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Sigma Designs, Inc. (NASDAQ:SIGM)

F4Q2014 Earnings Conference Call

April 9, 2014 5:00 PM ET

Executives

Ken Lowe – VP, Strategic Marketing

Thinh Tran – CEO

Elias Nader – CFO

Mustafa Ozgen – VP and General Manager of Home Multimedia Products

Analysts

Hamed Khorsand – BWS Financial

Quinn Bolton – Needham & Co.

Dan Scovel – Edison Group

Operator

Good day, ladies and gentlemen, and welcome to the Q4 2014 Sigma Designs earnings conference call.

My name is Jasmine [ph] and I will be your operator for today. (Operator Instructions)

I would now like to turn the conference over to your host for today, Mr. Ken Lowe, Vice President, Strategic Marketing. Please proceed.

Ken Lowe

Thank you. Welcome to Sigma Designs conference call to discuss financial results for our fourth fiscal quarter and yearend of 2014. I'm Ken Lowe, Sigma's Vice President of Strategic Marketing. With me today are Thinh Tran, Sigma's CEO; Elias Nader, Sigma's CFO; and Mustafa Ozgen, Vice President and General Manager of Home Multimedia Products.

The press release containing the quarterly results was just released on the wire today at 2:00 p.m., after experiencing some technical delays at MarketWire. The release is also available in the Investors section of our website.

Today's agenda will begin with my introduction, a review of financials by Elias, an executive overview by Thinh, a strategic update by myself, and finally, our forward guidance by Thinh. Then we'll open the call to questions from analysts and institutional investors. We expect to conclude the call within one hour.

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

The outlook factors that may affect our business and future results are detailed from time to time in Sigma's SEC reports, including Sigma's quarterly report on Form 10-Q, as filed with the SEC on December 12, 2013. A partial list of these important risk factors are 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'll 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 the detailed reconciliation of our GAAP to non-GAAP results.

With that, I'll turn it over to Elias.

Elias Nader

Thank you, Ken. Good afternoon everyone.

Net revenues for the fourth quarter of fiscal 2014 was $38.5 million, a decrease of $15.9 million or 29.2% compared to $54.4 million in the previous quarter. Compared to the year-ago quarter, our revenue decreased $5.7 million or 12.9% from $44.2 million. Net revenue for fiscal year 2014 was $199.2 million, a decrease of $17.4 million or 8% from $216.6 million in the previous year.

Our revenue breakout for the quarter are as follows. I'll go over this by target market and percentage of total revenues for the fourth quarter. DTV, $6.2 million or 16%. Set-top box $8.1 million or 21%. Home networking $13.8 million or 36%. Home control $4.3 million or 11%. License and other $6.1 million or 16%.

Gross margins. GAAP gross margins were 57.3% for the fourth quarter compared to 57.1% in the preceding quarter and 31.4% in the same quarter last year. GAAP gross margins were 54.3% for the fiscal year 2014, compared to 42% in the previous year.

Non-GAAP gross margins were 61.1% for the fourth quarter, compared to 59.3% in the preceding quarter and 46.2% in the same period last year. Non-GAAP gross margins were 57.5% for the fiscal year 2014 compared to 49.1% in the previous year.

Operating expenses. In the fourth quarter, our non-GAAP operating expenses decreased by approximately $1.5 million to $24.4 million compared to the previous quarter, mainly due to continued reductions in labor and labor-related expenses and other variable operating expenses. The non-GAAP operating expenses in the fiscal year decreased by $38.9 million to $105.5 million compared to the previous year. Since announcing our restructuring in the third quarter of fiscal 2013, we have reduced our operating expenses on an annualized basis by more than $40 million.

Mr. Tran will cover our forward guidance in more detail toward the end of our call, but I wanted to spend a moment discussing where we see our operating expenses next quarter in light of the extreme amount of attention we have paid to lowering our operating expenses over the last year and our continued rigor in this area.

While we continue to believe we must size our operating expenses with our revenue levels to make profitability, we do anticipate an increase in operating expenses of approximately 5% next quarter, primarily due to certain amortization of design tools we took delivery of late in the fourth quarter.

GAAP net loss and non-GAAP net loss and earnings. The GAAP net income for the fourth quarter of fiscal 2014 was $1.3 million or $0.04 per share. This compares to a GAAP net loss of $3 million or $0.09 per share in the previous quarter and a GAAP net loss of $35.2 million or $1.04 per share in the year-ago quarter. The GAAP net loss for fiscal year 2014 was $11 million or $0.32 per share. This compares to GAAP net loss of $101.8 million or $3.06 per share in the previous year.

Had it not been for $6.5 million benefit recorded for income tax provision, in the fourth quarter our GAAP net loss, in the fourth quarter, would have been $5.2 million. And had we not recorded a $3 million provision for income taxes for the whole year, our net loss would have been $8.4 million for the fiscal year. In the fourth quarter we reached settlements with two tax authorities that allowed us to reduce our income tax provision by $5.4 million on a GAAP basis.

The non-GAAP net loss in the fourth quarter was $4.5 million or $0.13 per share. This compares to a non-GAAP net income of $3.3 million or $0.10 per share in the previous quarter, and a non-GAAP net loss of $18 million or $0.53 per share in the year-ago quarter. On a non-GAAP basis, the net income for fiscal year 2014 was $1.1 million or $0.03 per share. This compares to a net GAAP net loss of $40.3 million or $1.21 per share in the previous year.

Had it not been for $3.8 million provision for income taxes recorded in the fourth quarter, our non-GAAP net loss would have been $700,000. And had we not recorded an $8.8 million provision for income taxes for the fiscal year, our non-GAAP net income would have been $9.9 million. Please refer to our press release for a detailed reconciliation of our GAAP to non-GAAP performance.

Now I'd like to cover a few areas on our balance sheet. Cash, cash equivalents, restricted cash and marketable securities totaled $89.4 million at the end of the fourth quarter, an increase of $1.3 million compared to the end of the last quarter. And we used $2.3 million to purchase shares under the buyback program that we announced during the quarter.

Net accounts receivable was $27.6 million at the end of the fourth quarter, a decrease of $11.6 million compared to the previous quarter, primarily due to a decrease in revenue of $15.9 million and, to a lesser extent, the timing of collections.

The average day sales outstanding, which is DSO, for our receivables, as of the end of the fourth quarter, was 65 days, which was the same as compared to the previous quarter. Net inventory was $20.4 million at the end of the quarter compared to $19.2 million in the previous quarter, an increase of $1.2 million. The increase in inventory was due to purchases of wafers for anticipated revenue in the first half of FY15. This brings our inventory turns for the quarter to 4.5 on an annualized basis, compared to 5.5 in the previous quarter.

Our trade payables were $16.2 million at the end of the quarter, compared to $12.6 million in the previous quarter, an increase of $3.6 million. Our trade payables include an invoice receipt and accruals. The increase in trade payables was mainly due to the timing difference of payments. Now I will turn the call over to Mr. Tran for an executive overview.

Thinh Tran

Thank you, Elias. I would like to start by thanking all of you for joining us today, and for your continued interest in Sigma. Since Elias has summarized our financial performance for the fourth quarter, I would like to take a more broad perspective of our company performance over the entire year we just completed.

Though fiscal 2014 was a challenging year in many ways, we are pleased with a number of results we achieved which are consistent with the commitment we made at the beginning of this year.

First, we were profitable on a non-GAAP basis for the fiscal year, a reflection of our dedication in maintaining a balance between expense and revenue. Our gross margins were strong, achieving an annualized non-GAAP average of 57.5% for the year, indicating the demand for our product is based on the differential features we offer.

Our operating expense was dramatically reduced, with nearly $39 million in savings over the prior year, demonstrating strong gain in efficiencies, reflecting the commitment we made at this time last year. While we must continue to be diligent in managing our operating expense at this new run rate, we intend to increase our focus on business development and top-line growth.

Last year our revenue grew sequentially during the first three quarters, before hitting a decline in fourth quarter, resulting in 8% decrease of fiscal 2014 from fiscal 2013. Securing top-line growth will be a priority as we move ahead into fiscal 2015 while we continue to keep our expense levels in check.

From business unit standpoint, our Home Multimedia business unit contributed $88 million of revenue for the year. $49.5 million of this came from the DTV product line which has been in the midst of a transition from legacy product business to new higher ASPs, smart TV SOCs. $38.5 million of this came from set-top box product line, which also went through its transition to new-generation SOCs for the mainstream IPTV segment.

Our home networking business contributed $73 million in revenue for the year, provided largely by the staying power of our legacy HVNA [ph] products. Our home control business contributed $20.7 million of revenue for the year, which achieved material gains from major service provider deployment while IP licensing program contribute $17.4 million in margin-rich revenue for the year, relative new business segment for us, but we would like to maintain as part of our portfolio.

Now let's review some of our major accomplishments over the year. During last year we were able to bring a variety of innovative new products to the market, mainly with key features on the leading-edge emerging market demand. We launched our new-generation Z-Wave 500 Series product portfolio, with new chips that offer over a 50% improvement in range, data read and power, supported by the Z-Wave software suite which now support IP protocol as well.

We launched several new digital TV chipsets including the new SX series or SmartTV processors, which is the first fully integrated SOC chip for smart television designed to support Ultra HD video with full 4K x 2K resolution. And our FRCX single-chip Ultra HD frame rate conversion chip which combine the functionality of as many as five devices into a single chip to reduce overall BOM costs and improve performance.

We launched a powerful new family of new-generation chipset for the set-top box market, which feature high-performance ARM processor, 3D graphics and the support of the HEVC coding standard, offering a competitive combination of performance and user experience and these are already winning new designs. In the connectivity line, we achieved certification of HomeGrid and TR-069 remote management capability for our second-generation G.hn chipset, validating the quality of our solution.

We also announced a number of industry partnerships to extend the depth of our solution, including the addition of biometric security [ph] and wide-play [ph] middleware support for our set-top box SOC family, to provide complete solutions to our customer. Mitsumi, as licensed second source for Z-Wave 500 series. This is a significant step into broadening the Z-Wave ecosystem as industry participants that has a comfort of a second supplier and is a necessary step in the natural evolution of Z-Wave standard as we continue to receive broader market acceptance.

Throughout the year we achieved many design wins including AT&T Digital Life launch using our Z-Wave and HomePlugAV chipset. Digital Life is a major initiative at AT&T and one of the most highly recognized home control offerings by major telecommunication service providers.

Centurylink, use our Z-Wave device to provide home automation services. Portuguese leader Novabase for HBBTV compliant set-top box to support hybrid set-top box market that deliver OTT services.

Pace began shipment of gen-2 set-top box for Mediaroom for the North and Latin America. G.hn Powerline network adaptors designed to product by ZTE, PMW and STMT [ph], creating the ecosystem for service providers as G.hn is gaining market acceptance. Belgium cable leader Telenet and Israeli provider Yes using our HomePlugAV chipset to roll out powerline connectivity solution to new markets.

In summary, we are proud of the existing, exciting technology we have developed, and feel that we are in position to strongly focus on customer adoption throughout the coming year. The strong margin and the restructuring -- restructured operating expense run rate, we remain committed to profitability for fiscal 2015 while focusing on top-line growth.

Now I would like to pass the call to Ken Lowe who will give you an update on our Sigma new products [indiscernible] the market trend and the industry.

Ken Lowe

Thank you, Thinh. As we move forward into a new fiscal year, I'd like to provide our future outlook, including the key market trends affecting the industry and our business strategy to achieve success.

To start with, we believe that Sigma has a strong future growth opportunity that's driven by several mega-trends in the industry which we're uniquely positioned to take advantage of. Looking out over the next several years, we believe that the outlook for our product shows increasing strength as follows.

First, our Z-Wave product line should experience strong growth over the next several years, driven by our leading market position in home control, widespread operator adoption, and an expanding industry thrust to support the internet of things. Second, our Digital TV product line should experience strong growth over the next several years, driven by advantages in picture quality, penetration in key accounts, and our leading technology support for the 4K resolution trend.

Third, our set-top box product line should experience mild growth, driven by our position in the media room segment, our penetration of emerging markets, and our strategies for cloud-based delivery. And fourth, our connectivity product line should experience mild decline, driven by some increasing migration to wireless technologies over the next several years, and offset somewhat by the growth of G.hn deployment.

To dig deeper into our long-term expectations, let's examine the key market trends and the drivers behind them. At this time, three mega-trends have emerged that will shape the opportunities for our industry over the next decade. These trends are the Internet of things, ultra high-definition video, and cloud technology.

The Internet of things is one of the largest movement in the electronics industry since the onset of cell phones, that's expected to drive shipments for many billions of devices over the next several years. It centers around everyday objects becoming connected that will enable to monitor and/or control widely-distributed activities for improving quality of life, business efficiency, and reducing overall risk.

Momentum is building quickly in this arena, includes moves such as Google's $3.2 billion acquisition of Nest Lab, key technology launches at CES2014 by industry leaders such as Qualcomm, Intel, Samsung and others, and widening deployments of the world's largest service providers [in retail] [ph].

Because this trend revolves around a new basis of connectivity for a wide range of devices that will be used in our homes, in our business and our persons, the key success factors for competing products will be, one, a low-power, secure, smart appliance platform; two, a widespread ecosystem of plug-and-play devices; and three, adoption by both service providers and major retail outlets.

Based on the velocity of this trend, the key success factors and competitive offerings, we believe Sigma's Z-Wave product line is well-positioned to capitalize on the growth of internet of things. Let's look at the facts.

Z-Wave has over 25 million products installed in the market, far exceeding any other home control technology. With applications such as CD remote controls and utility meters use similar technologies, that often result in misguided impressions of the market. The real demand is centered around home monitoring and control which is where Z-Wave dominates.

The Z-Wave ecosystem includes over a thousand devices across the broad spectrum of functionality and all certified as interoperable for the 350 manufacturers supporting them. The Z-Wave adoption includes deployments for market leaders AT&T, Verizon, Centurylink, Vivint and ADT, as well as mass retailers such as Amazon, Lowe's and Staples.

During this last year, our customer engagements for Z-Wave business has taken off with a total of nine major service providers in the process of deployment, and double that number, engaged in evaluation and planning.

The new Z-Wave 500 series provides a solid fifth-generation platform with ultra low-power wireless chipsets, network management tools and full software suite that makes adoption of these extremely simple.

Furthermore, Z-Wave products are now being software included in certain smart TV and set-top box product, creating additional synergies with our other product lines. In summary, we have all the indications that our Z-Wave business will show substantial growth in run rate and revenue over the next several years.

The industry move into ultra-high definition is beginning to take hold and is also propelling us for the next evolutionary step in television. This movement is connected to the underlying ATVC decoder technology that's required to deliver the higher resolution, and also results in more efficient use of home bandwidth. Each layer of the video ecosystem is impacted by this trend.

Consumers are drawn to the increasingly life-like images which get rendered by the new ultra-high 4K by 2K resolution. The TV industry is fully embracing the new 4K resolution and taking advantage of this opportunity to upsell customers to ultra large screens that reach 80 inches and more in size.

Service providers are in the process of planning the rollout of ultra HD offerings which not only offers special appeal to viewers of sports and movies but will also become an enabler for more intensive website interaction. Content providers are also providing their new slate of [ph] offerings that will expand their product lines from DVD to Blu-ray, to ultra HD.

Leveraging these trends, Sigma has a strong opportunity to become a leader in the ultra-high definition TV market. Our products have long been recognized with superior picture quality based on proprietary algorithms and rigorous testing. Our DTV line of chips have millions of units installed, is expected to continue to grow over the coming year based on top-tier smart TV design wins we've achieved during this past year [indiscernible] design wins at multiple top-tier TV vendors in the U.S., Europe and Asia.

Adding to this list were our technology partnership with U.S. streaming leader Roku to provide the chip for the first Roku TV model, a new class of smart TVs that feature the Roku OS and are fully Internet streaming ready. These TVs will be made by a couple of Asian DTV manufacturers, planning mass production in the second half of this year.

Supporting this increase in momentum is our new family of ultra-high definition smart TV chipsets which are a more powerful line of ARM-based SOCs that support the new ATVC standard, the 4K resolution output, and offering unique advantages in picture quality.

Furthermore, the 4K video processing and ATVC standards have been leveraged into our set-top box product line, providing directly-used leverage of these groundbreaking technologies. As a result, more customers are engaging the Sigma for the unique capabilities can offer, and we expect this to increase over time as 4K expands to become a larger portion of television volumes.

Cloud-based TV services have existed for many years. However, recent trends in the service sector show rapid movements for cloud computing, fully centralized, the control service features, user interface and stored content, while improving efficiency through the use of virtual servers. This trend will have a dramatic effect on set-top boxes and the retail VMA cousins, as more providers take advantage of this technology.

Homes are likely to continue to move toward gateway client topologies, where gateways connect to the internet services on one side and enable home devices to access content on the other. For managing user interface, HTML5 is becoming a dominant standard across a myriad of PC, mobile and set-top devices. This enables cloud-based services to be rendered on any local device that supports HTML5. This will ultimately result in a convergence of application processor technology and open up new device opportunities.

As a result, the central theme emerging is towards common platforms that can efficiently support the new industry standards as part of the set-top box DMA or television set. Furthermore, this movement will propel nearly all providers to embrace the IP streaming as the dominant delivery method, a technology that plays advantageously into Sigma's strengths.

Leveraging our market position and in-depth technology, we expect our set-top box business to grow in the future. Sigma set-top SOCs have an industry-leading position in IP streaming applications, with over 35 million devices deployed in worldwide applications. We're regaining momentum with major new wins in the media room space and expect this to be a growing segment of our business for the next several years.

We're also gaining momentum in emerging market areas including several government-sponsored programs in Latin America and the expansion of internet television use in Russia. Our set-top box solution include one of the most advanced audio/video rendering systems with ATVC decoding, ultra HD resolution, and proven carrier-class reliability.

Sigma's latest chips are targeted for the new cloud-driven strategy, with a proven HTML5 stack, high-performance on processors, and 3D graphics engines, all integrated into a strong value offering.

Furthermore, Sigma's unique position to help providers reach their goal of CPE [ph] cost reduction by offering smart TV chips that enable future TVs to become service-ready, eventually eliminating excess hardware cost. As a result, more providers are engaging with Sigma for the user experience and value proposition our solutions represent.

Wrapping up our product line review for connectivity, our HPMA and HPAD products are continuing to ship in material volume while our G.hn solutions are in field trials for two of the largest service providers in the U.S. and China.

As a result, we believe that our DTV, set-top box and home control product lines will continue to strengthen their market positions and contribute to the long-term growth of Sigma's top line.

Now I'd like to pass it Thinh for our future guidance.

Thinh Tran

Thank you, Ken. Though we are confident with our strategy and long-term prospect for the growth, we are still being affected by product transition in the near term. We will begin to see the impact that Ken discussed in the second half of this year as we position ourselves now to compete for these opportunities.

Now our look for the major product line in the first quarter are as follows. In set-top box, we expect demand to decrease due to year opening inventory adjustment made by service providers. In DTV, we expect demand to decrease due to typical seasonal slowness in the first quarter. In home networking, we expect demand to increase due to a surge in provider deployment. In home control, we expect demand to increase as service providers begin to ramp up their offerings or tools [ph].

Translating this into formal guidance for the first quarter, we expect total revenues for the quarter to be approximately $35 million to $38 million. We expect pro forma gross margins for the quarter to be between 54% to 56%, because of lower license revenues and the change in product mix. We expect pro forma operating expense for the quarter to be approximately $25.5 million, a 5% increase quarter over quarter, primarily due to certain amortization of design [indiscernible] we took delivery late in the fourth quarter.

In summary, I would like to underscore our commitment to growing our top line over the course of the year, while achieving overall profitability for fiscal 2015. We intend to continue to monitor our operating expense closely, while making investment necessary to capitalize on the market trends we have discussed today.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

And your first question comes from the line of Hamed Khorsand with BWS Financial. Please proceed.

Hamed Khorsand – BWS Financial

Hi guys. First off, just given where revenue fell in this past quarter and guidance, I mean is it practical to suggest, I mean, you're getting pushed out of your markets? I mean the revenues have just been falling off, especially in DTV and the set-top box business, quite considerably.

Ken Lowe

Yes, I know it may appear like that from the outside, but in fact we're not getting pushed out of the markets. What's really happening is that over the course of the last year or so we've been reformulating our product lines and we've been moving from a set of legacy products on the DTV side that was inherited, and on the set-top box side, that had moved past its timeframe, to a set of new product lines. And those new product lines feature much more powerful processors, much more industry-leading capabilities. And we're just now building the revenue underneath those products.

So what we're seeing is a race in time between the new products ramping up and the old legacy products ramping down. And sometimes we win that race and sometimes we don't win that race. So --

Hamed Khorsand – BWS Financial

I guess what I'm trying to get to, let's focus on the set-top box business. I mean, service providers have been talking about upgrade cycle for a while now and some have implemented that upgrade cycle, right? So why is it that it's not trickling down to? Because I mean they're still selling set-top box. That's -- I mean they're still getting customers, it's still a liquid form and everyone's, you know, still has viewing TV or accessing the Internet at different customers worldwide. So I just can't put the two and two together. Why is it not happening with you guys? I mean, how much of a price decrease are you guys seeing?

Ken Lowe

Well, I'm sorting through that question, I'd say the way that we look at it is that the transition is a continual one. A new generation begins and then it begins a series of transitions that start with the largest of the providers. In our space, that means people like AT&T. And then it starts trickling down to the next tier down and the next tier down.

So over the course of the last several years, we've continued to battle for design wins in the newer generation with our product lines. And last year and throughout this year, we're going to see the growth of those design wins. It's just one of the byproducts of set-top box is the timeframes are naturally long, but it's made even more challenging by the fact that in the media room space, the qualification cycles are exceedingly long. And so it just exacerbates the problem.

Hamed Khorsand – BWS Financial

Okay. I mean, is there any slowdown as far as at the service provider level or as far as these new gateway technology everyone is using? Or, you know, your implementation -- or it's a wrong word -- integration to a Comcast RDK count format, will that have any impact on you guys?

Ken Lowe

No, not the Comcast integration. We do see, you know, a couple of years ago there was a little bit of pause in the IPTV market. I think we've resumed seeing growth. And I think that the market has enough strength and I think that, you know, there are competitors that are entering, validating the market. I think what we're seeing is again just the timing of getting the growth funneled into our revenue. So I think, you know, we have not seen that much ASP erosion as of late. We're seeing fairly good stability as we move throughout next year in the products.

So our focus really is on capitalizing on the customer adoptions that we already have at hand and trying to gain more of them as we move into -- there's even a further generation that's coming up in another year and a half or so. So that's --

Hamed Khorsand – BWS Financial

Okay.

Ken Lowe

-- right now.

Hamed Khorsand – BWS Financial

My last question, given if you look back to last fiscal year and your outlook that you provided for second half of that year, and now you look at this year, you're saying, given the outlook for better second half, how much more confident are you that we're going to see that bump in revenue in this second half coming along?

Ken Lowe

Well, I think that we'd characterize the space that we're in, and I think we're very confident that we have the design wins in place at this point in time that'll fuel the second half of this year, right? There are always risks. We don't want to undermine the risks that exist. But, you know, at this point in time, everything looks fairly solid within the spaces that we're in at this point in time.

Hamed Khorsand – BWS Financial

Okay, great. Thank you guys.

Operator

And your next question comes from the line of Quinn Bolton with Needham. Please proceed.

Quinn Bolton – Needham & Co.

Hi guys. Can you hear me?

Thinh Tran

Yes.

Ken Lowe

Hey, Quinn.

Quinn Bolton – Needham & Co.

Perfect. Hey, first question, I just want to make sure I have sort of your annual guidance or annual sort of goal for fiscal 2015 downright. You guys I think had said a couple of times that your goal is to grow revenue on a year-over-year basis. Is that correct?

Elias Nader

Correct.

Quinn Bolton – Needham & Co.

Okay. So if you're starting the year at sort of a 35 to 38 run rate, you need to get to about $200 million, it certainly sounds like you need to be looking at a $60 million plus quarter in Q3, Q4. Just the way the math works out, it's, you know, it sounds like you're comfortable with that kind of ramp from first half into second half.

Elias Nader

Correct.

Quinn Bolton – Needham & Co.

Okay. Given that you talked about two businesses that are going to see strong growth going forward, one is the Z-Wave business or home control, the other being DTV, my guess is that a lot of that revenue growth probably is going to be dependent on DTV just because it's a much larger TAM. Can you give us any sense of your design wins or traction with the new SX and FRCX products for 4K? Is it going to be driven by 4K, or do you have some 1080p designs that also contribute to that second half ramp?

Ken Lowe

We have both. The 1080p designs have existed and that's what's carrying us right now. And the 4K is where all of our momentum is building. We have a unique position right now in 4K. we've offered some of the strongest picture quality capability in 4K that exists in the industry. So we actually are getting pulled into customers because of that.

That strength in DTV will build in the second and third quarter, and we will have a more traditional year this year where we see a substantive bump in the third quarter, as you would normally expect from somebody that's selling into the seasonal DTV market. So our, yes, our FRCX chip is the solution people use today to push quality up and achieve the 4K. And our SX6 product line is what we just rolled out at CES, and that will be the SOC that integrates together at a higher level that allows us to push down in the lower-end SKUs.

Quinn Bolton – Needham & Co.

Okay. Just somewhat historically the digital TV business is run at lower gross margins than I think many of the other product lines. Do you anticipate any sort of shift in the margin profile of the business as that DTV becomes I think a much more substantial part of the revenue in the second and third fiscal quarters?

Ken Lowe

Probably the easiest way to answer that would be that if we -- right now we do not anticipate a shift in the ASP for that product line, but if -- and the margins that result from that. But if we did, it would come at the benefit of volume. If we achieve some lower -- midrange to lower SKUs with some of the major vendors, we probably would end up sliding down on the ASP, pushing on the margins a little bit. So -- but that's a trade-off we'd be probably willing to make.

Quinn Bolton – Needham & Co.

Okay. Last two questions for me. Last quarter you talked about some of the licensing business where I think you had a particular licensing contract that would be strong last quarter, this quarter, and then it would start to tail off in April and into July. Can you give us an updates there?

And then second, just you talked about the growth in OpEx, up about 5% in the first fiscal quarter. Do you expect OpEx to be roughly flat beyond that, or could you give us any sense of the direction of OpEx beyond Q1 on a quarter-to-quarter basis?

Elias Nader

Yes, let me take over the OpEx question quickly, Quinn. When we said 5%, we basically believe that we have -- we are done with our restructuring as we had committed to, we have told everybody. We're now on a path of about $25.5 million, if you look at the range. And we believe that's where we're going to manage this business on. Okay?

Quinn Bolton – Needham & Co.

Okay. And that includes that amortization, the design tools, so kind of in that 25-1/2 is the right range.

Elias Nader

Everything.

Quinn Bolton – Needham & Co.

Got it. Okay.

Ken Lowe

And regarding the IP licensing revenues, this is an area that we've been able to very easily participate in as a leverage of the natural technology we developed. And we look at it opportunistically and we've been very fortunate we've been able to capitalize on some short-term opportunities.

We're continuing to pursue business in this area, but it's much harder to project than some of the other areas. So we'll continue to pursue those opportunities and continue to keep everybody updated on that.

Quinn Bolton – Needham & Co.

Okay. Thank you gentlemen.

Operator

And your next question comes from the line of Dan Scovel with Edison Group. Please proceed.

Dan Scovel – Edison Group

Yes. Can you hear me okay?

Thinh Tran

Yes.

Dan Scovel – Edison Group

Yes. Just a couple of sort of bigger picture questions. In terms of the 4K HDTV, do you sort of have a view on how big you think that market is going to be and maybe sort of what the profile and how much of that you can -- again, just sort of the bigger picture on there.

Mustafa Ozgen

This is Mustafa speaking. The market, you know, if you look at the U.S. market for 4K, we expected the markets in the U.S. will stay roughly 30% plus of the overall volume, the transition to 4K, you know, by the end of 2015 calendar year. This is mostly due to the fact that manufacturers have to refresh their lineups. And I don't think it's going to be a function of consumer needing it or not; it's more for when the manufacturers use their 55-inch [indiscernible] segment as the 4K and the panels being available, etcetera. But that's the model that we use, that's what we expect to happen.

Dan Scovel – Edison Group

And I guess what is your sort of current view on share in the DTV space? And do you sort of expect that to hold or do you expect to gain as the 4Q rolls out?

Mustafa Ozgen

We expect the gains. So the number I gave you is U.S. market. But as you know, 4K is growing in Europe and other markets. We do have high-quality design wins for U.S. and Europe and even the Japan market that we will see shipping second half of this year. And our goal is to retain those customers and help them go into market for their next-year lineup, as well as putting some new customers as a new design win.

And as the market segment grows, this year maybe we'll see 10% to 15% of the lineup will be converted to 4K. As it grows into the 30% kind of range, we expect our customers to do good and our volumes will increase as a function of them basically doing this conversion.

Dan Scovel – Edison Group

Okay. Shifting gears to the IT set-top box, I guess can you give us an update on how you're seeing that now that we've had a few months after the transition from Microsoft to Ericsson?

Mustafa Ozgen

Well, we see it as still positive change in terms of Ericsson being more focused on the IPTV and we believe that they've done their integration well and their focus is in place. And, you know, we're basically working with them for the Generation 3 technology and design win that will -- that [indiscernible] start developing with the set-top box OEMs.

Dan Scovel – Edison Group

In terms of I guess Ericsson sort of promoting the platform, would you -- is it more than Microsoft, about the same as Microsoft, maybe a little less? Just a little bit of color around that.

Mustafa Ozgen

In terms of the target customers that they have or the quantities? Can you clarify?

Dan Scovel – Edison Group

Well, just in the overall market space. Again, are they a little more enthusiastic about it than Microsoft was or are you basically seeing a similar sort of dynamic going on there?

Mustafa Ozgen

I see. So they're definitely more enthusiastic, more focused, I would say more aggressive in wining new designs worldwide. And we also see that finally IPTV from an underlying infrastructure and technology point of view becoming more realistic for emerging markets. We see IPTV generally has a growing trend in emerging markets and the media room to me [ph] is focused in winning some of those designs.

Dan Scovel – Edison Group

Okay. Finally, on your Z-Wave stuff here. I know you're really enthusiastic about it, with the internet of things. I apologize, it's kind of an underhanded question here, but as people, as outsiders sort of watching this, what should we benchmark that against? I mean, you know, what other technologies that are rolling out? I mean, how are you comparing the success of Z-Wave say over the next year or so against other technologies and unit adoptions? I mean how can we look at that?

Ken Lowe

Well, I think there's kind of the micro and the macro sense. In the micro sense, in the last couple of years we've faced off on the direct competitor ZigBee, and we have far outstripped them in terms of momentum, in terms of deployments, and the number of service providers that have adopted Z-Wave. So I think there's no question within the core of home control that Z-Wave has really accomplished what it set out to accomplish.

In the macro sense, we have developed the huge ecosystem of over a thousand different products that operate on it. They're all interoperable with each other. That's a goal that will take a long time for somebody like ZigBee to accomplish. In the larger picture, there's going to be -- there are newer technologies appearing but there's a long way for them to go to get an ecosystem like that, to get the momentum to get the confidence at the service provider level, that they could actually look at these things seriously.

So I think, you know, you look at the bottom line of where we're at right now, over the last several years it took us many years to get our first service provider going. Now we've moved, from last year, we had four, and this year we have nine, and moving into the following, there's another double that number that we're engaged with. So this thing is expanding on itself and the confidence is building within that sector.

Dan Scovel – Edison Group

So clearly the center of the effort there is in the home control space. I guess how are you doing expanding beyond that?

Ken Lowe

So we're actually being benefited by the multifaceted services that the service providers want to offer. So as they roll this thing out for home monitoring, then they continue to spread out. They cover more security, they cover more energy management, because it's additional ARPU. It's revenue per unit for them.

Once they've installed the system, got the infrastructure, they naturally want to expand, lead this into more opportunity. I would say that it's going to continue to be, in the next couple of years, focused on monitoring, security, a little bit energy management, and possibly hitting on a little bit of healthcare.

Dan Scovel – Edison Group

Okay. Thank you. Good luck.

Operator

(Operator Instructions) And there are no remaining questions in queue at this time.

Ken Lowe

We would like to thank everybody for participating in our fourth quarter conference call. We look forward to talking to everybody at this time next quarter.

Thinh Tran

Thank you.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. You all have a great day.

Thinh Tran

Thank you, Jasmine [ph]. Bye-bye.

Operator

You're welcome.

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