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

Good afternoon, everyone, and welcome to Baird's 6th Annual Consumer Tech & Services Conference. It's -- for those of you that may not know me, my name is Matt Krueger. I am a senior equity research associate here on Baird's research platform. And it's my pleasure to welcome Dolby Laboratories to the conference. With us from the company today. We have Lewis Chew, EVP and CFO; and Ashley Schwenoha, Senior Manager, Investor Relations. So with that, Lewis, I'll let you kick it off. Thanks.

Thank you, Matt. And they can't be a very long list of people who don't know you, right? I mean, let's just get that out on the table right away. Okay. Anyway, thanks, everyone, for joining this fun half an hour segment that we're going to have with Matt. The way we're going to do this is I do have a couple of slides just to provide a very high level brief introduction to the company. I won't dwell on that, and then we'll kick it back over for an open discussion with me and Matt, about what's going on in the economy, what's going on with the company and things of that nature. So let me quickly pull up the slides, give me a second. Okay. So as Matt said, we're Dolby. We often refer to ourselves as Dolby Labs. And no presentation like this is complete without kicking off with the forward-looking statements. So I will spare you the pain of me reading this in detail other than to highlight the fact that we are covered by the traditional safe harbor rules at the very core. Any forward-looking statements I make are covered by that and are subject to change, and we don't have any obligation to update that. Although I'm not going to be providing particularly any significant amounts of forward-looking information today. And also to highlight that our safe harbor rule are available by reading this on your own and other documents that we publish. Okay. So I thought I want to kick off with -- I have 2 slides. Like I said, I'll do -- since I'm the CFO, I'll start off with a slide with some numbers to give you some context. And then I'll jump into a slide that talks a little about who we are and what we do. So this is simply a chart that goes back to -- I just picked FY '15 because that was just a nice round number to pick off with and show you that over the last 5 years leading up to FY '20, which was pandemic, we were a company that was on a growth path, revenue growing in the neighborhood of 5%, 7% per year, earnings growing at least at that level. We're a company that's actually been around for quite a while. I think Dolby is now celebrating its 53rd or 54th year. So then FY '20 that you see on this chart is the year that the pandemic hit. We are, by the way, at September 30 year-end company. So that will affect even how our annual numbers are relative to the pandemic. And then the year we're in right now, which will end September of this year. This is simply the numbers relative to the guidance that we gave at our last quarterly earnings -- sorry, I'm going to move the box all the way here. Our last quarterly earnings' done. The numbers reflect the most recent revenue guidance that we gave for the year. So you'll see that after the FY '20 drop off, it is our current -- our outlook that we gave on May 4, our outlook that the revenue would be rising again this year. And then very quickly here, here's also, along with that. The operating margin, which is the blue line in the middle. We are a company that has consistently generated non-GAAP -- these are non-GAAP numbers, by the way, except for the revenue, which, of course, is GAAP. Non-GAAP operating margins in the 30-plus percent range. That slight dip that you see in FY '18 was simply an anomaly from that being the year that we adopted ASC 606, which caused some odd perturbations in our numbers because we did a recasting of our numbers. And then the final line, the orange line shows the progression of our earnings per share. And obviously, what we'll see is one more data point at the end of this year on how that goes for FY '21. So that's the extent of the numbers that gives you some sense of our size and sort of our recent patterns. Who is Dolby? It's hard to sum up Dolby in any one word, but we like to think of Dolby as being a unique company that significantly improves how you experience your content. And when I say content, historically, what I'm talking about here is things like movies and TV shows and then in more recent years, live sports. We are the company that started off the surround sound phenomenon in movie theaters. But that, of course, has migrated well into not only the living room, but on the road and certainly on things like mobile phones. In more recent times, we've also expanded into things like gaming and then even very recently, music. The technologies that you often hear us talk about in terms of Dolby are, things like Dolby Vision and Dolby Atmos, which I won't chew up a lot of time right now, but just kind of a teaser, if you want to come back and ask me what are those, Lewis? I'd be happy to explain it to you. And in the center of this, you see the word music. A lot of people might think, oh, Dolby is at music, until recently, we weren't, but now we are. And like I said, in terms of our progression as a company, one of the cool things that's happened recently is that Apple announced that their Apple Music service, which services tens of millions of people, will feature music and Dolby Atmos, which is a significant uplift in terms of how you experience that music and how enveloping it is. One of the more recent things we've done is beyond the premium entertainment space, which, like I said, movies, TV, live sports, music and gaming. In the last 1.5 years, we also launched an offering called Dolby.io, where we are now trying to take some of our Dolby capabilities in improving sound and eventually -- and also improving video and apply that through the whole world of content that's outside of this first bucket that I call premium entertainment. And so far, these are some of the areas we've seen some traction, people who are creating apps that address things like distance learning or podcast or music mastering. And like I said, that's through an offering that we call Dolby.io. As a teaser, I'll say, if you want to find out more about that, you can actually just go to the web and learn a lot more by going to Dolby.io. So that's a little high level flyover. You noticed I didn't bog that down with a lot of discussion about business models and customers. We have a very, very broad customer base, and we do have a very strong business model that, as you saw on the previous slide, produces very strong financial results. So with that, I am going to kick off of the sharing screen here. Come back over to Matt, and we can talk a little bit more about the company, Matt. How is that for a dime tour of Dolby Laboratories?

Great. That's perfect. That's perfect. Just a reminder to those in the audience, feel free to submit any questions through the online portal. Those will get directly sent to me, and I can prioritize client questions accordingly, of course, ahead of my own. Maybe just to kick things off, Lewis. You just gave us kind of your end market overview and your segment overview. Clearly a wide variety of kind of end market service and things like that, whether it be platforms that reach kind of sound systems, televisions, phones, gaming systems, automotive, any number of end markets. Can you give the audience a broad sense of the key end market exposure breakdown here, along with which of those end markets is really driving growth, which is maybe kind of topping out? Give us a sense of what's going on there.

Sure. If I kind of go on order by size, collectively, probably our biggest end market is the market you think of as in home entertainment, which would be TVs, set-top boxes. In fact, that's a category even when I report numbers each quarter, we call that broadcast. But even within consumer electronics, we might have things like stereo systems and speakers. So certainly, the whole home entertainment piece of the equation is a significant chunk of the company. Also big markets for us are mobile. We now have significant exposure to players in a mobile space like Apple, like Samsung and other names in that space. PC continues to be a significant chunk of our revenue as an end market. I know the PC industry has consolidated over the years, but big names like Lenovo and Dell and things like that. Apple, obviously, Apple does PCs as well. Automotive is an interesting one, Matt. You mentioned automotive, you know I didn't talk a lot about it in my prologue. But automotive is a market we've been in historically, mainly because we were -- Dolby Technology is in DVD players, and we've been in those backseat DVD players. But looking forward, all that time I spent talking about Dolby Atmos for music, we see that as being a very attractive one. So today, it's almost like 2 stories there. It isn't that automotive is necessarily a huge factor for us today. But going forward, that could be a significant market that we address. So really just a recap there, TVs and set-top boxes is probably our biggest chunk of business. Mobile, PC and then consumer electronics, which would include, like I said, the home stereo stuff, DMAs like Apple TV and Fire TV, and then finally, gaming. So gaming sits in the category we call other, but gaming consoles like the Xbox and the Sony PlayStation are -- that's like a -- that's an overview of all the key markets that we serve. Also, just a smaller piece of our business. We do actually sell some hardware products into the -- mainly into the cinema industry. So that's probably anywhere from 5% to 8% of our revenue goes into cinema. And then one final thing that I didn't mention in my prologue is we do have an offering that we call Dolby Cinema, which we believe is one of, if not the best way, to experience a movie today. So it's a premium cinema. One of our big partners there will be AMC. So if you go to Dolby Cinema, and you go in there, you'll -- it will just be a phenomenal movie experience. And we also get revenue from something like Dolby Cinema.

Got it. That's helpful. And then maybe can you talk about what the revenue growth rates look like across your business? And what you expect moving forward? Maybe which of those key businesses and end markets are really driving those growth rates at this point?

Sure. Maybe I'll break that up into 2 or 3 pieces. Prior to FY '20, which was the pandemic year, we had just come through a set of 3 years where, on average, over that 3-year period, we are growing to total company top line in the neighborhood of 7% to 8% in that neighborhood and growing the bottom line, probably closer to 10%. So that was sort of our growth rate. I think a lot of people think of as being this kind of a mid- to high-single-digit growth company. Within that, the things that were driving our growth, if I think about it from a technology standpoint, was really this Dolby Vision and Dolby Atmos technology that we've seen significant adoption because they're relatively new because I mentioned that Dolby has been around 50 years, but we only released things like Dolby Atmos and Dolby Vision within this past 5 to 7 years. So those are driving it. And then some of the things that we saw that growth -- saw driving that growth would be in areas like mobile. And high-end TVs and sound bars and DMAs, things like that. So I think those were the drivers of our growth. PC is an interesting story because PC for us, had been a declining market for a number of years because we used to be significantly exposed to the PC for a variety of reasons and that tailed down because of declining ASPs and also because DVD players as a thing has started to be phased out more and more in PCs as streaming became more prevalent. But certainly, now if I flip to the second half of my answer, Matt, in the current year, our current trajectory probably has us on pace based on the guidance that we gave at the last quarter end to potentially grow somewhere in the neighborhood of 10% this year based -- like I said, based on what we actually have reported through Q2 plus our guidance we gave and depending on the range. And I think some of that -- some of where we could see that coming from would be areas like PC because I think PC is a market that has done well. Because of work from home and maybe phenomenons like that. Also continuing adoption of our Dolby Vision and Dolby Atmos technologies in areas like TV and mobile are driving that as well. And also within our whole suite of offerings, we also generate significant revenue from our patent portfolio because we, at Dolby, have a lot of different technologies. And some of our technologies we license out through patent pool. So that's also helped drive some of our growth. If someone doesn't want to go for our branded technology, they could actually license some of our technology through our patent program. So we really do have a multipronged approach at the growth, but that probably gives you some sense of where the pockets of growth will be coming from either before the pandemic and in the current year, because obviously, the pandemic year itself, FY '20 was actually a down year for the obvious reasons.

Great. Yes. So -- and we mentioned the pandemic impact a couple of times already. I want to get to kind of the time line of how that impacted the business. But first, maybe one more general kind of overview question. If you could give us a sense of what your market share looks like and what your TAM looks like for your business over the next -- whether it be current and then how that's growing over the next several years? I think that could be helpful for the audience as well.

Sure. That's a great topic to talk about, Matt, because for us, it is sometimes challenging to point to a TAM. I think the way you ask that question is a great way to ask it. It's just hard to answer it that way because we are a company that derives so much of our revenue from our technology being adopted into other people's products, whether they be TVs or handsets or game modules. Then will I talk about TAM in terms of those markets? Or do I talk about TAM in the context of the revenue that we at Dolby derived? And we've struggled with that because Dolby does feel to me like a bit of a unique company, right? There's one Dolby. There's one company out there that does what we do, where we create these phenomenal technologies that help so many other companies improve how you experience your content. Imagine just in a normal Saturday for you, where you might get up in the morning, look at something on your cellphone, watch some TV programs, maybe go to a movie that night with your family, there's so many places where you're enjoying content where Dolby is affecting that. So I think we'd probably like to think more in terms of the TAMs of the markets that we address. And I'd say that, for example, the TV TAM is probably in that neighborhood of 250 million units a year, give or take. But the cellphone market is more like 1.5 billion to 2 billion units a year. And those can behave very, very differently. If I step back and think about areas where we see opportunities for growth, clearly, TV continues to be a big focus of ours because I've mentioned now several times, Dolby Vision. As an example of a data point that speaks to your question, at the end of FY '20, we said that we thought Dolby Vision was in anywhere between 15% to 20% of 4K TVs. So now you start to get some good granular sense. Okay, 4K TVs, what does that make up for the whole market? How big is the whole market? But historically, when I think about Dolby Audio technologies like Dolby Digital, we would get penetrated in TVs over 50%. So when you talk about share of market, Lewis, and the TAM, I would say to you, of the 250 million unit TV TAM, our share of that market might be 50%, and the other 50% might be just divided up amongst a lot of other approaches. Because like I said, there isn't an exact competitor to Dolby that I can point to that says, "Oh, they have the other 50%." But for Dolby Vision going into TVs, that number is a lot lower. So obviously, we see there being significant growth ahead. And then you can run similar numbers like that for mobile phones or for PCs. Today, there's a handful of PC models that have Dolby Vision or Dolby Atmos on them. We think those are tremendous opportunity. Because Dolby Vision fundamentally makes the picture better, makes all your content better and Dolby Atmos makes the sound better. And it seems like PCs are being used more and more these days to consume media or content, not just for conferences like this, but even I know my adult age kids, they even watch entertainment on their PC. I don't. I can't say that I do, but the newer generation does. So there's pockets like PCs where that's probably another couple hundred million unit a year market for which Dolby Vision and Dolby Atmos are very low penetrated. So our share of market in that context will be pretty low, and we think it could be significantly higher. And it's not share in the context of competing against someone else, but share in a context of penetration. So maybe -- I know I didn't give you one TAM number, but I try to sort of break it up into different pieces.

No. I think that's great context in terms of which markets kind of fall where and what -- where you guys are playing. I wanted to dive back into what we hinted at earlier in terms of the impact of the pandemic on your business. If we could go back 18 months or so, to kind of the kickoff of this pandemic, how did it impact your business from that period up until now. Clearly some headwinds throughout the process. But maybe if you can talk a bit about what opportunities Dolby came out of this pandemic with? I think that's always interesting and helpful as well.

Yes. Well, I think we, like so many companies didn't anticipate that the real effect of the pandemic or how long it would last. It's amazing to me that I can sit here today and say, I've not been in my office since March 6, 2020, which I don't think I ever would have said something like that. I think in the earlier days of the pandemic and especially when things like the shutdowns and the restrictions started kicking in. The first 2 things we saw an immediate impact on were any of our businesses that were tied to cinemas were directly affected. Because to the extent that cinemas were shut down, then you had 2 things. One, to the extent that we are generating revenue from the cinema like Dolby Cinema, that goes away. And then to the extent that you have customers, who are buying products from us because they're in that business, that went down significantly because now they were in trouble because they weren't getting revenue. So I think that was one. And then two, in the earlier months of the pandemic, a lot of the products that we are in, where we derive royalty income from, if these were products that were more commonly bought in a store and stores were in shutdown mode, we saw a big drop-off in revenue from there. And it kind of told us right off the bat that, that transition to just, well, I can't go to the store, I can buy it online was not immediate. There was a period of time there. I can think back to just a year ago, a year ago, this quarter and a quarter that preceded this one, we did actually have to lower our numbers of revenue because we could see that numbers were coming in much lower because of this impact of all the stores being shut down. Okay, then you move forward through the pandemic and some of the things that we saw emerging were TV sales seem to be strong. And the story behind that seemed to be, well, if people are going to be at home and working from home, they're also having to entertain themselves at home. So TV sales are strong. And certainly, I've already alluded to this in my previous comment during the session today, but PC sales turned out to be strong, and that did benefit us because we derive royalties from being in PCs, whether it be our audio or our video technology. Probably the harder ones to make a specific comment on would be mobile. Like even I've struggled to make a singular comment about whether pandemic helped or hurt mobile. Maybe it's because, Matt, that mobile is such a big market and so many people are so dependent on their phones and maybe there wasn't just one pattern. Whereas with TVs, it did seem more clear that people were buying TVs, you couldn't even find instances where things were sold out. Another example I can think of is around Christmas time, I went to go buy this new Sonos soundbar. Sonos came out with the -- Sonos with a soundbar that had Dolby Atmos in it. So I went to go get a couple of those for family members for gifts, and they were backordered. I gave them as Christmas gifts, but they were like backordered until February, and that was a little bit of a learning that there were some devices that were popular enough to where they actually stocked out because people were buying them. But I'd say that would be it. I'd say cinema businesses directly affected, definitely went down, maybe starting to climb back a little bit now. Consumer electronics probably had an initial hit, but started to come back a little bit. And in things like TVs and PCs probably did better than we would have anticipated for these other factors that we learned through the pandemic.

Great. Well, I think it makes me and probably some in the audience feel better that even your soundbars were delayed because I think I ran into the same issues.

Oh, yes. Yes.

I think we've talked about Dolby Vision and some of the other products. But I wanted to dive into Dolby.io a bit. Clearly an exciting opportunity in introduction. Can you give us kind of the latest and greatest here in terms of adoption, usage, et cetera?

Yes. One thing I should highlight is that Dolby.io is relatively new and so it's actually -- it's a little bit refreshing of a change for us that we're talking about this early because we only just launched Dolby.io less than 2 years ago. I'll rough it out, say, 1.5 years ago. If you look back at the long history of Dolby, it would not be uncommon for us to be working on this technology for several years before we would unveil it and then start talking about it and then eventually gets adopted and then it generates this long tail of revenue because it's continuing to be used by more and more people. Whereas Dolby.io, we launched it, like I said, somewhere in the neighborhood of 1.5 years ago, and it's exciting, Matt, because there is so much content out there in the world that is not movies and TV shows that could, we believe, benefit from the Dolby magic, from Dolby making the audio better and the video better. So what Dolby.io is, is it's a platform where we develop APIs that app developers can easily grab and incorporate into their app. So someone is developing an app where somewhere in that app, there's going to be some media going on that involves picture and/or sound, our argument would be take a look at our technology and see if we can make it sound better. And then in the future, make it look better because to be clear, right now, the platform doesn't have a video API, but we do plan to have that. And then the business model is also different because I've mentioned that the main Dolby structure today is typically our technology gets adopted in devices, and we earn a royalty when those devices sell. But Dolby.io is an app developer model where we make the API available. If you, the app developer, put the API in your app and it starts getting used, then we get paid money for the use of our technology in your app. And I don't want to go into a lot of detail here, but our website has that all on there. And there's published prices and everything like that. And it's exciting because there just seems to be so much content that could benefit from the Dolby Technology. And we've spent decades becoming really, really good at making audio better. And we spent the last decade becoming really, really good at making video better. And now through Dolby.io, we are sort of democratizing that. We are making it available where -- to a broad range of folks who even a couple of years ago, even if they wanted to do that, they couldn't have. I think my -- the executive team at Dolby probably got tired of me telling them the story about my daughter's boyfriend that when they were in college, he helped her do a video for the sorority she was in and then other sororities found out that, that was a good video and wanted him to do it for them. And I said, what he should have done is done yours in Atmos, so at least yours would still be better honey, except that, that was a false statement because there wasn't any way for him to do that. But going forward, someone could invent an app for that, and it would be possible. So we could invent an app that says, oh, you're out there doing home videos, my Apple allows you to do that and embed the Dolby Technology in there. It's really exciting for me to think that, that silly little example I used to talk about years ago is now getting closer to fruition. And I do think that the world would benefit from that too. There are so many different examples of where content could be improved with the Dolby magic.

Great. Great. Absolutely. I want to sneak a question in from the audience here. And it has to do with kind of some of your new partnerships, and specifically, can you talk about some of the key opportunities that your partnership with Apple Music is going to provide moving forward in terms of your expansion into music and other adjacent markets? And maybe you could talk a bit about some of your other recent partnerships in that question as well with Roku and Sonos and any other kind of call-outs you'd like to make?

Yes, we are very proud of the incredible depth of partnerships we've built up just in this past, I'll call it, this past decade. I mean you've mentioned a few already, right off the top, you've mentioned Apple. You mentioned Roku, you mentioned Sonos. Those are actually both very recent, by the way, and if I start rattling off other big names, Amazon, Netflix, Tencent, ITE goes on and on. And then in terms of device manufacturers, Microsoft, Lenovo. So with something like Apple, what's exciting about the Apple Music partnership and their launch of that is, first and foremost, Apple Music is a very popular service. Tens of millions of people as far as I understand that subscribe that. Two, we love being relevant to music as music is a very powerful and attractive medium for lots of people that we want to talk to that Dolby wants to connect with. And then from a pure business standpoint, it immediately makes us relevant to markets like the car. Because the car is where a lot of people still listen to their music, and we already have one example of a car company that has adopted Dolby Atmos into their car. This is this electric car maker called Lucid, and I encourage people to go out on the web. Just Google it. Just Google Lucid Air, Dolby Atmos and you'll find this great video where they talk about it, probably better than I could. So the partnerships are very important to us and something like Apple, not only as significant because people will now be able to enjoy their music in a much more pleasurable format through Dolby Atmos and I think Apple really refers to it as spatial audio, it's spatial audio powered by Dolby Atmos or featuring Dolby Atmos. So it improves your experience, but it does also open the door for us to be more relevant in things like the automobile and even things like the cell phone, I think a lot of people still listen to music on this. And of course, smart speakers in the house, Sonos, you name it. Music is just one of those very important mediums that we want to be a part of. And so we are very happy to see someone like Apple adopt Dolby Atmos on their platform.

Great. And then unfortunately, we're running up against time here. I guess the last question that I wanted to ask is, I was hoping that you could give kind of your pitch on Dolby Labs, from your perspective, to the investors, in a somewhat post-pandemic world, that's where vaccines are being deployed, mobility for consumers is improving rapidly. What does the investment opportunity look like for Dolby from your perspective?

Well, first and foremost, I go back to that second slide I shot up there, which is we, Dolby, are uniquely positioned in terms of how we improve the content that's out there in the world today. And looking forward, it's a very reasonable argument to make that there is a ton more content that we can improve. And we have these established technologies that we can bring to bear. So in a post pandemic world, where people are consuming content in so many different ways, I feel great about how we're positioned to somehow improve that experience and get embedded all through the ecosystem.

Great. Well, I think that's a wonderful way to wrap things up. Thank you, Lewis, and thank you, Ashley. Thank you, Dolby, and thanks to all of those that joined us. Operator, I think we can close out the call now.

Thank you.