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Entropic Communications (NASDAQ:ENTR)

Q1 2013 Earnings Call

April 30, 2013 5:00 pm ET

Executives

Debra Hart - Director of Investor Relations

Patrick C. Henry - Chief Executive Officer, President and Director

David Lyle - Chief Financial Officer

Analysts

Gary W. Mobley - The Benchmark Company, LLC, Research Division

Aalok K. Shah - D.A. Davidson & Co., Research Division

Philip Lee - Lazard Capital Markets LLC, Research Division

Erik Rasmussen - Stifel, Nicolaus & Co., Inc., Research Division

Hamed Khorsand - BWS Financial Inc.

Operator

Good day, ladies and gentlemen. Welcome to the Entropic Communications Earnings Conference Call. My name is Chevrolet, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. At this time, I'd like to hand the presentation over to your host for today, Ms. Debra Hart, Director, Investor Relations. Please proceed.

Debra Hart

Thank you, Chevrolet, and good afternoon, everyone. Participating in today's call are Patrick Henry, President and CEO; and Dave Lyle, our Chief Financial Officer. During the call, Patrick and Dave will present our first quarter 2013 results and our short-term outlook and then, we'll open it up for questions.

Throughout this call, we will be discussing certain non-GAAP financial measures. Today's earnings release and the related report on Form 8-K describe the differences between our non-GAAP and GAAP reporting, and present a reconciliation between the 2 for the periods reported in the release. We've also posted a schedule on the Investors section of our website, which includes our quarterly reconciliation of our GAAP to non-GAAP gross margins, operating expenses and taxes.

During this call, we will make forward-looking statements regarding future events and anticipated operating or financial results of the company. Actual events or results could differ materially from those projected in the forward-looking statements. Please refer to our SEC filings, including our most recent 10-K and 10-Q, which contain important factors that could cause actual results to differ from the forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statement to reflect future events or circumstances.

And now I'll turn the call over to Patrick Henry.

Patrick C. Henry

Thank you, Debbie, and thanks to everyone for joining the call today. In Q1, we achieved revenue of $74.5 million and we're breakeven on a non-GAAP basis, which is consistent with the updated guidance range we provided in mid-March. Dave will take us through the Q1 numbers and discuss guidance for the current quarter a little later in the call, but first I'd like to provide a general update on our business and our long-range objectives.

During our conference call in February, we discussed how we see 2013 as a transitional year for Entropic following last year's acquisition of Trident set-top box SoC business. We are focused on new product introductions and winning new designs with key customers for a leading pay-TV service provider deployments worldwide. To that end, we are investing in our integration product roadmap, allocating resources and prioritizing investment dollars where we see the highest potential for a return on investment. The strategy we put in place since closing the set-top box SoC acquisition in mid-2012 is beginning to play out. The first 2 products from the combined company were announced in Q1 and our first integrated set-top box SoC plus MoCA 2 solutions, which include HEVC video decoding, are on track to sample later this year.

With our new products for both integrated and discrete solutions, we see increased opportunities to gain share across a multibillion dollar connected home entertainment market as our new design wins ramp into production. We are strongly positioned to grow, not only with the market, but through market share gains starting in the second half of this year.

Q1 was a strong quarter with new product announcements. Most significant was the announcement of our cost-optimized set-top box SoC solution for entry-level set-top boxes, IP client set-top boxes and digital transport adapters or DTAs. Entropic's new SoC leverages the ARM architecture and offers an increased focus on security to meet operator demands while meeting stringent bill of materials cost requirements. This new cost-optimized SoC already has design wins behind it, and we expect to ship to customers in initial production volumes later this year.

We also announced our latest Ethernet-over-Coax broadband access solution for China. Our latest c.LINK solution delivers the industry's higher -- highest performance EoC solution in the smallest form factor. The technology employs the first-ever multichannel EoC system, giving cable operators a cost-effective architecture that enables the delivery of higher data rates for a more high definition video viewing experiences across the multiscreen environment.

On our previous calls, we have highlighted our strong design win traction and our success in building a wide diversified design win footprint with our discrete and bundled solutions. These include wins at Eris, Cisco, Humax, Motorola, Pace, Technicolor and TiVo for consumer electronics devices that will be deployed by service providers worldwide, including Tier 1 operators in the Americas such as Comcast, Time Warner Cable and DIRECTV, to name a few. As these design wins start going into production later this year, this helps us build a more stable revenue base and drive overall top line growth.

During the quarter, we saw continued robust new product design wins across a number of customers such as Coship and Yinhe; for our broadband access solutions, GlobalSat and Telepath; and for our SoC products, Geniatech with MoCA, providing evidence that customers are embracing our platform solution strategy. We're working on other design wins as well, which we'll announce as customers release products to production. These design wins will serve as a leading indicator of future revenue growth. While we're seeing revenue pressure continue in the first half of the year, which Dave will talk about in a moment, our growth expectations for the second half and beyond remain intact. And although we're still in the midst of a transition with our set-top box SoC business, we expect to resume growth drivers in the second half as we enter a seasonally stronger period and begin the initial ramp of new design wins in Q3. Now Dave will take the -- review the first quarter results and provide our Q2 outlook. Dave?

David Lyle

Thanks, Patrick. First quarter revenue of $74.5 million was down about $15 million from $89.7 million in Q4. The decline in revenue was due to typical seasonal softness in our end markets, MoCA product market share loss from designs lost prior to Entropic having a complete set-top box SoC plus MoCA solution and an unexpected change in deployment plans for HD-DTAs by one of our U.S. pay-TV Cable MSO end customers. This unexpected HD-DTA shift caused us to revise our guidance downward on March 18. However, I do want to point out that while the revised deployment plan will slow down the initial ramp of HD-DTAs and has therefore, resulted in excess inventory in the channel, we believe the total amount of HD-DTA units expected to ship by U.S. pay-TV Cable MSOs over the next 5 years has not changed. HD-DTA set-top boxes still remain strategically important to service providers in order to move basic cable service subscribers from analog to digital and for premium subscribers, who still have legacy analog TVs in some locations in the home. This initiative is sometimes referred to in the industry as analog reclamation.

We had 2 customers who accounted for greater than 10% of revenue during the quarter, WNC at 13% and MTI at 11%. Our non-GAAP gross margin in Q1 was about 50%, above previous expectations due to a product mix shift towards our connectivity products as set-top box SoC revenue fell sequentially due to the HD-DTA issue just described. Excluded from Q1 non-GAAP gross margin was about $200,000 in stock-based compensation expense and $2.2 million of amortization of purchased intangibles. Non-GAAP operating expense in Q1 was $37.4 million. Our Q1 non-GAAP operating expense excluded $3.3 million of stock-based compensation expense and $900,000 of amortization of purchased intangibles. Other income was about $400,000 for the quarter. Our Q1 non-GAAP results exclude charges of approximately $800,000 relating to the fair value accounting treatment associated with our investment in privately held Zenverge.

Our first quarter non-GAAP tax rate was 12%. With regard to our GAAP tax rate, we recorded a onetime net benefit in Q1 of approximately $2.1 million related to the extension of the federal R&D tax credits, which contributed to our GAAP tax benefit of 66%. Q1 non-GAAP net income was about $300,000 resulting in earnings per share of $0.00 based on a fully diluted weighted-average share count of about 92 million shares. GAAP net loss in the first quarter was about $2.4 million and GAAP loss per share was $0.03.

With regard to our cash position, cash and investments were about $178 million, a net cash increase of about $9 million at the end of Q1. During the quarter, we generated approximately $2.3 million of cash from our business operations. DSOs for the first quarter came in at 54 days. Inventory turns were much improved again at about 8.6x.

Now I'd like to provide our guidance for the second quarter of 2013. In Q2, we expect Entropic's top line revenue to be in the range of $70 million to $73 million, a 2% to 6% sequential decline from Q1. We expect to see seasonal softness from our service provider end customers for our connectivity products and continued revenue pressure in set-top box SoCs as one of our major Cable MSO end customers expect to work through their HD-DTA inventory in Q2 and Q3. We don't believe we are seeing incremental share loss in Q2 from any of our product categories and believe we have share gain opportunities later this year.

Moving on to gross margin, we expect non-GAAP gross margin for Q2 to be in the range of 50% to 51%. We'll exclude from Q2 non-GAAP gross margin about $200,000 in stock-based compensation expense and $2.2 million in amortization of purchased intangibles.

We expect Q2 non-GAAP operating expense to be approximately $36.5 million, about $1 million lower than in Q1. Although we will continue to invest in development of our long-term product roadmap, we are making deeper cuts in our discretionary spending in the quarter. Our non-GAAP operating expense will exclude $3.7 million of stock-based compensation expense and $500,000 of amortization of purchased intangibles.

We expect other income to be about $400,000. Our Q2 non-GAAP results will exclude a charge of approximately $700,000 relating to the fair value accounting treatment associated with the investment in Zenverge. Our non-GAAP tax rate in Q2 will be about 12%, also reflecting our revised annual forecast. At the midpoint of guidance, we expect earnings per share of $0.00 based on a fully diluted weighted-average share count of about 92 million shares. GAAP loss per share is expected to be $0.05. We expect our cash and investments balance at the end of the second quarter to remain approximately flat at $178 million or $1.93 per share. We expect DSOs to be about 55 days, and we expect inventory turns to be 7x in Q2.

Looking out into the second half of 2013, we expect the combination of second half seasonal strength, increased HD penetration, as well as international market expansion will provide growth for Entropic. We also expect to gain share with recent design wins and opportunities like the Xi3 client device and data and video gateway deployments at Comcast, which we expect to ramp later this year. We expect HD-DTA orders to resume by the end of Q3.

Now I'll turn it back to Patrick for some closing remarks.

Patrick C. Henry

Thanks, Dave. Just to close, despite the near-term softness we're seeing, we remain optimistic about Entropic's growth prospects over the coming quarters and years. We are seeing -- we're selling in the fast-growing multibillion market, where we have a clear opportunity to be a major supplier. We are strongly positioned to grow, not only with the market, but through market share gains starting in the second half of this year. We now have a much more complete and compelling product portfolio, which we add to on an ongoing basis to address the delivery, connection and consumption of multimedia content in the home and on the go. We expect to be able to announce additional Tier 1 design wins throughout 2013 and feel that we are strongly positioned for long-term revenue and earnings growth.

That concludes our prepared remarks and now Dave and I will take any of your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Gary Mobley with The Benchmark.

Gary W. Mobley - The Benchmark Company, LLC, Research Division

I was hoping, Dave, that you could share with us maybe some of undercurrents in the gross margin. And I think you mentioned the set-top box SoC sales were down sequentially in the quarter. Just curious why your gross margin, therefore, didn't increase sequentially. And maybe you can share with us what the trends have been for the MoCA gross margins?

David Lyle

Yes. We have continuous gross -- cost of goods sold improvement processes underway, and we'll continue to see improvements over time with -- across our entire product portfolio. And in this case, you're right, going into Q2, a lot of the -- we talked about some seasonal softness in our connectivity products, which generally have higher gross margins than our set-top box products. So I think you're right. Typically, you would see a little lower gross margin, but in this case, we continue to make some good improvements there so we were able to maintain kind of flattish to up gross margins for the -- all of Entropic.

Gary W. Mobley - The Benchmark Company, LLC, Research Division

Okay. Is this analog reclamation process, are you leveraged to one specific Cable MSO or are there multiple opportunities? And with this specific pay-TV service provider that is causing the softness in your business, could you talk about what the delay has been, maybe in broad terms, if you can only speak to that? And talk about what gives you the comfort in the second half ramp.

Patrick C. Henry

Yes. So it is -- the overall analog reclamation using DTAs is much more broad-based than a signal Cable MSO. We're seeing actually very prevalent across the U.S. market, across multiple MSOs, so we do see this as a broader-based trend. Historically, one particular MSO is using this strategy and the other is not. They're using other avenues to get additional bandwidth on their networks. Well, we're now seeing that with the move to DOCSIS 3, a broader-based set of deployment opportunities. In fact, aside from the one Cable MSOs, we do see continued expansion in that business. In the case of the one particular Cable MSO, it's -- we can't go into a lot of details. It's really more of a change in timing around deployment plans relative to their initial expectations, and this has created probably about 2-quarter inventory bubble that needs to be worked through. Beyond that, we think that the business opportunity returns at kind of the run rates that we historically had expected pretty rapidly. And this is based on direct feedback from that Cable MSO.

Operator

Your next question comes from the line of Aalok Shah with D.A. Davidson.

Aalok K. Shah - D.A. Davidson & Co., Research Division

Just a couple of quick questions. In terms of your second half of the year outlook, I guess, you're saying that design wins should be moving to production and I'm trying to get a sense of -- I know you don't want to give us guidance, but in terms of magnitude or even directionally more, how should we think about the second half of the year? Is there any way you can give us some kind of an idea of how we should be starting to think about the second half of the year and those design wins moving production?

Patrick C. Henry

Yes, I mean, we're not going to see much in terms of recovery in HD-DTAs in Q3 from the one particular Cable MSO. That really occurs in Q4. We might get a little bit in late Q3. Relative to the other deployment opportunities around IP clients and gateways and the cable market, we'll see the initial ramp of those in Q3. And like service provider deployments we've had in the past, these things typically go slow before they go fast. So we'll see an uptick, but not necessarily a big step function uptick in Q3. But we do enter a period of more seasonal strength in our connectivity business, especially around satellite. Our satellite weakest quarter is Q2 and their strongest quarter is Q3. So I think puts and takes, relative to the big opportunities, we should see sequential growth as we enter Q3 and then a bigger uptick as we get into Q4, as some of the new design wins kind of hit their stride and HD-DTAs recover.

Aalok K. Shah - D.A. Davidson & Co., Research Division

Okay, Patrick. And 2 other quick questions, in terms of the Latin American win that you had on the satellite, can you give us a sense of where you are with that at this point now?

Patrick C. Henry

Yes, with DIRECTV PanAmericana, it is ramping. Although we're in a seasonally softer period there as well. And we'll see incremental increases later this year, but really 2014 is where that hits more of its stride as it becomes more of the mainstream deployment model as opposed to the premium deployment model. We still see other opportunities in Latin America that we're pursuing that we haven't announced that should drive growth in 2014 as well. And then Claro TV, for our outdoor unit businesses, is similar to DIRECTV PanAmericana, which is a premium offering today. As we get into '14, it becomes more of a mainstream offering.

Aalok K. Shah - D.A. Davidson & Co., Research Division

Okay. And lastly, I may have missed this, but did you talk about the development yet -- progress on the SoC solution yet?

Patrick C. Henry

We did in the prepared remarks. We got our initial SoC that we kicked off right about the time of the acquisition. That's been announced now. We taped it out late last year. We got first silicon back, and that's looking very good. We should have production samples about the middle of the year are and have initial production volume on that before the end of the year. Our first integrated MoCA 2 plus SoC solution, which also includes advanced HEVC decoding capability, which is the latest advanced video decoding capability, also called H.265. Those products will be out later this year and we would expect production volumes, and those kind of second half, latter part of 2014.

Aalok K. Shah - D.A. Davidson & Co., Research Division

Okay. So for the most part, that is sampling with customers today or not yet?

Patrick C. Henry

Initial product, not the integrated product. The integrated product is still in development.

Operator

Your next question comes from the line of Daniel Amir with Lazard Capital Markets.

Philip Lee - Lazard Capital Markets LLC, Research Division

Patrick, Dave, this is actually Philip on behalf of Daniel. So are you guys still in the midst of the market share transition with Broadcom? And what gives you the confidence that you have the opportunity to gain share later this year?

Patrick C. Henry

I think if you look at the design win pipeline, you have pretty good predictability in terms of what designs are won versus lost maybe as much 12 months before the actual impact occurs. So just looking at designs that we're winning that are outlined in the SoC space and the timing that those go into production, those are all new opportunities for us where our market share is really going to go from 0 outside of DTAs and cable to something pretty meaningful in the video server client deployment model, both on the server gateway side as well as on the clients. Also as we see a recovery in DTAs, that's an expansion opportunity as well. Dave, you have any...

Philip Lee - Lazard Capital Markets LLC, Research Division

Okay. Patrick, as a follow-up, with the integrated set-top box and MoCA 2.0, if it's sampling later this year, can we expect to see revenues in early '14?

Patrick C. Henry

What -- can you -- I did not quite understand your question.

Philip Lee - Lazard Capital Markets LLC, Research Division

For your integrated set-top box and MoCA 2.0 chip.

Patrick C. Henry

Yes.

Philip Lee - Lazard Capital Markets LLC, Research Division

If it's sampling later this year, when can we expect to see a hit revenue? Is it early 2014 time frame?

Patrick C. Henry

Oh, no. It would be a late 2014 and really 2015 in a bigger way. However, we've already won designs based on a bundling strategy with SoCs that we acquired in the Trident acquisition plus discrete MoCA. That was kind of won in a bundled way. In fact, the IP client set-top boxes for the cable industry, specifically for Comcast is a bundled strategy as opposed to integrated SoC strategy. And we'll see the first fruits of that from a revenue standpoint later this year.

Operator

Your next question comes from the line of Tore Svanberg with the Stifel, Nicolaus.

Erik Rasmussen - Stifel, Nicolaus & Co., Inc., Research Division

This is Erik Rasmussen for Tore. Maybe just getting away from some of the headwinds you're seeing right now. But now you have several quarters of some of the SoC contribution, do you have any change or updates on when you think that business will be accretive? I think in the past you talked about the end of '14. Is that still on track?

Patrick C. Henry

We still think there's a chance. I mean, everything hits to the head [ph] path later this year in Q4, maybe Q1 of next year and still be getting back into our overall model, being in kind of the mid to high teens and operating margins by the end of '14 or early '15. So all depends on how quickly the new designs ramp, but that's still a target that we have.

Erik Rasmussen - Stifel, Nicolaus & Co., Inc., Research Division

Great. If you had -- second, if you had to rank all your opportunities, where do you see the most growth coming from this year? And then what specific regions -- what specific comments can you maybe give on different regions?

Patrick C. Henry

Yes. I think, North America cable is our biggest growth opportunity this year. And as you get into the next year, I think North America cable as well as some North America satellite, as well Latin America satellite, are big opportunities. Our other big area of growth in investment is in China both with our SoC and our broadband access business. And I think those are growth opportunities later this year, as well is into 2014.

Erik Rasmussen - Stifel, Nicolaus & Co., Inc., Research Division

Great. And if I could just ask one more, you haven't talked about it but on the PLX business that you acquired last year, what sort of progress you're making from those assets, maybe how do you see that market developing for this product?

Patrick C. Henry

Yes. So we're still the -- by far, the market leaders in the satellite outdoor unit business, although there's been noise from a number of different competitors around the space. We have a broad product portfolio in analog CSS, as well as BTS, where we continue to be really the major guy out there from a market share perspective. The PLX acquisition really gives us a roadmap extension from analog CSS to digital CSS. Those products are now completed. They're being designed into customer programs. We can't announce who those folks are yet but as we're able to do that, we will. So we feel like we're making significant design win progress relative to the assets that we bought from PLX.

Operator

Your next question comes from the line of Hamed Khorsand with BWS Financial.

Hamed Khorsand - BWS Financial Inc.

Just a couple of questions here. One is given the inventory issue on the set-top box side, what's the risk that once the inventory dies down that the set-top box makers just decide that -- give more to you competition, or just reduce the overall amount of spending that they do carry inventory?

Patrick C. Henry

Yes. In terms of the inventory buildup with the one particular Cable MSO, this has impacted both us and our competition, as well as the -- our design OEM's box competition. We still believe, based on feedback from that MSO, that the market share split will be very similar once the business comes back as it is today. We continue to invest in a product roadmap around DTAs based on the new SoC that we've developed. So we think we're in a strong competitive position as you add features and cost reduced those products going forward versus our major competitor. So feel like we're in a strong competitive position there to maintain share as that business returns.

Hamed Khorsand - BWS Financial Inc.

And I guess last, I think it's been at least 3 earnings calls that's been very repetitive about just revenues trending lower and so forth, inventory issues, something else. What's the strategy at the company just to right-side the ship or take advantage of the situation?

Patrick C. Henry

Yes, I think the major strategy since the acquisition of the SoC business has really been to invest in new products and focus on design wins and the SoC business initially with a bundled strategy and MoCA plus SoC outside the U.S., continuing to get new SoC products that don't require MoCA, getting those more cost-optimized for market opportunities outside the U.S. and then eventually integrated MoCA plus SoC. And we are bearing fruit from those efforts with initial design wins and we expect to continue to have design wins on an ongoing basis based on those investments.

Hamed Khorsand - BWS Financial Inc.

Okay. So when is the -- when should we expect the next milestone so we feel comfortable with the long-term model that you're setting up for us?

Patrick C. Henry

Well, I think in Q3, we'll see initial deployments, gateways, as well as IP clients in the cable industry, specifically initially with Comcast. I think their deployment plans are well advertised, and I think that we're in a very strong position to take advantage of that transition of traditional set-top box to client gateway architectures. DTAs are already being rolled out. We do have a little bit of short-term pressure relative to deployment plan change but it's really more transient than steady-state, so as that comes back, I think we're in a strong position there and we're also winning other design wins that we can't announce yet in the SoC business, as well as in other parts of our connectivity business that I think will drive growth, especially in 2014, but to some extent, in the tail end of 2013.

Operator

At this time, we have no further question. I would like to hand the presentation back over to Ms. Hart for closing remarks.

Debra Hart

Well, thank you, and thank you all for joining us today. Please feel free to call me if you have any additional questions. Thank you, and have a nice evening.

Operator

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

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