Dolby Laboratories, Inc.
Q3 2021 Earnings Call Transcript

Published: 31 Jul 2021

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome the Dolby Laboratories conference call discussing fiscal third quarter results. As a reminder, this call is being recorded, Thursday, July 29, 2021. I would now like to turn the conference call over to Jason Dea, Senior Director of Finance and Investor Relations for Dolby Laboratories. Please go ahead, Jason.

[Jason Dea:]

Good afternoon. Welcome to Dolby Laboratories Third Quarter 2021 Earnings Conference Call. Joining me today are Kevin Yeaman, Dolby Laboratories' President and CEO; and Lewis Chew, Executive Vice President and Chief Financial Officer. As a reminder, today's discussion will include forward-looking statements, including our fourth quarter second half and fiscal 2021 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.

[Kevin Yeaman:]

Thank you, Jason, and good afternoon, everyone. Q3 was another strong quarter for Dolby. Our revenue and earnings for the quarter were solid, and we are on track to deliver annual revenue growth of over 10% and year-over-year earnings growth at an even higher rate. At the same time, Dolby experiences are accessible to a growing number of people around the world, highlighted by the launch of Dolby Atmos on Apple Music and the Tokyo Olympics broadcasted in Dolby Vision and Dolby Atmos. Before Lewis takes you through the numbers, I wanted to highlight the recent progress we have made in enabling Dolby experiences across a much broader range of content, which creates opportunities for continued revenue and earnings growth. The inclusion of Dolby Atmos on Apple Music marks a significant step forward in bringing Dolby Atmos Music to a much larger audience and establishing it as the best way to create and listen to music. The Dolby Atmos music experience has been prominently featured by Apple and has been met with positive and enthusiastic reactions from artists, industry partners and consumers. Apple Music subscribers around the world can easily access albums and playlists of Dolby Atmos songs and can enjoy their music across Apple's wide range of products that support the combined Dolby experience. And recently, Dolby Atmos-enabled Android devices can also enjoy Dolby Atmos on Apple Music. Beyond Apple Music, Naver Vibe, a music streaming service in South Korea, launched support for Dolby Atmos this quarter.

[Lewis Chew:]

Good afternoon. And as Kevin said in his opening comments, we did have another solid quarter. So let me go through the Q3 numbers, and then I'll walk you through the outlook for Q4. So starting off with revenue. Revenue in the third quarter was $287 million, which was at the higher end of our guidance range and included a true-up of about $14 million for Q2 shipments reported that were above the original estimates, and that item is not uncommon. On a year-over-year basis, third quarter revenue was about $40 million above last year's Q3 as we benefited from higher market TAMs, along with greater adoption of our Dolby technologies. And then on a sequential basis, revenue was down from Q2, mainly due to timing of revenues from contracts and from patent licensing programs, and both of these topics were anticipated when we gave guidance. So Q3 revenue was comprised of $272 million in licensing and $15 million in products and services. So let's discuss the trends in licensing revenue by end market, starting with broadcast.

[Operator:]

Your first question comes from Ralph Schackart with William Blair.

[Ralph Schackart:]

First question is on io. Kevin, in the prepared remarks, you talked about a significant update. I think you said more specifically, it allows larger interactions with more participants. Just curious, was this sort of a limitation of the io offering and does this sort of widen the aperture for new customers? Just trying to gauge how significant this update is.

[Kevin Yeaman:]

Well, it significantly increases the number of participants we can support in audio/video events, and so we launched with our APIs about a year ago. We started out with a number of features that improve capture qualities. We have, of course, Dolby Voice embedded in the service. And yes, we began engaging with customers who had greater needs for more participants. And so the significance of this release is that it's going to enable us to engage with more developers for larger events and more usage. So we're excited to bring this to life.

[Ralph Schackart:]

Great. I guess now that you have the new release and then you've had, I guess, another quarter 2 with partnerships such as Box, can you maybe just sort of help us understand the monetization opportunities? And I know it's tough to put a number on the market opportunity, but any sort of methods or methodologies you sort of help us think about how to gauge this opportunity, I think, would be helpful.

[Kevin Yeaman:]

Well, starting at the very highest level, Ralph, there's hundreds of billions of audio/video interactions going on every month, and there's hundreds of billions of minutes of media content in the cloud. And we strongly believe at Dolby that people want to have the best quality experiences, and that's what we're seeing from the developers that are engaging with us today. So we're confident that there's a very large addressable market. And so today, what we're focused on is continuing to evolve the platform based on what we're hearing and bringing on more developers and getting more usage. We've seen some really great use cases developing. And so the monetization model, as you know, is a usage basis, and that's -- we're seeing that now. So it's all about getting more adoption and more usage.

[Ralph Schackart:]

Great. Last one, and I'll turn it over. Just curious if there's any updates on the CFO search?

[Kevin Yeaman:]

Well, we are in the process. I'm confident that there's a lot of great candidates out there. We also have a great team here at Dolby. So we're progressing, and we'll keep you updated.

[Operator:]

The next question is from Steven Frankel with Collier Securities.

[Steven Frankel:]

So a follow-up on the last question on io. Can you maybe give us an update on what kind of changes that you have in new leadership in that group?

[Kevin Yeaman:]

Yes. So thanks, Steve, you were cutting out quite a bit, not quite as silent as Lewis went on me, but I think I got the gist of your question. Just to confirm, you're asking about new -- Marie joining and kind of what the focus is. Is that the essence of the question?

[Steven Frankel:]

Yes, what exactly...

[Kevin Yeaman:]

Yes. So well, look, I think first and foremost, she's diving right into the road map we have. Like I said, this was a big release for us, which obviously was in the works even as Marie joined. And she's working with the team to look at the road map for our platform, to look at areas that we can accelerate, those that we think will create the most engagement with developers and increased usage. She also has spent decades involved in businesses that are centered around developer communities. So you can expect to see us engaging in stepping up our efforts to market this to developers, engage with developers and build that community.

[Steven Frankel:]

Okay. And congratulations on the progress of decision. Are there any on this that need to be updated before this really scales out of rather than a one-off of IP Olympics place?

[Kevin Yeaman:]

I'm sorry, Steve, you're really cutting in and out, but I gathered that the question is centered around live broadcast of the Olympics. And I think your question was about kind of what work has to be done in the future to accelerate that. Is that kind of -- keep that moving? Is that the -- I was getting the -- more parts, but not all of them. Now you've cut out altogether?

[Steven Frankel:]

Yes. How do you make this a more commonplace?

[Kevin Yeaman:]

How do we make it more commonplace, I think that's what you just said, right?

[Steven Frankel:]

Right.

[Kevin Yeaman:]

Right. Okay. Good. Well, look, first of all, of course, we're thrilled that Comcast is making the Olympics available in both Vision and Atmos, and as we've been working with Comcast for some time. Look, each event like this is a step towards making it more commonplace. It's a matter of making sure that the supporting cast that is supporting these live events. Some of them are obviously doing it for the first time. They're getting the right equipment and software in place. So each time that we go through an event like this, that's another step toward getting more events. So we're excited about that. We're excited about the other events we talked about in Dolby Atmos, and it's a big focus for our organization. So yes, there's definitely a certain amount of work that goes along with people doing it for the first time, but high-profile events like this are a really big step forward. And of course, you get people who will move from this event to other events, and so you'll get people who are familiar -- who aren't doing it for the first time.

[Operator:]

The next question is from James Goss with Barrington Research.

[James Goss:]

I'd like to start with Dolby Music. You've talked about a lot of devices and services, where there's availability and people can sample this. Now I'm wondering if you could synthesize it into, first, like what is required then for individuals to be able to take advantage of the service? And what do you think would be a currently enabled TAM, if you will, in taking advantage of music? And are there unit sales beyond the existing sales of AV receivers, sound barriers, PCs that would be a benefit from the music development?

[Kevin Yeaman:]

Sure. Yes. Thanks for the question. Well, anybody who is a subscriber of one of our service partners that has a Dolby Atmos device that supports that service is able to get the benefit of the Dolby Atmos experience. And of course, I've been through the names, but since you brought it up, we're very excited to have Apple Music. We've added Naver Vibe, which -- in South Korea. So we've noticed we've had a regional focus as well with companies like Hungama and Anghami. So the number of people that can support the service is growing -- that can receive the service is growing significantly. The significance, Jim, is that in the mobile phone and PC space, I mean you've seen us continue to garner wins at the high end that start with the movies and TV value proposition, it's being bolstered by our progress in mobile gaming. Music has very broad appeal, and we think it really expands the addressable market of mobile devices and PCs that are going to see value in supporting Dolby Atmos. In terms of new categories, which is where you, I think, ended your question, I would point to the automotive space because automotive is an experience where artists, service providers, everybody is really focused on that as a really important experience in the realm of music. And so we think that this really gives us an opportunity to make some headway in the automotive space.

[James Goss:]

And in that regard, are you developing relationships at the OEM level in the way SiriusXM would to try to get in the new systems and cars? Is that part of it?

[Kevin Yeaman:]

Yes, that's right. So you saw that we last quarter announced that Lucid Air would be bringing the Dolby Atmos music experience to life, and we are engaged across the industry looking to bring Dolby Atmos to more cars.

[James Goss:]

Okay. And one other thing. In cinema, obviously, you're in the middle of all of the windows issues and that sort of thing with Dolby Cinema. And today, there is a lawsuit with Scarlett Johansson trying to look at Disney to maybe pull back a little bit on the day and date and maybe help a business like yours and IMAX with the theatrical window. I wonder if you might comment on any reaction you have. It's a relatively expanding event, but perhaps you have some thoughts.

[Kevin Yeaman:]

I don't think so. I mean, honestly, I had not seen that news, but our belief is that for these blockbuster movies that are the ones that show in Dolby Cinema that people are going to want to see them in the big screen experience. And that what we've seen is that as we begin to see box office return, we have seen the percentage of box office trending toward premium experiences in Dolby Cinema specifically commanding more of the box office than it was pre-pandemic. And I believe that stands reasoning. I think as people come back to the cinema, they want to have the best experience possible.

[Operator:]

The next question is from Paul Chung with JPMorgan.

[Paul Chung:]

So your free cash flow has been very strong this year driven mostly by strong net income. So I don't really see any real kind of working cap benefits this year. So your free cash flow margin is kind of hitting levels last seen in 2011. Is this the new normal moving forward? Is this the baseline of free cash flow at $400 million plus kind of moving forward?

[Lewis Chew:]

You want me take that one, Kevin?

[Kevin Yeaman:]

Yes, please.

[Lewis Chew:]

I guess the first wonder was whether my phone is working. I guess you're always very focused on the free cash flow. So a couple of comments I would make is, one, you see now that our cash flow generation is now running fairly consistent with the business operations. Obviously, there's ebb and flow to working capital quarter-to-quarter. But you'll also notice that this year, our operating margins are very strong, and part of that is because our gross margins have ticked up a little bit, and the gross margin improvement is because the mix of our revenue has been stronger than maybe what we would have anticipated at the beginning of the year. So I think that all ties together in the sense that we do believe that as a business, we will continue to generate a high degree of cash flow relative in...

[Kevin Yeaman:]

Okay. We can hear you now, Lewis?

[Lewis Chew:]

Okay, good. The funny thing about this, Paul, is believe it not, I'm on a landline. So I'm not sure why it's cutting in out because I'm looking at my phone and it says it's connected. So we'll have to -- I don't know that I'll ever be able to figure it out. Anyway, I'll wrap up by saying that the strong cash flow that you see is very heavily linked to our operating performance. Obviously, the timing from quarter-to-quarter does depend on when we collect those receivables. And also the fact that this year, you see that our gross margins have ticked up and our operating margins are stronger than they've been historically. So I think that all ties together. I think it's a very good story right now.

[Paul Chung:]

And your OpEx levels are kind of in this 55% range of sales. Is that the right level to kind of think about -- I mean it's ranged anywhere between the mid-50s to 60. So...

[Lewis Chew:]

Yes. A couple of comments on that. One is that we, like so many companies, we are seeing some expenses that are lower because of pandemic, the most obvious thing being travel. And I don't think you should expect forever and other companies progress forward. I'm not sure if -- are you hearing me okay on this phone call right now?

[Paul Chung:]

Yes.

[Lewis Chew:]

Paul, okay, good. The second thing I'd like to point out to is just as a side note that FY '22, every 6 years or so, we have a 53-week year like many companies do, and we'll have a 53rd week next year. So that will be a little onetime blip next year in expenses. And so I think the OpEx to revenue range that you see right now is probably at the lower point of what we would normally run. But Kevin and I have talked quite a bit about the fact that we've always committed to keeping operating margins at or above that sort of 31% level. And now this year, with the improvement in gross margin, we see that ticking up a little bit. So probably some of that will come back a little bit, Paul, in terms of the OpEx ratio, not all of it. And think about it as just being this a little bit of a bounce back from COVID. But also, next year, we'll have that extra week, which also then in the following year, that will go away. So a lot of things to think about. I know we're not ready to give FY '22 guidance yet, but your question kind of almost goes beyond Q4. So I thought it'd be worth getting you thinking about that.

[Paul Chung:]

Great. And then Kevin, on vision, where are you on adoption rates in TVs today? Update there would be nice. And kind of what's your penetration rate kind of trending in PCs and smartphones? Do you see opportunities in auto? And then separately, Atmos in auto, given kind of the longer sales cycle, would adoption really take time for Atmos to take off in car speakers?

[Kevin Yeaman:]

Yes. So well, I guess, at the highest level, I would start by saying that with the wins we've garnered throughout this year around music, around gaming, around services like Bilibili, more recently, live sport, we feel really good about the sales proposition we have to continue to bring the Dolby experience to more devices across all of the areas that you just went through. We have continued to increase the penetration on TVs with Dolby Vision and with Dolby Atmos. You've heard me today and throughout the quarters talk about a number of wins in PC and mobile, and automotive is an area where we expect to make progress. And I mean, of course, there's a lead time to implementation that lead time has come down from what it might have been 3 to 5 years ago. And especially, in the pure-play electric vehicle players, that can be much faster. And even with the traditional car manufacturers, you can get time frames that are within a year or so, I think, from when. I mean, obviously, mileage varies, but a lot of what we're going to be doing is through the software. So it will vary, but we're out there engaged. We think it's a really compelling experience, and we'll keep you updated as we go.

[Paul Chung:]

And then last housekeeping question. What was the segment in which the back payment came in from Q2 would be helpful?

[Lewis Chew:]

The back payment that came in Q2. Can you give me a little more color on that question?

[Paul Chung:]

I thought you recognized the back payment in Q3 from Q2 shipments. Is that not the case?

[Lewis Chew:]

Oh, I'm sorry. Yes, you talked about the true-up. We don't break out the true-up by category generally, although I would say that our strongest segment -- market segment, if you will, is broadcast, and broadcast did benefit from that true-up. Yes. So sort of TV, the TVs and set-top boxes would have benefited significantly from that true-up.

[Operator:]

There are no additional questions waiting at this time. I will now pass the conference back to Kevin Yeaman for closing remarks.

[A - Kevin Yeaman:]

Well, thank you, everybody, for joining, and we look forward to keeping you updated on our progress. Thank you.

[Operator:]

That concludes the conference call. Enjoy the rest of your day.