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Sigma Designs, Inc. (NASDAQ:SIGM)

F2Q09 Earnings Call

August 28, 2008 5:00 pm ET

Executives

Thinh Q. Tran – Chairman, President & Chief Executive Officer

Thomas E. Gay, III – Chief Financial Officer & Secretary

Kenneth Lowe – Vice President Strategic Marketing

Ed McGregor – Investor Relations Manager

Analysts

Uche Orji - UBS

Sukhi Nagesh – Deutsche Bank

John Vinh – Collins Stewart

Mark Sue – RBC Capital Markets

Quinn Bolton – Needham and Company

Gary Mobley – Piper Jaffray

Eric Rasmussen – Ross Capital Partners

[Ian] – Goldman Sachs

Scott Herrmann – Robert Baird

Todd Cooper – Stephens Inc.

Operator

Welcome to the second quarter 2009 Sigma Designs earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Ed McGregor, Manager of Investor Relation.

Ed McGregor

Thank you. Welcome to the Sigma Designs conference call to discuss financial results for our second quarter of fiscal 2009. I am Ed McGregor, Sigma’s Manager of Investors Relations. With me today are Thinh Tran, Sigma’s Chairman and CEO, Tom Gay, our Chief Financial Officer; and Ken Lowe, our Vice President for strategic marketing. A press release contains the quarter results and selected income state in the balance sheet information was released after the market closed today. If you did not receive the results, the release is available in the investor section of our website.

Today’s agenda will begin with my brief introduction, a review of selected financials by Tom, an Executive Overview by Thinh, a market update by Ken, and comments on guidance by Thinh. We will then open the call of questions from analyst and institutional investors. We expect to conclude the call within one hour.

Before we begin, I would like to read our statements about Safe Harbor and non-GAAP information. This conference call contains forward-looking statements, including statements regarding Sigma’s Revenue expectations for future periods, anticipated gross margins, and anticipated trends in Sigma’s target market.

Actual results may vary materially due to a number of factors including, but not limited to the risk that the SEC disagrees with manner in which Sigma has accounted for and reported or not reported the financial impact of past stock options grants, actions by other regulatory agencies as a result of Sigma’s past stock option practices, ongoing derivatives litigation, a determination upon completion of further quarterly closing and review procedures, that the financial results for the second quarter of fiscal year 2009 are different than the results set fort in this call.

General economic conditions, including continuance of the currents economic conditions specific to the semiconductor industry, the rate of growth of IPTV, high-definition DVD and HDTV markets, the ramp in demand from our set-top box customers, our ability to deploy and achieve market acceptance for Sigma products in these markets, the risks that such products will not gain widespread acceptance and other risks including delays in manufacturers’ deployment of set-top boxes or consumer products.

Other risk factors are detailed from time to time in our SEC reports, including our Form 10-Q filed with the SEC on June 12, 2008. Readers are cautioned not to place undue reliance on these forward looking statements which speaks only as of the date hereof. Sigma undertakes no obligation to publicly release or otherwise disclose the result of any revision to this forward-looking statements that may be made as a result of events or circumstances after the date hereof or to reflect the occurrence of any unanticipated events.

In addition to reporting financial results in accordance with Generally Accepted Accounting Principles, or GAAP, we report non-GAAP net income which excludes amortization of acquired intangibles; stock based compensation calculated under APB no. 25 and FSAS 123® and with respect to first half of fiscal 2008, nonrecurring expenses associated with a tender offer to employees to result potential personal tax exposure and nonrecurring expenses associated with Company’s review with historical stock option, planting practices and related financial statements for prior periods with respect to the first quarter of fiscal 2009 in process development clause acquired during the quarter.

We believe that our non-GAAP net income provides useful information to management and investors regarding financial and business trends related to our financial conditions and the results of operations. We also believe the non-GAAP measures provide useful supplement to information for investors to evaluate our operating results in the same manner as the research analyst that follow us, all of whom present non-GAAP projection in our published reports. We caution investors, however, not to place undue reliance on non-GAAP measures and to read them in conjunction with our GAAP results, you can find a detailed reconciliation between our GAAP and non-GAAP results in the financial tables included in our written earnings release which is currently posted in our website.

Now, I would like to hand the call over Tom who will give an overview of our financial results.

Thomas E. Gay, III

Thank you Ed. For the second quarter of fiscal 2009, revenue increased 2% or $1.3 million to $58.2 million from $56.9 million in the previous quarter. Compared to the year ago, our revenue increased $15.7 million or 37% from $42.5 million. Our revenue breakouts are as follows. By market segments and percentage of total revenues for the quarter IPTV represented $49.2 million or 85%. High-definition DVD and other media players, $4.4 million or 7% of the total, and the other category came to $4.5 million or 8%.

By billing region, Asia came in at $29.5 million or 51% of the total; Europe, $25.7 million or 44%; and North America represented $3 million or 5 % of total. During the second quarter, we had two customers that exceeded 10% of our revenue. Cisco Systems represented $18.0 million or 31% of the total; and Motorola Singapore, $17.0 million or 29% of the total.

One development during the second quarter was the change in our accounting policy for our method of valuing the die bank segment of our inventory. This policy was changed as a result of segments implementation of an Oracle ERP System, which provided an improved method of tracking and valuing the tested die in our die bank. Since this portion of our inventory became significant only in the first quarter of fiscal 2009, the effect of the change in accounting policy has been applied retrospectively to the income statement and balance sheet for our first quarter of this year.

This retroactive adjustment was required under SFAS no. 154, and provides consistency and comparability to our financial statements. The most significant impact of this retroactive adjustment was to decrease our cost of good sold for the first quarter by $2.4 million which increased the gross margin from 45.1% to 49.3%, and after tax effect, increased net income by $1.9 million or $0.6 per diluted share.

An explanation of this change with the table showing the detail of these changes has been provided in our press release. The financial statements in the press release and those discussed in this conference call include the effects of this retrospective adjustment. GAAP net income for the second quarter of fiscal 2009 increased to $9.6 million or $0.35 per diluted share, up $3.0 million or 46% from $6.6 million or $0.22 per diluted share in the previous quarter. Compared to the second quarter of fiscal 2008, GAAP net income increased $1 million or 12% from $8.6 million.

Gross margins were 50.7% for the second quarter compared to 49.3% on the preceding quarter and 52.4% in the same period last year. Operating expenses on a GAAP basis were $16.8 million or 29% of revenue in the second quarter compared to $21.5 million or 38% in the previous quarter; and $13.5 million or 32% of revenue in the same period last year.

You can find the copy of our press release with detailed reconciliation of our GAAP to non-GAAP performance on our website. The reconciliation includes the following categories of differences for the second quarter. First of all, amortization of intangible assets associated with two acquisitions, $0.3 million for blue7 and $0.4 million from VXP, and stock based compensation expense of $2.4 million.

On a non-GAAP basis, net income for the second quarter, was $12.7 million or $0.47 per diluted share. Compared to the previous quarter, this is a decrease of $0.9 million or 6% from $13.6 million or $0.46 per diluted share. Compared to the year ago quarter, this is a decrease of $0.3 million or 2% from $13 million or $0.48 per diluted share for the non-GAAP net income.

In the second quarter, the provision for income taxes was $4.2 million or 30.5% of income before taxes, this rate is better than the full statutory rate of 41% due to our international tax strategy activities. Based on our most recent estimates, we expect to see an income tax rate on a GAAP basis of approximately 28.1% for the balance of fiscal 2009, and have now accrued up our year-to-date tax provision to meet this rate.

Now, I would like to cover a few key areas from our balance sheet. Cash, cash equivalents, and marketable securities totaled $179.6 million, a decrease of $96.1 million from the beginning of the fiscal year. The decrease is primarily due to cumulative stock repurchases of $85.9 million and the purchase of VXP assets for $18.2 million. These decreases were partially offset by cash generated by operations.

Of the total cash and securities amount $59.1 million is classified as long term securities. This breaks down into $16.1 million of securities with maturities longer than one year from the date of purchase, and $43.0 million of auction rate security that currently have limited liquidity. During the second quarter Sigma received a notice from its bank, UBS, that it would purchase all of the auction rate securities at face value beginning in mid 2010. In the interim, the securities are all expected to pay an interest rate that will be comparable to our other investments.

Net accounts receivable was $39.6 million decrease of $0.6 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 were 62 days as compared to 54 days in the previous quarter. The increase was principally caused by an increase in shipments to customers that have extended payment terms.

Inventory was $45.2 million, an increase of $18.9 million compared to the beginning of the fiscal year. The increase is primarily due to strategic purchases of wafers to better support the Company’s key customers. Accounts payable was $14.5 million, a decrease of $4 million from the beginning of the fiscal year. Shareholder’s equity was $29.0 million, a decrease of $55.6 million from the beginning of the fiscal year, principally due to $85.6 million of stock repurchases during the first half of the year.

Now, I will turn the call over Thinh for an Executive Overview.

Thinh Q. Tran

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

First off, we are pleased to report improved gross margin and GAAP net income while achieving an anticipated revenue growth for the second quarter. We continue to maintain a strong presence in the IPTV market, being the market leader for both Microsoft media room platform and Linux based platform and pushing for new wins within emerging TELCO deployment. We are also pushing forward our customer product, a consumer product agenda by working the wide range of vendors of Blu-ray player designs, successfully gaining ground with manufacturers from China and Taiwan.

For further disposition, we are in the midst of completing a number of new chipsets that will increase our competitiveness in the marketplace. Moving forward, we are also executing a number of strategic growth initiatives that we hope will result in future revenues streams. These initiatives include penetration into the HDTV market, ultra-wideband connectivity market, and the cable based IPTV set-top box market; as well as our growth of our recently acquired VXP video processor products. On the profitability side, we are pleased to be achieving gross margin at the target range of 50%. Additionally, our operating margin continue to reflect our profitable operations, and relatively stable in ongoing operating expense outside of the identified on time expense.

I would like to highlight some of the important business development we have achieved since our last conference call.

First, we announced jointly the collaboration with Monster to create advance wireless solution for HDMI home entertainment distribution. The first fruit of the Monster Sigma Design partnership will be the new Monster wireless digital express HD system, which will use Sigma wireless HDAV for high-definition AV cable replacement as well as ultra-wideband coax technology to offer consumers an elegant wireless, no new wire combination solution for enjoying HD content around the home.

We announced Co-air, the first ultra-wideband chipset with integrated wireless coax gigabit Ethernet to high-speed home networking. Developed for worldwide service provider, TELCO and consumer electronic manufacturer, Sigma coax chipset is the only technology available today that can tremendously deliver a multiple independent streams of video and data over coax cable as well as wireless.

We announced along with Sigma highly integrate 8654 media processor will be used to power at com IPVC set-top box, currently being deployed by major telecom company, cable providers, hotel, coming in store, restaurant, and college center throughout Japan. Furthermore, the Company is entering into collectivity relationship to develop next generation IPTV set-top box for the Japanese market based on Sigma 8654 media processor.

Announced along with our data, the Sigma’s leading 8654 media processor are being used in I-O data in new set-top box.

I would now like to past the call to Ken, who will discuss foreign market share, Ken…

Kenneth Lowe

Thank you Thinh, with this call I would like to focus primarily on the market trends for IPTV and Blu-ray, and briefly discuss our outlook for future contributions from other segments.

To start with, we believe that the IPTV market is continuing to experience growth. However, there are key markets such as Korea and France that have experienced temporary slowdown. As a result, we believe that the available market for IPTV set-top box for this year will be slightly less than 49 units, based in our internal analysis.

Let us now discuss the current IPTV landscape, the subscriber based model that leads that projection and then conclude with some market share expectations.

In North America, we continually be led by AT&T, dominating the scene with the state of goal of reaching one million subscribers this year. At their second quarter conference call AT&T reiterated that their universal service continued its strong ramp in the second quarter with a net subscriber gain of a 170,000 for a total-to-date of 549,000. They additionally indicated that their network compliance is on schedule. Their broadband attach rates are high and that their on target to achieve their goal of over one million subscribers by year-end.

Further act of North American deployments include a leading Canadian TELCOs, TELUS, Bell Alliant, MTS, Allstream and SaskTel with the potential that Dell Canada will start deploying late this year.

Consistent with our previous analysis, we believe the total North American demand for IPTV media processor should reach about 4 million units this year.

In Europe, there are 16 TELCOs in active deployment this time, where France lead to the volume deployment to free France Telecom and Neuf, followed by Germany’s Deutsche Telecom and English British Telecom. These major carriers are followed in term by a wider ray of smaller carriers that include Belgacom, Portugal Telecom, Swisscom, Telefonica, Ya.com, TDC, Telecom Italia, Tiscali, Fast Web Wind, and Telecom Italia.

Most of these carriers that we deal with appeared to be ramping their deployments this year at different rates exemplified by the following updates. British Telecom added 768,000 subscribers in the second quarter to reach 282,000. Deutsche Telecom added 46,000 subscribers in the second quarter to reach a total of 200,000. Belgacom added 86,000 subscribers in the first half to reach a total of 391,000. France Telecom added a 107,000 in the second quarter to reach a total of 1.54 million. Portugal Telecom also announced that it surpassed a 100,000 subscribers-to-date.

Adding up the impact of these net new subscribers, we believe that total European demand for IPTV media processor should reach about 5 million units this year. In Asia, there’s a total of 10 TELCOs in active deployments this time, for the major carriers in Korea and China dominate the volume. In order of volume, the largest TELCOs have been Korea Telecom, Eniro, China Telecom, and China Net Com; and these are followed by deployment for Heuson, KDDI, Chunghwa Telecom, PCCW, Singtel, and MTNL.

Signs of growth are still strong including China Telecom achieved a growth spurt during a win to the Beijing Olympics which received about 3,000 orders a day as the event approached. Shanghai Telecom recorded a total of 510,000 subscribers with expectation reaching 800,000 by year end. Korea telecom entered 133,000 subscribers in the second quarter to reach a total of 700,000. Chunghwa Telecom expected to continue adding 30,000 subscribers per month reaching a total of over 700,000 by the end of the year. Additionally, Eniro has been experiencing deployment slowdown due to Korean government regulatory action. Adding up impact of these net new subscribers, we believe the total demand for IPTV media processors in ASIA should reach about 4 ½ million units this year.

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

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

Examining IPTV market for a platform standpoint, you will find that 12 TELCOs are using the Microsoft Mediaroom platform while 20 use a customized Linux based platform. For the Mediaroom platform, we are confident in our belief that this will remain 100% Sigma based during the remainder of 2008 and likely through the first half of 2009. For the Linux based platforms, we also expect to retain our estimated 75% share of the market for least the remainder of this year if not beyond. As the Microsoft based TELCOs are growing rapidly as a group, Sigma believes its overall IPTV market share has been rising this year-to-date.

Also to date, Sigma remains for the market share leader in the IPTV media processor space and as you are aware, Broadcom has been demonstrating chips for about two years in an attempt to penetrate the IPTV market and still waiting to deploy their first units. Recently, Intel has announced its intentions offer chips that can be used for a number of embedded consumer applications, and include set-top boxes and Blu-ray players.

While we will be watching them closely, we do not believe that Intel will be directly competing for main stream IPTV set-top boxes. At this point their new CE 3100 chip represents a relatively high end offering from the standpoint of pricing, power, and performance. Most customers in the space cannot afford their price tag or power dissipation. Additionally, they have a significant development cycle head that develop an effective IPTV software solution. Although there are number of assumptions that are not within Sigma’s control, we are still confident we are in control of our IPTV business given our current market position, customer relationships and leading technology.

Now let us move on to the Blu-ray market. Although it appears as the Blu-ray demand has been modestly increasing this year, we still believe the overall results will be somewhat lower than expected for the year in total. With the format award decided in Blu-ray favor, there is an open market way to be tapped. But, it appears the industry will not experience any significant activity until its Christmas selling season. At that time we believe the prices of a certain players to the consumers will be reduced, with some players selling as low as $199.

Wide spread Blu-ray contents and its promotion will be taking place and new Chinese manufacture players will enter the market. That said, the current consumers satisfaction with DVD, combined with existing macro economic conditions may limit a large upswing in demand later this year. However, on balance, we do anticipate stronger growth for Blu-ray players as we move through 2009.

Moving forward, there is also an increase in some competition for this budding market, however, not all vendors are in position to obtain market share. Panasonic has taken their own captive business for now, while NECs ramps are courting other Japanese Blu-ray accounts, and Broadcom has a limited beach head with Korean Suppliers. We do not believe that any of our other competitors has sampled any Blu-ray products thus far, and meanwhile Sigma’s working alternate channels to secure several new designs from manufactures in Taiwan and China this year which will become an increasingly important as we move into the Christmas selling season and beyond.

Additionally, based on our strong relationships and positive reputations, we expect to regain some of our top chair accounts next year as our next generation chips move into player designs. In summary, we remain optimistic that we will be back on the growth trend in Blu-ray business at some point in the first half of next year.

Beyond our top 2 market, Sigma has strategic initiatives in place to develop and penetrate several other markets at future revenues streams. Our ultra-wide band development is beginning to bear fruit as evidenced by the recent joint announcement with Monster. This wireless cable replacement segment provides a very straight forward value proposition to consumers and requires very little technical effort on the part of the equipment vendors.

Similarly, we are very encouraged by the customer interests in our home media network solutions using ultra-wide band. Offering a compelling combination of high band with coax and wireless communications, this solution is being evaluated on the laps of some of the top TELCO and cable carriers. We anticipate some revenue contribution of ultra-wide band group will begin to ramp, start of next year.

In the television markets we are very excited about our strategic initiative to develop a world class line of HDTV chip. The strategy integrates our media processor expertise with our recently announced acquired DXP technology to bring studio quality video to consumer televisions. As an adjunct to our primary HDTV strategy, we are now in the process of penetrating the projector TV market which could begin to contribute early next year.

Furthermore, our VXP lines are already contributing minor revenues to the consumer and of the television market including front projection televisions and AV receiver applications. In short, we are optimistic about the opportunities to penetrate a greater portion of this market as we move into the next year.

As an adjunct to our IPTV set-top box products, we are continuing our push into the next generation cable set-top box business, this market is in a juncture as it nears the transition from carriers specific products controlled by the duopoly of Motorola and Scientific Atlanta to the merchant market boxes enabled by the open cable consortium, as well as the second transition from the QAM-based digital broadcast scheme to an IPTV multitask mechanism using DOC’s 3.0.

These transitions are opening up the market to a wider array of manufacturers at all level in some of the next several years. Sigma’s currently partnering with TI to offer one of the industries first solutions to feature DOC’s 3.0 and OCAP software. We are very encouraged with our business prospect in the segment based on the substantial interest we received since this was unveiled at the first of the year.

We hoped this analysis provide you some insight of our target markets and the opportunities that lie ahead for Sigma. We feel bullish about our market position, leading technologies and top tier accounts; and look forward of building on this foundation.

I will now pass the call to Thinh to cover our forward guidance.

Thinh Q. Tran

Thank you Ken, as Ken has indicated, we are very encouraged with the fundamental demand coming from IPTV, and I am confident in our ability to derive continue revenues based on the strength of our position. However, IPTV market growth has usually slowed in certain key market such as Korea; and though there are upcoming TELCO potentials that will spur new growth prospect for the future, we do not see strong growth for the near terms. Initially, our expectations from Blu-ray revenue contributions in the second half are modest as well.

In summary, we believe that our overall growth prospects for this second half of this year are relatively mild. So looking ahead, this is what we would expect. We expect that core revenues to be similar to the level experience in the second quarter. We expect our gross margin to remain relatively stable for the next few quarters, remaining the target of 50% plus, or minus 200 basis points.

In summary, I would like to reinforce that we believe our fundamentals remain strong. The target market should experience continued growth this year. That we remain dominant in IPTV market and that, we are redoubling our efforts in development to strengthen our position moving forward.

We would now like to open up the call for Q and A.

Question-and-Answer Session

Operator

Ladies and gentlemen, if you wish to ask for question (Operator Instructions).

Our first question comes from the line of Uche Orji with UBS, please proceed.

Uche Orji - UBS

Hi. This is (inaudible) for Uche. I just wanted to drill down further on the accounting change. Could you explain in greater detail as to why the accounting change is applicable to just to a per quarter and not the quarters before that given that you have the same ERP system? And secondly, inventory, sorry, the accounting change benefit immensely across the board or just some particular business segments?

Thomas E. Gay, III

Hello, see if I can cover both of those questions succinctly. When we came upon this accounting change, we needed to do extensive work looking back and looking into when and how much inventory would be affected, how the values would be ascertained. It turned out that the significant population in the die bank for Sigma only appeared in Q1 of this fiscal year. We did look into last fiscal year and there were relatively small and not material amounts at that time and that is why we chose, as is called for in the procedure, to only retrospectively adjust the first quarter of this fiscal year.

So we did a lot of checking and this is what we determined to be the correct adjustment. Let us see, the die bank did center mostly on our largest moving parts and that is part of the growth in the inventory value that you see in our balance sheet and that is part of the reason that we felt that this was a change that would make our financials clearer and more comparable from quarter to quarter.

Uche Orji - UBS

Okay. Second question, you indicated that you had inventory rose due to some strategic programs but your guidance does not indicate anything that there are any strategic buys. Would you explain what is happening there, please?

Thomas E. Gay, III

Well, this was something that came up during the quarter where our foundry indicated that there was, there was some reasons that we should consider building some inventory at this point. We checked with our customers and found that the orderly flow to them would also be served by growing inventory during this quarter.

Uche Orji - UBS

Okay, thank you.

Operator

The next question comes from the line of Sukhi Nagesh with Deutsche Bank. Please proceed.

Sukhi Nagesh - Deutsche Bank

Yes, hi. Thanks. What was your gross margin on like-to-like basis, Tom? Last quarter you reported 45%. If you would not have had the accounting change this quarter, what would your gross margin be?

Thomas E. Gay, III

Once we determined that this was the proper way to do the books, we did not spend any time trying to deal with what the previous version might have been because that was no longer pertinent to the way that we felt it was best suited to our bookkeeping.

Sukhi Nagesh - Deutsche Bank

Okay. In other words, what I am trying to get at, if you did see an improvement in your gross margin; can you, kind of, drill down into why you saw that improvement or where you saw the improvement?

Thomas E. Gay, III

Well, if you were to take the second quarter by itself, the growth in the die bank would have been about a $1 million change, according to this policy change. It was additional impact from what the Q1 impact was.

Sukhi Nagesh - Deutsche Bank

So what are you guys seeing on the pricing front, I guess, on both the IPTV chip as well as the Blu-ray side?

Kenneth Lowe

Well, I would comment on that, Sukhi. We are basically seeing stable prices. We are in the mature phase of these products. There really is no basis to take these things down any more at this point in time and so that is what we are doing. Part of our strategy actually is to try to hold the prices as strong as we can.

Sukhi Nagesh - Deutsche Bank

It felt, one other question I had, when you gave a breakout of your revenues, $49.2 million for IPTV. What was your total connected media business? I think I missed that part. Isn't that how much was Blu-ray?

Thomas E. Gay, III

Connected media was $4.4 million and we would estimate the majority…

Kenneth Lowe

Over half of that is Blu-Ray.

Thomas E. Gay, III

Yes.

Sukhi Nagesh - Deutsche Bank

Okay. And finally, if you look at the remainder of this year, are you expecting, given where we are today in macroeconomic conditions and TELCO spending and what have you, are you expecting sequential increases for the next couple of quarters here as IPTV continues to be a secular trend? And then in the overall tech space or are you going to see, I mean it seems like there might be a lot of excess inventory out there. Trying to figure out how long it is going to take for the inventory to burn off.

Kenneth Lowe

We do not sense that there is a lot of inventory out there. What we sense is that there is been varying degrees of temporary changes by different TELCOs in what they are doing in their programs. Sometimes when they go through a change, they go through a pause in the aggressiveness of their deployments. We have seen a regulatory issue with an RO in Korea. We have seen some transitional effects taking place at people like Free and things as they move from one strategy to another.

So, it affect the things in the short-term, but we see generally continued good growth in IPTV, but we have also entered certain quarters where we have been looking at a certain amount of business and then have seen pull-ins on that business occur throughout the quarters. But the problem is that we are not willing to project any of that. It is possible we will see a little bit more strength through the third quarter, but we are guiding flat right now because that's what we feel comfortable with doing.

Sukhi Nagesh - Deutsche Bank

So you're guiding third quarter flat, flat to where we are? Not growth?

Thomas E. Gay, III

Third quarter revenue should be flat. That is what we are guiding to.

Sukhi Nagesh - Deutsche Bank

Ok. Thank you.

Operator

Our next question comes from the line of John Vinh with Collins Stewart. Please proceed.

John Vinh - Collins Stewart

Good afternoon. A question on inventories. Orders from Motorola, seems like they bounced back quite strongly yet their shipments of IPTV boxes in Q2 seem to be down pretty sharply. Can you give us an update on what you guys are seeing there in terms of the inventory situation at Motorola? Have we cleared through most of that inventory or do you think there is more to go at this point?

Kenneth Lowe

Well, we cannot track their inventory nor do we get any hard data that supports that. Based on their order rates and based on the anecdotal conversations, we just simply get a sense as to whether or not inventory is a factor. We do not believe that inventory is a factor at this point in any material fashion. So we believe that they are back on a build cycle against their demand.

John Vinh - Collins Stewart

So currently you did about $10 million in Motorola revenues at this point. Would you expect them to continue to track at this run rate going forward?

Thomas E. Gay, III

That is generally the belief that we have, yes.

John Vinh - Collins Stewart

Okay.

Thomas E. Gay, III

That is the trend line we believe that they are on.

John Vinh - Collins Stewart

Okay, and then can you comment on Cisco revenues. Obviously those are also quite strong in the quarter. Can you give us some color in terms of the strength in the Cisco revenues? Was that primarily kind of a build as Cisco as a second source of AT&T or do you believe there are other deployments that you believe are ramping at this point?

Thinh Q. Tran

Cisco has a relative number of customers that they supplied these boxes to. AT&T is a portion of that. We have seen a lot of deployment outside of US, so it is really hard for us to estimate for you how much its customer for what because they do not disclose that information to us.

John Vinh - Collins Stewart

Got it. Okay, and then gross margins going forward, with the accounting change, can you give us an update on how we should be thinking about gross margins going forward?

Thomas E. Gay, III

Our guidance was to expect us to meet our target of 50% plus or minus 200 basis points for the next few quarters.

John Vinh - Collins Stewart

And then, going into 2009, would you be able to expect to hold your gross margins, and then, as a follow-on to that, when do you expect to ramp the 54 in volume at this point?

Thinh Q. Tran

We expect the 54 to ramp in the early part of 2009. Some volume will start deploying in Q4 of this year, but most of the volume will start in the first half of next year.

John Vinh - Collins Stewart

Great, thank you.

Kenneth Lowe

If we meet our targets, our margin should stay in the same target range on a region.

John Vinh - Collins Stewart

Got it. Thank you very much.

Operator

Our next question comes from the line of Mark Sue with RBC Capital Markets. Please proceed.

RBC Capital Markets

Hi, this is (inaudible) for Mark Sue. If you can talk a little bit more about the competitive landscape and specifically how it relates to Broadcom. Also, you mentioned that Intel has announced their intention to offer a higher end chip. Do you see them coming out with a lower end product any time soon?

Kenneth Lowe

Let us take the latter one first. We are not privy to Intel's strategy, but it would not be consistent with their MO to come out with lower end chips. They form a competitive value proposition when they focus on high end, when they focus on Intel architecture compatibility, when they take advantage of the forces that their corporation can bring to bear.

So we do not really view them as a potential low end competitor. Broadcom, as far as a competitiveness standpoint, they have had a Blu-ray chip on the market for quite some time. They have not done extremely well with that chip. They have really captured a little bit of business in Korea, but they have not really been able to become a worldwide presence. So they are still trying to become and as you know, Broadcom attempts to dominate any market that they penetrate. So I think they have been struggling to achieve their goal in that market.

IPTV similarly, they have come out with a new chip product over the last couple of years. They have gotten some software work under way with Microsoft. We believe they are also working on Linux solutions, but the net sum total is they have not deployed any units so far. So IPTV is a very sophisticated complete solution with hardware and software, so until you start deploying units, there are still some questions as to how clean the total solution is. So we remain positive that at this point in time, in our belief, that our position is very strong and that Broadcom is still going to have to work very, very hard to penetrate these markets.

Unidentified Participant

Okay, and if you can talk a little bit about your expectations in units for Blu-ray over the next quarter.

Kenneth Lowe

Not substantially high. We think the third quarter is much like the second quarter. We think the entire industry is gearing up for what they hope to be is a big Christmas. And so what we believe is most of the types of products that will hit the shelves in late September, early October will be geared up for a pretty strong Christmas selling season, so it is going to be a very, very eschewed year in that sense. You will have three quarters of fairly flattish growth and then what they are hoping to be is a big bang fourth quarter. There's a lot of factors that come into play there, including the economy. So it is a wait to be seen. While we are more confident that, in fact, demand will pick up next year because we will at least end this year we believe with lower-priced products, with more content and with a much higher degree of market education that Blu-ray is the wave of the future.

Unidentified Participant

Okay. Thank you.

Operator

Our next question comes from the line of Quinn Bolton with Needham & Company. Please proceed.

Quinn Bolton - Needham and Company

Tom, I just wanted to make sure I understand the accounting change properly. It sounds like you used to keep those charges on the balance sheet until you moved from raw materials to WIP, now you are going to charge it off immediately, right?

Thomas E. Gay, III

Actually, the expense went to cost of goods sold during the phase of production known as die bank, and Sigma in the past did not have a significant die bank until this fiscal year. So what there was, as a case where as wafers were sorted, the rejected die were expensed and then as we went to the next stage, WIP, the value of those were absorbed into the surviving die. So there was this temporary accounting change for that one location that was awkward to compare one quarter versus the next as we had a growing population in that one segment of our inventory.

Quinn Bolton - Needham and Company

Okay. Maybe I can come at it a different way. It looks like you restated the cost of goods down in the first quarter and the value of the inventory up as a result of the accounting change. I guess my question is, as that inventory flows through in future quarters, wouldn't that depressed future cost of goods… future gross margins?

Thomas E. Gay, III

The finished goods segment, which was the other primary component of cost of goods sold was at a full standard, so you had a temporary adjustment for that interim phase of production and now it is more in line with where the inventory was valued at before there was a significant die bank and will be consistently applied to future periods.

Quinn Bolton - Needham and Company

Okay. So no change in finished die, or finished goods, cost of inventory. So no long-term effect on gross margin going forward.

Thomas E. Gay, III

That is correct.

Quinn Bolton - Needham and Company

Okay, great. Second question, I think in Korea, it sounds like the Korean government is soon to allow sort of broadcast IPTV or at least live IPTV rather than just the video demand. Can you talk about how that might impact your Korean business? I know about a year or so ago, ST Micro had come out saying they were in an IPTV box for Korea Telecom. Wondering if this change in the IPTV model in Korea leads to potential competitive losses or you feel pretty well positioned for the live IPTV rollout in Korea later this year or early next year, whenever it is approved.

Kenneth Lowe

We are still waiting and watching on that. There are a lot of complications involved and so we are, this is going to be something that we'll have to wait and see. There has not been anything firm at this point in time that I am aware of.

Quinn Bolton - Needham and Company

So you think, you think the boxes for that live service are still being decided by the carriers and the set-top box providers?

Kenneth Lowe

I think there are a lot of decisions being made in the timeframe we are in right now and that can affect that.

Quinn Bolton - Needham and Company

Okay, okay. And then just last clarification for Tom. Did you say the tax rate of 21, sorry, 28.1 is a GAAP tax rate?

Thomas E. Gay, III

Yes.

Quinn Bolton - Needham and Company

Great. Okay, thank you.

Operator

Our next question comes from the line of Gary Mobley with Piper Jaffray. Please proceed.

Gary Mobley - Piper Jaffray

Hi, guys. Question starting off with Ken. China Telecom recently announced that they plan on rolling out services in various provinces in China and they have selected what seems to be about eight different set-top box vendors and I am wondering how you guys, from a competitive standpoint, shake out in the choices that China Telecom is putting out there in these different provinces?

Kenneth Lowe

It is actually a good question. That is fairly recent information and obviously in the past UT Starcom has been our number one supporter over there and has gotten us into a lot of opportunities through China Telecom and a little bit of China Netcom. I really can't tell you how many of the eight that we are represented in, to be honest. I think have typically been in more boxes than other competitors because we are so widespread, but I can't enumerate. I don't have that information.

Gary Mobley - Piper Jaffray

We can touch base on that later. With respect to the Blu-ray market, if I am not mistaken, you are primarily levered for the balance of the year to the Chinese manufacturers. I am just wondering if your more muted expectation for Blu-Ray revenue, at least in the third quarter, is a function of maybe some, your thoughts on the prospects of success for these Chinese Blu-ray manufacturers.

Kenneth Lowe

It is probably as much connected to them actually getting to the retail shelves as it is how much successful they will have. A lot of these guys, they are not going to be marketing under their own brand name. They will be marketing under store brands, like a Best Buy. They will be marketing under brands that have been repurchased for use, like Magnavox and such, so there's going to be a certain amount of demand based on the price attached to those types of labels, but it is really moreover, it is about them getting in the market. It's about them getting the license from the Blu-ray association, the certifications they need to put the logo on their box and things like these. So they are involved in the merchandising process at this point.

Gary Mobley - Piper Jaffray

Okay.

Kenneth Lowe

And it is pretty entailed. There's a pretty entailed set of steps with Blu-ray.

Gary Mobley - Piper Jaffray

Tom, I want to be on the top one more top, but with respect to the change in accounting, the change in how costs are, sorry, the change in the way inventory's accounted for in the first quarter, that provided about a 400-basis point boost to the gross margin for the April quarter, right?

Thomas E. Gay, III

Yes.

Gary Mobley - Piper Jaffray

Okay, and just to be clear, the same issue that provided a $1 million boost to gross profit in the July quarter, is that right?

Thomas E. Gay, III

Yes.

Gary Mobley - Piper Jaffray

Okay.

Thomas E. Gay, III

So it will now be comparable and in line with the finished goods cost of goods sold as it moves out the door.

Gary Mobley - Piper Jaffray

Okay. Very good. I appreciate it. Thanks, guys.

Operator

Our next question comes from the line of Eric Rasmussen with Ross Capital Partners. Please proceed.

Eric Rasmussen - Ross Capital Partners

Hi. This is Eric Rasmussen. I just wanted to real quickly on the revenue break-out; you have provided that these quarter you seen that pretty similar tracking next quarter. I know you are guiding to a flat quarter. Is it going to be pretty similar mix?

Thomas E. Gay, III

Yes, generally speaking, that is exactly what we would expect. IPTV is going to remain the big dog, so 85% IPTV makes sense. As we mentioned, we do expect some pickup in the fourth quarter perhaps for Blu-Ray, but third quarter is we're seeing it relatively flat. So that means probably flat in those segments in the mix.

Eric Rasmussen - Ross Capital Partners

Okay, and in the Blu-Ray you mentioned Taiwan and China. What kind of traction are you getting with these new designs and do you think you'll have the possibility of having a bigger impact as we head towards the end of the year and what kind of impact do you think it's going to have? Is it carrying most of the business or is it expected to carry a good chunk of the business in Blu-ray?

Thomas E. Gay, III

Well, yes. I mean the traction is really good in the fact that we have multiple design wins in terms of people who have decided on using our chips. They have worked really hard to make these productions worthy. They are working very hard to get their certifications and licenses all in place so they can go to the retail shelves. So that part of it is all good. The traction there is very strong.

The bottom line issue there is how much are they going to impact and there are factors outside of their control to a certain degree. I know a good number of them want to be the low cost offering. They are cutting out bells and whistles that they do not feel are necessary for the average consumer and, therefore, they can lower the price on these by keeping their costs down. But somebody like Sony or somebody else comes in priced aggressively, it may pull a little bit of the available volume away from that. So we will just have to wait and see.

Eric Rasmussen - Ross Capital Partners

Okay, and then the new chip for Blu-ray, that's going to be ready probably end of this year, early next year?

Thinh Q. Tran

We expect to assemble shortly and we expect some of the product will start shipping in Q1 next year with our new silicon.

Eric Rasmussen - Ross Capital Partners

And you have pretty good confidence right now or good visibility with trying to gain traction again with some lost traction with customers there?

Thinh Q. Tran

We believe so. Yes.

Eric Rasmussen - Ross Capital Partners

Okay. Great, thanks.

Kenneth Lowe

Thanks, Eric.

Operator

Our next question comes from the line of Jim Schneider with Goldman Sachs. Please proceed.

Ian - Goldman Sachs

Hi, guys. This is [Ian] in for Jim. With your comments on pull-ins for Q3, can you talk about at all your visibility for Q4 and what you might expect revenues to do at least qualitatively in that quarter?

Thomas E. Gay, III

It's too soon to tell. Our visibility is limited and the idea of pull-ins just means that even our backlog doesn't give us an exact estimate to be able to make and that's why we guide to a flat expectation at this point.

Ian - Goldman Sachs

Okay, and then just I guess on Q3 then to maybe give a sense of that, do you know or can you talk about what level of turns you're expecting to hit your flat guidance?

Thomas E. Gay, III

Fairly limited.

Ian - Goldman Sachs

So most of it is booked already and you are not expecting much turn?

Thomas E. Gay, III

Yes, that is right. Well over half of our total revenue is already booked.

Ian - Goldman Sachs

Okay, thanks. And then just on the new 8654, when do you think you will ship it first in production? I think you said you were sampling now.

Thinh Q. Tran

Yes, we expect to ship some volume end of this year and ramping quickly in the first quarter of next year.

Ian - Goldman Sachs

Okay, and then just one more, if I could. I just want to make sure I heard right. Did you say you expected the Blu-ray pricing to be stable going into next year or is that, was that just… ?

Kenneth Lowe

No, the indication was that I think people get aggressive enough in the Christmas selling season that as we move into next year, they will already have established aggressive price points, so you will have a whole year, next year, a whole year worth of attractively priced Blu-ray products in the consumer space.

Ian - Goldman Sachs

Okay. Okay, great. Thank you.

Operator

Our next question comes from the line of Scott Herrmann with Robert Baird. Please proceed.

Scott Herrmann - Robert Baird

Thanks, guys. I kind of want to dig down a little bit more into the accounting change and are we through the full impact this quarter, and am I thinking about it correctly also in Q2 that the Q2 cumulative impact would have been, if you had not made the change, would have been about 3.4 million on the cost of goods sold line and then for Q3 are you anticipating it to have another kind of incremental impact?

Thomas E. Gay, III

What we have done is retrospectively caught the books up with the consistent application of the improved policy so that going forward things should be comparable.

Scott Herrmann - Robert Baird

Okay.

Thomas E. Gay, III

And trying to figure out the before and after number is not a very worthwhile exercise and that was one of the difficulties that we are solving with this change in policy that as the die bank were to grow or shrink, you would get a confusing variation in the cost of goods sold number. With the consistent application of this policy, you should be seeing more stability and consistency and comparability from quarter to quarter in the cost of goods sold.

Scott Herrmann - Robert Baird

Okay, and just to clarify, Q1 still had in the kind of one-time charges of an inventory write-off and the VXP write-up, correct?

Thomas E. Gay, III

Yes.

Scott Herrmann - Robert Baird

Okay.

Thomas E. Gay, III

Those are still factors that were not effected by the policy change.

Scott Herrmann - Robert Baird

Okay, and I guess the inventory levels are a little bit higher on an inventory days basis than they have been. What would kind of be a new target range for inventory days going forward? How should we think about that and do you think you need to work down inventories or are you comfortable with where inventories are?

Thomas E. Gay, III

Where we are in this strategic purchase is pretty much near the end of it. There's still a little bit more to come, but we will also be shipping during the coming quarters. So I think we are relatively close to the peak and then going forward from there, we would expect to see that trimmed down a bit as we work our way through it.

Scott Herrmann - Robert Baird

So I mean should we expect them to come back down to the 70, 80-day range or would we expect more 90 days going forward?

Thomas E. Gay, III

I would expect it to be comparable at the end of Q3 and then tapering down after that.

Scott Herrmann - Robert Baird

Okay. And then real quick, on the DSOs, should we expect that to start to come down? I know you had talked a little bit about, I believe, giving some kind of generous terms on those. What should we expect for DSOs to do? I mean they are up, if you look at fiscal fourth quarter 2007; they are about two times those levels. So should we expect those to start to come in as well?

Thomas E. Gay, III

We believe that our customer mix and mix of terms and their weighted averages and others are going to probably be closer to where we are now and I have no reason to guide elsewhere.

Scott Herrmann - Robert Baird

Okay. All right. Well, thanks, guys.

Operator

Our last question comes from the line of Todd Cooper with Stephens, Inc. Please proceed.

Todd Cooper - Stephens Inc

Yes, thanks. I will make it brief. Just one question. There appears to be three HD AV standards in development, the wireless home digital interface, wireless HD and your ultra-wideband. Can you comment on your confidence in the UWB standard that you guys are backing?

Kenneth Lowe

We actually feel very strong about it. We feel good about the technological advantages. We feel good about the range of industry that is getting behind the Y media standard. I think the fact that Monster was willing to take a product like this to the retail market is a positive indication that it both has value and is a very solid technology. I think it is what partially causes questions in people's minds is the amount of time that it takes to evolve a new communication standard. That timeframe is a little bit alien to a lot of us who are used to much more rapid changes, but anything in the communications sector typically takes multiple years longer than a consumer feature edition or something like that.

Todd Cooper - Stephens Inc

Do you think that you will need a consumer electronics manufacturer, like Motorola, Samsung to get involved in addition to someone like Monster?

Kenneth Lowe

Oh, absolutely. In the end run, I mean it is absolutely necessary. I think what happens is we go through the cycle of…, that the technology shows itself to be meritorious, then it moves to the stage that we are in right now where retailers are starting to adopt dongle-type products that allow you to optionally connect it to your products. Then finally it moves in to built-ins within the consumer sector and then you achieve an absolute standard basis, and then volumes really take off.

Todd Cooper - Stephens Inc

Well, we are all waiting for a wireless solution, so I would just ask you to hurry up.

Kenneth Lowe

All right.

Todd Cooper - Stephens Inc

Thank you.

Kenneth Lowe

Thank you.

Todd Cooper - Stephens Inc

Thanks.

Operator

There are no further questions. I would now like to turn the call back over to Ed McGregor for closing remarks.

Ed Mcgregor

Thank you. Well, we want to thank you all for attending our conference call to discuss Sigma Designs financial results for our fiscal second quarter of 2009. We do appreciate your interest in Sigma Designs and we look forward to our next scheduled conference call to discuss our results for the third quarter of fiscal 2009. Thank you.

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Source: Sigma Designs, Inc. F2Q09 (Qtr End 08/28/08) Earnings Call Transcript
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