DTS Inc. (DTSI) reported third-quarter 2014 non-GAAP earnings of 31 cents per share compared with 13 cents reported in the year-ago quarter. Earnings also convincingly beat the Zacks Consensus Estimate of 17 cents per share. The year-over-year increase in earnings per share (:EPS) was primarily attributable to robust revenue growth exhibited in the third quarter.

Quarter Details

Revenues increased 26.7% on a year-over-year basis to $35.7 million. Revenues comfortably beat the Zacks Consensus Estimate of $32 million. Top-line growth was boosted by DTS’ network-connected segment as well as by the resolution of several royalty audit matters.

The network-connected business contributed approximately 50% of total revenue in the quarter, primarily driven by TV.

Revenues from base markets including Blu-Ray, Home AV and automotive remained flat in the reported quarter as an increase in sales of console driven games in Blu-ray was offset by a continued decline in home AV. Blu-Ray contributed just about 20% of revenues, while Home AV and automotive chipped in with a 10% and 15% share, respectively.

Operating expenses (excluding amortization & acquisition cost but including stock-based compensation) jumped 10.5% year over year to $27.5 million, primarily due to an increase in spending on new product initiatives.

DTS reported operating profit (excluding amortization & acquisition cost but including stock-based compensation) of $7.1 million compared with $3.1 million in the previous-year quarter. Operating margin expanded 880 basis points (bps) on a year-over-year basis to 19.9% in the third quarter.

Net income (excluding amortization & acquisition costs but including stock-based compensation) was $5.3 million compared with $2.5 million reported in the previous-year quarter.

During the quarter, the company signed a new expanded long-term global agreement with LG through which the latter will integrate DTS decoders in its 4K connected TVs, sound bars, AVRs and other equipment.

Dts, Inc - Earnings Surprise | FindTheBest

Balance Sheet & Cash Flow

Exiting the third quarter, DTSI had cash and short-term investments of $86.5 million. The company generated operating cash flow of $20.2 million in the quarter.

Outlook

DTS expects 2014 revenues to range between $140 million and $144 million. The Zacks Consensus Estimate for revenues happens to coincide with the lower end of management’s guidance range. Non-GAAP operating margin is expected to be in the mid to upper 20s range. Non-GAAP EPS is expected to range between $1.48 to $1.55 while the Zacks Consensus Estimate for the same is pegged at $1.00.

The company continues to expect organic growth in 2014 to come primarily from the network-connected markets, specifically connected TVs, mobile devices and PCs. Network-connected markets are expected to represent more than 50% of total revenue in 2014.

Recommendation

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, digital media players and the network-connected TV space.

We believe that the Play-Fi technology positions the company extremely well to capture a larger share of the expanding wireless audio market.

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 revenues from the acquisition of SRS labs will drive top-line growth in the long term.

Additionally, the partnership with Samsung to provide sound solutions for TV and inclusion of DTS’s technologies in Qualcomm’s (QCOM) latest generation of processors are positives for the company. It has also entered into several partnerships with tablet makers such as Pantech, Lenovo and Panasonic.

However, the company faces significant competition from Dolby Laboratories Inc. (DLB), Sony Corp. (SNE) and privately-held THX Limited, which may hurt its profitability.

Currently, DTS sports a Zacks Rank #1 (Strong Buy).

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