Dolby Laboratories, Inc. (DLB) Q3 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call Discussing Fiscal Third Quarter Results. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in the question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded, Wednesday, July 25, 2018. I’d 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.

Thank you. Good afternoon. Welcome to Dolby Laboratories third quarter 2018 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 captioned Risk Factors, as well as in our most recent 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 on 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 2018 outlook, and Kevin will finish with a discussion of the business. So with that initial behind us, I’ll turn the call over to Lewis.

Thanks, Elena, and good afternoon, everyone. Total revenue in the third quarter was $317 million, of which $286 million was from licensing, and $31 million was from products and services. And both of these were in line with the guidance that we provided at the beginning of the quarter. So let me go through a few details on our licensing revenue by end market. Broadcast represented about 33% of total licensing in the third quarter. Revenues in this market were down by about 11% sequentially and 7% year-over-year. The sequential decline was mainly attributable to seasonally lower volume from TVs, as well as lower volume of set-top boxes, and the year-over-year decrease also reflected lower volume of set-top boxes. Mobile devices represented approximately 23% of total licensing in the third quarter. Mobile was up sequentially by about 14% and up year-over-year by about 20%. In both cases, the growth in mobile was driven by higher adoption of our technologies into more devices. PC represented about 17% of total licensing in the third quarter. On a sequential basis, PC was up by more than 50%, mainly from timing of payments, and on a year-over-year basis, PC was up slightly on higher volume, but partially offset by declining ASP due to mix. Consumer electronics represented about 14% of total licensing in the third quarter. CE licensing increased by about 13% sequentially and about 8% year-over-year and the increase in both cases was driven primarily by higher activity from DMAs. Licensing in other markets represented about 13% of total licensing in the third quarter. In this category we were down by about 9% sequentially, but up year-over-year by about 3%. The sequential decline was attributable to a seasonal drop in revenues from gaming, partially offset by growth in other areas and the year-over-year increase was driven by higher revenue from Dolby Cinema, Dolby Voice, and Gaming offset partially by a decrease in recoveries in automotive. Product and services revenue was $31.1 million in Q3 compared to $28.2 million in Q2 and $27.6 million in last year's Q3. Cinema products and Dolby Voice both grew over the last year. So let’s move on to margins and operating expenses. Total gross margin in the third quarter was 89.1% on a GAAP basis and 89.6% on a non-GAAP basis. Product gross margin on a GAAP basis was 34.5% in the third quarter compared to 31.2% in Q2, and product gross margin on a non-GAAP basis was 37.5% in the third quarter compared to 34.6% in Q2. Operating expenses in the third quarter on a GAAP basis were $188.2 million compared to $184.1 million in the second quarter and operating expenses on a non-GAAP basis were $170.8 million in Q3 compared to $166.3 million in the second quarter. So operating income in the third quarter was $94.8 million on a GAAP basis or 29.9% of revenue and was a $113.8 million on a non-GAAP basis or 35.8% of revenue. Other income in the quarter was $1.8 million for both GAAP and non-GAAP, and this includes the non-cash write-down of approximately $3 million related to an equity investment. The effective income tax rate for the quarter was 13.8% on a GAAP basis and 14.4% on a non-GAAP basis. So net income, net income on a GAAP basis for the third quarter was $83 million or $0.78 per diluted share and that compares to $0.73 per diluted share in last year's Q3, and net income on a non-GAAP basis in the third quarter was $98.9 million or $0.92 per diluted share that compared to $0.86 per diluted share in Q3 of last year. During the third quarter, we generated over $140 million in cash from operations and ended the quarter with over $1.2 billion in cash and investments. We bought back about 900,000 shares of our common stock in Q3 and had about $60 million of stock repurchase authorization at the end of June. So combining that with the announcement today that Board is authorized an additional repurchase of up to $350 million of our common stock, means that we currently have about $410 million of stock repurchase authorization available going forward. We also announced today a cash dividend of $0.16 per share, which will be payable on August 14, 2018 to shareholders of record on August 6, 2018. So now let me provide the outlook for the fourth quarter of the year and of course the full-year along with that, and I’ll start with the full-year. For the full-year FY2018 we are maintaining the same midpoint of revenue guidance that we gave last quarter, but with one quarter to go tightening the range around that midpoint. We anticipate that full-year revenue will range from [$1,170,000,000 to $1,180,000,000]. Within that, we estimate that licensing will range from [$1,040,000,000 to $1,050,000,000] and products and services will be approximately $130 million. Here are some of the factors that are embedded in that full-year outlook. We anticipate that broadcast revenues for the year will be flat to down as higher revenues from consumer imaging will be offset by lower recoveries and lower volume from set-top boxes. Mobile will be up significantly over last year due to higher adoption of audio and consumer imaging along with a positive impact from a large recovery we got in Q1. PC licensing is expected to be down, while consumer electronics licensing is expected to increase. And the other licensing category is also projected to be up, benefiting from growth in Dolby Cinema, Gaming, and Dolby Voice, offset partially by lower recoveries for the year. And product revenue for the full-year is expected to be up. Full-year gross margin is projected to be around 88% plus or minus on a GAAP basis and about 89% plus or minus on a non-GAAP basis. Full-year operating expenses are expected to range from $744 million to $748 million on a GAAP basis, and from $670 million to $674 million on a non-GAAP basis. Other income is estimated to range from $10 million to $11 million for the year that would be $10 million to $11 million of course. And a full-year tax rate on a GAAP basis is expected to be around 67% plus or minus, and this of course includes the large tax accrual that we booked in Q1 that was related to the U.S. tax reform. On a non-GAAP basis, the full-year tax rate should be around 20% plus or minus. Our Q4 estimates are as follows: we anticipate that total revenue will range from $265 million to $275 million, and within that, we estimate that licensing will range from $2.25 million to $2.35 million, while revenue from products and services is projected to be around $40 million. Q4 gross margin on a GAAP basis is estimated to be around 86% plus or minus and the non-GAAP gross margin should be about a point higher. Operating expenses in Q4 on a GAAP basis are projected to range from $195 million to $199 million and from $176 million to $180 million on a non-GAAP basis. Other income is anticipated to be around $3 million for the quarter and the effective tax rate is estimated to range from 20% to 23%. Based on the combination of the factors I just covered, we estimate that fourth quarter diluted earnings per share will range from $0.25 to $0.31 on a GAAP basis and from $0.40 to $0.46 on a non-GAAP basis. Now let me turn it over to Kevin. Kevin?

Thank you, Lewis, and good afternoon everyone. We’re making progress on many fronts and I want to start by highlighting the momentum for the combined Dolby Atmos and Dolby Vision experience. This quarter, Apple announced that Dolby Atmos will be supported on Apple TV 4K and in iTunes. Of course, Dolby Vision is already supported by Apple and iTunes already has over 300 Dolby Vision titles. The Apple TV 4K now becomes the first DMA to support both Dolby Atmos and Dolby Vision. Earlier this month, Microsoft announced that it will be supporting Dolby Vision on the Xbox One. So this becomes the first gaming console to support both Dolby Vision and Dolby Atmos. And the first mobile phone with the combined Dolby experience was launched by Sharp in Japan. At the end of June, NTT Plala began streaming in Dolby Vision and Dolby Atmos to these phones. Along with the progress this quarter, there are many OTT providers streaming in both Dolby Atmos and Dolby Vision, including Netflix, VUDU, Rakuten, Tencent, and iQIYI and the combined experience is now on TVs from six OEMs, including LG, TCL, and Hisense to name a few. I’m very excited about the momentum with our combined Dolby Vision and Dolby Atmos experience. And beyond this, Dolby Atmos continues to gain traction. For example, Amazon will be streaming in Dolby Atmos to Fire TV and Fire TV Cube in addition to a variety of other compatible devices, including TV, sound bars, and home theater systems. Tom Clancy's Jack Ryan, a Prime Original will be the first title in Dolby Atmos and Prime Video. We also are seeing more and more adoption in live broadcast. The World Cup was carried in Dolby Atmos by broadcasters in Brazil, Russia, and China to name a few. We continue to make progress in live sport trials and our other new formats as well. This quarter, live Dolby Vision trials were done with the French Open to iOS devices, as you know Apple's iPhone 10, iPhone 8, iPad Pro, and Apple TV 4K have been supporting Dolby Vision since earlier this year. Also with the French Open, we partnered in trials with Dolby Atmos and AC-4 live streaming to Samsung and Huawei phones. Dolby Atmos is now available on a broad range of devices, including TVs, PCs, smartphones, tablets, AVRs, and sound bars at a wide range of prices. This quarter, Lenovo launched two new PCs with the Dolby Atmos speaker system. With this solution, we partnered with Lenovo on the layout of its subsystem and speaker design to deliver a truly great Dolby Atmos experience. Let me touch a little more on Dolby Vision. Alibaba's YouTube recently began streaming in Dolby Vision, and as a result, the top three OTT services in China now support Dolby Vision. We continue to see Dolby Vision being adopted in the mainstream TV models. We have nearly 15 Dolby Vision TV partners and TVs are now available at a price point as low as $350. The first PCs with Dolby Vision are now shipping from Lenovo and more Blu-ray players are coming to market from partners, such as, Sony, Panasonic, and LG. Let’s turn to Dolby Cinema. This quarter, we announced several new partners around the world. We are expanding our presence in Europe with two new partners. We are bringing Dolby Cinema to the UK for the first time with Odeon Cinemas Group, starting with seven locations. Also this quarter, Kinopolis announced it will be opening the first Dolby Cinema in Germany. We are also happy with the progress of Dolby Cinema with Gaumont Pathe and since opening its first Dolby Cinema in France in October, now they have nine screens open. Earlier this week, we announced our first partner in Kuwait. Kuwait National Cinema Company will be opening its first Dolby Cinema under the Cinescape brand. In total, we have about 160 screens open today and we reached the milestone with AMC this quarter as they open their 100 Dolby Cinema. In total, we have over 390 Dolby Cinema locations open or committed around the world. The content pipeline for Dolby Cinema continues to grow with over 180 titles in Dolby Vision and Dolby Atmos announced or released. We continue to see support from all major studios and recent releases include; Ant-Man and The Wasp and the Incredibles 2. We look forward to working with our partners to continue to make the best moviegoing experience more broadly available around the world. And on Dolby Voice, we did begin shipping our newest offering Dolby Voice Room at the end of the quarter and we are encouraged by the initial pipeline activity. So to wrap up, I am pleased with our results this quarter. We are seeing continued momentum in both content and devices for Dolby Atmos and Dolby Vision, including momentum in the combined experience. We’ve added several new Dolby Cinema partners this quarter and expanded our reach to consumers around the world. All of this creates opportunities for increased revenue growth and broadens the number of people that will enjoy Dolby experiences. I look forward to updating you next quarter. And with that, we will turn it over to Q&A.

Thank you, ladies and gentlemen. [Operator Instructions] Your first question comes from Ralph Schackart with William Blair.

Good afternoon. First question is on OpEx. OpEx was better than we had modeled, I think than you have sort of thought for the quarter. Just curious if you under spent in the quarter relative to original plans, and if there is any push of OpEx perhaps into next quarter?

I’d say Ralph – this is Lewis. That in any given quarter, we can have some of that, so yes, in this quarter we had a little bit of that. Also, I’d say this quarter, we are probably at the lower end of what we’ve modeled for foreign exchange. You may remember that last quarter, I highlighted that we’re seeing some fluctuations in foreign exchange. But beyond that, I think we are pretty much on tract. I think certainly we have programs that we modeled out for the year that can shift from one quarter to the next, yes.

Okay. Great. And then Kevin, sort of give you the usual question that you get at this point, just give us some thoughts on – or continued thoughts on your plan to march back to sustainable double-digit growth and serve an update what do you think about the new products during this year for selling plan to double those revenue streams?

Yes. We continue to be focused on returning to sustainable double-digit growth. I talked about some of the highlights from each of the new initiatives and we are really pleased with the progress. I really love to see the combined Dolby Atmos and Dolby Vision experience coming together and with so many services and so many devices. That bodes well for both of those initiatives. The progress in Dolby Cinema in Europe is really great to see. So I'm excited about that. So yes, we see the revenue from new initiatives on track to be about double. And that’s a big part of plain, obviously to get back to double-digit growth. We also this year have continued to see good strength in the core audio business. So that’s the big part of the equation as well. So we are not ready to give guidance for next year obviously, but if we can continue to grow the core business, which we believe we can, and we see strength there. And combined with the fact that really these new initiatives are each in pretty early innings. We feel good about how things are shaping up.

Okay. Great. Thanks Kevin.

Next we’ll here from Steven Frankel with Dougherty.

Hi, good afternoon. I know, Kevin, you don't like to talk a lot about what’s in the product pipeline. But the last three or four years, we focused on these new initiatives and you've launched them, you got a ton of momentum behind them. Maybe at a high level, could you lay out some of the things where the timing of what might come next?

Well, I guess to a quote you, I don't like to talk about products we haven't announced or released yet. But we do have a very strong culture and a strong pipeline of innovation at Dolby. I think that having over the last many years, expanded from what was primarily audio licensing entertainment to audio-visual experiences across entertainment and communications or surface area, so to speak, it's much broader. And that will give us the opportunity, I believe, to improve many more audio-visual experiences. And that both – and by that, I mean both contracts. So I think, I talked before about some of the very interesting early work and that we have going on in music. And then, of course the ways in which consumers experience there audio-visual. So the pipeline is strong. We certainly intend to find new experiences to improve, and we're confident we'll be able to do that.

Okay. And then on the Cinema business, now that you've reached this milestone in AMC and you've a pretty good install base, could you give us any sense of same-store sales growth or how your per screen averages are performing relative to how you model them when you got into the business?

Well, I guess, all I can really say about it at this point is that the – our per screen averages are very strong and we're very pleased about how that's going, both in absolute terms and in terms of what we came into expecting.

Okay. And then the last quick one on Voice, so you talked about the momentum around huddle rooms. Is there any momentum in the first way you entered the market with the partners like BTE or should we really think about this as a – it's a huddle room product that where you're going to make it as this business scales up?

I think it's fair to say that huddle room is where we see the – is what we're focused on most in terms of the growth opportunity and that simply because it's an area that people are investing in. They're both investing in more huddle rooms generally, they're investing in the ability to have collaborative audio-video experiences in those huddle rooms. Some of these rooms don't yet have the equipment to support that. Others have very complicated equipment. And so the reason we're very much focused on that is because, we think, that it's the right product at the right time for that market.

Okay, great. Thank you.

[Operator Instructions] We do have a question from Paul Chung with JPMorgan.

Hey, guys. Thanks for taking my question. So just on broadcast, can you help us size the emerging market opportunity and how big is this opportunity about TVs and set-top boxes for both audio and vision? Can you just kind of reaccelerate growth after two years of flattish results in broadcast? I know that vision will start to layer in more meaningfully probably next year?

Yes, sure and I think we – with our guidance coming into the year, we knew that we had some difficult comps on some of the recoveries in broadcast, that was one factor. TV volumes have not grown significantly. And while we do continue to have opportunities to increase the attach rate in emerging markets, we haven't seen a lot of growth in the overall TAM. And I think what it would take to spark that, perhaps if there was a big upgrade cycle around UHD, which is clearly an area where we were having great success with, not just our historical Dolby Audio products, but with Dolby Vision and Dolby Atmos. On the set-top box side, I would say that that tends to come more in ebbs and flows based on the timing and plans of the individual pay-TV operators. So what we saw last year was a pretty significant upgrade cycle in China for IPTV services. And I said earlier, we are the top three OTT providers in China, great adoption of both Dolby Atmos and Dolby Vision. This year, there were a couple of rollouts that we actually thought would have happened right now. It looks like those have been pushed out a little further, but we feel very good about just the amount of engagement and activity we have with operators around the world and their plans for set-top box rollout. It's just a little – it's always been a little bit harder to predict because it has so much to do with the timing of their bulk purchases as they go-to-market and do their rollout.

Gotcha. And then on Mobile, we've got some really nice momentum with Atmos and Vision adoption. Nice little step up here in 2018 revenues. So how should we think about longer term, maybe next year, is this going to be – the TAM is obviously a lot larger and then the broadcast or do you see this kind of moving forward?

Well, I think that mobile is a – it continues to be a big opportunity for us. I mean, we've gotten some very significant wins this year with Apple's adoption of Dolby Vision, and Samsung and Huawei adopting AC-4 and Dolby Atmos on their phones. It's been a really important year for us as far as that goes. So we're focused, like we always are, on making sure that we now deliver as much content as we can to those devices, deliver on the value proposition, which these partners are signing up with us which is to deliver a better experience. We think we can do that and we think that that is going to create a lot of opportunities throughout the mobile market.

Gotcha. And at this stage, it seems like eventually overtake your broadcast segment at some point. Do you see that happening in your long-term that company goal model?

Hey Paul, it’s Lewis. It's too soon to say something like that. Both of those markets are not only critically important to us, but both markets that were doing very well, and so I'd like to so both of those grow, quite frankly. And it seems like having two kids, that they're both important to us.

And then lastly, I have just one quick housekeeping on accounts receivable. What's been driving the jump this fiscal year, is there kind of a structural change in cash collections? Thank you.

Sure. I would not say that there's any change structurally. And in fact, if I look more narrowly at quarter-over-quarter from Q2 to Q3, our revenue was up like $16 million, but AR was only up $9 million. So certainly our day sales outstanding and our collection techniques have not fundamentally changed. Over time, you will see some shifting of things, but nothing I could point to that problem.

Thank you very much. End of Q&A

That will conclude today's question-and-answer session. I will now turn the call over to Kevin Yeaman for any additional closing remarks.

Great. Well, thanks everybody for joining us today. And we look forward to talking to you again soon. Thank you.