NDS Group F3Q07 (Qtr End 03/31/07) Earnings Call Transcript

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NDS Group (NNDS)
F3Q07 Earnings Call
May 1, 2007 9:00 am ET

Executives:

Julie Woods – Investor Relations Coordinator
Abe Peled - Chairman and Chief Executive Officer
Alex Gersh - Chief Financial Officer

Analysts:

Daniel Meron - RBC Capital Markets
Alan Gould - Natexis Bleichroeder
Murray Arenson - Ferris, Baker Watts
Dean Witter - Morgan Stanley
Todd Mitchell - Kaufman Bros.
Ari Bensinger - Standard & Poors
Jason Mauricio - Arete Research
Michael Walter - Goldman Sachs
Alan Bezoza – Oppenheimer

Presentation

Julie Woods

Welcome to the NDS Group third fiscal quarter conference call. On this call, we’ll make certain forward-looking statements within the meaning of the private securities education reform act of 1995. These statements are based upon management’s views and assumptions regarding future events and business performance at the time this statement was made.

Actual results may differ materially due to the changes in global economic business and competitive markets and regulatory factors. More detailed information about these and other factors that can affect future results can be found in our findings with the Securities and Exchange Commission.

The forward-looking statements included in the call are made only as of the date of the call. We do not have the obligation to publicly update any forward-looking statements to reflect subsequent events or circumstances expected, as required by law.

At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session at which time if you wish to ask a question, you must press *1 on your telephone.

I must inform you that this call is recorded today, Monday, May 1, 2007. I would now like to hand the conference over to Mr. Abe Peled. Please go ahead, sir.

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Abe Peled

Thank you everyone and welcome to our Q3 conference call. Alex and I will discuss briefly our results and then opening up for questions. This quarter, we are very happy with some of the operational achievements that we’ve had, but I know that we’re going to have a number of questions.

Many of you have called to ask what happened to our margin and why operating profits didn’t increase. Alex will discuss this in greater detail, but I just want to emphasize that we stand by our full year guidance.

Second, as we have highlighted in our press release, a big impact had to do with increasing our operating expenses and our revenues, thereby having an impact on the margin, which had to do with foreign currency.

The weakness of the dollar is really an issue that we are contending with and as we’ve said in the press release, it had a positive impact of $20 million on our revenue and our expenses by $19 million dollars.

If you look at the year, two year gross, we’re talking about really half of it being the result of currency fluctuation. Let me now move a little bit to the operational side, and Alex will go into more detail in the continuation of the call.

The first thing that we feel quite good about is that we’ve won two CA systems in the quarter, both of which were previously Kadolsky systems. I think that it reflects what we believe is a strength of our technological operations and the strength in conditional access, where we continue to enjoy zero piracy along the strength of our roadmap, which includes advanced Middlewear DVR technology integrated with our Conditional Access, Hybrid, interactive capabilities, and so on.

We did that while commanding premium pricing. So we think that’s good. They’re not the biggest accounts, but in Germany, who is undergoing a revival in the cable market, we are particularly focused on additional operators and we hope to make further progress.

Another area we think is really interesting and we find it exciting, not only because it is a big market in its own right, but the business model which Dogan Media is trying out, is one that we believe that we believe can be applicable to a lot of developing markets, where television advertising revenues are still growing rapidly.

So while people move to digital, the primary driver for that is not necessarily subscription TV, which may reduce the number of people that can be exposed to the advertising, but actually the ability to use the sophistication and capabilities of the box including electronic program guides, interactive capabilities, and the ability to monitor is what is going on to drive advertising.

Dogan media, is primarily a free to view box, but it does ship with our conditional access - with our MediaHighway Middleworld electronic program guide, interactive applications are being used primarily for advertising sponsorship or various advertising related things on the channels.

Also, the ability of some of those boxes to be connected back to broadband over time as they already come equipped with an internet connection, will make targeted and comfortable advertising possible in television.

I think that a lot of the Eastern European and the Indian market can benefit from that kind of business model. We obviously are going to try and apply it into other areas. Another thing that we feel quite good about is the Indian market. The Indian market has 80 million pay television households that are ready and able to pay for television.

This is a small, about 30%, of the overall households in India, this is still not a big factor but that number is growing rapidly. In addition, Top of Sky is doing very well and will get to 9 million subs certainly before our year ends. We’re also competing in a number of other DPH platforms that are planning to launch. Our (inaudible) cable customer is also making significant progress.

So we expect India to be a strong growth market for us and we are continuing to focus on Eastern Europe. Indeed in our markets, we are focusing our development activities, our sales activities and our R&D on these three distinct markets that we believe will drive NDS revenue and profit growth.

In western developed markets, where competition is increasing for many of our customers, attractive functionality and rapid deployment of things like high definition, DVR, broadband connected set-up boxes, and so on, will be driving us.

I’m pleased to say our DVR continues to gain momentum with over 6.4 million DVRs already deployed, which makes us certainly at the top of DVR suppliers in the world. But also, HD is gaining further momentum, and we’re most of the new boxes that are being released are broadband capable.

The second is our markets that are for our traditional technology, albeit a low end version of them to begin with, these are low developing countries where initial functionality is really relatively straight forward. Although it does include interactive gains and will soon start using DVRs as well, at least for a portion of the population, but that’s where we see major growth.

And then the third one, we’ve identified the broadband as a distinct market where a lot of our new product development like the Video Guard DRM key, are playing into and are they are developing those to enable our current customers to deliver their content via broadband to their subscribers or perhaps new subscribers, in addition to the broadcast, as well as new players that want to take advantage of this growth in these markets.

That puts, I think, a full plate for us both in terms of sales marketing R&D, but we believe that this represents outstanding opportunities for NDS to deploy and leverage the technologies that we already have.

So I would like perhaps to turn it over to Alex, who will take you through the numbers in more detail, and then we will open it for questions. Alex?

Alex Gersh

Thanks, Abe. Good morning and good afternoon, everybody. Again, as Abe said, I will focus on the margin and the guidance, we'll discuss that one more time.

But highlights of the quarter, as you have seen from our press releases, total revenue $178 million, which is a 28% increase on last year. Again, it's important to say that a significant proportion of that has to do with the foreign exchange as the dollar weakens against the pound and the euro. And as I've said before, roughly 49% of our revenue is pound and euro denominated.

Operating income is $38.5 million versus $34.5 million in Q3 of last year. Operating income margin, of course, is 20%, versus 24% in Q3 of last year. Net income for the quarter is $29 million, versus $28 million in Q3 of last year and diluted earnings per share stand at $0.50 for the quarter, versus $0.49 in Q3 of last year.

Having mentioned the foreign-exchange component for revenues, and year-to-date, the impact of foreign exchange on revenue is $19 million and conditional access revenues increased by 14%. Other than the foreign exchange, obviously a higher security fee because of the increased number of authorized cards. We now have 73 million, versus 64 million authorized cards, with 83% paying the monthly fee. That is due to the increase in conditional access, offset by a slightly lower card shipment. We shipped 6.4 million of the cards in the quarter, versus 6.8 million in Q3 of last year.

It's worthwhile saying what Abe talked about a number of times, developing markets in Asia and Eastern Europe, and we've seen an increase in the number of cards that we're shipping to that region, a substantial increase.

Integration development and support revenue decreased by 29% to $7 million. Really, the decrease was due to a lower number of projects completed, and therefore less revenue recognized in Q3 of this year versus Q3 of last year. However, it's very important to say that as we focus more and more on new technologies, it's just important for everybody to remember that integration development and support revenue from new technologies like DVR, like our gaming revenues, and of course Jungo, that all is resided in our new technology line.

So the integration and development overall for the company has not really seen a decline, it's just the allocation of where the integration and development is changing as our product mix changes.

Licensing and royalties increased 43% to $27 million. We've shipped 5.1 million middleware-enabled set-up boxes, versus 4.3 million in Q3 of last year. In addition to that, as we gain new customers, conditional access royalties as well as electric program guide royalty also contributed to increase in revenue.

As of March, we estimate 57.3 million set-up boxes containing NDS middleware have been shipped, and we have now included, as seen on our press release, the Jungo middleware as part of our overall count of middleware shipped in the numbers.

New technologies increased by 40% to $41 million. The increase is due really primarily to the DVR and the development of DVR as Abe said. We continue to increase the shipments of DVR, and we continue to do more work on integration and development, when it comes to DVR. Of course, a portion of it has to do with increased gaming. That continues to perform well. Of course, this is the first quarter of full inclusion of Jungo revenues, so that contributed as well.

We have added 1.1 million DVR-enabled set-up boxes in the quarter, versus 700,000 in Q3 of ‘06. As of March, as Abe said, we estimate that 6.4 million DVR-enabled set-up boxes have been shipped.

Just to give a sense of this, and we like to do this as people always ask us, roughly 71% of our revenue came basically from related parties and that is a decline from Q3 of last year, where 77% of our revenue came from related parties.

Gross margin has decreased from 61% in Q3 of '06 to 60% in Q3 of '07. Increased headcount, facility and IT costs, including Jungo, have increased the costs, as well as the increased royalties cost. All of those contributed to the slight reduction in gross margin. However, there is one particular royalty cost increase that arose as a result of one specific contract, and can be viewed as effectively a one-time effect.

Operating expenses increased by 29% to $70 million. Again, I will emphasize that when I talk about all of the expenses, $20 million of the increase in expenses has to do with the foreign-exchange effect. And as Abe said, if you look at our nine months to nine months comparison of total expenses, they went up by $49 million, of which $20 million is really just the effects. So I mention that, and now I'm going to talk about the other increases clearly.

In general, as you know, our costs are driven by higher employee numbers, and associated costs such as facilities and IT. Clearly a full quarter of Jungo acquisition accounted for some increase in costs. We also have some increases in our legal costs, as we are getting close to some of the court dates in some of our litigations, which will be disclosed in our 10Q.

Just in terms of the individual expense lines, R&D expenses increased 25%, really due to the higher number of employees and infrastructure costs. As we've said before, we continue to work on a number of projects. We've discussed before the new-generation middleware, which we continue to invest in such as VideoGuard, DRM Key, and other projects. So that's the reason for the increase in the number of employees, and obviously the related facilities and infrastructure costs.

Sales and marketing increased 41% to $11 million, really as a result of higher infrastructure costs and higher employee numbers. And all the employees are strategically positioned in Asia to take advantage of the opportunities in Asia, as well as in Eastern Europe. We've added some employees in sales and marketing. Again, Jungo plays a role in the increase in expenses.

G&A increased by roughly 33% to $12.3 million, as a result of higher legal fees, higher facilities costs, and lower foreign-exchange costs on our cash balances of non-US or non-British-pound holdings.

The company's headcount increased by 553 employees from March '06 to March '07. And again, just to re-emphasize, 71% of our costs are shekel, pound, and euro-denominated, and the effect is $20 million for year-to-date on our overall cost base.

I've tried to describe to you what has affected our operating margin, and why the operating margin has declined. But let me just summarize the major effects, and I'll name them in the order of their magnitude in order to give a clear understanding of why the margin is where it is.

Foreign exchange, including the adverse effect of foreign exchange on our cash holdings, is the primary reason for the decrease in operating margin. Higher non-recurring royalty fees that I've mentioned previously certainly contributed. Jungo, while performing well, as we're going through the integration stage, the contribution for the quarter was lower than we've anticipated. However, this is the timing of some revenue that we expect to materialize in Q4.

As we said for the year, maybe slightly dilutive to our earnings but generally slightly diluted to our earnings, they correctly said, as Abe said before, we expect our full year operating margin within the range of 22.5-23% which is effectively what we've guided doing in the past.

The incoming tax rate is still 70% and we expect it to continue to that perspective. Just in terms of jumping a little bit in terms of the guidance, as I said 22.5-23% operating margin for the full year. As Abe correctly said, we are not changing our operating income guidance, it's still $155-160 million, however due to the effects and other considerations we are increasing our revenue guidance to a new range of $685-695 million from our old range which was $670-690 million.

Just a few words on the major balance sheet items. I'm sure you've seen if you looked at our press release, the increase in the accounts receivable in the quarter. That is really substantially due to a very large shipment of cards that was done in March. Clearly we expect our DFO to be unaffected and it's simply that the billing was done in March and the collections will happen in April.

Increasing the inventory is really due to the anticipated customer demand. We built up inventory for a number of our customers. You may have also noted that we have adjusted the deferred fees from long term to current. We have made certain adjustments.

Really those adjustments, as we said before, every quarter we value it on the basis of what our customers are telling us. One of the assumptions that go beyond the deferred recalculations and the only thing I can say is that we have adjusted those assumptions on the basis of our latest understanding and latest discussion with our customers.

Just in terms of the cash flow. As of March 2007 cash in short term investments stands at $522 million. In the quarter we've issued approximately 295,000 shares to employees upon exercising of their stock options. The total number of shares issues for nine months is 621,000.

As of the end of March 2007 we have 3 million shares of stock options outstanding with 2.1 million invested, and as I mentioned, and let me just reiterate this one point, we're upgrading our revenue guidance from $670-690 million which was the old range, to the new range of $685-695 million. We maintain our operating income guidance in the range of $155-160 million which implies the operating margin percentage of 22.5-23%.

Thank you very much

Abe Peled

OK thank you Alex. Operator, we are ready to take questions.

Question-and-Answer Session

Operator

We will now begin the question and answer session. If you wish to ask a question please press *1 on your telephone and wait for your name to be announced, and if you should cancel your request, please press *2.

Your first question comes from Daniel Meron from RBC Capital Markets. Please ask your question.

Daniel Meron - RBC Capital Markets

Thank you and good morning. First you had several announcements this quarter about competitive wins. Can you elaborate a bit more about what you are seeing out there as far as, do you think you can displace the more (inaudible) that you can state, specifically with Kabel in Germany?

Thank you

Alex Gersh

Sure, Daniel. Which announcement, could you just repeat?

Daniel Meron - RBC Capital Markets

The one in Germany with Kabel BW. For example, and then you also had HOT and just a string of announcements that indicate (inaudible) here.

Abe Peled

I think as I mentioned in my comments, Germany has three big cable companies: Kabel Baden-Wurttemberg which is the smallest of the three, KPG, and Unity, all of which are looking at accelerated digital deployment.

We certainly going to do our best to try and win additional subscriptions in Germany. There'll continue to be a number of other customers that are looking at access. As I've said previously, our challenge is to win the business without getting into a price war or going to prices that we believe will not be effective and commensurate with long term support and partnership that is needed and will adversely impact our business.

Daniel Meron - RBC Capital Markets

Can you quantify the scales? Are we talking about a handful of projects like this that you can count the competitors or more?

Abe Peled

Well, a handful I assume is five on one hand.

Daniel Meron - RBC Capital Markets

Yeah, I guess

Abe Peled

Yeah, it's in that range. Less than a handful

Daniel Meron - RBC Capital Markets

OK, very good. I'll back into the queue. Thank you.

Operator

Your next question comes from Alan Gould from Natexis. Please ask your question.

Alan Gould - Natexis Bleichroeder

Thank you. I've got a couple of questions. First, I believe in the last quarter you said that there would be some catch-up and some DirectTV DVRs that were shipped late in December that were going to hit in the March quarter. How much of that hit in the March quarter and do we have ongoing catch-up of late shipments in March to them that will help us in the June quarter?

Secondly what was the impact of Jungo to revenue in the quarter?

And third, can you give us any comment on the card changeover? I know Alex did point out that deferred income $12 million got moved back from short term to long term this quarter.

Alex Gersh

We can't comment on Jungo because we don't disclose Jungo numbers separately at this point. In terms of the catch-up, what we said last quarter is that we were one quarter behind on recognition of middleware revenues because we generally got our reports at a later point in time and because we did not have a lot of history, we were not able to approve the additional quarter.

We didn't say that there was going to be any incremental additional revenue. We're effectively, every quarter we're recognizing our revenue and when we get more information, the only thing that is going to happen is we are going to be able to accrue it and therefore we won't be one quarter in arrear.

Alan Gould - Natexis Bleichroeder

So you're still three months to pay on that. How about Direct TV with DVRs?

Abe Peled

There's not material numbers that you would see as a volume and I really can't comment on DVR numbers for DirectTV. But again just saying that from our point of view they're not materially big numbers to the volume of DVRs is not huge.

Alan Gould - Natexis Bleichroeder

And the card changeover?

Abe Peled

We really I think, for confidentiality reasons, we can not comment on card changeover plans for our customers. All I can say is that when it will happen, we will have a certain event, we will let you know. At the moment all our cards in the field are enjoying zero (inaudible) which puts our customers in a good position to not have to accelerate the deployment and give them the option to do it at a pace or rate that they would like.

Alan Gould - Natexis Bleichroeder

Thank you.

Operator

Your next question comes from Murray Arenson from Ferris, Baker Watts. Please ask your question.

Murray Arenson - Ferris, Baker Watts

Thank you, good morning guys. In the integration line items, you talked in your comments about shifting some of that from that line item to the new technologies line item. In the press release you talked about higher deferred revenues associated with that. I wonder if you could just be a little more specific. Were there any push-outs or are we really just talking about moving from one line item to the other? What should we expect of that line item going forward since this is lower level than we've seen historically?

Alex Gersh

In impressions, when we talk about deferred revenue when we really mean, and I tried to say the same on the call, is that we simply have not reached revenue recognition criteria. We recognize revenue at a certain point of the project, at the project completion.

So we haven't reached that point in a number of deals. So, it's simply a question of when can revenue be recognized and when effectively the projects are, and the movement between the two. I just wanted to point out that integration, development, and support for us sits on a number of revenue lines. And depending on how revenue moves as we get more and more contracts with the PDRs, you may see some of that integration development shift to the PDR line. But it really just is a function of what we happen to be working at the moment, and which components of the work happen to be increasing.

Murray Arenson - Ferris, Baker Watts

Given the revenue recognition issue, should we be looking for that line item to rebound or not necessarily?

Alex Gersh

It's not a revenue recognition issue. It's simply when the projects are completed. So if you completed a big project in a particular quarter, you will recognize the revenue in that quarter. If you complete it in the next quarter, you will recognize it in that quarter. So it's simply a question of when the project gets completed.

Abe Peled

Yes, this is the reason we don't do quarterly guidance. We cannot control in detail a lot of timing, or card shipments, or when projects are completed. A year is kind of a long enough period for these things to average out. But certainly, on a quarterly basis, I think, as you know in the past also, we cannot anticipate that with any precision, since we really don't control it, and it has to do with many factors that are beyond our control: demand, inventory builds up, and customers, and so and so forth. That's the reason we do not provide quarterly guidance but annual guidance. I know some of you guys provide quarterly guidance and have the difficult job of dividing it into quarters. But our view is that you really have to look at this on an annual basis rather than on an individual quarter.

Murray Arenson - Ferris, Baker Watts

OK. A little bit into the quarter you had your HD radio product. Can you talk a little bit about that and the opportunity associated with that?

Abe Peled

Well, we're very excited to have this. I mean, it's an exciting technological development. You know, iBiquity is an interesting and innovative company. I think radio in the United States, from what I understand, the stations are looking for better ways of competing with satellite and introduce new products. And there's the whole issue of the potential to provide services, not only to anybody who listens to the airwaves but likes cable to provide only to people who opt-in, and that reduces the risk of obscenity and violence that are currently regular on open airwaves or broadcasts, versus closed communities like cable. And the technology in these HD radios allows essentially the creation of such closed communities, special services in addition to the regular services, and so on.

The way the deal works is that every HD radio that will be shipped as of the middle of this year will have that capability built-in. The royalties that we get per device is really quite small. Our potential revenue can come from head-end installations. And the different radio stations across the United States, there are 12,000 stations, many of them really have to do deals with the big station groups. And then if special services are activated, we get an additional fee. It's very hard for us to quantify the impact of such revenue or the size of it, before we get any experience with actual deployment.

So we haven't really incorporated any material revenues from that, obviously not now, but also for next year, we're still looking at it, but I doubt that we will already have a feel for it. It's really a much longer play to see how it takes off, and so on.

Murray Arenson - Ferris, Baker Watts

OK, and lastly, if I could ask you about OpenBet. You had a few announcements during the quarter about that one-wallet solution. Can you kind-of set some expectations for us for what else to expect from that, either in terms of new business or in terms of how that adds to the income statement?

Abe Peled

Well, One Wallet is the ability to, in a common account, to bet both on sports and casino games. As you know, we have introduced casino games, essentially a year ago, leveraging our small acquisition of NT Media. In the case of casino games, or content that we provide, we actually have a revenue share. I'm pleased to say that the revenue-share portion of the Orbis revenue has been increasing steadily, and we expect it next year to hopefully double from the rate this year, which is double from the year before.

Having said that, they are still small in our overall numbers. We launched this quarter the poker that was launched on Skybet which is done by Orbit, both internet and the television side, and that seems to be starting to get traction.

So, you know, we're very pleased with the performance of Orbis, which we acquired in 2001, and which I think has been a very healthy contributor to our revenue and profit. I think after leveling off for a couple years, introduction of the casino games, and I think the whole opening up of that has been really able to re-kick their growth and increase profitability. So we're looking at that as quite promising.

We believe that over time as broadband will connect to television, set top box has the ability to do these multi-user games in combination with entertainment channels, as is the case with sky poker, which is actually an independent channel. You can play poker alone, but still, if it's not broadband connected, it's not as convenient.

We believe in the long term this will be a really good growth thing. I have to emphasize that Orbis, which provides the technology to operate all this, does not accept US debts, and as a matter of fact, its software has various measures to ensure that no (inaudible) can be played, in case anyone listens and has any plans for (inaudible).

Murray Arenson - Ferris, Baker Watts

OK. Thank you very much.

Operator

Our next question comes from Dean Witter of Morgan Stanley. Please ask your question.

Dean Witter - Morgan Stanley

Hi there, just following on that last question, regarding the gaming applications. You said the numbers are still small. But just looking at the big sequential job in new technologies revenues from $29 million to $41 million, could you maybe just provide some idea of what was the main driver of that increase? Because the press release does mention the gaming and I'd just be curious to know if all of the increase is due to the gaming, or only a small part of that, if you could even give some figures there. I know it's a level of detail that you probably don't want to disclose, but I'd just be curious if you give a flavor there.

And then, secondly, I know you just said that you're not looking to provide the quarterly guidance, but you have provided it for the full year, and there's only (inaudible) in this fiscal year. And if I look at it, it looks like what's implied for the fourth quarter is a range of operating profit of $37 million to $42 million on a margin level that would imply an increase in the sequential margin from the third quarter. And if I just look back over the last few years, the margins have always decreased in the fourth quarter, and I believe that was a source of disappointment last year. And I think that what a lot of people are forgetting is that, I think it is in that quarter that pay a lot of the bonuses for your staff.

So why would the margin increase this year, unlike in the last several years? Is it because we don't have this one-off royalty in the cost of goods sold? It doesn't look to me as if the dollar is getting any stronger. So I'm just trying to get a better feel on that, please. Thanks.

Abe Peled

Well, I think your arithmetic is impeccable, and we stand by our numbers that we just provided. I think this whole business about bonuses, I think each individual quarter has its own fluctuations. So I don't think this is...I mean, bonuses were last year an element that we mentioned simply because we provided more than usual, but at this moment, obviously, you can do your arithmetic and we, from what we know at this point stand by.

Alex Gersh

Just one thing. As we’ve always said, our margin is very dependent on the mix of revenue.

Abe Peled

Right, and let’s you know, one of the answers clearly is the one I mentioned, but the other answer is we clearly expect a mix of revenue to be slightly different and that’s really as much as we can probably answer.

On your first question, when I’ve mentioned the new technologies and I’ve mentioned PVR, I’ve mentioned (inaudible), and I’ve mentioned Jungo and that’s as much as we’re going to say but obviously I’ve mentioned the areas of particular growth in new technologies.

Dean Witter - Morgan Stanley

Great and so I guess that would help us with the margin in the fourth quarter. New technologies more kind of software based if I’m not wrong and therefore a rebound in the gross margin. Right?

Alex Gersh

The mix of revenue has a big impact on our margin.

Dean Witter - Morgan Stanley

OK. So thanks a lot. Thanks.

Operator

Your next question comes from Todd Mitchell from Kaufman Brothers. Please ask your question.

Todd Mitchell - Kaufman Bros.

Thank you. Two questions on the deferred revenue. Not to belabor the point, but first of all in terms of the margin, is it possible that there were expenses met ahead of revenue recognition and that the reverse on the increase margins for the fourth quarter will come from reversing that phenomena? That’s the first question.

The second would have to do with the shift from short term to long term deferred revenue. Is there a risk that your technology is so officious from the CA side, was there (inaudible) that it’s pushing out the annuity cycle on upgrade? And then one last question which is a housekeeping question. Is Jungo all new technology or is there an element of it in licensing?

Abe Peled

Well, let me answer the last question first. All is in new technology. And the second question is it possible to cost cuts ahead of revenue. I think we’ve said many many times before that in fact costs on our business always come ahead of revenue. I don’t think you can look at it on a quarterly basis and again this is why we don’t give quarterly guidance because one of the things I mentioned was we’re continually investing in this new middleware that we’re developing and clearly these are longer term investments but we have been investing now for the revenues that will come over the next few years. So I think that continues to be the case I think. And what was the other question? I’m sorry.

Todd Mitchell - Kaufman Bros.

Just in the shift from short term to long term on the deferred, are we to read into it that someone who may have been scheduled for an upgrade has no piracy and no need for an upgrade and maybe because of the efficacy of the new technology, the upgrade cycle’s getting pushed out.

Abe Peled

I think it’s true that our technology has unprecedented quality with regard to piracy and clearly our customers appreciate that. Also, probably the only other thing that I can say is that we’re contemplating discussion with our customers about the pace of the upgrade, the type of the change and all of these other things. I can’t say anything more than that, but clearly moving it out of current and into long term indicates our current state of discussion with our customers which could change but that is our current best view on the basis of our discussion with customers.

Todd Mitchell - Kaufman Bros.

Thank you very much.

Operator

Your next question comes from Ari Bensinger from Standard & Poors. Please ask your question.

Ari Bensinger - Standard & Poors

Yes, thank you, just some clarifications on some of the financial metrics that you provided in the quarter. If we exclude the one off on the gross margin, how much in terms of basis points I guess how much did that impact the overall number?

Alex Gersh

I can tell you that it probably would have made our gross margin the same as it was in 23.

Ari Bensinger - Standard & Poors

Very good, and I’m just trying to understand, I think there’s two moving pieces you mentioned in terms of integration and support revenue as to why it was down. You know you talked about some revenue recognition or deferred revenue issues and also in terms of some of the integration and support shifting towards the new technology line on digital DVR increasing. And I’m just wondering looking forward does that mean this type…because I think last quarter you’d mentioned a certain type of upgrade? Or maybe 11 million or so per quarter on…is this a new type of rate that we should look forward for integration or support because of the shift or is this something that…how much was it in terms of deferred revenue that impacted that number as opposed to the shift I guess what I’m trying to get looking forward in the model?

Alex Gersh

I can’t discuss the specific deferred revenue because obviously it has to do with specific customers

Ari Bensinger - Standard & Poors

I’m just wondering, looking forward, I think last quarter you mentioned a certain type of rate of maybe $11 million or so per quarter. Is this a new type of rate that we should look forward to for integration or support because of the shift, or how much was it in terms of deferred revenue that impacted that number as opposed to the shift is what I’m trying to get, looking forward in the model?

Alex Gersh

I can’t discuss the specifics in terms of revenue, because obviously it has to do with specific customers. First let me make sure that I’m absolutely clear, it’s not a question of revenue recognition in terms of any kind of change in the way we do business. What it’s about is completing a project at a certain time.

Again Abe said this is one of the reasons we don’t give quarterly guidance. If the project completes in March, we’ll recognize revenue in March, if the project completes in April, we’ll recognize revenue in April.

That is just an ongoing way that NDS conducts its business. In terms of the shift into DVR, obviously DVR has been one of our key products, new developments, this is why it’s still a new technology and clearly we spend a lot of time continuing to gain customers in the area and continued through integration development and support in the area of DVR.

Again, I would say that the whole idea of $11 million or $10 million per quarter, this is the reason why we don’t give quarter guidance. And as we get into new projects, that could shift again.

My point was really just to say that, overall as a business, we are not doing any less integration and development. We’re just doing it with the different projects and that’s just the nature, as we introduce new functionality, new products, that shift just occurs.

Abe Peled

I think, the reason Alex mentioned that, is to explain that even though we have lower integration, development, and support, you would have a legitimate question to say, why do you still have more head count? It’s because integration, development, and support is basically a people business.

The whole point is that it’s not that we have fewer projects. In fact, we have more projects than we’ve ever had before, which is why we are adding people. But the revenue from that will not always show up just in integration, development, and support line.

But the new technology line also has a strong and growing element of people business which is integration, development, and support also. That’s the only reason for the comment. It has nothing to do with that particular line or whatever.

Ari Bensinger - Standard & Poors

Could you tell me a little bit about your outlook for ITT TV and your partnership with Nortel?

Abe Peled

My outlook for ITT TV remains cautious, as it has been for the last few years. Worldwide deployment for ITT TV continues to be much slower than the expectations provided by analysts, companies, etc. We see the same in the ITT projects in which we are participating.

On the other hand, I’ve also said that we believe that a Hybrid model, where set-up-boxes will be increasingly connected with broadband, provided they will be part of the overall broadband solution, which will be the case whether it’s a stand alone or connected to broadband.

We believe that we need to work closely with major telecommunication providers. We have worked in the past and have continued incidentally to work with Alcatel. We have also announced an alliance with Nortel.

The focus there is really to look at integrated messaging services and other capabilities that can only be developed in partnership with Cellcom’s Integrated Multimedia Services, called IMS, to offer the added value into the home.

We have demonstrated I believe, as the fact that if you have a home, for arguments sake, with a Jungo residential Gateway that provides quality of services by voice of high quality of service for video and it’s integrated. So you could get your multimedia messages on your television for example, your voice over IP calls come in, you could see who is there and so on.

And thirdly for those reasons that we are increasingly finding that we want to work with Cellcom with Cellcom equipment providers. Actually I should also say that in terms of the effectiveness of sales these people sale satellite television, very large amounts of equipment, and they found what we sale is considerably smaller. So having them in front, which is part of the re-seller agreement, is a very important way to market our products and reach a broader customer set cost-effectively and really if you look back at many of our IP televisions systems having been employed like Telekom Austria employed last year. It was sold through Alcatel as part of our agreement with Alcatel so we expect Nortel, who at best was our senior management, seems to have a major commitment to really come back and win a lot of business in these areas hopefully will help us further with our IT Television penetration both with new customers as well as help provide innovative solutions for our current customers who want to expand to hybrid growth.

Ari Bensinger - Standard & Poors

Thanks.

Operator

Your next question comes from Jason Mauricio with Arete. Please ask your question.

Jason Mauricio - Arete Research

Hi there, two quick questions. Abe I was wondering if you could talk about VVR trends? You had flat units sequentially which most would say is, most would say is a good sign given seasonality, but was there any impact from inventory shipments that were being help back? Anything in there that would have been one off and made the number look a little bit higher this quarter?

And second question is when you price products in various markets do you price in local currency or US dollars?

Abe Peled

Regarding VVR shipments, again, I can't comment on the individual. It's not even quarterly seasonality trends because it has to do with....and we recognize it in the wheels when we get the…sometimes a quarter and sometimes only a month for a really established customer. But the long term trends we see is just an increasing penetration and expanding popularity of VVRs and frankly the only thing it depends on is how aggressively the individual people in certain markets promote it and price it. For the year we still expect to do well over 4 million VVRs, which would be double from a year ago.

Now on your question on our pricing, we usually price our products in dollars, pounds, or euros. We really don't do local pricing in any other countries. Mostly when it’s not in a European country or the UK, it will be priced in dollars.

Jason Mauricio - Arete Research

Great thank you very much.

Operator

Your next question comes from Michael Walter from Goldman Sachs. Please ask your question.

Michael Walter - Goldman Sachs

Thank you very much for taking my questions. I actually have two if I may. The first one refers to in your press release, you talk about extreme high level of complex (inaudible) not being able to recognize revenue because of your very strict revenue recognizing criteria. I was wondering if you could somehow quantify that to some extent. I think that if your differed revenue increased this quarter by $5 million more than what the usual run is, hen equally we saw how integration revenues came down by about $5 million Let me ask you to dispatch the correct number to see if its in the ballpark when that then gets recognized perhaps at the 100% margin, given that you have already taken a course.

And my second question concerns the (inaudible) and the decision by your customers to delay these. I was wondering to what extent, I can understand when you decide for us but it’s either because of security issues or when that your customers desire some of their newer features? For example audience monitoring that you offer. I was wondering if this decision was mostly a consequence of reassessing the security situation or did you decide from your customers to maybe start using these new functionalities? Thanks very much.

Abe Peled

I don't think that we said anything about extreme type, and again it’s not anything that we can't, it's not anything that we can get a trend or put an economic trend to. Again, as I said before, if a major project and a lot smaller of a project are completed, we will recognize the revenue out of it and it will be recognized. As any US GAAP software company, we have stringent revenue re-cognizant criteria. We've always had stringent recognition criteria. There is nothing here as far as I'm concerned to be able to see any kind of a trend or anything to extrapolate.

In quarter three we recognized, we're in quarter three of last year, we recognized from one particular project that I can think of off the top of my head which was a fairly large project for one of our customers in that's one of the things that affected the numbers. Again its not something that I think any trend can be used to try to extrapolate it.

On the second question, it’s really the primary consideration, except in unusual circumstances, where say the new car will support things like VVR or whatever. In many cases it has to do strictly with security considerations. With all the other things the operator wants to do in that particular period in the priority that they assign to that versus new business initiatives or whatever. It clearly is a reflection of the fact that our security continues to be maintained with your privacy.

Michael Walter - Goldman Sachs

Thank you very much.

Operator

Your next question comes from Alan Bezoza from Oppenheimer. Please ask your question.

Alan Bezoza - Oppenheimer

Hi, good morning. Question on a pirate question that someone's already asked, the one time gross margin that you've already mentioned, what was the impact of that? Did you say that with out that that you're gross margins would have been the same quarter to quarter?

Alex Gersh

Yes, I did say that.

Alan Bezoza - Oppenheimer

OK so if you have.. You said earlier that the margins would be impacted by a better mix and now you're saying that the margins impacted basically by this one time revenue in fact…and there are a lot of questions on the kind of moving pieces and a lot of conflictions. I'm just trying to get a better sense on the margin question.

Abe Peled

I think what Alex said is that the gross margin had to do with the one time thing and that would have been the same and except for only something like point something percent. The gross margin was 0.01%

Alex Gersh

0.6%

Abe Peled

Right, so I think that the effects, and I don't want to put words in Alex's mouth, but that it was a big contributor to the operating mountain which has two components. The actual currency rate as well as the valuation of our currency holdings, which had a particularly positive impact last year and there was no such matching impact this year. So when you take out the two it would have been a wash.

Alan Bezoza - Oppenheimer

But on the gross margin question your comment was within the same from last quarter or last year.

Alex Gersh

No, my comparison was quarter three of last year to quarter three of this year.

Alan Bezoza - Oppenheimer

OK that was my confusion. OK. And my other question was on the DVR seasonality. It's Christmas, I would have expected a bigger quarter, granted you do have, you do get recognized over some areas, could we expect that June quarter will be seasonally stronger because of Christmas?

Abe Peled

The June quarter will be stronger because of Christmas?

Alan Bezoza - Oppenheimer

If you're getting…you're recognizing the areas…

Abe Peled

If only if Christmas were to come in May.

Alan Bezoza - Oppenheimer

Four times a year.

Abe Peled

No I don't. I think that traditionally, first of all even for customers with whom we have a really good track record we're a month offset, so typically February.

But, again, we stand by the fact that the next quarter as Alex pointed out that we do in effect give guidance that is the result of additional project all of which will have impact.

I think another point is that, if you look at the PVR, at deployments, we (inaudible) until the 9 months we’ve deployed 2.9 million, and having said that we’re going to do around 4 million for the year. So that gives you a sense of where the PVR deployment and therefore revenues are going to be.

Alan Bezoza - Oppenheimer

OK. And then on direct TV, you’re still on the high-definition DVR. How far are we from getting on the standard definition platform in full?

Abe Peled

What?

Alan Bezoza - Oppenheimer

Are you on the standard definition DVR for direct TV at this point?

Abe Peled

I’m sorry, I can’t understand you.

Alan Bezoza - Oppenheimer

Are you guys deploying the standard definition version of the DVR for direct TV at this point?

Abe Peled

Are we deploying the standard definition?

Alan Bezoza - Oppenheimer

Uh-huh.

Abe Peled

Yes.

Alan Bezoza - Oppenheimer

OK, just making sure on that one.

Abe Peled

What do you mean?

Alan Bezoza - Oppenheimer

Just making sure, bbecause you mentioned that the HD was slow, so I just wanted to make sure I understood exactly what you were saying before.

Abe Peled

No, I didn’t say it was slow, I said it’s still a small number that is not material. I did not mean to imply anything about the take-up rate, which is far from zero. The take-up rate is good, but the absolute number is still a small number in terms of being a big impact on our numbers.

Alan Bezoza - Oppenheimer

Right, I was just making sure. On the capital side, should we expect a pretty decent cash flow quarter next quarter given the reversal of some of the working capital?

Abe Peled

Yes, I think that’s fair.

Alan Bezoza - Oppenheimer

Right. OK, thanks guys.

Operator

Once again, if you wish to ask a question, please press *1.

We have no further questions at this time, please continue.

Abe Peled

I want to thank everybody, it was a long call so I will let everybody go. I look forward to talking to you again with our August full-year results. And at that time we will also be providing guidance for our next year. Thank you very much.

Operator

That does conclude our conference for today. Thank you for participating. You may all disconnect.

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