we've seen is that consumers are attracted to the Premium Edition and that's going well. But it's fairly early on the enterprise edition probably too early to conclude, to draw any even initial conclusions about the mix of Ultimate and the Enterprise Edition. But clearly, that is something that is one of the variables that goes into our growth rate for next year is whether the mix of Premium holds up to what the initial success has been.

Bill Jasper

As well as whether or not that people continue to putdown on ISV software solution on top of Vista.

Mike Olson - Piper Jaffray

Okay. Nice work. Thank you.

Operator

And we'll move now to Andrew Abrams with Avian Securities.

Andrew Abrams - Avian Securities

First, congratulations on the quarter. And second, just if you could give a little color on the increments that you are getting out of the ATSC tuner business and how that's changed over the last maybe quarter or two quarter since the mandate went through?

Kevin Yeaman

And by increments, could you elaborate on what you mean.

Andrew Abrams - Avian Securities

Just how much, if you can define it how much incremental business has come out of that over the last two or three quarters considering where you were six or nine months ago?

Kevin Yeaman

Sure. So, that is the primary driver. ATSC turners are one of the primary drivers behind our broadcast market, which we do breakout separately as part of the licensing revenue. It was just over 10% of our licensing revenue in '06, and we are now expecting it to be over 15% in 2007. So the primary driver of that has been the inclusion of the ATSC tuners in digital televisions and set-top boxes. The other driver is the demand for premium audio services that are being offered by cable and satellite providers in Europe.

Andrew Abrams - Avian Securities

Is it have you seen any change in that ramp or is it been a fairly linear ramp over the last couple of quarters.

Kevin Yeaman

Well, I said in my prepared remarks. We saw that the, our broadcast market was relatively flat from Q2 to Q3 and that's probably because our Q2 reflects the holiday quarter shipments. So that's what we saw most recently, but overall it's been a strong market for us and we continue to see growth in that market for us going into the next fiscal year.

Andrew Abrams - Avian Securities

Thank you

Operator

This concludes the question-and-answer session. Mr. Jasper, I will turn things back to you for additional or closing remarks.

Bill Jasper

Okay. Thank you operator and thank you all for joining us. I am very pleased we had a very, very reasonable quarter. And we look forward to speaking with you after or yearend this fall. Thank you very much.

Operator

That concludes today's presentation. We appreciate your participation and wish you all a great day.

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