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DTS Inc. (DTSI - Snapshot Report) reported dismal third quarter results. The company reported a loss of 70 cents per share (excluding amortization & acquisition cost but including stock-based compensation), which was significantly down from the Zacks Consensus Estimate of 3 cents. The reported loss per share plummeted from earnings of 18 cents in the year-ago quarter due to higher operating costs.

Quarter Details

Revenue was up 8.2% year over year to $22.2 million, but missed the Zacks Consensus Estimate of $25 million. Year-over-year growth was driven by a 41% increase in network-connected business, which fully offset flat revenue growth from the Blu-ray segment. The company also witnessed a decline in demand for broadcast products, DVD and stand-alone DMP.

Gross profit (excluding amortization & acquisition costs but including stock-based compensation) for the quarter increased 8.1% year over year to $22.2 million. Gross margin contracted 10 basis points (bps) on a year-over-year basis to 99.7%.

Operating expenses (excluding amortization & acquisition cost but including stock-based compensation) jumped 53.7% year over year to $24.6 million, primarily due to a 103.1% surge in research & development expense (R&D) and a 40.7% rise in selling, general & administrative expense (SG&A) related to continuing investments in network connected business in the quarter.

DTS reported operating loss (excluding amortization & acquisition cost but including stock-based compensation) of $2.4 million, which plunged from an operating profit of $4.5 million in the previous-year quarter due to higher operating expenses.

Net loss (excluding amortization & acquisition costs but including stock-based compensation) was $12.8 million or 70 cents compared to a net profit of $3.1 million or 18 cents reported in the previous-year quarter.

Exiting the third quarter, DTS had cash and short-term investments of $80.6 million compared with $100.7 million at the end of second quarter of 2012. Cash flow from operations was $6.7 million compared with $3.8 million in the previous quarter.

Outlook

DTS expects full year 2012 revenue to be in the range of $100 million to $105 million (down from a prior outlook of $110 million to $115 million). Operating margin is expected to be approximately 20% and non-GAAP earnings in the range of 5 cents to 20 cents per share (down from prior outlook of 90 cents to $1 per share).

For fiscal 2013, DTS expects revenue to be in the range of $140 million-$150 million (down from $160 million to $175 million).

Recommendation

DTS’s tepid outlook, in addition to an 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.

However, 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 and digital media players.  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 revenue from the acquisition of SRS labs, will drive top line in the long term.

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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