I would like to establish whether/how ESST will be profitable this year. ESST says it has achieved market share gains in all of its three main product areas: video (VCD/SVCD), audio and communications (modem).
From the conference call, it was apparent that Q4 was especially strong for VCD/SVCD products in China, presumably associated with significantly increased market share and seasonal demand in this business. Although there will be a seasonal decrease in demand, the SVCD chip carries a higher margin than VCD which should help ESST as SVCD becomes more popular. It should be noted though that Chan talked about VCD remaining a viable low-end product, instead of being completely superseded by SVCD, as well as an increasing trend towards DVD. The unfavorable scenario would be new competitors (Zoran, Luxsonor, Winbond) driving down SVCD margins (CUBE may show restraint, given their strategy to focus on higher margin products). All in all, this area probably continues to be the safest bet for ESST.
PC audio remains very competitive. The H&Q report in December, which talked about strong design win activity in this area, is very encouraging. However, this is a cut-throat market. The transition to PCI-based audio chips has been not been as quick as expected, illustrated by the fact that ESS's sales continued to be dominated by ISA-based chips last quarter. For some reason, certain competitors (such as Crystal, Yamaha, Creative/Ensoniq and Aureal) have been able to profit more than ESS has from the PCI audio transition so far. This is especially true because Intel, an early adopter of PCI audio, has been using these competitor's chips on its motherboards. Why has Intel stayed away from ESS chips? Intel endorsing ESS's audio/modem technology with motherboard design wins would be sweet. Intel's latest, ZX-chipset based Celeron motherboard does not use an ESS chip. However, one would expect that the design wins mentioned above include high-volume PCI audio contracts that will ramp in the first of half of the year, as indicated in the conference call, which hopefully carry better margins than ESS has been accustomed to.
Negative points about audio include the trend towards minimal, commodity digital audio support, embedded in core logic or graphics chips, which is already manifesting itself in notebooks. ESS used to the dominant player in the notebook audio market. However, among recently announced notebook models based on new Intel processors, ESS presence appears to be very weak. This is disappointing, since this area is the most promising for ESS's audio + modem solutions.
The communications area (modem chips) is a relatively new market for ESS, but it is highly competitive. ESS needs to capture a certain amount of market share in order to be profitable in this area. ESS said in the conference call that this area was profitable, but I would contest that fact given the huge write-off related to modem chips in the September quarter. Although ESS seems to be approaching this area full-blooded with a diverse product offering, ESS probably needs to leverage its audio + modem technology to be succesful. ESS has been talking about modem design wins; they should include high-volume design wins with major OEMs, otherwise ESS will continue to struggle in this area. The recent design win in a Packard Bell/NEC notebook is encouraging, but probably reflects dumping of written-down inventory. If ESS does succeed, this will be a nice boost to revenues.
Finally, ESS has chips for Internet set-top boxes, targeted at the China market, where such a device could be combined with a DVD or SVCD player. We should hear more about this later in the year. ESS also has a MPEG2 decoder chip for DVD players, which is probably targeted towards China. I presume that ESS is spending R&D to support all ASIC requirements of a DVD player, as it doing with VCD.
Overall, I think ESS is pretty well positioned, certainly better than in the recent past. |
