Pixelworks Inc (PXLW) 2005 Q4 法說會逐字稿

Good day and welcome to the fourth quarter earnings announcement for Pixelworks. Today's call is being recorded. At this time, the call will be turned over to Mr. Jeff Bouchard, Chief Financial Officer. Please go ahead, Mr. Bouchard.

Good afternoon and thank you for joining us. With me today is Allen Alley, President, CEO and Chairman.

The press release we issued today includes an outlook section containing forward-looking statements about our business. Additionally, on this conference call we are going to be commenting on our business outlook and making forward-looking statements based on our current expectations.

All of our forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to today's press release for a description of factors that could cause actual results to differ materially from those forecast. The forward-looking statements we make today speak as of today and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today.

Our comments will also include references to certain non-GAAP financial results, which differ from results prepared in accordance with GAAP. A detailed reconciliation between net income on a GAAP and non-GAAP basis is included with the financial statements that accompany the press release we issued today.

I will now turn it over to Allen.

Thanks, Jeff. I'll spend a few minutes providing an overview of the business, then turn it over to Jeff to cover the fourth quarter financial results and first quarter outlook.

Revenue for the fourth quarter was $43.3 million. Upside strength in advanced television business was offset by weakness in advanced media processor and projector business, so we came in below our targeted range.

Gross profit margins and operating expenses were both on the favorable end of our outlook. The improvement in gross margin is due largely to shipping a higher percentage of our new products in the fourth quarter and we expect this trend to continue as we again ship a greater percentage of new products in Q1.

Q4 operating expenses came in at the low end of our range as we maintained our focus on expense control. As a result, our pretax operating results were in line with our outlook.

The bottom line, on a GAAP basis, was adversely affected by an unusually large non-cash tax charge that Jeff will cover later in the call. Without the large tax charge, EPS on a GAAP and non-GAAP basis would have been $0.01 better than the high end of our outlook.

Before we start the review, I wanted to say a few words about Jeff's resignation that we announced earlier today. Jeff has been a great business partner for over six years. He and I had the unique experience of taking Pixelworks public in May of 2000 at a time when many thought it would be impossible to do an offering. He's been a steady hand guiding us through that offering and through the implementation of SOX 404 control environment that we now have in place.

Jeff has expressed a personal interest to get back home and will be joining a private company, in fact a Sequoia portfolio company, in the Silicon Valley. Jeff has been an outstanding business partner and I look forward to continuing our professional relationship in the future.

We have begun a search to fill the CFO role and are very fortunate that on an interim basis Hans Olsen, our Chief Operating Officer, can step into the duties of CFO. Hans has been with us since 1998 and he is intimately familiar with our operations and financial controls.

On the call today, I'll start by giving you an overview of the products that we introduced at the Consumer Electronics Show in Las Vegas. As we have discussed, a key area of focus for us over the past six months has been improving product development efficiencies and we are seeing the results of our focus and investment.

The broad range of products and technologies that we demonstrated at CES are tangible evidence of the results we have begun to see. The products we introduced and demonstrated at CES were -- Pearl, an image processor targeting larger-screen TVs with advanced video processing technology. Pearl incorporates a fifth generation 12-bit video decoder, a 10-bit, high-speed ADC and HDMI receiver.

Pearl is the key product in our strategy to target the most demanding, top-tier television accounts in the world. We believe Pearl can go toe-to-toe with any video processor on the market and deliver outstanding image quality at a very competitive price.

Pearl was developed in a truly collaborative effort across all of our design centers, including Portland, Toronto, Shanghai and Silicon Valley. We expect Pearl to begin volume production in the second half of this year.

[Opal 2], which is an enhancement to the Opal image processor that went into volume production late in the third quarter, will improve our competitiveness for TVs being built for sale in Europe. Opal 2 includes the EuroSync 3D video decoder core that is tailored for European televisions, with performance optimized for features such as fast blanking support, integrated teletext and 2-2 pulldown. In addition, EuroSync technology integrates a SCART multiplexer for full SCART support for simpler board designs and lower cost.

As we've said in the past, Europe is an extremely important region for us, with customers including Vestel and Beko. We also have several large OEMs in Taiwan that design and manufacture TVs for European sale, built under their own brands and for other top consumer electronics companies.

We anticipate volume production of Opal 2 products beginning in the second quarter.

The PWM2020 and 2030 ICs introduced improve upon the PWM2000, which went into production late in the third quarter. These products are the latest generation of media processor ICs for digital television for both Europe and North America. Both of these products leverage our production-proven Indigo software platform and offer cost-effective, fast time to market for those looking introduce to DTV solutions in the coming year.

We also officially re-entered the digital CRT race with the introduction and demonstration of two new image processors, code named PixelGX and Opal CRT. These chips are among the first developed entirely by our design center in Shanghai, so we are beginning to see the fruits of our investment in China pay off over the past year and a half. We believe these products will enable us to compete effectively for digital CRT designs, which we believe will be a meaningful market for many years despite the overall movement to flat panel TVs over the long run.

On the technology front, we continue to aggressively develop and roll out products that integrate the entire video and audio signal path. At the CES we demonstrated our PW3500 family of audio and video processing chips. All three ICs in the family include audio IF, or intermediate frequency, demodulators, which separate the audio stream from the incoming video signal for all of the worldwide audio standards.

Once the audio signal has been separated, the chips process the sound for stereo speakers and with the PW3515, users can implement other, more-advanced, sound-enhancement technologies. The audio processor, in combination with other Pixelworks chips, features an audio delay function that ensures that the video and audio signals are synchronized in order to avoid distracting lip synch issues.

We also introduced DreamStream application reference software for developing next generation devices for network digital media streaming in consumer and commercial environments. This will help manufacturers of connectivity devices for low video bandwidth applications in which high-quality performance is necessary, such as IP-based set-top boxes.

And last, but not least, at CES we demonstrated what became known as the “Great Wall.” This was literally a wall of LCDs where we showed a glimpse into the future of Pixelworks' image processing capability. We demonstrated stunning image quality side by side with some of the most advanced televisions in the world.

These image processing techniques will be integrated into our product offerings over the next year. We believe we are already at the forefront of image processing quality with our Opal 2 and Pearl production products and with the Great Wall we are demonstrating the ability to pull ahead of the pack.

While I am pleased with our showing at CES, we must and we will continue to relentlessly focus on improving our product development efficiency. As we announced previously, we completed a restructuring in the fourth quarter in order to reduce spending in the short term, but, more importantly, rebalance our resources and allow us the latitude to invest in some critical positions. The net result is a rebalancing within our engineering team in order to improve efficiency.

To be a world-class IC system-on-silicon design, you must invest in a unified design flow across all design centers. Only by implementing a unified flow can you reap the benefits from a global engineering organization that can operate literally 24 hours a day and 7 days per week.

After a several month evaluation in the fourth quarter, we also struck multi-year deals with two leading EDA companies to provide leading edge front-end and back-end tools that will be utilized by our worldwide design teams in Portland, Shanghai, Silicon Valley and Toronto. This investment is targeted to allow us to develop system-on-silicon projects in multiple locations and to easily reuse IP across the corporation.

I'll now turn to a review of the markets for our various products, starting with projectors. After two quarters of sequential growth, projector revenue declined about 13% in the fourth quarter to approximately $12.6 million. While we had anticipated a more modest reduction, we do not believe there were any competitive dynamics such as lost market share or shifts from polysilicon to DLP projectors that caused the decline, but rather the decline was the result of a weak projector market and some inventory balancing.

Pacific Media Associates, a leading industry analyst, is estimating that 4.2 million projectors were sold in 2005, an 18% increase over 2004. This estimate is unchanged from a quarter ago, but our suspicion is that when the year-end numbers are finally calculated it will come in a little lower than the 4.2 million units.

Looking to 2006, Pacific Media Associates is expecting a 21% growth in the market to 5.1 million units. I just spent some time in Asia with our major projector customers and believe they are cautiously positive about the prospects for 2006.

Although there is general agreement that Pacific Media may be a little optimistic with their outlook, there seems to be agreement that the overall market growth in 2006 should be slightly higher than the growth we saw in 2005. For the first quarter we believe our projector revenue will increase 5% to 10% over the fourth quarter.

LCD monitor revenue in the fourth quarter was slightly better than our expectations entering the quarter, decreasing only about $200,000 sequentially to approximately $2.7 million. Due largely to a long-running monitor design with a major customer reaching end of life, we expect LCD monitor revenue to decrease to $1.5 million to $2 million in the first quarter.

On the panel products side, at our CES presentation I mentioned that we shipped about 20,000 units of our timing controller, code named Peanut, to Samsung in Q4. We are pleased to be able to achieve this first production milestone.

While significant, this only represents early production volume for one television panel. We continue to work with Samsung to optimize the performance of Peanut to increase its applicability to a broader set of panel applications. We expect to continue the early production ramp of Peanut in the first quarter, but will not see dramatically larger volume until we get the revised chip qualified by Samsung for the broader set of applications.

I'll now turn to advanced media processors. Advanced media processor, or AMP, revenue in the fourth quarter was approximately $4.2 million, which was below our expectation.

Of the $4.2 million, a little over half came from networked communication business, which includes the video conferencing market. This part of the business was roughly in line with our expectations. The miss was primarily due to lower IPTV set-top box business.

The IPTV set-top box business represented 5% of total AMP revenue in the fourth quarter, down from about 30% in the third quarter. The IPTV set-top box business has been lumpy and somewhat unpredictable as IPTV introductions are in their early stages of rollout. We believe that the IPTV market will be an attractive growth opportunity over the long term, especially with the integration of IPTV capabilities into the television itself.

Looking out at the future of the AMP business, at CES we demonstrated an ATSC-compliant TV with integrated IPTV capabilities. This demonstration showed our vision for the future of integrated IPTV.

I am encouraged with the discussions and the early customer engagements that are resulting from this demonstration. We are now in the process of unifying the road maps for our image processors and media processors to dramatically lower the price point for integrated IPTV, while preserving our investment in software.

Turning to Q1, we believe we will see some growth in the AMP business, leading to revenue of approximately $4.5 million to $5.5 million.

I'll now turn to the advanced television business. The advanced television business was the bright spot for us this quarter as revenue increased 16% sequentially to approximately $23 million, above our estimate for 10% to 15% growth. Unit shipments were up 20% sequentially and our average sale price declined 3%.

Our TV customer base remained diverse in the fourth quarter with over 80 customers in total. Our largest TV customer represented approximately 20% of total TV revenue and the top five customers represented about half of total TV revenue.

Geographically, shipments to China represented the largest share at approximately 29% of total TV revenue, followed by Europe at 25%, Korea, Taiwan and Hong Kong representing about 14% each and China-- and Japan, I'm sorry, representing approximately 4%.

We shipped to over 20 customers in China in the fourth quarter, including Amoisonic, Changhong, HiSense, [Konka], [Qanta], Sanyo, [Skyward], TCL and [Sosiko]. In Europe, notable customers included Beko, Sharp and Vestel. In Japan, NEC, Panasonic, Sanyo, Seiko-Epson and Sony represented most of the business. In Korea, we shipped to approximately 20 customers, including Daewoo, Samsung, LG and Humax. In Taiwan, we had over 25 customers, including many of the leading ODMs.

Q1 is typically a seasonally slower quarter for the TV business. In addition, this year we're also rolling out Opal 2 specifically for the European market that is replacing our older [YEM] products.

A significant example of this transition is occurring at one of our largest European TV customers. This YEM-to-Opal-2 transition alone, we expect, will result in a $3 million reduction in revenue from Q4 to Q1 before ramping back up in Q2.

Taking these factors into account for Q1, we expect TV revenue to decline 10% to 20% from the fourth quarter. We expect to see things pick up in late Q1 and into Q2 as Europe ramps for World Cup television sales.

On the new customer front, we're pleased to welcome one of our oldest monitor and projector customers, VSonic, as one of our newest television customers. VSonic announced at CES their new lineup of NextVision 60 series integrated ATSC television, including 32, 37 and 40-inch models, all powered by Pixelworks. This design win is especially gratifying because by using Pixelworks' proven ATSC reference software, VSonic was able to get these complex ATSC designs into production quickly with outstanding image quality.

VSonic also featured Pixelworks' DNX video processing in their CES introduction materials. The software investment that we made in 2005 for ATSC-compliant TVs is paying dividends.

I'll now turn the call over to Jeff for his review of our financial results.

Thanks, Allen. Before I begin my overview, I want to mention that I will be referring to both GAAP and non-GAAP numbers. Please refer to the financial statements and notes in the earnings release for a reconciliation of the differences between financial results on a GAAP and non-GAAP basis.

Revenue in the fourth quarter of $43.3 million increased 13% from a year ago, but was down 7% from the third quarter. Backing out the revenue contribution from advanced media processors, which resulted from the mid-year acquisition of Equator Technologies, revenue in the fourth quarter was up approximately 2% year-over-year.

For the year, revenue of approximately $172 million decreased approximately 3% from $176 million in 2004. Advanced television revenue increased $13 million or 16% in 2005 to approximately $89 million, but that was more than offset by a $25 million decrease in projector revenue, which declined from $78 million in 2004 to $53 million in 2005. The decline in projector revenue was mainly due to Texas Instruments entering the market with a competitive solution, plus a market share shift from LCD to DLP projectors.

LCD monitor revenue declined $6 million in 2005, while advanced media processor revenue from the Equator acquisition contributed $13 million, all in the second half of the year.

In the fourth quarter, business was strongest in China, Europe and Korea, which were up 39%, 19% and 7% sequentially. Taiwan and Japan, however, were down 21% and 11%, respectively.

In terms of customer concentration, we had two 10% customers in the fourth quarter and the top 10 customers represented approximately 55% of total revenue.

Gross profit margin on a GAAP basis in the fourth quarter was 35.1%, which was up from 31.3% in the third quarter. Included in cost of sales, thereby negatively impacting GAAP gross profit margins, was approximately $3.9 million of non-cash acquisition-related and stock compensation expenses representing 8.9% of revenue. Excluding these expenses, non-GAAP gross profit margin was 44%, which improved from 43.8% in the third quarter.

On a GAAP basis, operating expenses were $24.4 million in the fourth quarter, which was down from $24.8 million in the third quarter. Included as GAAP operating expenses were $1.2 million in restructuring expense related to the headcount reduction that was completed in October and approximately $585,000 for non-cash acquisition-related and stock compensation expenses.

Non-GAAP operating expenses, which exclude restructuring and non-cash acquisition-related and stock compensation expenses, were $22.6 million in the fourth quarter, which was down $1.2 million from $23.8 million in the third quarter. The decrease was primarily attributable to reduced compensation expenses related to the reduction in headcount from the restructuring.

The loss before taxes, both on a GAAP and non-GAAP basis, was in line with our outlook. On a GAAP basis, the loss before taxes was $8.8 million in the fourth quarter, which improved from a loss before taxes of $10 million in the third quarter. On a non-GAAP basis, the loss before taxes was $3.2 million in the fourth quarter, which compared to a loss before taxes of $3.1 million in the third quarter.

The tax provision, both on a GAAP and non-GAAP basis, was unusually large in the fourth quarter due to a $31.4 million tax expense representing $0.66 per share on both a GAAP and non-GAAP basis that was related primarily to recording valuation allowance against deferred tax assets. The recorded valuation allowance was necessary as a result of the company's current and projected loss position.

Through the end of the fourth quarter, there was valuation allowance placed against approximately $89 million in deferred tax assets. Should the valuation allowance be released in future periods as a result of the company returning to profitability, approximately $41 million would be available to reduce future tax expense in the income statement and $48 million would be available to reduce goodwill on the balance sheet.

On the bottom line, the GAAP net loss was $34-- $35.9 million or $0.75 per share, which included the $31.4 million or $0.66 per share in tax expense from the recording of valuation allowance. Excluding the $31.4 million tax expense, the GAAP net loss would have been $4.5 million or $0.09 per share, which compared to our October outlook for a $0.10 to $0.11 loss.

On a non-GAAP basis, the net loss was $32.1 million or $0.67 per share, which also included the $31.4 million or $0.66 per share in unusual tax expense. Excluding the unusual tax expense, the non-GAAP net loss would have been approximately $666,000 or $0.01 per share, which compared to our outlook for a $0.02 to $0.03 loss.

Now turning to the balance sheet to review some of the notable line items. Cash and marketable securities consisting of cash and cash equivalents, short-term marketable securities and long-term marketable securities were $145.6 million at the end of the fourth quarter, which was down $1.7 million from the prior quarter.

On a related note, on our last call we had been asked about whether we would consider utilizing some of our cash for a stock buyback. We did discuss the pros and cons of a stock buyback at a recent board meeting and at that point in time decided not to pursue a stock buyback as we believe there are other investments that need to be made that will provide a greater return to shareholders over the long run.

For example, in the fourth quarter we made commitments for EDA tools and IT licenses totaling $20 million. We believe it is critical for the company to have significant and readily available cash reserves in order to be able to make critical investments necessary to further expand the breadth of our product offerings in the future.

Having said this, the company will continue to regularly evaluate the pros and cons of using cash to repurchase stock.

Moving on to other line items on the balance sheet, accounts receivable of $19.9 million, representing 41 days sales outstanding, was down from $27.4 million or 53 days sales outstanding in the third quarter.

Inventory of $26.6 million was down from $27.8 million in the prior quarter. While inventory came down in the quarter, it's still higher than we'd like it to be and will continue to be an area of focus.

Property and equipment of $29 million increased $14.2 million, primarily as a result of the multi-year EDA tool agreement that Allen spoke of earlier in the call.

I'll now provide details behind some of the elements of the first quarter outlook provided in the earnings release issued earlier today.

We expect revenue in the first quarter to be approximately $39 to $43 million, which is roughly flat to down about 10% from the fourth quarter. Projector, panel products and advanced media processor shipments are expected to increase, while TV and LCD monitor shipments are expected to decrease.

Non-GAAP gross profit margin, which excludes the non-cash acquisition-related expenses and stock compensation expenses, is expected to be approximately 45.5% to 47.5% in the first quarter, up from 44% in the fourth quarter. Improved product margins in advanced televisions and a more favorable mix of business in the first quarter are expected to drive the increase in gross profit margin.

R&D and SG&A expenses combined are expected to be $25.5 to $26.5 million. Included in these expenses are an estimated $2.5 to $3 million in non-cash stock compensation expenses as a result of the implementation of FAS 123R. On a non-GAAP basis, R&D and SG&A expenses are expected to be $23 to $23.5 million, which is up from $22.6 million in the fourth quarter, primarily as a result of higher depreciation expenses related to the EDA tool purchases made in the fourth quarter.

Given the projected loss before income taxes on a GAAP and non-GAAP basis, we expect the tax provision to be immaterial for both GAAP and non-GAAP purposes in the first quarter.

That concludes the review of fourth quarter financial results and some elements of the first quarter business outlook. For information on all elements of our financial results and business outlook, please refer to the press release issued earlier today announcing fourth quarter financial results.

I will now turn the call back to Allen for his closing comments.

Thank you, Jeff. 2005 was not our best year as a company, but we feel 2006 began on an excellent note. The Consumer Electronics Show in January represented a huge step forward for us.

The investments we made during 2005 are beginning to bear fruit. We rolled out a broad line of products that extends our penetration of the signal path. We have continued to make investments in tools and intellectual property necessary to lead our industry.

After reviewing our new product portfolio at CES, several customers and analysts seemed to agree that our road map is equal to anyone in the industry in terms of quality, that we need to accelerate our single-chip MPEG integration, but that we have pulled ahead in terms of offering the broadest set of solutions for the signal path.

With the investments we have made in IC design tools, we feel we are well on the way to perfecting our IC design engine to address integration and believe our investment in software leads our competition.

The projector market seems to have stabilized with polysilicon LCD-based projectors and DLP projectors remaining around 50/50. We're even beginning to see formerly exclusive DLP customers bring back polysilicon and LCD-based projectors into their lineup. We continue to make progress in our strategy of anchoring our solutions to the panel with the first early production shipments of our Peanut timing controller.

Our advanced television business grew nicely in the fourth quarter. We announced a broad array of new products, including Pearl, our lead product to penetrate the top tier television accounts, and Opal 2, our enhanced European TV chip, in anticipation of World Cup 2006.

Pixelworks has been a very successful company since our inception in 1997. We've won many awards and accolades, including being named by “Forbes” as the fourth fastest-growing technology company in America last year. We thrived during the last semiconductor downturn, putting together a string of record quarters when other companies floundered.

This is the level of performance that we expect. We believe we have put the people, products and processes in place to again return to this level of performance as we move through 2006 and into 2007.

We will now open the call for questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Tore Svanberg with Piper Jaffray.

Hi, guys. This is Heidi Poon calling in for Tore.

Hello.

Hi. Regarding the projector business, you mentioned that your customers are cautiously positive going into '06. Can you let us know about your view of the pricing trends this year?

The end-- the end-projector pricing trends?

Yes and your product.

Yes, this is just sort of anecdotal stuff from talking to people. I would say that they will-- they will mirror, pretty much, what we saw in 2005, that certainly people are seeing the pricing trends continue to go down, but that there's nothing out there that I saw that would cause any precipitous drop in pricing. So it's kind of the same trend that we saw during 2005.

Okay. For advanced TV, you gave the reason for a Q1 weaker performance, but do you see any, maybe, early feedback from CES that might lead you to think that you will have a stronger ramp in the second half, sort of come back from the weaker levels and have a, maybe, decent growth rate in this segment in '06?

Yes. We said that there's a couple things affecting us. First of all, Q1's just generally a little bit softer and second of all, we're going through this product transition specifically with Opal 2s replacing older generation YEMs and called out one customer, in particular, where we could have as much as a $3 million swing in the first quarter as they burn through their YEM inventory and just start ramping Opal 2s.

I think that's a general trend that we're expecting to see as we get through the last half of Q1 and get into Q2. Our success and ramp in Q2 really depends on how aggressively we can ramp those Opal 2s into production. We think we've got the design wins in place to do it and it's a matter of getting the product out and getting those customers ramped.

Okay. And one followup question on the gross margin line. You're guiding for positive sequential growth on the gross margin, based on your product ramp. Maybe it's too early to say, but where do you see that in Q2, especially with Opal 2 ramping?

Jeff, do you want to--?

Yes, I mean, it's hard to get out much more than one quarter at any point in time, but the-- we're expecting the gross margins to improve in the first quarter, obviously, and then beyond that, I think some of the new TV products that we have have nice margins associated with them, at least in the-- kind of in the near-to-intermediate future in terms of looking out.

So depending on kind of the mix of revenue between new and old products, that will influence gross margins. So the better that we do in the new product area, the higher the margins can be. So there's opportunity, but I wouldn't plan on kind of a continuing upward trend in gross margins.

Okay. Thank you.

We'll take our next question from Tayib Shah with Longbow Research.

Hi, guys. You talked about the YEM-to-Opal transition in Europe. Can you also talk about the life cycle of your discrete parts shipping in other geographies? When do you expect the revenues from these discrete parts to fall off during the coming two to three quarters?

When you say the discrete parts--?

I mean, YEM and other parts that Opal is going to replace.

Oh. We specifically talked about Europe because there are-- there are a couple of large TV customers. There seemed to be a concentration of the use of YEM in Europe and for European TVs and that's why it was particularly highlighted.

In general, we're rolling out of those YEM parts across the entire product line. They-- they tend to be a little stickier in projectors where projectors have a longer life cycle, so I don't think we'll be out of the YEM parts for probably a couple of years, at least, Jeff, right?

Right.

But the TV guys will roll out faster and roll to Opal 2 and then later on in this year be rolling to Pearls.

So, I mean, let's say the Opal ramp doesn't come through, then do the-- the discrete parts, will they-- will the revenues completely disappear by this time next year or what's going to be the pace of that revenue decline?

Well, in most of the cases, it's a rolling out of a design win that we have and rolling in to another design win that we have. In some cases, we have, I guess I'd call them, conquest design wins where we have new-- new customers for Opal 2 that-- it might be somebody we're expanding our footprint with Opal 2 or with Pearl. And in that case, we're not rolling out of something and into another. I'd said in some limited cases, sure, there's probably some cases where we're rolling out of YEMs and they rolled into somebody else's part, but probably a majority of it-- or, yes, probably a majority of the YEMs are rolling from YEMs into Opal 2.

Okay. And then, can you give-- provide some color on the breadth of the design wins for Opal? I mean, is it multiple customers among the top five or--?

Yes, I don't have that data in front of me. We have over 80 television customers. It's been very, very well received by all of our customers. I would say, generally speaking, and this is a gross generalization, is that Opal 2 is a product that tends to be sold more to our existing customer base that is very, very broad and Pearl is a product that tends to be a product that we go into accounts where we're under-penetrated and with the features and performance with Pearl try to win back share in those accounts.

Okay. And finally, the TCON product. It looks like it's going through another revision. Are you guys any more confident than you were last quarter that the revenues from this will start flowing from a wide range of models sometime in second half of this year?

Yes. I'm more confident because we got into production with the first panel, which is a huge hurdle. There's an awful lot of production qualification work that you have to go through to do this. I mean, we're on the critical path for Samsung's television-- this is a television panel, in particular, for this panel. And they don't take that lately.

The trick now is to expand our base in the TV panels to larger sizes and different sizes and then make sure that this product is qualified for monitors and for notebooks. And the characteristics of driving it for a monitor and for a notebook, the environmental characteristics, and several of the tests that you go through, are different. We have to tweak the product in order to do that and get through the qualification product with those other groups.

So I'm certainly more confident than I was a quarter ago because we are in production, but the game is far from over.

Thank you, guys.

We'll take our next question from Michael Bertz with W.R. Hambrecht.

Good afternoon, gentlemen.

Hello.

Just a couple of quick questions here. So for starters, the--looking for-- Jeff, I know you and I have talked about this a few times, but in terms of impact of stock-based comps on a quarterly basis, how do you plan to break that out and what should we think about in terms of what size it should be?

Yes, so we provided that, actually, within the outlook today, Michael, so we're estimating-- we're estimating it'll be about a $2.5 to $3 million per quarter impact in operating expenses and about a $200,000 to $300,000 per quarter impact within cost of sales. So roughly in the-- kind of the $2.7 to $3-plus million range.

Okay. Will that be broken out in terms of a non-GAAP number?

Yes. That'll be excluded for non-GAAP purposes.

Okay, great. And then, Allen, as you look into Q1 here, you gave some directional indicators for most of your different pieces of business, but if you had to think about one that's probably got the most variability to it, you either could surprise the upside or surprise the downside, I mean, what are the ones that you're paying most attention to that could really impact the needle?

Well, I think if you just go back through what we said, television, I think we said, was down, what was it, Jeff, 10% to--?

For the forecast? 10% to 20%.

Yes, 10% to 20%. And that's a pretty broad range, typically from where we are and it's the biggest number. So it's the biggest percentage on the biggest number. And I'd say that would be the area that I would-- that I'd naturally look at.

Okay, but in terms of-- Well, I guess I'm asking a little different way. Not just in terms of the biggest number, but what-- what has the most chances of changing in that three month time? Or do you feel pretty much like, well, we have pretty good visibility and that's where it should shake out?

Well, it's-- there's ups and downs available in any of these. I think with Chinese New Year being right now and European World Cup coming on in the springtime and us going through a product transition with Opal and YEM, again, that kind of brings me back to focus on the television number.

Projectors are-- usually we're pretty good at getting projectors. We weren't so good last quarter, but usually we're pretty good at the projector number and I've just been out to talk to the projector customers and it seems like everything's pretty much on track in the projector business.

I think those are the areas, but it's really the TV area that I'm focused on.

Okay. And then if you could give, maybe, a little update on sort of the outlook for the Equator-derived AMP part of the business over the longer term? I know you guys talked about seeing some probably better return than we've seen from that so far. Where do you see that sort of trending and at what point might that sort of investment kind of break even?

Yes. We haven't broken out a P&L for it, have we, Jeff, in terms of--?

No, we haven't. It's not-- we provided, Michael, some information on that part of the business about the point when we were making the acquisition and actually, that-- it's not-- If you were to kind of do a stand-alone P&L for that part of the business, it's not a huge drag from contributing to our loss position at this point. But in terms of trying to project the point in time at which some of the markets that those products serve really begin to take off is really tough.

Like, for example, we're seeing this IPTV market as very lumpy, very unpredictable. Some of the rollouts aren't as successful as those people rolling out those programs thought they would be and yet we remain optimistic about the prospects for that-- that opportunity, longer term.

I don't know if that-- if that gives you the color you're looking for--?

No, that's fair, Jeff. And then last question, on-- on the balance sheet, obviously inventory is basically sort of flat to up slightly as revenue's come down in the last couple of quarters. I mean, are you guys at all concerned with where levels of inventory are versus revenue and how might we think about how aggressive you might be about bringing that down?

Yes, it's definitely too high. I mean, we'd like to get inventory levels somewhere around the 8-week range on an ongoing basis. We have a few specific products that, based on contracts that we have with some suppliers, it kind of necessitates us to purchase inventory, sometimes, in advance of even demand that we would expect and then in the short term it's been complicated by the fact that we've come in a little bit under where we expected to be, but that's kind of the overall longer-term goal is to get back into that-- that 8-week or so range and we're going to work hard to do that.

Okay, terrific. Thanks. And, Jeff, congratulations and good luck.

Thank you very much.

We'll take our next question from Craig Berger with Wedbush Morgan.

Good afternoon and, Jeff, good luck at-- at your new gig.

Thanks, Craig.

Hi, Craig.

I just wanted to dig in a little deeper into your design win visibility for 2006. I know it may be hard to gauge this, but if, hypothetically, there were 1000 analog image processor sockets to be won worldwide for 2006, kind of what percent of the design wins do you think you might have garnered? And how do you expect that to ramp over the course of the year?

Obviously, we haven't given that color up until now. It's an interesting way to look at it, Craig. I'd say-- let me take a little different tack and then if it doesn't answer the question, please come back and ask again.

I would say we've done a very good job of holding design wins and holding relationships where we had older products and we're rolling in our newer products. And that isn't to say we held every single one of them, but a large, large percentage of them we held. And that's across an extremely broad set of customers.

The place where we've been weak and where our competition has kicked us around a little bit, is really in those top-tier accounts, the big names that heretofore have really moved the tonnage in this business. And that's been a focus for us over the past, gosh, I'd say over the past year, 2005.

Now I'd say early in 2005 we didn't really have the products to go after those-- those slots and that's where the development of Pearl really came from. Where Opal 2 was sort of a defend our flank, Pearl is the product that we're going after those larger accounts with.

And so through 2005 through FPGA demos and things that we could do to get into those accounts we used Pearl to really open up those doors and then with the demonstration at Pearl at CES -- and I think you probably saw it at CES; it was only about five days old there -- some of those things started to come to fruition. Now it's going to take through the first half of 2006 to really engage with those customers, get their designs done and get it rolled out, so we won't really see a Pearl uplift until the second half of 2006, probably late Q3 and into Q4, but that's been the strategy.

I don't know if that came close to answering your question, but that's what we've been pursuing.

So when you say you've held those relationships, does that mean that your revenues could grow with the market as you maintain the number of sockets you have and the customers-- those customers grow their volumes?

Yes and I think, Craig, certainly our-- our mission has been to grow faster than the market. I think we-- we didn't quite have the products in order to do that in 2005. We believe we've got those products as we enter 2006. Whether we grow faster than the market or not, that's-- that's the roll of the dice for us this year as we work with these guys to get Opal 2 rolled out and get Pearl rolled out and actually get our new flock of PWM2020s and 2030s rolled out, as well. But our goal is to grow faster than the market, certainly, from where we are today.

And then if we look at the-- the P&L a bit, your OpEx is over 50% of revenues, 55% of guided revenues in Q1. Do you plan on maintaining that level of investment through the year and just new products come in and start to ramp? Or is there, at some point, that we take a look and rationalize the spending in some of these various areas?

Well, maybe Jeff can comment on this, too, but we certainly think the market opportunity that we're going after more than supports this level of spending. We've-- we've-- we believe that we've got a product portfolio out there that can-- that can support a revenue rate and a margin rate that would certainly more than offset that level of spending and return us to profitability.

Now what-- what Jeff and I talked about in the call is we've also been really, really prudent about spending during the last half of last year and coming into this year, cranking down in areas where we thought we could crank down, but at the same time, Craig, we've had to make some investments and wanted to make some investments, specifically in computer-aided-design tools for our IC designers across the entire corporation that is probably-- Did we break out how much that was per quarter, Jeff?

No.

But it's a sizable amount of spending as we move forward and, in fact, it is-- the jump in spending that you see between Q4 and Q1, a chunk of that, a large chunk of that, is attributable to depreciation of the new tools that we just invested in.

Got it. And then if we take a look at the Equator acquisition, obviously, $4 million of revenue is significantly under-performing your expectations. Kind of what's going on there, specifically in the IPTV piece of the business and what type of visibility do you have into design wins in '06? Because, frankly, Sigma Designs wasn't seeing lumpiness recently. So any visibility you can give us there would be great.

Yes. We've certainly seen lumpiness there and maybe it was because we got some of our products out a little bit before they did and we're seeing some of the market uptake issues before they're seeing them. Maybe, maybe not. That's complete speculation on my part.

What we really have begun to see and what we've really begun to see people light up on is the somewhat unique combination of our access to TV customers and the IPTV capabilities brought to us through the Equator acquisition. Our television customers have really been struggling to say, “How am I going to do this? How am I going to start rolling out products where the TV's connected to the Web?” We think we're developing a strategy where we can offer them a path to do that with multiple levels of capabilities, all the way up to a fully integrated IPTV solution.

And that's kind of the long-term vision. We'll be rationalizing the road map between what was the Equator products and what is the high end of our image processor products and if you look at a block diagram of those products, especially a year or two out, they really start to look the same. We're being driven in the same direction and then all it is is making sure you get the right blocks and the right software.

For the balance of this year, we didn't outlook anything beyond the first quarter for Equator and we think that Q1 is going to be a little bit better than Q4 was. And we'll just have to take a look at it as we get farther into Q1 and get into Q2 and give you an update then.

And then just my last question is on the IPTV stuff, I mean, is the market looking for a programmable solution or is it looking for a fixed-function solution? Because it seems to be going fixed function.

Yes. It depends, obviously. Some of the-- some of the folks are looking for fixed function. When you start to go into a television, I think they're looking for flexibility in the TV because TVs tend to have a longer life. It's not a stand-alone set-top box that I'm going to have for a couple years and then toss it if it doesn't work. So the programmable function certainly helps us when we talk about integrated solutions for television. So it depends upon the customer, Craig.

Thanks and good luck.

Thanks.

We'll go next to Brian Alger with Pacific Growth Equities.

Hi, guys.

Hello.

I want to clarify a couple of things. Following up on Mike's questions, the inventory -- clearly we want to bring it down and the goal of 8-weeks over the long haul certainly seems admirable. I'm wondering a couple of things. One, what is the composition of the inventory, new product versus older product? And what-- what orders do we have in place to bring that down here in the short term? I.e., what I'm getting at is what's the probability that we could be facing a write-down?

Yes. So just to give you a-- I don't have kind of the new product/old product breakdown with me, but to give you a sense for kind of how much is finished goods versus WIP, about $20 million of the roughly $27 million is finished goods and so that means $7 million, roughly, in work in process.

Like I said, most-- most of the product inventory is pretty healthy. There's a couple products that we have a number of months of inventory. We don't think there's any inventory risk, obviously, at this standpoint or else we've already reserved for it, but it's just going to take some while to burn through it, take some time to burn through it.

So that's something that will have to be evaluated on a quarterly basis, but some of these things-- a couple of the products, in particular, are just going to take some time to burn through it based on the latest forecasts we have. But we've reserved for what we think is necessary at this point.

Okay. And you mentioned ViewSonic as a new customer or kind of a different customer coming into the TV world. Obviously, ViewSonic's a brand that most of us know. As I understand it, that was a competitive win against one of your other competitors. Is that correct?

This is a-- it's a new ATSC design for them. So I don't think they had an ATSC design before this, Brian, but another competitor is in that account and we got this design win. So however you want to phrase it, is-- I guess I'll leave that up to you.

Okay, fair enough. And then-- and then finally, as we're kind of looking at the splits, historically you used to give us a breakdown between LCD-plasma versus digital CRT and I guess we've kind of gotten away from that. Where do we see the growth or the lack thereof in the March quarter as we look at kind of those different categories and how does that change as we move through the year?

Yes. So, hey, Brian, I can give you the data for the fourth quarter. We just didn't do it in the script, but--

Okay.

The LCD and plasma revenue, combined, was about 93% of our total TV revenue, which was unchanged compared to the prior quarter. It was roughly the same.

The same percentage or the same dollar amount?

Same percentage. I think it was 94% in Q3 and 93% in Q4. The-- roughly, I can give you the ratio of revenue, LCD to plasma. We haven't-- there's some variability in this. We rely on our customers' orders and the information they provide us to come up with this, so it's not necessarily 100% accurate, but in Q4 it was about a 7 to 1 ratio, LCD to plasma business, in terms of revenue dollars.

And then as you look forward to Q1, our expectation is to see both plasma and LCD come down a bit. And I don't remember exactly what the-- what the percentages were. I think it was roughly the same, so I don't think there was expected to be any kind of significant shift between LCD and plasma in the first quarter relative to the fourth.

Okay and we'd assume a seasonal effect on digital CRT, as well?

Yes, interestingly enough-- yes, digital CRT was up quite a bit for us in Q4. It's really small numbers. And then in Q1, I think it was expected to be down a little bit, maybe not quite as much as the LCD and plasma business looked to be.

Okay. Okay. And then finally, I guess, everybody seems to be keying in on this-- this IPTV market and we're, I guess, looking at a market that is so small that it's tough to describe whether it's lumpy or just trial runs here. When do you guys think that you'll start seeing meaningful revenues? I mean, $200,000 this past quarter, obviously, I wouldn't clarify as meaningful. When do you think you'll get meaningful revs from IPTV-related products starting to hit your P&L on a regular basis?

Yes. Well, and that's part of the lumpiness story. Like, for example, in Q3 there was about $3 million in set-top box revenue supporting IPTV applications. So-- but in terms of growth from kind of either the level that we were at in Q4 or even what we were at in Q3, it's really, really difficult to predict at this time.

Some of the designs that we're in today haven't been very successful in the market, so they're re-evaluating the products that they need to bring to market. And we're-- we're kind of learning as we're going through this process a little bit.

Brian, I think one of my observations is people are starting to have a better idea of sort of target markets and rifle-shotting products at these markets. There's a-- there's one company that we've worked with that's actually doing Indian narrowcast -- India Indian -- narrowcast television through a set-top box to bring the Bollywood-type movies to an Indian population living here in the United States.

And that seems to be a much, much better profile rather than just a broad range of capabilities, not really targeted, going straight against the cable guys, because the narrowcasting of something like these Bollywood movies to an Indian population is something that is much more effectively done with IPTV than it is with cable TV. So I don't think it's going to happen-- it's not like a light switch is going to get thrown, but I certainly see the macro trends moving in the direction where they're really focusing on what the great capabilities of IPTV are.

So, I guess, if I'm hearing this right, it's not so much that the boxes aren't working, per se, or aren't meeting the service providers' expectations, but rather that the services that are being provided aren't finding a market that has any demand?

It's-- it's more about finding the markets where you have kind of a resonance between product, customer and content and really hitting that sweet spot. I think that's-- if I was going to try to crystallize it in one thing, it's that. It's not that you can't digitize video and send it over the Internet and get an image up on the other side reliably or with a reasonable quality. I don't think that's it as much as it is the former.

All right. Well, thanks for the insight, Allen.

Thanks.

We'll take our next question from Jennifer West with Merriman Curhan Ford.

Good afternoon.

Hello.

I had another question on Equator, just, again, specifically to your expectations in the March quarter. Can you kind of give us some color as to the direction of your IPTV set-top box of that business versus the video conferencing?

Yes. We're expecting to see some-- some growth in the IPTV set-top box part of the business and then relative to the network communications part of the business I think that we're expecting to see a little bit of growth there, as well.

Okay. And then can you give us what the ASP difference is between the YEM and then your new generation Opal products? And then talk about your expectations on if you're expecting to see the product transition that you're seeing now in Europe affect other customers in other geographies later on this year or how is that going to trend?

Jeff, do we have anything on YEM versus Opal?

No. I mean, YEM is a-- is an image processor that doesn't have as much integrated onto-- onto it as Opal does, but in every kind of generation of products you tend to kind of try to get more integrated onto a chip and then try to hold the prices kind of similar to where they were with the less-integrated chip.

Yes. I would say they're actually similar.

Yes.

But YEM-- you probably don't remember, but YEM actually uses embedded DRAM, so there's a whole frame buffer embedded in a YEM chip. In the Opal chip, the frame buffer moves off the chip, but the analog-to-digital converters and some of the higher deinterlacing functions are included.

So the ASPs are-- are similar. Maybe Opal is even a little bit lower.

But kind of-- I would say in the teens, generally, is a-- kind of to give you a reference point.

Yes. And then on Europe, will our competitors see the same things that we're seeing in Europe? Yes, but we've-- we think we have a greater reliance on European business than some of our competitors, so it exacerbates anything that happens in Europe. I think the other thing is, maybe because we have a greater reliance on Europe, we've really focused on creating and tuning a chip for Europe and that's the Opal 2 chip.

So on that side of that, I think the reliance on Europe has been good for us. Our broad customer rollout across Europe has given us some feedback that maybe some of our competitors don't have.

Okay, I guess my-- my question was that are you expecting to see the same kind of production transition hiccup in your sales across other customers and in other geographies other than Europe?

Oh, I see. Not to the same extent as this one, in particular. It's a-- it's a very, very large YEM customer swinging a broad product line over to an Opal and it's just-- it's just more pronounced, more product simultaneously. Generally, you'd see somebody phase something like this and this one just happens to be a bigger-- a bigger switch.

All right. Thank you.

Sure.

We'll take our next question from Jason Pflaum with Thomas Weisel.

Good afternoon. This is Alex Kim.

Hi, Alex.

Hi. How are you? Just-- just another question on inventory. In particular, are you more concerned about inventory levels on the projector business or the TV business? Perhaps do you have a breakdown of your inventories by product, just roughly?

Yes. I don't have the breakdown by product. The TV business is, I would say, less predictable. So just on an ongoing basis it's harder to get that right in terms of placing orders that are outside the lead times that our customers have with us. So that's the tougher one to manage. The projector market has been relatively stable. There aren't really competitive dynamics affecting that part of the business and it's just much more easy-- it's much easier to predict and manage, all around.

Okay. And just a question on gross margins. I think if you look at Q4/Q1, the nice surprise there is gross margins and it doesn't seem like it's mix, just looking at my detailed models. Is it perhaps better-- a better gross margin profile on some of your product? I know that you alluded to it somewhat, maybe you could just add some more color?

That's what it is. It's definitely-- a richer mix of new products helps and then also the projector margins tend to be nice margin business for us and that's growing-- expected to grow in the first quarter. So there is some-- a favorable impact from a mix standpoint there.

Okay. And just a final question on the projector market. I know that you had said that the broader projector market is experiencing a little bit of an inventory correction. I'm wondering if you could add some more color there with respect to when do you see inventory levels from your customers being back to normal?

Yes, I think it's-- I don't think there is anything major going on. I think it's just a-- it's just a little bit of a slow-growing market at this point in time. And so I think in the fourth quarter there appeared to be some inventory balancing.

At our distributors in Japan, which is where most of our product is sold, inventory went down a little bit in the quarter. It seems to be at very healthy levels.

So-- and that may be why we're seeing some-- a bias towards the revenue increasing in the first quarter. But I don't think there's any major inventory issues in the projector side of the business. It's just kind of a slow-growing market at this point.

Okay, perfect. Thanks, guys.

Thanks.

You bet.

We do have time for one more question. Our last question will come from Adam Benjamin with Jefferies & Company.

Thanks, guys. With respect to the gross margin guidance you provided for Q1, obviously, you're having some mix shift going on within some newer products, so that's helping a little bit. But I'm just trying to understand within the buckets of revenue how you get to those levels.

You'd previously talked about LCD monitors having gross margins kind of in the 20% range. Has that changed since the ramp of some of this business at Samsung?

Yes. We've actually never been specific on LCD margins, LCD monitor margins, so I'm not quite sure where you got that number. But they are-- they have improved from where they were years ago. Essentially at the point a couple of years ago when we decided to stop developing products for that market, just be selective in terms of what business we pursued, the margins started going up, because we're getting decent business, profitable business.

So the margins aren't that-- anywhere close to what you have for LCD monitor margins, suggesting they're at near 20%. So they're definitely much higher than that.

Still, projector margins are very healthy and TV margins are coming up nicely for us as we're getting a richer mix of new products.

Okay. Let me ask it a different way, Jeff. You talked previously about the monitor gross margins being above the corporate average and TVs being below. Is that still--

No, it's just the opposite.

Excuse me?

It's just the opposite.

I'm sorry, I meant projector being above and TVs being below. I think that's--

No, we haven't said TVs were below. They haven't been below the corporate average.

Okay. Following up on the Samsung piece of business, you had talked about initial ramp in Q1. Does that, then, kind of fall off a little bit going forward, or--? I'm just trying to better understand that ramp at that particular-- at Samsung.

No, I think the position that we're in right now is we have a TV panel, one specific size, that we've qualified the timing controller for and that's-- that's terrific news that we're-- we're in production with that.

The trick now is to expand that out across a broader range of television panels and then to expand it out into monitors and even into notebook computers. So we expect to see it ramp up a little bit more in Q1, but it's really now going to be dependent upon a breadth of applications.

This isn't going to be a home run business if we only have one timing controller on one panel and, in fact, that's kind of a bust business for us. But if we can expand it out across a wide range of television panels and then if we can move it into monitor panels and notebook panels, then it can be a really nice business for us. And we'll be trying to do that as we go through the year.

Okay, great. Just to circle back on the gross margin, with respect to the increase that you're seeing in Q1 due to some product mix shift, is that something you'd expect to continue in Q2 as you shift to some newer products with, likely, higher ASPs?

Yes. I mean, I think it's going to completely depend on the mix of new products that-- and the rate at which we ramp those. The new product margins are much better than the products that we've been shipping for a couple years. So the quicker new products ramp, the more upward bias there would be on gross margin.

Just to give you a sense for where margins are, kind of by the different product areas, the AMP-related margins are very, very good, above the corporate average. Projectors are high. TV tends to be higher and then monitor tends-- has tended to be a little bit lower, but they've been coming up.

Okay, great. Thanks a lot.

Thank you.

And, Mr. Alley, I'll turn the conference back over to you for any additional or closing remarks.

Thank you. Before signing off, I'll mention that we plan on attending several investment conferences this quarter and just please stay tuned to our website for the specific dates and times. Thank you.

And that does conclude today's conference. We thank you for your participation. You may now disconnect.