Dolby Laboratories, Inc. (DLB) Earnings Call Transcript & Summary

So good afternoon. Welcome to the Dolby Laboratories presentation. I'm Rob Mason with the advanced industrial equipment team at Baird. Pleased to have Dolby Labs at the Baird CT&S Conference this year. Dolby Labs being a market leader at enhancing the audio and video of today's entertainment content. With us today from Dolby Labs, I want to welcome Lewis Chew, who's the CFO of Dolby. Lewis is going to start off with a presentation. Perhaps we'll have a few minutes at the end for questions. [Operator Instructions] I'll turn it over to you, Lewis.

Thank you, Rob, and thanks for having us. It's -- so far today, I would have to compliment you guys that the logistics have been pretty flawless on the meeting. So I know that these virtual conferences are a new thing, but judging by today, it's something that you guys have adapted to very well, so thank you for having us.

Good to hear.

Okay. So as Rob said, I was asked to make a brief presentation today, but I will leave time for Q&A at the end. So in light of that and being mindful of the time and the fact that I can be fairly long-winded, I've reduced my presentation to 2 substantive slides with a few click-throughs. So I think, as always with these types of presentations, let's start quickly with a slide that -- sorry, there's something in my screen here. I'll let everybody take a minute to look through here. It's customary for all companies like us to have a safe harbor about forward-looking statements. I'm not planning to make any particular comments today on guidance or anything like that, but it still is important and necessary to highlight this. So I'll just give it another 20 seconds for people to scan through this and you can always access this later. It's very similar to the safe harbor that we have any time we make statements in forums like this, might be on our website as well. Okay. So in terms of my slides today, I've divided my discussion into -- sorry, I want to get rid of this. I've divided my discussion into 2 slides. The first slide is sort of a financial overview. I'm mindful at these conferences that there might be a mixture of folks listening in or watching in who know the Dolby story and some who are not familiar with it at all. So I've got one slide to give you some financial perspective of what we look like, and I'll talk through this, and another slide that talks about what we do, what do we make, who do we sell it to, et cetera. So the slide I have in front of me here shows roughly a 8-year history that coincides with when I became the CFO of Dolby back in 2012. And for a period of time, you can see that we went through a period sort of from FY '12 through FY '15, where our revenues were relatively flattish. We're going through a period where some mature products were rolling off and some of the newer things are not kicked in. And then after that, we started to show some growth. So for the next couple of years, we had roughly 5% growth. And then over the last 3 years, on average, we've shown about 7% top line growth. I do want to highlight on this slide that FY '18 was a year that looks a little bit wonky on this slide because we adopted the new 606 accounting standard for revenue recognition in FY '19. And we did the full adoption, which meant that we went back and recast FY '18 under the new rule so that -- and there's lots of disclosures and lots of discussion about why that is. But just as a reference point then, in that year before we got to FY '19, we had reported revenues of $1.172 billion. So you can see that, that would have been another data point on here that would have continued that trajectory. But nevertheless, because of that 606 recast, we'd look at it as being over the last 3 years, on average, the top line growth has been about 7%. Okay. Now let's kick over to what's happened during that time frame with operating margins. If I scroll all the way to the left here, back in FY '12, you can see that -- these are non-GAAP, by the way. Our non-GAAP operating margins were -- or quite high by any measures. And during a period of a number of years, we went through an investment cycle where we ramped up our R&D and our selling and marketing to reinvigorate the pipeline of opportunities for future growth. And then you can see that heading into FY '15 all the way through '19, if you set aside the FY '18 sort of aberration just because, like I said, that recast has its own idiosyncrasies, we've leveled off and maintained operating margins at roughly the 30%, 31% level. If I round off, I'd say roughly 31%. And part of that was us now getting back to a revenue growth mode and sort of finishing that "investment cycle" where we're investing much faster than we were growing our revenues and now moving to a mode where our revenues were growing at a faster rate than our operating expenses were growing, which allowed our operating margins to stabilize. Then in terms of our earnings per share, you can see here that the earnings per share didn't dip as dramatically during that period of time, but did dip but then consistent with our return to growth over the last several years. You've seen the earnings per share climb as well. And in rough terms, over that same 3-year period, I said that we average roughly 7% per year in annual top line growth. Our earnings per share grew faster than that at roughly 9% to 10% level. We are -- before I move to our products, fundamentally, if I try to think about who we are as a company financially, we are a company that tends to have very high gross margin revenues. As you can see from this chart, even with the decline from where they were in FY '12, we operate with a relatively higher operating margin, very profitable. That translates into significant cash flow as well. Of the revenues that you see here, we are a company where roughly 90% of our revenues come from licensing a broad suite of our technologies, which I'll talk about in a second, and roughly 10% of our revenues historically have come from sales of products and services, which tend to be lower on gross margin scale. So it's a really, really high-level flyover on what we look like financially. If I talk about the balance sheet just for 1 quick second, especially in this current environment we're in, where the economy has taken some hits because of the pandemic crisis, we currently have roughly $1 billion in cash and investments on the balance sheet with no debt. We tend to be a relatively low capital intensity company because we generate so much of our revenues from licensing our technologies as opposed to selling hard products with cost of goods sold. A lot of the products that we do sell, manufacturing is done offshore with contract manufacturers as well. So that's a quick flyover on the rest of our financials. All right. So with that, let me move into a discussion about the company's business. What it is that we make? Who we sell to? Where we see our growth coming from in the future? What makes me excited about the future of this company? Et cetera. So at the top here, you see 4 big-branded logos of products that we offer. Starting from the left. Historically, Dolby has been known as an audio technology company. I think a lot of people, if you stop them on a street, might not necessarily know exactly what we make, but I think our marketing study show that there's a lot of brand recognition of Dolby. In the early days, we were known for the noise reduction for cassette tapes and then moving on to revolutionizing audio from movies in the cinema and, in more recent years, some additional innovation. So going across top here, if I think about Dolby Audio, Dolby Audio is at the very core of the company. It's what we've done for a long time. It's where we provide technology to companies to make the recorded media have better audio. And some of the branded technologies we offered over time would include things like Dolby Digital and Dolby Digital Plus. Then scrolling to your right, the next 3 items are the 3 of the key things we've offered in recent years that have helped us reinvigorate growth in the company. And I'm going to quickly rattle through these 3 things and what they are and then move on to the rest of the slide. So Dolby Cinema is probably the preeminent offering that we have made available to the world to really illustrate the power of the Dolby technology. Dolby Cinema is a premium-format theater that encompasses all of our best video and audio technology, which is Dolby Vision and Dolby Atmos, including a design concept that enhances that experience. It's done in partnership with a cinema exhibitor, the largest of which is AMC and predominantly here in the United States. So imagine that you go to a cinema -- multicinema site and there will be a Dolby Cinema there. And when you walk in, it's branded as a Dolby Cinema. It's reserved seating. It's luxury seating, and the movie experience is unlike any other that you'll have. So that is probably the most prominent example of the full Dolby experience. To the right of that, you see Dolby Vision and Dolby Atmos. Those are 2 of our newer technologies. Dolby Vision is a video technology, our first video technology that enhances, significantly enhances the quality of the video image you see when you watch movies or TV shows. And it's not by increasing the number of pixels or anything to do with resolution, but rather it addresses how your eyes see the picture, the contrast ratio, the saturation of the colors. It's the richness of the picture that Dolby Vision enhances. And the way it works is that the whatever content you're watching is mastered in Dolby Vision, and then whoever is streaming or providing that content provides it to a device that has Dolby Vision on it so that ultimately, you the consumer is watching a piece of content in Dolby Vision that has been mastered in Vision and is also being played back in Dolby Vision on whatever end device that you're watching on. I'll talk about that more in a second. Dolby Atmos is our latest, greatest sound technology. I think one of the best ways I can think about describing it is if you started off in sound with mono, mono went to stereo and then stereo went to surround sound, which Dolby was largely accredited for sort of creating that phenomenon and sort of inventing surround sound, which now manifests itself as 5.1 or 7.1 channels of sound. Dolby Atmos allows the sound to be placed in a 3D field all around you. It allows sound to be much more naturally placed where you want it to be coming from, which creates a much more enveloping sound experience. So combined with a really awesome picture experience really makes for a very rich experience for whatever media you're watching. Typically, like I said, a movie or a TV show and someday in the future, hopefully, things like live sports. So those represent 4 key things that we at Dolby make, what we've invented and then what we sell. So let me move on then to talk about the way we sell that and sort of how the whole ecosystem works. Even though we often use the phrase "chicken and egg" to describe how we run our business, I'll still use the phrase "where does it start?" It really starts with the content. So somebody who is making a movie or a TV show or even recording a song because we recently announced, last year, Dolby Atmos for music, content is where the Dolby technology really manifests itself most strongly because typically you have content that's being created by an artist, and they have an intention for how that content should be enjoyed, whether it be a movie or a TV show or a song. And the Dolby Vision and Dolby Atmos technology allow for the best video experience and the best sound experience. So really, content is critical to the success of the company, and we are very widely known throughout the creative industry for our technologies. Okay. So then if I move on to talk about how that manifests itself, we tend to think of it as being experiences, and that is a word that you hear a lot these days because I even saw it the other day on a cooking show where they talked about it's not just the food, it's the experience of eating the food. And for us, it's the same thing. It's not just a movie. It's not just a TV show. It's not just a song. It's an experience. It's content that you're experiencing. How do you be immersed in that content? How do you fully enjoy whoever created that content wanted you to enjoy? And on the screen right now, you see some of the different ways that, that can be experienced. Of course, one obvious way is in a theater, like I just talked about, Dolby Cinema. But TVs, historically, TVs and the home theater, if you will, has been a significant area that Dolby has enjoyed success in. In more recent years, you've seen some of our technologies get adopted for mobile phones and other mobile devices because now people are enjoying content on their mobile devices. You might be watching a movie on a tablet or a phone while you're on the go. PCs are another device that people often enjoy experiences on. Gaming, of course, another one. And down at the lower left, you'll see speakers. There are a broad range of devices that Dolby technology is featured in. And maybe I'll pause for a second to talk, again, going back to sort of a financial assessment, how do we run our business? How do we monetize? We operate in a way where we seek to have a broad ecosystem completely aligned around our technology. And today, a significant, a large majority of our revenue is monetized at the device level. So for example, somebody who uses our technology to make content as someone who uses it to stream content or broadcast content, they do need to have permission to use our technology, but they're not paying us on a recurring basis to use that. And then if that technology is then embedded into a device like the PC that I'm talking to you through right now or a TV or a mobile phone, then we -- the providers of those devices pay us a royalty for having our technology in those devices. So the experiences that you see on here are manifested through some form of a device like that. In the case of something like Dolby Cinema, that's a little bit newer, a little bit more unique in the sense that it's not monetized at a device level, but we share in the ticket revenues for movies that are shown in a Dolby Cinema. And over time, one of the things we're trying to do as a company from a strategy standpoint is expand the breadth of ways by which we can monetize all the great innovations that we come up with. All right. So moving on then to talk about partners. Over the last several -- sometimes I get questions from investors like, hey, what am I not asked about? What am I missing about the Dolby story? And I know I'm really giving you the dime tour right now and talking very, very quickly. But one of the areas where I feel we've made great strides and great advances and have greatly enhanced the value of this company is the relationships we have with key partners. Across the bottom of your screen, you can see just a selection of the names for which we are -- have strong relationships with either by virtue of them embedding our technology in their devices, that might be the most basic level but -- or someone like a Netflix or Disney+ offering lots of content that feature Dolby Vision and/or Dolby Atmos and promoting that. Then you might have vertical companies that do both where they make devices and offer content, in some cases, offer streaming. Then you have different industries that are represented. You have TV partners. You have PC partners, studios and Hollywood, streaming services like Netflix and large powerful companies like Amazon and Apple. So our key partners are a critical element of our value and our success story. But I think we feel like we also offer a ton of value to them as well, that if you are somebody who's selling a device or offering a service that the media that you're providing through that device or that service is greatly enhanced by the experience you get from having the Dolby technology. So I'm going to pause there for a quick second and highlight that everything I've talked about so far is really addressing what we think of as premium entertainment. Maybe that's our phrase, maybe it's not. But it really is addressing things that you think about there being produced at a professional level in a Hollywood or wherever Netflix makes their content or even things like live sports, which are major industries and networks putting that on. As we think about where Dolby is relevant today and where it can be relevant tomorrow, the last point I'll leave you with as an example, something that we invest our R&D on that we see future opportunity on, is content even beyond premium entertainment. Examples might be in the near term here, online education or telehealth. But more broadly speaking, think about all the content that's out there in the land that manifests itself in YouTube videos or user-generated content and n all manners of those things as I'm sure I don't even have enough time now to describe all that. One of the things that we're working on very earnestly right now is finding ways to enable that content to enjoy the benefits of Dolby's expertise in making that experience better, making the audio better, making the video better. We recently launched a website called Dolby.io. I would encourage you to go take a look at that. I mentioned earlier Dolby Atmos for music. We have long been very broadly associated with movies and TV shows and live sports, but only recently have we released something like Dolby Atmos for music, and we're now seeing very prominent artists adopt Dolby Atmos for recording and mixing their music and have heard testimonials from quite a number of them about how transformational that technology has been to their music. So at the very core, what I'm saying here is that, not only do we have a very strong core business that addresses this broad ecosystem and is embedded in all these devices, we have new technologies that we're seeking to get penetration in all these devices. And then beyond that, we have new forms of content that we think we can address down the road as we develop ways for companies and people and developers to do that. So that was a lot. There was a lot that I dropped on you. I think I'll pause there and flip back over to Rob. I don't know where we are in the time line here, Rob, at least some time for questions.

Yes. We have a bit of time for questions. [Operator Instructions] Lewis, real quick. I know you didn't want to touch on guidance, and I'm not really going to get into it. But when you did give the third quarter guidance, you spoke of the challenges of just trying to develop a forecast in this environment. A lot of your external sources were out of sync, so to speak. And you broadly spoke to maybe a 15% to 25% decline in -- blended decline in consumer devices kind of underpinning your outlook. I'm just curious with -- that was about 30 days ago, a month ago. Have you seen any improvement just in the ability to develop forecast, projections, what you look at?

Yes. I don't think I can point to anything specific. In fact, I think we even signaled at the time that we get our data points on this fairly sporadically. I mean our industry is not designed to provide a lot of real-time updates. And certainly, our customers are not providing us real-time updates, let's say, weekly or anything like that. I think we, like so many people, are watching the broader environment for things like loosening of the stay-at-home restrictions because that is a factor. Because I think I signaled and commented on when we did give guidance and we -- as you said, Rob, we indicated that we were saying, if you assume unit volumes broadly down 15% to 25%, this is the impact on our revenue. And we did indicate that, that was being affected by the stay at home and people not being able to go shopping and/or people not having as much income because the jobs were down. So we're watching closely signs for that to loosen, and I think there is a relationship between those signs loosening and hopefully an improvement in those conditions. But I think it's way too early and too premature for me to make any specific comment about whether I've seen some positive signs because it really, quite frankly, there hasn't been that much elapse of time. I think we came out with earnings guidance just about a month ago. And even though a lot has happened this month, we're not typically a leading-indicator-type company because we're farther down the supply chain in the sense that our technology goes into someone else's product and they're selling their products. So it takes a while for that information to make its way back to us.

Yes, yes. Fair enough. So if we think about it at a high level, you mentioned your more recent growth rate, I guess, around 7% top line. How should investors think about -- we'll have to get through COVID and some of the dynamics there, but how should investors think about a longer-term growth rate? Should it remain in that high single-digit rate? Is that the expectation or aspiration? And then if I think about the various buckets within your -- just take the License business, obviously, which buckets there would you call out as maybe have a disproportionate impact on your growth rate?

Yes. I'm a big fan of looking at things first as they are today. So as they are today, without regard to the aspirations that me and the rest of the management team have, we are a company that's 8 years ago was not growing, that then became 5% growth, that then have been, on average the last 3 years, 7%. So I think we're trending in the right direction, but we've not yet achieved that aspiration of consistent double-digit growth or even a single instance of that, if you set aside the 606, 605 wonkiness. But that is our aspiration. We do get asked that question all the time. And I think it's not unfair for a company like us to have aspirations of growth like that when you look at the great -- not only the great technology that we have but the markets that we address. And the fact that in the finishing bit of my prepared comments there for which I did unscripted, there's a whole layer of content out there in the world, a whole universe of content that does not currently today -- currently today is probably redundant -- that does not currently benefit from a lot of the Dolby technology, the Dolby magic, as we call it, the better audio, the better video. So it's not hard for me to be optimistic that, boy, if we could unlock that and figure out a way to address that, not only could that be a very revelational thing to happen, but it could also open up new ways for us to monetize our technology as well because that's a much, I think, a broader, maybe more fragmented market that has different ways that we can monetize. So the way I think about it is as an statement today, we are a company that has been growing, on average, 7% on the top line. By the way, higher on the bottom line, I think our EPS growth has been closer to 9% or 10%. So that's been good. High cash generation with a lot of that cash being also not only being reinvested in the company but being returned to shareholders in the form of dividends and/or buybacks. We raised the dividend consistently over the last 4 or 5 years. It seems like a pretty attractive picture. We don't have a ton of obvious competitors. I think the challenge for us is to continue to find ways to unlock that awareness, the awareness of people to know enough about Dolby to seek it out. I hear my CEO sometimes say, "I want people to want Dolby." Not just recognize when they have it, but we want you, Rob, when you're going to go buy a TV to say, "I want the TV that has Dolby Vision or I want the sound bar that has Dolby Atmos." And even though that is happening today, I think it could be happening a lot more. So we have some work to do in terms of how we market ourselves and how we make ourselves more visible but stay within financial constraints. So I know there's a lot in that answer, but there's also, I think, a lot of opportunity out there for us to achieve that higher growth rate. But we really have to say right now that it's an aspiration because we don't have any recent data point to say, "Hey, we did 10% the last 2 years. We should be able to do it next year." We haven't quite reached that metric. But I'm very happy that we have stepped up from flat to 5% to 7% and have earnings kind of go along with that.

Yes, yes. Well, maybe that's a good segue. Just when you think about adoption rates, and maybe it's easier just to speak to your 2 larger buckets, the Broadcast and Mobile pieces over half the business. I mean can you help level set people where you are today, and maybe what you see as your entitlement within those segments?

Yes. I think Broadcast is the most established core part of our business. Broadcast is, like you said, it tends to run in the 40% range of the company's Licensing revenues. And it constitutes all the revenue we get from TVs and set-top boxes, which is why we call it Broadcast. I think there's plenty of opportunity for growth in the TV space. In the set-top box space, that one has a couple of different dynamics going on because you have the cord-cutting phenomenon, which has been talked about and happening for a while. But on the other hand, we have things like Dolby Vision and Dolby Atmos, which are not at all heavily penetrated in the set-top box. So our strategy is to try to offset whatever secular decline you think there might be with more dollar, hopefully more dollar penetration in set-top box. That's kind of like the first big nugget within the company that's a very solid franchise business for which we do get lots of exposure broadly around the world. Mobile phone is an interesting market because mobile phone is, of course, dominated by a few key names. Because obviously, you have -- Apple is a dominant player. Samsung is a dominant device player. Google created Android, and the Android ecosystem is the other one to Apple. And we have varying degrees of penetration there. We have Dolby Vision and Dolby Atmos featured broadly in Apple's lineup. In Samsung, we have Atmos in their high-end phones, more opportunity in the lower-end phones, but we don't have Vision yet with Samsung. And for Android broadly, then it's sort of more choppy because there's no uniform adoption in Android per se. It isn't promulgated or mandated by Google, and maybe someday that will happen and maybe it won't. I don't know. So we see the mobile market as not only being very important to us because of the way people consume their media today, these days, but that there still is plenty of opportunity for growth, either by -- either or both by unit growth in that market or by further penetration of our technologies into those pieces of the mobile space that I've already indicated were not yet penetrated. And there's some pretty significant opportunity in mobile.

I see. What about -- should I look at it or think -- should investors think about your adoption rates geographically as being dramatically different? Does that represent a different driver or -- I mean, we're talking about global device makers. So I'm thinking that the -- there may not be a big difference there unless it's in -- when the content producers -- that are a limiting factor regionally, that is.

Yes. Well, I'll start by saying we clearly are -- not only are a global company, but we think of ourselves as a global company that we have regional-specific things we had to deal with, but we want to think of our platform, our technologies as being global. So that when content is being created, it's being created in Dolby for regions all around the world, not just the U.S. or not just Europe or not just China or Japan. In terms of specific markets that we serve and what the regional idiosyncrasies are, it is fair to say, for example, like in Broadcast, that we probably have more significant growth opportunities in Broadcast, truly in Broadcast, meaning Broadcast services, which then triggers the purchase of devices that have Dolby on them, in regions beyond the U.S. or Europe or Japan, where we already have very broad adoption of Dolby technologies in Broadcast. So in that case then, we have selected regions around the world, like, say, China or India, where we have teams that seek to get our adoption more further penetrated with broadcast providers so that, that then stimulates devices going into those markets needing to be compatible with the Dolby technology. But for things like mobile, I would say, yes, there's going to be some regional aspect to it, but nevertheless, big, large providers like the Apples and Samsungs that are global anyway. And then with markets like PC, I think that tends to behave like a global market as well. We have partnerships with Dell and with Lenovo. In fact, Lenovo is actually the laptop I'm using right now, the ThinkPad. Lenovo is an example of a PC manufacturer who has already implemented Dolby Vision and Dolby Atmos in 1 or 2 different laptop models, and we're encouraged by that because we think that PCs is a good area where Dolby Vision and Dolby Atmos can help that experience, especially if you're using it more than just for doing spreadsheets or for PowerPoint. So in that case, that tends to be a global approach as well. So I think there is some regionality to what we do, but we tend to think first about what we can do globally.

Very good. We're up against the time limit, so we probably need to wrap right there. Lewis, I want to thank you for presenting. That's -- glad to have you at the conference.

Okay. Thank you for having me.

Yes. Have a good day.

Thank you.