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DTS Inc. (DTSI - Snapshot Report) reported a loss of a penny in the second quarter, much narrower than the Zacks Consensus Estimate of a loss of 7 cents per share. DTS had reported earnings of 7 cents per share in the year-ago quarter.

Quarter Details

Revenues jumped 25.0% year over year to $27.2 million, in line with the Zacks Consensus Estimate. The strong year-over-year growth was primarily driven by solid performance from the network-connected business (up 100.0% year over year).

However, DTS recorded year-over-year declines from Home A/V (down 19.0% year over year) and Blu ray (down 10.0% year over year) lines of business.

Operating expenses (excluding amortization & acquisition cost but including stock-based compensation) as a percentage of revenues increased to 96.7% from 87.9% in the year-ago quarter.

This was primarily attributed to a 190 basis points (“bps”) increase in selling, general & administrative expense (SG&A) and 680 bps surge in research & development expense (R&D) during the quarter.

The sharp rise in operating expenses dragged down profitability in the quarter. DTS reported operating income (excluding amortization & acquisition cost but including stock-based compensation) of $0.7 million compared with $2.7 million in the year-ago quarter.

Net loss (excluding amortization & acquisition costs but including stock-based compensation) was $0.1 million compared to a net profit of $1.2 million in the year-ago quarter.

Exiting the second quarter, DTS had cash and short-term investments of $71.7 million compared with $69.1 million at the end of the first quarter. Cash flow from operations was $2.4 million compared with $1.3 million cash used in operations in the previous quarter.

Outlook

DTS lowered its fiscal 2013 outlook. The company now expects revenues in the range of $130.0 million to $136.0 million (prior outlook was $140.0 million-$146.0 million).

The trimmed guidance primarily reflects weak consumer electronic business environment, lower-than-expected royalty recoveries and uncertainties around shipment of certain mobile and Play-Fi products (now expected to be in 2014).

The company expects revenues from the Blu-ray segment to be approximately 25% of the total revenue, due to the impact of new game console cycle. However, DTSI expects flat to marginal growth in standalone players and a decline in Blu-ray-enabled PCs.

DTS expects non-GAAP operating margin in the low to mid-20s and non-GAAP earnings in the range of 98 cents to $1.12 per share (down from $1.05 to $1.20).

Recommendation

We believe that DTS will continue 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, digital media players and network-connected TV space.

Moreover, DTS continues to invest in the network connected business, which will help it to gain significant market share going forward. This, coupled with higher penetration in the Chinese smartphone market and incremental revenues from the acquisition of SRS Labs, will drive top-line growth in the long term.

Additionally, its partnership with Samsung to provide sound solutions for TV and inclusion of DTS’s technologies in Qualcomm’s (QCOM - Analyst Report) latest generation of processors are positives for the company. The company has also entered into several partnerships with mobile and tablet makers such as Huawei, Pantech, Lenovo and Panasonic.

However, the ongoing volatile macroeconomic environment, weakness in the consumer electronics market and sluggish consumer spending are the near-term headwinds for the company. Moreover, higher costs are likely to hurt profitability in the near term.

Further, the company faces significant competition from Dolby Laboratories Inc. (DLB - Snapshot Report), Sony Corp. (SNE - Snapshot Report) and privately-held THX Limited, which may hurt its profitability.

Currently, DTSI has a Zacks Rank #3 (Hold).

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