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

All right. Good morning. Thanks for attending our Annual Growth Stock Conference. I'm Ralph Schackart, our Internet analyst here at William Blair. Excited to have Kevin Yeaman back at our conference, CEO of Dolby Laboratories. Kevin is going to do a brief overview of the company. So I will not provide that at this point, but [ Amanda ] wants to come up and do a safe harbor, and then we'll kick off. We're going to have a fireside chat format.

We may make some forward-looking statements today, so we should note that actual results may differ materially from any of these statements. We may also get into non-GAAP numbers. Seeing our GAAP reconciliations were to get more info on factors that could cause our results to differ from what we say here. I'll refer you to our investor website, our latest earnings announcement and the risk factors listed in our latest 10-Q.

Great. And I have to inform everybody to check our website for all the disclosures. So make sure you check the compliance box. But thanks again, Kevin, for joining us. As you know, we have kind of a different conference format. We have more generalists versus just sort of tech-focused investors. So if you wouldn't mind, maybe spend a few minutes, give us a broad overview of Dolby, the financial model, the problems you're trying to solve for the end markets, and then we'll take it from there.

Sure. So thanks for having me again. And thanks to each of you for coming to learn a little bit more about Dolby, I also enjoy this conference. I'm looking forward to the fireside chat format. So I'd like to start by giving you a sense of what we do at Dolby. One of the great things about Dolby that we've been hearing for quite some time now is that so many of the people that I encounter share their first Dolby experience with me. And when I first started, this was more often than not, the button on the cassette player or the first time they experienced Star Wars in surround sound. But increasingly, I'm hearing from people who don't want to see their movies in any other way than a Dolby Cinema with the full Dolby Atmos and Dolby Vision experience. I hear from people that have just experienced Dolby Atmos music for the first time, perhaps in their car, and they don't want to experience their music any other way. Even on our phones today, we can capture content in Dolby Vision and get more realistic and life-like videos to share with our friends. And so that's the power of the Dolby model when it all comes together. That's our passionate at Dolby. Our passion is enabling artists and the creator in all of us to tell better stories and bringing out the full emotion of those experiences. However, consumers receive that content, and however, they're playing back and experiencing that content. Our financial model is largely driven by licensing revenue. That's the majority of our revenue, and that revenue comes from a royalty per each device that ships with our technologies on it. But it's important to understand that and something I'll refer back to, I'm sure you heard the word ecosystem a lot. But for us, it's building these ecosystems which puts us in a position to increase revenue and have Dolby experiences adopted on more devices. And for us, what that means is content, distribution and then playback. So in the example of Dolby Atmos and Dolby Vision, which are our most immersive audio and imaging experiences, respectively. When we first came up with these experiences, the first place we go is to the creative community. So we were sitting down with colorists, sound mixers, movie directors. And what we're looking for is whether we're expanding their palette in a way that inspires them. I'm not much of an artist myself, but I imagine a painter knows everything there is to know about the texture of canvas and brushes and the viscosity of paint. In the case of the creatives we work with, sound and light is their palette. And so we're looking to expand that palette in ways that tells -- give them an ability to tell a more complete and more emotional story. And then once we're on to something, we work to make sure that we can integrate that into their workflows that we meet each and the needs they have. We begin working through the distribution channels, each of which has its own unique constraints, whether that's broadcast, streaming, mobile, cinema, that brings us into partnerships with chipset manufacturers, content owners, content distributors. And all of this -- all the while, we're, of course, working with our OEM partners, who are constantly working to advance their hardware capabilities and working with them so that we can bring the full force of these experiences to life. That's what puts us in a position to drive adoption across television, set-top boxes, PCs, mobile devices and more. And it's these ecosystems as they grow that further strengthens the value proposition and makes for a robust and recurring licensing revenue model. And so we have a very strong brand. We have strong profitability and cash flow. And there's never been a time where there's been a greater demand for entertainment content. And that's what creates opportunities for us and why we're excited about our growth opportunities. We're focused every day on bringing more Dolby experiences to more people and more types of content and that's what ultimately drives growth and drives shareholder value.

Great. So I've sort of coincidentally covered the company since your IPO, which makes me hold. But would love your perspective from an outsider looking in, you've evolved from back then DVD 5 channel to Blue Ray, that was sort of not necessarily a cycle to streaming. So I've seen the evolution of the model, but you've kept sort of the core licensing as sort of a basic framework on monetization. I know you're extending into Dolby.io, but I would love your perspective. I think you've been there about 17 years. Just maybe kind of speak to how you evolve and how you become relevant during platform changes and how you continue to control your destiny?

Yes. Now you're making me feel [indiscernible]? So I think I'll talk a little bit about how things have evolved and we could probably spend the rest of the 23 minutes and 21 seconds talking about how dynamic the environment has been in just the last 3 years. But the key to how we have thrived through that evolution starts with the things that have not changed. One thing that has not changed is our purpose and our passion and the passion our people have for staying engaged with the creative communities, the distribution communities, the playback OEMs to continue to raise the bar on the quality of these experiences. We've been doing that for decades, and we plan to do it for decades to come. Another thing that has not changed is people love their content. You probably all have favorite movies and TV shows. Most of you, if not all of you probably have a favorite sports team that probably hasn't changed in 25 years. We're very emotionally attached to these experiences. And the third thing that hasn't changed is that throughout all of this time, artists, content creators are never satisfied with the status quo. So over 17 years, there have been periods of time where everybody was on board with wanting to push the bar in immersive experiences. There are periods of time where I felt like we were evangelizing a little bit for the need for more immersive experiences. Artists have always wanted to push the boundaries and to expand their storytelling palette. And so I guess I bridged into one thing that those are the things that haven't changed. I think so many things have changed. First of all, there's just more content. There are more types of content. There are more ways to enjoy that content. There are more ways to receive that content. And that across the board has created opportunities for Dolby to make a difference in each of those experiences and all of the ways in which they're delivered. We have seen many, as you talked about, Ralph, so many technology transitions over this period of time, right, I mean, as you know, when we first met, much of our revenue was from DVD playback. Of course, today, it's all about streaming and broadcast and mobile. So that was a major transition. We've seen major transitions in the playback capabilities from 2K to 4K before that from standard definition to high definition. With each of those shifts, comes opportunity by engaging regularly with the creative community, content distributors and the OEM community, that's where we -- that's where we find our opportunities to introduce more technologies into more devices and to more experiences. And that's also been a change. We've greatly expanded the number of content experiences that Dolby is relevant to and where you can enjoy Dolby experience. It's not just movies and TV. It's music, it's sports, it's gaming, it's user-generated content, and we're constantly looking to expand that relevance, which also makes us relevant to a broader range of devices and use cases. So those are some of the things that have changed. And the way we -- I guess, the intro to your question was, how we evolved? How have we continue to go through that evolution? It really is by staying engaged across these ecosystem partners. It's by staying really focused on the value that we bring to the world. And then especially over these last 3 years in what's been a very dynamic environment, we have been very agile about making sure that when we wake up every day, we're focused on the opportunities that are most available to us to go expand the number of Dolby experiences with our partners.

Great. I want to touch on the macro, but maybe before we get there, you recently changed the reporting structure from foundational sort of IP patents to newer technologies, which is Dolby Vision, Atmos and Imaging. Maybe for the audience, sort of talk about the dynamics between those licensing revenue streams and how you view both of them?

Yes. Maybe just -- if I could just set that up a little bit. There's a couple of constructs you'll see in the way we report. One is we report our -- we provide information on our licensing revenue by end market. And by that, we mean what's the device target. So we have broadcast, which is primarily TVs and set-top boxes, PC, mobile, consumer electronics, which includes things like sound bars and smart speakers. And then we have another category, which are the collection of things that aren't yet 10% of license revenue in their own right, but notably would include automotive, gaming and Dolby Cinema, which is a licensing as a share of box office. So that information, you can see historically about how those markets and I think that's valuable to investors because I'm sure you each study these markets and have your own views on what the outlook is for those markets. What we introduced more recently, in the last year or 2, is we're also sharing a construct of our foundational audio technologies. These are our core audio codecs and audio patents that are essential today to the way entertainment content is delivered across a very broad range of use cases. And so we're very diversified across the ways that content is delivered, we're diversified geographically, and we're diversified with very high attach rates across televisions, PCs, mobile devices and more. And we break that out separately because of our broad presence, that is going to tend to be more sensitive to the macroeconomic environment. Then we have our Dolby Atmos and Dolby Vision, our most immersive offerings, combined with our imaging patent portfolio, which are higher growth areas. They grew about 30% last year. And this is where we're seeing much of our growth because this is where we continue to see. We expand into new use cases and more devices.

Great. Maybe talk about the macro in a couple context. Just kind of big picture, if we could sort of get an update on how it's impacting the business. I know it's impacting a lot of companies that attach to consumer end market sales. And then maybe just your perspective how has the macro evolved since you set your initial guidance to where we are today? And then maybe just to kind of layer under that some perspective, is it impacting other end markets, maybe more than others?

Sure. So as I said a moment ago, foundational because of our broad presence across so many devices is going to be more sensitive to these macroeconomic trends. And so we came into the year expecting foundational to be down low single digits, and that was because of lower unit shipments across most of the categories I've talked about. And we've seen that more pronounced and if I were going to call out one category in PC, but at the same time because we do have such a diversified base, we've seen some lower, some higher. We're still -- it's playing out about the way we expected coming into the year. Over the long term, this diversified base of revenues is a very strong position to be in, and we believe that when the economy settles, it will return to growth, and we continue to work to strengthen that position across each of those markets. Dolby Atmos, Dolby Vision, our imaging patents, those have continued to grow throughout this period of time. I said it was 30% last year. That's because it is far more about getting on more of the devices that are shipping right now than it is about how many devices are shipping quite simply. And where we have not seen any -- where we continue to see very strong demand is on content creators, content owners, device manufacturers wanting to invest in these experiences and bring the best possible experiences to life for consumers. So net-net, we do see the growth in Dolby Vision, Dolby Atmos and imaging patents. We see growth in licensing because those areas are greater than what we're seeing in foundational. Particularly, we see growth in broadcast, mobile and the other markets, which, again, are automotive, gaming, Dolby Vision, those areas.

Maybe touch on growth a little bit. Maybe you can give us a little bit more color in terms of what drives the growth, maybe starting at the artist level. My perspective has always been that, you come into the professional market, consumers are -- see their favorite artists or see their favorite movie with Dolby, it means something when they go at a point of purchase or shopping at Amazon, but maybe some more perspective on Atmos, Vision and Imaging in terms of what's driving those growth segments?

Yes. So yes, you've set that out very well because those are the -- it's driving those content ecosystems that creates the demand for the device -- at the device level. And we have 3 primary focus areas right now. One is continue to invest in the movies and TV ecosystem. It's our most established ecosystem. It was the largest growth driver for that category last year. It will still be a big growth driver this year. Movies and TV, of course, can be -- are enjoyed across a very broad range of devices. So it drives demand across all those areas. But in particular, for that category, we look at TVs, set-top boxes, sound bars, the living room experience. Then we have a couple of newer ecosystems for us. Music, which was first introduced in 2019, we have -- has grown very quickly. And again, music is an experience that we enjoy on mobile phones, on sound bars, smart speakers. We're particularly focused on automotive because that is a relatively new opportunity for us, and that's an area where we've been getting a lot of traction. And then lastly, I would point to user generated content and Dolby Vision Capture has been included on the Apple ecosystem since the fall of 2020. And since then, we've been focused on that ecosystem because -- with a focus on adoption in mobile devices. Now we have a number of use cases that kind of -- that do apply to mobile devices, movies and TV, music, but the ability to capture in Dolby Vision and play back in Dolby Vision and share and capture creates us -- a big opportunity for us to continue to drive growth in mobile devices.

So Mobile has been one of those markets that I don't know if you've had fits and starts, but I think you had Apple originally in 2016, thereabouts. It's sort of the initial partnership. And I would have guessed Mobile would have been larger sitting here in 2023, but it seems more recently that you're starting to have more of the Mobile OEM licensing agreements. And then auto seems to be a pretty interesting new area for you. So maybe kind of touch on, if my observation is sort of correct, maybe a slower build or at least the way I think maybe investors see about Mobile, maybe starting to catch a little backdrop. And then it seems like there's quite a bit of new OEM partnerships announced in auto, which I think is a new opportunity. So maybe kind of touch on those 2, if you could, please?

I guess to the first part of your question, obviously, we would always like to see growth happen sooner and faster. But we're really excited about the progress we've made. Mobile is up to -- close to 20% of our licensing revenue last year. We do expect growth this year. As I said earlier, Dolby Atmos drives adoption on mobile devices, one on the Samsung Galaxy with Dolby Atmos, we're included throughout the Apple ecosystem. But currently, we're very focused on this user-generated content opportunity. And we've had some really exciting wins this year, particularly in China, where Oppo, Vivo and Xiaomi have all had significant enhancements around support of Dolby Vision and Dolby Capture. Automotive, I mentioned music launch in 2019. We've been in market with a solution for automobile manufacturers to play back Dolby Atmos for about 2 years. And by the way, when we started, as we always do with the artists, this was -- if not the first question, it was one of the very first questions every time we spoke with an artist or a label. They wanted to know, are people going to be able to experience this in the car? It's just one of those experiences that people want to be able to have in their car, and it's a perfect environment to have an amazing using experience. So over the last 2 years, we've brought on 9 automotive partners. And this year, Mercedes has announced that they'll be expanding into additional models. Volvo announced the release date for its EX90. Did I get that right, EX90, I think, at the beginning of next calendar year. We last -- in the last month or so, added Guangzhou Automotive, which is the fourth largest manufacturer in China. So that continues to be a significant area of focus for us.

Then music is a newer area where you're able to sort of capture royalties, particularly for smart speakers. So if you can maybe sort of frame what's driving the growth there and adoption? I'm sure it starts with the artist, but maybe kind of frame the opportunity since it's a little bit newer one for Dolby?

Yes, it starts with the experience. And I wish I could start every one of these presentations with a 10-minute Dolby experience. But I -- we have truly seen more than one artist brought to tears the first time that they experience Dolby Atmos music. And many consumers who say they just don't want to experience it any other way. So the music experience is very powerful. It's emotional to us and Dolby Atmos really emerges you in a different way. It was 2019 that we launched with Apple Music and their Echo Studio. It was spring of 2021 that Apple adopted Dolby Atmos into Apple Music. And since then, we've been focused on bringing more devices on board. So just in the last -- just this year, recently, the Sonos Era 300, their premium single speaker solution, supports Dolby Atmos. And they've been a great partner for us. JBL even more recently announced support for Dolby Atmos in their Boombox single speaker solution. And then again, with the focus on the automotive side, we're engaged throughout the automotive industry. So I talked about some of the wins there, but the watch this space and what to watch from us is to continue to bring on more auto manufacturers and to continue to get deeper and deeper into the lineups and the partners that we brought on board so far.

And Dolby.io is sort of a newer revenue stream. I know it's a nascent but building rapidly, but maybe sort of kind of frame the opportunity, how you're sort of expanding beyond the sort of traditional OEM licensing model?

Yes. Like I said, we're always looking to raise the bar. And as it relates to the areas we've just been talking about, we're continuing to do that. But we also believe that the Dolby experience has a lot of value to add beyond the premium content and the highest production value content. And specifically, our developer platform, the audience is developers. Developers who are building the apps and experiences that we use every day. And the idea is for us to bring our decades of know-how, our decades of IP, our ability to solve just about any audio/video challenge and put that in the hands of developers so that we can unlock the creativity of millions of developers to bring more Dolby experiences into the world. That's the purpose behind Dolby.io. We -- a couple of things that we're doing. So of the use cases that we -- we started out with a set of use cases. We learned quite quickly what we suspected is that developers like all of us care about quality of experience. And where we're starting to see more concentration of interest is around a couple of capabilities. So we have one developer who builds virtual events for corporations. They, for instance, did -- McDonald's has an annual marketing awards and internal marketing offsite. They built a virtual trade show environment for that. They have a customer that launched an airplane in a virtual hanger. Now to be clear, these experiences are -- people are experiencing it over their PC. They have an avatar. They're in their experience. There's 2 challenges this presents that Dolby solves really well. One is, capturing that complexity of an audio environment with that many people and all the ambient noise. I mean it sounds like you're in the hanger. If you're having a conversation with people, a lot of these solutions today will limit the number of people that you can hear. So if you're in a group of 8 people, but it can only capture 5, somebody steps back, somebody steps forward. That's very disorienting plus you can have music in the background. So these larger scale environments, Dolby knows how to solve these at scale and make it very realistic and immersive. The other technology that was incorporated to those events and can be incorporated elsewhere is the ability to real-time stream and by that, I mean, hundreds of milliseconds, high-quality audio/video into any kind of environment really. But in the case of these environments, it could be the screening of a movie. It could be the streaming of a live concert performance. And because of the low latency, you can also get interaction with the audience so that you're getting real-time feedback in a realistic kind of environment. Maybe that's more than you bargained for, but I will mention one other. We have developers and we're pretty excited about it. It's related to this real-time streaming ultra low latency. We have developers who are working to enable high-quality and real-time second screen experience. So you could imagine an in-stadium experience where you really are able to get high-quality multiple angles, but get it in real time so that you're consistent with what's going on.

Right. Maybe just kind of pulling this together. So one of the key focus for investors is how does Dolby get back a return to double-digit growth. I think you're sort of low to mid-single digits for a guide this year. But if you could sort of walk us through the building blocks, how you get back to sustained double-digit growth. And then another focus, obviously, is on the OpEx spend sort of. Does Dolby have the right level of OpEx. So if you could sort of rip on both those points would be great.

Sure. Sure. And let me actually close on my last point as a lead into the next, which is to make it clear that the way the Dolby.io works is that we get paid on usage. So it's a permanent type of model or per volume kind of model. So backing out, how do we get to double digit -- sustainable double-digit growth. So as it relates to the foundational audio revenues, as I said, we're expecting that to be down low single digits this year due to the kind of overall environment. But we continue to strengthen those ecosystems. We have a very broad adoption across many markets. And when the economy settles, we expect that, that will return to growth. And then with Dolby Atmos, Dolby Vision, Imaging patents, we believe that we can double revenues from those areas in the next 3 to 5 years. And so we're targeting 15% to 25% a year. We believe we're on target for that this year. And with that formula between foundational, Atmos, Vision, Imaging patents, that gets -- that could get us into the ballpark of that double-digit -- sustainable double digit. Beyond that, we're never done. I mean we are innovating every day to bring new experiences to -- once we done everything we want to do on movies and TV and music and user-generated content, we see more opportunities to apply Dolby Atmos and Dolby Vision. And then, of course, we have initiatives like Dolby.io, which we think can be contributors to that growth rate over this period of time. You mentioned OpEx. We've been running at over 30% non-GAAP operating margins, and we have said that we can continue to do that. And I think at double-digit growth, that would give us more flexibility to think about how much of that is leveraged to operating margins versus invested in growth. But at the same time, we are always looking at opportunities for efficiency, especially in G&A, and we review that regularly. We're looking to be agile with, as I said earlier, focusing on the opportunities where we can bring to life in those Dolby experiences, but also with our resource allocation and capabilities. And so we're never done. I see that as a dynamic and continuous process.

We have -- I'll pause here for a second on a couple of minutes if there's any questions from the audience. All right. I'll ask one just because it's topical. So the cold VR, AR movement, Apple had announcement yesterday. Maybe if you could kind of frame that opportunity? I know it's very expensive, but we're not at mass market pricing at that point, but just sort of how you're thinking about that at Dolby and how that could potentially be a contributor to growth?

Yes. I was at the event yesterday before getting on the -- I wasn't wanting to come here. It was fantastic. Yes. And I was able to get a taste of the experience. I think it's -- it really opens the mind to how powerful those experiences can be. And I think in the Dolby sense, any time that you have new and increased hardware capabilities to vendor experiences, anytime you have the creative community inspired by that, and we saw that Bob Iger spoke about that as it relates to Disney and what they see in this experience. That's where we see opportunities to stay engaged with those partners to meet the future needs of future experiences. Dolby Atmos and Dolby Vision can and we expect will provide value to these kind of ecosystems. And also with Dolby.io, while today, we're one of the areas that I had mentioned, we have some traction is in building kind of virtual events. That's mostly in the sense of engaging through PCs and mobile devices. But we would like to establish ourselves as the company that developers look to when they're looking to build these highly immersive experiences. And I think that AR, VR could only be positive to that.

Great. Unfortunately, we're almost out of time here. But Kevin, really appreciate your time and always coming back to our conference. And thank you for all your interest in Dolby and attending William Blair's Annual Conference. Thank you so much.

Yes. Thank you for joining us. Thank you, Ralph.