Dolby Laboratories, Inc. — Q1 Fiscal 2019 10-Q
Reporting period: 13 weeks ended December 28, 2018; comparisons are with the 13 weeks ended December 29, 2017. Dolby develops and licenses audio, imaging and communications technologies and sells related products and services. Licensing remained the primary revenue source, at 86% of revenue.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $302.4m | $299.5m | +1% |
| Licensing revenue | $260.3m | $270.2m | -4% |
| Products and services revenue | $42.1m | $29.4m | +43% |
| Gross margin | $263.7m; 87.2% | $268.6m; 89.7% | -2% in dollars |
| Operating expenses | $195.1m | $174.7m | +12% |
| Operating income | $68.7m; 22.7% margin | $94.0m; 31.4% margin | -27% |
| Net income (loss) attributable to Dolby | $98.2m | $(53.3)m | Prior period included a large tax-related charge |
| Diluted EPS | $0.93 | $(0.52) | — |
| Cash from operations | $57.0m | $17.1m | +$39.8m |
Products and services growth reflected higher Dolby Cinema and cinema-equipment sales and more Dolby Voice units. Licensing declines included lower mobile revenue and lower broadcast recoveries and payment timing; gains in other licensing markets partly offset those declines. Sales and marketing expense rose 22%, principally from marketing programs, product launches and compensation.
Liquidity, cash flow and capital allocation
- At December 28, 2018, cash and cash equivalents were $790.8m; short- and long-term investments totaled $377.0m. Cash, cash equivalents and investments totaled approximately $1.168bn. About 48% of that portfolio was held by foreign subsidiaries.
- Working capital was $1.129bn. Total liabilities were $474.1m; the balance sheet presents no borrowings or debt line item.
- Cash used in investing activities was $41.6m, including $18.5m of PP&E purchases and $12.1m of intangible-asset purchases. Cash used in financing was $138.4m, including $112.5m of share repurchases and $19.6m of dividends.
- Dolby repurchased 1.64m shares at an average $68.54 per share; approximately $239m remained authorized. The quarterly dividend was $0.19 per share.
- Management said existing cash, investments and operating cash flows should meet anticipated cash needs for at least the next 12 months.
Material changes, outlook and risks
- Revenue accounting: Dolby adopted ASC 606 using full retrospective application. It now estimates shipment-based royalties and records revenue in the shipment period, with subsequent true-ups when licensee reports arrive. Adoption increased September 28, 2018 retained earnings by $174.4m and changed the timing and presentation of prior-period results, but did not change cash flows or total contract consideration. Estimation differences may increase quarterly revenue volatility.
- Taxes: The quarter recorded a $24.1m income tax benefit, an effective tax rate of -32.5%. The prior-year quarter included a substantial one-time Tax Act charge, making the net-income comparison unusually distorted. After quarter-end, Treasury regulations led Dolby to expect an additional $18.9m tax expense in the quarter ending March 29, 2019.
- Business outlook: The filing provides no quantitative revenue or earnings guidance. Management highlighted expansion in Dolby Cinema, Atmos, Vision and Dolby Voice, but outcomes depend on adoption by device makers, content availability, theater deployments and box-office performance. Dolby reported about 190 Dolby Cinema locations operating and more than 400 open or committed; over 4,300 Atmos-enabled cinema screens were installed.
- Key risks: Dependence on licensees’ product shipments and accurate royalty reporting; competition and pricing pressure; declining optical-disc and PC-drive markets; rapid technology and standards changes; international, China and IP-enforcement risks; and foreign-exchange exposure. Approximately 60% of quarterly revenue was international, versus 74% in the prior-year quarter.
- Regulatory and legal matters: The Korean Fair Trade Commission requested information about Dolby’s Korean business practices in October 2018; Dolby said it was cooperating. The company reported ordinary-course legal proceedings but could not estimate certain potential losses. Contractual commitments totaled $320.0m, including naming rights, operating leases, purchase obligations and donations.
Most important facts for investors to verify
- Whether estimated shipment-based royalties and later true-ups materially affect reported licensing revenue in subsequent quarters.
- Whether products and services growth can offset licensing declines, including the trajectory of mobile and broadcast licensing.
- The timing and final effect of the additional $18.9m tax expense and any further tax-law developments.
- Dolby Cinema deployment, box-office revenue and adoption of Dolby Atmos, Dolby Vision and Dolby Voice.
- Progress and potential outcomes of the KFTC inquiry, other legal matters, and international IP-enforcement challenges.
- The use of cash for repurchases and dividends relative to operating cash generation and stated investment needs.