Techwell Q3 2007 Earnings Call Transcript

Techwell, Inc. (TWLL)

Q3 2007 Earnings Call

October 29, 2007 5:15 pm ET

Executives

Beverly Twing - IR of Shelton Group

Mark Voll - CFO

Hiro Kozato - President and CEO

Analysts

C.J. Muse - Lehman Brothers

Jay Srivatsa - Roth Capital Partners

Quinn Bolton - Needham

Chris Longiaru - Sidoti

Eric Rasmussen - Montgomery & Company

Heidi Poon - Thomas Weisel Partners

Greg Weaver - Kern Capital

Presentation

Operator

Good day ladies and gentlemen, and welcome to the Techwell's Third Quarter 2007 Financial Results Conference Call for the period ended September 30, 2007. My name is Candice and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's conference, Ms. Beverly Twing of Shelton Group, Investor Relations. Ma'am, you may proceed.

Beverly Twing

Thank you and good afternoon. Welcome to Techwell's third quarter 2007 financial results conference call. The press release and financial tables associated with today's conference call were distributed after the close of the market today. If you do not have a copy, you may find them on the company's website at www.techwellinc.com. This call is being broadcast live over the Internet, and may be accessed in the Investor Relations section of Techwell's website.

Before management begins the discussion of the third quarter's results, I would like to remind you that this conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which include but are not limited to the company's belief that the demand for its products will continue to grow; the company's ability to better address customer requirements, leverage technology capabilities and integrate additional functionality and achieve greater market share; its anticipated revenue, growth margins, and operating expenses for the fourth quarter of 2007; its anticipated tax rate for the fourth quarter of 2007 and full year 2008; anticipated new product announcements and anticipated trends and growth in the company's business and end markets in which it operates.

Any forward-looking statements made during this call are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Additional information concerning factors that could cause actual results to differ materially from any forward-looking statements made during this call are contained in the company's quarterly report on Form 10-Q filed with the Securities and Exchange Commission on August 9, 2007. Techwell undertakes no obligation to publicly update any forward-looking statement for any reason, except as required by law, even as new information becomes available or other events occur in the future.

Thank you for your time and attention. I will now turn the call over to Mark Voll, Techwell's Chief Financial Officer. Mark, please go ahead.

Mark Voll

Thanks, Beverly. Good afternoon everyone, and welcome to our third quarter financial results conference call.

With me today is our President and Chief Executive Officer, Hiro Kozato. I will begin today's call with a review of our quarterly financial results and conclude with an outlook for the fourth quarter of 2007. Following my remarks, Hiro will provide an overview of our business. We will then open the call for a question-and-answer session.

Please keep in mind that all reported financial results, unless otherwise noted, are presented on a GAAP basis.

For the third quarter ended September 30, 2007, we reported total net revenue of $15.1 million. Revenue for the quarter was within our revenue guidance range of $14.5 million to $15.5 million.

Total net revenue for the third quarter compares to $15.1 million in the same period a year ago and $14.7 million last quarter.

Total net revenue in the third quarter for each of our product lines consisted of security surveillance revenue of $10.2 million, representing 68% of total net revenues, LCD display revenue of $1.3 million, or 9% of total net revenues, video decoder revenue of $3.3 million or 22% of total net revenues, and other revenue of approximately $262,000, representing 2% of total net revenues.

Security surveillance revenue of $10.2 million this quarter represented a 40% increase over the third quarter of 2006. LCD revenue was $1.3 million, represented a 35% decrease from the same quarter last year. Video decoder revenue of $3.3 million represented a decrease of 41%, compared to the same quarter last year.

In the third quarter, we had three customers, two of which are distributors that each represented more than 10% of total net revenues, with the largest customers representing 24%, 12% and 11% of total net revenues. Although our largest customer this quarter was our distributor in China, that customer is shipping to several end-customers. Combined, our 10 largest customers represented 84% of total net revenues in the third quarter, of which five of these customers are distributors.

Gross margin continues to exceed our long-term target of 60% for the quarter. This compares to gross margins of 58% in the third quarter of 2006 and 59% in the prior quarter. Third quarter 2007 gross margins were positively impacted by the favorable product mix composing of our revenues as security surveillance's revenue was 68% of revenues.

Additionally, during the quarter, we continued our transition of new products to the 0.18-micron manufacturing process, which will provide us additional cost savings. For the third quarter, 40% of total net revenues were earned from products fabricated in 0.18-micron.

Total operating expenses were approximately $6.6 million in the third quarter, representing approximately 44% of total net revenues. This compares to operating expenses of $4.4 million or 29% of revenues in the same quarter last year and $5.7 million or 39% of revenues last quarter.

Third quarter results contained expenses for research and development of $3.5 million, which includes more than $825,000 of tape-out expenses related to new product development.

Tape-out costs for the third quarter includes approximately $300,000, we had targeted to incur in the fourth quarter. Operating expenses also included approximately $1.3 million of pre-tax stock-based compensation expenses under SFAS 123R.

Net income for the third quarter totaled $5.4 million or $0.25 earnings per diluted share, which includes a $2.2 million tax credit in the quarter or $0.10 earnings per diluted share.

The tax credit is due to $5.1 million non-cash tax benefit from the release of valuation allowance on the company's deferred tax assets. The release of the valuation allowance was necessary under Statement of Financial Accounting Standards No. 109 as a result of our continued profitability.

Net income for the quarter also includes pre-tax stock-based compensation expenses equating to $0.06 per share charge. Fully diluted earnings per share for the quarter were calculated using 21,768,000 shares.

Now turning to the balance sheet, accounts receivable were $1.9 million at the end of the third quarter, compared to $2.4 million at the end of last quarter. Historically, we have sold on credit terms only to OEM customers, and as a result, our accounts receivable balances had been low in comparison to overall revenues.

In the third quarter, revenues from direct sales to OEMs represented 36% of our revenues, while sales to distributors represented 64% of total net revenues.

Net inventory as of September 30, 2007 was $4.5 million, decreasing from $4.8 million we recorded at the end of the second quarter of 2007. Our cash, cash equivalents in both short and long-term investment balance as of September 30, 2007 was approximately $65.4 million, compared to approximately $60.9 million as of June 30, 2007 and $54.5 million as of December 31, 2006.

The increase in cash, cash equivalents in both short and long-term investments for the second quarter of 2007 is a result of approximately $4.5 million in cash provided from operations in the third quarter.

At the end of the third quarter, we had 125 employees, up from 108 employees at the end of last quarter with a majority of the new hires in research and development, which increased to 50 employees.

In terms of guidance for the fourth quarter of 2007, we expect to see growth in our security surveillance product line. As a result, we expect fourth quarter revenues to be in the range of $16 million to $16.5 million.

Gross margin for the quarter is expected to continue to run above the long-term target of 55%. Total operating expenses will be down slightly because tape-out expenses will decrease to approximately $250,000 in the fourth quarter and as a result, will remain in the range of $5.0 million to $5.5 million, excluding stock-based compensation expenses.

The tax rate in the fourth quarter will be zero as we will complete the tax benefit from the release of our evaluation allowance. We are expecting our tax rate for 2008 to be 35%.

This concludes my prepared remarks. Now, I will hand the call to Hiro for additional comments.

Hiro Kozato

Thanks Mark. Good afternoon, everyone. Thank you for joining us today. Today, I would like to provide you with greater detail on the results of the past quarter and greater insight into our business.

During the quarter, as Mark has mentioned, revenue from our security surveillance business again accounted for the majority of our overall revenue. The market for security surveillance equipment continues to be very strong with growth coming from all market segments and geographic locations.

In particular, China is showing significant growth. Recently I was able to spend several days meeting and talking to customers in China. For the first time, these customers have indicated to me that they are beginning to see significant purchase orders for products to be delivered under the China Safe City initiative.

We believe this is providing added momentum to an already healthy market environment. I will be returning to China this week as Techwell will be exhibiting at the China Public Security Expo on November 1st through the 4th in Shenzhen. At the show, we will demonstrate our four line of security surveillance ICs including our market leading four in one video decoders, integrated multiplexers, our motion JPEG [turnkey] solutions and our PCI, DVR Card solution designed especially for the security surveillance market.

We also plan to have a number of product and customer announcements that will take place during the Expo.

In products, this will include a next generation four in one video decoder solution, and a next generation PCI DVR Card solution. We produce new products such as these will continue to help, maintain and draw our leading market position in 2008 and beyond.

Now, I would like to turn to our LCD display units. Similar to the previous quarter, our customers continue to tell us that North American SUV and minivan manufacturers are continuing to work through inventory issues. We believe this is impacting the sales of rear-seat entertainment displays that integrate our ICs.

As a result, we continue to see weak order volumes for our LCD display product in the third quarter and we expect this to continue into fourth quarter. However, we have reasons to be optimistic about our LCD display business of 2008.

We expect this inventory issues to be mitigated by the end of this year. We also have significant design win momentum at Tier 1 OEMs and ODMs, automotive infotainment suppliers that we expect to start generating revenues in 2008.

In addition, we expect to announce a series of new LCD display product at the CES show in January 2008 that would include highly integrated solutions of the automotive infotainment market segment as well as for advance TV applications.

As a result, we believe we are positioned significantly through our LCD display business in 2008 compared to 2007.

Let me now discuss about our video decoder business. We saw our video decoder business decline in the third quarter. We believe there are two main reasons for this decline. First; Techwell has migrated most video decoder customer in the security market to more highly integrated Techwell security IC solutions. This revenue was previously recorded as video decoder revenue and has now shifted to security surveillance revenue as we are now providing applications to specific products for this market.

Second, our delay in releasing our integrated audio/video decoder has caused us to lose market share at some key consumer electronics customers. As a result, we expect video decoder revenues to decline in the fourth quarter. However, we do expect our video decoder business to stabilize in 2008. Markets for standalone video decoders remain across multiple consumer application and we believe we are winning a significant portion of these market.

In addition, we plan to formally announce our audio/video decoder product at CES and we are continuing to work with all of our customers to generate design wins that we believe will lead to increasing revenues for this product line in 2008.

In the first three quarters of this year, we have continued to aggressively invest in research and development, and we will continue to increase these activities until we have significantly ramped new product development.

In the third quarter, we added 10 new engineers to our research and development group and we also taped out four new products. We believe the investments we make in research and development in 2007 to expand our new product offering in each of our product line will produce results for Techwell for the next several years.

That concludes my prepared remarks. Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instruction). Our first question will come from the line of C.J. Muse of Lehman Brothers. Please proceed.

C.J. Muse - Lehman Brothers

Yeah. Good afternoon. Thank you for taking my question. Couple quick ones here on my end. I guess first on, can you provide an update on the TW9930 audio/video decoder? I know sampling is underway, if you could talk about how you are progressing there and I guess in particular with the [current]?

Hiro Kozato

Yes. This is Hiro. We are now sampling the first version of our TW9930 and currently, we have a couple of customers working on the design wins with our chip. But we still need to re-spin another version, which fits in a minor performance issue.

C.J. Muse - Lehman Brothers

And when do you expect that to be taped out?

Hiro Kozato

Yes. We have to tape it out by end of this year. But currently, customers are laying out the report with our current samples. Only one minor issues remains.

C.J. Muse - Lehman Brothers

Okay. And I guess, Mark, a question for you. If we pull out the excess 250 tape out that was pulled into the September quarter, it looks like your operating margin is running about 18% and R&D nevertheless still up a little bit. Can you talk a little bit, how we should think about OpEx going forward into 2008 and what kind of operating margin model we should be looking for?

Mark Voll

Well, we have said that our target model is on a non-GAAP basis to be -- have operating margins 25% to 30%. And we believe that we can accomplish that. But we have and we believe that we will continue to do that into 2008.

C.J. Muse - Lehman Brothers

Okay. And one last question from me. Not to be too nitpicky here but you guys got it to $16 million to $16.5 million revenues for Q4, but then $59 million to $59.5 million for the full year and that $59 million to $59.5 million implies $15.6 million to $16.1 million in revenues for Q4. So I guess, the question is, which one should we be looking at?

Mark Voll

The quarterly guidance of which we said $16 million to $16.5 million.

C.J. Muse - Lehman Brothers

Okay. Great. Thanks.

Operator

Our next question will come from the line of Jay Srivatsa of Roth Capital Partners. Please proceed.

Jay Srivatsa - Roth Capital Partners

Yeah. Thanks for taking my question. Couple of questions, if I may, could you tell us what percentage of your revenues was in China?

Mark Voll

Past quarter, it was 28%.

Jay Srivatsa - Roth Capital Partners

Looking ahead, do you expect that percentage to continue to grow given the strength that you are seeing there in that security and surveillance segment?

Mark Voll

Yes. We do.

Jay Srivatsa - Roth Capital Partners

Okay. In terms of penetration in other countries, are you seeing any exposure in Japan and what is the situation there?

Hiro Kozato

Yes. We will start seeing more customers in Japan now for the new design wins. And as we mentioned in the last earning call, starting from second half next year, we will see more revenues from car TVs from the current design wins.

Jay Srivatsa - Roth Capital Partners

Okay. Hiro, last quarter you talked about some display panel shortages in the automotive segment. What's the situation now?

Hiro Kozato

I think this is still continuing, probably, to end of this year.

Jay Srivatsa - Roth Capital Partners

Okay. So, it's both display panel and inventories, you expect that problem to continue till the end of the year?

Hiro Kozato

Yes. We believe so.

Jay Srivatsa - Roth Capital Partners

Okay. Looking ahead, till next year, is there any seasonality you expect in the March quarter or does this bumps backs from the automotive side elevate that?

Hiro Kozato

We think starting from Q1 the automotive business will come back. I think our customers are consuming the inventory this year. But early next year, we think we should see more revenues from car TVs.

Jay Srivatsa - Roth Capital Partners

Okay. I might have to take it that you don't expect too much seasonality then in the March quarter?

Hiro Kozato

Seasonality, not really from car TVs.

Jay Srivatsa - Roth Capital Partners

Okay. From an overall revenue standpoint?

Hiro Kozato

Yes. Q1 usually is lower and Q2 usually it's a better quarter for security surveillance market.

Jay Srivatsa - Roth Capital Partners

Okay. In terms of the transition to 0.1-micron, you had a healthy growth to 40%. Do you expect the December quarter to contribute more with 0.18-micron?

Mark Voll

Yes, we do.

Jay Srivatsa - Roth Capital Partners

Okay. Maybe a last question, then I'll step out of the queue, comparatively in the security surveillance segment, what are the things out here? Could you set the landscape for us?

Hiro Kozato

We are still seeing the same competitors and we are still leading the market share. But competitors are trying to under [call] us in price. So, we are seeing some price pressure but nothing unusual at this moment.

Jay Srivatsa - Roth Capital Partners

Thank you very much. Good quarter.

Hiro Kozato

You are welcome. Thank you.

Operator

Our next question will come from the line Quinn Bolton of Needham, please proceed.

Quinn Bolton - Needham

Hey, guys. Just wanted to follow up Hiro on that last comment around tracing. Can you be a little bit more specific, what you saw especially in the security business in Q3 and whether you are seeing continuing price pressure in Q4?

Hiro Kozato

The price DSP was quite flat and Q4, I think it will stay quite flat.

Quinn Bolton - Needham

Okay. So, it looks like in Q4, you are going to have flat pricing, a mix shift towards security products, because you commented earlier on the call that video or the video decoder the consumer business would be down and auto it sounds like it's still weak. So, why wouldn't the gross margin actually trend up with that mix shift towards security in a stable pricing environment?

Mark Voll

We think that the environment will be quite favorable for gross margins. What we don't know is what will be the exact mix of product within security surveillance itself as we would have different products that have different gross margins. Overall, we think that the environment just like Q3 would be quite favorable for us. Yeah.

Quinn Bolton - Needham

Okay. So, if you have a good mix of security, it's not out of the question that gross margin could actually increase quarter-on-quarter?

Mark Voll

I don't know if I can go that far, but we think it's a pretty favorable environment where we believe we will continue to get some cost savings and we think pricing would be stable.

Quinn Bolton - Needham

Okay. And then for Hiro, I think last quarter, there might have been some product transitions around a new DaVinci Platform and H.264 decoding. Can you just talk about whether you think the market is now mostly through that DaVinci Platform change?

Hiro Kozato

Actually, I don't think we simply change yet. I think the only thing that we would see is where we have got a reference design with TI where our 2835 or 2835 business was quite strong in Q3 different from Q2.

Quinn Bolton - Needham

Okay. But I guess you haven't seen any adverse impact on security business now because of any platform changes on the DSP.

Hiro Kozato

Not yet.

Quinn Bolton - Needham

Okay.

Hiro Kozato

Usually, the design cycle, the qualification cycle is very long in security.

Quinn Bolton - Needham

Okay. And then for Mark, you talked about reverse in evaluation, reserve against deferred tax assets, it looks like that results in a slightly higher tax rate for next year. Is there anything you can do or you are looking at any strategies to try and move some of the IT offshore, to try and lower that 35% tax rate beyond 2008?

Mark Voll

We are looking at deferred scenarios, but we won't be able to have any benefit for 2008.

Quinn Bolton - Needham

Okay. Great. Thank you.

Operator

Our next question will come from the line of Chris Longiaru of Sidoti. Please proceed.

Chris Longiaru - Sidoti

Hi, gentlemen.

Hiro Kozato

Hi.

Chris Longiaru - Sidoti

My first question is, you were talking about the addition of two new LCD display customers last quarter. Are those still online for I guess the first half of '08, is what you guided to?

Hiro Kozato

We think it's second half of '08.

Chris Longiaru - Sidoti

Second half of '08.

Hiro Kozato

Is it first or --?

Mark Voll

No, second half.

Chris Longiaru - Sidoti

Second half of '08.

Mark Voll

Right.

Chris Longiaru - Sidoti

Okay. And beyond that, just to get an idea here, the inventory situation, you've got pressure bailing starting in '08 and then kind of building out or it that kind of start in the first quarter and that's gone by second quarter? How do you see that playing out?

Hiro Kozato

You mean inventory in car TV?

Chris Longiaru - Sidoti

Right. In LCD in the cars.

Hiro Kozato

Sorry. Would you repeat the question again?

Chris Longiaru - Sidoti

How do you see the inventory? You said that you expect that -- I guess you have signs that point to this inventory situation amongst your customers, kind of working ourselves out and starting to -- I guess you should start to feel some relief in the beginning of '08. How do you see that playing out? Is there going to be something that all of a sudden that just going to hits in Q1 or is that going to kind of ease?

Hiro Kozato

I think that'll provide upside for us in Q1.

Chris Longiaru - Sidoti

In Q1, okay. Anyway, I think that I missed was, you said the video surveillance market was up year-over-year. What was the percentage again?

Mark Voll

About 40%.

Chris Longiaru - Sidoti

40%?

Mark Voll

Yes. That's correct.

Chris Longiaru - Sidoti

Okay. All right, thank you guys.

Mark Voll

Welcome.

Operator

Our next question will come from the line of Eric Rasmussen of Montgomery & Company. Please proceed.

Eric Rasmussen - Montgomery & Company

Hi, guys. Thanks for taking the questions. Just a follow up from Jay's comment earlier, you talked about 0.18-micron around 40% this quarter. Are you still looking at that targeting at 50% by year-end or somewhere close to there?

Mark Voll

That will be close. We see it increasing. Yes. So, we should be close to that.

Eric Rasmussen - Montgomery & Company

Okay, great. And the competitive landscape in the past, you talked about Texas, TI and Philips, any change in your relationships there in terms of any dynamics happening that might increase the competitive landscape there?

Hiro Kozato

Actually, I think our relationship with TI and Philips is getting better.

Eric Rasmussen - Montgomery & Company

Okay, great. And just one other final question. Any possibility, you said that the inventory correction should be mitigated by year end. But what's giving you the confidence with that right now as you see the business heading into the end of the year?

Hiro Kozato

The system providers are telling us that they should be able to finish up the inventory soon. We don't know exactly when, but we guess if it's starting from Q1, they will probably start ordering new inventory.

Eric Rasmussen - Montgomery & Company

Okay, great. Thanks gentlemen.

Hiro Kozato

Welcome.

Mark Voll

You are welcome.

Operator

Our next question is a follow up question from the line of C.J. Muse of Lehman Brothers. Please proceed.

C.J. Muse - Lehman Brothers

Yes, thank you. Just a quick follow up, I guess to seasonality of security surveillance. I guess with Safe City potentially driving inner strength there, do you think that we could see better than typical seasonality in Q1 for that segment of your business?

Mark Voll

It's possible, yes.

C.J. Muse - Lehman Brothers

Okay. So, I guess '07 Q1 was down 8% sequentially, so better than that you can give in regards?

Mark Voll

'07 was down about 15% from '06.

C.J. Muse - Lehman Brothers

At 8.9% versus 9.7%?

Mark Voll

No. And we were at 15.5% from 16.1%, yeah.

C.J. Muse - Lehman Brothers

No, just for security surveillance, sorry.

Mark Voll

For security. We were down from 10% to 9% I believe. 10% in Q4 and 9% in Q1. So, about 10% down.

C.J. Muse - Lehman Brothers

So, down 8% to 10% is what we should expect without [steady] potentially shown better?

Hiro Kozato

I think it would be better.

C.J. Muse - Lehman Brothers

Okay. And remarkably to drill I guess still a little bit deeper on the gross margin leverage up 60 bits here in the quarter. Can you just I guess talk about how much of that came from just better top line versus I guess the higher 180 mix?

Mark Voll

It's going to be coming from the cost savings. So, the pricing has been pretty stable. The one aspect that's improved was with the cost savings, we have gotten from more and more product going to 0.18. And this quarter, the mix was pretty favorable with the high percent of revenue coming from security surveillance products.

C.J. Muse - Lehman Brothers

Got you. And earlier you said 48% was what you are targeting exiting Q4?

Mark Voll

48% --

C.J. Muse - Lehman Brothers

Of 0.18-micron for the next?

Mark Voll

No. It should be greater than 40 approaching 50 we believe.

C.J. Muse - Lehman Brothers

Okay. And what's the theoretical maths there giving where you see mix overall for the company from various segments and what you are driving down the 0.18?

Mark Voll

I would imagine as we get further into next year, the vast majority of our revenues becoming 0.18. It's greater than 75%.

C.J. Muse - Lehman Brothers

Okay. So, this 0.18 story may still have legs in terms of benefit to the gross margin line in first half of '08.

Mark Voll

Yes. We believe we would be getting cost savings from that, correct.

C.J. Muse - Lehman Brothers

All right. Thank you.

Mark Voll

You are welcome.

Operator

Our next question is a follow-up question from the line of Jay Srivatsa of Roth Capital Partners. Please proceed. Jay your line is open.

Jay Srivatsa - Roth Capital Partners

Quick question. Sorry about that. Can you tell me what is the stock-based comp for the next quarter, Mark?

Mark Voll

It should be about same level that was obtained in Q3.

Jay Srivatsa - Roth Capital Partners

Okay.

Mark Voll

It should be flat.

Jay Srivatsa - Roth Capital Partners

Okay. Hiro, maybe you can help us understand the China business a little bit more. We are seeing a lot of contracts that China's security and surveillance is getting. Could you share with us, how does it roll out, meaning, what is the time lag between when China security gets a contracts and when you start getting the orders and how they get deployed?

Hiro Kozato

This is difficult question. Depends on what stage they are in. They can sign the contract today and deliver the parts in six months or three quarter. So, I don't know exactly what contracts they've signed. But one of their subsidiary who is using 100% our product is telling us that they are raising their forecast.

Jay Srivatsa - Roth Capital Partners

Okay. Well, if the security business is not going to have much seasonality and the automotive business is going to bounce back in Q1, why do you expect any seasonal impact in the March quarter?

Mark Voll

I think we are just approaching in general, where we see a seasonal chart in Q1. But this time, we are much more constant.

Hiro Kozato

May be it won't be as drastic as been in other years.

Mark Voll

Right.

Jay Srivatsa - Roth Capital Partners

Fair enough. Thank you very much.

Hiro Kozato

Okay.

Mark Voll

You are welcome.

Operator

Our next question will come from the line of Heidi Poon of Thomas Weisel Partners. Please proceed.

Heidi Poon - Thomas Weisel Partners

Hi, Hiro and Mark. I just want a follow up on the China opportunity. Do you actually have any feasibility as to what you're customers are designed into, where in terms of cities or provinces do you have a sense of the deployment? Or do you just basically get the orders from your DVR customer and go from there?

Hiro Kozato

Case by case, depends on the customer too. Some customer will tell us, some customer won't tell us. And unfortunately, I don't have order information for you today, but I am sure our sales team has more information.

Heidi Poon - Thomas Weisel Partners

So, so far your sense is that as the deployment is concentrating in certain major cities or is there any surprise cities where smaller cities are also deploying? I just want to get a sense of is it really just rolling out in a very initial stage?

Mark Voll

I think it's in at the initial stage and I think it's more for the big cities at this moment.

Heidi Poon - Thomas Weisel Partners

And I know that you are [definancing] the major DVR companies, but do you think that there's any local competition or maybe the bigger guys like TI also trying to get into this market? Do you see them when you are trying to get into designs?

Hiro Kozato

Yes. We are competing with many people everyday. But at this moment, we don't see a big change.

Heidi Poon - Thomas Weisel Partners

Okay. And more on the gross margin side, I remember in Q1, you usually negotiate contracts with some of your larger customers. So, do you think that we are going to see that in Q1 that we might see some pressure because sort of a new pricing contract would take effect?

Hiro Kozato

We think so. I think so. But we will be offering the 0.18-micron product to negotiate the contract.

Heidi Poon - Thomas Weisel Partners

Okay. Do you expect that to help you at least maybe maintain the gross margin, potential or pricing?

Hiro Kozato

Right.

Heidi Poon - Thomas Weisel Partners

Okay, great. Thank you.

Hiro Kozato

Welcome.

Operator

Our next question comes from the line of Quinn Bolton of Needham. Please proceed

Quinn Bolton - Needham

Hey, guys. Just a quick follow up on the consumer business for the general purpose video decoder business. You mentioned that, that was going to be down in the fourth quarter because of some market share loss. Any quantitative comments you can put around that? Is that something we should think of down around 10%? I think you said it was $3.3 million in September, but just trying to get a hand on, how big of a decline are you expecting in that business?

Hiro Kozato

I would say less than $1 million in revenue.

Quinn Bolton - Needham

Okay. So, it sounds like it could be down 20%, 30%?

Hiro Kozato

From the video decoder?

Quinn Bolton - Needham

Yeah. The video decoder business I think it was $3.3 million in September and I think you had made a comment earlier on the call that that would likely be down in the fourth quarter?

Hiro Kozato

Yeah.

Quinn Bolton - Needham

So, that could be down to somewhere in the 2.3 to 2.5 range?

Mark Voll

I would tell you, we do expect it to be down about 10% to 20%.

Quinn Bolton - Needham

10% to 20%. Okay. Great. Thank you.

Operator

At this time, we have time for one final question and that question will come from the line of Greg Weaver of Kern Capital.

Greg Weaver - Kern Capital

Hi. Just one more follow up on the China thing here. Hiro, could you talk a little bit more about it here. Could you think of [hazard to guesses] the size of the opportunity for you next year or maybe even the year after?

Hiro Kozato

Yeah. Many people have been asking this question, but it's very difficult to quantify. Yet, there in some cases, in some customers, customers are telling us, they would double their orders and some customers, they think it's flat. Well, case-by-case, I would say, just a rough idea, Overall, I think it's outgrowing the worldwide market growth which is 20% to 25% normally. China is definitely outgrowing and I am sorry, I don't know exactly what the percentage would be, maybe 50%.

Greg Weaver - Kern Capital

No. I was just trying to get a hand on the total dollar opportunity in terms of number of cameras or some metric that you might have worked out yourself to try to access how big this could be?

Hiro Kozato

Well, let me put it in this way. We think we'll do something around $38 million to $40 million in security business this year and next year, we think we will do more than $50 million in revenue worldwide.

Greg Weaver - Kern Capital

Okay. So, what about the [delta] coming from China?

Hiro Kozato

Yeah, more from China. Japanese is increasing. The Korea still in flat and the China is outgrowing Japan and other territories.

Greg Weaver - Kern Capital

Okay. Thank you very much.

Hiro Kozato

You are welcome.

Operator

Ladies and gentlemen, this concludes the question-and-answer portion of today's conference. I will turn it back to Mr. Voll for any closing remarks. Sir?

Mark Voll

We encourage you to visit our website at www.techwellinc.com to view our latest announcements as well as our calendar of events. This quarter, we will be presenting financial and industry conferences including AeA Financial Classic Conference in Monterey on November 5th and 6th in room 431 and at the UBS Global Technology and Services Conference in New York on November 14th.

Additionally, if you have any question or would like more information, please contact Shelton Group or me directly. Thank you for joining us today.

Operator

Thank you for your participation. You may now disconnect. Have a great day.

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