Elena Carr - Director, Corporate Finance & IR Kevin Yeaman - President & CEO Lewis Chew - EVP & CFO

Mike Olson - Piper Jaffray Steven Frankel - Dougherty Ralph Schackart - William Blair Paul Chung - J.P. Morgan Pat Sholl - Barrington Research

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories Conference Call Fiscal Second Quarter Results. During the presentation, all participants will be in a listen-only mode. [Operator Instructions]. As a reminder, this call is being recorded, Tuesday, April 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 second 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-Q. 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 two is available on 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 our fiscal 2018 outlook, and Kevin will finish with a discussion of the business. So, let's go ahead and get started, Lewis.

Okay. Thanks, Elena, and good afternoon everyone. Our total revenue in the second quarter was $301 million, of which $273 million was from licensing, and $28 million was from products and services, and we continue to see positive momentum in our revenue. We are raising our revenue outlook for the full-year. We are also increasing the range of estimated operating expenses and I will have more comments on these two topics in just a few minutes. But first, let me jump back to Q2 results, starting with some commentary on our end markets. Broadcast represented about 39% of total licensing in our second quarter. Our revenues in this market increased about 4% sequentially and was flat year-over-year. The sequential increase was driven mainly by some higher activity that we saw in TVs and set-top boxes and that's what the TV trend being helped by holiday seasonality. And year-over-year, we saw higher revenue in TVs offset by some lower volumes in set-top boxes, so that's broadcast. In mobile devices, our mobile devices represented approximately 21% of our total licensing in the second quarter. Mobile revenue was down by about 6% sequentially but increased year-over-year by more than 100%. The sequential decline was mainly due to a large recovery in Q1 that didn't repeat in Q2 nor did we expected to and the year-over-year increase was due to some higher penetration we're getting in new models and also helped by timing of payments. Consumer electronics and this represented about 13% of total licensing in the second quarter. Consumer electronic licensing in Q2 was up by about 32% sequentially and up slightly year-over-year. The sequential increase was driven mainly by holiday seasonality and along with some higher penetration we're getting into DMAs. PC represented about 12% of total licensing in the second quarter and PC was up about 19% sequentially, but down by about 15% year-over-year. The sequential increase was due primarily to higher volume and higher recoveries and the year-over-year decline reflected lower recoveries along with lower blended ASPs due mainly to mix. Licensing in other markets represented about 15% of total licensing in the second quarter. Other licensing increased by about 2% sequentially and about 19% year-over-year. The sequential increase was due primarily to higher revenue from Dolby Cinema and seasonally higher revenue from gaming and this was partially offset by lower fees from via and lower revenue from automotive. The year-over-year increase was driven by higher revenue from Dolby Cinema and from gaming. Products and services revenue was $28.2 million in Q2 compared to $29.8 million in Q1 and $25.9 million in last year's Q2 and we saw year-over-year growth from Cinema products as well as from Dolby Voice. Let's move on to margins and our operating expenses. Total gross margin in the second quarter was 89.7% on a GAAP basis and 90.2% on a non-GAAP basis. Product gross margin on a GAAP basis was 31.2% in the second quarter compared to 31.7% in Q1 and product gross margin on a non-GAAP basis was 34.6% in the second quarter compared to 35.1% in Q1. Operating expenses in the second quarter on a GAAP basis were a $184.1 million compared to $174.7 million in the first quarter and operating expenses on a non-GAAP basis were $166.3 million in Q2 compared to $155.9 million in the first quarter. Operating income in the second quarter was $86.3 million on a GAAP basis or 28.6% of revenue and was a $105.7 million on a non-GAAP basis or 35.1% of revenue. Other income in the quarter was $3.2 million for both GAAP and non-GAAP. And the effective income tax rate for the quarter was 20.9% on a GAAP basis and 23.2% on a non-GAAP basis. Net income on a GAAP basis for the second quarter was $70.6 million or $0.66 per diluted share compared to $0.49 per diluted share in last year's Q2. Net income on a non-GAAP basis in the second quarter was $83.5 million or $0.78 per diluted share compared to $0.63 in Q2 of last year. During the second quarter we generated about $80 million in cash from operations and ended the quarter with about $1.2 billion in cash and investments. We bought back about 78,000 shares of our common stock in Q2 and we ended the quarter with about $117 million of stock repurchase authorization still available to us. We also announced today a cash dividend of $0.16 per share which will be payable on May 16, 2018, to shareholders of record on May 7, 2018. So now let me provide the outlook for the full-year and for Q3. For the full-year FY18 we now anticipate that total revenue will range from $1.165 million to $1.185 million. And within the revenue total, we estimate that licensing will range from $1.35 million to $1.55 million, while products and services are estimated for the year to be around a $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 will be up significantly over last year due to higher adoption of audio and consumer imaging along with a positive impact from a large recovery we got in Q1. PC licensing will likely to be down, while consumer electronics should be up modestly. And in the other category, other licensing is also projected to be up modestly and this will be benefiting from growth in Dolby Cinema, gaming, and Dolby Voice, offset partially by lower recoveries. And finally, product revenue is expected to grow for the year driven by higher volume from cinema products and from Dolby Voice. Gross margin for the year is projected to be around 88% plus or minus on the GAAP basis and about 89% plus or minus on a non-GAAP basis. Let me turn to OpEx. I mentioned in my opening comments that we are increasing our range of operating expenses for the year and here is the primary reason. Currency exchange rates have been unfavorable to us as it relates to the local expenses at our non-U.S. operations and it looks like that's persisting and so this will negatively impact the dollar value of those foreign expenses for the year. As such, we're now projecting full-year operating expenses to range from $744 million to $749 million on a GAAP basis and from $670 million to $675 million on a non-GAAP basis. Other income is estimated to range from $11 million to $13 million for the year and the effective income tax rate for the remaining two quarters of the year is expected to range from 20% to 23%. Adding that to the actual tax we recorded in Q1 and Q2 would yield a full-year tax rate on a GAAP basis of about 69% plus or minus. Now let me cover the quarter ahead of us Q3. For Q3 of FY18, we anticipate that total revenue will range from $310 million to $320 million and within that, we estimate that licensing will range from $280 million to $290 million, while products and services are projected be around $30 million. Q3 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 Q3 are projected to range from $190 million to $194 million on a GAAP basis and from $172 million to $176 million on a non-GAAP basis. Other income is projected be around $3 million for the quarter and the effective tax rate is estimated to range from 20% to 23%. Based on the combination of the factors I just covered, we estimate that Q3 diluted earnings per share will range from $0.64 to $0.70 on a GAAP basis and from $0.78 to $0.84 on a non-GAAP basis. So now I'd like to turn it over to Kevin. Kevin?

Thank you, Lewis, and good afternoon everyone. We made a lot of great progress this quarter as we continued to expand our leadership in audio entertainment and bring our new audio visual experiences to more consumers around the world. In fact, we're seeing revenue growth in both our audio business as well as our new initiatives. Let me start with Dolby Atmos. It was a big quarter for mobile. Samsung announced support for Dolby Atmos in the Galaxy S9 at Mobile World Congress in late February. More recently, Huawei announced its first mobile phones with Dolby Atmos. This significantly expands the availability of Dolby Atmos on mobile devices. And by the way in both of these wins Dolby Atmos will be delivered with AC4. So this further drives adoption of our next-generation codec which delivers higher efficiency and more features. Beyond mobile, Vizio announced its first three sound bars with Dolby Atmos. We now have a 11 sound bar partners supporting Dolby Atmos and recent launches from LG and Sony have price points starting below $600. The number of televisions with Dolby Atmos is also growing. Last quarter, we announced that TCL and Skyworth would be joining LG in offering Dolby Atmos TVs. This quarter Hisense, Konka, and Changhong all announced TVs with Dolby Atmos. More Dolby Atmos content is available with over 975 African titles announced to release and global support for major OTT services. Throughout the year, BT and Sky Sports have been delivering live sports in Dolby Atmos and more recently both Comcast and DIRECTV delivered portions of the Winter Olympics in Dolby Atmos. Now let me turn to Dolby Vision. Earlier this month Vizio announced the expansion of Dolby Vision beyond its mid and high end models into the E-Series and as a result TVs with Dolby Vision are now available at price points as low as $350. We have nearly 15 Dolby Vision TV partners with an increasing number of mainstream models with Dolby Vision. We made some great progress in expanding the reach of Dolby Vision to more people through more devices. As you know, Dolby Vision was included in iPhone 10, iPhone 8, iPad Pro, and Apple 4K TV at the start of the year. And the first PC with Dolby Vision have now been launched from Lenovo. More Bluray players are coming to market from Dolby Vision from partners such as Sony, Panasonic, and LG. At the same time the amount of Dolby Vision content continues to increase around the world. There are nearly 300 movies available in Dolby Vision on iTunes and more than 300 hours on Netflix. In China, there are now over 1,200 Chinese titles in Dolby Vision available through Tencent and ITE. And recently in Europe, RocketOn one of the largest services in the region launched its service with Dolby Vision and Dolby Atmos in Spain, UK, France, Germany, and Italy. We're seeing widespread industry adoption of Dolby Vision and these experiences are moving to the mainstream. So let's turn to Dolby Cinema. This quarter we announced two new partners, Jinyi, one of the largest cinema chains in China will be rolling out 20 Dolby Cinema screens. This adds to our presence in the growing Chinese market where we now have seven Dolby Cinema partners. Also this quarter, Shochiku Multiplex Theaters announced its plans to roll out the first Dolby Cinema in Japan. Jinyi and Shochiku join a growing list of partners for Dolby Cinema. The number of locations has grown rapidly over the past year with 143 now open compared to about 90 a year ago. In total, we have over 380 Dolby Cinema locations open or committed around the world. It was another great quarter for Dolby Cinema content with titles such as Black Panther and Ready Player One. The overall content pipeline continues to grow with over 165 titles in Dolby Vision and Dolby Atmos announced or released. We continue to see support from all major studios and last week Disney announced 20 titles in Dolby Atmos and Dolby Vision adding to a growing slate of movies to be shown at Dolby Cinema including two upcoming Star Wars titles and two titles in the Avengers franchise. We look forward to working with our partners to make the best movie going experience more broadly available around the world. Let's turn to Dolby Voice. This quarter we announced a camera product as a companion device to the Dolby Voice conference phone. Together, this is the Dolby Voice Room solution. In addition to all of the benefits of the Dolby Voice audio experience, Dolby Voice Room introduces new innovations to the video experience. This combination creates an experience that more closely resembles an in-person meeting. The Dolby Voice Room is easy to set up and the initial reaction from the market has been very positive. Our first go-to-market partners are BlueJeans and HighFive and we think this product will address a broader set of customers in the growing huddle space. So to wrap up, we continue to see great momentum for our newest Dolby experiences and continue to grow our audio business. Dolby Vision and Dolby Atmos are becoming increasingly available in mainstream devices. We had a new Dolby Cinema partners this quarter and we expanded our Dolby Voice offering. 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'll turn it over to Q&A.

Thank you. [Operator Instructions]. We will take our first question from Mike Olson from Piper Jaffray. Please go ahead.

Hey good afternoon. I had two questions if I could. First one is with your continued success in mobile obviously being an important driver, is there anything you can say about how mobile pricing for technologies like Dolby Vision and Atmos compare to implementations on non-mobile stuff like TVs, PCs, or other consumer electronics?

Well you want to start us right off of the tough one now, Mike.

Sorry about that.

In general we don't make broad comments about pricing. I would say that, it's well known in the industry that there is a connection between volume and size of the customer and the typical factors but it's really hard to make a general comment about pricing in mobile versus "rest of our business".

Okay, no problem. Secondly are you still looking for a doubling of new initiative revenue year-over-year in 2018 which would imply I think around $120 million versus $60 million or so last year and if so within that new initiative revenue can you say what the largest contributor will be between Vision and Cinema assuming it's not voice. Thanks.

Yes. We are looking to double revenue from new initiatives this year and you're right that would put it at around $120 million. We are getting contribution from all three of these initiatives including Voice, Dolby Cinema, and consumer imaging which you remember includes both Dolby Vision and our imaging patent licensing programs. I talked about a number of the wins on the call today but we're seeing good contribution from all of them.

Yes, that was easier question, Mike. Thanks.

All right, yes. Thank you.

And we will take our next question from Steven Frankel with Dougherty. Please go ahead.

Good afternoon. So let me follow-up Mike's difficult question with my own possibly difficult question. Should we still anticipate that your large mobile customer that pays once a year does that again in the June quarter? Or is something changed in the way that arrangement flows through the year?

Well let me go back to even something that I said last year, Steven, play off of that which was I highlighted last year that we had timing of payments and by the way that's not a new topic per se, all the years I've been here almost every year we had issues with timing of payments. But last year I did indicate that timing of payments affected that bump in Q3 and going forward, we would see similar circumstance in the future years and so our view has not changed on that.

Okay. And then I think in past years you've kind of characterized where you thought mobile would be as a percentage of license revenue for the year or for the June quarter, I wonder if you might hazard it I guess on that?

Yes, we haven't published a number for the year. We see this quarter it was up 20 something percent and that's probably a little bit on the high side because it's not evenly weighted throughout the year, but certainly we expect to see substantial growth in mobile revenues year-over-year this year.

And you can see the fundamentals underlying that I mean coming into the year getting Dolby Vision adopted on Apple. Now this quarter Dolby Atmos with AC4 on Samsung and Huawei, I'm really pleased with the progress we've made in demonstrating the value that our audio and video technologies provide and at the same time there is still opportunity throughout the mobile ecosystem.

Correct.

So that will continue to be a big focus for us but it's definitely one of the big highlights of quarter and one of the big highlights of the year.

Yes.

Great. And on Voice, do you have some proof points in the huddle-room market that leads you to believe that you can materially ramp that business?

Well, yes there are couple of things. One is, as Lewis said, one of the growth drivers in products this quarter was the Dolby Voice business and that's our big go-to-market partners in this huddle-room space are HighFive and BlueJeans. So we had a couple of good solid quarters. We entered those markets kind of coming into the year with BlueJeans and middle of last year with HighFive. So a lot of it is based on the reactions we're getting from customers, from the pipeline and the revenue results for the first half of the year.

And the partners.

The partners are excited about it. It really is a -- it's an incredible value proposition. I mean it I think we've all kind of accepted what the quality of an audio/video conference call should and can be like and this really raised the bar on both the audio and the video experience and now that we pivoted the business toward this huddle-room space we're in a sales cycle where it's much more natural to buy equipment for rooms that may not have it or that have equipment that's overly complex for the room that it's coming into. And so, we're optimistic that we're on the right path and by adding -- by bringing the Dolby audio/video experience together, I think that for customers who felt like they were forced to choose between this amazing natural voice experience and easily integrated video experience they don't have to make that choice now and of course we brought innovation to it as well. I mean it's much -- it's highly effective that the kind of shadowy environment that are typical to these rooms, it has a whiteboard feature where cameras typically pointed at the table, it's static, we don't have any moving parts but it can pick up a whiteboard on the side wall, so perpendicular to where the people are and we will straighten that out make it look like you're looking at it straight on as just makes for a really natural competitive experience. So I'm excited because of the value proposition because the feedback we're getting from partners and because of the pipeline we see developing.

And are these partners positioning you with their premium offering or is this a mainstream huddle-room offering for them with premium features because of your technology.

It varies by the partner I think in one case it is positioned as a premium offering but I think the premium offering is the predominant offering and in other case it's marketed as the huddle-room solution for those customers who choose to purchase hardware. So in one case, the hardware is a integral part of the solution with each purchase and in the other case, the equipment is optional, but Dolby is the huddle-room solution for that.

And we will take our next question from Ralph Schackart with William Blair.

Good afternoon. First on the increased revenue outlook again Kevin maybe if you could just give us a sense sort of what are the main driver or drivers of the second time that you raised outlook on the top-line for the year, some perspective on that would be great and then on the increased outlook also on OpEx was that predominantly just the unfavorable currency movement that's driving that increased OpEx or was there sort of increased spend also within the business in there as well? Thanks.

Sure. So let me take the first one and I'll let Lewis give some more color on OpEx. As far as the revenue guidance you'll notice that we increased the bottom end of the range substantially and the top end slightly and that really reflects the fact that we're halfway through the year. What I think is really, one of the things I like about the way this year is shaping up is we're seeing strength really on a broad basis. So we have growth in audio business, we have success in the new initiatives, we're on track to double revenue from those new initiatives, and so the bringing up of the bottom end of the range really reflects the fact that we're halfway through the year and we like what we've seen for the first half and we see that continuing into the second half. And if had to highlight a couple of things beyond that one again is the fact that we are on track to double revenue from new initiatives and we're getting contribution from each of them. And then as we talked about earlier mobile and the fact that we're getting adoption this year at both Dolby Vision and Dolby Atmos in mobile devices.

Yes, and there's a little pocket even you mentioned Kevin like I made a comment in my thing about consumer electronics being slightly better than we thought.

Yes.

So it's really it feels very solid right now. Okay Ralph on the OpEx, the short answer is yes. For us raising the range this quarter predominantly being driven by the FX and it’s a natural follow-on question why now at the end of last quarter we were really only one quarter in on the full-year and if I look back in history most years things sort of normalize through the year. So we don't typically cry or whine about FX but now two quarters in, I use the word "persisted" in my prepared comments because that is what we're seeing, we're seeing a persistent environment where the global economy have decided to create these conditions and so we baked in the amount for the full-year and it is essentially the driver of this increase.

[Operator Instructions]. We'll take our next question from Paul Chung with J.P. Morgan.

Hi, good afternoon, thanks for taking my questions. So a couple from me, so first on R&D spend assume the bulk of R&D is now going towards new products, now with Vision, Cinema, and Voice kind of finding their footing, can you expand on where you are putting incremental capital to work?

Well I'd say first of all as with any business in each of those of businesses, there is recurring engineering investment, there's investment in the next-generations of those technologies and products we just brought the new Dolby Voice product to market this quarter. And at the same time, we do have always some investment in the what's next category. There's always some great things going on at the labs, at Dolby Laboratories and over the longer-term as we've expanded from audio entertainment into audio/visual entertainment and communications, we really believe we have the opportunity to improve a very wide range of audio/visual experiences and so we continue to invest in new things. But I wouldn't want you to conclude that all R&D goes into just new things because like any -- as I said like any business there is always recurring engineering and customer support and the evolution of those product offerings.

All right. And then how should we be think about the pace of spending in the short to medium term?

Sure. I would say aside from the update I gave today, we've focused a lot on FX which is unusual for us but just the way we're shaped to just have new on those years. The pace of spending is actually fairly consistent with our attitude coming into the year because broadly speaking by far the largest driver by a wide margin of uptick this year is driven by this FX.

Got it. And then last question is any update on capital allocation priorities, should we expect any kind of material changes to the strategy over the course of the year? Thank you.

Sure. I think it’s -- I’ve been on record saying that we do have a multi-pronged capital allocation strategy. We do pay dividends, we do buybacks, we have acquisitions from time to time. So I think going forward we’re going to continue to do that. I think all three of those items appeal to various parts of the audience listening in here and on the buyback of course in any given quarter that can tend to fluctuate but longer-term at minimum we like to at least offset the dilution that comes from our stock comp.

[Operator Instructions]. And we will take our next question from Jim Goss with Barrington Research. Please go ahead.

Hi, this is Pat Sholl on for Jim. Just one question related to Dolby Cinema, based on the updates on the increased signings that you guys are getting across the number of partners, I was just wondering if you could provide a little bit of color on just how the product like indexes in terms of box office relative to your screen footprint as it is right now and then just if you could repeat where you set on the number of total installed at the end of the quarter?

Yes. So let me start with that. We said that we have 143 Dolby Cinemas up and running that's compared to about 90 a year ago. As you pointed out we continue to add more partners this quarter. We are really -- we're very pleased with the performance of our screens both qualitatively because of course we do consumer surveys and quantitatively the first three averages are very, very strong and I think that's a function of the quality of the experience.

Next we'd have a follow-up question from Ralph Schackart with William Blair. Please go ahead.

Hi, just want two more quickly. On mobile you talked about higher penetration rates and as well as payment timings in the quarter. I'm sorry for the year-over-year growth of 100 plus percent can you just provide me little bit more color in terms of where the higher weighting maybe between those two. And then, Kevin surprised nobody asked this quarter just wanted to get your current thinking on the long-term goal in terms of so if you're still sort of marching towards a double-digit growth rate. Thanks.

Well, what I probably can do Ralph is sort of give you some sort of pro rata breakdown by quarter but clearly I want to highlight that the driver for the increased revenue in mobile this year is from CE and new models or higher volumes in new models. But this quarter we also were helped by the fact that the timing of payments was not evenly spread throughout the year. So we had more land this quarter that you could argue is revenue that's attributable to a full fiscal year, but it's really hard for me to break that down other than to say that it was helped by both.

Yes, and Ralph continues to be our goal to return to sustainable double-digit revenue growth. I really like our progress as you pointed out earlier we've raised guidance each of the last couple of quarters and that's because we're getting a strong contribution across the business. As I said we're growing in both the audio business as well as our new initiatives and we're getting contribution across our new initiatives and that's the formula that we need to continue to get to achieve our goal of sustainable double-digit revenue growth.

And that does conclude our question-and-answer session for today. I'd like to turn the conference call back over to Kevin Yeaman for any additional or closing comments.

Great, well thank you everybody for joining us today. And we look forward to updating you again soon.

And that concludes today's conference call. We thank you all for your participation and you may now disconnect.