Dolby Laboratories, Inc. — Q3 FY2010 Form 10-Q
Reporting period: Fiscal quarter ended June 25, 2010; year-to-date represents the first nine months of fiscal 2010. Comparisons are with the quarter and year-to-date periods ended June 26, 2009. Amounts below are in millions of dollars unless stated otherwise.
Business context and key financial metrics
Dolby earns most of its revenue from licensing audio technologies, with additional sales of cinema and broadcast products and related services. International markets generated about 66% of year-to-date revenue.
| Metric | Q3 FY2010 | Q3 FY2009 | FY2010 YTD | FY2009 YTD |
|---|---|---|---|---|
| Revenue | $230.3 | $171.2 | $694.9 | $555.6 |
| Operating income | $95.9 | $78.4 | $332.2 | $298.4 |
| Net income attributable to Dolby | $63.5 | $51.1 | $218.4 | $198.7 |
| Diluted EPS | $0.55 | $0.44 | $1.89 | $1.73 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $259.5 | $195.3 |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $24.9 | $9.2 |
- Quarter revenue increased 34%; year-to-date revenue increased 25%. Licensing revenue rose 20% for the quarter and 17% year to date. Product revenue rose 142% and 85%, respectively; services revenue was flat for the quarter and down 5% year to date.
- Quarter gross margin was 83% versus 88%; year-to-date gross margin was 85% versus 91%. The quarter included a $9.6 million impairment charge on digital cinema equipment leased to exhibitors. Year-to-date 2009 gross margin benefited from a $20.0 million gain from an amended patent licensing agreement.
- Quarter operating margin was approximately 41.7% versus 45.8%; year-to-date operating margin was approximately 47.8% versus 53.7%. Operating expenses increased 29% for the quarter and 23% year to date.
- At June 25, cash and cash equivalents were $519.1 million; short- and long-term investments totaled $526.4 million. Working capital was $840.6 million. Total debt was approximately $6.1 million, including current and long-term portions.
Material changes and unusual items
- Higher digital cinema and 3D equipment sales drove product growth, alongside adoption of revised multiple-element revenue accounting. Under the new guidance, more digital cinema server revenue is recognized upon delivery; the filing reports $56.1 million of year-to-date revenue from fiscal 2010 multiple-element product arrangements.
- Demand for 3D and digital cinema equipment, together with component and supplier capacity constraints, created a shipment backlog earlier in the year. The backlog declined in Q3; management expected to fulfill most remaining orders by fiscal year-end.
- The company recorded a $9.6 million impairment after reducing its estimates of virtual print fees and equipment resale values. Management said the remaining leased equipment carrying value was recoverable.
- Dolby announced a reorganization affecting about 60 general and administrative employees and estimated approximately $5.0 million in severance and related costs, recognized over the employees’ service period through November 15, 2010.
- Year-to-date share repurchases totaled $177.6 million for 3.1 million shares under a $250 million authorization. Remaining authorization at quarter-end was approximately $72.4 million.
- Failed-auction auction-rate certificates had been illiquid since 2008. On June 30, 2010, after quarter-end, Dolby exercised its UBS put rights and received $26.5 million, including accrued interest.
Outlook, risks and contingencies
- Management said cash, investments and expected operating cash flows should meet anticipated requirements for at least the next 12 months. The filing provides no specific revenue, earnings or margin guidance.
- Management cited opportunities in digital television, Blu-ray, mobile devices, digital cinema and 3D, while cautioning that expected growth may not materialize. It did not expect significant fiscal 2010 revenue from certain newer products and technologies, including Dolby Volume and Dolby Axon.
- Key risks include weaker discretionary consumer spending; declines in standard-definition DVD and traditional film cinema; competition and pricing pressure in digital cinema; and Dolby’s lack of a 4K digital cinema solution. Dependence on licensee shipment reporting, intellectual-property enforcement, international markets and suppliers also presents risks.
- Routine legal proceedings, including intellectual-property matters, were not expected by management to have a material adverse effect, although an unfavorable outcome could affect a particular period. A previously agreed litigation settlement had approximately $3.0 million remaining to be paid. Certain IP indemnification obligations have no reasonably estimable maximum potential payment.
- Dolby reported disclosure controls were effective at quarter-end and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the rapid product-revenue growth reflects shipment volumes versus the revised revenue-recognition method, and whether the remaining digital cinema backlog was subsequently delivered.
- Whether the reduced virtual print fee outlook or equipment values could prompt further impairment charges.
- Whether licensing growth—particularly from Windows 7, broadcast and Blu-ray—can offset declines in legacy DVD and other markets.
- Progress and total cost of the employee reorganization, and remaining spending under the repurchase authorization.
- Investment portfolio exposure and liquidity after the auction-rate certificate put exercise, along with interest-rate and foreign-currency sensitivities.
- Potential effects of digital cinema competition, including 4K offerings, and any material developments in litigation or IP indemnification matters.
- Governance and voting concentration: Ray Dolby and affiliates held approximately 91.4% of combined voting power at June 25, 2010.