Dolby Laboratories Inc (DLB) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal results. During the presentation all participants are in a listen-only mode. Afterward you will be invited to participate in a question-and-answer session. (Operator Instructions). As a reminder this call is being recorded Thursday, July 25, 2013.

I would like to turn the conference call over to Alex Hughes, Senior Director of Investor Relations for Dolby Laboratories. Please go ahead, sir.

Thank you, Heather. Good afternoon. Welcome to the Dolby Laboratories' third quarter fiscal 2013 earnings conference call. Joining me are Kevin Yeaman, Dolby Laboratories President and CEO, and Lewis Chew, Executive Vice President and Chief Financial Officer.

On this conference call we will be making forward-looking statements that include projections of future operating results for our fourth quarter and fiscal year ending December 27, 2013; market trends and developments for the industries in which we compete, and in the broadcast, PC, consumer electronics, mobile, cinema industries in particular, and our expectations and beliefs concerning how those trends affecting our operating results; the capabilities and marking acceptance of our products and technologies, expectations relating to licensing arrangements, and our strategic and operational plans and objectives.

These statements are based on management's current expectations and assumptions that subject to risks and uncertainties. Actual results may differ from materially from those set for in such statements. Important factors such as general economic, PC, broadcast, consumer electronic, mobile or cinema market conditions could cause actual results to differ materially from those in the forward-looking statements. These factors are addressed in the earnings press released that we issued today and under the section captioned Risk Factors and elsewhere in our most quarterly report on Form 10-Q available www.sec.gov, or on our website at dolby.com under the Investor Relations section. Dolby disclaims any obligation to update information contained in these forward-looking statements, whetheras a result of new information, future events or otherwise.

During this call we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings release and in the Dolby Laboratories investor relations data sheet on our Investor Relations section of our website.

As for the structure of this call, Lewis will begin with a recap of Dolby's financial results and provide our fiscal 2013 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, Alex. Good afternoon, everyone. During my segment of call today I will provide comments on the third quarter that we just completed, and also provide an outlook for the fourth quarter of the fiscal year. And let me start that off by discussing our revenue for the quarter we just finished.

In the third quarter total Company revenue was $207 million, and within that licensing revenue was $184.7 million, which was down $41.8 million sequentially from Q2 of fiscal 2013 and up $3.8 million year over year from Q3 of fiscal 2012. In general the sequential decline in licensing revenue was driven by seasonality, while the year-over-year improvement was driven by increases in mobile and broadcast, offset partially by declines in PC and consumer electronics.

Here is some additional detail on our licensing revenue and the various end markets we serve. Broadcast represented about 38% of total licensing in the third quarter. Revenues in this category were down about 19% sequentially, [so we're] up about 10% over last year's third quarter. The sequential decline was mainly attributable to seasonality as well as a modest decline in the TAM for set top boxes. The year-over-year increase was primarily due to higher tax rates for set top boxes.

Our PC revenues comprised about 22% of total licensing in Q3. They were down about 31% sequentially and about 25% compared to last year's third quarter. The sequential decline was driven by lower unit volume that was attributable to seasonality and as well as declining market trends. And the year-over-year decrease was primarily driven by declining until trends in market.

I should note that although our PC decline in Q3 stand alone was noticeably larger than the decline in the overall PC market, some of this is due to timing between quarters as well as other factors. If you look at all three quarters this year combined, the gap between our decrease and the market decrease is much smaller.

Consumer electronic revenues in Q3 made up about 15% of total licensing. They decreased sequentially by 17% and by about 12% over Q3 of last year. The sequential decline was mainly due to the seasonality, while the year-over-year decrease was driven primarily by lower unit volume trends in the market.

Mobile device revenues represented about 12% of licensing in the third quarter. They were down about 9% sequentially and up by more than 80% compared to last year's third quarter. The sequential decline was attributable to timing of royalty streams from a large licensee, offset partially by increased revenues from tablets, which included amounts recognized that had previously been deferred. The year-over-year increase was due to a combination of higher market volume in smartphones, higher revenues from tablets, and higher amounts recorded related to back payments.

Revenues in other markets, which primarily includes gaming and automotive, represents approximately 13% of total licensing in Q3. They were about flat sequentially and up about 25% over last year. This increase was due to one-time license fees for the use of certain imaging technologies and applications that are outside of our typical core markets.

Product and services revenue was $22.4 million in Q3, which was down about $0.5 million sequentially and down $7 million year-over-year. The year-over-year decline was driven by lower unit volumes and ASPs for mature cinema products, offset partially by products associated with our newest cinema technology, Dolby Atmos, that began shipping and generating revenue during the third quarter just completed.

Now I would like to discuss margins and the rest of the income statement. Total gross margin in the third quarter was 88.2% on a GAAP basis and 89.5% on a non-GAAP basis. Product gross margin on a GAAP basis was 6.4% in the third quarter, compared to 25.5% in Q2 and 34.4% in last year's third quarter.

On a non-GAAP basis product gross margin was 14.1% in the third quarter, compared to 33% in Q2and 37.2% in last year's Q3. The gross margin percentages in this year's third quarter include about 20 points of unfavorable impact from charges incurred during the quarter, mostly for obsolescence products, and to a lesser extent the manufacturing cost variances due to lower volume of production as we reduced our inventory during the quarter. We anticipate that gross margins will return to more typical levels in the fourth quarter.

Operating expenses in the third quarter on a GAAP basis were $145.8 million, compared to $141.9 million in the second quarter. On a non-GAAP basis operating expenses for Q3 were $122.7 million, compared to $124.1 million in Q2, and the difference was primarily attributable to lower expenses associated with variable compensation plans.

Operating income in the third quarter was $36.9 million on a GAAP basis, or 17.8% of revenue, and $62.7 million on a non-GAAP basis, or 30.3% of revenue. The effective tax rate for the quarter was 19.4% on a GAAP basis and 23.3% on a non-GAAP basis, as we benefited in the quarter from discreet items.

Net income in the third quarter was $30.2 million on a GAAP basis, or 14.6% of revenue, and was $48.5 million on a non-GAAP basis, or 23.4% of revenue.

Diluted earnings per share in Q3 were $0.29 on the GAAP basis, compared to $0.60 in Q2 and $0.48 in Q3 of last year. On a non-GAAP basis Q3 diluted earnings per share were $0.47, compared to the $0.74 in Q2 and $0.57 in last year.

During the third quarter we generated about $85 million of cash flow from operations. And as of the end of Q3 we had about $853 million in total cash reserves, which would include cash and cash equivalence as well as both short and long-term marketable securities. During the third quarter we repurchased about 250,000 shares of common stock for $8.7 million, aimed at offsetting dilution, and we ended the quarter with $124 million remaining available under our approved stock repurchase program.

Looking forward, here is our outlook for Q4 and for the year as a whole. In the fourth quarter, we estimate that total revenue will range from $205 million to $215 million. Within that, we anticipate that licensing will range from $180 million to $190 million, with product and services totaling about $25 million plus or minus.

This means that for the full fiscal year 2013, we estimate that our revenue will range from $900 million to $910 million. This compares to the prior estimate of $910 million to $940 million. Within the new range for the full year, we anticipate that licensing will range from $795 million to $805 million, and product and services together will be about $105 million plus or minus.

We have lowered the high end of our licensing revenue range to adjust for current weakness in consumer spending, which affects most of our end markets. We have also lowered our range for product revenues to reflect the activity levels we are currently seeing in digital cinema equipment adoption cycles I alluded to a few minutes ago.

Gross margin in the fourth quarter is projected to be about 90% on a GAAP basis and around 91% on a non-GAAP basis. We estimate that operating expenses in the fourth quarter will be around $142 million on a GAAP basis and $124 million on a non-GAAP basis plus or minus. Other income in the fourth quarter is expected to be approximately $1 million, and our effective tax rate for the fourth quarter is estimated in a range of 27% to 28% on a GAAP and non-GAAP basis.

So based on a combination of factors I just went over, fourth quarter diluted earnings per share are projected to range from $0.30 to $0.36 on a GAAP basis and from $0.45 to $0.51 on a non-GAAP basis. Full year 2013 operating expenses are estimated to be around $574 million on a GAAP basis and $496 million on a non-GAAP basis plus or minus.

We estimate that full year gross margins will be around 90% or 91%. Other income is estimated to be around $5 million. And the effective tax rate for the full year is anticipated to range from 27% to 28%. Now I would like to turn the call over to Kevin Yeaman. Kevin?

Thank you, Lewis, and good afternoon, everyone. The third quarter came in as we expected. We continue to see significant headwinds in CE and PC, and while those have largely been offset by strength in broadcast and mobile, we are adjusting our outlook for the remainder of the year.

As we finish fiscal 2013, we remain focused on diversifying our revenue and returning Dolby to a path of long-term growth. To achieve this we are focused on three priorities; driving the adoption of our technologies internationally in broadcast, expanding our technologies across the mobile ecosystem, and bringing new solutions to market such as Dolby Atmos, Dolby Voice and Dolby 3D for the home. On today's call I will briefly cover our progress in each of these areas.

In broadcast we continue to drive the adoption of our technologies internationally, especially in the area of set top boxes. In the Asia Pacific region seven new operators adopted Dolby Digital Plus in their set top boxes, including four in China, as well operators in Malaysia, Vietnam and the Philippines. In India, Digicable and UCN Cable Network have chosen Dolby Digital Plus for their high definition set top boxes, as their country starts its shift to digital cable.

In Europe, Austria began broadcasting all of its digital TV signals in Dolby Digital Plus, while Serbia Broadcasting Corporation began broadcasting high definition content in our format. In the UK, Virgin Media upgraded its set top box to include Dolby Digital Plus. And in North America, Time Warner has upgraded its set top box to include Dolby Digital Plus as well as Dolby Volume.

Turning to mobile, we continue to expand the use of our technologies across the mobile ecosystem. In the Windows ecosystem we continue to make progress extending our format to content aimed at Windows 8 devises. In the third quarter PPTV began distributing movies with Dolby Digital Plusto its Windows 8 application in China. Likewise, in the Amazon ecosystem, Amazon Instant Video is distributing movies and TV shows with Dolby Digital Plus soundtracks to the Kindle Fire HD.

With that, let me move on to discussing the progress we are making in bringing new solutions to market, including Dolby Atmos, Dolby Voice and Dolby 3D for the home.

Dolby Atmos continues to have strong momentum with studios, post-production facilities and exhibitors. Within a year of launch Dolby Atmos is in 60 titles worldwide, including seven of the top 10 grossing titles this year. All of the major Hollywood studios have released Dolby Atmos titles, and 35 post-production facilities worldwide are now mixing in Dolby Atmos.

With the exhibitors Dolby Atmos is now deployed in nearly 200 screens worldwide. In the third quarter, leading cinema chains around the world began deploying Dolby Atmos, including Wanda Cinema Line, China's leading exhibitor and owner of AMC Theaters. Wanda plans to deploy Dolby Atmos in its X-Land premium screens.

Likewise, one of the leading exhibitors in India announced it would deploy 37 systems across its main theaters in key cities. And in North America, Regal began installing Dolby Atmos in 20 of its RPX screens, its premium theater experience.

Turning to our other new solutions, we remain on track to bring to market Dolby Voice and Dolby 3D for the home.

Through our partnership with BT, Dolby Voice is expected to be available in the fourth quarter. Dolby Voice provides a conference call experience that sounds more like an in person meeting, aimed at greatly improving productivity and the user experience. Feedback on the technology has been very positive.

Finally, Dolby 3D for the home, which delivers a full resolution experience without the need for glasses, continues to be well received. Last quarter the Cameron Pace Group and the Foundry both announced that they would integrate the format into their 3D video production work flows, and since then we have made progress further integrating the solution into the TV-OEM supply chain.

We believe glasses-free 3D is the best way forward for 3D consumption in the home. We expect to see products on display with Dolby 3D for the home at the Consumer Electronics show in January.

In summary, we continue to grow our presence in mobile devices and in broadcast around the world, which is further diversifying our revenue base. In addition, we continue to gain traction bringing new solutions to market, giving us confidence that we can return to long-term growth.

And with that I will turn it over to Q&A.

(Operator Instructions). We will go first to Paul Coster with JPMorgan.

Thanks very much. Kevin, can you talk a little about the mobile category? Obviously many of us are seeing a slow down in the smartphone space at the moment, and to what extent that weighs on things moving forward? And just looking beyond the next quarter, what has to happen do you think for growth to resume for Dolby? Thank you.

Sure, thanks, Paul. So first of all, we did, as we reported have another outstanding quarter in terms of mobile growth year-over-year. We continue to see quite an opportunity in the market. We have seen reports from others that indicate the growth rates might be slowing down a little bit in the high end of the market, but we still see a lot of opportunity to continue to penetrate in that area, and also to move our solution into -- to begin to penetrate the mid and lower tier devices, whereas we are mostly concentrated in the high end today, which is what has allowed us to build up a significant position, with 25% of the devices in the Android ecosystem, ofcourse the Amazon ecosystem, and beginning to penetrate the Windows ecosystem through our inclusion of Windows 8.

In terms of moving forward and returning to growth, I think it really comes back to the three priorities I outlined, Paul. You know a big focus of ours over the last couple years has been making sure that we continue to extend our presence in broadcast into international markets, emerging markets as they go live with digital broadcast, and penetrating the mobile ecosystem. In doing so we transformed the composition of our business, so that this quarter about 70% of our revenue was coming from non-optical sources, with about 30% from optical, which is nearly the reverse of what we saw a few years ago.

That's really important, because while there are still headwinds in PC and broadly across CE categories, a lot that is concentrated in that 30% category. We continue see attach rate growth in the mobile and the emerging market broadcast. And so really hard, Paul, to predict exactly what CE trend consumer spending is going to be over the mid to long-term, but we look at that we still think there is an opportunity to get our core audio business back to growth.

Now to get to the double-digit growth that we aspire to, we are looking to our newer initiatives. And those are the initiatives like Dolby Atmos, like Dolby Voice, like Dolby 3D for the home. And we are pleased with how that is progressing. We are hitting our targets for this year to get in commercial milestones, and weexpect to begin seeing some revenue from those things in the coming year.

Kevin, just a quick follow-up. Now that you have Atmos, Voice and 3D kind of up and running, can we expect the rates of increase in R&D to moderate, if not even come down?

Well, I guess I would take that at the kind of overall company level. We have been very regularly shifting our investments within the overall spending envelope between -- as initiatives move to different stages of maturity or from research to commercialization. And so we are being pretty dynamic about shifting our investments to reflect the stages of this portfolio of investments.

As we said throughout the year, we came into the year saying that it was a year of investment, but that we were going to hold that to about $120 million to $125 million of OpEx a quarter on a non-GAAP basis. We've done that. We are going to -- we think it is really important to continue to invest in the business . At the same time, while we are not given guidance for next year, we don't see operating expenses increasing at the kind of rates we saw year-over-year this year.

All right, thank you.

(Operator Instructions). At this time we will go next to Corey Barrett with Pacific Crest Securities.

Hi, thanks for taking my questions. So first I guess I just wanted to touch back on your guidance. I was hoping maybe you could provide a little more detail on why we are going to see a sequential decline there heading into the fourth quarter? Or, I'm sorry, a decelerate in year-over-year growth.

[Say] I just highlight two things that impact that. One is that because we are typically a little lagging trends in the market, we are continuing to see headwinds in PC and consumer electronics broadly in Q4, which offsets a little bit of what you might say historically, Lewis, when we see a little seasonal pick up.

And then also we have dialed back a little bit our broad expectations for revenue in products and services just based on the current activities. As you probably know, whenever you go through one of these transitions where one cycle is tailing off and a new technology is being adopted, that overlap is not that easy to predict accurately, so we are just making some adjustments. But we are happy with the current pace of adoption, for example, Dolby Atmos, which Kevin said is up to nearly 200 screens out there and growing.

So I would say those two factors, a dialing back of products and services, and then broadly these headwinds we see in the PC consumer electronic markets that we quite frankly can't do a lot about, because weare driven a lot by what is happening in the market place.

Thank you. And was there really a greater offset to the growth you have seen in Atmos than you anticipated heading into the quarter? I think we anticipated a stronger product revenue than what you saw, and I was just trying to differentiate between what you are seeing in Atmos and what you are seeing in the legacy business.

The legacy business, I would blame more of it on [that], if that is what you are asking. In other words the scale of dropoff when these cycles start to come to an end, you try to predict what the slope looks like. ButI would say that dropoff was steeper this quarter than what we had anticipated even a few months back.

Okay, thanks. And then two more quick ones. Can you tell us what the mix of optical revenue was in the quarter? I think you divulged that in the past.

Yes, 70% non-optical and 30% optical. I think that adds up to 100%.

Perfect. And then lastly, haveyou considered an accelerated cash return program, given your strong cash position?

Well, we've not only considered things like that, but just six months ago we did return about $408 million to the shareholders, one fell swoop. So, yes, we are not going to do one of those every quarter.

I was asking about more of an ongoing -- on an ongoing basis.

Yes, well, even prior to that, Corey, it is fair to say the Company was pretty steadily buying back stock. At the time we did the dividend I think what we tried to tell investors was, if you look at the cash flow generation, this is obviously much more than one quarter's worth of cash flow, so give us a little bit of leeway. But we pay very close attention to our cash balances and what we do with those. I would say the Company has been responsible in watching that, and we'll continue to watch that closely as well.

Okay, that's all I have. Thank you.

Thanks.

We will go next to John Bright with Avondale Partners.

Thank you. Kevin, can you talk -- give us your current thoughts about commercialization at Atmos, Dolby Voice, Dolby 3D? Maybe a time frame of when you think that is going to happen and what that might look like?

Sure, let me start with Dolby Atmos, since we are well underway. As we said in our prepared remarks, we at nearly 200 screens today. What we are doing is as we are going through, as is the case with these kinds of adoption cycles, it is the top grossing screens, often the premium format screens of the exhibitors where these are going in, and that will be the focus certainly here for the rest of the year to continue to roll that out and to continue to focus on titles.

60 titles now. Seven of the top 10 grossing, and so we are pleased with how that is progressing. Dolby Atmos is well under way.

It is a relates to Dolby Voice, as you know, we announced our partnership with BT to get our enterprise audio conferencing solution in market. We have been working with them very closely to integrate it. It has been a great partnership.

We are really excited that that is -- we are expecting that to go live this quarter. So by the next time I speak with you, I expect us to have some real experience with end users having used the solution. And so that'snext on deck.

And then as it relates to Dolby 3D for the home we have a deep engagement throughout the supply chain and the ecosystem. I had mentioned earlier that some of the leading post-production houses, especially those that are focused on 3D, are integrating our solution to the work flow. We are really involved at every point in the supply chain to bring this to life, and we expect to have -- we expect to see commercial products on display at CES in January.

And can you talked about how you are going to get paid for each?

Well, in the case of Dolby Atmos, it is a product sales model. In the case of Dolby Voice, this is a solution that is integrated deeply into the BT service, and then can include soft client integrations into various end points. And we will get paid base on the scale of implementation and the scale of usage of the system. And then as far as Dolby 3D for the home, that's a traditional -- we see that being our traditional model on a per device.

And were you paid for Dolby Atmos this quarter?

Pardon me?

Were you paid for Dolby Atmos deployments this quarter?

Yes.

Thank you very much.

(Operator Instructions). We will go next to Jim Goss with Barrington Research.

Hi. I just have a question about what you just said about Dolby Atmos as a product sales model. Did you also give consideration to possibly either paying for the installation and collecting royalties or doing a hybrid version or something of that nature to try to get past the barrier of what the exhibitors seem to have of how are they going to get paid? Will people pay a higher ticket price or something like that? And therefore why would they do it unless they are building a brand-new auditorium? And as a way to answer those questions and maybe have a continuing relationship with that particular product and service?

We have considered a range of options for the best business model, with a focus on what works best for the exhibitors, our paying customers. AndI would say over the long-term we haven't ruled anything out, but to date with 200 -- the nearly 200 screens that are in market, this is the model that our exhibitor customers have responded to.

And maybe just one other thing. Given the size of Dolby at this stage, how many different initiatives do you think you need to have going simultaneously to restore the type of momentum you have been able to achieve when you were much smaller and maybe one or two things would work. I would imagine the math works differently now, given the more substantial size of the Company.

That's a great question. We have really increased the pipeline of new offerings coming to market over the last several years. And you are beginning to see them come to market now in the form of commercial offerings, whether it is Dolby Atmos, whether it is Dolby 3D for the home, whether it is a Voice for audio conferencing, which is interesting because it opens up an entirely new enterprise market for us, new customer base, to a substantial industry that we are serving there.

I would say those are the ones that are visible and coming to the market now, and behind that we see significant opportunity. As we look at the increase in the amount of audio/visual content and the role it plays in entertainment and communications, as combined with increasing bandwidth and technological capabilities, we just -- whether we are talking to content partners, communication partners, OEMs, there is a real demand to continue to up-level that experience and to really differentiate. And we see that with artists as well.

And so when you combine that with our experience of being able to provide the technologies and the pallet for artists to better tell their stories, to better capture communication experiences, and in particular our ability to work across complex ecosystems to ensure that that's delivered to any device, anytime, however people want to enjoy it. That intersection leads to we think a rich set of opportunities for Dolby, and the ones we are talking about today and are very focused on are the ones you can see coming to market in the near term. But we believe that behind those are a good pipeline of opportunities.

Is it still true that you have a rolling three-year cycle of R&D, that whatever is going to happen now probably developed several years ago? And that you are -- that's what you are talking about with this transition, such that you are just starting to hit a period where several of these initiatives are starting to come into play?

There is certainly, for any given opportunity or investment areas, there is a period of time between investment and bringing products to market. I would say that varies a little bit within each of our different markets. But it is true that it was about three years ago that you can see that we really began investing in R&D, and yes, you are beginning to see the fruits of that investment.

We think that we have developed a rich set of IP, combined with some great relationships in the market. We have developed very deep relationships throughout the mobile ecosystem. We are now entering the enterprise voice market. And we think that leads to a number of opportunities, and we expect that pipeline to continue to flow going forward.

Thanks a lot.

And at this time I would like to turn things back to Kevin Yeaman for closing remarks.

Great. Well, thank you for joining us today, and we look forward to talking to you again next quarter. Thank you.

Again, thatwill conclude today's conference. Thank you all for joining us.