Dolby Laboratories, Inc. — Q3 FY2018 Form 10-Q
Reporting period: Fiscal quarter ended June 29, 2018; year-to-date covers the first three quarters of fiscal 2018. Comparisons are with the quarter ended June 30, 2017 and the corresponding year-to-date period. Amounts are U.S. dollars.
Business context
Dolby develops and licenses audio and imaging technologies and sells cinema, broadcast, and communications products and services. Licensing generated 90% of revenue in both the quarter and year-to-date period. About 73% of year-to-date revenue was international. The company operates as one reporting segment.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | First 3 quarters FY2018 | First 3 quarters FY2017 |
|---|---|---|---|---|
| Revenue | $317.4M | $305.7M | $906.6M | $839.4M |
| Gross margin | $283.0M (89.1%) | $273.5M (89.5%) | $810.3M (89.4%) | $750.3M (89.4%) |
| Operating income | $94.8M | $95.9M | $263.3M | $225.3M |
| Net income attributable to Dolby | $83.1M | $76.0M | $72.2M | $180.0M |
| Diluted EPS | $0.78 | $0.73 | $0.67 | $1.73 |
| Cash from operations | Not presented by quarter | $240.5M | $297.4M |
Quarterly revenue increased 3.9%; licensing rose 3%, products 16%, while services declined 3%. Quarterly operating income fell 1.2%, as sales and marketing and general and administrative costs increased. Quarterly net income rose 9.3%, aided by a lower effective tax rate of 13.8% versus 20.9%. Year-to-date operating income increased about 17%, but year-to-date net income fell sharply because of the Tax Act-related tax charge recognized in Q1.
Liquidity, capital, and other metrics
- At June 29, cash and cash equivalents were $829.6M; short- and long-term investments totaled $438.5M. Cash, cash equivalents, and investments together were approximately $1.268B.
- Working capital was $998.6M, up from $765.7M at fiscal year-end. Total liabilities were $481.9M; non-current tax liabilities were $188.0M. The balance sheet presents no separate debt balance.
- Year-to-date capital expenditures were $54.9M. Cash used for repurchases was $90.5M and dividends paid were $49.6M. The quarterly dividend was $0.16 per share.
- On July 25, 2018, the board increased the repurchase authorization by $350M, bringing future repurchase availability to $412M.
Changes, outlook, risks, and unusual items
- Tax Act: Dolby recorded a provisional $154.6M tax charge in Q1 FY2018, including a $57.9M reduction in net deferred tax assets and a $96.7M deemed-repatriation tax liability. Year-to-date effective tax rate was 73.2%, versus 21.6% a year earlier. The company expected to finalize related estimates by the quarter ending December 28, 2018.
- Operating drivers: Higher mobile adoption, patent licensing, Dolby Cinema, and Dolby Voice activity supported revenue. Lower set-top-box volumes, especially in China and North America, weighed on quarterly broadcast results. PC licensing faced lower average royalties as optical-disc functionality declined.
- Growth initiatives: Dolby reported about 160 Dolby Cinema locations operating and over 390 open or committed; approximately 3,800 Dolby Atmos-enabled cinema screens were installed. Dolby Voice Room began shipping near quarter-end.
- Management outlook: No numerical revenue or earnings guidance is provided in the supplied filing text. Management said available liquidity and operating cash flows should cover anticipated cash requirements for at least 12 months.
- Accounting changes: Dolby planned to adopt the new revenue recognition standard and lease standard on September 29, 2018. Revenue adoption effects had not yet been quantified; lease adoption was expected to materially increase balance-sheet assets and liabilities, without a material income-statement impact.
- Key risks: Licensee product volumes and royalty reporting, competition and pricing pressure, technology and content adoption, declining optical-disc use, IP enforcement, international trade and currency exposure, and the success of newer markets. The filing notes July 2018 U.S. and Chinese tariffs and uncertainty around their scope and duration.
- Legal and commitments: Dolby said pending legal matters were not expected to have a material adverse impact, but unfavorable outcomes could affect a period and potential losses could not be estimated clearly. Contractual commitments totaled $290.2M, including naming rights, operating leases, purchase obligations, and donations.
- Cash-flow disclosure inconsistency: The cash flow statement reports year-to-date operating cash flow of $240.5M versus $297.4M, a decrease of $56.9M. MD&A describes this as an increase of $56.9M; the discrepancy should be checked against the filed financial statements.
Important facts for investors to verify
- Reconcile the $56.9M operating-cash-flow direction inconsistency between the cash flow statement and MD&A.
- Track final Tax Act measurement adjustments, the timing and cash payment of the transition-tax liability, and the effect of new international tax provisions.
- Assess royalty growth and recoveries against lower set-top-box volumes, PC royalty pressure, and the adoption of Dolby formats by device makers and content providers.
- Monitor execution and returns from Dolby Cinema, Dolby Voice, and imaging initiatives, including site commitments, adoption, and associated spending.
- Review the full risk-factor and commitments disclosures, including international trade developments, IP disputes, and the concentration of voting control in the Dolby family and affiliates.