Dolby Going Gangbusters

Dolby (NYSE:DLB) for a long time has been synonymous with surround sound for cinemas. However, as the concept of entertainment has been extended over the years from movie theaters into home theaters and personal computers, so has surround sound technology. Let’s take a closer look.

Ray Dolby founded Dolby Laboratories in 1965. The company develops products and technologies that improve the entertainment experience. Annual revenue in 2008 was $640.2 million, growth of 33% yoy led by strong licensing revenue. The company has three revenue streams: licensing, accounting for 84%, products at 11% and services at 5%. Dolby licenses its technologies to manufacturers of consumer electronics products and media software vendors in about 35 countries. In 2008, about 66% revenue was from outside the US.

With Dolby Digital selected as a mandatory audio standard and Dolby Digital Plus and Dolby TrueHD as optional audio standards in the Blu-ray Disc format, the company is well positioned for growth in DVD players, digital televisions, digital set-top boxes, personal computers, and gaming consoles. Until 2006, the consumer electronics (CE) market was Dolby’s largest market, but it has now been surpassed by the personal computing (PC) market. In 2008, the CE market accounted for just 25% (versus 45% in 2006) while the PC market accounted for over 40% licensing revenue. Microsoft Corporation, which incorporates Dolby technologies in the Windows Vista Home Premium and the Windows Vista Ultimate editions accounted for more than 10% revenue. The boom in the set-top boxes and digital television market has resulted in the broadcast market accounting for about 20% revenue in 2008.

In product sales, cinema products accounted for nearly 75% of product sales till 2006 but now account for 55% of product sales while broadcast products account for about 24% of product sales.

Last year, Dolby entered the mobile market with the release of Dolby Mobile and HAAC. Sharp and LG Electronics are the first manufacturers to ship products adopting Dolby Mobile.

Dolby’s competitors include DivX, DTS, Fraunhofer Institute for Integrated Circuits, Microsoft, Philips, RealNetworks, Sony, SRS Labs and Thomson.

In its third-quarter results reported on July 30, Dolby reported revenue of $171 million, up 11%. Net income was $51 million or $0.44 per share versus $46.4 million, or $0.40 per share last year. Analysts were expecting earnings of $0.31 per share on revenue of $147.2 million.

Licensing revenue was $142.1 million, up 11% y-o-y and down 11% q-o-q. Product revenue was up 21% y-o-y and down 39% q-o-q to $21.8 million. Services revenue was $7.3 million.

Total gross margin was 88.5% with licensing gross margin at 97.6% and product gross margin at 39.7%. Dolby ended the third quarter with $864.4 million in cash.

Earlier, Dolby expected fiscal 2010 revenue to be $650 million to $700 million and expected its PC revenue to decline as it expected more people to go for the low-cost netbooks that come without DVD playback functions as opposed to standard notebooks.

However, Microsoft has incorporated its technology in four editions of its new Windows 7 OS. Dolby is now targeting revenue of $700 million to $715 million and net income of $232 million to $237 million, or $2.01 to $2.06 per share. The stock is currently trading around $37 after hitting a 52-week high of $42.34 on July 29 and a 52-week low of $24.50 on November 21. Its market cap is about $4.2 billion. A kick-ass company that I suggest you start tracking!