
Dolby Laboratories
5/4/2023
Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal second quarter results. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question and answer session. At that time, if you have a question, you will need to press star 1 on your telephone. As a reminder, this call is being recorded Thursday, May 4, 2023. I would now like to turn the conference over to Maggie O'Donnell, Head of Investor Relations for Dolby Laboratories. Please go ahead, Maggie.
Good afternoon and welcome to Dolby Laboratories' second quarter 2023 earnings conference call. Joining me today are Kevin Yehman, Dolby Laboratories CEO, and Robert Park, CFO. As a reminder, today's discussion will include forward-looking statements, including our fiscal 2023 outlook and our assumptions underlying that outlook. These statements are subject to risks and uncertainties, that may cause actual results to differ materially from statements made today, including, among other things, the impact of current macroeconomic issues, COVID-19, ongoing supply chain issues, inflation, changes in consumer spending, and geopolitical instability on our business. A 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 Factors section of our most recent quarterly report on Form 10-Q. Dolby assumes no obligation. It 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 non-GAAP financial measures. A reconciliation between GAAP and non-GAAP financial measures is available in our earnings press release and in the Interactive Analyst Center on the Investor Relations section of our website. So with that introduction behind us, I will now turn the call over to Liz Krakowski, who is going to be leading the conversation with Kevin.
Thanks, Maggie. So Kevin, let's get started. How are you thinking about the business in context of the macro environment?
Well, first and foremost, we're going to continue to focus on what we at Dolby can control. We continue to execute well against each of our growth areas. There do continue to be questions about the macro environment. What I can say with confidence is that there has never been greater demand for entertainment content. There's never been greater demand for content to be more engaging. And our consumers and partners want high-quality, immersive experiences. This is our passion at Dolby. We have a proven track record of being able to adapt to a world of change and focus on the pursuit of those inspiring experiences. And that's where we're going to stay focused.
So, Kevin, we're halfway through the year. How's the business progressing?
Well, the first half of the year has come in stronger than we expected, and we continue to see some transactions closing earlier in the year. And as it relates to our foundational audio technologies and the underlying business trends, the first quarter, you'll remember we saw TVs come in a little bit stronger than we had expected. In the second quarter, we saw PCs, DMAs, sound bars come in a little lighter than we had expected. But for the year overall, we see things playing out within the range of what we expected. Our foundational audio technologies, importantly, continue to be essential to the way entertainment content is delivered. It's true that these areas are more sensitive to the macro environment. We continue to expect that when the economy stabilizes, these areas will return to growth. For Dolby Atmos, Dolby Vision, and imaging patents, we see all the signs that give us confidence that we can double these revenues in the next three to five years. And we're on track to hit our growth target of 15% to 25% this year. And we expect to do this by continuing to focus on expanding our ecosystems around movies and TV, music and automotive, and user-generated content.
You just mentioned that you're seeing signs that give you confidence that you can achieve your long-term goals with Dolby Atmos and Dolby Vision. Can you talk about what you're seeing?
Yeah, sure. So Dolby Atmos, Dolby Vision, and imaging patents grew 30% last year, and one of the largest contributors to that growth was Dolby Atmos and Dolby Vision in our movies and TV ecosystem. And we continue to expect that to be a big driver this year. The movies and TV ecosystem drives growth across TVs, set-top boxes, smart speakers. It also drives revenue across each of our end markets, whether it's PCs or mobile devices. Growing ecosystems at Dolby means being a part of more and more of the content that people love and then becoming a part of all the ways that people experience that content. In the case of movies and TV, Dolby Vision and Dolby Atmos are included on roughly a quarter of 4K TVs, which is a significant position for consumers to enjoy that experience, but it also leaves significant opportunity for growth. So we're focused on driving deeper adoption into TV lineups with our existing partners. We talked about this last quarter with partners like TCL, Hisense, and others announcing their lineups at CES. We're also focused on increasing our presence with regional streaming partners and local OEMs, which addresses a large part of the market. And so, for example, We had some good wins this quarter in India. Disney Star and Geo Cinema announced that all of their 2023 Indian Premier League cricket matches will be available on Dolby Atmos, and we also had a number of local OEM wins. Going beyond movies and TV, we're really excited about the progress we're making within our user-generated content and music ecosystems. While they're both at early stages, they're shaping up to be significant growth contributors going forward. So I want to start with user-generated content because we had some great wins this quarter. Oppo became our newest partner for Dolby Vision Capture, launching their flagship phone. Xiaomi now has half a dozen Dolby Vision Capture phone models in China. And this quarter, they started shipping phones to India, Southeast Asia, Europe, and the Middle East. Vivo began shipping Dolby Vision Capture phones in China. And Weibo, one of China's largest social media platforms, now supports Dolby Vision and Dolby Atmos. joining the likes of WeChat, Bilibili, and QQ.
So what's driving the demands in the user-generated content ecosystem?
Well, consumers are passionate about the experiences that they can create and share with Dolby Vision. And that's our focus, to make the content that people care most about more engaging. And as we've talked about before, the camera is a major reason people upgrade their phones. And so as we progress throughout the year, We expect more phones to be available with Dolby Vision capture and playback and more services with the ability to capture, share, and edit that content.
I personally really enjoy having Dolby Vision capture on my phone and sharing memories and pictures and things, especially my two little kids. So, Kevin, let's move on to music. What do you think there?
We continue to see tremendous momentum across content, streaming services, and devices, particularly in wireless speakers and automotive devices. This quarter, Sonos launched their premium smart speaker, the Sonos Aero 300 with Dolby Atmos. And this product comes at a time when studios, streaming service, and artists are all coming together to embrace the Dolby Atmos music experience. As it relates to automotive, in just under two years, we've gone from announcing our first partner to today having cars in market from multiple manufacturers, including Mercedes, who's releasing additional models this year, and Volvo, whose cars will be available early next year. Just a few weeks ago, Guangzhou Automobile Group, which is the fourth largest auto manufacturer in China, announced that they're launching Dolby Atmos in their new sports sedan. So we continue to see strong demand across the automotive market, and we're working to bring more partners on board during the rest of this year. On the services side, Amazon began streaming to a wider set of devices, including more wireless speakers, sound bars, and DMAs. NetEase Music is one of the largest music streaming services in China, and they began streaming to more devices, including mobile, PC, and the automobile. It's great to see these services are continuing to add more and more content. Apple Music this quarter launched Apple Music Classical, which is a new classical music app where listeners can enjoy thousands of recordings in Dolby Atmos. Every day there's more and more content available. top artists across genres and generations are creating in Dolby Atmos. And whether that's the Billboard Top 100 artist or, you know, a favorite song from a special moment in your life, you are more likely than ever to find your favorite songs in Dolby Atmos. Beyond music, you can enjoy audiobooks and podcasts in Dolby Atmos. Audible is now streaming a number of their most popular audiobooks and podcasts in Dolby Atmos. They joined Wondery and Regional Services in India, South Korea, and the Middle East. So more and more ways to enjoy Dolby, very relevant experience in the car and on the go, and we're excited to continue to make stories more immersive and more experiential. So as it relates to continued growth in Dolby Atmos, Dolby Vision, and imaging patents, we continue to make progress across each of these focus areas, movies and TV, automotive and music, user-generated content, And beyond that, we remain focused on bringing Dolby to a far wider range of use cases with Dolby I.O. We continue to see strong interest from developers who are creating the next generation of online immersive experiences. What we bring is unparalleled audio quality and ultra-low latency for large-scale environments, and we continue to see an increase in the number of developers and customers that are using Dolby I.O.
So Kevin, before I move on to Robert, Any final thoughts?
Well, as long as people want to watch movies and TV, listen to music, or connect with each other through social media apps and gaming, there continues to be a big opportunity for Dolby to make a difference. We're confident about our growth opportunities, and we're making progress across each of our ecosystems and focus areas. We're coming at this from a position of strength, with a strong business model, strong profitability, and strong cash flow. we're going to continue to be agile and responding to changes in the market. And we're going to focus on the opportunities to bring Dolby Atmos and Dolby Vision to all the ways that people experience their content.
Thanks for that context, Kevin. Okay, so let's turn it over to Robert. Robert, can you start us off with some highlights for the quarter?
Yeah, thanks, Liz. Yes, before we get into the details, I want to point out a couple of things. First, Total revenue of $376 million was higher than the guidance we provided last quarter. We saw transactions close earlier than anticipated, and we benefited from higher imaging patent royalty revenue in our broadcast and mobile markets, partially offset by lower unit shipments than expected in our PC and consumer electronic markets. Second, we continue to operate in an uncertain environment. That said, based on what we're seeing today, we continue to expect revenue growth Our revenue outlook range for the year is $1.27 billion to $1.33 billion, or 1% to 6% year-over-year growth. With that as a backdrop, let's get into the Q2 details. Q2 revenue of $376 million was up 12% year-over-year, with growth in mobile and broadcast, primarily from Dolby Atmos, Dolby Vision, and imaging patents, higher box office, positively impacting our Dolby Cinema, and higher products and services revenue. This was partially offset by lower revenue in PC and CE markets, primarily from lower unit shipments. Q2 revenue was comprised of $352 million in licensing revenue and $24 million in products and services revenue. Now, let's talk about licensing revenue by end market. As a reminder, our licensing business is based on unit shipments. We also have transactions that reflect revenue from units shipped in prior periods, which we call recoveries, and minimum volume commitments where all or a portion of the revenue for a given period is recognized upfront. These transactions are all related to unit shipments. Broadcast represented about 37% of total licensing in Q2 of 23, of 24 million or 23% on a year-over-year basis, driven primarily by minimum volume equipment and imaging patents and Dolby Atmos. Mobile represented about 26% of total licensing in Q2 of 23, up 27 million or 41% on a year-over-year basis, driven by minimum volume commitments, primarily in Dolby Atmos, Dolby Vision, and imaging patents. Consumer electronics represented about 12% of total licensing in Q2 of 23, down 15 million or 28% on a year-over-year basis, driven by lower unit shipments in the first half, primarily in DMAs and soundbars related to foundational audio technologies. PC represented about 12% of total licensing in Q2 of 23, down 14 million or 25% on a year-over-year basis, driven by lower unit shipments in the first half, primarily related to foundational audio technologies. Other markets represented about 13% of total licensing in Q2 of 23, up 15 million or 48% on a year-over-year basis, driven primarily by adoption of Dolby Atmos and Auto, higher box office for Dolby Cinema, and higher unit shipments and gaming. Beyond licensing, our products and services revenue were $24 million in Q2-23, up 18% on a year-over-year basis. The year-over-year increase was driven primarily by higher cinema product sales. We also saw growth in Dolby I.O. Let's turn to expenses and margins. Total non-GAAP gross margin in the second quarter was 89% compared to 90% in the second quarter of fiscal year 22. Non-GAAP operating expenses in the second quarter were $195 million compared to $187 million in the second quarter of fiscal year 22. The increase was driven primarily by timing of marketing program spend. Non-GAAP operating income for Q2 was $141 million, or 38% of revenue compared to 34% of revenue in Q2 of last year. Non-GAAP income tax in Q2 was 18% compared to 17% in last year's Q2. Net income on a non-GAAP basis in the second quarter was $123 million or $1.26 per diluted share compared to $94 million or $0.92 per diluted share in Q2 of fiscal year 22. During the quarter, we generated $105 million in cash from operations compared to $63 million generated in last year's second quarter. We ended the second quarter with approximately $916 million in cash and investments. During the second quarter, we bought back about 630,000 shares of our common stock and ended the quarter with $262 million of stock repurchase authorization available going forward. We also announced today a cash dividend of 27 cents per share. The dividend will be payable on May 23, 2023 to shareholders of record on May 16, 2023. Our patent pool administrator, VIA, completed a small acquisition after the close of the quarter. The financial results of the acquired company are not expected to be material and are included in our guidance.
With that, Robert, let's get into guidance.
Great. We continue to operate in a challenging and uncertain environment. For fiscal year 23, we expect that our revenue from foundation audio technologies will decline low single digits year over year, reflecting lower unit shipments, particularly in PC, TV, CD, and mobile, consistent with what we've said previously. We are still targeting 15% to 25% growth in Dolby Vision, Dolby Atmos, and imaging patents, driven by growth in broadcast, mobile, and other markets. We assume this will more than offset the declines in foundational audio that we are expecting. With these assumptions, our full year 2023 revenue is expected to range from $1.27 billion to $1.33 billion. Within this, we anticipate licensing revenue to range from $1.17 billion to $1.22 billion. With growth in mobile, broadcast, and other markets outpacing the decline in PC and CE, products and services revenue is expected to range from $100 million to $110 million. Non-GAAP gross margin is estimated to be roughly 88%. We still expect that non-GAAP operating expenses will increase roughly 2% compared to prior year. and expect operating margins of roughly 30% on a non-GAAP basis for the year. We will continue to be disciplined with our spend, review our resource envelope, and allocation on a regular basis. We anticipate non-GAAP earnings per share of $3.15 to $3.65. In terms of the full year split, we still expect that revenue in the second half will be lower than revenue in the first half at a similar split to what we saw last year. Let's move on to guidance for the third quarter. Q3 revenue is expected to range from $285 million to $315 million. Within that, licensing revenue is estimated to range from $260 million to $285 million, while products and services is projected to range from $25 million to $30 million. Compared to Q3 of last year, we expect growth in Dolby Atmos, Dolby Vision, and imaging patents, particularly in broadcast, mobile, and other markets to more than offset lower revenue from foundational audio technologies driven by lower unit shipment estimates in PC and timing of committed volume transactions in mobile. Non-GAAP gross margin is estimated to be 86% to 87%. Operating expenses in Q3 on a non-GAAP basis are estimated to range from $195 million to $205 million. Our effective tax rate for Q3 is projected to range from 19% to 21% on a non-GAAP basis. We estimate that non-GAAP Q3 diluted earnings per share could range from $0.47 to $0.62. We are pleased with the start to the year. While the macro environment remains uncertain, we're making progress on our long-term growth opportunities. We continue to believe the fundamentals of Dolby's durable operating model, balance sheet, and cash flows remain strong. Now let's open it up for questions.
All right. Thanks, Robert. Operator, I think we're ready to open up the queue for questions.
Thank you. Ladies and gentlemen, if you wish to register a question for today's question and answer session, you may do so by pressing star one. If you would like to withdraw your question, please press star one again. If you are on a speakerphone, please pick up your handset before entering your request. To be fair to all participants, we ask that you limit yourself to one question and a follow-up question until all participants have had a chance in the first round. If time allows, we will then come back to answer any remaining questions. One moment, please. Your first question comes from the line of Steven Frankel with Rosenblatt.
Good afternoon. Thanks for the opportunity. Kevin, maybe we could start with some color on this notion that even in this environment, you have deals closing faster than anticipated, which is the opposite of what you experienced over the last couple of years. What could you contribute that to?
Yeah, Steve, thanks for the question. Well, first I would say that, yes, last year when we were seeing some deals take longer, what we said and what continues to be true is that we do have strong engagement throughout each of our ecosystems and a strong pipeline of deals. And this year we've started to see that turn in our favor with deals closing earlier than we had forecasted. I don't think I would attempt to draw any broad macro conclusions from that. other than it's a case-by-case basis. And, you know, as I've said before, that in an environment like this, you know, each of our partners is focusing on all the things they have to focus on. And so we're pleased that we've been able to get a lot of that business in in the first half of the year.
Okay. And you seem fairly insulated from the disastrous PC market. Is that a function of having exposure to minimum commitment in that business as well, like you do in mobile?
I think that it's a function of having a diversified business across a lot of device categories and everything that we do. To be clear, we do see PC shipment estimates being weaker than we thought coming into the year, but as Robert said, You know, we've had some things that are doing a little better than we had estimated, some things that are a little worse. So as far as the underlying business trends, especially as they're playing out in foundational, we see that playing out, you know, more or less what we expected. And then, of course, we continue to focus on driving growth in Dolby Atmos, Dolby Vision, and imaging patents, which is all about our three focus areas.
And then for Robert, what were true ups in the quarter?
Hi, Steve. The net true-up for the quarter was 1 million positive, which represented revised estimates for units shipped last quarter in PCs and CEs, which was a negative true-up offset by higher imaging patents related to patents that were once reported in arrears, which is also a true-up.
Great. Thanks so much.
We'll take our next question from Paul Chung with JP Morgan.
Hi, thanks for taking my question. So just on broadcast, you know, very strong performance there. What drove the large step up there? And can you provide kind of an update on, you know, vision and at most penetration across TVs and how much more kind of incremental runway there is?
Yeah, well, it relates to. broadcast, we are with Dolby Vision and Dolby Atmos. We're on roughly 25% of 4K TVs coming here this year, which is a great position and also one that leaves a lot of room for growth. It's also notable, I think, that Atmos has now caught up to Dolby Vision, which is, we think, a really good development because from our perspective, from the perspective of content creators, It's the Dolby experience, the combined experience, and we want more and more consumers to be able to enjoy it that way. So the key to continuing to drive that forward is, as I've talked about before, is continuing to work with our existing partners to drive the combined experience further and further into their TV lineups. And we talked about a lot of our partners, I should say, talked a lot about their lineups at CES. And then also, A pretty large part of the market is also regional. White label brands from big box retailers served by often regional streaming services. And so that's a big focus area of ours. And as I said earlier, India was a market where we had some progress this quarter. We also had an OEM win in Brazil. So that's what's going to continue to drive that. And we're also... switching markets a little bit on you, but as it relates to driving progress on the value of the movies and TV ecosystem, we continue to see good strength across, you know, sound bars and other areas as well.
Gotcha. And then on other revenues, you know, you're seeing a very nice rebound there. Talk about the contribution across cinema, you know, Atmos in the car was driving some of that nice rebound there. And is this the kind of new quarterly run rate we should be thinking about here and kind of, you know, grow from these levels?
So on the other category, I'll let Robert speak to kind of what we're guiding to that for the second half of the year. But I will say, generally speaking, yes, we look at that as a growth area. Two of the growth drivers have been gaming, where I think they've started to come out the other side of some of the supply chain challenges that we were experiencing last year, and I think even the year before. And then, of course, automotive. And we are, of course, beginning to see revenue from automotive, with NIO having been in market for over a year now. I had the opportunity to experience one of their cars yesterday. It's absolutely a spectacular experience. We had Mercedes begin shipping last year. They've announced more models on the way. Volvo will begin shipping next year. Those are kind of the standouts in terms of what's been driving the growth this quarter. And we absolutely see those as drivers. In particular, automotive is, you know, that's one of our key focus areas with music. That's not limited to automotive. We talked today about Sonos, its Era 300 product. We also announced yesterday that the JBL Boombox 3 has Dolby Atmos. So, music reaches a lot of categories, but automotive is a big focus for us.