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

Good morning. I'm Ralph Schackart. Thank you for attending our Annual Growth Stock Conference. Really great to see everybody. I have to tell you to check our website for disclosures for compliance. So that was important to get that all the way. Today, we're really excited to have Kevin. Kevin does our conference every year. So we really appreciate your time. Kevin has been CEO of at Dolby for a while and previously the CFO. So really has a good sort of overview of the business from the finance as well as a strategy perspective. So I've asked Kevin to maybe spend a few minutes this morning since our conference appeals more to journalists. So maybe just sort of riff a bit on the history of Dolby sort of legacy roots, the product cycles that he has observed and how the business has sort of grown through each of the cycles. And then maybe that will be sort of a good launching point to take it from there. That sounds cool?

Sounds great. And thanks, as always, for having me. Thank you all for joining us today to learn a little more about Dolby. Hopefully, you're familiar with us. At Dolby, we are in the business of bringing spectacular experiences to life in the world of entertainment. And we do that by focusing on the science and engineering of sight and sound and working with creatives, content owners and distributors and ultimately making those experiences available on all the consumer devices that we use every day and also in the cinema. The way we do that is that we build ecosystems. We build ecosystems around content, around distribution, setting up these experiences where we earn our revenue on devices and in the cinema. So to give you an example, Dolby Atmos is our flagship audio experience. I hope you've all experienced in one context or another. When we first brought that innovation to life, when I first heard it on our own cinema and the team, all they could let [ me hear ] so far was rain. And they played rain in surround sound, and it sounded like rains, surround sound was awesome. When they played rain in Dolby Atmos, I literally had a visceral reaction. I felt like I needed to reach for an umbrella. So the first thing we do is we go to the creative community. That's where we start. So we go talk to movie directors, sound mixers, we want to understand whether we are providing them a palette to better tell their story. And when we start hearing them, first of all, see their reaction. And then second of all, when we know we are on to something is when they start talking about what they can do with their story, they might not have otherwise been able to do. In the case of Dolby Atmos, I remember specifically, there was a scene where the car was flipping off the screen and the director said, "Now I can shoot that scene before I couldn't keep people on the audio of that visual experience. Same was true when we bought Dolby Vision to life, the Director exclaimed, "Now I can use night as a character. I'm not accretive. I don't know what that means, but I know it means that we're providing the value we aim to provide. And so from there, we work to provide the tools and technologies to integrate into the workflow of their creative process to the content owners and distributors and the people responsible for packaging that content for distribution whether it's movies, TV, gaming, sport, music. And then we work with the distribution channels, whether it's going to be distributed through the cinema, through traditional broadcast channels, through streamers, through mobile. And ultimately then, of course, we are providing software deliverables and technologies needed for the device manufacturers to make that experience available to all of you and then all of its glory. And so these are the ecosystems that we build. And to your point, Ralph, since I've been here, I mean, I joined the company was in the midst of the analog to digital transition. And I want to thank you for saying I've been here a while because you were about to make me feel old and now I just did it to myself. But we've seen many transitions. We've seen the transition from physical media to streaming, from standard def to high def from high def to 4k. What's significant about those cycles is that we stay focused on making sure that we're strengthening these ecosystems of content to distribution to device, we stay focused on innovating and bringing new technologies and capabilities to life. And with each of those upgrade cycles, you tend to get increases in device shipments, which is, of course, good for us. But maybe even more importantly with each of those cycles, we improved our position in terms of being able to bring more technologies to bear on each of those experiences. Now I should say not everything we do is about the wow. If we get the opportunity to have any of you in our, in one of our facilities, the first thing we'll do is wow you with the latest and greatest. But a lot of what we do is focused on quality and efficiency. If you're the mixer in the broadcast truck or if you're in the recording studio, what you're going to care about is the ease of use, about efficiency, all of those things are part of what we offer. So where we generate revenue is from licensing. That's over 90% of our revenue into each of these devices. We have a portfolio of technologies, which include Atmos and Vision. They also include our branded audio codec portfolio, which is essential to the way so much of entertainment content is delivered today. We have patent licensing, where we primarily participate through pools for audio and video codecs that are commonly used. All of that is what makes up over 90% of our revenue. And it's these ecosystems that make those revenue streams very durable. It's participating in a broadening number of ecosystems, which puts us in a position to continue to innovate and continue to anticipate where the world is going and how we need to help people with that. That's very high margins. The licensing business yields about 98% gross margin revenue. And so you asked me to riff a little Ralph, and I'm going to be careful because I could riff for 30 minutes, why don't I pause there?

Cool. Maybe we'll segue a little bit. You're talking about cycles and then also on your most recent calls, the macro has obviously been impacting at least sort of the near-term growth. Maybe an update on the macro and what you're seeing and if you can give us some perspective between foundational and then sort of the new growth drivers too.

Sure. So we have primarily talked about our licensing revenue to help you understand what the dynamics are by end market, broadcast, which includes TV and set-top boxes, PCs, mobile devices and so on. But we also, early in the pandemic, began providing what you just referred to, foundational versus Atmos and Vision imaging patents. And the reason we did that is because people wanted to and still want to understand how to relate the macro environment to our businesses. And so our branded audio codecs and our audio patent licenses are included on so many of these devices. We have very high attach rates across a very broad spectrum of consumer electronic devices. We call that our foundational audio technologies. The reason we make that distinction is because such high attach that what's happening with consumer device shipments is going to be a very big factor in what's going on with that revenue stream. Early in the pandemic, things went down in 2021, there was this enormous amount of pandemic buying, and we had great revenue growth and at 98% gross margins that goes very quickly to profitability. The last few years have been a rough time for our OEM partners. I mean most of our revenue is coming from TV OEMs, mobile OEMs, PC OEMs. And so that's weighed on foundational. But at the same time, we're very confident having been through so many of these technology cycles and economic cycles that we're doing the right things to be positioned for when that comes back. Dolby Atmos, Dolby Vision imaging patents, obviously, is still affected by that macro environment. But what's different is that we have the opportunity to continue to get garner the wins to get on more of the devices that are shipping. So that's what we focus on first. And so we've continued to focus on that. And we're targeting 15% to 25% compounded annual growth over the next 3 to 5 years. This year, we've guided to high single-digit growth for that category. And like I said, it's not immune to the macro, but we still have many opportunities to continue to and we do continue to drive additional adoption and get new wins.

Just to provide some context of the number, when Kevin and I refer to foundation that was about 2/3 of the business, it's effectively flat with the macro. And then 1/3 of the business is guided over the medium term. I think it's appropriate to say, 15% to 25%. That would be Dolby Vision that makes the darks darker and the brights brighter? How is that for technical, that good?

I like it, yeah.

And then Dolby Atmos instead of going around the room, basically, you feel like the rain is coming from down. So just provide some context there.

Yes. Well, if you're a [ creator ], I mean, I'll do it really quick -- I'm glad you -- first of all, thank you for grounding the foundational as 2/3s. We think we can get that back to low single-digit growth. But right now, we're looking at the uncertainty in the environment we're in. But Dolby Atmos and Dolby Vision just really quickly. Yes. Dolby Vision is -- it makes the darks darker, the lights lighter. It's just much more realistic and or much more fantastical. That's what the look you're going for. And Dolby Atmos, surround sound is just if you're a creator, whether you're a musician, making a movie, making a TV show, your creative -- degrees of creative freedom are to designate which 5 spots in the room you want the sound to come from. You've got 50 speakers, they're just in groups of 5. With Dolby Atmos, we're giving them a 3D rendering environment. They're literally placing up to 128 objects in space at any given moment in time, and then we are taking the audio physical capabilities and replicating that as faithfully as possible. That could be the 50 speakers in the cinema, that could be through ear buds on your phone, streaming app with music, that could be over a sound bar.

And then a question I often get from investors is what are the signs look for, when will Dolby return back to growth? Maybe give a quick update, if you can, is there any [indiscernible] in the macro, just anything that if you were an investor, what would you look for? And then sort of maybe transition from there to growth and give some perspective, if you can, please, between Atmos and Vision and the end markets and sort of what's growing today? And how would an investor think about how to analyze the growth in the business?

Yes. So for the most part, the -- through this period of time, that we've had growth in Dolby Atmos Vision imaging patents. And then we've been -- and that's been offsetting the last few years, what we've been seeing in the foundational because of the overall macro environment. So drives growth is the recovery cycle helps us a lot. But we're not sitting still. We believe that we can continue to drive growth in those things that we can control. And where some of our biggest focus areas for growth as it relates to Atmos and Vision, our continued focus on the living room, TV, your audio devices, et cetera. We continue to see growth opportunities there. We were last year on about 25% of 4K televisions for each of Dolby Vision and Dolby Atmos. If you break that down further, we're at a very high percentage of TVs above a certain price point, and we're on a lower but growing percentage of TVs at the low to mid end. So that's our focus. And again, because we always think, first in terms of content, one of our big focus areas right now is sport. So we've been getting a number of key sporting events over the last several years, and we're starting to see more traction in that regard. So fairly recently, Maxx announced that they will stream all of their live sports in Dolby Atmos and Dolby Vision. They're doing that today. And then we're looking forward to some big events coming up this year, the Olympics, Premier cup soccer championship. These are things that can drive TV sales. Big focus also is Dolby Atmos music and automotive. So Dolby in 1965 came to life with music that was the button on the cassette player that reduced noise reduction. And we've not actually had a presence in music for a long time until we brought Dolby Atmos Music to the world. And we did it again by working with music labels, with artists. We now have over 90% of the top 100 billboard artists are producing music in Dolby Atmos. We have strong presence increasingly globally as well. And it was, I want to say, 2021 that Apple began streaming in Dolby Atmos. We have Apple, we have Amazon, we have TIDAL. We have most of the large streamers in China. So we've brought to life this new ecosystem of content, which drives value across most of the devices we serve, but it opens up a new opportunity in automotive. And so over the last couple of years since we began targeting -- bringing this to the automotive space, we've brought on about 15 OEMs including many of the large EV companies in China, BYD, NIO, Li Auto, Mercedes, which is already up to, I want to say, 15 models or so supporting Dolby Atmos and even just last week, GM announced that its EV Cadillac, The Optic will include Dolby Atmos. So that's driving growth. That's in our other end markets category. We break it out when it's more than 10% of revenue. So it's a fast grower within other, and we're continuing to see a lot of momentum there.

Great. Can you expand maybe a little bit more on autos. Historically, you may have seen just more, I guess, domestic OEMs sort of pushing on rest of world. But I guess, now we're seeing some of the Chinese particularly EV OEMs maybe adopting faster and sort of the implications of how that might roll out faster potentially?

Look, it's -- well, first of all, it's always our aim to have, in the case of Dolby Atmos Music, we want everybody, wherever you are in the world and how you're listening to it to experience Dolby Atmos music, which is to say we love all of our partners. But I would say the implications have been that, yes, the -- any of the Chinese EV companies have been the first to adopt our technologies. And I think as a general rule, they're fast. They are -- they have global ambitions. They recognize that Dolby Atmos is a really strong value proposition. It really is one of the most compelling demo experiences that we've ever had. It just sounds incredible. And by the way, we couldn't have chose a better ecosystem to bring to life during the pandemic because we were able to take cars to the homes of music executives and musicians at a time where otherwise might have been hard to get the engagement we needed. It was actually a great way to engage.

And sometimes when I do marketing and walk through the Dolby story. I'm not sure -- I probably don't do a good job at this, so that's probably my fault. But investors tend not to sort of, I guess, appreciate when you're working with artists who you see the particular pop artist or whatever that may be working with Atmos or the Cutting-Edge Dolby technologies. Then how that works its way through the ecosystem and ultimately drive sales. Can you walk us through why that's so important and eventually, how that turns into, I guess, revenue for Dolby?

Yes. Well, I think I'm fortunate to have an amazing and passionate group of people about bringing these experiences to life. And they have a lot of muscle memory on how to solve what looks like a pretty intimidating chicken and egg problem. Nobody is going to want to do content if they don't believe anyone's ever going to experience it. No one wants to put in the technologies of experience it if they don't think that there's ever going to be content. So to answer your question, the more content we get the more value there is to providing that experience to consumers. And the more likely it is that consumers are experiencing it and they're giving good feedback on it, and they're asking for it, which creates more content. And so once we get it going, it's this -- it's this virtual cycle of that is how we bring these ecosystems to life and is why our revenue streams are so durable it's because it's we're growing across content, around of distribution, around the experiences. When we're first bringing this to life, I would say, look, there's a lot of reasons people have to buy, right? But I think in the beginning, there are always people who are focused on quality. One group of people that will consistently never ever utter the phrase good enough are the artists themselves. So if we can get -- if we can get them excited, we're off to a really good start. On the device side, usually, our first adopters are those that have quality of experience as one of their strategic differentiators. That's how they're going to go drive differentiation in the market. And it's often -- it's often that combined with being a challenger like somebody who's doing well and looking to take on the larger companies. From there, we -- this ecosystem continues to build, continues to build. You get people that are -- it becomes -- as you go through the cycle, it can become an expectation that well, if we're going to do a movie and TV streaming service, then clearly, it's got to have the best experience. That's still the Atmos and Dolby Vision. So it's that virtual cycle that we continue to drive.

Great. And then increasingly, investors are, I guess, excited about the Dolby.io product. You maybe sort of frame for investors how that model, go-to-market strategy is transition? What is it today and sort of the use case for the product?

Yes. So at the level at which we started the discussion, let me lead into this by saying that we have this market that is defined by plus or minus 2 billion devices just over 100,000 cinemas. We continue to have opportunities to grow with our new technologies. We continue to innovate into that. We believe that the value we bring as a company applies beyond that and specifically to all of the audiovisual experiences that we're consuming over our devices through apps and services every day. So to answer your question, you referred to the transition. Our first -- so what we did first was we made a number of audiovisual technologies available over a Software as a Service as a sell service developer platform to allow developers to come and take advantage of Dolby Technologies to improve the quality of their experiences. And over a period of time, we got 400 or 500 developers doing a very wide range of things. And coming into this year, we made a shift in the strategy. We made a shift in the strategy because of where we were seeing demand. So people were using a lot of different technologies. I think we proved to ourselves that yes, there are people out there that care about the quality of these experiences. And yes, we have the experience to help them do that. Where we saw demand was -- and where we're seeing demand is one of those technologies, in particular, is the ability to stream audio video content and ultra-low latency. That means hundreds of milliseconds. It means that if you were watching a live stream of this, there would be virtually no perceptual difference between Ralph and I talking and what you're seeing on your screen. And we began to see demand for that at -- from larger enterprises at a larger scale. So we shifted the model from self-service to focus on that. And in a larger sense, we believe the opportunity is that we're focusing on the sports and entertainment vertical, where companies are very focused on real-time, interactive more personalized digital experiences to engage their consumers in their content. Ultra-low latency streaming is a capability that opens up some of those possibilities for them. Over the long term, we're also confident that we have a lot of technologies to bring to bear and that we have a history of building trusted relationships with companies and that we believe that whatever their aspirations or challenges are on the audio video front, we can play a key role in solving them. So pretty early days. Like I said, we've refocused this coming into the year, but we did close our first couple of 7-figure deals in that first quarter out of the gate. And so the opportunity is to create really a new -- open up a new TAM for Dolby exercising our fundamental ability to, we think, solve any challenge in the audiovisual entertainment space.

Great. Maybe kind of shift to margins in the balance sheet. So you obviously got a lot of questions. I get a lot of questions too and sort of the margin opportunity for Dolby with the high gross margins, you're showing leverage and basically a flat top line this year. But maybe talk about where your investments are today. I think some investors sort of have some perception, what you're spending money on to sort of be really direct and maybe frame that for us. And then once the business starts growing again, sort of, give some perspective of the leverage in the model?

Yes. So kind of if we go back to some of the constructs we've already introduced the foundational audio technologies, which make up 2/3s of the business are the most at scale. The investment there would be in sustaining engineering and continuing to address new device types, content types, et cetera. With Dolby Atmos and Dolby Vision, we're at varying levels of scale, right? It takes investment to bring to life the music ecosystem because in the beginning, what you're doing is working with the labels and the artists and coming up with the first demos of how great the car experience could be. So -- and then obviously, we have our newer initiatives like Dolby.io. So all of those -- that's kind of one and then I would also point out that we do have an advanced, we call it the Advanced Technology Group. But this is the group that is always looking to have a pipeline of innovations around what's next to drive the businesses that we have. I don't remember if I answered all of your questions...

Yes, just about the margin opportunity, like how are you able to scale and [ up ] with the flat top line this year.

Yes. So we have non-GAAP operating margins of over 30%, and we are expanding margins this year and have said that we believe we can continue to grow earnings faster than revenue growth. And I would say that this has been a period of time where I think like many companies were adopting to the environment and getting very focused on where the most -- the growth opportunities that are available to us today, and you're seeing that with our progress in areas like music and automotive, the living room, mobile devices something we haven't talked about and the ability to capture Dolby Vision video and share it on your phone. So we've just gotten more focused. And at the same time, we planted many of these cycles quite some time ago, music, mobile. By the time we're talking about it or you're able to experience on a device, we've been working on it for a while. So that's some of what goes into our confidence that we can continue to drive operating margin expansion over time. Not to mention just the [ foundational ] we talked about the macro. I mean, with foundational having been down the last few years, speaking of the things we can't control, but we've been through a lot of these cycles. When that does turn, that obviously opens up our model quite a bit.

Got a few minutes here. I just want to sort of turn it to audience and see if there's any questions for Kevin?

Yes.

[indiscernible].

Yes. And the question in case you couldn't all hear it is how to think about the opportunity for Dolby.io? So again, this is a -- we're offering this as Software as a Service. So it's based on the volume of the bandwidth and volume, the number of streams. And the way to think about it, again, it's early days for us, so we're not providing specific guidance on this. But we think that it's a -- we think that it can be a contributor to growth. And what we're focused on right now is capturing that opportunity that we see for people who are looking to go from live streaming, which is on average, think of it as 7 or 8 seconds delay, but it could be 3, it could be 15, who see value in that ultra-low latency streaming for the whole or maybe even a part of their service. So we think that's a significant opportunity, and we think the even bigger opportunity is then to provide the other audio video capabilities that will help them build these experience that we can bring to bear, whether that's on the fidelity and quality of the audio and video, whether that's on the ability to interact and communicate with one another. So we think it has the opportunity to be a significant part of our company over the long term. That's why we're focused on it. But it is early days. So we're focusing today on making sure that we can get a sustainable, predictable building that pipeline and getting compelling these cases.

Time for 1 or 2?

1 or 2 more. If I answer quickly enough, it will be 2.

Yes.

AI [indiscernible]?

Well, I think that in the -- I mean I think whenever we're talking about AI, you have to -- you probably have to say, yes, all of the above, right? But I think that we don't think that it has any imminent implications to our business. We think it does have implications to each of the industries we serve, like particularly in the content creation process. That's an area where there's a lot of work going on in terms of how it can help people do their job more efficiently and effectively. And whenever you have work going on in those areas, it's really important that we are working with our partners to make sure that we continue to make it easy for them to use and efficient to use. Now having said that, we have a number of our product features and recurring innovation, which has been developed with the use of AI methods, including but not limited to language models. And each of the offerings we have and each of the innovation ideas we have in our pipeline are things that we look both at how AI could affect that across the ecosystem and how it could help us in developing a better solution or develop it faster. And I think depending on the idea on the pipeline, it's a big assist or maybe even has the potential to be more core to it, but those are the very early ideas and we're -- we've got a great advanced technology team, and they -- a big part of what they're doing is staying connected to top universities, meeting with the technology leaders at many of our customers with whom we have strategic partnerships to share knowledge, understand where the world is going to make sure that we continue to be a big part of it going forward.

Well, looks like we're bumping up in time. Thank you for your interest in Dolby and attending our conference. And Kevin, thanks again for attending. Really appreciate it.

Thank you, Ralph, and thanks, everybody, for coming to learn more about Dolby.