Zoran (ZRAN) and ESS (ESST) predict a slump in DVD chip sales

 |  Includes: ESST, ZRAN
by: David Jackson

Zoran's stock price was sliced by about 22% today because it reported ballooning inventories of DVD chips and predicted a slump in fourth quarter sales. Zoran is the leading merchant vendor of video chips for DVD players; 62% of its revenues during Q3 came from that market. Zoran competes with ESS Technologies (ESST) and MediaTek, among others.

Analysts expressed shock and surprise at the inventory levels and dire sales forecast. Odd, in light of the comments by Cirrus Logic (NASDAQ:CRUS) quoted here a week ago, which are eerily similar to the words you're about to read from Zoran.

The sunny side? The inventory glut will probably lead to discount pricing, and that's good news for consumers. Zoran said that the price of DVD recorders could fall to $129 by year-end. Here's the blow-up in Zoran's and ESS's own words:

Quotes are from the CCBN StreetEvents transcripts. Here's Zoran first:

…two primary reasons for the third quarter shortfall. First, there was a significant buildup of inventory in the DVD manufacturing channel… Second, there was a substantial tightening of credit lines in China, causing more conservative manufacturing commitments and shorter-term outlook. In addition to this, the global DVD licensing authorities began enforcing strict penalties on unlicensed DVD manufacturers, forcing many of them to exit the business. While initially we believed that this was not going to impact Zoran's major customers, it may have had an impact on Zoran's tier 2 and tier 3 customer base that were being served via the distribution channels.

…the industry is now facing a major inventory correction that could possibly create an overhang through the first half of next year.

For the fourth quarter of 2004, we currently anticipate that revenues will decrease 35% to 39% from third quarter levels… primarily the result of the continuing challenges related to the ongoing inventory correction in the DVD market.

… towards the end of the quarter, we realized that a significant amount of the turns business was not going to materialize. It was quite a surprise for us…

ESS Technology reported results after market-close this evening. In its press release, ESS CEO Robert Blair was quoted as follows:

As we stated in our update last month, third quarter worldwide video demand did not materialize as expected for the industry as a whole. In fact, it now appears that this year's second half demand for video products will be lower than the first half demand.

In particular, we are seeing slow demand for video recording products and we find that the inventories built earlier this year in anticipation of the fast growth of this product line are higher than necessary, and per our inventory valuation policy, we have taken an $8.1 million reserve for these inventories.

Additionally, with the lower demand for all DVD products, in order to maintain our market position and to compete, we have reduced our prices to maintain market share. Accordingly, we have taken an $8.4 million inventory reserve to reflect lower anticipated selling prices of our DVD inventory.

The ESS conference call gave more detail about price pressure due to the inventory glut:

…because of the lower demand for DVD products, our competition in this market has become much more aggressive in their pricing. In order to maintain our market position in this important market, we have reduced our prices to be more competitive… the selling prices for DVD chips decreased 8 percent during the quarter, which was in line with our guidance of down 5 to 8 percent. Going forward, because of the significantly more progressive competition, we expect ESS' DVD billing prices to decline 20 to 25 percent in the December quarter.

The December quarter is normally down slightly from the September quarter and because of the current lower video demand an increased price pressure in the high volume DVD market, for the fourth quarter we are projecting revenue of $48 to $52 million or down about 20 percent from the September quarter.

ESS's stock was down over 10% in late trading.

What? Didn't the people who sold the stock on the news read Zoran's report last night or Cirrus Logic's a week ago?

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