Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories conference call discussing fiscal fourth 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, November 16, 2021. I would now like to turn the conference call over to Ashley Schwenoha, Senior Manager of Investor Relations for Dolby Laboratories. Please go ahead, Ashley..

Good afternoon. Welcome to Dolby Laboratories fourth quarter 2021 earnings conference call. Joining me today are Kevin Yeaman, Dolby Laboratories' CEO and Robert Park, CFO. As a reminder, today's discussion will include forward-looking statements, including our first quarter and fiscal 2022 outlook and our assumptions underlying that outlook.

These statements are subject to risks and uncertainties that may cause actual results to differ materially from the statements made today, including, among other things, the extent of the continuing impact of COVID-19 on our business.

A discussion of these and additional risks and uncertainties can be found in the earnings press release that we issued today under the section captioned Forward-Looking Statements as well as in the Risk Factors section of our most recent Annual 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 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 today's call, Kevin will start with a discussion of the business.

And Robert will follow with a recap of Dolby's financial results and provide our first quarter and fiscal 2022 outlook. So with that introduction behind us, I will now turn the call over to Kevin..

Thank you Ashley and good afternoon everyone. Our Q4 EPS came in above midpoint while revenue came in towards the low end of our guidance range.

Looking at the full year, we had a strong fiscal 2021, with 10% revenue growth and our highest operating margins since fiscal 2014 and we created considerable momentum across many of our growth initiatives that will allow more people to be entertained by premium Dolby experiences.

Consumers can now easily record, edit and share their videos in Dolby Vision with their Apple iPhone. Music in Dolby is being enjoyed by a significantly larger audience with the launch of Dolby Atmos on Apple Music and we have the first partners who will enable the Dolby Atmos music experience in the car with Mercedes-Benz and Lucid Motors.

And gamers can now play some of their favorite titles in Dolby Vision for the first time on the latest Xbox. During FY 2021, our revenues benefited from robust increases in consumer device shipments combined with increased adoption of Dolby Atmos and Dolby Vision, partially offset by a decrease in cinema- related revenues.

As we enter FY 2022, we are expecting revenue growth in the mid to high single digits as we anticipate a shift in those factors with accelerating growth of Dolby Atmos and Dolby Vision and a partial recovery in cinema-related revenues offset by a macro slowdown in consumer device shipments. It has been a dynamic environment.

And before Robert takes you through the numbers in more detail, including a discussion on our licensing and markets, I want to walk you through some of the most important factors as we think about long-term revenue growth.

Our foundational audio technologies, increased adoption of Dolby Atmos and Dolby Vision and our opportunity to expand our addressable market with initiatives like Dolby.io. Let's start with our foundational audio technologies, which include Dolby Digital Plus, AC-4 and our audio patent licensing.

These foundational technologies made up roughly three-quarters of our licensing business in FY 2021 and have high attach rates across a diverse set of devices and end markets.

In FY 2021, our foundational audio technologies grew about 11% year-over-year, due largely to robust global shipments of PCs and higher TV volumes, particularly in North America and Europe. We also benefited from higher than normal true-ups coming into the year.

As we look ahead to FY 2022, industry analyst reports indicate that we will not see the level of market growth we saw the previous year, noting uncertainties around global supply constraints and consumer spending. Of course, we partner with OEMs across multiple device categories across all geographies and each of them is impacted differently.

When we take all of this into account, we expect a decrease in the low single digits for our foundational audio revenues.

Over the long term, we expect our foundational licensing revenue to generally reflect market trends in device shipments, driven by our strong presence across a wide set of consumer devices and markets with opportunities to increase adoption in certain areas like mobile and automotive.

The remainder our licensing revenue includes Dolby Atmos, Dolby vision and our imaging patent technologies where growth is being driven primarily by new adoption and new licensees.

this portion of our licensing revenue also includes Dolby Cinema, where we expect strong year-over-year growth as box office recovers from low attendance throughout FY 2021 driven by the pandemic. In total, this portion is approaching one quarter of our licensing revenue and grew nearly 20% in FY 2021.

We see this growth accelerating to over 35% in FY 2022. Our continued momentum with Dolby Vision and Dolby Atmos is a key driver here. And I would like to take a few minutes to highlight our progress in these areas. Let me start with Dolby Atmos Music. The response from artists and consumers is clear. Dolby Atmos creates a whole new way to enjoy music.

The engagement continues to build with some of the world's most popular music artists like Justin Bieber and The Weeknd describing the Dolby Atmos music experience as game changing and an immersive world where you can feel every detail.

We also recently launched a new venue, Dolby Live at Park MGM where concert attendees will be able to enjoy their favorite artists with the ultimate Dolby Atmos music experience and then seek the experience in all the ways they enjoy music.

Amazon Music recently announced that they are making Dolby Atmos music experiences more broadly available to their subscribers. The music in Dolby experience significantly increases the value that Dolby brings across a wide range of devices including mobile, PC and speaker products.

Our growing presence in music has created a new value proposition for Dolby in the automotive space. Mercedes-Benz announced last month that they are adopting the Dolby Atmos music experience in two of their top luxury cars, Mercedes-Maybach and the Mercedes-Benz S-Class.

And just yesterday, Chinese electric car maker NIO announced they are including Dolby Atmos in their ET7 model. We are excited that these new partnerships add to our early momentum within automotive that started with Lucid Air earlier this year, which is now on the road in the U.S.

We are just at the beginning of the significant opportunity we see ahead in this space. This quarter, the launch of the iPhone 13 line up again highlighted the capability to enable consumers to record and share their videos in Dolby Vision.

With a significant increase to the amount of Dolby Vision content being created through the iPhone, we are seeing a range of content platforms now enabling support for Dolby Vision for the first time. This quarter, Bilibili, one of China's largest social video sites, began to support the upload and sharing of user generated Dolby Vision content.

More recently, Vimeo becomes the first all-in-one platform to support playback of Dolby Vision content for the Apple ecosystem. With more content platforms supporting Dolby Vision content to broader audiences and use cases, we look to drive increased adoption of Dolby Vision playback and capture across more devices, particularly in mobile and PC.

We are also building momentum to enable more live broadcast events in Dolby. Comcast delivered the 2021 MLB World Series and playoff games in Dolby Vision on Fox Sports. Thursday night football games will be available in Dolby Vision through Fox and NBC will be delivering select college football games in Dolby Vision.

Growing the number of Dolby content experiences, especially live content with dedicated followings, provide more impetus for greater adoption of Dolby Vision and Dolby Atmos. Gaming in Dolby Vision is now available on the Xbox series X and S, marking the first time gamers can enjoy playing in the combined Dolby experience.

Microsoft also expanded their support of the combined experience by adding Dolby Vision to their Surface devices.

In the living room, we see our partners like Amazon, Xiaomi, TCL and Sky highlight the combined Dolby Vision and Dolby Atmos experience in their latest TV launches and we continue to garner support from streaming services with Hulu adding Dolby Vision this quarter. The newest sound bar products from LG and Sonos showcased support for Dolby Atmos.

And in mobile, we saw new Android phones and tablets this quarter from Samsung, Xiaomi and Realme with Dolby technologies.

With a solid foundation and increasing adoption of Dolby Atmos and Dolby vision, we are able to broadly address the world of premium content experiences like movies, TV and music and are confident in our ability to drive continued growth.

With Dolby.io, our developer first API platform, we see an opportunity to greatly expand our addressable market by focusing on use cases that benefit from Dolby's unique experience in media and communications.

While our platform has broad applicability across a range of use cases, we are focusing where we think we can offer the most differentiation, virtual live performances, online and hybrid events, social audio, premium education, gaming and content production.

Each of these verticals represents an opportunity of hundreds of billions of minutes annually and collectively, we estimate the addressable market to be about $5 billion and growing.

With the breadth and depth of our expertise, we are enabling higher quality capture, processing and playback capabilities compared to what is currently available in the market.

Last quarter, we released a major platform update which puts us in a position to address more of our potential customers' needs by making our APIs more competitive on the number of concurrent users we can support.

As we focus our target use cases and learn from our engagement with developers, we continue to introduce new APIs and features that address the needs of developers and improve the overall developer experience.

With these recent improvements, we are beginning to see increased self-service activity and with our new leadership in place, we are focused on increasing awareness and building the pipeline.

This quarter, we saw a number of new music distribution services including UnitedMasters integrating our music mastering API and enabling their users to create high-quality music tracks.

Also Cloudinary recently launched an integration of Dolby.io's audio enhances APIs with their MediaFlows product allowing their customers to easily improve the audio quality of their videos. While we are still in the early days of Dolby.io, we are excited about the significant opportunity ahead.

Before I wrap up, let me spend a minute on our operating model. We significantly increased operating margins in FY 2021, due to a combination of gross margin improvements and reduced spending levels due to COVID.

We anticipate a partial return of some of these operating expenses in FY 2022 by travel and events, as well as a few specific items like our 53rd week of payroll.

At the same time, on the strength of our operating model, including our improved gross margins, we will continue to generate higher operating margins as compared to our pre-pandemic levels while investing in our growth areas.

So in summary, we have a strong foundation and fiscal 2021 was highlighted by significant wins like Dolby Atmos on Apple Music, the first cars that will support Dolby Atmos and enabling Dolby Vision across a wider range of content from live events to gaming to user-generated content.

We see much of the opportunity ahead as we drive broader adoption across more content and more devices even as we seek to significantly expand our addressable market with Dolby.io. All of this gives us confidence in our ability to drive long-term revenue and earnings growth as we look to FY 2022 and beyond.

So before the financials, I would like to welcome our new Chief Financial Officer, Robert Park. Robert is an experienced leader with a track record of guiding companies through growth while delivering operational excellence and accountability. Robert has been on board for about four weeks now.

We are excited to have his expertise as we work towards Dolby's next phase of growth. And with that, I will hand it over to Robert to take us through the financials in more detail..

Great. Thank you Kevin. Good afternoon everybody. I am very excited to be here and join the Dolby team. I hope that in the near term I get a chance to meet you all, if not in person, at least virtually. So let's go through the numbers for Q4 and full year 2021 and then I will take you through our outlook for fiscal year 2022.

Total revenue in the fourth quarter was $285 million, which was within the total revenue guidance range we provided and also included a favorable true-up of about $3 million for Q3 shipments reported that were above the original estimate.

Revenue landed towards the low end of our guidance range due to timing of a deal that pushed out of the quarter and is now anticipated to result in revenue in fiscal year 2022. With our Q4 results, full year 2021 revenues were $1.28 billion compared to $1.16 billion in fiscal year 2020, generating 10% year-over-year growth.

Within that, licensing revenue was $1.21 billion while products and services revenue was $67 million. On a year-over-year basis, fourth quarter revenue was about $14 million above last year's Q4 as we benefited from greater adoption of Dolby Vision and Dolby Atmos and higher cinema-related revenues, partially offset by lower true-ups.

Q4 revenue was comprised of $266 million in licensing and $19 million in Products and services. Let's discuss the full year and year-over-year quarterly trends in licensing revenue by end market and I will also highlight the key factors as we look ahead to fiscal 2022. Broadcast represented about 39% of the total licensing in fiscal year 2021.

Our full year revenues grew by $36 million or 8% on a year-over-year basis, driven by higher adoption of Dolby Vision and Dolby Atmos in TVs and set-top boxes. We also saw higher foundational audio revenues due to increased TV shipments in North America and Europe compared to fiscal 2020.

In Q4, we saw broadcast revenues decline from prior year's Q4 as we saw lower true-ups for foundational audio revenues on a year-over-year basis, partially offset by higher revenues from Dolby Vision and Dolby Atmos.

As we look out to fiscal 2022, we currently anticipate broadcast revenues to grow in the low single digits from fiscal 2021, driven by higher adoption of Dolby Vision, Dolby Atmos and growth in our imaging patent programs.

These growth factors are projected to be partially offset by lower foundational audio revenues as we see lower recoveries and lower true-ups on a year-over-year basis and industry analysts are projecting TV shipments to be flat to down low single digits. Mobile represented approximately 22% of total licensing in fiscal 2021.

Mobile revenue increased by $34 million or 15% compared to fiscal 2020 as our foundational audio revenues benefited from timing of revenues and we saw higher Dolby Vision revenues from increased adoption. Our Q4 mobile revenues were up about 2% as compared to the prior year due to higher adoption of Dolby Vision and Dolby Atmos.

In fiscal year 2022,, we anticipate that mobile revenues could grow mid to high single digits, driven by increasing adoption of Dolby Vision and Dolby Atmos as well as growth in our imaging patent programs. These factors will be partially offset by lower foundational audio revenues due to timing of revenues under contract.

Consumer electronics represented about 15% of total licensing in fiscal year 2021. On a year-over-year basis, CE licensing increased by $29 million or 19%, driven by higher foundational audio revenues as a result of increased unit volumes in sound bars and AVRs as well as higher recoveries.

We also saw growth from higher adoption of Dolby Atmos and Dolby Vision across CE devices. Our Q4 CE revenues increased 28% compared to prior year, which was in line with full year growth drivers of both higher foundational audio revenues and growing adoption of Dolby Atmos and Dolby Vision.

As you look ahead to fiscal year 2022, we see CE revenues relatively flat year-over-year. We expect to see higher revenues from Dolby Vision and Dolby Atmos adoption as well as increasing contributions from our imaging patent programs.

These growth drivers will be partially offset by lower foundational audio revenues as industry analysts are estimating unit volumes in DMAs and sound bars to decrease year-over-year and we anticipate lower CE recoveries. PC represented about 12% of total licensing in fiscal year 2021.

Our fiscal year 2021 PC revenues were higher than prior year by about $10 million or 7%, driven by higher foundational audio revenues as a result of strong PC shipments throughout the year and growing revenues from Dolby Atmos and Dolby Vision. These growth factors were partially offset by lower recoveries compared to fiscal year 2020.

Our Q4 PC revenues were about 7% higher compared to prior year Q4, driven by increased Dolby Vision and Dolby Atmos revenues. As we look ahead to fiscal year 2022, we see low to mid single digit growth in our PC revenues as more PCs continue to adopt Dolby Vision and Dolby Atmos as well as growth in our imaging patent programs.

Other markets represent about 12% of total licensing in fiscal year 2021. They were up about $26 million or 21% year-over-year, driven by higher revenues from gaming due to the console refresh cycle and higher foundational revenues related to patents.

In Q4, we saw other markets grow about 26% year-over-year due to increased Dolby Cinema revenues as theaters reopened and higher revenues from gaming.

As we look ahead to fiscal 2022, we anticipate that other markets revenues could grow at an even higher rate of over 25% as we estimate Dolby Cinema revenues to continue momentum from Q4 as more people are able to return to the movies and we also see continued growth in gaming.

Beyond licensing, our products and services revenue was $67 million in fiscal year 2021 compared to $83 million in fiscal year 2020. Prior year included about two quarters of pre-pandemic activity related to our cinema products business and included revenues for our communications hardware business, which we exited in early fiscal year 2021.

Products and services revenue in Q4 was $19 million compared to $14 million in last year's Q4. The year-over-year increase reflects higher demand in the cinema industry. Total gross margin in the fourth quarter was 89.2% on a GAAP basis and 90.0% on a non-GAAP basis.

Operating expenses in the fourth quarter on a GAAP basis were $214 million, Operating expenses in the fourth quarter on a non-GAAP basis were $189.9 million compared to $176.5 million in the prior year. Operating expenses were at the low end of our guidance for Q4.

Operating income in the fourth quarter was $40.4 million on a GAAP basis or 14.2% of revenue compared to $30.1 million or 11.1% of revenue in Q4 of last year. Operating income in the fourth quarter on a non-GAAP basis was $66.6 million or 23.4% of revenue compared to $54.3 million or 20% of revenue in Q4 of last year.

On a full year basis, operating income was $340.4 million on a GAAP basis or about 26.9% of revenue compared to $218.7 million or 18.8% in fiscal 2020. Full year operating income in fiscal 2021 on a non-GAAP basis was $450.7 million or about 35.2% of revenue compared to $317.9 million or 27.4% in the prior year.

Income tax in Q4 was minus 3% on a GAAP basis and 13% on a non-GAAP basis. Our tax rate benefited from a number of discrete items, including return provision true-ups. Net income on a GAAP basis in the fourth quarter was $44.2 million or $0.42 per diluted share compared to $26.8 million or $0.26 per diluted share in last year's Q4.

Net income on a non-GAAP basis in the fourth quarter was $60.4 million or $0.58 per diluted share compared to $45.8 million or $0.45 per diluted share in Q4 of last year. During the fourth quarter, we generated $110 million in cash from operations compared to $113 million generated in last year's fourth quarter.

We ended the fourth quarter with about $1.3 billion in cash and investments. During the fourth quarter, we bought back about one million shares of our common stock and ended the quarter with about $291 million of stock repurchase authorization available going forward.

We also announced today a cash dividend of $0.25 per share, an increase of $0.03 or 14% compared to the prior quarter. The dividend will be payable on December 8, 2021, to shareholders of record on November 30, 2021. Now let's turn to guidance for fiscal 2022.

We currently estimate total fiscal year 2022 revenues could range from $1.34 billion to $1.4 billion. This would result in about 5% to 9% of year-over-year growth as compared to the $1.28 billion in fiscal year 2021.

Within this, licensing revenue could range from $1.260 billion to $1.315 billion compared to $1.214 billion in fiscal year 2021, which would result in a 4% to 8% year-over-year growth.

As I referenced earlier, discussing our revenue by end market, we expect strong growth in our other markets for increased Dolby Cinema and gaming revenues as well as growth in mobile, PC and to a lesser extent, broadcast, due to increasing adoption of Dolby Vision and Dolby Atmos and growth in our imaging patent programs, partially offset by lower foundational audio revenues.

For products and services revenues, we anticipate this could range from $75 million to $90 million for fiscal year 2022, with improvements in cinema products and growth in Dolby.io. Gross margin for fiscal year 2022 are expected to be relatively consistent with fiscal year 2021. Let me shift to operating expenses.

We have several factors that impact our year-over-year expectations. First, fiscal 2022 is a 53-week fiscal year for us and that results in an extra week of payroll in Q1.

As Kevin mentioned, we also see a return of some expenses like travel and events that were lower during the pandemic, in addition to normal annual merit increases that will typically go in effect in fiscal Q2. Lastly, we continue to invest in areas like Dolby Vision, Dolby Atmos and Dolby.io.

With these considerations, we are estimating operating expenses for fiscal 2022 could range from $869 million to $889 million on a GAAP basis and between $750 million to $770 million on a non-GAAP basis.

With all of this, our business model remains very strong as we expect to deliver operating margins between 24% to 26% on a GAAP basis and between 34% and 36% on a non-GAAP basis. Based on the factors above, we estimate that full year diluted earnings per share will range from $2.53 to $3.03 on a GAAP basis and $3.52 to $4.02 on a non-GAAP basis.

Let me shift to how that translates to what we see for fiscal Q1. For Q1, we see total revenues ranging from $345 million to $375 million. Within that, licensing revenues will range from $330 million to $355 million.

Note that in the prior year Q1, we benefited from a significant favorable true-up of over $21 million for Q4 fiscal 2020 shipments that was larger than normal, given the volatility of conditions during the pandemic. Last year's Q1 also benefited from recoveries and timing of revenue under contract.

This was partially offset by increasing adoption of Dolby Vision and Dolby Atmos and growth in our imaging patent programs. Q1 products and services revenue could range from $15 million to $20 million. Let me move on to the rest of the P&L outlook for Q1.

Q1 gross margin on a GAAP basis is expected to be 90% to 91% and the non-GAAP gross margin is estimated to be about 91% to 92%. Operating expenses in Q1 on a GAAP basis are estimated to range from $221 million to $231 million.

Operating expenses in Q1 on a non-GAAP basis are estimated to range from $190 million to $200 million, which contemplates the impact of the 53-week fiscal year. Other income is projected to range from $1 million to $2 million for the first quarter.

And our effective tax rate for Q1 is projected to range from 18% to 19% on both a GAAP and non-GAAP basis. Based on the combination of the factors I just covered, we estimate that Q1 diluted earnings per share could range from $0.71 to $0.86 on a GAAP basis and from $0.98 to $1.13 on a non-GAAP basis. With that, let's move on to Q&A.

Operator, can you please queue up the first question..

[Operator Instructions]. The first question is from the line of Ralph Schackart with William Blair. You may proceed..

Good afternoon. Thanks for taking the question. And thanks for the increased disclosure. Very helpful. I guess first question is on the FY 2022 revenue guide for foundational audio revenues. Kevin, I think you called for a decrease in low single digits.

Just curious if that's sort of unit-based sort of factored into there, which I am guessing it is? and maybe just a broader commentary on the macro environment with chip shortages, et cetera and how that might be impacting that portion of the guidance?.

Yes. Ralph, I guess the most I can say about the macro environment, as you observed, it's still dynamic. And when we forecast, as you know, we start with industry analyst reports and I would say that the unit shipment estimates, it does vary by device category. Some are a little up. Some are a little down.

Overall, we might best characterize it as kind of flattish with people noting a lot of uncertainty around supply chain and consumer spending.

The reason why this year then that's just slightly down single digits in our estimation is, that we did have the larger than normal true-up that we are lapping from Q1 of last year and we also had the timing of a particular contract that crossed the year.

So given that the unit environment is kind of flattish, it's a little more sensitive to those things. So you could see we had that 11% growth last year and this year, we see low single digits. But going forward, Ralph, I also want to make sure it's clear that it's a really strong foundation.

It's diversified across a lot of different devices across a lot of different geographies. When we look back several years, dating back to a couple of years before the pandemic, this is on average. It's growing low single digits. And so that's kind of how we look at it going forward.

And in any given year, it's going to be based on these individual dynamics. And obviously, these last couple of years have been particularly dynamic..

Great. And then I appreciate you framing the Dolby.io opportunity for us tonight. On the call, you talked about increasing the API features and some improvements and then also I think seeing some increase in self-serve activity.

Just curious had some of the features or functionality been a limitation to adoption? Or is that just some product enhancements that you see necessary to sort of, I guess, drive further adoption going forward?.

Yes. I think I would frame it like this. As you know, Dolby.io has been in market for, like, about 18 months now, right. So if I were to simplify that into a couple of phases, I would say Phase 1 was we were getting our first APIs out into the world.

They tended to focus on where we are highly differentiated, improving audio quality, improving capture, being able to spatialize voice. And that gave us a lot of confidence that there is a value to being able to improve media and communications across all these applications and services that we use every day.

During that time, we also learned a lot and we learned a lot about scale and specifically to get to the use cases we want to get to and maximize usage, how many users do we need to support for audio and video, whether it's passive or people that are active speakers. And as you know, we had a major update in July around that.

We have continued actually now to advance that. We have also added a lot more in terms of differentiation.

So the way I would characterize where we are today, Ralph, is that I feel like now that that major release has been in market for a few months and we have rolled that out to all of our existing customers and we have tested it and they have expanded their use cases and usage and it's getting great feedback that we are now, we think, in a position to compete on kind of the scale and what we learned during the customers we have today.

And we have a very robust schedule of continuing to differentiate and we have, in fact, even a couple of weeks ago, we are introducing some new features that continue to raise the bar on quality. So yes, so more recently, we have begun to see that take the form of some really exciting self-service activity.

As you know, we brought a new leader onboard towards the end of June. And in addition to being focused on the roadmap and all the things we just talked about, she's really focused on now really increasing awareness, building, increasing the pipeline. So we are excited about what's ahead..

Great. One more quick one, if I could. It doesn't seem like any earnings call for calendar Q3 would be complete without asking the company and how they might benefit from the metaverse. But just love your thoughts on that, Kevin, be it on the foundational side or I guess, Vision or Atmos or any other technologies? Thank you..

Sure. I guess I would start by saying that, well, first of all, I think the metaverse, I guess, can take many forms. But ultimately, it is an audiovisual experience.

And I think that creates opportunities across both foundational and what we are doing with Dolby.io and likely more immediately with Dolby.io because of the form it takes, which is that developers can come in and it's certainly something that the team is watching closely as we build the roadmap and think about the use cases that we are going after and engaging with.

I mean I think some of our developers, they even define themselves as virtual environments and maybe by extension, the metaverse. But where there's an audiovisual experience like that, we certainly see that as opportunity across Dolby..

Great. Thanks Kevin..

Thank you. The next question is from the line of Steven Frankel with Colliers..

Good afternoon. Thanks for the opportunity. You guys, in your script, said something that I have never heard Dolby talk about before, this notion of a contract that slipped out of the quarter and into the new fiscal year.

So I wonder what you could tell us about that and how we should think about it?.

Yes. So Steve, first of all, as you know, the vast majority of our revenue comes from royalties that are reported, estimated quarterly and then trued up based on royalty reports quarterly. But we do have revenue from things like recoveries.

We have contracts that have things like minimum commitments, which means that we might have periodic payments that usually are at least once a year, but they are periodic. And there's a lot of reasons why when we are forecasting revenue recovery or one of those payments could shift in timing. And this one just happen to cross our fiscal year, yes..

Okay.

And does it shift into Q1? Or given that where Q1 revenue landed, it's going to end up later in the year?.

It's included in our range of estimates for Q1. We certainly see it in FY 2022. And remember that as it relates to Q1 that we had a couple of things going on there as well. One, we are lapping the larger-than-normal true-up from last year.

And last year, we highlighted that Q1 last year did benefit from recovery and some of the timing of those contract payments. So that's why you are seeing the jump in the Q1 trend compared to last year..

Okay. Shifting over to .io. I am hoping you could lay out for us maybe some markers that we could look to? How are we, as outsiders, supposed to judge the success of io in fiscal 2022..

Yes. So I would say, Steve, that first and foremost, I talked today about while io can be applied to a very broad set of use cases, I talked about the use cases where we think we can really bring significant differentiation. So I would watch for our ability to bring developers and talk about experiences within those focused verticals.

And then over time, of course, we do look to share more specific metrics with you. And I would look to that's likely to include a number of active developers, revenue run rate. We are not there yet. So in the meantime, I would focus on our ability to bring great experiences to light..

Okay. And it was a significant quarter for hiring given the pace of the last few quarters. Maybe you could share some insight as to where those bodies are going..

Yes. So two things. One is certainly, as it relates to our growth initiatives. And as you can tell from the script, one is, as it relates to Atmos and Vision. We are focusing on context where we are making a lot of progress like music, like gaming, like automotive. And we are also focusing on Dolby.io.

I would also say that I think during the pandemic, we had probably fallen behind in hiring a little bit and we did manage to catch up a little bit in the last quarter, as it is kind of across worked on it..

Okay.

And then last one, where do you think the Vision market share is in the 4K market as we head into another holiday season in terms of the licensing share?.

Yes. So for TVs, we focus on the percent of 4K TVs, which we think are about 60% of the market. We think we are at about between 20% and 25%. And I have learned to give a range because I have learned that screeners will adjust their numbers and arrears. And so my number will move around a little bit.

That's up from 10% in 2019 and 15% to 20% in last year. I would also note, Steve, that Dolby Atmos on 4K TVs is catching up to that number pretty quickly. And remember that a lot of our growth in Dolby Vision will be coming from mobile, PC and other use cases where we still have outside of the Apple ecosystem.

We are still really at the pretty early stages as it relates to PC. You probably saw that we added only with Dolby Vision playback last quarter. So that's kind of how we see that. But I guess I would, we talked about. So sorry, go ahead..

And then the only other the last one I would slip in is, any comments around where the backlog stands in cinema today? And what's the state of discussions now as the world opened up about new screen signings for the new year, especially given the slate in 2022?.

Yes. We do see, I mean, we have some new openings scheduled. We would still expect it to be a lower number than pre-pandemic years.

But of course, we expect growth in Dolby Cinema revenues just from the return to the box office and also the fact that premium format Dolby Cinema and premium formats in general are garnering a higher share of the box office than pre-pandemic..

Okay. Great. Thank you Kevin..

And Steve, if I could come back one second to add to the Atmos and Vision. You asked specifically about TVs and attaché rats. So think about that category and that category is a growth driver.

We do believe that the combination of Dolby Atmos, Dolby Vision, the imaging patent portfolio, which currently is approaching a quarter of the licensing revenue, we see that having the potential to be as high as the foundational revenue is today.

And I just give you that as a way of thinking about it, stepping back a little bit from attach rates on TVs, et cetera..

Well, that's really helpful. Thank you..

Thank you. The next question is from the line of Paul Chung with JPMorgan. You may proceed..

Hi. Thanks for taking my question. So just on Atmos, particularly in auto, you are really starting at the high-end here at Mercedes.

So do you expect to see kind of further adoption across Mercedes? Are you seeing accelerating discussions with other OEMs? And then how do we think about the auto opportunity in particular? Will this be kind of higher ASP per car given kind of the multiple speakers? Or is the right way to think about it like per car side? That's the first question..

Yes. Thanks. We are excited about the automotive opportunity. I think, in terms of our demo experiences and our ability to wow people right now, our automotive Atmos music demos are very high on that list. And yes, you are right. We are starting with some high-end cars and wins in that.

So I think you see that as a pattern with everything we do, right, whether it's what we have done with Dolby Vision and Dolby Atmos in any context, usually, that's going to start at the higher end models.

But of course, like always, we are looking to make the Atmos music experience as broadly available across all the ways in which people enjoy music and their other entertainment experiences.

And to circle back to another of your question, yes, while we still aren't going to go into specific ASPs, we do anticipate that the automotive would be amongst our higher, quite a bit higher than the average..

And then on the Atmos music streaming side, what's been the feedback at Apple Music? And is that generating interest from other large streaming services? And will that eventually kind of translate over into auto demand at some point?.

Yes. Well, I think, the response from our partners, from consumers, from artists has been really strong. And you can see the reviews out there and the social media posts from artists and from consumers. We are just really excited about the reception and the momentum.

And of course, that generates interest from other potential partners, whether it's services or OEMs. And that's, I am sure you saw we did engage in some great marketing activities last quarter, which also helped to raise that awareness.

So yes, that generates interest and that's where we have to go execute and that's are one of the many reasons why we are able to forecast the kind of growth we are in that part of our revenue..

Got you.

And did I hear you correctly on io that it's going to be included in product revenue, the contribution there? And how much of that contribution, $75 million to $90 million, is from the io business? Did I hear that correctly?.

Hi Paul. It's Robert Park. Yes, it's sitting in products and services. It's considered a service. So it's not included as licensing. And when it's big enough, we will include it or break it out separately..

Okay. And then last question from me. Go ahead..

No. That's okay. Go ahead..

Yes. So free cash flow hit a record this year, primarily on earnings, which is always nice to see. And your revenue and op margin guidance kind of suggests pretty strong profitability again despite some come back in OpEx and discretionary spend.

So can we expect free cash flow up in 2022 as well? And then will you be increasing CapEx on more cinema build, et cetera? And then given the cash balance and pretty strong free cash flow generation over the past couple of years, should we expect some more aggressiveness on buybacks and any other investments? Thank you..

Yes, I will start with the last one on the buybacks. We did increase the buyback this quarter, $96 million versus Q3. You saw we bought back $39 million, kind of impacted by the shorter window of the buyback. But we expect to continue buybacks with a focus at least to offset dilution and we will also continue to be opportunistic.

And with our authorization, we have $291 million remaining, it provides an opportunity and it represents our intent to continue to return cash to shareholders and that's what we want to do in terms of a balanced capital allocation. We are also investing in the business.

But the capital expenditures for 2022 are not expected to be much different than they were for fiscal year 2021..

Great. Thank you..

Thank you. The next question is from the line of Jim Goss with Barrington Research. You may proceed..

Good afternoon. The operating expense guidance was roughly $10 million a quarter above what I think we were sort of budgeting in.

I wonder if you might break it down in terms of where the key growth elements would be in that category in the operating expense relative to the three major categories?.

Yes. Good question. If I step back and I think about the architecture and the model that we have, first off, we are guiding our operating margins at midpoint of 35%. So that's our kind of our North Star to try and maintain a healthy operating margin, just given the revenue that we have, which is stronger than our pre-pandemic operating margins.

That said, there are a number of factors driving the impact, the increase in OpEx, in fiscal year 2022. First, this year we have the course of the year I am here, a 53-week fiscal year for us, which adds an extra week of expenses rise like payroll, depreciation and rent.

Also, our annual focal increases go into effect in Q2, which is part of the increase. And then the third item is really expending a partial return of expenses that were hampered during the pandemic, like travel, events, facilities and others.

But we also routinely rebalance our investments into the areas that we think are most impactful like .io, Atmos, Envision, particularly in gaming and cars. So I think it's a balanced approach to making sure we invest for the future in both innovation and growth.

Just you know that extra 53rd week is not small, it's between $7 million and $8 million by itself..

Okay. That's good.

And within those expenses, does R&D sort of maintain sort of the relationship it's had? Or does that go get bigger or smaller as you are pursuing this growth?.

It's going to grow commensurate with the growth of the business. So yes, we are going to continue investing in R&D, absolutely..

Okay. And then the other category I would like to ask about is the foundational technologies. I don't know if I have heard you talk about it quite in the same way, but it makes a lot of sense, of course.

Could you frame out roughly what share of total would be represented by that category? And how some of the major categories would be in terms of what you deem to be foundational versus the growth elements..

Yes. Sure. So this is foundational as a percentage of licensing revenue. it is about three-quarters of licensing revenue, roughly. And you can really think of that as a grouping of our technologies and what we have grouped there are the ones that tend to have really high adoption rates across broad segments of our revenues.

So this is Dolby Digital Plus, AC-4, our audio patents. And then the approaching 25% is Dolby Atmos, Dolby Vision and our imaging patent portfolios. And that's where we are seeing growth rates accelerating from 20% last year to over 35% this year. And that would include the Dolby Cinema licensing revenues as well.

And just tying into that, is the management process and the people looking at foundational versus some of the growth elements, like is it all the same? Or are there different management techniques and different people assigned to those areas?.

We are not organized that way. We are really sharing that construct as a way of helping you to understand our revenue drivers. And I think it's important in that regard. Because on the one hand, we have our foundational, which while there's always categories that we are looking to grow into. It's a large base with high attach rates.

So it's much more sensitive to kind of the overall dynamic around what's happening with unit shipments, whereas our offerings like Dolby Atmos, Dolby Vision, our imaging patent portfolios are all about the new wins and the new licensees that we have been talking about and that's what's driving the growth.

Organizationally, we have people who are selling all of those things. We have engineers that are engineering all of those things. Some people might be specific to one thing. A lot of people would be across more than one thing. So this is really a way to think about how to understand our revenue growth drivers going forward..

All right. Thanks Kevin. I appreciate it.

[Operator Instructions]. There are no additional questions. I will now pass it back over to Kevin Yeaman for closing remarks..

Great. Well, thank you, everybody, for joining us today. Thank you for the questions and we look forward to seeing you throughout the quarter and updating you again next quarter. Thank you..

That concludes today's conference call. Thank you and have a great day..