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DTS Inc. (DTSI - Snapshot Report) reported fourth-quarter 2012 non-GAAP earnings per share of 33 cents compared with 52 cents per share earned in the year-ago quarter. Including stock-based compensation of 16 cents, earnings per share came in at 17 cents, outpacing the Zacks Consensus Estimate of 5 cents per share.

Quarter Details

Revenues for the quarter increased a modest 2.6% on a year-over-year basis to $29.8 million (including royalty recoveries of 1.6 million in the fourth quarter of 2011). Sequentially, revenues increased 34.2%.

However, reported revenues lagged the Zacks Consensus Estimate of $31.0 million. The year-over-year increase in revenues was primarily boosted by DTSI’s network-connected business. However, DTSI recorded year-over-year declines from Home A/V and Blu-ray business.

Gross profit (excluding amortization & acquisition costs but including stock-based compensation) for the quarter increased 2.4% year over year to $29.7 million. Gross margin contracted 20 basis points (bps) on a year-over-year basis to 99.7%, primarily due to business model transition and amortization of purchased intangibles connected to the SRS and Phorus acquisitions.

Operating expenses (excluding amortization & acquisition cost but including stock-based compensation) jumped 47.7% year over year to $24.9 million, primarily due to a 101.3% surge in research & development expense (R&D) and a 32.5% rise in selling, general & administrative expense (SG&A) related to continuing investments in network connected business in the quarter.

DTSI reported operating profit (excluding amortization & acquisition cost but including stock-based compensation) of $4.7 million, which was down from $12.1 million in the previous-year quarter, due to higher operating expenses.

Net income (excluding amortization & acquisition costs but including stock-based compensation) was $3.2 million or 17 cents compared to a net profit of $7.3 million or 43 cents reported in the previous-year quarter.

Exiting the fourth quarter, DTSI had cash and short-term investments of $72.0 million compared with $80.6 million at the end of third quarter of 2012. Cash used in operations was $2.5 million compared with $6.7 million cash flow from operations in the previous quarter.

Outlook

DTSI provided an outlook for fiscal 2013. Revenues for 2013 are expected in the range of $140 million to $146 million. 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.

DTSI expects non-GAAP operating margin in the low to mid-20s and non-GAAP earnings per share in the range of $1.05 to $1.20. Moreover, DTSI also hinted that the primary growth drivers in 2013 will be network connected business (TV’s and mobile devices).

Recommendation

We believe that DTSI 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, DTSI 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 growth in the long term.

Additionally, partnership with Samsung to provide sound solutions for the TV and inclusion of DTSI’s technologies in Qualcomm (QCOM - Analyst Report) latest generation of processors are positives for the company. The company has also garnered several partnerships with tablet makers such as 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., 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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