Dolby Laboratories Inc (DLB) 2014 Q2 法說會逐字稿

Welcome to the Dolby Laboratories conference call discussing fiscal second-quarter results.

(Operator Instructions)

As a reminder this call is being recorded Tuesday, April 29, 2014. I would now like to turn the conference call over to Elena Carr, Director of Corporate Finance and Investor Relations from Dolby Laboratories. Please go ahead, Elena.

Thank you. Good afternoon. Welcome to Dolby Laboratories second-quarter 2014 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories President and CEO, and Lewis Chew, Executive Vice President and Chief Financial Officer.

As a reminder, today's discussion will include forward-looking statements. These statements are subject to risks and uncertainties that may cause actual results to differ materially. 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 report on Form 10-Q filed with the SEC. 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 we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings press release and in the Dolby Laboratories Investor Relations data sheet on the Investor Relations section of our website.

As for the content of this call, Lewis will begin with a recap of Dolby's financial results and provide a fiscal outlook for 2014. Kevin will then finish with a discussion of the business. So with that introduction behind us, I will now turn the call over to Lewis.

Thanks, Elena, for that stirring introduction. Good afternoon everyone, let's begin by going over revenue.

In the second quarter that we just completed, total Company revenue was $278.6 million. And within that, revenue from licensing was $258.6 million, which was $53 million higher sequentially from Q1 and $32.2 million above last year's second quarter.

Q2 licensing was above what we had originally projected and I will address that, along with other details, in the following commentary of our licensing revenue by end market. Broadcast represented about 46% of total licensing in the second quarter and included a $24.7 million back payment settlement we reached with a large licensee during the quarter.

As a result broadcast licensing revenues increased about 61% sequentially and about 37% year-over-year. If we exclude the back payment of $24.7 million from those comparisons, then broadcast licensing would have been about 28% sequentially, and would have been about 9% year-over-year. The sequential increase was driven by higher seasonal activity and the year-over-year increase was driven primarily by higher attach rates on TVs.

PC revenues represented about 16% of total licensing in Q2. They were down about 4% sequentially and down about 29% compared to last year's second quarter. The year-over-year decrease of 29% was much larger than the market decrease, mostly due to our transition from Windows 7 to the Windows 8 business model. This was in line with the comments I made on the last earnings call when I said that this Q2 should be the last quarter in which there was such a large gap. Going forward, we anticipate that our year-over-year PC revenue trends will be more closely aligned with market trends.

Consumer electronic revenues in Q2 comprised about 14% of total licensing. They were down about 11% sequentially and higher by about 4% year-over-year, and the sequential decrease was due to lower back payments offset partially by higher unit volume from holiday seasonality.

Mobile device revenues represented about 12% of licensing in the second quarter. They were up about 4% sequentially and up about 36% compared to last year's second quarter. The sequential improvement was driven by timing of royalty reporting and higher back payments. The year-over-year increase was driven by higher unit volume growth along with higher back payments.

Revenues in other markets which primarily includes gaming and automotive, represented approximately 12% of total licensing in Q2. They were up about 68% sequentially and up about 28% from last year's Q2. Both increases were driven by higher revenue attributable to the new PS4 and Xbox One gaming consoles that were launched in late 2013.

If I look at total company licensing in Q2, even without the $24.7 million item that I mentioned, the growth would have been 14% sequentially and 3% year-over-year. By the way, it's normal for us to have back payments in our licensing revenue stream every quarter. These payments don't always land in the same market segments by the same amount each quarter, but they can be highlighted as a factor when we go over the ups and downs in the segments. Very large amounts, like the $24.7 million item that we got in Q2, are not as typical so we call those out separately.

So let me finish the discussion of Q2 revenue. Product and services revenue was $20 million in Q2 which, was down $5.6 million sequentially from Q1, and down $2.9 million year-over-year. Both of the declines were driven by lower revenue from mature digital cinema products offset partially by higher sales from Dolby Atmos.

During the quarter, we announced that we had signed an agreement to acquire Doremi Labs, a leading provider of digital cinema video playback solutions. The acquisition is subject to review by regulators along with other closing conditions and since the acquisition has not yet closed, our Q2 product revenues do not include anything from Doremi.

Now I would like to discuss margins and the rest of the income statement for Q2. Total gross margin in the second quarter was 93.7% on a GAAP basis and 94.5% on a non-GAAP basis. Product gross margin on a GAAP basis was 29.3% in the second quarter compared to 23.8% in Q1 and 25.5% in last year's second quarter. Product gross margin on a non-GAAP basis was 35.8% in the second quarter compared to 28.9% in Q1 and 33% in last year's Q2. The increase in Q1 to Q2 was primarily due to lower product cost and improved sales mix.

Operating expenses in the second quarter on a GAAP basis were $156.2 million compared to $150 million in the first quarter. On a non-GAAP basis, operating expenses in Q2 were $137 million compared to $130.3 million in Q1. The increase from Q1 to Q2 was driven by higher personnel costs including, company-wide annual salary increases that went into effect at the beginning of the quarter and also higher expenses from industry trade shows.

Operating income in the second quarter was $104.9 million on a GAAP basis or 37.7% of revenue. And $126.4 million on a non-GAAP basis or 45.4% of revenue. The effective tax rate for the quarter was 25.6% on a GAAP basis and 25.7% on a non-GAAP basis.

Net income in the second quarter was $75.9 million on a GAAP basis or 27.2% of revenue, and was $91.7 million on a non-GAAP basis or 32.9% of revenue. Diluted earnings per share in Q2 were $0.73 on a GAAP basis compared to $0.43 in Q1 and $0.60 in Q2 of last year. On a non-GAAP basis, Q2 diluted earnings per share were $0.88 compared to $0.59 in Q1 and $0.74 in Q2 of last year.

During the second quarter we generated $102 million of cash flow from operations. And as of the end of the quarter, we had a little over $1 billion in total cash and investments which includes cash and cash equivalents, as well as both short and long-term marketable securities. We entered the third quarter with about $104 million remaining available under our approved stock repurchase program.

Looking forward, here's our outlook for Q3 and the full year. In the third quarter, we estimate that total revenue will range from $205 million to $215 million. Within that, we anticipate that licensing revenue will range from $185 million to $190 million, which would be roughly flat with last year's Q3 licensing but a decrease from Q2.

The projected sequential decrease has three main drivers. First, the $24.7 million item in Q2 that we don't expect to repeat in Q3. Second, our fiscal Q3 is always down seasonally from our Q2 since the second quarter benefits from the holiday selling season. And third, we are projecting our mobile revenues to drop to roughly 10% of total licensing revenue in Q3.

Mobile is affected by seasonality and timing. In addition, we are currently working through our arrangement with Samsung regarding our mobile technologies. And at present, Dolby Digital is one of several third-party features that were in the Galaxy S4, but not included in the Galaxy S5, just released in April.

Q3 products and services revenue are projected to range from $20 million to $25 million. Gross margin in the third quarter is projected to range from 91% to 92% on a GAAP basis, and 92% to 93% on a non-GAAP basis.

We anticipate that operating expenses in the third quarter will range from $153 million to $158 million on a GAAP basis, and from $135 million to $140 million on a non-GAAP basis. And, included in our updated expense projections, is an estimate of the range of transaction costs that will be incurred related to the pending Doremi acquisition.

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 range from 27% to 28% on both a GAAP and non-GAAP basis. Based on a combination of the factors I just went over, third-quarter diluted earnings per share are projected to range from $0.24 to $0.29 on a GAAP basis and from $0.38 to $0.43 on a non-GAAP basis.

For the full FY14, we now estimate that total revenue will range from $930 million to $950 million. Within that, we anticipate that licensing will range from $845 million to $855 million. This is up from the projection I gave last quarter of $820 million to $835 million in licensing for the year.

Embedded in our licensing outlook, we anticipate that the PC market in units will be down by about 6 to 7 points for the year and that our revenue will decline by a similar degree in the second half of the year. Our mobile licensing will be lower in Q3 as I mentioned a minute ago and are projected to level out or increase modestly in Q4 over Q3.

We anticipate that products and services revenue will range from $85 million to $95 million for the full year 2014, which is lower than our last projection mainly because of a shift in timing for some of our new product revenue streams. FY14 operating expenses on a GAAP basis are estimated to range from $611 million to $616 million. And, on a non-GAAP basis operating expenses are projected to range from $535 million to $540 million.

We estimate that full-year gross margins on a GAAP basis will range from 91% to 92%, with non-GAAP gross margins roughly about one point higher. Other income is estimated to be around $1 million for the year which includes a $3 million non-cash write-off of an equity investment that was in our Q2 results. And the effective tax rate for FY14 is anticipated to range from 26% to 27%.

So now, I'd like to turn the call over to Kevin Yeaman, Kevin?

Thank you, Lewis. And good afternoon, everyone. We had a strong second quarter led by broadcast where we continued to increase our presence in emerging markets. And in gaming, which benefited from the release of the Sony PlayStation 4 and the Microsoft Xbox One.

And I'm particularly pleased with the momentum we're building in our new initiatives. During today's call I will update you on our progress in each of our key growth areas.

Let's start with mobile. We've been steadily growing this business for the last several years. As Lewis discussed, we expect our mobile revenue to decline in the next quarter. While we were disappointed that Dolby Digital Plus is not included in the recently launched Samsung models, we continue to work through our arrangement with Samsung regarding Dolby technologies for mobile devices.

In any event, we expect mobile revenue to come in at about 10% of licensing revenue next quarter. And more importantly, we continue to see opportunities for growth in the mobile market. Dolby's audio solution makes online content even more engaging in mobile devices.

Mobile premium content is still in its early stages, but it is clearly a key vector of growth for the ecosystem. The Dolby value is best seen when our technologies enable an entire ecosystem, from content creation to distribution and ultimately the consumer device.

A great example of this is Amazon. We've partnered with them to enhance the audio experience in the Prime Instant Video library and the full line of Kindle Fire tablets. Together, we have delivered a premium audio experience in these tablets and this is evidenced by the critical acclaim for the impressive audio delivered by the Kindle Fire HD and HDX. This quarter, Amazon added to their ecosystem with the launch of Fire TV. Dolby Digital Plus is featured on this device, and will stream content in Dolby to televisions.

Beyond the Amazon ecosystem, we have been working with over-the-top mobile content providers, to stream in Dolby. In just one year, we have grown from one mobile over-the-top service provider streaming in Dolby, to six services today. Four of these are currently streaming on the Android ecosystem, Amazon is streaming to its devices, and our most recent mobile OTT provider, iQIYI in China, will be streaming on both the Android and Amazon ecosystems. We believe that consumers want convenience while not compromising quality; and that there are opportunities to provide value across the major ecosystems as premium content consumption and device capabilities are on the rise.

Let's move to broadcast. Broadcast continues to grow and excluding the large settlement, revenue was up 9% this quarter. We have built a strong position in North America and Europe and continue to focus on extending our technologies into emerging markets.

Large opportunities still exist in these markets because the transition to digital broadcast is still in the early stages. Our efforts are focused on working with operators and standards bodies to adopt our technologies, a strategy that drove our success in North America and Europe and is showing results in Asia.

We continue to make progress in two of our largest market opportunities in Asia: China and India. Currently, about 65% of HD channels in China are in Dolby, and we expect to see continued increases in both the percentage and number of HD channels in Dolby. In India, we see similar trends to China, with nearly 60% of HD channels in Dolby.

Last quarter, I told you about UCN, the first cable operator in India to go on air with Dolby Digital Plus. This quarter, our success and increased adoption in India was further validated by the inclusion of Dolby in the terrestrial HD set-top box standard.

In addition to China and India we continue to make progress in other parts of the world. In Thailand, TrueVisions, the country's largest pay TV operator, will air all of its 50 HD channels in Dolby Digital Plus. During the quarter we also saw the first terrestrial channel in Thailand broadcasting in Dolby.

In Indonesia, Dolby has been included in the terrestrial receiver standard. This is a significant win as Indonesia is the third most populous country in Asia. Finally, Russia has now included Dolby Digital Plus in their HD standard.

In the cinema business we continue to focus on Dolby Atmos. Specifically, building our momentum with studios, content creators, post-production facilities, and exhibitors, to drive deployment and adoption. Currently, there are over 600 screens committed to Dolby Atmos, of which about 440 are installed.

The presence of Dolby Atmos spans more than 40 countries over 150 exhibitor partners. To date, over 120 titles have been released or announced in Dolby Atmos including titles from all of the major studios. Eight of the top ten highest grossing films of 2013 were Dolby Atmos titles. Including Gravity, which won the Academy award for best sound editing, and for best sound mixing.

With that let me move on to discussing our progress in bringing new products to market. In October, BT launched BT MeetMe with Dolby Voice. BT MeetMe with Dolby Voice transforms conference calls and improves productivity by giving attendees the sound and feel of in person meetings. We're seeing good early adoption. The service not only provides a superior experience it can also reduce conferencing costs for enterprises.

During the quarter at Enterprise Connect, we unveiled two new elements that will further enhance the Dolby Voice experience. The Dolby Voice conference phone and the Dolby Voice mobile application. The elegant and intuitive conference phone has received rave reviews and for the first time, will bring the Dolby Voice experience into the meeting room.

It provides wideband audio, voice separation, noise suppression, and the ability to capture all voices in the room. The net result is the ability to have a natural conversation eliminating some of the common frustrations of today's conferencing experience. We expect the conference room will be available for purchase later this year.

The mobile app for Dolby Voice extends the in-person experience to participants on mobile devices. It can utilize a Wi-Fi or cellular data network to join calls on the BT MeetMe with Dolby Voice service. We expect to see this available in app stores in May. With the addition of the conference phone and the mobile app, the Dolby Voice solution will now be available anywhere with desktop, mobile and conference phone access options.

Last quarter we talked about initial reaction to our demonstration of Dolby Vision at CES. And how it garnered widespread press coverage from major outlets across the US and internationally. This end-to-end video technology offers more realistic distinctions in color and brighter highlights while also delivering improved shadow details. It focuses on the quality of the image each pixel represents and is not dependent on the number of pixels.

We continue to see great support from the content community and are working quickly to enable the post production and color grading processes to create content in Dolby Vision. We expect to see televisions with Dolby Vision shipping by the end of the year. The industry and press momentum was evident at the recent National Association of Broadcasters conference.

In summary, we've had a great first half of 2014. We have increased our revenue outlook for the year and remain committed to driving growth in our core businesses. Our new offerings, such as Dolby Voice and Dolby Vision are resonating with early adopters and industry leaders, promising to extend the in Dolby experience even further. We remain focused on bringing these products and technologies to market, which in turn, will help further drive our long-term growth.

And with that, I'll turn it over to Q&A.

(Operator Instructions)

Steven Frankel, Dougherty & Company.

Good afternoon. Kevin, I wonder if you might give us a little more detail on the Samsung decision? Was it cost that motivated them to get rid of Dolby Digital Plus or what are they thinking and what are your chances of getting back into that ecosystem?

Sure. First of all, as we said in the remarks, we're really working through the contract details with them now. It's come up for its natural renewal cycle and so there's a lot of moving parts right now, which I'm not going to get into the details of each of the moving parts, except to say that we feel pretty comfortable, very comfortable in saying that it's going to be about 10% of our revenue, mobile that is, in Q3 that we have opportunities to grow from there. And that everything's still on the table.

I think clearly it shows that we have work to do, the fact that it's not shipping in the S5. But we continue to believe we have a value proposition to bring at a time when, yes, I think it is pretty clear that a lot of people in the smartphone industry are very much focused on cost. We continue to focus on building value across all of the major ecosystems and continue to see growth opportunities from here.

On Atmos, what do you think your share of large-format theaters is, excluding IMAX, of the house brands? What does that 660 mean in terms of your market share?

I don't know if I have, top of my head, the exact number of the house-branded [PLF]. It is fair to say that the vast majority of the 440 we have installed and the 600 committed are targeted at the growing PLF market.

On a global basis, there is still a lot of room to grow in the existing PLF market. And it's also an area where we see quite a lot of investment from exhibitors. It's where we anticipate their investments to be going forward, is in the PLF format.

Thank you.

Michael Olson, Piper Jaffray.

Good afternoon. I know these back payments are difficult for you to predict the timing of. But through the remainder of the fiscal year, are you seeing anything out there or are anticipating anything that could be anywhere close to, as large as the $ 24.7 million that you saw this quarter?

Hi Mike, this is Lewis.

Generally, no. As I mentioned in my prepared comments, when it's that large I think it's fair to call those out. But I think it's also not only fair, but a statement of fact that we always have back payments every quarter. Currently we don't anticipate a singular item of that size for the remainder of this year.

And then, regarding Samsung would you be willing to share an estimate of what percent of your mobile revenue has been from any Samsung related revenue that you've seen in the last few quarters?

This is Lewis again.

We don't break it out that way because, as you can imagine, we do get revenue from Samsung from a lot of different sources because our technology that goes into things. No. I don't know how much more I can give you than that.

We're not going to break out separately as a subsection of mobile. But maybe at a high level, I think what Kevin, and I think even I had in my comments, was to reset the baseline of being around 10% of revenue and grow from there.

That makes sense. And then, Kevin, as far as Dolby Vision, can you just repeat what you said about where we are for initial testing and adoption there? And what your expectations are as far as when it potentially gets to be more a material part of the business?

Sure. We're expecting televisions to be in the market by the end of the year. And in the meantime, we have engagement from across the industry from content creation to device manufacturers and everything in between, to support the introduction of these televisions later this year.

Thank you.

(Operator Instructions)

John Bright, Avondale Partners.

Good afternoon. This is Alex Hu in for John Bright.

Just a quick question for the three initiatives. Namely, Atmos, Voice and Vision. I know you guys touched on Atmos and Vision, but for Voice, strategically speaking, where do you see this initiative going? How are you guys getting paid? And are there any ASPs you can provide us with?

Sure. Strategically, this is an application of our expertise in sound to bring a transformational experience to an experience, which frankly, has had, a lot of people a lot of frustrations with. We thinks it's a big opportunity. It's about the audio conferencing market, the enterprise audio conferencing market, which is where we're targeting first and foremost, is about a $4 billion industry that we're serving.

So we see a big opportunity here. The way we will earn revenue is both on the scale of the implementation, which is to say, a fee per each of the ports installed. And then also, a share of the minutes revenue where the Dolby voice service is utilized. And then on top of that, as I mentioned today, later this year we expect to begin shipping the Dolby conference phone, which will bring that lifelike experience and connect it to the service, from capture to playback effectively. And that will be another revenue stream. And we have not released the list price on that yet.

Just one more question. For the guidance it seems you guys beat on revenue by about $30 million and the bottom line by about $0.24 or so. And yet the full-year guidance you guys provided, it doesn't seem like you guys are flowing through--? You guys are flowing through some of the topline beat, but not so much on the bottom line. I was just wondering why not flow-through the entire the beat?

I think a share math exercise like that has limited application when you've got things moving around. So first of all, on the revenue beat flowing through the full year guidance, we have two things going on. Most of the licensing fee does flow-through but I mentioned that we took down our product revenue outlook for the rest of the year only due to timing because we see some of that pushing out but feel good about that stream going forward.

And second, in our OpEx, we do have to absorb some transactional OpEx that is going on related to Doremi. And we're going to try to get that deal closed as soon as we can to shut off that spigot but some of that is subject to the procedures we have to go to through with the regulators. So that is probably causing some of the noise in terms of your flow-through.

Thank you.

It appears there are no further questions at this time. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

Thank you everyone for joining us today. We look forward to updating you again soon.

Thank you and this does conclude today's Dolby Laboratories conference call. We thank you again for your participation.