Dolby Laboratories, Inc. (DLB) Q2 2015 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call discussing Fiscal Second Quarter Results. [Operator Instructions]. As a reminder, this call is being recorded Tuesday, April 21, 2015. I would now like to turn the conference over to Elena Carr, Director of Corporate Finance and Investor Relations for Dolby Laboratories. Please go ahead, Elena.

Good afternoon. Welcome to the Dolby Laboratories' second quarter 2015 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 our earnings press release that we issued today under the section captioned 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 of the result of new information or future events. During today's call, we'll 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 Web site. As for the content of this call, Lewis will begin with a recap of Dolby's financial results and provide our fiscal 2015 outlook and 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, good afternoon everyone, thanks for joining our call. Let's get right to the numbers. Our second quarter revenue was $271.9 million and within that total licensing was $243.3 million and products and services were $28.6 million. Like to make a quick comment on the comparison of licensing revenue year-over-year, last year in Q2 total licensing was $258.6 million but that included a one-time back payment settlement of $24.7 million, so if I exclude that notable item from the comparison then our total licensing would be 4% higher than last year's Q2. The breakout of this year's Q2 licensing by major market is as follows, broadcast represented about 42% of total licensing in the second quarter. Revenues in this market were up sequentially by about 14% mainly due to seasonality and year-over-year Q2 broadcast licensing was down about 15% due to last year's notable back payment that I mentioned a minute ago, so excluding that item from the comparison broadcast licensing was up about 8% over last year driven by higher unit volume in TVs and set top boxes. PC revenues represented about 17% of our total licensing in the second quarter. They were up by about 14% sequentially as one of our large customers reported higher units than we had projected for this quarter due mainly to timing. Year-over-year PC licensing was down about 2%. Consumer electronic revenues in Q2 were about 15% of total licensing, they were up about 22% sequentially driven by seasonality and year-over-year consumer electronics increased by about 8% due to higher back payment and higher volume in certain products such as sound bars offset partially by lower revenue from Blue Ray and DVD. Mobile devices represented about 11% of licensing revenue in Q2, they were down about 19% sequentially and about 14% year-over-year. The sequential trend was driven by a higher timing of revenues in Q1 relating to a customer contract and this is consistent with what we had projected at the beginning of the quarter when we provided our Q2 outlook. Revenues in other markets represented approximately 15% of total licensing in the second quarter and were up by about 34% over Q1 mainly due to seasonality. And on a year-over-year basis other markets grew about 14% in Q2 as we saw higher revenues from gaming and Dolby Voice and via. Products and services revenue was $28.6 million in Q2 which was $11 million higher than Q1 and $8.6 million above last year's Q2. Both trends were about what we had projected and were driven by sales of Doremi products, since we acquired Doremi labs in Q1 earlier this year. Total gross margin in the second quarter was 90.8% on a GAAP basis and 92% on a non-GAAP basis. Product gross margin on a GAAP basis was 20.7% in the second quarter compared to 5.1% in Q1 and 29.3% in last year's second quarter. Product gross margin on a non-GAAP basis was 29.6% in the second quarter compared to 17.2% in Q1 and 35.8% in last year Q2. The improvement from the first quarter to second was driven by higher volume. Operating expenses in the second quarter on a GAAP basis were $168.2 million compared to $161.3 million in the first quarter and on a non-GAAP basis operating expenses were a $149.5 million in Q2 compared to a $141.7 million in Q1. Operating income in the second quarter was $78.6 million on a GAAP basis or 28.9% of revenue and a $100.7 million on a non-GAAP basis or 37% of revenue. The effective tax rate for the quarter was 26.7% on a GAAP basis and 26% on a non-GAAP basis. Net income in the second quarter was $58 million on a GAAP basis or 21.3% of revenue and was $74.9 million on a non-GAAP basis or 27.6% of revenue and diluted earnings per share in the second quarter were $0.56 on a GAAP basis, compared to $0.40 in the first quarter and $0.73 in Q2 of last year. On a non-GAAP basis Q2 diluted earnings per share were $0.72 compared to $0.56 in Q1 and $0.88 in Q2 of last year. Cash flow from operations was a $164 million for the quarter, as a reminder last quarter I highlighted the fact that cash flow from operations in Q1 was unusually low because of timing issues in receivables and accrual. And as is often the case those issues reversed course in Q2 such that our year-to-date cash flow from operations is back to more typical level for us and cumulative number through two quarters is a $167 million. During the second quarter we repurchased about $15 million of our common stock and have $227 million remaining of our stock repurchase authorization. We also announced a cash dividend today of $0.10 per share which will be paid on May 12, 2015 to shareholders of record on May 4, 2015. As of the end of Q2 we have slightly more than a billion dollars in total cash and investments which includes cash and cash equivalent as well as both short and long-term marketable securities. So looking forward here's the outlook for Q3 and the full year. In the third quarter we estimate that total revenue will range from $230 million to $240 million. Within that we anticipate that licensing revenue will range from $200 million to $210 million and products and services revenues combined would be about $30 million. Within the Q3 estimates we anticipate that our PC licensing revenue in Q3 will be down by about 20% year-over-year due to lower mix of optical disk and we also anticipate that mobile will remain at around 11% or 12% of our total licensing. Gross margin in the third quarter is estimated to range from 89% to 90% on a GAAP basis and 90% to 91% on a non-GAAP basis. Operating expenses in the third quarter are projected to range from a $167 to $171 million on a GAAP basis and from a $148 to a $152 million on a non-GAAP basis. Other income in the third quarter is expected to be approximately $1 million. And our effective tax rate for the third quarter is estimated to be around 26% on both the GAAP and non-GAAP basis. Based on a combination of the factors I just went over diluted earnings per share in the third quarter are projected to range from $0.27 to $0.33 on a GAAP basis and from $0.43 to $0.49 on a non-GAAP basis. Moving on to the full year, we are maintaining our estimate of total revenue for fiscal 2015 at range of $970 million to $1 billion. Within that we anticipate that licensing will range from $865 million to $885 million and products and services will range from a $105 million to a $115 million. Full year operating expenses are estimated to range from $660 million to $670 million on a GAAP basis and from $585 to $595 million on a non-GAAP basis. We estimate that full year gross margins on a GAAP basis will range from 89% to 90% with non-GAAP gross margins about a point higher. 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 25% to 26%. Now I’d like to turn the call over to Kevin Yeaman, Kevin.

Thank you Lewis and good afternoon everyone. We had a solid quarter with strong performance in broadcast, and with mobile coming in right about where we expected. Today I'd like to spend a few minutes updating you on progress we've made on our new initiatives, which played important role in our plan to deliver long-term, sustainable growth. I'll start with Dolby Cinema which brings Dolby Vision and Dolby Atmos together to deliver the ultimate movie going experience. I'm excited to say that we've announced two key Dolby Cinema partners this quarter, AMC Theatres and the Walt Disney Studios. Let me start with AMC, we announced that we'll be partnering with AMC to deploy Dolby Cinema at AMC Prime across the United States with four sites up and running by May and up to 10 sites by the end of the summer. The first sites will be installed at some of the highest grossing complexes in the country and will result in a fantastic platform to extend the Dolby Cinema program. Over time we are looking to work together to deploy a 100 Dolby Cinema at AMC Prime sites. Of course every great cinematic experience needs a great content. We are thrilled that Disney and Pixar are the first studios to announce their commitment to create Dolby Vision theatrical titles for release in Dolby Cinema locations. These include Tomorrow Land, Inside Out and the Jungle Book with Tomorrow Land being released next month. Dolby Vision combined with Dolby Atmos pulls movie goers more deeply into the story through breathtaking sound and captivating images. We're excited to be working with AMC and Disney to deliver the total cinema experience. I'm pleased that Dolby Cinema is off to a strong start and I look forward to keeping you up to date on our progress. Let me turn to Dolby Atmos, which continues to get to get broadest option in the cinema and beyond. There are now over a 1,000 screens committed globally and more than 275 titles released or announced in Dolby Atmos. 13 of the 15 highest grossing titles in 2014 were in Dolby Atmos and we have a strong slate of titles in 2015 including upcoming titles such as The Avengers: Age of Ultron and Antman. Dolby Atmos for the home also continues to gain momentum, Dolby Atmos is included in AVRs and Home Theatre in a Box system from Denon, Onkyo, Marantz, Pioneer, Integra and Yamaha. Dolby Atmos enabled speakers are currently available from Pioneer, KEF, Triad, Atlantic Technology, Definitive Technology and Onkyo and we expect more product launches throughout the year. Last quarter I mentioned that the first Dolby Atmos Blue Ray title had been released, now I'm pleased to report that there are around 25 Dolby Atmos Blue Ray released or announced from studios such as Paramount, Warner Brothers, Lionsgate and Universal including Gravity, American Sniper and the Hunger Games Mocking Jay. Dolby Atmos continues to be adopted in mobile devices to create immersive audio experience on the go. Our solution creates a richer and more compelling experience over headphones or speakers. This quarter Lenevo announced three new Atmos enabled mobile devices, the Lenevo A-7000 which is the first Smartphone to include Dolby Atmos as well as two Lenevo A-Series tablets. We are also seeing applications for Dolby Atmos in virtual reality. This quarter we announced that we are partnering with Jaunt a provider of virtual reality content to enable the next generation of immersive story telling in cinematic virtual reality. The precision placement of audio objects in virtual reality allows content creators to ensure that viewers always know what is happening and where it is happening. Dolby Atmos is a perfect solution for this new and growing experience. Now let me update you on Dolby Vision, we recently reached a significant milestone as the first TV with Dolby Vision was announced by Vizio, the new Vizio reference series will feature Dolby Vision and is the most sophisticated and technologically advanced television made by Vizio. Dolby Vision is of course our end to end imaging solution which gives creative teams the freedom to use the full gamut of colors, brightness and contrast resulting in an enhanced entertainment experience. On the content side Warner Brothers have announced that will be mastering titles in Dolby Vision for home distribution. That first slate of titles will include Edge of Tomorrow, Into the Storm and the Lego Movie with initial distribution via VUDU Wal-Mart's video on demand service. Turning to Dolby Voice, our partnership with BT continues to gain traction with about 50 customers signed up. The service transforms conference calls by giving attendees the sound and feel of in person meetings. During the quarter BT MeetMe with Dolby Voice launched in Asia Pacific and Africa and so is now available globally. The Dolby Voice solution is also being made available in more used cases as BT has integrated the service into its Cisco WebEx and Microsoft Lync services. We are excited about the continued momentum with Dolby Voice and recently Gartner analyst Steve Blood said it best when he tweeted that he had died and gone to audio conference heaven after a demo. So with that let wrap up. Even as we continue to roll ahead in the core business with broadcast, mobile and gaming we're really excited about the adoption of our new offering from our audio imaging and voice platforms. We're seeing widespread adaption of Dolby Atmos in both the cinema and the home with additional applications emerging. With Dolby Voice an increased number of customers are signing up for the service and our solution is being applied to broader used cases. Dolby Vision is coming to theatres through Dolby Cinema and to the home with the announcement of the first television from Vizio. We've made a lot of progress this quarter on our new initiatives and this gives us confidence that we are on the path to drive sustainable long-term growth. I look forward to updating you again next quarter and with that I will turn it over to Q&A.

Thank you ladies and gentlemen. [Operator Instructions]. And your first question comes from Steven Frankel with Dougherty.

I was hoping to get a little more detail on cinema and perhaps you could start with how many titles do you think you'll have in Dolby Cinema in calendar '16?

In calendar '16?

Yes.

So we did talk about 10 by the end of the summer, right, and we're working to get over time a 100 with AMC, we haven't disclosed the number for 2016 but look I think going from deploying 10 between now and the end of the summer gives you a sense for the pace at which we're able to do this even at an early stage and we're a 100% focused on making the four that we're targeting in May and the 10 by the end of the summer, a spectacular experience because if we do that then I'm confident that there's going to be demand and we're going to be able to roll these out and address a broader audience.

Right, Kevin my question was on the content side, how many films do you think you'll have next year. When you don't have a film can the exhibitor put whatever they want unprocessed in their Dolby Cinema?

Right, so right now we have the first three titles, obviously our goal is to have a healthy slate of titles in Dolby Vision and Dolby Atmos, that allow for a regular rotation of films through the top screen, that’s our goal ultimately. In the meantime yes we do envision allowing the exhibitors to have the flexibility to bring titles to screens.

And then let me sneak in one last follow up which is, what capital expenditures [indiscernible].

Steve, this is Lewis, it's still early but we figured somebody would want to get some gauge so for the first four theaters which are the ones that are really on the slate right now we anticipate that that'll be somewhere in the neighborhood of a $3 million to $4 million investment by us to get those rolling and over time we'll keep you posted on how that progresses because obviously those are the first four.

Our next question from Ralph Schakart with William Blair.

Kevin I was wondering if maybe you could give us a little bit of perspective on some of the recent R&D ramp and spend and then I think historically you've talked about at some point the R&D will moderate and we should see more commercial wins and or more products, sustained longer term revenue growth, are you thinking perhaps maybe 2015 might be sort of the ramp or the peak year for R&D spend and maybe some of sales and marketing continues to support those efforts into 2016 but maybe if you could give us some perspective on those dynamics.

Sure, so, we're pleased that we are seeing a number of those early wins that we talked about looking for as we look to move these businesses to scale, with wins that we just talked about in Dolby Cinema with AMC and Disney, with Vizio for Dolby Vision, great progress in Dolby Atmos, and as it relates to the spending directly let me start by addressing total operating expenses. The peak actually was really three, four years back when we were increasing OpEx at a rate of about just around 15% annually, we brought it down to 10% last year, this year we are looking at something single-digits and that includes having brought on the Doremi acquisition which was virtually the entire year of spending from there, so we have been in total bringing those expenses down and within that we are regularly allocating resources based on which projects are getting traction in the market and allocating between research and development, sales and marketing as the market really leads us to do. So, we believe we have begun to moderate, we have in fact moderated the rate of growth we're very conscious that the spend levels, obviously the reason we're doing this, we stated this, is because we believe that in addition to the growth we have in front of us in the core business in areas like broadcast and mobile we look to these new initiatives to be an important cornerstone of how we return to long-term sustainable growth. You know this year I said we will see, we are seeing some revenues as you know from Dolby Voice, we'll be seeing some revenue from Dolby Cinema, what I would like, what I believe is that across this portfolio of initiatives that we have in play right now with Dolby Cinema, Dolby Vision, Dolby Voice, the combination of these new initiatives will be, we expect, I expect them to be a factor in our growth rate for 2016.

We'll take our next question from Mike Olson of Piper Jaffray.

Just following on kind of your last comment there Kevin, if you look at Atmos, Vision, Cinema or Voice, not to make you kind of rank your initiative, but which do you feel has kind of the potential to have the most material impact to revenue most quickly. In other words I guess what would you suggest we should be focusing most on these various initiatives as far as, as you just mentioned potential revenue impact in 2016.

Yes, I do, I get asked this internally as well and I do refuse to pick my favorite child, I'm excited about each of these initiatives, I think the answer to your question has a lot to do with all of them have the potential at this point for hitting revenue growth curve and it all comes down to making sure that these first experiences for our customers in the case of Dolby Cinema as we bring the four screens up for Tomorrow Land, as we get to the 10 by the end of the summer, Inside Out comes into play, we are -- if we have what we believe we can do which is really spectacular experience then that's what will drive the pace of adoption and the pace of revenue growth, we absolutely believe that that we have a real opportunity here to build a sustainable profitable business. With Dolby Voice, the pipeline is building really nicely and we're seeing the pipeline shift toward much larger enterprises and so the key for revenue growth and the pace of revenue growth there is going to be all about the adoption cycle, as you know these are large enterprise accounts and adoption cycles it is time for us to sink our teeth into some of those larger accounts with BT and get the adoption going and that's what I think will determine the pace of adoption there, and you know as it relates to Dolby Vision, obviously the big milestones they have the first announced television with Dolby Vision, I think that also has a lot to do with the broader market, the good news is HDR is clearly on everybody's agenda, we were very early to recognize that, we've been in the game for five -- seven years really. And so as a result we have the most complete and highest quality solution available for the playback of consumer HDR content. And like most of our areas of focus that requires great content, it requires playback and on the content side we're well on our way to broad adoption on the creative and distribution side, publically Warner has come out and talked about their plans for Dolby Vision content for the home, we just couldn’t be more thrilled that Disney has come forth with support for titles in the cinema and we've got broad engagement across the creative and distribution community and that's no small feat and it's a requirement to succeed in something like HDR. When I look to the playback side we’ve got our first public win, we're really excited about that and again we have a complete solution that's implementable today, highly flexible, adopts to a very high level of contrast and color gamut and puts what we think will be a way to generally acknowledge HDR would be a big part, will be the wow factor for wherever ultra high definition settles out and we have a solution available today. So I think at that pace we'll have a lot to do with the industry pace, but it's clearly getting started. All of these opportunities, I mean when I look at our platforms in audio with Dolby Atmos in imaging led by Dolby Vision and voice communications led by Dolby Voice each of these platforms we think all of them have the opportunity to be as large, larger than any of the markets we talk about today. So our focus right now is get the initiatives that rest on each of those platforms to scale starting with the initial wins which we're seeing through now and so we have to make, we are focused like I said on making those first customer experiences as often as we know we can make them and that what's going to drive the pace of additional adoption and revenue growth. So again net at the end of the day as I look forward from where we're at right now I do expect the portfolio of these initiatives even if I can't, it is a portfolio and I think if I look at them as a portfolio I do expect that the combination of these initiatives will be a factor in the growth rate we look at for 2016.

If I can sneak in one other quick one, is there anything you can say about how Dolby's technology may or may not be incorporated in the upcoming release of Windows 10?

No, I don't think, as usual we're just not in a position to announce things that aren’t ours to announce.

[Operator Instructions]. We'll now go to Steven Frankel with Dougherty.

Kevin, think I'll follow up on [indiscernible] comment, if you're at 50 customers today what would that have been in the last quarter.

Well so first of all 50 customers signed up right, they're in various stages of deployment, or preparing for deployment and I think the number, I think the last number we gave was a couple of quarters ago and it was around 20.

Is in the 20.

I don't think we have any other questions. So, well, thank you all for joining us today and as always we look forward to keeping you up to date throughout the quarter and when we speak again next quarter, thank you.