Zoran Looks Picture-Perfect

Why is everyone getting so excited if Zoran (ZRAN), a developer and marketer of integrated circuit cores (ICs) and embedded software for DVDs, digital cameras, and set-top boxes, guided that all segments, except for DTV (Digital TV), are expected to be down next quarter?

Good question. The stock was up 15% on Tuesday (over 20% the past couple of days) on the back of the earnings coverage found here. Most outlets assumed that it was off the back of an upgrade by Needham.

Revenues were all much stronger than consensus. In short, ZRAN had a blow out quarter ($146M over the expected $138M, and $0.51 vs. $0.37). It achieved record revenues for DTV, and its Printer Imaging units, while also seeing strength in the DVD market. Digital Cameras shipped a record amount of units.

Revenues were up almost 13% Q/Q and 13.2% Y/Y. Although gross margins were down from the previous quarter, they were still above where they were tracking a year ago. Cash was up 6% Q/Q, and up almost 30% Y/Y.

Although there will be some near-term volatility in earnings, ZRAN has certainly become more consistent in its results. Those of us who have traded ZRAN in the past are familiar with its volatility in performance — it looks like ZRAN has matured operationally.

So, what’s going to take this puppy up even more so that even my colleague, Aaron “Buy Everything” Katsman wants to own it?

Needham cites a few 2008 revenue drivers:

Ramp to ATSC converter boxes: Did you know that in February 2009, the U.S. will turn off analog TV broadcasts, forcing the conversion to digital TV? In order to receive the new signals, the installed base of analog TVs will need to connect to an ATSC converter box. Congress has approved a coupon program such that each qualifying household will receive two $40 coupons to defray the cost of buying a converter box. Management estimates that the number of converter boxes sold ahead of the turnoff could reach 20-25 million units. Zoran typically sees a high-single digit dollar content off of these units. Nice driver.

Growth in DTV and tier-one OEM design win: Zoran markets a SupraHD product to the DTV market. Zoran experiences sequential growth of 41%, and forecasts more DTV revs in Q4. Zoran is positioned well in Insignia, Magnavox, RCA and Sanyo (found in Best Buy) and has new wins at Fujitsu and Mitsubishi. The company feels confident it can secure a tier-one win with an LCD TV OEM in 2008.

Launch of Approach processor for handsets: LG will be marketing its U990 touch-screen, 5MP camera phone. Based on initial design wins, Needham believes that Approach revenues could reach 5% of total sales next year, up from virtually 0 this year.

Further market grab in DCAM (digital cameras): Zoran has about 30% market share of the DCAM silicon market. Given current penetration and the market opening up for high-end digital SLRs, Needham thinks ZRAN can eke out some more share grab and exit 2008 with 35% of a growing market.

With a lot of cash on the books, and some potential upside to margin expansion, ZRAN may look picture-perfect for our incessant march to a digital life.

Say cheese!

Disclosure: The author’s fund has a position in ZRAN as of October 24, 2007.