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

All right. Good morning. Why don't we go ahead and get started. I'm Ralph Schackart, Internet analyst here at William Blair. Thanks again for attending our Annual Growth Stock Conference. Today, we're really excited to have Kevin back from Dolby to give you an overview on the business. Just a quick overview of the company because I think it will help level set. I've covered the company since the IPO, which is a long time ago. And through the history of Dolby, every time there's been a product cycle, you've seen the business sort of grow on top of each other. So if you go way back to when there was analog surround to digital surround to mobile to now what we would call streaming and then whatever is beyond streaming, Dolby is -- the business has sort of grown and become larger over time. And I think at this point, if you look over the last 4 years, the business has been relatively flat. But I think what we'll focus on today is sort of coming out of that flat period, the business is starting to grow again, They'll add about 200 basis points of margin expansion as a result of the business growing. So I think that will be sort of the focus here today. We'll do a fireside format instead of a presentation and then definitely some questions at the end -- time for questions at the end. And then I think the breakouts and sell of it, if I'm not mistaken. And I have to tell you to check our website for disclosures. So my...\

With that, we'll go ahead and kick it off. Maybe Dolby, sort of an overview, Kevin, to kick things off. You've been here for a long time, previous role as a CFO, have transitioned and been in the CEO role for a while. Maybe kind of walk us through the evolution of Dolby as you see it through your eyes and kind of where we are today.

Yes. Thanks, Ralph, and thanks for having me. Thanks for coming to learn a little more about Dolby. Yes, I've been -- I joined right after the IPO. So along with you about 20 years. And hopefully, you all have had some experience with Dolby. I think one of the great things about working at Dolby is that you often have people share their first experience with Dolby and that could have been depending on the generation that could have been the button on the cassette player that eliminated noise for music. It could have been the first time that they experienced surround sound in the theater, oftentimes that was Star Wars is what people remember. And of course, what we've been doing is working through these transitions and through the changing times to make sure that we still have those moments and we get those moments. We get people who are excited about the first time they experienced Dolby Cinema and Dolby Vision and Dolby Atmos. Increasingly, it's about the first time they're experiencing Dolby Atmos in the car, which is one of our newest initiatives. And that's what -- ultimately what everybody in our company is focused on is providing the technologies required for these ecosystems to deliver high-quality entertainment, often producing these spectacular moments that people remember forever. And while also meeting the efficiency needs of all the people that have to do all the work to produce that content, get it through the chain, whether you're in the back in the broadcast center or in the mixing truck, that's what we do at Dolby. And yes, it's been -- the company has been around for 65 years. I've enjoyed 20 years of that journey, about 15 as CEO. So obviously, during that time, we've seen a lot of different economic cycles. And to Ralph's point, we've seen a lot of technology transitions just since I've been at Dolby, Analog to Digital, DVD to streaming, standard def to high def to 4K. Those are some of the technology transitions that were really critical to the work that we do. And each of those times, we've not only made those transitions, but we've also introduced new technologies, which have enabled us to have add more value on the devices that we're on and also expand into new ecosystems. So we've gone from movies in TV to gaming to sports to music and more recently to user-generated content. And I think that's -- the way we've been able to make those transitions is, I think, first of all, we're very clear on our role in the industry. We have a group of people that is passionate about focusing on the science and the engineering of sight and sound to bring to life these spectacular experiences and again, to meet the quality and efficiency needs of these ecosystems that we serve, which is the second thing. I think it's important to maybe just spend a moment on what I mean by ecosystem. For us, that means that while we earn revenue on a royalty for each device that includes our technology, depending on how much technology is in that device. The way we earn that revenue is by serving the needs of the artistic content creation community. We're providing them with the ability to expand their palette with our technologies audio video is their medium. We're working with everybody in the distribution chain, content owners, streamers, broadcasters, to make sure that, that -- what that creator intended can efficiently be delivered to the device. And then of course, we're working with the device manufacturer to meet their goals and objectives as it relates to kind of how they want to bring this offering to consumers. And ultimately, it's the consumer that then gets to enjoy this more compelling, more emotive experience. And that's why over 65 years, so many of the film, so much of the music, so many of the stories that people love and remember, are in Dolby and that from Star Wars to Avatar from the Grateful Dead to Taylor Swift from the World Cup to the Super Bowl, from your walkman to your home theater to your DVDs to streaming, Dolby is a part of that.

Great. And then a few years ago, I think when Robert joined, you broke out the revenue from foundational to growth products, which I think has been helpful for investors. Maybe if you could sort of give an overview of what that means to investors and sort of give us a sense of the growth -- relative growth between the products?

Yes, of course. So we now provide this breakout between foundational audio technologies and Dolby Atmos, Dolby Vision and our imaging patents to give you a sense of how to relate it to the macroeconomic environment, which has been a pretty big feature in our thinking really since the onset of the pandemic. So the foundational audio technologies include our licensed -- we have patent pool technologies where we contribute patents along with other patent holders in accordance with standards that are collaboratively established with the industry and that we innovate into. They make needs around compression and content delivery, et cetera. So that's one of the technologies it's included in foundational. And the other is our branded Dolby Audio Codex. This is where we're building these ecosystems. And again, to meet the core needs of delivery for multichannel audio might relate to a stereo or surround. And what those 2 technologies have in common is that they have been around for a little while, so they have very significant attach rates across a very wide number of devices. The point of which, as you think about Dolby's growth is that what's happening with the health of consumer device shipments overall is going to be a pretty big factor in how -- what the growth rate will be for the foundational audio technologies. Last year, that was about 60% of our licensing revenue. And we think that going forward, we think over the midterm, it can grow in the low single digits. And I'm sure, we'll talk more about that in a moment. Dolby Atmos, Dolby Vision and imaging patents obviously, health of consumer device shipments affects everything we do, but these are technologies that are well established, yet still have a lot of room to grow in attach rate, and we have been growing the attach rates of Dolby Atmos, Dolby Vision and the imaging patents. And so that category, we've been able to grow over the last 4 years at a compounded annual growth rate of about 20%. So 4 years ago, that made up 15% of the revenue. Today, it makes up 40% of that licensing revenue. And that's how to think about the foundational versus Dolby Atmos, Dolby Vision imaging patents.

Great. Maybe just kind of drilling in on that, maybe can you give an overview of against feedback on this [indiscernible]. An overview of foundational -- I think we covered that actually. Can we drill into a little bit more to Atmos and Vision and the imaging patents and maybe what that means at the consumer level and then maybe what value that adds to your ecosystem as well?

Yes. So again, at the consumer level, if we're doing our jobs, what -- you're just more immersed in the story, and it's a more emotive experience. If we take Dolby Atmos and Dolby Vision, the value, what really makes it special, I think, is that we are expanding the palette for the artist. So when we first conceived of something like Dolby Atmos and Dolby Vision, the first place we go is to the creative community. Each of those came to life via the movies and TV ecosystem. So with Dolby Atmos, when we were first demoing that to directors, I'm always looking for and even more so, the team that is doing all this work is looking for the artist that moment where they realize they can express something that they weren't able to express with the previous version of the technology. So as it relates to Dolby Atmos, I remember a couple of moments that I happen to be a part and one of them was there was a director who had shot a scene where it was a car chasing and there was a crash and the car flipped off the screen and sort of towards you and off the top screen. And he gets so excited because he didn't want to use that scene because he felt like he couldn't keep people in the audio experience. But with Dolby Atmos, he believed he could keep people in the -- Dolby Atmos is a far more specialized experience. So as -- if you were creating a movie, if you think of surround sound, which you're all familiar with, your creative control is to direct which of 5 spots in the room you want the sound to come from. If you're in a cinema with 50 speakers, it's just in group -- into group of 5, and that's coming from one of those directions. With Dolby Atmos, they are mixing the sound in a 3D interface, it will kind of look like a gaming mixing to you because you can put up to 128 objects at any one point in time in the room. And then Dolby, with our technology, we'll process that, whether it's 50 speakers in a cinema or 2 ear buds and try to replicate that as faithfully as possible. And so that's why when he saw this car flipping off the screen, he said, "Oh, now I can keep that scene and I can keep the audience in that scene." In a similar moment with Dolby Vision, where one director was we were halfway through a presentation, he just screamed in the middle of it, "Oh, now I can use night as a character" which is, I can't say that creatively, I necessarily understand, but it's the kind of thing I love to hear because I know that they're seeing that we're helping them to better express themselves. What Dolby Vision does is it provides for high dynamic range, much starker difference between the darks and the light, you get true blacks. You can allocate more between the blacks and the lights. So if there's a seam where behind me, there was a window and a skyline scene, it doesn't get washed out. You can get the skin tone, but you can also preserve the detail of what's going on in the background. And it also expands the range of color. So standard cinematic dynamic range was pre Dolby Vision was 4,000 to 8,000 to 1. Dolby Vision peaks out at over 1 million. So it's just a completely different experience, and that's why they get excited about it. And so that's why people get -- it starts with that creative passion because the content owners and the distributors, of course, they want to -- it's an important constituent to them is who's going to make the content. They want to support them in telling their stories in the best possible way and then that, of course, creates the value proposition for device manufacturers who are looking to offer the best possible experiences and stay competitive. And ultimately, it's the consumer who hopefully has one or more of those moments where, oh, gosh, I remember the first time I saw Dolby in Dolby Cinema.

You know when I listened to Rocketman in a demo, I cried personally.

Thank you for sharing. Thank you for sharing. I know your joke. But we have had A-list artists who literally when we introduced Dolby Atmos into music, our team some of them agreed to be kind of filmed had given their first react and we had more than one who broke down in tears when they heard their favorite song in Dolby Atmos. So it's just -- it's such an immersive experience. It wasn't usually their song, it was their favorite song.

Maybe pivoting to OptiView, which is a new term for what needs to be called Dolby IO, which is a newer business model for you, which is more of a SaaS model, maybe if you can provide some perspective on sort of your thoughts for that, maybe an overview of the business first and how you think about the business going forward?

Yes. So the licensing model and the ecosystem we've built is such a great model with 98% gross margins. One of the big differences between that and this Software-as-a-Service model is that the Software-as-a-Service model, we are charging based on consumption, based on the amount of content that is streamed and consumed. And in particular, we're focused on the area of mainstream sports, including sports betting and also iGaming, because our value proposition is targeted at companies that are increasingly looking to introduce or enhance the real-time interactive digital experiences to increase engagement with their audiences. So what Dolby does specifically is we have a video player that they can integrate into that experience. We provide the capability to live stream, high-quality audio video in ultra-low latency, which means we can do this in sub-seconds. So on average, and I'm sure you've all experienced this there's a delay in streaming. It can be, on average, I think it's 7 to 8 seconds, but it could go up to 20, 25, 30 seconds. We can do that in subsecond, Importantly, we can also ensure that everybody is getting it at the same and this is important because if we're trying to engage with one another on one of these apps, if I see the touchdown 20 seconds before you see the touchdown, it's not a very fun interactive experience. We've also introduced a technology, which allows for real-time ad insertion at that same rate, taking into consideration the various types of screen types and things that you might be watching on. So we're excited about this opportunity because first of all, I think sports is a part of our business across our whole business, where there is a lot of investment in improving the experience. And in particular, across the landscape, people are really focused on how to really lean into these digital experiences. Everybody wants to increase engagement with their audiences. And so we feel like we're hitting the market at a very good time with this offering.

We're in Europe with your team recently, and we're seeing some of the sporting betting shops, Paddy, [indiscernible]. Maybe give us some perspective why they would license your technology and sort of the practical use case of like when the betting window would close and how your technology sort of optimize that for their customer?

Yes. In the sports betting use case, there's a number of reasons to want consistency of delivery and ultra-latency. I mean, first of all, a lot of the betting comes in kind of late in the window. So by streaming in ultra-low latency, you're keeping that window open for 5, 10, 15 seconds longer. Secondly, in something like Paddy Power, where they are using us to stream in all their shops, it's not just a single screen, it's like it can be 50 screens with 50 different events. And sometimes, you might have the same event on here and over there. So having it happen in real time and at a consistent level is really critical to them. So yes, like I said, sports betting is one area where this is really a strong interest. And mainstream sports is also very interested in it. I mean, leagues, teams who are looking to build connections with their and all the companies that are developing around that to support those experiences. Like last quarter, we brought on board a customer by the name of Huddle & Huddle is a service and application that you can log on to watch anything from college games down to Little League and school games. So maybe some of you have experienced it. And they -- for the highest -- if it's the big 10, they're going to be charging a per view kind of fee or a subscription, but for the rest of it, they're excited to be able to use our real-time ad insertion technology to be able to get -- to be able to monetize that part of their service.

Great. Maybe transitioning to the -- I think it's maybe sometimes difficult for investors to understand. Can you give us some perspective? I know you don't disclose exact royalty rates, but from the range of royalties that maybe start with mobile devices, all the way through autos and how they might think about how you monetize this end markets?

Yes. So first of all, our end markets -- maybe I should start with the end markets. Our 2 largest end markets are what we call broadcast, which essentially TVs and set-top boxes and mobile. And then we also break out PC and consumer electronics, which are all the other devices in your home sound bars and DMAs et cetera. And then we have another category. We break out end markets when they become 10% of licensing revenue. So other notably include automotive, which is one of our fastest-growing areas, gaming, the box office share we get from Dolby Cinema. Those are the end markets. The model for device licensing is it's per shipment. So after 30 to 90 days, depending on the customer after the end of a quarter, they report how much they shipped, and we charge an amount per device each of these technologies is additional price. So if you have both foundational technologies and Dolby Atmos and Dolby Vision and imaging patents, then that's going to be a larger royalty for us. Some devices might just have a couple of those technologies. There does tend to be a correlation between kind of volume and price. So mobile is going to be -- is going to tend to be one of our lowest ASPs. I mean that could be under $1 or tens of cents depending on how much technology, whereas automotive is going to be typically our highest where you could be much higher than our average.

Maybe if we walk through some of the growth vectors, Android mobile, auto and some of the others and sort of kind of frame how you're returning back to growth. And then maybe to bolt on another one, investors have been really focused -- the question I get often is when does Dolby start really growing again? And so maybe we could kind of lead into that and remind us of your long-term growth rate and how you get there?

Yes. So let me take the second part of the question first. So we talked a little bit earlier about this construct to be foundational in Dolby Vision, Dolby Atmos imaging patents. And we started breaking that in around 2021. You might remember 2021 was the year that everybody during the pandemic bought TVs and PCs. So there was a big spike in consumer device shipments. We grew quite nicely as a result. And then since then, we were seeing declines. There was a pretty big hangover from that in '22 and even '23 and '24 device shipments were still coming down. And so that weighed on our foundational business. We saw declines in foundational over each of the last 3 years. On the other hand, Dolby Atmos, Dolby Vision and imaging patents, as I said earlier, grew on average, compounded at a growth rate of 20% a year over those 4 years, based with the same device environment, but it's just that we're getting on more cars, we're getting on more mobile devices, we're getting on more TVs. So a couple of things looking forward. One, as we came into the year, we saw the consumer device shipment outlook stabilizing. And we continue to believe that Dolby Atmos, Dolby Vision imaging patents can grow at a comp -- at a growth rate of between 15% and 25% on a year. That category is now 40% of the revenue. So it's going to have a -- it started at 15% when we broke this out in 2021. So one, it's contributing more to the overall growth rate. And two, as foundational stabilizes, that's what gives us the ability to drive growth. And that's why coming into this year, we did guide to growth this year, as you pointed out earlier. And that also is the reason between our -- part of the reason between the guiding for the increase in operating margins, which we also increased last year.

All right. And then maybe kind of transitioning to more current events just on the macro and tariffs. I know you talked about it on the last call, but if you could kind of frame the potential impact if tariffs persist on your model?

Yes. So what we said on the last call, and I'll just say right away that I don't think I would -- even today, I'm not sure I would change what I said a month ago on the last call, which is that the tariffs don't impact us significantly directly in the sense of paying tariffs. We have a little bit of cinema product revenue, but it's not material. But obviously, what's important to us is we've talked about is device shipments. Tariffs can affect that. But it's a broad range of things, tariff, trade policy more broadly, just the health of consumer spending. All of those things have an impact on ultimately how many devices are being purchased. So I guess it was about a month ago that we were doing our earnings call. Our take at that time, and like I said, I don't think it will have change significantly is as things stand, we would say it probably looks like there could be some slight headwinds from that. There are some things that mitigate it. As I said, our 2 largest categories are TV and mobile. It turns out that the point of manufacturer for most TVs, even for Chinese manufacturers is Mexico. So that's a good mitigating fact for us. Mobile, is a category where, while it's fundamentally based on units shipped, that industry tends to have a higher propensity for us of minimum volume commitments, which is to say that we're not as sensitive to in the near term to the fluctuations in device shipments. And then as it turns out auto, which is our fast-growing category for us, most of that is not -- we have -- we're just getting started really in the U.S. So we have a lot of Chinese manufacturers for China, that's not affected, and a lot of European manufacturers that are shipping into various places. So -- but still, we think it could result in slight headwinds. But the main takeaway was that could change on a dime because things are changing every day. So we widened the range. We lowered it just little bit at the midpoint, but we widened the range to reflect the fact that if there is continued escalation or dragging out, then it's really beginning to weigh on the consumer, then that could put us at the lower end of the range. And if it's -- we start seeing trade deals and it's resolved kind of at the higher end. But I would say compared to a month ago, I just -- I don't think there has been any real significant change to what I would say about that.

Great. We're coming close to the end. I'll pause here and see if there's any questions.

[indiscernible] your technology really allows audience to seriously experience your new [indiscernible] really able to take more price or like what is like the...

Well, look, I think always our goal is to get a fair price for what we're doing, and we're also trying to set it at a -- maintain that price at a rate where we can get these very high adoption rates. That's part of the value of the ecosystem is getting this virtuous cycle where the more content you have, the more devices adopt, the more devices adopt, the more content you get, and that becomes a kind of what establishes the durability of our ecosystem. So yes, of course, our discussions are always about the value of the technology. And we think we get a fair, we establish fair pricing and get strong margins and have a very durable business model where these relationships can last decades and half.

[indiscernible] like you and the end customer like are they [indiscernible] technology in their device [indiscernible].

Oh no, no, no. When we're -- when we sign on a new customer for a set of technologies and a device type, we're agreeing on the price then that's when we're agreeing on the price. And then over time, like I said, often over decades, they are shipping products against that. And then -- but of course, throughout the course of that relationship, we will have discussions about new technologies for those devices or technologies for additional devices and each one of those is where we would have the pricing discussion.

[indiscernible].

Yes. No, there in the examples I gave. So it could be -- there could also be infrastructure providers who are selling to the sports better. So that -- or for any of these -- so we could be selling to that kind of white label service provider or to the actual -- the face to the customer, the sports team, the sports betting.

[indiscernible].

Yes. In fact, the parlor is sort of a use case we hadn't anticipated, but it's an interesting one, nonetheless. But for the most part, you should think of this as a solution for digital experiences you'll be experiencing on your phones and on your PC and across all your devices, yes.

[indiscernible].

Yes, sure. So Dolby Cinema is our branded theater experience that is fully inclusive of Dolby Vision and Dolby Atmos. The U.S. is where we have our largest presence, approaching about 170 screens, and we announced at CinemaCon earlier this year doing 40 more. So we'll get to over 200 in the U.S. And then in Korea, we have a relationship with Megabox where we have, I want to say, about half a dozen screens, but they also -- we also announced an expansion there. So we're seeing more screens going to South Korea. At the same time, we talked about our entry into the Indian market. So we're going to be seeing our first 6 screens to India. The -- I mean, the cinema market is a whole subject upon itself. But the one thing I'll say about it is that where there is strength is the premium moviegoing experience. Since the 4 or 5 years ago, really since the onset of the pandemic, the percentage of the box office that accrues to premium experiences has increased significantly. And so as the industry comes out of the effects of the pandemic and the strikes and the list of things they've had to deal with, where they're looking to invest is that premium moviegoing experience and Dolby Cinema is the best way to experience a movie. So we are beginning to see a lot of interest from exhibitors now that they're kind of coming out of that period of time of where they want to invest their capital dollars is in premium moviegoing experiences.

Unfortunately, we're out of time. Kevin, thank you so much for attending our conference and for your time today. And then thank you for your interest in Dolby and the breakout room will be in Richardson upstairs. Thank you very much.

Thank you.