Dolby Laboratories

Ladies and gentlemen, thank you for standing by. Welcome to Adobe 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 that time, if you have a question, you need to press star one on your telephone. As a reminder, This call is being recorded Thursday, August 3rd, 2023. I would now like to turn the conference call over to Liz Krakowski from Dolby Laboratories. Please go ahead, Liz.

Good afternoon, and welcome to Dolby Laboratories' third quarter 2023 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories CEO, and Robert Park, the CFO. As a reminder, today's discussion will include forward-looking statements, including our Q4 and 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, ongoing supply chain issues, inflation, changes in consumer spending, and geopolitical instability on our business, and other risks and uncertainties specific to 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 captured forward-looking statements, as well as in the risk factor section of our most recent quarterly form, 10Q. Dolby assumes no obligation and does not intend to update any forward-looking statements made during the 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, Kevin, let's get started. What are you seeing in the business?

Well, Q3 came in about where we expected, and our outlook for the year is in line with what we shared last quarter. What we're focused on every day is driving towards sustainable double-digit growth by bringing more Dolby experiences to more people and more types of content. With our foundational audio technologies, we have a diversified base, and we continue to work to strengthen our position across each of our end markets. Over the long term, having this diversified base of revenues is a very strong position to be in. As it relates to Dolby Atmos, Dolby Vision, and imaging patents, we're focused on the design wins that drive long-term growth. And our three areas of focus continue to be movies and TV, music, including automotive, and user-generated content. And if I take a step back, there's just never been a time where we're seeing greater demand for entertainment content, and that's what creates opportunities for Dolby.

On the focus areas you just mentioned, can you talk about progress with movies and TV?

Yeah, so with movies and TV, We're focused on driving adoption across all your living room devices and beyond, PCs, mobile devices. And driving that demand starts with being a part of the content that people care most about. We partner with the top creators who are passionate about continuing to push the boundaries on the experience that they're creating. There's been a lot of excitement this quarter around this summer's blockbusters in the cinema. Moviegoers can enjoy both Barbie and Oppenheimer in Dolby Cinema. So we have a strong presence across movies and TV, and that includes sports. And sports is an area where we continue to make progress. Sports is, of course, a big demand driver for devices, particularly TVs. Many of you likely love the same sports team today that you did 10 or 25 years ago. And these events are what bring communities together. People are emotionally attached to these experiences, and they want to have the best experience however they watch in their game or their match. This quarter, Sports fans were able to enjoy the French Open in Dolby Vision and Dolby Atmos, Wimbledon and Dolby Atmos on Sky Germany, and the UEFA Championship Games, including the finals where Man City took home the win, are available in Dolby Atmos. On the service side, Max launched their top-tier service, Max Ultimate, with Dolby Atmos and Dolby Vision. So now consumers can enjoy more content in Dolby across services including HBO, Discovery, and Warner Brothers. As we've talked about, Regional streaming partners and local OEMs are a significant part of the market. And so we continue to focus on increasing our presence. And this quarter, TCL, who earlier this year announced that Dolby Vision and Dolby Atmos will be included in all of their new 4K TV models in the US, announced that they are expanding Dolby Vision and Dolby Atmos into all of their regional models in India. Acer launched a local line of TVs with Dolby Vision and Dolby Atmos TVs in India. and we added our first pay TV partner in Vietnam. So we continue to make good progress with these regional providers. We're focused on expanding further into the lineups with our global partners, and that's what continues to drive growth in this area.

Can you talk about what you're seeing with music?

Yeah, well, once again, it all starts with content. And globally, the library of songs and Dolby Atmos from artists across genres continues to grow. And just this quarter, we added the Beach Boys, Snoop Dogg, and many more. More than 85% of the global billboard top 100 artists continue to create music in Dolby Atmos, and we're expanding further into regional content. This quarter, Wink Music, a free streaming service available to India Airtel's 360 million subscribers, announced that they are going to support Dolby Atmos music. We now have three of the top five streaming services in India, and there are thousands of songs by local artists available in Dolby Atmos, from the biggest music labels, including Serigama, T-Series, and Yash Raj Films. Expanding local music catalogs in Dolby Atmos Music is important because it brings more consumers into the Dolby Atmos music experience, and it creates more value for our hardware partners, which creates for us the opportunity to gain adoption across a much wider range of devices. That includes soundbars, phones, smart speakers, and particularly automotive, anywhere that consumers enjoy music.

You just mentioned several device categories where you're driving growth with Dolby Atmos Music. Can you talk more about bringing the Dolby Atmos Music experience to the car?

Yeah, from the early days when we first started demonstrating Dolby Atmos Music, one of the questions we always got, whether it was artists or music labels, is are we going to be able to have this experience in the car? Because people love their music experience in the car, and it's the perfect environment for Dolby Atmos Music. And our partners continue to add more models across more markets, which is increasing the availability of Dolby Atmos to consumers. Nearly half of our partners now have multiple car models with Dolby Atmos. This quarter, NIO and Lotus, which started in the domestic Chinese market, have now launched cars in Europe. And Mercedes has over a dozen car models available with Dolby Atmos, and they continue to add and ship more models globally. So in just over two years, we went from our first announcement, to having nine car manufacturers, and it's still early days. Our current partners are still ramping up, and we continue to engage with more auto manufacturers.

Today, you talked about the growing demand for different types of content. What are you seeing with user-generated content?

Well, with user-generated content, more and more people are able to unleash their creativity and their storytelling, and it's increasing the amount and the types of content, and by bringing the power of Dolby Vision, We're enabling people to capture the experience that inspires them and to share those videos in the most realistic and lifelike way. We have great momentum in China where people can create and share their stories on social media platforms that include WeChat, Bilibili, and QQ. From a device perspective, Dolby Vision Capture is a part of iOS globally, and with Android, we have our first device wins with Xiaomi, Oppo, and Vivo. This quarter, India's largest short video platform, Moj, became our latest social media platform to adopt Dolby Vision. It has more than 300 million subscribers, and they can now create and share their stories in Dolby Vision with their iOS devices or their Xiaomi phones. We also added a partner in Singapore this quarter. VidC is a short film video platform that now supports Dolby Vision and Dolby Atmos. So their global community of storytellers can now create and share films in Dolby. And Motorola became our latest partner to announce and start shipping their first Dolby Vision playback phone. Growing our user-generated content ecosystem is all about continuing to expand further the services, giving access to creators to create in Dolby, and that's what creates more demand for our device partners to expand further into their lineups and, of course, to bring on new partners.

As you look beyond movies and TV, music and user-generated content, what else is the team working on?

Well, of course, we're really excited about the areas we just talked about, but we're also always working on a number of new things. We haven't talked about gaming. You may have seen earlier this week that Sony made an announcement about PlayStation 5 and Dolby Atmos. As it relates to Dolby I.O., we're seeing a lot of interest in online immersive experiences personalized experiences that have the promise of increasing audience engagement. In particular, our ability to provide high quality audio and video streamed in ultra low latency, along with the ability to have natural sounding conversations between participants, opens up a possibility of new experiences that our developers and potential customers are really excited about. Stepping back, What's exciting is that there continues to be a tremendous amount of innovation on both content creation and storytelling. And those storytellers are always looking to push the boundaries of the stories they can tell. And, of course, we see the same thing with our hardware partners who are looking to push the boundaries of what's possible. And that's what creates opportunities for us. We're always hard at work reinventing what it means to have a Dolby experience and bringing the experiences that are most important to people to life.

Kevin, do you want to do a quick wrap-up before Robert comes on to talk about the numbers?

Yeah, well, this is our passion. It's enabling artists and the creator and all of us to tell better stories and to bring out the full emotion of those experiences. There's been a significant increase in the amount of content available to us as consumers. There are more types of content. There are more ways to enjoy that content. There's more ways to receive and experience that content. And across the board, that's what creates opportunities for Dolby. to make a difference in each of those experiences and all the ways in which they're delivered. So we're going to continue to focus on raising the bar on the quality of those experiences. We've been doing that for decades, and I'm confident in the growth opportunities ahead.

Thanks, Kevin. Robert, can you walk us through the financials for the quarter?

Of course. Before we get into the details, I'd like to highlight a couple of things. First, total revenue of $298 million was in line with the guidance we provided last quarter. Based on what we're seeing today, revenue outlook for the year is expected to range from $1.285 billion to $1.315 billion. This results in 2% to 5% growth year over year, also in line with what we shared last quarter. With that as context, let's turn to the details for Q3. Q3 revenue of $298 million was up 3% year over year. Licensing revenue was $273 million, up 1% year over year. Growth in our Dolby Atmos, Dolby Vision, and imaging patent category, primarily in other markets, PC and broadcast, more than offset lower revenue from foundational audio category, primarily in mobile, CE, and PC. Products and services revenue was $25 million, up 24% year-over-year, driven by higher cinema product sales. 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 out front. These transactions are all related to unit shipments, and the only difference is timing. Broadcast represented about 38% of total licensing in Q3 2023, up 4 million or 4% year over year, with higher revenue from minimum volume commitments and imaging patents. revenue from foundational technologies were roughly flat and higher recoveries offsetting low revenue from unit shipments and minimum volume commitments. Mobile represented about 18% of total licensing in Q3 23, down 13 million or 20% on a year-over-year basis, driven by lower revenue from minimum volume commitments, primarily impacting foundational technologies. PC represented about 11% of total licensing in Q3 23. up 3 million or 9% on a year-over-year basis, driven by higher revenue from minimum volume commitments and imaging patents, partially offset by lower unit shipments, primarily impacting foundational technologies. Consumer electronics represented about 13% of total licensing in Q3-23, down 4 million or 11% on a year-over-year basis, driven primarily by lower unit shipments of soundbars and DMAs, primarily impacting foundational technologies. Other markets represented about 20% of total licensing in Q3-23, up 15 million or 36% on a year-over-year basis, driven by higher patent pool admin fees related to imaging patents, a higher true-up in gaming, and increased adoption of Dolby Atmos and Auto. Now let's turn to expenses and margins. Total non-GAAP gross margin in the third quarter was 87% of revenue versus 88% in the third quarter of last year. due to a higher mix of products and services revenue. Non-GAAP operating expenses in the third quarter were $193 million compared to $179 million in the third quarter of fiscal year 22. The increase was primarily driven by higher labor, timing of patent programs sent, and higher travel. During the quarter, we recorded a non-GAAP restructuring charge of about $17 million in the quarter comprised of severance and related benefits along with charges related to the exit of a lease facility, as we continue to align resources to our most impactful opportunities and optimize our geo footprint. Non-GAAP operating income was $65 million, or 22% of revenue, compared to 26% of revenue in Q3 of last year. The non-GAAP income tax rate was 25.6%, compared to 13.9% in Q3 of last year, which included more discrete items than this year. Net income on a non-GAAP basis was $54 million or $0.55 per diluted share compared to $69 million or $0.68 per diluted share in Q3 of last year. During the third quarter, we generated $121 million in cash from operations compared to $173 million generated in last year's fiscal Q3. We ended the third quarter with about $987 million in cash and investments. During the third quarter, we bought back about 295,000 shares of our common stock and ended the quarter with $237 million of stock repurchase authorization available going forward. We also announced today a cash dividend of $0.27 per share. The dividend will be payable on August 22, 2023 to shareholders of record on August 14, 2023. Thank you, Robert.

With that, let's turn to FY23 guidance.

We continue to operate in a challenging and uncertain environment. For the full year, fiscal 2023, we continue to expect that our revenue from foundational audio technologies will decline low single digits year over year, reflecting lower unit shipments in PC, CE, broadcast, and mobile, consistent with what we've said previously. We are on track to hit our target of 15% to 25% growth in Dolby Atmos, Dolby Vision, and imaging patents, driven by growth in broadcast and other markets. We expect 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 $1.285 billion to $1.315 billion. Within this, we anticipate licensing revenue to range from $1.185 billion to $1.21 billion, with growth in other markets and broadcast, driven by Dolby Atmos, Dolby Vision, and imaging patents, outpacing the decline in PC, and CE, primarily impacting revenue from foundational technologies. Products and services revenue is expected to range from $100 million to $105 million. Non-GAAP gross margin is estimated to be roughly 88%. Non-GAAP operating expenses are expected to range from $760 million to $770 million. We continue to be disciplined with our spend and review our resource envelope and allocation on a regular basis. we expect operating margins to be roughly 30% on a non-GAAP basis for the year. We anticipate non-GAAP diluted earnings per share of $3.30 to $3.50. Thanks, Robert.

Any closing thoughts before we open it up for questions?

Of course. We continue to make progress, are confident in our long-term growth opportunities, and believe the fundamentals of Dolby's durable operating model, balance sheet, and cash flows remain strong.

All right. With that, we are ready for questions, operator.

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 1. If you would like to withdraw your question, press star 1 again. If you are 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. We'll pause for just a moment to rearrange the queue. Our first question comes from Ralph Skalkart from William Blair. Please go ahead.

Good afternoon. Thanks for taking the question. Kevin, just on the macro, if you could just kind of take a step back, you know, where you're sitting today, maybe relative to, let's say, last quarter, and perhaps if you could sort of, you know, go back to when you provided the initial outlook for this fiscal year, how would you sort of you know, characterize the macro now versus when you provide that outlook as well?

Yeah, well, I think, you know, when we entered the year, we expected that we would see lower unit shipments across a number of our end markets, particularly PC and mobile, and that's what we've seen play out. So, I guess I would say some of the things we were expecting at the beginning of the year have transpired, and as I look to where we are on macro now, we're You know, it's encouraging to see economists and pundits increasingly giving chances for a soft landing in the U.S. At the same time, you know, we're talking to our partners, particularly in areas like mobile or PC. I would say they're still understandably cautious. It's been a dynamic period of time, and they're still working through some of those issues. And, of course, we're a global company. So, you know, the real feel of the economic environment differs depending on where you are.

Okay, great. And then just, you know, looking at products and services gross margin, looks like there's a little break in trend there. Just curious, you know, what's driving that?

Hey, Ralph. This is Robert here. In terms of product and service gross margin, in the third quarter, the lower gross margin is attributable to higher excess and obsolete reserves in the quarter. But if you look at in terms of the full year, it should be closer to mid-teens. We're not quite back to what I'd say the pre-pandemic levels. That's what we'd like to get back to. But in the current period with the volumes lower than they were, the pre-pandemic levels, they are slightly depressed. Okay.

Thanks, Robert. Thanks, Kevin. Thank you.

Our next question comes from Steven Frankl from Rosenblatt Securities. Please go ahead.

Last quarter, I think one of the dynamics was some of the deals kind of got pulled in and signed earlier than expected. What's the environment like now if you go to do annual negotiations with some of these larger customers? Are you seeing them wanting to push back and take their time, or do you think the decision-making patterns are going to return to normal?

That's a tough one to generalize, Steve. I think even last quarter we observed in the latter part of last year, we had some deals that took longer. And then the first half of this year, we had some deals that came in earlier in the year. It really is facts and circumstances based. What's the partner? What are they prioritizing? What's their dynamic? But of course, all of that is considered into our guidance for the quarter and the year, which is You know, coming in about in line with what we expected when we last spoke. So, you know, I think stepping back a level, what we're really focused on is, you know, are the demand signals around our key focus areas. And on that front, you know, we've been able to add the partners we're seeking to add for Dolby Vision Capture and mobile with, you know, this year, including Oppo, Vivo, and Xiaomi. We've continued to add auto partners, and we've continued to make progress in TB, particularly with some of the regional partners. India was a highlight again this quarter. So the demand's there, and I don't think I can generalize on deal timing, except that it can always vary, and the climate's about what we expected it would be.

Okay. So there was a big step up in goodwill and intangibles for the quarter. Was that related to managing IP pools, or is there something else that you acquired in the quarter?

Hey, Steve. Yeah, the step up in intangibles and goodwill is related to the acquisition we talked about last quarter, which was MPEG LA, to strengthen and diversify our imaging patent portfolio.

I just wanted to make sure. And then what were true ups in the quarter and were there any material recoveries in the quarter that you would call out?

Hey Steve, yeah, the troops are really a nonfactual this quarter. Positive about a million, so nothing really to note in terms of our troops from last quarter's volume. Of course they vary by end device, but overall it's about a million.

OK, and then you know there's a case of the buyback versus last year. So what does that say about your capital allocation strategy going forward?

Yeah, Steve, with respect to the buyback, what we've said is our policy is really to at least offset dilution from stock-based compensation. And that's what you're seeing we're doing right now is executing on that plan. Last year was a little accelerated or a heightened level of buyback, but for this year we're kind of going with the policy of offsetting our dilution.

Okay. And then on the restructuring, can you give us any details on kind of what particular areas you were deemphasizing or, you know, projects you might be pulling people off of versus areas where you're investing?

Most of it, Steve, it was across a range of areas, and they were areas that we'd identified for efficiency across a broad range of areas. I wouldn't attribute it to any one project or initiative. Some of it was facilities related. And so, nothing that is directly, certainly no, nothing as it relates to a change in any of the business focus areas we've been talking about.

Okay, great. I'll jump back in the queue. Thank you.

Our next question comes from Jim Goss from Doge.

Please go ahead.

Hi. I got on a couple of moments late, so maybe I missed this, but I didn't hear a lot of comment about music. I'm wondering if there were any further developments in that particular application.

Yeah, we talked about the fact that we continue to add artists and songs, great momentum on the artist side. We did add a new service in India, Wink, which we now have three at the top music services in India and a large catalog of local music with three major labels. So on the content and services side, a lot of progress. That's what creates the demand for the device side and all the ways that people experience music. And then on that front, we noted that NIO and Lotus, who had initially launched in China, have now launched in Europe. Mercedes launched more models. So we continue to have strong engagement, a strong pipeline for bringing more auto manufacturers on board.

OK. Are you seeing these applications as having any significant impact in terms of any of the licensing revenues or in any other way?

Yeah, well, if we look at it on, you know, it's always best for us to look at this on an annual basis. And automotive has consistently been one of the categories Robert highlights as a driver of increases in other markets. And that's, you know, that really is a result of Dolby Atmos in cars. You know, other areas for music, of course, are soundbars, speakers, et cetera. That falls in our CE category, which, you know, on the foundational side has lower unit volumes this year, but then that's being partially offset or being, yeah, that's being offset to some extent by, increased adoption of Atmos and Vision, and some of that would be driven by music.

Okay. Is that gaming and other 20% roughly equally split then between gaming and automotive?

We haven't broken the categories out yet, but it is, as you point out, it's gaming, it's automotive, it's Dolby Cinema that contribute to that category, also our patent administrator fees for our licensing pools. So those are the categories, and when they rise to individually large enough, then that's when we would make it a category of its own.

You're very focused on Atmos and Vision, which you should be, obviously, and that's increased penetration is driving the company right now. We always look for the next big thing. Are there any things more that can be done in terms of sound quality and placement? that near mortals are probably not considering right now. It always seems that something might come along and I'm just wondering if your engineers are developing things that might not be obvious on the surface that could create that extra category or even a nuance that can command some higher royalty rates in the future, say with the top level products.

They're always focused on the next thing. We just had our our tech summit a couple weeks ago, and it's a combination of tech talks, kind of a hackathon, if you will, of top ideas. And, you know, what they're doing that week, and hopefully what they're doing year, and I believe what they're doing year-round, is, yeah, they're looking at the current state of technology, the future state of technology, what types of experience is that going to make possible. Obviously, we engage across the ecosystem, whether it's creators, content owners and distributors and where hardware manufacturers are pushing the boundaries and looking to solve the problems that are going to pave the way for that next set of experiences. And in that respect, there's a lot of things that go into that equation of the types of things you're thinking about, whether it's where AR and VR take us, what the implications of AI are, But that's what they are always thinking about. Yes, we have a lot of things we're excited about.

Okay. Well, thank you. Thank you very much.

I will now turn the call over to Kevin for closing remarks.

Okay, great. Well, thank you, everybody, for joining us today. We look forward to updating you again soon.

Ladies and gentlemen, that concludes today's call. Thank you for all joining. You may now disconnect.