NDS Group F1Q08 (Qtr End 9/30/07) Earnings Call Transcript

| About: NDS Group (NNDS)

NDS Group PLC (NNDS) F1Q08 Earnings Call October 29, 2007 10:00 AM ET


Abe Peled - Chairman and Chief Executive Officer

Alexander Gersh - Chief Financial Officer


Jason Mauricio - Arete

Ali Mogharabi - B. Riley and Company

Alan Gould - Natexis Bleichroeder

Ari Bensinger - Standard & Poor's

Murray Arenson -Ferris Baker Watts

Tim Boddy - Goldman Sachs

Ziv Tal - Oscar Gruss

Todd Mitchell - Kaufman Brothers

Daniel Meron - RBC Capital Markets

Conrad Werner - Morgan Stanley

Gorm Thomassen - AKO Capital


Thank you forstanding by, and welcome to the NDS First Quarter Results Conference Call. Onthis call, we will make certain forward-looking statements within the meaningof the Private Securities Litigation Reform Act of 1995.

These statementsare based on management's views and assumptions regarding future events andbusiness performance as of the time the statements are made. Actual results maydiffer materially from these expectations, due to changes in global economicbusiness, competitive markets, and regulatory factors.

More detailedinformation about these and other factors that could affect future results iscontained in our filings with the Securities and Exchange Commission. Theforward-looking statements included in this call are made only as of the dateof this call, and we do not have any obligation to publicly update anyforward-looking statements to reflect subsequent events or circumstances,except as required by law.

At this time, allparticipants are in a listen-only mode. There will be a presentation followedby question and answer session. (Operator Instructions). I must advise you theconference is being recorded today, Monday, the 29th of October 2007.

I would now liketo hand the conference over to your speaker today, Dr. Abe Peled, Chairman andCEO of NDS.

Abe Peled

Thank you andwelcome to our Q1 FY ‘08 conference call. NDS is pleased to report anotherstrong quarter. In spite of the various onetime effects of this quarter, whichclearly to some extent flattened our results, we have seen a very strongperformance across the board in all our deliveries, as clearly seen from theperformance metrics that we provide, increase in smart card deliveries, verysignificant increase in authorized cards, as indeed our momentum in developingmarkets continues; strong shipments of middleware, which both includeMediaHighway and certain catch-up in high-definition boxes on the DirecTV,which now all DIRECTV boxes have our technology and the latest are the H-seriesof high-definition MPEG-4 boxes; and DVR, obviously, very strong performance,was $1.5 million deployed in the quarter, as new shipments of DVR havecommenced in the number of accounts, Sogecable, Canal+ and continued strongshipments in all other customers.

NDS has also donevery well in winning new platforms. We’re particularly pleased with our win in India;Bharti Airtel is the largest cellular operator in India.They are a very professional company; intend to launch a very strong offeringon DTH. As you know, we view Indiaas a very strong growth opportunity for DTH, over 80 million middle-classhouseholds. We already have customer obviously in Tata Sky that continues togrow well, Hathaway Cable, which is one of the few large cable operators.

But clearly thereis room for more operators, given the massive size of the market and the demandfor quality pay-TV service. Bharti Airtel will launch directly with the MPEG-4standard definition boxes, but clearly puts them in a position for futureupgrades, faster. We're already working on DVRs for Tata Sky. And I am surethat the new technology deployment will intensify also in the Indian market.

Similarly, in China,while a different characteristic of the market, we are very pleased with ourwin in the Tianjin. Tianjinis one of the four largest cities in China,which are special administrative regions directly under, like a province.

And Tianjin whointends to deploy a leading-edge platform that can deliver not only standarddigitized television of the analog, which is part of the PNGI initiative, butare looking forward to delivering more sophisticated capability and, therefore,we are pleased that they have chosen NDS.

Similarly in the Ukraine,VisionTV, which is, by the way, Modern Times Group, are a partner in it; weexpect that to be a strong performer. Additional wins like Anhui,which is a smaller province, Serbia Broadband extending its relationship withNDS to cable as well as its satellite platform.

And these allindicate that our strategy of winning platforms in developing markets, both inEastern europe, India, and China, is working and will be and continue to be anengine driving NDS growth going forward.

Now, having saidthat, NDS has grown its headcount again reasonably; quite substantially, Ishould say, not reasonably. The reason for that is that we have a very strongpipeline of projects that we are working on, many of which we will not see fromrevenue in this year. But we are clearly a company that takes a multiyear viewon all of these platform wins and, therefore, they are very important for NDS.

In addition to, ofcourse, working on the standard platforms, both advanced technology in ourleading markets, streamlining our technology for developing markets, NDS isalso strongly involved and investing in preparation for the changing medialandscape.

That will not be aquick process. But then we have to make investments and put together ourtechnologies in a way that they will be ready for both our current customers aswell as new players that will enter into this marketplace that is beingreshaped through the ubiquity of broadband access of television on the PC, onmobile devices, on portable devices, and so on.

Part of this hasbeen our acquisition of CastUp, a small company specializing in thedistribution of video over the Internet. And I think that will give ussubstantial know-how and experience in video delivery over the standardInternet.

I think also ourpartnership with Yes, in which Yes has chosen NDS for its delivery of both convergedsatellite and broadband to PCs as well as just a broadband delivery of its newweb-based video content portal.

So all in all, wehave seen a very good quarter. NDS is strongly committed to continuing toinvest and prosper in our current market, which continues to grow, and Ibelieve we are making the necessary investments and acquisitions that willenable us to prosper in the landscape delivery.

So having saidthat, I would like to turn it over to Alex Gersh who will take you through ourresults in more detail, and then we will open it up for questions.

Alexander Gersh

Good morning,everybody, good afternoon. As always, I will go through the results for the Q1of this year and compare it to the Q1 of last year. Total revenue is up $205million, which is a 25% increase over last year's first quarter.

Operating incomeis $58 million, an increase of 31% over last year's first quarter. Operatingmargin is a 28.4% versus 27.2% in Q1 of last year. Net income for the quarter,$46.3 million versus $35.1 million; we had a 32% increase. And the dilutedearnings per share stands at $0.79 for the quarter versus $0.61.

I'm going to gothrough some, as always, through the detail in revenue and expenses. As Abealluded, there are certain onetime effects. They have to do primarily withconditional access revenue, which I'll talk about next.

Obviously, foreignexchange continues to play a part in our financials, as well as, of course,French R&D tax credit. It was another very successful year for us andanother first quarter in which we achieved a very, very substantial R&D taxcredit of $6.7 million.

But let me take itstep-by-step. So, conditional access revenue increased by 31%, as you can see,to $121.6 million. The increase was principally due to recognition of a portionof the security service previously deferred, as all the remaining obligationfor a particular customer on a particular contract have been satisfied.

Clearly, just topreempt any questions, we cannot talk about specific contracts. We cannot talkabout any specific contract terms. We also, as always, do not comment on anyindividual changeovers or any possible changeovers that occur, but there hasbeen a change in which an obligation for which we deferred revenue has now goneaway in a particular contract, which is why we talk about the onetime event. Becauseobviously, while it can happen on other contracts, this is clearly a specifictreatment related to a specific contract.

However, on top ofthat, of course, conditional access continues to be powered by the authorizedsmart cards, which now stand at $78.6 million for the quarter versus $66.6million at the end of Q1 of '07. And we have delivered $7.4 million smart cardsin the quarter versus $6.7 million in quarter one of last year.

Going down tointegration, development and support revenue, that decreased by about 41% toabout $11 million. We always talk about this as being practically one of thelumpiest portions of our revenue. We have recognized in last year revenue fromdelivery of conditional access, EPG and middleware to Tata Sky, our customer inIndia, andtherefore as the system went into operation last year, clearly that did nothappen this year. We did not have such big new systems going in Q1 of thisyear. And in addition, we have recognized enhancements to several of our majorcustomers relating to high-definition box integration last year.

License fees androyalties increased by 19% to $28.9 million. This increase was due to highernumber of units of middleware shipped, conditional access and EPG royalties.And in Q1 of this year, we have deployed 8.1 million middleware clients versus3.1 million in Q1 of '07. We've got a number of new customers, as well as ourexisting customers, that continue to accelerate the deployment of middleware.As of September 30th, we estimate 70 million middleware clients approximatelyhave been deployed.

New technologiesincreased by 54% to $42.5 million. The story there is, of course, DVR continuesto power that gaming and continues to be an important player. ResidentialGateway Technology, which is the acquisition we've made last year, also has contributedstrongly here, as well as CineMedia, and our IP TV platform has also shown anincrease from the first quarter of last year.

And as Abe said,we have added 1.5 million DVRs for the quarter, a substantial increase over700,000 we added to the first quarter of last year. Again, as of September30th, we estimate 9 million DVR enabled set-top boxes that have been deployed.

Again, as always, whenI talk about revenue and I talk about expenses; I talk about foreign exchange.52% of our revenue is euro- and Pound-denominated. The relative weakness in theU.S. dollar, we estimate impacted us favorably on the revenue line by about 4%or about $8 million for the quarter. And obviously, I will talk about theexpense side. Clearly, it has effect on the expenses as well as in our cashholdings, the foreign exchange.

Cost of salesincreased by 10% to $68.5 million, and clearly the result is increased numberof cards shipped. We have an increase in third-party royalties, which directlyrelate to revenues, and increase in the number of employees. As Abe hadmentioned, we have added 553 employees from Q1 of last year to Q1 of this year;although it is important to say about 36% of that 553 came from our twoacquisitions, which is Jungo and CastUp. So, the organic growth in headcounthas actually been somewhat lower.

Now, I think mostof you have noticed we have changed the presentation of cost of sales on ourfinancial statements. And we have changed it for the following reason. As ourbusiness gets more and more complex, it became clear to us that our cost ofsales really doesn't reflect how our business is developing.

Just to give youan example, the elements of our smart card costs, staff costs, and third-partyroyalty costs really are reflected in all the revenue categories. Therefore,this new presentation, we believe more accurately reflects the businessrealities of how the NDS business develops.

In terms of grossmargin, the gross margin increased from 62% to 67% for the quarter, but clearlythe impact of the conditional access increase in revenue, which I've talkedabout previously, the decrease in the deferral clearly has impacted thissignificantly.

In terms of expenses,overall expenses, operating expenses increased 36% to $78 million. Clearer,higher employee numbers, higher employee costs, associated facilities costs, aswell as legal costs, which we highlighted for you last year, particularly asthey relate to our EchoStar litigation, have contributed to the increase incosts.

Again, as I havementioned before, the increases were offset by $6.7 million R&D grant,which we received from the French government that compares to $5.5 million lastyear. And just for everyone who is looking at our balance sheet, these numberssit in other non-current assets. When you see the increase in other non-currentassets, that’s what you're seeing. You're seeing the increase in the R&Dtax spread.

We talked aboutheadcount. We now stand at 3610 employees as of the end of September, withabout 84% being technical employees.

As always, a fewwords on FX. This quarter for the first time, we had no substantial negativeeffect from the foreign exchange. The reason for that are the following. Ofcourse, as the dollar continues to weaken and 68% of our expenses are pound andeuro and Israeli Shekel denominated, the expenses have been adversely affectedby about 4%, which is about $6 million.

However, NDS hascash holdings in both Israeli shekels as well as in euro, which offset thatloss and created a gain on the cash holdings of $5.7 million. So, in effect,the majority of the FX gain on revenue was not offset by the FX losses onexpenses, and therefore, the majority of FX gain on the revenue is reflected inthe bottom line.

Income taxeffective tax rate is 30%. Really, that is what we have been telling people andthat is what we expected, and that is what we have. Our tax rate does varyslightly, depending on in what jurisdictions the taxable income comes from, aswell as from the research and development incentives in differentjurisdictions, but that's where we are today - $622 million in cash.

In the firstquarter, we issued approximately 110,000 shares to our employees as a result ofequity compensation award. As of September 30th, NDS has 2.9 million shares ofequity awards outstanding, with 1.8 million vested.

We have and as Abereferred to and as we put out in the press release, we have made an acquisitionof CastUp. That acquisition is now reflected in our financial statements. Youcould see on the cash flow the cost of acquisition roughly $10.4 million. Obviously,this is a very small acquisition, and so no additional disclosure really isnecessary, other than what you see in the financial statements in the cashflow.

Now, back toguidance, I think again recognizing that some of the effects that we've seen inthis quarter are maybe considered a onetime effect, we are maintaining ourguidance on revenue for the year of $800 million to $820 million, and operatingincome range is $185 million to $195 million. We are maintaining the range inoperating margin between 23% and 23.8% or so.

So that’s it.Thank you very much and, operator, we are ready for questions.



(OperatorInstructions) Your first question comes from Jason Mauricio of Arete.

Jason Mauricio- Arete

Hi, thanks a lot.Alex, I was just wondering if there was anyway you could quantify, even if it’sjust rough numbers, the impact of the revenue recognition on the conditionalaccess line.

Also, how do yourecognize revenue on PVRs? Is it upon shipment of a set-top box to thecustomer, or is it from the shipment from your customer to the end subscriber?Thanks.

Alexander Gersh

Well, on the firstquestion, unfortunately, no, I cannot comment on specific and quantify thespecific numbers. As you know, our deferred revenue has a number of differentcomponents in it. But on your second question, it varies from customer tocustomer.

Jason Mauricio- Arete

Okay. There is noway even roughly, in terms of the impact of one-off revenue recognition?

Alexander Gersh

You can take alook at the deferred revenues and make your own determinations. I think,roughly, you can probably get some kind of a guess, but it would just beroughly.


Your next comesfrom Ali Mogharabi of B. Riley and Company.

Ali Mogharabi -B. Riley and Company

Thanks. Alex, Iguess another way to approach this, can you let us know at what level you canmaintain the gross margins? I know you basically with the recognition of somedeferred revenues were looking at 66% in this past quarter, but what should webe looking for going forward?

Alexander Gersh

As I said before,one of the biggest things about our gross margin, it has to do with where ouremployee costs are being attributable. So if our employees are working onspecific projects, the costs will be in the cost of sales. If they're workingon other projects, it could be in the R&D. Therefore, it’s very difficultto have some kind of a detailed estimate. But my view is if you look at ourhistorical margins that we have had on a continuous basis, I do not expect ourgross margin to significantly improve over those levels.

Ali Mogharabi -B. Riley and Company

Okay. Then, Abe,really quickly can you talk about the Chinamarket? Give us an idea about the market and also how you basically stack upagainst it. I'm sure everyone is aware of STB, digital Chinatelevision, on the conditional access side. And then, of course, stacking upagainst OpenTV and possibly some other smaller players on the middleware sidein the Chinamarket.

Abe Peled

I just want to addto Alex's previous answer that as a management team, we're really focusing onoperating income. That’s our management yardstick and that’s the one that wehave said we will continue to improve with an intermediate target of getting to25%. How it moves between R&D and gross margin happens to be more difficultto predict.

Going back to yourquestion on China,the NDS strategy in Chinahas been to focus on the larger cities, larger provinces that are obviouslyricher, and look at more ambitious technology deployments that go beyond themandated or encouraged by the government initiative of simply digitizing thecurrent analog cable, an initiative referred to as PNGI.

So that’s why ifyou look at the NDS wins in China and the places where we have deployed, Shenzhen,which is obviously the large industrial city right next to Hong Kong, we haveover one million subscribers.

In Shanghai,Chongqing, all large cities, Chongqingis the single largest city in China,and now the addition of Tianjin. Wehave additional provinces like in Guangzhou,which is again in that triangle next to Hong Kong, whichis quite well-off. Anhui issmall, but again, a reasonably well-off province.

So our focus hasbeen to really go after what would be the market leaders, and I think it alsois, from a point of view of covering, a giant country like China effective froma cost of sales for a foreign company that necessarily pays its employeessignificantly more because of the premium that people get for knowing Englishand so on.

In terms of CDTVor China Digital TV Group, we know them quite well. They are a company thatstarted by providing, I would say, relatively simple conditional access system,which is suitable for PNGI. Obviously, PNGI doesn't have any either highsecurity requirements or scale issues.

I believe therevenues are composed, instead of NDS, which has like eight major accounts,they have tens of small accounts, each of which deploy certain numbers. Youknow, I still believe that there is room for both models, although I have tosay that looking at the valuation that China Digital TV Group achieves, eitherthat is too high or NDS is way too low, because clearly there is a bigdiscrepancy.

We looked a coupleof years back into either investing or acquiring China Digital TV Group, and mymain consideration was that if it is a very low technology barrier, othercompetitors of similar ilk can enter the market, and indeed there is now a newcompany called Sumavision that has some ex-China Digital TV Group people thatare offering an even lower cost straightforward TA system.

I am pleased tosay that in a city like Tianjin, wehave to face all these competitors. And whenever technology and scalability andfuture roadmap count in the RFP, we will tend to win. When it is only aquestion of price, then obviously we are not in that market, which is for avery simple, small system.


Your next questioncomes from Alan Gould of Natixis Bleichroeder.

Alan Gould - NatexisBleichroeder

Thank you. I havegot a few questions. First, this deferred revenue question, typically yourdeferred income increased from the balance sheet about $7 million a quarter,and this quarter it decreased by $9 million. Is $16 million a reasonableestimate as to how much deferred revenue was recognized as income this quarter?

Alexander Gersh

We can't commenton -

Abe Peled

Your calculations.

Alexander Gersh

On yourcalculations. I think, unfortunately, I’ve said everything that I can say onthis issue.

Alan Gould - NatexisBleichroeder

Okay. Alex, youdescribed it a little bit as one time, but I saw short-term deferred incomeincrease this quarter. So that’s saying, I assume, that there could be morerevenue recognition throughout this fiscal year on deferred income.

Alexander Gersh

As you know, whenwe look at on a quarterly basis, we assess all of the parameters that we haveto assess and make adjustments. So the adjustments are always happening. Wealways talk to customers, different things occur. That’s the difference betweenour long-term and from short-term.

Alan Gould - NatexisBleichroeder

Okay. There was abig increase in middleware shipments, and I guess, Abe, in your comments youmentioned all of DirecTV now has your technology. Was there a download catch upof middleware this quarter?

Abe Peled

First of all, youknow, the headline number of middleware now includes Jungo as well, and I thinkonly in the actual text do we give the split; but in any case, yes. So you haveto compare that. But in answer to your question, yes, all the MPEG-4 HD boxes,digiboxes in DirecTV now have our middleware. And that was probably 1 million,1.5 million or so.

Alan Gould - NatexisBleichroeder

Okay, so thatwon't be repeated, that 1 million, 1.5 million catch-up?

Abe Peled

Correct. Althoughthere is we see a strong uptick in HD, obviously.

Alan Gould - NatexisBleichroeder

Okay, can you giveus some update of the trend in smart card costs? Are they continuing todecline?

Abe Peled

Well, you know,smart card costs depend both on the volume of the individual card for theindividual customer, as well as the capability. So, therefore, to look at theaverage is quite misleading. It is also fair to say that cards in certainmarkets, which are not as sophisticated are obviously lower cost than cardsthat are in other markets.

By and large, Ithink we have done well both in improving the amount of technology that we putin versus what we buy, for example, in terms of customization and the amount ofdesign that we do versus what we buy from some of the silicon manufacturersthat allows us to continually improve that.


Your next questioncomes from Ari Bensinger – Standard & Poor’s.

Ari Bensinger -Standard & Poor's

Yes, thank you.Just wondering on the DVR take, is there any seasonality in that business? Youknow, it ramped up pretty good I think in the June quarter, decelerated a bitthis quarter, and I'm wondering if you have any annual forecasts for thedivision.

Abe Peled

Well, I don't knowabout seasonality. It is so spread across the world that it's very hard topinpoint seasonality. I think we said last year we did a little over $4million. This year, we certainly will do more than $6 million, we believe. Butit is probably the biggest uncertainty in our guidance is to know the exactnumber of DVRs, because a million more or less DVRs, while it doesn't make abig difference on the revenue, it does make a big difference on the bottomline.

Ari Bensinger -Standard & Poor's

Then I'm wonderingon your guidance, this quarter certainly exceeded expectations on almost allfronts, revenue and operating income, yet you are maintaining your full yearguidance. And I'm just wondering, is that just being conservative or was thissomething, the change over, that was already baked in to happen?

Abe Peled

Well, I want toremind people that we do not provide quarterly guidance because it is verydifficult to divide our year into exact quarters. Over a 12 month period, wehave a fairly good sense of where the business is going to grow, and we clearlywhen we provided the full year guidance in August, recognized all of the eventsthat already happened this quarter and things that are likely to happenthroughout the year.

So our guidancehas not changed because that was at least in our plan part of what was going tohappen. I'm sorry that we cannot provide you quarterly guidance. It is just toodifficult ahead of time to do that.


Our next questioncomes from Murray Arenson of Ferris Baker Watts.

MurrayArenson - Ferris Baker Watts

Thanks. Goodmorning guys. A couple questions first is, can you talk a little bit more aboutforeign exchange? I know you generally try to match the revs and expenses, andyou're obviously providing an update to guidance, and foreign exchange makes animpact on that.

Is there any wayto get any sort of sense in the coming quarters as to how effective you will beat matching those or what your expectations are on the ForEx front, anythinglike that?

Alexander Gersh

As I said, I thinkfor us, when we were talking about matching, the change that happened this yearin the first quarter is that we have bought a significant amount of shekels totake care and pay our shekel-denominated salaries in Israel.

And we are holdingthose shekels. Now, we are using them up as we go along. So right now, webought them, and clearly when we bought them, we bought them at a morefavorable exchange rate than the exchange of U.S. dollar to the shekel istoday.

But we are usingthem up, and as we continue to use them up, obviously you'll see, unless therate goes favorably and we buy more, you will see some of this eventdiminished. I also will tell you that in the 10-Q, we do talk about how much ofour cash is in some of these currencies. So you'll see that 13% of our cash isin British pounds, 9% of our cash is in shekels, and we have got, as I said,we've got some cash in euro.

So we are usingthat up, and unless we buy some more at a more favorable exchange rate, you maysee us return to effectively a matching of the costs and the revenues from theFX, rather than having a significant positive impact that you've seen in thefirst quarter.

MurrayArenson - Ferris Baker Watts

Okay, great. Thatdoes help. I also wanted to ask you a little bit about India.You talked some about Chinajust a little bit ago, but looking at Indiathere are number of different DTH offerings, I guess, coming to the tablethere. I guess that looks a little bit unusual relative to what we have seenfrom DTH in other markets.

I just wondered ifyou comment on how you expect that to grow? Do you expect an increasingproliferation of those numbers of players, or do we consolidate down, and whatimpact does that have on you?

Abe Peled

Well, as I saidbefore, the characteristic of the Indian market, which is different than China,is that there is a rising middle class, which are not served with a goodtelevision proposition. Mostly are served by cable, which are very low quality,typically offered by local, shall we call them, entrepreneurs that often stealthe signal.

And the result islow quality, low level of service. You put that versus 80 million people thatcan now afford large screen TVs, are getting bigger houses, have a risingincome. Indiais a country in which television is viewed, I think, the second most hours perweek after Brazil,so it is a very high television viewing country. So there is an unmet need.

What all the DTHcompanies are seeing is the opportunity to reach that middle class, which as Isaid is 80 million homes, and do that over the next five years will be a rush.And I believe there is room for multiple players in that, and each of them caneasily get to 5 million to 7 million subscribers because there are seriousplayers.

Obviously, thereis Tata Sky, there is DISH, which is a Zee network, has been around for awhile. And Reliance, Bharti have also announced that they are going here. Andthen there is the regional player, SUN TV more in the South.

So clearly thereis room to get to about 40-50 million, and if you divide it even by 5, they canget to more than the critical mass to be profitable, given the very low cost ofthe technology. What will happen after that is obviously harder to tell, but tobegin with, everybody sees a clear run, including a run to profitability inoffering like Bharti a broad range of telecom services and entertainmentservices.

So that’s, Ithink, the nature of the market, which is quite different.

MurrayArenson - Ferris Baker Watts

Okay. And last question,I guess, is a follow up on that. With some of those comments in mind, what doyou think the outlook is for DVR penetration in that market, now that you'rebringing an offering out there? Are we talking about the same level of robustDVR offering in that market?

Abe Peled

Well, you know,DVR is one of these offerings that grow by word of mouth, because people don'treally understand it unless they have it in their home and then point out totheir friends. In our experience, in every country in the world, DVRpenetration has kind of started low and then grown as word-of-mouth and theunderstanding of the market increases. And therefore, I expect the same to bein India.

It is not just aquestion of money. It is a question of understanding what the product is andwhat it does. It is very difficult to explain that in an ad or difficult toexplain it in any other way until you see it in your friend’s house or yourrelative’s house or whatever.


Your next questioncomes from Tim Boddy, Goldman Sachs.

Tim Boddy -Goldman Sachs

Yes, thanks verymuch. I don't know if it is a guidance question, but I'm struggling tounderstand how such a significant factor of upside is not falling through intosome increase in the guidance. I guess you're saying this is entirelyanticipated in your guidance.

Abe Peled


Tim Boddy -Goldman Sachs

In which case withall your metrics ahead, if you like, is it again the opportunity to invest inyour business for the future, which is where this incremental profitability isbeing in the short-term contributed towards?

Abe Peled

I'm not sure Iunderstand your question. Let me rephrase it. Are you saying we could make moremoney if we did not invest in the future? I guess that's true.

Tim Boddy -Goldman Sachs

I guess given theextent of some $20 million of upside to probably most people's forecast on theoperating income level, is that gradually over the year being reinvested? Thatis really the question.

Abe Peled

Well, first ofall, I believe that the performance of the first quarter, as you said, wasanticipated as part of our guidance and as part of what we have said we willdo. Now some people believed us more than others. Some people divided it inquarters; some differently.

But I do not thinkwe are increasing our level of investment. As I've often said in the past, NDSkind of maintains its level of investment in new technologies, things that arenot immediately bearing fruit, to about 10% of our R&D. But what we dohave, and the biggest increase in headcount goes towards that, is we have avery full pipeline of projects, which we will not see revenue from in thisfiscal year.

To name just KabelBaden-Wurttemberg as an example, another win that we have which we are workingon already. Some of these wins that we've just talked about will either notcontribute revenue or contribute very little revenue this fiscal year, but wehave people working on them diligently, and that is part of our cost. So we donot simply, oh, we can make more money so we will spend more on discretionaryR&D. I think we've been fairly disciplined about that.

Tim Boddy -Goldman Sachs

No, that is reallyclear. That's very helpful. I guess sort of a question that I appreciate youcan't tell us the number, but in terms of the treatment, was the one-offcarried right down through the P&L, or was there costs associated with itas you would perhaps have deferred smart card royalties and, therefore, wasthere tax associated with it as well, because your tax rate looked normal?

I guess if it isX, should we put X on the sales line and then take something off X in the grossmargin and something off again for the net, or does it fall right through?

Abe Peled

I can't give you aspecific, but I want to make a clarification. Clearly, the result of our smartcards performing extremely well and having zero piracy, which allows ourcustomers to either defer changeovers or even potentially skip a generation ordo other things, it can have a beneficial result on NDS, and that is part ofthe premium you would say for having a perfect security record, and part of theupside that both our customers enjoy and we enjoy.

And as thesecalculations get done, some of it gets reflected back into our actual income asour obligations are fulfilled. I cannot really go beyond that, but it is aonetime in a particular contract, but it does not mean that it's a onetimeevent that will never occur again in other contracts, because we see thatimpact of our excellent security possibly being translated positively in othercases.


Your next questioncomes from Ziv Tal of Oscar Gruss.

Ziv Tal - OscarGruss

Hi, Congrats on agood quarter. Did Bharti, did they announce a specific target of subscribersfor the next year just like Tata did before?

Abe Peled

I don't believeso. I don't know that they did.


Your next questioncomes from Todd Mitchell, Kaufman Brothers.

Todd Mitchell -Kaufman Brothers

Thank you. I havea question about new RFP activity in general. It seems that if you look outover the past 12 to 18 months, the deal flow has been decidedly more robustthan the period prior to that. Does the RFP activity going forward, is it asrobust as it has been over the past 12 to 18 months?

Are you seeingshifts in the geography? Are you seeing shifts in the different end markets,and could you flesh that out for us? I also have a follow-up question on Jungo.

Abe Peled

Well, Todd firstof all, you are right. We have emphasized the point that as the technologycosts are coming down, developing markets are really waking up. If you look alot of the deal flow has been in these developing markets, and the wins havebeen there.

I would include Germanyin that because the nature of cable in Germanyis really more as a utility rather than as a particularly premium service. Wecontinue to see activity in developing markets. We just announced a low-endcable offering for India,because clearly some cable operators are now consolidating and they will try torespond to the sort of satellites that we have announced, VideoGuard Express inIndia, andexpanded our operation there.

There is,obviously, we have responded to the Verizon RFP in the United States, for whichI don't hold particularly, I'm not sure really, I can't tell you what ourchances there are. I think that if they are going to pick anybody other thanthe duopoly in the United States,NDS has a very good chance. But it's very hard to predict.

And as I've saidbefore, you know, there's a number of already existing platforms that aretalking to NDS about moving to NDS to improve their security, and we see quitea bit of activity there. So to say, to summarize it, I think we're quite busy.

Todd Mitchell -Kaufman Brothers

Okay. And then Ihave a question on Jungo. It has been a while since the acquisition, and Iwanted to know do you qualify deployment and where, and with whom, but how isthat working out into your sort of a portfolio offering for your broader,bigger customers? Did that not make much sense?

Abe Peled

No, I understand.I will give you an example. Jungo is deployed in Verizon files, so when wetalked to Verizon, which did not know NDS from a hole in the wall until theacquisition of Jungo, when I meet them, yes, they know NDS through Jungo, funnyenough, as a good supplier and so on.

They can see howthe roadmap that we paint of broadband combined with set-top boxes and so onactually would work. So I can use that perhaps as a very specific example, butI would say that we bought Jungo on the premise that telecom companies willincreasingly recognize the value of having a uniform middleware in all theirresidential gateway routers, and will either spec the Jungo software oractually buy the Jungo software themselves in the same way that televisionoperators specify the middleware.

In the 10 monthsof the acquisition, I would say that this premise has proved itself as moretelcos, whether it is Telefónica or Telos or others, France Telecom, specifyactually the Jungo software. And we see manufacturers coming to Jungo andsaying we need to use your middleware. But I believe we're getting tractionwith the telcos.

In terms ofintegration with the rest of the NDS product line, I think you're going to seeat our Analyst Day; we’ve shown it at IBC. That will take, obviously, it is aslower term thing, but we continue to believe strongly that there is a good fitin our portfolio as we see the home of the future that integrates broadband andbroadcast seamlessly.

Todd Mitchell -Kaufman Brothers

Can you quantifyplatforms where it's been deployed?

Abe Peled

What do you meanquantify? How many they have deployed were?

Todd Mitchell -Kaufman Brothers


Abe Peled

Well, I mean, allof the Verizon residential gateway routers have Jungo software. France Telecomhas just started shipping it in Livebox. As I said, there are a number of otherlarge telecom operators that have it already.

We always do apress release whenever there is something, so you have to look at the variouspress releases.


Your next questioncomes from Daniel Meron of RBC Capital.

Daniel Meron -RBC Capital Markets

Thank you.Congrats on the continued execution here. Can you give us a sense of thedynamics in the IP TV markets and how you are seeing it? You did have a coupleof announcements with SCS in the U.S.

But also I waswondering what is going on with larger platforms, either in the U.S.or in europe? Thank you.

Abe Peled

Well, I think thatI feel a bit repetitive, because I've had the same view on IP TV for a longtime. We see continued small IP TV deployment. We've just done another deal.But all the numbers are small compared to the kind of numbers that we report. Ifwe do a quarter 3.2 million new authorized markers, the number of IP TV on themis quite small, and I would say that is not true only for NDS; that is true, period.

So, you look atU-verse, and they have been talking about it for four years. They now havestarted deploying it for over a year, and it's 120,000 or so slots. I mean,these are not big numbers for pay-TV, you look at Telecom Italia. I would saythe only exception is really France Telecom and some in Telefónica, where thereare some special circumstances that perhaps explain the larger number ofdeployment.

But everywhereelse it has been quite slow, and I think we get our fair share of whatever isbeing deployed.

Daniel Meron -RBC Capital Markets

Okay, andswitching gears to other emerging technologies, or at least markets, can youjust give us a sense on what is the impact of those new initiatives that you'vehad either in the Ukraine,in Turkey--I know that Indiais starting to ramp up--but those announcements that you've made to date, howlong will it take until these things kind of start moving the needle for you?

Abe Peled

Well, the Ukrainehas not yet started, so I mean, hasn't clearly moved the needle.

On the other hand,I would have to say Turkey is a very exciting market, and I think theproposition that Doğan Media had was their D-Smart, which is really afree-to-air box that you buy but already has in it all NDS technologies and isenabled by Doğan Media as a free-to-view set-top box in which they offerpay-per-view through scratch card, they offer interactive advertising, theyoffer various occasional pay programs. It’s very interesting, and they havevery strong attraction. So, I would say while it hasn't moved the needle a lot,it is already visible in our results even this quarter.

Daniel Meron -RBC Capital Markets

Okay. And thenlast one for me, as far as the cash position, you do have $620 million. Youmentioned that you're going to invest in the business.

What kind ofM&A are you looking for right now? Is there something suitable enough thatcould use up all this cash, or is there going to be another Jungo-style kind ofacquisition which is more like something that would materialize two, threeyears out, so, it won't gobble up all this cash position?

Abe Peled

Well, look, we arenot ruling out a large acquisition, but we are not specifically looking at anyspecific one at the moment.

On the other hand,I think as I said, the changing the media landscape offers both threats andopportunities, and we feel that having a strong cash position will allow us tomove, should we have to, if things happen quicker than we thought in this area.

So, the areas thatwe are looking at is really the intersection of the delivery of video onInternet and broadcast and how they combine, how advertising can change in thatenvironment, as a result of offering really in conjunction with broadcast televisiontargetable advertising that can come through broadband.

And I think, forexample, the acquisition of CastUp, which while it is small, obviously, wecould have paid more if we bought an American company, but it gives us theinsight. And should we think that there is a real technological and serviceedge in expanding something like that, we would be in a position to do that.


Your next questioncomes from Conrad Werner of Morgan Stanley.

Conrad Werner -Morgan Stanley

Most of myquestions have been answered, but maybe just one question on the increase inthe headcount. You mentioned the strong pipeline going forward and then talkeda bit more about that in terms of existing customers. Are there also unnamedpotentially new customers that we should be looking forward to in futurereleases that could be contributing to this increase in headcount? Thanks.

Abe Peled

First of all, Iwant to reemphasize Alex's point that a big portion of that headcount, 36%, soabout 180 or so people came from acquisitions. If you look historically, we'vekind of slowed down a little bit.

And the answer toyour second question is yes, we are working already on things that have not yetbeen released, because they are either in advanced presale stage or in finalcontract negotiations or there was a confidentiality clause that doesn't allowus to disclose it.

So, as I said inmy introductory remarks, we have a very strong pipeline and we are very busyworking on probably the largest number of projects in our history.


Your next questioncomes from Gorm Thomassen of AKO Capital.

Gorm Thomassen- AKO Capital

Two questions,first one is just to clarify on the ramp-up of R&D and headcount, you saidthat you can only spend about 10% on, call it, far-out projects.

So, this increasewe've seen does not mean that the 10% is kind of gradually inching up; it ismainly related to client-driven projects in the pipeline of existing commercialcontracts?

Abe Peled

No, we treat 10%as actually 10%. And so, obviously, if the total headcount increases, theamount that we can do are not…

Gorm Thomassen- AKO Capital

Sure, sure.

Abe Peled

We do keep itfixed.

Gorm Thomassen- AKO Capital

Is there are anyincrease in the blue sky stuff, basically?

Abe Peled

Well, I'd like tothink we don't do any blue sky, but it's still kind of things that are furtherout than analyst’s typical horizon.

Gorm Thomassen- AKO Capital

Fair enough.Second question I had was on India.Does the clients win now of Bharti mean that you have significantly increasedyour competitive position in India, given that if one thinks about the verylong-term strategic end play in India that it makes sense to have onetechnology platform rather than two or three? Is that a powerful impact nowgoing forward?

Abe Peled

Well, obviously,if you think several years down the road and you're thinking consolidation,then clearly we would be in two of the large platforms, which I expect will be successful,but it’s really too early to comment on that.

I think, in theshort-term, look, Bharti is going to be a very serious player. Tata Sky hasalready demonstrated it's a serious player. And so we are very pleased becausewe'll have a shot at a big part of that together with Hathaway, which hasaccess to 2.5 million and 3 million analog subs. So I think we're in a verystrong position in India.

Gorm Thomassen- AKO Capital

Great. Just on thepotential of perhaps breaking into the duopoly you mentioned of Verizon and theU.S., are there any technological changes down the road, which might play intoyour hands when you go and talk to Verizon about how they see their technologyroadmap and how that might kind of fit with what you're doing relative to whatthe two incumbents are doing in the states?

Abe Peled

I would say not inthe short-term. I think perhaps in the longer-term as they look out, but in theshort-term it is all, they are really trying to compete in the same, especiallyVerizon who was doing quam to begin with, but it is exactly like Motorola orScientific Atlanta, deployments in other cable companies.

I think theadvantage that we have is that obviously we’ve demonstrated we have a largecable customer in the U.S.,Cablevision. So, we’ve demonstrated our ability to operate in this environment,and we’ve demonstrated our ability to integrate with Scientific Atlanta, forexample. I think, in that respect, we are a very credible alternative should theydecide that they would like to not, to move out of combining conventionalaccess and set-top box manufacturers in the same supplier.

Gorm Thomassen- AKO Capital

Okay, thank youvery much. I'm looking forward to seeing you at Capital Markets Day.


(OperatorInstructions) You have a further question from Daniel Meron of RBC Capital.

Daniel Meron -RBC Capital

Thank you. A quickfollow-up on the potential for you to raise the trading volume here. Is thereany chance that you would consider a stock split?

Abe Peled

Well, I note thatthe volume today is 214,000 shares, but clearly I don't think that people thatare willing to pay cannot find the stock. But seriously, I do have, it'sclearly one of the big issues. I don't know if stock split would really solveit or not, but, liquidity and capital structure are things that while we don'thave an answer in the short-term, we are part of our overall considerationmoving forward.


There are nofurther questions at this time, sir. Please continue.

Abe Peled

Okay. Well, onbehalf of Alex and myself, I would like to thank all of you for your patienceand we will see you on our next conference call at the end of January. Thankyou.


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