DTS Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: DTS, Inc. (DTSI)


Q3 2013 Earnings Call

November 06, 2013 4:30 pm ET


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


Steven B. Frankel - Dougherty & Company LLC, Research Division

James Medvedeff - Cowen and Company, LLC, Research Division


Good day, ladies and gentlemen. Thank you for standing by. Welcome to the DTS Third Quarter 2013 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, November 6, 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 third quarter 2013 financial results. Joining me on the call today are Jon Kirchner, Chairman and CEO; Mel Flanigan, CFO; and Brian Towne, COO. Before we begin, I would like to provided 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 Factors section in our SEC filings, included in 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, and impute a normalized 40% effective tax rate on the pretax earnings of the company. 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.

The 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.

Melvin L. Flanigan

Thanks, Anne, and good afternoon, everyone. I'll review market and financial performance as well as our 2013 outlook and then turn the call over to Jon for his strategic comments and observations on how we're positioned for the remainder of 2013 and beyond.

Revenue for the quarter was $28.2 million, up 27% year-over-year. Our network-connected business continues to drive growth, coming in up 104% year-over-year. For the fourth quarter in a row, this business was the largest contributor to total revenue at over 45%.

Breaking down the network-connected category. Network-connected TV revenue was the leader, up 92% year-over-year. DTS is now in over half of all smart TVs, and the market continues to experience tremendous growth as network connectivity enables consumers to enjoy a wider base of higher quality content in the home.

We continue to provide OEMs with greater opportunity to differentiate their product offerings through enhanced services and innovative technologies that help overcome the physical challenge of today's flat TVs. Simply put, our technologies make TVs sound better. Over time, we expect the overall market and our penetration to continue to grow.

Network-connected PC revenue grew 429% year-over-year and our share in this large market continues to grow. We're attracting more interest from PC manufacturers who are finding our combination of the solutions with decoders, audio processing and Play-Fi to represent the most robust, complete and compelling PC entertainment suite available today.

Mobile was up 130%, continuing its growth in Q3. Our technology is now incorporated into more than 180 unique smartphone models, and interest for mobile product manufacturers in our newest audio solution, which Jon will describe in a moment, has been very encouraging.

We expect phones incorporating DTS' newest technology Headphone:X to begin shipping next spring, which will result in mobile revenue further ramping in the second half of 2014.

Blu-ray revenue was down 10% year-to-year and comprised over 20% of revenue in Q3. Much of this decline was caused by anticipation surrounding the new game console cycle and as consumers pause ahead of the 2 major new product releases. We're confident, though, that these new game consoles will drive some pick-up in the Blu-ray market, most likely impacting our revenue beginning in Q4 2013 and ramping into next year.

Sales of Blu-ray discs continue to grow nicely, with the trade group DEG reporting overall sales of Blu-ray discs up 15% in the first half of 2013 and sales of new titles on Blu-ray up even more at 19%.

Electronic sell-through was up 50% in the same time period. So it's clear that, as we've said for some time, Blu-ray and electronic sell-through will continue to coexist for the foreseeable future.

Home A/V was down 12% from a year ago, reflecting the continuing market decline in DVD-based products and home-theater-in-a-box systems as consumers transition to Blu-ray and connected devices. Overall, home A/V represented just under 15% of revenue again this quarter.

Auto was down negligibly relative to the last year, and comprised under 15% of revenue. Broadcast was up modestly over last year and continues to represent less than 5% of revenue.

Now let's turn to the financials. Non-GAAP gross margin was 99% in the third quarter. GAAP gross margin, which includes amortization of certain purchased intangibles, was 91%, flat with the third quarter of 2012.

GAAP operating expenses, less the impact of certain fair value adjustments, totaled $26.3 million compared to $32.9 million in the third quarter of 2012.

During the quarter, because sales of Phorus-branded speakers have trended below our original expectations, we adjusted both the contingent consideration liability and the asset carrying values related to the Phorus acquisition, resulting in a net P&L credit of $2.5 million

To be clear, these adjustments relate to the Phorus-branded hardware business, which is distinct from the underlying Play-Fi technology and our ongoing and positive strategic efforts to develop and build out the Play-Fi platform.

On a non-GAAP basis, operating expenses were $22 million compared to $21.7 million in last year's third quarter. Operating income improved significantly year-over-year, coming in at $1.9 million on a GAAP basis compared to an operating loss of $12.8 million in the third quarter of 2012.

Non-GAAP operating income was $6 million compared to $440,000 last year. Similarly, GAAP net income was $2 million, or $0.11 per diluted share, compared to a net loss of $19.1 million, or $1.04 per share, in the third quarter of 2012.

On a non-GAAP basis, net income was $3.6 million, or $0.19 per diluted share, compared to a net loss of $11.1 million, or $0.61 per share a year ago.

With respect to income tax, our third quarter 2013 GAAP results reflect the full year projected effective tax rate of 65%, as we continue to provide a valuation allowance against future U.S. tax benefits as we've described in previous quarters.

We're making progress towards resolving the U.S. valuation allowance issue, and we expect to provide a thorough update on our next call. Until then, we expect some volatility and we anticipate a more favorable tax rate beginning next year.

Overall, our year-over-year comparisons of various profitability measures reinforce the progress we've made as we affect the strategic migration of the business. We believe that 2014 will see further improvement in our business and financial performance, as we reap more benefit from years of work and recent strategic acquisitions.

Moving to the balance sheet. We finished the quarter with $81 million in cash and investments, and generated more than $11 million in cash flow from operations.

During the quarter, we repurchased 278,000 shares of our common stock for a total of $5.7 million. That leaves us with about 800,000 shares remaining under the current repurchase authorization.

At current valuations, we expect to continue to work expeditiously to close out our repurchase authorization as soon as we can, given the existing trading volume restrictions.

Further, we expect resolution of our various international tax issues to improve our cash flow into the U.S., which in turn should facilitate our ability to more aggressively repurchase shares.

Now let's move to the Q4 outlook. Q4 is typically our seasonally strongest quarter, and we expect our growth drivers will continue to come from the network-connected markets, particularly TVs and mobile devices, plus the addition of a meaningful contribution from the new game console cycle.

We expect the sequential growth to be partially impacted by some broader CE market weakness in the short term, which has us guiding revenue to the lower end of the previously stated range of $130 million to $136 million for the year. Importantly, looking ahead into 2014 and beyond, we remain confident in our long-term growth prospects and in our ability to drive greater operating leverage as revenues increase.

Non-GAAP operating margin is expected to be in the lower to mid-20s, and non-GAAP EPS in the range of $0.98 to $1.12 per diluted share based on a normalized 40% effective tax rate.

Stock-based compensation expense is expected to be in the range of $0.38 to $0.41 per diluted share net of tax, and amortization of intangibles is expected to be in the range of $0.32 to $0.35 per share net of tax in 2013.

On a GAAP basis, the contingent consideration and asset fair value adjustments mentioned earlier net to an increase in our expected GAAP operating margin of approximately 2 percentage points and an increase in expected GAAP EPS of approximately $0.08 per share.

As a result, we expect GAAP operating margin of approximately 5% to 8%, and GAAP EPS in the range of $0.03 to $0.08 per diluted share.

With that, I'll turn the call over to Jon.

Jon E. Kirchner

Thanks, Mel, and thank you, everyone, for joining us.

Our results from the third quarter reflect our continued progress over time in penetrating network-connected, even as we experienced some weakness in the traditional consumer electronics market.

Looking at the big picture, we've been talking about network-connected driving growth for some time now and tracking our progress over the last few years. We are seeing momentum in the business build as key new products launch and we continue to pursue our strategic goals.

As our business continues to ramp in newer markets like mobile, and we increasingly bring a more advanced suite of technologies, it is important to remember that our ability to drive growth on the margin is partially dependent upon the extent to which customer product shipments happen as originally expected.

As we've seen this year, unforeseen delays in customer product shipments can cause our revenues to shift from quarter-to-quarter and will remain a challenge until we have a larger base of business to absorb this kind of errant volatility.

That said, we are very optimistic about the long-term picture. Over the past 2 years, DTS has significantly evolved our business and strategic direction to address the huge new opportunities being created by the connected on-the-go consumer lifestyle.

We are no longer just a codec company. Today, we are the provider of a complete and unparalleled set of audio solutions catering to the network-connected ecosystem. We believe DTS is laying the foundation for a transformative audio experience anytime, anywhere, on any device and on any platform.

We are creating value for the entire ecosystem from the artists who want to use our enhanced technologies, to OEMs who are trying to address multiple platforms and want to differentiate their products, to the end users who are increasingly demanding a superior audio experience everywhere they go.

One key element of this superior experience is our Headphone:X technology, which fundamentally addresses how an ever larger percentage of entertainment is and will be consumed.

Headphone:X continues to generate excitement and very positive reactions from across the ecosystem, including artists, labels and studios. Most importantly, Headphone:X is gaining interest from OEMs and not only because we can deliver a compelling spatial audio experience for music, movies and games, the Headphone:X platform is much more than that. It is the beginning of a compelling, multi-year roadmap that we believe will transform how consumers interact with and enjoy their entertainment.

We now expect to see initial products come to market in the first half of 2014 with continued launches throughout the year.

We are also excited about our Play-Fi technology platform, which continues to generate buzz in the industry. Importantly, we recently announced that Play-Fi streaming is now compatible with iOS, expanding Play-Fi compatibility to hundreds of millions of connected devices.

We now license the only wireless audio platform solution that can deliver a true cross-platform experience across Apple, Android and Windows PC devices for 2014 product implementations.

This is a boom for consumers with multiple devices on different platforms, like households who own a mix of Android and Apple products, as well as the speaker manufacturers who can now support Play-Fi, DLNA and other streaming technologies on a single product SKU. We are pleased to be collaborating with Core Brands to deliver whole home multi-room wireless streaming systems based on Play-Fi technology. Core Brands own Speakercraft, Niles, Sunfire and other leading audio brands in the high-performance custom install and retail space.

Additionally, we have signed contracts with 5 OEM manufacturers that are currently building their own Play-Fi-enabled reference designs across a number of form factors.

In an effort to further expand content support for the platform, during the quarter, we announced an agreement with Deezer to integrate its global music service into the Play-Fi app for Android, allowing millions of Deezer's subscribers around the world to stream music on Play-Fi-enabled products over a standard Wi-Fi network. We expect more announcements regarding Play-Fi as we enter 2014, and we look forward to showcasing some of our Play-Fi developments at CES.

On the content and tools front, we recently had a very strong show at IBC where we demonstrated a range of available DTS solutions for OTT, broadcast and streaming delivery, including our innovative layered-audio solution, which enables online media services to offer adaptive bit-rate audio streaming from a single encode. Customers are increasingly showing interest in our solutions as the market moves toward higher definition experiences and industry players begin to focus on differentiating their services.

On the device side, we've just come off the most robust customer roadshow in our history. And we're seeing particular interest from manufacturers and service providers regarding our ability to provide comprehensive end-to-end solutions that truly address the primary use cases and challenges facing today's connected consumer.

We are committed to building a long-term ecosystem around the Headphone:X and Play-Fi technologies, and as a result, we're taking the time necessary to ensure we lay a truly strategic foundation. While we do this, we expect the revenue trajectories from both of these technology platforms to develop as we move through 2014 and accelerate more aggressively in 2015.

All of my comments today really focus on one key thing: Progress. We continue to drive our long-term strategic agenda and many of the goals we've set are increasingly being realized despite some time shifting here and there. I am very positive on how we're positioned to continue driving long-term growth from the large and evolving network-connected market.

We look forward to seeing many of you at CES in January where we, again, will be hosting a VIP analyst event. At the show, we expect to have meaningful news about our progress with partners, products and technologies.

With that, I'll turn the call over to the operator for questions. Operator, Please go ahead.

Question-and-Answer Session


[Operator Instructions] And our first question is from Steven Frankel with Dougherty & Company.

Steven B. Frankel - Dougherty & Company LLC, Research Division

Maybe you could help me by refining some timing issues. When do you expect these Play-Fi licensees to have -- to be shipping product? And the same goes for the UltraViolet files with DTS soundtracks?

Jon E. Kirchner

Okay, we expect -- let me start by saying, we've got, obviously, product in the market today. But in terms of seeing some of that acceleration, I think you're talking about for 2014-related shipments, likely in the back half of next year based on what we're seeing from people today. With regard to UltraViolet-related files, we're continuing to work on the back end of things and as you know, UltraViolet has not yet essentially gone out in a big way from studios but we do expect to see files available through UltraViolet and third-party partners certainly as we get into the first half of next year.

Brian D. Towne

Steve, this is Brian. I'd add on that. When we talk about UltraViolet, we specifically talk about something that's called CFF, known as the Common File Format and that's what really the 1.0 spec I'm told now is up for ratification and you'll see that in 2014.

Steven B. Frankel - Dougherty & Company LLC, Research Division

And then could you refine for us what percentage of revenue is coming from mobile today?

Melvin L. Flanigan

So Steve, we're -- this is Mel. We're not providing a lot of granularity around network-connected yet, as you're, I think, aware until we see the market maturing a little bit more. When we talk about network-connected being north of 45% of the total revenues, TV is certainly the largest percentage of that and mobile makes up a smaller portion. We're on roughly single-digit penetration in the mobile space today.


And your next question comes from James Medvedeff with Cowen and Company.

James Medvedeff - Cowen and Company, LLC, Research Division

So my question is around the TV market. We're hearing that the TV market is a little bit softer, and I'm wondering how that has impacted your sell-in or your customers sell-in in the third quarter, which would impact the fourth quarter royalty receipts? And then I have a follow-up.

Brian D. Towne

James, this is Brian. I think as you know, we work on a one quarter lag, so we are just now starting to see reports around what Q3 manufacturing look like. So we really can't speak to how people built in for the holiday season as of yet. I think for us, what's more important is really the work we've been doing around what new products will be shipped at CES and announced. And I think we're pretty pleased with the progress of the team has made around the world and look forward to sharing some of that with you here in about 45 or 60 days.

James Medvedeff - Cowen and Company, LLC, Research Division

Okay. And my follow-up question has to do with the emerging UHD-TV market. Products are shipping, small quantities, and I'm wondering what sort of advance intelligence you're seeing on a how much that may pull through of replacement of existing home A/V equipment, for example, or just pull through more demand for surround sound, in general?

Jon E. Kirchner

It's a great question and I think it's also too early to tell. Certainly, there's a lot of energy. It's the first time since the attempt of launching 3D that the TV manufacturers have had a true reason to increase their ASPs. We have seen public statements from a couple of licensees that, that, in fact, is happening through the independent retail channels. So they're excited about the potential. I think consumer feedback has been good and they understand it. But we're in a very, very early times around 4K and UHD. Obviously, there are limited ways to obtain that technology. We expect -- we're content in that format. We expect that to grow moving into 2014. And there's still some technical barriers around HDMI 2.0 and upgrading in the connectivity for true 4K at 60p.

Jon E. Kirchner

Jim, I would add just one more data point, which is I do think, as you think about UHD, in general, that as we get into '15, '16, '17 and all of a sudden there is real ecosystem support for 4K, which means not just panels are available but you've got content available, I do think there will also be a meaningful, if you will, upgrade in next-generation audio-related technology that will drive a new replacement cycle, if you will, in order to get the best of both the video and the audio experience.


[Operator Instructions] And we have a follow-up question from James Medvedeff with Cowen and Company.

James Medvedeff - Cowen and Company, LLC, Research Division

What I'll -- the other -- the third question that I had, and I thought I'd let other people in, has to do with the timing of the game console sell-in. You said that you expect to see some of that in Q4 and I understand those reports are just becoming available. But just order of magnitude, could you sort of give us a sense of size of, like, say if the Christmas selling season, if the holiday selling season is x, then what percentage of x for that game console business do you think will show up in the Q4 results and how much will be in Q1 of next year?

Jon E. Kirchner

Really, really, really hard to say because we don't have a good sense of what's being airfreighted in, in Q4 in order to meet the retail demand versus what's on boats and, so on and so forth because we candidly haven't seen now reporting around either console yet. So in a different time period where we maybe have some historical experience and greater visibility, we might have a slightly different answer. But at this point, can't tell you which is one of the things that we've been looking at all year long. In fact, we originally thought we might begin to see some stuff in Q3, but we have not. So what we do know is that there's a retail date. There's a lot of enthusiasm in the consumer channel for the consoles and hopefully, that bodes well as we begin to see some of the manufacturing reports. So Jim, [indiscernible]...

James Medvedeff - Cowen and Company, LLC, Research Division

But you do see -- I'm sorry.

Brian D. Towne

Sorry. Go ahead. I was just going to add the color that I was with a couple of executives from Sony Computer Entertainment 2 weeks ago. They're clearly manufacturing, they clearly have our technology. They're not really talking around timing because I think it's very -- and how much their shipping into which markets because it's very sensitive information internally to them. The other thing I would say, they've been manufacturing for a while, so we certainly are going to see some revenue. We've been working on -- because there are slightly different technology sets upgrading from, for example, PS3 to PS4, that requires some new contract in which we're just buttoning up. After which we'll start to see some reporting.


This concludes the question-and-answer session. As a reminder, a replay of this call will be available on the Investor Relations section of the company's corporate website at www.dts.com. An audio replay of the call will also be available by dialing 1 (800) 406-7325 or 1 (303) 590-3030 outside the U.S. and Canada, and entering passcode 4646564-pound. Thank you for your participation in the call today.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!