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Dolby_Laboratories_DLB

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Dolby_Laboratories_DLB

  1. 1. Important disclosures appear on the last page of this report. The Henry Fund Henry B. Tippie School of Management Ajay Kaushik Rajagopalan [ajaykaushik-rajagopalan@uiowa.edu] Dolby Laboratories, Inc. (DLB) March 8, 2016 Information Technology – Diversified Electronics Stock Rating Sell Investment Thesis Target Price $37-$44 Dolby Laboratories is a leader in audio technologies and since its inception in 1965, it has established itself as the de-facto standard for lossless audio technologies. Dolby has supplemented its audio technology offerings with image technologies such as Dolby Vision. The current offerings of Dolby have positioned it well to leverage the digital television boom in emerging markets. The future growth prospects of Dolby are for good measure factored into the current stock price and hence this report recommends a sell rating. Drivers of Thesis  The demand for Set Top Boxes (STBs) and Digital TVs is expected to grow at 7% CAGR through 2020 and this is expected to drive the broadcasting licensing growth at 6.7% CAGR through 2020.(10)  Wanda group is partnering with Dolby to open 200 new Dolby Cinema halls by 2024 and this is expected to drive the product segment growth at 16.6% CAGR through 2020.(8,19)  Future Audio/Video conferencing products of British Telecom and Premier Global Services Inc. (PGi) will incorporate the Dolby Voice technology. Dolby Voice witnessed a 30% growth in customer base in Q1 16. Risks to Thesis  Dolby employs the pull marketing strategy by partnering with content creators. The content creators have no obligation to use Dolby, and if they stop partnering with Dolby, the entire strategy of Dolby to leverage the end market demand for content would fall apart.  Increased clamor for open standards for broadcasting, if successful, will eliminate Dolby’s licensing revenue base.  Greater than anticipated decline in PC sales, DVD players, and Blu-ray players will significantly lower the DCF stock price. Current 5-year CAGR assumptions stand at -6.6% and -3.4% for these segments respectively. DCF $40.65 DDM $19.77 Relative Multiple $34.33 Price Data Current Price $39.57 52wk Range $29.87 – 41.84 Consensus 1yr Target $39.00 Key Statistics Market Cap (B) $3.97 Shares Outstanding (M) $101.35 Institutional Ownership 94.6% Five Year Beta 0.695 Dividend Yield 1.21% Analyst Est. 5yr Growth 10.00% Price/Earnings (TTM) 24.42 Price/Earnings (FY1) 18.8 Price/Sales (TTM) 3.36 Debt/Equity 0.00 Profitability Operating Margin 22.00% Profit Margin 18.69% Return on Assets (TTM) 8.81% Return on Equity (TTM) 10.31% Earnings Estimates Year 2013 2014 2015 2016E 2017E 2018E EPS $1.86 $2.02 $1.77 $1.82 $1.83 $1.84 growth -24.7% 8.60% -12.38% 2.56.% 0.74% 0.52% 12 Month Performance Company Description Dolby Laboratories is a technology company that develops audio, imaging, and voice technologies used in the entertainment and communications industry. Dolby Laboratories, since its inception in 1965, has established itself as the de-facto standard for lossless audio technologies. The company offers technologies to audio, video, and gaming content creators such as artists, directors, studios, and game developers. 18.8 10.3 13.3 17.7 0 5 10 15 20 P/E ROE (%) DLB Sector Source:FactSet -30% -20% -10% 0% 10% 20% 30% M A M J J A S O N D J F S&P 500 DLB Source: Yahoo Finance
  2. 2. Page 2 EXECUTIVE SUMMARY Dolby Laboratories is a technology company that develops audio, imaging, and voice technologies used in the entertainment and communications industry. Dolby’s business model revolves around generating demand for their products by partnering with audio, video, and gaming content creators such as artists, directors, studios, and game developers. The business model is unique because Dolby offers deep discounts on the services and equipments that it provides to content creators. This strategic relationship with content creators helps Dolby leverage the end market demand for the content created and drive the demand for its technologies to be incorporated in consumer electronic devices. The Semiconductor companies and the Original Equipment Manufacturers (OEMs) must pay Dolby licensing fees to use Dolby’s proprietary technologies and such is the magnitude of these licensing revenues that it accounts for nearly 90% of the total revenue earned by Dolby in a fiscal year. The consumer electronics segments that will be major drivers of revenue for Dolby are the demands for Set Top Boxes and Digital TVs. The number of digital TV households globally are expected to grow at 7% CAGR through 2020 and most of this growth is expected to be seen in the emerging markets of Asia, Latin America, and Sub-Saharan Africa. (9) Dolby Vision is an imaging technology that improves resolution, increases brightness, and enables the capture of High Dynamic Range (HDR) images. Dolby is working with 4K TV manufacturers to integrate its Dolby Vision into their products and with content creators who create content fit for 4K TVs. Dolby Voice and Dolby Cinema are two other initiatives of Dolby that will aid in incremental revenue generation for the company. After weighing the individual end market demand for each individual segment that Dolby caters to, the 5-year CAGR revenue growth was modelled to be 5.7%. Dolby’s current share price when compared to the DCF model price indicates that the future growth potential of Dolby is mostly factored into the current stock price. Hence this report recommends a sell rating for Dolby. COMPANY DESCRIPTION Dolby Laboratories, since its inception in 1965, has established itself as the de-facto standard for lossless (perfect reconstruction from compressed files) audio technologies. With over 5100 issued patents and another 3200 pending patents, Dolby has a strong portfolio of proprietary technologies. The patents that are current to the period of Dolby’s last 10k filing are expected to run until April 2040.(5) It is very important to keep track of the health of the intellectual property rights (IPRs) held by Dolby as close to 90% of Dolby’s revenue is through licensing of its proprietary technologies. During fiscal year 2015, Dolby completed the acquisition of Doremi and the Doremi-related assets for total purchase consideration of $112.5 million. (21) Doremi boasts of a product line that includes Audio/Video equipments and also holds important patents in 4K resolution area. This acquisition will help Dolby to provide an end-to-end system. A release can now be filmed in Dolby, have its sound mixed in Dolby, be encoded in a Dolby format, be sent to the customer on a Dolby-licensed disc format or through a Dolby-equipped set-top box, and be decoded with Dolby to be played back on Dolby-licensed speakers. (1) Revenue Decomposition Source: 10K (5) As can be seen from the pie chart above, Dolby generates its revenue from three segments, the largest being licensing. Dolby charges its customers a licensing fee for using its audio/video technologies. The technologies that are licensed are either developed in house, acquired, or licensed from third parties. As licensing primarily deals with licensing of IPRs, the majority of the cost incurred is through amortization of the acquired IPRs or royalty obligations on third party IPRs. Dolby enjoys a 99% gross margin on its licensing revenue stream. 89.4% 8.6% 1.9% FY 15 Revenue Streams Licensing Product Services
  3. 3. Page 3 Most of the licensing business consists of a two-tier licensing model whereby the Dolby technology is licensed to a semiconductor manufacturer as well as Original Equipment Manufacturers (OEMs). Dolby’s 10k refers to these semiconductor manufacturers as implementation licensees. These manufacturers then sell their ICs to OEMs and these OEMs need to obtain what Dolby calls system licenses to use the Dolby technology. While implementation licensees pay a one-time licensing fee upfront, the system licensees are charged both a one-time fee and royalties. The royalties collected are dictated by the number of Dolby technologies used and the volume of the product sold by the OEMs. Source: 10K (5) Licensing can be further broken down into 5 major segments based on the product segment that the Dolby technology serves. These segments are Broadcast (TVs, STBs), PCs, Consumer Electronics (DVD, Blu-ray Players), Mobile, and other devices such as gaming consoles and automobile entertainment systems. Source: Statista (10) Source: Statista (9) Licensing Revenue from broadcasting has generally shown an increasing trend except for FY 2015 where it only grew by 1.1%. FY 15 marked a year of tepid growth for licensing in general. However going forward, the Broadcasting segment will witness tailwinds to end market demand facilitated by the policy decisions in emerging markets such as India to move from analog to digital television services. This is reflected in the graphs shown above. The number of households worldwide with digital TVs is forecasted to grow at 7% CAGR through 2020. 44.0% 17.0% 14.0% 13.0% 12.0% FY 15 Licensing Revenue Breakdown Broadcast PC Consumer Electronics Mobile Others 57.9 71.9 126.7 0. 100. 200. 2014 2015 2018* Forecasted demand for Set Top Boxes (STB's) North America Europe Asia/Pacific Latin America
  4. 4. Page 4 Source: IDC (2) As shown in the graph above, PCs have and will be witnessing depressed demand and hence its contribution towards licensing revenue has and will be declining. The biggest revenue generator in PCs for Dolby is the optical disk drives that are built into these PCs. Slowing demand for PCs as well as the trend to move away from building PCs without optical disk drives will continue to impact the revenue generated from licensing the Dolby technology to PC manufacturers. Source: IC Insights (11) The consumer electronics segments also suffers from depressed end market demand, not too dissimilar to the PC segment. The demand for DVD and Blu-ray players will keep declining in the coming years as more and more media is consumed through streaming services as opposed to DVDs and Blu-ray discs. Dolby does not enjoy a stellar clientele in terms of its mobile business except for LG, Lenovo, and HTC. Losing its place in the flagship Samsung Galaxy models has significantly impaired the growth potential in the mobile licensing segment. This is reflected in the drastic drop in mobile licensing revenue growth rate from 57.4% in 2013 to -1.2% in 2015. The end market demand for mobile devices is expected to grow at around 9-10% through 2018. Considering Dolby’s clientele in terms of its mobile segment, it is expected to witness 3.1% CAGR growth through 2020, much lesser than the near double digit growth expected for mobile devices on the whole. Source: IDC (13) Dolby Voice has added 30 new A/V conferencing product manufactures as customers in Q1 16. This is a 30% rise in the customer base. FY 15 witnessed an 18.5% increase in “Other” licensing revenues from FY 14. With several large customers in the rollout stage and with BT Conferencing expected to maintain its momentum, “Other” licensing revenues should witness strong growth through 2020. In addition to contributing to licensing revenue growth, Dolby Voice will also spur the growth for “Other” Product revenues with increased sales of the conference phones that incorporate Dolby Voice. Dolby Cinema would be a premium offering for exhibitors and moviegoers and would include both Dolby Vision and Dolby Atmos technologies. Not only will this spur the licensing revenue growth, but also will contribute to the
  5. 5. Page 5 product segment growth of Dolby in terms of increased demand for cinema servers, projectors, and audio devices. Wanda group, which also owns AMC, has decided to open 50 new Dolby Cinema screens in AMC Prime auditoriums in 2016. This number will go up to 100 by 2024. In China, Wanda group plans to unveil 100 new Dolby Cinema theatres by 2020. PVR Cinemas has announced its plan to open 50 screens fitted with Dolby Atmos technology by 2017. (8, 19, 16) These developments portend a healthy market for Cinema and Broadcast products. The increased adoption of BT MeetMe audioconferencing technology will help grow the “Other” products revenue from $4.2 million in 2015 to $16.7 million in 2020. The “Other” product segment witnessed a 77.1% YoY growth between 2014 and 2015 and this clearly signals that the BT MeetMe adoption is gaining traction. Services provide support for theatrical and television production and hence growth in services segment revenue is tied to the product segment growth. The services segment has been modelled to grow at 9.9% CAGR through 2020. The product segment is modelled to grow at 16.6% CAGR through 2020. Geographic Distribution of Revenue Dolby generates over 70% of its annual revenue outside of the US and hence has significant international exposure. Source: 10K (5) With such a significant exposure to international markets, Dolby has various foreign currency forward contracts to hedge against currency risks. The licensing revenue generated is based on the location of the licensees’ headquarters. Product revenues are recognized based on the destination of the product shipment and services revenues are similar to products as they are recognized based on the location of the service contract. Efforts on Dolby’s part to hedge against currency risks have dictated the model’s assumption to disregard loss or gain due to strengthening dollar on earnings. While this is a reasonable assumption to make for the forecast horizon, the strength of the US dollar needs to be continuously monitored against the hedging contracts that Dolby has, as any adverse developments in this regards will cause more than a trivial change to the earnings of Dolby. Doremi Acquisition In 2014, Dolby agreed to purchase Doremi Labs for $92.5 million in cash plus an additional $20 million in contingent consideration that may be earned over a four year period. Doremi labs has a strong patent portfolio in 4K technology space and manufactures A/V equipment that can help Dolby to position an end-to-end technology solution for its customers. With this diversified product portfolio, content can be created, encoded, transferred, transmitted, and played using Dolby technologies. Since Doremi’s acquisition, the growth for Cinema products has gone from -27.6% in 2014 to 46.6% in 2015. The benefits of this acquisition will play out in the coming years and the DCF model assumes positive synergies from this acquisition driving the 16.6% CAGR growth for the Cinema Product Segment through 2020. (1) Pull Marketing Strategy Dolby’s business model revolves around generating demand for their products by partnering with audio, video, and gaming content creators such as artists, directors, studios, and game developers. Dolby offers deep discounts on the services and equipment that it provides to content creators in an attempt to tie the content creators to Dolby’s technologies. 29% 21% 13% 13% 10% 7% 7% FY 15 Percentage Sales by location US South Korea Japan Europe Taiwan China Other
  6. 6. Page 6 Source: 10K (5) The graph above reflects the impact of pull marketing strategy on Dolby’s gross margins across segments. By leveraging the end market demand for the content created, Dolby charges licensing fees on its technologies to be used by Semiconductor companies and the Original Equipment Manufacturers (OEMs) in the design and manufacture of consumer electronic devices that aid in content consumption. Such is the magnitude of these licensing revenues that it accounts for nearly 90% of the total revenue earned by Dolby in a fiscal year. This pull marketing strategy is driver of Dolby’s historically high gross margin levels as 90% of the revenue generator has a gross margin close to 99.5%. Despite the forecast horizon indicating a greater thrust to Product Segment growth, Licensing will still account for majority of the total revenue and hence this strategy will be relevant going forward. Since content drives demand, it would be prudent to monitor the popularity that Dolby enjoys with the content creators as any tectonic shift away from Dolby technologies for creating content would signify catastrophic falls in revenue for Dolby. RECENT DEVELOPMENTS Recent Earnings and Future Guidance FY 2015 (A) Q1 16 (A) FY 16 (Guidance) Revenue (M) 967.4 240.8 1000-1030 Consensus Revenue (M) 973.7 239.1 1017.2 Surprise history (%) -0.6 0.7 N/A Actual EPS 1.73 0.30 N/A Consensus EPS 1.61 0.28 1.72 Surprise history (%) 7.7 5.88 N/A Source: FactSet It can be seen that the consensus estimate for revenue is very close to the actual sales reported by Dolby. For FY 16, Dolby has given a revenue guidance in the range of $1 billion to $1.03 billion. Even the consensus estimate predicts that Dolby would become a billion dollar company in FY 16. In terms of EPS, Dolby has consistently performed better than what the analysts predicted and it wouldn’t be surprising if that remains a theme in FY 16 as well. The growth estimates for Dolby that have been assumed for the DCF model place the sales for FY 16 at around $1.02 billion. This revenue estimate is not too far away from the consensus revenue estimate and also falls within the guidance band of Dolby. Wanda Cinema Line in China Wanda Cinema Line Corporation Ltd and Dolby Laboratories announced a collaboration to open 100 Dolby Cinema locations through 2020. The first location is expected to be opened during the second quarter of 2016. Dolby Cinema would be a premium offering for exhibitors and moviegoers and would include both Dolby Vision and Dolby Atmos technologies. Not only will this spur the licensing revenue growth, but also will contribute to the product segment growth of Dolby. (8) AMC Prime Wanda group that also owns AMC has decided to open 50 new Dolby Cinema screens in AMC Prime auditoriums in 2016. This number will go up to 100 by 2024 therefore bringing the total number of Dolby screens in the two largest markets (USA& China) to 200. These developments 0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 900.0 1000.0 Licensing Products Services FY 15 Revenue vs Costs by Segments Revenue (millions) Costs (millions)
  7. 7. Page 7 suggest that Cinema is best positioned in terms of product segment growth for Dolby. (19). IMAX, the closest competitor to Dolby in the Cinema segment has 943 commercial multiplex theatres in operation as of December 31, 2015. Dolby Voice Updates British Telecom (BT) conferencing collaborated with Dolby to use the Dolby Voice technology in designing BT MeetMe. Dolby Voice provides noise cancellation solutions that eliminate background noise while also helping in voice separation and project individual voices as coming from different virtual locations. BT conferencing is the leading provider of conferencing technologies globally. Dolby Voice has added another significant audio conferencing provider in the last year in Premier Global Services (PGi). PGi is a multinational corporation that provides conferencing and collaboration solutions. Its iMeet and GlobalMeet product lines are expected to incorporate Dolby Voice in future product rollouts. Dolby Vision Updates Source: lowendmac.com (20) Current display technologies work with a very limited colour palette and do not have the requisite brightness to mimic reality. Dolby Vision is a technology that aims at increasing the brightness range and hence improving the details in the bright and dark regions of images. Unlike High dynamic range (HDR) imagery, Dolby Vision goes beyond the 24 bit range used for JPEGs and standard photography to accurately record more colours and brightness. Increased adoption of digital TVs across the world and the consumer demand for better looking content create a market opportunity that Dolby Vision can cash in on. New content created that captures the extended brightness and details will need upgrades to the display technologies. Dolby Vision and HDR 10 are the two competing technologies vying for the market growth that the display technology upgrade will bring about. In terms of partners, Dolby has entered agreements with LG, TLC, and Vizio to incorporate Dolby Vision in some of their new 4K TVs. However, Samsung has moved away from using Dolby Vision and has instead created a HDR 10 based TV line with LG also following suit. As more and more 4K content is created and consumed, the direction that display technologies take will become clear. However in terms of pure technical standpoint, Dolby Vision is a superior technology to HDR 10 as Dolby Vision equipment encodes or decodes images differently rather than just adding a few more levels of brightness. With OEMs looking to promote their own offerings of HDR and trying to avoid licensing fees that they would incur for Dolby Vision, it remains to be seen if Dolby’s pull marketing strategy again leverages the content creators to make OEMs switch to Dolby Vision. Dolby Atmos for Virtual Reality Dolby has announced a partnership with Virtual Reality (VR) content creator Jaunt to bring its Atmos surround sound technology to the world of VR. The market potential for VR is very uncertain as it is a very recent technology with most of the VR users comprised of early adopters. However, by partnering with VR content creators, Dolby has signaled a forward looking approach towards exploring new markets. The management has stated that Dolby is deeply committed to exploring prospects in augmented reality and VR. If VR takes off, then Dolby would be ideally positioned through its partnerships with content creators to push the Dolby Atmos licenses to mobile devices manufacturers. It would again be a case of content driving licensing demand.
  8. 8. Page 8 INDUSTRY TRENDS Streaming media Source: Statista (12) Streaming media sites such as Netflix, Hulu, and Vudu are fueling the industry trend of moving away from conventional media consumption avenues such as DVDs and Blu-ray discs to online content consumption. The graph above represents the growth that Netflix has witnessed and is expected to witness through 2020. The number of household subscribers to Netflix alone is expected to increase by 63% from 2015 to 2020 and this paradigm shift in content consumption has resulted in declining revenue for Dolby from consumer electronics segment. Source: Statista, AHAM (3) The chart above shows the declining shipments of DVD players and this declining trend is expected to continue. In terms of emerging markets, the decline in demand for DVD and Blu-ray players would not be as stark in the near future as slow broadband speeds are a bottleneck to enjoying streaming services such as Netflix. However, the shift in customer preferences is real and as more and more content is consumed online, consumer electronics such as DVDs and Blu-ray players would lose relevance for Dolby. The consumer electronics segment accounted for nearly 45% of the total revenue in 2007 and this has fallen to 14% in 2015.During the forecast horizon, the revenue contribution from DVDs and Blu-ray players is expected to decline to 11.4%. Virtual Reality Source: Statista (22) Virtual Reality (VR) is an industry trend that is exciting in terms of growth prospects for Dolby. As VR headsets gain momentum and traction among users, Dolby can leverage its Atmos technology to enable VR content with spatial audio surround system. As represented by the graph above, VR is just starting out and is expected to reach $4 billion by 2017. There is however no certainty about the growth trajectory of VR, but any growth in VR would augur well for Dolby. Not only can Dolby leverage its Atmos technology, but it can also leverage its Dolby Vision technology to enable premium content creation. MARKETS AND COMPETITION As described earlier in the report, Dolby works closely with content creators to spur demand for its products. Close to 90% of the revenue is generated from the licensing segment. The majority of the licensing revenue comes in two forms; i) One-time fee paid by semiconductor/software companies for using Dolby’s technology in designing their hardware/software 19.1 54.5 70.4 81.5 114.9 0. 50. 100. 150. 2010 2014 2015 2016* 2020* NUMBEROFHOUSEHOLDSIN MILLIONS Number of households subscribing to Netflix worldwide from 2010… 16418.2 14754.9 13841 12000 14000 16000 18000 FY 14 FY 15 FY 16 E DVD Players Shipped in US (1000s)
  9. 9. Page 9 ii) Royalty payments based on number of consumer electronic units sold. The remaining revenue comes from product sales (digital cinema servers, projectors etc.) and services. Due to this business model, Dolby competes in many different markets and in many different customer segments thereby making it hard to assign well defined competitors. The underlying factors dictating the licensing revenue suggest a strong dependence on the patent portfolio held by the firms. This suggests that competition is along product differentiation and exclusivity rather than cost. On the other hand, product segment demand is dependent on how closely Dolby works with the content creators and the discounts it offers on its products. That would mean that price is one of the underlying factors determining the product competitive landscape. Emerging Markets The number of digital TV households globally are expected to grow at 7% CAGR through 2020 and most of this growth is expected to be seen in the emerging markets of Asia, Latin America, and Sub Saharan Africa. Policy decisions across the emerging markets have mandated the switch from analog to digital television. India is one such example of an emerging market where policy decision has mandated the switch to digital television standards. The market demand for STBs and digital TVs in various markets has already been explored previously in the Revenue Decomposition sub section of this report. Countries such as India and China have included Dolby Digital Plus as part of their broadcast specification standards and these emerging markets are expected to contribute to the steady growth of broadcasting revenue for Dolby through the forecast horizon. Global Television Broadcast Standards Source: Wikimedia Commons (23) ATSC refers to Advanced Televisions Systems Committee, an international non-profit organization that develops standards for digital television. As shown in the map above, the whole of North America has adopted the ATSC standards and Dolby’s AC3 audio technology is the audio standard for ATSC. All other broadcast television standards use an open standard audio format called MPEG ACC. It is in these other television standards that Dolby is trying to establish its AC3, AC4 audio technologies. DVB-T, ISDB-T, DTMB correspond to the broadcasting standards followed in the emerging markets making it imperative for Dolby to target these broadcasting standards. Peer Comparisons Source: FactSet (6) Dolby operates in various spheres and hence it does not have very well defined publicly traded competitors. DTS Inc.’s audio technologies compete directly with those of Dolby’s in the consumer electronics audio market. However, most Blu-ray disc players as well as other audio codec and sound bar manufacturers include technologies from both companies in their products. This coexistence will continue as long as long content creators do not chose one technology over the other. When the revenue streams of both companies are aligned and compared for similar product lines, it is seen that Dolby earns 6.3 times the revenue that DTS Inc. earns. FY 15 profit margin of DTS is negative while Dolby earned a healthy after tax profit of 18.7%. This suggests that Dolby is perched favorably in comparison to DTS Inc. Dolby is competing with IMAX in the cinema market with both companies having similar partnerships with movie theater chains such as Regal Entertainment Group, AMC Entertainment Inc. , or Cinemark Theatres. With most Dolby theatres opening in 2016 or beyond, accurate comparison in terms of revenue isn’t possible. When looking at the FY15 numbers, Dolby is seen to earn 2.6 times as much revenue as IMAX. These Sales (M) Net Profit Margi n (%) ROA (%) ROE (%) P/E (ntm ) Debt/ Equity Dolby 970.6 18.7 8.8 10.3 18.8 0.0 IMAX 373.8 14.7 7.1 10.9 34.8 4.8 DTS Inc. 138.2 -8.9 -3.5 -5.8 19.3 77.1
  10. 10. Page 10 comparisons suggest that Dolby’s financial health and growth prospects are better than its closest competitors. ECONOMIC OUTLOOK The demand for Dolby’s technologies is driven by consumer spending and hence all economic parameters that affect consumer spending will impact the growth potential of Dolby. The product portfolio that uses Dolby technologies include Smartphones, set top boxes, PCs, Blu- ray players , automobile entertainment systems, gaming consoles , cinema technology , and other audio video entertainment devices/solutions. Discretionary consumer spending is positively correlated to GDP, negatively correlated to unemployment rate, and impacted adversely by rising interest rates. Going forward, the GDP growth is expected to remain stable at around 2% (2016-2018) and this should translate to a steady demand in consumer discretionary electronic products such as smartphones, tablets, PCs, and other electronic devices. The forecasted decline in the Chinese GDP growth is a cause for concern. Any slowdown in the end market demand in China would be partially offset by the increasing demand from India. India’s GDP is expected to grow at 7-8% during the forecast period. Source: Global Economic Prospects 2016, World Bank (15) Unemployment rates have a negative correlation with consumer discretionary sales. Increasing employment increases the median disposable income and that correlates positively with spending on consumer discretionary electronics such as smartphones, tablets, PCs, TVs etc. The unemployment rate in the US has continued to decline and the Henry Fund team believes that unemployment will settle between 4.95% over the next 2 years. Near 0% interest rates have kept the cost of debt low for firms as well as individuals. Once the recent weakness in the economy passes, the fed fund rates are expected to move towards the 1.25% in the coming years. Even though this increase in the fed fund rates will not take the interest rate to the levels that were existing before the economic recession of 2008-2009, it is still expected to make the cost of capital dearer. Premium electronic devices such as 4K TVs would see greater demand if easy financing options were available. In a rising interest rate scenario, easy financing options would be hard to come by. Source: IBIS World (4) The Per capita disposable income chart suggests that the disposable income available for discretionary spending will remain steady through 2021. Per capita disposable income is an important measure of customer’s willingness to pay and the steady levels indicate a similar spending outlook throughout the forecast horizon. CATALYSTS FOR GROWTH R&D spending as a percentage of sales currently stands at 20.7%. Increased R&D spending as a percentage of sales increases the probability of innovation, which would lead to filing of new patents and potential increase in licensing revenue. With over 5100 issued patents and another 3200 pending patents, Dolby has a strong portfolio of proprietary technologies. There are patents current to the last 10K filing that are expected to run till 2040. The OEMs that use the Dolby licenses are supposed to pay royalty for every unit sold and some royalty payments are expected to run till the last patent of that particular technology expires. Increased R&D spending can help add quality patents to the portfolio. 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 2013 2014 2015E 2016F 2017F 2018F Real GDP Growth US China Global
  11. 11. Page 11 Another major catalyst for growth would be the healthy relationships that Dolby creates and maintains with its content creators. The business model of Dolby is set up in such a way that if content creators move away from Dolby, OEMs and semiconductor manufacturers would no longer see the need to buy Dolby licenses. INVESTMENT POSITIVES  The global shift towards digital television standards will be the biggest driver of broadcasting licensing growth. Dolby has successfully entered the Indian and the Chinese broadcasting market and these emerging economies will drive a significant portion of Dolby’s future revenue.  The relationship that Dolby maintains with its content creators is very strong as is evidenced by the increasing number of titles created using Dolby Atmos and Dolby Vision technologies. In the 4 years since Dolby Atmos was released, more than 200 film titles have used it as their audio format. The Wanda Cinema Line has committed to install Dolby Atmos and Dolby Vision in over 200 theatres across US and China. The online streaming services such as Vudu and Netflix have announced support for Dolby Atmos content. As content created using Dolby Technologies continues to increase, revenues from both product and licensing would increase.  Dolby Voice’s strategic partnerships with BT Conferencing and PGi will continue to drive growth. Dolby Voice witnessed a 30% growth in customer base in the last quarter alone and there is expected to be increased product rollout activities in the years coinciding with the forecast horizon. INVESTMENT NEGATIVES  Though Dolby provides technologies that are the de- facto standards for audio broadcast, there is however no binding contract on the content creators to use Dolby. If the relationships that Dolby maintains with content creators start to sour, then the whole business model of content driving licensing revenue would fall apart.  Headwinds for Dolby’s technology offerings can also come from OEMs who are trying to push for open broadcasting standards. Samsung has moved away from Dolby in recent years and in CES 2016, it unveiled its own line of SUHD televisions. This is a trend that needs to be monitored closely as OEMs moving away from buying Dolby licenses will have significant earnings impact due to declining incremental revenues through royalties. VALUATION DCF, DDM, and relative P/E analysis have been used to value Dolby Laboratories. These three valuation techniques computed stock prices of $40.7, $19.8, and $34.3 respectively. We believe that the value of the Dolby stock is closest to the DCF model. Dolby’s dividend payout policy is relatively recent as it started only in the first quarter of 2015. The insufficient history in terms of dividend payout has limited the scope for making reasonable assumptions in terms of future dividend payout. In the DDM model, for the next five years, we assumed a constant payout ratio of 26.4% and since this assumption does not have sufficient historical backing, we have disregarded the DDM model. In FY 2015, the payout ratio for Dolby was 22.6%. Among all available competitors, IMAX and DTSI are the two most aligned publicly traded competitors in terms of business activities. The relative P/E analysis with these two publicly traded competitors reveals a share price that is lower than what the share trades at currently. Weighing the price reflected by the relative P/E analysis model against the fact that there are only 2 publicly traded competitors suggests a limited scope of the relative P/E model. Considering the abovementioned limitations of the relative P/E valuation model, the share price suggested by the model will be viewed subservient to the DCF model. Short Term Revenue Growth Assumptions Dolby has multiple business segments and each segment faces differing end market demand. The revenue growth rates for the DCF model have been projected by studying the individual end market demand for each of these business segments. Each of these segments have been described in detail in the Revenue Decomposition sub section under the Company Description section earlier in this report. The end market demand drivers have also been clearly delineated and discussed in detail in the Revenue Decomposition sub section. Dolby generates nearly 88-90% of its revenue by licensing its technologies. The entire licensing segment of Dolby is
  12. 12. Page 12 projected to grow at 4.3% CAGR through 2020. By 2020, the contribution of licensing to the entire revenue of Dolby is expected to drop below the 85% range. The reasons for this decrease is not because of headwinds for licensing, but because of the tailwinds in growth that will be seen for the product segment of Dolby. The proposed Wanda Cinema line Dolby Cinema theatres in China and the AMC prime Dolby Cinema locations that in the US will drive the product segment of Dolby to grow at 15.7% CAGR through 2020. Services segment, the last macro revenue segment of Dolby mirrors the growth seen in the product segment as Services deals with product support, installation, product integration, and other engineering activities related to Dolby products. Hence the CAGR growth rate of Services segment is assumed to be 9.9% through 2020. Dolby Voice has added 30 customers over the quarter that took its customer base from 90 to 120. With several large customers in the rollout stage and with BT Voice expected to maintain its momentum, “Other” licensing revenues should witness strong growth through 2020. Given the strong end market demand prediction for Dolby Voice, the 14.6% CAGR growth assumption through 2020 for “Other” licensing revenues seems justified. At this projected growth, “Other” will increase its contribution to the total licensing revenue from 12% in 2015 to 22.9% in 2020. In addition to contributing to licensing revenue growth, Dolby Voice will also spur the growth for “Other” Product revenues with increased sales of the conference phones that incorporate Dolby Voice. The revenue contribution of “Other” products to the product segment is expected to reach $16.7 million by 2020 from its current level of $4.2 million. The growth assumptions for individual segments of Dolby have been presented in the table below: Source: HF Estimates Costs and Margins In FY 14, Dolby’s management indicated that that Dolby is nearing the end of a significant investment cycle. The construction of new Dolby Headquarters and the Doremi acquisition were part of that significant investment cycle. These developments have dictated the modelling of capital expenditure assumptions. Investments in Property, Plant, and Equipment are modelled to grow at 9.4%, a level that reflects the historical expenditure incurred by Dolby to maintain its computer systems and software, equipments, furniture, and other activities needed to run its daily operations. What this end to the significant investment cycle also signifies is the smoothening of the depreciation expense across the years as significant portion of the depreciation expense would be the depreciation of the new headquarters building of Dolby. Selling, General, and administrative (SG&A) costs are modelled at 45.2% of revenue. Doremi acquisition resulted in an increase in SG&A costs and with increased assimilation of Doremi’s activities and the ensuing economies of scale make the 45.2% assumption a reasonable one. A sensitivity analyses run on the SG&A assumptions reveal that at 2015 levels of 47.5%, the DCF stock price falls below $40. If SG&A costs do not stabilize to pre-acquisition levels either through increased revenue or greater economies of scale, then current trading stock price would indicate a premium value to the price mentioned above. This is one of the reasons for taking a sell position on Dolby as current stock price levels are trading very close to the target price range arrived at using the DCF model. Research and Development (R&D) expenses are expected to remain at 2015 levels of 20.7% to revenue. 20.7% indicates a healthy expenditure on R&D and with the growth outlook that faces Dolby justifies this assumption. Other costs have been modelled at historical average levels as there are no indications to suggest any adverse developments to skew the cost assumptions in either directions of historical assumptions. The revenue growth assumptions and cost assumptions result in gross margins that are expected to stay above 85% during the forecast horizon. This is a reasonable level for gross margin considering the growth outlook especially for the broadcast licensing segment and the product segment of Dolby. Dolby Vision, Dolby Atmos, Dolby Digital Plus, and Dolby Atmos are the key technologies that are going to drive the gross profit margins of Dolby. These assumptions have also driven the net profit margin of Segment Model assumption for 5-year CAGR growth (through 2020 in %) Licensing-Broadcasting 6.7 Licensing-PC -6.6 Licensing-Consumer Electronics -3.4 Licensing-Mobiles 3.1 Licensing-Others 14.6 Products-Cinema 15.7 Products-Broadcasting 13.9 Products-Other 31.8 Services 9.9
  13. 13. Page 13 Dolby to settle at 15.1% through the forecast horizon. The net profit margin in 2015 for Dolby was 18.7% and this suggests that the product growth outpacing the licensing growth would eat into the profit margins of Dolby as products are often sold at discounts unlike licenses that enjoy a 99.5% margin on every agreement signed. Perpetuity Growth Assumption Source: Statista, IMF (14) The forecast for Global GDP suggests a 3.9% GDP growth in 2020 and this has driven the long term growth assumption of 3.5% as the end market segments that Dolby targets are essentially dependent on the health of the economy. Since the DCF model price is most sensitive to the perpetuity growth assumption, a sensitivity analysis was done by varying the CV growth of NOPLAT. If Dolby were to maintain a status quo after 2020, i.e. a 0% growth in perpetuity, then its DCF stock price should be around $30. Even in the no growth scenario, Dolby’s intrinsic value according to the DCF model returns a positive value suggesting that Dolby can weather rough and uncertain times in the future as long as it makes relevant products that shields it from contraction. Valuation Summary The stock price according to the DCF model is $40.65 and this represents a 4.2% premium over the consensus estimate of $39. The sensitivity analysis performed on the DCF model’s stock price by varying the CV Growth rate, Beta, WACC, SG&A costs, Capex growth, and cost of products suggests the consensus estimate stock price to be a valid estimate of Dolby’s intrinsic worth if it doesn’t perform as well in the emerging market as the DCF model assumes or it fails to consolidate its post-acquisition costs. The current market price of Dolby suggests that the market has for good measure priced in Dolby’s growth prospects and hence the consensus estimate actually lends support to the sell rating that this report recommends. KEYS TO MONITOR One of the key trends that needs to be monitored is the growth of VR systems and the popularity that VR content gains. If Dolby is positioned appropriately through its Dolby Atmos technology to ride the VR growth, then smartphone makers such as Apple, Samsung would be forced to buy Dolby licenses. As VR is still in its infancy, this report has not modelled the future growth that could ensue due to VR. The UHD alliance that was created in 2015 to determine the specifications of Ultra HD has included Dolby Vision as a supporting technology. However, there is still a push from TV manufacturers to move towards open broadcasting standards and this trend needs to be monitored closely. A key assumption for growth in the DCF model is the growth that Dolby Cinema will witness due to the proposed Dolby Cinema theatres to be opened by the Wanda Cinema Line Corporation. This trend needs to be monitored as increased adoption of Dolby’s technologies by either retrofitting existing theatres or building new ones signify significant growth opportunities for Dolby. Among the emerging markets, India’s adoption of Dolby’s cinema technologies needs to be monitored. PVR group of India announced in 2015 to retrofit 50 screens with Dolby Atmos technology by 2017. However, the other component of Dolby Cinema, i.e. Dolby Vision is yet to be widely adopted in the Indian market. Any change in this trend will indicate significant increases in revenue. REFERENCES 1. Seeking Alpha ‘s article on Doremi acquisition: http://seekingalpha.com/article/2190603-dolby-you- cant-argue-with-90-percent-margins 2. Short term forecasts for PC demand: http://www.idc.com/getdoc.jsp?containerId=prUS258666 15 3.2 3.4 3.6 3.8 4. 4.2 2016 2017 2018 2019 2020 Forecasted Global GDP (%) Forecasted Global GDP (%)
  14. 14. Page 14 3. DVD shipments in the US: http://www.statista.com.proxy.lib.uiowa.edu/statistics/2 20729/forecast-in-dvd-player-shipments-in-the-us/ 4. Per Capita disposable income: https://www.ibisworld.com/gosample.aspx?cid=1&rtid=4 5. Dolby Laboratory Inc., 2015 form 10-K 6. Financial data for peer comparisons from FactSet 7. Dolby smartphone clientele: http://www.dolby.com/us/en/categories/smartphone.ht ml 8. News on Wanda Line in China: http://investor.dolby.com/releasedetail.cfm?ReleaseID=9 51961 9. Number of Digital TV households worldwide from 2010 to 2020 by region: http://www.statista.com/statistics/268538/number-of- digital-tv-households-by-world-region-since-2008/ 10. Forecasted Demand for Set Top Boxes: http://www.statista.com/statistics/461527/tv-stb- shipments-worldwide-by-region/ 11. Comparing market sizes and forecasted growth rates for systems, ICs: http://electroiq.com/blog/2015/03/comparing-market- sizes-and-forecasted-growth-rates-for-systems-ics 12. Number of households subscribing to Netflix worldwide from 2010 to 2020: http://www.statista.com/statistics/273885/quarterly- subscriber-numbers-of-netflix/ 13. Worldwide Smartphone Vendor Market Share: http://www.idc.com/prodserv/smartphone-market- share.jsp 14. Global GDP forecasts: http://www.statista.com/statistics/273951/growth-of- the-global-gross-domestic-product-gdp/ 15. World Bank GDP forecasts: http://pubdocs.worldbank.org/pubdocs/publicdoc/2016/ 1/88501452035054522/Global-Economic-Prospects- January-2016-Table1.pdf 16. PVR’s announcement to use Dolby Atmos: http://www.dolby.com/in/en/technologies/dolby- atmos/pvr-announcement.html 17. Earnings news, transcripts, and earnings calls: http://investor.dolby.com/releases-financial.cfm 18. P/E and ROE for sector: http://people.stern.nyu.edu/adamodar/New_Home_Pag e/dataarchived.html#returns 19. AMC Prime news: http://www.indiewire.com/article/why-dolby-cinema-at- amc-prime-is-a-great-place-to-see-the-fall-blockbusters- 20151208 20. Dolby Vision commentary: http://lowendmac.com/2016/dolby-vision-the-future-of- television/ 21. Doremi Acquisition: http://investor.dolby.com/releasedetail.cfm?releaseid=8 27738 22. Virtual Reality revenue forecasts: http://www.statista.com/statistics/426496/virtual-realiy- hmds-sales-revenue-worldwide/ 23. Global broadcasting standards: https://en.wikipedia.org/wiki/Broadcast_television_syste ms#/media/File:PAL-NTSC-SECAM.svg IMPORTANT DISCLAIMER Henry Fund reports are created by student enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa’s Tippie School of Management.
  15. 15. Page 15 These reports are intended to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.
  16. 16. Dolby Laboratories Revenue Decomposition All figures in millions Fiscal Years Ending Sep 30 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Licensing 807.08 878.84 868.11 899.15 936.63 979.47 1029.12 1072.18 Product 80.60 59.22 83.90 100.99 122.10 146.97 169.67 180.82 Services 21.99 22.11 18.62 19.55 22.49 25.86 28.45 29.87 Total revenue 909.67 960.18 970.64 1019.69 1081.21 1152.31 1227.23 1282.87 % Licensing 88.72% 91.53% 89.44% 88.18% 86.63% 85.00% 83.86% 83.58% % Product 8.86% 6.17% 8.64% 9.90% 11.29% 12.75% 13.83% 14.10% % Services 2.42% 2.30% 1.92% 1.92% 2.08% 2.24% 2.32% 2.33% % Total Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Licensing Growth Rate 1.58% 8.89% ‐1.22% 3.57% 4.17% 4.57% 5.07% 4.18% Product Growth Rate ‐22.04% ‐26.53% 41.68% 20.36% 20.90% 20.38% 15.44% 6.57% Services Growth Rate ‐22.33% 0.56% ‐15.78% 5.00% 15.00% 15.00% 10.00% 5.00% Total Revenue Growth Rate ‐1.79% 5.55% 1.09% 5.05% 6.03% 6.58% 6.50% 4.53% Licensing Revenue Breakdown: Broadcast (TVs,STBs) 298.62 377.90 381.97 408.71 437.32 465.74 496.01 528.26 PC 193.70 166.98 147.58 135.77 124.91 117.42 110.37 104.85 Consumer Electronics (DVD,Blue Ray Players) 129.13 131.83 121.54 115.46 109.69 106.40 104.27 102.18 Mobile (Smartphones,tablet) 96.85 114.25 112.85 116.80 120.89 124.52 128.25 131.46 Others(Gaming,Automotive ) 88.78 87.88 104.17 122.40 143.82 165.40 190.21 205.42 Total Revenue from licensing  807.08 878.84 868.11 899.15 936.63 979.47 1029.12 1072.18 Broadcast Growth Rate 10.54% 26.55% 1.08% 7.00% 7.00% 6.50% 6.50% 6.50% PC Growth Rate ‐12.94% ‐13.79% ‐11.62% ‐8.00% ‐8.00% ‐6.00% ‐6.00% ‐5.00%  Consumer Electronics Growth Rate ‐14.46% 2.09% ‐7.81% ‐5.00% ‐5.00% ‐3.00% ‐2.00% ‐2.00% Mobile Growth Rate 52.36% 17.97% ‐1.22% 3.50% 3.50% 3.00% 3.00% 2.50% Others Growth Rate 1.58% ‐1.01% 18.53% 17.50% 17.50% 15.00% 15.00% 8.00% % Broadcast 37.00% 43.00% 44.00% 45.45% 48.64% 51.80% 55.17% 58.75% % PC 24.00% 19.00% 17.00% 15.10% 13.89% 13.06% 12.28% 11.66% % Consumer Electronics 16.00% 15.00% 14.00% 12.84% 12.20% 11.83% 11.60% 11.36% % Mobile  12.00% 13.00% 13.00% 12.99% 13.45% 13.85% 14.26% 14.62% % Others  11.00% 10.00% 12.00% 13.61% 16.00% 18.40% 21.15% 22.85% % Total licensing revenue  100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Products Revenue Breakdown: Cinema  70.12 50.93 74.67 88.86 106.64 127.96 147.16 154.51 Broadcast  7.25 5.92 5.03 6.04 7.25 8.34 9.17 9.63 Other 3.22 2.37 4.20 6.08 8.21 10.68 13.34 16.68 Total Products Revenue  80.60 59.22 83.90 100.99 122.10 146.97 169.67 180.82 Cinema Growth Rate ‐22.04% ‐27.37% 46.63% 19.00% 20.00% 20.00% 15.00% 5.00% Broadcast Growth Rate ‐29.83% ‐18.37% ‐14.99% 20.00% 20.00% 15.00% 10.00% 5.00% Other Growth Rate 3.95% ‐26.53% 77.11% 45.00% 35.00% 30.00% 25.00% 25.00% % Cinema 87.00% 86.00% 89.00% 87.99% 87.34% 87.06% 86.73% 85.45% % Broadcast  9.00% 10.00% 6.00% 5.98% 5.94% 5.67% 5.40% 5.32% % Other 4.00% 4.00% 5.00% 6.02% 6.73% 7.26% 7.86% 9.22% % Total Products Revenue  100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% International Revenue %  72.00% 67.00% 71.00% 71.00% 71.00% 72.00% 72.00% 74.00% Domestic Revenue %  28.00% 33.00% 29.00% 29.00% 29.00% 28.00% 28.00% 26.00%
  17. 17. Dolby Laboratories Income Statement All figures in millions Fiscal Years Ending Sep 30 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Revenue: Revenue ‐ licensing 807.08 878.84 868.11 899.15 936.63 979.47 1029.12 1072.18 Revenue ‐ product 80.60 59.22 83.90 100.99 122.10 146.97 169.67 180.82 Revenue ‐ services 21.99 22.11 18.62 19.55 22.49 25.86 28.45 29.87 Total revenue 909.67 960.18 970.64 1019.69 1081.21 1152.31 1227.23 1282.87 Cost of licensing 16.86 10.81 10.88 13.70 14.27 14.93 15.68 16.34 Cost of products 64.27 45.13 70.49 80.78 97.66 117.56 135.72 144.64 Cost of services 15.59 14.23 13.45 13.52 15.55 17.88 19.67 20.66 Gain from amended patent licensing agreement 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Impairment of products provided under operating leases 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Total cost of revenue 96.72 70.18 94.82 108.00 127.49 150.37 171.07 181.63 Gross margin 812.96 890.00 875.82 911.68 953.73 1001.93 1056.16 1101.24 Operating Expenses:  Research & development expenses 168.75 183.13 201.32 211.50 224.26 239.00 254.55 266.09 Selling, general & administrative expenses 393.07 430.75 461.35 460.91 488.72 520.85 554.72 579.87 Restructuring charges, net 5.87 2.40 ‐0.08 0.00 0.00 0.00 0.00 0.00 Loss (gain) on settlements 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Total operating expenses 567.69 616.28 662.59 672.40 712.98 759.86 809.27 845.95 Operating income 245.26 273.72 213.23 239.28 240.75 242.08 246.90 255.28 Interest income 3.85 3.34 4.54 3.96 4.04 4.12 4.21 4.30 Interest expense 0.58 ‐0.18 0.18 0.00 0.00 0.00 0.00 0.00 Other income (expenses), net 2.11 ‐1.15 28.19 6.52 6.91 7.37 7.85 8.20 Income (loss) before provision (benefit) for income taxes 250.65 276.10 245.78 249.76 251.70 253.57 258.95 267.78 Provision for income taxes 60.34 67.38 62.54 66.44 66.95 67.45 68.88 71.23 Net income (loss) including controlling interest 190.30 208.72 183.24 183.32 184.75 186.12 190.07 196.55 Less: net income (loss) attributable to controlling interest ‐1.03 ‐2.62 ‐1.85 ‐1.94 ‐2.04 ‐2.14 ‐2.25 ‐2.36 Net income (loss) attributable to Dolby Laboratories, Inc. 189.27 206.10 181.39 181.38 182.71 183.98 187.82 194.19 Year end shares outstanding 101.739 102.269 101.035 100.94 101.11 101.38 101.72 102.13 Net earnings per share ‐ basic 1.86 2.02 1.77 1.82 1.83 1.84 1.87 1.93 Payout Ratio 215.05% 0.00% 22.60% 26.44% 26.44% 26.44% 26.44% 26.44% Dividends per share 4.00 0.00 0.40 0.48 0.48 0.49 0.49 0.51
  18. 18. Dolby Laboratories Balance Sheet All figures in millions Fiscal Years Ending Sep 30 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Assets: Cash & cash equivalents 454.40 568.47 531.93 628.51 779.00 919.88 1055.73 1187.60 Net Cash & cash equivalents 454.40 570.61 534.86 628.51 779.00 919.88 1055.73 1187.60 Short-term investments 140.27 231.21 138.90 139.85 140.80 141.75 142.72 143.69 Accounts receivable, gross 97.97 87.78 103.11 108.32 114.85 122.40 130.36 136.27 Less: allowance for doubtful accounts 0.51 1.62 1.54 1.52 1.61 1.72 1.83 1.91 Accounts receivable, net 97.46 86.17 101.56 106.80 113.24 120.69 128.53 134.36 Raw materials 2.05 1.01 3.25 4.64 4.92 5.24 5.58 5.83 Work in process 0.00 0.05 3.28 1.33 1.41 1.50 1.60 1.67 Finished goods 8.04 7.48 7.35 10.31 10.93 11.65 12.40 12.97 Inventories 10.09 8.54 13.87 16.27 17.25 18.38 19.58 20.47 Deferred taxes 78.38 86.45 97.10 98.56 99.33 100.06 102.19 105.67 Prepaid expenses 10.20 11.67 13.68 15.18 16.10 17.16 18.27 19.10 Other current assets 14.04 7.15 7.53 10.78 11.43 12.18 12.98 13.57 Income tax receivable 7.89 4.06 10.83 8.06 8.13 8.19 8.36 8.65 Assets held for sale 0.00 0.00 0.00 0 0 0 0 0 Prepaid expenses & other current assets 32.12 22.88 32.03 34.03 35.66 37.53 39.61 41.31 Total current assets 812.72 1005.85 918.33 1024.01 1185.27 1338.29 1488.36 1633.10 Long-term investments 306.34 296.34 321.02 329.43 338.06 346.91 356.00 365.33 Property, plant & equipment, gross 376.05 461.19 604.77 661.57 723.71 791.68 866.04 947.39 Less: accumulated depreciation 133.14 171.44 201.68 274.23 343.95 412.31 480.60 549.98 Property, plant, & equipment, net 242.92 289.76 403.09 387.34 379.76 379.38 385.45 397.41 Intangible assets, net 41.32 63.70 127.51 109.98 95.30 85.51 75.86 66.08 Goodwill 279.72 277.57 307.71 307.71 307.71 307.71 307.71 307.71 Deferred taxes 43.29 41.75 46.18 45.96 46.32 46.66 47.65 49.28 Other non-current assets 11.64 9.05 9.46 10.87 11.53 12.29 13.09 13.68 Total assets 1737.95 1984.01 2133.29 2215.29 2363.94 2516.75 2674.11 2832.59 Liabilities and Stockholder's equity Current Liabilities: Accounts payable 10.70 15.90 20.71 15.71 16.66 17.76 18.91 19.77 Accrued royalties 6.08 2.53 1.95 3.25 3.45 3.67 3.91 4.09 Amounts payable to joint licensing program partners 40.09 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Amounts payable to patent administration program partners 0.00 43.44 40.47 44.32 46.99 50.08 53.34 55.76 Accrued compensation & benefits 54.42 71.68 70.32 61.41 65.11 69.39 73.91 77.26 Accrued amounts payable to patent pool partners 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Accrued professional fees 4.40 6.16 6.52 5.97 6.33 6.74 7.18 7.51 Accrued current portion of litigation settlement 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Other accrued liabilities 32.80 34.57 50.05 36.42 38.62 41.15 43.83 45.82 Accrued liabilities 137.80 158.38 169.31 151.36 160.49 171.05 182.17 190.43 Income taxes payable 3.39 2.60 0.75 2.22 2.23 2.25 2.30 2.38 Current portion of long-term debt 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Deferred revenue 20.93 12.50 18.91 22.19 23.53 25.08 26.71 27.92 Total current liabilities 172.82 189.37 209.68 191.48 202.92 216.13 230.09 240.49 Long-term debt, net of current portion 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Long-term deferred revenue 19.66 19.28 30.58 22.25 23.59 25.14 26.78 27.99 Long-term portion of litigation settlement 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Supplemental retirement plan obligations 2.14 2.41 2.40 2.33 2.47 2.64 2.81 2.93 Non-current tax liabilities 30.99 30.72 62.84 43.72 44.06 44.39 45.33 46.87 Other liabilities 12.31 10.59 11.78 13.04 13.83 14.74 15.70 16.41 Other non-current liabilities 45.44 43.72 77.02 59.09 60.36 61.76 63.83 66.22 Total liabilities 237.92 252.36 317.29 272.83 286.87 303.03 320.70 334.70 Stockholder's Equity: Common Stock (net of treasury and ESOP) 18.91 46.52 17.67 9.26 8.00 7.81 7.78 7.77 Retained earnings 1454.38 1660.49 1800.86 1933.79 2067.61 2202.31 2339.79 2481.90 Accumulated other comprehensive income 7.81 3.01 ‐11.46 ‐11.46 ‐11.46 ‐11.46 ‐11.46 ‐11.46 Total stockholders' equity - Doly Laboratories, Inc. 1481.11 1710.02 1807.07 1931.58 2064.14 2198.65 2336.10 2478.21 Controlling interest 18.92 21.63 8.94 10.88 12.92 15.06 17.31 19.67 Total stockholders' equity 1500.03 1731.65 1816.01 1942.47 2077.06 2213.72 2353.42 2497.89 Owner Equity + Liabilities 1737.95 1984.01 2133.29 2215.29 2363.94 2516.75 2674.11 2832.59
  19. 19. Dolby Laboratories Cash Flow Statement All figures in millions Fiscal Years Ending Sep 30 2013 2014 2015 Cash flow from operations: Net income (loss) including controlling interest 190.30 208.72 183.24 Depreciation & amortization 53.25 53.28 69.13 Stock-based compensation expense 64.33 65.68 67.07 Accretion of discounts on debt securities ‐ ‐ ‐ Accretion of discounts or amortization of premium on investments ‐ ‐ ‐ Amortization of premium on investments 10.23 9.40 9.16 Excess tax benefit from exercise of stock options ‐ ‐ ‐ Excess tax benefit from exercise of stock options & vesting of restricted stock ‐ ‐ ‐ Excess tax benefit from excercise of stock options ‐0.48 ‐2.43 ‐2.54 Provision for doubtful accounts ‐0.17 1.12 0.03 Litigation settlement ‐ ‐ ‐ Losses (gains) on put rights ‐ ‐ ‐ Losses (gains) on auction rate certificates ‐ ‐ ‐ Deferred income taxes ‐19.64 ‐6.70 ‐14.48 Gain from amended patent licensing agreement ‐ ‐ ‐ Loss (gain) on sale of ownership interest in subsidiary ‐ ‐ ‐26.22 Loss on impairment of long-lived assets ‐ ‐ ‐ Payment on litigation settlement ‐ ‐ ‐ Cash distributions to controlling interest ‐ ‐ ‐ Other non-cash items affecting net income ‐1.03 1.82 5.13 Restricted cash ‐ ‐ ‐ Accounts receivable ‐53.64 10.17 ‐7.01 Inventories 9.17 3.82 5.84 Prepaid expenses & other current assets ‐ ‐ ‐ Prepaid expenses & other assets 3.89 ‐0.35 ‐3.60 Accounts payable & accrued liabilities ‐ ‐ ‐ Accounts payable & other liabilities 21.89 24.12 ‐7.38 Income taxes, net 2.31 0.95 21.77 Deferred revenue ‐1.08 ‐8.73 8.98 Other non-current liabilities ‐4.68 0.69 0.27 Net cash flows from operating activities 274.66 361.55 309.38 Cash flow from investing: Purchases of investments ‐ ‐389.28 ‐392.94 Purchases of available-for-sale securities ‐482.37 ‐ ‐ Proceeds from sale of available-for-sale securities 548.74 ‐ ‐ Proceeds from maturities of available-for-sale securities 143.75 ‐ ‐ Proceeds from sales of investment securities ‐ 159.56 305.23 Proceeds from maturities of investment securities ‐ 137.06 146.15 Purchases of property, plant & equipment ‐26.71 ‐78.72 ‐157.55 Payments for business acquisitions, net of cash acquired ‐ ‐ ‐93.52 Acquisitions, net of cash acquired ‐ ‐ ‐ Other investments ‐3.00 ‐ ‐ Purchases of intangible assets ‐4.05 ‐37.95 ‐37.42 Proceeds from sale of property, plant & equipment & assets held for sale 0.50 3.36 0.03 Proceeds from sale of ownership interest in subsidiary, net ‐ ‐ 27.22 Change in restricted cash ‐ 1.03 ‐0.79 Other investing activities ‐ ‐ ‐ Net cash flows from investing activities 176.87 ‐204.94 ‐203.60 Cash flow from financing: Payments on debt ‐0.08 ‐ ‐ Proceeds from the exercise of stock options ‐ ‐ ‐ Proceeds from issuance of common stock 15.96 33.37 28.63 Issuance of class A common stock (Employee Stock Purchase Plan) ‐ ‐ ‐ Repurchase of common stock ‐82.25 ‐56.03 ‐107.35 Payment of cash dividend ‐408.21 ‐ ‐41.02 Distribution to controlling interest ‐5.04 ‐ ‐5.62 Excess tax benefit from the exercise of stock options 0.48 2.43 2.54 Shares repurchased for tax withholdings on vesting of restricted stock ‐8.83 ‐13.65 ‐15.71 Payment of deferred consideration for prior business combination ‐ ‐6.71 ‐ Net cash flows from financing activities ‐487.96 ‐40.58 ‐138.52 Effect of foreign exchange rate changes on cash & cash equivalents ‐1.77 ‐1.95 ‐3.81 Net increase (decrease) in cash & cash equivalents ‐38.20 114.08 ‐36.55 Cash & cash equivalents at beginning of year 492.60 454.40 568.47 Cash & cash equivalents at end of year 454.40 568.47 531.93
  20. 20. Dolby Laboratories Forecasted Cash Flow Statement All figures in millions Fiscal Years Ending Sep 30 2016E 2017E 2018E 2019E 2020E Cash flow from operations: Net Income (loss) 183.32 184.75 186.12 190.07 196.55 Add Depreciation 72.56 69.72 68.36 68.29 69.38 Add Amortization 17.53 14.68 9.78 9.66 9.78 Changes : Less Accounts Receivables -5.23 -6.44 -7.45 -7.85 -5.83 Less Inventory -2.40 -0.98 -1.13 -1.20 -0.89 Less Deferred Taxes -1.24 -1.12 -1.08 -3.11 -5.11 Less Prepaid Expenses & Other current assets -2.00 -1.63 -1.87 -2.08 -1.70 Add Accounts Payables -5.00 0.95 1.10 1.15 0.86 Add Accrued Liabililities -17.95 9.13 10.55 11.12 8.26 Add Deferred Revenue 3.28 1.34 1.55 1.63 1.21 Add Income Taxes Payable 1.46 0.02 0.02 0.05 0.08 Add Long Term Deferred Revenue -8.33 1.34 1.55 1.63 1.21 Net Cash flow from operating activities 236.01 271.75 267.49 269.37 273.80 Cash flow from investing: Changes: Less Short term investments -0.94 -0.95 -0.96 -0.96 -0.97 Less PP&E Gross -56.80 -62.14 -67.98 -74.36 -81.34 Less Long term investments -8.41 -8.63 -8.86 -9.09 -9.33 Less Goodwill 0.00 0.00 0.00 0.00 0.00 Less Other non current assets -1.41 -0.66 -0.76 -0.80 -0.59 Add Other non current liabilities -17.93 1.27 1.40 2.07 2.38 Net Cash flow from investing -85.50 -71.11 -77.15 -83.14 -89.85 Cash flow from financing: Less Current Portion of LT debt 0.00 0.00 0.00 0.00 0.00 Add Long Term debt , net of current portion 0.00 0.00 0.00 0.00 0.00 Less Dividends -48.45 -48.89 -49.28 -50.34 -52.08 Add Common Stock (net of repurchase and ESOP) -8.41 -1.26 -0.19 -0.03 0.00 Net cash flow from financing -56.87 -50.15 -49.47 -50.37 -52.08 Change in cash 93.65 150.49 140.88 135.86 131.87 Beginning Cash 534.86 628.51 779.00 919.88 1055.73 Ending Cash 628.51 779.00 919.88 1055.73 1187.60
  21. 21. Dolby Laboratories Common Size Balance Sheet Fiscal Years Ending Sep 30 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Assets: Cash & cash equivalents 49.95% 59.20% 54.80% 61.64% 72.05% 79.83% 86.03% 92.57% Net Cash & cash equivalents 49.95% 59.43% 55.10% 61.64% 72.05% 79.83% 86.03% 92.57% Short-term investments 15.42% 24.08% 14.31% 13.71% 13.02% 12.30% 11.63% 11.20% Accounts receivable, gross 10.77% 9.14% 10.62% 10.62% 10.62% 10.62% 10.62% 10.62% Less: allowance for doubtful accounts 0.06% 0.17% 0.16% 0.15% 0.15% 0.15% 0.15% 0.15% Accounts receivable, net 10.71% 8.97% 10.46% 10.47% 10.47% 10.47% 10.47% 10.47% Raw materials 0.23% 0.11% 0.33% 0.45% 0.45% 0.45% 0.45% 0.45% Work in process 0.00% 0.00% 0.34% 0.13% 0.13% 0.13% 0.13% 0.13% Finished goods 0.88% 0.78% 0.76% 1.01% 1.01% 1.01% 1.01% 1.01% Inventories 1.11% 0.89% 1.43% 1.60% 1.60% 1.60% 1.60% 1.60% Deferred taxes 8.62% 9.00% 10.00% 9.67% 9.19% 8.68% 8.33% 8.24% Prepaid expenses 1.12% 1.21% 1.41% 1.49% 1.49% 1.49% 1.49% 1.49% Other current assets 1.54% 0.74% 0.78% 1.06% 1.06% 1.06% 1.06% 1.06% Income tax receivable 0.87% 0.42% 1.12% 0.79% 0.75% 0.71% 0.68% 0.67% Assets held for sale 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Prepaid expenses & other current assets 3.53% 2.38% 3.30% 3.34% 3.30% 3.26% 3.23% 3.22% Total current assets 89.34% 104.76% 94.61% 100.42% 109.62% 116.14% 121.28% 127.30% Long-term investments 33.68% 30.86% 33.07% 32.31% 31.27% 30.11% 29.01% 28.48% Property, plant & equipment, gross 41.34% 48.03% 62.31% 64.88% 66.93% 68.70% 70.57% 73.85% Less: accumulated depreciation 14.64% 17.85% 20.78% 26.89% 31.81% 35.78% 39.16% 42.87% Property, plant, & equipment, net 26.70% 30.18% 41.53% 37.99% 35.12% 32.92% 31.41% 30.98% Intangible assets, net 4.54% 6.63% 13.14% 10.79% 8.81% 7.42% 6.18% 5.15% Goodwill 30.75% 28.91% 31.70% 30.18% 28.46% 26.70% 25.07% 23.99% Deferred taxes 4.76% 4.35% 4.76% 4.51% 4.28% 4.05% 3.88% 3.84% Other non-current assets 1.28% 0.94% 0.98% 1.07% 1.07% 1.07% 1.07% 1.07% Total assets 191.05% 206.63% 219.78% 217.25% 218.64% 218.41% 217.90% 220.80% Liabilities and Stockholder's equity Current Liabilities: Accounts payable 1.18% 1.66% 2.13% 1.54% 1.54% 1.54% 1.54% 1.54% Accrued royalties 0.67% 0.26% 0.20% 0.32% 0.32% 0.32% 0.32% 0.32% Amounts payable to joint licensing program partners 4.41% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Amounts payable to patent administration program partners 0.00% 4.52% 4.17% 4.35% 4.35% 4.35% 4.35% 4.35% Accrued compensation & benefits 5.98% 7.46% 7.24% 6.02% 6.02% 6.02% 6.02% 6.02% Accrued amounts payable to patent pool partners 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Accrued professional fees 0.48% 0.64% 0.67% 0.59% 0.59% 0.59% 0.59% 0.59% Accrued current portion of litigation settlement 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Other accrued liabilities 3.61% 3.60% 5.16% 3.57% 3.57% 3.57% 3.57% 3.57% Accrued liabilities 15.15% 16.49% 17.44% 14.84% 14.84% 14.84% 14.84% 14.84% Income taxes payable 0.37% 0.27% 0.08% 0.22% 0.21% 0.20% 0.19% 0.19% Current portion of long-term debt 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Deferred revenue 2.30% 1.30% 1.95% 2.18% 2.18% 2.18% 2.18% 2.18% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Total current liabilities 19.00% 19.72% 21.60% 18.78% 18.77% 18.76% 18.75% 18.75% Long-term debt, net of current portion 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Long-term deferred revenue 2.16% 2.01% 3.15% 2.18% 2.18% 2.18% 2.18% 2.18% Deferred taxes 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Long-term portion of litigation settlement 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Supplemental retirement plan obligations 0.24% 0.25% 0.25% 0.23% 0.23% 0.23% 0.23% 0.23% Non-current tax liabilities 3.41% 3.20% 6.47% 4.29% 4.07% 3.85% 3.69% 3.65% Other liabilities 1.35% 1.10% 1.21% 1.28% 1.28% 1.28% 1.28% 1.28% Other non-current liabilities 5.00% 4.55% 7.94% 5.80% 5.58% 5.36% 5.20% 5.16% Total liabilities 26.15% 26.28% 32.69% 26.76% 26.53% 26.30% 26.13% 26.09% Stockholder's Equity: Common Stock 2.08% 4.84% 1.82% 0.91% 0.74% 0.68% 0.63% 0.61% Retained earnings 159.88% 172.94% 185.53% 189.65% 191.23% 191.12% 190.66% 193.47% Accumulated other comprehensive income 0.86% 0.31% ‐1.18% ‐1.12% ‐1.06% ‐0.99% ‐0.93% ‐0.89% Total stockholders' equity - Doly Laboratories, Inc. 162.82% 178.09% 186.17% 189.43% 190.91% 190.80% 190.36% 193.18% Controlling interest 2.08% 2.25% 0.92% 1.07% 1.20% 1.31% 1.41% 1.53% Total stockholders' equity 164.90% 180.35% 187.09% 190.50% 192.10% 192.11% 191.77% 194.71%
  22. 22. Dolby Laboratories Common Size Income Statement Fiscal Years Ending Sep 30 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Revenue: Revenue ‐ licensing 88.72% 91.53% 89.44% 88.18% 86.63% 85.00% 83.86% 83.58% Revenue ‐ product 8.86% 6.17% 8.64% 9.90% 11.29% 12.75% 13.83% 14.10% Revenue ‐ services 2.42% 2.30% 1.92% 1.92% 2.08% 2.24% 2.32% 2.33% Total revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Cost of licensing 1.85% 1.13% 1.12% 1.34% 1.32% 1.30% 1.28% 1.27% Cost of products 7.07% 4.70% 7.26% 7.92% 9.03% 10.20% 11.06% 11.27% Cost of services 1.71% 1.48% 1.39% 1.33% 1.44% 1.55% 1.60% 1.61% Gain from amended patent licensing agreement 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Impairment of products provided under operating leases 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Total cost of revenue 10.63% 7.31% 9.77% 10.59% 11.79% 13.05% 13.94% 14.16% Gross margin 89.37% 92.69% 90.23% 89.41% 88.21% 86.95% 86.06% 85.84% Operating Expenses:  Research & development expenses 18.55% 19.07% 20.74% 20.74% 20.74% 20.74% 20.74% 20.74% Selling, general & administrative expenses 43.21% 44.86% 47.53% 45.20% 45.20% 45.20% 45.20% 45.20% Restructuring charges, net 0.65% 0.25% ‐0.01% 0.00% 0.00% 0.00% 0.00% 0.00% Loss (gain) on settlements 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Total operating expenses 62.41% 64.18% 68.26% 65.94% 65.94% 65.94% 65.94% 65.94% Operating income 26.96% 28.51% 21.97% 23.47% 22.27% 21.01% 20.12% 19.90% Interest income 0.42% 0.35% 0.47% 0.39% 0.37% 0.36% 0.34% 0.33% Interest expense 0.06% ‐0.02% 0.02% 0.00% 0.00% 0.00% 0.00% 0.00% Other income (expenses), net 0.23% ‐0.12% 2.90% 0.64% 0.64% 0.64% 0.64% 0.64% Income (loss) before provision (benefit) for income taxes 27.55% 28.76% 25.32% 24.49% 23.28% 22.01% 21.10% 20.87% Provision for income taxes 6.63% 7.02% 6.44% 6.52% 6.19% 5.85% 5.61% 5.55% Net income (loss) including controlling interest 20.92% 21.74% 18.88% 17.98% 17.09% 16.15% 15.49% 15.32% Less: net income (loss) attributable to controlling interest ‐0.11% ‐0.27% ‐0.19% ‐0.19% ‐0.19% ‐0.19% ‐0.18% ‐0.18% Net income (loss) attributable to Dolby Laboratories, Inc. 20.81% 21.47% 18.69% 17.79% 16.90% 15.97% 15.30% 15.14%
  23. 23. Dolby Laboratories Value Driver Estimation Fiscal Years Ending Sep 30 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Marginal Tax Rate Calculation:  Federal Statuatory rate 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% State income taxes, net of federal effect 0.60% 0.60% 0.70% 0.70% 0.70% 0.70% 0.70% 0.70% Foreign rate differential  ‐4.50% ‐8.90% ‐9.10% ‐9.10% ‐9.10% ‐9.10% ‐9.10% ‐9.10% Marginal Tax Rate  31.10% 26.70% 26.60% 26.60% 26.60% 26.60% 26.60% 26.60% EBITA Calculations:  Net Sales  909.67 960.18 970.64 1019.69 1081.21 1152.31 1227.23 1282.87 Less COGS 96.72 70.18 94.82 108.00 127.49 150.37 171.07 181.63 Less SG&A 393.07 430.75 461.35 460.91 488.72 520.85 554.72 579.87 Less R&D Expsense 168.75 183.13 201.32 211.50 224.26 239.00 254.55 266.09 Add Implied Interest on operating leases 7.94 7.96 9.65 9.57 9.93 10.30 10.70 11.10 EBITA 259.08 284.08 222.80 248.84 250.68 252.38 257.59 266.38 Less Adjusted Income Taxes: Provision for income taxes 60.34 67.38 62.54 66.44 66.95 67.45 68.88 71.23 Less Tax on Gain from amended patent licensing agreement 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Add Tax Shield on Impairment of products provided under operating leases 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Add Tax Shield on Restructuring charges, net 1.83 0.64 ‐0.02 0.00 0.00 0.00 0.00 0.00 Add Loss (gain) on settlements 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Less Interest income 1.20 0.89 1.21 1.05 1.08 1.10 1.12 1.14 Add Interest expense 0.18 ‐0.05 0.05 0.00 0.00 0.00 0.00 0.00 Less Other income (expenses), net 0.66 ‐0.31 7.50 1.73 1.84 1.96 2.09 2.18 Add Tax Shield on Implied lease interest 2.47 2.13 2.57 2.54 2.64 2.74 2.84 2.95 Adjusted income Taxes 62.97 69.51 56.43 66.19 66.68 67.13 68.52 70.86 Add Change in Deferred Taxes:  Change in DT  ‐19.64 ‐6.70 ‐14.48 ‐1.24 ‐1.12 ‐1.08 ‐3.11 ‐5.11 NOPLAT : EBITA ‐ Adjusted Taxes + Change in DT  NOPLAT  176.47 207.88 151.89 181.41 182.87 184.17 185.96 190.42 Operating Current Assets: Inventory Turnover  (days) 50.56 48.45 43.13 50.93 47.98 43.25 40.50 40.24 Receivables Turnover (days)  31.87 38.13 39.47 42.29 42.87 43.59 44.20 44.75 Payables Turnover (days)  48.17 69.16 70.46 61.55 46.35 41.78 39.12 38.87 Working Capital Gap (INVT+ ART ‐APT)  34.26 17.42 12.13 31.67 44.51 45.06 45.57 46.12 Contingency operating period adjustment (days) 30 30 30 30 30 30 30 30 Operating Cash Assumption (%) : (Working capital gap + contingency adjustment) /  365 18% 13% 12% 16.90% 20.41% 20.56% 20.71% 20.85% Operating Cash (operating cash assumption * BS cash (t‐1) 86.73 59.04 65.62 89.88 128.30 160.19 190.46 220.17 Accounts receivable, net 97.46 86.17 101.56 106.80 113.24 120.69 128.53 134.36 Inventories 10.09 8.54 13.87 16.27 17.25 18.38 19.58 20.47 Prepaid expenses & other current assets 32.12 22.88 32.03 34.03 35.66 37.53 39.61 41.31 Operating Current Assets 226.41 176.62 213.09 246.97 294.44 336.79 378.19 416.30 Operating Current Liabilities: Accounts Payable 10.70 15.90 20.71 15.71 16.66 17.76 18.91 19.77 Accrued royalties 6.08 2.53 1.95 3.25 3.45 3.67 3.91 4.09 Amounts payable to joint licensing program partners 40.09 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Amounts payable to patent administration program partners 0.00 43.44 40.47 44.32 46.99 50.08 53.34 55.76 Accrued compensation & benefits 54.42 71.68 70.32 61.41 65.11 69.39 73.91 77.26 Accrued amounts payable to patent pool partners 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Accrued professional fees 4.40 6.16 6.52 5.97 6.33 6.74 7.18 7.51 Other Accrued Liabilities 32.80 34.57 50.05 36.42 38.62 41.15 43.83 45.82 Income taxes payable 3.39 2.60 0.75 2.22 2.23 2.25 2.30 2.38 Deferred revenue 20.93 12.50 18.91 22.19 23.53 25.08 26.71 27.92 Operating Current Liabilities 172.82 189.37 209.68 191.48 202.92 216.13 230.09 240.49 Other Operating Assets: Intangible assets, net 41.32 63.70 127.51 109.98 95.30 85.51 75.86 66.08 Other non-current assets 11.64 9.05 9.46 10.87 11.53 12.29 13.09 13.68 PV of Opearting Leases  140.69 170.48 169.00 175.40 182.06 188.96 196.12 203.56 Other Operating Assets 193.64 243.23 305.97 296.25 288.88 286.76 285.07 283.32 Other Operating Liabilities: Long-term deferred revenue 19.66 19.28 30.58 22.25 23.59 25.14 26.78 27.99 Non-current tax liabilities 30.99 30.72 62.84 43.72 44.06 44.39 45.33 46.87 Other liabilities 12.31 10.59 11.78 13.04 13.83 14.74 15.70 16.41 Other Operating Liabilities 62.96 60.59 105.21 79.01 81.48 84.27 87.80 91.27 PP&E (Net) 242.92 289.76 403.09 387.34 379.76 379.38 385.45 397.41 Invested Capital:  Invested Capital 427.19 459.65 607.26 660.07 678.68 702.53 730.81 765.27 Return on Invested Capital: NOPLAT 176.47 207.88 151.89 181.41 182.87 184.17 185.96 190.42 Beginning Invested Capital  479.88 427.19 459.65 607.26 660.07 678.68 702.53 730.81 ROIC 36.77% 48.66% 33.04% 29.87% 27.71% 27.14% 26.47% 26.06% Economic Profit: Begin IC * ( ROIC ‐WACC)  Beginning Invested Capital 479.88 427.19 459.65 607.26 660.07 678.68 702.53 730.81 ROIC 36.77% 48.66% 33.04% 29.87% 27.71% 27.14% 26.47% 26.06% WACC 7.81% 7.81% 7.81% 7.81% 7.81% 7.81% 7.81% 7.81% Economic Profit  138.99 174.51 115.98 133.98 131.32 131.16 131.09 133.34 FCF: NOPLAT+Change in  Invested Capital NOPLAT 176.47 207.88 151.89 181.41 182.87 184.17 185.96 190.42 Add: Beg Invested Capital 479.88 427.19 459.65 607.26 660.07 678.68 702.53 730.81 Less: Current Invested Capital 427.19 459.65 607.26 660.07 678.68 702.53 730.81 765.27 FCF 229.16 175.42 4.27 128.60 164.26 160.32 157.67 155.96
  24. 24. Dolby Laboratories Key Management Ratios Fiscal Years Ending Sep 30 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Liquidity Ratios Current Ratio (Current Assets/ Current Liabilities) 4.70 5.31 4.38 5.35 5.84 6.19 6.47 6.79 Operating Cash Flow Ratio (Operating CF/ Current Liabilities) 1.59 1.91 1.48 1.23 1.34 1.24 1.17 1.14 Quick Ratio (Cash and other liquid assets) / current liabilities 4.00 4.69 3.70 4.57 5.09 5.47 5.77 6.09 Activity or Asset‐Management Ratios Asset Turnover Ratio (Sales/Total Assets) 0.52 0.48 0.45 0.46 0.46 0.46 0.46 0.45 Inventory Turnover Ratio (Sales/Total Inventory) 7.22 7.53 8.46 7.17 7.61 8.44 9.01 9.07 Receivables Turnover Ratio (Sales/Average Accounts Receivable) 11.45 9.57 9.25 8.63 8.51 8.37 8.26 8.16 Financial Leverage Ratios Debt‐to‐Equity Ratio (Total Debt/Total Equity) 9.38% 9.84% 9.31% 9.03% 8.77% 8.54% 8.33% 8.15% Equity Ratio (Total Equity/ Total Assets) 86.31% 87.28% 85.13% 87.68% 87.86% 87.96% 88.01% 88.18% Interest Coverage (Operating Income) / (Interest Expense) 426.5426 ‐1495.73 1165.18 NA NA NA NA NA Profitability Ratios Return on Assets (Net Income/Total Assets) 10.95% 10.52% 8.59% 8.28% 7.82% 7.40% 7.11% 6.94% Return on Equity (Net Income/Shareholders Equity) 12.78% 12.05% 10.04% 9.39% 8.85% 8.37% 8.04% 7.84% Gross Margin (Revenue‐COGS)/Revenue 89.37% 92.69% 90.23% 89.41% 88.21% 86.95% 86.06% 85.84% EBIT Margin (EBIT/Sales) 26.96% 28.51% 21.97% 23.47% 22.27% 21.01% 20.12% 19.90% Profit Margin (Net Income/Sales) 20.81% 21.47% 18.69% 17.79% 16.90% 15.97% 15.30% 15.14% Payout Policy Ratios 258.47% 27.18% 81.46% 55.64% 51.56% 50.83% 50.27% 49.50% Payout Ratio (Dividend Payout Ratio) 215.05% 0.00% 22.60% 26.44% 26.44% 26.44% 26.44% 26.44% Total Payout Ratio (Dividends paid + Repurchases)/NI
  25. 25. Weighted Average Cost of Capital (WACC) Estimation Marginal Tax Rate 26.60% Cost of equity Calculation Risk Free Rate  2.62% (30 Yr Treasury Note)  + Beta* 1.069 Market Risk Premium 5.00% = Cost of Equity 7.97% WACC Calculation All figures in millions Shares outstanding* 101.035 MV of share 39.57 =Total MV of Equity [E] 3997.95 MV of debt [D] 169.00 Only Operating Leases as they don't have long term debt Cost of Debt 5.66% MV of equity 3997.95 + MV of debt 169.00 = MV of the firm [V] 4166.95 Cost of Equity * 7.97% (E/V) 95.94% + Cost of Debt * 5.66% (1‐Marginal tax Rate) 73.40% (D/V) 4.06% = WACC 7.81% Dolby Laboratories
  26. 26. Dolby Laboratories Key Inputs:      CV Growth 3.50%      CV ROIC 26.06%      WACC 7.81%      Cost of Equity 7.97% Fiscal Years Ending Sep 30 2016E 2017E 2018E 2019E 2020E DCF Model Discount period 1 2 3 4 5 NOPLAT  181 183 184 186 190 Continuing Value  3824 Free Cash Flow 129 164 160 158 156 Net FCF 129 164 160 3982 PV of free cash flows 119 141 128 2947 Value of Operations 3336 Non Operating Assets Excess Cash 469 ST Instruments 139 LT Instruments 321 Controlling Interest  9 Value of Non Operating Assets 938 Non Operating Liabilities PV of Operating Leases 169 Total Debt 0 PV of Pension Obligations 2 PV of employee stock options 114 Value of Non Operating Liabilities 286 Equity Value 3988 Shares outstanding 101 Intrinsic Share Price (FY 15 End) $39.47 Intrinsic Share Price (Today) $40.65 Current Share Price  $39.57 EP Model Periods to discount 1 2 3 4 5 Economic Profit 134 131 131 131 133 Continuing Value 3093 Net  EP  134 131 131 3224 PV of Economic Profit 124 113 105 2387 Initial Invested Capital 607 Value of Operations 3336 Non Operating Assets Excess Cash 469 ST Instruments 139 LT Instruments 321 Controlling Interest 9 Value of Non Operating Assets 938 PV of Operating Leases 169 Total Debt 0 PV of Pension Obligations 2 PV of employee stock options 114 Value of Non Operating Liabilities 286 Equity Value 3988 Shares outstanding 101 Intrinsic Share Price (FY 15 end) $39.47 Intrinsic Share Price (Today) $40.65 Current Share Price  $39.57 Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation  Models
  27. 27. Dolby Laboratories Fiscal Years Ending Sep 30 2016E 2017E 2018E 2019E 2020E Period of Discount  1 2 3 4 4 EPS 1.82 1.83 1.84 1.87 1.93 Key Assumptions    CV growth 3.50%    CV ROE 7.84%    Cost of Equity 7.97% Future Cash Flows      P/E Multiple (CV Year) 12.39      EPS (CV Year) 1.93      Future Stock Price 23.90      Dividends Per Share 0.48 0.48 0.49 0.49      Future Cash Flows 0.48 0.48 0.49 0.49 23.90      Discounted Cash Flows 0.44 0.41 0.39 0.36 17.59 Intrinsic Share Price (FY 15 End) $19.20 Intrinsic Share Price (Today) $19.77 Price Today  $39.57 Dividend Discount Model (DDM) or Fundamental P/E  Valuation Model
  28. 28. Relative Valuation Models Peer Comparison EPS EPS Ticker Company Price 2016E 2017E P/E 16 P/E 17 DTSI DTS, Inc  $21.42 $2.14  $2.42  10.0         8.9            IMAX IMAX Corporation $30.75 $1.19  $1.42  25.8         21.7          Average 17.9       15.3         DLB Dolby Laboratories $39.57 $1.82  $1.83  21.8         21.6          Implied Value:    Relative P/E (EPS16) $    32.54     Relative P/E (EPS17) 27.90$    Industy Comparison EPS EPS Ticker Company Price 2016E 2017E P/E 16 P/E 17 DTSI DTS, Inc  $21.42 $2.14  $2.42  10.0         8.9            IMAX IMAX Corporation $30.75 $1.19  $1.42  25.8         21.7          STRZA Starz Inc  Class A $25.73 $2.41  $2.93  10.7         8.8            HRS Harris Corp $76.99 $5.73  $6.17  13.4         12.5          IPGP IPG Photonics Corp $95.01 $4.88  $5.50  19.5         17.3          LGF Lions Gate Entertainment $20.91 $0.58  $1.41  36.1         14.8          DIS The Walt Disney Corporation $98.68 $5.84  $6.24  16.9         15.8          Average 18.9       14.2         DLB Dolby Laboratories $39.57 $1.82  $1.83  21.8         21.6          Implied Value:    Relative P/E (EPS16) $    34.33     Relative P/E (EPS17) 26.04$    Dolby Laboratories
  29. 29. Beta $40.65 0.5 0.6 0.7 0.8 0.9 1 1.069 1.1 1.2 1.3 1.4 1.5 4.00% 137.74 104.02 84.15 71.06 61.78 54.87 51.04 49.51 45.24 41.76 38.87 36.43 4.25% 124.92 95.47 77.82 66.06 57.66 51.37 47.87 46.48 42.57 39.37 36.71 34.46 4.50% 114.40 88.31 72.45 61.78 54.12 48.35 45.14 43.86 40.25 37.30 34.83 32.74 4.75% 105.61 82.23 67.84 58.09 51.05 45.73 42.75 41.56 38.22 35.47 33.18 31.23 5.00% 98.15 77.00 63.84 54.87 48.35 43.42 40.65 39.54 36.43 33.86 31.72 29.90 Risk Premium 5.25% 91.74 72.45 60.34 52.03 45.97 41.37 38.79 37.75 34.83 32.43 30.41 28.70 5.50% 86.18 68.46 57.24 49.51 43.86 39.54 37.12 36.15 33.40 31.14 29.24 27.63 5.75% 81.30 64.93 54.49 47.26 41.96 37.91 35.62 34.71 32.12 29.98 28.19 26.66 6.00% 77.00 61.78 52.03 45.24 40.25 36.43 34.27 33.40 30.95 28.93 27.23 25.78 6.25% 73.16 58.96 49.81 43.42 38.70 35.08 33.04 32.22 29.90 27.97 26.36 24.98 6.50% 69.73 56.42 47.80 41.76 37.30 33.86 31.92 31.14 28.93 27.10 25.56 24.25 6.75% 66.64 54.12 45.97 40.25 36.01 32.74 30.90 30.15 28.04 26.30 24.83 23.58 Beta $40.65 0.5 0.6 0.7 0.8 0.9 1 1.069 1.1 1.2 1.3 1.4 1.5 0.00% 42.96 39.80 37.15 34.88 32.94 31.24 30.19 29.75 28.44 27.26 26.21 25.26 0.50% 45.68 41.96 38.89 36.32 34.12 32.23 31.07 30.59 29.15 27.87 26.73 25.71 1.00% 49.07 44.60 40.99 38.01 35.51 33.38 32.09 31.54 29.95 28.55 27.32 26.21 1.50% 53.40 47.89 43.55 40.04 37.14 34.71 33.26 32.65 30.87 29.33 27.97 26.77 2.00% 59.14 52.10 46.74 42.51 39.10 36.29 34.63 33.94 31.94 30.22 28.72 27.41 CV NOPLAT  2.50% 67.11 57.69 50.83 45.61 41.50 38.19 36.26 35.47 33.18 31.24 29.57 28.12 Growth 3.00% 78.90 65.46 56.26 49.58 44.50 40.51 38.23 37.30 34.65 32.44 30.56 28.95 3.50% 98.15 77.00 63.84 54.87 48.35 43.42 40.65 39.54 36.43 33.86 31.72 29.90 4.00% 135.21 95.93 75.13 62.25 53.49 47.16 43.71 42.36 38.60 35.57 33.09 31.01 4.50% 236.07 132.72 93.75 73.29 60.69 52.15 47.70 45.98 41.32 37.67 34.74 32.33 5.00% 1584.61 235.12 130.26 91.60 71.48 59.16 53.11 50.83 44.83 40.30 36.76 33.92 CV NOPLAT Growth $40.65 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 6.50% $35.17 $36.62 $38.34 $40.40 $42.91 $46.06 $50.10 $55.49 $63.04 $74.37 $93.24 6.75% $34.07 $35.38 $36.92 $38.76 $40.98 $43.72 $47.20 $51.74 $57.93 $66.88 $80.94 7.00% $33.05 $34.24 $35.63 $37.27 $39.24 $41.64 $44.65 $48.52 $53.68 $60.90 $71.72 7.25% $32.10 $33.18 $34.44 $35.91 $37.66 $39.79 $42.41 $45.73 $50.07 $56.00 $64.55 7.50% $31.21 $32.20 $33.34 $34.66 $36.23 $38.11 $40.41 $43.29 $46.99 $51.91 $58.81 7.75% $30.39 $31.29 $32.32 $33.52 $34.93 $36.60 $38.63 $41.14 $44.31 $48.46 $54.12 7.81% $30.20 $31.08 $32.09 $33.26 $34.63 $36.26 $38.23 $40.66 $43.72 $47.71 $53.12 8.00% $29.61 $30.43 $31.38 $32.46 $33.73 $35.23 $37.02 $39.22 $41.97 $45.50 $50.21 8.25% $28.88 $29.64 $30.50 $31.48 $32.63 $33.97 $35.57 $37.51 $39.90 $42.93 $46.89 WACC 8.50% $28.20 $28.89 $29.68 $30.57 $31.61 $32.82 $34.25 $35.97 $38.06 $40.68 $44.05 8.75% $27.55 $28.19 $28.91 $29.73 $30.67 $31.76 $33.04 $34.57 $36.42 $38.70 $41.59 9.00% $26.94 $27.53 $28.19 $28.94 $29.80 $30.79 $31.94 $33.30 $34.94 $36.94 $39.44 9.25% $26.36 $26.91 $27.51 $28.20 $28.98 $29.88 $30.92 $32.15 $33.60 $35.36 $37.54 9.50% $25.82 $26.32 $26.88 $27.51 $28.22 $29.04 $29.98 $31.08 $32.38 $33.94 $35.85 9.75% $25.30 $25.76 $26.28 $26.86 $27.51 $28.26 $29.11 $30.11 $31.27 $32.66 $34.34 10.00% $24.81 $25.24 $25.71 $26.25 $26.85 $27.53 $28.31 $29.21 $30.25 $31.49 $32.98 $40.65 $40.65 8% $41.08 75% $41.86 9% $40.77 75.50% $41.74 9.39% $40.65 76% $41.62 10% $40.46 76.50% $41.50 11% $40.14 Cost of 77% $41.38 P&E (Capex) 12% $39.81 Products 77.50% $41.26 13% $39.46 78% $41.14 14% $39.11 78.50% $41.01 15% $38.75 79% $40.89 16% $38.37 79.50% $40.77 17% $37.99 80% $40.65 18% $37.59 80.50% $40.53 19% $37.18 $40.65 40% 49.90 41% 48.12 42% 46.34 43% 44.56 44% 42.79 SG&A 45.20% 40.65 45% 41.01 46% 39.23 47% 37.45 48% 35.68 49% 33.90 50% 32.12
  30. 30. Present Value of Operating Lease Obligations & other obligations (2015) Present Value of Operating Lease Obligations & other obligations (2014) Operating Operating Fiscal Years Ending Sep 30 Leases Fiscal Years Ending Sep 30 Leases 2016 30.06 2015 31.26 2017 21.06 2016 20.50 2018 21.06 2017 20.50 2019 15.75 2018 14.45 2020 15.75 2019 14.45 Thereafter 134.40 Thereafter 145.73 Total Minimum Payments 238.096 Total Minimum Payments 246.876 Less: Interest 69 Less: Interest 76 PV of Minimum Payments 169 PV of Minimum Payments 170 Capitalization of Operating Leases Capitalization of Operating Leases Pre‐Tax Cost of Debt 5.66% Pre‐Tax Cost of Debt 5.66% Number Years Implied by Year 6 Payment 8.5 Number Years Implied by Year 6 Payment 10.1 Lease PV Lease Lease PV Lease Year Commitment Payment Year Commitment Payment 1 30.063 28.5 1 31.258 29.6 2 21.0625 18.9 2 20.4985 18.4 3 21.0625 17.9 3 20.4985 17.4 4 15.7535 12.6 4 14.447 11.6 5 15.7535 12.0 5 14.447 11.0 6 & beyond 15.7535 79.2 6 & beyond 14.447 82.6 PV of Minimum Payments 169.0 PV of Minimum Payments 170.5 Present Value of Operating Lease Obligations & other obligations (2013) Present Value of Operating Lease Obligations & other obligations (2012) Operating Operating Fiscal Years Ending  Leases #REF! Leases 2014 28.70 2013 17.58 2015 16.05 2014 17.09 2016 16.05 2015 17.09 2017 11.32 2016 12.58 2018 11.32 2017 12.58 Thereafter 121.73 Thereafter 132.40 Total Minimum Payments 205.168 Total Minimum Payments 209.315 Less: Interest 64 Less: Interest 69 PV of Minimum Payments 141 PV of Minimum Payments 140 Capitalization of Operating Leases Capitalization of Operating Leases Pre‐Tax Cost of Debt 5.66% Pre‐Tax Cost of Debt 5.66% Number Years Implied by Year 6 Payment 10.7 Number Years Implied by Year 6 Payment 10.5 Lease PV Lease Lease PV Lease Year Commitment Payment Year Commitment Payment 1 28.696 27.2 1 17.583 16.6 2 16.048 14.4 2 17.0925 15.3 3 16.048 13.6 3 17.0925 14.5 4 11.3245 9.1 4 12.576 10.1 5 11.3245 8.6 5 12.576 9.5 6 & beyond 11.3245 67.9 6 & beyond 12.576 74.2 PV of Minimum Payments 140.7 PV of Minimum Payments 140.3
  31. 31. Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding All figures are in millions Number of Options Outstanding (shares):  8.84 Average Time to Maturity (years): 7.19 Expected Annual Number of Options Exercised: 1.23 Current Average Strike Price: 35.84$             Cost of Equity: 7.97% Current Stock Price: $39.57 2016E 2017E 2018E 2019E 2020E Increase in Shares Outstanding: 1.23 1.23 1.23 1.23 1.23 Average Strike Price: 35.84$             35.84$         35.84$          35.84$         35.84$         Increase in Common Stock Account: 44.05              44.05          44.05           44.05          44.05          Change in Treasury Stock 52.46 45.31 44.24 44.08 44.05 Expected Price of Repurchased Shares: 39.57$             42.72$         46.12$          49.80$         53.76$         Number of Shares Repurchased: 1.33                1.06            0.96             0.89            0.82            Shares Outstanding (beginning of the year) 101.04 100.94 101.11 101.38 101.72 Plus: Shares Issued Through ESOP 1.23 1.23 1.23 1.23 1.23 Less: Shares Repurchased in Treasury 1.33 1.06 0.96 0.89 0.82 Shares Outstanding (end of the year) 100.94 101.11 101.38 101.72 102.13
  32. 32. VALUATION OF OPTIONS GRANTED IN ESOP All figures are in millions Ticker Symbol DLB Current Stock Price $39.57 Risk Free Rate 1.51% Current Dividend Yield 1.26% Annualized St. Dev. of Stock Returns 29.60% Average Average B‐S Value Range of Number Exercise Remaining Option of Options Outstanding Options of Shares Price Life (yrs) Price Granted $13.90 ‐ $24.59 0.022 18.39 0.50 21.07$        0$                        $24.60 ‐ $28.90 1.876 27.82 4.70 14.83$        28$                      $28.91 ‐ $33.40 1.647 30.48 6.70 14.53$        24$                      $33.41 ‐ $37.33 0.248 35.09 6.30 12.40$        3$                        $37.34 ‐ $47.45 4.981 40.55 8.40 11.78$        59$                      $47.46 ‐ $58.07 0.041 49.00 3.60 5.61$          0$                        $58.08 ‐ $62.29 0.020 59.69 5.20 5.08$          0$                        Total 9 35.84$        7.19 15.06$        114$                  

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