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

So good afternoon. My name is Paul Chung. I'm the applied emerging tech analyst here at JPMorgan. And I'm pleased to have with us, Ashley Schwenoha, Senior Manager of Investor Relations; and Maggie O'Donnell, Head of IR. So unfortunately, Kevin couldn't make it last minute. But fortunately, we have these lovely ladies here to talk about Dolby. So welcome.

And I guess to start off, can you provide kind of a quick overview of the business.

Yes. Thanks, Paul. Glad to be here. So Dolby was founded on the belief that people want to have compelling and immersive experiences. And we're unlocking the science of sight and sound to create these awe-inspiring experiences and really transform how we connect to the people in the world around us. Our foundational audio technologies serve as a really strong base and give us a unique position in the industry. And we have newer immersive technologies like Dolby Vision and Dolby Atmos. Those have really been the key drivers of our growth over the last 5 years or so. We have a strong position in movie and TV content. And now we're focusing on broadening the range of content that we're relevant in such as gaming, music and live sports. And we see those as areas to increase our value proposition in areas like PC, mobile, and most recently, automotive. And now with Dolby.io, we have the ability to address a much broader range of content through apps and services with developers.

Great. And what makes everyone kind of excited about Dolby right now? Why is it a good investment opportunity now?

Yes. Sure. So I'll take that. So I think there are 3 things that we would call out as part of our investment thesis. The first is it's a really hard to replicate business model, and we have a really strong ecosystem of very sticky customers. The second thing is that -- there are a lot of exciting growth opportunities with Dolby Atmos, Vision and imaging and with Dolby.io. The third is that we have really strong business fundamentals, so a really pristine balance sheet, high gross margins and positive cash flows. And I'll go into a little bit more detail on each of those. So first, on the business model. We've been around for over 60 years, and we've always been a leader in the advancement of sight and sound. We've gone through a lot of different tech shifts and economic downturns, and we always come out ahead. And throughout all of that time, we've built out an ecosystem with content makers, distributors and device makers and now developers that see a really strong value proposition within the Dolby platform. We also are really just focused on creating the best experience for people. On the growth side of things, so the second point, on Dolby Atmos, Vision and imaging, we're gaining customers and expanding into device lineups of all of our existing customers. And for this year, we're expecting growth of greater than 35% revenue growth. On Dolby.io, we're integrated into more apps, and we're getting into more apps and services. There, we see that there's about the $5 billion TAM, and it's amazing to see how developers are incorporating our technology into what they're building. On the last piece, the fundamentals. So we have 90% gross margins. We generate over 350 -- between $350 million and $450 million in operating cash flow. We have $1.2 billion in cash and absolutely no debt. So in this environment, I think these are just characteristics that make for a really compelling opportunity.

Great. So common theme across a lot of companies this time during the conference has been what kind of happens during the recession. You have some cracks in consumer sentiment here in North America and Europe. So what kind of macro trends are you guys kind of paying attention to and why?

Sure. So really, in any environment, we're going to be keeping an eye out on trends that impact consumer demand. So whether that be a recessionary period, things like inflation, et cetera, those macroeconomic trends are generally going to impact our foundational audio revenues more heavily because of -- in our foundational audio, we have such high penetration across a broad range of products. So they're going to be more heavily impacted by macroeconomic trends. We're also keeping an eye out on supply chain impacts, and we've seen that impacting our gaming and automotive devices. So in terms of how we're tracking that, we continue to monitor third-party industry analysts. We're also working closely with our customers. But given the environment, there is still a lot of uncertainty, and that does limit our visibility. One thing we have seen is that in general, and this is things we're hearing from our partners as well, is that the premium end of products are -- tend to be doing a little bit better. And that's beneficial for us, especially for Dolby Vision and Dolby Atmos. We have a tendency to start adoption on those high-end products. So we're not seeing as much of a heavy impact on that areas compared to our foundational audio.

Okay. And just to level set, you've started to split out foundational versus Atmos, Vision and some of the imaging patents. But what are the common characteristics of foundational audio, that's your core kind of audio? If you can expand on that. And we can get into all the segments.

Sure. Yes. So this is Maggie. I'll take the just general overview of foundational. So it's the base of our business. In fiscal year 2021, it was 75% of our licensing revenue, and licensing is by far the biggest part of the business. I think it's around 95%. And it's comprised of audio codecs, which include Dolby Digital, Dolby Digital Plus and AC-4, and it also includes audio patent licensing. It's heavily penetrated, so there's really broad adoption across the entire landscape. And you can think of it kind of as an index for consumer devices. So we expect really low single-digit growth with an opportunity for us to increase attach rates as new devices come on to the market. This is something that's most impacted by external factors. So things like Ashley mentioned, like economic downturns and things of that sort. There are going to be years where device units do go down, especially in TV, but there are also going to be years where it goes up. And in the long term, I think this will track to market trends but with an opportunity to increase adoption in certain areas like mobile and auto.

Okay. Great. So let's just walk through the different verticals. So you have a big presence in digital media adapters, sound bars, AV receivers. Talk about how Consumer Electronics segment has kind of evolved. You guys kind of take advantage of any emerging new form factors. So if you could talk about just the Consumer Electronics kind of segment in general.

Sure. So we have a really strong presence in Consumer Electronics. Historically, you've seen this, especially in areas like DVDs and Blu-ray players, and that's transitioned over time to streaming devices like your Amazon Fire Stick, Apple TV, et cetera. During the pandemic, we -- folks were really excited about amping up their home entertainment experiences since they were stuck there. So we've seen great adoption of Atmos across those devices like sound bars and AVRs, and with Vision in the -- for DMAs as well. For the year, we expect our CE segment -- our CE market to be up year-over-year slightly, and that's really going to be driven by increased adoption of Vision and Atmos.

Okay. Great. And then PCs, you're seeing continued strength there. You do have some lapping of tough comps, but talk about the strength you're seeing in overall PCs.

Yes. So PCs really strong adoption of our foundational audio technologies there, and still early days for Atmos and Vision. During the pandemic, there was a very sizable increase in units. Industry analysts this year are -- some are still showing some slight year-over-year growth as folks return to the office and back to school. But we're -- for this year, we're expecting our PC market to be up high single digits, driven primarily by Atmos and Vision. In terms of adoption there, again, still early days, but we've had a number of great wins this year. Dell and ASUS are the latest to adopt the combined experience this year in their product lines. We are also across Lenovo and across the Apple ecosystem. So we look forward to growing adoption there. And I think as we are focused on broadening the range of content, especially in areas like gaming and music, that's going to help increase the value proposition for PC.

Great. So let's move on to Broadcast, so TVs. There was very strong demand during the pandemic. Talk about this newer base of revenues and where demand trends go from here. And then I guess you could also kind of expand with Atmos and Vision. Samsung is taking on Atmos for the first time, which was great. So just talk about some of the offsets there when unit demand is maybe trending a little softer now.

Yes. So similar to PC in that we saw a sizable increase in units during the pandemic for TV. And now for this year, we are seeing year-over-year decreases and even higher decreases in areas like North America and Europe, where we're even more heavily penetrated for our foundational audio technologies. So as a whole -- Broadcast as a whole, which includes TVs and set-top boxes we are expecting mid-single-digit declines for the year, and that's really driven by the TV unit decreases impacting our foundational audio. But at the same time, we're seeing a lot of momentum with Atmos and Vision. Paul, you mentioned Samsung has adopted Atmos for the first time in their TV. So we're really excited about that. And we're continuing to gain momentum with Dolby Vision. You've seen this more recently as we're getting adopted by big-box retailer brands from Walmart and Best Buy. And we're also -- as well as gaining new customers, we're also working on increasing adoption with our existing customers from just being in their high-end products to those more mid-tier and entry-level products as well.

Great. Let's move on to set-top boxes. There was an opportunity to kind of expand in the emerging markets. Is this kind of still the case? Any kind of update there?

Yes. I think set-top boxes are still an opportunity for emerging markets. I think the set-top boxes as a whole, we've seen declines in units as folks are cord-cutting and transitioning to more streaming services. But we've seen 2 things here. One is that -- some of the initial expectations were, well, will set-top box go away completely? And the answer to that is no. Cable operators, it's still a really big part of their business. What we have seen is complementary products like DMAs to help offset that. And at the same time, even if units are declining, we're still seeing growing adoption from Dolby Vision and Dolby Atmos. So that's helping to offset some of those headwinds.

Right. So on the DMA front, you're with everyone that matters, right, pretty much, Comcast and Fire Stick and Apple TV and all those, yes. So that's been a good offset. So let's switch to the Mobile category. You have a pretty strong presence there with very big key customers. Talk about kind of broadening that customer base as well. What are OEMs kind of excited about?

Yes. Mobile is a great opportunity for us. And again, this is something that content like gaming and live sports and music are really going to play into that opportunity. We have adoption across the entire Apple ecosystem with Dolby Vision and Dolby Atmos. And we've had a number of great wins this year with Xiaomi as well with the combined experience. Aside from that, we were really excited. This last quarter, Vivo launched their very first product to include Vision and Atmos. It's a tablet. So we're gaining new customers there. For Atmos, they're -- although on high-end products from Samsung, Sony, Motorola, Oppo, so not only is there an opportunity to expand beyond those customer sets, there's also an opportunity to go further down into device lineups. And for the year, we see Mobile increasing in the mid-single digits.

That's great. So let's talk about Atmos and Vision and imaging patents and how that kind of is different from your foundational and where do you see the biggest opportunities. And from my understanding, when there's a foundational audio customer, when you add on some of these Atmos or Vision, that's just incremental ASP. So if you could expand on that.

Sure. So Atmos and Vision are going to benefit from a lot of the same characteristics as our foundational audio, really high margins and a really sticky customer base. Where they differ is that those technologies are earlier in their adoption cycle. So growth is really going to stem from adding new customers as well as going deeper into device lineups. And Maggie mentioned earlier, we're expecting that area of our business to grow over 35% in FY '22. As it relates to if it's incremental, it's -- you are correct, Paul. Vision and Atmos are going to sit on top of our foundational audio technologies. So there's no cannibalization there. And as we -- we're really increasing the amount of revenue per device by having customers adopt those technologies in addition.

Great. So Atmos on Apple Music, that was a big kind of new feature. Why is this very important? I mean you have curated list now on Apple Music, where people can experience Atmos in general. So what's been the feedback there? And why is it important?

We're really excited about the momentum that we're seeing with Dolby Atmos Music, and that's not only from our Apple's amazing partner. We're also with Amazon Music, TIDAL, some regional players like Naver and Anghami. And it really speaks to the trend that folks are focusing on HD music. What this does for us is enables entirely new use cases, especially in areas like auto. So it's a brand-new opportunity for us to have Atmos in the auto experience. And that's really where folks experience a lot of their music as it is. We see artists sitting in their car, demoing their new songs. So to be able to get that really immersive experience through Atmos Music is fantastic. In terms of feedback that we've gotten, 2/3 of the Billboard Top 100 artists now have at least one track in Dolby Atmos. And Apple has said that plays in spatial audio tracks on Apple Music have quadrupled in the last several months. So it's definitely gaining a lot of momentum.

That's great. And then -- so that kind of leads to the auto opportunity. So you have Mercedes S-Class and also the Maybach, very high-end cars. But you start from the top always and then kind of move on to the other parts of the portfolio, so where could we see more adoption for Atmos in the car beyond those key partners? And if you want to mention any others that I missed.

Sure. So we had our first win in auto. It's been less than a year actually. I think Lucid announced back in June, if I remember. And the Lucid Air is now on the road. So it's really exciting to have a car out there that can play Dolby Atmos Music. And then more recently, we've had wins with Mercedes with the Maybach and the S-Class. I don't have the money for a Maybach. I'm going to be waiting until we go down maybe to the E, as well as NIO, who is an electric car manufacturer out in China. So we're seeing a lot of really good engagement from auto partners. We talked about this in one of our last earnings call. We saw this especially during CES, a lot of partners really excited about the opportunity. It's one of our most compelling demos for sure. So we're continuing to engage and are excited about the opportunity ahead.

Great. So let's move on to kind of Vision. Dolby Vision on TVs, what's the penetration rate today. Kind of what's next for Vision as well? And what kind of incremental features can we start to think about?

So Vision on TVs, for FY '21, we said that Vision was on between 20% and 25% of 4K TVs, with 4K being about 60% of the global TV market. And I mentioned earlier, we're seeing continued adoption from our existing partners as well as adoption from new customers like these big-box brands from Walmart and Best Buy. In terms of incremental features, we've launched Dolby Vision IQ, which is a set of incremental features that really improve the contrast and can alter the picture based on the surrounding environment. And we're seeing growing adoption from that from folks like LG, TCL, Skyworth. We also have Dolby Vision capture. So Apple has adopted this, and it's the ability to record video in Dolby Vision. And right now, we're -- we focused on building out that ecosystem for Apple. You've seen that with our partnership with Vimeo, for example, to be able to play that content back, but we look forward to adding more partners for Dolby Vision capture in the future.

Right. And then Samsung is always -- everyone always brings up Samsung on the Vision front, but they do have a pretty big market share in the TV market. I mean now you have this relationship with Atmos, so I'm sure these discussions are taking place. So is Samsung kind of a possibility here?

Never say never. Samsung is a great partner of ours, and we're really excited about the growing adoption of Atmos across their products. As it relates to Vision, we feel that given our strength in the ecosystem, especially around the amount of content that's available in Dolby Vision, our great partnerships with distributors like Netflix, Disney+, et cetera, there's a lot of value in Samsung adopting Dolby Vision. So we are nothing, if not persistent. And we are -- we see the value there.

Okay. So let's move on to some fun stuff. Dolby.io, which is what everyone likes to talk about, what exactly is this opportunity? I think you just mentioned the TAM here earlier and how material can this business be over time.

Yes. We're really excited about the traction that we're seeing with Dolby.io. Our focus has really been on increasing awareness of the platform itself as well as bringing more developers to and using the platform. So we think that at the end of the day, quality matters everywhere. But we're focused on the verticals in which high quality is really top of mind. So we're focused on verticals like virtual performances, online and hybrid events, gaming, social audio, content creation and production. And those verticals alone we see as an addressable market of about $5 billion and growing. So it does represent a really big opportunity for us. And we've seen some great examples: customers using Dolby.io to enhance the quality of podcasts as well as customers that are building these immersive virtual environments. And with Dolby.io and our ability to improve the capture of the content at ultra-low latency streaming to massive audiences, our ability to have manual spatial placement, so it feels like the people are around you, all of those can really enhance those virtual environments.

Got you. And then can you sign on like a larger app like a Zoom or a Teladoc? Is that somehow in the cards at some point? I mean you are addressing a lot of different use cases here, but could you do something like that?

We can address those enterprise -- have an enterprise solution, but we are focused on really the developer community. And it's a -- historically, our technologies have really been available to a kind of content elite, the Hollywood content creators, the big broadcasters. And now with Dolby.io, developers can easily create an account, log in, put a credit card number and sign up, and it's a nice and easy plug-and-play-type solution. So that's where we're focused right now.

And the pricing has been pretty transparent on the website. Is there any kind of dynamic pricing we should be thinking about? Or it's kind of -- the way I like to think about it is number of users times the sessions, times the price. Is that still the right way to kind of think about how to monetize it?

Yes. That's the right way to think about it. It is all priced per minute. And we do have more flexibility with that pricing than we do our traditional licensing technologies. So we have altered those prices over the course of time.

Okay. So I forgot to touch on Dolby Cinema. So people are out and about. People are at our conference, and you're seeing people return to this kind of activity. Remind us how many screens you have today, how many builds you expect, and how material can this business be this year or next year and beyond.

Sure. So we still believe that Dolby Cinema is the best way to experience a movie. And what we've seen is that as folks return to the cinema -- I guess we can't say post-pandemic. As people return to the cinema, there has been a positive skew towards the more premium experiences like Dolby Cinema. So that's been really beneficial. At this point, we have over 275 cinemas. And we've continued to open cinemas during the pandemic in areas like the U.S., the U.K., China and the Middle East. But we are -- there's still a question of how the industry will look at builds going forward and how the industry is going to progress in a post-pandemic world.

But the way in which you guys kind of recognize the revenue is really based upon these box office receipts. Is that right?

That's correct. And we've seen some really strong -- we've seen more positive box office performance with titles more recently, like The Batman, Spider-Man: No Way Home. I had to take my son to see it twice. And then there's a really strong slate of titles coming up.

Okay. Great. So let's jump into the P&L a bit. The margins have been pretty steady on the gross margins because it's -- mostly licensing pretty steady in that 90% range. You do have less hardware kind of flowing through now. Any fluctuations we should kind of expect there on the gross margin line?

No. So we don't expect any fluctuations. Gross margins have come up in the last few years as we've exited several of our product businesses, specifically some of our conferencing hardware. But in general, I think we anticipate it will stay around that 90% range.

Okay. And then the OpEx levels are quite healthy. Where are you investing in R&D and SG&A? Where do you see some opportunities for some operating leverage?

Yes. So we're investing in a lot of our new growth areas. So as we've mentioned, Dolby.io, music, gaming, those are some of the big areas where we're investing. We're trying to accelerate growth through our current investments. So in the past, R&D has been around 18% to 20% of our revenue, which we believe is a very healthy level. And it's supporting our innovations and our future applications that we're building. So 4 main areas are the existing businesses; new innovations like Dolby Vision, Dolby Atmos; the third is our innovation pipeline; and the fourth is our brand-new businesses, such as the Dolby Vision capture. So that's really -- R&D, I think, is at a very healthy level and will probably stay at that level. On sales and marketing, there are many opportunities for us to drive adoption in all of our growth businesses. So marketing has become more of a program spend type of budget. We have some very visible brand activations, specifically like the Dolby Atmos Music campaign that featured Justin Bieber, Olivia Rodrigo, The Weeknd and a few others. And as we grow our revenue, we're expecting that we can create leverage across all parts of our spend, but particularly in G&A.

Got you. And I guess I'll open it up to questions, if anybody has one, but I have a follow-up here. So cash flow, very strong licensing model, especially relatively attractive in this volatile market. So CapEx levels are pretty steady. How do we think about cash flow this year? Working cap dynamics, if you could expand on that a little bit. And then the $300 million to $400 million in free cash flow has been quite consistent over time. So...

Yes. So there's not much we can add here, but based on our business model, net income really correlates with cash flow. There's nothing unusual about the working capital dynamics that I'd want to point out. Actually, I don't know if there's anything else that you would think of. You covered it.

Okay. And then let's talk about your kind of cap allocation strategy. I mean your -- you got $1.1 billion in cash. You paid a dividend here. Buybacks have stepped up and pretty consistent. Can you kind of do more material buybacks here beyond kind of annual free cash flow generation?

Yes. So I mean, there's 3 pillars of our capital allocation strategy. The first is the dividend program. So currently, we're doing about $0.25 per quarter, which is a step up from about $0.22 last year. The second part is buybacks. So in the last quarter, we bought back 1.1 million shares, which was a pretty big step-up from $400,000 the previous quarter. We expect more in the second half, and it's based on a 10b5-1 trading plan that we've set up. We're going to continue to do buybacks with a focus on offsetting dilution at the minimum, and hopefully, we'll be more opportunistic in the future. The third part, of course, is M&A. Historically, we haven't done a ton of M&A. It's mostly been a lot of IP in tech tuck-ins, but we're open to opportunities and specifically with some of our newer businesses. So Dolby.io, I think, opens up a lot of opportunity there. And the Millicast acquisition that we did last quarter actually brings the ability for our customers to stream with ultra-low latency to massive audiences. So that's an example of a smaller acquisition that we did. And in the current environment, we're taking a look at what opportunities might come up. If valuation of businesses goes down, it could create a really good opportunity for us to take advantage of the growth there.

Great. And then we have a question here from the audience.

I just was curious, your view on streaming, if you assume this: streaming were to cannibalize some of the theater attendance, how does that impact your business?

Sure. I think this was especially relevant during the pandemic when theaters were shut down, and they were going to be shut down regardless from the pandemic. The benefit is that with these -- with the increase in streaming, it's also helping to provide more value for adoption on devices like DMAs and TVs, et cetera.

Any other questions? Oh we got another...

Specifically though, if in that case were to continue, is it a negative to your business? I appreciate what you just said in terms of more adoption on devices, but you also hurt on the cinema. So if cinema, let's say, suffers a quantitative effect in terms of attendance, so you have less people going, that suggests that maybe the studios will rethink -- possibly rethink. So I'm just wondering from your business, if studio -- if streaming takes off and there's less attendance at theaters in time, is that a negative for your business?

I would say that content creators also want to see their films on the big screen. And it provides a really great opportunity in Dolby Cinemas and in these premium experiences. I think movies in general are -- can be a cheaper form of entertainment. So people are going to continue to go to the cinema to get that great experience. So I think there's still opportunity there. And while we did see during the pandemic companies that were releasing films simultaneously both in the cinema and streaming, we are seeing a number of these big titles now go back to a cinema-only release.

Great. Okay. Well, with that, thank you guys for coming, and I appreciate the time here. And that's a wrap. Thanks, guys.

Thank you.

Thanks.