Dolby’s Royalties Help Crank Out Earnings Surprises

Over the past five years, no company in the Russell 3000 stock index has exceeded Wall Street estimates more often than Dolby Laboratories Inc.

The inventor of surround sound and other audio technologies posted earnings of 62 cents a share in the quarter that ended June 25, up 24 percent from a year earlier. Dolby beat by 17 percent the average of analysts’ estimates compiled by Bloomberg.

For its fourth quarter ended Sept. 24, analysts estimate San Francisco-based Dolby boosted earnings-per-share by 33 percent.

“We would be buyers of the stock in front of earnings,” Brian Thackray, a Deutsche Bank analyst, wrote Oct. 3.

Dolby’s track record means it has a lot to live up to, Bloomberg reports today. Bloomberg assigns a “surprise score” to companies based on how often and by how much they have beaten analysts’ estimates over the past 20 quarters.

Dolby’s average quarterly earnings-per-share surprise over the past five years is 39.7 percent. Its surprise score is 84.1, the highest in the Russell 3000, followed by Amphenol Corp. at 83.1 and Apple Inc. at 82.1. The average score of the Russell 3000 is 38.9.

Dolby Laboratories, founded by inventor and audio engineer Ray Dolby in 1965, has a market value of about $6.8 billion. The company reported $719.5 million in sales in its 2009 fiscal year, with net income of $243 million.

‘Unique Revenue Drivers’

Analysts have been consistently surprised by Dolby for two reasons, says Andy Hargreaves, an analyst at Pacific Crest Securities in Portland, Oregon.

When executives provide projections for future quarters, “they tend to be pretty darn conservative,” he says. Also, the company has “had pretty unique revenue drivers that it took people a long time to catch up to.”

Sean Durkin, a spokesman for Dolby, declined to comment.

Dolby is paid, in the form of licenses or royalties, whenever its technology is incorporated in other companies’ products, including movie theater sound systems, computers, DVDs, video games and digital television and cable.

Dolby has been particularly helped by the inclusion of its technology in Microsoft Corp. Windows operating systems -- both Windows Vista and Windows 7 -- and by the growth of digital television, Hargreaves says.

Slowing Markets

While Dolby shares are up 26 percent in 2010, their performance has been mixed. The stock hit an all-time high of $69.37 on June 15. The shares then fell 22 percent from July 26 to Aug. 24, a decline William Blair analyst Ralph Schackart, in an Aug. 27 report, attributed to data indicating the “PC and TV end-markets are slowing.”

On Sept. 15, International Data Corp. projected U.S. household spending on consumer electronics will fall 17 percent in 2010 compared with 2009, the largest estimated decline among 20 countries surveyed by IDC.

Nonetheless, just as the broader stock market has rebounded, so have Dolby shares, which are up 12 percent since Aug. 24.

The recent rise in major U.S. stock indexes is a sign of higher investor hopes for the third-quarter earnings season, says Robert Bacarella, portfolio manager of the Monetta Mutual Funds. The Russell 3000 index is up 13 percent since the end of August, and the large-cap Standard & Poor’s 500 index has advanced 12 percent.

Earnings Season

“The run-up is partly due to the feeling that this earnings season is going to be decent, and companies are going to continue to surprise us on the upside,” Bacarella says. “If that doesn’t materialize, we could have a pullback.”

For most companies, the third quarter ended Sept. 30. Alcoa Inc. kicked off earnings season Oct. 7; Dolby’s results will be released in early November.

Deutsche Bank’s Thackray upgraded Dolby to a “buy” rating on Sept. 22. He’s one of 11 analysts who have assigned the stock that rating -- a total of 69 percent of those compiled by Bloomberg. One analyst, Goldman Sachs’s Ingrid Chung, gives Dolby a “sell/neutral” rating, and the remaining four analysts rate Dolby a “hold.”

“Several catalysts should alleviate some of the concerns on the stock,” Thackray wrote Oct. 3. Dolby technology is being incorporated in mobile phones, including smart phones by Nokia OYJ and HTC Corp. Mobile phones may be “another $100 million market opportunity for the company,” he said.

Online Streaming

Investor concerns that Dolby will lose out as consumers start accessing media by streaming it over the Internet, rather than through DVDs or media supported by Dolby, may be alleviated soon by the adoption of online streaming standards that include Dolby, Thackray said in his Oct. 3 note. They may also be abated by a potential deal with Netflix Inc., Thackray wrote then.

Netflix, the mail-order and online movie-rental service, said in a statement today that it would use Dolby Digital Plus surround sound for films and television shows streamed from its site.

Dolby continues to benefit from a “revenue tsunami” from both the adoption of Windows 7 by corporate buyers and the conversion of the large Chinese television market to digital, Thackray said in his note.

Last quarter, revenue was 34.5 percent higher than a year earlier. Hargreaves, who has a “sector perform” rating on Dolby, says this can’t continue forever. “Our concern has to do with slowing growth,” he says.

In fact, he says Dolby investors may be disappointed this quarter, even if the company maintains its long track record of surprising Wall Street. He says the company may once again come through with better-than-expected earnings while, at the same time, executives offer gloomier-than-expected projections. That may be one set of mixed signals even Dolby’s famed engineers can’t fix.

To contact the reporter on this story: Ben Steverman at

To contact the editor responsible for this story: Tom Giles at

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