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Executives

Edward McGregor – Manager Investor Relations

Thomas Gay – Chief Financial Officer

Thinh Tran – Chairman, Chief Executive Officer

Kenneth Lowe – Vice President, Business Development and Strategic Marketing

Analysts

Uche Orji – UBS

Scott for Tristan Gerra – Robert W. Baird

John Vinh – Collins Stewart

Daniel Amir – Lazard Capital Management

Sukhi Nagesh – Deutsche Bank

Gary Mobley – Noble Financial Group

Hamed Khorsand – BWS Financial

Quinn Bolton – Needham & Company

Dunham Winoto – Avian Research

Sigma Designs Inc. (SIGM) Q2 2010 Earnings Call August 26, 2009 5:00 PM ET

Operator

Welcome to the second quarter 2010 Sigma Designs earnings conference call. (Operator Instructions) I would now like to turn the presentation over to Mr. Ed McGregor.

Edward McGregor

Welcome to Sigma Designs conference call to discuss financial results for our second fiscal quarter 2010. I'm Ed McGregor, Sigma's Manager of Investor Relations. With me today are Thinh Tran, Sigma's Chairman and CEO, Tom Gay our CFO and Ken Lowe, Vice President of Strategic Marketing.

The 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 of Thinh, a market update by Ken and comments on guidance by Thinh. We'll then open the call for questions from analysts and institutional investors and expect to conclude the call within one hour.

Before we begin I would like to remind everyone that today's call contains forward-looking information including guidance we provide about our future revenue, gross margins and other financial measures and anticipated trends and target markets. We caution you that the forward-looking information that we present today is based on our current beliefs, assumptions and expectations and speak only as of todays date and involve risks and uncertainties that could cause actual results to differ materially from our current expectations.

Specific factors that may affect our business and future results are discussed in the risk factors section of our annual report on Form 10-Q filed with the SEC on June 11, 2009. A partial list of these important risk factors is set forth at the end of today's earnings press release. Sigma undertakes no obligation to revise or update publicly any forward-looking statement except as required by law.

In addition, during today's call we will be reporting certain financial information on a non-GAAP basis such as non-GAAP net income which excludes certain costs and expenses. These excluded items are described in more detail in today's earnings press release along with a detailed reconciliation of our GAAP to non-GAAP results.

Now I'd like to hand the call over to Tom who will review our financial results.

Thomas Gay

For the second quarter of fiscal 2010 revenue was virtually unchanged at $51.3 million compared to $51.2 million in the previous quarter. Compared to the year ago quarter, our revenue decreased $6.9 million or 12% from $58.2 million. Our revenue breakouts are as follows: by market segment and percentage of total revenues for the quarter, IPTV represented $43.1 million or 84% of the total.

Connected media players came in at $5.4 million or 11%. The consumer segment represented $1.6 million or 3% of the total and the category we are now going to be labeling connected home technologies which would be our wireless products came in at $1 million or 2% of the total.

By billing region, Asia represented $38.1 million or 74% of the total. Europe was $11.7 million or 23% of the total and North America $1.5 million or 3%. During the second quarter we had two customers that each exceeded 10% of our revenue; Motorola Singapore was $13.6 million or 26% and Gemtek was $8.5 million or 17% of the total.

Gross margins were 45.3% for the second quarter compared to 47.6% in the preceding quarter and 50.7% in the same period last year. The decrease is attributable to a higher concentration of larger Set-Top box customers during the quarter.

GAAP net income for the second quarter of fiscal 2010 increased over the prior quarter to $4.8 million or $0.18 per diluted share. This compares to GAAP net income of $2.7 million or $0.10 per diluted share in the previous quarter which included a tax write off of $3.5 million or $0.13 per diluted share due to changes in California corporate income tax laws. Compared to the second quarter of fiscal 2009, GAAP net income decreased $4.8 million or 50% from $9.6 million.

On a non-GAAP basis, net income for the second quarter was $7.8 million or $0.28 per diluted share. Compared to the previous quarter, this is a decrease of $0.5 million from $8.3 million or $0.30 per diluted share. Compared to the year ago quarter, this is a decrease of $4.9 million from the $12.7 million or $0.47 per share that we reported.

Please refer to our press release for a detailed reconciliation of our GAAP to non-GAAP performance. The reconciliation includes the following categories of differences for the second quarter. First was amortization of intangible assets associated with three acquisitions, a total of $0.8 million from Blue Seven, VEX and Zensus. The second category was stock based compensation that totaled $2.2 million for the quarter.

In the second quarter the provision for income taxes is based upon a revised projected tax rate for fiscal 2010 of 10% of year to date GAAP income before taxes.

I'd now like to cover a few key areas from our balance sheet. Cash, cash equivalents and marketable securities totaled $228.8 million, an increase of $36.6 million or $1.31 per share outstanding from the beginning of the fiscal year. The increase is due to the $5.6 million reduction in receivables, $14.2 million reduction in inventory and $3.3 million increase in accounts payable and $13.6 million of cash generated by other operations activities.

Based on our shares outstanding at the end of the quarter, this represents a total value of cash, cash equivalents and marketable securities of $8.55 per share.

Net accounts receivable was $25.2 million at the end of the first quarter, a decrease of $5.6 million compared to the beginning of the fiscal year. The average day sales outstanding for our receivables as of the end of the second quarter was 45 days compared to 37 days in the previous quarter.

Net inventory was $21.9 million at the end of the quarter, a decrease of $14.2 million compared to the beginning of the fiscal year. This reduction brings our net inventory turns to 4.3 times per year, a level we consider to be appropriate for our business at this time.

Now I will turn the call over to Thinh for an executive overview.

Thinh Tran

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 for the second quarter and emphasize the significance of our [inaudible].

First off, we are pleased to report that our revenue for the second quarter was in line with our expectations as we began the quarter. We feel that our primary markets have shown continued stability in the face of a difficult economy and we are continuing to place heavy efforts on bolstering sales as well as expanding the breadth of our market opportunities.

The IPTV market has remained relatively flat during this year and we remain confident that it will start to demonstrate some growth by the end of the year. We also are pursuing design activity in the cable industry and helping to drive the transition from to true two-way IP cable solutions, the deployment of which will substantially increase our addressable market.

We are continuing to build up our consumer opportunities on multiple fronts including Blu-ray players, digital media adaptors and home entertainment connectivity devices.

Finally, we have begun to pursue opportunities through our Z-wave brand wireless home control solutions. I'd also like to highlight the recent revenue trends within our primary market for IPTV center box. Sales of the IPTV market segment over the last four quarters have been $35.7 million, $36.4 million, $34.4 million and $43.1 million respectively.

Though our increase in the second quarter appears significant, we believe that we are in a relatively stable to low growth phase of the market and expect market demand to remain in the general range for the remainder of the year.

On the profitability side, our gross margin dipped due to the change in customer and product mix, resulting in higher concentration in larger customers during the quarter. We continue to watch both our cost and pricing closely to keep our margin as stable as possible.

I would like to highlight some of the important work we have achieved since our last conference call. First, we announced that the company has begun assembly of the CU8642 media processor designed for mainstream Blu-ray players. The 8642 coupled with Sigma full run Blu-ray to 5.20 software suite provides a high performance interactive experience and a cost effective architecture for competing in today's player markets.

We announced the availability of the company's 8652 processors. The 8652 is designed to provide the optimum price performance for [T-line] applications. This includes IPTV set up box used on the adaptor and IP cable.

We are now furnishing OEM manufacturers which are Networks, GigaFast and Gemtek. As a result, each OEM will offer a reliable co-active internet solution at a low cost for consumer electronic manufacturers.

We announced a partnership with 4Home, a leading provider of home control services. We expect the range of services in home for Sigma box designs. As a result, Sigma will be able to offer step up box suppliers an integrated home solution based on for home software platform and a Z-wave echo system for RFB controller boxes.

We announced our relationship with Entropic Communications, a leader provider of home connector and silicon software solutions to develop high definition, low compliant cable TV and IPTV design powered by entropic EN2515 and Sigma 8654.

We were named by Fortune Magazine as the second fastest growing company in their 2009 100 fastest growing company list, an annual ranking based on three year records of revenue growth, profit growth and total shareholder return.

We were selected by Standard and Poor's to join the S&P Small Cap 600 index which will become effective as of today's market close.

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

Kenneth Lowe

On this call I would like to provide an update on some of Sigma's market opportunities, technology developments and new potential that lies ahead for us, and first I would like to start with an update on the IPTV market and then move on to our other segments.

We believe the IPTV market remains strong, albeit somewhat dampened in its growth rate. While this year appears to be relatively stable with the latest expectations coming down to single digit growth, we believe that next year will see an increase in this growth rate due to the advantageous features and service that can be leveraged from market penetration.

Now let's discuss the current landscape on a regional basis. In North America, AT&T's Universe program continues unabated and their efforts to establish themselves as a viable alternative for TV service. At the end of the second quarter AT&T reiterated that their Universe service continued a strong ramp with a network subscriber gain of 248,000 for a total to date of 1.6 million.

Additionally, AT&T indicated that the Universe broadband attach rate continues to run above 90% and that over 75% of the Universe TV subscribers of triple play or quad play options from AT&T. Other active North American IPTV performance include four of the leading Canadian Telco's, TELUS, MTS Allstream, Sasktel and Alliant.

Europe is continuing to show IPTV deployment growth although it slowed down as a reflection of the economic rebuilding taking place. There are currently over 16 Telco's in active deployment in Europe with multiple new carriers emerging every year. The following updates provide a glimpse of the current status in trends and deployment.

[Boda] Comm added 34,000 subscribers last quarter to reach a total of 589,000. British Telecomm added 10,000 subscribers last quarter to reach a total of 423,000. British Telecomm added 122,000 subscribers last quarter to reach a total of 722,000. France Telecomm now claims to have 2.7 million subscribers to its Orange TV service.

Portugal Telecomm added 59,000 subscribers last quarter to reach a total of 443,000. Swiss Comm doubled its IPTV subscribers from a year ago reaching a total of 165,000. Telecomm Italia has reached a total of 387,000 subscribers and Telephonic has reached a combined total of 2.4 million paid TV subscribers, up 19.4% this year with 1.7 million subs in Latin America, 610,000 subs in Spain and 133,000 IPTV subs in the Czech Republic.

In Asia, there are a total of 10 Telco's in active deployment at this time which include Korea Telecomm, China Telecomm, China Netcom, [Heusin], KDDI, PCCW, LGDay Comm, Shanghai Media Group, [Singtel], and MT&L as well as one IPTV cable supplier, [GungZow].

There are continued signs of growth in this region as indicated by the following; in Korea, the government pushed to increase the rate of IPTV growth has resulted in 127,000 new subscribers in July alone in addition to the existing DOD business. Korea Telecomm leads in Korea with a total of 274,000 real time IPTV subscribers. [LGDay Comm] is Korea's second largest provider with 189,000 IPTV subs and SK Broadband has 132,000 real time IPTV subscribers.

Shanghai Media Group indicated that its best TV service has achieved over two million subscribers to date.

Now let's talk a little bit about the Set-Top boxes in our solutions. The 8654 is in full production and we're in the process of expanding our product line to address both lower cost and higher performance nodes with a single software compatible family. Towards this goal, we announced the 8652 in June at the Computech show providing an aggressive new platform for thin client applications. Based on current interest, we feel that this new platform will find success in IPTV, cable and digital media adaptor applications.

Turning to the media segment, Microsoft indicated the subscribers using this platform had increased to 3.5 million by mid year, more than double the number of a year ago. It's noteworthy that all 3.5 million consumers are using Set-Top boxes based on the Sigma 8634 chip.

So far during 2009, Microsoft has also added nine new Telco accounts which are [Quanzow], MTS Allstream, Telus, Prototel, ViaPass, Sherwest, Farmers and Votophone.

Turning to the cable segment, certain providers are in the process of planning a careful transition to IPTV technology for future video delivery; a transition that requires new areas of expertise. To take advantage of this, Sigma is offering its vast depth of IPTV expertise and technology leadership to the cable industry to help drive the adoption of 3.0 to two-way and delivering the first generation of hybrid IPTV cable Set-Top boxes.

This transitional opportunity represents a market potential much larger than the current Telco based IPTV deployments. To address this market, we're investing heavily into cable gateway platforms, thin clients and associated software to provide a complete solution to drive this transition. Each quarter we are increasing the number of cable companies that we are engaging with for continued evaluation and potential deployment.

Next, in digital media adaptor markets, to which Sigma has enjoyed a dominant position while the market interest develops, recent events have increased the appeal of this market and we have been receiving increased revenue contributions over the past few quarters. The driving force behind this change is linked to mobilizing your video library, somewhat akin to the I-pod concept for your music library.

We are continuing to work on more advanced solutions with increasing amounts of web access features to increase the appeal as we move into the future.

Now let's move on to the Blu-ray market. It appears that Blu-ray demand continues to see modest increases this year though this holiday season is expected to bring about increased sales to reduced price players. Sigma continues to proactively address this market with new hardware and software solutions. In June, we announced the availability of our 8642 media processor as it aggressively position chip for mainstream Blu-ray players.

In spite of the increased competition this segment, it appears that many first generation products from our competitors have been somewhat disappointing and windows of opportunity may be opening up in some accounts. Sigma expects to leverage our strong relationships with the top consumer vendors to work on gaining new design wins in both mainstream and high end players.

One of the key segments that most operators are exploring is home control services for security and energy maintenance. By placing a Set-Top box in the home connected to the internet, operators can provide ready access to any number of connected electronic devices in the home for a modest fee.

To enable carriers to tap into this demand, Sigma can now offer them a Z-wave solution. Z-wave brand devices are already the most popular solution for home control, providing hundreds of options for RF based remote control of energy, security and convenience appliances.

Now, by connecting the Z-wave network to an internet link, this set of home control devices becomes accessible to consumers online or in the alternative to the utility companies for energy savings or security companies for home monitoring.

In summary, Sigma remains the market share leader in the IPTV processor space. We believe our market share is continuing to grow, and we're confident that we'll remain a leading provider for some time to come. Moreover, Sigma has become a complete technology provider for the way consumers want to live. With four distinct but inter-related product lines, Sigma now offers the diversity to deliver complete solutions for a wide variety of high demand consumer electronics.

This includes media processors as full system on chip solutions, video image processors marketed under the VXP brand, high band width ultra wide brand devices and low bit rate RF home control devices marketed under the Z-wave brand.

We hope this analysis has provided you with some insight about 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'll now pass the call to Thinh to cover our forward guidance.

Thinh Tran

As Ken has indicated, we expect the IPTV market to remain relatively stable for the remainder of this year and to exhibit growth as we head into next year. That said, Sigma IPTV grows by 25% for the quarter partially due to the timing of customer shipments. We expect a counter balance in the third quarter. IPTV currently represents the majority of our revenues, however we expect that certain segments and other products will build up to meaningful revenue streams in the future giving more balance to our business.

To be reasonable at this time I will remain conservative in our future projections. Given those conditions, our forward looking guidance is as follows; we expect temporary softness in our third quarter revenues which will likely dip 5% to 10% from the second quarter. However, we expect our gross margin to improve during the quarter.

In summary, I would like to reinforce that we believe our fundamentals remain strong. Our target markets should experience growth and we remain dominant in the IPTV market, and that we redoubling our efforts in developing the strength in 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 Uche Orji – UBS.

Uche Orji – UBS

Can you give us any idea as to, when you describe the market going forward, are there any drivers that could influence gross margin if we look down for the rest of the year. Can you give us any guidance as to what are the factors that will influence gross margin.

Thomas Gay

The dominant factor in the most recent quarter was the customer mix as we saw an increase in our largest Set-Top box customers who because of their size get more aggressive pricing. But as we look forward, we feel that some of our cost reduction efforts will start to offset some of that and that is part of the reason for our guidance of feeling that we should see some increase in our margins going into the next quarter.

Uche Orji – UBS

If I look at your operating expenses, any insight as to if there is any room to take OpEx down? Most companies have been very active at doing that. How should we think about operating expenses with the environment as you've described.

Thomas Gay

We generally feel comfortable with the current levels. There may be some mild increases as we continue to invest in product development and efficiencies.

Uche Orji – UBS

Can you give us any updates on the new opportunities especially on cable TV? Any update on your qualification process and how much progress you're making in this market?

Kenneth Lowe

In general, each quarter we get a little bit further with the various cable operators that we're dealing with. We've spread out to reach quite a number in both North America and Asia and have touched base a little bit in Europe as well.

We feel that the planning process is moving ahead as expected and we believe that some of the more aggressive operators will be making their, moving into trial probably sometime in the first half of next year, and then hopefully if all goes well, moving into early deployments in the second half of next year.

Uche Orji – UBS

On the Set-Top box inventories, I'm not quite sure I understood why there was a spike in IPTV in the second quarter. Are there any comments in terms of what's happening on the inventory side? Can you give us any insight as to how to explain your inventory and also what insight into the China inventory?

Thomas Gay

You're inferring because we jumped up by 25% during the quarter that that's probably an inventory bump.

Uche Orji – UBS

Yes. I just want to know how think about that.

Thomas Gay

On one hand, our visibility is somewhat limited in the exact numbers to what we receive from our OEM's so we don't have a lot of look through to the other side of the deployment chain. But at the same time, we don't see any reason that there would be any substantive inventory build. I think moreover, the vagaries in the quarterly numbers for the IPTV units happens to coincide with customer shipments, in some cases transitions taking place between products and I think that drives a lot of the reason why we will vacillate a little bit while we're at this low growth phase.

Operator

Your next question comes from Scott for Tristan Gerra – Robert W. Baird.

Scott for Tristan Gerra – Robert W. Baird

Could you talk a little bit about what happened in the connected media player business and why that fell off as much as it did?

Kenneth Lowe

We had seen a surge in that area last quarter in Q1 based on a particular customer being very successful with the model that they had developed that started shipping back in our fourth quarter. What they have done is start to tool up and transition to a next generation product based on our next generation chip and so the timing of that transition meant that there was going to be a gap in our revenues during the second quarter.

Scott for Tristan Gerra – Robert W. Baird

So they did do an end of life purchase for their own product. Should we start to see that ramp back up to a pretty decent level any time soon?

Kenneth Lowe

I can't indicate the level but we do expect their participation in the next quarter's revenues.

Scott for Tristan Gerra – Robert W. Baird

On the gross margin guidance, just trying to get a little more color on that. Are you expecting it to be up in the 50 to 100 basis point range or are you expecting it to bounce back to where it was in fiscal first quarter?

Thomas Gay

At this point we'd say somewhere between the two of them.

Scott for Tristan Gerra – Robert W. Baird

So in the 100 to 200 basis point type range?

Thomas Gay

That would be our current guestimate range.

Scott for Tristan Gerra – Robert W. Baird

The 8650 series seems to be doing pretty well. Can you give us what percentage of your IPTV business you'd expect to be 8650 series by year end? Is that going to be kind of in the 20% to 25% shipments or revenues?

Kenneth Lowe

The 8650 series has actually been pretty successful across the board if you look at the range of applications. If you isolate IPTV, we're probably still in the single digits by the time we go through this next couple of quarters for IPTV alone. If you broaden that to include all applications, it's well into the double digits of our products.

Scott for Tristan Gerra – Robert W. Baird

You're talking about this return to growth in IPTV in the second half of 2009, but you expect revenue to be stable. Can you talk about what you're expecting for 2010 growth rate, what we could see as an acceleration and do you see that happening in the fiscal fourth quarter or do you see that happening mostly in the fiscal first quarter of 2010?

Kenneth Lowe

Consistent with the industry analysts, our OEM's believe that next year should offer and increased growth rate over what it has been. Part of that is reflected in their confidence with the Telco's continuing more aggressive activities. Many of the Telco's are just now reaching their stride in terms of their marketing efforts to supplant their competitors.

For instance, AT&T has a new aggressive marketing program for the second half of this year that they're rolling out to promote the Universe service and increase its ramp rate. So I think what we'll see is a resumption in the growth of IPTV. Perhaps not at the level that it was a couple of years ago, but at some reasonable level of growth as it eats its way into cable and satellite.

Scott for Tristan Gerra – Robert W. Baird

Any 10% OEM customers, kind of like Gemtek would be an OEM customer or best guess on that front, and then you mentioned France Telecomm and Telephonica. Are you shipping to either of them currently.

Kenneth Lowe

The two 10% customers we mentioned were Motorola Singapore which is a contract manufacturer and Gemtek also is serving in that capacity in the marketplace.

Scott for Tristan Gerra – Robert W. Baird

France Telecomm and Telephonica you mentioned both of them in your opening statements, so are you shipping to either of those customers currently?

Kenneth Lowe

No, they're not active shipments. What we're trying to do there is provide an overall flavor for the market trends and trying to cover it comprehensively.

Operator

Your next question comes from John Vinh – Collins Stewart.

John Vinh – Collins Stewart

A follow up question on the IPTV bump up in revenues, after the inventory pressure that you experienced last year it seemed that most of your customers had moved to a more of a just in time model for orders. Can you help reconcile the sharp spike in the bump up in IPTV revenues in Q2. I would expect more of a modest ramp through the year. Is it a specific customer that are ordering that, or could you talk about that a little bit more?

Kenneth Lowe

I think we wait until the end of the year to look backwards, it will have looked like a modest ramp. I think what you're seeing is perhaps the orders in the first quarter, the timing of some of the shipments didn't fall correctly so the first quarter looked a little bit dampened. The second quarter as a result then shipments fell advantageously looks a little robust and I think what we're gong to see by the end of the year is that there's this very slight single digit growth line of performance for the year for the IPTV market and that's kind of where we're at.

That's why we're saying we expected, we have 25% IPTV increase this quarter. We'll get a counter balancing effect of a little bit of that in that in the third quarter and then we're hoping that as the year ends, we'll start to see the positive uptick in our order rate whether that connects to our bottom line or not, we don't know, but just the visibility of the market.

John Vinh – Collins Stewart

In terms of your guidance, if you can talk about the segments. It sounds like IPTV will be down next quarter. Do you expect connected media to be up? And just to follow up on the digital question, with the ramp of Western Digital, the next gen box, is there any reasons or what's your visibility in terms of the magnitude of that ramp? Could you get similar run rates on Western Digital that you'd previously seen in previous quarters?

Kenneth Lowe

We'll address the markets and not the customer. The answer is yes and yes. We do expect that IPTV wanders back down a little bit to oscillate around the high 30's per quarter in revenue rate for us and we expect that we will get a pick up in the DMA as the transition gets completed and some of our larger customers move back into production with the newer chips. So there will be offsetting factors there.

John Vinh – Collins Stewart

On the pricing side, my understanding is that most of your larger customers have reached a volume price discounts and pricing on them is obviously a little bit more favorable just given their volumes. Can you comment on how we should be thinking about gross margins going forward? Should we be trimming down gross margins and bottoming out when the 8654 comes in or what's your ability to get back to high 40's gross margin levels over the longer term at this point?

Thomas Gay

The question from Scott just previous to you clarified we do expect a bit of a pick up or benefit in our gross margin in the third quarter as some of our cost reduction efforts and customer mix predictions come into play. Longer term, the transition into the 8650 series, we also have some optimism that that will be beneficial to our gross margin.

John Vinh – Collins Stewart

It seems like in Q3 the gross margin is going to bounce back because the IPTV mix is going to be lower, right? And I'm just thinking longer term once the IPTV mix starts to come back, will your gross margins start to dip back to current levels?

Thomas Gay

As I said, the cost reduction efforts also are part of the mix there, and that's part of the process that we're trying to work at.

John Vinh – Collins Stewart

On Blu-ray, with the 8642, what sort of bottom cost do you think you can hit on that and also can you give us an update on the integrated front end? Are you still working on that at this point?

Kenneth Lowe

It's kind of hard to talk about bottom costs exact targets. It gets into the costing of the products that we deal with, but I guess the best way we could answer that is 8642 enables us to offer a bottom cost that's competitive with just anybody else that's out there. So we don't fear competition from a pricing standpoint and we do have performance advantages, so that's kind of the way we look at it.

John Vinh – Collins Stewart

And on the front end integration?

Kenneth Lowe

We certainly are working with partners on front end solutions and we feel that the business model that we're working within with the partners will end up providing a very nice configured solution.

Operator

Your next question comes from Daniel Amir – Lazard Capital Management.

Daniel Amir – Lazard Capital Management

On the IPTV market, what are your expectations now in terms of units for this year in terms of size of market?

Kenneth Lowe

We didn't roll that up this quarter. We've been kind of looking at things as they run off here. I think we're a little bit off the original chart that had been drawn up a couple of years ago and we updated it last year and to be honest, we really haven't updated it. So I'd rather put off getting back to you with some exact number for that.

Daniel Amir – Lazard Capital Management

Is there any impact here in terms of your guidance and your IPTV outlook related to pricing in the market? Can you comment a bit about what's going on there in terms of ASP's right now?

Kenneth Lowe

Are you saying is our pricing coupled into what we think the market size will be?

Daniel Amir – Lazard Capital Management

No, in terms of what the current environment in terms of ASP's for your chips, declines and is the competitive environment impacting your ASP's?

Kenneth Lowe

I guess in that context the overview I would give is that over the last year to year and a half, there's been an onslaught of competition from Broadcom and certain other people to a smaller extent. We've gone through a certain amount of pricing adjustments in the market in general, finding our way to the right price zone.

At this point in time, most of the competitive offerings are remaining in a similar mid teen zone. There tends to be a movement now towards successive generations that increase the features at those price points. We're also seeing a little bifurcation in the market between the mainstream mid to high performance parts and certain low end markets. So what we're having is low end markets open up and kind of provide diversification.

So I guess the long winded answer is, what we're not seeing is a continual slide down in prices for our mainstream parts. What's happenings is we're bifurcating and creating new low end parts that can address lower end lower feature demand.

Daniel Amir – Lazard Capital Management

On the connect to media player, just to understand, as we look into the January quarter, do we expect the January quarter to be back at the level of what it was in your Q1 level in terms of your customer as it rolls out its new products or was that a one time end of life product that too many orders were ordered at that time and the level is much lower than that?

Thomas Gay

I think it would be a bit optimistic to predict that it would be equal to that level, but we are also trying to penetrate alternative customers and see what we can do to broaden the customer base in the DMA arena now that we've demonstrated our success so we'll just have to see how we can do it continuing with the winner that we have and working with new ones.

Operator

Your next question comes from Sukhi Nagesh – Deutsche Bank.

Sukhi Nagesh – Deutsche Bank

Can you provide a little bit more clarity on the OpEx going forward in term of how we should model it?

Thomas Gay

Our general trend for R&D is to have a 5% quarter over quarter growth there as we continue to roll out new products and mild head count growth. This quarter we were a little below that. Our sales and marketing tends to be a little seasonal according to shows and promotional activities and things like that, but a mild up tick, maybe 2% or so quarter over quarter is a big picture trend.

G&A, if you look at the non-GAAP number, you'll see that we were down almost a half million over Q1 where we had year end expenses that tend to surge at that point with the audit and some of the filings and things that go on. So we expect G&A in Q2 to be similarly down from where it is at year end and then Q4 will once again start to suffer from some of those seasonal expenses.

Sukhi Nagesh – Deutsche Bank

On the revenue side, I thought I heard you say you expect either revenues to grow this year or was it more units?

Kenneth Lowe

Units have been growing. I think revenue is going to, the general expectation is by the time we look at the end of the year that we're in single digit growth.

Sukhi Nagesh – Deutsche Bank

I would assume given what you guided for fiscal third quarter being down 5% to 10%, you would by definition be a nice double digit come back in the January quarter. Is that fair to assume?

Kenneth Lowe

It's possible. We don't want to address it directly. We don't really have total visibility at this point, but we would like to believe that the market starts showing us its strength for next year before we actually end this year. Whether or not we see a whole quarter of that strength in growth or just a month, we don't really have a firm projection at this point.

Sukhi Nagesh – Deutsche Bank

On the gross margin front, did you say that it would improve by about 150 basis points for the fiscal third quarter?

Thomas Gay

That's more or less in the middle of the range that we're shooting for at this point.

Sukhi Nagesh – Deutsche Bank

Is it reasonable to assume that it will improve in the January quarter as well?

Thomas Gay

Too soon to predict.

Sukhi Nagesh – Deutsche Bank

Are you going to be building inventory this quarter?

Thomas Gay

I believe that the current inventory level is probably an ideal one for us and we'll be making efforts to maintain it.

Sukhi Nagesh – Deutsche Bank

In terms of your confidence for the January quarter being a snap back, AT&T's net sub ads were actually down 18% Q on Q for the June quarter and from everything we seem to understand, I think you have as well, they seem to have dampened down some of their roll outs. It just seems like, what gives you confidence for the January quarter to see a snap back in IPTV revenues?

Thomas Gay

I think the bottom line there is just that the projections and discussions that we have with our OEM's. The OEM's at large are giving us the feeling that we're going to see a little bit better performance as we hit the end of the year.

Kenneth Lowe

AT&T is rolling out a rather aggressive campaign of promotions right now and I believe that some of their forecasts are starting to reflect their hope that that will get them on a growth phase, so that may be one of the factors that we're starting to get mild indicators of.

Operator

Your next question comes from Gary Mobley – Noble Financial Group.

Gary Mobley – Noble Financial Group

I was hoping that you could give us a little more detail on the significance of your android development efforts and how you expect to utilize android to position yourself vis a vis your competitors and IPTV, how this, the Microsoft strategy for development. And then with respect to R&D focus, when you look at your R&D spending now compared to last year, what has been some of the most notable changes? Are you at a maintenance spend rate for the IP end market? Is it more of your focus on two way? Just a little clarity would be helpful.

Kenneth Lowe

On the android question, android has provided a very high quality packaged version of Linux that's brought by Google which gives it some play in the market and has gone very well in the mobile space. That popularity in the mobile space has now spilled over to the consumer space and we have a lot of our customers and partners that want to move ahead with product offerings t here.

It makes for a lot cleaner development environment and released product, so it is something that we are jumping on. We have partners that want to very heavily focus on it and so we are taking advantage of all the popularity it's creating right now.

What it really means is that it's a slightly different version of Linux we're supporting and from a software standpoint, it only affects the lower layer of the operating system and doesn't affect the upper layers of code that we provide with our solution.

From an R&D strategy standpoint, I don't think our R&D strategy has changed very much at all. We're still focused on coming out with some of the highest performance chips that can be re-purposed for multiple markets and we're still focused on complete solutions in the target applications that we go after with those. So in general, that's the 20,000 foot level of what our strategy is.

Thomas Gay

Looking back one year, you will need to take into account that we have added the Zensus R&D group which is largely in the R&D expense category. Also we have increased the rate of tape outs as we're developing more products. That's been an effort that's increased a bit in the last year, so two very specific factors as well as just generally trying to be efficient.

Operator

Your next question comes from Hamed Khorsand – BWS Financial.

Hamed Khorsand – BWS Financial

When will we see the 8654 receive Microsoft certification?

Kenneth Lowe

I guess the general answer to that is that both Broadcom and Sigma are embroiled in efforts with Microsoft to validate and get ready to ship Set-Top boxes with Telco and Set-Top box customers so we're basically mired in the same process as they are. At the end of the day, it all has to do with getting a box out into deployment with a specific Telco with them.

I would say at this stage of the game, it is very likely that both Broadcom and Sigma will be deploying second generation products next year. It depends on which Telco and what timing and that's more detail than we can reveal.

Hamed Khorsand – BWS Financial

Throughout the call you've been talking about visibility and clarity, and I'm trying to understand what's giving you the confidence? What do you see and what are you hearing that you're now being a little bit more optimistic with the clarity and visibility that you're saying?

Kenneth Lowe

I think part of it is we've gone through the, we believe we've gone through the bottom or trough of the demand malaise on the market as a result of the economic impact. So we believe that next year, 2010 is going to offer more opportunities, and this year it's going to offer additional, there's going to be additional pushes by a lot of people to incentivize revenue growth and we think we'll be the beneficiary of that.

Incentive programs are being offered by AT&T, Duetsche Telecomm goes in and out of the market with incentive programs. We have incentive programs from the Korean government that has helped push like I mentioned, 127,000 units in July alone. There's a lot going on to try to boot strap the economy and we think as a chip supplier, we get the benefit of a certain amount of that.

Hamed Khorsand – BWS Financial

Last year you took on a lot of inventory like the 8634. Now that your inventory levels have come down, how much of your inventory is split between the 34 and the 50 series?

Thomas Gay

It's still too early to be stocked up too deeply in the 8650 series. We are also starting to get some qualification levels and preliminary runs of the 8640 series, but we know that the 8634 is going to continue to ship for years to come, so we're still comfortable with any inventory that we have there.

Hamed Khorsand – BWS Financial

And incremental new orders that you make to fill your inventory levels, are they going to be at optimal cost levels to keep your gross margins stable?

Thomas Gay

We continue to press for better costs each time we order, so as conditions change, capacities shift and we move to the next technology node, the mix shifts and we hope to come out with a better cost every time.

Operator

Your next question comes from Quinn Bolton – Needham & Company.

Quinn Bolton – Needham & Company

I just wanted to clarify again, when you're talking about single digit growth, is that for Sigma and is that on a revenue basis or is that TV market on a unit basis?

Kenneth Lowe

We were actually talking about the IPTV market on a revenue basis, so the total market units times ASP.

Quinn Bolton – Needham & Company

So not necessarily your comments, we shouldn't necessarily be saying that your growth year on year will be up low digit single percentage year over year in fiscal 2010.

Kenneth Lowe

No. We're not trying to create a growth statement vis a vis our own revenue. We were just talking about the IPTV market.

Quinn Bolton – Needham & Company

One of the drivers for the improved gross margin was some cost reductions. It sounds like that must be on wafer prices or test assembly on the 8634 rather than mix shift to say the 40 series or the 50 series, but again I just wanted to clarify, if you could [inaudible] cost reduction actions.

Thomas Gay

That's correct. The 8634 is still the majority of our revenues and the efforts that we make to reduce any of those cost elements would have its effect in the next quarter or two.

Quinn Bolton – Needham & Company

Has there been any [inaudible] of the 8634 to a smaller process geometry or is it still on the original process geometry?

Kenneth Lowe

It's still on the original and the future generations are on the smaller geometry.

Quinn Bolton – Needham & Company

In your prepared comments you talked a little bit about the 3.0 and the IPTV functionality and cable. I was wondering if you're also seeing any interest in your parts for a low end digital Set-Top box in some of the cable operators look at analog spectrum and try to go to all digital signals down the coax cable. Is that also an opportunity or are you really most engaged just on some of the higher end 3.0 IPTV related set tops.

Kenneth Lowe

We're primarily focused on the movement to [Doxus] and through two-way as a whole new solution transition for the cable industry. But at the same time, one of the things that we're gaining a lot of traction in, is for generic thin client solutions. We've got some very aggressively positioned chips and good software to go with it for creating a thin client that's as efficient as anybody can create out there.

Opportunities like the transition to low end digital Set-Top boxes would be something we could address. Whether or not it would be fruitful, we don't know at this time.

Operator

Your next question comes from Dunham Winoto – Avian Research.

Dunham Winoto – Avian Research

I was wondering if you could give us some additional clarification as to what your opportunity might be in a [Doxus] versus what you have in the IPTV so we have a better idea how to model going forward.

Kenneth Lowe

The cable market is a few times larger than IPTV and we believe eventually the vast majority of cable will transition to either a hybrid or IP based approach. So we believe over time the entire TAM of the cable market becomes part of our target board.

Dunham Winoto – Avian Research

What do you think your opportunity would be in that market? There's obviously a lot more players in that market as opposed to the IPTV space.

Kenneth Lowe

We're targeting this because it is a big opportunity. We do have the technology to play and we would like to believe that we will become a significant player. To us, being a significant player means that if there's three major players, then we want at least our fair share or more, so we'd like to be able to think that eventually we could get up to a third of the market.

But that's a long term goal. Certainly we have to establish ourselves, then we have to further penetrate and we have to set up barriers to entry for the other guys. So it's a long term goal.

Dunham Winoto – Avian Research

I don't know if I heard you correctly, but I wanted to talk a little bit more about the Blu-ray space. Did you say that you have products that are about to ship that will be targeting the value of mainstream segment? Did I hear that right?

Kenneth Lowe

We have products that are capable shipping today that can address the mainstream of Blu-ray and we certainly are engaged with both our older customers, the top consumer vendors as well as other customers that we're trying to get this planted into. So we're certainly hoping that we will continue to gain progress in that area.

Dunham Winoto – Avian Research

Is that a change from what you have been thinking, because I was under the impression that because of the direction the market is taking, that you had shifted your focus more on the high end segment of the Blu-ray space.

Kenneth Lowe

We had a strategy that allowed us to tap into, uniquely allowed us to tap into the high end and we felt that we certainly want to take advantage of that, but as time moved on we also found that our mainstream solution could be just as competitive as anybody else's so we've put that into certain opportunities, then we become aware that there's some softness within some of the customers out there for the current solution we're shipping.

So we felt that we might as well press out advantage while we can and see if we can add a little bit more opportunity there.

Dunham Winoto – Avian Research

Everyone has been waiting for Blu-ray to go mainstream but it seems that the wait has been forever. Can you give us any more thoughts as to what you think? Prices have come down quite a lot. Content maybe hasn't come down quite as much. But what do you think would be critical for this thing to start taking off?

Kenneth Lowe

I think it's kind of a matter of the cross over timing between what the industry offers and where the consumer is at economically. While the consumer is economically pressed right now, buying DVD's for an average of $6.99 seems very attractive. As we come out of the economic malaise and as the Blu-ray market heats up to try to increase its share and the content manufacturers decide it's better to sell a Blu-ray for $15.00 than to sell DVD's at $7.00, then you'll start to see the volume start to pick up. Blu-ray starts to replace DVD, everybody sees it as mainstream then.

It's probably not in the next year, but it's probably not any more than a couple of years out.

Operator

This concludes the question and answer portion of today's conference. I would now like to turn the call back over to Ed McGregor for any closing remarks.

Ed McGregor

We would like to thank everybody for attending our conference call to discuss our results for our second fiscal quarter 2010. We do appreciate your interest in Sigma and we do look forward to our next scheduled conference call to discuss our third fiscal quarter results for 2010. Thanks a lot.

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Source: Sigma Designs Inc. Q2 2010 Earnings Call Transcript
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