Dolby Laboratories Inc (DLB) 2018 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call discussing fiscal first year quarter results. (Operator Instructions) As a reminder, this call is being recorded, Wednesday, January 24, 2018.

I would 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.

Good afternoon. Welcome to Dolby Laboratories First 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 report on Form 10-K.

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 2 is available in our earnings press release and in the Dolby Laboratories' Investor Relations data sheet on our 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 behind us, I will turn the call over to Lewis.

Okay. Thanks, Elena, and good afternoon, everybody. I think I'll just get right to the numbers. Total revenue in the first quarter was $288 million, of which $258 million came from licensing and $30 million came from our products and services. The licensing revenue in the quarter did exceed the high end of our guidance by more than $20 million and a lot of this was timing because in Q1 we finalized a large recovery that we were expecting this year, but sometime after Q1.

But it is nice to start the year on a positive note and we are raising full year guidance for FY '18 and I'll discuss that in a few minutes.

But first, let me give you my comments on licensing trends in the end markets that we serve. I'll start with broadcast. Broadcast represented about 40% of total licensing in the first quarter, and revenues in this market increased about 1% sequentially, but were down about 4% year-over-year, and the sequential increase was driven mainly by higher revenue in TVs, while year-over-year the decline was mainly due to some lower volume of set-top boxes along with lower recoveries, but that was partially offset by growth from our consumer imaging programs. Mobile devices represented approximately 23% of total licensing in the first quarter, as mobile was the category that benefited from the large recovery that I mentioned earlier.

Mobile revenue increased by more than 200% sequentially and 150% year-over-year, driven mostly by the large recovery, but beyond that we also saw higher revenue from -- mostly from tablets. Consumer electronics represented about 11% of total licensing in the first quarter. Licensing in this area increased sequentially by about 8%, driven by higher volumes in DMAs and sound bars, as well as higher patent licensing from a broad portfolio of consumer electronic devices. Consumer electronics year-over-year was up by about 3%, driven by similar reasons as what I just discussed for the sequential increase.

Let's do PC. PC represented about 10% of total licensing in the first quarter. PC was down about 13% sequentially and about 24% year-over-year. In both cases, the decline was driven by lower recoveries along with lower average pricing due to mix. Licensing in other markets represented about 16% of total licensing in the first quarter. They increased by about 11% on a sequential basis, and that was driven by seasonally higher revenue from gaming consoles, offset partially by lower recoveries in automotive. From a year-over-year perspective, although licensing increased slightly, and that was driven by higher revenue from Dolby Cinema and from Via, and that was partially offset by lower recoveries in automotive. Products and services revenue was $29.8 million in Q1 compared to $28.7 million in Q4 and $33.6 million in last year's Q1.

Our product revenue this quarter was about $5 million below what we have projected, mainly because some of our cinema products didn't ramp as quickly in Q1 as we had anticipated.

Let's move on to margins and operating expenses.

Total gross margin in the first quarter was 89.3% on a GAAP basis and 89.8% on a non-GAAP basis. Product gross margin on a GAAP basis was 31.7% in the first quarter compared to 38.5% in Q4. And product gross margin on a non-GAAP basis was 35.1% in the first quarter compared to 43.3% in Q4. Operating expenses in the first quarter on a GAAP basis were $174.7 million compared to $189.5 million in the fourth quarter. And as a reminder, the fourth quarter total included a $12.9 million charge for severance-related costs.

Operating expenses in Q1 on a non-GAAP basis were $155.9 million compared to $159.9 million in the fourth quarter. Though operating income in the first quarter was $82.2 million on a GAAP basis or 28.6% of revenue, and $102.6 million on a non-GAAP basis or 35.7% of revenue.

Now for income taxes. Let me spend next to a minute or 2 on that topic. As you know, U.S. tax reform, in other words the Tax Cuts and Jobs Act was adopted into law in late December. And we, like so many other companies, are immediately impacted by certain aspects of the new rules. And the 2 most notable items that affected us this quarter are: one, we had to accrue a mandatory tax on our undistributed foreign earnings. For us, the vast majority of these undistributed foreign earnings is held in cash and will be tax at the rate of 15.5%. Under the new rules, this tax assessment is payable over the next 8 years and those payments are more heavily weighted towards the later years.

Two, we had to write-down the carrying value of our deferred tax assets to reflect the fact that the standard federal tax rate for corporations was 35% and is now 21%. And this change reduces the value of deferred tax assets currently on our books, because those assets essentially represent future tax deductions. So as a result of these 2 items, we booked an estimated $155 million of discrete tax expense in Q1.

Beyond the tax reform, we also have in Q1 a tax benefit of approximately $6 million due to a new accounting treatment required for the tax impact of stock compensation. This item used us to flow through the equity section of the balance sheet, but now must flow through the quarterly income tax rate. And in future quarters, the amount will fluctuate and could be either expense or benefit depending on circumstances in that quarter.

So if I sum all this up, our total GAAP tax expense in the first quarter was $166.3 million or an effective tax rate of 196%. And I guess, you could say you don't see that too often. So when we calculated our non-GAAP tax rate this quarter, we not only adjusted for the usual non-GAAP items, we also excluded the $155 million discrete expense for the new tax law and the $6 million tax benefit for the new stock comp treatment.

And ultimately, where that lands is, the non-GAAP effective tax rate for the quarter was 20%, which brings us to net results. On a GAAP basis, we had a net loss for the quarter of $81.6 million or $0.80 per diluted share. And of course, this includes the tax items I just mentioned.

On a non-GAAP basis, using the adjusted income tax rate of 20%, we had net income of $84.1 million in Q1 or 29% of revenue. Non-GAAP diluted earnings per share was $0.79 in the first quarter compared with diluted earnings per share of $0.45 in Q4 and $0.66 in Q1 of last year.

During Q1, we generated about $17 million in cash from operations and ended the quarter with over $1.1 billion in cash and investments. We bought back about 495,000 shares of our common stock in Q1 and ended the quarter with a little over $120 million of stock repurchase authorization still available.

We also announced today a cash dividend of $0.16 per share, which will be payable on February 14, 2018, happy Valentine's Day, to shareholders of record on February 5, 2018. So now let me provide the outlook for the full year and for Q2.

For the full year, FY '18, we now estimate that total revenue will range from $1,150,000,000 to $1,180,000,000. Within that revenue total, we estimate that licensing will range from $1,020,000,000 to $1,050,000,000. While products and services are estimated to be around $130 million. Here are some of the factors that are incorporated into this annual outlook. We anticipate that broadcast revenues will be flat to modestly up, as higher revenues from consumer imaging will be somewhat offset by lower recoveries. Mobile is expected to be up year-over-year due to higher revenue from audio and consumer imaging, as well as the positive impact from the Q1 recovery.

PC licensing is projected to be down, while CE, consumer electronics, is projected to be up modestly. The other licensing categories projected to be down because of lower recoveries but that's partially offset by revenue growth from Dolby Cinema. And then we do expect to see growth in products revenue from Cinema and from Dolby Voice.

Gross margin for the year is projected to be around 88% plus or minus on a GAAP basis and about 89% plus or minus on a non-GAAP basis. Operating expenses are projected to range from $727 million to $742 million on a GAAP basis, and from $655 million to $670 million on a non-GAAP basis.

Other income is estimated to range from $10 million to $12 million for the year. And the effective tax rate for the remaining 3 quarters of the year is expected to range from 20% to 23%. Adding that to the actual tax we recorded in Q1, would yield a full year tax rate on a GAAP basis of about 68% plus or minus. For Q2 of FY '18, we anticipate that total revenue will range from $295 million to $305 million.

Within that, we estimate that licensing will range from $265 million to $275 million, while products and services is projected to be around $30 million. Q2 gross margin on a GAAP basis is estimated to be around 89% and the non-GAAP gross margin is estimated to be around 90%. Operating expenses in Q2 are projected to range from $183 million to $187 million on a GAAP basis, and from $166 million to $170 million on a non-GAAP basis.

Other income is projected to range from $2 million to $3 million for the quarter, and the effective tax rate for the quarter is estimated to range from 20% to 23%. Based on the combination of the factors that I just covered, we estimate that Q2 diluted earnings per share will range from $0.60 to $0.66 on a GAAP basis and from $0.74 to $0.80 on a non-GAAP basis.

So with that, let me turn it over to Kevin.

Thank you, Lewis, and good afternoon, everyone. We're off to a strong start to 2018, as we continue to focus on growth by expanding our leadership in audio entertainment solutions and by bringing our new Dolby experiences to market. Our momentum with Dolby Vision and Dolby Atmos was once again on display at CES this year, as our partners highlighted Dolby experiences across the show floor. We're seeing widespread industry adoption of Dolby Vision and Dolby Atmos, and these experiences are moving to the mainstream. Let me start with Dolby Atmos. Both Sony and LG announced their new Dolby Atmos sound bars and what's significant about these new sound bars is that they appeal to a larger consumer base with price point starting below $600. In addition, to being more affordable, Sony's new Dolby Atmos sound bar was awarded TechRadar's pick for best audio accessory at CES.

The number of TVs with Dolby Atmos is also growing. Last year at CES, LG announced its first Dolby Atmos TV. And this became the first time that consumers can get a combined Dolby Vision and Dolby Atmos experience in 1 product.

This year, LG announced that it would expand this experience to all of its 2018 OLED and Super UHD TVs. At the same time, both TCL and Skyworth announced that they would be bringing Dolby Atmos to TVs this year. Let me turn to Dolby Vision. I'm excited that the first PCs with Dolby Vision have now been announced. They are part of Lenovo's new ThinkPad X1 line and the X1 Carbon with Dolby Vision was named best new PC by Endgadget at CES. We also saw an expansion of the number of TVs that will incorporate Dolby Vision. We now have over 10 TV partners, all of whom announced their 2018 Dolby Vision TVs. Many are expanding Dolby Vision into the mainstream lines with price points starting as low as $500.

We also saw further adoption in Blu-ray players with Sony and Panasonic announcing their first Dolby Vision players, joining LG, Philips and OPPO. Just 2 years ago, we launched with a few TV partners and since then we've expanded the Dolby Vision experience into smartphones, tablets, DMAs, set-top boxes and now PCs. Content is also a key part of building the Dolby Atmos and Dolby Vision ecosystems. Apple and Netflix have been providing Dolby Vision content to IoS since the release of iPhone 10, iPhone 8, iPad Pro and Apple 4K TV, with Dolby Vision early in our first quarter.

More recently, Tencent began streaming Dolby Vision content to these devices. In addition, we've added a few new OTT partners to our roster. Rakuten, one of the largest services in Europe announced it will support both Dolby Vision and Dolby Atmos content and Okko, the largest provider of premium VOD content in Russia began delivering Dolby Atmos content just this quarter.

Today, over 200 movies are available in Dolby Vision on iTunes compared to 100 last quarter, and Netflix has over 200 hours of original content in Dolby Vision. Major Hollywood studios, including Disney, Lionsgate, Paramount, Sony Pictures, Universal and Warner Bros. support Dolby Vision and Dolby Atmos content for the home. And we continue to expand beyond premium movie and TV content to gaming and live broadcast. In gaming, there are now 6 Dolby Atmos games available for Xbox, including Assassin's Creed Origins, and Final Fantasy XV. Also this quarter, EA's Battlefield 1 was updated with support for Dolby Vision. While we continue to broaden the availability of the Dolby Atmos in live sports, our broadcast partners are expanding into new types of content.

This quarter, Sky TV delivered the season finale of Sing in Dolby Atmos. In China, 2 Tier 1 TV stations broadcast the New Year's Gala in Dolby Atmos, including Hunan TV, which is one of the most-watched channels in China. More recently, Canal Plus announced their first Dolby Atmos set-top box and content will be available in the next few weeks. Looking forward, Comcast had just announced that they'll be delivering the Winter Olympics in Dolby Atmos.

Now let's turn to Dolby Cinema. We added about 20 screens this quarter, bringing the total to 133 Dolby Cinemas open around the world with over 360 committed. When we talked to you last quarter, Pathe in Europe had just opened its first screen. Today, they now have 5 screens open. I'm pleased with the speed of adoption this quarter and we are on track to open about as many screens this year as we did in fiscal 2017.

The content pipeline for Dolby Cinema continues to grow with about 130 titles in Dolby Vision and Dolby Atmos released or announced with participation from every major studio. During calendar year 2017, all 10 of the top 10 highest grossing films in the U.S. were optimized for Dolby Cinema. We look forward to working with our partners to make the best movie-going experience more broadly available around the world.

So to wrap up. We continue to see great momentum for our newest Dolby experiences across new use cases and in new geographies. Dolby Vision and Dolby Atmos are becoming available to the mainstream and Dolby Cinema continues to grow. 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, I will turn it over to Q&A.

(Operator Instructions) The first question comes from Steven Frankel with Dougherty.

And I wonder what you're thinking about the company's return to double-digit revenue growth given your strong licensing growth you saw in the quarter?

Sure, Steve. Thanks for the question. Well, look, we -- that is our -- continues to be our goal, returning to sustainable double-digit growth. The way we're doing that is we continue to be focused on expanding our leadership in audio solutions. We, of course, are very focused on bringing our new Dolby experiences to more people around the world. And yes, we had a good quarter and we're able to raise the outlook for the year. We saw some strength on the audio side, which was good. And it's all another step in the right direction.

Okay. And on Dolby Voice, you talked a couple of quarters ago about focusing in on the huddle room market. And I wonder whether that's had any impact on the ramp of that business? And if not, what are the next steps there?

Sure. Yes, so we are excited about the shift towards the huddle room market. And the reason you might remember is that, that is a high-growth market. People are investing more of their space in these types of rooms. They expect to have a cloud-based collaboration and there is demand for a quality audio experience.

We launched with BlueJeans in -- during our first quarter. So it's -- while it's still early days, we are very pleased with the progress. And so we will continue to focus on that and to -- we think that's a good market for us. We think we're pointed at a high-growth market and so we feel good about that.

Right, if I can sneak one more quick one in. What if any implications does the Tax Reform Act have on capital allocation, pace of buybacks, repatriation of cash, et cetera?

Well, I think, as you know, we've had a program in place where we've returned cash to shareholders through a combination of dividends and buybacks. Of course, as a result of these reforms, a substantial amount of cash that is offshore will become available. My understanding from Lewis is that there is a process to go through for that, so that probably won't actually become available for 3 to 6 months. So that will factor into our calculus going forward. We don't have any specific plans to announce around that.

Our next question comes from Ralph Schackart with William Blair.

Two questions, if I could. First on the new ATSC 3.0 standard, where I believe some of your technologies were referenced as it relates to HDR. Can you sort of give us some perspective in terms of what you think what that could do for the business going forward? And then, secondly, maybe along with Steve's question, I know historically you've talked about the new products revenue being able to double year-over-year. Just curious if that's still your current thinking for 2018?

Yes, thank you. So to start off with ATSC 3.0. Well, you might remember our AC-4 audio technology was included earlier, the development as it relates to Dolby Vision is that they have included some of the foundational components within the specification of which are important for the adoption of Dolby Vision.

So the way to think of it is, is that it enables the right conditions to be in place for customers and would be customers of Dolby Vision to adopt it in the context of ATSC. And so that's great for us because, of course, our focus as always is, we're working throughout the ecosystem, OEMs, streaming providers and really the whole ecosystem. So having what's required in ATSC 3.0 for them to be able to follow through on that and bring the Dolby Vision experience to the consumers is a great development for us.

As it relates to our new revenue initiatives, which you remember, what we include in that is consumer imaging, which includes both our patent licensing programs as well as Dolby Vision, Dolby Cinema, Dolby Voice. Yes, we do believe that we're focused on doubling revenue again this year from the combination of those programs.

Great. If I can sneak one more in. On the royalty recover in Q1, just to understand that, was that something that was contemplated within the 2018 guidance it just occurred faster in Q1? So the first question. And maybe a follow-up, the full year outlook was not raised as much as sort of the overachievement in Q1. Was that just sort of related to the onetime nature of that royalty recovery or anything else you could add to that?

Hi, Ralph, this is Lewis. Probably obvious since I don't sound like Kevin. So it sounds like there is 2 halves to that question, so let me address them both. First one is essentially yes. It was a recovery that we had modeled in for sometime this year, but not necessarily for Q1, so it was great to get that done in Q1. Two, on the question regarding the guidance. A lot of things go into a range when you come out beginning of the year, but coming off of Q1 we do feel some strength in that audio licensing part of our business. Some of that also falls into mobile and that's not all related to recovery. And so it was based on all of that calculus that made us feel comfortable we could bump the guidance by 10.

Our next question comes from Mike Olson with Piper Jaffray.

I missed the very beginning of the call, so apologies if this was discussed. But it sounds like revenue upside in the quarter was largely driven by CE and mobile, and could you just talk about what specific devices or types of devices are driving upside particularly in CE? It sounds like sound bars was one area, was that the primary category?

Yes. I think CE, in general, Mike, we continue to see both sound bars and DMAs as our areas of strength, when you talk about CE.

Yes, so that was reflected in the quarter and it was also -- as it relates to the future, one of the things we talked about that was on display at CES as we continue to see a great uptick in Dolby Atmos for sound bars, and we're really focused on bringing those experiences to more price points and more consumers.

Okay, got it. And then on mobile, you've obviously had huge wins with Apple recently. Are you seeing that translate into interest from other device makers, as I guess, Apple serves as kind of a strong reference customer in the space or do you think it will just take some time to drive interest from others in the space on mobile?

Yes, I guess, I would start by observing that we've developed a really healthy Dolby Vision ecosystems. I mean, when you think back 2 years ago, when we were at CES announcing our first couple of TV partners to today where we have over 10 partners, we have Apple devices, we announced our first PC, we have content coming from iTunes, from Netflix and an increasing roster of partners. I think that, that is always going to be one of the questions of this next stage of adoption. I mean, obviously in the beginning you are going after people who want to -- who see the opportunity to bring this to market first and really believe. And as time goes on and the ecosystem build, it begins to answer more questions that the others might have. And I think that it would be -- I think it is clear that Apple is an exclamation point on that. And it flows through to content providers as well, because anybody who's thinking about investing and making Dolby Vision content available, in particular, if they're thinking about making available to mobile devices this answers another question that might have been on someone's mind. So I think that overall, I would start with we're really pleased with the health of the ecosystem and how it's expanding. And certainly, Apple is a really important part of that.

Our next question comes from Paul Chung with JP Morgan.

So just a follow-up on the recovery in mobile. So is it fair to assume that for F3Q '17, it was considerably understated? And given the back payment in Q1. Just trying to a sense for expectations for that big payment in F3Q '18 or do you expect another big back payment in 1Q of '19? How does that work?

Yes, there is a couple of different elements. Paul, this is Lewis. There's a couple of different elements to your question then we try to break those down. First, I would not say that for any of our recoveries, you could ever make any one assumption about where it related to. We have a very broad business spread across a lot of different markets and industries. So I would very much hesitate to say, oh, this was -- to put in more in your words, this was revenue that we should have gotten last year, we got this year. I wouldn't think of it that way. At a high level, recoveries are a part of our businesses. And in any given year, we tend to have a certain amount where we tend to see some movement as which market segment it lands in. Like, for example, this year I've been very clear that we expect recoveries to be lower in the broadcast segment and that's creating some headwinds there. But that's still would not imply that this is simply revenue we should have gotten "last year" that we got this year. So we'll continue to address recoveries as they come in, but I wouldn't go so far as to say that. Now in terms of on a recurring basis, typically when we have a recovery like this, then, no, we would not say, "Oh, in Q1 of next year, Paul, I'll get this recovery again," I would not say that. But that's true for any of our recoveries, I would not say that. So hopefully, I've answered both halves of your question.

And then the jump in AR is probably temporary relates to that back pay as you see that cash in F2Q queue?

Correct. I would say, in general, we tend to have a very strong, very clean balance sheet and a lot of that is just timing of when things get reported to us. This is when we get collected. And you look at previous quarters where this has happened, typically by the very next quarter we've collected those amounts.

Okay. And then last question is on cinema. Can you give us a sense on unit economics now? I mean, you guys got a material amount of locations opened. Just trying to get a sense of revenue per screen, maybe operating margin per screen would be helpful.

Sure. Yes, Paul, first of all, Dolby Cinema is making great progress. Kevin mentioned that we're now up to 130 screens open this quarter. I think that's still well short of the 360 we have in our pipeline. So my net answer is no, it's still too early to give you unit economics right now, because only a subset of those 132 have been running for a full year. And I think what we need to do is get to a point where a larger critical mass will have run for the full year before we can get there. But we'll keep monitoring that and when the time is appropriate we will share that information with you.

(Operator Instructions) And our next call comes from Jim Goss with Barrington Research.

I was wondering if you have a sense that your success with Dolby Vision has spurred some additional competition, competitive response or it's created more of a moat for you as like the only standard in the branded space?

Well, I would say that I think that with Dolby Vision we are playing into and leading the way on one of the most important and impactful elements of the UHD experience. And I would say that the same is true for Dolby Atmos as it relates to immersive audio. And so I think that what we've seen is that, over time that we've really built a very strong ecosystem and that's self-reinforcing, because it is all about the ecosystem. You don't get the benefit of these experiences unless you have a breadth of content and service providers and ways to enjoy it. And so I think that what we're seeing is that clearly HDR is a very important aspect of the next generation experience. And we've been obviously investing in this ecosystem for a long time. So we have a robust ecosystem that meets the needs of a broad range of partners and we continue to focus on extending that into ever more use cases. And I said earlier, we're really excited to be able to show the first Dolby Vision PC from Lenovo.

Okay. And Kevin, with LG's interest in spreading its [product] to their HDR product line. Does that -- are they viewing that as a very strong competitive element that probably will be merit by others?

Well, I think that our partnership with LG, the foundation of that partnership is a shared passion for providing the very best visual experience. And there is, of course, a lot of elements that go into providing that and we are very proud to be a part of it with the Dolby Vision experience. And so we're always looking to add value for our partners. And of course, they -- that's why they're working with us.

Okay. With -- separate issue, with the taxes, the tax changes, will there be any impact on your operating strategy in terms of physical locations in which you are operating? Besides from just repatriating of funds, how does that seem to impact your operations?

Yes. At the current time, there is nothing that I can say has changed. It will take some time, of course, to work the new tax law changes through the system. As part of that, we will look at things like tax strategies. But I think it's fair to say that we, like so many companies, would say, this new tax law has been in place for barely a month, it's too early to know whether or not we would have any significant changes. So we will keep you posted on that, if anything changes.

Okay. And one last thing. Product margin pressure in the first quarter doesn't seem to be repeated in the guidance going forward. What was the issue in the first quarter and why will it be different?

Sure. So one of the things I highlighted in my prepared comments was that we did miss our target this quarter in product revenue. And when that happens, of course, we have to be prudent about how much we build and how much volume we run. And that typically is the kind of thing that ripples through the gross margin. We've held our guidance for the year to hopefully make up some of that difference as we go along. But we'll keep monitoring that. But as you know, Jim, product margin has a relatively minor impact on the company's overall margin. And certainly, the products we are looking to sell all seem like they are great new products that are exciting, it's just a matter of how quickly they ramp. But we will, obviously, pay attention to that going forward.

And at this time we have no further questions. I would like to turn the conference back to Kevin Yeaman for any closing remarks.

Great. Well, again, thank you everybody for joining us today, and we look forward to keeping you updated. Thank you.

Thank you. This does conclude today's presentation. We thank you for your participation.