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NDS Group PLC (NNDS)F1Q08 Earnings CallOctober 29, 2007 10:00 am ETExecutivesAbe Peled - Chairman and Chief Executive OfficerAlex Gersh - Chief Financial OfficerAnalystsJason Mauricio - AreteAli Mogharabi - B. Riley and CompanyAlan Gould - Natixix BleichroederAri Bensinger - Standard &Poor'sMurray Arenson - Ferris Baker WattsTim Boddy - Goldman SachsZiv Tal - Oscar GrussTodd Mitchell - Kaufman BrothersDaniel Meron - RBC Capital MarketsConrad Werner - Morgan StanleyGorm Thomassen - AKO CapitalPresentationOperatorThank you for standing by, and welcome to the NDS FirstQuarter Results Conference Call. On this call, we will make certainforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995.These statements are based on management's views andassumptions regarding future events and business performance as of the time thestatements are made. Actual results may differ materially from theseexpectations, due to changes in global economic business, competitive markets,and regulatory factors.More detailed information about these and other factors thatcould affect future results is contained in our filings with the Securities andExchange Commission. The forward-looking statements included in this call aremade only as of the date of this call, and we do not have any obligation topublicly update any forward-looking statements to reflect subsequent events orcircumstances, except as required by law.At this time, all participants are in a listen-only mode.There will be a presentation followed by question and answer session. (OperatorInstructions). I must advise you the conference is being recorded today,Monday, the 29th of October 2007.I would now like to hand the conference over to your speakertoday, Dr. Abe Peled, Chairman and CEO of NDS. Please go ahead, sir.Abe PeledThank you and welcome to our Q1 FY ?08 conference call. NDSis pleased to report another strong quarter. In spite of the various onetimeeffects of this quarter, which clearly to some extent flattened our results, wehave seen a very strong performance across the board in all our deliveries, asclearly seen from the performance metrics that we provide, increase in smartcard deliveries, very significant increase in authorized cards, as indeed ourmomentum in developing markets continues; strong shipments of middleware, whichboth include MediaHighway and certain catch-up in high-definition boxes on theDIRECTV, which now all DIRECTV boxes have our technology and the latest are theH series of high-definition MPEG-4 boxes; and DVR, obviously, very strongperformance, was $1.5 million deployed in the quarter, as new shipments of DVRhave commenced in the number of accounts, Sogecable, Canal+ and continuedstrong shipments in all other customers.NDS has also done very well in winning new platforms. We?reparticularly pleased with our win in India; Bharti Airtel is the largestcellular operator in India. They are a very professional company; intend tolaunch a very strong offering on DTH.As you know, we view India as a very strong growthopportunity for DTH, over 80 million middle-class households. We already havecustomer obviously in Tata Sky that continues to grow well, Hathaway Cable,which is one of the few large cable operators.But clearly there is room for more operators, given themassive size of the market and the demand for quality pay TV service. BhartiAirtel will launch directly with the MPEG-4 standard definition boxes, butclearly puts them in a position for future upgrades, faster. We're alreadyworking on DVRs for Tata Sky. And I am sure that the new technology deploymentwill intensify also in the Indian market.Similarly, in China, while a different characteristic of themarket, we are very pleased with our win in the Tianjin. Tianjin is one of thefour largest cities in China, which are special administrative regions directlyunder, like a province.And Tianjin who intends to deploy a leading-edge platformthat can deliver not only standard digitized television of the analog, which ispart of the PNGI initiative, but are looking forward to delivering moresophisticated capability and, therefore, we are pleased that they have chosenNDS.Similarly in the Ukraine, Vision TV, which is, by the way,Modern Times Group, are a partner in it; we expect that to be a strongperformer. Additional wins like Anhui, which is a smaller province, SerbiaBroadband extending its relationship with NDS to cable as well as its satelliteplatform.And these all indicate that our strategy of winningplatforms in developing markets, both in Eastern Europe, India, and China, isworking and will be and continue to be an engine driving NDS growth goingforward.Now, having said that, NDS has grown its headcount againreasonably, and the reason, quite substantially, I should say, not reasonably.The reason for that is that we have a very strong pipeline of projects that weare working on, many of which we will not see from revenue in this year. But weare clearly a company that takes a multiyear view on all of these platform winsand, therefore, they are very important for NDS.In addition to, of course, working on the standardplatforms, both advanced technology in our leading markets, streamlining ourtechnology for developing markets, NDS is also strongly involved and investingin preparation for the changing media landscape.That will not be a quick process. But then we have to makeinvestments and put together our technologies in a way that they will be readyfor both our current customers as well as new players that will enter into thismarketplace that is being reshaped through the ubiquity of broadband access oftelevision on the PC, on mobile devices, on portable devices, and so on.Part of this has been our acquisition of CastUp, a smallcompany specializing in the distribution of video over the Internet. And Ithink that will give us substantial know-how and experience in video deliveryover the standard Internet.I think also our partnership with Yes, in which Yes haschosen NDS for its delivery of both satellite, converged satellite andbroadband, to PCs as well as just a broadband delivery of its new web-basedvideo content portal.So all in all, we have seen a very good quarter. NDS isstrongly committed to continuing to invest and prosper in our current market,which continues to grow, and I believe we are making the necessary investmentsand acquisitions that will enable us to prosper in the landscape delivery.So having said that, I would like to turn it over to AlexGersh who will take you through our results in more detail, and then we willopen it up for questions. Alex?Alex GershGood morning, everybody, good afternoon. As always, I willgo through the results for the Q1 of this year and compare it to the Q1 of lastyear. Total revenue is up $205 million, which is a 25% increase over lastyear's first quarter.Operating income is $58 million, an increase of 31% overlast year's first quarter. Operating margin is a 28.4% versus 27.2% in Q1 oflast year. Net income for the quarter, $46.3 million versus $35.1 million. Wehad a 32% increase. And the diluted earnings per share stands at $0.79 for thequarter versus $0.61.I'm going to go through some, as always, through the detailin revenue and expenses. As Abe alluded, there are certain onetime effects.They have to do primarily with conditional access revenue, which I'll talkabout next.They will have to do with, obviously, foreign exchangecontinues to play a part in our financials, as well as, of course, FrenchR&D tax credit. It was another very successful year for us and anotherfirst quarter in which we achieved a very, very substantial R&D tax creditof $6.7 million.But let me take it step-by-step. So, conditional accessrevenue increased by 31%, as you can see, to $121.6 million. The increase wasprincipally due to recognition of a portion of the security service previouslydeferred, as all the remaining obligation for a particular customer on aparticular contract have been satisfied.Clearly, just to preempt any questions, we do not talkabout, obviously we cannot talk about specific contracts. We cannot talk aboutany specific contract terms.We also, as always, do not comment on any individualchangeovers or any possible changeovers that occur, but there has been a changein which an obligation for which we deferred revenue has now gone away in aparticular contract, which is why we talk about the onetime event.Because obviously, while it can happen on other contracts,this is clearly a specific treatment related to a specific contract.However, on top of that, of course, conditional accesscontinues to be powered by the authorized smart cards, which now stand at $78.6million for the quarter versus $66.6 million at the end of Q1 of '07. And wehave delivered $7.4 million smart cards in the quarter versus $6.7 million inquarter one of last year.Going down to integration, development and support revenue,that decreased by about 41% to about $11 million. We always talk about this asbeing practically one of the lumpiest portions of our revenue.We have recognized in last year revenue from delivery ofconditional access, EPG and middleware to Tata Sky, our customer in India, andtherefore as the system went into operation last year, clearly that did nothappen this year.We did not have such big new systems going in Q1 of thisyear. And in addition, we have recognized enhancements to several of our majorcustomers relating to high-definition box integration of last year.License fees and royalties increased by 19% to $28.9million. This increase was due to higher number of units of middleware shipped,conditional access and EPG royalties. And in Q1 of this year, we have deployed8.1 million middleware clients versus 3.1 million in Q1 of '07.We've got a number of new customers, as well as our existingcustomers, that continue to accelerate the deployment of middleware. As ofSeptember 30th, we estimate 70 million middleware clients approximately have beendeployed.New technologies increased by 54% to $42.5 million. Thestories there is, of course, DVR continues to power that gaming and continuesto be an important player. Residential Gateway technology, which is theacquisition we've made last year, also has contributed strongly here, as wellas CineMedia, and our IPTV platform has also shown an increase from the firstquarter of last year.And as Abe said, we have added 1.5 million DVRs for thequarter, a substantial increase over 700,000 we added to the first quarter oflast year. Again, as of September 30th, we estimate 9 million DVRs arecurrently, 9 million DVR enabled set-top boxes that have been deployed.Again, as always, I want to and when I talk about revenueand I talk about expenses, I talk about foreign exchange. 52% of our revenue iseuro and pound denominated. The relative weakness in the U.S. dollar, weestimate that we had a favorable impacted us favorably on the revenue line byabout 4% or about $8 million for the quarter.And obviously, I will talk about the expense side. Clearly,it has effect on the expenses as well as in our cash holdings, the foreignexchange.Cost of sales increased by 10% to $68.5 million, and clearlythe result is increased number of cards shipped. We have an increase inthird-party royalties, which directly relate to revenues, and increase in thenumber of employees.As Abe had mentioned, we have added 553 employees from Q1 oflast year to Q1 of this year; although it is important to say about 36% of that553 came from our two acquisitions, which is Jungo and CastUp. So, the organicgrowth in headcount has actually been actually somewhat lower.Now, I think most of you have noticed we have changed thepresentation of cost of sales on our financial statements. And we have changedit for the following reason. As our business gets more and more complex, itbecame clear to us that our cost of sales really doesn't reflect how ourbusiness is developing.Just to give you an example, the elements of our smart cardcosts, staff costs, and third-party royalty costs really are reflected in allthe revenue categories. Therefore, this new presentation, we believe moreaccurately reflects the business realities of how the NDS business develops.In terms of gross margin, again, the gross margin increasedfrom 62% to 67% for the quarter, but clearly the impact of the conditionalaccess increase in revenue, which I've talked about previously, the decrease inthe deferral clearly has impacted this significantly.In terms of expenses, overall expenses, operating expensesincreased 36% to $78 million. Clearer, higher employee numbers, higher employeecosts associated facilities costs, as well as legal costs, which we highlightedfor you last year, particularly as they relate to EchoStar, our EchoStarlitigation, have contributed to the increase in costs.Again, as I have mentioned before, we have received however,the increases were offset by $6.7 million R&D grant, which we received fromthe French government, that compares to $5.5 million last year.And just for everyone who is looking at our balance sheet,these numbers sit in other non-current assets. When you see the increase inother non-current assets, that?s what you're seeing. You're seeing the increasein the R&D tax spread.We talked about headcount. We now stand at 3610 employees asof the end of September, with about 84% being technical employees. As always, afew words on FX. This quarter for the first time, we had no substantialnegative effect on the P&L from the foreign exchange.The reason for that are the following. Of course, as thedollar continues to weaken and 68% of our expenses are pound and euro andshekel, Israeli shekel denominated, the expenses have been adversely affectedby about 4%, which is about $6 million.However, we have, NDS has cash holdings in both Israelishekels as well as in euro, which offset that loss and created a gain on thecash holdings of $5.7 million. So, in effect, the majority of the FX gain onrevenue was not offset by the FX losses on expenses, and therefore, themajority of FX gain on the revenue is reflected in the bottom line.Income tax effective tax rate is 30%. Really, that is whatwe have been telling people and that is what we expected, and that is what wehave. Our tax rate does vary slightly between, depending on whether the incomecomes from, in what jurisdictions the taxable income comes from, as well asfrom the research and development incentives in different jurisdictions, butthat's where we are today; $622 million in cash.In the first quarter, we issued approximately 110,000 sharesto our employees as a result of equity compensation award. As of September30th, NDS has 2.9 million shares of equity awards outstanding, with 1.8 millionvested.We have and as Abe referred to and as we put out in thepress release, we have made an acquisition of CastUp. That acquisition is nowreflected in our financial statements. You could see on the cash flow the costof acquisition roughly $10.4 million. Obviously, this is a very smallacquisition, and so no additional disclosure really is necessary, other thanwhat you see in the financial statements in the cash flow.Now, back to guidance, I think again recognizing that someof the effects that we've seen in this quarter are maybe considered a onetimeeffect, we are maintaining our guidance on revenue for the year of $800 millionto $820 million, and operating income range is $185 million to $195 million.And operating margin, we are maintaining the range in operating margin between23% and 23.8% or so.So that?s it. Thank you very much and, operator, we areready for questions.Questions-and-Answers SessionOperator(Operator Instructions) Your first question comes from JasonMauricio of Arete. Please go ahead.Jason Mauricio - AreteHi, thanks a lot. Alex, I was just wondering if there wasanyway you could quantify, even if it?s just rough numbers, the impact of therevenue recognition on the conditional access line. Also, I guess as afollow-up or actually a second question, how do you recognize revenue on PVRs?Is it upon shipment of a set-top box to the customer, or is it from theshipment from your customer to the end subscriber? Thanks.Alex GershWell, on the first question, unfortunately, no, I cannotcomment on specific and quantify the specific numbers. As you know, ourdeferred revenue has a number of different components in it. But on your secondquestion, it varies from customer to customer.Jason Mauricio - AreteOkay. There is no way even roughly, in terms of the impactof sort of one-off revenue recognition?Alex GershYou can take a look at the deferred revenues and make yourown determinations. I think, roughly, you can probably get some kind of aguess, but it would just be roughly.Jason Mauricio - AreteOkay, thanks.OperatorYour next comes from Ali Mogharabi of B. Riley and Company.Please go ahead.Ali Mogharabi - B. Riley and CompanyThanks. Alex, I guess another way to approach this, can youlet us know what -- at what level you guys can maintain the gross margins? Iknow you basically with the recognition of some deferred revenues were lookingat 66% in this past quarter, but what should we be looking for going forward?Alex GershAs I said before, one of the biggest things about our grossmargin, it has to do with where our employee costs are being attributable. Soif our employees are working on specific projects, the costs will be in thecost of sales. If they're working on other projects, it could be in theR&D. Therefore, it?s very difficult to -- have some kind of a detailedestimate. But my view is if you look at our historical margins that we have hadon a continuous basis, I do not expect our gross margin to significantlyimprove over those levels.Ali Mogharabi - B. Riley and CompanyOkay. Then, Abe, really quickly can you talk about the Chinamarket? Give us an idea about the market and also how you guys basically stackup against it. I'm sure everyone is aware of STB, digital China television, onthe conditional access side. And then, of course, stacking up against OpenTVand possibly some other smaller players on the middleware side in the Chinamarket.Abe PeledI just want to add to Alex's previous answer that as amanagement team, we're really focusing on operating income. That?s ourmanagement yardstick and that?s the one that we have said we will continue toimprove with an intermediate target of getting to 25%. How it moves between R&Dand gross margin is really -- happens to be more difficult to predict.Going back to your question on China, the NDS strategy inChina has been to focus on the larger cities, larger provinces that areobviously richer, and look at more ambitious technology deployments that gobeyond the mandated or encouraged by the government initiative of simplydigitizing the current analog cable, an initiative referred to as PNGI.So that?s why if you look at the NDS wins in China and theplaces where we have deployed, Shenzen, which is obviously the city, the largeindustrial city right next to Hong Kong, we have over one million, the largestsingle -- China was over a million subscribers.In Shanghai, Chongqing, all large cities, Chongqing is thesingle largest city in China, and now the addition of Tianjin. We haveadditional provinces like in Guangzhou, which is again in that triangle next toHong Kong, which is quite well-off. Anhui is small, but again, a reasonablywell-off province.So our focus has been to really go after what would be themarket leaders, and I think it also is, from a point of view of covering, agiant country like China effective from a cost of sales for a foreign companythat necessarily pays its employees significantly more because of the premiumthat people get for knowing English and so on.In terms of SB TV or China Digital TV Group, we know themquite well. They are a company that started by providing, I would say,relatively simple conditional access system, which is suitable for PNGI.Obviously, PNGI doesn't have any either high security requirements or scaleissues.I believe the revenues are composed, instead of NDS, whichhas like eight major accounts, they have tens of small accounts, each of whichdeploy certain numbers. You know, I (inaudible) believe that there is room forboth models, although I have to say that looking at the valuation that ChinaDigital TV Group achieves, either that is too high or NDS is way too low,because clearly there is a big discrepancy.I think the issue in -- and we looked a couple of years backinto either investing or acquiring China Digital TV Group, and my mainconsideration was that if it is a very low technology barrier, othercompetitors of similar ilk can enter the market, and indeed there is now a newcompany called Sumavision that has some ex-China Digital TV Group people thatare offering an even lower cost straightforward TA system.I am pleased to say that in a city like Tianjin, we have toface all these competitors. And whenever technology and scalability and futureroadmap count in the RFP, we will tend to win. When it is only a question ofprice, then obviously we are not in that market, which is for a very simple,small system.OperatorYour next question comes from Alan Gould of Natixis. Pleasego ahead.Alan Gould - Natixix BleichroederThank you. I have got a few questions. First I'm going totry and this deferred revenue question, typically your deferred incomeincreased from the balance sheet about $7 million a quarter, and this quarterit decreased by $9 million. Is $16 million a reasonable estimate as to what the-- how much deferred revenue was recognized as income this quarter?Alex GershWe can't comment on -- Abe PeledYour calculations.Alex GershAnd then your calculations. I think, unfortunately, I?vesaid everything that I can say on this issue.Alan Gould - Natixix BleichroederOkay. Alex, you described it a little bit as one time, but Isaw short-term deferred income increase this quarter. So that?s saying, Iassume, that there could be more revenue recognition throughout this fiscalyear on deferred income.Alex GershAs you know, when we look at on a quarterly basis, we assessall of the parameters that -- we have to assess and make adjustments. So thisis, the adjustments are always happening. We always talk to customers,different things occur. That?s the difference between our long term and fromshort term.Alan Gould - Natixix BleichroederOkay. There was a big increase in middleware shipments, andI guess, Abe, in your comments you mentioned all of DIRECTV now has yourtechnology. Was there a download catch up of middleware this quarter?Abe PeledFirst of all, you know, the headline number of middlewarenow includes Jungo as well, and I think only in the actual text do we give thesplit or but in any case, yes. So that?s, you have to compare that. But inanswer to your question, yes, all the MPEG-4 HD boxes, digiboxes in DIRECTV nowhave our middleware. And that was probably 1 million, 1.5 million or so.Alan Gould - Natixix BleichroederOkay, so that was a little bit of -- that won't be repeated,that 1 million, 1.5 million catch-up?Abe PeledCorrect.Alan Gould - Natixix BleichroederOkay. Can give us some ??Abe PeledAlthough there is we see a strong uptick in HD, obviously.Alan Gould - Natixix BleichroederOkay, can you give us some update of the trend in smart cardcosts? Are they continuing to decline?Abe PeledWell, you know, smart card costs depend both on the volumeof the individual card for the individual customer, as well as the capability.So, therefore, to look at the average is quite misleading. It is also fair tosay that cards in certain markets, which are not as sophisticated are obviouslylower cost than cards that are in other markets.By and large, I think we have done well both in improvingour own the amount of technology that we put in versus what we buy, forexample, in terms of customization and the amount of design that we do versuswhat we buy from some of the silicon manufacturers that allows us tocontinually improve that.Alan Gould - Natixix BleichroederOkay, thank you very much.OperatorYour next question comes from Ari Bensinger. Please goahead.Ari Bensinger - Standard &Poor'sYes, thank you. Just wondering on the DVR take, is there anyseasonality in that business? You know, it ramped up pretty good I think in theJune quarter, decelerated a bit this quarter, and I'm wondering if you have anyannual forecasts for the division.Abe PeledWell, I don't know about seasonality. It is so spread acrossthe world that it's very hard to pinpoint seasonality. I think we said lastyear we did $4 million, a little over $4 million. This year, we certainly willdo more than 6, we believe. But it is probably the biggest uncertainty in ourguidance is to know the exact number of DVRs, because million more or lessDVRs, while it doesn't make a big difference, the revenue does make a bigdifference on the bottom line.Ari Bensinger - Standard &Poor'sThen I'm wondering on your guidance, this quarter certainlyexceeded expectations on almost all fronts, revenue and operating income, yetyou are maintaining your full year guidance. And I'm just wondering, is thatjust being conservative or was this something, the change over, that wasalready baked in to happen?Abe PeledWell, I want to remind people that we do not providequarterly guidance because it is very difficult to divide our year into exactquarters. Over a 12 month period, we have a fairly good sense of where thebusiness is going to grow, and we clearly when we provided the full yearguidance in August recognized all of the events thatalready happened thisquarter and things that are likely to happen throughout the year.So our guidance has not changed because that was at least inour plan part of what was going to happen. I'm sorry that we cannot provide youquarterly guidance. It is just too difficult ahead of time to do that.Ari Bensinger - Standard &Poor'sFair enough, thank you.OperatorOur next question comes from Murray Arenson of Ferris BakerWatts. Please go ahead.Murray Arenson - Ferris Baker WattsThanks. Good morning guys. A couple questions first is, canyou talk a little bit more about foreign exchange? I know you generally try tomatch the revs and expenses, and you're obviously providing an update to guidance,and foreign exchange makes an impact on that.Do have -- Is there any way to get any sort of sense in thecoming quarters as to how effective you will be at matching those or what yourexpectations are on the ForEx front, anything like that?Alex GershAs I said, I think for us, the change when we were talkingabout matching, we did not have -- what we have done the change that happenedthis year in the first quarter is that we have bought a significant amount ofshekels to take care and pay our shekel denominated salaries in Israel.And we are holding those shekels. Now, we are using them upas we go along. So right now, we bought them, and clearly when we bought them,we bought them at a more favorable exchange rate than the exchange of U.S.dollar to the shekel is today.But we are using them up, and as we continue to use them up,obviously you'll see, unless the rate goes favorably and we buy more, you willsee some of this event diminished. I also will tell you that in the 10-Q, we dotalk about how much of our cash is in some of these currencies. So you'll seethat 13% of our cash is in British pounds, 9% of our cash is in shekels, and wehave got, as I said, we've got some cash in euro.So we are using that up, and unless we buy some more at amore favorable exchange rate, you may see us return to effectively a matchingof the costs and the revenues from the FX, rather than having a significantpositive impact that you've seen in the first quarter.Murray Arenson - Ferris Baker WattsOkay, great. That does help. I also wanted to ask you alittle bit about India. You talked some about China just a little bit ago, butlooking at India there are number of different DTH offerings, I guess, comingto the table there. I guess that looks a little bit unusual relative to what wehave seen from DTH in other markets.I just wondered if you comment on how you expect that togrow? Do you expect an increasing proliferation of those numbers of players, ordo we consolidate down, and what impact does that have on you guys?Abe PeledWell, as I said before, the characteristic of the Indianmarket, which is different than China, is that there is a rising middle class,which are not served with a good television proposition. Mostly are served bycable, which are very low quality, typically offered by local, shall we callthem, entrepreneurs that often steal the signal.And the result is low quality, low level of service. You putthat versus 80 million people that can now afford large screen TVs, are gettingbigger houses, have a rising income. So there is and India is a country inwhich television is viewed, I think, the second most hours per week afterBrazil, so it is a very high television viewing country. So there is an unmetneed.What all the DTH companies are seeing is the opportunity toreach that middle class, which as I said is 80 million homes, and do that overthe next five years will be a rush. And I believe there is room for multipleplayers in that. What will happen, and each of them can easily get to 5 millionto 7 million subscribers because there are serious players.Obviously, there is Tata Sky, there is DISH, which is a Zeenetwork, has been around for a while. And Reliance, Bharti, have also announcedthat they are going here. And then there is the regional player, Sun TV more inthe South.So clearly there is room to get to about 40 million, 50million, and if you divide it even by 5, they can get to more than the criticalmass to be profitable, given the very low cost of the technology. What willhappen after that is obviously harder to tell, but to begin with, everybodysees a clear run, including a run to profitability in offering like Bharti abroad range of telecom services and entertainment services.So that?s, I think, the nature of the market, which is quitedifferent.Murray Arenson - Ferris Baker WattsOkay. And last question, I guess, is a follow up on that.With some of those comments in mind, what do you think the outlook is for DVRpenetration in that market, now that you're bringing an offering out there? Arewe talking about the same level of robust DVR offering in that market?Abe PeledWell, you know, DVR is one of these offerings that grow byword of mouth, because people don't really understand it unless they have it intheir home and then point it to them and then point out to their friends. Inour experience, in every country in the world, DVR penetration has kind ofstarted low and then grown as word-of-mouth and the understanding of the marketincreases. And therefore, I expect the same to be in India.It is not just a question of money. It is a question ofunderstanding what the product is and what it does. It is very difficult toexplain that in an ad or difficult to explain it in any other way until you seeit in your friends' house or your relatives' house or whatever.Murray Arenson - Ferris Baker WattsThank you.OperatorYour next question comes from Tim Boddy, Goldman Sachs.Please go ahead.Tim Boddy - Goldman SachsYes, thanks very much. I don't know if it is a guidancequestion, but I'm struggling to understand how such a significant factor ofupside is not falling through into some increase in the guidance. I guessyou're saying this is entirely anticipated in your guidance.Abe PeledCorrect.Tim Boddy - Goldman SachsIn which case with all your metrics ahead, if you like,where the sort of, is this again the opportunity to invest dual business forthe future, which is where this incremental profitability is being in theshort-term contributed towards?Abe PeledI'm not sure I understand your question. Let me rephrase it.Are you saying we could make more money if we did not invest in the future? Iguess that's true.Tim Boddy - Goldman SachsI guess given the extent of some $20 million of upside toprobably most people's forecast on the, operating income level, is thatgradually over the year being reinvested? That is really the question.Abe PeledWell, first of all, I believe that the performance of thefirst quarter, as you said, was anticipated as part of our guidance and as partof what we have said we will do. Now some people believed us more than others.Some people divided it in quarters. Some are differently.But I do not think we will increasing our level ofinvestment. As I've often said in the past, NDS kind of maintains its level ofinvestment in new technologies, things that are not immediately bearing fruit,to about 10% of our R&D. But what we do have, and the biggest increase inheadcount goes towards that, is we have a very full pipeline of projects, whichwe will not see revenue from in this fiscal year.To name just Havelbadel Wiltenburg (ph) as an example,another win that we have which we are working on already. Some of these winsthat we've just talked about will either not contribute revenue or contributevery little revenue this fiscal year, but they were all, we have people workingon them diligently, and that is part of our cost. So we do not simply, oh, wecan make more money so we will spend more on discretionary R&D. I thinkwe've been fairly disciplined about that.Tim Boddy - Goldman SachsNo, that is really clear. That's very helpful. I guess sortof a question that I appreciate you can't tell us the number, but in terms ofthe treatment, was the one-off carried right down through the P&L, or wasthere costs associated with it as you would perhaps have deferred smart cardroyalties and, therefore, was there tax associated with it as well, becauseyour tax rate looked normal?I guess if it is X, should we put X on the sales line andthen take something off X in the gross margin and something off again for thenet, or does it fall right through?Abe PeledI can't give you a specific, but I want to make aclarification. Clearly, the result of our smart cards performing extremely welland having zero piracy, which allows our customers to either defer changeoversor even potentially skip a generation or do other things, it can have abeneficial result on NDS, and that is part of the premium you would say forhaving a perfect security record, and part of the upside that both ourcustomers enjoy and we enjoy.And as these calculations get done, some of it getsreflected back into our actual income as our obligations are fulfilled. Icannot really go beyond that, but it is a onetime in a particular contract, butit does not mean that it's a onetime event that will never occur again in othercontracts, because we see that impact of our excellent security possibly beingtranslated positively in other cases.Tim Boddy - Goldman SachsOkay, thanks for that.Operatoryour next question comes from Ziv Tal of Oscar Gruss. Pleasego ahead.Ziv Tal - Oscar GrussHi, Congrats on a good quarter. Did Bharti, did theyannounce a specific target of subscribers for the next year just like Tata didbefore?Abe PeledI don't believe so. I don't know that they did.Ziv Tal - Oscar GrussI see, okay. Thanks.OperatorYour next question comes from Todd Mitchell, KaufmanBrothers. Please go ahead.Todd Mitchell - Kaufman BrothersThank you. I have a question about new RFP activity ingeneral. It seems that if you look out over the past 12 to 18 months, the dealflow has been decidedly more robust than the period prior to that. Does the RFPactivity going forward, is it as robust as it has been over the past 12 to 18months?Are you seeing shifts in the geography? Are you seeingshifts in the different end markets, and could you flesh that out for us? Ialso have a follow-up question on Jungo.Abe PeledWell, Todd first of all, you are right. We have emphasizedthe point that as the technology costs are coming down, developing markets arereally waking up. If you look at, a lot of the deal flow has been in thesedeveloping markets, and the wins have been there.I would include Germany in that because the nature of cablein Germany is really more as a utility rather than as a particularly premiumservice. We continue to see activity in developing markets. We just announced alow-end cable offering for India, because clearly some cable operators are nowconsolidating and they will try to respond to the sort of satellites that wehave announced, VideoGuard Express in India, and expanded our operation there.There is, obviously, we have responded to the Verizon RFP inthe United States, for which I don't hold particularly, I'm not sure really, Ican't tell you what our chances there are. I think that if they are going topick anybody other than the duopoly in the United States, NDS has a very goodchance. But it's very hard to predict.And as I've said before, you know, there's a number ofalready existing platforms that are talking to NDS about moving to NDS toimprove their security, and we see quite a bit of activity there. So to say, tosummarize it, I think we're quite busy.Todd Mitchell - Kaufman BrothersOkay. And then I have a question on Jungo. It has been awhile since the acquisition, and I wanted to know how you can, how do I get atthis, do you qualify deployment and where, and not with whom, but how is thatworking out into your sort of a portfolio offering for your broader, biggercustomers? Or is that not a -- did that not make much sense?Abe PeledNo, I understand. I will give you an example. Jungo isdeployed in Verizon Fires, so when we talked to Verizon, which did not know NDSfrom a hole in the wall until the acquisition of Jungo, when I meet them, yes,they know NDS through Jungo, funny enough, as a good supplier and so on.They can see how the roadmap that we paint of broadbandcombined with set-top boxes and so on actually would work. So I can use thatperhaps as a very specific example, but I would say that we bought Jungo on thepremise that telecom companies will increasingly recognize the value of havinga uniform middleware in all their residential gateway routers, and will eitherspec the Jungo software or actually buy the Jungo software themselves in thesame way that television operators specify the middleware.In the 10 months of the acquisition, I would say that thispremise has proved itself as more telcos, whether it is Telefonica or Telos orothers, France Telecom, specify actually the Jungo software.And we see manufacturers coming to Jungo and saying we needto use your middleware. But I believe we're getting traction with the telcos.In terms of integration with the rest of the NDS productline, I think you're going to see at our Analyst Day; we?ve shown it at IBC.That will take, obviously, it is a slower turn thing, but we continue tobelieve strongly that there is a good fit in our portfolio as we see the homeof the future that integrates broadband and broadcast seamlessly.Todd Mitchell - Kaufman BrothersCan you quantify platforms where it's been deployed?Abe PeledWhat do you mean quantify? How many they have deployed were?Todd Mitchell - Kaufman BrothersYes.Abe PeledWell, I mean, I don't-- all of the Verizon residentialgateway routers have Jungo software. France Telecom has just started shippingit in Livebox.As I said, Telos, there are a number of other large telecomoperators that have it already.Todd Mitchell - Kaufman BrothersOkay, thank you very much.Abe PeledWe always do a press release whenever there is something, soyou have to look at the various press releases.Todd Mitchell - Kaufman BrothersOkay, thank you very much.OperatorYour next question comes from Daniel Meron of RBC Capital.Please go ahead.Daniel Meron - RBC Capital MarketsThank you. Congrats on the continued execution here. Can yougive us a sense of the dynamics in the IPTV markets and how you are seeing it?You did have a couple of announcements with SCS in the U.S.But also I was wondering what is going on with largerplatforms, either in the U.S. or in Europe? Thank you.Abe PeledWell, I think that I feel a bit repetitive, because I've hadthe same view on IPTV for a long time. We see continued small IPTV deployment.We've just done another deal. But all the numbers are small compared to thekind of numbers that we report.And also, if we do a quarter 3.2 million new authorized markers,the number of IPTV on them is quite small, and I would say that is not trueonly for NDS; that is true, period.So, youlook at U-verse, and they have been talking about itfor four years. They now have started deploying it for over a year, and it's120,000 or so slots.So, I mean, these are not big numbers for pay TV, you lookat Telecom Italia. I would say the only exception is really France Telecom andsome in Telefonica, where there are some special circumstances that perhapsexplain the larger number of deployment.But everywhere else it has been quite slow, and I think weget our fair share of whatever is being deployed.Daniel Meron - RBC Capital MarketsOkay, and switching gears to other emerging technologies, orat least markets, can you just give us a sense on what is the impact of thosenew initiatives that you've had either in the Ukraine, in Turkey, even in -- Iknow that India is starting to ramp up.But those announcements that you've made to date, how longwill it take until these things kind of start moving the needle for you guys?Abe PeledWell, the Ukraine has not yet started, so I mean, I can't --hasn't clearly moved the needle.On the other hand, I would have to say Turkey is a veryexciting market, and I think the proposition that Dogan Media had was theirD-SMART, which is really a free-to-air box that you buy but already has in itall NDS technologies and is enabled by Dogan Media as a free-to-view set-topbox in which they offer pay-per-view through scratch card, they offerinteractive advertising, they offer various occasional pay programs.It?s very interesting, and they have very strong attraction.So, I would say while it hasn't moved the needle a lot, it is already visiblein our results even this quarter.Daniel Meron - RBC Capital MarketsOkay. And then last one for me, as far as the cash position,you do have $620 million. You mentioned that you're going to invest in thebusiness.What kind of M&A are you guys looking for right now? Isthere something suitable enough that could use up all this cash, or is theregoing to be another Jungo style kind of acquisition which is more likesomething that would materialize two, three years out, so, it won't gobble upall this cash position?Abe PeledWell, look, we are not ruling out a large acquisition, butwe are not specifically looking at any specific one at the moment.On the other hand, I think as I said, the changing the medialandscape offers both threats and opportunities, and we feel that having astrong cash position will allow us to move, should we have to, if things happenquicker than we thought in this area.So, the areas that we are looking at is really theintersection of the delivery of video on Internet and broadcast and how theycombine, how advertising can change in that environment, as a result ofoffering really in conjunction with broadcast television targetable advertisingthat can come through broadband.And I think, for example, the acquisition of CastUp, whichwhile it is small, obviously, we could have paid more if we bought an Americancompany, but it gives us the insight.And should we think that there is a real technological andservice edge in expanding something like that, we would be in a position to dothat. Daniel Meron - RBC Capital MarketsOkay, great. Congrats going forward.OperatorYour next question comes from Conrad Werner of MorganStanley. Please go ahead.Conrad Werner - Morgan StanleyHi, it?s Conrad from Morgan Stanley, London, I thought I hadpulled my question from the queue. Most of my questions have been answered, butmaybe just one question on the increase in the headcount.You mentioned the strong pipeline going forward and thentalked a bit more about that in terms of existing customers. Are there alsounnamed potentially new customers that we should be looking forward to infuture releases that could be contributing to this increase in headcount?Thanks.Abe PeledFirst of all, I want to reemphasize Alex's point that a bigportion of that headcount, 100 -- 36%, so about 180 or so people came fromacquisitions. It's not -- if you look historically, we've kind of slowed down alittle bit.And the answer to your second question is yes, we areworking already on things that have not yet been released, because they areeither in advanced presale stage or in final contract negotiations or there wasa confidentiality clause that doesn't allow us to disclose it.So, as I said in my introductory remarks, we have a verystrong pipeline and we are very busy working on probably the largest number ofprojects in our history.Conrad Werner - Morgan StanleySounds great, thank you very much.OperatorYour next question comes from Gorm Thomassen of AKO Capital.Please go ahead.Gorm Thomassen - AKO CapitalHi, guests and guys. Two questions, first one is just toclarify on the ramp-up of R&D and headcount, you said that you can onlyspend about 10% on, call it, far- out projects.So, this increase we've seen does not mean that the 10% iskind of gradually inching up; it is mainly related to client-driven projects inthe pipeline of existing commercial contracts?Abe PeledNo, we treat 10% as actually 10%. And so, obviously, if thetotal headcount increases, the amount that we can do are not?Gorm Thomassen - AKO CapitalSure, sure.Abe PeledWe keep it fairly, we do keep it fixed.Gorm Thomassen - AKO CapitalIs there are any increase in the (inaudible) blue sky stuff,basically? Abe PeledWell, I'd like to think we don't do any blue sky, but it'sstill kind of things that are further out than analysts' typical horizon.Gorm Thomassen - AKO CapitalFair enough. Second question I had was on India. Does theclients win now of Bharti mean that you have significantly increased yourcompetitive position in India, given that if one thinks about the verylong-term strategic end play in India that it makes sense to have onetechnology platform rather than two or three? Is that a powerful impact nowgoing forward?Abe PeledWell, obviously, if you think several years down the roadand you're thinking consolidation, then clearly we would be in two of the largeplatforms, which I expect will be successful, but it?s really too early tocomment on that.I think, in the short-term, look, Bharti is going to be avery serious player. Tata Sky has already demonstrated it's a serious player.And so we are very pleased because we'll have a shot at a big part of thattogether with Hathaway, which has access to 2.5 million and 3 million analogsubs. So I think we're in a very strong position in India.Gorm Thomassen - AKO CapitalGreat. Sorry, a final question if I might. Just on thepotential of perhaps breaking into the duopoly you mentioned of Verizon and theU.S., are there any technological changes down the road, which might play intoyour hands when you go and talk to Verizon about how they see their technologyroadmap and how that might kind of fit with what you're doing relative to whatthe two incumbents are doing in the states?Abe PeledI would say not in the short-term. I think perhaps in thelonger-term as they look out, but in the short-term it is all, they are reallytrying to compete in the same, especially Verizon who was doing quam to beginwith, but it is exactly like Motorola or Scientific Atlanta, deployments inother cable companies.I think theadvantage that we have is that obviously we?vedemonstrated we have a large cable customer in the U.S., Cablevision. So, we?vedemonstrated our ability to operate in this environment, and we?ve demonstratedour ability to integrate with Scientific Atlanta, for example. I think we dohave, in that respect, we are a very credible alternative should they decidethat they would like to not, to move out of combining conventional access andset-top box manufacturers in the same supplier.Gorm Thomassen - AKO CapitalOkay, thank you very much. I'm looking forward to seeing youat Capital Markets Day.Abe PeledThank you.Alex GershThank you. GormOperator(Operator Instructions) You have further question fromDaniel Meron of RBC Capital. Please go ahead.Daniel Meron - RBC CapitalThank you. A quick follow-up on the potential for you guysto raise the trading volume here. Is there any chance that you would consider astock split?Abe PeledWell, I note that the volume today is 214,000 shares, butclearly I don't think that people that are willing to pay cannot find thestock. But seriously, I do have, it's clearly one of the big issues. I don'tknow if stock split would really solve it or not, but we are, liquidity andcapital structure are things that while we don't have an answer in theshort-term, we are part of our overall consideration moving forward.Daniel Meron - RBC CapitalOkay, thank you.OperatorThere are no further questions at this time, sir. Pleasecontinue.Abe PeledOkay. Well, on behalf of Alex and myself, I would like tothank all of you for your patience and we will see you on our next conferencecall at the end of January. Thank you.OperatorThat does conclude our conference for today. For those ofyou wishing to review the conference, the replay facility can be accessed bydialing the U.K. on country code +44 145-255-0000.The UK local call number is 0845-245-5205 and the U.S.A.free phone number is 1-866-247-4222. The reservation number is 19729637followed by the hash key. Thank you for participating. You may all disconnect.Copyright policy:All transcripts on thissite are copyright Seeking Alpha. 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