Dolby Laboratories, Inc.
Q4 2018 Earnings Call Transcript

Published: 25 Oct 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call Discussing Fiscal Fourth and Fiscal 2018 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 today, Wednesday, October 24, 2018. I would now like to turn the conference call over to Elena Carr, Director of Corporate Finance and Investor Relations for Dolby Laboratories. Please go ahead, ma'am.

[Elena Carr:]

Good afternoon. Welcome to Dolby Laboratories' fourth quarter 2018 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. These statements are subject to risks and uncertainties that may cause actual results to differ materially from the statements made today. A discussion of some of these risks and uncertainties can be found in the earnings press release that we issued today, under the section captioned Risk Factors, as well as in our most recent 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 GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings press release and in the Dolby Laboratories Investor Relations Data Sheet on the Investor Relations section of our website. As for the content of the call, Lewis will begin with a recap of Dolby's financial results and provide our fiscal 2019 outlook, and Kevin will finish with the discussion of the business. So with that introduction behind us, I will turn the call over to Lewis.

[Lewis Chew:]

Thanks, Elena. I love how you do that from memory. Okay. Good afternoon, everyone. I will focus on three topics today

[Kevin J. Yeaman:]

Thank you, Lewis, and good afternoon, everyone. 2018 was a strong year for the company. It was fueled by the progress we've been making over a number of years in bringing Dolby experiences to market. I'm particularly excited about Dolby Vision and Dolby Atmos increasingly coming together as a combined experience. Just this quarter, Apple enabled Dolby Atmos in Apple TV 4K, making it the first DMA to support both Dolby Vision and Dolby Atmos. Consumers can now enjoy a wide range of Dolby Vision and Dolby Atmos content which is prominently featured in the iTunes Store. And even more recently, Amazon announced the Fire TV Stick 4K supporting Dolby Vision and Dolby Atmos. Over the summer, Jack Ryan was the first Amazon original series to support the combined Dolby experience and we look forward to seeing more content in the future. We also made progress with pay TV operators. Orange announced its first set-top box with both Dolby Vision and Dolby Atmos this quarter, with its first services launching in 2019. And at a large trade show in September, Comcast began demonstrating its new set-top box that supports both Dolby Vision and Dolby Atmos. On the gaming front, Microsoft began supporting Dolby Atmos earlier this year and has now rolled out support for Dolby Vision on the Xbox, making this the first gaming console to offer the combined experience. And in August, Lenovo released the first PC with the combined experience. It's a fantastic finish to the year. We started the year with LG OLED TVs as the first device supporting both Dolby Atmos and Dolby Vision. We now have TVs from six partners, the first smartphones from Sharp in Japan, as well as the recent product announcements for DMAs, the Xbox, PCs and set-top boxes. On the content side, in addition to iTunes and Amazon, other partners streaming in Dolby Vision and Dolby Atmos include Netflix, Rakuten, Tencent and iQiYi. Of course, we had many other highlights this year. Mobile stands out, in particular, with Apple, including Dolby Vision on iPhone X, iPhone 8 and iPad Pro, to start the year. Also this year, Samsung and Huawei adopted Dolby Atmos and have expanded the number of models supported beyond their flagship lines. Dolby Atmos and Dolby Vision are increasingly being adopted in more mainstream devices. Sound bars with Dolby Atmos are now being offered at $499, and Dolby Vision has increasingly been included in mid-tier TVs with price points starting at $350. Early adoption in live events has been another highlight. Starting with Dolby Atmos, throughout the year, BT and Sky Sports have been delivering Premier League football, and Comcast and DIRECTV delivered the Winter Olympics. This summer, the World Cup was carried by broadcasters in Brazil, Russia and China, to name a few. In the U.S., NBC is airing all Notre Dame home football games in Dolby Atmos. And as it relates to live Dolby Vision content, we have been working on trials throughout the year, and this quarter, Tencent streamed the first live event in Dolby Vision, an all-star basketball game. Overall, 2018 has been a pivotal year for the adoption of Dolby Vision and Dolby Atmos. We are confident that we are creating a robust ecosystem which is rapidly gaining support from content and device partners. At the same time, we are still in the early stages of this opportunity in terms of adoption and awareness. As we go into 2019, we're focused on continuing with this momentum and driving broader availability of these experiences. Dolby Cinema was, of course, the first combined Dolby audio-visual experience. We currently have about 180 screens open around the world, compared to 115 a year ago. In total, we have over 390 Dolby Cinema locations open or committed, and we expect to roll out a similar number of screens this year as we did in fiscal 2018. This quarter, Wanying Cinema Line announced plans to open Dolby Cinemas in Shenzhen and Southeast China. We now have seven partners in China, including Wanda and CGV, with an increasing flow of content. Also this quarter, T-JOY announced that it will be opening its first Dolby Cinema screen in Japan. And during the year, we've expanded our presence in Europe. We started the year with our first screen in France with Pathé and they have now grown their footprint to 10 screens. More recently, we've announced ODEON Cinema Group (sic) [ODEON Cinemas Group] (00

[Operator:]

Thank you. We'll hear first from Steven Frankel with Dougherty.

[Steven Frankel:]

Good afternoon. Kevin, wonder if you might start by updating us on whether the new initiatives hit the revenue target for the full year and what's your expectations for new initiatives in fiscal 2019?

[Kevin J. Yeaman:]

Sure. Thanks, Steve. We came in at just over $100 million on our new initiatives, which is a little bit short of what we were aiming for. I'll say, though, that we're very pleased with the momentum we're building and how that puts us in a position to continue to grow going forward. Like I said, I think we've built robust ecosystems which are rapidly gaining partners. And so, we're at the early stage of these opportunities. So, I feel good about the opportunity to grow it again at least the same growth rate going forward.

[Steven Frankel:]

And what's that growth rate? And was it supposed to double – almost double in...

[Kevin J. Yeaman:]

Yeah, we reported that it was about $60 million in 2017 and we're just over $100 million in 2018.

[Steven Frankel:]

And again, you said same growth rate in 2019. And the shortfall in the China cinema business, is that just a timing issue or did something change in the marketplace that caused that equipment not to be sold in the quarter?

[Kevin J. Yeaman:]

I think that I'd probably be hesitant based on one quarter to draw any broad conclusions about the Chinese market overall, but what we can say is that many of our larger partners pushed new builds into future quarters. So, that's what we're seeing so far.

[Steven Frankel:]

Okay. And then, on the expense guidance for the year, that's a little higher than you'd been running. What's leading you to up the expense guidance and what should shareholders expect for that extra money?

[Kevin J. Yeaman:]

Well, I think OpEx as a percentage of revenue is down a little bit at the midpoint, but yes, it's higher in absolute terms, and that reflects our continued investment on the growth opportunities we have. It also reflects the fact that we do have a pipeline of innovation that we're excited about and we think that will continue to create new growth opportunities going forward.

[Steven Frankel:]

Okay. I'll pass the baton and come back to you in the next round. Thank you.

[Operator:]

We'll hear now from Ralph Schackart with William Blair.

[Ralph Edward Schackart:]

Good afternoon. Lewis, I was curious, I think for FY 2019 licensing revenue, so it would be roughly $1.08 billion to $1.2 billion under ASC 606. Can you give us what FY 2018 licensing revenue would have been on a comparable ASC 606 basis, please?

[Lewis Chew:]

Well, I gave you the – I don't know if I break that out of the call or not.

[Ralph Edward Schackart:]

Maybe we could do it offline. That'd be fine, too.

[Lewis Chew:]

No, no, no. I don't (00

[Ralph Edward Schackart:]

Okay. I guess what – okay, so, is the majority of the growth, is it – maybe the simpler way to ask it – primarily driven by licensing then in 2019 over 2018?

[Lewis Chew:]

No, no. Clearly, in 2019, we see a blend of growth coming from both licensing and products. As I mentioned in my prepared comments, we do specifically have things that are growing from areas like cinema products. We have some new products that we were releasing throughout the year. We anticipate growth in product, for example, from Dolby Voice. And I also mentioned, too, that in FY 2019 in our base plan, we are anticipating some portion of Dolby Cinema revenues to be classified as products and services revenue if they do end up being deals that have this blend of upfront money versus share of box office. So, all of those contribute to growth in products and services on a real basis. And then, also, organically, we see licensing growth as well in FY 2019 no matter how you look at it. But obviously, the growth on a ASC 606 basis is larger than comparing to the ASC 605 number.

[Ralph Edward Schackart:]

Okay. Thank you.

[Lewis Chew:]

Okay.

[Operator:]

And from Barrington Research, we'll move to Jim Goss.

[James Charles Goss:]

Thanks. In terms of the theatrical installations this past year, were the – was it number of installations or terms of the installations? Have they – have those changed at all? Just trying to look at the shortfall in the product sales area.

[Kevin J. Yeaman:]

Well, remember that Dolby – so you're talking about cinema products?

[Lewis Chew:]

Yeah, he's talking about cinema products.

[James Charles Goss:]

Yeah, the – yes, the cinema product sales.

[Kevin J. Yeaman:]

Yeah. So Jim, I would say that substantially all the shortfall was due to volume-related reasons. It's not related to anything to the terms and conditions. So, it'd be primarily due to customers pushing out or delaying installations that we thought were going to happen earlier.

[James Charles Goss:]

Then, does that imply that you would get that back, plus the growth you are getting – you thought you might get, for the New Year or like would it double off a little bit and you'd get an accelerated growth in the product sales this coming year? I know you outlined some of the numbers. Is that part of what you expect to be happening?

[Kevin J. Yeaman:]

Well, obviously, when we put out a plan, we believe in that plan but it's really hard for me to say that there's any doubling up. We have a good pipeline of cinema products. We obviously, in this quarter but going into next year, we do anticipate growth in that area. But I wouldn't try to translate that into a doubling up because timing is always a tricky thing to discuss there.

[James Charles Goss:]

Okay. And to some extent, maybe it's less important then, you're getting the branding out there and you're getting the payback through the licensing sales. Is that fair?

[Kevin J. Yeaman:]

Maybe you could clarify that, Jim.

[James Charles Goss:]

Well, it seems like the – you've always said the royalty generation is going to be in the product sales for the – that – or license for the Dolby technology, and that, as you've outlined, a number of the television manufacturers and sound bars, et cetera, are carrying Atmos and Vision. So, a lot of the payback for this technology is through those items more than the theatrical installations.

[Kevin J. Yeaman:]

Yeah. I mean, there's no doubt, Jim, that success in the cinema reinforces success in our other areas. Having said that, we also look at them individually as businesses and we evaluate them on their performance individually even though they certainly mutually reinforce each other.

[James Charles Goss:]

Okay. And one last clarification, under the shift from ASC 605 to ASC 606, when you say there would be adjustments that would be necessary, would the adjustments wind up coming into the statement at the time of the adjustment or would there be a restatement to the prior quarter to reflect that?

[Kevin J. Yeaman:]

Yeah, they would be recorded in the period where the adjustment was determined. So, let me give you a clear example for everyone on the call to be crystal clear on this. Let's say in the first quarter, we estimated revenue of $20, and in the following quarter, the actual revenue was $21, that $1 difference would be recorded in Q2, not in Q1, in that example. So to your question, we record the adjustment in the quarter that we determined it, not going back and restating the previous quarter.

[James Charles Goss:]

All right. That's what I thought but I wanted to make sure. Thank you.

[Kevin J. Yeaman:]

Yeah.

[Operator:]

We'll hear next from Eric Wold with B. Riley.

[Eric Wold:]

Thank you. Good afternoon. Can you give us – I know that – on your guidance for fiscal 2019, can you give us the amount of revenue that was I guess "lost" under ASC 606 that you would have recognized with all the agreements in place prior to year-end fiscal 2018?

[Lewis Chew:]

Hey, Eric, this is Lewis. It's a relatively small amount; it's not anywhere near the magnitude of what we saw in 2018, but yeah, there was a small amount of revenue that you could say under old world might have landed in FY 2019, but because of the recast and shift to ASC 606, gets push back to a previous year, but it's nowhere near the scale of FY 2018. 2018 is probably the year most prominently affected by the recast.

[Eric Wold:]

Okay. And then, on Dolby Cinema, are you at a point now where you can provide a few more metrics around performance of kind of an average screen on kind of a broad sense or is it still too (00

[Kevin J. Yeaman:]

Yeah. I think it's fair question, Eric. We're getting closer. I think one of the things we're still dealing with is that we have one major customer that does make up a large portion of that and I'd love to see us get a little more critical mass. So when we use those blended average numbers, we're not necessarily disclosing anything proprietary. So, we'll continue to look for the right moment to disclose some more details around those Dolby Cinema metrics. But happy to report that it is growing nicely.

[Eric Wold:]

Okay. And then, on kind of speaking with your CE and (00

[Kevin J. Yeaman:]

Well, most of our partners support Dolby Vision and HDR10 and we offer a combined solution through our implementation. As it relates to HDR10+, there's still not enormous amount of announced support. So, we'll wait and see. And I think that's even more true on the content side than it is on the device side. So right now, we're focused on continuing to help them roll out Dolby Vision, and as you can see, we're getting a lot of momentum with that both on device and content.

[Eric Wold:]

Perfect. And then, just final question was just the number. So, (00

[Lewis Chew:]

Correct.

[Eric Wold:]

Okay. Thank you. Thanks, guys.

[Operator:]

And from JPMorgan, we'll move to Paul Chung.

[Paul J. Chung:]

Hi. Thanks for taking my questions. So first up, just on broadcast, after two years of flattish growth, so what drivers can kind of jumpstart growth in 2019? I know you mentioned it would grow, but can you give us a sense of magnitude and which markets you're bullish about?

[Kevin J. Yeaman:]

Well, I think that certainly in terms of the success we're having in Dolby Vision and Dolby Atmos, those are both potential growth drivers there. On the one hand, we have really strong demand and an ecosystem that is gaining support in terms of both content and device. At the same time, most of our television partners were still on their higher end models. VIZIO and TCL have each gone quite a bit deeper than that. So, we still see ourselves at the early stages of adoption for those. I think another dynamic to watch is just the – to the extent that there is an upgrade cycle as it relates to either UHD, 4K or hopefully the desire to get Dolby Vision and Dolby Atmos, then anything that drives upgrades drives all of our technologies beyond Dolby – or many of our technologies, I should say, beyond just Dolby Atmos and Dolby Vision. And that's not really reflected in the analyst estimates that we rely on right now. I would say it's kind of pretty comparable trends to what we've seen in the last couple of years, but that's another thing to watch.

[Lewis Chew:]

And hey, Paul, Kevin mentioned in his prepared comments just now – you mentioned, Kevin, in the fourth quarter two set-top boxes with Dolby Vision – we're not even in the first inning. We're in the warm-up circle on that. So, I think that is another element of growth driver. When it happens, we can't know for sure, but clearly, there's going to come a time when there's more adoption there, and that's another example of a growth driver.

[Kevin J. Yeaman:]

Yes.

[Paul J. Chung:]

Got you. And then, just on the topic of tariffs, what's been your read-through on your kind of end markets? Any potential impact you're seeing on demand for kind of unit sell-through in any segment? And did tariff effects kind of cause any lower sales in cinema in China?

[Kevin J. Yeaman:]

Well, first of all, you're asking a question that's a pretty broad topic. I mean, right now, what we try to track in (00

[Paul J. Chung:]

Okay. Great. Thank you.

[Operator:]

We'll take a follow-up from Steven Frankel.

[Steven Frankel:]

Let me try to attack the tariff question another way because I keep getting this from investors. Obviously, you have a global business. Do you have a kind of off-the-cuff number of what percent of your customer sales end up in the U.S. and therefore would be subject to the tariff?

[Lewis Chew:]

No. I don't have an off-the-cuff. I mean, as you know, we get a variety of data reported by our customers but we've historically not try to report where the end device ended up.

[Steven Frankel:]

Right. That's – yeah. And I guess that's the other point, is you're reporting like some people look in the 10-K. That's where the headquarters is, not where the end device ends up. You just don't have that level of capability.

[Lewis Chew:]

Correct.

[Steven Frankel:]

And then, Kevin, to go back to Vision and the TV market one more time, where do you think your penetration rate in the UHD market is this Christmas and kind of how do you see that playing out over the next year or two?

[Kevin J. Yeaman:]

Well, like I said earlier, I think we're still at early stages because most of our partners are still in their higher end models. Again, VIZIO and TCL are great examples of partners that have gone quite a bit deeper. But of our dozen or so partners, most of them are still at the higher end models. And I think that's where we are today and I think it'll gradually change, but we probably won't see a market change by Christmas at this point.

[Lewis Chew:]

Yeah, yeah. (00

[Steven Frankel:]

...next year, yeah.

[Kevin J. Yeaman:]

Yeah. I think going forward, look, our goal is to have Dolby Vision and Dolby Atmos be a part of all in this context UHD experiences. Now obviously, that's a ambitious goal, but when we come to work every day, we believe that Dolby Vision and Dolby Atmos can improve every experience. And you've seen from previous adoption cycles that we have to keep focused on broadening the value proposition in terms of connecting content to devices. It's never easy to predict exactly when we're going to get hit an inflection point. But we leave an inflection point as possible and we believe that we've created the potential for that and we're just going to stay focused on scaling this opportunity. And I think the growth in the ecosystem over this last year is what's most encouraging. And again, on the content side, now having Apple, Netflix, Amazon, Rakuten, iQiYi, Tencent, Youku, it's encouraging. But that, combined with the – now the first pay TV operators and the activity we have going on in the live area that just – it's all about continuing to broaden that value proposition. So, people have as many reasons as possible to include Dolby Vision and Dolby Atmos and so that as many consumers as possible can have their experiences that way.

[Steven Frankel:]

And certainly, that theory of you take what you've done in Apple where you've gotten Vision and there on the phone, what impact has that had on the pipeline in Android? We've seen some announcements, but my hope would have been that there would have been a whole – a lot more activity in the Android market. What's the pipeline of interest like in Android in Vision and Atmos?

[Kevin J. Yeaman:]

Yeah. I mean, I don't know that I can ever isolate the impact of any one event on how some other partner is thinking, but there's no doubt that the success that we've had together with Apple over this last year getting Dolby Vision into the Apple ecosystem, ending the year adding Dolby Atmos to the Apple TV 4K, and the amount of content and the growing amount of content on iTunes is significant and people take notice of that. So on the scale of when we go to articulate a value proposition, each one of these wins makes a difference because it becomes more and more compelling that more and more content is going to be coming and that more and more consumers are going to be expecting this kind of experience and the reviews continue to be outstanding.

[Steven Frankel:]

Okay. Great. Thank you so much.

[Operator:]

We'll take a follow-up from Eric Wold.

[Eric Wold:]

Thank you. Just want to drill in on the products and services guide a little bit deeper, I guess. I guess, one, first question is, is there any impact to products and services revenue in fiscal 2018 from the recast? And then, second question is looking at that line item, it's been fairly minimal growth over the past few years, $109 million in 2016; $115 million, 2017; $114 million last year. And now, you're looking for $150 million to $170 million. I guess, you gave three reasons in there, new cinema products, Voice and Dolby Cinema or somebody else line (00

[Lewis Chew:]

Sure. Hey, Eric, let me take a first crack at it, and then, I'll let Kevin add on to my comments, which are going to be more numeric in nature. But first of all, from a recast standpoint, I think I'll tie it back for a second to a question that Ralph asked about the recast and the impact on FY 2018 licensing. I think what I said to him was that the substantial majority of the – virtually all of the recast in 2018 affected licensing, not in products and services. And that's because of the way ASC 606 and ASC 605 differs on that. Within that, I think I mentioned in my prepared comments that the markets that were most affected by that were mobile, PC and broadcast. And really, mobile is the majority of it. So if I look at the recast of 2018 and spend one second on that, that difference between the $1.172 billion and that range I gave, the majority is mobile, then there's a chunk in PC and a little bit smaller part from broadcast, which then puts me to your question, which is no, the trend in the product and services revenue from 2018 and 2019 is really not affected by what I'm characterizing here as the ASC 606 recast. The growth is coming from a blend of, first, I would point out that the cinema products group released a number of newer products at the beginning of this year and during the year ranging from multi-channel amps to more user-friendly speakers for Atmos installations and things like that. And we've built up a pipeline. We have customers out there who've indicated demand and that demand didn't come as soon as we thought. And Jim Goss asked earlier whether it's all timing, it's hard to know how much of it is all timing, but we do have some confidence that we'll see growth there. So cinema products, we expect, will grow next year. We also expect growth in Dolby Voice. Dolby Voice, they're growing off of a relatively smaller base. So, right near the latter part of this fiscal year was when we released this new product called the Dolby Voice Room, which combines this integrated easy to use camera – visual device with our phone and that's in the very early days. So, we have some expectations for growth there. And then also, I mentioned that a portion of our Dolby Cinema deals in FY 2019 we anticipate will land in products and services, and those would be deals where we're pursuing more hybrid transactions where a chunk of the money is received upfront and that could be classified as a sale at the time of the deal and that would (00

[Eric Wold:]

No, that's perfect. Just one quick follow-up, if I may, so the – what is the behind the desire to pursue more hybrid transactions? I was just trying to be a little more risk adverse in kind of an uncertain world and kind of take a little less – put a little less capital out there into these new installations.

[Lewis Chew:]

Yeah. In some cases, it might be the market or the customer where that circumstance worked out better for them. In some cases, it might be a factor of what the profile of that market is and financial considerations for the customer. In some cases, it could be currency. So, I think there's a blend of factors that go into why we do this. Our base model, of course, as you know, is to generate ongoing share of gate receipts. So, this would be a subset of those deals. But there are going to be times where we have an opportunity to do a deal and doing it this way might make good sense.

[Kevin J. Yeaman:]

Yeah, I would just add, it's primarily going to be markets where we believe that the financial market conditions make this a better...

[Lewis Chew:]

Attractive.

[Kevin J. Yeaman:]

...balance for us. Yeah.

[Eric Wold:]

Perfect. Thanks, gentlemen.

[Operator:]

And at this time, I'd like to turn things back to Kevin Yeaman for any closing remarks.

[Kevin J. Yeaman:]

Great. Well, thanks everybody for joining us and we look forward to updating you again soon.

[Operator:]

And that will conclude today's conference. Again, thank you all for joining us.