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

We're happy to have Robert Park, newer CFO of Dolby here to present. We're just talking -- I think this is my fourth or fifth CFO of Dolby. So it's good to have some new fresh perspective.

Maybe that's the last.

Those aren't familiar, Dolby has effectively 2 licensing streams, I think, Robert was instrumental in breaking out. One is foundational. For those of you that know the sort of Dolby of the path, those are legacy mandatory license and the newer technologies that we'll jump into today. I have to tell you to check our website for disclosures. And we're going to do a little bit of a different hybrid approach here. I'm going to ask some questions to Robert and then he's going to provide some slides with some answers. And hopefully, that's a good format for everybody.

So maybe to kick things off, Robert, you joined, I think, October last year. Maybe provide a little bit of your background. What attracted you to join Dolby?

Sure. In terms of the background, I've been in finance for over 30 years. One thing I can tell you that finance is hard, but making finance interesting is harder. So I'll keep this brief. I started my career in public accounting, but please don't hold that against me. I spent the rest of my time moving to the dark side FP&A, did that at PayPal and a number of companies, helping them grow in scale. All of my career has been solely in technology, mostly in Software-as-a-Service, e-commerce and payments. So that's my background. What brought me to Dolby? What excites me about Dolby? Well, first is the financial confidence. So why don't I show some numbers? So obviously, fundamentals are key. The Dolby fundamentals are high revenue. Who doesn't love good operating margins, high gross margins and reliable cash flows? That's really important. But also a pristine, and I call it a fortress balance sheet with a lot of cash and no debt. In today's market, this is not a bad place to be. The second thing that attracted me to Dolby was the brand. I mean, the brand was founded on the belief that people want compelling and immersive experiences. From 1976, first -- the first Star Wars movie that was presented in Dolby Stereo to Memorial weekend, hopefully you guys got a chance to see a Top Gun: Maverick that was done using Dolby's Atmos and Dolby Vision Magic. So they've been wowing audiences for decades. How do you take that experience and bring that into the living room? How do you take the studio experience and bring that into your car, PC and mobile phone? That's what the Dolby story is all about. And what's also great, obviously, the -- highlight the charts that are open to the right. These are the kind of things you like to see any strong fundamentally financial -- financially fundamentally strong company. But the thing -- the fundamentals, you got to be based on something. It's not based on quicksand, it's based on granite. They've built over time a very strong ecosystem with a powerful ecosystem of creators, distributors and content playback. These are our partners today. It's very hard to replicate business model. We've got content created in our technology. We've got partners to distribute that content and that technology. And then where we get paid our fair share is through playback. So that's the value proposition to our playback customers is you want your customers to experience the way the content creators wanted them to experience it. And it's got to go through the entire value chain to get there. Very hard to replicate, very hard to get in, and that's one of the other things that protects our business pretty well. And -- sorry. And we're getting into new formats, more and more gaming, 2/3 of the billboard, 100 artists are creating their music in Dolby Atmos. We've got gaining more and more games being created in Dolby Atmos and Dolby Vision. And then live sports, live sports like the World Series. We've got cricket, the World Premier League and more and more live sports that will be played in Dolby Atmos and Dolby Vision. When you have these content and streaming services played in that format, the playback people have to have their things built for Dolby.

Great. Maybe sort of high level, provide investors an overview of how the company has evolved from mandated standards of creating new products that are increasingly getting adopted by our OEM partners?

Yes. So I started about 8 months ago, and the first thing I did was I said, if you guys look at everything that has been written by Dolby before, you just get one big licensing bucket. And -- but the license bucket are really broken into 2 different components that have totally different characteristics and growth drivers, and that's what we did starting in Q1 of this year. Our foundational audio codecs and patent licensing, which is more we talked about more on the standards, that's about 75% of our revenue in fiscal year '21. That has a large penetration rate across a wide set of devices and D. So that's basically going to reflect the health of the unit shipments in those devices. So as unit shipments go up, that revenue goes up. As those unit shipments go down, our revenue goes down. It's like an index for consumer electronics. Think about it like that. And then the other part of our business, which is our Dolby Atmos, Dolby Vision and our imaging patent technologies has a lot more headroom, much more areas of penetration, much lower in the adoption cycle. And so I broke those out to be 25% of revenue in fiscal '20, growing at 19%. And in fiscal -- excuse me fiscal '21 and fiscal '22, growing over 35%. And so I think it's really important to show those dynamics between sort of the standards, yes, we are in everything, everywhere, everything you listen to has Dolby in it, this could be more branded Dolby Atmos, Dolby Vision and imaging patent technologies that have a lot more headroom to go.

Great. Maybe you could provide some background for those in the audience that may not be as familiar with the standards-based technologies, what some of those are and how that brings you into the conversation for the newer technologies? And then if you could stretch out the conversation a little bit, provide some perspective on what Dolby Atmos is and what Dolby Vision is?

Sure. So think of Dolby foundation are these codecs, Dolby Digital, Dolby Digital Plus, AC-4. These are practically user plumbing, the engineers will tell me if I say that. But it's the way to transmit in a highly efficient way found through a device, through a multiple set of devices. And each iteration, Dolby Digital, Dolby Digital Plus to AC-4, the compression gets better, it uses less bandwidth and it comes through more efficiently and in better stomp. That's the plumbing. But that doesn't create the experiential spatial audio that Dolby Atmos does. So Dolby Atmos sits on top of that and creates this revolutionary spatial audio, which is the most Everest experience there's available. The same thing with our imaging patents. Our imaging patents provide that foundation to play video in a highly efficient bandwidth compression is a big issue for video away. And then our Vision sits on top of that for amazing contrast, color and brightness.

Then maybe kind of walk out into where they might see some of the technologies when they're at home?

So if you've got an LG TV, basically, any TV you have with the exception of Samsung, will have Dolby Atmos and Dolby Vision in it or some of it actually, it still got a lot of headroom to go. But they will definitely have our underlying technology, which is the Adobe Digital Plus or AC-4. And the key is to try and bring that theatrical experience into the living room through those 2 technologies.

And maybe you could sort of frame the opportunity for growth for both Vision and Atmos and maybe provide some numbers that you've talked about on the call in terms of growth and percentage of the business?

Yes. So as I said, it was 25% of our business, the Dolby Atmos, Dolby Vision, imaging technologies and was growing about 19%. And then in '22, it was accelerating to 35-plus-percent in fiscal year '22 in terms of growth and expansion.

And then how big could those businesses be over time or new products? And as you think about historically pre your tenure with Dolby is to break out how large it was? But maybe if you could sort of give a sense, could it be as big as the base business today over time? Any perspective on that.

Yes. If you see the math and you think it's 25% of the business is growing at 19% to 35%, we could see our Atmos, Vision and imaging technology being as large as the foundational. I mean that we see that much headroom and opportunity there. Even in today's climate, we're seeing design wins. We just had Dell and Asus adopt Dolby Atmos and Dolby Vision, both in all their PC lineup. We've had Vivo create the first tablet in Dolby Atmos and Dolby Vision. And then earlier this year, we had Samsung adopt Atmos in their TVs for the first time. So even in this climate we're in today, our consumers and customers are still engaging in designs in making their experiences better. So you would think in a time like today, they would shrink and hunker down into the bunkers, but they're actually focusing more on the premium end of the market, and that's where Dolby's rise. And we're seeing that conversation happen across the board.

One area I've always been surprised is that you've had great adoption, let's say, with large screens and PCs, et cetera, but the mobile devices has been, at least from my perspective, outside of Apple, which is a great iconic brand, slower to head out. Maybe kind of walk through why that may be the case? I think historically, Kevin has said that different companies and audio engineers move different than video engineers, but maybe some perspective on that opportunity and maybe why it's been slower, at least in the eyes of investors to be adopted?

Yes, I can't speak to what happened 4, 8 months ago, but the conversations are continuing. And Apple is a great customer, but there are a tons of other large mobile providers we're having conversations to add that technology. But you're right, we've got to get into the road map, get it in there, get the design win and then get it implemented as quickly as possible. But the conversations are happening.

And then are there any use cases beyond what we could see today that you had talked to for either, one thing that occurs to me is cars become more autonomous, can Dolby Vision move into autos in a more meaningful way, but maybe kind of frame the future of some of those products?

Yes, for the terrestrial world we're in today, we're focusing more on Atmos, and we've got the design wins with Mercedes, putting in the Maybach and the S-Class, I'm sure all you guys drive one of those or the Lucid Air electric car, which is $180,000 top end car. What you find with the Dolby Atmos and Dolby Vision product line and technology as they start up premium, they start up in the highest end models and then over time, they get pushed down to the right -- the other lower end models. Vision in the car, I think, would be probably not the safest thing to do right now, but you never know with autonomous cars where you're not driving anymore, what are you going to do? You want that imaging technology to watch your news, watch your sports, watch something. But right now, I think it's better to keep both hands on the wheel.

Sounds good.

Maybe your navigation takes 1.5 hours to get here from the airport exit. Chicago could use a better navigation.

On roads. All right or use the M word. Just in terms of the metaverse, how can Dolby sort of play into that, both from an audio or video or what conversations are you having in there?

Yes. So it's interesting. I think Dolby's getting into one of the most exciting stages there is, I mean, more video and audio has been consumed, streaming than ever before. And with the metaverse, whatever you want to think that is AR or VR or whatever that is, is going to only make that even bigger down the road. I mean, I've got a 12-year-old fun. I only see the top of his head because he's always playing with his Quest 2 Oculus, playing games, and he loves it. I tried it. I get a little motion sick, but he can do that for hours. And that may be the future of how people engage, people do conduct business, people play games, attend concerts. But in that experience, video pixels matter, quality matters. The audio is even more important because it's not just going to be left and right. It's going to be up down 360, 720. We believe Dolby will play a big part in any of that. And the great thing about Dolby is we're not -- we don't pick a winner. We help all the winners. We're agnostic to the device technology.

Maybe just kind of stay with newer products because I think that's where a lot of focus are. Maybe talk about Dolby IQ and how that has evolved from Dolby Vision and sort of what that adds to the sort of new product mix?

Yes. So we spent about 17% to 20% of our revenue in R&D because we want to keep being ahead of the curve on things. So Dolby Vision, while we're still getting ramped on Dolby Vision, and we still have a lot of headroom, we're not resting on our laurels with Dolby, but we already have some iteration to Dolby Vision that make it even better. Dolby Vision IQ intelligently senses the ambient light in the room and adjust the contrast and brightness accordingly. So if you're going to watch a movie in the pitch back dark, and you wanted to change the contrast, you find that a little gear wheel and try it, it's too tough. You want your PD the dynamic to do that for you. That's what Vision IQ is. And we already have some companies adopting that technology. And Dolby Vision Capture -- I'm sorry, Dolby Vision Capture, it is another way to capture video in Dolby Vision. So for people creating UGC or user-generated content, which is the fastest-growing content there is, you can create your TikTok, you can take your whatever want video, you can go to capture today on the Apple, but we're working on other devices.

Dolby.io, for those of you that may not be familiar, it's sort of a Twilio model and is an evolving SaaS model that Dolby is trying to build. Maybe sort of give a broader perspective on the product, frame the TAM and help us think about that opportunity longer term?

Yes. As you said, 95% of our business is licensing. So Dolby.io gives us the great opportunity to democratize our advanced audio and voice technology to developers, creators and companies to help make their experiences for their customers better. And that's what Dolby.io does. It's an API. I think Twilio, but for audio and voice and streaming. And Agora, those are the 2 kind of companies do that in a SaaS way. You only pay if you use it, and that's a great try-and-buy. The TAM, we believe, is about $5 billion and growing. And the use cases are endless, but we're focusing on just a handful of verticals right now where it makes sense. For example, we have companies who enhance their podcasts and music, the enhance the audio on their podcast using Dolby.io APIs so that their content to their users is better. We've got companies creating virtual experiences, whether concerts, events, et cetera, using our spatial audio, Dolby.io APIs and making that better because quality and spatial audio does matter in that space.

And there was, I think, a recent product release as it relates to IO. Can you maybe kind of talk about is that sort of jump start of the ecosystem and how important was that for the rollout?

Yes. So we also acquired a company called Millicast in Q1 of this year, and what they provide is low latent -- super low latency -- ultra-low latency streaming to a large audience. So create your content, taxes some out and then -- you want to be able to stream that to a large audience and latency is the killer of large audiences. And so we've got customers using that for the virtual environment they're doing, while they're creating a virtual environment for a small group of interactive customers playing interacting with Lunar, X and others and concerts, but also streaming it to a very large audience using our Millicast technology so that other people can see it, they don't interact, but they can actually view it. And that's sort of where the future is going.

Maybe kind of shifting gears to macro. You touched a lot of devices all around the world. I guess from your perspective, what are you currently seeing? And how is that impacting the business?

Yes. I think since October, when I started, there's been a few things that happened in the world. 4Q inflation, maybe we sit here in inflation now. We've got a war in Ukraine. We've got ongoing COVID with shutdowns in China. So it's been pretty hmm how for me. But that really impacts our foundational business. So one thing, as I said before, that's an index for consumer electronics. So if there's a supply chain challenge, we can't ship TVs, they can't ship mobile, they can't ship PCs. Our foundational revenue will go with that, and that's kind of like an index for that. But the powerful thing about Dolby Atmos, Dolby Vision and imaging is it's so much lower in the adoption cycle that we can still grow through it. And so our growth for that part of our business is as strong as it was in September as it is today. And the other parts of your business just flows with you can read about who's having trouble shipping units, and you can see the impact on our foundational revenue. But at some point, when this subsides, don't ask me when it's going to subside, but when it does, I think we'll be well positioned to take advantage because the consumers are going to get what they want. If they can't get what they want, they're going to ultimately get what they want, Dolby will be inside, and that's a nice thing about our business.

And then just if you could kind of walk through the segments to the audience between broadcast and mobile and PC and gaming and how the macro has maybe impacted one of those markets more than others? And in turn, maybe how that's impacted your business?

Yes, I'd say the 2 big areas that really we see this acute challenge is TVs, which is about broadcast is about 39% of our revenue with a TV set-top boxes, et cetera. But TVs, it's fairly pronounced. We saw a huge take-up in fiscal '21 in Europe, particularly by overall of TV shipments. And then this year, we're seeing an actual decrease in unit shipments globally mid-single digits. But in North America and Europe, high single-digit negative growth. So that could be either what's going on in the economy today or the tail end of the pull-through from COVID where people are loading up their living rooms. The other place where we really see challenge is the gaming consoles. I don't know if you have kids, but if you try to get a PlayStation 5 for them, you're a hero. I'm not a hero, only have the Xbox, trying to get to PlayStation 5, but there's been a serious shortage. It's very pronounced for Sony to get those PlayStation 5s out. And with that, headsets don't go and other things don't go. So sort of a trickle down issue where if those don't get shipped, they don't get you. And then auto, of course, that's been going on for a while, but that's really not getting any better. And because of our penetration for our core technologies and auto, we're seeing impact there.

And then despite these headwinds and chip shortages, et cetera, are your OEM partners that excited about adopting new technologies and what's the design cycle to get that on to new chips?

Yes. So you would think in this world that they would be focused on getting things out, but they are focused on getting things out. They're focused on getting the premium things out. So we've seen that the higher-end SKUs and higher end product lines are faring better than the lower end because if you only have 100 chips to ship, you're going to ship the ones that have the highest margin, that's going to be your premium TVs like the 4K, et cetera. Same with your mobile, same with your PCs. Those are the ones that typically have the Dolby branded technologies on them. So we believe that over time that will help us. And by the way, they're still engaging. So the conversations are still engaging right now with adding Atmos, and that's why we're still growing our Atmos and Vision is we're signing more licensees and we're going deeper into the product lines are the ones that we have today.

Has the macro environment, I guess, as we sit here today, deferred? Let's say, I don't know, any OEM partnerships or hesitancy to adopt some of the newer technologies or in other words, sort of push it out into the future?

I haven't seen any pushing out in the future. The only thing that may happen is their ability to actually get the shipments out to actually fulfill the unit shipments. We get paid on the units are shipped. So we don't get paid when you design it, we don't get one paid when it's put in the trip or the product we get paid on unit shipments when it ships from the manufacturer to their customers. So the only issue we would see is delays on being able to actually get cars off the line. I mean Maybach, still a few of them, but there's some -- there's definitely some delays even on the premier end of some of these products.

And then historically, kind of switching to financials and growth are going back to where we started, I guess, predates you that the company has talked about getting back to double-digit growth. Maybe sort of lay out what does that path look like? How do you get there? And then it sounds like the macro environment, you're still able to grow through it, but how much is that going to impact the longer-term goal?

Yes. I mean we're in it for the longbow, we're not in it for the next quarter or the quarter after. Dolby has turned around for almost 60 years. Yes, we still have that goal of 10%. We got the 10% revenue growth in fiscal '21. Think of it as a 3-cylinder car. And we need all 3 cylinders to hit. And in fiscal '21, 2 of the 3 cylinders hit. The free cylinders are foundational revenue, Atmos, Vision and imaging technology, and at some point, IO, we believe will contribute meaningfully to our growth rate. So in fiscal '21, we got the 10% growth with 2 cylinders. Foundational audio was helped by the shipment increases of units in general. We saw strong shipments of PCs, mobile and TVs in '21 that could be a pull-through or could be just stimulus checks, who knows what it was. We got that, plus our Dolby Atmos, Vision and imaging technology is growing, and we are executing very well with no IO contributions. This year, we're growing faster on Dolby Atmos, Vision and imaging, but unfortunately, our foundational is impacted by the market economics or the market unit shipments in general. So if you do the math, you can see high single-digit growth or just over time, if our foundational -- if unit shipments can stay to the low single digits, that's what it has been historically for a long time, pre '19, 2021, '22, our Dolby Atmos and Dolby Vision, this is a theoretic, I'm not giving long-term guidance, whoever's recording this, is that, that closes the 20% to 25%, you could see a path to double-digit growth. And then IO when that starts to contributing meaningfully to growth.

I guess the logical question is how important is IO to the sustainment of the double-digit growth? And I know you can't give guidance, but is that a medium-term thing or perhaps something that could happen a little bit faster in terms of contributing to growth?

Yes. I would say we're very optimistic about how IO will grow and how it will contribute medium term, long term, I couldn't say. If you look at SaaS companies, the best franchise company I've worked for a lot of them, think about how long it takes them to get to $25 million of revenue. How long it takes to get to $50 million of revenue. The data is out there. We've been out of 2 years. We get a head start because we have the Dolby brand. We've got the relationships. So the brand helps. But think about the companies that how long it takes to them to ramp, unless they do ramp, it's terrific, and I think we have that opportunity.

Maybe kind of moving down the P&L, the OpEx. It's always been a focus for investors currently and before you in the seat. Maybe walk investors through philosophically how Dolby thinks about OpEx and the pushback has always been -- it seems like the OpEx load is fairly heavy for a company that receives royalties?

All right. That's really healthy, but...

I said investors, not me.

Sure, you're projecting. So how do we think about OpEx and allocation of capital? Again, first of all, we want to spend enough money on R&D. If we did not spend money on R&D 10 years ago, we would have no Atmos, Vision, imaging patent business. We would be a large boat just going with the wind on what's going on in the marketplace. So we've got to control our own destiny. So we continue -- and that's how we came out with Dolby IQ, Dolby Vision Capture, how we're working on how will things work with the AR and VR equipment in the future. We've got to work on that. It takes a lot of hard research. These are hard scientific problems to solve. We have more 3-letter, and I call them TLAs at the office, about all the technology that has to have these things to work. And then we spend a lot in our IP. So we protect our IP, we have to enforce IP, and we help enhance and manage it over time. That takes money and that takes dollars. So we want to protect even the royalties on that for a long period of time. And that takes a lot of legal work, it takes a lot of product work. It takes a lot of work in general. And then sales and marketing, we've got awareness. We've got to build up the awareness for Dolby Atmos, Dolby Vision. Tom Cruise is helping us this last couple of weeks. But at some point, that will fade. We need that constant awareness to people know that Dolby is not just royalties.

Then Dolby's tradition, always had a really, really strong balance sheet, which obviously is a great position to be in now. Coming in with a fresh perspective, maybe provide the audience some views then how you think about the balance sheet?

Yes. I do have a lot of cash and you -- it doesn't take the brain surgeon to know that we have more cash than we need to operate the business. So well, we're not going to spend the money frivolously. So how I think about capital, how we've allocated capital in the last 8 months, increased our -- there's 3 ways to do it: invest in the business. We're continuing to do that. 2 is get back to shareholders. We increased our dividend program this year and starting in Q1 and significantly increased our buyback. So we've ramped up our buyback since fiscal year '21, where it increased significantly. We're doing a 10b5-1 plan so that we can trade even through the closed windows. So -- and we're doing dollar cost averaging. We're not doing an ASR. We believe the dollar cost averaging makes a lot of sense rather than trying to depend on the market. How that on an ASR in Q1, I'd be kicking myself. So I think the dollar cost averaging is the best way to do it. And then the third one is M&A. As you saw in Q1, we're not afraid to do M&A as it accelerates our time to market or gets us closer to that growth that we're looking for, and we did that with Millicast in Q1. So the pipeline is strong of deals out there, especially in this market with the multiples that are out there. So if it's the right opportunity for us, we have the balance sheet to do it.

Great. I'll close the best and turn over the audience, but maybe what surprised you to the positive coming to Dolby that's excited to you more than when you were outside looking in and maybe some areas that you think are going to maybe take a little bit longer work previous to coming in?

So what excited me. If you read the SEC reports prior to when I came on board, I couldn't see anything except the licensing of one big bundle by end market. And so it just kind of looked like a bland growth, overall licensing approach. But when you peel back the onion, when you talked about the business and those products and technologies, there are 2 totally separate pieces. That's why we had to break that out because that's how you think about the technologies. And we've got those growth drivers and waves of growth that you can't see by looking at total licensing. And that's the problem with total licensing and that's why we broke out the framework. The other thing is this ecosystem. I didn't really understand the power of this ecosystem, this virtuous circle until I got in on it. And why are we working with artists like Justin Bieber, Olivia Rodrigo, The Weeknd to get them to create their music in Atmos and tell people about it. It's because that is a value proposition to why that you need to have in your mobile, Apple needs to have it in there AirPod Pros, that's the value proposition because The Weeknd wants you to hear it in the format he created it. And so its ecosystem that Dolby has built. I have nothing to do with it. It was built when I got there. And also having to distribute some partners wanting to distribute our technology in a way was brilliant. People said, well, you should have monetized the entire cycle. Well, if we try to monetize everything in this ecosystem, you would probably see a fraction of the brands you see today. You want it to be friction-free where we make money on the playback, and we get our fair share.

So we got time for a couple of questions, if there are, go ahead and pause.

Those conclude my prepared statements.

Yes. Just maybe on the studio business, given how much investment you're seeing into streaming and movies and I guess, what do you think that business can be? Can you exceed where it was pre-pandemic? Or what do you think the new normal is for that business and how much investment there is into streaming and movies and just the overall money spent there?

So we don't spend the money on the movies that the producers do and the movie content providers. We spend the money on the playback and making sure the plays back, take that experience put it into your living room, put it into your PC, put it into your mobile. So our investment on the ecosystem is to get -- we've got hundreds of Dolby studios, where artists can create music in Dolby Atmos. We make it easy for them to do that. So we have studios, they're not our theaters, but other people's theaters, but they have our equipment in there so they can make and create music, and we'll continue to grow those to make ours to do that. We want to have labs where people who create movies like James Cameron, Joe from Top Gun to see what it would look like in that Magic so they can create the movies. That's the money we spend on. We have Dolby Live in Las Vegas, which is the MGM, if you guys have been the Vegas. So in the MGM, you'll see Dolby Live everywhere where we can have artists for the first time, playing live music in Dolby Atmos. Our first client was supposed to be Aerosmith in August, but they had some challenges with the band. So that's going to happen. And now you'll be able to experience Dolby Atmos in a live environment. That's going to be huge for concerts and creating that very immersive experience if you guys have been to a concert.

Unfortunately, we're out of time. Robert, thank you so much for joining us today. Thank you and the audience for your interest. And the breakout will be up in Richardson. Thank you.

Thank you. Thank you very much.