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Sigma Designs, Inc. (NASDAQ:SIGM)

F3Q 2009 Earnings Call

December 2, 2008 5:00 pm ET

Executives

Edward McGregor – Manager, Investor Relations

Thinh Q. Tran – Chairman, Chief Executive Officer

Thomas E. Gay, III – Chief Financial Officer

Kenneth Lowe – Vice President, Strategic Marketing

Analysts

[Unidentified Analyst] - RBC Capital Markets

John Vinh - Collins Stewart LLC

[Unidentified Analyst] - UBS

Sukhi Nagesh - Deutsche Bank Securities

Hamed Khorsand - BWS Financial

Johnny Brown - Stephens Inc.

Operator

Ladies and gentlemen welcome to the third quarter 2009 Sigma Designs earnings conference call. My name is [Tonya] and I will be your coordinator for today. (Operator Instructions) I would now like to turn the call over to Mr. Ed McGregor, Manager of Investor Relations. Please proceed.

Edward McGregor

Thank you and welcome to Sigma Designs conference call to discuss financial results for our third quarter of fiscal 2009. I’m Ed McGregor, Sigma’s Manager of Investor Relations. With me today are Thinh Q. Tran, Sigma’s Chairman and CEO; Tom Gay, our Chief Financial Officer; and Ken Lowe, our Vice President of Strategic Marketing.

A press release containing the quarter results, including selected income statement and balance sheet information was released after the market closed today. If you did not receive the results, the release is available in the Investor section of our website.

Today’s agenda will begin with my brief introduction, a review of selected financials by Tom, an executive overview by Thinh, a market update by Ken and comments and guidance by Thinh. We will then open the call to questions from analysts and institutional investors. We expect to conclude the call within one hour. Before we begin, I would like to read our statements about safe harbor and non-GAAP information.

This conference call contains forward-looking statements, including statements regarding Sigma’s expectations of its revenue level for the fourth fiscal quarter and anticipated gross margins and anticipated trends in Sigma’s target markets.

Actual results may vary materially due to a number of factors, including but not limited to the risk that the SEC disagrees with the manner in which Sigma has accounted for and reported or not reported the financial impact of past stock option grants; actions by other regulatory agencies as a result of Sigma’s past stock option practices; ongoing derivative litigation; a determination upon completion of further quarterly closing and review procedures; that the financial results for the third quarter of fiscal year 2008 are different than the results set forth in this call; general economic conditions, including continuance of the current economic conditions specific to the semiconductor industry; the rate of growth of IPTV; high definition DVD and HDTV markets; the ramp and demand from our set-top box customers; our ability to deploy and achieve market acceptance for Sigma’s products in these markets; the ability of our SoC’s to compete with other technologies or products in emerging markets; the risk that such products will not gain widespread acceptance or will be rendered obsolete by the product offerings of competitors or by alternate technologies; the risk that anticipated design wins will not materialize; and that actual design wins will not translate into launched product offerings; and other risks, including delays in the manufacturer’s deployment of set-top boxes or consumer products.

Other risk factors are detailed from time to time in our SEC reports, including our Form 10-Q, filed with the SEC on September 11, 2008. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. Sigma undertakes no obligation to publicly release or otherwise disclose the results of any revision to these forward-looking statements that may be made as a result of events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

In addition to reporting financial results in accordance with generally accepted accounting principles or GAAP, we report non-GAAP net income, which excludes amortization of acquired intangibles with respect to the second fiscal quarter of 2008, non-GAAP results, non-recurring expenses associated with the tender offer to employees to resolve potential personal income tax exposure, stock based compensation calculated under APB #25 and SFAS #123R and with respect to the second fiscal quarter of 2007 through the second fiscal quarter of 2008 non-GAAP results, non-recurring expenses associated with the company’s review of its historical stock option grant and practices, and related financial statements for prior periods.

We believe that our non-GAAP net income provides useful information to management and investors regarding financial and business trends related to our financial condition and results of operations. We also believe the non-GAAP measures provide useful supplemental information for our investors to evaluate our operating results in the same manner as research analysts that follow us, all of whom present non-GAAP projections in their published reports.

We caution investors, however, not to place undue reliance on non-GAAP measures and to read them in connection with our GAAP results. You can find detailed reconciliation between our GAAP and non-GAAP results in the financial tables included in our written earnings release, which is currently posted on our website. Now I would like to hand the call over to Tom who will review our financial results.

Thomas E. Gay, III

Thank you Ed. For the third quarter of fiscal 2009, revenue decreased 20% or $11.4 million to

$46.8 million from $58.2 million in the previous quarter. Compared to the year ago quarter, our revenue decreased $19.4 million or 29% from $66.2 million. Our revenue breakouts are as follows; by market segment and percentage of total revenues for the quarter, IPTV represented

$35.7 million or 76%; Blu-ray DVD and other connected media players, $7.6 million or 16%; the XP, $2.0 million or 4% of the total; and the other category came to $1.4 million or 3% of the total.

By billing region, Asia represented $26.3 million or 56% of the total; Europe, $16.9 million or 36%; and North America, $3.6 million or 8% of the total. During the third quarter, we had three customers that each exceeded 10% of our revenue. Motorola Singapore totaled $7.9 million or 17%; Cisco Systems, $5.7 million or 12%; and Netgem, $5 million even or 11% of the total. There is one footnote to this information that needs to be explained.

Part of the reason for the decrease in revenues for Cisco Systems during the quarter compared to the second quarter is their outsourcing of manufacturing to two sub-contractors. The revenue from those manufacturers in the third quarter was $5.8 million or 12% of our revenue. GAAP net income for the third quarter of fiscal 2009 decreased to $3.7 million or $0.14 per diluted share, down $5.9 million or 62% from $9.6 million or $0.035 per diluted share in the previous quarter.

Compared to the third quarter of fiscal 2008, GAAP net income decreased $17.3 million or 83% from the $21 million we reported. Gross margins were 46.3% for the third quarter compared to 50.7% in the preceding quarter and 53.2% in the same period last year. The decrease is attributable to $0.7 million or 1.6% additional expense from a recent increase in our assembly costs due to the cost of gold, and $0.6 million or 1.2% of the total in reserves for the write down of older inventory.

Operating expenses on a GAAP basis were $18.1 million or 39% of revenue in the third quarter compared to $16.8 million or 29% of the previous quarter and $12.8 million or 19% of revenue in the same period last year. Compared to the previous year, the $5.3 million increase in operating expense is primarily due to a 39% growth in headcount, including about half of that from the VXP acquisition in Canada and increased other R&D expenses associated with our increased new product development.

You can find a copy of our press release with a detailed reconciliation of our GAAP to non-GAAP performance on our website. The reconciliation includes the following categories of differences for the third quarter. First would be amortization of intangible assets associated with two acquisitions; $0.3 million from Blue7 and $0.4 million from VXP. Second category would be stock based compensation of $2.8 million. On a non-GAAP basis, net income for the third quarter was $7.2 million or $0.27 per diluted share.

Compared to the previous quarter, this is a decrease of $5.5 million from $12.7 million or $0.47 per diluted share. Compared to the year ago quarter, this is a decrease of $15.8 million from

$23 million or $0.79 a share. In the third quarter, the provision for income taxes was $1.1 million or 22.5% of income before taxes. This brings our year-to-date income tax rate to 27%. The rate is better than the full statutory rate of 41% due to our international tax strategy activities.

Now I would like to cover a few key areas from our balance sheet. Cash, cash equivalents, and marketable securities totaled $197.3 million, a decrease of $78.4 million from the beginning of the fiscal year. The decrease is primarily due to cumulative stock repurchases of $85.9 million and the purchase of the VXP assets for $18.2 million. These decreases were partially offset by

$25.7 million of cash generated by operations, $17.6 million of which occurred in the third quarter.

Based on our shares outstanding at the end of the quarter, this represented a total cash value and including investments of $7.48 per share. Of the total cash and securities amount, $65 million is classified as long term securities. This breaks down into $12 million of securities with maturities longer than one year from their date of purchase and $43 million of auction rate securities that are expected to be held until July, 2010. There is also a standing offer from our bank to lend us the full face value of these securities upon request.

Net accounts receivable was $26.8 million, a decrease of $13.5 million compared to the beginning of the fiscal year. The average day’s sales outstanding for our receivables as of the end of the third quarter was 52 days as compared to 62 days in the previous quarter. Inventory was

$45.2 million, the same amount as we held at the end of the previous quarter and an increase of

$18.9 million compared to the beginning of the fiscal year.

Accounts payable was $13.1 million, a decrease of $5.4 million from the beginning of the fiscal year. Shareholders equity was $296.3 million, a decrease of $49.3 million from the beginning of the fiscal year, principally due to $85.6 million in stock repurchases during the first half of this year, offset by $19.8 million in earnings. I will turn the call over to Thinh for an executive overview.

Thinh Q. Tran

Thank you Tom. I would like to start by thanking all of you for joining us today and for your continued interest in Sigma. In today’s call, I would like to review the results of the third quarter and emphasize the significance in activities and achievements.

First off, like many other companies facing the challenge while struggling economy, we are disappointed to report a decline in revenues for the third quarter. However, we are placing every effort on bolstering sales within our market segments. We continue to maintain a strong presence in the IPTV market, being the market leader for both the Microsoft media room and Linux based platforms, and pushing for new wins within emerging TELCO deployment.

We are also pushing forward to our consumer products agenda by working with a wide range of vendors to improve Blu-ray player design, many of whom have began to place the orders. For further disposition, we are in the midst of completing a number of new chipset products that will increase our competitiveness in the marketplace.

Moving forward, we are also executing on a number of strategic growth initiatives designed to result in future revenue streams, including penetration into the cable-based IPTV set-top box market, the home networking market, and selected segment of the HDTV market. On the profitability side, our close margins were affected by changing power in our product mix and additional variable expenses.

We continue to monitor both our costs and pricing closely to keep our margins as stable as possible. Furthermore, to help maintain visible operating profits, we are already taking action to reduce our operating expense moving forward. These actions include establishment of a hiring freeze, reducing our site and [something] service and timing restriction on [inaudible] travel.

Now I would like to highlight some of the business developments we have achieved since our last conference call. We announced the availability of our new 8644 media processor, designed for future reach consumer products including [imagination] IPTV set-top box; IP cable set-top box and Blu-ray players. The 8644 provides substantial improvement in performance, coupled with a broader ray of interface capabilities required to support greater activity, expand its system features, and see a level of image quality typically associated with high-end consumer products.

We announced the availability of the Wireless Home Theater Audio Development Kit, based on the company Windeo Ultra wideband chipset. We also demonstrated the Wireless Home Theater Audio Development Kit along with its new CoAir solution, the industry’s first UW chipset for combined wireless, coax, and Ethernet capabilities. We demonstrate a wide range of consumer technology solution at IBC 2008 in Amsterdam.

These solutions include the 8654 media processor, which increases the performance while decreasing overall set-top box costs; multiple ultra wideband connection solutions including CoAir; and Sigma’s new DOCSIS 3.0 set-top box reference design featuring Tru2way middleware for next generation cable deployment.

We announced the appointment of David Lynch as Senior Vice President of newly combined Sales and Marketing Department. Mr. Lynch is taking on the responsibility for the company’s demand generation, including forecasting, distribution, account management, product management, marketing and promotional programs. We announced that we have been ranked #7 on Fortune 100’s fastest growing companies in the U.S. and chosen for the second consecutive year by the Deloitte and Touche’s Silicon Valley Fast 50 company for 2008.

I would like to pass the call to Ken who will discuss current market trends. Ken.

Kenneth Lowe

Thank you Thinh. For this call I’d like to focus primarily on the market trends for IPTV and briefly discuss our outlook for future contributions from other segments. Though it may appear that the IPTV market growth is faltering, we believe that most Telco’s are becoming dependent on the revenue streams and remain committed to their deployment schedules. This is evident by the many public comments made by the carriers during the quarter.

On the other hand, we believe this contraction reflects a more conservative stance on forecasting and service inventory levels, and therefore there is some uncertainty about the strength of the market growth going forward. Reassessing the available market for IPTV set-top boxes this year; we believe that the IPTV set-top box chipset market for 2008 will now be around 12.5 million units, compared to our initial forecast of 14 million units.

Let’s now discuss the current IPTV landscape, our subscriber base model of some market share expectations. In North America, AT&T continues to push forward with their IPTV rollouts. At the end of their third quarter, AT&T reiterated that the U-verse service continued its strong ramp with a net subscriber gain of 232,000 subscribers for a total of 781,000. They additionally indicated that their network deployments are on schedule; their broadband attach rates are high; and that they are on target to achieve their goal of over 1 million subscribers by year end.

Additionally, the U-verse network deployment now passes 14 million living units. Other active North American deployments include leading Canadian Telco’s TELUS, Bell Alliant, MTS Allstream and Sask Tel with Bell Canada set to begin shortly. We believe that the total North American demand for IPTV media processors should reach nearly 4 million units this year.

In Europe, there are over 16 Telco’s in active deployment at this time which include Free, France Telecom, Neuf, Deutsche Telecom, British Telecom, Belgacom, Portugal Telecom, Swisscom, Telefonica, Ya.com, TDC, Telecom Italia, Scali, Fast Web, Wind and T-com affiliates. Most of the carriers that we deal with appear to be ramping their deployments this year at differing rates, as exemplified by the following updates.

British Telecom added 38,000 subscribers in the quarter to reach a total of 320,000. Deutsche Telecom added 60,000 subscribers in the quarter to reach a total of 333,000, hoping to reach 500,000 by the end of the year. Belgacom added 52,000 subscribers in the quarter to reach a total of 443,000. Portugal Telecom announced that it added 95,000 subscribers in the quarter to reach a total of 211,000 subscribers to date with the goal of reaching 300,000 by year end. Swisscom reported that it added 15,000 subscribers in the quarter, reaching a total of 95,000 to date.

And Telefonica announced that it added 13,000 subscribers, reaching a total of 590,000 to date.

Adding up the impact of these net new subscribers, we believe that the total European demand for IPTV media processors should reach about 4.5 million units this year.

In Asia there are a total of 10 Telco’s in active deployment at this time which include Korea Telecom, Eniro, China Telecom, China Net Com, Heuson, KDDI, Chunghwa Telecom, PCCW, Singtel and MTNL in India. There are still signs of growth in this region as indicated by the following updates from the carriers.

China Telecom reportedly surpassed 1.5 million subscribers this quarter, up from 940,000 reported in May of this year. Korea Telecom added 102,000 subscribers in the quarter to reach a total of 808,000. Eniro has been experiencing deployment slowdown due to Korean government regulatory action, and lost 36,000 subscribers in the third quarter. Chunghwa Telecom added 82,000 subscribers, reaching a total of 591,000 to date with expectations of 700,000 by the end of the year. Adding up the impact of these net new subscribers, we believe that the total demand for IPTV media processors in Asia should reach about 4 million units this year.

Now let’s talk a bit about set-top boxes and competition. The IPTV market is currently being supplied with Sigma power boxes from Motorola, Cisco, Free Box, UT Starcom, Celrun, Deison, Netgem, Tatung, Pirelli, and Pace. As the market grows, there is an increasing thirst for a wider variety of chipset solutions for which Sigma is developing an expanded array of offerings. We’re currently sampling the 8654 to our key set-top box partners, many of whom are using this as the basis for their next generation offerings.

Additionally, we’re expanding our product line to address both lower cost and higher performance modes within a single, software compatible family. As a result of the set-top box deployment cycle, we believe that next generation set-top box deployment will likely begin in volume around mid-2009. Spanning across multiple application segments will also be a plus, which underscores the importance of Sigma’s investment in the new cable solutions based on DOCSIS 3.0 and Tru2way.

Examining IPTV market from the platform standpoint, we find that 12 Telco’s are using the Microsoft media room platform, while 20 users customized Linux base platform. For the Microsoft media room platform, we’re confident in our belief this will remain 100% Sigma based during the remainder of this year and Sigma is likely to remain the leading supplier throughout 2009. As indicated in a recent Microsoft announcement, their media room offering added more than 500,000 new subscribers in the third quarter, bringing the total to over 2 million subscribers and 4 million deployed set-top boxes to date.

For the Linux based platforms we also expect to retain our estimated 75% share of the market for the foreseeable future. As the Microsoft based Telco’s are growing rapidly as a group, Sigma believes its overall IPTV market share has been rising this year-to-date. In summary, Sigma remains the market share leader in the IPTV processor space.

And as you are aware, Broadcom has been demonstrating chips for about two years in its attempt to penetrate the IPTV market and though they have made inroads working with Microsoft and others, they are still waiting to deploy their first units. Recently Intel has also announced its intention to offer chips that can be used for a number of embedded consumer applications, including set-top boxes.

While we are taking actions to aggressively defend our current market position, there will undoubtedly be competitive penetration of this market as we move throughout the next few years. As an adjunct to our IPTV marketing efforts, we’re continuing our push into the next generation cable set-top boxes. This market is at a juncture, as the nearest transition from the carrier specific boxes controlled by the duopoly of Motorola and Scientific Atlanta, to the merchant market boxes enabled by the open cable consortium as well as the transition from the [quam-based] digital broadcast scheme to an IPTV [multi-hask] mechanism using DOCSIS 3.0.

These transitions are opening up the market to a wide array of manufacturers at all levels over the next several years. Sigma is currently partnering with TI to offer one of the industry’s first solutions to feature DOCSIS 3.0 and Tru2way software. As a result of direct meetings with major cable operators, we’re very encouraged with our future business prospects in this segment and will be making efforts to further our position.

Now let’s move on to the Blu-ray market. It appears that Blu-ray demand has seen only modest increases this year, though this holiday season could bring about increased sales of reduced price players selling under $200.00. That said, the current consumer satisfaction with DVD combined with the existing economic conditions may limit a large upswing in demand during this Christmas season. However, on balance we do anticipate stronger growth for Blu-ray players as we move through 2009.

Moving forward, there’s also an increased amount of competition for this budding market. Aggressively priced offerings from NEC and Panasonic have made their way into players by some of the largest Japanese consumer vendors. Sigma has also introduced new products into this sector and by leveraging our strong relationships we are working to gain new design wins into some of our top tier accounts.

Meanwhile, Sigma has established design wins from manufacturers in Taiwan and China this year, which we hope will become increasingly important as we move into the next year. In summary, we hope to achieve meaningful revenue contribution from Blu-ray, but the level of competition limits our forecast growth with any certainty.

Beyond these top two markets, Sigma has strategic initiatives in place to develop and penetrate several other markets to add future revenue streams. Our Ultra wideband products continue to show promise, especially our CoAir offering as a multiple media home entertainment network solution. Offering a compelling combination of high band with coax, Ethernet and wireless communications, this solution is being evaluated in the lab of some of the top Telco and cable carriers.

However, since it involves strategic decisions in the telecommunications market, evaluation development cycles are quite long and this business could take a year or more to develop into significant demand.

For the television market we’re continuing to pursue our strategy of diversification in order to provide us with a wider range of available sockets to sell into. This includes the development of an integrated HDTV chip that combines our media processor expertise with our high performance VXP technology to bring [CO] quality video to consumer televisions. Furthermore, our VXP line is already contributing minor revenues to the prosumer end of the television market, including front projection televisions and AV receiver applications.

We remain optimistic about our opportunity to penetrate a greater portion of this market as we move into next year. We hope this analysis provided you with some insight about our target markets and the opportunities that lie ahead for Sigma. We feel strongly about our leading technologies and established market position and look forward to building on this foundation. I’d now like to pass the call to Thinh to cover our forward guidance.

Thinh Q. Tran

Thank you Ken. As Ken has indicated, we believe that our primary markets are fundamentally strong. We do expect the IPTV market to continue growing in the long term and for Sigma to remain a leading player. We also expect the Blu-ray market to continue growing in the long run and for Sigma to maintain some reasonable market share.

We also expect to receive some more contribution from our other emerging markets toward the end of next year. However, as indicated, we have limited our short term visibility and are somewhat subject to the impact of our economic slowdown and its ramifications. So looking ahead is what we would expect. We expect fourth quarter revenues to be similar to the level experienced in the second quarter, although it is possible to see up to a 10% decline.

We expect our gross margin to remain relatively stable in the next few quarters. However, we are adjusting our target to be 48% plus or minus 200 basis points. In summary, I would like to reinforce that we believe our fundamentals remain strong and our target markets experience continued growth, that we remain dominant in the IPTV market, and that we are redoubling our efforts in development to strengthen our position moving forward.

We’d now like to open up the call for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [Unidentified Analyst] - RBC Capital Markets.

[Unidentified Analyst] - RBC Capital Markets

As you mentioned, Blu-ray players are now below $200.00 and our price checks specifically show as low as $149.00 to $199.00. If you could give us a sense of your product’s roadmap and what growth assumptions you’ve included as well as the pricing.

Kenneth Lowe

Well, as we indicated, the Blu-ray market right now is – our short term visibility is fairly limited. We are still participating in the market with various different customers and we’re looking to gain additional sockets as we move forward. This industry, as it develops, is adding more and more players coming into the market and there are more and more socket opportunities coming. So we’re broadening our impact on that.

We’ve got new products we’re rolling out, including our 8644 that we introduced, and we’ve got additional lower cost parts coming out as well. We also have a big push into China and Taiwan, where we received a lot of success with our turnkey solutions. One of the noteworthy things about the Sigma offering is we have a – we own the entire software suite that goes with our Blu-ray chipsets. So we uniquely can offer turnkey solutions to many of the emerging vendors that have never done these types of products before.

That said, the timing and impact of the various new consumer vendors we’re working with is a little bit hard to predict at this point in time. So the amount of Blu-ray business that’s factored into the next quarter is at this point in time no more than what we’ve had in the current quarter.

[Unidentified Analyst] - RBC Capital Markets

Do you expect pricing to stabilize where it is right now or continue to go down over the next quarter or two?

Kenneth Lowe

I think we expect pricing to be relatively stable for the short term, but it will go down over time. This is getting more and more competitive.

Operator

Your next question comes from John Vinh - Collins Stewart LLC.

John Vinh - Collins Stewart LLC

Just first a clarification, Tom you mentioned the drop-off in Cisco revenues was partly due to the fact that they had started outsourcing to two sub-cons and so is the way to think about that is they outsourced with their revenues were 12%, but they also outsourced another 12% to another sub-con, so together Cisco was 24% of your revenues?

Thomas E. Gay, III

That’s correct.

John Vinh - Collins Stewart LLC

Okay, so did the – I think you mentioned that you have three 10% customers. If they outsource to another sub-con wouldn’t you have four 10% customers?

Thomas E. Gay, III

Well, that was more than one sub-con.

John Vinh - Collins Stewart LLC

Second question is just a follow-up, Ken, on the Blu-ray pricing can you give us a sense of where you guys are seeing market pricing today for Blu-ray chip pricing? And do you think that the 644 has been cost optimized enough that you’d be able to compete in a price competitive market going forward?

Kenneth Lowe

Well, I guess the way I would answer that is that there for new sockets; there are continued price pressures to get more and more cost effective. Sigma is participating in really two types of products in Blu-ray. The more premium type solutions, where there isn’t as much cost pressure, and we believe the margins will be a little bit better. And the mainstream units where price pressures will continue to depress prices down over the next couple of years.

In the mainstream area, prices are pushing down into the probably into the mid-teen areas and it’ll continue to slide down from there. That’s why one of the strategies we have is to bifurcate our line and be able to play it both high-end and low-end and only opportunistically play at the low-end.

John Vinh - Collins Stewart LLC

Can you just give us an update in terms of where you guys stand in terms of kind of front end integrated Blu-ray chip and what do you anticipate kind of integrated chip pricing to be on that?

Thinh Q. Tran

Our goal is to have a product ready so it can be at volume deployment by Christmas 2009. And we expect these integrated chips to be sold in the mid-teens type of pricing and volume.

John Vinh - Collins Stewart LLC

Will we see any sort of updates from you guys that see yes on the front-end integrated chip?

Thinh Q. Tran

Well, probably a little bit later than that, yes.

John Vinh - Collins Stewart LLC

On IPTV, obviously you guys gave a lot of color in terms of where the subscriber trends are. Obviously somebody with a larger deployment seems to be on track and tracking in line, AT&T obviously coming out and reiterating its guidance for the year. Is what you’re seeing in terms of the drop off in revenues more a function of inventory correction and less of an issue with weakness in the end markets? Or can you maybe comment and give us some more qualitative color on drop off in revenues in terms of the impact from inventory corrections versus end market trends?

Kenneth Lowe

We believe it is. We believe that any sort of drop off at the level that we saw is due to an immediate response by the Telco’s in adjusting their service inventories, against the level of deployment that they’re getting. In other words, at one point in time the idea is as this is ramping strongly, they don’t ever want to get their channel starved, so they run excessive inventories. As they see the economy struggling like this I think there is financial decisions inside the firms to back down on those a little bit, run a little leaner.

You know maybe even not be as aggressive with their forecasting, just to make sure that they’re not running on the high side of inventory.

John Vinh - Collins Stewart LLC

What is your level of visibility in terms of inventories at your major customers right now and is there further risk in terms of Q4 do you think in terms of further inventory correction? Or do you think that’s reflected in your guide at this point?

Kenneth Lowe

You know, it’s possible part – it’s built into what we indicated was our guidance, that we think it’s going to be flattish but there could be up to a 10% decline. We believe that most of it was built into the third quarter numbers. We don’t how much more there is or if there is any left to bleed out next quarter and we don’t have any direct visibility into our Telco inventories. We have anecdotal evidence and conversational level information. So that’s really what we have to go on.

Operator

Your next question comes from [Unidentified Analyst] – UBS.

Unidentified Analyst – UBS

Coming back to the inventories, inventories are quite a bit higher, they’re about 175 days and I was just wondering what is the position of this inventory; particularly once this is headed for a list of write downs going forward?

Kenneth Lowe

I don’t have the specific breakdown in front of me, but one of the trends that did occur during the third quarter was that finished goods built up a bit. We had actually expected inventory to come down and been managing toward that goal, but with the drop off in revenues during the quarter our build plan wasn’t quite matching it. So we’ll be able to sell through on those finished goods during the fourth quarter and should see the results of our inventory managed efforts occurring then.

Unidentified Analyst – UBS

On OpEx side you indicated [inaudible] reduction. Just wondering can you quantify how much reduction you expect going forward? And also does it include any headcount reduction?

Kenneth Lowe

At this time we’re comfortable with our headcount continuing at the current level in support of our R&D initiatives, feel that that doesn’t need to be addressed in the short term. The other initiatives are going to take a bit of time to have their effects, travel, and other ways of managing discretionary expenditures, so we don’t want to quantify it at this point. But we do want to let you know that we are going to be watching and be more careful about those levels of expense.

Operator

Your next question comes from Sukhi Nagesh - Deutsche Bank Securities.

Sukhi Nagesh - Deutsche Bank Securities

If you look at your sequentials for the December quarter and the April quarter, is April quarter seasonally down? And how should we think about if you were to have, you were saying flat January quarter, and then is April seasonally down?

Kenneth Lowe

Not really because with 75% of our business being IPTV and we’ve maintained for a long time that IPTV is not really seasonal by nature, that we really don’t expect to see that much of an impact for seasonality. So if it’s up, down or sideways it really is an indication of the market adjusting to the current situation.

Sukhi Nagesh - Deutsche Bank Securities

And then for January, you said fiscal fourth quarter guidance it’s going to be something similar to the fiscal third quarter or maybe down 10%. Can you help us understand what could cause – what needs to happen for you to hit the high end of that range? And what needs to happen at the low end of the range?

Thomas E. Gay, III

Well, one thing as you noted our guidance for the third quarter had not really been reflected in our ultimate results of being down so much. And that was the result of some pushouts and other adjustments by our customers. What we now interpret the trend to be is to level off, similar to where we are, but we’re a bit concerned about more pushouts that we haven’t heard of yet. So we’re just trying to be a little conservative here and feel that our guidance is reasonably expectable to occur.

Sukhi Nagesh - Deutsche Bank Securities

So in other words, Tom, you’re saying that the low end of your guidance would be achieved if you were to see more pushouts or cancellations from customers?

Thomas E. Gay, III

Yes.

Sukhi Nagesh - Deutsche Bank Securities

Just in terms of if we look at Motorola and Cisco, I think if I look at my model here, Motorola was roughly 17 million last quarter, they did roughly 8 million this quarter, was down 53%. You know Cisco was down 36%, yet you’re worst than your overall IPTV business. Is the fair way to look at that that they’re hesitant to order and that they’re just not? How should I look at that from the perspective of your IPTV business being down 27% sequentially, yet both your largest customers are down significantly worse?

Thomas E. Gay, III

Well, since those are two of the largest customers they’re going to account for the majority of the slide in the IPTV. And I think in aggregate, Motorola and Cisco are dealing with some of the largest Telco’s in the world and those are the kind of people that I think are in the process of trying to adjust how many boxes they’re asking for.

And I think both Motorola and Cisco again wanting to offer high level service has probably been managing their own levels of inventory higher than they possibly would like to. So I think they’re all going to adjust in time inventory system, the whole channel is going to adjust in time inventory system we believe. So it just simply – they’re gobbling up what’s out there, so you lost some percentage of units to basically eating away at inventory.

Sukhi Nagesh - Deutsche Bank Securities

So what would you expect inventory to do at the end of the January quarter? In other words I mean you ended this quarter flat on a dollar basis. Is it fair to assume that your inventory’s going to go down? How much should we – I mean, should it go down by 10? Remain flat? How should we look at that?

Kenneth Lowe

Well, if we achieve our goals that finished goods number will come down quite a bit and the overall replenishment of dye is also going to taper off a little bit this quarter, so I can’t really quantify what the net effect would be, but both of those trends should bring down the overall level.

Sukhi Nagesh - Deutsche Bank Securities

And Tom on the OpEx front, you did kind of a profile base I think of $15.2 million for the quarter. How should we look at your pro forma OpEx on a quarterly basis, you know, January and April quarters?

Thomas E. Gay, III

One thing that we can predict is that there will be some year end audit and SoC’s expenses. That’s been a seasonal trend for us. G&A does pop up, but we also believe that our cost controlling initiatives and hiring freeze should pretty much keep the R&T and sales and marketing expenditures similar to where they were in Q3.

Sukhi Nagesh - Deutsche Bank Securities

One last question then. You mentioned the Blu-ray connected business was $7.6 million in the quarter. What was the split between just Blu-ray DVD players and other connected?

Kenneth Lowe

Would you repeat that again, Sukhi? I’m not sure I picked up the exact angle you’re –

Sukhi Nagesh - Deutsche Bank Securities

Your total Blu-ray connected player revenues in the fiscal third quarter were $7.6 million if I recollect you saying. I just wanted the split between your Blu-ray DVD versus other connected media.

Kenneth Lowe

The Blu-ray DVD was under half this time. It was probably under 40%. It was the minority of the number at this point.

Sukhi Nagesh - Deutsche Bank Securities

The 40% Blu-ray and then the remaining being connected media?

Kenneth Lowe

Yes. That’s an estimate though. Some of the manufacturers actually do both boxes.

Operator

Your next question comes from Hamed Khorsand - BWS Financial.

Hamed Khorsand - BWS Financial

I just wanted to see on where Broadcom stands with the testing process? Are you guys seeing them in the testing? I think you guys are going out with your 8654 processor to carriers. What kind of feedback are you getting right now from the channel?

Kenneth Lowe

Well, the feedback we’re getting is that Broadcom is certainly out there, trying to get involved in more and more opportunities. But the way it kind of works right now is that their chips are being integrated into certain select set-top boxes. Those set-top box vendors then are offering them when RFQ’s come up from different Telco’s. We certainly are represented by the largest contingent of set-top box vendors out there. And so our job is to make sure that we stay as the primary offering for those set-top box vendors.

In some case Broadcom has historic alliances with certain people and they’ve been able to pressure those relationships. In other cases the majority of the small or medium sized set-top box vendors are typically at a size where they would find themselves more optimized just continuing to deal with Sigma, as they’ve made a huge investment into the both software and hardware infrastructure to deal with us.

Hamed Khorsand - BWS Financial

The follow-up on that comment you just made, I’m aware of who Broadcom’s relationship is with, so given that it’s more your larger vendors, how much could you lose if Broadcom keeps pushing on this set-top box vendor? Are you guys looking forward to that? How are you guys trying to compete against that possibility?

Kenneth Lowe

Well, you’re going to lose some portion. And you’re going to lose some portion by bit of very nature that you won’t lose at all, and that is that the very largest of the set-top box vendors have corporate mandates to have supplier diversity programs within all their major lines. And this is no different. So by that mandate, they do want to have multiple suppliers. They don’t want to be held captive by somebody. So Broadcom has to have a certain amount of penetration into that.

At the same time, they can only push Sigma out so far because of the fact that they’re going to maintain some level of balance. So I think moving forward, we do see some penetration into some of the larger guys and but frankly it’s still a big battlefront out there right now.

Hamed Khorsand - BWS Financial

And then the last question is 8654 you’re testing out right now, at what point can we see the 8634 be phased out? And it’s all the set-top boxes have 8654 or 8644 chip?

Kenneth Lowe

You know, the 8634 is in such a wide range of both applications and customers, it will continue for quite some time. Now it’ll pass the tip of its curve and start going down, but it’s – we believe it’s going to stay in production for quite some time. For probably years, but the other way to answer that is we believe the 8654 will start providing material contributions in IPTV starting perhaps in the second quarter of next year.

Hamed Khorsand - BWS Financial

Is that calendar Q2 or fiscal Q2?

Kenneth Lowe

Use fiscal.

Operator

Your next question comes from Johnny Brown - Stephens Inc.

Johnny Brown - Stephens Inc.

If we can touch back on the competition in the Blu-ray and IPTV markets a little bit. I mean, it seems like the Blu-ray market competition has kind of creeped up fairly significantly here recently and I was kind of wondering if you could give – you touched on this a little bit in the call, but could you give a little bit more color on why the same thing would not happen in the IPTV market? And maybe how many competitors besides Broadcom do you see and Intel maybe jumping in? And what the timing of that might be?

Kenneth Lowe

Well, let’s take them in reverse order. We – you know, it takes such a substantive amount of work to enter now that you – so you’ve noticed that in the last couple of years, what we’ve seen is people of the size of Intel and Broadcom are entering this market as opposed to small companies. So we really don’t expect to see a horde of people entering. That said, I think you were accurate in portraying the competitiveness of the markets. Certainly Blu-ray has a widened amount of competition there.

It’s a fixed specification. It’s much easier to enter. There are third parties that will provide the software and so just spinning out a piece of integrated silicon is a little bit lower barrier there. So and we do see a lot more competitors there, and we do think it will be reflected in the pricing and everything else you’ll see moving forward, the market fragmentation.

On the other hand, IPTV we believe will remain a separate and distinct market. We believe it will be something that we’ll be able to defend our stake there for quite some time. So I guess that’s how I would posture it. We’re going to be – I guess the bottom line is we’ll be much more selective in the Blu-ray segment as to how and where we play in that market and what kind of products we offer as opposed to IPTV what will continue to be a broad based supplier.

Johnny Brown - Stephens Inc.

And in the Blu-ray with the new profile 2.0 I think it’s called, the lower cost solution, what do you see in there in terms of your success as compared to the earlier version?

Kenneth Lowe

I think it’s, you know, generally very similar to us. It’s just a continued evolution. The software has expanded and in some cases presses on the amount of performance you need out of the chip, and Sigma is one of the leading providers of performance in these types of chips. So those aspects of the player doesn’t really make a big impact on us. The key thing is that’s happening, though, is I think the pricing competition from the range of vendors coming in is just creating – it’s creating a new low end market is what it’s doing.

And there are various people that want to play at any price and so therefore it’s going to create a very distinct split between, we believe, the premium type of players and the low end or mainstream type players.

Johnny Brown - Stephens Inc.

Switching gears here, your cash position’s getting pretty large again, almost $200 million. What are your plans to deploy your cash? Maybe additional buybacks or M&A, what can you say about that here going forward in the next few quarters?

Thomas E. Gay, III

Well, we are in interesting times and there are opportunities arising out in the M&A area but we’re – we have been fairly conservative in what we do about these things, and we have no specific plans we want to announce at this point. But other than that, we feel this is a good time to have some cash on the balance sheet and are comfortable where we are. The buyback is subject to market conditions and could be resumed, but we’re not willing to give any specifics on that.

Operator

There are no more questions at this time. I would now like to turn the call over to Mr. Ed McGregor for closing remarks.

Edward McGregor

Thank you. Well we would like to thank you all for attending our conference call to discuss Sigma Designs’ financial results for our third fiscal quarter of 2009. We appreciate your interest in Sigma Designs and we look forward to our next scheduled conference call to discuss our results for our fourth fiscal quarter of 2009.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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Source: Sigma Designs, Inc. F3Q 2009 (Qtr End 11/1/2008) Earnings Call Transcript
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