Paula Dunn - IR Bill Jasper - CEO, President Kevin Yeaman - CFO Tim Partridge - SVP

Ralph Schackart - William Blair Steve Lidberg - Pacific Crest Securities Ingrid Jones for Anthony Noto - Goldman Sachs Daniel Ernst - Hudson Square Research Michael Kern - Canaccord Adams Mark Anderson - Atfield Capital Eric Mentz - Eagle Asset

Thank you. Good afternoon, everyone.

Welcome to Dolby Laboratories' second quarter fiscal 2006 earnings conference call. Joining me today are Bill Jasper, Dolby Laboratories' President and CEO; Marty Jaffe, Executive Vice President Business Affairs; and Kevin Yeaman, Chief Financial Officer.

In addition to Tim Partridge, Dolby's Senior Vice President and General Manager of the Professional Division, is 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 29, 2006; market trends for the industries in which we compete; our ability to expand our presence in existing markets and to penetrate new markets; the impact of inclusion of our technologies in certain HD and DVD technology standards; DVD player sales and sales of our professional broadcast products; trends in the PC, broadcast, gaming, automotive and portable entertainment device market; our expectations regarding the success of our Digital Cinema initiative; the capabilities and market acceptance of our products and technologies and our strategic and operational plans.

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' in our quarterly report on Form 10-Q for the fiscal quarter ended December 30, 2005 available at www.sec.gov.

Dolby disclaims any obligation to update information contained in these forward-looking statements whether as the result of new information, future events or otherwise. In this call we will describe certain pro forma financial measures which should be considered in addition to and not in lieu of comparable actual financial measures.

Please refer to our earnings release for the second quarter of fiscal 2006 at our website at www.Dolby.com under the Investor Relations section for the most directly comparable actual financial measure and related reconciliation. As for the structure of this call, Bill will begin with a discussion of Dolby's strategy and focus, and Kevin will follow with a rundown of Dolby's financial results.

So with introduction behind us I'll now turn the call over to Bill.

Thank you, Paula. Good afternoon, everybody.

I am pleased to announce a strong second quarter for Dolby as we continue to make progress towards our long-term objective of being an essential element in the best entertainment technologies available. Our second quarter benefited from a robust holiday season, reflecting growing consumer interest in digital electronics.

Consumers are embracing a wider array of digital devices, which in the long run expands Dolby's addressable market. The proliferation of digital media and content is creating near term and longer term opportunities for Dolby.

Today I would like to discuss how we are further positioning Dolby to benefit from this growth. First, we are extending Dolby digital further into existing markets.

In broadcast, we have advanced Dolby Digital Plus to be included in the ATSC digital tuner standard in the North American and Korean markets. In addition, we continue to make progress in making Dolby Digital a de facto standard in Europe for HD broadcast, while winning new customers in China with Dolby Digital.

Today, the China Movie Channel launched the China Home Theater Channel HD Movie Channel, China's third HD channel. This is the first broadcaster in China to commit to broadcasting 100% of its programming in Dolby Digital.

This illustrates a growing opportunity for Dolby to benefit from the delivery of HD set-top boxes using Dolby Digital 5.1 decoders in China. In Europe, we continued to see high demand for our professional broadcast products in preparation for broadcast of FIFA World Cup matches in Dolby Digital 5.1.

In April, the Canal Plus group launched its first HD station on satellite with Dolby Digital 5.1 so that any set-top box it deploys receiving an HD signal must contain a Dolby Digital decoder. In our core DVD market, we will benefit from in the shipment of both Blu-Ray and HD DVD players, as Dolby technologies are mandated audio standards in both next-generation DVD formats.

While we don't expect either of these formats to have a meaningful impact on our fiscal 2006 results, we are encouraged by the fact that some initial HD DVD players are arriving on the market, and by the announcement of Universal and Warner Studios that they are releasing movie titles on HD DVD. In gaming, Sony plans to ship the PS3 with Blu-Ray playback in November.

Today, Dolby technologies are in the top gaming platforms, including the Playstation 2, Xbox and Xbox 360 and Nintendo Game Cube. In the PC market, Dolby technologies are mandated in both next-generation DVD formats and consequently Dolby will benefit from any PC shipping with Blu-Ray or HD DVD disc playback capabilities.

In addition, we are working with Intel to encourage OEMs developing new PCs featuring Intel Vive technology to also include the Dolby PC Entertainment experience. In the automotive market, Dolby benefits from the inclusion of DVD-based audio and video entertainment systems in certain models, as well as from the implementation of Dolby Pro Logic 2 technology in the audio system.

To date, Pro Logic 2 is in 43 models of automobiles. In our professional division, we introduced the Dolby Lake processor, which combines Dolby and Lake's audio expertise to provide advanced loudspeaker management and equalization functionality for live tour sounds, fixed installations or studio applications.

Second, we are focusing on opportunities to offer premium Dolby technologies in more consumer devices. Our Dolby headphone technology creates a simulated 5.1 surround sound effect with an ordinary pair of headphones.

Dolby headphones complements the use of entertainment devices such as portable DVD players or game consoles in public areas or shared spaces. Denon is now offering Dolby headphones in a new line of home theatre systems.

JVC has also begun offering a surround sound headphone adapter featuring our Dolby headphone technology. In addition, Audistry by Dolby gives listeners the ability to personalize their audio and hear it the way they like it.

We believe Audistry could suit the portable market as it can be used to enhance sound from digital media players, media-capable mobile phones, and other entertainment devices providing an exceptional personal listening experience. This quarter, Sharp announced three 2.1 home theatre systems that include Audistry technology.

These are available at retail in Japan and are arriving soon in the U.S. Third, we are focusing on longer term opportunities in the mobile and digital cinema markets.

In the mobile market, we believe our technology can enhance mobile entertainment devices by giving the listener a new way to enjoy a simulated 5.1 channel experience. We are positioning Dolby Headphone and Audistry by Dolby for this emerging market.

Currently, through our Via licensing subsidiary, we benefit from the growth in AAC based music devices such as the Apple iPod and the Nokia n90 series of phones, as we receive a portion of the royalties paid to the Via AAC patent pool. In digital cinema, we are extending Dolby beyond audio and into imaging with our Dolby Digital Cinema System.

Currently, approximately 150 screens are equipped with Dolby Digital Cinema Systems worldwide. These systems continue to provide valuable marketing momentum with studios and exhibitors.

Major film releases that have played on a number of our systems include Warner Brothers Harry Potter and the Goblet of Fire, and V for Vendetta. Disney's The Chronicles of Narnia, The Shaggy Dog and Chicken Little; Touchstone Pictures, Casanova; Universal's Inside Man and Paramount's She's the Man.

We continue to work in conjunction with the movie industry towards DCI compatibility. At Show West in March, we demonstrated Dolby's enhanced Digital Cinema System which will give exhibitors the flexibility to support both JPEG 2000 and MPEG 2 file formats.

In 2006, we will be working with exhibitors to upgrade existing Dolby Digital Cinema Systems to support JPEG 2000. Yesterday, we announced that MegaPlex Theaters selected Dolby to outfit 20 of its screens throughout its chain of multiplexes in Utah with Dolby Digital Cinema Systems.

This includes 10 of our systems that will be installed in MegaPlex's new multiplex in Jordan, Utah of which seven screens will be dedicated to digital cinema presentations only, making it one of the first multi-screen installations of digital cinema only theatres. As evidenced by this year's Show West, the movie industry is making steady progress towards digital cinema.

We have seen increased interest in digital cinema from the financing community, and exhibitors were clearly more enthusiastic about the transition to digital cinema than in the past. While it is too soon to definitively say when digital cinema will take off, given the industry bottlenecks and cost barriers that I've mentioned before, we believe its momentum is gaining.

Finally, in order to address these many opportunities we are taking steps to improve our effectiveness and efficiency as an organization. Dolby's strong history of technology and innovation has earned us the trust and confidence of the many licensees that we work with today.

Looking ahead, we have an opportunity to further build on this success by balancing our engineering strength with a more market-driven organization aimed at better anticipating licensee and consumer needs. We plan to hone our ability to understand the dynamic needs of our licensees, and anticipate earlier the innovations and premium technologies that will make their products better.

Some of the steps we are taking in consumer licensing include: In summary, the quarter saw an increase in the adoption of our consumer entertainment technologies, as well as in the momentum behind the roll out of digital cinema. As a company with an over 40 year history of working with the entire entertainment industry, from studios to exhibitors to broadcasters to consumer electronics manufacturers, we believe Dolby is uniquely positioned to benefit from the creation and playback of digital content.

We are focused on both near term and long term opportunities, as we concentrate on our long-term objective of being an essential element in the best entertainment technologies. With that, I will turn it over to Kevin.

But before he starts, I just want to mention that if Kevin sounds a little slurred at times it is because his wife just had their second baby in the last few hours, and so he is operating on very few hours sleep. With that, go ahead, Kevin.

Thanks, Bill. In the second quarter revenue was approximately $105 million, up 23% year-over-year, which consisted of 79% licensing revenue and 21% product sales and production services revenue.

In the technology licensing segment, revenue was $83 million, an increase of 29% year-over-year, driven primarily by the strength in our consumer electronics and PC markets. The CE portion of our licensing business benefited from a strong holiday season for our licensees.

Although we began the year expecting CE to be flat to slightly down, we now expect it to be flat to slightly up for the year. Having said that, with the holiday seasons behind us we would expect CE revenues to be substantially lower in the second half of the year as compared to the first.

In the PC market, we saw strength on increased unit volumes, and expect this market to be flat to slightly down in the second half of the year as compared to the first. In our other markets, we saw good performance in gaming due to strong holiday demand for the PlayStation Portable, PlayStation 2 as well as for available units of the Xbox 360.

And in broadcast, as a result of the continuing shift toward HD broadcast-related products. In the products and services segment, revenue for the second quarter was up 6% year-over-year, primarily on strong demand for professional broadcast products.

Turning to the details of the P&L for the second quarter, licensing gross margin was 91%, or up 1 point sequentially. Products gross margin was 56%, up 35 points from the previous quarter, which included a $5.7 million charge reflected in cost of product sales for the funding of our Digital Cinema initiative.

Excluding this charge, product gross margins continue to run higher than in 2005, primarily due to higher production volumes associated with demand for broadcast products. Services gross margin was 60%, up 8 points from the previous quarter, which included a $700,000 charge reflected in cost of services last quarter for installation of equipment in our Digital Cinema imitative.

Excluding this charge, services gross margin was slightly down. SG&A expense was 37% of revenue in the second quarter, down 3 points sequentially on higher Q2 revenue.

R&D expense was 8% of revenue for the second quarter, down 1 point sequentially on higher revenue. Dolby's effective tax rate for the quarter was 38%.

We now expect the tax rate for the full year to be about 40% as we will begin shifting some of our cash into tax-free municipal securities. Net income for the quarter was $28 million, or $0.25 per diluted share compared to $10.3 million or $0.10 per diluted share for the second quarter of fiscal 2005.

Per share calculations are based on $111.4 million diluted shares in the second quarter of fiscal 2006. On a pro forma basis, which gives effect to Ray Dolby's intellectual property contribution in February 2005, second quarter net income was also $28 million or $0.25 per diluted share, compared to $14.9 million or $0.14 per diluted share in the second quarter of 2005.

Net income also includes stock-based compensation charges of $5.1 million for the second quarter of 2006, compared to $5.3 million for the second quarter a year ago. Turning to the balance sheet, Dolby finished the quarter with over $450 million in cash and equivalents.

The growth in cash is primarily due to net income, and strong collections by our Via subsidiary late in the quarter. We had previously discussed the fact that Via accounts receivable had been building the last few quarters, and that most of the money Via collects is subsequently paid out to patent pool members.

As the collections occurred late in the quarter, the amount payable to these parties grew to about $30 million, a significant portion of this amount has been paid out in the early part of the third quarter. From operations, we added $41 million in cash during the second quarter, and capital expenditures were $2 million.

Before I cover the guidance section of my presentation, an aspect of our business model that we want to continue to stress is the lack of a predictable quarterly pattern in our results. Our revenues are lumpy, different quarters are higher in different years.

Secondly, we license our technologies to consumer electronics manufacturers and software developers who use them in products. Our licensees are required to report to us between 30 and 60 days after the end of the quarter in which they ship their products.

Since licensing royalties comprise roughly three-quarters of our revenue, our overall revenue can fluctuate quarter to quarter as a result of the timing of our receipt of those royalty reports. In addition, it is not uncommon for royalty reports to include corrective or retroactive royalties that cover extended periods of time.

This could cause our results to vary from forecasts. We are pleased to see revenue up 16% through the first half of 2006 compared to the same period last year.

We are also, however, cognizant of the effect of a particularly strong holiday season for our licensees on the CE portion of our business in the first half of the year. And therefore, would expect single-digit year-over-year revenue growth in the second half of the year.

Essentially, the year is playing out consistent with our initial guidance, except that we are expecting CE to be flat to slightly up rather than flat to slightly down. In light of this, we now expect fiscal 2006 revenue to come in between $350 million and $365 million.

Additionally, we expect fiscal year net income to come in between $65 million and $72 million. We expect diluted EPS to be in the range of $0.58 to $0.64.

While under FAS 123R, stock-based compensation expense may vary based on factors such as stock price or volatility, we currently expect stock-based compensation expense for the full year to be between $19 million and $21 million. With that, I would like to turn the call over to the operator for the Q&A portion of our call.

Can you give us a little bit more color on the underlying licensing growth, specifically within the PC HDTV and DVD end market? I believe from the prepared remarks you had mentioned that PC potentially could be flat to down in the back half of the year?

I am just curious as to what is driving that.

So as we said on the call, PC was strong in the first half on strong unit volumes. We are expecting flat to slightly down.

Basically we are expecting pretty similar unit volumes. There is a lot of shifting between the OEM providers, which just gives us cause to be cautious in terms of who our licensees are.

We still see that as a good growth area going forward. In terms of HDTV, we continue to see good growth out of broadcast.

The second half of the year is typically a slower part of the year for television sales. Hard to tell how much HD may change that, if at all.

The other thing that drives our broadcast segment is set-top box sales, and it is our understanding that most of the cable manufacturers are looking at their major roll outs in '07 so that looks good going forward.

One follow up on the Chinese enforcement activity, can you give us a little bit of an update there? And additionally too, were there any one-time royalties that we should be aware of in the quarter.

On the Chinese government enforcement activities, we are really pleased with the results to date that we've had. We've started our audit programs, we've had some good success.

I think we think the real measure of that is going to be to see how much more of the royalties we are collecting from those under the lower-cost manufacturing regions compared to what our expectations were, everything else being equal.

Any one-time royalties in the quarter?

Every quarter, as part of our business on an ongoing basis, there are always going to be cash up payments, late payments, a lot of these things. It is just a normal part of our business, so there is nothing that we want to call out at this point in time, out of the normal.

Sounds like nothing material. Great.

Thanks. Great quarter, guys.

[Inaudible - technical difficulties] Was it in higher end, home theatre or I guess more traditional DVD players? And then with regard to Digital Cinema, the Utah installation -- how is that being financed?

Is this different than what we saw from your first relationship with Disney and the roll out of 100 screens? Thanks.

Steve, we missed about the first five seconds of the first part of your question, it didn't come through.

Sure, just with regards to the consumer electronics business, where did you see strength? Was it in the higher end segment of home theatre, or more traditional, standard volume DVD player growth?

We saw strength across the consumer electronics. Really, it did pretty well across both of those product lines.

We don't really break it out. As to the Digital Cinema, Tim Partridge is with us, the head of the Pro division, I will let him address Utah.

Yes, David it is under a different arrangement to the other Chicken Little roll out in that this will be treated as an operating lease, so it will be depreciated over time and the VPS coming in over time will offset that depreciation.

Thank you.

Just again on DVD, just a little bit more color. My question specifically is about the U.S.

Do you see some stabilization in the U.S. with most of the growth in CE coming Internationally?

Well we don't really break it out in terms of the market. We are just addressing the total market.

We've never broken it out geographically. But as Kevin said, we did see higher than anticipated growth overall in that CE market on a worldwide basis.

What was in your other income item?

Mostly it is interest income.

Great, thanks.

Good afternoon, thanks for taking the call and congrats on a great quarter. Kevin, congrats on the new baby.

I can't believe you are on the call here. My wife would kill me.

That aside, two questions. One, maybe you can just give us a little bit of a break out here on what percentage of the licensing revenue came out of CE versus broadcast and other NPC?

I think you've given us some ranges in the past, maybe a deviation from those ranges because obviously it seems like broadcast is on a roll, both domestically and abroad. My follow-up question, on the Digital Cinema side, what is the hurdle on getting to the DCI specification from here?

As a reminder, when we came into the year we said that in '05 our consumer electronics market had made up just over 50% of our revenue. PC made up 25% to 30% and that are other markets, including broadcast, gaming, automotive made up the balance.

Coming into this year, we saw consumer electronics being flat to slightly down, and the growth coming roughly evenly between PC on the one hand and those other markets on the other hand. That is pretty consistent with what we've seen, except that CE we now see being flat to slightly up on the strong holiday season.

Within that, let me just clarify an earlier point because I think I misheard the question. The one underlying trend is from industry reports, we have seen from them that they are expecting home theatre in a box sales to be a little bit softer, but DVD sales and building home theatres in the broader sense, we had good business.

So all told, that probably means that CE is still headed to be less than 50% of our business going into next year, because we see good growth from these other markets and are getting better diversification.

Tim, DCI.

There are probably three hurdles to meeting full DCI compliance. The first was JPEG that was announced relatively late in the DCI process, so when the DCI recommendations were published, it had JPEG in it and we needed to engineer that into the product.

As you’ve seen, we did do that and we demonstrated that at Show West and we will be converting our theatres over to JPEG in the coming months. There are also some of the standards that were recommended by DCI in their publication, still need to be formalized by the standards bodies such as SMPCE so that is ongoing work that will also come to completion in the next few months.

Finally, the industry needs some kind of compliance program such that so all of these manufacturers can submit their equipment to some kind of compliance agency that can give a stamp of approval that it does actually meet the DCI standards. That is also work that is in progress with bodies employed by DCI to develop a compliance program, which we expect also to come to completion in the next few months.

So just to clarify, you don't see yourself currently at a disadvantage to some competition, particularly with Doremi who had press releases out recently on a number of deployments?

Yes, there are a lot of people out there that are claiming DCI compliance, of course, but without a compliance agency that can actually certify that, it is difficult to know what is compliance and what isn't. So we are striving to get there and hopefully at the same time there will be some way of proving compliance.

The market is still rolling out very slowly, so we don't see ourselves at a disadvantage at this point.

Hi, guys. Sorry I missed the answer on this, but with Digital Cinema, are the Megaplex rollouts that you have, are you financing that or are they buying that outright?

No, we're financing it but unlike the previous roll out that we did with Disney, we are doing this under an operating lease treatment so the equipment will be depreciated over time and the revenue stream, the virtual print fees coming in from the studios, will offset that depreciation.

Thank you very much for the clarification.

I was hoping you could address the longer term opportunities within the mobile space, whether it is in handhelds or gaming devices and how you see that potentially playing out and when we might see traction in that part of your business?

Well as you well know, the mobile market is a huge market. If you are talking specifically mobile headphones, we do see some opportunities from technologies such as Dolby Headphone and some of the Audistry products we've talked about.

Those will probably, to the extent we can be successful there, would be taking place in the next year or two. As we mentioned, we've already seen one model of phones from Nokia which are including some AAC technology, so we expect to hopefully move the market forward in terms of more use of AAC.

It is not something that happens overnight. There are cost issues in terms of the cost of implementing those technologies; royalty costs, et cetera.

We are looking very hard at getting into that market.

In the AAC, what are your splits on that right now? What is in the JV?

I'm not sure what you mean by JV. Our licensing --

Yes, your licensing subsidiary, rather.

The licensing subsidiary, which is Via, handles the MPEG licensing for AAC and as such, all of the patent pool owners who have contributed patents to the pool share in the royalties that come in; and they share in the royalties after Via has taken a small administrative fee off of the top.

And your share of the patent pool is roughly how much?

It is in the neighborhood of 30-35%.

That's great.

That's including our administrative fee that Via gets.

Your administrative fee is a percent of the total revenue or it is just a basic fee?

It is percentage of the pool.

Great, thank you.

Great quarter, guys.

Thank you.

The cash is obviously mounting here on the balance sheet. Anything interesting in the acquisition pipeline you want to allude to?

Just that we are taking a hard look at potential acquisitions in a number of the areas which we see as being our future.

Previously you had indicated that Digital Cinema in Europe might get traction sooner than the U.S. Anything to speak of there?

Not really, Eric. Still lots of ongoing initiatives that we are involved in on both sides of the pond, and certainly actual roll outs, it is happening right now here before it is in Europe.

Thanks a lot, guys.

Thank you everybody for participating. We appreciate your time and we look forward to speaking with you next quarter.

Thanks for joining us today. Good bye.