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DTS Inc. (DTSI - Snapshot Report) reported first quarter 2012 earnings (excluding amortization but including stock-based compensation) of 27 cents per share, beating the Zacks Consensus Estimate by 1 cent. However, on a year-over-year basis, earnings plunged 18.2% in the reported quarter.

Quarter Details

Revenues increased 0.4% year over year to $26.9 million during the quarter and moved past the Zacks Consensus Estimate of $26 million. Royalty revenue was $2.25 million in the reported quarter. During the quarter, DTS witnessed 13% rise in the network-connected revenue, but was offset by decrease in DVD-related products and Blu-ray game consoles. Moreover, supply chain constrains continued due to the Thailand flood.

Gross profit (excluding amortization but including stock-based compensation) for the quarter increased 0.4% year over year to $26.9 million. Gross margin remained flat on a year-over-year basis at 99.9%.

Operating expenses increased 12.9% year over year to $19.3 million, primarily driven by a 6.9% rise in selling, general & administrative expense (SG&A) and 39.1% increase in research & development expense (R&D) in the quarter. As a percentage of revenue, operating expenses deteriorated from 63.6% in the previous-year quarter to 71.6%.

Operating income (excluding amortization but including stock-based compensation) decreased 21.5% year over year to $7.6 million. Operating margin for the quarter was 28.3% compared with 36.2% in the previous-year quarter.

Exiting the first quarter, the company had cash and short-term investments of $79.0 million compared with $85.6 million at the end of fourth quarter of 2011. The company had no long-term debt at the end of the fourth quarter. Cash flow from operations was $6.8 million compared with $9.6 million in the previous quarter.

Outlook

The company reiterated its fiscal year outlook and expects revenues in the range of $112.0 million to $116.0 million, operating margin of approximately 40.0% and earnings in the range of $1.60 to $1.65 per share. The earnings exclude stock-based compensation of 37 cents to 38 cents per share. Currently, the Zacks Consensus Estimate projects earnings of $1.24 per share (including stock based compensation) for fiscal 2012.

Recommendation

We believe that DTS will continue to gain market share riding on its strong product portfolio, and increasing penetration into network connected devices. However, we believe that the volatile macro environment and sluggish consumer spending will remain headwinds for Blu-ray sales going forward.

Moreover, we believe that the strong growth of network connected devices will eventually cannibalize the sales of DVD-based products and Blu-ray sales. This in turn will likely hurt DTS’ growth over the long 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 remain the headwinds going forward.

Thus, we remain Neutral over the long term (6-12 months). Currently, DTS Inc. has a Zacks #3 Rank, which implies a ‘Hold’ rating in the near term.

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