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

Good afternoon, everyone. Thanks for coming to the last session. I'm actually not a JPMorgan person. I'm -- our JPMorgan person isn't here. I actually do IR for Dolby Labs. So very friendly interview here.

Well, we can also have -- we can open up. Anybody has a question as we're going, just raise your hand. We don't have to wait until...

I might have a word -- if you guys have questions. But with me is Kevin Yeaman, our President and CEO, a 17-year veteran, 17...

Of Dolby.

17-year veteran of Dolby. Maybe the best way to start is just a brief intro to the company what struck me I joined Dolby 8 months ago as it's a 60-year-old tech business that had multiple innovator dilemma situations in front of it, yet every time we're faced with a new technology or a new paradigm, we seemed to have emerged to come out the other side stronger and better business.

Just from your perspective, if you had to encapsulate the last 60 years in a 3-minute thought process, how would you describe the situation and where we find ourselves now?

I know it is, right? This is like a lot of qualifications to that. Thank you, Peter. First of all, I would start by saying that our passion at Dolby is bringing to life high-quality audiovisual experiences. We do that across movies, TV, sports, music, gaming. We do it because we are obsessed with the science and the engineering of sight and sound, and we do it by building robust ecosystem, starting with the content creation community. That's where we start. We like to validate that what we do matters by finding movie directors, musicians who look at what we can do for them and they see a pallet to better tell their story. And then we work across content, distribution, to devices, which is where we make the majority of our revenue, devices and cinemas. You might think of us as -- from a revenue perspective -- perspective, having a TAM of plus or minus 2 billion devices and 100,000 cinemas. And the way we create that value is by working across that ecosystem. And to Peter's point, we've been through at Dolby, a number of technical transitions, number of economic cycles. As you said, I've been here 17 years, and just in that time, I was coming in on the tail end of the analog to digital transition. I saw the -- I came in at a time that where we were beginning to see that there was going to be a transition from physical media to streaming. We have seen standard def to high def, high-def to 4K. What's significant about that is that each of those -- the technology upgrade cycles that give people a reason to go buy more devices, that drives high-margin revenue for us from our existing position. But we are also always innovating. So with each of those cycles, we significantly increased the amount of technology, we're bringing to these experiences in these devices. And that's what has consistently driven our business. So Today, we're about $1.3 billion of revenue, about $1.2 billion of that is licensing revenue that has about 98% gross margins. And on the one hand, we have our branded Dolby Audio Codec, Dolby Digital Plus, our patent licensing portfolio, that's about 2/3 of our licensing business, has very high adoption rates across a very broad variety of consumer devices. And so the consumer spending environment and consumer device shipments are a big factor on that business and upgrade cycles or consumer spending cycles drive high margin revenue and opportunities for us to bring more to those devices. Dolby Atmos and Dolby Vision are our premium audio and visual experiences respectively. It's now about 1/3 of our business. It's grown considerably since its introduction in about 2016, is when it really started coming to life. And that's been the higher growth part of our business, very prevalent across movies and TV. More recently, we've brought the Dolby Atmos experience to music, which is driving really strong demand for cars where people love to have a great music experience. And I feel like, Peter, if I don't stop soon, I'm not going to let you answer -- ask any questions. This is what happens towards the end of the day, once you wind me up, I just keep talking.

So you started to describe the revenue model a little bit. 90% of our revenue is license revenue, very high margin. And within that license revenue, about 2/3 of that license revenue is what we call foundational revenue and 1/3 of that license revenues, Atmos, vision and imaging patents. Can you talk a little bit about that foundational business and how it correlates to device sales and then a little bit that same question for Amos and Vision and the impact of device sales on that business?

Yes. So first, I would say that it is a single business in how we run the business and how we drive demand. But the distinction here is the foundational, which is our branded audio codec and the audio patents have very high adoption across TVs, PCs, mobile devices. And so we really started providing this distinction early into the pandemic when everybody had a lot of questions about how is the macroeconomic environment and consumer spending going to affect your business. And it had -- we were down in 2020 of supply chain concerns. And the initial effects of pandemic '21 was a great year with the pandemic purchasing. And the last 3 years have been -- that part of the business has been declining about 5% a year as the industry has been going through all of the uncertainty that we're -- that all of us have been adjusting to every day. But over the long run, we still see that as a growth business. We believe that the economy will stabilize. People will begin driving devices again. And we always look for what might drive that next upgrade cycle that would help people to go out and want to replace their devices that drives revenue growth for us. On Atmos and Vision, it's far more about getting on more of the devices that are shipping than how many devices are shipping because we're earlier in that growth cycle. So Dolby Atmos and Dolby Vision was on about 25% of 4K TVs last year, so we still have considerable room to grow. And then at even earlier stages we have, I mentioned earlier, automotive where we brought Dolby Atmos to music streaming starting with Amazon in 2019, Apple Music began supporting us. I think it was the spring of 2021. And since then, we've added about 14 auto manufacturers. It's one of the higher growth parts of our business as we are seeing a healthy pipeline of new auto manufacturers, the ones we have in market are adding a lot of models, Mercedes, NIO, Li Auto and we're getting higher volumes on each of those. So that's been a bright spot for us.

So to recap you, 2/3 of that licensing business is tied to device sales and you would expect that if and when device sales strengthen, then that part of the business would grow again and -- that's probably the highest margin segment of the business. And then on Dolby Atmos and Dolby Vision, there's growth there because that market is still underpenetrated. But what are the things -- what do you think are the 2 or 3 most important things that are going to drive that growth in Dolby Atmos and Dolby Vision, you mentioned autos. What are the other key indicators you look for traction in that business or things you can do -- what you can do as a company to drive that growth?

Yes. So for Dolby Atmos and Dolby Vision, we've said that we're targeting 15% to 25% CAGR over the next 3 to 5 years. And our top 3 focus areas are continuing to drive more adoption in movies and TVs and that's driven by the strong presence we have in movie and TV content and also an increasing presence in sports content. So most recently, Max has announced and has begun to stream all of it sports content in Dolby Atmos and Dolby Vision, which is driving a lot of other demand. We also have support around the globe. The Premier Cricket League in India will be streaming in Dolby Atmos and Dolby Vision. We're looking forward to the Olympics later this year. So that continues to be a big focus for us. Music and automotive, we're still in the early days with -- but with a lot of momentum. And so we think that can be -- it's our largest percent grower right now, and we think it can -- it has a lot of room to grow. And then mobile is our second largest end market as a company, still a lot of room to grow in Atmos and Vision. Particularly focused on the adoption of Dolby Vision in the mobile space. We, over the last 18 months, have brought on most of the major mobile phone OEMs in China, Xiaomi, Oppo, Honor to name a few. And they are bringing the ability to both capture in Dolby Vision. We have broad support in China across social media and video sharing sites. So you're seeing it adopted by influencers and people just wanting to have the best quality experience in their own videos. So those are the 3 primary focus areas for us, TV in the living room, automotive with music and mobile devices, particularly with the Dolby Vision experience.

Great. We have a question from the audience. Any words of encouragement on Dolby Vision at Samsung?

So you have -- people are able to submit the questions?

Yes.

Great. Well, I would start with Samsung is one of our largest and longest-standing customers. And over the last several years, they've really embraced Dolby Atmos. Across their TV lineup, across their sound bar lineup. It's included on the Galaxy. And we think we have a strong value proposition with Dolby Vision, and we will continue to strengthen it by expanding to more types of content and more experiences. But they -- as implied by the question, Samsung has not yet adopted Dolby Vision, but we're -- we will continue to work on that.

Maybe since we're on the competitive threat. Can you talk a little bit about the competitive environment, who we see competitively why we win? when we win and why we lose if we lose?

Yes. Well, it might sound a little cliche, but our biggest competition is do-it-yourself or is what we have good enough. What really creates the strength and the sustainability of our business is the strength of these ecosystems. They usually start with a unique -- they do start with a unique technology, which is -- we're an R&D company at heart. So it's very well thought through and protected by patents and IP. Over time, the defensibility and the sustainability of this business is really about the ecosystem and the ecosystem of content, the ecosystem of distribution, combined with our presence on the devices that makes it very sustainable. I feel like there was a second part to your question. Yes.

Thanks. Sorry, just on the competitors, I mean -- are there any other competitors that didn't sound like there were any -- I didn't quite get the answer to that?

Yes. No, fair enough. There are competitors across each aspect of our business, very few that do all of it. When we're talking about audio codecs, there are patent licensing pools that we're a part of, like HE AAC and AAC. So that's a part of our foundational revenues, and we share in those licensing pools as do other licensors. There are smaller competitors that do virtualized audio technologies or other things, but no one that -- competes across the entirety of the ecosystem that we've built. But again, there is -- the do-it-yourself is a real competitor. It's particularly when we're going through a new cycle like Atmos and Vision, we have to compel people to believe that this is a significant improvement over the audio or video experience they could otherwise offer.

So you're at around $1.3 billion now. Have you put out any type of long-term revenue goals based on either growth in your current customer base or the rollout of your next wave of technology offerings and any perhaps, I don't know if litigation is potentially material to winning new licensees?

So what we've said in terms of long-term revenue guidance is we are -- our goal is to get to sustainable double-digit growth. As we talked about a minute ago, the -- and the foundational -- where we have these large attach rates. We believe that we will return to low single-digit growth in that part of the portfolio and that in these higher-growth areas with a CAGR of 15% to 25% that gets us to about the double-digit rate. And of course, we always have a number of new initiatives in the pipeline, which we expect to contribute to growth as well.

Got you. And just in terms of the device variability when you have your larger customers like Samsung, do they peak out? Are they -- the larger ones flat fee at some point?

Typically, even for our larger customers, it's tied to device shipments. What we do often have a minimum volume commitments for which they would pay above a certain amount. That's particularly prevalent in mobile, but it can happen throughout other parts of the business.

They have a minimum but not at Max?

On the licensing side, that's right, yes. The patent licensing pools that we participate in, sometimes have caps for particular use cases, but that's us participating as a license order of that pool.

Where are you right now in terms of adoption on the content creation for Dolby Vision on that side of the equation?

Very strong in movies and TV. It's -- over 75% of the box office is in both Vision and Atmos, higher for either one of them individually or supported across Netflix, Apple, Disney+, most of the major streamers in China and regional around the world. That's where we brought -- first brought Atmos and Vision to life. In music, we've got Amazon, Apple, TIDAL. We have most of the major streaming services in China, large regional providers in Korea, in India and Singapore. Sports is where we're seeing some momentum at the moment. I mentioned that Max has announced that they'll stream all of their sports content in Dolby Atmos and Dolby Vision, which is also generating a lot of interest from a lot of other partners. Typically, sports takes longer for us when we usually start with the movies. Audio mixers literally have 3 months to spend on the sound. And by the time you get to sports, you have seconds. So all the tools come together, and we're -- we are -- we will be part of the Olympics. And -- so it's an area of focus. But that's important because it does drive where we have -- I mentioned more than 25% of 4K TVs. At the high end, the attach rate is very high at the low to mid end, it's smaller and growing, but sports is a really compelling content experience for driving those sales.

Can you talk -- spend a little more time talking about the opportunity in automotive. You don't break it out explicitly. It's in the other category -- how big can it be? What's the use case? Where are you if it was a baseball game or part, what inning would we be in -- and how do you view the opportunity at a high level?