Executives
Anne McGuinness
Melvin L. Flanigan - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance
Jon E. Kirchner - Chairman and Chief Executive Officer
Brian D. Towne - Chief Operating Officer and Executive Vice President
Analysts
Paul Coster - JP Morgan Chase & Co, Research Division
Andy Hargreaves - Pacific Crest Securities, Inc., Research Division
James C. Goss - Barrington Research Associates, Inc., Research Division
Robert W. Stone - Cowen and Company, LLC, Research Division
Steven B. Frankel - Dougherty & Company LLC, Research Division
DTS (DTSI) Q4 2012 Earnings Call March 11, 2013 4:30 PM ET
Operator
Good day, ladies and gentlemen. Thank you for standing by. Welcome to the DTS Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Monday, March 11, 2013. I would now like to turn the conference over to Anne McGuinness of DTS Investor Relations. Anne, please go ahead.
Anne McGuinness
Good afternoon, ladies and gentlemen. Thanks for joining us as we report fourth quarter and fiscal year 2012 financial results for DTS. Joining me on the call today are Jon Kirchner, Chairman and CEO; Mel Flanigan, CFO; and Brian Towne, COO of DTS.
Before we begin, I would like to provide 2 reminders. First, today's discussion contains forward-looking statements that are predictions, projections or other statements about future events, which are based on management's current expectations and beliefs and therefore, subject to risks, uncertainties and changes in circumstances. Please refer to the Risk Factor section in our SEC filings, including our most recent forms 10-K and 10-Q for more information on the risks and uncertainties that could cause our actual results to differ materially from what we discussed today. Please note that the company does not intend to update or alter these forward-looking statements to reflect events or circumstances arising after this call.
Second, we refer to certain non-GAAP financial measures, which generally exclude charges for stock-based compensation, amortization of intangibles and certain acquisition and integration related expenses and the related tax effects, if any. We have provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the earnings release and on the Investor Relations section of our website. A recording of this conference call will be available on our Investor Relations website at www.dts.com, and unauthorized recording of this webcast is not permitted.
Now I will turn the call over to Mel. Please go ahead, Mel.
Melvin L. Flanigan
Thanks, Anne, and good afternoon, everyone. I'll review the financials and our 2013 outlook, then turn the call over to Jon for his strategic comments and observations on how we're positioned coming off a very productive and transformational 2012.
Revenues in the fourth quarter came in at $29.8 million, up 9% year-over-year and 34% sequentially. Full year revenues were $100.6 million, up 3% over the prior year. We continue to be pleased with the performance of our network-connected business, which grew 86% in the fourth quarter on a year-over-year basis.
Similar to last quarter, we saw impressive year-over-year growth rates in several segments of this business, with connected PCs up 259%, mobile up 126% and network-connected TVs up 86% in the fourth quarter. Consistent with our expectations, the network-connected business was the largest contributor to total revenue for the quarter at nearly 40%.
On full year basis, network-connected was up 58% year-over-year and represented just under 30% of total revenue. As we've said previously, we expect this business to continue to increase as a percentage of total revenue and to be our largest revenue contributor going forward.
As expected, SRS contributed revenues in the $7 million range, most of which falls into the network-connected markets category. Importantly, DTS and SRS technologies are now offered as fully integrated solutions and thus, we will not be providing separate SRS detail going forward. I'm also pleased to report that we fully realized our target synergy goals.
Blu-ray revenue for the quarter was up 19% sequentially as a result of typical seasonality, although down 30% year-to-year due to a stronger Q4 2011 holiday season and lower ASPs due to a changing product mix. We began to see the configuration of players change in the fourth quarter as Blu-ray players mature into the lower ends of the mass market. Historically, ASPs peak north of $0.75 per unit and are now, depending on the product mix in any particular quarter, expected to average in the lower 60s, still well within the $0.50 to $0.75 range we've previously discussed.
Overall, Blu-ray contributed north of 25% of total revenue for the fourth quarter and just over 30% of total revenue for the year. Blu-ray is still the gold standard for quality. We believe it will remain relevant within digital video entertainment as the demand for high-end, higher-resolution content continues to increase.
For example, Blu-ray Disc sales were up 10% in 2012, and the catalog of titles continues to expand. Also, keep in mind that Blu-ray enables us to maintain a meaningful revenue stream with low marginal expense.
Home A/V was down 9% for both the quarter and the full year as consumers continue to transition from DVD to Blu-ray and network-connected devices. The Home A/V category constituted just under 20% of total revenue for the quarter and just over 20% of total revenue for the year.
Q4 revenues for the automotive business saw relatively modest year-over-year growth of 2% for the quarter and 7% for the year. Automotive contributed nearly 15% of revenue for both the quarter and the year. This segment remains quite interesting to us as the automotive entertainment experience is increasingly integrated with mobile devices and cloud-based entertainment delivery. This opens the door for DTS to deploy a wider range of our audio solutions, which we expect will drive further growth in the space going forward.
Broadcast represented under 5% of revenue for both the quarter and the year. As a reminder, our broadcast business primarily consists of license fees for dedicated set-top boxes and professional broadcast equipments. To be clear, it does not include TVs, which we include in the network-connected category.
On a non-GAAP basis, gross margin for the quarter and year remained at nearly 100%. In the fourth quarter, GAAP gross margin of 94% showed the impact of our continuing business model transition, including the impact of amortization of purchased intangibles related to the SRS and Phorus acquisitions.
Non-GAAP operating expenses for the quarter were $22 million, up from the $14.4 million in last year's fourth quarter, due in part to ongoing expenses from our recently acquired businesses. On a GAAP basis, operating expenses totaled $30 million for the quarter, which included $4.8 million in integration-related expenses, $3 million in stock-based compensation and $253,000 in amortization of intangibles.
Non-GAAP SG&A was $15.2 million, up 37% from $11.1 million in the fourth quarter of 2011. This increase was partially attributable to incremental costs related to the SRS and Phorus acquisitions and increased spending on branding and various initiatives necessary to support our expanded product portfolio.
Non-GAAP R&D was $6.8 million in Q4, up from $3.3 million in the prior year's fourth quarter. The increase reflects our recent acquisitions and organic headcount growth in support of a robust R&D pipeline and accelerating product development activities like our recent demonstration of Headphone:X, which Jon will discuss in more detail shortly.
On a non-GAAP basis, operating income was $7.7 million compared to non-GAAP operating income of $14.6 million in last year's fourth quarter. Non-GAAP operating margin for the -- in the fourth quarter was -- of 2012 was 26% compared to 50% in the fourth quarter of 2011. GAAP operating loss for the fourth quarter of 2012 was $2 million compared to GAAP operating profit of $11.7 million in the fourth quarter of 2011.
On the bottom line, non-GAAP net income for the fourth quarter of 2012 was $6.1 million or $0.33 per diluted share compared to non-GAAP net income of $8.8 million or $0.52 per diluted share a year ago.
In the fourth quarter of 2012, GAAP net income was $302,000 or $0.02 per diluted share compared to GAAP net income of $7.1 million or $0.42 per diluted share in the fourth quarter of 2011.
GAAP net income for the fourth quarter of 2012 includes $0.15 per diluted share net of tax in acquisition and integration costs, $0.09 per diluted share net of tax in stock-based compensation expense and $0.06 per diluted share net of tax in amortization of intangibles.
In December, we finalized the settlement with the IRS regarding our Irish licensing headquarters operation. For the past few quarters, we've discussed our efforts to resolve certain matters with the IRS relating to our global legal structure. And after working with the IRS on this for a long time, we're pleased that it has been favorable resolved. While impacting our 2012 financial results, the tax settlement results in a reduction in cash taxes payable over the next several years and improves the ability of our Irish subsidiary to utilize withholding tax credits going forward.
We currently expect our effective tax rate to be in the upper 30s in 2013, and we expect it to trend down from that point in the future as our profitability in both absolute and percentage terms improves. However, in the near term, we may continue to experience some variability in our tax rate resulting from the impact of geographic earnings on our ability to realize both deferred tax assets and withholding tax credits paid in foreign jurisdictions.
Turning to the balance sheet. We generated $14.8 million in cash flow from operations in 2012 compared to $24.2 million in 2011. We closed the year with cash and investments totaling $77 million and $30 million of long-term debt. During the quarter, we repurchased an additional 564,000 shares of our common stock at an aggregate cost of $8.7 million. We have approximately 1.2 million shares remaining under our 2 million share repurchase authorization.
Moving onto our outlook. For 2013, we expect revenue in the range of $140 million to $146 million, including a normal level of royalty recoveries. Midpoint of this range reflects approximately 42% year-over-year growth, of which, we expect roughly 16 percentage points to be from organic growth and approximately 26 percentage points from acquired technologies, which have now been integrated into our ongoing business. The primary growth drivers will continue to come from the network-connected markets and particularly, from TVs and mobile devices. We expect the network-connected markets to grow to more than 40% of total revenues in 2013, with TVs comprising more than half of that amount.
We expect Blu-ray to be nearly 25% of revenue, reflecting the impact of the new game console cycle, flat to minimal growth in standalone players and a modest decline in Blu-ray-enabled PCs. We expect the automotive market to be between 10% and 15% of revenue and home A/V just under 15% of total revenue in 2013.
Based on reports regarding the 2012 holiday season, we expect revenues to be sequentially flat in Q1 and to accelerate in the second half of 2013 based on known or expected product releases resulting from development activities in 2012.
We expect non-GAAP operating margins in the low to mid-20s and non-GAAP EPS in the range of $1.05 to $1.20 per diluted share. In 2013, stock-based compensation expense is expected to be in the range of $0.44 to $0.47 per diluted share net of tax, and amortization of intangibles is expected to be in the range of $0.39 to $0.42.
On a GAAP basis, we expect an operating profit of approximately 3% to 6% and EPS in the range of $0.22 to $0.31 on an estimated 18.5 million weighted average shares outstanding.
With that, I'll turn the call over to Jon.
Jon E. Kirchner
Thanks Mel, and thank you, everyone, for joining us today. The fourth quarter concluded an important year for DTS as we made significant progress on our strategic priorities. We believe the Q4 results demonstrate this progress and the success we've had in shaping our business for where the market is going, a fully network-connected world dominated by mobile devices and cloud-based entertainment delivery. We're seeing growth where we expected it, and we continue to see the strong cash-generating power of the business. Most importantly, we are particularly excited about where we stand heading into 2013.
Over the past 2 years, we've been talking to you about our focus on the network-connected space. We've made a number of investments in support of this strategy. With the SRS and Phorus acquisitions successfully completed and fully integrated in 2012 and with a number of new products and partnerships recently showcased at CES and Mobile World Congress, we have begun to demonstrate how these investments will accelerate our progress and increase the unique value proposition of DTS in the network-connected space.
We are confident that DTS will have an important role to play in the cloud-based delivery of high-quality entertainment. Products and services that we have acquired and developed organically over the past 2 years have completely transformed our business. We have come a long way from our days as predominately a premium surround sound codec company servicing the home theater and optical media markets. DTS now brings a truly complete and unparalleled set of audio solutions and services focused on serving a much broader market opportunity, including the vast market for mobile, portable and wireless audio entertainment products. Our solutions address how users consume their entertainment today, anytime, anywhere, on-the-go on multiple devices, products that are immersive, personalized and simple, making DTS the best solution for playback of cloud-based entertainment.
So let's talk about mobile. Sound matters on mobile devices. Over the past 5 years, the significant investments and improvements made by manufacturers in video and UI technology have set the stage for higher-quality entertainment experiences. Yet, much of the emotion and experience in movies, video, games and music comes from audio, which to date, has not been the primary focus of product innovation. That is beginning to change as the industry increasingly recognizes this fact.
Take for example the popularity of premium headphones, demonstrating that consumers are willing to spend hundreds of dollars for a better mobile entertainment audio experience, and herein lies our opportunity. Our enhanced product suite and global service platform is generating a tremendous amount of excitement amongst our customers who are increasingly viewing us as the go-to source for best-in-class audio technologies for tomorrow's mobile products.
Let me give you a quick review -- overview of where we are in each of our markets heading into 2013. In TV, we are continuing to increase our footprint in the network-connected TV space. This segment of the market continues to grow rapidly and is expected to represent about 1/3 of all digital TVs sold in 2013. As a reminder, with Sony now shipping, we have licensing relationships with all of the top 10 connected TV manufacturers and estimate that by the end of 2013, we will be in over half of connected TVs. Due to growing demand for our audio solutions, we are continuing to expand our customer relationships and broadening our TV footprint.
In January, we announced that Samsung, the world's largest TV manufacturer, will be incorporating DTS Studio Sound, Premium Sound, Premium Sound 5.1 technology suites into their 2013 Smart TV lineup. We also announced the integration of DTS' decoding capability within certain models of Panasonic's new PDP and LCD TVs in North America.
We are also continuing to make great strides in mobile. DTS technology is now incorporated on Qualcomm's latest generation of processors, Snapdragon 800 and 600, both of which are currently sampling and expected to be available in commercial devices in the latter half of 2013. Our growing partnership with Qualcomm and the inclusion of DTS technologies in their industry-leading chip platforms makes it significantly easier and faster for our customers to deploy DTS' advanced audio solutions in their devices. This is expected to help drive the accelerated penetration of DTS solutions on phones and tablets going forward. In fact, this acceleration is already taking place.
In the past few months, we've announced a number of new mobile handsets featuring DTS solutions, including mobile phones from Huawei and Acer. We also recently announced that DTS Sound will be incorporated into Spice Mobiles' latest smartphones which will begin shipping in May. Spice Mobile is India's largest mobile handset brand. Overall, DTS technology is now incorporated in more than 150 unique smartphone models.
We're also beginning to see more activity in the tablet space, with announcements from partners like Pantech, Lenovo and Panasonic, indicating their upcoming tablet products will feature enhanced audio solutions from DTS.
We made significant progress in the PC space during 2012 as well, including enhancing our suite of audio solutions and services for the PC market with the SRS acquisition. The SRS team brought strong relationships with premier PC manufacturers such as ASUS, HP, Toshiba and others, and the combination of a larger technology portfolio and a stronger DTS brand has positioned us well for accelerating PC growth over time. Importantly, despite the limited penetration of Blu-ray in PCs, we expect the PC business to grow meaningfully going forward as we focus on licensing our solutions in support of network-connected entertainment delivery and playback.
In the wireless audio space, our recent Phorus acquisition has extended our opportunity in both mobile and the home through the launch of DTS Play-Fi, groundbreaking wireless audio delivery technology targeting the rapidly growing market for wireless speakers. This technology allows consumers to easily and affordably stream high-definition music from smartphones, tablets and PCs over standard 802.11 wireless home networks.
Importantly, it allows multiple smartphones to deliver up to 8 different streams of music to up to 8 Play-Fi compatible speakers simultaneously. Play-Fi enables you to distribute perfectly synchronized music throughout an entire house right from the phone, even if that phone is used to make calls, send email or play games. Play-Fi was very well received at CES. In January, we also announced support for Play-Fi with Windows, as well as for the Android ecosystem. We expect modest revenues from Play-Fi in 2013 and further acceleration in 2014 and beyond, as we continue to build out the platform for this business.
On the content front, we continue to make progress in building out the tools necessary to support DTS technologies in cloud-based content ecosystems. During the quarter, we announced that Digital Rapids, Elemental Technologies and Rovi now support DTS Express surround sound for the creation of content in the UV format. In January, we announced support for DTS-HD in Microsoft's IIS media services and smooth-streaming platforms. This paves the way for all services using Microsoft smooth streaming to easily support the distribution of DTS-enabled content to network-connected devices.
Additionally, we announced a partnership with Moshcam, a video service that will stream high-quality live concert experiences in DTS through its Moshcam app. In the Mobile World Congress a few weeks ago, we announced the collaboration with Saffron Digital, who provides premium end-to-end video solutions on a global scale, customers including KDDI, Sky and HTC. This partnership will enable content providers and operators to stream UV content with DTS-HD encoded audio to network-connected devices through Saffron Digital's client.
Lastly, in January, we debuted our newest technology, Headphone:X, to rave reviews. This product is squarely focused on 2 key markets: Mobile and headphone accessories. Entertainment is increasingly being consumed on the go, and Headphone:X dramatically improves the portable entertainment experience, whether through ear buds or premium headphones. Our initial demo of the product at CES generated incredible industry and customer excitement.
At Mobile World Congress, we announced that we are partnering with Qualcomm to bring the technology to market on the Snapdragon 800 series chips later this year. We are very excited about this technology and look forward to sharing more Headphone:X updates with you over the course of the year.
In short, we remain intently focused on emerging trends in consumer entertainment consumption, and we are making significant progress in building a lasting network-connected business. After a year of such significant transformation, we are truly no longer a "surround sound company" or a Blu-ray story dependent upon optical media for future growth. We have strategically moved the business well beyond these boundaries and look forward to a much bigger market opportunities ahead.
I'd like to take a moment to thank all of our employees for their continued hard work and I also want to thank our partners and customers for their support and efforts during the quarter.
With that, I'll turn the call over to the operator for questions. Operator, please go ahead.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from the line of Paul Coster with JPMorgan.
Paul Coster - JP Morgan Chase & Co, Research Division
Really, it's to do with the royalty rights for Play-Fi, for Headphone:X, for the mobile applications. Can you give us some sense of what the business model is around each of those newer growth initiatives?
Jon E. Kirchner
Sure. Paul, we are in the process naturally of having a bunch of discussions with customers, industry-wide, about each of those technologies. And so at this point, given the sensitivity of those discussions, I don't think we're going to be in a position -- or won't be in a position, I think, prudently to provide that data, at this point. However, over time, I think we will certainly have more to say on the subject. But suffice it to say that we believe that these technologies, in addition to our long-standing technologies, will be licensed on a similar basis and increasingly, as part of suites of solutions that will, we think, provide attractive value for our customers and I think more than recover and provide attractive returns in the investments we've made in their development.
Operator
Our next question comes from the line of Andy Hargreaves with Pacific Crest Securities.
Andy Hargreaves - Pacific Crest Securities, Inc., Research Division
Maybe -- actually, a follow up to that. Can you give us any sense are -- are ASPs in the network-connected device segment basically holding up? Or has there been incremental competition that's driven pricing pressure there?
Jon E. Kirchner
No, Andy, I would say they are -- they're definitely holding up. And one of the things to appreciate here is that we are offering more technology today than we ever have and more compelling solutions. And so a straight apples-to-apples comparison, let's say, between what may have historically happened or around the licensing of a codec from one market to another is no longer really an apples-to-apples comparison because we're providing all these other technologies where we're really selling and licensing solutions, which solve problems and they have their own market value estimates that are, we think over time, going to hold up very well and ever more so, as we add more and more innovative technology to the mix to provide people with better performing products.
Andy Hargreaves - Pacific Crest Securities, Inc., Research Division
And then you've had quite a few design wins in the network-connected space recently. Do you expect most of those to lead to meaningful revenue this year or does some of that not show up until 2014?
Jon E. Kirchner
I think you're going to see a mix. I mean, some of it certainly will come in the back half of the year. Some of -- we tend not to announce things that are happening way, way out in front of us. So we wouldn't typically be announcing anything that's not happening until '14 at this point. But with customer product schedule -- release schedules always being slightly subject to change. You may see some things late in the year push into '14. But generally speaking, I would say that what you're seeing announcements about has been the cumulative effort that's been going on for the last year or 2 and product that we expect to hit the market in '13.
Andy Hargreaves - Pacific Crest Securities, Inc., Research Division
And then last, this is a little speculative, but are you guys anticipating in your guidance consoles from 2 OEMs that have Blu-ray players in them this year?
Jon E. Kirchner
I think we expect the console cycle to result into increased gaming revenues, but not in a position to comment on the specifics.
Operator
Our next question comes from the line of Jim Goss with Barrington Research.
James C. Goss - Barrington Research Associates, Inc., Research Division
I'm wondering if in the television space, connected television device or maybe even more so in the smartphone area, does Dolby's presence in certain devices make it impossible for DTS rendering it unnecessary? Or is there still a likelihood that both of you can wind up in the same devices?
Brian D. Towne
Jim, it's Brian. Absolutely, we believe that not only our 2 companies technologies, but other technologies reside in the devices side-by-side, particularly when you're talking about the codec transport business. As you think about post-processing and audio rendering, it can turn into an either or, which is why we are incredibly focused on providing new and unique experiences such as Headphone:X.
James C. Goss - Barrington Research Associates, Inc., Research Division
Okay. And could you go into a little more detail in Headphone:X? And does any of this involve the psychoacoustics you've talked about such that you can get a 5.1 surround experience through those channels? Or are there limiting factors using that amount of information?
Brian D. Towne
Jim, it's somewhat complex. But if you think about the Headphone:X as the portable equivalent to Neo:X, which we launched as 11.1 kind of 3D experience a couple of years ago, it is psychoacoustic-related. But throughout the value chain, right out to headphones, there are very unique things we can do.
Operator
Our next question comes from the line of Rob Stone with Cowen and Company.
Robert W. Stone - Cowen and Company, LLC, Research Division
My question -- I have 2 questions, if I may. First, can you comment on the run rate of expenses excluding the acquisition integration related? And is there going to be any further integration expense this year?
Melvin L. Flanigan
So on the last part of that, Jim -- or Rob, the answer is no. We have fully integrated both businesses, and the vast majority of those expenses have already hit the P&L. In terms of the run rate, if you do the math to get to the guidance that we gave, you'll see that it's going to be running -- OpEx is going to be running in the mid-20s, for the most part, for the -- throughout the year, probably a little bit higher in Q1 just because there's a couple of big trade shows. And then, generally, at the end of the year, there's another peak in Q4.
Robert W. Stone - Cowen and Company, LLC, Research Division
Okay. And in terms of the contribution of, particularly Play-Fi and Headphone:X, you've said that's sort of a second half phenomenon, given OEM licensing being recognized in arrears, stuff gets launched in the Q3 time frame, the first revenue you would see is in the fourth quarter. So is that the right way to think about it? What revenue you'll get from these new technologies is most likely going to be in the fourth calendar quarter?
Melvin L. Flanigan
Yes, most of the revenue will be in the fourth calendar quarter. We will see some prior to that, but there clearly will be a larger ramp at the end of the year.
Robert W. Stone - Cowen and Company, LLC, Research Division
Okay. So in terms of the quarterly trends, I just wanted to make sure I interpreted your prepared remarks correctly, where you said the sequential trend versus December was going to be relatively flat because of a weak 2012 holiday season. Would we still expect to see Q2 the lowest quarter of the year as is the usual pattern?
Melvin L. Flanigan
Yes, Q2 is typically going to be the lowest quarter. I don't know that we'll see the significant falloff in Q2 that we have in some years in the past where it's been as much as 25% down quarter-to-quarter. But it will likely be a little softer than Q1.
Robert W. Stone - Cowen and Company, LLC, Research Division
Yes. With a flat March versus December, I wouldn't expect it to be down as much.
Operator
[Operator Instructions] Our next question comes from the line of Steven Frankel with Dougherty & Company.
Steven B. Frankel - Dougherty & Company LLC, Research Division
On Play-Fi, are you having success getting third parties to license this technology? Or in the near term, should we just expect these revenues to come from products that you're going to produce?
Brian D. Towne
Steve, it's Brian again. We are certainly selling the Phorus-branded products. We made 2 announcements publicly, in and around CES, a second hardware manufacturer by the name of Wren, W-R-E-N and an announcement around ASUS having drivers on their products in the second half of the year. We are aggressively pursuing this. CES was a great show for us, which was really the first true public coming-out outside of the announcements in September, followed up at Mobile World Congress in Barcelona a couple of weeks ago. So we are still working on what the second half of '13 revenue will look like, but certainly believe '14 is when you will really start seeing revenue.
Operator
Ladies and gentlemen, this concludes the question-and-answer session for today, as well as the DTS Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. We thank you for your participation in today's call, and you may now disconnect.
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