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NDS Group (NNDS)

F4Q07 Earnings Call

August 7, 2007 9:00 am ET

Executives

Abe Peled - Chairman & CEO

Alex Gersh - CFO

Analysts

Daniel Meron - RBC Capital Markets

Ali Mogharabi - B. Riley & Company

Tim Boddy - Goldman Sachs

Jason Mauricio - Arete Research

Alan Gould - Natexis Bleichroeder, Inc.

Todd Mitchell - Kaufman Brothers

Ari Bensinger - Standard & Poor's Equity Research

Conrad Werner - Morgan Stanley

Presentation

Operator

Welcome to the NDS Fourth Quarter Results Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session (Operator Instructions). I must advise you that this conference is being recorded today, Tuesday, the 7th of August 2007.

On this call, we’ll make certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based upon management’s views and assumptions regarding future events and business performance as of the time the statements were made.

Actual results may differ materially from these expectations due to changes in global economic business, competitive markets and regulatory factors. More detailed information about these and other factors that could affect future results is contained in our filings with the Securities and Exchange Commission.

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

I would now like to hand the conference over to your speaker for today Dr. Abe Peled. Please go ahead, sir.

Abe Peled

Thank you, and welcome to our Q4 and full year fiscal ’07 results. We at NDS are pleased to have completed another year of very solid growth in line with our long-term view that we can grow the business 10% to 15% and grow operating profits higher than the 20% to 25%.

We are particularly pleased to see that our conditional access authorized base continues to grow, up 16% from last year to $75.4 million, and we are really quite proud of our security record, which we are enjoying zero piracy worldwide on all our smart cards.

During this year we shipped over 26 million cards with very good growth in obviously our traditional base, but we now see the investments that we’ve made in getting into China, India and Eastern Europe starting to payoff and significant contribution to smart card shipments, the subscriber growth has been from these areas.

We’ve also seen very solid growth in the MediaHighway middleware with obviously in the last year we enjoyed one-off as we downloaded into DIRECTTV set-top boxes, but taking that out, we’ve seen very good growth in the number of MediaHighway boxes.

As you know, we’ve also acquired during the year, Jungo and we are reporting some of those midldleware clients as part of our total middleware. At this point, these numbers are not a largely material to the total number, but should they become big enough, we will consider splitting that out.

Shipments in middleware to Premiere, TATA Sky, DirecTV LA contributed to the growth in addition to obviously very good growth in our other platforms.

DVR, a key growth factor, $3.8 million DVR licenses, different set-top boxes in different accounts where NDS supplies that DVR technology with close to doubling of the number from last year. With NDS, DVR is now in over 14 accounts and continuing to grow. We expect to see continuing healthy growth in DVR, which also obviously fuels our new technologies growth.

New technologies has performed particularly well with revenues in new technologies increasing for the year over 35%. And contributing to that has also been the very successful Orbis product, part of it is as a result of a small acquisition we made, by now almost a couple of years ago NT Media, which has given us a number of casino games.

We’ve introduced casino games for a number of our accounts and OpenBet, which is an open platform that accepts both sports betting and casino games is now really leading in that integration of Single Wallet and the ability to bet on a number of areas.

Sky Poker launch, Ladbroke's Backgammon, Centrebet in Australia, all of those have really contributed to a very solid growth of Orbis contributing also to a new technologies.

In terms of new pay-TV customer wins we’ve had ten wins all together this year again a good mixed in different countries.

Again it was focus on Eastern Europe and we are particularly excited with some of the wins we announced also last quarter like Kabel Baden-Wurttemberg, Dogan Media, which in Turkey, which is doing very well. This time we announced additional wins in telecom and also Korea telecom is obviously a leader in -- say in broadband provision in Korea and they’re picking NDS for their commercial launch is an important milestone.

At the moment, they still don’t have a broadcasting license for linear channels or the initial Mega TV service is for on the demand. But KBR expecting to get also for broadcast license. Korean market is bright and advanced in the aggressive market, we expect not only that to spur obviously the growth in broadband but also Korean cable companies which today have really deployed in limited numbers due to the various consolidations is still going on in the Korean market.

We would expect that as a result of the intensifying composition. Korean cable will also accelerate their deployment. We have three cable companies in Korea all of which are deployed still small numbers. So we think that that’s an important area.

We also have launch our metal solution with SES AMERICOM IP PRIME demonstrating that the show earlier this quarter and we really are continuing to see broadband a lot of activity the numbers as we’ve said in the past are still not very large but NDS is very committed to this technology. We believe it will play a major role in hybrid set-top boxes in standalone in many individual cases and therefore we’re pleased with our continuing progress in this area.

So all-in-all, we feel it has been really good year for us, Alex will give you an update on our guidance for next year which again we feel is inline with our long term objectives. NDS is continuing to invest in not only insuring that we continue to lead in our current market which have a long way to run and indeed we’re thinking of our market as three distinct areas of focus.

One is in our well-developed established markets; intensifying competition is creating demands for the more rapid deployment of advance technologies, a high definition DVR; DVR in general, hybrid set-top boxes, advanced applications and so on.

So it’s a technological challenge that lower cost and continuing hardware declines are making digital pay television affordable in all of the developing markets and yes, there is focus whereas competitive solutions that are ready to grow, like our VideoGuard Express that are quite successful in this area.

And finally the media landscape is delivery, is changing rapidly as a broadband becomes more ubiquitous. There are many new ways to consume media, NDS focus on capitalizing and the opportunities in this area. We have the acquisition of CastUp, which we announced this morning, is simply in indication of our focus on delivery of television over Internet and the opportunities that are opening up for NDS in this area.

The ability to combine that in a single customer interface, whereas traditional media deliveries making this part of the customer relationship, as well as the potential for new players. Where our traditional technologies maybe helpful, but not necessarily in the traditional role of insuring the security of the system, but rather authenticating and targeting, advertising in solidifying, how it has been delivered from the point of all the audience measurement capabilities.

And NDS is actually focused internally, its resources to line up with this three different market segments and then sure we have an adequate focus investing to maintain our leadership in the new areas as they merge. I want to remind you that, these things take a long time to come preparation and as stockers were, investing in its DVR technology.

And 99 having 71st demo at International Broadcasting Convention and now almost seven years later as when we are seeing really substantial revenues coming out of that, similar for some of these new technologies, which I think will become, will take a while to mature and become significant revenue contributors, but it is key for us to invest to retain our leadership. We will be doing that and as Alex, will emphasize again, inline with our commitment to stay focused on achieving our financial goals.

So I'd like to turn it over now to Alex, who will take you through some more detail on the results, as well as provide our view on guidance for next year. Alex?

Alex Gersh

Thank you Abe. Thank you everybody. Well as we’ll startup as always with the total revenues and as you've seen the press release $709.5 million an increase of 18% over last year. Operating income increased 23% to $160.4 million, operating margin is up 22.6% versus 21.8% in '06. Net income increased almost 36% to a $135.7 million and diluted EPS stands at $2.33 a share, which is a 34% increase over 2006.

We’ll talk about some of the key drivers of course of all those parameters. So if we start with revenue as we always do start with Conditional Access, it increased by 30% to $396 million or so. Clearly higher security fee and increase in number of authorized cards. Have impacted this $75.4 million as Abe, said. Authorize cards versus $65 million as of the end of the last year, and 82% of these pay as a monthly fee.

And a higher card shipments $26.3 million versus $24.4 million and again last year -- and again as Abe, has emphasized a very important point the growth is coming from places like China, India, Eastern Europe as well.

Integration development and support revenue increase by 20%, to $56 million or so. In '07 we of course, as we have said before we've recognized revenue from delivery of conditional access EPG and middleware to Tata Sky, which commenced operations in August of 2006.

In addition, we recognized a number of enhancement a revenue on a number of enhancement for a number of our projects and importantly a number of those projects relate to high definition integration and development. So that played a significant role in the growth in the growth in integration development and support line.

License fees and royalties increased by 21% to $107 million and really the increase is principally due to higher conditional access in EPG royalties, offset by as Abe, said a lower middleware a royalties due to the last years download to DirectTV, which was talked about.

And again, this is both our new customers that Abe, had mentioned as well as some of our current customers increasing the number of boxes, they shift to their subscribers. As of June, we estimated accumulative number of 61.8 million middleware clients have been deployed. And again as I've said, it does include some of the Jungo deployments in there and we will be considering as Jungo gets bigger to split that out for you.

New technologies again, Abe mentioned increased by 35% or $143.5 million, and really the increases is substantially due to the increase in DVR technology, advanced middleware that relates to the DVR, gaming and residential gateway devices.

So, other things Abe mentioned, 3.8 million DVR clients deployed during the year versus 2.5 million in FY '06. And we estimated reps at 7.3 million; total DVR is currently deployed.

Again then and if you looked at the press release we now have a section on foreign exchange to give you the average exchange of both '07 and '06. This is important because we want to underscore the impact of the foreign exchange has on us. On revenue as we've said before, and we continue to say 50% of our revenue is Pound and euro denominated.

Due to the relative weakness in the U.S. dollar, we estimate that, that the revenue was favorably impacted by 4%, or about $26 million. Our total revenue from related parties, again people obviously ask these questions as about 73% versus 76% in '06. So again, we see an increase in some of the other customers shown up here.

Gross margin increased from 59.6% to 62%, and while the cost of sales increased due to the number of employees, and employment related costs attributable to development and integration and support activities for our customers, which of course show up in cost of sale.

The sales increases in higher margin lines of sales, like new technologies, like licensees and royalties, like integration and development supported at higher margin for the business during the year.

Our operating expenses now look just spend a little bit time of that talking about expenses. Operating expenses increased 24% to $280.7 million. In general, when we look at operating expenses, and we'll talk about individual line of course.

But, really that they're driven by higher employee numbers, we've added 583 employees during the year, including roughly a 140 that came from Jungo, when we acquired Jungo. Associated facilities costs have increased, last year if you'll recall we've moved in a number of new facilities in a number different places.

Last year, we had half a year roughly of that impact of course this year we have full affect of those facilities. And of course, lets not forget the foreign exchange accounted for very large increase.

Again, as we've said before 72% of our expenses are denominated in shekel, pound, and euro that contributed to $28 million increased in the expenses 4%; $28 million increase in the expenses for the year. And that obviously had a very significant effect.

In terms of sales and marketing, it increased to 35% to $41.4 million. The results are increased activity in India, China and Europe and Eastern Europe; we've increased our headcount in marketing in those targeted areas. Clearly foreign exchange had an impact, as we talked about overall, as well as, we've opened some new offices in the number of places and increased some of our marketing activities in terms of shows and attendance and so on.

So, that really accounted for increase. G&A increased by 30%, I have to say that by far the largest increase in G&A has to do with legal expenses. These legal expenses are attributable to our case of majority of the legal expenses attributable to our ongoing case with EchoStar. We now have a trail date in February, obviously this is a ramping up of those expenses, and we expect that to continue into next year, because obviously as you get into this trial the expenses significantly increase.

And that is by far the largest percentage of the G&A increase. Although of course equity compensation costs, higher facilities costs, as well as, some increased headcount also contributed to some of the increases.

As I said, the total headcount increased by 583 employees and clearly that and, as well as, the employees that we've added last year, we now have a full impact, full year of those employees costs, all of these are contributed to the increase in the cost.

We currently have 3,572 employees as of the end of the year with 84% of them being technical employees. Operating margin increased to 22.6% and as I said, and if you look at the -- what I talked about carefully about the exchange rate, if I said $26 million of positive on revenue, $28 million negative on cost.

Foreign exchange impacted operating margin adversely by about 1.1%. So, 22.6% was affected by about 1.1% due to the foreign exchange, negatively affected due to the foreign exchange fluctuation. I think it's important when we look at the revenue, clearly our revenue number is above and has been above what we've guided the top range of our guidance.

And I think there has been a number projects, as I said that we’ve -- that as technological innovation accelerates in our customers ask for and demand products and introduction sooner. We have recognized a number of projects that we perhaps, did not anticipate recognizing in -- when we looked at our guidance at the end of the last quarter.

However, at the same time, of course, we have -- in April, our Board approved the next equity plan and the impact on 2007 was about $2 million. I talked about the additional legal expenses and of course, the affects, the net affect of the affects, we were able to absorb all of those costs as part of -- to make sure that we continue to achieve on our target and achieved our at the higher end of our guidance in terms of the operating income.

Income tax, I think, is an important point here to say. If you look at the income tax for the year, the affective rate is about 26.9%, which is quite good of course, for us. And there are really two major reasons for that. Number one is, we continue to be very much focused on making sure that we are tracking and applying and getting R&D credits around the world for the research that we perform, that many governments offer, and we -- and that focus has produced additional money this year for -- that reduced the tax, the tax expense.

The other thing, of course, is the -- because we operate in so many jurisdictions, the very -- the tax rates in jurisdictions are different and depending on where the profit is originated within the business, clearly that impacts the tax rate. In terms of kind of going forward, we would expect next year to continue to be -- to look at the 30% tax rate. But after 2009, due to the new legislation in the U.K., we expect the tax rate, the affective tax rate to come down to about 28%, going forward.

In terms of the balance sheet, of course, you see the increase in inventory, which we again we talked about last time. We have accumulating some inventory of -- due to the demand of our customers and some of the new chips, which we already started shipping at the end of this year and will, of course, continue to do so.

Receivables, while the overall receivable balance has gone up, the GSO remains well below 60 days and clearly, this is simply a function of billing in the last quarter and we’ve billed more in the last quarter. Of course, Fx also affects that as you would imagine.

And from a cash flow perspective, as you could see, $593 million in the bank. We have issued approximately 846,000 shares to the employees for the exercise of stock options during the year. We currently have 2.8 million shares.

Our share stock options are outstanding with 1.8 million invested. And, of course, now onto the guidance. Our preliminary guidance for 2008 is, revenue in the range of $800 million to $820 million. Operating income range of $185 million to $195 million, and operating margin range is between 23.1% and 23.8%.

Clearly again, the dependencies of the roll out of the PVRs and the speed of the roll out, as we’ve talked about in the past, as well as of course, foreign exchange continues to be a very significant -- continues to have very significant impact particularly, in our operating margin. These are the results kind of in a nutshell. And I will now turn you back to the moderator for -- to start the question and answer period. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Daniel Meron from RBC. Please ask your question.

Daniel Meron - RBC Capital Markets

Hi. Good morning. Abe, Alex, congratulation on a very good quarter and excellent guidance. Can you give us a sense on what’s driving the top line growth in 2008? It’s clearly above my expectations I think, as does of the rest of the as well. Which is great and I just wanted to understand if it’s more related to subscribers and all that? Thank you.

Abe Peled

Well, I mean I think that -- first of all, thank you, Daniel. The same old factors that has been driving our growth this year which came in above expectations and slightly above our guidance. I think we see the same factors at work. We have a very strong win pipeline, and we see good orders for these platforms as they grow.

We have a number of other bids, which we are optimistic on that we believe will continue further. And the gross in these bids results in gross in all the lines from conditional access, middleware and license fees and royalties. In addition we can see continuing strong growth under new technologies areas.

We expect the number of PVRs to continue to grow also as a result of increasing penetration, but also the result of more customers deploying our PVR’s and introducing them into the market.

So, clearly there is nothing specific either then, I believe that all of the different cylinders continue to fire.

Daniel Meron - RBC Capital Markets

Okay. So, and you mentioned that you are expecting several bids. Is that, what kind of a impact is it on your guidance? How much of that they can into that right now?

Abe Peled

As usual, the new bids that we will win in the year contribute relatively little to the revenue in that particular year, although obviously depending a little bit on timing and so on.

But the great majority of the revenue is result of business where we have or been already won. I think the bids in pipeline contribute a little bit, but not really a big amount.

Daniel Meron - RBC Capital Markets

Its okay. Thanks.

Abe Peled

Thanks.

Daniel Meron - RBC Capital Markets

Okay. That’ll make sense. Thanks -- it look like its just on going business that you already have and then on top of that just a few wins to add on. Alex, can you provide us with a sense on the job and the deferred income, what has changed there, especially in long-term, I stick to that?

What are the implications from the placement cycle that we’ve been talking out for a quite few quarters now?

Alex Gersh

Well, to your first question, Daniel, of course, we keep saying this and we keep emphasizing. Clearly that if you look at Q3 and Q4 some assumptions with regard to some of our contracts have changed.

I can’t obviously comments on specifics, but there is no question that the current portion has increased, overall there is off course no job, but the current portion of deferred revenue have increased from Q3 to Q4.

And I can tell you, all I can tell you is that the assumptions have changed. I can’t really comment on anything in terms of change or was there any future change over there at this point.

Daniel Meron - RBC Capital Markets

Okay. So it doesn’t look like there is a major change to the piece of change over at least at this point, is this assumption correct?

Alex Gersh

As of the end of the year, what I said is that we have, the Q3 and Q4, the assumptions as to the change over have changed and that’s pretty much as I can say. Going forward, I really can’t comment on the piece or anything else at this point.

Abe Peled

Yes, I just want to emphasize that, due to confidentiality reasons for customers and security configurations these of the hacker’s etcetera. We do not comment on any intending or any changeover that may, may not happened and so on.

So, I think you will, you have take our guidance for what it’s worth. And we can’t really give you any details on these aspects.

Daniel Meron - RBC Capital Markets

Okay. That’s fair. And we just want to get a clarification there. Again congrats on a great execution and good luck going forward. Thank you.

Operator

Your next question comes Ali Mogharabi from B. Riley & Company. Please your question.

Ali Mogharabi - B. Riley & Company

Hi, guys great quarter. Couple of questions on the acquisition that you guys announced this morning cashed up. Can you give us an idea how much of revenues this guys are actually generate a year?

And also keeps a coupled examples, on the clients where they tuning at?

Abe Peled

In terms of revenue we haven’t included that because they are slower revenues obviously don’t fined somebody for a little over the $11 million, that has a lot of revenue, it’s really more of a know how and the extra rupees and delivering debut over the public internet.

There really local play in this environment, that to expect. Their clients really almost every one, I believe its almost over 80% of this early video streams, that are provide by people like television, stations, like cash head (ph) to channel 10, the sport channel, the public broadcast authority and newspapers that provide video streaming all of those are done by them.

They have a salary of which rapid flow of integrated ability to in just video in different formats, and published, distributed and cost effective and efficient manner, that optimizes the performance as well the ability to track and will provide detail report things on viewing patterns and whosoever are concerned.

So, we see it, I would say primarily, as a shortcut to acquire know-how capability in this area that we can subsequently apply in other countries where similar opportunities may arise, but also as part of our ex-base, and of concept of delivering internet video not only to PCs but also to set-top boxes through hybrid connections or vice versa, taking contents from our broadcast, pay-TV customers and delivering it in addition to via set-top boxes, HD and so on, but also a version of that via the public broadband network to personal computers and other devices in the future.

Ali Mogharabi - B. Riley & Company

Okay. And then the -- in terms of the -- you guys, of course, are well aware of the news last week, BSkyB acquiring Amstrad. Abe, give me an idea, I mean how may that impact or does it in anyway impact your relationship with BSkyB?

Abe Peled

It -- we have been working with Amstrad before when they were a separate company. BSkyB expects to continue working with all other suppliers. So, as far as we can tell, there it has really no impact on our relationship with BSkyB or our revenue expectations from BSkyB. And so, I think it’s completely neutral.

Ali Mogharabi - B. Riley & Company

Okay. And then a couple of housekeeping questions for Alex. I know you can’t breakout the middleware, number of middleware related to Jungo, but in terms of revenues, overall revenues, can you give us an idea of how much revenues did Jungo business brought in?

Alex Gersh

Well, we don’t disclose the revenues for Jungo at this point.

Ali Mogharabi - B. Riley & Company

Okay.

Alex Gersh

Oh. Unfortunately, I can’t.

Ali Mogharabi - B. Riley & Company

Got you. And one last question, new offices, I know it seems a lot of housekeeping here, but give us an idea where you guys or how many new offices you guys have opened up and where?

Alex Gersh

Well, this is mainly -- last year’s openings and the offices are in India, in the U.K. and in the U.S.

Abe Peled

And Moscow.

Alex Gersh

And Moscow, this year. Right.

Ali Mogharabi - B. Riley & Company

Moscow?

Alex Gersh

So, Moscow this year, and then there is -- yeah. There’s a couple of in India. We will -- we are in the process of occupying another office in India, so that will have a future effect, but obviously that’s all part of the guidance and all.

Ali Mogharabi - B. Riley & Company

Got you. So, nothing in addition to Moscow this year?

Alex Gersh

No.

Ali Mogharabi - B. Riley & Company

Okay. Got you. Thanks guys.

Operator

Your next question comes from Tim Boddy from Goldman Sachs. Please ask your question.

Tim Boddy - Goldman Sachs

Yes. Thanks very much. I just wanted to ask a bit about OpEx, where I understand obviously, there is a reasonably meaningful Fx impact on that, but it’s still like underlying OpEx. It’s kind of being going up certainly faster than you would’ve expected it earlier in the year.

And we’re hopeful to get a feel for what the trend now looks like for the next fiscal year, for fiscal ’08 and what are the, sort of, swing factors to that? I mean is right another stand in this rising OpEx reflects an increasing momentum in the business or is it reflecting an increasing investment in long-term projects?

Abe Peled

I think the predominant increase in OpEx is from contract that we have, on which we are already working and we will not see -- haven’t seen yet revenues. And so, I think a very modest, maybe 10% of that, is attributable to our continuing investment in longer-term technologies.

So, this has always been the nature of NDS. We are working on Kabel’s Baden-Wurttemberg. Clearly, we are going to be working on this for the whole year, and have been working on it for a few months. We’ll continue working on it. Getting revenue from that would probably be only later.

So, that’s typical of our contract. So, therefore I think, you should see that as reasonably good news rather than our people getting lazier and we have to hire more of them or a large increase in advanced R&D that is not tied to revenue.

Tim Boddy - Goldman Sachs

And how do you see that trend in the current fiscal year in OpEx?

Abe Peled

Similar.

Tim Boddy - Goldman Sachs

But maybe a 20% rise or thereabout?

Abe Peled

I don’t think so, Alex?

Alex Gersh

No. I mean if you strip -- if you take all of our -- the total cost of both OpEx and cost of sales and you back out your effects, your rise is about a 11%, if I did my math correctly. So, I think that that’s the kind of run rate that Abe is talking about.

Tim Boddy - Goldman Sachs

Okay. Now, that makes sense. And I certainly get that it’s effectively an indication of future business momentum rather than necessarily deterioration in margin. And just, the other question I was hoping to get -- just for the task based on -- it’s just whether there’s any updates on the DirectTV relationship and any noise at all from that customer regarding the impact of the potential change in relationship of DirectTV.

Abe Peled

No. I think our relationship with DirectTV is very good. I think they are obviously quite pleased with our conditional access, especially, given that their competitor Ecostar continues to have when publicized challenges in the piracy area.

I think on the middleware, I think they’ve really bended down, all of our products or shipping. And they are getting excellent reception. A bunch of new applications have been introduced. We’ve just started downloading the middleware into the high definition boxes. So, I would say, our relationship is as good as it has ever been, obviously, they’re very demanding customer.

The Liberty transaction has obviously closed here. And we would expect that these -- our performance would be equally recognized once Liberty closes the transaction as well. Our contract obviously goes to 2010.

Tim Boddy - Goldman Sachs

Yes. And then lastly that’s very clear. In terms of middleware and DVR, it seems to be sequential slowdown in the quarter. Is that just seasonality?

Abe Peled

Yes. I think that, its very hard to reach something into any particular part of that shipments because they had to do with the number of boxes that were shipped and how they are activated and so on. So, I don’t think you can read anything particular. We expect our next year to see good growth in both of those lines.

Tim Boddy - Goldman Sachs

Great. Thanks very much.

Operator

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

Jason Mauricio - Arete Research

Yes. Hi guys. I’ve got three questions. First on the headcount of about 580 staff, I was wondering if you still going to hire aggressively this year? And how do you track productivity on this headcounts? When should it start, these employees being ramped to full productivity so that they’re contributing fully to both the top and bottom lines? And is this just something that at this level or you know, this level we’ll see again this year?

Abe Peled

Well, you really have to think of NDS to some extent, like a services company rather than a product company because the more projects we have or contracts that we have, the more people is required because these -- its not like we tell somebody something and then go away, and the same team tells it to somebody else.

A contract with a customer is an ongoing revenue-generating contract that constantly has improvements updates. New technologies being introduced and that’s why there is a cumulative increase. I think, in terms of the productivity of our people, are pretty happy with it.

That, in terms of your question, how many of these 500 are already productive, then obviously 500 include 200 authority in -- sorry, 140 or so, that in Jungo that where productive continue Jungo is continuing to increase and the typically we see people within six months already being fully on-board. We hire mostly experienced people.

In terms of next year, we certainly expect to hire a smaller number because part of it was an acquisition and so on. But having said that, that’s what we expected the year before. It is obviously modulated by the business that we get and the contracts that we secure on which we have to deliver. And should we get additional contract beyond, what we have already planned and we may add more people than in our current budget, which is the basis for our forecast.

Alex Gersh

The only thing that I would add is that, we have a fairly sophisticated system that tracks time that people build to particular project and all of the R&D and delivery managers were actually where the majority of its people are, track that’s very, very carefully. So in terms of what people are doing, what they are working on, what are those projects we have, it’s a very, very detailed process…

Jason Mauricio - Arete Research

Could we see a shift in your hiring’s, from what I understand is been mostly R&D related to maybe more sales and marketing focus type hires?

Abe Peled

Well they’re big numbers, I mean we’ve been added to sales and marketing obviously, we’ve opened an office in India. We have opened an office in Muscat. But these numbers are relatively small compared to the sales and marketing or re-sales, which are all technical people. It’s really is a highly technical sale and then mostly delivery and development focus.

So yes, while we continue to increase slowly the number of people in sales, the predominant additions are still in the technical area, either delivery or R&D.

Alex Gersh

Yes. I mean just in terms of the numbers out of this 583, 82% are technical and 9% are sales and marketing. So we have said, there is an increase in both, but its not really compatible.

Jason Mauricio - Arete Research

Okay. And maybe Abe, I was wondering if you could give us, maybe talk to you some of the trends you’re seeing in DVR rollouts. You know three big events. Certainly, next year that’s included in your fiscal year like year 2008, would you expect this to be sort of a pivotal year for PVR rollout? In the past you've given some targets for where you’d like to end-up at the end of the year any characteristics out of that one?

Abe Peled

Well I mean first of all we see PVR continuing to gain rapid acceptance by consumers. I think, you’ll probably know from your experience in the U.K. that Sky Plus is widely viewed as a terrific product. The introduction of things like remote booking, Sky anytime, which is the ability to move out of your box as further increased the appeal of this product similar capabilities that would have been introduced in the U.S. in another markets like Australia. So we just see a very good growth in that I don’t think, we give particular numbers, or the number of PVR that we expect, but we expect the continuance.

Second, there is an expansion into number of people that in the number of countries where PVR is being pushed combined as a fact that as the cost of the hardware comes out. It would be increasingly promoted by upper items as a way to keep the business sum-up or even considering making that a standard box.

So, although, I think the cost are still a bit high for that, because that would provide real impetuous to the anytime notion that you could release in new millions or billions of PVR. So I would say over the next two to three years, we will surely get to that position but next year the scale continuing in the momentum.

Jason Mauricio - Arete Research

Okay. And finally the China business, you called it out. Just curious if you can give any metrics or data points around that to help us correct that in a bit more closer detail?

Abe Peled

Well, we’ve said that we have already more than three million subs in China, it’s clearly the tip of the iceberg and as the Pinge (ph) which is the national initiative to digitization continuous to gain momentum. We would expect to see continuing penetration in China and we expect revenue growth year-to-year from our business in China.

Jason Mauricio - Arete Research

Okay. Thanks a lot.

Operator

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

Alan Gould - Natexis Bleichroeder, Inc.

Hi. Yes. Thank you. I’ve got two for Abe and two for Alex. Abe, following-up on China with the Olympics in 2008, does that have any impact, is the government going to be investing more trying to get more digital boxes ready before the Olympics, since that impact you? Secondly, could you give us an update on project Fusion?

And for Alex, the last two quarter has been a first quarter R&D credit from France, are we going to see that again in the September quarter, or did that just occur in the quarter that was just announced? And lastly, your operating margin adjusted for foreign exchange was 237. Last year your guidance is 231 to 238. You have shown sequential increases each year. I'm wondering why it’s flattish in your guidance for this year?

Alex Gersh

Let me just go first the R&D credit, just to be clear that French R&D credit happens in the first quarter, in our fiscal first quarter every year. So, clearly what have happened over the last two years, clearly we don’t know whether or not its going to happen the way and I think I have described the way the R&D credit in France work as you have to submit to the French Government the totality of the projects that you work out and then they judge whether or not they qualify for the particular credits. So to answer your question, we will not know until we actually know whether or not we are going to have the credit next year.

In terms of the margin, your question on the margin I think again the answer is as Abe said before we have won a lot of new platforms. We have won a lot of new business that Abe mentioned. Again as Abe said you know the investment requiring to bring these -- to bring these projects to their conclusion have to come before the revenue actually starts. So this is the investment that we see continuing in the business for those projects and those and that is why the margin while was improving is not improving that’s as much as you would expect.

Abe Peled

And I think that a lot of it as to do with our assumptions on when we will be able to recognize our revenues from these projects. So, obviously, we provide updates as that picture becomes clearer. And we would rather increase our guidance then decrease our guidance has been traditionally our view of the world. So this is our best guess given what we know today in terms of schedules and possible rollouts and so on.

Now, about China, first of all, the government has already been pushing this whole thing, so it’s not a new. I think a lot of the pace is really dictated by the local municipal government approving the rate increases in basic cable affair and so on so. While there is these whole things has been towards the Olympics, I don’t think that we will see suddenly a spike may be a few but not things that we weren’t expecting. Some of that will, some of it deploy 1 million boxes because of the Olympic.

Alan Gould - Natexis Bleichroeder, Inc.

Okay. And project fusion?

Abe Peled

Project fusion is I think going, we’re very pleased with our progress. And we have commitments from some people to use it. We have been very effective as a roadmap in selling our current middleware. And we would expect in fiscal 2008 to start making the first product deliveries.

On fusion it’s continues to be well received by manufacturers set-up box manufactures as well as chip manufactures all of which are implementing the CBI which is a common device driver inter phase layer that makes them ready for fusion.

And some of our current products were we are starting to run on that layer so that in the future they could be upgraded to fusion. So as far as we can tell, it’s a well on track both in customer acceptance in our development.

Therefore, I think our guidance for next year includes further ramp-up in the development activity and the only part of which is cover by revenue a lot of it will come obviously in the future as we start deploying it on the number of things.

I think it improve our competitive posture in the middleware and really has allowed us to win the number of cases head-to-head with like open TV, nobody have anything like this in terms of breadth, scopes and modality and advance of the technology embedded.

Alan Gould - Natexis Bleichroeder, Inc.

Okay. Thank you.

Operator

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

Todd Mitchell - Kaufman Brothers

Thank you very much. I have a couple of questions. Actually, first housekeeping. Alex, could you tell me the FX or the foreign exchange impact on revenue expenses in the quarter?

Alex Gersh

I try to remember now, I believe that the FX on revenue was about 9 million. If I’m not mistaken, I can’t remember right now. I have to take a look. If you look at our third quarter Q, we give the year-to-date number and as I said the total year is 26 and 28 on revenue expenses. But I just don’t remember. I don’t have in front of me handy.

Todd Mitchell - Kaufman Brothers

I’ll look at it. Also you brought up legal expenses rising because of the Echostar litigation. Can you flush out sort of what the time map or the time horizon on that is going to look like in terms of the processes? And also can you remind us what Echostar alleges your exposure is here?

Abe Peled

First of all, the timing is that the trials date in February was the positions and so on ending in September. So clearly, if this is a period in which there is a lot of activity, the quarter and the next quarter because of all of the positions and so on. Then there are trial preparations, and then it’s a jury trial. There are no specific financial demands, that EchoStar has made the allegation is that one of our employees has posted their code in 2001, on a Internet site.

Of course, we believe that, and we know, that this is not to be true, as well as, a number of other allegations, which again have no basis. We continue to pursue this, because obviously, we will defend ourselves rigorously, but we don’t believe that there is any basis or exposure for us in this area.

Todd Mitchell - Kaufman Brothers

Okay. Also, one of your fellow News Corporate affiliates JimStar announced that they were looking at strategic alternatives. Can you address, given your amount of cash and their customer relations as particularly with U.S. cable company. How you reveal those assets are -- is there any interest in some of those assets? Have you taken a look at them?

Abe Peled

We are not at this point looking at JimStar, while theoretically some of these assets maybe of interest NDS in the future, as part of this particular review, given the ownership of News Corp., it would be inappropriate for us to look at these assets, because that may hamper the ability of a transaction to be concluded. So, we are not looking at them, and they can comment on anything beyond that.

Todd Mitchell - Kaufman Brothers

Okay. And lastly, and this is sort of a looking over the horizon question. You’ve seen recently in the U.S. competitive, Clearwire and Sprint getting together to put together a national WiFi offering in the likelihood that it will be part of a bundled offering with the DBS down the road. In terms of technology wise, what kind of opportunities does that offer NDS?

Abe Peled

Well, we are, as you know, are big believers in the hybrid set-top box; set-top box that going to receive both broadcast and broadband signals. And the broadband content can be complementary, supplementary, can be the long tail, can provide access not only to specific operator provider VOD, but also to the increasingly rich videoconference that’s available on the broadband Internet.

Frankly, the hybrid set-top box does not depend on having -- it doesn’t have to be Clearwire, as it can be a regular broadband connection. The Clearwire and the ability to bundle a television with broadband is more of a pricing issue, than technological issue.

I think that from our point of view, once you have a broadband connection, you have to in a way to get it conveniently to a broadband enabled set-top box. We believe it offers up in number of -- obviously people will want to replace existing boxes with boxes which has that capability.

And we have, as I said in XSPACE we have the software and servers that can transform these streams and deliver them to the set-up boxes and then that like you should also look at our acquisition of CastUp, where we want to improve our whole ability of delivering that video effectively over the public network doesn’t have to be a dedicated network versus quality of services especially if you are going to do progressive download, which can by suitable amount of profiling can mitigate the effect of evaluating load on the network.

So, we are very focused on these technologies and believe they hold a big opportunity for us. However, are not necessarily dependent on having BPS (ph) bundle as through ownership or other alliances with a broadband provider because they can be deliver to any broadband provider.

Todd Mitchell - Kaufman Brothers

Okay, did you, I maybe wrong here, but wasn’t there about several quarters, so didn’t you make a small acquisition of a company in Israel they had a WiFi, and 10A technology?

Abe Peled

No.

Todd Mitchell - Kaufman Brothers

No, Okay. Thank you.

Abe Peled

We think the company that has dimensional gateway, which is a Jungo.

Todd Mitchell - Kaufman Brothers

Right. But I was thinking earlier than that.

Abe Peled

No, there is a company in Israel that specializes in a WiFi and the ability to repeat it and. We’ve had demonstrations with them at CES and then IPC that this will work, but we have not acquired anybody in this area.

Todd Mitchell - Kaufman Brothers

Okay. Thank you very much.

Abe Peled

You’re welcome.

Operator

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

Ari Bensinger - Standard & Poor's Equity Research

Yes. Thank you. And all have my congratulations to the quarter. I have a couple of questions and guidance, I just want to clarify that the fiscally '08 guidance does not include the impact if any firm change over?

Alex Gersh

As we’ve said before we cannot comment on anything or any specific issues with regard to change over. So, that was much as we are going to see our change over that’s it.

Ari Bensinger - Standard & Poor's Equity Research

Okay. And then in terms of – I understand operating expenses are going to be up because you’re investing in the business. But in terms of gross margin, am I correct to assume that I think new technologies becomes a bigger part of the company that the gross margin impact related to that segment will be positive due to the software intensity in some of those products?

Alex Gersh

Yes. You’re correct to assume that absolutely.

Ari Bensinger - Standard & Poor's Equity Research

So, I mean, so last year didn’t you have last quarter or one time impact in gross margin from some type of royalty cost. So really looking forward gross margin should improve going forward or how should we view that?

Alex Gersh

I think you’re right. I think one of the issues again is with how many of our technology personnel are working on specific customer projects. So you are absolutely right in saying that all – everything staying equal as it is today, as we move towards new technology into some of the higher margin revenue lines clearly you will see an improvements in gross margin.

The only thing that would effect that is that we have more employees working on specific revenue derive customer projects and then they move from R&D and into the cost of sales, but all things being equal you’re correct, your assumption is correct.

Ari Bensinger - Standard & Poor's Equity Research

So, that makes sense. So then getting back to guidance it seems like the operating margin guidance would assume that operating expenses grow faster than itself. And I’m wondering in a longer term if the Company goes to sort of to capture that leverage from the higher sales in this good environment, because I don’t think that’s what’s happening in fiscal year ’08.

Alex Gersh

Ari, well, If you look at our margin of 22.6% this year and our operating margin guidance is 23.1% to 23.8% next year, improvement in operating margin by definition would mean that the sales are going faster than the costs. So, no, we expect the sales to continue to grow faster than the costs.

Ari Bensinger - Standard & Poor's Equity Research

Okay. And then lastly, in terms of integration and support, there are some moving items in terms of just recognizing revenue. What’s sort of a sustainable level in terms of modeling that we could look at going forward?

Alex Gersh

It’s very hard to say. This is, I mean as we always, we always keep saying that this is the lumpiest part of our business. And you see them, some of these new project wins and if there is integration revenue associated with them when they go on line, there will be a recognition of that.

So this a very, very hard question to answer. I think we’ve said before that the sustainable level is somewhere around $10 million to $13 million a quarter or something like that, but again, that’s just a very -- that’s a very top-level guidance. This is -- that’s the part that relates to ongoing development and support rather than one-off integrations.

Ari Bensinger - Standard & Poor's Equity Research

Understood. Fair enough. Thank you.

Operator

Your next question comes from Ian Khatnani (ph) from Morgan Stanley. Please ask your question.

Conrad Werner - Morgan Stanley

Hi, there. It’s Conrad Werner calling from Morgan Stanley. Again, congratulations on the good quarter. Just to further ask about this guidance, what assumption on foreign exchange has been made for the guidance for ’08? Is it just to assume that the exchange rate stays flat year-over-year or is it just to assume --?

Alex Gersh

Yes, it is -- I mean it’s based on the current exchange rates. When -- at that time we did the guidance, so to be honest with you, there is slightly -- it’s based on slightly lower exchange rate there today, on the basis of Euro and on the basis of the Pound, but basically it’s the same.

Conrad Werner - Morgan Stanley

Okay. Because I’m just trying to understand that the comparison should be against the 22.6% that was the reported margin or whether we should be comparing the new margin guidance to the underlying margin effectively?

Alex Gersh

I mean, I say, I mean, we -- from our perspective, we talk about -- we highlight effects but we view it as a real cost, and this is what happens. So, we look at the 22.6% as a gross margin achieved, and therefore, we view the improvement from 22.6%. And I think that’s the right way to look at it.

Conrad Werner - Morgan Stanley

Understood. And then, have you also baked into this guidance a higher legal expense around the cycles?

Alex Gersh

Yes. I mean, we’ve certainly trying -- I mean, the best we can do is estimate obviously. But again, this is a very significant and it could fluctuate, but we haven’t made an estimate.

Conrad Werner - Morgan Stanley

So, it sounds like you’ve been fairly conservative on all of that. And then, maybe just a sort of a longer-term question, you mentioned -- Abe, you mentioned in your speech at the beginning, the opportunities in advertising and managing of sort of advertising assets for the operators.

Could you talk a bit more about kind of where we stand in that new product development and how big an opportunity that could possibly be?

Abe Peled

Well, I could say the point of view that, many people say, all advertising improves to be individual and targeted and arrive at the set-top box through the broadband connection instead of being incorporated in broadcast and then it’s $65 billion opportunity.

But I mean, obviously that’s not my view. We think that it represent a real opportunity for a technological infrastructure. If you envision DVR enabled to the broadband connection, then you can really move on broadcast television to a much more targeted auditable delivery video ads that are more tailored to the individual either by his request or by his viewing pattern and that transition will take a long time.

That I believe is inevitable and we are working to put a technological infrastructure in place for doing all this ad insertions on the fly. Who is in work? How do you determine based on the audience measurement capability that we have? What are the best things to deliver, so that is the ability to request things? How would you do promotions and so on.

So I would say it’s in early stages of our studying and you wouldn’t see products in this area since there isn’t really a big enough deployed base in advertising goes, when there is big enough deployed base.

But once that deployed base start showing up and incidentally in Israel we have the largest number of deployed hybrid set-top boxes and they can be already start to experiment with things like that, pending regulatory agreement.

So it was the cast of ability we can have a small laboratory to try something’s out. But we view it as an important long-term trend that will keep NDS at the forefront of this changing landscape of media delivery.

Conrad Werner - Morgan Stanley

Great. Thank you.

Operator

There are no further questions.

Abe Peled

Okay, well I would like to thank everybody for your patience on a relatively long call and we wish you all or talk to you all next quarter. Thank you.

Alex Gersh

Thank you.

Operator

That does conclude our conference for today. For those of you wishing to review this conference, the replay facility can be access by dialing within the U.K. on 0845-245-5205 or on country code press 44-1452-550-000. The registration number is 643-7458, followed by the hash key. Thank you for participating. You may all disconnect.

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Source: NDS Group F4Q07 (Qtr End 6/30/07) Earnings Call Transcript
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