Dolby Laboratories, Inc. — Q2 Fiscal 2019 Form 10-Q
Reporting period: 13-week fiscal quarter ended March 29, 2019; year-to-date (YTD) figures cover the first 26 weeks. Comparisons are to the corresponding 2018 periods, as adjusted for ASC 606 adoption. Amounts are in U.S. dollars unless stated otherwise.
Business context
Dolby develops and licenses audio, imaging, and communications technologies, and sells related products and services. Licensing supplied 92% of Q2 revenue. The company operates as one reporting segment.
Financial performance
| Metric | Q2 2019 | Q2 2018 | YTD 2019 | YTD 2018 |
|---|---|---|---|---|
| Revenue | $338.3 million | $299.7 million | $640.6 million | $599.2 million |
| Gross margin | $301.7 million; 89.2% | $268.7 million; 89.6% | $565.4 million; 88.3% | $537.3 million; 89.7% |
| Operating income | $102.9 million | $84.6 million | $171.6 million | $178.6 million |
| Net income attributable to Dolby | $73.4 million | $65.2 million | $171.7 million | $11.9 million |
| Diluted EPS | $0.70 | $0.61 | $1.63 | $0.11 |
| Operating cash flow | Not presented quarterly in this filing | $105.8 million | $98.0 million |
Q2 revenue rose 13%, led by licensing revenue, up 14% to $310.3 million; products and services revenue was nearly unchanged at $28.0 million. Broadcast licensing increased, while mobile and PC licensing declined. Sales and marketing expense increased 25% to $92.7 million, mainly due to marketing, IP-related activity, and compensation. Operating income rose 22% in Q2, but declined 4% YTD.
YTD net income comparisons are heavily affected by taxes: fiscal 2018 included a large one-time Tax Act charge, while fiscal 2019 YTD recorded a $12.3 million income tax benefit. Q2 2019 tax expense was $36.4 million, with a 33.1% effective rate, versus 25.6% in Q2 2018.
Liquidity, cash flow and capital
- At March 29, 2019, cash and cash equivalents were $726.6 million; short- and long-term investments totaled $358.0 million. Cash, cash equivalents, and investments were approximately $1.085 billion, excluding restricted cash.
- Working capital was $1.130 billion. Total liabilities were $494.1 million; the balance sheet does not list borrowings or other debt.
- YTD investing cash outflow was $63.5 million, including $56.1 million of property, plant, and equipment purchases. YTD financing cash outflow was $231.5 million, including $197.9 million of share repurchases and $39.0 million of dividends.
- Cash, cash equivalents, and restricted cash decreased $190.4 million during the first half, ending at $734.9 million. Management said available liquidity and operating cash flows should meet anticipated cash needs for at least the next 12 months.
- The quarterly dividend was $0.19 per share. Approximately $154 million remained under the repurchase authorization at quarter-end.
Material changes, outlook and risks
- Revenue accounting: Dolby adopted ASC 606 using the full retrospective method. It now estimates licensee shipments and recognizes related sales-based royalties in the shipment period, with later true-ups. This affects timing and may increase quarterly revenue volatility, but management said it does not change contract cash flows or total revenue. Q2 included an approximately $8.0 million favorable adjustment for October–December shipments. Adoption increased opening retained earnings by $174.4 million.
- Contract estimates: Contract assets increased 48% to $244.9 million from September 28, 2018, mainly reflecting estimated royalties awaiting licensee reports. Remaining performance obligations were $42.5 million; Dolby expected to recognize 31% in fiscal 2019, 25% in fiscal 2020, and the balance thereafter.
- Tax item: Final U.S. transition-tax regulations prompted $19.0 million of additional tax expense in Q2. Dolby reported a $104.4 million final recorded Tax Act amount as of March 29, 2019.
- Business developments: Dolby reported more than 4,600 Dolby Atmos-enabled cinema screens and over 200 Dolby Cinema locations at quarter-end, with another 200 screens committed. Management emphasized continued investment in audio and imaging technologies and expansion across cinema, broadcast, mobile, and consumer markets. The filing gives no specific quantitative earnings or revenue guidance.
- Risks and contingencies: Key risks include licensee adoption and royalty-reporting accuracy, competing or royalty-free technologies, declining optical-disc and PC royalty trends, content and cinema demand, international trade and IP-enforcement challenges, foreign exchange, and dependence on industry partners. Dolby said pending legal matters were not expected to materially affect results or financial condition, but outcomes could be unpredictable. The Korean Fair Trade Commission had requested information about Dolby’s Korean business practices; Dolby said it was cooperating.
Important facts for investors to verify
- Whether licensing growth, particularly in broadcast, can offset pressure in mobile, PC, and legacy optical-disc markets.
- How actual licensee reports compare with shipment estimates, and whether the large contract-asset balance converts to cash as expected.
- Whether increased sales and marketing spending and ongoing investment translate into durable growth and margins.
- How much reported earnings and tax rates are affected by discrete tax items versus ongoing operations.
- Progress on Dolby Cinema, Dolby Atmos, and Dolby Vision adoption, including committed screens and content availability.
- Developments in the KFTC inquiry, other IP or licensing disputes, and international trade and regulatory risks.
- The pace of cash use for repurchases and dividends relative to operating cash generation and investment needs.