Dolby Needs A 4K Solution

It is not just the great three-dimensional sound effects in “Avatar” where you will hear the Dolby effect. Dolby today is everywhere, as part of, fittingly enough, its Dolby Everywhere campaign for Web-connected TVs, Blu-ray movie players, PCs, smartphones, set-top boxes, and game consoles. Let’s take a closer look at the company’s performance.

Dolby (NYSE:DLB) reported its fourth quarter and fiscal 2009 results on November 3. Q4 revenue was $163.9 million, up slightly from $163.1 million last year. Net income was $44.3 million, or $0.38 per diluted share, compared to $48.6 million, or $0.42 per diluted share last year and $51 million or $0.44 per share last quarter. The company’s revenue in 2009 was up 12% to $719.5 million and net income was $243.0 million, or $2.11 per diluted share, up from $199.5 million, or $1.74 per diluted share, in 2008. Earlier coverage is available here.

In 2009, licensing revenue grew 11% to $594.7 million, or 83% of revenue. The increase was driven by increased revenue from the broadcast and mobile markets. Dolby’s broadcasting market accounted for about 25% revenue in 2009. Its consumer electronics market also accounted for 25% of revenue in the year, but this is down significantly from 40% ofrevenue in 2007 due to decreased sales of standard definition DVD players. Dolby expects to offset this decrease with growth in the emerging Blu-ray format.

The company’s PC market accounted for about 35% revenue in 2009 compared to 40% in 2008. Revenue was affected by the economic slowdown and lower PC sales,  but the decline was somewhat offset by the inclusion of Dolby technology in media applications or operating systems. Dolby technology is included in two editions of the Windows Vista OS as well as four of the six available editions of the recently launched Windows 7. Microsoft was a key licensee, accounting for 10% of Dolby’s revenue in 2009.

Total gross margin was 88%, down from 89% last year, with licensing gross margin at 101%, product gross margin at 40%, and services gross margin at 56%. Dolby ended the year with $451.7 million in cash versus $394.8 million in 2008.

For fiscal year 2010, Dolby is targeting revenue of $720 million to $750 million and total gross margin of 88% on a GAAP basis and 89% on a non-GAAP basis. In addition, Dolby is projecting fiscal year 2010 operating expenses to be $313 million to $324 million on a GAAP basis and $280 million to $290 million on a non-GAAP basis, with a tax rate of about 35%. These targets lead to a fiscal 2010 EPS target range of $1.85 to $1.96 on a GAAP basis and $2.07 to $2.20 on a non-GAAP basis. The stock is currently trading around $50 with market cap of about $5.75 billion. It hit a 52-week high of $50.62 on January 7.

With the global transition from analog to digital broadcasting as well as advances in high definition, online, and mobile content, Dolby’s target market is expanding. But the company needs to keep up with these advances. Sony has come up with higher resolution 4K technology, and Regal and AMC have signed deals to install thousands of Sony 4K systems in their movie theaters across the country. These 4K systems have a resolution of 4,096 by 2,160 pixels — that is four times the resolution of the 2K systems used in most theaters. A picture with 2K resolution would have 2.2 million pixels and one with 4K resolution would be four times that, or 8.8 million pixels.

Texas Instruments’ DLP Cinema division has also announced plans to introduce a 4K digital projection platform, and Cinemark, which has theaters across both the United States and Latin America,  has committed to implementing it.

With the major theater companies turning to 4K resolution, it would not be long before the smaller companies follow suit. As the film industry transitions to digital cinema and 4K, demand for Dolby’s traditional cinema products is declining. The company’s digital cinema solutions include Dolby Digital Cinema Server and Dolby 3D Digital Cinema technology but it also needs to come up with a 4K digital cinema solution or its growth prospects in digital cinema will be limited.