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Text: In particular, we are currently in the midst of the COVID-19 pandemic.
The extent of its continued impact on our business will depend on several factors, including the severity, duration and extent of the pandemic, as well as actions taken by governments, businesses and consumers in response to the pandemic.
All of which continue to evolve and remain uncertain at this time.
As for the content of today's call Lewis will begin with a recap of Dolby's financial results and provide our fiscal 2020 outlook and Kevin will finish with a discussion of the business.
And I hope you're all staying safe out there.
I'm glad to report that Q3 revenues came in at the high-end of the scenario that we provided three months ago and our earnings were above the range as we had a large tax benefit in the quarter to go along with some lower than projected operating expenses.
While we did do better than Q3 outlook, its worth noting that the numbers were lower than the original forecast from the start of the year before COVID-19 came into the picture.
So here the numbers.
Third quarter revenue was $247 million, compared to $352 million in Q2, and $302 million in Q3 of last year.
Our Q3 revenue guidance coming into the quarter was a range of $225 million to $250 million.
Now if I compare that to what we assumed in our guidance, revenues from TVs, PC and mobile were at the higher end, while consumer electronics and set-top boxes were at the lower end of our scenario.
Products and services were at the high-end of the range, but remember that we had lowered our expectations by 70% to 80%, because of the significant impact of COVID-19 shutdowns on the cinema industry.
Now looking at total company quarter-over-quarter, revenue was down by about $105 million from Q2, roughly half of that was driven by timing of revenue under contracts, as well as lower recoveries, and roughly the other half of that was attributable to the impact from COVID-19, which includes lower royalties from unit shipments across a variety of devices, lower sales of cinema products and services and lower revenue from box office share at Dolby Cinemas.
Now looking at total company year-over-year, revenue was down by about $55 million versus last year's Q3, and that was predominantly attributable to COVID-19, and similar to what I said a minute ago, lower unit shipments, lower products and services and lower Dolby Cinema revenue.
The composition of Q3 revenue was $235 million in licensing; and $12 million in products and services.
So, let's go through a breakdown of licensing revenue by end market, starting with Broadcast.
Broadcast represented about 38% of total licensing in the third quarter.
Broadcast revenues were down about 34% year-over-year, and that was driven by lower recoveries and lower unit volume due to the pandemic, despite the fact that adoption of Dolby Vision and Dolby Atmos into TVs and set-top boxes is higher than last year.
On a sequential basis, Broadcast was down by about 31% due to lower recoveries and lower unit volume.
Mobile represented approximately 33% of total licensing in Q3.
Mobile was up by about 65% over last year, due to higher recoveries and revenues from our patent programs, offset partially by unit volume impact from the pandemic.
On a sequential basis, Mobile was up by about 3%, driven by recoveries offset partially by unit volume impact from the pandemic.
PC represented about 10% of total licensing in the third quarter.
PC was down by about 4% year-over-year, due to lower recoveries and lower unit volume, although, its worth noting that adoption of Dolby Vision and Dolby Atmos of the PCs has increased since last year.
And sequentially PC was down nearly 50%, due to timing of revenue under contracts and also lower recoveries.
Consumer electronics represented about 9% of total licensing in the third quarter and on a year-over-year basis CE licensing was down by about 29%, driven by lower volume and lower recoveries.
On a sequential basis, CE was down by nearly 60%, due to timing of revenue under contracts, as well as lower unit volume.
Other markets represented about 10% of total licensing in the third quarter.
They were down by about 34% year-over-year due to significantly lower revenues from Dolby Cinema, because nearly all of those screens were closed for the quarter and lower revenues from gaming due to console life cycles.
On a sequential basis, Other Markets was down by about 16% driven by lower revenue from Dolby Cinema and from via admin fees and those are the fees in the patent pool program that we administer.
And this was offset partially by higher recoveries in automotive and gaming.
Beyond licensing our products and services revenue was $11.8 million in Q3, compared to $23 million in Q2, and $30.3 million in last year's Q3.
We had anticipated a big drop-off in sales in this category, as most of this revenue comes from equipment that we sell to cinema exhibitors.
And these customers in general, continue to be negatively affected by the pandemic.
Now let's cover margins and operating expenses for Q3.
Total gross margin in the third quarter was 87.9% on a GAAP basis, and 89% on a non-GAAP basis.
Products and services gross margin on a GAAP basis was minus $5.5 million in the third quarter, due to fixed cost not fully covered by the lower volume that we ran.
And as a reminder, the guidance I gave at the beginning of the quarter was for GAAP gross product margin to range from minus $6 million to minus $9 million.
Products and services gross margin on a non-GAAP basis was minus $3.5 million in the third quarter for the same reasons as I just went over in the GAAP discussion, and there as a reminder, our guidance for non-GAAP product gross margin was minus $5 million to minus $8 million.
Operating expenses in the third quarter on a GAAP basis were $182.9 million, compared to $209 million in Q2.
Operating expenses in Q3 were about $8 million less than the low end of the range we've guided, mostly driven by timing of certain marketing programs that were pushed into Q4, lower legal expenses and lower travel and outside services.
Operating expenses in the third quarter on a non-GAAP basis were $159.2 million, compared to $188.4 million in the second quarter.
And the Q3 non-GAAP total was also below the range we projected and for the same reasons that I discussed in the GAAP expenses.
Operating income in the third quarter was $34.1 million on a GAAP basis, or 13.8% of revenue, compared to $34.3 million or 11.3% of revenue in Q3 of last year.
And last year's Q3 included a $30 million charge for restructuring mostly associated with an early exit from a leased facility.
Operating income in the third quarter on a non-GAAP basis was $60.5 million, or 24.5% of revenue, compared to $85.9 million or 28.4% of revenue in Q3 of last year.
Income tax was a $27.4 million benefit in Q3 on a GAAP basis, and a $21.2 million benefit on the non-GAAP basis.
The Q3 income tax amounts include approximately $36 million of discrete benefits for a specific item that were resolved during the quarter.
Net income on a GAAP basis in the third quarter was $67.3 million, or $0.66 per diluted share, compared to $39.6 million or $0.38 per diluted share in last year's Q3.
Net income on a non-GAAP basis in the third quarter was $87.5 million or $0.86 per diluted share, compared to $79.3 million, or $0.76 per diluted share in Q3 of last year.
For both GAAP and non-GAAP net income in Q3 was above our original guidance, due to revenue being at the higher end of our range, operating expenses at the lower range and the favorable income tax that I discussed.
During the third quarter, we generated about $134 million in cash from operations, which compares to about $91 million generated in last year's third quarter, and we ended the third quarter with a little over $1.1 billion in cash and investments.
During Q3, we bought back about 500,000 shares of our common stock and ended the quarter with about $230 million of stock repurchase authorization still available.
We also announced today a cash dividend of $0.22 per share, which will be payable on August 26, 2020 to shareholders of record on August 17th, 2020.
Now let's cover the outlook for Q4.
Three months ago, when I went over the guidance for Q3, I highlighted the challenges that we are facing in the environment.
Consumer demand was dropping, visibility was much more limited than usual, and industry data reports were not consistent or current.
Fast forward to now, we have updated TAM data for some of our end markets, but not all of them.
Customer visibility is still very limited and remember we won't have actual shipment data for the June quarter until all our customers send us the reports over the next few months and the economy is still pretty uncertain.
So with that as a backdrop, here's our current scenario for Q4, along with some key assumptions that we've embedded into the outlook.
Let's start with products and services revenue, most of which goes into the cinema industry.
The screens are opening more slowly than we thought last quarter, so we are assuming that there will not be any significant uptick in equipment, purchasing activity from exhibitors in Q4.
We estimate that products and services revenue in Q4 could range from $10 million to $15 million.
Let's talk about licensing.
We estimate that licensing revenue in Q4 could range from $215 million to $240 million, that's in comparison to the $235 million that we had in Q3.
As I look at the transition from Q3 actual to the Q4 outlook scenario, there is downward movement from timing of revenue under customer contracts.
This is not unusual, and I think of it as Dolby seasonality.
In other words, within the course of our fiscal year, we tend to have higher revenue in our Q2 and our Q3, and lower amount in our Q1 and Q4, and a lot of this is because of timing of revenue under various contracts.
Partially offsetting it this year is an assumption that total unit shipments could increase modestly in Q4 over Q3 as consumer spending starts to improve.
Our Q4 scenario assumes that there will roughly be a 5% improvement in unit shipments plus or minus blended across all device categories.
For Q4, we're also assuming very little revenue from Dolby Cinema box office share.
So to summarize, our scenario for total revenue in Q4 is a range of $225 million to $255 million.
If I compare that to last year's Q4 actual revenue of $299 million, the majority of the potential decline would be attributable to the economic ripple effect of the pandemic, and the remainder would largely be due to lower recoveries.
Gross margin for Q4 on a GAAP basis is estimated to range from 85% to 86%; and non-GAAP gross margin is estimated to be about 1 percentage point higher than the GAAP number.
Products and services gross margin will remain a negative territory in Q4, mainly because of fixed costs that are not fully covered at the lower revenue levels.
At the revenue range in the outlook I provided, products and services gross margin on a GAAP basis could range from minus $6 million to minus $9 million in Q4; and on a non-GAAP basis, it could range from minus $5 million to minus $8 million.
Operating expenses in Q4 are estimated to range from $187 million to $197 million on a GAAP basis; and from $167 million to $177 million on a non-GAAP basis.
Other income is projected to range from $2 million to $3 million for the quarter; and our income tax rate for the fourth quarter is projected to range from 19% to 21% on both the GAAP and non-GAAP basis.
Based on a combination of the factors I just reviewed, we estimate the Q4 diluted earnings per share on the GAAP basis could range from five -- from about $0.05 to about $0.20; and then on a non-GAAP basis, we estimate, it would range from about $0.22 to $0.37.
And as for the full-year, if you do the math, that would mean that our FY '20 revenue for the full-year could range from $1,115 million to $1,145 million; GAAP diluted earnings per share could range from $2.04 to $2.19; and non-GAAP diluted earnings per share could range from $2.76 to $2.91.
With the strength of our financial model, balance sheet and value proposition, Dolby continues to be well positioned to navigate through these challenging times.
Our people continue to bring their creativity and passion to enable more Dolby experiences to more people around the world.
While our Q3 revenues came in at the high-end of our scenarios, there is still a lot of uncertainty across many of the markets in which we operate.
In addition to lower consumer spending the pandemic has resulted in some shifts in the timing of new customer wins and revenues.
At the same time, our partners remain deeply engaged with enabling new Dolby Vision and Dolby Atmos experiences.
As consumer spending does return, we are confident that with our strong positioning across a broad range of devices and services, we will return to our path of driving revenue and earnings growth.
Our formula for growth has always started with increasing the amount of compelling content available at Dolby.
The Dolby Vision and Dolby Atmos experience in movie and TV content has led to growing adoption across a broad range of devices.
We are also expanding the Dolby experience in areas such as gaming and music that broaden our value proposition and create more opportunities in device categories like mobile, PC and automotive.
In addition, we are beginning to address a growing population of content beyond premium entertainment, most recently with the launch of our development platform Dolby.io.
All of these gives us confidence in our ability to drive long-term growth.
Let's turn to some of the highlights this quarter.
As people are watching a growing amount of streamed content, Dolby Vision and Dolby Atmos continues to be highlighted within the content that matters most to people.
The highly anticipated releases of Hamilton on Disney Plus and Greyhound on Apple TV Plus are both available in Dolby.
This quarter, we began to see the first titles in Dolby Vision on Google Play.
And Hotstar, the largest streaming service in India, began to support Dolby Vision for Disney Plus content.
This quarter, we saw several partners adopt Dolby Vision and Dolby Atmos within their products.
Apple, which supports Dolby Vision and Dolby Atmos across most of their devices, announced that AirPods Pro will support Dolby Atmos with the release of iOS 14.
Sonos launched the Sonos Arc, their first soundbar that supports Dolby Atmos.
Free, one of the largest Internet service providers in France, launched their first set-top box to support Dolby Vision and Dolby Atmos.
And last month, Xiaomi launched their first TV supporting the combined experience.
Adoption of both Dolby Vision and Dolby Atmos within TV is continuing to expand globally, most notably in India.
This quarter TCL, Sony, OnePlus and Nokia all announced new TV models in India supporting the combined experience.
Also, Panasonic expanded their adoption of Dolby Vision IQ to additional models in this quarter.
In FY '19, Dolby Vision was included on about 10% of 4K TV shipments, and we are on track to materially increase that adoption rate for fiscal '20 with a significant growth opportunity still ahead of us.
Our strong presence in movie and TV content has enabled the initial option of Dolby Vision and Dolby Atmos within PC and mobile devices.
Beyond that, we see a significant opportunity to accelerate the adoption by enabling more experiences on these devices, including gaming and music.
Recently, title significantly expanded the number of devices that support Dolby Atmos music to include Dolby Atmos enabled sound bars and home theater equipment.
We are also seeing examples of how Dolby Atmos can create unique experiences across a wide range of music genres.
This quarter, we saw examples of classical music from John Williams, and recordings from the London Philharmonic Orchestra mixed in Dolby Atmos.
Empire, an independent label, began releasing music in Dolby Atmos from artists like Fat Joe and Remy Ma.
The music in Dolby experience elevates our engagement with partners and strengthen the value proposition for Dolby Atmos in existing device categories; such as mobile phones and creates new opportunities for us in areas such as automotive and smart speakers.
Let me shift to Cinema.
During the quarter, most cinemas remained closed with a few regions slowly beginning to reopen.
The closure of cinemas around the world has significantly reduced demand for our cinema products.
We believe that when Cinemas do begin to reopen, exhibitors will look to highlight their premium offerings and consumers will seek out the best experience.
And there is none better than Dolby Cinema.
Last month, the first Dolby Cinema in South Korea was opened with our partner Megabox.
We have also added our second partner that will bring Dolby Cinemas to Saudi Arabia, where we saw our first site opened just last week.
As we look ahead, we are excited by the unique opportunity to significantly broaden the content experience we addressed with Dolby technologies.
During the quarter, we launched our developer platform Dolby.io.
Dolby.io enables developers to access Dolby technology to raise the bar on the quality of the media and communications experiences within their apps and services using our APIs.
Among our initial customers, we have seen the application across a wide range of use cases, including podcast, e-learning and telehealth.
Beginning a few weeks ago, artists can optimize the quality of their music recordings with mastering on SoundCloud powered by Dolby's platform.
We are excited by the initial reception of Dolby.io, and by the potential to bring Dolby to the growing amount of media and communications content, it is part of our daily lives.
To wrap up, Dolby has a solid foundation with a strong business model and more than ever, people want immersive entertainment and communications experiences.
The quality of these experiences matter.
We continue to focus on growing the number of devices that support Dolby Vision and Atmos.
We will accelerate adoption and broaden the device categories that support the Dolby experience by enabling new forms of content like music and gaming.
And we are excited by the opportunity to enable an even broader range of Dolby experiences most recently with the launch of Dolby.io.
All of these reinforces our belief in the opportunities that are still ahead of us and give us confidence in our ability to drive revenue and earnings growth.

user
dolby laboratories q3 non-gaap earnings per share $0.86.
q3 non-gaap earnings per share $0.86.
q3 gaap earnings per share $0.66.
sees q4 2020 revenue $225 million to $255 million.
sees q4 2020 gaap earnings per share about $0.05 to $0.20.
q4 diluted earnings per share is anticipated to range from about $0.22 to $0.37 on a non-gaap basis.
fy diluted earnings per share is anticipated to range from $2.76 to $2.91 on a non-gaap basis.

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