Zoo Digital's ongoing diversification will help offset the decline in DVD related business, says CEO Green.

Zoo Digital's (LON:ZOO) chief executive Dr Stuart Green believes that the firm's ongoing diversification plan will help it recover from a faster than expected decline in its DVD related home entertainment business. 

The Sheffield-based firm supplies software that is used in all forms of creative media and as consumers have tightened their belts, the home entertainment market, particularly for DVDs, has felt the squeeze. 

This has largely come as a result of a sudden drop in DVD sales across the industry as consumers look to rent DVDs rather than buy them. 

This morning Zoo revealed that overall revenues fell to US$5.9 million in the six months to September from US$8.1 million. The group posted a loss of US$1.3 million against a profit of US$388,000 in the first half of last year.

The shares almost halved in value after today's results. At 15:50 the Zoo shares were trading at 14p each, down 46 per cent.

“What happened in the home entertainment market was disappointing,” chief executive Dr Stuart Green told Proactive Investors.

“We weren’t expecting growth in the DVD business and we had planned for the DVD component of our revenue mix to decline. But it has declined faster than the company, or indeed the industry, had been expecting.”

Green says the drop has hit the television series box set segment of the DVD market particularly hard.

With each TV series comprising as many as eight DVD discs these products aren’t really suited to the DVD rental market, Green explained. As a result many of the studios have cut back production significantly.

“The problem is these products account for the lion’s share of the volume for the industry’s DVD production. And that has had a knock on effect through to us,” he said.

Green added: “But Zoo still sees growth coming from a number of other areas of the business, from the home entertainment business as well as other markets.

“Product diversification into additional markets and other customers is a big push of ours.”

In this regard Zoo has been going pretty well, he said.

Zoo already has working relationships with some of the big Hollywood studios. And according to Green these studios are looking to use the firm’s software in other parts of their businesses.

Meanwhile other parts of the home entertainment business are seeing growth, namely the high-definition Blu-ray format discs and movie downloads. 

“The production of Blu-ray discs is showing good growth in the market,” he said.

“Zoo is seeing more and more of our customers wanting to increase their Blu-ray production using our systems. Also electronic sell through products – the type of downloadable movie content sold via Apple’s iTunes store, for example – is another big growth area for the industry,” Green added.  

“And we are also seeing many of our customers wanting to produce this kind of content using our tools.”

However, Green says that growth from the new business areas is not yet sufficient to offset the rapid decline in DVD business right away. 

But he believes that these growing revenue streams will in time replace the lost DVD revenue and the overall business will then start growing again. According to analysts at house broker finnCap, this may not be until 2013.

In a note to clients today analyst Andrew Darley downgraded his forecasts for revenue and profits for the next two years. 

He does however say that ZOO’s products deliver savings for customers and achieve cross sales in customer organisations, and this sets the scene for a return to growth in the 2013 financial year.

“Hollywood studio clients of ZOO confirm expectations that while ZOO retains market share, the market is contracting,” Darley said.

“Customers remain impressed and consider wider adoption of ZOO’s tools in the group environment; however visibility is limited in FY12.” 

The broker today cut its price target by a third from 75p to 50p – this does still imply more than 100 per cent upside to the current price of 16.25p.

Apart from the home entertainment part of the business, Green says that the next-generation of e-books can provide another exciting growth prospect for Zoo.

Most e-book readers are limited in their ability to display more complex page layouts. Layouts that include illustrations, charts or diagrams are not easily displayed. 

But that is about to change due to the increasing popularity of more advanced tablet devices and the next generation of colour e-readers like Amazon’s Kindle Fire. These devices make it easier for a more varied page layout to be implemented, and Zoo hopes to capitalise as a broader range of e-books gain popularity.

“Our technology is designed for books that have complex page layouts that incorporate imagery. Things like children’s books, comic books, cook books and travel guides,” Green said.

“We are building systems that enable publishers of these kinds of books to take their designs for traditional books and convert them into e-books in an easy to use and very cost effective way.

He added: “This way the publishers can preserve the quality and integrity of the printed version of the book in a digital form.” 

Green says that the major platform providers like Apple and Amazon are recognising that this is an important area of the e-book market and Zoo Digital is very well placed to be able to capitalise on this opportunity.

“We believe that in the next calendar year this is a part of our business that can provide rapid growth. It could be a very significant contributor to our revenues and profits going forward,” he added.