Dolby Laboratories' CEO Discusses F1Q13 Results - Earnings Call Transcript

| About: Dolby Laboratories, (DLB)

Dolby Laboratories, Inc. (NYSE:DLB)

F1Q13 (Qtr End 12/28/2012) Earnings Call

January 29, 2013 5:00 PM ET


Alex Hughes - Senior Director, Investor Relations

Kevin Yeaman - President and Chief Executive Officer

Lewis Chew - Executive Vice President and Chief Financial Officer

Ramzi Haidamus - Executive Vice President, Marketing and Business Development.


Ralph Schackart - William Blair

Steven Frankel - Dougherty & Company

Jeremy Henrard - Avondale Partners

Perry Huang - Goldman Sachs

Michael Olson - Piper Jaffray


Welcome to the Dolby Laboratories' conference call discussing fiscal first quarter results. (Operator Instructions) I would now like to turn the conference call over to Mr. Alex Hughes, Senior Director of Investor Relations for Dolby Laboratories.

Alex Hughes

Good afternoon, and welcome to Dolby Laboratories' first quarter fiscal 2013 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories' President and CEO; Lewis Chew, Executive Vice President and Chief Financial Officer; and Ramzi Haidamus, Executive Vice President of Marketing and Business Development.

On this conference call, we will be making forward-looking statements that include projections of future operating results for our fiscal year ending September 27, 2013; market trends and developments for the industries in which we compete, and in the PC, online and portable industries in particular; and our expectations and beliefs concerning how those trends and developments will affect our operating results; the capabilities and market 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 are subject to risks and uncertainties. Actual results may differ materially from those set forth in such statements. Important factors, such as general economic, PC, broadcast, consumer electronics or cinema market conditions, could cause actual results to differ materially from those in forward-looking statements.

These factors are addressed in the earnings press release that we issued today and under the section captioned Risk Factors and elsewhere in our most recent quarterly report on Form 10-Q available at or on our website at, under the Investor Relations section. Dolby disclaims any obligation to update information contained in these forward-looking statements, whether as a result of new information, future events or otherwise.

During this call, we will discuss GAAP and non-GAAP financial measures. The 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; and Kevin will finish with a discussion of the business.

So with that introduction behind us, I will now turn the call over to Lewis.

Lewis Chew

Thanks, Alex. I think it's pretty impressive that you have that entire Safe Harbor memorized, didn't need any paper. Good afternoon. During my portion of the call today, I'll discuss following areas: first quarter revenue and the related trends; our operating expenses and margins; and I'll go with the outlook for the second quarter as well as an update for the fiscal year '13 in total.

So let me start with the revenue discussion. Total revenue in the first quarter was $236.6 million, of which licensing comprised $204.9 million and $31.7 million came from products and services. The Q1 licensing revenue was up sequentially over Q4 by $12.7 million or about 7%, and up $4.5 million or about 2% from Q1 of last year.

The sequential increase was driven primarily by seasonally higher unit volume and several areas, namely PC's, Blu-ray and DVD, TV's and gaming consoles. These positive factors were partially offset by sequential declines in our other markets category and also by timing of customer specific annual contract amounts that we received in Q4, but didn't repeat in Q1.

The year-over-year increase in Q1 licensing was due to higher revenue in set-top boxes, TV's and mobile devices, driven by increase volume along with higher IP settlements. This was offset partially by lower unit volume and various consumer electronics, such as DVD and Blu-ray players and gaming.

A profile of our revenue by market categories would be as followed: broadcast revenues in the first quarter were above 33% of licensing. They were up about 5% sequentially and above 9% over last year's first quarter. The sequential increase can be attributed primarily to seasonally higher activity. And in the year-over-year increase, we saw higher units in the set-top box market as well as higher attach rate, while TV had higher attach rates, partially offset by lower units in the market.

In Q1, PC revenues comprised of about 29% of licensing. They were up about 11% sequentially and were about flat compared to last year's Q1. The sequential increase benefited from seasonality like back-to-school and also from back royalty that reflected in the first quarter.

Consumer electronics revenues in Q1 made up about 17% of licensing. They were up about 13% sequentially, but down about 12% compared to Q1 last year. The sequential increase was mostly seasonal, while the year-over-year declined reflects softness in the market.

Mobile device revenues were about 11% of licensing in the first quarters and they were down about 9% sequentially, but were higher by about 35% over last year's first quarter. The sequential decline was attributable to timing of annual payments related to specific customer contracts, offset partially by higher unit volume, and the year-over-year increase was due to higher TAM as well as attach rates.

Revenues in other markets would include gaming and automotive, represented approximately 10% of total Q1 licensing, and they were up about 12% sequentially due primarily to seasonally higher unit volume in gaming, but down about 12% year-over-year also mainly because of gaming.

Product and services revenue was $31.7 million in Q1, which is down roughly $2 million sequentially and year-over-year. Product revenues in Q4 of FY '12 benefited from the release of a new cinema product after it had reached DCI compliance, but Q1 didn't have anything with a similar impact, and I discussed this briefly last quarter when it happened. The year-over-year decline was due to lower revenue from film-based cinema product and some broadcast products, offset partially by higher sales of digital cinema products.

So now, I would like to discuss margins and rest of the income statement. Total gross margin in the first quarter was 89% on a GAAP basis and 90% on a non-GAAP basis. Product gross margin on a GAAP basis was 27.5% in the first quarter compared to 26.6% in the preceding fourth quarter, and 47.4% in last year's first quarter.

On a non-GAAP basis, product gross margin was 33% in the first quarter compared to 30.5% in the preceding fourth quarter, and 49.8% in last year's Q1. The sequential increase in non-GAAP product gross margin was due primarily to a combination of better ASPs and net manufacturing cost, and the year-over-year decline was due primarily to lower ASPs and product mix.

Operating expenses in the first quarter on a GAAP basis were $144 million compared to $127 million in the preceding fourth quarter. Included in the Q1 total were about $18 million of stock compensation expenses, which included approximately $3 million incremental from the impact of a pro-rata adjustment to existing stock options at the time of the special dividend that we declared in December 2012.

Operating expenses for Q1 on a non-GAAP basis were $125.7 million compared to $113.2 million in the preceding fourth quarter and compared to an estimate of $120 million, when we gave guidance at the beginning of the quarter. And the difference between our Q1 estimate and actual was due to earlier timing of some marketing programs as well as classification of certain IP settlement credits from licensees.

Our full year outlook for non-GAAP operating expenses is staying essentially the same as the guidance from last time, and I'll discuss that a little more in a minute.

Operating income in the first quarter was $67 million on a GAAP basis or 28.3% of revenue, and $88 million on a non-GAAP basis or 37.2% of revenue. The effective tax rate for the quarter was 25.5% on a GAAP basis and 26.1% on a non-GAAP basis, as we benefited from discreet items in the quarter.

Net income in the first quarter was $51.3 million on a GAAP basis or 21.7% of revenue, and was $66.4 million on a non-GAAP basis or 28.1% of revenue. Diluted earnings per share in Q1 were $0.50 on a GAAP basis, which was $0.01 above than we had in the preceding Q4 and down about $0.17 from the last year's Q1.

On a non-GAAP basis, Q1 diluted earnings per share were $0.64, which was about $0.03 higher sequentially over the preceding Q4, and down about $0.12 from last year's first quarter.

During the first quarter, we generated about $67 million of cash flow from operations and we also paid a special dividend near the end of the quarter of $4 per share or a little over $400 million in aggregate. As of the end of Q1, we had about $743 million in total cash reserves, which would include cash and cash equivalents as well as both short and long-term marketable securities.

During the first quarter, we repurchased about 1.7 million shares of common stock for approximately $54 million and we ended the quarter with about $144 million remaining available under our approved stock repurchase program.

So now looking forward into the second quarter of fiscal 2013, here is our outlook for Q2 and for the year. We currently estimate that total revenue in the second quarter will range from $240 million to $250 million. Within that, we anticipate that product and services revenue could decline sequentially by around $6 million to $7 million, while licensing revenue is expected to increase mainly because of seasonality.

Within the licensing revenue outlook, we are projecting that broadcast, mobile, gaming and consumer electronics will all show sequential increases, while PC is projected to go down mainly due to softness in the PC TAM.

Gross margin in the second quarter is projected to be roughly the same as it was in the first quarter on both the GAAP and non-GAAP basis. We estimate that operating expenses in the second quarter of 2013 will be around $145 million on a GAAP basis and about $127 million on a non-GAAP basis plus or minus.

Our annual focal adjustments to payroll went into effect for the second quarter and that together with some seasonally higher expenses is reflected in the higher estimate of Q2 over Q1. All else equal, I would anticipate that non-GAAP operating expenses will drop back down in Q3 of this year compared to Q2.

Other income in the second quarter is expected to be approximately $1 million and our effective tax rate for the second quarter is estimated to range from 26% to 27% on both the GAAP and non-GAAP basis. Based on a combination of the factors I just went over, diluted earnings per share in the second quarter are projected to range from $0.53 to $0.60 on a GAAP basis and from $0.68 to $0.75 on a non-GAAP basis.

With respect to the full-year estimates for fiscal 2013, we gave guidance last November that FY '13 revenue will range from $900 million to $950 and that non-GAAP operating expenses would be about $490 million plus or minus. The $490 million expense number included about $10 million of projected settlement credits that we are now classifying within revenue.

So the former $490 million estimate is now bumped to $500 million to exclude the $10 million of projected credits. Likewise, we are increasing the lower end of our revenue range by the same $10 million, which means that our revenue outlook for the year is now in a range of $910 million to $950 million.

We did increase the top-end of our range, because of uncertainties affecting the market outlook for PCs, TVs and other consumer electronics that have seen reductions in unit estimates since the time we gave guidance back in November. Regarding operating expenses on a GAAP basis, we estimate that for the year there'll be around $572 million plus or minus.

Finishing up with the rest of the outlook for the year, our gross margin estimate for fiscal 2013 remains unchanged at around 90%. Other income is estimated to range from $4 million to $6 million and the effective tax rate for the full year is projected to range from 27% to 28%.

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

Kevin Yeaman

Thank you, Lewis, and good afternoon, everyone. We had a strong first quarter in an uncertain economy. At the same time, we continued to extend our presence in mobile devices and to broadcast in the emerging markets.

In addition, we are encouraged by our early market engagements around newer initiatives, such as Dolby Atmos, Dolby Voice, and consumer 3D without glasses. We remain focused on continuing to diversify our revenue base and on executing against our strategic priorities to position Dolby for long-term growth.

Let met turn to updating you on each of the initiatives that I outlined at the beginning of the year. Starting with mobile, we continue to expand the use of our technologies in online content and mobile devices. In the Android ecosystem we are now in about a quarter of all tablets and smartphones, including the Samsung Galaxy S III and new models from Huawei and ZTE.

In the Windows ecosystem, Dolby Technologies are in all Windows 8 based tablets, and have recently been added to Nokia's Lumia 920 smartphones. In the Amazon ecosystem, the Kindle HD Fire started shipping last quarter with our technologies and has been well received by the market. We should get our first revenue from the Fire in our fiscal Q2 and Amazon has now begun expanding into international markets.

Turning to online and mobile content, our formats are used by the leading over-the-top services. We're focused on increasing the amount of content in Dolby formats available to mobile devices. For instance, Netflix began streaming Dolby enabled content to certain Windows 8 devices.

In addition, Sony Pictures, Universal Studios and Warner Bros. recently selected Dolby Digital Plus for their UltraViolet libraries. UltraViolet is a cloud-based system, which allows consumers to download and stream their movies and TV shows from their own digital locker to their connected devices. This will ultimately lead to an increase in online content in our formats to mobile devices in order to deliver a better audio experience.

Turning to broadcast, our priority is to increase the adoption of our technologies globally. In the developed economies like the U.S. and Europe, where Dolby audio technologies are widely adopted, we are focused on bringing new solutions to the market, such as our format for 3D TV without glasses. In the emerging markets we still see a significant opportunity to grow the adoption of our audio technologies as broadcasters continue to transition to digital broadcast.

In the Asia-Pacific region, we continue to expand the use of our technologies by both content creators and broadcasters. In China TV production company, Hairun announced it would begin producing new shows in Dolby technologies for its video-on-demand service. In addition, over-the-top provider LATV will begin deploying our technologies in its content and playback devices to ensure a better audio experience for its customers.

Elsewhere in Asia, Indian satellite provider Sun Direct launched another HD channel in Dolby, while Singapore's IPTV provider SingTel launched two. In Latin America a number of operators are preparing to launch in Dolby

Another priority of ours is to redefine the audio experience in the cinema through our next-generation technology Dolby Atmos. Dolby Atmos enables artists to create and deliver a far more realistic and immersive audio experience. In the first quarter more studios and exhibitors embraced Dolby Atmos.

To-date 14 titles have been released across six studios, including Paramount Pictures, Warner Bros pictures, Walt Disney Studios, Universal Pictures, Twentieth Century Fox and DreamWorks Animation. Dolby Atmos is also being embraced internationally with local titles produced in China, India and Singapore.

In the exhibitor community, over 40 exhibitors around the world have deployed Dolby Atmos systems. Looking forward, we have over a dozen titles committed, dozens more in the pipeline and expect to grow the number of Atmos enabled screens significantly. And this all tells me that the industry is embracing Dolby Atmos and looking to bring a more immersive audio experience to consumers.

Finally we are focused on bringing new technologies to market, such as Dolby Voice. Dolby Voice enables service providers to provide a conference call experience that sounds more like an in-person meeting. This is an exciting growth initiative, and that it represents a whole new market for us in the area of enterprise communications. Leading service provider, BT plans to deploy Dolby Voice this year to deliver a differentiated conference call experience to its customers.

In summary, we had a strong first quarter. And we continue to make progress in diversifying our revenue base and positioning Dolby for long-term growth. We have continued to expand the adoption of our audio technologies throughout the mobile market, while increasing our broadcast presence globally. In addition we are creating new growth opportunities by bringing new solutions to the market such as Dolby Atmos and Dolby Voice.

Question-and-Answer Session


(Operator Instructions) We'll go first to Ralph Schackart with William Blair.

Ralph Schackart - William Blair

First question is for Lewis. Lewis I was wondering if you could quantify the marketing pull-through in Q1. And then I know you've talked about step down in OpEx in Q3 or the back half of the year, but as we look at our model last three year, it's seasonally the second half is a step-up in OpEx. So just trying to understand the visibility we have on the cost structure?

Lewis Chew

Sure. I'd say there was probably a few, I would characterize it as a few million dollars of pull-through related to, as you can probably imagine some of our bigger programs like Atmos and some branding initiatives. Also one of the things that's hitting us seasonally in Q2 is that, that's when we typically incur the expenses as far as some of our bigger tradeshow that we attend. And we would expect that to subside in Q3. And Kevin and I are very committed to meeting our budget commitment to everyone for the year and so that's why effectively we are making that fit into the whole year.

Ralph Schackart - William Blair

And maybe one for Kevin. I think last call you talked about a five point step-up in sort of mobile penetration with the new Dolby products that you have. Going out in the market just curious if you are still sort of marketing towards that 5% increase for the year?

Kevin Yeaman

Yeah, that's still our goal for the year and we're pleased with the progress we're making across each of the major mobile ecosystems. And you'll notice that for the first quarter where we've broken out our mobile revenue in the segment, 11% of revenue for the quarter and it grew 35% year-over-year. And that's driven by both the increased adoption and our goal of increasing by five percentage points this year as well as the fact, of course, that the underlying market is growing very strong with well over 20% year-over-year growth in units.


We'll go next to Steven Frankel from Dougherty & Company.

Steven Frankel - Dougherty & Company

Could you start Lewis with some clarity on the catch-up royalty payments that occurred in Q1? How much was that and what category did that come from?

Lewis Chew

First of all, I'd say that this is really a subset of all those items, so that going forward now, starting with this quarter, all of our catch-up, whether they'd be settlements or back growth royalties, will all be classified in revenues. So that will get rid of any remaining. I know in the past we've talked about some of these that were recorded as credits to expense.

The impact both year-over-year and quarter-to-quarter was about plus five. And in terms of market categories, in any given quarter they are spread across and this quarter was the same. They happened in several of our different buckets. The normal buckets we talk about, set-top box, PC, TV, et cetera, but that's the impact is about plus five, both year-over-year and quarter-over-quarter.

Steven Frankel - Dougherty & Company

And for, Kevin, could you kind of sketch at a high level what the business model for Atmos might look like?

Kevin Yeaman

Sure. So first of all, we're up to as I said 40 exhibitors have installed system with the goal of enhancing the audio experience and ultimately getting more consumers into the cinema. We are currently expecting to begin shipping our generally available product and therefore recognizing revenue in the second half of the year. And we're working with exhibitors right now for the models that will work best for them. It could go along the lines of our traditional product sales model, but we're also open to exploring other models that you've commonly seen in with vendors to exhibitors.


We'll go next to John Bright with Avondale Partners.

Jeremy Henrard - Avondale Partners

This is Jeremy Henrard in for John Bright. I wanted to ask you could you remind us what you were assuming for PC shipments last time you provided guidance and what your outlook is today?

Lewis Chew

Last time, I would say published market reports were up slightly for the year. We are assuming flattish to up slightly and this time around I think the market reports are that for the year, PC TAM is going to be down in the neighborhood of 4%. So we've adjusted our full-year guidance to reflect that new TAM along with obviously the 50 other factors that affect our revenues outlook.

Jeremy Henrard - Avondale Partners

Then still on PCs, could you just quickly revisit the Windows contract? Generally speaking our ASPs going to be the same for all Windows products? How is that going to trend relative to prior years?

Lewis Chew

No. I can let Kevin expand on this, but have you talk about the under the new Windows 8 structure? Basically we get a royalty on all Windows 8 machines that ship that people properly report out there, if you're listening. But then there is step-ups for, depending on functionality, for example, if they want it enabled with DVD playback, there is a step-up. So there is a range of prices.

As you know, we don't specifically disclose our ASPs. If the rate for optical playback and decoding from any source is consistent with the rates that we've historically gotten from the PC market, there is also a lower rate for non-optical playback that doesn't include optical display back. And we came into the year expecting that where there is an optical disc, people will want that for the use case.

We're estimating coming into the year that about somewhere around 80% of PCs shipments this year are going to include optical discs. And we're still running with those assumptions for now, and it's still pretty early for us in the Windows 8 cycle to make any refinements to that, especially because previously we were recognizing revenue when Microsoft shifted certificates into the channel. Now we're getting paid directly by the OEMs. So we're getting paid when the PC is ship. So we expect to get more visibility as we get deeper into this Windows 8 cycle.

Jeremy Henrard - Avondale Partners

And just for clarification, where are you recognizing Windows 8 tablet revenues? Is that in PCs or in mobile?

Lewis Chew



And Perry Huang with Goldman Sachs has our next question.

Perry Huang - Goldman Sachs

I wanted to ask a question about the mobile segment. In terms of thinking about full-year guidance, how important attraction is from the tablets like the Kindle Fire HD and Windows 8 to sort of hit the full-year license guidance? And are tablets expected to be the key growth driver for mobile or smartphones or sort of a balanced mix between the two?

Kevin Yeaman

Well, it's a mix between the two and yes we have factored in our estimates for what we expect from each of our design wins, including the Kindle Fire and Windows 8 tablets that you referred to. But it's a combination of tablets and smartphones. And as I said, it's a combination of a fast growing market combined with our expectations that we're going to continue to garner additional design wins and additional penetration throughout the year.

Perry Huang - Goldman Sachs

I guess for the follow-up, just a clear question on headcount. It looks like the average headcount grew about 10% year-over-year, kind of a slower growth in total GAAP OpEx growth. I guess a couple of things here; the first, our headcount levels where at you would like them to be for the remainder of the year? And is there anymore color you can provide on what positions were filled, for example were they mobile related, in R&D or sales and marketing? And second; I guess the increase in the full-year OpEx target, is that largely related to headcount growth or spend, not really a headcount growth on a GAAP basis?

Lewis Chew

Let me address the uptick and then I'll throw it over to Kevin to give you the real meat on the bones. So just to clarify, the uptick is not an increase in what we'll spend, it's simply that when we originally gave you the $4.90 guidance, that had netted in there approximately $10 million of this small slice of credit that we get that historically we had classified within expense. And starting this quarter, we're going to put that in revenue along with the rest of our settlement credit.

So all we did was bump the 490 to 500 to reflect. That was a budgeted item and they are moved it over to revenue, and that's why we also bumped with the revenue range from 900 to 910. But let me turn it over to Kevin to answer the real question which was, it was headcount, it was where are we hiring new people, do we have any open racks? Are you applying for a job, Perry or you just wanted to know what we're hiring right now?

Kevin Yeaman

Well, I would say that most of our investment right now is in the areas of R&D and in the area of the sales and marketing organization especially as it relates to serving the markets in the growth areas we've outlined, whether it'd be emerging markets, in the case of broadcast, or in the case of mobile. It's a combination of headcount and non-headcount spend, and for the most part the team is managing to a spend number, but as Lewis and I have said we expect that overall OpEx number to level out is not even in fact settled down a little bit in Q3 and in Q4.


We'll go now to Michael Olson with Piper Jaffray.

Michael Olson - Piper Jaffray

Quick question for Kevin. For internet delivered content and mobile flash connected devices, you guys have obviously successfully shown ability to get integrated in some of the content and some of the devices for that matter. I was curious if you're expecting a dual audio technology situation for streaming content in those mobile and connected devices, similar to what we have seen with Blu-Ray or if you expect the content owners and device makers to focus on one audio technology?

Kevin Yeaman

Do you mean by that like an AAC and Dolby Digital Plus by dual format, is that an example of what you mean?

Michael Olson - Piper Jaffray

No, I mean more or like how Dolby and DTS were both mandated on Blu-Ray.

Kevin Yeaman

Well, in current course and speed we are in a 100% of all content delivery services. We are confident that we're providing the content delivery companies with everything they need. We believe their value proposition to the content creators, distributors as well as playback devices, it's complete. And therefore we frankly don't see a reason why there would be a second offering at this point.

Michael Olson - Piper Jaffray

And then secondly Kevin, you mentioned the change in how you're getting paid on the PC side going forward OEMs versus Microsoft, does that change the timing as far as the typical one quarter lag in rev rec on the PC side?

Kevin Yeaman

Well, it's still a one quarter lag. And just that it used to be a one quarter lag off of when Microsoft sold their operating systems certificates to the OEMs. Now, it's a one quarter lag off of when the OEMs ship their PCs. Whether that is a net-net one quarter difference or maybe half a quarter difference, it's really hard for us to tell, but we'll be getting a better history with it over the next quarter or two.

Alex Hughes

Well if we don't have any further questions, then thank you all for joining us. And we look forward to keeping you apprised of our progress. Thank you.


That will conclude today's conference. Thank you all for joining us.

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