Dolby Laboratories, Inc. — Fiscal 2017 Third-Quarter Form 10-Q
Reporting period: Fiscal quarter ended June 30, 2017 (13 weeks); year-to-date period covers the first nine months of fiscal 2017. Comparisons are with the quarter ended July 1, 2016, and the corresponding year-to-date period. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context
Dolby develops and licenses audio and imaging technologies and sells cinema, broadcast, and conferencing products and services. Licensing generated 91% of quarterly revenue and 90% year to date. The company operates as one reportable segment and earns most revenue outside the United States.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | FY2017 YTD | FY2016 YTD |
|---|---|---|---|---|
| Revenue | $305.7 | $277.6 | $839.4 | $792.7 |
| Gross profit | $273.5 | $253.0 | $750.3 | $714.0 |
| Gross margin | 89.5% | 91.1% | 89.4% | 90.1% |
| Operating income | $95.9 | $81.2 | $225.3 | $202.7 |
| Operating margin | 31.4% | 29.3% | 26.8% | 25.6% |
| Net income attributable to Dolby | $76.0 | $63.6 | $180.0 | $161.9 |
| Diluted EPS | $0.73 | $0.62 | $1.73 | $1.59 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $292.5 | $284.0 |
Quarterly revenue rose 10% and year-to-date revenue rose 6%. Quarterly licensing revenue increased 10%, products revenue 9%, and services revenue 27%. Licensing gross margin percentage declined to 95% from 97% in the quarter; products margin improved to 34% from 32%. Higher licensing costs, including fees, Dolby Cinema equipment depreciation, and amortization of acquired assets, weighed on gross margin. Quarterly operating expenses increased 3% to $177.6 million, with higher R&D partly offset by lower sales and marketing expense. The quarterly effective tax rate was 20.9%, versus 22.0%; year-to-date it was 21.6%, versus 20.9%.
Cash, liquidity and capital
- Cash and cash equivalents were $592.6 million at June 30, 2017, compared with $516.1 million at September 30, 2016. Short- and long-term investments totaled $551.0 million, versus $515.5 million.
- Working capital was $764.9 million, up from $546.6 million. Total liabilities were $350.7 million; the balance sheet reports no borrowings or debt.
- Year-to-date operating cash flow was $292.5 million. Investing activities used $131.1 million, including $81.7 million of PP&E purchases; financing activities used $84.1 million. Cash increased $76.5 million from fiscal year-end.
- The company said available cash, investments, and operating cash flows should meet anticipated cash requirements for at least the next 12 months. Approximately $805 million, or 70% of cash, cash equivalents, and investments, was held by foreign subsidiaries; repatriation could incur U.S. and foreign taxes.
- Year-to-date share repurchases totaled $75.0 million and dividends paid totaled $42.8 million. The quarterly dividend was $0.14 per share. Remaining repurchase authorization was approximately $177 million.
Material changes and management commentary
- Growth reflected licensee recoveries and Dolby Cinema, higher set-top-box and certain consumer-electronics volumes, and increased patent licensing. Recoveries are recurring but fluctuate and are difficult to predict.
- Management highlighted increasing adoption of Dolby Atmos and Dolby Vision in cinema, televisions, mobile devices, and streaming content, and the launch of Dolby AC-4 in TVs. Dolby Atmos was installed or committed for more than 3,000 screens; more than 100 Dolby Cinema locations were operational and over 325 were open or committed.
- R&D expense increased 8% in the quarter, primarily from higher project headcount and compensation. Fiscal year-to-date R&D also reflected increased funding for product and technology development.
- Interest income increased with higher investment yields. Other expense included a non-cash approximately $2 million impairment of a cost-method equity investment.
- Management is evaluating adoption of the new revenue recognition standard, expected beginning in fiscal 2019. Potential effects include recognizing licensee shipment royalties in the shipment period rather than when reported, a possible transition adjustment to retained earnings, and capitalization of certain sales commissions; the impact had not been quantified.
Risks, contingencies and commitments
- Key business risks include dependence on licensees’ product shipments and accurate royalty reporting; competitive and pricing pressure; changing standards and technology; declining PC and optical-disc markets; and adoption of Dolby technologies by device makers, content providers, and cinema exhibitors.
- Dolby cited risks in emerging markets, including difficulty enforcing IP and contractual rights, and risks from foreign regulation, currency movements, and international operations. The Dolby family and affiliates held 88.6% of combined voting power through the dual-class share structure.
- Gross unrecognized tax benefits were $91.9 million, up from $75.2 million at September 30, 2016. Legal proceedings arise in the ordinary course; the company said it could not estimate certain potential losses and did not expect currently known matters to materially affect results or financial condition.
- Contractual commitments totaled $284.0 million, including $126.4 million for naming rights, $88.6 million for operating leases, $60.9 million of purchase obligations, and $8.1 million of donation commitments. Certain IP indemnification exposures cannot be reasonably estimated; no amounts were accrued.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much quarterly and year-to-date licensing growth came from recurring shipments versus recoveries, and whether recoveries continue.
- Whether lower licensing gross margin persists as Dolby Cinema investment, licensing fees, and acquired-asset amortization affect costs.
- Adoption and monetization progress for Dolby Atmos, Dolby Vision, AC-4, Dolby Cinema, and Dolby Voice, including content availability and competing formats.
- The eventual financial and transition effects of the new revenue recognition standard and any changes in tax contingencies or foreign cash repatriation plans.
- Execution of the $177 million remaining repurchase authorization, dividend policy, and the company’s significant foreign cash concentration and long-term contractual commitments.