Dolby Laboratories, Inc. (NYSE:DLB) Q1 2023 Earnings Call Transcript

Dolby Laboratories, Inc. (NYSE:DLB) Q1 2023 Earnings Call Transcript February 2, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call discussing Fiscal First 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. As a reminder, this call is being recorded Thursday, February 02, 2023. I would now like to turn the conference call over to Maggie O’Donnell, Head of Investor Relations for Dolby Laboratories. Please go ahead, Maggie.

Maggie O’Donnell: Thank you. Good afternoon, and thank you everyone for joining. Welcome to Dolby’s first quarter 2023 earnings conference call. Joining me today are Kevin Yeaman, our — Dolby Laboratories’ CEO; and Robert Park, our CFO. As a reminder, today’s discussion will include forward-looking statements including our second quarter 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 the statements made today, including, among other things, the impact of current macroeconomic events, COVID-19, 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 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 non-GAAP financial measures. A reconciliation between GAAP and non-GAAP financial measures is available on our earnings press release and in the new Interactive Analyst Center on the Investor Relations section of our website. So, last quarter, we spent some time covering 2022, what we were seeing as we were going into 2023 with a focus on the long-term growth.

Now, we’re one quarter into the year, so Kevin, let’s get started in our conversation. Can you start with giving us a take on your Q1 results?

Kevin Yeaman: Yes, of course. And thanks everybody for joining us today. So, I guess I’d start by saying it’s nice to start the year with results coming in higher than what we expected when we came into the quarter. That’s largely because we see some transactions landing earlier in the year than we originally expected. The underlying trends in our business are pretty consistent with what we thought coming into the year. There are, of course, some end markets that are a little higher, some that are lower. Robert will take us through all those details in just a moment. But like I said, when I net all that out, pretty consistent with what we saw coming into the year. So, it’s early in the year. We continue to be operating in an uncertain environment. So, we’re going to keep focusing on what we can control and what guides growth in the long-term.

Maggie O’Donnell: Okay, great. So, looking further ahead, how are you feeling about long-term growth?

Kevin Yeaman: There is — there continues to be strong demand from consumers for entertainment content, and demand for content to be more immersive and engaging. And that’s what drives demand for Dolby experiences. So, this quarter, we continue to make progress on each of our key focus areas, movies and TV, music, user-generated content. And so, we continue to be confident that we can double our revenues from Dolby Atmos, Dolby Vision and imaging patents over the next three to five years, which means we continue to target annual growth of 15% to 25%. And of course, our foundational audio technologies are essential to the ecosystem for entertainment audio. They’re delivered across a very broad range of consumer entertainment devices.

And so, while that does make it sensitive to macro trends, it’s a very strong position to be in. And when the market settles down, we expect this to be a contributor to growth. And then, of course, we continue to be focused on opportunity to bring the Dolby experience to an even wider range of use cases and that’s what we’re doing with Dolby.io. So, overall, we continue to be very confident in our long-term opportunity.

Maggie O’Donnell: That’s great to hear. So, just a few weeks ago, we were at CES in Las Vegas. What were some of the highlights for Dolby from your perspective?

Kevin Yeaman: Well, there were two big stories for us at CES this year. Dolby Atmos Music and Movies & TV in the living room. Let me start with music. So, we kicked off CES with a concert by Imagine Dragons, which was live in Dolby Atmos. It took place at Dolby Live in Las Vegas. And Dolby Live is a venue where one of the things that is exciting about it is that we can engage with artists to create an experience that they want to deliver. And the result was that the energy and the excitement from the band and from the thousands of fans and partners who joined us was just fantastic. And so, this is important because this is where the ecosystem starts for us. It is all about our ability to inspire creators to want to create in Dolby.

And artist passion for Dolby Atmos continues to grow. We now have 85% of Billboard’s Top 100 artists in 2022 have one or more songs in Dolby Atmos. There’s increasing availability of content on streaming services, so you can stream through Apple, Amazon, TIDAL, there’s Melon in South Korea, Tencent in China. And it’s this combination of content and availability that’s what creates the value proposition for the playback experience and our device partners. And as I’ve shared before, the Car Experience is a big focus for us. And that’s — not just for us, that’s the whole industry. It’s often — it’s very quickly the first question from artists, from music labels, from streaming services, they want to know what the Car Experience is like and consumers care deeply about that.

And so, over the past year, we’ve added more than half a dozen car manufacturers, including Mercedes, Volvo, Lucid. At CES, Mercedes was featuring their electric SUV with Dolby Atmos Music. We had Maybachs on hand at our booth. There were in-car entertainment partners like Bose. They were highlighting Dolby Atmos music in their proof-of-concept cars. And it’s not just about automotive. You could experience Dolby Atmos Music in a number of form factors. So, across the show floor, there were partners who were demoing the Dolby Atmos experience on sound bars, on wireless speakers, on mobile devices. And so, when I step back, music today reminds me a lot of where we were with Dolby Vision in the movies and TV ecosystem, not that long ago. It started with a handful of Warner Brothers movies that started with — they were available on Voodoo.

You could experience them on LG and VIZIO TVs. And we quickly broadened adoption to include partners like Netflix and Sony. And if you scroll forward to today, we’re deeply embedded across the movie and TV content ecosystem. Streaming is broadly available across all the major services and increasing number of services. And Dolby Vision and Dolby Atmos are widely available across the TV market and other devices. So, we’ve built these ecosystems many times over the years. And so, we have a pretty good sense of what signals to look for across content, delivery and devices that tell us we’re building momentum. And that’s what we’re seeing with Dolby Atmos Music. And so, we continue to be confident in the opportunity there.

Maggie O’Donnell: Great. And you mentioned specifically Movies & TV at CES. What stood out to you there?

Kevin Yeaman: Well, with Movies & TV, what was great about that was that our story was being told through the voice of our partners. This was across the show floor. So, as I talked about last quarter, a big focus of ours in that area is growing beyond the premium tier of televisions and expanding that deeper into their lineup. So, that’s why it was so great to see announcements from partners like TCL. TCL announced that Dolby Vision and Dolby Atmos will now be included on all of their new 4K TV models in the U.S. Hisense is another great example. They announced several new TVs that are going to include Dolby Vision and Dolby Atmos. And it wasn’t just TVs. So, Samsung and LG announced their new soundbar models with Dolby Atmos.

And what was exciting about their announcements is that they’re taking — they’re becoming a part of smaller form factors, Dolby Atmos is. And so, this creates the potential for a broader audience and to expand the reach of Dolby Atmos. And we continue to make progress on the content side as well. So, we have — already have a very strong presence, and we also have added Peacock to the roster of streaming companies that are streaming in Dolby Vision. We talked about this last quarter, Maggie, but the World Cup was available in Dolby Vision and Dolby Atmos. So that was exciting. And excited to share that Comcast will be broadcasting the Super Bowl on Fox in Dolby Vision next week. And so, if anyone out there is throwing a Super Bowl party, it’s not too late.

And there is a Dolby page on Amazon store, which can point you toward all of our great partner products.

Maggie O’Donnell: That’s great. So, what other highlights were there for the quarter beyond what happened and what was announced at CES?

Kevin Yeaman: Well, we haven’t yet talked about mobile and Dolby Vision capture. And as we’ve talked about before, Dolby Vision capture on mobile devices enables people to capture and share life’s moments in a more realistic way on the device that we carry with us daily, every hour of the day. So, we’re focused on continuing to expand that value proposition. And so, we’re excited that Vivo this quarter adopted Dolby Vision capture and playback on its flagship phone. They joined Apple and Xiaomi. And OPPO launched its first phone with Dolby Atmos and Dolby Vision playback. And so, we look forward to continuing to drive more momentum in mobile. We also haven’t talked about Dolby.io, where we’re focused on bringing Dolby to a far wider range of use cases.

We’re seeing more developers signing up for accounts. We are seeing strong growth in the number of active developers who are working with our APIs for the first time. And what we’re enabling these developers to do is to make day-to-day interactions in the apps and services that, that we’re all using every day more immersive and more lifelike in how they sound and how they feel.

Maggie O’Donnell: Great. So, before I hand it over to Robert to go through the numbers, is there anything else that you want to add and close on?

Kevin Yeaman: Yes. Well, if I take a step back again, this quarter, I think further demonstrates that we continue to bring more Dolby experiences to more people around the world. There is an ever-increasing demand for content and for that content to be more engaging and immersive, and making that happen is what we do at Dolby. So, continues to be uncertain environment and that’s not new. I mean in a lot of different ways it’s been an uncertain environment for a number of years now. And what I’m most proud of is all that the team has been able to accomplish during this period, and they’ve done it by staying focused, focused on where Dolby can make a difference and focused on where the biggest opportunities are. And so, we’re creating momentum across each of our ecosystems.

We’ve launched entirely new ecosystems in the form of Dolby Atmos Music and we’re just talking about user-generated content. And so, the long-term trends point to more opportunity. And we come at this from a position of strength. We have a very strong financial position with strong cash flows, a solid business model. I’m confident that our foundational technologies will continue to be central to the entertainment experience for many years to come. We continue to grow the adoption of Dolby Atmos and Dolby Vision, and we’re reaching more use cases with Dolby.io. So, we’re going to stay focused on raising the bar on all of these experiences and growing the business.

Maggie O’Donnell: Great. Thanks so much, Kevin. So, Robert, before we get into all the details, I was thinking it would be helpful if you start out with some of the key things that investors and analysts should be focused on in our results.

Robert Park: Yes. Thanks, Maggie. Yes, before we get into the details, I wanted to point out three main highlights. First, total revenue of $335 million was higher than the guidance that we provided last quarter, largely due to transactions closing earlier in the year than anticipated and higher products revenue. As it relates to trends in our underlying business, we are on track with where we thought we would be coming into the year overall. We came in a little higher than expected in broadcast and gaming, mostly driven by higher Q4 shipments than we had estimated, lower in PC, driven by further weakness in the market and lower box office proceeds, which negatively impacted Dolby Cinema revenues. Second, operating expenses of $175 million on a non-GAAP basis were lower than we had guided for the quarter, which is mostly due to timing of marketing and patent program spend and lower labor costs.

We will continue to be deliberate about our hiring, evaluate our long-term priorities and opportunities and make spending adjustments accordingly. Third, I’m going to talk about guidance in detail in a few minutes. But based on where we’re seeing today, our outlook for the full year is consistent with what we said last quarter. It’s nice to start the year with a quarter that came in better than our expectations, but at the same time, it’s still early in the year and we continue to operate in a very uncertain environment. With that as the backdrop, let’s get into the Q1 details. Q1 revenue was down 5% year-over-year, primarily due to mobile, PC, broadcast and consumer electronics, consistent with the overall trends in the market. This was partially offset by adoption of Dolby Atmos and Dolby Vision and higher products and services revenue.

Q1 was comprised of $308 million in licensing revenue and $27 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. In general, we estimate revenues from unit shipments each quarter and trued up the following quarter based on actual reported unit shipments from our partners. We also have transactions that reflect revenue from units shipped in prior periods, which we call recoveries, and transactions where the customer will commit to minimum volumes for a given period where all or a portion of the revenue is recognized upfront. These transactions are all related to unit shipments. The only difference is the timing and amount of revenue in any given quarter.

Dolby, Music

The timing of these transactions can vary depending on number of internal and external factors. Broadcast represented about 38% of total licensing in Q1 2023, down $4 million or 4% on a year-over-year basis, driven primarily by lower TV unit shipments and lower recoveries. This was partially offset by the Q4 true-up for TVs and higher revenue from Dolby Atmos and Dolby Vision. Mobile represented about 21% of total licensing in Q1 ’23, down $11 million or 14% on a year-over-year basis, as the prior year benefited from timing of revenue from minimum volume transactions and also lower units. This was partially offset by increased adoption of Dolby Atmos and Dolby Vision. Consumer electronics represented about 18% of total licensing in Q1 of ’23, down $2 million or 4% on a year-over-year basis as the prior year benefited from higher recoveries, which is partially offset by increased adoption of Dolby Atmos and Dolby Vision.

PC represented about 8% of total licensing in Q1 ’23, down $10 million or 30% on a year-over-year basis, driven by lower recoveries and lower PC unit shipments. Other markets represented about 15% of total licensing in Q1 of ’23, up $4 million or 8% on a year-over year basis, driven by a favorable Q4 true-up in gaming. This was partially offset by lower box office proceeds from Dolby Cinema. Beyond licensing, our products and services revenue were $27 million in Q1 of ’23, up 39% 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.io. Let’s turn to expenses and margins. Total non-GAAP gross margin in the first quarter was 90% compared to 91% in the first quarter of fiscal year ’22.

Gross margins came in lower driven by a higher mix of products revenue. Non-GAAP operating expenses in the first quarter were $175 million compared to $195 million in the first quarter of fiscal year ’22. The decrease was driven by lower labor costs as we had an extra week last year, lower headcount and favorable FX. Program marketing spend was also lower due to timing of campaigns in the prior year compared to this year. And we benefited from lower bad debt expense compared to the prior year. Non-GAAP operating income for Q1 was $126 million or 38% of revenue compared to 36% of revenue in Q1 of last year. Non-GAAP income tax in Q1 was within our guidance range at 19% compared to 18% in the last year’s Q1. Net income on a non-GAAP basis in the first quarter was $107 million or $1.11 per diluted share compared to $104 million or $1.01 per diluted share in Q1 of ’22.

During the first quarter, we generated $56 million in cash from operations compared to $31 million generated in last year’s first quarter. We ended the first quarter with approximately $900 million in cash and investments. During the quarter, we bought back about 700,000 shares for our common stock and ended the quarter with $311 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 February 22, 2023 to shareholders of record on February 14, 2023. Now, let’s move on to guidance. We continue to operate in a challenging and uncertain environment. For fiscal ’23, we continue to expect that our foundational audio revenue will decline mid-single digits year-over-year, reflecting lower unit shipments, particularly in PC, TV, consumer electronics and mobile.

We are still targeting 15% to 25% growth in Dolby Vision, Dolby Atmos and imaging patents, and we expect this to be driven by growth in broadcast, mobile and other markets. This could more than offset the declines in foundational audio that we are expecting. With these assumptions, we continue to project that total revenue for fiscal ’23 will grow low-single digits year-over-year. Within this, we anticipate licensing revenue to be up low-single digits with growth in mobile, broadcast and other markets outpacing the decline in PC and consumer electronics. Products and services revenue expected to grow low-double digits. In terms of the full year split, given more transactions are expected to close earlier in the year than anticipated, we currently expect revenue in the first half to be higher than the second half, closer to last year’s split.

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 allocations on a regular basis, and evaluate the need to make adjustments based on the economic realities of the business. We anticipate that non-GAAP earnings per share could grow at a slightly higher rate than revenue. So, now let’s move on to guidance for the second quarter. Q2 revenue is expected to range from $340 million to $370 million. Within that, licensing revenue is estimated to range from $320 million to $345 million, while products and services revenue is projected to range from $20 million to $25 million.

Compared to Q2 of last year, we expect growth in Dolby Atmos, Dolby Vision and imaging patents, particularly in broadcast and mobile to more than offset lower foundational revenue, driven by lower unit shipments estimates in consumer electronics, PC and TVs and lower recoveries. Non-GAAP gross margin is estimated to be 89% plus or minus. Operating expenses in Q2 on a non-GAAP basis are estimated to range from $193 million to $203 million, as we expect certain marketing and patent program expenses to shift from Q1 to Q2. Our effective tax rate for Q2 is projected to range from 19% to 21% on a non-GAAP basis. We estimate that non-GAAP Q2 diluted earnings per share could range from $0.90 to $1.05. In summary, it’s a good start to the year as Kevin said.

It is still early days and we continue to navigate through an uncertain environment. That said, we remain laser-focused on the things we can control and are excited about the progress we’re making on the long-term growth opportunities ahead. While the economic realities around us continue to change, the fundamentals of Dolby’s durable business model of high gross margins, healthy cash flows and a strong balance sheet, have not changed.

Maggie O’Donnell: Great. Thank you, Robert. Operator, I think we’re ready to turn it over to questions.

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Q&A Session

Operator: Absolutely. Your first question comes from Steven Frankel with Rosenblatt. Please proceed.

Steven Frankel: Thank you. Kevin, congratulations on the Super Bowl. That’s a long-time coming. That’s a big win. Maybe start with what do you think finally tipped Comcast and Fox to do this?

Kevin Yeaman: Well, I think as with all of our big wins, this has been a journey from the team. We start off with movies and TVs. For movies, you have three months to produce. And for TV shows, you have days to weeks to months. And then, we get started on live sport, obviously, you have a matter of seconds. So, it’s a combination of engagement with community, it’s working through all the . It’s working. The mixers are the creators, and then, of course, it’s always working through all of the business arrangements that go far beyond just Dolby. There’s all the rights and all the other things that are going on. But we’re just super pleased to have the Super Bowl coming right after World Cup, just not long ago. And this is the kind of thing that we think really broadens demand for the Dolby experience.

Steven Frankel: Okay. And on the notion that you had some minimum paid contracts that were signed earlier in the year than you expected, was there any strategic reason for that to happen? Or was this just — it’s hard to tell when those are coming in and they just came in? Any kind of characterization you can give us?

Kevin Yeaman: I think it’s more the latter than the former, Steve. And remember that our transactions, we have two types. There’s the minimum volume commitments like you just pointed to, there’s also recoveries (ph) practice. Those are both types of transactions we have. And we do our best to predict when those are going to sign throughout the year, and we — some of those were landed earlier this year, which is a — it’s a nice way to start, but I wouldn’t — I don’t think at this point — I think it would be too early for me to draw any particular trends from that information.

Steven Frankel: Okay. And one — I’ll sneak one more in, and this probably is going to be difficult for you to answer, but let me try. Obviously, you have one large TV maker that — you have one large TV maker that’s yet to get the Vision religion. You have a lot of others that have. But in — everybody outside the one, where do you think you are in your ultimate penetration? In 2023, are you 70% there? Are you not even that high yet?

Kevin Yeaman: Well, I think, I mean, obviously, we’re patient and persistent. So, one thing we do is we are always looking to continue to increase the value that we’re providing. We just talked about Super Bowl coming after the World Cup, that’s another example how we will be hard at work, increasing the value proposition to bring as many partners on board as we can. What we talked about coming into the year in terms of increasing the attach rate is we have a very strong presence at the premium end of our partner lineups, and we’re really looking to drive that all the way through their 4K lineups. And so, that’s why — that’s the significance of an announcement like TCLs where all of their 4K models going forward in the U.S. will be Dolby Vision and Dolby Atmos.

We also feel like we have an opportunity to increase penetration as it relates to the big box retailers and some of the house white label brands that they have. So, we still think there’s room to grow, Steve. And it was — as you know, it was one of the biggest drivers of the strong growth in Dolby Vision and Dolby Atmos last year and we continue to see it to be a big growth driver this year.

Steven Frankel: Okay. Thank you. I’ll jump back in the queue.

Operator: Thank you. The next question comes from the line of Paul Chung with J.P. Morgan. Please proceed.

Paul Chung: Hey, guys. Thanks for taking my questions. So, just talk about the — I know you mentioned it briefly, but if you could talk about kind of the traction and momentum you saw at CES, particularly for Atmos in the car and for io? Have you seen some uptick in interest from other auto OEMs and app developers? And I guess, I know it’s early days, but how do we think about sizing Atmos in the car in terms of both kind of a reasonable auto penetration rate and respective ASPs for car kind of in both the near-term and long-term? It sounds like a pretty interesting opportunity.

Kevin Yeaman: Yes. So, as it relates to music, I think what was really fun about CES for us this year was the opportunity to really tangibly demonstrate the entire ecosystem, starting with the concert in Dolby Atmos, but having all of our partners there throughout the ecosystem, punctuated, of course, by the ability for people to actually experience Dolby Atmos Music in the Mercedes and at some of the partners Bose — like what Bose had going on. So, that — yes, there’s a lot of great momentum there. And we had a lot of engagement going into CES and we have very strong engagement coming out of CES. The team is busy at work, working with major players from throughout the ecosystem, throughout the industry, and working with them on their plan.

So, it was a good — it was a very good show for Dolby Atmos Music. I think it was the highlight of our show really. We also were — we did have an io presence. We were demonstrating — in fact, our customers — some of our customers and developers were demonstrating what they have built with Dolby.io. And so, that was a nice opportunity for us to, I guess, cross pollinate, if you will, some of our partners from the broad ecosystems that we serve and give them an opportunity to see what we’re doing with Dolby.io. We had a lot of partners that were using both real-time streaming and our ability to have audio/video interactions with large audiences and sophisticated spatialization. And I think that what we continue to be excited about is we feel like we’re still at the early stages with the companies that are looking to build the next-generation virtual experiences of the future.

And to be clear that it’s most immersive, that can be in a headset environment, but these are experiences that are largely going to be enjoyed on PCs and mobile devices. And with io, developers can build those experiences. And so, yes, we did have customers there that were demonstrating some of those experiences and it sparks ideas of what other partners might want to be able to do in the future.