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

All right. Good morning. My name is Drew North and I'm the research analyst at Baird. I have the pleasure of introducing Dolby Laboratories, including CFO and Senior Vice President, Robert Park. Thanks for being here, Robert.

Because we have some people here that might be unfamiliar with the Dolby story, I thought I'd start off by asking you to kick it off from a high level. What would you tell them about the business? What is Dolby Laboratories?

First, Drew, thank you for having me. This is the first time -- it's good to see people in person. This is the first time I've been in New York since the pandemic. I'd like to introduce Ashley and Maggie in the back who run IR at Dolby. They actually do all the work. I just -- they just tell me where to show up and when to show up. So here I am. Dolby Laboratories. I'm sure you guys have heard of Dolby but let me tell you 3 things you want to take away from Dolby today. First and foremost, Dolby is an enduring and exciting company that's been around a very long time. It's always been in the forefront of the advancement of sight and sound. We've gone through a ton of technological change, shifts in the marketplaces over time, and we've come out stronger each time. The second thing you guys need to know about Dolby Laboratories, this is an investor conference, so let's talk about numbers. We've got strong financial fundamentals. Obviously, good revenues, a pristine and fortress balance sheet with a lot of cash and no debt, high gross margins and very reliable cash flows. In today's marketplace, it's a nice thing to have positive cash flows here. And the third thing I want you to take away is that we've got a very powerful ecosystem and hard to replicate business model that we've built over time. This is our trends. These are the kind of trends you like to see [ up and ] to the right. But we have a very hard to replicate business model with a strong powerful ecosystem where content creators, content distributors and content playback utilize Dolby technologies to make their customer experiences better. That's what Dolby does. Dolby was founded on the premise that people want premium and immersive experiences, and we deliver that for these powerful brands out there. Hard to replicate that's why it's a very powerful business model. And the third thing -- or fourth thing I want to take away is there's a lot of opportunity for growth in the future.

Great. Can you share a brief history of Dolby? It's a company that's been around for over 60 years, I believe. I guess, how has the company evolved over time? And perhaps, how has it evolved through the pandemic here in more recent years?

Yes. I wasn't born when the company was founded, but I would say that if you guys saw the [ small ] movie called Star Wars in 1976, that was the very first movie produced and played in Dolby stereo. Dolby stereo was the big thing to do in 1976. Go back to last weekend, I don't know how many of you guys saw a Top Gun. That's Top Gun, that's Dolby of today. Tom Cruise utilizing Dolby Atmos and Dolby Vision to create that sound. In fact, tomorrow, we're showcasing Top Gun at our home office in our lab in San Francisco. And Tom, he's got some YouTube videos -- you guys had search for it, he talks about how he couldn't have done the movie without Dolby Atmos and Dolby Vision and how -- that's how he wanted the movie be seen. But that's not really our business today. That's how we showcase our business. We want to take that theatrical experience and bring that into your living room. We want to take that music studio experience, bring that into your car, bring that into your headphones, bring that into your PC and your mobile. So that's what Dolby is really all about. But the theatrical magic that you see is really the power of Dolby on the large scale.

Great. You've spoken about your business briefly there is one that's hard to replicate, which has created a strong ecosystem and sticky customer base. I guess maybe talk a bit about what makes Dolby's business model unique relative to the competition.

Yes. So this is why I have the ecosystem or why it's going to be hard to do. It will take decades for someone to replicate building -- having content created in your format. That's the first thing that you do. That's the first obstacle, getting content creators like the [ weekend ], Justin Bieber, Olivia Rodrigo, bands that my kids know that I don't know, create the music and movies and TV shows in that format. But it's no good to create that format if you can't play it in that format. So we've got Netflix, Disney+, Hulu, playing the content in our format. And finally, it doesn't do any good if you can't watch it in that format. So we go to the OEMs and manufacturers and say, you need to embed our technology in your products so that your customers can experience it the way the content creators wanted you to experience it. Content creators are super sensitive to how their content is consumed and we provide that. So it would take a long time for someone to displace us in this ecosystem. And we keep -- and our investments in the future are to add more content, add more distribution to be more relevant where we make our money, which is on playback.

Great. Can you -- you touched on it here briefly, but can you talk about the competitive landscape? You mentioned that it would take a lot for someone to disrupt you, but maybe who do you compete with in the various verticals?

Yes. It's one of the beautiful things that coming to Dolby is we really don't have any one competitor. So we're in a lot of spaces. So if you think about what we're competing against, our foundational audio codec, which is the ability to play back sound on multiple of devices, we're competing against good is good enough. In Atmos and Vision, we compare -- we compete with things like HDR10+ or Sony 360 on the surround sound on that piece of our business. And then of course, in the movies, we compete with PLFs like IMAX for the movie experience compared to our Dolby Cinema. But we don't really have one predator in the wild. I mean in the business world, there's one king and that's revenue and we're doing pretty well there in cash.

Perfect. Can we dig into each of your business segments in a bit more detail, maybe starting with foundational sound? I guess what exactly are the products within that segment? And how would you characterize that business model?

Yes. So our -- we're 95% licensing. So less than 10% -- 5% of our business is products and services. And within that licensing, what we did starting this fiscal year is we broke out that license revenue into 2 pieces. One of it, as you talked about, which is the foundational audio. That's the foundational audio codecs, it's been around a long time. That product enables sound to be played in a very highly efficient way across multiple devices. You can't play music or any sound out of a device without mostly tripping on Dolby technology. And that's got a high penetration rate across a wide variety of products. [ Slower ] growing, it grows at the pace of unit shipments. So as unit shipments go up, that revenue goes up. As unit shipments come down, it goes down. So think of it as an index for consumer electronics. Then 25% of our -- that's 75% of our business in fiscal '21. 25% of our business is Dolby Atmos, Dolby Vision and our imaging patent technologies. This is growing this year at 35%. This is where we have a lower adoption cycle for a lot of these products. These are the higher-end surround sound, spatial audio, high-definition video. And then imaging technologies that, for example, TVs, I think we've talked about the fact that it's only 20% to 25% penetrated. That's a lot of headroom. So we're growing a lot by adding licensees and going deeper into the products within the licensees we have today. So that's the big piece of our revenue. And then the third part of our revenue is what we call Dolby.io. That's the ability to democratize our voice, video and imaging technology into developers to get embedded in the process earlier and it gets more out there, whole new world of content.

I'll pause there for a moment and just mention that you can e-mail the iPad e-mail listed on your tables as if you'd like to ask the management team a question, I'll get it here on the iPad. So I just wanted to pause and send that message out...

So I was going to say, and what we're doing is we're expanding into new content experiences, right? So think about music. I mentioned Olivia Rodrigo, about 66 of the Billboard 100 create their titles in Dolby Atmos. And we're trying to build more and more of those title slates, and same with movie. Games, more and more games are being created in Dolby Atmos and Dolby Vision. And then live sports, live sports is where you want that low latency, you want that high-definition experience. And that sounds so you can sound when the Warriors are beating the Celtic last night, you want to hear that in spatial audio. I hope there's not Celtic fans in here. That's really powerful. The Super Bowl, the World Series, the World Cricket League, World Premier League, they're all being played back. Tokyo Olympics -- I think the Beijing Olympics were all played in Dolby Atmos and Dolby Vision. So that's where the magic is and you want your content -- device players to know that you want your customers to watch that in the best experience possible and that's Dolby.

Great. So how are you thinking about the macroeconomic environment and how it impacts your business? Maybe what macro trends are you paying attention to here in the U.S. or globally as it relates to your business?

Yes, that's a great question. And I would say that we've got a multitude of factors impacting our business, but I'll tell you -- talk about it. So obviously, the 40-50-year inflation rate, we've got a war in Ukraine. We've got supply chain challenges. We've got ongoing COVID challenges, including shutdowns in China and in many ports of China. That's impacting the supply chain and our ability to have units shipped. So as I talked about before, our foundational audio revenue, audio codec revenue is based on unit shipments. So it's an index for units being shipped. So that's really the part of our business that's impacted by this, what I would call these headwinds right now. The other part of our business, which is Dolby Atmos, Dolby Vision and imaging, are still growing as fast as we anticipated at the beginning of the year because we are signing more licensees and going deeper. And in this market right now, if you're a manufacturer and you've got to prioritize which TVs to ship, you're going to ship your premium TVs, the one with the highest margins. Well, those are the ones that have Dolby Atmos and Dolby Vision on them. So we've seen that our higher-end revenue streams are doing quite well. It's the foundational piece that I think is being impacted by these macroeconomic factors. And our operating model, our balance sheet, cash flows, I think, with our model, once these things subside, I think we're going to be very well positioned coming out of this, whenever this comes out. And don't ask me when it's going to end.

I won't ask. All right. Let's touch on Dolby Cinema. How much of your revenue comes from the Cinema segment? And how should we think of that opportunity? The pandemic obviously changed consumers' patterns, going out to the theater, et cetera. So I guess, are you thinking about the opportunity differently relative to a few years ago? Or can you expand on the Cinema piece of your business?

Well, obviously, Cinema is just -- is less than 10% of our revenue, but it is a way for us to showcase the magic. And it does revenue stream for us, don't get me wrong. We want that revenue stream, but it is a way for content creators and content contributors to really showcase the Dolby magic on the large screen. The last 2 years has been very brutal. No one has gone to a movie. You've seen a lot of changes, AMC, et cetera. You've seen a lot of challenges in the cinema industry. But we're starting to see -- I hate to say the W recovery, like we're on the second part of the W, where we got a lot of titles coming out. Doctor Strange, Top Gun, one of the largest, I think, Memorial Day weekend openings ever. We've got Jurassic World coming out. We've got 2 other movies coming out also with a lot -- Avatar, James Cameron is a huge Dolby Atmos, Dolby Vision fan -- very demanding person, by the way, as he should be, because he wants the output to be that special. So we've got a slate of great hits coming out that's just been backed up for a while. So I think that movie experience is going to come back. It's just a experience you just can't replicate at home although I was watching movies at home for 2 years.

Yes. So was I. You've mentioned Dolby.io earlier. Can you give us an overview of what that is specifically and the opportunity you see ahead? I believe in the past, you've mentioned a $5 billion total addressable market opportunity for Dolby.io. One, is that correct? And maybe expand on that business.

Yes. So just in simple terms, I always think about it as a SaaS business, an API business. Think Twilio, think, Agora, the ability for developers to embed our technology in voice, video and audio into their technologies, making their podcast better, making their music better, making their voice better. Virtual events, virtual concerts, virtual conferences and user-generated content, UGC, and using our technology to make it better and also our technology with the acquisition we just made last quarter for Millicast to be able to stream that in a low latency way. So one of the things in video in this interactive world is latency. Latency kills the experience, and we have that super ultra-low latency streaming ability with high-quality video. So that's what io is. It's we want to get embedded earlier. Right now, everyone decodes in Dolby, we want them to encode in Dolby as well. So we think it's a $5 billion opportunity and growing. Again, competitors like Twilio and Agora are examples of that.

Yes. You mentioned the growing opportunity in that market. Maybe from a high level, can you step back and tell us how fast other segments are growing, whether it be the foundational sound business or market that you're in and the other key business segments? What is the industry growing? And what do you expect to be growing in the future?

Yes. So the -- for a foundational audio codec business, we're going to grow at the same pace as we call it the index of consumer electronics, TV, set-top boxes, PCs, mobile. That portfolio of products, as that grows, that part of our business will grow, it just falls kind of like clockwork. But the Atmos Vision and imaging part of our business, which is 25% of our business in '22, it will be a bigger part in '20 and -- excuse me, '21 and '22, it will be bigger. It's growing at 35% plus on a big number. And then io is growing on smaller numbers, but it's growing tremendously as we're getting more traction and getting more use cases and more developers in the funnel. And yes, the industry, we're in many industries. And then Cinema, Cinema is part of that AVI and products and services business, too.

Yes. At the beginning, you mentioned the remarkable business fundamentals and the graphics on the screen helped to depict that. I guess, can you share more details on your margins and cash flows that you're proud of? The high margins and stable cash flow would be especially attractive in this volatile market. So maybe expand on those metrics that you shared earlier?

It's always nice to start with high gross margins. When you start with high gross margins and the rest you can determine how to allocate their resources to best feed the future growth. Dolby has been around for almost 60 years and has done a great job of developing and research and being ahead of the curve on a lot of these technologies. Think of where we are today, 5 years from now, it's going to be much different than [ versus ] today. I think 5 years ago, it's much different than it is today. There's more content. I mean, I think our future is -- we're in a very exciting spot. There's more content being consumed in video and audio than ever today, and that's not going to go away. I think that phenomenon is going to continue. With the Metaverse, AR and VR down the road, there will be more and more high-quality video and audio required to run those programs. And we're agnostic. The great thing about Dolby is we don't sell hardware. We're not into a device, we're in all devices. So we don't have to pick a winner. They're all going to be winners if they use the Dolby technology to help their products do well. And again, these are the numbers, and these cash flows are very reliable.

Before I field one from the audience, I'll just ask, I believe the latest update you shared is that you have over $1 billion in cash and no debt on the balance sheet. An enviable position, I'm sure, for some in this environment. So any plans to change how you allocate capital?

Yes. We think of allocation of capital 3 ways. One is -- the best way is to invest back in the business for growth, finding new technologies, finding new commercial products to take the market and fight and win. The second one is return to shareholders. We upped our dividend this year, and we've upped it -- also upped our buyback. So the 2 ways to allocate capital is to get it back to investors. And we've significantly accelerated our buyback program this year as well as increased our dividend. And the third one is acquisitions. We did a small acquisition in Q1, Millicast, to have that low latency streaming for our io business. But given the market today and the multiples right now, I wouldn't be afraid if there are some opportunities to invest to grow in that area as well.

Perfect. I have one here from the audience. Can you better clarify the longer-term growth algo for Atmos and Vision specifically? I guess as a steady state, will this revenue also be tied to that consumer electronics index. Just trying to understand the volatility of that Vision and Atmos business.

It's a great question. So Atmos, Vision, imaging was 25% of our business. In fiscal year '21, it was growing 19%. It's accelerated a 35% growth in fiscal year 2022. That's some nice growth on a big number. Long term, sure, it will hit that same. When we get to the attach rates and adoption rates that we have for foundational, it will follow then the index of those products. But by that time, we will have other streams that will also be going into that realm. But we've got a long way to go in terms of the headroom when -- I think we've talked about provision, an example for TVs, we have 20% to 25% attach rates right now. That's a lot of headroom. And it takes a while to get into the further products and push them down through different SKUs and different product lines, but it will take a while for that to happen.

And then Robert, you've only been at Dolby since late 2021. I'm sure investors would like to know what are your priorities here as you sit today for the coming months and years ahead.

Well, the first one was, obviously, when I started -- since when I started, we've had inflation issues, the COVID issue. We've had a war in Ukraine. So I've been focused on just making sure that we understand what's going on in the impacts of our business. That's the first and foremost thing. Second thing I focused on, as you can see the transparency of really looking at our licensing revenue between the foundational audio pieces and the Atmos, Vision, imaging. As never been broken out before, we've broken it out by segment -- by market segment and products. But you really couldn't see the 2 different licensed products we have and they have totally different growth dynamics and drivers. So we wanted to make sure that's there. So my focus is to continue that transparency, improve the transparencies [ so ] people understand our model, making sure we are investing on the things that have the biggest impact down the road and increase that size of the outcome. That's really the goal we have going forward. But we're sitting in a nice place. It's a nice [ problem ] to have is how we're going to use our cash.

And again, I'll remind the audience, if you have any questions, feel free to e-mail via the address that's on your tables and I can tee it up for Robert. And then I think one of the last questions that I have for you is just what makes you most excited about Dolby right now, as you sit here today.

So I would have said something a week ago, but then I took my whole family to go see Top Gun in the Dolby Cinema, and I took my neighbors and their kids and -- I paid for it. And they were just so -- they were so excited that -- I haven't seen that look in their face for 2 years, right? You watch your movie in your house. We've got the full surround sound, the theater everything else. But you don't get that same visceral excitement before the movie, getting the popcorn after the movie and the sound, the shaking, the visuals, they all want to see it again, and I'm happy to do that again. But that was really powerful. And they were so proud that their dad worked at Dolby. And taking that theatrical experience and bringing it down to the living room and down to your laptop, to your mobile, I mean that's magic. So people think magic is fake, but magic is also great. And it's hard to please partners like Apple, Disney, Netflix, I mean, your product has to be like durable, perfect and exactly how the content creators wanted it to see. So the fact that we're able to please so many, I would say, high-bar partners in our ecosystem. This is a testament to everything we do. Yes, it takes a while for products to come out. But once they're out, they are durable.

Now that you've seen Top Gun, are you able to share what movie you're most excited about seeing next in the Dolby experience?

Well, Avatar is going to be, I think, one of the most expensive movies made. And we did a lot of work with James Cameron to make sure the postproduction is exactly how he wants to see it. So I want to see what that looks like in the theater. I personally don't like 3D, makes me sick, but I would love to see it in 2D in the Dolby Cinema. I have 3 boys, 2 wonderful kids and then the third one. But they like to see all the Marvel movies. That was a joke. I tell my kids all the time. May never know which one is the third one. But they want to see movies more and more now. So I'm very excited for that. But also, I'm excited for the other use cases. I think I talked about it before is we're just getting started in the car. Think about your car today. It started with Dolby noise reduction in the past. You got maybe stereo, you got maybe 4 speakers in your car. They have something called surround sound. But Dolby Atmos is out of this world. And we just -- we've had a few wins lately, obviously, Mercedes, Lucid -- Lucid Air and Nio. So we're in the top brands, the higher premium brands. And they're putting it into Maybach. I don't know how many of you drive a Maybach, but if you have one, you can have the Dolby Atmos experience in there and also the rest class. And then over time, what happens is it democratizes, and it starts to get more mass, and that's what we're excited about. It's going to start in the premium brands. We've got others in the pipeline. They're all going to add it to their premium packages. But just like what happens with Atmos and Vision, you'll see that start to go down to the other pieces. And there's, what, 70 million to 100 million cars out there a year, forget about supply chain, but on a normal basis. And having that Atmos experience in your car, you can listen to NPR with that nice voice of God sound in the vehicle is really exciting. And live sports. Live sports is -- I love live sports, getting that experience on your TV, on your mobile is really exciting.

Great. We have a few from the audience. To start, you spoke about what makes Dolby's business model hard to replicate and unique. But why would a customer choose a competitor? Or when they choose a competitor, what's the reason?

Some of it is good is good enough, right? So if they don't want to use Atmos, they'll use Sony 360 for surround sound. So they may use surround sound that's good enough, and they may not want to pay any more to use the Dolby Atmos. For Dolby Vision, they may use HDR10+ because they think that's good enough. But what they don't see and they see over time, and that's why they start to come around is the distribution. So you might have that on your playback, but the content is not created in that, and it's not played back in that on distribution. So you're not going to reach your full audience, the people who are using your device to be able to experience in that, unless it's all in the ecosystem created. So we spend a lot of money and time generating that ecosystem, make sure we've got quality content, we've got quality distribution, so that it's there in the playback. And that's the real magic for us and the difference for someone saying, good is good enough, it's good enough, but it's not even good enough unless the content is created in that format. And so when someone sees on Apple TV, a movie that's in Dolby Atmos and Dolby Vision, if they don't have Dolby Atmos, Dolby Vision on their LCD or their TV, they're only going to get it in regular definition or high definition, but not Atmos and Vision. Not optimized the way it should be. Not the way Apple wants you to see it.

And another one here. Can you talk about your R&D expenditures and the new technology developments, particularly for music streaming that sits beyond Atmos?

Yes. So we spend -- on a normal year, I mean, we've had some hiccups of what, I think, 17%, 20% of revenue on R&D. So we're always working on it. We've got an advanced technology group. That's what they do is they [ tanker ] and figure out how to make the science of sound and visuals better. And I've been through some of these labs, okay? It's -- these guys have more degrees than a thermometer. I can't understand what they do, but I can see how it looks on the end product. it's very hard to replicate. We've got decades of experience doing that. For Dolby Atmos, yes, we're working on the next use cases. So we want to make sure Dolby Atmos can work and not just a 16 speaker Maybach, but how do we make that work and make that same sound out of an 8 speaker Camry. Okay, maybe not a Camry, maybe at E-class, how do you make that -- how do you -- that takes research because it takes a lot of things to do. And on a TV, TVs are getting thinner. How do you get the Atmos experience at a TV if you don't have a sound bar? You can get that Atmos experience and Atmos sound based on how it's designed on the speakers on the back end, having angled certain ways, the size of the box, there's different ways that we can make that sound, sound as good as -- if you had a sound bar, of course, it's better if you have a sound bar or surround sound in your house. But we want to make it for everybody. So you should be able to experience Atmos, no matter what you have.

Perfect. And bouncing around a little bit here, but on Dolby.io. Can you talk about the use cases for Dolby.io?

Yes. So we've got -- so I've got a few here -- so we've got, for example, one of the verticals is social audio. I won't name the company who uses Dolby.io. They call it conversation as a service. They use our app to improve their audio and then use our Millicast streaming service to stream that video to large-scale events, right? That's one use case. We've got other examples. I won't name the company using our streaming service to stream content into a virtual work environment. So virtual work environments for them is really huge. And then virtual live performances. There are companies that drive these virtual concerts with little [indiscernible], a little [ Wayne ]. I can't remember -- a little [indiscernible]...

I'm not [indiscernible]

I'm looking at the ones who might know these bands. But they're doing these virtual concerts to engage with their audience in a different way that you can't. You can literally engage with them while they're doing these concerts. And the company driving that is using our technology to stream it interactively. And then user-generated content, tons of people creating podcasts, and other things who want to enhance that audio to make it sound better, so they sound more professional, and that's what we do.

Well, that's perfect. I think we can leave it there. We're running out of time. So I want to thank Robert Park for being here and giving us an in-person session on Dolby Laboratories.