DTS Sees Physical and Digital Coexisting Despite Q3 Drop in Blu-ray Revenues

Referring to DTS as “no longer just a codec company,” CEO Jon Kirchner said on its Q3 earnings call late Wednesday that the company is “laying the foundation for a transformative audio experience anytime, anywhere, on any device and on any platform.” The company’s Q3 results reflect progress in its effort to penetrate the network-connected market, while it is experiencing “some weakness” in the traditional CE market, Kirchner said.

Five OEMs are building Play-Fi-enabled reference designs “across a number of form factors” that will likely appear toward the back half of 2014, Kirchner said. DTS acquired Play-Fi developer Phorus in July 2012 and announced in September (CED Sept 20 p1) a collaboration with Core Brands for a multi-room lossless audio product based on Phorus for the custom channel. Also in the quarter DTS announced an agreement with Deezer to integrate its global music service into the Play-Fi app -- now available for iOS in addition to Android devices -- allowing Deezer subscribers worldwide to stream music on Play-Fi-enabled products over Wi-Fi. DTS will showcase more Play-Fi developments at CES, Kirchner said.

In a 10-Q filing at the SEC, DTS said it amended an asset purchase agreement for Phorus that would have required DTS to pay $10 million based on achieving revenue milestones, in addition to what it already paid to acquire Phorus in July 2012. But the revenue milestone for the end of the first anniversary “was not achieved” and no payment was made, the document said. Additional payments of $3 million and $4 million “could have been due and payable” at the end of the second and third anniversaries, it said, with any unpaid contingent considerations up to the $10 million total to be paid in the final six months of the three-and-half year period following the purchase. The amendment to the agreement cut the total potential consideration to $2 million, with the revenue milestones reduced to reflect changes made to the business model, it said. Under the amendment, “contingent consideration of $500,000 could be due and payable at the end of 2013 and 2014, and $1 million could be due and payable at the end of 2015,” it said. For the period ended Sept. 30, DTS recorded a “decrease to the fair value of the contingent consideration associated with the Phorus acquisition, resulting in a gain of $5.3 million” that was recorded separately in the consolidated statement of operations, according to the filing. Certain of the beneficial owners of Phorus prior to the acquisition are employed by DTS, it said.

Kirchner said Headphone:X surround-sound technology will come to market in first-half 2014 “with continued launches throughout the year.” The technology is gaining interest from OEMs for the audio experience it provides for music, movies and games, but it is also the beginning of a “compelling, multiyear roadmap” that DTS believes will “transform how consumers interact with and enjoy their entertainment,” he said.

Regarding DTS’s initiative with Paramount to encode the studio’s library of UltraViolet movies that will be available in Common File Format (CFF) with DTS-HD surround sound, Kirchner said DTS is “continuing to work on the back end of things,” noting that “UltraViolet has not yet essentially gone out in a big way from studios.” When the Paramount announcement was made last summer (CED July 17 p1), Kirchner had expected CFF content to be out by year-end. On the call Wednesday he said the company now expects to see files available “through UltraViolet and third-party partners certainly as we get into the first half of next year.” Chief Operating Officer Brian Towne added that the CFF 1.0 spec is in the ratification process and is expected to be completed in 2014.

DTS continues to work toward penetrating the network-connected market as the traditional home AV, Blu-ray and automotive categories show decline, Kirchner said. For 2013, the company expects network-connected smartphones, TVs, tablets, digital media players and PCs to account for 40-50 percent of revenues, followed by Blu-ray at 20-25 percent, automotive at 10-15 percent and home AV at less than 15 percent. Broadcast accounts for less than 5 percent of revenue, according to Chief Financial Officer Mel Flanigan. DTS technology is found in 180 smartphone designs today, representing “single-digit penetration” of the mobile market, Flanigan said.

While Blu-ray revenue was down 10 percent for the quarter, Flanigan attributed much of the decline to anticipation surrounding the new game console cycle “as consumers pause” ahead of the release of Xbox One and PS4. DTS expects the new consoles to “drive some pickup” in the Blu-ray market beginning in Q4 and continuing into next year. Flanigan cited Digital Entertainment Group data that said sales of Blu-ray discs were up 15 percent in first-half 2013, and sales of new titles in Blu-ray were up 19 percent. Electronic sellthrough (EST) was up 50 percent in the same period, supporting DTS’s position that Blu-ray and EST will “continue to coexist for the foreseeable future."

Home AV revenue was down 12 percent from a year ago, reflecting the “continuing market decline” in DVD-based products and home-theater-in-a-box systems as consumers shift to Blu-ray and connected devices, Flanigan said.

Q3 revenue at DTS grew 27 percent to $28.2 million over the year-ago quarter, and the company swung to a $2 million profit after posting a loss of $19.2 million in Q3 2012, it said. DTS is guiding to the lower end of its previously forecast range of $130 million-$136 million for the year, Flanigan said. Heading into the holiday season “amidst some broader CE market weakness,” DTS is “confident in its strategic direction and growth prospects” for 2014 and beyond, Kirchner said.