Dolby Laboratories - Q3 2023
August 3, 2023
Transcript
Operator (participant)
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 a question and answer session. At that time, if you have a question, you need to press star one on your telephone. As a reminder, this call is being recorded Thursday, August third, 2023. I would now like to turn the conference call over to Liz Krukowski from Dolby Laboratories. Please go ahead, Liz.
Liz Beisler-Krukowski (VP of Communications and People Experience)
Good afternoon, welcome to Dolby Laboratories' third quarter 2023 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories' CEO, and Robert Park, the CFO. As a reminder, today's discussion will include forward-looking statements, including our Q4 and fiscal 2023 outlook and our assumptions underlying that outlook. These statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today, including, among other things, the impact of current macroeconomic issues, ongoing supply chain issues, inflation, changes in consumer spending, and geopolitical instability on our business, and other risks and uncertainties specific to our business. A discussion of these and additional risks and uncertainties can be found in the earnings press release that we issued today under the section captured Forward-Looking Statements, as well as in the Risk Factors section of our most recent quarterly Form 10-Q.
Dolby assumes no obligation and does not intend to update any forward-looking statements made during the call as a result of new information or future events. During today's call, we will discuss non-GAAP financial measures. A reconciliation between GAAP and non-GAAP financial measures is available in our earnings press release and in the Interactive Analyst Center on the Investor Relations section of our website. With that introduction behind us, Kevin, let's get started. What are you seeing in the business?
Kevin Yeaman (CEO)
Well, Q3 came in about what we expected, and our outlook for the year is in line with what we shared last quarter. What we're focused on every day is driving towards sustainable double-digit growth by bringing more Dolby experiences to more people and more types of content. With our foundational audio technologies, we have a diversified base, and we continue to work to strengthen our position across each of our end markets. Over the long term, having this diversified base of revenues is a very strong position to be in. As it relates to Dolby Atmos, Dolby Vision, and imaging patents, we're focused on the design wins that drive long-term growth, and our 3 areas of focus continue to be movies and TV, music, including automotive, and user-generated content.
If I take a step back, there's just never been a time where we're seeing greater demand for entertainment content, and that's what creates opportunities for Dolby.
Liz Beisler-Krukowski (VP of Communications and People Experience)
On the focus areas you just mentioned, can you talk about progress with movies and TV?
Kevin Yeaman (CEO)
Yeah. With movies and TV, we're focused on driving adoption across all your living room devices and beyond: PCs, mobile devices. And driving that demand starts with being a part of the content that people care most about. We partner with the top creators who are passionate about continuing to push the boundaries on the experience that they're creating. There's been a lot of excitement this quarter around this summer's blockbusters in the cinema. Moviegoers can enjoy both Barbie and Oppenheimer in Dolby Cinema. We have a strong presence across movies and TV, and that includes sports. And sports is an area where we continue to make progress. Sports is, of course, a big demand driver for devices, particularly TVs.
Many of you likely love the same sports team today that you did 10 or 25 years ago, and these events are what bring communities together. People are emotionally attached to these experiences, and they wanna have the best experience however they watch in their game or their match. This quarter, sports fans were able to enjoy the French Open in Dolby Vision and Dolby Atmos, Wimbledon in Dolby Atmos on Sky Germany, and the UEFA Championship games, including the finals, where Man City took home the win, are available in Dolby Atmos. On the service side, Max launched their top-tier service, Max Ultimate, with Dolby Atmos and Dolby Vision. Now consumers can enjoy more content in Dolby across services, including HBO, Discovery, and Warner Bros.
As we've talked about, regional streaming partners and local OEMs are a significant part of the market, and so we continue to focus on increasing our presence. This quarter, TCL, who earlier this year announced that Dolby Vision and Dolby Atmos will be included in all of their new 4K TV models in the US, announced that they are expanding Dolby Vision and Dolby Atmos into all of their regional models in India. Acer launched a local line of TVs with Dolby Vision and Dolby Atmos TVs in India, and we added our first pay TV partner in Vietnam. We continue to make good progress with these regional providers. We're focused on expanding further into the lineups with our global partners, and that's what continues to drive growth in this area.
Liz Beisler-Krukowski (VP of Communications and People Experience)
Can you talk about what you're seeing with music?
Kevin Yeaman (CEO)
Yeah. Well, once again, it all starts with content, and globally, the library of songs in Dolby Atmos, from artists across genres continues to grow. Just this quarter, we added the Beach Boys, Snoop Dogg, and many more. More than 85% of the global Billboard top 100 artists continue to create music in Dolby Atmos, and we're expanding further into regional content. This quarter, Wynk Music, a free streaming service available to India Airtel's 360 million subscribers, announced that they are going to support Dolby Atmos Music. We now have three of the top five streaming services in India, and there are thousands of songs by local artists available in Dolby Atmos from the biggest music labels, including Saregama, T-Series, and Yash Raj Films.
Expanding local music catalogs in Dolby Atmos Music is important because it brings more consumers into the Dolby Atmos music experience, and it creates more value for our hardware partners, which creates for us the opportunity to gain adoption across a much wider range of devices. That includes sound bars, phones, smart speakers, and particularly automotive, anywhere that consumers enjoy music.
Liz Beisler-Krukowski (VP of Communications and People Experience)
You just mentioned several device categories where you're driving growth with Dolby Atmos Music. Can you talk more about bringing the Dolby Atmos Music experience to the car?
Kevin Yeaman (CEO)
Yeah. From the early days when we first started demonstrating Dolby Atmos Music, one of the questions we always got, whether it was artists or music labels, is: Are we gonna be able to have this experience in the car? Because people love their music experience in the car, and it's the perfect environment for Dolby Atmos Music. Our partners continue to add more models across more markets, which is increasing the availability of Dolby Atmos to consumers. Nearly half of our partners now have multiple car models with Dolby Atmos. This quarter, NIO and Lotus, which started in the domestic Chinese market, have now launched cars in Europe. Mercedes has over a dozen car models available with Dolby Atmos, and they continue to add and ship more models globally.
In just over 2 years, we went from our first announcement to having 9 car manufacturers, and it's still early days. Our current partners are still ramping up, and we continue to engage with more auto manufacturers.
Liz Beisler-Krukowski (VP of Communications and People Experience)
Today, you talked about the growing demand for different types of content. What are you seeing with user-generated content?
Kevin Yeaman (CEO)
Well, with user-generated content, more and more people are able to unleash their creativity and their storytelling. It's increasing the amount and the types of content. By bringing the power of Dolby Vision, we're enabling people to capture the experience that inspires them and to share those videos in the most realistic and lifelike way. We have great momentum in China, where people can create and share their stories on social media platforms that include WeChat, Bilibili, and QQ. From a device perspective, Dolby Vision Capture is a part of iOS globally. With Android, we have our first device wins with Xiaomi, OPPO, and vivo. This quarter, India's largest short video platform, Moj, became our latest social media platform to adopt Dolby Vision.
It has more than 300 million subscribers, and they can now create and share their stories in Dolby Vision with their iOS devices or their Xiaomi phones. We also added a partner in Singapore this quarter. Vidsy is a short film video platform that now supports Dolby Vision and Dolby Atmos, so their global community of storytellers can now create and share films in Dolby. Motorola became our latest partner to announce and start shipping their first Dolby Vision playback phone. Growing our user-generated content ecosystem is all about continuing to expand further the services, giving access to creators to create in Dolby, and that's what creates more demand for our device partners to expand further into their lineups and, of course, to bring on new partners.
Liz Beisler-Krukowski (VP of Communications and People Experience)
As you look beyond movies and TV, music and user-generated content, what else is the team working on?
Kevin Yeaman (CEO)
Well, of course, we're really excited about the areas we just talked about, but we're also always working on a number of new things. We haven't talked about gaming. You may have seen earlier this week that Sony made an announcement about PlayStation 5 and Dolby Atmos. As it relates to Dolby IO, we're seeing a lot of interest in online immersive experiences, personalized experiences that have the promise of increasing audience engagement. In particular, our ability to provide high-quality audio and video streamed in ultra-low latency, along with the ability to have natural-sounding conversations between participants, opens up a possibility of new experiences that our developers and potential customers are really excited about.
Stepping back, what's exciting is that there continues to be a tremendous amount of innovation on both content creation and storytelling, and those storytellers are always looking to push the boundaries of the, the stories they can tell. Of course, we see the same thing with our hardware partners, who are looking to push the boundaries of what's possible. That's what creates opportunities for us. We're always hard at work reinventing what it means to have a Dolby experience and bringing the experiences that are most important to people to life.
Liz Beisler-Krukowski (VP of Communications and People Experience)
Kevin, do you want to do a quick wrap-up before Robert comes on to talk about the numbers?
Kevin Yeaman (CEO)
Yeah. Well, this is our passion. It's enabling artists and the creator and all of us to tell better stories and to bring out the full emotion of those experiences. There are more types of content, there are more ways to enjoy that content, there's more ways to receive and experience that content, and across the board, that's what creates opportunities for Dolby to make a difference in each of those experiences and all the ways in which they're delivered. We're gonna continue to focus on raising the bar on the quality of those experiences. We've been doing that for decades, and I'm confident in the growth opportunities ahead.
Liz Beisler-Krukowski (VP of Communications and People Experience)
Thanks, Kevin. Robert, can you walk us through the financials for the quarter?
Robert Park (CFO and SVP)
Of course. Before we get into the details, I'd like to highlight a couple of things. First, total revenue of $298 million was in line with the guidance we provided last quarter. Second, based on what we're seeing today, revenue outlook for the year is expected to range from $1.285 billion to $1.315 billion. This results in 2%-5% growth year-over-year, also in line with what we shared last quarter. With that as context, let's turn to the details for Q3. Q3 revenue of $298 million was up 3% year-over-year. Licensing revenue was $273 million, up 1% year-over-year.
Growth in our Dolby Atmos, Dolby Vision, and imaging patent category, primarily in other markets, PC and broadcast, more than offset lower revenue from foundational audio category, primarily in mobile, CE, and PC. Products and services revenue was $25 million, up 24% year-over-year, driven by higher cinema product sales. Now, let's talk about licensing revenue by end market. As a reminder, our licensing business is based on unit shipments. We also have transactions that reflect revenue from units shipped in prior periods, which we call recoveries and minimum volume commitments, where all or a portion of the revenue for a given period is recognized upfront. These transactions are all related to unit shipments, and the only difference is timing.
Broadcast represented about 38% of total licensing in Q3 2023, up $4 million or 4% year-over-year, with higher revenue from minimum volume commitments and imaging patents. Revenue from foundational technologies were roughly flat and higher recoveries offsetting lower revenue from unit shipments and minimum volume commitments. Mobile represented about 18% of total licensing in Q3 '23, down $13 million or 20% on a year-over-year basis, driven by lower revenue from minimum volume commitments, primarily impacting foundational technologies. PC represented about 11% of total licensing in Q3 '23, up $3 million or 9% on a year-over-year basis, driven by higher revenue from minimum volume commitments and imaging patents, partially offset by lower unit shipments, primarily impacting foundational technologies.
Consumer electronics represented about 13% of total licensing in Q3 2023, down $4 million or 11% on a year-over-year basis, driven primarily by lower unit shipments of soundbars and DMAs, primarily impacting foundational technologies. Other markets represented about 20% of total licensing in Q3 2023, up $15 million or 36% on a year-over-year basis, driven by higher patent pool admin fees related to imaging patents, a higher true-up in gaming, and increased adoption of Dolby Atmos in auto. Now, let's turn to expenses and margins. Total non-GAAP gross margin in the third quarter was 87% of revenue, versus 88% in the third quarter of last year, due to a higher mix of products and services revenue. Non-GAAP operating expenses in the third quarter were $193 million, compared to $179 million in the third quarter of fiscal year 2022.
The increase was primarily driven by higher labor, timing of patent program spend, and higher travel. During the quarter, we recorded a non-GAAP restructuring charge of about $17 million in the quarter, comprised of severance and related benefits, along with charges related to the exit of a lease facility, as we continue to align resources to our most impactful opportunities and optimize our geo footprint. Non-GAAP operating income was $65 million, or 22% of revenue, compared to 26% of revenue in Q3 of last year. The non-GAAP income tax rate was 25.6%, compared to 13.9% in Q3 of last year, which included more discrete items than this year. Net income on a non-GAAP basis was $54 million, or $0.55 per diluted share, compared to $69 million, or $0.68 per diluted share in Q3 of last year.
During the Q3, we generated $121 million in cash from operations, compared to $173 million generated in last year's fiscal Q3. We ended the Q3 with about $987 million in cash and investments. During the Q3, we bought back about 295,000 shares of our common stock and ended the quarter with $237 million of stock repurchase authorization available going forward. We also announced today a cash dividend of $0.27 per share. The dividend will be payable on August 22, 2023, to shareholders of record on August 14, 2023.
Liz Beisler-Krukowski (VP of Communications and People Experience)
Thank you, Robert. With that, let's turn to FY twenty-three guidance.
Robert Park (CFO and SVP)
We continue to operate in a challenging and uncertain environment. For the full year FY 2023, we continue to expect that our revenue from foundational audio technologies will decline low single digits year-over-year, reflecting lower unit shipments in PC, CE, broadcast, and mobile, consistent with what we've said previously. We are on track to hit our target of 15%-25% growth in Dolby Atmos, Dolby Vision, and imaging patents, driven by growth in broadcast and other markets. We expect this will more than offset the declines in foundational audio that we are expecting. With these assumptions, our full year 2023 revenue is expected to range from $1.285 billion-$1.315 billion.
Within this, we anticipate licensing revenue to range from $1.185 billion-$1.21 billion, with growth in other markets and broadcast driven by Dolby Atmos, Dolby Vision, and imaging patents, outpacing the decline in PC and CE, primarily impacting revenue from foundational technologies. Products and services revenue is expected to range from $100 million-$105 million. Non-GAAP gross margin is estimated to be roughly 88%. Non-GAAP operating expenses are expected to range from $760 million-$770 million. We continue to be disciplined with our spend and review our resource envelope and allocation on a regular basis. We expect operating margins to be roughly 30% on a non-GAAP basis for the year.
We anticipate non-GAAP diluted earnings per share of $3.30-$3.50.
Liz Beisler-Krukowski (VP of Communications and People Experience)
Thanks, Robert. Any closing thoughts before we open it up for questions?
Kevin Yeaman (CEO)
Of course, we continue to make progress, are confident in our long-term growth opportunities, and believe the fundamentals of Dolby's durable operating model, balance sheet, and cash flows remain strong.
Liz Beisler-Krukowski (VP of Communications and People Experience)
All right, with that, we are ready for questions, operator.
Operator (participant)
Thank you, ladies and gentlemen. If you wish to register a question for today's question and answer session, you may do so by pressing star one. If you would like to withdraw your question, press star one again. If you are a speakerphone, please pick up your handset before entering your request. To be fair to all participants, we ask that you limit yourself to one question and a follow-up question until all participants have had a chance in the first round. If time allows, we will then come back to answer any remaining questions. We'll pause for just a moment to rearrange the queue. Our first question comes from Ralph Schackart from William Blair. Please go ahead.
Ralph Schackart (CFA Charterholder and Partner)
Good afternoon. Thanks for taking the question. Kevin, just maybe, on the macro, if you just kind of take a step back, you know, where you're sitting today, maybe, relative to, let's say, last quarter, and perhaps if you could sort of, you know, go back to when you provided the initial outlook for this fiscal year. How, how would you sort of, you know, characterize the macro now versus when you provided your, that outlook as well?
Kevin Yeaman (CEO)
Yeah. Well, I think, you know, when we entered the year, we expected that we would see lower unit shipments across the, you know, number of our end markets, particularly PC and mobile, and that's what we've seen play out. I guess I would say some of the things we were expecting at the beginning of the year have, have transpired. As I look to where we are on macro now, we're, you know, it's encouraging to see economists and pundits increasingly giving chances for a soft landing in the US. At the same time, what, you know, when we're talking to our partners, particularly in areas like mobile or PC, I would say they're still understandably cautious. It's been a dynamic period of time, and they're still working through some of those issues.
Of course, we're a global, global company, so, you know, the real feel of the economic environment differs depending on, on where you are.
Ralph Schackart (CFA Charterholder and Partner)
Okay, great. Then just, you know, looking at products and services, gross margin, looks like there's a little break in trend there. Just curious, you know, what's, what's driving that?
Robert Park (CFO and SVP)
Hey, Ralph, it's Robert here. In terms of product service gross margin, in the third quarter, the, the lower gross margin is attributable to higher excess and obsolete reserves in the quarter. If you look at, in terms of the full year, it should be closer to the mid-teens. We're not quite back to what I'd say the pre-pandemic levels, that's what we'd like to get back to. In the current period, with the volumes lower than they were the pre-pandemic levels, they are slightly depressed.
Ralph Schackart (CFA Charterholder and Partner)
Okay. Thanks, Robert. Thanks, Kevin.
Kevin Yeaman (CEO)
Thank you.
Operator (participant)
Our next question comes from Steven Frankel from Rosenblatt Securities. Please go ahead.
Steven Frankel (Director of Research and Senior Research Analyst)
Last quarter, I think one of the dynamics was some of the deals kind of got pulled in and, and signed earlier than expected. What's the environment like now as you go to do annual negotiations with some of these larger customers? Are, are you seeing them wanting to, you know, push back and, and take their time, or do you think the decision-making patterns are, are gonna return to normal?
Kevin Yeaman (CEO)
That's a tough one to generalize, Steve. I think even last quarter, we observed, you know, in the, in the latter part of last year, we had some deals that took longer, and then the first half of this year, we had some deals that came in earlier in the year. It really is facts and circumstances based, where, you know, what's the partner, you know, what's the, you know, what, what are they prioritizing? What's their dynamic? Of course, all of that is considered into our guidance for the, for the quarter and the year, which is, you know, coming in about in line with what we expected when we last spoke. You know, I think stepping back a level, what we're really focused on is, you know, are the demand signals around our key focus areas.
On that front, you know, we've been able to add the partners we're seeking to add for Dolby Vision Capture in mobile with, you know, this year, including OPPO, vivo, and Xiaomi. We've continued to add auto partners, and we've continued to make progress in TV, particularly with some of the regional partners. India was a highlight again this quarter. The demand's there, and I don't think I can generalize on deal timing, except that it, it can always vary, and the climate's, you know, about what we expected it would be.
Steven Frankel (Director of Research and Senior Research Analyst)
Okay. There was a big step-up in goodwill and intangibles for the quarter. Was that related to managing IP pools, or is there something else that you acquired in the quarter?
Robert Park (CFO and SVP)
Hey, Steve. Yeah, the, the step-up in intangibles and goodwill is related to the acquisition we talked about last quarter, which was MPEGLA, to strengthen and diversify our imaging patent portfolio.
Steven Frankel (Director of Research and Senior Research Analyst)
I think that's, I just wanted to make sure. What were, true-ups in the quarter, and were there any material recoveries in the quarter that you would call out?
Robert Park (CFO and SVP)
Hey, Steve. Yeah, the true-ups are really a non-factor for this quarter. They're positive about $1 million. Nothing really to note in terms of our, our true-ups from last quarter's volume. Of course, they vary by end device. Overall it's about $1 million.
Steven Frankel (Director of Research and Senior Research Analyst)
Okay, you know, there's, there's a noticeable decrease in the pace of the buyback versus last year. What does that say about your capital allocation, strategy, going forward?
Robert Park (CFO and SVP)
Yeah, Steve, with respect to the buyback, what we've said is our, our policy is really to, at least offset dilution from stock-based compensation. That's what you're seeing we're doing right now, is executing on that plan. Last year was a little accelerated or a heightened level of buyback. For this year, we're kind of going with the policy of offsetting our dilution.
Steven Frankel (Director of Research and Senior Research Analyst)
Okay, then on the restructuring, can you give us any details on kind of what particular areas you were de-emphasizing or, you know, projects you might be pulling people off of versus areas where you're investing?
Kevin Yeaman (CEO)
Most of it, Steve, it, it was across a range of areas, and they were areas that we'd identified for efficiency across a broad range of areas. I wouldn't, I wouldn't attribute it to any one project or initiative. Some of it was facilities related. And so nothing that is directly... Certainly no, nothing as it relates to a change in any of the business focus areas we've been talking about.
Steven Frankel (Director of Research and Senior Research Analyst)
Okay, great. I'll jump back in the queue. Thank you.
Operator (participant)
Our next question comes from Jim Goss from Dolgie. Please go ahead.
Speaker 6
Hi. I don't, I got on a couple of moments late, so maybe I missed this, but I didn't hear a lot of comment about music, and I'm wondering if there were any further developments in that particular application.
Kevin Yeaman (CEO)
Yeah. We talked about the fact that, you know, we continue to add artists and songs, great momentum on the, on the artist side. We did add a new service in India, Wink, which, you know, we now have three of the top music services in India and a, and a large catalog of local music with, with three major labels. So, on the, on the content and services side, a, a lot of progress. That's what creates the demand for the device side and all the ways that people experience music. On that front, we noted that NIO and Lotus, who had initially launched in China, have now launched in Europe. Mercedes launched more models.
You know, we continue to have strong engagement, a strong pipeline for bringing more auto manufacturers on board.
Speaker 6
Okay. Are you seeing this, these applications as having any significant impact in terms of any of the licensing revenues or in any, any other way?
Kevin Yeaman (CEO)
Yeah, well, if we look at it on, you know, it's always best for us, I think, to look at this on an annual basis, and automotive has consistently been one of the categories Robert highlights as a driver of increases in other markets. And that's, you know, that really is a result of Dolby Atmos in cars. You know, other areas for music, of course, are soundbar, speakers, et cetera, that falls in our CE category, which, you know, on the foundational side, has lower unit volumes this year, but then that's being partially offset or being, yeah, that's being offset to some extent by increased adoption of Atmos and Vision, and some of that would be driven by music.
Speaker 6
Okay. Is that gaming another 20%, roughly equally split then between gaming and automotive?
Kevin Yeaman (CEO)
We haven't broken the categories out yet, but it is, as you point out, it's gaming, it's automotive, it's Dolby Cinema, that to contribute to that category, also our patent administrator fees for our licensing pools. Those are the categories and, you know, when they rise to individually large enough, then that's when we would make it a category of its own.
Speaker 6
I see. You're very focused on Atmos and Vision, which you should be, obviously, and that's, increased penetration is driving the company right now. We always look for the next big thing. Are there any things more that can be done in terms of sound quality and placement that mere mortals are probably not considering right now? It always seems that something might come along, and I'm just wondering if your engineers are developing things that might not be obvious on the surface, that could create that extra category or even a nuance that can command some higher royalty rates in the future, say, with the top-level products.
Kevin Yeaman (CEO)
They're always focused on, on the next thing. We, we just had our, our tech summit a couple weeks ago, and it's a combination of tech talks, kind of a, a hackathon, if you will, of top ideas. And, you know, the, what, what they're doing and that week, and hopefully what they're doing year- and I believe what they're doing year-round, is, yeah, they're looking at the current state of technology, the future state of technology, what types of experience is that gonna make possible? Obviously, we engage across the ecosystem, whether it's creators, content owners and distributors, and, you know, where hardware manufacturers are pushing the boundaries and looking to solve the problems that are gonna pave the way for that next, that next set of experiences.
You know, in that respect, you know, there's a, there's a lot of things that, that go into that equation of the types of things you're thinking about, whether it's where, you know, AR and VR take us, what the implications of AR, AI are, but that's, that's what they are always thinking about. Yes, we have a lot of things we're excited about.
Speaker 6
Okay. Well, thank you. Thank you very much.
Operator (participant)
I will now turn the call over to Kevin for closing remarks.
Kevin Yeaman (CEO)
Okay, great. Well, thank you everybody for joining us today. We look forward to updating you again soon.
Operator (participant)
Ladies and gentlemen, that concludes today's call. Thank you for all joining. You may now disconnect.