Dolby Laboratories' CEO Discusses F2Q 2014 Results - Earnings Call Transcript

Apr.29.14 | About: Dolby Laboratories, (DLB)

Dolby Laboratories, Inc. (NYSE:DLB)

F2Q 2014 Results Earnings Conference Call

April 29, 2014, 05:00 PM ET


Elena Carr - IR

Kevin Yeaman - President and CEO

Lewis Chew - EVP and CFO


Steven Frankel - Dougherty & Company

Michael J. Olson - Piper Jaffray

Alex Hu - Avondale Partners


Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call discussing Fiscal Second Quarter Results. During the presentation all participants will be in a listen-only mode. Afterwards you will be invited to participate in a question-and-answer session. (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, for Dolby Laboratories. Please go ahead, Elena.

Elena Carr

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 may differ materially. A discussion of some of these risk and uncertainties can be found in our earnings press release that we issued today under the section captioned 'Risk Factors' as well as in our most recently 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 this call we'll 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 us with 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.

Lewis Chew

Thanks, Elena for that stirring introduction. Good afternoon, everyone. Let’s began 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’ll address that along with the 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 above 37% year-over-year. If we exclude the back payment of $24.7 million from those comparison then broadcast licensing growth 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 in TVs. PC revenues represented above 16% of total licensing in Q2. They were down about 4% sequentially and down about 29% compared to last year 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 biz model this was in line with the comments I made in 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 comprise about 14% of total licensing. They were down about 11% sequentially and higher by about 4% year-over-year and a sequential decrease was due to lower back payments offset partially by higher unit volume from holiday seasonality.

Mobile device revenue 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 market which primarily include 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. Those increases were driven by higher revenue attributable to the new PS4 and Xbox-1 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 not always land in the same market segment by the same amount each quarter but they can be highlighted by the fact when we go over the up and down in the segments. Very large amounts like the $24.7 million item that we got in Q2 are not atypical so we call those out separately.

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 $2.1 million year-over-year. Both of the declines were driven by lower revenue from matured Digital Cinema product offset partially by higher sales in Dolby Atmos.

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

Now I'd like to discuss margins and the rest of the income statements 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 from 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 cost, 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 a $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 a $1 billion in total cash and investments which includes and 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 is 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 will be roughly flat with last year's Q3 licensing or 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 arrangements 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 product 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 a $153 million to $158 million on a GAAP basis and a $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 cost 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 rates 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 factor that 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 fiscal year 2014 we now estimate the 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 markets in units will be down by about 6 point to 7 points for the year and that all 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 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 projections mainly because of our shifting timings for some of our new product revenue gains.

Fiscal 2014 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 a point higher. Other income is estimated to be around $1 million for the year which conclude the $3 million non-cash right offs of an equity investment that was in our Q2 results. And the effective tax rate for fiscal 2014 is anticipated to range from 26% to 27%. So now I’d like to turn the call over to Kevin Yeaman. Kevin?

Kevin Yeaman

Thank you Lewis and good afternoon everyone. We had a strong second quarter led by broadcast where we continue to increase our presence in emerging markets and in gaming which benefited from the release of the Sony Play Station 4 and the Microsoft Xbox 1. And I am particularly pleased with the momentum we are building in our new initiatives. During today’s call I’ll update you on our progress in each of our key growth areas.

Let’s start with mobile, we’ve been steadily growing this business in the last several years. As Lewis discussed we expect our mobile revenue to decline in the next quarter. While we are disappointed that Dolby Digital Plus is not included in recently launched Samsung model we continue to work through our range in the 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 markets. Dolby’s audio solution makes online content even more engaging in mobile devices. Mobile premium content is still on its early stages but is clearly a key vector of growth for the eco system. The Dolby values is best seen when our technologies enable an entire eco-system from content creation to distribution and ultimately the consumer device.

A great example of this is Amazon. We partnered with them to enhance the audio experience in the prime instant video library and the full line of Kindle Fire tablets. Together we’ve delivered a premium audio experience in these tablets this is evidenced by the critical acclaim with 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 television.

Beyond the Amazon ecosystem we have been working with over the top mobile content providers to stream in Dolby. In just one year we've 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 ITE 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 expanding 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 to focus on working with operators and standards bodies to adopt our technologies our 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 percentages 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 our 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 True Visions, the country's largest PayTV 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 streams 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 10 highest grossing films in 2013 were Dolby Atmos titles including Gravity, which won the Academy awards 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, DT launched D T - MeetMe with Dolby Voice. DT MeetMe with DolbyVoice transforms conference calls and improves productivity by giving attendees the sound and feel of in person meetings. We are seeing good early adoption. The service not only provides a superior experience, it can also reduce conferencing cost 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 views and for the first time will bring the Dolby Voice experience into the meeting room. It provides wide band audio, voice separation, noise suppression and the ability to capture all voices in the room. The net result is ability to have a natural conversation, eliminating some of the common frustration 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 edition 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 reactions to our demonstration of Dolby Vision at CES and have garnered wide spread coverage for major outlets across the U.S. 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 evidence at the recent National Association of Broadcasters conference. In summary we’ve had a great first half of 2014. We’ve increased our revenue outlook for the year and remained committed to driving growth in our core businesses. Our new offerings such as Dolby Voice and Dolby Vision are resonating 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 term will help further drive our long term growth. And with that I’ll turn it over to Q&A.

Question-and-Answer Session


Thank you. (Operator Instructions). Your first question comes from Steven Frankel with Dougherty & Company.

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?

Kevin Yeaman

Sure so, no first of all as we said in the remarks we are really working through the contract details with them now. It’s come up for its natural renewal cycle. So there is a lot of moving parts right now which I am not going to really not going to get into the details of each of the moving parts except to say that we feel pretty comfortable in saying that it's going to be about 10% of our revenue, mobile that is in Q3 that we have opportunity to grow from there. And that -- yeah everything is still on the table.

I think clearly it shows that we have worked to do, if we are going to start shipping in FY but we continue to believe we have a value of proposition to bring at a time when -- yeah I think it's pretty clear that a lot of people in the Smartphone industry are very much focused on cost. But we continue to focus on building value across all the major ecosystems and continue to see growth opportunities from here.

Steven Frankel - Dougherty & Company

Okay, and then on Atmos what do you think your share of large format theaters is, excluding IMAX, kind of the house brands, what does that six centers terms of your market shift?

Kevin Yeaman

I don’t know if have top of my head the exact number of the house brand in PLF, but it is fair to say that the vast majority of the 440 we haven’t sold and the six centers committed are targeted at the growing PLF market. There is still, I mean on a global basis there is still a lot of room to grow in the existing PLF market and it's also the area where we see quite a lot of investments from our exhibitors where we anticipate their investments to be going forward is in the PLF format.

Steven Frankel - Dougherty & Company

Thank you.


Thank you, Mr. Frankel. We’ll take our next question from Mike Olson with Piper Jaffray.

Michael J. Olson - Piper Jaffray

Hey, good afternoon. So you know these [back ins] are difficult for you to predict at this time. But through the remainder of the fiscal year are you seeing anything out there and anticipate anything could be anywhere close to as large as the $24.7 million that you saw this quarter.

Lewis Chew

Hey 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 it's saying the fact that we always have back ins every quarter. But currently we don't anticipating a singular item of that size for the remainder of this year.

Michael J. Olson - Piper Jaffray

Okay, and then regarding Samsung, would you be willing to kind a share an estimate what percent of your total revenue is in from any Samsung related revenue the last few quarters?

Lewis Chew

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. So no I don't know how much more I can give you on that. We're not going to break it out separately as a subsection of mobile. To me at a high level I think what Kevin and I think even I had in my comments was to sort of reset the safe line of being around 10% of revenue and then kind of grow from there.

Michael J. Olson - Piper Jaffray

Okay, yeah that makes sense. And then Kevin as far as Dolby Vision, can you just repeat what set what we are for kind of initial estimated adoption there and what your expectations are as far as when it potentially gets to be more material part of the business.

Kevin Yeaman

Sure, well we're expecting television 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 new televisions later this year.

Michael J. Olson - Piper Jaffray

All right, thank you.


And at this time we do have one question remaining in the queue. (Operator Instructions). We'll take our next question from John Bright with Avondale Partners.

Alex Hu - Avondale Partners

Good afternoon, this is Alex Hu in for John Bright. So just a quick question about the three initiatives namely Atmos, Voice and Vision. I know you guys touched on Atmos and Vision, but for Voice should strategically speaking where do you seeing initiatives going like how you are getting paid and are there any ASPs you can provide us with?

Kevin Yeaman

Sure. So strategically this is application of our expertise in sound to bring transformational experience to an experience which frankly has had a lot of people had a lot of frustrations with. We think it's a big opportunity; it's about audio conferencing market. The enterprise audio conferencing market which is what we're targeting first and foremost is about a $4 billion industry that we're serving. And we see a big opportunity here. The way we are getting revenue is both on the scale of the implementation which is to say a fee for each of the ports installed, and then also a share of the minute revenue where the Dolby Voice service is utilized. And then on top of that as we as I mentioned today, later this year we expect to begin shipping the Dolby, the conference phones which will bring that live like experience and connected to the service from capture to playback effectively. And that will be another revenue stream and we've not released the list price on that yet.

Alex Hu - Avondale Partners

Okay, and just follow-up questions. What is the guidance that [CMC] guys be on the revenue by about $30 million and on the bottom line by about like $0.24 or so, on that product the new guidance that you guys provided? It doesn't seem like you guys are flowing through, are you guys are flowing through some of the top line be but not so much on the bottom line. I was just wondering why not flow through like the entire amount.

Lewis Chew

Yes. I think yes I think a sheer mass exercise like that has limited applications when you got things moving around. So first of all on the revenue be flowing through to the full year guidance, we have two things going on, most of the licensing be does flow through but I've 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 going forward. And second in our OpEx we do have to absorb some transaction OpEx that's going on related to Doremi. And we're gone try to get that deal closed as soon as we can to the short [OpEx] they get but some of that is subject to the procedures we have to go through with the regulators. So that's probably causing some of that noise in terms of your flow through

Alex Hu - Avondale Partners

All right, thank you.

Kevin Yeaman

All right.


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.

Kevin Yeaman

Well, thank you everyone for joining us today. And we look forward to updating again soon.


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

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