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Entropic Communications, Inc. (NASDAQ:ENTR)

Q3 2008 Earnings Call Transcript

October 28, 2008, 5:00 pm ET

Executives

Debra Hart – Director, IR

Patrick Henry – Chairman and CEO

David Lyle – CFO

Analysts

Gomabas [ph] – Barclays Capital

Daniel Amir – Lazard Capital Markets

Krishna Shankar – JMP Securities

Eric Kainer – ThinkEquity

Gene Webber – Webber Capital Management

Sandy Harrison – Signal Hill

Operator

Ladies and gentlemen, good afternoon. At this time I'd like to welcome everyone to the Entropic Communications Conference Call. (Operating instructions)

Today's conference call is being recorded. And now I would like to turn the call over to Debra Hart, Director of Investor Relations for Entropic Communications. Please go ahead, ma'am.

Debra Hart

Good afternoon, everyone, and welcome to Entropic Communications Third Quarter 2008 Conference Call. Leading the call today are Patrick Henry, Chairman and CEO, and David Lyle, our Chief Financial Officer.

Before we begin, I would like to remind you that various remarks that we make on this call concerning our expectations, opinions or beliefs about the future, including remarks about our future financial results, revenue, gross margins, expenses and potential income or loss, anticipated timing and size of product deployments by service providers, future product offerings by our competitors, market trends, our goals, and our prospects, all constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act. These forward-looking statements and all other statements that maybe made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially from the results indicated by such statements.

We refer you to our most recently filed Form 10-Q, in particular, to the section entitled “Risk Factors” and other reports that we may file from time-to-time with the SEC for additional information on factors that could cause actual results to differ materially from our expectations. Please also note that any such forward-looking statements we make on this call only speak as of today's date. We undertake no obligation to update these forward-looking statements.

In addition, Entropic reports gross margin, operating expenses and net income and basic and diluted net income per share in accordance with GAAP and additionally on a non-GAAP basis. Management believes the non-GAAP information is useful because it can enhance the understanding of the company's ongoing economic performance and Entropic therefore uses non-GAAP reporting internally to evaluate and manage the company's operations.

Entropic has chosen to provide this information to investors to enable them to perform comparisons of operating results in a manner similar to how the company analyzes its own operating results. The full reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued earlier today and we ask that you review it in conjunction with this call. We have posted the GAAP to non-GAAP reconciliation on our Web site.

Now I'll turn the call over to Patrick Henry. Patrick?

Patrick Henry

Thank you, Debbie, and thanks to everyone for joining the call today. In Q3 2008, revenue was $31.7 million coming in above the high-end of the outlook range of $30 million to $31 million that we provided on our earnings call last quarter. This was accomplished in face of excess inventory levels at our largest end customer deployment.

Our last quarter end traffic has been focused on five key initiatives. First, we have focused on cash conservation and put in place operating expense reductions to preserve our cash, while working through the inventory at Verizon. Second, we continue to drive key product initiatives with our OEM customers for the Verizon deployment. Third, we have worked to increase our penetration rates within our satellite outdoor unit product line within Directv. Fourth, we continue to work with additional service providers to enable new deployments of MoCA in 2009. And fifth, we focused on new product development initiatives, including new product architectures, process geometry shrinks, future enhancements and integration. Entropic made great progress on all fronts.

Our cash conservation efforts included implementing a series of cost control initiatives that Dave will cover in greater detail later in the call. These efforts included tightening up on controllable spending and a small reduction in force implemented in late August.

These actions were taken to enable us to reach cash flow break even at a lower revenue base. We believe we've right-sized the company to be cash flow neutral to positive in the short-term and we expect our operating leverage to kick into gear as new service provider deployment in the ramp.

Entropic has over $32 million in cash on the balance sheet and no debt. We will continue to operate with tight fiscal discipline including preservation of our cash while focusing on key customer design activity and product development initiatives.

Verizon, our largest home networking deployment announced in their earnings call yesterday that they added 233,000 net new FiOS TV customers in Q3, 32% more than the 176,000 they added in Q2, and they added 225,000 net new FiOS internet customers in Q3, 20% more than the 187,000 they added in Q2.

Verizon indicated that the sequential growth in FiOS net adds was due primarily to a resumption of promotion, marketing, and advertising activities. Further, Verizon indicated in their call that their FiOS triple play service remains the center of their consumer strategy.

Verizon indicated they were on track with their FiOS build out and pleased with their early progress in New York City where they've recently entered the pay TV market and began marketing to an additional 1.2 million homes. They indicated the strong increase in homes open for sale to FiOS service in Q3 bodes well for consumer growth in subsequent quarters.

Our DBS outdoor unit business is on track with Directv's single wire module, or SWM capability. Each of Directv's SWM enabled ODU products uses three of Entropic's CSS chips. We are targeting to be in 100% of all new HD installs as we exit this year. We believe there is potential for even greater attach rate within Directv for our CSS technology in 2009.

With respect to new revenue streams in the MoCA home networking space, we see continued progress on new design wins with OEMs, technical field trials by operators, and a firming up of deployment timelines. We still expect two new tier one US service providers to deploy MoCA by mid-2009 with additional tier one service provider deployments in late 2009.

We believe the killer application for MoCA, multi room DVR is rapidly becoming a must have feature for consumers. According to a July survey by the research firm, Parks Associates, more than 10% of consumers would switch to a new TV provider to get multi room DVR functionality. This equates to over 10 million TV homes in the U.S. alone.

Based on this we expect service providers want to launch multi room DVR to defend against the potential churn. The Parks survey also found that 16% of consumers would be willing to pay more per month for multi room DVR capability. We believe this third party research validates how quickly multi room DVR service is gaining traction and the value it has for consumers.

Service providers can launch multi room DVR service to increase their average revenue per user or ARPU. Once a home network for digital entertainment is deployed in a home using MoCA, the service provider can also use this network for distribution of additional services such as online gaming, personal content sharing and downloadable movie services.

MoCA provides a true value proposition to both service provider and for the consumer. For the service provider it provides the path for delivering advanced services and driving higher ARPU. For the consumer it allows anytime, anywhere access to all their home entertainment content.

Entropic continues to extend our market leadership in MoCA. Last week, we announced our silicon received MoCA 1.1 golden node certification by the board of directors of MoCA. A golden node is used for interoperability testing and certification to the MoCA 1.1 standard.

Any system based on Entropic's MoCA solutions or any competitive MoCA silicon software will need to pass MoCA certification and interoperability testing which ensures that all products work together and are backward compatible with the MoCA 1.1 standard. To-date, Entropic remains the only source of MoCA silicon solutions in MoCA certified products.

We remain enthusiastic about Entropic's opportunity within our share of markets. We will continue to prudently invest in product development and new design wins while maintaining our fiscal discipline.

Now I'll turn the call over to Dave for a more detailed report on our financial results for the third quarter and guidance for the current quarter. Then I'll provide some closing remarks and will open the call for your questions. Dave?

David Lyle

Thanks, Patrick. Third quarter revenue of $31.7 million was down $11.1 million sequentially from $42.8 million in Q2 as a result of excess inventory levels at our largest end customer Verizon. In Verizon's Q2 earnings call, they announced softer file subscriber additions. However, as Patrick indicated earlier, Verizon has returned to a growth mode in Q3 and they are working through their inventory as we expected.

Because our product shifted towards a richer mix of DBS outdoor unit products, our non-GAAP gross margin for the quarter was up 250 basis points to 50.6% from 48.1% in Q2. Non-GAAP gross margin excludes $1.6 million of amortization of purchase intangibles associated with prior acquisitions and approximately $63,000 of stock-based compensation expense.

Non-GAAP operating expense of $17.3 million was down $2.4 million from Q2. This was better than the low end of our Q3 target range of $17.5 million to $17.8 million due to our aggressive cost reduction efforts implemented during Q3. Those efforts included pushing out projects such as our international tax structure implementation and tightening up on controllable spending such as consulting and outside services. We did not sacrifice the future growth of the company by cutting into R&D projects and key customer design activity critical to our intermediate and long-term success.

There were two additional actions we took in Q3 to reduce costs. First, based on our Q3 revenue decline and our lower Q4 revenue expectations the annual performance targets for our 2008 management bonus plan will not be met. As a result, we stopped accruing for the management bonus plan for the remainder of 2008 and reversed the bonus accrual from the first half of the year.

And second, we completed a reduction in force of approximately 20 employees spread proportionately across all functions, R&D, marketing and sales, as well as G&A. Although the majority of the savings from the reduction in force will be experienced in the fourth quarter, we did experience a reduction in operating expenses in Q3 from this action. Q3 total head count of 303 employees worldwide declined 14 net heads from the second quarter due primarily to our reduction in force.

Our Q3 non-GAAP results exclude $3.5 million in stock-based compensation expense, approximately $700,000 in amortization and purchase intangibles from prior acquisitions, and approximately $200,000 for a reduction in force restructuring charge.

Interest income for the quarter was approximately $150,000 and income taxes were immaterial for the quarter. We recorded a non-GAAP net loss in the third quarter of $1.2 million, down from Q2 non-GAAP net income of $1.2 million.

We had a non-GAAP net loss per share of approximately $0.02 based on a basic weighted average common share count of approximately 67.7 million shares. Our GAAP – our non-GAAP fully diluted weighted average share count would have been approximately 72.6 million shares if we had non-GAAP net income rather than the non-GAAP net loss.

Moving to our balance sheet, we ended the quarter with approximately $32 million in cash, cash equivalents, and marketable securities, an increase of approximately $3 million from Q2. The increase was due to a higher amount of collections in Q3 from heavier quarter end billings in Q2.

Our cash, cash equivalents and marketable securities are mainly invested in high grade money market funds with no exposure to auction rate securities and all other short-term investments material within the next two quarters. Entropic has no bank debt and has had no need to utilize our working capital line of credit.

Our DSOs were 57 days in Q3, a significant improvement from 76 days in Q2 due to improved sales linearity throughout the quarter. Our inventory turns were 2.8 times on a non-GAAP basis, below the 4.2 times achieved in Q2 as inventory ordered in Q2 was received in Q3. This kept inventory levels relatively flat Q2 to Q3 on a lower sequential cost of revenue as a result of a lower revenue base.

Now I'd like to provide our guidance for the fourth quarter of 2008. In Q4, we expect top line revenue to increase slightly to approximately $32 million to $33 million. We anticipate that Entropic's demand for MoCA chips in the Verizon deployment will continue to be soft while they work through their excess inventory levels. However, we do expect that our DBS outdoor unit product line will continue to ramp.

We believe we will see further improvements in non-GAAP gross margin in Q4 to between 52.5% and 53.5% due to an even richer mix of higher margin DBS outdoor unit products. We believe non-GAAP operating expense will increase slightly to a range of $17.4 million to $17.6 million in Q4. Please note that we will exclude from our non-GAAP operating expense approximately $700,000 of amortization of purchase intangibles from prior acquisitions and approximately $3.5 million for stock-based compensation expense.

We expect to generate approximately $100,000 of interest income and we do not expect to record any material income tax expense in Q4. We estimate that our non-GAAP weighted average share count will be approximately 68 million shares in the fourth quarter, a slight sequential increase due primarily to shares we expect to issue under our employee stock purchase plan. Assuming the mid-point of our guidance, we would expect to be near breakeven in Q4, but non-GAAP EPS of approximately $0.00

Moving to the balance sheet, we expect cash, cash equivalents and marketable securities to be approximately $31 million in Q4, down from $32 million in Q3 due primarily to one large nonrecurring capital expenditure item, a production level tester that will enable faster time to market, lower and more predictable operating expense, and better gross margins over the long-term.

With regard to our DSOs, we expect DSOs to be approximately 55 days to 60 days in Q4. We expect inventory turns in Q4 to begin to improve slightly from Q3 as we work off our higher than normal inventory levels.

And now, I'll turn it back over to Patrick.

Patrick Henry

Thanks, Dave. In summary, I remain enthusiastic about the opportunity ahead. We have a solid revenue base that will grow modestly in Q4 with strong gross margins. And we've shown fiscal discipline by lowering our operating expenses which will allow us to preserve our cash and enable Entropic to reach P&L breakeven on a non-GAAP basis for the current quarter.

We remain focused on operational and engineering execution and driving our next set of service provider deployments. We're confident in our strategy, our product roadmap, our customer relationships, and our business opportunity.

We'll now open the call to your questions.

Question-and-Answer Session

Operator

(Operating instructions). And we'll take our first question from Tim Luke with Barclays Capital.

Gomabas – Barclays Capital

Hi, this is Gomabas [ph] for Tim Luke. Congratulations on the quarter.

Patrick Henry

Thank you.

Gomabas – Barclays Capital

I was just looking – if you look at the geographical focus you guys had in China, Korea, could you give me some more color on that and how you see crashing in North America and Europe as well?

Patrick Henry

Yes, currently over 95% of our direct customer sales are in Asia, primarily China, but from an end customer standpoint, nearly, all of our current revenue is based in the U.S. I would say. What do you think, Dave, about 95% plus?

David Lyle

Right.

Patrick Henry

Because it's primarily based on the Verizon deployment for MoCA and then for our somewhat outdoor unit business with Directv and Echostar. We do see some opportunities for growth in Asia, somewhat smaller in terms of Japan and Korea, but a longer term growth opportunity in mainline China with our access business. We don't anticipate that being a significant revenue growth opportunity for us until late 2009. In the European market our growth opportunity is there, really in the satellite outdoor unit space we're working with a number of satellite providers. But Directv and Echostar by far the largest satellite service providers and we'll see some incremental improvement from revenues as we get into the second half of '09 from the European satellite operators. The other opportunity we have in Asia is with our silicon tuners as we move to a CMOS silicon tuner. We see that we should see some growth from the tuner business in late 2009 as well.

Gomabas – Barclays Capital

Thanks. One more question. What's the typical seasonality that Entropic sees in Q1 and Q2 if I may ask?

Patrick Henry

Yes, from a traditional seasonality standpoint once we get to a run rate business level as we have with the Echostar portion of our satellite outdoor unit business, we see a strong seasonal quarter in Q4 and a lighter seasonal quarter in Q1. With Directv we're still in a ramp mode, so we're more of a product cycle company so we're not as subject to seasonality while we're in a ramp mode with a new operator base deployment. In the case of Verizon, although they did have this bump in the road in Q2 relative to their business, we do see that we're still in a growth mode with the Verizon business over time, so we might see some modest seasonality in Q1, but I think it will be a little bit muted by the fact that we're still in a product cycle story with them as well.

Gomabas – Barclays Capital

And lastly if I may on the operating expense side, would it be fair to assume that the operating expense would you keep trying to keep a tab on operating expense and keep it let's say linear passing more towards the first half of '09?

Patrick Henry

Dave, why don't you comment on that one?

David Lyle

Yes, we give guidance only one quarter out, but we're – like we said we're targeting not burning cash and trying to be cash flow and P&L neutral. So you can move all backs around with whatever revenue assumptions that you may want to make.

Gomabas – Barclays Capital

Thanks so much.

Operator

We'll take our next question from Daniel Amir with Lazard Capital.

Daniel Amir – Lazard Capital Markets

Thanks a lot. Thank you for taking my call. Couple questions. First of all on Verizon, when do you expect – or when's your best visibility in terms of the inventory situation being solved at Verizon?

Patrick Henry

Thanks for your call, Daniel. I guess the main thing that we're seeing is when we first got into the situation with Verizon we were anticipating it was more than a one quarter issue, maybe up to a two quarter issue. Although we've seen some good sequential growth and a pretty strong recovery of their sell-through in Q3, with the overall economy situation we are seeing that they're tightening down inventory positions even though we do expect to see some continued growth out of that business. So probably looking at, as Dave talked about, a full quarter in Q4 as we continue to work through that. Doesn't mean that we're not selling some level of product to our customers that service the Verizon business in Q4, but it is more modest. As we get through that and get into Q1 I think we'll start seeing a stronger recovery to kind of historical unit run rate levels. We have seen, as we've always forecasted, continued ASP erosion as we forward price this product to go down a price curve. So the recoveries will see some slightly lower ASPs. I think we've been forecasting historically around 25% ASP erosion on an annual basis. I think we're on track with that kind of curve.

Daniel Amir – Lazard Capital Markets

Okay. And with regards to the new MoCA deployment that some – some of your couple other customers, I guess last conference call, you were highlighting that it was I guess slower than expected. Where do you kind of stand right now? I mean is mid-09 realistic? What's kind of the feedback you're getting from some of these potential customers?

Patrick Henry

Yes, the two main guys that we're working with that have pretty established timelines for deployment, they seem to be holding those timelines pretty well. There is always challenges in these types of deployments but we're working through those as we go through a technical trial stage and we still feel pretty good about the mid-2009 time frame for those two deployments. And we are seeing some additional activity for some additional service providers that we're expecting to launch in the latter part of 2009. So I think we're pretty much sticking with the previous guidance that we provided on the last call. There was a push out of about six months that we gave on the last call for a variety of different reasons, but I think that looking at the movement from last quarter to this quarter things have stayed consistent and tightened up around the specific launch timeline that we're outlining.

Daniel Amir – Lazard Capital Markets

Okay. Thanks. And last question on Directv, can you comment a bit how the ramp is going there? What's – how has it been so far and where do you expect it to go into next year?

Patrick Henry

Yes, Directv as we mentioned we're expecting to get to 100% attach rate on all HDTV new installs by the end of this year. Directv is looking at additional opportunities to expand the footprint beyond that, there's no commitment at this point. But we're continuing to work with them on what kind of value proposition we can drive there. So, as Dave mentioned, we don't really want to give guidance beyond one quarter out, but we are excited about the ramp and the way it's gone so far and we do think there is a pretty strong value proposition to expand beyond that initial footprint as we get into '09.

Daniel Amir – Lazard Capital Markets

Okay, thanks a lot.

Patrick Henry

You bet. Thanks, Daniel.

Operator

And we'll take our next question from Krishna Shankar with JMP Securities.

Krishna Shankar – JMP Securities

Yes, good execution and good control of the cash flow, folks, congratulations. A couple of questions. Can you give us some sense once Verizon does come back where do we stand in terms of the Verizon – Verizon rollout and kind of the total revenue opportunity of Verizon, say over 2009, 2010?

Patrick Henry

Yes, we're kind of reluctant to give kind of long-term guidance like that. If you look at the sell-through that they had in the most recent quarter and versus kind of historical, they still haven't gotten back to their queue run peak, so I think there still is a growth opportunity. They are marketing to a pretty large footprint of homes past now, so if you assume unit growth at a more modest level than we saw in '06 and '07, but still some decent growth in 2009. ASPs that are maybe 25% lower on an average basis per year, I think that would probably give you some pretty good idea of where we think the business is going to be. Dave, do you want to comment any more on that?

David Lyle

No, I think that's exactly right.

Krishna Shankar – JMP Securities

Okay. And then the Directv business where do you – you said that you did a 100% install base – 100% attachment by the end of '09. So what is kind of the unit growth rate that you expect for Directv in terms of subscriber additions in '09? What are they saying?

Patrick Henry

Yes, I think that we said that we would see 100% of HD new installs by the end of '08. As far as how we do in '09 and penetrating that it's still undetermined. Directv, if you take some seasonality out of the equation, they have about a million gross adds per quarter. We think that somewhere between a third and a half of those are HD new installs. In addition to those gross adds, Directv does service upgrades of current subscribers from standard def to high def or from non-DVR to DVR. Those are some additional opportunities that we have although there hasn't been a commitment to deploy the SWM module, the CSS based product into those additional footprint opportunities. But we continue to pursue those and work closely with Directv as well as the ODMs that service that business to try to capitalize on the additional opportunity.

Krishna Shankar – JMP Securities

Okay. And my final question is anything new on the competitive front? One of the large competitors did indicate I guess some progress on their MoCA efforts. And can you talk about the competitive landscape and how you folks assess that?

Patrick Henry

Specifically, regarding MoCA, we haven't seen any change in the competitive landscape since our last conference call. We've seen no product announcements related to MoCA from any potential competitors and from discussions with our customers, they still haven't seen any engineering samples of MoCA based products at this point.

Krishna Shankar – JMP Securities

Thank you.

Patrick Henry

Thanks, Krishna.

Operator

(Operating instructions). And we'll go next to Eric Kainer with ThinkEquity.

Eric Kainer – ThinkEquity

Thank you very much for taking my call. First question is about the FiOS program. If I understood Verizon right yesterday it sounds like they're moving from passing about 3.5 million households per year up to about 4 million or million a quarter. I assume that that's going to be additional opportunity for you, but in conjunction with that, as you mentioned earlier, it's going to be – we're going to see a richer mix of MDUs and obviously, New York City is part of that. What should we expect as far as kind of the number of chips per household as we move into more of an MDU oriented deployment environment?

Patrick Henry

We don't have an exact percentage of the total homes in terms of how many of MDUs versus single family. If you look at some early discussions we had with some of the operators around this we think that anywhere from 15% to 20% of the overall number of households passed would be MDUs, so it's not as overwhelming as you might think. If it's a small apartment it could be a couple of TVs, plus a residential gateway. Some MDUs they're going to do VDSL to the premises as opposed to doing fiber all the way to the premises. There is other opportunities where they're going to fiber all the way to the premises even in an MDU situation. So we haven't gotten that level of granularity from Verizon or from our direct customers. So if you look at kind of total number of units if you think 20% of it is MDU versus single family, it doesn't really move the needle in a huge way in terms of the total number of chips per household. Maybe it on an average basis reduces the number of chips per household by less than one chip.

Eric Kainer – ThinkEquity

Okay. And you probably get some pick up then on the additional number of households wind up passing. Maybe that's a wash?

Patrick Henry

I think everything that's pretty instructive on this is their penetration rates have been really good. On FiOS internet, 24.2% up from 20% as of September 2007 and FiOS TV 19.7%, up from 15.2% in September 2007. So we are seeing some good uptick in terms of penetration rate versus homes passed. The other thing that was interesting on the – the most recent news from yesterday and this is the first time that FiOS TV subscriber growth has been greater than FiOS internet growth. It's too early to call it a trend, but I think that bodes well for us that you're getting a higher pick up rate on pay TV service from Verizon while we do get an additional on average three chips per home on FiOS TV because of the set top boxes.

Eric Kainer – ThinkEquity

Okay. Good. Next question is about MSO deployments. As we move into the initial couple of deployments, and I guess technically speaking they're not definitely MSO although it will be either MSO or satellite TV I guess. Will those be regional deployments as we look at MSOs or are they going to be maybe more national? How should we think about the way that rollout takes place?

Patrick Henry

Yes, typically an operator, cable operator would deploy in one or two regions initially, go a little bit slow before they would go fast. A satellite operator might launch in a broader footprint out of the gate, because that more of a nationwide type of footprint. So I think that, that would be kind of the way to look at it, not that we're saying which type of operators are going to be deploying next year, but if you look at kind of historically how operators are deployed that's kind of been the case.

Eric Kainer – ThinkEquity

Okay. Last question from me and this is about competition. I assume all along you had a fairly good read on what was happening competitively because of your relationship with the OEMs and such. I assume maybe we get – we get a little bit better read now given that you guys are part of the golden node for MoCA 1.1. Is that a – is that a fair way to think about that or am I overstating the case?

Patrick Henry

We also provided golden nodes for MoCA 1.0 so it is an indication, kind of an early indication of somebody is submitting products for MoCA certification that they've got something that they're comfortable with, that is at a level that they think they can pass MoCA certification and interoperability. To-date we haven't seen any solutions based on competitive silicon submitted for MoCA certification. So that would definitely one of the gates in addition to just kind of the competitive information that we pick up from our customers.

Eric Kainer – ThinkEquity

Okay. Great. Thanks again and good luck.

Patrick Henry

Alright. Thanks a lot, Eric.

Operator

And we'll take our next question from Gene Webber with Webber Capital Management.

Gene Webber – Webber Capital Management

Hi, Patrick and David. Congratulations on keeping the ship tight.

Patrick Henry

Thanks, Gene.

Gene Webber – Webber Capital Management

Just two quick questions. I can't recall Echo's – is Echostar also a customer for the SWM product that you have for Directv or is that just Directv?

Patrick Henry

It's just Directv. With Echostar, we have our first generation satellite outdoor unit chip which is called BTS, that's band translation switch. So we're – the BTS chip is in about 95% of Echostar outdoor unit installs. With Directv they're using our CSS technology which is our channel stacking switch. So the Directv SWM trade name is actually a Directv brand that's based on our CSS technology.

Gene Webber – Webber Capital Management

Okay. So you are still selling then your first generation technology to Echostar?

Patrick Henry

Correct. Yes, and that's more in the run rate business. That business has been around a few years now, but we continue to sell in that product as well.

Gene Webber – Webber Capital Management

Got it. Okay and then switching gears to just multiroom DVR, just can you give some updates, just a couple quick conceptual questions. Do you have any anecdotal information from Verizon as to whether people – whether consumers are actually using the feature?

Patrick Henry

Yes, the anecdotal information is that they are – they are using the feature and, in fact, it's one of the key selling points for FiOS TV service. It is one of the key differentiators that Verizon has offered. In fact, AT&T and their U-verse deployment also launched whole home DVR this summer, and I think that also is going to increase consumer awareness around multiroom DVR and the value of that, that feature in products which should put additional pressure on all service providers to have a competitive offering in this area.

Gene Webber – Webber Capital Management

Okay. That's great. And then lastly, longer term is this multiroom DVR feature something that can become part of the middleware on a set top box or is the chip based solution?

Patrick Henry

It's actually a combination of both. There is a – you would need a chip based solution for the physical layer, the link layer interconnection, which is the home networking technology. That's what Entropic provides with MoCA. But there is also middleware software that controls the user interface and control for the consumer. So, as an example, in the Verizon deployment, they use MoCA as the backbone technology to communicate room to room at a physical layer standpoint, but there's also software that's baked into the Motorola set top boxes that basically allows the multiroom DVR functionality and user interface.

Gene Webber – Webber Capital Management

And is that software that Motorola has developed themselves?

Patrick Henry

I think that within the Verizon deployment I think they collaborated closely with Verizon. I don't know the specifics about who owns what in the set top box. I know Motorola has made a pretty significant investment in this area. Early on they bought a company called Ucentric a number of years ago and they made a pretty significant investment there. There is a variety of different companies that offer kind of this middleware software. Microsoft is involved in it, Mediabolic which I think is now owned by another company, the Ucentric stuff that got bought by Motorola, Digital Five. There is a number of different companies out there that are doing it. Also some of the traditional TV Guide companies like TV Guide, GuideWorks, the folks like MDS are also potential guys that could develop this type of technology in conjunction with the service provider.

Gene Webber – Webber Capital Management

Okay, but you don't see any threat from a software solution to what you do?

Patrick Henry

No, I mean they are going to need some type of physical or home networking technology, this modem type of technology to do it in some kind of software emulation on a multimedia processor isn't really practical.

Gene Webber – Webber Capital Management

Got it. Okay. Understood. Thanks very much.

Patrick Henry

You bet. Thanks, Gene.

Operator

(Operating instructions). We'll go next to Sandy Harrison with Signal Hill.

Sandy Harrison – Signal Hill

Thanks for taking my call.

Patrick Henry

Hey, Sandy.

Sandy Harrison – Signal Hill

Quick question. As far as the c.LINK, if you could maybe spend a second on that product, how is that going over there with some of the deployments? We've heard sort of mixed messages in general from the Asian markets, but we've heard some pretty positive stuff as far as building up broadband to the multi-drawing units over there. How is c.LINK coming and what are some of the cows to look forward to for that product in '09?

Patrick Henry

Yes, on the c.LINK access product we do have some deployments in Japan, in northern Europe, some small deployments in Korea. So we do have a business there, but the unit volume is relatively modest. The biggest opportunity that we think that we have in the next couple of years is really in mainline China. We're in some larger scale trials right now with a couple of major operators, MSOs in mainline China and we're kind of working through that. We do think it's going to take a little bit longer than what we initially anticipated in terms of getting real revenue growth out of that business. '09 is probably still a modest revenue year. If we're successful we'll probably see some pretty significant increases in revenue towards the tail-end of 2009 and then 2010 could be a pretty decent size year in terms of revenue in the access business.

Sandy Harrison – Signal Hill

Got you. And from a – just kind of looking at the mix in the FiOS TV versus FiOS internet and some of those other market dynamics, is that increasing as greater need for broad or wider bandwidth in the home networking environment? Is it similar just sort of what are some of the dynamics Verizon would be facing from its customers with any kind of mix shift from either TV to internet or just FiOS in general?

Patrick Henry

Yes, in terms of – I can't really comment on specific home networking roadmap opportunities at Verizon, but I would say generally kind of this home network for digital entertainment, MoCA 1.1 does a pretty good job in terms of current generation types of requirements. We do see the potentially longer term that would be a requirement for higher data rates if you went into something that has watch and record capability from every single set top box or every single node in the house where maybe you have two tuners in every node location whether it be a TV set or a set top box and I can use every tuner in the house for both watch and record. That could start loading up the home network with quite a bit of traffic where that could create an opportunity for a treadmill of higher performance for next generation home networking technologies that are backward compatible with the installed MoCA 1.1 base. So that is something that obviously is a potential interest to Entropic.

Sandy Harrison – Signal Hill

And Patrick just sort of on a qualitative basis, when you look at sort of the landscape out there as far as the competitive landscape between the MSOs and the other service providers, and then you look at sort of the challenges that people are talking about for the overall economic environment, yet MoCA and providing services are just now sort of entering their real ramp. If you were to look for 6 months, 12 months, I mean would you say that you think that are we sort of still heading on that path? Has that path changed? And in fact with sort of a slowing in some areas would this be a chance for some of the potential customers, employers of MoCA to sort of step up and try to make a run for the head of the pack when others might be retrenching.

Patrick Henry

Yes, I would say – generally obviously in the current economic conditions the consumer is a concern. I think if we were selling more into standalone retail consumer it would be a bigger concern for us. I think the two things that help us relative to that type of a company are that number one, we're selling in the service provider based deployments where these service providers need to keep their current subscriber base and both from a defensive and an offensive standpoint, multiroom DVR is both an opportunity and a threat. The threat side of it is this recent Parks data where a 10% churn is potential if you don't have a multiroom DVR offering I guess that, that would be a big concern for most pay TV service providers. I think the other flip side of that is that there is an increased ARPU opportunity with MoCA for multiroom DVR as well as other value-added services. And the second part of this is the fact that we're in more of a product cycle business whereas we start launching with new operator based deployments that can provide potential growth opportunities with a company like Entropic as opposed to a company that's more of a run rate situation with a tough consumer base. So I think for both of those reasons we're pretty optimistic about our opportunity even if we're in kind of a tough economy in 2009.

Sandy Harrison – Signal Hill

Got you. Alright, thanks guys. Good luck.

Patrick Henry

You bet. Thanks, Sandy.

Operator

And it appears there are no further questions at this time, I'd like to turn the conference back over to Ms. Hart for any closing or additional comments.

Debra Hart

We would like to thank you for joining us today. There will be an audio replay of this call available in the IR section of our Web site. You can also access the replay by telephone by calling 719-457-0820 and entering the reservation number 1241580. Please note that although this call will be available for replay, except for our historical results all information in the call is as of today's date, October 28, 2008. We have undertaken no obligation or commitment to update any information presented today. Please feel free to contact me if you have any additional questions. Again, thank you for your participation today. Have a great evening.

Operator

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.

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Source: Entropic Communications, Inc. Q3 2008 Earnings Call Transcript
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