Dolby Laboratories, Inc. — Q2 FY2015 Form 10-Q
Reporting period: Fiscal quarter ended March 27, 2015 (13 weeks); year-to-date (YTD) covers 26 weeks. Results are unaudited. Dolby primarily licenses audio technologies and also sells products and services.
Financial performance
| Metric | Q2 FY2015 | Q2 FY2014 | YTD FY2015 | YTD FY2014 |
|---|---|---|---|---|
| Revenue | $272.0 million | $278.6 million | $506.2 million | $509.9 million |
| Gross margin | $246.8 million (90.8%) | $261.1 million (93.7%) | $461.6 million (91.2%) | $471.0 million (92.4%) |
| Operating income | $78.6 million | $104.9 million | $132.1 million | $164.8 million |
| Net income attributable to Dolby | $58.0 million | $75.9 million | $99.3 million | $120.4 million |
| Diluted EPS | $0.56 | $0.73 | $0.95 | $1.16 |
| Operating cash flow | Not separately stated | Not separately stated | $177.9 million | $179.4 million |
Q2 revenue declined 2.4%; licensing revenue fell 5.9% to $243.3 million, while products rose 57.8% to $23.0 million and services rose 4.0% to $5.6 million. Q2 operating income declined 25.1%, and net income attributable to Dolby declined 23.6%. YTD revenue was down 0.7%; operating income fell 19.8% and net income fell 17.5%.
Margins and expenses: Q2 gross margin rate declined to 90.8% from 93.7%, primarily reflecting the greater share and lower margins of products. Operating expenses rose to $168.2 million from $156.2 million, including R&D up 26% to $56.6 million. YTD gross margin rate was 91.2%, compared with 92.4%.
Liquidity and capital: At March 27, cash and cash equivalents were $514.0 million, short-term investments $188.2 million, and long-term investments $330.3 million. Working capital was $720.9 million, down from $816.5 million at September 26, 2014. Total liabilities were $315.5 million; the balance sheet presents no debt line item. YTD investing cash outflow was $173.1 million, including $78.5 million of capital expenditures and $93.5 million of acquisition payments, net of cash acquired. Financing cash outflow was $55.5 million, including $32.4 million in share repurchases and $20.5 million in dividends.
Material changes and developments
- Licensing revenue fell in Q2, notably because the prior-year quarter included $24.7 million of broadcast back payments from a large licensee. Other factors included lower PC average selling prices and lower shipments in some consumer electronics and mobile categories.
- Products revenue benefited from Doremi Labs, acquired October 31, 2014. Q2 product gross margin rate fell to 21% from 29%; YTD product gross margin rate declined to 15% from 26%, with excess and obsolete digital video inventory write-downs contributing to the YTD decline.
- Dolby acquired Doremi for $98.4 million in cash, net of acquired cash, with up to $20.0 million of contingent consideration. Doremi’s results did not materially affect consolidated revenue or net income in the period.
- Property, plant and equipment increased to $358.4 million from $289.8 million, reflecting ongoing investment in the San Francisco headquarters and other capital spending.
- Dolby began a recurring quarterly dividend program in October 2014 and repurchased $32.4 million of shares YTD. The declared dividend was $0.10 per common share for Q2.
- Foreign currency translation reduced YTD other comprehensive income by $11.9 million. The effective tax rate was 27% in Q2 versus 26% a year earlier; YTD it was 25% versus 26%.
Outlook, risks and unusual items
Management stated that cash, investments and operating cash flows were expected to meet anticipated cash requirements for at least the next 12 months. The filing provides no specific revenue or earnings guidance. Growth initiatives discussed include Dolby Voice, Dolby Vision and Dolby Cinema; their success depends on customer adoption, ecosystem and content development, and execution with partners. Dolby and AMC planned approximately ten Dolby Cinema at AMC Prime locations by September 2015, with up to 100 locations by December 2024.
Key risks include reliance on licensees’ product shipments and royalty reporting; declining optical-disc and PC-related opportunities; rapid change and competition in mobile, imaging and audio markets; patent expirations; pricing pressure; and integration and execution risks related to Doremi and new offerings. Approximately 45% of cash, cash equivalents and investments was held by foreign subsidiaries and could incur tax and withholding costs if repatriated. Contractual commitments totaled $240.7 million, including $141.6 million of Dolby Theatre naming-rights payments and $80.2 million of operating leases.
The Korean Fair Trade Commission review remained ongoing. In early May 2015, China’s NDRC confirmed that its review had been resolved on mutually agreeable terms. Dolby said ordinary-course legal matters were not expected to materially harm results or financial condition, while noting that outcomes are uncertain. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Unusual reporting item: The filed cash flow statement corrects a $10.467 million misclassification in the figures previously included in the April 21, 2015 earnings release: accounts payable and other liabilities changed from a $7.244 million outflow to a $3.223 million inflow, with the offset reflected in capital expenditures.
Investor verification priorities
- Assess whether licensing revenue can stabilize, particularly after the prior-year broadcast back-payment comparison and amid patent expirations and lower PC and consumer-electronics trends.
- Track Doremi integration, cinema product margins, inventory levels and whether Dolby Cinema deployments and content commitments translate into revenue.
- Reconcile headquarters capital spending, the corrected cash flow classification, acquisition payments and the decline in working capital.
- Monitor the effective tax rate, foreign-held liquidity and potential repatriation costs, as well as the status of the Korean competition review.
- Review the sustainability of dividends and repurchases against investment needs and the $240.7 million of disclosed contractual commitments.