Creative Technology Q4 2006 Earnings Conference Call Transcript (CREAF)

| About: Creative Technology (CREAF)

Creative Technology Ltd. (OTCPK:CREAF)

Q4 2006 Earnings Conference Call

August 9, 2006 8:00 pm ET

Executives

Sim Wong Hoo - Chairman and Chief Executive Officer

Ng Keh Long - Chief Financial Officer

Phil O’Shaughnessy - Senior Director of Corporate Communications

Analysts

Vladimir Guevarra - Dow Jones

Keng Hock Lim - Credit Suisse

Hong Hen Lu – Citigroup

Prunab Sharma – Bayou Securities

Don Si – DBS

Operator

Good afternoon. My name is Derek and I will be your conference operator. At this time, I would like to welcome everyone to the Creative Technology Q4 fiscal year 2006 earnings conference call. (Operator Instructions) I will now turn the conference over to Mr. Phil O’Shaughnessy, Senior Director of Corporate Communications. Please go ahead, sir.

Phil O’Shaughnessy

Thank you. Good morning to those of you joining us in Singapore, and good afternoon and evening to everyone in the U.S. Thank you for joining us today. I am Phil O’Shaughnessy, Creative’s Senior Director of Corporate Communications, and I would like to welcome you to Creative Technology’s fourth quarter and full fiscal year 2006 earnings release conference call.

The press release can be downloaded from our website, which is www.creative.com. We are also offering a webcast of today’s call, which you can access through the investor relations page on creative.com.

Today’s call will be hosted by Craig McHugh, President of Creative Labs. Craig will be joined on the call by Sim Wong Hoo, Creative’s Chairman and Chief Executive Officer, and Ng Keh Long, our Chief Financial Officer.

During our call today, Craig and the other participants who may be speaking on the call, will, with the exception of historical information, be making forward-looking statements, including statements relating to inventory, operating expenses, gross margin, profitability, and market potential for our products. These forward-looking statements are based on the information that is available to us as of today, and reflect management’s current analysis, belief or expectations. Actual results could materially differ for a number of reasons, including those detailed in today’s press release, and in our filings with the Securities and Exchange Commission over the last 12 months.

You are urged to review the risk factors set forth in our press release and in our SEC filings, including our annual report on Form 20-F. Also, please note that Creative undertakes no obligation to update any forward-looking statement made in today’s conference call or in our press release to reflect events or circumstances that occur after today.

For today’s call, all results are stated in U.S. dollars.

We will begin today with Craig McHugh providing a review of the results of the fourth quarter of our 2006 fiscal year. We will then open up the call for questions and answers.

At this time, I would like to turn the call over to Craig McHugh, President of Creative Labs. Craig.

Craig McHugh

Thank you, Phil. Good morning, everyone. Sales for the fourth quarter were $230.9 million, compared to sales of $305.4 million this same quarter last year. Sales for the 2006 fiscal year were $1.1 billion, compared to $1.2 billion for the previous fiscal year.

Net loss for the fourth quarter was $12.7 million, with a loss per share of $0.15, including a $10 million tax credit. This compares to a net loss of $31.9 million, with a loss per share of $0.38 for the same quarter last year, including an investment gain of $9.3 million. Excluding the investment gain, net loss for the same period last year was $41.2 million, with a loss per share of $0.49.

Net loss for the 2006 fiscal year was $118.2 million, with a loss per share of $1.42, including investment gains of $18.9 million, and one-time charges of $41.6 million, primarily related to good will and restructuring charges for 3D Labs.

Excluding the investment gains and one-time charges, net loss for the 2006 fiscal year was $95.4 million, with a loss per share of $1.15. This compares to net income of $0.6 million, with EPS of $0.01 for the previous fiscal year, including a non-cash impairment charge of $65.2 million and investment gains of $74.4 million.

Excluding the non-cash impairment charge and investment gains, net loss for the previous fiscal year was $8.6 million, with a loss per share of $0.10.

Now, let’s take a look at our breakdown of our sales by category and geography.

Sales for our personal digital entertainment, or PDE category, which includes our MP3 players and our web cameras, contributed 65% of total sales in the period. This compares to 60% of revenues last quarter, and 68% of revenues from PDE in the same quarter of last year.

In the PDE category in the fourth quarter, we announced the Zen V, and also the Zen V Plus MP3, Photo, and Video player. The Zen V features a beautiful, 1.5-inch OLED color screen, our patented Zen user interface for ease of use, and a tiny, ergonomic design that fits wonderfully in your hand. It is packed with features, including line-in recording and voice recording.

The Zen V Plus has all these that are in the Zen V, and it adds video playback and FM radio. These players are designed to appeal to both males and females in virtually every age group, and come in high-gloss black with blue, green or orange accents, and high-gloss white with either green or orange accents.

The Zen V player began shipping at the end of the quarter, with our one-gigabyte version priced at under $120. The Zen V also comes in two- and four-gigabyte models and is available online and at all major retailers worldwide.

The Zen V Plus, which has already won the coveted Editor’s Choice Award from CNET, will begin shipping later this quarter.

Also in the PDE category, we have just shipped our new live cam voice web camera. The camera is really amazing for the improvements it makes in voice quality during video IM voice-over-IP applications.

We have incorporated directional adaptive array audio technology with two built-in microphones, which virtually eliminate background noise. This enables crystal clear audio for video instant messaging and voice-over-IP, even in noisy environments, such as a cubicle in a crowded office or in a coffee shop.

Our audio category contributed 13% of sales for the period, compared to 11% for the same quarter last year and 13% of sales last quarter. Our speaker business contributed 13% of revenues in the third quarter, compared to 13% of revenues for the same period last year, and 17% of revenues last quarter.

Revenues from all other products accounted for 9% of total sales for the period.

Looking at the breakdown of revenue by specific geographic regions, the Americas represented 46% of sales compared to 41% for last quarter, and 41% for the same period last year.

Europe contributed 37% of total sales, compared to 38% last quarter and 39% for the same period last year.

Asia contributed 17% of revenues compared to 21% last quarter and 20% for the same period last year.

Our gross margin in the period was 14%, and we continue to target getting gross margin back to 20% or higher by the end of this calendar year.

In our efforts to improve our gross margins, we are aggressively exploring ways to reduce product costs, including evaluating strategic alternatives for our operations, from supply chain to manufacturing and product distribution.

Our operating expenses for the period came in at $58.4 million. This represents a 17.5%, or $12.4 million reduction of operating expenses compared to last quarter’s operating expenses of $70.8 million. Those expenses were excluding one-time good will and restructuring charges.

During the quarter, we brought our operating expenses below the target we had shared with you last quarter, which we had set at $65 million. We will continue to focus on reducing operating expenses as we streamline our product lines, and we will transition out of any of our product areas that we believe do not have acceptable growth and profit potential.

We are working through these operating expenses to bring them in line with our revenue and targeted gross margin to achieve profitability by the end of the calendar year.

Moving on to our balance sheet, we ended the quarter with $214 million in cash compared to $224 million last quarter, and $187 million for the same quarter last year.

During the quarter, we reduced our net inventory by 15%, bringing inventory down to $235 million, which compares to $276 million of net inventory at the end of last quarter. The $235 million represents a 41% reduction from our inventory level of $396 million for the same period last year.

Again, we are evaluating strategic alternative from our operations, including supply chain and manufacturing, with one key goal being to further reduce our net inventory, allowing us to maintain reduced levels of net inventory in future quarters.

Day sales outstanding at the end of the fourth quarter were 52 days. This compares to 53 days last quarter and 48 days for the same period last year.

The value of our investment portfolio as of June 30 was $74.6 million. Of this total, approximately $63.5 million is in listed investments, including $19.5 million of unrealized gains.

During the fourth quarter, we did not repurchase any shares from our share buyback program.

Now, looking forward, based on the progress we are making and our outlook for the market potential for our products ahead, we believe we will return to profitability by the end of this calendar year and continue to be profitable going forward.

We are very excited about the new products we introduced this quarter, the Zen V, the Zen V Plus, Live! Cam Voice, and we are very excited about our strong product roadmap leading up to the holiday season.

The key strategic areas we are focusing on now include the following:

  • Returning our gross margins to 20% or higher by the end of the calendar year;
  • Examining each of our product categories to determine how we can best achieve their revenue growth potential. and transitioning out of any product area that we believe does not have acceptable growth and profit potential;
  • Aggressively cutting our operating expenses, in order to bring them in line with our revenue and targeted gross margins, to achieve profitability by the end of the calendar year and going forward;
  • Growing our audio business by expanding the market for X-Fi and Extreme Fidelity in the consumer electronic space; and
  • Exploring strategic alternatives for improving our operations -- again, we are looking at supply chain, procurement, and inventory management.

At this time, I would like to open up the call to questions and answers. Operator, if you can open the call line, please?

Question-and-Answer Session

(Operator Instructions)

You have no questions at this time.

I apologize. You do have a question at this time from Vladimir [Guevarra] with Dow Jones.

Vladimir Guevarra - Dow Jones

Hello?

Phil O’Shaughnessy

Hello, Vladimir. Go ahead, please.

Vladimir Guevarra - Dow Jones

Can I just confirm a few figures? One is that you plan to grow gross margins 20% by the end of 2006. Is that right?

Second of all, you talked a bit to lower your operating costs. Can I know by how much please and when?

Next would be, we are hoping to get some updates on the legal battle you have with Apple regarding copyright infringement. I understand in July that you guys were open to a settlement. Can we have an update on that, please?

Last question would be, Microsoft’s Zune product is coming out in the fourth quarter. Are you involved in any way in the production or design of this product? If not, how do you plan to face up to the competition, not just the Zune but also Apple’s iPod products? Thank you.

Craig McHugh

Let me take those questions in order.

On the gross margin, I shared that we are targeting to raise our gross margins to 20% or higher by the end of the calendar year.

Vladimir Guevarra - Dow Jones

That is 2006, right?

Craig McHugh

End of calendar year, 2006. Our gross margins, we are targeting to bring them in line with our revenue and margin expectation, so we should return to profitability by the end of the year, but we are not sharing a specific numeric target, but we are aggressively looking to reduce our expenses, as I discussed today.

With regard to our litigation with Apple, our most recent update was a press release that was issued on June 14th. We announced that the ITC had voted to investigate Apple for infringement of our Zen patent. We have had several discussions with Apple and we continue to be open to reaching an amicable solution.

With regard to reports with regard to Microsoft’s entry into the market with Zune and the Zune player, as of now, we do not know what Microsoft’s plans and strategies are in this highly competitive market, so we cannot comment there because we do not have knowledge of what their plans are in this space.

Vladimir Guevarra - Dow Jones

Can I just make a quick follow-up? What is the current gross margins today?

Craig McHugh

Our current gross margins reported today were 14%.

Operator

Your next question comes from Keng Hock Lim with Credit Suisse.

Keng Hock Lim - Credit Suisse

Just wondering, with the fall in flash prices, what has this done to your MP3 sales? Have the numbers this quarter actually reflected the lower flash prices, or could we see more profit impact coming through in the following quarters?

Craig McHugh

We did not see a material impact from the drop in prices in the quarter. Going forward, we see that the lowered memory prices are going to provide Creative a much more competitive environment where we can be price competitive with all of the other players.

We shared last quarter that the high memory prices, when they crash going forward, it would be able to allow Creative to be very competitive, as we could buy flash memory at the same level as our largest competitors.

Previously, Apple and others did have a purchasing advantage on us on memory. That has been, in our opinion, gone away because of the very low price of the memory, so we believe that we can be more competitive and be able to improve our margins going forward.

We continue to see a low price for flash, at least in the current quarter, and for our flash players, we have been able to reduce the price of our flash players in the most recent quarter, and we are seeing strong increases in demand in the market for the Creative flash players at these new prices.

We do see that the lower prices provide a great opportunity for Creative. We plan to take advantage of it going forward. That is one of the key reasons we are looking at being able to bring our margins at or above 20% by the end of the year based on what we see the flash market to be through the holiday season.

Keng Hock Lim - Credit Suisse

How about on the drive front? Are you seeing price drops for hard drives as well? Any plans to come up with the new, higher-capacity 1-inch drive players?

Craig McHugh

I think as you see, we have talked already about the drop in prices for flash memory. That will enable higher capacity flash. With the Zen V and the Zen V Plus, we introduced four-gigabyte models, which based on initial reaction, we are very excited about how they are going to be received by the consumers and the demand, especially the higher configuration models.

I think you are going to see a shift to higher capacity in the flash.

Our Zen Vision M at 30-gigabytes is enjoying strong global demand. In the hard drive market, we see the opportunities for 30-gigabytes, and we see opportunities for our 60-gigabyte players as well. We offer 60-gigabytes in several of our player configuration.

The hard drive market, especially if you look at our Zen Vision M, with its beautiful video, does require the higher disc capacities, so you will see a split in the market. I think you will see demand for higher capacities in flash, hence our push with the four-gigabytes, and you will also see 30- and 60-gigabyte demand for the video players, with our Zen Vision M and our Zen Vision.

Keng Hock Lim - Credit Suisse

But the cost of the hard drive, is that also coming down? Are you also enjoying margin expansion for your hard drive MP3 players?

Craig McHugh

As with previous years, the standard configurations, hard drive prices do tend to fall in the back-half of the year, and then you bring higher capacity drives to keep up the ASP’s, so I think you will see opportunities to either reduce prices or improve margins in the 30-gigabyte and still maintain higher ASP’s as we move to the higher capacities.

Keng Hock Lim - Credit Suisse

Then, on the cost cuts, could you let us know what you have done so far to actually achieve the lower cost, and whether this lower cost is sustainable? Also, going forward, could we see further reduction or is this the level that you are happy with?

Craig McHugh

I am sorry, I apologize. I missed the very first part. Are you referring to the…

Keng Hock Lim - Credit Suisse

Cost-cutting, cost-cutting efforts, just wondering what has been done so far actually to reduce the costs and whether these lower costs, are they sustainable?

Craig McHugh

We have been analyzing and evaluating each of our product areas and product categories, and we are actively looking to transition out of those that we don’t believe provide the growth opportunities and the profit opportunities that we need going forward.

We have shared in the past that we’ve transitioned our group at 3D Labs and we did close our operation in Huntsville. We significantly cut the expenses in that area. We’ve trimmed some of our other product categories, and have had reductions in spending in each part of our operations worldwide. We are going to continue to aggressively transition out of any of the product areas that don’t provide real strong growth and profit opportunities going forward.

At the same time, with all of the exciting products we have, the ZEN V, the ZEN V Plus, and those that we will be introducing by holiday, we are also very cognizant that we want to continue to invest in marketing, building customer demand and building awareness for the products we have coming out. So we are looking at both cutting those areas operationally, including the headcount reductions we’ve made, to reduce expenses but continue to invest in marketing. So we are not breaking out a specific operating expense goal, with the exception that we are going to drive operating costs down so we can be profitable by the end of the year and get them in line with our margins and revenue.

I think if you could look at just the way we drove expenses down over 17% quarter-over-quarter, I think it shows that we have the ability to make the tough decisions to drive the expenses down, but still at the same time continue to release great products and invest in marketing and advertising.

We are excited about the holiday season, so we are going to have the dual role of increasing our spending as appropriate and promoting our products, but at the same time reducing infrastructure and other costs to bring expenses down.

We will be bringing expenses down by the end of the quarter, I just don’t want to break out a specific target number at this time.

Operator

Our next question comes from Hong Hen Lu – Citigroup.

Hong Hen Lu – Citigroup

Good morning, everyone. Just in terms of your cost savings through your manufacturing efficiencies you have mentioned, I just wanted to understand the background there. How much of your products are actually done in-house?

Craig McHugh

We have two facilities. One in China and one in Malaysia. We manufacture most, if not all, of our audio and MP3 and some of our travel speakers. Typically speakers, because of the size and the type of manufacturing, that is done on a subcontract basis with key partners in China. We also do a significant portion of some of our webcams with our partners.

So if you look at our make-up of revenue, the audio business and the MP3 business is done typically in-house, but not solely. We do have some subcontractors on those businesses as well.

Hong Hen Lu – Citigroup

Would you consider outsourcing most of this production in the future, to save your costs?

Craig McHugh

What I tried to stress today is we are strategically looking at all parts of our operations. We are analyzing our supply chain. We believe we can improve our productivity and reduce costs by streamlining our supply chain, working closely with our vendor partners, and we seek improvements in that area. We believe there are opportunities to improve our distribution, both within our manufacturing facilities, but primarily distribution of our products to the market. I believe there is room for improvements in our distribution strategies in Europe, the Americas and Latin America. Those all will help serve to reduce our product costs, especially in a time of rising fuel prices and rising freight costs.

At the same time, we are giving a critical look to our manufacturing strategy, looking at what is the right mix between in-house and partners, and we are committed to doing those things that we believe are going to help us reduce our inventories, reduce our exposure and bring down our product costs.

So we are in the middle of that analysis now. All of our groups are participating and we are open to making those changes that will improve our operations and reduce our costs going forward. So we aren’t ruling out any of the various options, and we are studying them now.

Hong Hen Lu – Citigroup

Thank you very much.

Craig McHugh

Thank you.

Operator

Our next question comes from Prunab Sharma – Bayou Securities.

Prunab Sharma – Bayou Securities

Thank you. I have a couple of questions. First, could you give us a breakdown on the inventory? What percentage you have on finished goods, work in process, and raw material at the end of the financial year?

Craig McHugh

It is very close, I would say 50% in parts and 50% in finished goods.

Prunab Sharma – Bayou Securities

And inventory by product category would be quite similar to what is your revenue breakdown now?

Craig McHugh

Yes, it is very similar, it is approximately the same as I shared with you as far as the revenue breakdown. That is very close to what we have in our inventories now.

Prunab Sharma – Bayou Securities

Could you give us some idea, what was volume growth on the MP3 on the last financial year over previous years? I don’t need the exact number, volume growth is fine.

Craig McHugh

We didn’t break out the volume growth this year.

Prunab Sharma – Bayou Securities

To see the progress trend, basically how the market is trending up or down.

Craig McHugh

We see the market trending up at over 50% year-over-year.

Prunab Sharma – Bayou Securities

And your volume growth year-over-year was about, say 50% or would it be lower than that?

Craig McHugh

Again, I don’t want to break that out at this time.

Prunab Sharma – Bayou Securities

Could you give us some color on what are the new products we can expect on the second half of ’06 on the audio segment? The second half of calendar year ’06?

Craig McHugh

We have talked about, in past calls, the significance of X-Fi and Xtreme Fidelity. Our product roadmap for audio is to move us outside of the PC and focus on the consumer electronics market. We see a great opportunity for enhancing the playback of our players and other companies’ players in the market by bringing Xtreme Fidelity and X-Fi into the market.

So in the very short term, you are going to see some very exciting announcements from Creative, we will make X-Fi available outside of the PC; available for hooking directly to players, supporting the MAC platform and supporting notebook computers. Making it very easy for people to be able to take advantage of what X-Fi can do. Significantly enhancing their MP3 music, enhancing their CDs and enhancing their movie playback.

So we believe that just as we pioneered and sold over 300 million sound cards for the PC, there is a much more significant opportunity outside of the PC. So as we shared with you, at the end of the year we are moving into the living room, we are moving into the den. We are going to focus on enhancing MP3 and digital audio playback for all of the players on the market, and there will be introductions by the end of the year. You will see a whole series of introductions that continue in the audio space. Some will be at CDS and some in the first half.

So very openly, we see tremendous opportunity in the audio space moving X-Fi out of the PC and into the living room and into the MP3 arena.

Prunab Sharma – Bayou Securities

For this new product launch, are you going to tie up with any leading consumer electronics player, or you will be just putting that product by yourselves?

Craig McHugh

We haven’t broken out or announced any design wins with other consumer electronics companies, but we have shared that our goal is to have X-Fi everywhere; X-Fi in headphones, X-Fi in speakers, receivers and set-top boxes. We are comfortable that we are able to achieve that goal of having X-Fi everywhere.

As we move forward, I think by the end of the year and early next year you will see some announcements in that area.

Prunab Sharma – Bayou Securities

Thank you very much.

Craig McHugh

Thank you.

Operator

Our next question comes from Don Si – DBS.

Don Si – DBS

Hi. Good morning, guys. I would like to check with you, what is your sales trend growth like for some of your products like your earphones, the X-Fi and also I think you have given us some color on the average [inaudible] but if you can share more, it would be great as well.

Craig McHugh

Thank you, Don, for the question. It gives me a chance to talk more in-depth about our strategy. We have positioned Creative into some of the most exciting areas for growth and margin enhancement, and some of the most exciting areas in technology right now.

As I mentioned, we are transitioning out of any of the areas that don’t have growth potential, because we see great opportunities for our product area. We have just introduced our new headphone business, with the introduction of the ZEN Aurvana. We have introduced Blutooth headphones for wireless. And we have a whole line of MP3 headphones and accessories. That we see as a high margin business, but also one with very high growth.

As you know, we’ve done millions of MP3 players, over 10 million to date. All of those have headphones, so we’ve always been in the business. But with our technology, we are driving very high-end headphones. The ZEN Aurvana is priced at about $100. The reception has been fantastic. It has the best type of noise reduction, and it has some of the best clarity of any of the headphones out. We compared the headphones from our competitors at $149 and $179; we brought it to the market at $100. I think the reception is going to be terrific, as well as our whole line.

We see that as an extension of our speaker business, because we’ve always been in that area, but we’ve never focused on the headphones. You will see a major focus from Creative in that space.

As you look at the European retail, the U.S. and even the Asian markets, the headphone segment is one of the largest both in revenue and margin opportunity. We are focused in multiple areas. We will focus at some of the entry prices, very high volume. As with the Aurvana, we will focus it at the top end.

We will have three more introductions in the next six months of very high end headphones and headsets that I believe will position us as a world leader. We will go up against some of the top folks in the space, and we will go very aggressively, both in price and more importantly in quality and functionality. So that is a very high growth market opportunity for Creative.

The MP3 business, of course, is one of the most explosive in the last several years. We are number two to Apple, but we are number one outside of the Apple environment. Along with that, we believe our Travel Dock speakers, our travel speakers, to be a very high volume market for us.

Today we focused on our own players, but going forward we are looking at all of the players in the market for opportunities to expand our Travel Sound speakers. Our Travel Dock speakers, both within Cambridge SoundWorks and Creative.

So we are going to focus on that high growth segment, not just the PC market but the market for digital audio. That will tie to a strategy of growing that speaker business aggressively. That is one we see in all parts of our markets, a very high demand online as well as in the stores.

We’ve always been a leader in the PC speaker market, and with Cambridge SoundWorks we have a great reputation in the home. Combining those together I believe gives us the chance to position ourselves as a leader in the travel speaker market. That hasn’t contributed significantly to revenues in the past, but I would encourage you to look at some of the product announcements we are going to be coming out with shortly, that we are going to have some great offerings in that whole speaker area with regard to MP3.

Another key area, as I just mentioned earlier, is what we are doing in audio. This is an area that we have talked a lot about X-Fi and it is all culminating in products we are going to start introducing by the end of this year and early next year. That is being able to bring X-Fi to the home listening environment.

You can imagine, if you would, being able to bring home your ZEN Vision M, being able to not go to your PC, but go directly to a device that we are going to be introducing that allows you to have the ZEN Vision M playback in X-Fi, or any of our Creative players, to be able to have your MP3 music enhanced up to the X-Fi standard. That is a wonderful experience, and we are going to be coming out with those products for the home this year.

For audio business to date, as you saw, we came in at 13% of revenues, the same as the previous quarter. We have a chance, and I believe a great opportunity to ignite our audio business. This should be an area of major focus. We are going to harness the power of X-Fi, we are going to be able to bring it into a family of products. I think that are going to excite the home. Not just the living room, but every room in the house. So we believe that will be an extremely high growth market for us.

The last one I would like to touch on as far as growth – and this is an area that offers very high growth opportunities – is what we are doing in web cameras. The web camera we introduced, the LiveCam Voice, the reason I highlighted that today, it is an amazing product. When you hear the product, what it can do for you, you could be in a very crowded coffee shop, you could be in a cubicle with a lot of background noise, but as soon as you turn on the LiveCam Voice you are able to essentially block out all of that background noise and have the person you are talking to hear a crystal clear audio representation of what you are saying without having the background noise. It is remarkable.

We focus very heavily on technology, because in webcams we believe there is a chance to have unit growth potential, strong growth as far as the number of units, but we are driving up the ASPs. We believe we can do very well at the $49 and above segment, as well as the high-volume, $29 through $49 segment.

So we really have positioned our product category going forward in four very high growth, high margin areas. In all of those areas, you have opportunities to benefit from what we are doing in MP3. The volume in MP3 in our cameras, as you see, represented 65% of sales in the period. Our goal is to take advantage of those units in selling all of our other products. We haven’t done this as well in the past as we would have liked. I believe that we are going to do it extremely well going forward.

All of our product groups and all of our marketing efforts talk about the synergy around our release products, tie it around what we are doing in digital audio, and now digital video. So you will see opportunities in the cameras, opportunities in audio, our new headset business and what we are going to be able to do in the travel speaker area.

I think those are some of the highest growth markets right now in technology. That is why we are really focused on moving away from any of our businesses that don’t have the growth and profit potential, so we can focus and streamline our product into these four areas.

Don Si – DBS

Okay, thanks. Two more follow-up questions. First, your R&D expenses. Going forward, what level can we expect you to have your R&D expenses – more or less? What do you see as the trend going forward?

Craig McHugh

The absolute dollar level, just as all of our operating expenses, we are going to aggressively bring down our costs, so we are looking at all areas, including our R&D investments. As an overall percentage, we believe that we need to continue driving the R&D. The products already mentioned today, what we are doing in technology and technology leadership. But we are not breaking out specific targets, but all areas are going to have an absolute dollar reduction between now and the end of the year as we move back to profitability.

Don Si – DBS

The restructuring of the graphics business, how much has that contributed to lower R&D expenses?

Craig McHugh

Right now I don’t want to break down to that specific level. I think in the going forward quarters you will be able to see how we have moderated all the categories of expenses, but I don’t want to go into that specific. Because the operation we closed, we still have a significant investment in ongoing R&D in that area, so I don’t want to break out what the current spending is in that, graphics particularly.

Don Si – DBS

Finally, how do you see the MP3 market, especially with the MP3 functions in phones, and some of them are actually getting better. The Flash prices are getting cheaper, so you will probably have a lot more capacity in the hand phones as well.

Craig McHugh

There are a couple of different elements of the question. I think the area of the lower-priced Flash is critical for Creative’s competitiveness. We are able to get Flash at great prices as compared to the shortages we saw at the end of last year, which drove the prices up. We are seeing very high volume demand for our entry Flash players, as well as up to the mid range.

So we see very strong ongoing demand and very strong growth in the market under $99. So that I think will move independent of any entries into the phone market or others, because we are seeing such a strong growth and we continue to predict strong growth in that area.

Another key area for us is what we are doing with the ZEN V, specifically the ZEN V Plus where we have added video. At a very low price we have our 1, 2 and 4 Gigabytes. Basically, reaction of what we are seeing as far as demand for that product, the video-enabled player and that video-enabled market is really exciting the market, and there are great opportunities. So we are seeing tremendous opportunity for growth again this year in the $99 to $199 space.

As I mentioned earlier, what we are doing with ZEN Vision M, at the $299 level and then increasing it where we have 60 Gigabytes, is we are seeing so much excitement around video, both for TV shows, for video-enabled blogs, for people being able to download movies, being able to watch movies. We see significant demand in that space. As you know, that requires the 20, 30, 60 Gigabyte configurations which are ideally suited for the ZEN Vision M.

Then we have our high-end ZEN Vision, which is perfect for movies. So actually now, as the market matures, there are four categories. The entry, what we are doing with the ZEN V and ZEN V Plus, what we are doing with the ZEN Vision M with video, and then the high end Vision video players. So the market is actually expanding, not just in units but it is expanding as far as categories of products. We have compelling, and I believe, the best offerings in each of those areas.

So you are going to see significant growth in the low-price entry level. I think there are still opportunities for growth in each of those areas. We haven’t seen any market statistics or any projections that are below 50% for the next few years, even when those industry analysts take into account cell phones and others.

So I think there will obviously be rapid growth of cell phones with MP3, but when you look at the capabilities, features and video of our players, I think there is going to continue to be that strong growth in our area. So we have to look at areas where we can continue to grow that business.

I think if you look at entries, even as we talked earlier today about Zune, I think it shows the importance of this space and those types of companies entering this space show that there are significant growth opportunities going forward.

Don Si – DBS

Thanks.

Operator

Our next question comes from Vladimir Guevarra – Dow Jones.

Vladimir Guevarra – Dow Jones

Yes, hi Craig. Can I just have an understanding of your revenue by product category? The first question is about the PDE segment. Can I understand how many percent of this come from MP3, and what is the breakdown of the other products under the PDE segment?

My second question is, is there a plan to have a more balanced revenue by product mix? Because currently you have 65% PDE and audio speakers and others are a bit low. You did mention that you see yourselves as a leader in the travel speaker category. Is there a plan to boost contributions to revenue from audio and speakers and other segments?

Third and last question would be, revenue by geographical region. Can I have an understanding of why Europe and Asia fell when it comes to revenue contribution? Is there a plan to boost marketing in these areas to increase revenue from Europe and Asia and the rest of the world? Thanks so much.

Craig McHugh

Within our personal digital entertainment business, that encompasses both our MP3 as well as our web cameras. For competitive purposes, we don’t break that out in finer granularity than PDE. So PDE did represent 65% of total revenues in the period. But we don’t break it out further than that.

The audio area and speaker areas, we believe, can have significant growth opportunities. I didn’t want to misstate on the speaker business. Right now we believe there is great opportunity for us in the travel dock business. We haven’t had the revenues outside of our player areas that we would like to see. So we are expanding our travel speaker business not to just be incumbent with Creative players, but look at all players in the marketplace. So we see opportunities to become a key leader in that space.

We’ve always been the leader with our high quality, high volume PC speakers. We see that there is a significant opportunity for revenue growth by moving into the travel dock and the travel speaker area. So that is a future opportunity.

In audio we see the opportunity coming from the CE market, where we bring X-Fi everywhere and we release product outside of the PC over the next few months. So the audio business and the speaker business, we plan on and expect them to be able to grow as a percentage of our overall revenue. Those are key components of our efforts in improving our margin, because those are our higher margin products and higher margin categories.

In the geographies, we did have a difficult quarter in Asia as represented by the drop in percentage of contributions both quarter-over-quarter and year-over-year. To a lesser extent, Europe. But both of those regions were impacted by the pricing volatility and the downturn in demand of MP3 that we talked about in the beginning of the year with the drop in Flash prices. The steep decline or actually the drop of Flash prices in the first quarter caused very difficult times in the market and in sell-through. It caused concern on the retailers about where the price points were going. The price points, of course, crashed on the Flash side and the retailers were cognizant of that pricing move and were trying to see what was going to happen in the player market.

Asia and Europe started out very slow as a result of that this quarter, and didn’t really turn back until the very end of the quarter, so we saw depressed revenues, particularly in Asia and to a lesser extent in Europe.

Conversely, we had strong performance in the U.S. market. We saw opportunities in Canada as well as in Latin. The strength of the U.S. I think now is being mirrored by what we saw at the end of the quarter in Asia and in Europe. So we would look to see them return to their more normal contributions as a percentage in the back half of this year.

Vladimir Guevarra – Dow Jones

Thanks.

Operator

You have no further questions at this time.

Craig McHugh

I would like to thank all of you for joining our call today and with no further questions, we will end the call now. Thank you all for joining and good bye to everyone. Good morning and good night.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!