Dolby Laboratories, Inc. ($DLB)

All right. Let's get going. Great. Well, thank you, everybody, for joining us today. My name is Vik Kesavabhotla. I lead our research coverage of Internet and media here at Baird. Very excited to be hosting the conference this week. And right now, it's my pleasure to welcome Dolby to the stage. Joining me up here is Robert Park, CFO of the company.

I think we have about 30 minutes scheduled for this fireside chat, plenty of things to get through. So we'll dive right in. Robert, let me start off by saying thanks for joining today. Appreciate you being here.

Great. Thanks for having me. Great to see you last night too.

Yes, it was good. Great day in New York. So let's start off with this. I mean, when I think about Dolby, obviously, you touched a lot of different parts of the media ecosystem, creators -- content creators and then the OEMs as well. Maybe to start off for those who are not as familiar with the company, if you can start talking about how you work with those different partners in the ecosystem and the value proposition you provide to all these players.

Yes. Thanks, Vic. When you take a step back for Dolby, a lot of people have heard about the Dolby brand, but very few people know what we do and how we make money. So I'd like to start off with 3 things you need to know about Dolby. The first thing is where a global trusted standard embedded in billions of devices around the world. That's with our foundational technologies, and I'll talk about that a little bit later. The second thing is we've got a deep technology moat rooted in decades of professional science. We're the leader in the science of sight and sound. And the third thing that's really good that Vik just talked about is our place in the ecosystem entertainment for creators, distributors and end market OEMs. That is the key to our success, and that's what's kept us durable for the last 6 years. And what we do for creators, we help creators tell their stories with immersive entertainment experiences. They can tell their stories in a powerful way, bringing users and their audiences closer to the movie to the TV shows, to the characters, to the songs and more recently, to live sports, and we help them do that through immersive sound and through immersive video with our Vision technology. For distributors, they want eyeballs, they want subscribers. They want the best audio and video quality there is for their subscribers, and Dolby Atmos and Dolby Vision provide that for them. And then finally, where we make our money today, is on the end market. And so for the end market devices for TVs, mobile phones, PCs, and more recently in your car, to be able to play back that Dolby Atmos and Dolby Vision experience, you need that license, you need that technology in your device, and that's what we do. And that's where we provide the OEMs, is providing that superior audio/video on that device.

Yes. When you look back to the last 60 years, so much has changed about technology and the way that we consume all these products. And one thing that stay consistent, you guys have stayed relevant in the ecosystem throughout the time. What is it about the company, the processes you have in place that has allowed the technology to stay relevant throughout all these changes?

That's a great question. So Dolby has been around longer than I've been alive, I'm not going to tell how old I am. Barely. Thanks, Peter. It's been around for 60 years. Pushing entertainment experiences for the last 6 years. And if you remember, I remember because I saw it in the theaters, 1977, Start Wars: A New Hope. Dolby revolutionized how audio is played in the theater by the first major movie using Dolby Stereo. It really changed how audiences listen to sound in a movie theater and what changed and fundamentally changed how theater owners changed all their sound equipment to handle 4 channel audio. That's front, back, left right. And then if you remember in the '80s, I don't know how many you are live in the '80s, do you guys remember this? This is my -- this is called the Sony Walkman for those of you who don't know. You can't play Spotify on this. It had what's called a Dolby Noise Reduction. It says right on the front. They would put Dolby Noise Reduction. What that was is if you play in a consent tape back in the '80s, it had [indiscernible], it's just analog. It's an awful his. It's kind of humming in the background. Dolby using their signal process figured out a way to eliminate that analog hit. And so when you turned on Dolby Voice Reduction, you could hear just the music. And it was so impactful that if you guys remember, some of these devices had a button, Dolby Noise on Dolby Noise off, that was only there for marketing. So you can hear how terrible sound without it and you press the button and it sound better with it. Why would you not want to have it on, but it was a way to show the contrast of Dolby technology. And so over the last 6 years, Dolby has gone through analog to digital, movies and film to DVDs to Blu-ray to streaming, to mobile, and it's always been on the forefront, enabling high-quality audio and video throughout that process, and we're always trying to be in the forefront. And if we think about our name Dolby Laboratories, we spend a lot of money in R&D. People wonder why we spend such an R&D. It's because we always want to be in the forefront of where entertainment is going and not be behind.

And so maybe we'll talk about the way you monetize all of this right now. You talked about that predominantly the way you do it right now is through licensing with the end market. And when I think about that licensing business, right, there's the foundational piece and then there's Dolby Atmos, Vision and Imaging. Maybe for the benefit of those here, if we can talk about each of those components and talk about how you think about growth rates of those different parts of the business right now?

It's a great question. So about 90% of our revenue, a little over 90% is licensing revenue. And so we came up with the construct, a framework to help people understand the different growth dynamics of that licensing. It's not a monolithic licensing model. So the thing I talked about before about being a global trusted standard embedded in billion of devices, that's called our foundational technologies, foundational audio technologies. These are audio patents, audio codecs that our standards across the world, that are embedded across buildings and devices, think of it as an index for consumer electronic devices. 90-plus percent attach rates across devices around the world. In '21, that was about 50% of our licensing revenue. Today, only about 20% because the other part is growing much faster. And I think of that as growing low single digits, flattish. This year will be slightly down, but it kind of grows up and down with unit shipments [indiscernible] growth. Dolby Atmos, Dolby Vision and Imaging patents revenue is the second part that we broke out separately in the this framework is because they're driven -- yes, they're tethered to device shipments, but growth is more on getting more and more devices. For an example, for 4K TVs, we're about 30% penetrated with Dolby Atmos and Dolby Vision. That's 70% to go. We're highly penetrated at the high end of 4K TVs, and we're getting more and more penetration in the mid- to lower end. We'll talk about that, how we're doing that in a little bit. For mobile phones, we're on IOS deep and wide, trying to get on more and more Android devices. We're on 4 of the 5 top hand makers in China and getting on more and more devices, again, starting at the high end and wanting to get pushed down lower in the market. And then other, speakers and other things who are we're trying to get attach rates on all those things.

Yes. And so when you look at all those different end markets...

that's going about 15% this year.

When you look at all the different end markets that you're involved in right now, what are some of the trends that are standing out to you across the different industries? And what does your end market exposure look like today across those businesses? .

Yes. Our largest market today is broadcast TVs. I mean, TVs is a large piece of our business. We see that in terms of unit shipment, it's kind of flattish, kind of stable. Our second largest market is mobile. Mobile is an area of 1.4 billion devices out there. And as I said before, our goal is to try and get more and more of the devices with Dolby Atmos and Dolby Vision. And how we do that, we'll talk about that in a little bit. And then our third largest end market is other. And in other has Auto Dolby Cinema Gaming, but Auto is becoming a very larger component of our revenue as we just got started about 3 years ago. and we're about 40 OEMs in and growing and growing and Atmos, Dolby Atmos in the car and also Dolby Vision are a natural place to fit and Auto for us is a market that's growing and getting more meaningful.

Yes. So maybe let's follow up on auto then because it does seem like it's becoming a more significant part of the business over time. What are some of the most significant points of progress in that end market for you recently, updates you have? And what's your vision for where auto can go over time for Dolby?

Yes. What's interesting about auto is auto really came about our investment in the Dolby Atmos ecosystem with music. Dolby Atmos Music and getting music created thousands and thousands of tracks created in Dolby Atmos, we you need place to listen to it. And for auto, you think about auto today. Auto today for most daily drivers, the in-cabin experience is the most important factor in buying a car. Horsepower doesn't really matter anymore because you get tickets. Range is not an issue because that's fairly solved pretty quick. The in-car experience is more and more becoming a really big powerful piece of buying a car. And cars are now differentiating that in-car experience with the infotainment. And infotainment is very important. And Dolby Atmos fits perfectly into that factor. It's hard to explain how much better. I mean, I'm sure you thought Dolby Stereo stranded pretty good. But once you hear Dolby Atmos, do these demos all the time for both creators, the likes of JZ and others, labels to have them listen to it and also the carmakers. When I sit with the engineers, I sit with engineers from Mercedes, and they came to our lab, and they told me that they hit a ceiling, even with all the audio and endures that they had, they hit a ceiling of how good the music could sound, not loud, and we can make music loud. You have to make it down transparent. It's come through you, not at you, the clarity, no distortion. All the things audio files care about, they could not -- it was a math problem. They just could not get it any better. with Dolby Atmos, they said, we just help them break through that ceiling. And they started with the Maybach. They started with the S-Class, and I'm sure all you guys own one of those. And since then, they've pushed it down to 15 different models where most humans can afford. In the U.S., we have Lucid, Cadillac. In Europe, we just won BMW recently. We've got Mercedes, Volvo, Polestar. In Korea, we've got Hyundai and Genesis. And in China, we've got BYD, [indiscernible], Neo, and we're adding more and more OEMs just about every quarter. And what they typically do is start at the top and then they start pushing with a premium because Dolby is considered a premium experience. But over time, what we want to -- we don't want to democratize that experience. We should think everyone should experience it, push it down to the lower end cars. Think about the rearview camera. When the review came first came out, you only got that with the highest package, the highest models. But you can't buy a car today without review camera. It's just necessarily. Our hope is that over time, of course, Dolby Atmos is the only way to listen to music or podcast and sports in your car and watch it with Dolby Vision. We have Dolby Vision primarily in China because China has the infrastructure to stream video into the car. Don't have that yet in the U.S. or in Europe. But we believe, over time, that will happen. And for those of you who sit [ shot gun ] or sit in a Waymo, you can watch video in your car with Dolby Vision and Dolby Atmos.

Yes. And so one of the things you referenced earlier in the discussion, too, is some of the changes that you've ran to the TV experience. And specifically, you guys recently launched Dolby Vision 2. It would be great if you could talk about what is different about Dolby Vision 2 and what's improved in that offering there?

Yes. So I talked about the fact that Dolby Atmos and Dolby Vision are about 30% of 4K TVs today, again, very highly penetrated at the high end of TVs, not as much in the mid- to low end. That's because a lot of TV OEMs want to maintain that Dolby Vision and Atmos experience at the top end. They want you to buy the expensive TVs. While TCL and Hisense, kind of changed that a little bit by implementing and adopting Dolby Atmos across their lineup. And that put a lot of pressure on the top end. Well, what we had to do was 2 things to solve a Dolby Vision 2. The first thing Dolby Vision solves is a technical ability to have Dolby Vision capabilities in a lower NTV, lower components, lower chipsets, lower panels, lower components. We were able with our Sydney processing expertise and use of AI to make that happen to make a great experience with lower and technical. So they didn't have to change their [ BOM ] to upgrade it to the television standards. That was one thing typically. The second thing we offered was Dolby Vision 2 Max, which you put on the high end, which still allows differentiation from the mid- to low to the high end. So for those manufacturers worried about cannibalization of someone buying a $2,500 TV now buying a $500 TV with Dolby Vision 2 Max, the Max is even better, better color, brightness control, motion control, less jetter. That's a technical term for shaky screen. The bigger the screen it gets, the more shaky you get, particularly with fast movement. And what Dolby Vision 2 does even for lower TVs is eliminate the jetter, especially for high-motion activity. So the technical solve was for the ability to do it. And the marketing sale was the ability to have differentiation at the high end and TV should be launching at the end of this year. So there's some adoption and TVs will start shipping into this year.

Yes. And I think you announced some partners that are already using Dolby Vision committed to using Dolby Vision do? Who are some of those so far? And how is that influencing your discussions with the industry?

Yes. So over time, we're going to get more and more distributors and streamers to adopt Dolby Vision 2 once it's out in market. We got Peacock doing that, particularly if you're watching live sports. It's great because you're watching live sports. Of course, that's -- most of it is fast motion. You want that motion control to be really great on those large TVs, and we've got more in the pipeline to add. But the more -- again, this ecosystem is what makes our business so durable, and our moat so wide is it's hard to replicate the entire ecosystem. It's not just a technology for technology's sake.

Yes. So one of the other things you guys have talked about is you've seen more and more adoption with the social media platforms as well. Can you talk about the latest updates there and why some of those platforms has really started to engage more with Dolby.

Yes. So for us, mobile is our second largest market, and it's a large market. And to strengthen that ecosystem, in order to have the value proposition to have Dolby Vision on the phone, unique creators, and we've got creators influencers, creating content with Dolby Vision. And now we've got a great partnership with Meta, who adopted Dolby Vision, both on the Facebook and Instagram properties. And if you think about Meta on decision-making, it wasn't just because they like the Dolby Vision, they did test. There's a blog out there, if you want to see of what process they went through to determine what to use for these platforms. And you can read it. It's a lot of technical stuff. But at the end of the day, what they found was that their influencers -- and are not their influencers, their viewers, their users spent more time on platform when it was in Dolby Vision than it was on a large task, large-scale test. So for them, it's very compelling to have that. And there's many reasons why that might be. One of the reasons is Dolby Vision creates a consistent experience throughout. So have you ever done reels or shorts, I don't know if you guys do that eye-candy stuff, but as you scroll through, depending on the content that comes in, the brightness can be super bright or dark. And if you're in a room or in an airplane like I was today or yesterday, it's bright, you're just going to get off. It's just -- it's knowing it's in a dark room. But Dolby Vision, it makes it more consistent. So your eyes don't have to adjust to dark, bright, depending on the content and the content type that comes in, and they thought that was very compelling. It was also a hard problem to solve because of all the various types of content where it comes from, the standards, all those things that come in where Dolby is very good at doing that. So having Meta with Facebook and Instagram and Douyin in China, which is the TikTok of China, adopting it creates that value proposition, and we call it should inspire more mobile OEMs to adopt Dolby Vision because they want their users to have the best experience possible.

So on that piece, I mean, when you get the head of adoption from the social media platforms from the streamers that you mentioned, what is that process of then having that translate into the business and getting the end markets to adopt this more broadly across these OEMs?

Well, it's twofold. One, when we go to the OEM and say, you should adopt Dolby Vision into your phones all the way down the line up because your buyers aren't going to have that experience. They're spending a lot of time on these platforms. And if they're spending a lot of time on these platforms, they should have the best experience, or they'll buy this one over here that has it, and your users will really appreciate that. So it's that pressure us to have them do it. But also, I think there's going to be pressure for the platforms to go to the OEMs, particularly the big ones and say, "Hey, my users on your phone are not having a great experience. You need to put this in there. We're doing it, you should do it too." And I think over time -- and this is just -- these are recent announcements in the last couple of quarters. We think over time or anything about patient should get into the cycle of more and more adoption.

I mean it's only been a couple quarters. Are you seeing any signs at this stage that it's starting to affect the discussions at all or move the needle on that front?

We have -- we're engaged with all of them.

Yes. So maybe taking a step back and thinking about the macro environment here. It's a topic that we get a lot of questions from investors. When you look at some of the factors out there, consumer spending. Right now, I think memory pricing is a big topic as well. What are you seeing out there in the market and how it's affecting the different environments that you operate in?

I read the same thing you all read, consumer sentiment is low. Consumer sentiment is low. It's been low, it's been low due to persistent inflation, high oil prices, yet consumer spending is surprisingly resilient. I don't know what that says about the consumer, but spending is still there. And what we found, and we see this year, is unit shipments are relatively flat in a market where you would think with persistent inflation and low consumer sentiment that things would drop things are relatively stable in terms of unit shipments. There's plus and minuses here and there. In terms of memory prices, we don't see a lot of impact on TVs. For TVs, I think memory is a smaller component of the [ BOM ] where panels and other components are much more a bigger part. Where we see potential is in mobile, and mobile, obviously, memory is a larger component and an important component for mobile. And it depends on OEM to OEM, what their strategy has been, their ability to procure chips, make our own chips, what they're going to do, push the price to the consumer, eat the price. Every OEM has a different approach to the memory challenges coming up, and we'll see how that plays out. For Dolby specifically, our Dolby end market, the way we do business with mobile is primarily through minimum volume commitments. So mobile handset makers will commit to a volume to get a price, and they'll commit to that for the year or longer. So these are ways for them to predict their costs and to get a better per unit rate. And so we haven't seen as much of an impact for our mobile. Our mobile is still going to grow this year despite the memory, but we are watching the headwinds. I think the takeaway is, yes, the factors point to turbulence, but we don't see things dramatically different than they were 3 months ago.

And when you look at the full year that you guys have for this year, how have you gone about incorporating that in the guidance for the year?

Yes. So we incorporate all this into our guidance. If you recall, when we gave guidance for the rest of the year, we maintained our guidance for the full year, but we didn't change the range. Typically, when you have 6 months behind you, you would think you would shrink the range because you only have 6 months to go. But given the uncertainty and given the challenges in the marketplace, we kept the range the same, but maintaining what we see.

Yes. So when we started the conversation, you said the way you predominantly make money right now is through the OEMs. And I think that was alluding to some of these newer monetization initiatives that you guys have in place that, I think, have been gaining traction in the past quarters. It'd be great if we could talk a little bit more about some of these newer ways that you're monetizing the technology that you have. One of those, I think, is Dolby OptiView. So great if you could talk a little more about what that is and how that's going.

Yes. So you're right. If you take a step back, over 90% of our revenue is licensing, and that's predominantly through device shipments. So people have to buy devices for us to grow in that respect. We have a couple of areas where we are diversifying and increasing the TAM for our revenue and that's OptiView and the video distribution program. And those are 2 things that are not tethered to device units and allow us to grow revenue despite device revenueships. I'll start with the VDP. The is our way of licensing our imaging patent technology to streamers. And you'd say, "Why are you doing that?" Well, one, you can all see the growth in streaming. There is a growth in streaming. And there's increased recognition that high-quality modern codecs, video codecs are important and critical to their service and critical to their success, and we've created a structure to do that. Without the structure, what you would do with licensing patents is a [indiscernible] since patents one at a time. Those are called bilaterals. We have 30,000 patents. You can imagine the friction and inefficiencies are trying to license. Both our license orders and licensees licensing those patents. So we created a pool with excess advance of about 40 licensors, contributing their patents to this pool so that licensees can license this video technology through [indiscernible] and kind of an all you can eat. So they have to worry about individual patents coming at them at various times. Very efficient licensees. I call them industry-friendly pricing, and very efficient for a stores as well. And so we're starting to see adoption. And now these programs generally start with you have critical mass of licensors providing their assets into the pool, and we have that now. SK and Sharp joined last quarter. So more and more recognition that this is a real program. And then licensees start to go as we go to market and educate and inform and license the technology. And we've got half a dozen licensees so far. But we just got started just a couple of quarters ago, and the pipeline remains pretty strong on this. The second thing you talked about is Dolby OptiView. Dolby OptiView is our ability to -- we have both the player and the back office to create ultra-low latency and high-quality audio and video, particularly in sports and sports entertainment. What we're focused on is creating customized views, highlights and content to the year based on needs. What does that mean? Well, with traditional broadcast, it's the one to many. Everybody sees the same view. Everybody sees the same content with sports. With streaming, you can do one to one. You can have your stream to that individual customized based on their user preferences, behaviors, other things. Think about -- for those of you who play Fantasy Football, like I do, I'm terrible at it, I still like it, is I only care about my local team, which is the 40 [ Diners ], but I like to watch the other teams for my players. So [ Josh Allen ], one of my players typically. And I don't really care about the team he plays on. I don't care what the bills. I care about how he's doing. So I'd like to see in my content, more highlights from Josh Allen, whoever is on my team, you can do that with streaming. And we've demonstrated this at NAB last year and got a lot of interest from football leagues, motor sports. Think about your favorite F1 driver. Think about your favorite GP motorsports driver. If you like [indiscernible], they're never on TV, but we can make it so you can see them on TV. They only see the top 3 typically who are in the race. We can help customize that using AI by creating -- getting the data to understand behavior, preferences and customizing that content for them real time with low latency and high quality.

Yes. So you mentioned these really just started as initiative story, but where do you see those going over time? How big are the part of the business can this more consumption-based monetization go? And what are the key blocking and tackling that's going to be required to get there?

Yes. So we see this -- we can anticipate both these parts of our business, which are not tethered to devices being around 10% of licensing within 3 years. We've got the pipeline. We've got a lot of residents, a lot of product market fit. We've got big customers with OptiView, the NFL, NASCAR, SIS, Genius Sports. So the thing is to start at the top and then you start kind of land and expand. You start here, you add customization, you add services, and add more layers as we normally would and build it over time.

Yes. So clearly, I mean, as we talked about -- throughout this conversation a lot going on in the business right now, what would you say are the biggest investment priorities for the company right now? And when we think about this year's margin guidance, I believe, is 34%. What are the puts and takes that will affect margins as we go forward when you think about investments, but also things can drive operating leverage in the business?

Yes. The nice thing about Dolby is there's a lot of operating leverage in our model. We've got 90% gross margins, 95% licensing margins. So when you see growth, a lot of it not -- we don't have to spend as much money as our growth, as that revenue rose. Our focus now is focused on the areas of growth for us, which is auto, mobile, TV, Dolby Vision 2, OptiView and the VDP. So we're making sure we allocate resources to make sure increase the size of success and ensure we're on the right track.

Yes. And past few quarters, it's also -- not just the past few quarters, but you guys are doing a fair amount of share repurchasing as well with your balance sheet. You guys have a reasonable amount of cash built up, no debt on the balance sheet. How are you thinking about capital allocation as you go forward from here?

Yes, I've been told I have a lot of cash and no debt, which is a kind of a nice problem, and I think we throw off $350 million to $450 million operating cash flow. Yes, we have a nice balance. I think of capital allocation in 3 ways. One, first, investing in the business. If that means investing in R&D, investing in new product with 33%, 34% operating margins, if we wanted to compress this we could, we have the [indiscernible] to do that if we saw there's a nice outcome for that. So we look at investing in the business first. The second thing we look for is attractive M&A opportunities out there. We don't do a lot of M&A, but when we do, it's usually around patents or cloud technologies. We bought these imaging patents from GE a couple of years ago, and that's what helped drive that VDP program we have today. We have imaging patents, but we bought more. We're looking for other patents that are out there, the next-generation technology. These patents and standards migrate over time, if you will. It started with ABC a long time ago, which are still valid. HEVC today, which is high efficiency video codec, which is driving the high-quality video at half a bit rate. The next one down the road is VVC, which is the same high-quality video at half the bit rate of HEVC. But these things take time for the ecosystem to adopt, and we want to get them on the front of those and find those assets that are 5, 10 years out. That's how we became relevant today. If we just started buying assets today for what's relevant today would cost a lot more than it was 10 years ago. So getting them while we know how to drive them, bedroom is important for us. And then for cloud, we bought a player OptiView because with the player, we can impact what the viewer looks like for -- that's the front end. What actually is playback, using someone else's player has more -- it's one more integration we have to do. So we don't need to do the integration. We own it. And our partners really appreciate that because we're end-to-end now. The viewer, which is what the subscribers see and the back end to make the ultra-low latency audio and video happen. So those are kind of the areas that we think of M&A and then whatever giving back to shareholders through dividends and buyback. Yes, you did notice that I think I bought back in the first 2 quarters of this year as much as I did the entire prior year because we see an opportunity of undervalued stock, and we wanted to take advantage of that. But we will continue to do that. We do that every quarter. We look at it every quarter. We've had a dividend program for 10 years. I think you've increased at almost 10%. Every year except one. So we get back to shareholders their money as well.

I think we're just about up on time. It's probably a good place for us to wrap. Robert, thanks so much for being here today. Thanks, everyone, in the room as well, and we'll leave it there. Thanks, everybody.

Thank you.