Dolby Laboratories, Inc. (DLB) Q4 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference call discussing fiscal fourth quarter results. [Operator Instructions] As a reminder, this call is being recorded Thursday, October 23, 2014. I would now like to turn the conference call over to Elena Carr, Director of Corporate Finance and Investor Relations for Dolby Laboratories. Please go ahead, Elena.

Good afternoon. Welcome to Dolby Laboratories' fourth quarter 2014 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories' President and CEO; and Lewis Chew, Executive Vice President and Chief Financial Officer. As a reminder, today's discussion will include forward-looking statements. These statements are subject to risks and uncertainties that may cause actual results to differ materially from the statements made today. A discussion of some of these risks and uncertainties can be found in the earnings press release that we issued today under the section encaptioned Risk Factors, as well as in our most recent report on Form 10-Q. Dolby assumes no obligation and does not intend to update any forward-looking statements made during this call as a result of new information or future events. During today's call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings press release and in the Dolby Laboratories' Investor Relations data sheet on the Investor Relations section of our website. As for the content of this call, Lewis will begin with a recap of Dolby's financial results and provide our fiscal 2015 outlook. Kevin will finish with a discussion of the business. So with that introduction behind us, I will now turn the call over to Lewis.

Thanks, Elena. And before I dive into the numbers, I was asking Kevin if we could start off with a "Let's go, Giants!" chant, but then he reminded me there could be some people on from American Century which is based in Kansas City. So instead, I think I will jump into the numbers. So good afternoon, everyone, and today I will go through the fourth quarter results in detail. I'll also recap the full year at a summary level and I'll finish up with an outlook for fiscal 2015. So let's start with the fourth quarter. Total company revenues in Q4 was $227 million versus the range we gave of $210 million to $220 million at the beginning of the quarter. Licensing revenue was $208.9 million; which was about what we originally expected. And product and services revenue was $18.1 million; which was slightly below our expectation. Licensing in the quarter grew by about $18 million over last year's fourth quarter, while products and services were down about $8 million from last year's Q4. So let's go through our major markets to discuss those trends in more depth. Broadcast licensing was the biggest contributor to the revenue above projection. They represented about 47% to total licensing in the fourth quarter. Revenues in this market increased 11% sequentially over Q3 and grew 38% year-over-year, and both those trends benefited from higher attach [ph] rates in TVs and set-top boxes as well as higher back payments. PC licensing revenues increased slightly this quarter, about 2% sequentially and also 2% year-over-year. We saw higher units reported during the quarter than we originally modeled. And PC represented about 19% of Q4 total licensing; which is a similar percentage to what we saw last quarter. Consumer electronic revenues in Q4 were about 13% of total licensing. They were down about 2% sequentially and about 12% from last year's Q4. And the year-over-year decline was mainly due to lower revenues from DVD and Blu-ray. Mobile device revenues represented about 11% of total licensing in Q4. Revenues were down about 9% sequentially and about 26% year-over-year. And these results are consistent with the comments I made about the mobile space when I gave guidance at the beginning of the quarter. Revenues in other markets; which primarily include gaming and automotive, represented approximately 10% of total licensing in the fourth quarter. Revenues were seasonally down, about 19% sequentially, but increased about 14% year-over-year, driven by Xbox One and the PS4 gaming consoles. Product and services revenue of $18.1 million in Q4 was about the same as it was in Q3, but was down $7.6 million year-over-year, driven by lower activity in mature products. Now with respect to the product revenue and our acquisition of Doremi Labs, we currently estimate that, that deal should close by early November. Let's cover the rest of the income statement for Q4. Total gross margin in the fourth quarter was 94.5% on a GAAP basis and 95.5% on a non-GAAP basis. This includes the one-time positive impact of about 2 points that came from the favorable resolution during the quarter on the costs of certain items we have relating to patents that we licensed from other companies. Product gross margin on a GAAP basis was 25% in the fourth quarter compared to 16.3% in Q3 and 18.5% in last year's fourth quarter. Product gross margin on a non-GAAP basis was 31.9% in the fourth quarter compared to 23.4% in Q3 and 25.2% in last year's Q4. The improvement was driven by lower charges for excess inventory and warranty expenses. Operating expenses in the fourth quarter on a GAAP basis were $156.2 million compared to $153.9 million in the third quarter. On a non-GAAP basis, Q4 operating expenses were $138.4 million compared to $137.4 million in Q3. Operating income in the fourth quarter was $58.3 million on a GAAP basis or 25.7% of revenue and $78.5 million on a non-GAAP basis or 34.6% of revenue. The effective tax rate for the quarter was 23.6% on a GAAP basis and 24.3% on a non-GAAP basis. Net income in the fourth quarter was $45.9 million on a GAAP basis or 20.2% of revenue and was $60.8 million on a non-GAAP basis or 26.8% of revenue. And diluted earnings per share in Q4 were $0.44 on a GAAP basis compared to $0.38 in Q3 and $0.44 in Q4 of last year. And on a non-GAAP basis, Q4 diluted earnings per share were $0.58 compared to $0.52 in Q3 and $0.57 in Q4 of last year. Let me now summarize the full year results before I get to the forward outlook. Total revenues for the year grew 6% from $910 million in FY '13 to $960 million in FY '14. Within that total, our licensing revenue increased by $72 million, which included a $25 million one-time back payment that we received in the second quarter. Products and services revenue decreased $21 million during the year. Operating income for the year was $273.7 million on a GAAP basis and $356.1 million on a non-GAAP basis. Net income for the year was $206.1 million on a GAAP basis and $267.4 million on a non-GAAP basis. And diluted earnings per share for FY '14 were $1.99 on a GAAP basis and $2.58 on a non-GAAP basis. Now I'd like to discuss our outlook for Q1 and also the full fiscal year 2015. These numbers will incorporate our estimate of the revenue and expense impact from the Doremi acquisition. So let's start with Q1. We estimate that total revenue in Q1 will range from $235 million to $245 million. And within that, we anticipate that licensing revenue will range from $205 million to $215 million and products and services revenue combined would be about $30 million. In our licensing outlook, we anticipate that PC revenues will decrease modestly and mobile revenues will remain relatively comparable with what we had in Q4. The amount of revenue we get from the Doremi acquisition in Q1 will depend on the actual timing of the close. Gross margin in the first quarter is estimated to range from 88% to 89% on a GAAP basis and 89% to 90% on a non-GAAP basis. Operating expenses in the first quarter are projected to range from $159 million to $164 million on a GAAP basis and from $140 million to $145 million on a non-GAAP basis. Other income in the first quarter is expected to be approximately $1 million, and our effective tax rate for the first quarter is estimated to range from 24% to 26% on both the GAAP and on a non-GAAP basis. So based on the combination of factors I just went over, first quarter diluted earnings per share are projected to range from $0.35 to $0.40 on a GAAP basis and from $0.51 to $0.55 on a non-GAAP basis. Moving on to the full year. For the full year, we estimate that total revenue will range from $970 million to $1 billion. We anticipate that licensing will range from $850 million to $870 million and products and services will range from $120 million to $130 million. With respect to licensing, if we exclude the one-time $25 million settlement that we received in 2014, the FY '15 outlook is up slightly for the year. Broadcast revenues are expected to grow, excluding that large settlement, and Dolby Voice; which is a new source of licensing revenue, is expected to grow. We also expect increases in consumer electronics and gaming. And then, partially, offsetting these growth items are headwinds in PC and mobile, where we do anticipate revenues to decline year-over-year. Within our products and services revenue, the biggest year-to-year impact relates to the acquisition of Doremi; which we estimate would drive $35 million to $50 million of new revenue for us in FY '15. We should also see our first product revenue from the Dolby Voice Conference Phone; which is expected to be available to customers during our first fiscal quarter of 2015. Full year operating expenses in FY '15 are estimated to range from $661 million to $671 million on a GAAP basis and from $585 million to $595 million on a non-GAAP basis. Going from '14 to '15 -- fiscal '14 to '15, the acquisition of Doremi is expected to add about $20 million of operating expense. Within Dolby, we are planning for higher selling and marketing expenses related to bringing some of our new offerings to market, and we will also record incremental depreciation expense for the new headquarters building, which we expect to occupy during FY '15. We estimate that full year gross margins on a GAAP basis will range from 88% to 89%, with non-GAAP gross margins about a point higher. And the margin trend year-over-year is driven by the higher mix of product revenue in FY '15 compared to FY '14. Other income is estimated to be around $4 million for the year and the effective tax rate for the year is estimated to range from 24% to 26%. I'd like to finish with a couple of comments about our business model and cash flows. During Q4, we generated $99 million of cash flow from operations, repurchased about $15 million of our common stock and ended the quarter with a little over $1 billion in cash and investments. As we enter Q1, we have about $260 [ph] million of stock buyback authorization available, which includes the new approval of $200 million that was announced in our press release today. We also announced that we are now starting our quarterly dividend program, and the first such dividend will be $0.10 per share and we'll pay that on November 20, 2014 to shareholders of record on November 3, 2014. Since fiscal 2010, we have returned over $1.2 billion of cash to shareholders through stock repurchases and a special cash dividend in December 2012 but, at the same time, we have been investing in a number of important programs that drive long-term growth for Dolby. And so to talk more about our progress on those growth initiatives, let me turn the call over to Kevin Yeaman. Kevin?

Thank you, Lewis, and good afternoon, everyone. We ended fiscal 2014 on a strong note, with Q4 revenue ahead of expectations. We continue to be focused on driving sustainable long-term growth by creating and enabling compelling experiences built on our audio, voice and imaging platforms. Today, I'd like to talk about our progress. First, I'll talk about how we are continuing to raise the bar on the audio entertainment experience and making that experience available through all the new ways in which entertainment content is being consumed. Then I'll cover our new offerings, which build on our expertise in voice and imaging and extend into new markets and opportunities. So starting with the audio entertainment experience. We continue to extend our presence in digital broadcast and to establish our value proposition in online and mobile services and devices. Additionally, we've had great success in creating the next generation of audio entertainment with Dolby Atmos in the cinema and are now moving this offering beyond the cinema. Broadcast has been our most consistent growth driver in recent quarters. We work with operators and standard bodies around the world to adopt Dolby solutions. This year, our TV attach rate increased to the mid-70s and 30 new TV operators began shipping Dolby Digital Plus in their set-top boxes. A big focus of our efforts continues to be the adoption of Dolby technologies in emerging markets where the transition to digital broadcast is still in progress. During the year, Dolby Digital Plus was confirmed in 5 new standards. These were in India, Russia, United Arab Emirates, Kenya and, most recently, Nigeria. These 5 countries represent over 200 million households and further expand the addressable market for Dolby. In China and India, we also continue to see development of content ecosystems. Over 2/3 of high-definition channels in China are in Dolby, and we see an increase in local TV programming. In the past year, 14 programs aired in Dolby 5.1, including The Voice of China, one of China's most popular TV shows. This compares to only 4 in the previous year. In India, we continue to see positive trends. Earlier, this year, Dolby was included in the terrestrial HD set-top box standard. This quarter, 2 additional cable networks in India adopted Dolby Digital Plus in their HD services, resulting in 12 of the leading cable operators in India using Dolby Digital Plus. Currently, more than 2/3 of HD channels in India are in Dolby. Beyond China and India, we continue to drive adoption of Dolby technologies in other parts of the world. Africa is another region where we've made a lot of progress recently. During the quarter, as I mentioned earlier, Nigeria, the largest country in Western Africa, included Dolby in their TV and set-top box standards. Along with previous standards wins in Kenya, South Africa and Ghana, we are well positioned to deploy Dolby across Africa as digital broadcast rolls out. So now let me move on to mobile. Revenue came in at 11% of licensing for the quarter, and we continue to focus on creating value in each of the mobile ecosystems. Amazon is a great example of a full implementation of Dolby technology in a mobile ecosystem. We've partnered with Amazon to enhance the audio experience in their full line of Kindle Fire tablets, the Fire TV and the Fire Phone. And with the release of our Audio API to developers last year, we see a growing number of apps using Dolby to enhance game play and the user experience. We're also really excited that Amazon is including our next-generation audio solution, Dolby Atmos, into the Kindle Fire HDX 8.9. This is the first implementation of Dolby Atmos into a mobile device. Dolby Atmos creates an amazing headphone experience that has unparalleled richness and depth. I'd like to highlight some of the other successes we've had in mobile. In the Windows ecosystem, Dolby technologies are featured in the full line of Surface tablets. Nokia's Lumia 830, 930, 1520 and Icon use Dolby technologies for both playback and surround sound capture. In the Android ecosystem, Dolby is included on a growing number of Lenovo smartphones and tablets, including the YOGA, S and A series. LG's flagship products, including the G3 and G Pro 2, also feature Dolby Audio. We are excited about what we've accomplished with our current partners and we will continue to keep you informed on our progress in these ecosystems. Turning to cinema. We've seen tremendous growth with Dolby Atmos, increasing our screens by 150% this year to over 750 screens committed globally. Providing content to these screens is a key focus, and we now have more than 200 titles released or announced in Dolby Atmos; which includes content from all of the major studios. 14 of the 15 highest grossing titles in 2014 were in Dolby Atmos and we have a strong slate for the rest of the year, including The Hunger Games: Mockingjay and The Hobbit: The Battle of the Five Armies. Continuing on the momentum in cinema for Dolby Atmos this quarter, we launched Dolby Atmos for the home. In September, Dolby Atmos was the key highlight of the leading home technology trade show, CEDIA. In addition to our own presence, Dolby Atmos was featured by leading AVR manufacturers, including Onkyo, Denon, Pioneer and Yamaha, as well as by speaker brands including Pioneer, Onkyo and Definitive Technologies. Initial reactions were extremely positive with 1 reviewer noting that, with Dolby Atmos, home entertainment consumers are about to hear their soundtracks go to 11. And of course, I couldn't resist to put in the reference to Spinal Tap, in the earnings script. So at the same time, we've announced that Paramount and Warner Bros. are among the first studios that will release Dolby Atmos' Blu-ray titles and VUDU as the first streaming service to support Dolby Atmos for the home. Now let me talk about our new offerings from our 2 new technology platforms, voice and imaging. Dolby Vision is our end-to-end imaging solution, which can enhance the imaging experience across a wide range of use cases. This year, we introduced Dolby Vision for televisions and received great acclaim at CES. Dolby Vision offers more realistic distinctions in color and brighter highlights while also delivering improved shadow details. It focuses on the quality of the image each pixel represents and is not dependent on the number of pixels. Dynamic range is now high on the agenda of content creators and device manufacturers. In the coming year, we will continue to focus on building up the ecosystem, ensuring the pieces are in place for content creation, delivery and playback in order to create the full Dolby Vision experience and the foundation of a successful business. And we expect the first TV using Dolby Vision to ship early in calendar 2015. Our voice technology platform was developed through the application of our deep expertise in audio to the area of voice. Even though voice communications has become a more important part of a wide range of use cases, it has suffered from relatively poor quality. During the year, BT launched its service, BT MeetMe with Dolby Voice, targeting the enterprise audio conferencing market. The service gives attendees the sound and feel of in-person meetings through outstanding fidelity and suppression of background noises. BT MeetMe with Dolby Voice not only provides a superior experience, it can also reduce conferencing costs for the enterprise. The Dolby Voice experience consists of the integration of our software into BT service, the mobile application and the conference phone. The conference phone, which is the last piece of the experience to become available, will start shipping in November. By now offering the full solution, we expect to see additional momentum behind the ongoing deployment of the service. There are now 25 customers who have signed up to implement the service and a growing pipeline. In summary, we grew revenue 2014 from the company overall. We continue to elevate the audio entertainment experience and extend our presence in digital broadcast, online and mobile. We're also excited about the opportunities we have in front of us with Dolby Voice and Dolby Vision. In 2015, we will continue to focus on these initiatives. Beyond that, Dolby is uniquely positioned to provide and enable enhanced experiences in audio, voice and imaging in a world where content and the ways consumers will experience that content continues to expand and evolve. I look forward to updating you again next quarter. And with that, I will turn it over to Q&A.

[Operator Instructions] And we'll go first to Yung Kim with Piper Jaffray.

You mentioned back payment in this past quarter. Could you talk about how significant that was to the upside in 4Q?

Sure. I mentioned that back payment specifically in the broadcast area. So if you don't mind, I want to remind -- I didn't put in my caveat verbiage in my prepared comments, but to remind everybody that as a total company, we always have back payments every quarter, but not necessarily in the same market segments so we try to break those out. So in the quarter, and I look at broadcast being the main provider of the -- ahead of expectation, most of that did come from, I'd call it core activities and then the rest of that would have come from the back payment. But we don't break those out separately. So hopefully, I'd given you some sense with the scale.

Okay. So it's fair to say that the core activities were the primary drivers in that segment though?

Yes. More than -- the majority of the above expectation in broadcast was from core activities, but it was helped by, also, higher-than-expected back payments.

[Operator Instructions]

All right. Listen, it looks like we answered everybody's questions. I want to thank all of you for joining us today, and we look forward to talking with you again soon. Thank you.