Dolby Laboratories, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Fiscal quarter ended March 30, 2018 (13 weeks); year-to-date (YTD) covers the first half of fiscal 2018. Comparisons are with the quarter and YTD periods ended March 31, 2017. Amounts below are in millions unless noted.
Financial performance
| Metric | Q2 FY2018 | Q2 FY2017 | YTD FY2018 | YTD FY2017 |
|---|---|---|---|---|
| Revenue | $301.4 | $267.5 | $589.2 | $533.7 |
| Gross margin | $270.4 | $240.5 | $527.3 | $476.8 |
| Gross margin percentage | 89.7% | 89.9% | 89.5% | 89.3% |
| Operating income | $86.3 | $63.3 | $168.5 | $129.4 |
| Net income (loss) attributable to Dolby | $70.6 | $50.6 | $(11.0) | $104.0 |
| Diluted EPS | $0.66 | $0.49 | $(0.11) | $1.00 |
| Operating cash flow | Not presented quarterly | $98.0 | $159.3 |
Q2 revenue rose 13%, led by licensing revenue of $273.1 million (+13%); products revenue was $22.7 million (+9%) and services revenue was $5.5 million (+8%). Licensing represented 90% of revenue. Q2 operating margin was approximately 28.6%, versus 23.7% a year earlier. YTD operating income increased 30%, but the company reported a YTD net loss because of the tax charge described below.
YTD licensing revenue increased 12%, while products revenue fell 3% and services revenue fell 1%. Products and services gross margins declined to 31% and 10%, respectively, from 35% and 21% YTD in the prior year, mainly due to lower manufacturing capacity utilization; products also faced higher excess and obsolete inventory charges.
Liquidity, cash flow and capital
- At March 30, 2018, cash and cash equivalents were $705.5 million and short- and long-term investments totaled $502.6 million. Working capital was $941.5 million, up from $765.7 million at September 29, 2017.
- YTD operating cash flow was $98.0 million, down $61.3 million year over year. Management attributed the decline primarily to tax-related effects, the Q1 net loss, and working-capital movements, including higher receivables and lower accrued liabilities.
- YTD investing cash outflow was $4.8 million, compared with $68.1 million; financing cash outflow was $17.9 million, compared with $72.2 million. Cash increased $78.5 million from fiscal year-end.
- No material borrowings or debt balance is reported in the presented balance sheet; interest expense was $0.1 million YTD. Total liabilities were $452.7 million, including $185.9 million of non-current tax liabilities.
- Dolby stated that cash, investments and operating cash flows should be sufficient for anticipated requirements for at least the next 12 months. About $875.7 million, or 72% of cash, cash equivalents and investments, was held by foreign subsidiaries.
- YTD capital expenditures were $39.7 million. The company paid $33.0 million in dividends and repurchased $35.0 million of shares under its program; approximately $117 million of repurchase authorization remained at quarter-end. The quarterly dividend was $0.16 per share.
Material changes, outlook and risks
- Tax Act impact: Dolby recorded a provisional $154.6 million tax charge in Q1 FY2018: a $57.9 million reduction in net deferred tax assets from the lower U.S. corporate tax rate and a $96.7 million deemed-repatriation tax liability. This drove the YTD net loss and a 106.1% YTD effective tax rate. The company was still evaluating the final impact and expected to finalize adjustments by fiscal year-end.
- Business outlook: Management said new growth initiatives—primarily Dolby Vision, Dolby Cinema and Dolby Voice—generated approximately $60 million in FY2017 and were expected to approximately double in FY2018. This is initiative-specific outlook, not a consolidated revenue or earnings forecast.
- Operating developments: Dolby Atmos was installed on approximately 3,600 cinema screens, with 142 Dolby Cinema locations operational and more than 380 open or committed at quarter-end. Dolby Voice Room was introduced during Q2. Management cited PC-market declines and lower optical-disc functionality as pressure on PC revenue and average selling prices.
- Accounting changes: Dolby planned to adopt the revenue-recognition standard using the full retrospective method beginning September 29, 2018; the impact had not been quantified. The company anticipated material balance-sheet effects from lease accounting, chiefly recognition of operating-lease assets and liabilities, but no material income-statement impact.
- Key risks and contingencies: Licensing depends on licensees’ product shipments and accurate royalty reporting; recoveries and settlements can fluctuate. Other risks include competition and pricing pressure, technology and standards changes, patent enforcement and licensing disputes, international trade and currency exposure, and reliance on cinema partners and content pipelines. Management did not expect pending legal matters to materially affect results or financial condition, but said outcomes are uncertain and potential losses could not always be estimated. Contractual commitments totaled $284.9 million, including naming rights, operating leases, purchase obligations and donations.
Most important facts for investors to verify
- How the provisional $154.6 million Tax Act charge and $96.7 million transition-tax liability are finalized, paid and reflected in future effective tax rates and cash flows.
- Whether licensing growth is sustained, including the contribution and variability of recoveries, mobile licensing, and broadcast and PC trends.
- Whether the expected doubling of new-initiative revenue in FY2018 is achieved, and whether Dolby Cinema, Dolby Vision and Dolby Voice adoption translates into durable revenue.
- The effect of the retrospective revenue-standard adoption on reported periods, and the balance-sheet impact of lease accounting.
- Receivables and working-capital trends, foreign-held liquidity, and the continuing capacity to fund investment, dividends and repurchases.