Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Zoran Corporation (NASDAQ:ZRAN)

Q2 2008 Earnings Call

July 28 2008 5:00 pm ET

Executives

Bonnie McBride - IR

Dr. Levy Gerzberg - President and CEO

Karl Schneider - SVP of Finance and CFO

Dr. Isaac Shenberg - SVP of Business Development

Analysts

Gary Mobley - Piper Jaffray

Mahesh Sanganeria - RBC Capital Markets

Daniel Amir - Lazard Capital

Suji De Silva - Kaufman Brothers

Blaine Curtis - Jeffries

Craig Berger - FBR Capital Markets

Vijay Rakesh - Thinkpanmure

Michael Cedar - Oppenheimer

Arnab Chanda - Deutsche Bank

James Schneider - Goldman Sachs

Operator

Good day, ladies and gentlemen, and welcome to the Zoran second quarter 2008 conference call. My name is Amy and I will be your coordinator for today. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to your host for today's conference, Ms. Bonnie McBride. Please proceed.

Bonnie McBride

Thank you. Good afternoon, everyone, and thank you for joining us today to discuss Zoran's second quarter 2008 results. By now, you should have each received a copy of today's earnings release.

Joining us today from Zoran's management team are Dr. Levy Gerzberg, President and CEO; Mr. Karl Schneider, Zoran's Senior Vice President of Finance and Chief Financial Officer and Dr. Isaac Shenberg, Senior Vice President of Business Development.

Before we begin, I would like to remind you that during the course of this conference call, we may make forward-looking statements regarding the marketing of the company's products, revenue projections, the outlook for our manufacturing capacities and new product development, and certain trends effecting gross margins and operating expenses for future periods.

I wish to caution you that such statements are just predictions and actual results or events may differ materially. We refer you to the documents the company files from time-to-time with the SEC. These documents contain important factors that could cause the company's actual results to differ materially from those contained in our forward-looking statements.

I will now turn the call over to you, Levy. Please go ahead.

Levy Gerzberg

Thank you, Bonnie, and good afternoon, everyone. During the second quarter, we achieved records in our DTV and mobile phone processor lines, growing revenues 34 and 29% respectively.

Our COACH product line performed well, growing 47% over the last quarter, while we also achieved strong growth in the set top box segment, which saw 114% growth during the same period. Last quarter, we discussed an anticipated decline in our DVD business, which was exhibiting signs of abnormal seasonality, given the economic environment and declines in consumer spending.

During the quarter, this business segment declined by nearly 20%, which was greater than we have anticipated and is the primary contributor to the weaker than expected revenues reported today. We also discuss an expected downturn in our printer imaging business, which in fact came to pass. At the same time, our outlook for the remainder of 2008 has changed significantly as the global economic slowdown which many believe has put the U.S. economy into a recession is driving substantially reduced consumer spending. The result is unusual seasonal softness, particularly in our more mature end markets, DVD and digital cameras.

I will comment more on each business segment now and Karl will follow up with a more detailed financial discussion of our current outlook. In digital cameras, Zoran's result exceeded our initial expectations. While we have facing challenging market conditions, particularly in the entry level sub-segment, our COACH processors are being well received in the mid and higher-end segments where there are signs of stability and even strength.

Driven by the growing demand for high ISO image capture, as well as blur prevention and other technologies, our COACH 10 processor is being well received in the market and is currently in production with ODMs and top few brands such as Fujifilm, Nikon, Pentax, Samsung among others.

Consumers are requiring cameras that capture excellent quality images, under poor lighting conditions and our customers tell us that our high-speed ISO capabilities are a key differentiator in this selection process. These high-end performance functions are enabling Zoran to outpace the competition and maintain a leading market share.

During this time of intense competition and price sensitivities, Zoran's strategy to address the full range of the market is crucial to sustaining success in the market. For example, our new COACH 11 processor, which is already starting production shipments, delivers some of the COACH 10 technologies class face tracking and other features in a more cost effective solution, enabling our customers to address the midrange markets. As a result, both Zoran and our customers are able to remain competitive in all segments.

However, we are now seeing increasingly cautious ordering patterns from our customers, and there are also signs of a slowdown in ODM outsourcing among the major Japanese manufacturers. The leading Japanese captive manufactures have have gained market share which is having an adverse affect on the Taiwanese market where we have a leadership position.

The pricing environment, which was consistent with our expectations as camera makers are aggressively driving prices down in order to win business, particularly in the low end segment. Looking to the second half of 2008, we expect the pricing environment to remain competitive. We believe we can maintain our share in the market.

However, given the broad-based concern over the global economy and in light of the market trends we just discussed, we are maintaining a cautious outlook. In the multimedia mobile phone market, revenues of our APPROACH 5C processor grew 29% sequentially. However, this is substantially less than we expected. In addition to LG Electronics Viewty camera phone, the APPROACH processor is now powering the recently launched Secret Black Label phone, which is now shipping in Europe, South America, and Asia. Reviews of the Secret of excellent and often highlight the exceptional feel in video capture experience as compared to the competition.

Sales of the LG Secret are not expected to meet our, or exceed those of Viewty phone however, for two primary reasons. First, the Secret is a slider phone, which is a substantially more crowded and competitive market. Second, we are not seeing the same level of promotion for the Secret model from LG that we saw for the Viewty phone.

Although this is somewhat disappointing, LG’s position in the market continues to strengthen and they have just become the world's third largest supplier of mobile handsets. This is excellent news for Zoran, as we have gained several additional design wins for models to be launched later this year and into 2009.

5 Megapixel and above mobile phones are dominating sales in the Asian and European markets, a trend that has yet to reach the U.S.. However, we think that as price points come down and the economic environment stabilizes, 5 Megapixel camera phones launches into new geographies including the U.S. will drive further growth. We remain optimistic about this market and our prospects for future projects with LG and others.

In DVD, we face some challenges as reflected in our results for the quarter. Geographically, we saw pronounced softness in the U.S. and Europe, two of our primary target markets. In addition, we had delays in a new product introduction and we are not able to diversify and increase our market coverage in a timely manner. With that said, we are seeing relative strengths in certain sectors of this market such as automotive and we expect that Blu-Ray will emerge as a compelling reason to drive replacement purchases in this market once retail prices come down, which is expected to happen in 2009.

We are actively addressing the issues facing our DVD market segment. First, despite being late to market with our new HDMI 1080 PSoC solution, we have now secured multiple new design wins in this segment.

Future models are coming to market later this year or next year, including new high quality DVD Upconverter models from Toshiba and Samsung. We have multiple customers in the production phase, or in many cases shipping, with Zoran's existing HDMI solution. Second, we have introduced new functions into our main stream DVD product line that will allow us to improve our position and share in the local China market, as well as establishing a stronger position in India and Russia, where the market is growing.

Third, we continue to ship solutions to major OEMs such as Clarion, JVC, Kai Pine and Sony for the expanding automobile DVD market, which remains a higher margin business for Zoran. Finally, our forthcoming integrated solution for the Blu-Ray market, which includes both the front and back ends position us to take a leading position in this segment of the market.

Last quarter we spoke generally about weak conditions in DVD with the expectation that we would see a turnaround during the second half of the year. We are now anticipating that this turnaround may not occur until later in the year or even into next year, as we work to refocus our sales and marketing efforts to more broadly diversify our geographic coverage. However, in the near term, we do not expect to see the same seasonality as in years past that normally drives a significant increase in demand in Q3.

In printer imaging, we saw an expected decline as a result of a tough competitive environment in the Inkjet all-in-one space, a trend we anticipate will continue for the balance of the year. This decline was in line with our expectations, as well as with our comments on the last quarter's conference call.

It is during such challenging market conditions that superior technology and integration become critical to achieving future success. Our recently launched Quatro 4301 and 4302 processors are the industry's most highly integrated solutions on the market with an unmatched interfaces for controlling mechanisms advance touch screen user interfaces and connectivity options such as Wi-Fi and Ethernet networking. We believe the availability of these new Quatro processors will further build on our success by offering integration and improved performance that is ideal for ink jet products with differentiated features.

We remain confident that our investment last year in the emerging color laser segment has positioned us to take a leadership position late this year and more significantly in 2009. During the quarter, we continued to work on laser development programs based on our Quatro processor family at several major OEMs, including Lexmark, which recently began shipping its X 560 N color laser multifunction printer.

Softer revenues were driven by continued demand for IPS software, which is now shipping in over 288 printers and MSPs. Some examples of recently introduced products based on this technology include HP's monochrome and color laser jet printers, and MSP's Cannon's NFP's, Cannon’s refreshed color image runner NSP Ricoh's fish yo printer and MFP's and Xerox phaser printers.

In addition, two of our top 10 customers are now shipping product that have gained certification for their Windows with Vista logo and we are working closely with other Zoran licensees to do the same for 2008 and 2009 product launches. In DTVs, Zoran's performance was exceptional, once again achieving new records in revenues and units shipped. The strong growth was driven primarily by demand for our latest generation of Supra HD processor for the LCD, APSC converter set-top box markets.

In LCD TVs, multiple new models continue to enter the retail market through Best Buy, Costco, Wallmart and other retail stores under well known brands such as MSN and Magnavox, Sanyo, Sylvania and Toshiba, among others. In addition, new models under the brand name ViewSonic and Westinghouse are expected to enter the retail market during the current quarter, all based on Zoran's Supra HD processor.

During the quarter we demonstrated new members of our SupraHD 700 family to key OEM partners and top tier brands at Computex in Taiwan. These new ICs are our most integrated solutions for the market, yet and will enable us and will enable our customers to design TV electronics product that support additional features in the main stream LCD TV segment while reducing customer costs.

Our customers are now delivering HDTV to the market sweet spot from 26-inch LCD models up to 40-inch full HD 1080p televisions for the US and Europe, where we are seeing substantially growth in addition our SupraHD families also beginning to penetrate the larger LCD TVs, including 47” and 52” televisions, which will enable us to expand our presence in the U.S. market, while increasing value to our customers.

In Europe, our top tier customer Funai using Zoran SupraHD 670 SOC is now shipping models to retail channel. It is expected that Funai will expand its product offering during the second half of this year to address a substantial portion of the volume throughout Europe.

We anticipate that we will grow our European market share in 2008 with a further ramp in 2009. Our newly acquired team in France Let It Wave continues to execute and we plan to sample new best in class 120 Hertz field rate conversion solution in the beginning of 2009, further enhancing our product offering to the highest segment of the HDTV.

In the ATC converter set top box market, we saw substantial growth of our SupraHD 741 processor based products. Some examples of new products based on Zoran's technology include XH HD and Apex Digital ATSC converter boxes, both of which support the recently added Analog Pass-Through feature.

While market data is not yet available, we believe we are one of the leading IC vendors in this segment based on shipments to date. We believe we will continue to grow shares throughout the remainder of the year, as our customers move into higher volume deployments to the retail channels. In China, digital cable, their market appears to have recovered from their weather-related issues in Northern China. While we are maintaining our share in this market, its growth is somewhat subdued as a result of the restriction of deployments during the Olympics. However, this appears to be creating demand for the post-Olympics market this fall. We are actively supporting new designs with our advanced set top box SOC that will enter production in early 2009 and we expect to be a major player in this market.

In summary, we are facing challenges in certain segments of our business. We are aggressively addressing the issues and believe we can protect and enhance our leadership positions within each market. We have a long history and track record of success in these markets and have weathered fluctuations in the past. This time is no different.

Despite these challenges, our diversification efforts over the past few years are paying off as we are able to benefit from markets that are experiencing growth even with major declines in consumer spending. We continue to expect solid annual growth in our DTV and mobile phone processor product lines and anticipate growth in 2009. We are confident that when the macroeconomic environment improves, our overall growth rate will return to historic levels. I will now turn the call over to Karl for a review of the financials. Karl?

Karl Schneider

Thank you, Levy and good afternoon everyone. For the second quarter ended June 30, 2008, Zoran recorded revenues of $128.7 million compared to the $109 million reported last quarter and $129.9 million for the second quarter of 2007.

Net loss under generally accepted accounting principles, GAAP, for the period was $36.6 million, or $0.71 per share on 51.7 million common and equivalent shares. These results include a one-time in-process research and development expense of $22.4 million as part of the acquisition of Let It Wave, charges of $9.3 million related to the amortization of acquired intangible assets, and $3.6 million of stock-based compensation. This compares with a net loss of $4.7 million or $0.09 per diluted share for the previous quarter and net income of $200,000, or $0 per share for the second quarter of last year, which also included similar non-cash charges.

Our GAAP net income was adversely impacted by a significant change in our tax rate as a result of changes to the geographic mix and income projections for the remainder of the year. The increased rate has been applied to our year-to-date earnings. Zoran will continue to utilize its tax assets, which significantly reduce the actual cash paid out on income taxes.

On a non-GAAP basis, which excludes the one-time in-process research and development expense, non-cash charges for amortization of purchased intangibles, stock-based compensation expense and an adjustment of the tax provision to a non-GAAP rate our net income for the second quarter was $1.5 million or $0.03 per diluted share compared to net income of $3.5 million, or $0.07 per diluted share for the previous quarter.

For the second quarter of 2007, we recorded a non-GAAP net income of $16.9 million or $0.33 per diluted share.

As mentioned earlier, our non-GAAP net income was also adversely affected by the substantial change in the annual effective tax rate which increased to 73.2%. Excluding the net effect of the tax rate change, our non-GAAP net income for the quarter based on a projected 31.5% annualized tax rate would have been $8 million or $0.15 per diluted share.

Hardware product revenues increased to $113.6 million from $93.4 million reported last quarter and decreased slightly from $114.5 million in the same period of the prior year. Software royalties, licensing and other revenues increased to $15.1 million from $14.7 million last quarter and decreased 300,000 from the $15.4 million recorded in the second quarter of 2007. Revenues by product market for the second quarter of 2008 were 33% digital camera, 28% DTV, 15% DVD, 15% printer imaging, 7% mobile phone processors and 2% other. Sales by geographic region during the second quarter were 43% China, 21% Taiwan, 14% Japan, 12% Korea, and 10% U.S. and the rest of the world. Overall gross margin for the second quarter was 46.9% which compares with 47% last quarter and with 53.7% for the second quarter of 2007.

Our gross margins remained a challenge as a result of several factors, including product mix, ASP erosion and costs associated with new product ramps. The allocation of stock-based compensation expense and our GAAP income statement for the second quarter is 105,000 to manufacturing overhead included in cost of product sales, $1.3 million in R&D, and $2.2 million in SG&A. Excluding the stock-based compensation expenses, research and development expenses increased $2.8 million in the second quarter of 2008 to $29.5 million compared to the $26.7 million in the prior quarter.

Compared with the same quarter of last year, R&D spending increased $1 million from $28.5 million. On a sequential basis, R&D spending tends to fluctuate from quarter to quarter based on the timing of major engineering-related expenses such as tapeout’s, which include mass sets and engineering wafers. With the recent addition of Let It Wave, R&D spending is expected to be slightly higher in the third and fourth quarters.

Excluding the impact of stock-based compensation charges, selling, general and administrative expenses decreased slightly to $22 million in the second quarter from the $24 million reported last quarter. Compared to the same quarter last year, SG&A expenses decreased $3.5 million from $25.5 million. The decrease is the result of fluctuations in marketing expenses.

Other income and expense for the second quarter of 2008 was $2.8 million compared to $3.8 million in the prior quarter. The component of interest income included in these figures was $3.3 million and $4.5 million respectively. The decline in interest income was the result of the declining rates in our investment portfolio. Overall, other income and expense also included foreign translation losses as a result of the decline in the value of the US dollar in comparison to currencies in countries in which we operate. Our book tax rate post the release of the differed asset tax asset valuation allowance has become increasingly dependant upon fluctuations in the geographical mix of our estimated annual income.

From a geographical perspective, we currently have our consumer electronics IP domiciled in Israel, where most of it was developed and where we benefit from lower income tax exposure than we would otherwise have experience in the United States. Here in the U.S. where the tax rate is a substantially higher, we are primarily exposed to income tax on our very profitable printer imaging business as well as interest earnings on our cash balances. With the challenges we are now facing in the consumer side of our business, the expected income associated with Israel has declined substantially relative to the U.S. and has adversely impacted the book's tax rate we are required to report.

As our results in the consumer markets improve with the growth we are experiencing in DTV and handset, as well as our move into the Blu-Ray DVD market, we expect we will recover the profitability in Israel and see our global book tax rate returned to more reasonable levels in the future. Moving over to the balance sheet, cash, cash equivalents and total investments decline by $17.1 million to $360.2 million compared to $377.3 million reported last quarter. Approximately $22.8 million was used in the acquisition of Let It Wave, which closed during the quarter.

Cash provided from operations during the quarter was $4.5 million. Accounts receivable at the end of the quarter were $57.9 million, an increase of $2.8 million from $55.1 million last quarter. With DSOs decreasing to 40 days compared to 45 days for the previous quarter. Inventory balances at the end of the quarter decreased $4 million to $60.6 million compared to $64.6 million for the previous quarter.

Inventory turns for the second quarter were approximately 4.4 versus 3.4 in the previous quarter. I will now address the company's outlook for the third quarter of 2008. During the Q&A session that follows, you are encouraged to ask any questions that may not be covered during the course of our comments as we do not anticipate having to provide any additional financial guidance after this call. Before we provide any forward-looking guidance, we want to remind you that any forward-looking statements related to revenue projections, gross margin expectations and all other comments on the expected financial results for Zoran are just predictions.

Actual results may differ materially. For the third quarter of 2008, we currently anticipate that revenues will range between 123 and $128 million, with overall gross margins ranging between 46% and 47%. Excluding amortization of acquired intangibles and stock base compensation, operating expenses are expected to range between 54.5 and $55.5 million. Acquisition-related costs are expected to be approximately $4.5 million. Stock-based compensation expense is expected to be between $3.2 million and $3.6 million.

The company expects to record GAAP earnings for the quarter in the range of a loss of 4 cents per share to 0 cents per diluted share or break-even. Excluding amortization of acquired intangibles and stock-based compensation, non-GAAP net income for the quarter is expected to range between $0.02 and $0.04 per diluted share on approximately 52.2 million shares. With that, we will open up the call for questions. Operator, please go ahead.

Question-and-Answer Session

Operator

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Gary Mobley from Piper Jaffray. Please proceed.

Gary Mobley - Piper Jaffray

We are certainly incorporated to meet typically seasonality in the third quarter here, I am wondering what the chances are we might see some atypical seasonality in the fourth quarter, or should we expect the normal 10% sequential decline, and if you are not willing to answer that question, maybe if you can talk regarding your operating expenses heading into your seasonally weak period. Do you plan to carry the same level of operating expenses into Q4 and Q1?

Karl Schneider

Well, Gary, to the first part of that question, you know, I think it is still early to go out and call Q4. I mean we do expect it is down on a seasonal basis. We just can not predict how much at this point in time. As far as operating expenses goes, of course we are doing, looking across the board at areas where we can save and cut back, but of course we do not want to cut into the meat of the company and misexecute going forward. Because the reality is we got good positions in the markets. We have got new products under development and we believe that this situation will recover and we want to be in position to take advantage of it.

Gary Mobley - Piper Jaffray

Okay. Just had a quick follow-up question relating to the inventory turns, they are improved from the first quarter level, but your turns are still I think well below historical norms. What are the chances of seeing some inventory write-down?

Karl Schneider

At this point in time, we are not expecting inventory write-downs. I would say the biggest surprise from an inventory's perspective from us, and it is not really a surprise, of course, well, the event was a surprise, but the reality is that we did not deliver in the handset area to the level we were expecting to deliver and so that is where the inventory did not decrease as much as we would like to have.

Gary Mobley - Piper Jaffray

Thank you.

Operator

Your next question comes from the line of Mahesh Sanganeria with RBC Capital Markets please proceed.

Mahesh Sanganeria - RBC Capital Markets

Thank you for the call, Levy. Can you talk about the DTV market? Looks like overall the market is a little bit weaker and you talked some about your strength primarily coming from market shares. Can you gives us more color on how should we look at it going forward? Can you continue this growth rate?

Levy Gerzberg

Well, Mahesh, we see a continuing growth in the DTV market. As we mentioned, we feel that actually the quarter was an excellent quarter for us. We see our market share continuing to grow. We expected, based on the new products that we developed and the support infrastructure that we have in place, so we see a nice momentum, both, mostly right now in the ODM segment, but we start to see some momentum also in some direct design wins that we have. So as mentioned, we are in the sweet spot of the TV size, the 32 up to 40, now we see design wins in the wider screens, bigger screens. So all in all, we see a good, positive momentum. Also, the move into Europe, we view it as very positive. As mentioned earlier in our comments, we see Funai gaining momentum in Europe and this is a major customer and partner of Zoran and as you may recall from previous quarters and announcements, Funai in some segments will now carry the Phillips brand name, which will continue the momentum, the positive momentum that we see. Also the integration we introduced to the market and the low cost solution and at the same time very good quality is buying us market share. So we are positive about the outlook of the HDTV business.

Mahesh Sanganeria - RBC Capital Markets

Where do you think you can get the gross margins? Can you improve the gross margins further? I think this is one of the lower gross margins business for you, right?

Karl Schneider

Yes, TV gross margins have come down lately. We are looking to see those gross margins improve over time as we go forward, as we introduce new products. The new products are more integrated. We are cost optimizing those products. So, yes, we are looking for TV margins to pick up as we move forward.

Mahesh Sanganeria - RBC Capital Markets

Another question I have on your cash flow, do you think you can stay cash flow positive every quarter and also I want to just say if you can tell us what is your cash tax debt?

Karl Schneider

From a cash flow perspective, as I said this quarter in the prepared remarks, we generated about $4.5 million of cash. The cash balances would have been up rather than down had we not spent the money on Let It Wave. I do believe if we look out in the future, we are not expecting to move the P&L on a pro forma basis or a cash basis into a negative position so we are anticipating that cash flow is not going to be an issue.

From a cash tax perspective, the rate is very low. When we look out across this year at the end of the year, we are pretty sure on a global basis, including all of the countries we operated in and all their local taxes that we pay for whatever reason, we probably will not have a tax bill bigger than $1.5 million across the globe for the year. So I think from a cash basis, we are in pretty good shape. We do not expect that to change in the near future anyway.

Mahesh Sanganeria - RBC Capital Markets

Well, that leads me to my final question. The stocks rating around 815 Bob till I was and with your close to $7 in cash, and your cash flow not dipping into negative, why will not you go ahead and aggressively buy back the stock?

Karl Schneider

Well, as we announced last quarter, we do have a buyback in place and we will use that buyback on an opportunistic basis to support the stock.

Mahesh Sanganeria - RBC Capital Markets

Okay, thank you, Karl.

Operator

Your next question comes from the line of Daniel Amir with Lazard Capital. Please proceed.

Daniel Amir - Lazard Capital

Thanks a lot, and thank you for taking my question. A question on the mobile phone side; You say you were slightly disappointed a bit in the numbers although the numbers were up slightly, and related to that, what, what type of color should we be seeing going forward in that segment, if it is with LG or with other customers and what the time line would be there?

Levy Gerzberg

Well, Daniel, We were disappointed because we thought LG would do better with the Viewty and with the launch of the new product. So we see some delays in terms of momentum in the launch of the new product, and we are expecting to be in more models in the near future.

So the catalyst that you asked about will be when you hear about a new model coming out to the market and more noise about the Secret; that is the name of the phone, the Secret phone, I think you will see the momentum coming with it. We had no control on this development and based on the inputs that we got from the market and from LG themselves, we expected that the units shipped in Q2 and Q3 will be higher. However, still as compared to last year, this is fantastic growth and we hope the momentum will continue. We see a number of new models that our chip is designed in.

Of course in addition to Viewty, we are working on the next generation chip that is gaining a lot of interest, but it is not generating revenues yet, but we believe that you will hear about new models in the later part of the year and the momentum will come with it.

Daniel Amir - Lazard Capital

Okay, and with regard to your guidance, do you expect any of your segments to be up Q-over-Q?

Karl Schneider

For the third quarter?

Daniel Amir - Lazard Capital

Yes.

Karl Schneider

Yes, we do, as a matter of fact. I think we are looking at possibly DVD being up a little higher in the third quarter than it was in the second quarter. So that is good news.

Daniel Amir - Lazard Capital

Okay, and which segments do you expect to be significantly down? Is that the digital camera segment?

Karl Schneider

I think digital camera is certainly challenged. I do not know how far down it will be. I think that we are expecting some more decline in the printer imaging hardware side of the business. TV is probably, plus or minus. It is flattish plus or minus.

Daniel Amir - Lazard Capital

Okay, and my last question, related to the Blu-ray, when do you expect to begin shipments of your Blu-ray chip and recording revenues?

Karl Schneider

Our target is second half of next year. Our strategy is to come out with the solution and be in production with a product that will enable our customers to really increase the volume in this market. So our solution will be fully integrated front end and back end. We have done it before in the red laser and this is the strategy now based on the feedback that we see, we believe that we will gain good momentum and we will be a real catalyst in the market to drive the costs of the system for consumers down and increase the volume. So for us, real revenue is the second half of the year, next year.

Daniel Amir - Lazard Capital

Okay, thanks a lot.

Karl Schneider

You are welcome.

Operator

Your next question comes from the line of Suji De Silva with Kaufman Brothers. Please proceed.

Suji De Silva - Kaufman Brothers

How are you doing? So on the DVD market; actually, I want to make sure that the share there is staying stable on the digital camera side. You said share is stable, but you talk about the magnitude, the length of this decline and the way you think we would come out of it maybe 4Q or beyond?

Karl Schneider

So I think, Suji, on the DVD side, I think our share is, maybe declined slightly in first half of this year. I think it is stabilized. We have got new projects on the table with customers, and we believe that we are solid in that market. Going forward, you know, it is anybody's guess on when these markets are going to turn around, but we expect to maintain solid share, growth share in certain of our markets. On the camera side, you know, we have a very solid base. Yes, we are seeing new competition come in on the low end of the segment, camera segment, but we, our plans are to remain very competitive and keep or grow share in digital cameras.

Suji De Silva - Kaufman Brothers

Okay, and then beyond the competition there, what are you seeing in terms of your customer inventories perhaps is another angle into the recovery?

Karl Schneider

Customer inventories, I do not think are out of line. We will have to see what happens as we move into the second half of the year. The holiday season is still in front of us. I think there is still a lot of caution in the markets and inventories are probably fairly lean in the channel.

Suji De Silva - Kaufman Brothers

Okay, and then perhaps this question is for Levy, on the handset type Levy it sounds like the first LG part of Viewty was highly promoted the second one sounds like a little more muted in promotion. What do you expect the characteristics of the upcoming products your in terms of the promotion level? Are they going to be low unit niche products, or more high runners as you can see.

Levy Gerzberg

We think first of all these will be very exciting models. They will have very unique features and based on what we hear, there will be a lot of promotion around these products. So we are waiting to see. I have seen the prototype. It looks really good, but it is not ready for production, yet it is coming.

Suji De Silva - Kaufman Brothers

Okay. Then last question, on the numbers, Karl, can you tell us how much of the Opex bump up is Let It Wave versus organic growth? Thanks.

Karl Schneider

Well, what I can tell you about Let It Wave is they were approximately 36 employees or so that we acquired and so the run rate of that in France will add a couple of million to the number.

Suji De Silva - Kaufman Brothers

Great. Thanks.

Levy Gerzberg

You are welcome.

Operator

Your next question comes from the line of Adam Benjamin with Jefferies. Please proceed.

Blaine Curtis - Jeffries

Good afternoon. This is Blaine Curtis for Adam. You say DVD strength in the seasonally weaker period as you ran through the new customers can you talk about how your modern trained inventory levels at those customers given the weaker end markets specifically for those how is France?

Levy Gerzberg

DVD the question was or DTV?

Karl Schneider

DTV.

Blaine Curtis - Jeffries

DTV.

Levy Gerzberg

Well, we do not see, actually we had a pretty good demand in Q2 for the DTV products and we are gaining more momentum in the market, we have good design wins. So at this point we do not see a real inventory issue in the DTV market. We are focusing on being able to deliver what we need to deliver on time.

Blaine Curtis - Jeffries

Then do you expect Funai to ramp in the second half of this year? Also, what percent in Q2 was the converter box of that DTV number?

Levy Gerzberg

I am sorry. I missed the, can you repeat the question?

Karl Schneider

Blaine can you repeat the question for Levy?

Blaine Curtis - Jeffries

I am sorry it is two questions, one, I just wanted to clarify whether you are expected the Funai Movement in Europe to be in the second half of this year and I also was curious if you could quantify in rough terms what, how much the converter box was of the DTV revenue?

Levy Gerzberg

Okay. So as far as Funai in the second half this year in Europe, yes, definitely. That is what we expect and that is what we see happening. As far as the percentage or the portion of the converter box in Q2, it was, somewhere between 25% to 30% of the units shipped.

Blaine Curtis - Jeffries

Okay, great. Then just finally, Karl, the tax rate for Q3 and Q4 on a pro forma basis, I just want to make sure I got that right. Given your guidance, it is somewhere fairly high, but then you were talking that the cash tax rate is much lower. I was just wondering if you would clarify what the pro forma tax rate is?

Karl Schneider

So the pro forma tax rate in, for non-GAAP is about 72% or 73.2% projected for the rest of the year, assuming that our forecast does not change. If the forecast happens to change as we get through the end of Q3, then of course the rate is likely to move up or down. So if we happen to do better in our forecast in the second half, the rate will come down a little bit. Most likely if we go the other way, then the rate will change negatively.

Blaine Curtis - Jeffries

Okay, great. Thanks, Karl.

Operator

Your next question comes from the line of Vijay Rakesh with ThinkPanmure please proceed.

Vijay Rakesh - ThinkPanmure

On the digital camera side, can you go at what the outsourcing trends and what you see your second half, just market share overall at the tier one OEMs here and let's say how do you see that market share as we look at first half '09?

Levy Gerzberg

So actually we see an interesting trend in the markets. We see that some of the first year suppliers are gaining market share, and in '09 actually it will help us because we are gaining market share with some of the first tier. We mentioned some of the names on the call. Unfortunately, we cannot share with you some other names, but this is our first year. So we talked about Fuji film. We talked about Nikon, Samsung was gaining market share very nicely. However, at the same time, a big part of the volume are ODMs and Japanese manufacturers, for example, are buying from Taiwanese ODMs, whom we service as well, but it was interesting to see that some of the first tiers are designing themselves. So it is a longer process and as I mentioned, a good number of them are relying on our solution and we hope to see the impact of it, especially in the mid-to-higher range of the camera, but we continued to work with ODMs in Taiwan. It is a more competitive market. We see some low end, lower quality solutions on the market and we are trying to respond to it with our existing and upcoming solution. I mentioned in the prepared remarks the COACH 11, which will address it very nicely. It is relatively speaking a very high performance device at low cost.

Vijay Rakesh - ThinkPanmure

On the TV side, looks like try and guiding down was 25% quarter-to-quarter, and you had a flat guidance. Just overall, on the TV market, how is TV sale in Q3 versus Q2? Is it flat? What are you seeing during economic backdrop is?

Levy Gerzberg

Well, we as mentioned, we do not see the significant increase in Q3 as we have seen for the season in prior years. However, we see it going slightly up, at least for us, and of course we have been talking to the channels directly as well. You know, we are talking to the Best Buys of the world. We not only talk to them; we provide them with solutions via ODM suppliers that we work with very closely, so a large number of the Insignia of our product line, for example, Best Buy, is based, so we have a direct input from the channels, so we see it going up slightly, at least for us. We do not see the huge jump that we saw in previous years in Q3.

Vijay Rakesh - ThinkPanmure

I have one last question. The tax rate, what do you see for '09 and 2009 and then looks like flattish in Q2. How do we see that for Q3?

Karl Schneider

Well, Vijay, with regards to the tax rate, I am going to have to withhold comment because that all depends on how 2009 shapes up as an income year by geography and it is a little for us to go there. As far as inventory goes, look, we are doing our best to manage inventory and get our inventory turns back up to where we historically are, which is somewhere between five and six. That is our company goal, and we have been, we have had some success at operating at those levels the past several years. Yes, we have some blips up and down, and we are on the way back to recovery. We are not worried too much about inventory going into 2009.

Vijay Rakesh - ThinkPanmure

Great. Thank you.

Levy Gerzberg

You are welcome.

Operator

Your next question comes from the line of Yaiar Rainer with Oppenheimer. Please proceed.

Michael Cedar - Oppenheimer

Hi. This is [Michael Cedar] with Yaiar Rainer just a question about the up convert DVD. Approximately what percentage of TV derived revenues would be?

Levy Gerzberg

The Up converter DVD, this HDMI DVD what percentage

Karl Schneider

Of the mix in our DVD revenues.

Levy Gerzberg

Probably around 15% or so. Hopefully will go up in the future.

Michael Cedar - Oppenheimer

Okay, concerning the DVD market, I know you do not really have much comment on 2009, but do you think it is going to see a rebound in 2009 in general, or is this some, you know, something a lot more secular depression in the DVD market?

Levy Gerzberg

Well, you know, we continued to see the DVD market new features and that is what we are focusing on. Furthermore, we see some new markets that we have not been addressing very addressing aggressively. For example, India, market segments in South America, and even in China in the domestic market, where we have seen some weakness, we believe that there is a good chance for us to gain some momentum. I did not mention Eastern Europe and Russia these are other segments and its interesting has its own requirements and we liked it because we can react it to special software and hardware.

Of course the Blu-ray is going to be a major, we hope it will be a major growth driver next year. We are great believers in very high quality Blu-ray solution, but at very reasonable cost. We have done it before, and this is why we are designing a very attractive solution from a cost performance point of view. Furthermore, the fact that we have a very long legacy and experience with the playability of the red laser, which turns out to be a problem in some blue laser we believe it will give us an advantage in addition to the very integrated device and new features that we are incorporating. So 2009, we believe there will be growth in the DVD market driven by the new geographies and the Blu-ray.

Michael Cedar - Oppenheimer

Okay. One final question, if you do not mind. If you would give a little commentary on handset margins. You mentioned that it is got more than one component to it that you can not really control in terms of margins. Have you seen any progress over there?

Karl Schneider

Absolutely. I think what you are referring to is the fact that we have our multi-chip module with memory die and we have mentioned in the past challenges of yielding that multi-chip module and we are in the middle, if not fairly well along the way of changing some of the vendor out there and we expect to see improved margins.

Michael Cedar - Oppenheimer

Great, thank you.

Levy Gerzberg

You are welcome.

Operator

Your next question comes from the line of Craig Berger with FBR Capital Markets. Please proceed.

Craig Berger - FBR Capital Markets

Thanks for taking my question. Can you give us a little bit of ASP commentary for the digital camera, digital TV and DVD chips in the second quarter?

Karl Schneider

Okay. ASP commentary basically across all our product lines… Craig, is that what you are asking?

Craig Berger - FBR Capital Markets

Well, the big three. Look, typical ASP erosion, TV actually held its own for the most part. We did not see a lot there. I would say we continue to see price pressure on the camera segment and what was the third one? DVD?

Karl Schneider

DVD? We still have some pressure there, but not as substantial maybe as camera.

Craig Berger - FBR Capital Markets

On the, do we need a Pro forma tax, or a GAAP tax benefit in order to get Pro forma and GAAP guidance to meet? You know, to get to both your guidance numbers, so we need to have a …?

Karl Schneider

So in the second half of the year, I think what you are referring to based on the guidance we give on a GAAP basis, yes, the GAAP tax rate is actually a benefit.

Craig Berger - FBR Capital Markets

Okay. So like 500,000?

Karl Schneider

Somewhere in that neighborhood.

Craig Berger - FBR Capital Markets

Have you considered with your stock being so low and not trading on earnings, but trading on sales, have you considered on moving stock compensation expense out of the excluded items and then to the recurring?

Karl Schneider

Well, our plan of course is to, you know, give you that information and you can choose to treat it however you like.

Craig Berger - FBR Capital Markets

Okay. Last one, how much revenues came with Let It Wave and also who is the new low end competition in digital cameras? Is that Sunplus or somebody else?

Levy Gerzberg

The low end competition is mostly in Taiwan. We do not think its Sunplus. It is some local companies and we have seen some competition in Japan from an AC vendor and historically these vendors do not last in markets like these for long time with a solution. They need to have all the infrastructure and the software and tools. So we are anticipating that there will be a change there. However, right now we see some small players in Taiwan and one AC vendor in Japan.

Karl Schneider

Let It Wave, Craig, was, there were no revenues. No existing revenues.

Craig Berger - FBR Capital Markets

Thank you very much.

Levy Gerzberg

You are welcome.

Operator

Your next question comes from the line of Arnab Chanda with Deutsche Bank. Please proceed.

Arnab Chanda - Deutsche Bank

Yes, thank you. Couple of questions, first, for Karl, if you look at your direction of gross margin, how much of that is dependent on mix changes as well as versus pricing pressure? I know you are also reducing some of the costs. If you could go with a sense of if the mix does not change, is this a good range for gross margins, or does it have fluctuations potential? Then I have a couple follow-ups, please.

Karl Schneider

Okay. From a gross margin perspective, Arnab, I would say our gross margins are highly dependent upon mix and so for example we saw improvement over last quarter in our COACH gross margins because we have launched COACH 11, which was a lower cost product. If you recall, we have been shipping COACH 10 into some lower cost sockets, which had brought the margin down.

So it has a lot to do with mix, with new product ramps, as we go through those processes. Going forward, you know, our longer-term business model says that we would be quite comfortable. We think if our gross margin targets range between, say, 47% and 50%. We have got some work to get there based on where we are did, but we believe there is an opportunity to do that.

Arnab Chanda - Deutsche Bank

Great, and couple of other questions. One, if you look at digital TVs excluding the converter box, what is the qualitative direction you see there? Could you talk what it is been from Q1 to Q2 and what do you expect to do for Q2 to Q3. You may have already covered that, I just wanted to clarify that point. Thank you.

Levy Gerzberg

If I am to send you a question on than in the digital TV, we have seen a good momentum and significant market share gain in the U.S. from early. We are doing it via the ODMs and via some direct work or design wins with some suppliers that we discussed. So this has been a major positive change for us and we see this momentum continuing. Furthermore, we mentioned Europe. We believe that the momentum that a number of our customers are gaining, but especially Funai in Europe is very significant and we see good upside as a result of it and of course the integration. We have integrated more functions.

Next we are going to have the 120th integration, which we believe is very unique compared to any other solution we have seen on the market, including some competing solutions that just do not work. You buy these televisions and we plug in some sequences of images and they get stuck.

So we believe it will help us gain market share, so it is cost effectiveness, very high quality, and we covered the entire range and we are working on getting into the higher end as well, working on from the first year. I do not know if I answered your question, but that is what we see. Mostly in the U.S. in Q2 and continuing in Q3.

Arnab Chanda - Deutsche Bank

Okay. Couple other questions of products. On the DVD side, I think originally the plan was to come up with three different products. Are you going to directly enter the market now with integrated product? In that case, you know, is it are you a little bit late to the market? then second question is on the handset side, are we expecting basically ramp within LG, or are we likely to see other handset makers? Thank you.

Levy Gerzberg

Karl?

Karl Schneider

Okay. Arnab, with respect to the first half of your question on Blu-Ray entering the market, yes, if you recall, we were planning to go into that market with a two-chip solution front end and back end. However, what we see today is that market does not appear to be taking off quite as fast as people were hoping it would. The prices are not coming down. I think some of the major OEMs have basically stated there is no reason to bring it down right now.

However, it is going to come down and to be successful and drive those price points down on a box, we are going to we have decided the best way to do that, of course, which is with a lower cost single-chip integrated solution, so that is where we are going to go.

We have modified our strategic plan as far as that product goes and that is what is going to come out. That will help drive the price points down closer to $100 a box, which is where we believe this thing will really explode and take off, of course. With respect to the handset market, we have every intention to go out and add additional handset manufacturers outside of the current LG situation.

Arnab Chanda - Deutsche Bank

Thanks, Karl. Thanks, Levy.

Levy Gerzberg

You are welcome.

Operator

Your next question comes from the line of James Schneider with Goldman Sachs. Please proceed.

James Schneider - Goldman Sachs

Hi, good afternoon. Maybe you could start off on the gross margin side. I think you have had this asked a couple of different ways, but put another way, do you think your gross margins are at the low water mark around 46% or could they drop further than that if mix deteriorates further in the Q4?

Karl Schneider

Right now, I think we are anticipating that is the low watermark.

James Schneider - Goldman Sachs

Okay, fair enough. Then just in terms of OpEx, do you anticipate there could be any increases in OpEx as we move into Q4, or conversely, are there any opportunities for spending reductions going into the end of the year, please?

Karl Schneider

Well, we are going to see OpEx go up primarily because of let it wave. We are looking across all of the company's operating functions to see where we can save money. I think we have done a pretty decent job of holding OpEx over the last year, but we are not going to get to the point where we cannot be successful in the markets that we are chasing.

OpEx will tend to fluctuate from quarter-to-quarter based on timing of new products, you know, the tapeout costs are pretty expensive these days, and only getting more expensive as we look to newer, smaller geometries in silicon design.

James Schneider - Goldman Sachs

Fair enough. Then just lastly, there has been a lot of commentary about TSMC pushing through incremental pricing increases, especially on the more leading edge geometries. Is that impacting any of your products, or not so much?

Karl Schneider

Let's just put it this way. It makes life challenging.

James Schneider - Goldman Sachs

Okay. Fair enough. Thanks.

Levy Gerzberg

You are welcome.

Operator

Your next question comes from the line of Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Hi Karl, I had a quick question on amortization of intangibles. Your intangible assets have not gone down and you are forecasting a reduction in amortization of intangibles. Are you changing the accounting here?

Karl Schneider

No, actually, the intangibles are going down. Most of the purchased intangibles we are talking about related to the acquisition of Oak technology which we are getting out towards the five-year mark there, which is where we had set the amortization up on a lot of those intangibles. So we are going to start to see that fall off.

Mahesh Sanganeria - RBC Capital Markets

Okay. So that is driving the drop in…

Karl Schneider

Right. So we have gone from, say, nine-point-something in the second quarter to I think the guidance was 4.5 million or so in the third quarter.

Mahesh Sanganeria - RBC Capital Markets

Well, I will try to sneak in one more question, as far as my models show, it starts on year 2000 you have grown every year since then, probably before that also. Are you going to try to keep that record this year?

Karl Schneider

We certainly would love to do that, okay? However, we are subject to market forces and we will see what happens.

Mahesh Sanganeria - RBC Capital Markets

All right, thanks.

Operator

You have no further questions at this time.

Levy Gerzberg

Okay. So we would like to thank everyone for joining us and also to remind you that we will be presenting at several conferences in the coming months. All these conferences are posted on our website, so we invite you to check it out and visit us at the conference. So thank you, again, and good-bye.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Zoran Corporation Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts