Chip maker Zoran (Nasdaq: ZRAN) published its fourth quarter and 2002 financial reports last Thursday. As expected, the fourth quarter report showed a 9% decline in revenue compared with the preceding quarter. The next day, Zoran’s share nosedived 21% to $10.85, reflecting a market cap of $295 million.
At the conference call with analysts that accompanied the reports’ publication, Zoran president and CEO Levy Gerzberg said, “Zoran increased its market share for DVD and digital camera chips in 2002. Zoran’s growth in the DVD chip sector exceeded the general market growth. Zoran’s unit sales to this market rose 123% in 2002, compared with 61% growth for the market as a whole.
“We also achieved good results in the digital camera chip market. Our unit deliveries to manufacturers rose 169% in 2002, compared with 30% unit growth for the entire market.”
Zoran predicted that its first quarter 2003 revenue would decline 8-10% compared with the fourth quarter of 2002, due to seasonal factors. This decline is less than the normal decline between the fourth and first quarters. The company also stated that its first quarter gross profit margin would fall 26-28% and its pro forma profit per share would fall to $0.01-0.03.
As for its forecasts for 2003 as a whole, Zoran predicted a 30-35% increase in revenue to $194-200 million, and a net profit of $23-24 million, or $0.80-0.85 per share.
Zoran currently has 26-28% market share for DVD chips and 18% for the non-captive digital camera chips, i.e. for digital camera manufactures who do not make their own chips. The non-captive digital camera chip market accounted for 40% of the total market in 2001, and an estimated 45% in 2002.
Zoran stated that one development in the fourth quarter that might have a positive effect on the company’s long term results was that Samsung (KSE:830) had begun installing Zoran chips in a wide range of its products. Zoran estimates Samsung will install Zoran chips in over 70% of its DVDs 2003.
“Globes”: How do you explain the share’s fall?
Zoran senior VP business development Isaac Shenberg: “In principle, nothing unusual or unexpected happened in the fourth quarter that can explain the share’s fall. Moreover, in contrast to most companies that have not published any forecasts for 2003 at all, Zoran predicted it would grow.
“The share’s fall might be because some analysts looked at the decline in revenue from the fourth quarter in 2002 to the first quarter in 2003. But anyone who understands Zoran’s business knows that this decline is traditional and seasonal as we are a consumer products-oriented company.
“In principle, 40% of annual revenue in the consumer product market comes in the first half of the year, and 60% in the second half. The third quarter is Zoran’s strongest, due to the upcoming Christmas holiday season and the Chinese New Year, which falls in February. The fourth quarter is also strong relative to the year, although slightly less than the third, while the first quarter is the weakest.
“Although demand for products like DVDs and digital cameras is especially strong in November-December, manufacturers buy our chips in advance, mostly in the third quarter. Our strength in the fourth quarter is mostly due to sales toward the Chinese New Year in February, although there are also late Christmas sales. As I mentioned, first quarter sales are characteristically lower than in the fourth quarter.
“I assume that another reason for the share’s fall was that analysts expected a higher gross profit margin in the first quarter. Most of the decline in the gross profit margin in the fourth quarter was derived from our first sales of the PixelCam CMOS Image Sensor. PixelCam sales adversely affected our gross profit margin, because production has only just started and there are still problems with production costs. We expect that the negative effect on costs, and therefore on the gross profit margin, will continue in the first quarter. We believe the problem will be solved beginning in the second quarter. In addition, higher sales of the Vaddis 6 chip will also improve the gross profit margin.”
How did Vaddis 6 chip sales affect your fourth quarter results, and how will the effect the results in the coming quarters?
“We began selling Vaddis 6 in the fourth quarter, although we’ve only had small deliveries of a few hundred thousand units so far. Initial sales of this chip were a small step in the fourth quarter, but a major step for 2003. The importance of the initial sales is that, besides Zoran, only one other company is delivering commercial quantities of similar integrative chips that combine several functions on a single chip.
“Vaddis 6 has a unified shared memory architecture controlled by a single internal CPU. Zoran has delivered the DVD front end (read channel, servo, data processor, CPU) and back end functions (MPEG decode, CPU, video encoder, and progressive scan output) on a single integrated circuit. It digitalizes analog signals and corrects errors. Since a single chip carries out all these functions, DVD makers don’t have to buy and integrate different chips for each function, thereby saving money, and significantly lowering DVD prices.
“The lower price of Vaddis 6-equipped DVDs makes them available to the larger middle market. In other words, even though Vaddis 6 is more expensive than the higher performance Vaddis 5E chip, which is designed for the high-end market, Vaddis 6’s cost structure is more efficient. First, it’s cheaper to manufacture, and second, DVD makers can sell DVDs more cheaply. That means that Zoran makes a higher profit and gross profit margin compared with other chips.
“We predict Vaddis 6 chip sales will grow in the first quarter, but will still account for relatively few sales. We expect the boom in sales to arrive toward the second half of the year.”
Which developments in the digital television chip market will become Zoran’s new growth engine?
“We’re continuing our efforts in the digital television market, and expect to see significant results in the second half of 2003.”
How has the competition against MediaTek Corp. (Taiwan:2454) affected Zoran in the Chinese market?
“The Chinese market is growing. Although we saw competition from MediaTek in the second half of 2002, it mainly affected the sales of ESS Technologies (Nasdaq; XETRA:ESST), whose sales also fell in the third quarter. While the competition affected Zoran, mainly due to the competition’s lower prices, we believe Zoran is well positioned for continued growth in its market share in China.
“As for the Japanese market, although MediaTek is not a major player in the Japanese DVD market, the competition in the Chinese market could spread to Japan, because Japanese manufacturers have OEM agreements with Chinese and Korean chip makers. MediaTek might therefore enter Japan through the back door. However, that would be only a partial entry, that isn’t based on a long-term relationship.”
Union Bank analyst Bernard Manor says, “Zoran had a very good fourth quarter. The company met its forecasts precisely. Remember, Zoran’s management had predicted its fourth quarter revenue would be 9% less than in the third.
“The decline in profit was due to a one-time $6 million allowance from the fall in value of negotiable securities and a $1.2 million amortization of goodwill and other intangible assets. Excluding these one-time expenses, Zoran posted a profit of $6.87 million.
“Despite the good quarter, we think that competition in the DVD market, especially in China, will continue to affect Zoran’s results in the coming quarters, and possibly in the next few years as well. We’re therefore lowering our estimate of Zoran’s value from $580 million to $465 million.”
What is Zoran’s revenue breakdown by product?
Manor: In the fourth quarter, 71% of Zoran’s revenue came from DVD chip sales, compared with 77% in the third. Digital camera chips contributed 17% of revenue, compared with 15% in the third. Video and audio chips for PCs and digital television chips contributed 12% of revenue in the fourth quarter, compared with 8% in the preceding quarter.
“The quarterly drop in revenue from DVD chip sales was mainly due to the fall in prices for Vaddis 4 and Vaddis 5 chips. MediaTek is trying to increase its share of China’s DVD market by aggressively cutting prices, thereby dragging down the entire market. This will affect Zoran’s first quarter 2003 results, too. Although most of the competition in the Chinese market is between MediaTek and ESS Technologies, Zoran is indirectly affected.
“DVD chips accounted for 82% of Zoran’s revenue in 2002, digital camera chips - 11%, and video and audio chips for PCs and digital TV - 7%.”
What was the geographical breakdown of Zoran’s revenue?
“US sales accounted for 7% in the fourth quarter, compared with 1% in the third; Europe 6%, compared with 4%; Japan 23%, compared with 51%; China and the rest of the Asia-Pacific region 64%, compared with 44%.
“US sales accounted for 3% of Zoran’s revenue in 2002, Europe 3%, Japan 42%, and China and the rest of the Asia-Pacific region 52%.”
What are the developments in the DVD recorder field?
“In the fourth quarter, Zoran began marketing its Activa 100 chip for DVD recorders. DVD manufactures plan to begin marketing DVD recorders in 2003 for less than $400. In the next two years, DVD recorder prices are expected to fall to $300, or even $200. That will make it a mass market consumer product, which will increase Zoran’s potential market.”
What’s next?
“The Vaddis 4 chip is about to be taken off the market and replaced by the Vaddis 5, Vaddis 5E and Vaddis 6 chips. Zoran will therefore begin producing smaller quantities of the Vaddis 4, whose price will fall. That means that Zoran’s revenue from DVD chips in the first quarter will mainly be derived from sales of Vaddis 5E and Vaddis 6 chips.”
Published by Globes [online] - www.globes.co.il - on February 3, 2003