Dolby Laboratories

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal third 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. At the time, if you have a question, you will need to press star 1 on your telephone. As a reminder, this call is being recorded Monday, August 3, 2020. I now turn the conference call over to Jason D., Director of Investor Relations for Dolby Laboratories. Please go ahead, Jason. Good afternoon. Welcome to Dolby Laboratories' third quarter 2020 earnings conference call. Joining me today are Kevin Yamin, Dolby Laboratories President and CEO, and Louis Chu, Executive Vice President and Chief Financial Officer. As a reminder, today's discussion will include forward-looking statements, including our fourth quarter and full-year fiscal 2020 outlook and our assumptions underlying that outlook. These statements are subject to risk and uncertainties that may cause actual results to differ materially from the statements made today. In particular, we are currently in the midst of the COVID-19 pandemic. The extent of its continued impact on our business will depend on several factors, including the severity, duration, and extent of the pandemic, as well as actions taken by governments, businesses, and consumers in response to the pandemic. all of which continue to evolve and remain uncertain at this time. The discussion of these and additional risks and uncertainties can be found in the earnings press release that we issued today under the section captioned, forward-looking statements, as well as in the risk factor section of our most recent quarterly report on Form 10-Q. There will be assumed no obligation and does not intend to update any forward-looking statements made during this call as a result of new information or future events. During today's call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings press release and in the Dolby Laboratories investor relations data sheet on the investor relations section of our website. As for the content of today's call, Lewis will begin with a recap of Dolby's financial results and provide our fiscal 2020 outlook. And Kevin will finish with the discussion of the business. So with that introduction behind us, I will now turn the call over to Lewis.

All right. Thank you, Jason. All right. Good afternoon, everyone, and I hope you're all staying safe out there. I'm glad to report that Q3 revenues came in at the high end of the scenario that we provided three months ago, and our earnings were above the range as we had a large tax benefit in the quarter to go along with some lower than projected operating expenses. While we did do better than Q3 outlook, it's worth noting that the numbers were lower than the original forecast from the start of the year before COVID-19 came into the picture. So here are the numbers. Third quarter revenue was $247 million compared to $352 million in Q2 and $302 million in Q3 of last year. Our Q3 revenue guidance coming into the quarter was a range of $225 million to $250 million. Now, if I compare that to what we assumed in our guidance, revenues from TVs, PC, and mobile were at the higher end, while consumer electronics and set-top boxes were at the lower end of our scenario. Products and services were at the high end of the range, but remember, that we had lowered our expectations by 70 to 80% because of the significant impact of COVID-19 shutdowns on the cinema industry. Now, looking at total company quarter over quarter, revenue was down by about $105 million from Q2. Roughly half of that was driven by timing of revenue under contracts as well as lower recoveries. And roughly the other half of that was attributable to the impact from COVID-19. which includes lower royalties from unit shipments across a variety of devices, lower sales of cinema products and services, and lower revenue from box office share at Dolby Cinemas. Now, looking at total company year over year, revenue was down by about $55 million versus last year's Q3, and that was predominantly attributable to COVID-19. And similar to what I said a minute ago, lower unit shipments, lower products and services, and lower Dolby Cinema revenue. The composition of Q3 revenue was $235 million in licensing and $12 million in products and services. So let's go through a breakdown of licensing revenue by end market, starting with broadcast. Broadcast represented about 38% of total licensing into third quarter. Broadcast revenues were down about 34% year over year, and that was driven by lower recoveries and lower unit volume due to the pandemic, despite the fact that adoption of Dolby Vision and Dolby Atmos into TVs and set-top boxes is higher than last year. On a sequential basis, broadcast was down by about 31% due to lower recoveries and lower unit volume. Mobile represented approximately 33% of total licensing in Q3. Mobile was up by about 65% over last year, due to higher recoveries and revenues from our patent programs, offset partially by unit volume impact from the pandemic. On a sequential basis, mobile was up by about 3%, driven by recoveries offset partially by unit volume impact from the pandemic. PC represented about 10% of total licensing in the third quarter. PC was down by about 4% year-over-year, due to lower recoveries and lower unit volume, although it's worth noting that adoption of Dolby Vision and Dolby Atmos into PCs has increased since last year. And sequentially, PC was down nearly 50% due to timing of revenue under contracts and also lower recoveries. Consumer electronics represented about 9% of total licensing into third quarter, and on a year-over-year basis, CE licensing was down by about 29%. driven by lower volume and lower recoveries. On a sequential basis, CE was down by nearly 60% due to timing of revenue under contract as well as lower unit volume. Other markets represented about 10% of total licensing in the third quarter. They were down by about 34% year-over-year due to significantly lower revenues from Dolby Cinema because nearly all those screens were closed for the quarter and lower revenues from gaming due to console life cycles. On a sequential basis, other markets was down by about 16%, driven by lower revenue from Dolby Cinema and from via admin fees, and those are the fees in the patent pool program that we administer. This was offset partially by higher recoveries in automotive and gaming. Beyond licensing, our products and services revenue was $11.8 million in Q3, compared to $23 million in Q2 and $30.3 million in last year's Q3. We had anticipated a big drop off in sales in this category as most of this revenue comes from equipment that we sell to cinema exhibitors. And these customers in general continue to be negatively affected by the pandemic. Now let's cover margins and operating expenses for Q3. Total gross margin in third quarter was 87.9% on a GAAP basis and 89% on a non-GAAP basis. Products and services gross margin on a GAAP basis was minus $5.5 million in the third quarter due to fixed costs not fully covered by the lower volume that we ran. And as a reminder, the guidance I gave at the beginning of the quarter was for GAAP gross product margin to range from minus $6 million to minus $9 million. Products and services gross margin on a non-GAAP basis was minus $3.5 million in the third quarter for the same reasons as I just went over in the GAAP discussion. And there, as a reminder, our guidance for non-GAAP product gross margin was minus $5 million to minus $8 million. Operating expenses in the third quarter on a GAAP basis were $182.9 million compared to $209 million in Q2. Operating expenses in Q3 were about $8 million less than the low end of the range we had guided mostly driven by timing of certain marketing programs that were pushed into Q4, lower legal expenses, and lower travel and outside services. Operating expenses in the third quarter on a non-GAAP basis were $159.2 million compared to $188.4 million in the second quarter. And the Q3 non-GAAP total was also below the range we projected and for the same reasons that I discussed in the GAAP expenses. Operating income in the third quarter was $34.1 million on a gap basis, or 13.8% of revenue, compared to $34.3 million, or 11.3% of revenue, in Q3 of last year. And last year's Q3 included a $30 million charge for restructuring, mostly associated with an early exit from a leased facility. Operating income in the third quarter on a non-gap basis was 60.5 million dollars or 24.5 percent of revenue compared to 85.9 million dollars or 28.4 percent of revenue in q3 of last year income tax was a 27.4 million dollar benefit in q3 on a gap basis and a 21.2 million dollar benefit on the non-gap basis the q3 income tax amounts include approximately 36 million dollars of discrete benefits for specific items that were resolved during the quarter. Net income on a GAAP basis in the third quarter was $67.3 million, or 66 cents per diluted share, compared to $39.6 million, or 38 cents per diluted share, in last year's Q3. Net income on a non-GAAP basis in the third quarter was $87.5 million, or 86 cents per diluted share, compared to $79.3 million, or 76 cents per diluted share in Q3 of last year. For both GAAP and non-GAAP, net income in Q3 was above our original guidance due to revenue being at the higher end of our range, operating expenses below our range, and the favorable income tax that I discussed. During the third quarter, we generated about $134 million in cash from operations, which compares to about $91 million generated in last year's third quarter. and we ended the third quarter with a little over $1.1 billion in cash and investments. During Q3, we bought back about 500,000 shares of our common stock and ended the quarter with about $230 million of stock purchase authorization still available. We also announced today a cash dividend of 22 cents per share, which will be payable on August 26, 2020, to shareholders of record on August 17, 2020. Now let's cover the outlook for Q4. Three months ago, when I went over the guidance for Q3, I highlighted the challenges that we were facing in the environment. Consumer demand was dropping, visibility was much more limited than usual, and industry data reports were not consistent or current. Fast forward to now, we have updated TAM data for some of our end markets, but not all of them. Customer visibility is still very limited. And remember, we won't have actual shipment data for the June quarter until all our customers send us their reports over the next two months. And the economy is still pretty uncertain. So with that as a backdrop, here's our current scenario for Q4, along with some key assumptions that we've embedded into the outlook. Let's start with products and services revenue, most of which goes into the cinema industry. Screens are opening more slowly than we thought last quarter. So we are assuming that there will not be any significant uptick in equipment purchasing activity from exhibitors in Q4. We estimate that products and services revenue in Q4 could range from $10 million to $15 million. Let's talk about licensing. We estimate that licensing revenue in Q4 could range from $215 million to $240 million. that's in comparison to the $235 million that we had in Q3. As I look at the transition from Q3 actual to the Q4 outlook scenario, there's downward movement from timing of revenue under customer contracts. This is not unusual, and I think of it as Dolby seasonality. In other words, within the course of our fiscal year, we tend to have higher revenue in our Q2 and our Q3 and lower amounts in our Q1 and Q4. And a lot of this is because of timing of revenue under various contracts. Partially offsetting it this year is an assumption that total unit shipments could increase modestly in Q4 over Q3 as consumer spending starts to improve. Our Q4 scenario assumes that there will roughly be a 5% improvement in unit shipments, plus or minus, blended across all device categories. And for Q4, we're also assuming very little revenue from Dolby Cinema box office share. So to summarize, our scenario for total revenue in Q4 is a range of $225 million to $255 million. If I compare that to last year's Q4 actual revenue of $299 million, the majority of the potential decline would be attributable to the economic ripple effect of the pandemic. and the remainder would largely be due to lower recoveries. Let me finish up with the rest of the Q4 outlook so I can turn it over to Kevin. Gross margin for Q4 on a GAAP basis is estimated to range from 85% to 86%, and non-GAAP gross margin is estimated to be about one percentage point higher than the GAAP number. Products and services gross margin will remain in negative territory in Q4 mainly because of fixed costs that are not fully covered at the lower revenue levels. At the revenue range in the outlook I provided, products and services gross margin on a GAAP basis could range from minus $6 million to minus $9 million in Q4. And on a non-GAAP basis, it could range from minus $5 million to minus $8 million. Operating expenses in Q4 are estimated to range from $187 million to $197 million on a GAAP basis, and from $167 million to $177 million on a non-GAAP basis. Other income is projected to range from $2 to $3 million for the quarter, and our income tax rate for the fourth quarter is projected to range from 19% to 21% on both a GAAP and non-GAAP basis. Based on a combination of the factors I just reviewed, we estimate that Q4 diluted earnings per share on a GAAP basis could range from about 5 cents to about 20 cents. And then on a non-GAAP basis, we estimate it would range from about 22 cents to 37 cents. And as for the full year, if you do the math, that would mean that our FY20 revenue for the full year could range from about $1,115,000,000 to $1,145,000,000. Gap diluted earnings per share could range from $2.04 to $2.19. And non-gap diluted earnings per share could range from $2.76 to $2.91. So now I would like to turn it over to Kevin. Kevin?

Thank you, Lewis. And good afternoon, everyone. With the strength of our financial model, balance sheet, and value proposition, Dolby continues to be well-positioned to navigate through these challenging times. Our people continue to bring their creativity and passion to enable more Dolby experiences to more people around the world. While our Q3 revenues came in at the high end of our scenarios, there is still a lot of uncertainty across many of the markets in which we operate. In addition to lower consumer spending, The pandemic has resulted in some shifts in the timing of new customer wins and revenues. At the same time, our partners remain deeply engaged with enabling new Dolby Vision and Dolby Atmos experiences. As consumer spending does return, we are confident that with our strong positioning across a broad range of devices and services, we will return to our path of driving revenue and earnings growth. Our formula for growth has always started with increasing the amount of compelling content available at Dolby. The Dolby Vision and Dolby Atmos experience in movie and TV content has led to growing adoption across a broad range of devices. We are also expanding the Dolby experience to areas such as gaming and music that broaden our value proposition and create more opportunities in device categories like mobile, PC, and automotive. In addition, we are beginning to address a growing population of content beyond premium entertainment, most recently with the launch of our developer platform, Dolby.io. All of this gives us confidence in our ability to drive long-term growth. Let's turn to some of the highlights this quarter. As people are watching a growing amount of streamed content, Dolby Vision and Dolby Atmos continues to be highlighted within the content that matters most to people. The highly anticipated releases of Hamilton on Disney Plus and Greyhound on Apple TV Plus are both available in Dolby. This quarter, we began to see the first titles in Dolby Vision on Google Play. And Hotstar, the largest streaming service in India, began to support Dolby Vision for Disney Plus content. This quarter, we saw several partners adopt Dolby Vision and Dolby Atmos within their products. which supports Dolby Vision and Dolby Atmos across most of their devices, announced that AirPods Pro will support Dolby Atmos with the release of iOS 14. Sonos launched the Sonos Arc, their first soundbar that supports Dolby Atmos. Free, one of the largest internet service providers in France, launched their first set-top box to support Dolby Vision and Dolby Atmos. And last month, Xiaomi launched their first TV supporting the combined experience. Adoption of both Dolby Vision and Dolby Atmos within TVs continues to expand globally, most notably in India. This quarter, TCL, Sony, OnePlus, and Nokia all announced new TV models in India supporting the combined experience. Also, Panasonic expanded their adoption of Dolby Vision IQ to additional models this quarter. In FY19, Dolby Vision was included on about 10% of 4K TV shipments, and we are on track to materially increase that adoption rate for fiscal 2020, with a significant growth opportunity still ahead of us. Our strong presence in movie and TV content has enabled the initial adoption of Dolby Vision and Dolby Atmos within PC and mobile devices. Beyond that, we see a significant opportunity to accelerate adoption by enabling more experiences on these devices, including gaming and music. Recently, TIDAL significantly expanded the number of devices that support Dolby Atmos music to include Dolby Atmos-enabled soundbars and home theater equipment. We are also seeing examples of how Dolby Atmos can create unique experiences across a wide range of music genres. This quarter, we saw examples of classical music from John Williams and recordings from the London Philharmonic Orchestra mixed in Dolby Atmos. Empire, an independent label, began releasing music in Dolby Atmos from artists like Fat Joe and Remy Ma. The music in Dolby experience elevates our engagement with partners and strengthens the value proposition for Dolby Atmos in existing device categories such as mobile phones and creates new opportunities for us in areas such as automotive and smart speakers. Let me shift to cinema. During the quarter, most cinemas remained closed with a few regions slowly beginning to reopen. The closure of cinemas around the world has significantly reduced demand for cinema products. We believe that when cinemas do begin to reopen, Exhibitors will look to highlight their premium offerings, and consumers will seek out the best experience. And there is none better than Dolby Cinema. Last month, the first Dolby Cinema in South Korea was opened with our partner Megabox. We have also added our second partner that will bring Dolby Cinemas to Saudi Arabia, where we saw our first site open just last week. As we look ahead, we are excited by the unique opportunity to significantly broaden the content experience we address with Dolby Technologies. During the quarter, we launched our developer platform, Dolby.io. Dolby.io enables developers to access Dolby Technology to raise the bar on the quality of the media and communications experiences within their apps and services using our APIs. Among our initial customers, we have seen application across a wide range of use cases, including podcasts, e-learning, and telehealth. Beginning a few weeks ago, artists can optimize the quality of their music recordings with mastering on SoundCloud, powered by Dolby's platform. We are excited by the initial reception of Dolby.io and by the potential to bring Dolby to the growing amount of media and communications content that is part of our daily lives. To wrap up, Dolby has a solid foundation with a strong business model. And more than ever, people want immersive entertainment and communications experiences. The quality of these experiences matter. We continue to focus on growing the number of devices that support Dolby Vision and Atmos. We will accelerate adoption and broaden the device categories that support the Dolby experience by enabling new forms of content, like music and gaming. And we are excited by the opportunity to enable an even broader range of Dolby experiences, most recently with the launch of Dolby.io. All of this reinforces our belief in the opportunities that are still ahead of us and give us confidence in our ability to drive revenue and earnings growth. And with that, I will turn it over to Q&A.