DTS Inc. (DTSI) reported third quarter 2010 results, with earnings up 65.0% to 20 cents from 12 cents reported in the prior-year quarter.
Earnings including stock based compensation, but excluding one-time items were well above the Zacks Consensus Estimate of 16 cents, beating by 4 cents.
The strong year-over-year growth was driven by an accelerating revenue growth and margin expansion in the quarter.
Revenue
Revenues increased 40.0% year over year to $21.0 million, beating the Zacks Consensus Estimate of $20.0 million. The growth was primarily driven by a strong performance in the Blu-ray and automotive markets.
The car market contributed 15.0% to quarterly revenues. Blu-ray contributed 30.0% to revenue growth and posted a 60.0% year-over-year growth. Standalone players and game consoles achieved robust year-over-year growth rates of 50% and 65%, respectively.
DTS continues to experience strong contributions from markets that serve network-connected consumers, including television, personal computers and smartphones. In the reported quarter, these represented just fewer than 15% of total revenue.
The standard definition home AV business decreased 3.0% in the quarter and contributed 30.0% of the total revenue. Broadcast contributed 5.0% to revenues in the quarter.
New Partnerships
During the quarter, DTS agreed to incorporate its digital technology into Orange’s Internet Protocol television (IPTV) service. DTS entered into a partnership with Digital Rapids, a premier provider of encoding and transcoding solutions. As per the terms of the agreement, DTS and DTS-HD audio support will be integrated into the prospective versions of all Digital Rapids solutions.
DTS also entered into a partnership with computer hardware manufacturer Micro-Star International (MSI), under which the company will incorporate Surround Sensation UltraPC software into MSI’s latest line of G-Series notebooks.
Most recently, DTS entered into a partnership with Fujitsu to integrate DTS technologies into a range of laptop PCs and desktop All-In-One computers.
DTS also has other important partnerships with renowned technology companies such as Onkyo, Pantech and Intel Corp. (INTC) that will augment its top-line growth. Over the long term, the widespread adoption of DTS high definition Master Audio technology would help DTS expand into new markets, particularly in Europe and Asia, thus driving further market share gains.
Operational Performance
Gross profit escalated 42.0% year over year to $20.7 million and gross margin increased to 98.5% from 97.0% in the prior-year quarter.
Total operating expenses were up 29.3% year over year to $15.1 million, due to higher selling, general & administrative expenses and research & development expenses. The majority of the increase reflects expansion of sales and marketing investments, coupled with headcount increase during the quarter.
However, higher operating expenses were fully offset by strong revenue and gross margin growth, as operating profit leaped 77.8% year over year to $6.0 million in the quarter and the operating margin climbed 610 basis points to 28.3% in the third quarter of 2010.
Net income on a non-GAAP basis (including stock based compensation, but excluding one time items) increased 63.8% year over year to $3.61 million in the quarter.
Balance Sheet
As of September 30, 2010, cash and short-term investments were $84.3 million as compared with $76.6 million at the end of June 30, 2010. The company had no long-term debt at the end of third quarter.
Cash flow from operations was $8.4 million as compared with a cash outflow of $1.2 million in the prior-year quarter.
DTS repurchased 169,000 shares for a total of $5.8 million under its share repurchase program.
Outlook
For fiscal year 2010, DTS raised its guidance. DTS expects revenues in the range of $82.0 million to $85.0 million (previous guidance $81.0 million to $84.0 million), operating margins in the upper 20’s and earnings per share in the range of 77 cents to 81 cents (previous guidance of 75 cents to 80 cents). Non-GAAP EPS is expected to be in the range of $1.05 to $1.10.
For fiscal year 2011, DTS expects revenue growth to exceed 20.0% and projects a strong operating margin growth.
Our Take
We maintain a Neutral rating on a long-term basis (6-12 months). We believe DTS continues to gain market share, riding on its strong product portfolio, increasing online availability and accelerated expansion of the DTS technology into new markets, such as smartphones, portable devices and digital media players.
In the near term, a weak Blu-ray unit growth and increasing operating expenses could dig into the company’s profitability. Moreover, DTS continues to face stiff competition from Dolby Laboratories Inc. (DLB”>DLB), Sony Corp. (SNE”>SNE) and privately held THX limited.
Currently, DTS has a Zacks #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).
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