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Entropic Communications, Inc. (NASDAQ:ENTR)

Q3 2009 Earnings Call Transcript

October 26, 2009 5:00 pm ET

Executives

Debra Hart – Director, IR

Patrick Henry – President and CEO

Dave Lyle – CFO

Analysts

Sandy Harrison – Signal Hill

Daniel Amir – Lazard Capital Markets

Tore Svanberg – Thomas Weisel

Ruben Roy – Pacific Crest Securities

Aalok Shah – D.A. Davidson

Hamed Khorsand – BWS Financial

John Pitzer – Credit Suisse

Tim Luke – Barclays Capital

Presentation

Operator

Good day, ladies and gentlemen, and welcome to today’s Entropic Communications Q3 2009 earnings conference call. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Debbie Hart. Please go ahead ma’am.

Debbie Hart

Thank you Peter and good afternoon everyone. This is Debbie Hart, Director of Investor Relations of Entropic Communications. We appreciate you joining us for today’s call. If you haven’t yet seen our third quarter earnings release, you can access it on the Entropic Website at www.entropic.com. This conference call is also being broadcast live from our Website. A recording of this call will be available later today within about two hours of the call’s completion, and will remain available via phone and Internet playback for two weeks.

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 third quarter results and our short-term outlook, and then we will open it up for your questions. During today’s call, we will refer to several non-GAAP financial measures. We present this information in order to provide investors with useful information regarding our results, operations, and business terms. We have included reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in today’s earnings release. We have also updated the schedule on the Investors section of our Website, which include the historic quarterly and annual reconciliation of our GAAP to non-GAAP gross margin and operating expenses.

Next, I would ask you to please note that the information we are about to discuss include forward-looking statements, which are subject to risks and uncertainties. The company’s actual results could differ materially from any results expressed or implied by such forward-looking statements. Factors that could contribute to such differences include but are not limited to those described in the company’s SEC filings, including the risk factors section of our most recent quarterly report on Form 10-Q. The forward-looking information that is provided by the company in this call represents the company’s outlook as of today. Subsequent events and developments may cause the company’s outlook to change. Therefore, this conference call will include time-sensitive information that may be accurate only as of the day of this live broadcast, which is October 26th, 2009. We do not undertake any obligation to update any forward-looking statements made by us.

Now, I will turn the call over to Patrick Henry. Patrick?

Patrick Henry

Thank you, Debbie, and thanks to everyone for joining the call today. Entropic’s third quarter revenue was $31 million, up 19% from the second quarter. We returned to profitability on a non-GAAP basis and posted a non-GAAP EPS for the quarter of $0.02. All in all, it was a great quarter, and Q4 looks to be very strong as well. Our MoCA business is now becoming diversified enough to offset expected softness in Entropic’s business into Verizon FiOS Deployment in Q4. Our satellite outdoor unit business is growing as our attach rate of DIRECTV begins to increase and as we see general strength in our satellite business in Q4. We are also seeing some growth in our CMOS silicon tuner products and our broadband access products.

In Q3, Entropic not only achieved strong revenue growth, but we also made significant progress towards our long-term objectives. Dave will take you through the numbers in greater detail and discuss guidance for the fourth quarter later in the call, but first, I would like to recap a few key events which have occurred since our last quarterly conference call. I am pleased that Bill Bradford has joined Entropic as our Senior Vice President of Worldwide Sales. Bill is a seasoned executive with more than 20 years of experience in direct sales, sales management, marketing, and business development in the semiconductor industry. Bill brings a strong combination of experience and energy that will be instrumental to Entropic’s growth as we continue to lead the charge towards ubiquitous home entertainment connectivity. Entropic recently received the Deloitte 2009 North America Technology Fast 500 Award, and was recognized as the fastest growing technology company in San Diego and the fifth fastest growing in North America. The Deloitte Technology Fast 500 is an annual list of the 500 fastest growing technology, media, telecommunications, life sciences and clean technology companies in the US and Canada based on percentage fiscal year revenue growth over five years.

During the quarter, we strengthened our MoCA home networking partnerships through collaborations with NXP in the set-top box space, ViXS for advanced HD network attached storage or NAS devices, Intel for Universal Plug and Play or UPnP 3.0 over MoCA, and Intellon to align MoCA capabilities with HomePlug AV solutions. We also further expanded our relationship with Cavium Networks and announced support for the ECONA family of processors. In our broadband access product line, we are collaborating with PMC Sierra to provide cable MSOs with a cost-effective solution to expand the fiber reach.

Now, to assess some highlights from each of our product lines, I will start with our MoCA home networking products. Currently, Verizon’s FiOS triple-play service offering is our largest service provider base deployment. FiOS continues to gain popularity and is attracting new subscribers. Earlier today, Verizon announced that they added 191,000 net new FiOS TV customers and 198,000 net new FiOS Internet customers in the third quarter. As of September 30th 2009, there are over 3.3 million total FiOS Internet subscribers and over 2.7 million FiOS TV subs. In the FiOS deployment, Verizon deploys 3 MoCA chips for every FiOS Internet installation and on average an additional 3 MoCA chips for every FiOS TV customer. With roughly 3 million Pay-TV subscribers, Verizon serves only a fraction of the overall Pay-TV market in the US. The top 25 cable MSOs have approximately 60 million Pay-TV subscribers and the two largest satellite providers combined, Dish Network and DIRECTV, serve over 30 million Pay-TV subs. Verizon was our beachhead deployment for MoCA and we are now fanning out to additional Pay-TV service providers to support their multi-room DVR and connected home entertainment deployment plans. With this diversification, we are becoming less dependent on any single service provider.

With regard to new service provider deployments of our MoCA home networking products, Time Warner Cable, Cox Communications, and Bright House Networks, the second, third and sixth largest cable operators in the US have each announced plans to deploy new MoCA 1.1 enabled set-top boxes to deliver multi-room DVR, and other connected home entertainment services. In addition to the announced MoCA deployment plans, we continue to focus on other Tier 1 service providers including, Comcast and DIRECTV who are MoCA members and key targets for us. Both of these service providers have indicated they intend to roll out multi-room DVR as a service in 2010 and both have made public statements committing to the use of MoCA in their networks. We are also seeing initial momentum from second-tier cable MSOs as they move to enhance their product offerings and our OEM customers start to promote MoCA from multi-room DVR. A variety of MoCA-enabled set-top boxes utilizing Entropic’s silicon are now available for multiple Tier 1 OEMs, including ADB, Cisco, Humax, Motorola, Pace, Panasonic, and Samsung. We are seeing demand in Q4 as our OEM customers build products to support new service provider deployments. We anticipate a more retro ramp in these products as deployment and attach rate of MoCA expands in 2010.

We are also making good initial progress in the resale aftermarket of our MoCA home networking products. Our consumer electronics customers Actiontec, D-Link and NETGEAR each have branded offerings for our Ethernet-to-MoCA bridge products using Entropic’s home networking chips. These MoCA bridge products are currently available through online outlets including Amazon and bricks and mortar retailers including Best Buy and Fry’s Electronics. Top accelerate the demand for MoCA retail products, MoCA recently joined the professional installer organization CEDIA, which stands for the Customer Electronics Design and Installation Association. Entropic plans to create training and educational programs for CEDIA installers.

And now, I will spend a few minutes updating you on our MoCA partnership strategy. Entropic develops partnerships with best-of-breed companies and experts in their respective technology domains. Our collaborations with Cavium, Intel, Intellon, NXP, Sigma Designs, Texas Instruments, and ViXS show how we can target specific segments to produce best-in-class solutions for our customers. Our partnership strategy may initially start with joint reference designs which OEMs can take to market very quickly. Longer term, these partnerships allow us to collaborate on market opportunities and to align product roadmaps and silicon feature sets. For example, our recent collaboration with NXP, a leader in MPEG SOCs in the set-top box space allows each company to capitalize on its core capabilities and leverage our combined expertise. Entropic is the leader in MoCA technology and our solutions are mature and feel proven. Likewise, NXP is the leader in MPEG set-top box SOCs. Together, we are able to deliver a total systems solution. We expect NXP to combine its set-top box and digital TV product lines with Trident Microsystems early next year based on their recent press release.

Similarly, with our recent collaboration with ViXS, we provide a reference design for advanced HD network attached storage or NAS devices that enable premium content capture, storage and sharing of our MoCA network. By combining Entropic’s proven MoCA solutions with the ViXS advanced video processing technology, we are able to deliver a powerful, robust and cost-effective solution to the consumer electronics market, enabling high-definition video recording capabilities as well as sharing of both personal and premium content throughout the existing home over existing coax cables. Entropic and Intellon Corporation recently announced a collaboration to align MoCA capabilities with HomePlug AV solutions. The partnership will ensure continued compatibility with tens of millions devices already deployed by service providers and consumers throughout the world and offer customers a solid pathway to the MoCA 2.0 and HPAV-2 standards.

We expect Atheros, a leader in the Wi-Fi and Ethernet markets will complete its acquisition of Intellon later this year based on their recent press release. We also partnered with Intel Digital Home Group to demonstrate the world’s first UPnP 3.0 QoS capability over MoCA on a cable set-top box platform during the CableLabs Summer Conference in Denver. Entropic and Intel share a vision for ubiquitous connected home entertainment. Our demonstration showcased how cable MSOs can enable and deliver on the future convergence of high bandwidth personal content applications without comprising delivery of premium service offerings. We also recently expanded our relationship Cavium Networks and announced support for the announced support for the ECONA family of processors. Pairing Entropic's EN2510 a 65-nanometer CMOS, single chip MoCA 1.1 compliant solution with Cavium’s ECONA dual-core ARM-based processor family will enable the development and fast delivery of best-in-class home networking solutions ideally suited for fiber-to-the-home and IPTV service provider deployments. Partnerships remain a key element of our long-term MoCA strategy and we expect to announce additional collaborative relationships moving forward.

Longer term in the MoCA market, we believe there is an emerging trend towards IP-based video delivery. This trend started with the over-the-top streaming video services from Apple, Amazon, Hulu, Microsoft Xbox LIVE, Netflix, YouTube, and Voodoo. However, we are now seeing the cable, telco and satellite Pay-TV service providers will also deliver IP-based video to set-top boxes and homes. We believe that this trend will drive the next wave of growth in MoCA beyond the current wave being driven by new multi-room DVR deployments. To summarize, the first growth for the Entropic MoCA home networking products was driven by the Verizon FiOS deployment. We are now entering a second wave of growth driven by new multi-room DVR deployments for multiple Pay-TV service providers, which should last for the next couple of years. We expect a subsequent, a third wave of growth in MoCA, driven by IP-based video delivery to and throughout the home and through penetration of international markets. This third wave of growth leveraging MoCA’s large installed base should drive growth for the next several years.

Turning to our DBS outdoor unit business, this product line consists of our Channel Stacking Switch or CSS family and our Band Translation Switch, our BTS family of products. Our satellite ODU products simplify the installation of satellite TV service. We are shipping our CSS solutions to DIRECTV for their integrated Single Wire Module, or SWM ODU deployment. Each DIRECTV SWM-enabled satellite DISH products uses three of Entropic’s CSS chips. Historically, DIRECTV deployed their SWM ODU in new high-end HD installations and we are now beginning to see an increase in our attach rate beyond high-end HD installs. We also have an opportunity to further expand revenue from the DBS ODU product line internationally. We are currently working with several international operators and OEMs to deploy CSS single cable solution for volume ramp beginning in the first half of 2010. We expect demand for single wire technologies will continue with the proliferation of DVRs and HDTV worldwide. The international free-to-air or FTA satellite market provides an additional opportunity for our DBS ODU product line especially in the higher and single family and multiple dwelling unit markets, where multiple set-top boxes and DVRs are deployed. Recently, Inverto, a leading design house controlled by FTA Communications Technologies announced the utilizing Entropic’s CSS silicon technology in its family of Black Unicable Multiswitches. As the mid to low end of this market transitions towards multiple set-top boxes and DVRs, we expect to trend towards single wire technologies will continue. Entropic’s CSS technologies enables reuse of existing cabling to support multiple tuners and set-top boxes thereby lowering system and installation costs.

Our BTS family of satellite products is used by EchoStar/DISH Networks and continues to ride nice run rate business for us. Historically, Q4 is a seasonally strong quarter for our satellite ODU business and we expect it to be the case this quarter as well. Turning to our silicon TV tuner product line, we are encouraged by design wins and orders for our new CMOS silicon tuner, which is now in production. Entropic’s CMOS tuner, the EN4020 is the best-in-class performance hybrid multimode tuner. The 4020 can address both analog and digital signals for international cable and domestic and international terrestrial TV markets. The TV tuner market is starting to switch from discrete implementations, the silicon tuners and the world is converting to digital television while needing to maintain legacy support for analog TV. Both of these transpire well for Entropic and we believe we are well positioned for a significant growth in the tuner market in 2010 and beyond.

In our broadband access product line, Entropic remains focused on driving new deployments of our access technology in international markets with a specific focus on Mainland China. Entropic’s access technology uses existing coaxial infrastructure to deliver high-speed last kilometer connectivity to single-family homes and multiple dwelling units. Our recent announcement with PMC-Sierra highlights how it can collaborate to address those market opportunity. By combining PMC’s high-speed 10-gig EPON and Entropic’s broadband access products, cable MSOs will have a cost-effective solution to extend the reach of fiber.

We are seeing heightened activities in the China cable market, as the government accelerates the analog digital conversion. As part of this process, Entropic is actively involved with the broadband communication selection at major Chinese cable MSOs. Yesterday, Skyworth, one of China’s leading home entertainment providers announced that it selected Entropic’s broadband access products for use in Skyworth’s Ethernet-over-coax solutions to enable broadband access in multiple dwelling units in China. Entropic’s broadband access revenues were still modest since these volumes are primarily based on large-scale trials and small-scale deployments. However, it all goes well with our trials in China, this could be an additional growth driver for Entropic in late 2010 and beyond.

I would now like to turn the call over to Dave Lyle, our Chief Financial Officer, who will provide the details of our third quarter performance and our fourth quarter guidance, then I will provide some closing remarks, and we will open the call for your questions. Dave?

Dave Lyle

Thanks, Patrick. Third quarter revenue increased 19% from $26.1 million in Q2 to $31 million in Q3, above the high end of our previous guidance. Top line revenue growth was driven primarily by strength in our MoCA product line. Non-GAAP gross margin in Q3 was 51.9%, above the high end of our previous guidance and an increase from 51.2% in Q2. Excluded from Q3 non-GAAP gross margin, this $41,000 in stock-based compensation expense and $400,000 of amortization of purchased intangibles. Non-GAAP operating expense increased approximately 5% quarter-over-quarter, from $14 million in Q2 to $14.7 million in Q3, due primarily to higher variable R&D expenses. Our Q3 worldwide headcount was 255 employees, an increase of 3 heads from the prior quarter. We excluded from our Q3 non-GAAP operating expense $2.2 million for stock-based compensation expense and $70,000 in restructuring charges. Net interest income and income taxes for the quarter were immaterial. We recorded a non-GAAP net income in the third quarter of $1.4 million, an improvement from a non-GAAP net loss of $700,000 in Q2. We recorded a non-GAAP earnings per share of $0.02 based on a fully diluted weighted average common share count of approximately 74.5 million shares.

With regard to our cash position, we ended the quarter with $34.3 million in cash, cash equivalents and marketable securities, an increase of $2.1 million from Q2. Our cash balance primarily benefited from a higher revenue base. The company paid out $225,000 in plan attainments related to the restructuring, which occurred in the first quarter of this year. Our DSOs improved to 47 days in Q3 from 52 days in Q2, primarily due to better revenues (inaudible) during the quarter. Our inventory turns were 4.2 times on a non-GAAP basis, an improvement over Q2 turns of 3.8 times.

Now, I would like to provide our guidance for the fourth quarter of 2009. In Q4, we expect revenue to be in the range of $34 million to $35 million, a quarter-over-quarter increase of between 10% and 13%. Significant top line revenue growth in light of softness at Verizon, demonstrates a rapidly diversifying business for Entropic. Our fourth quarter revenue outlook reflects solid growth from OEMs preparing for initial launches of our MoCA products by new service providers, increased penetration of our CSS products in the DIRECTV satellite deployment, and improvements in demand for our BTS products deployed by EchoStar/DISH Networks. We expect these increases to be somewhat offset by lower revenue from OEM supporting to Verizon deployment. We believe non-GAAP gross margin would be 52% to 53% in Q4 due to our product mix shift toward DBS ODU product line. Excluded from Q4 non-GAAP gross margin is approximately $40,000 of stock-based compensation expense and approximately $400,000 of amortization of purchased intangibles. We believe non-GAAP operating expense will increase from $14.7 million in Q3 to between $14.9 million and $15.1 million in Q4. We will exclude from our non-GAAP operating expense in Q4 approximately $2.2 million for stock-based compensation expense.

We expect net interest income and income tax expense in Q4 to be immaterial. Assuming the midpoint of our guidance, we would show profitability on both non-GAAP and a GAAP basis in Q4. We would expect to show approximately $3.1 million of net income on a non-GAAP basis and $500,000 of net income on a GAAP basis. Non-GAAP earnings per share would be about $0.04 based on a fully diluted weighted share count of 76 million shares.

Moving to the balance sheet, we expect cash, cash equivalents and marketable securities to be approximately $35 million at the end of Q4, as increases in profitability are somewhat offset by working capital needs as we ramp for new launches of MoCA and expand our CSS business. With regard to our DSOs, we expect DSOs to be in the range of 45 to 50 days in Q4, and we expect inventory turns to be similar to Q3. Now, I will turn it back to Patrick for some closing remarks.

Patrick Henry

Thank you, Dave. To summarize, we are very excited about our team’s solid execution, our revenue growth and our return to profitability. We continue to see our company’s vision playing out with our MoCA products being deployed in the new Pay-TV service provider offerings and our other product lines showing strength. Our MoCA business is now becoming sufficiently diversified to offset softer quarterly sub adds at any single service provider, and our other product lines are beginning to penetrate the large markets they serve. Our partnership strategy around MoCA product line continues to expand with new partnerships being forged each quarter. Our satellite outer unit business is beginning to grow as our attach rate to DIRECTV increases and we penetrate international markets with CSS. Our silicon TV tuner and broadband access product lines should contribute to revenue in a more meaningful way in 2010 and we view them as important building block technologies. We believe that we continue to grow our top line revenue in 2010, as the markets we serve continue to drive for ubiquitous connected home entertainment.

Longer term, we believe the trend to deliver IP-based video will drive the next wave of growth in MoCA beyond the current wave being driven by new multi-room DVR deployments. We are very excited about the opportunity in front of us, and believe we have a solid product portfolio and product roadmap as well as a compelling long-term growth strategy.

That concludes our prepared remarks. Dave and I will be happy to answer any of your questions.

Question-and-Answer Session

Operator

(Operator instructions) We will first go to Sandy Harrison at Signal Hill.

Sandy Harrison – Signal Hill

Thanks, good afternoon guys.

Patrick Henry

Hi, Sandy.

Dave Lyle

Hi Sandy.

Sandy Harrison – Signal Hill

So, it sounds like you guys are really – Patrick, to your prepared remarks, it sounds like you guys are starting to see the diversification from some of the other folks in the channel for your MoCA stuff, when did Verizon or when did you start to see Verizon softening? In other words, what kind of visibility are they giving you guys through their channel? I am just trying to get a view of the lead time of how they are managing their supply chain now versus where they were, maybe say a year ago?

Patrick Henry

Yes, so, obviously we saw their quarterly sub adds this morning like everybody else did. You know, we had a sense, we are talking to our customers as well as to our contact at Verizon at, quarterly sub adds would come in about where they did. One thing that we saw as a result of kind of a situation that happened to us last kind of June, July, was that the entire supply chain has been much more tighter from an inventory management standpoint all the way from Verizon to our direct OEM customers to Entropic ourselves. So, we don’t see a major inventory overhang, and a really fortunate thing in addition to that, that we see is new service provider deployments starting to ramp and advance of their launches later this year and into next year. So, we are seeing really strong strength and diversification based on new MoCA deployments as well as strength in our satellite business.

Sandy Harrison – Signal Hill

And then, Patrick, I get a sense sort of renewed vigor in your tuner opportunity and broadband access opportunity than it was six or nine months ago. Is that just the market coming your way, is that you having additional product out there, is it design wins, what sort of changed your tone a little bit there and gotten you more optimistic?

Patrick Henry

I mean, there’s two separate things, they are specifically on the tuners. Some of the designs that we won earlier this year and now going into production, and we are seeing a trend away from discrete CAN tuner implementations to silicon tuners. So, we are seeing the markets moving our direction and we won some designs that are starting to generate some revenue, although it’s still modest from an overall company standpoint, we are seeing pretty significant percentage growth going from Q3 to Q4. On the broadband access opportunity, that’s one the businesses that’s going to take a while to develop, but we are continuing to get momentum, we are meeting our modest goals in that market, and assuming that things continue to go well for these new deployments and large-scale trials, we see that, that could be a more significant contributor late next year and in the out years as well.

Sandy Harrison – Signal Hill

Got you, and then a quick question on the model, you guys have managed your OpEx pretty well through all of this, and as you start to see your revenues accelerated in sort of upside not only to the September quarter but your outlook for the December quarter, are you going to be able to stay on top of those as we move into 2010 and manage them, and what should we be thinking in sort of a modeling in a longer-term perspective.

Dave Lyle

Yes, I can take that one. This is Dave. The focus for Entropic is to continue to control OpEx in a pretty strict way. We are not going to pull back too much to slow down critical projects, but in general, kind of the theme for next year is to grow revenue and profitability both.

Patrick Henry

As you can already see, we are actually investing quite a bit in R&D already, and I think that’s going to be the life ball of the company going forward, is continue to do new product development, but we are making pretty substantial investments there, and we think that this was some modest increase in OpEx primarily in R&D and a little bit in the sales portion of SG&A in 2010. We can deliver quite a bit of operating leverage from the model, so, while still making sure we are investing in the future.

Sandy Harrison – Signal Hill

Okay. Great, thanks. I will drop into the queue, thanks.

Patrick Henry

All right. Thanks.

Operator

We will take our next caller, Daniel Amir with Lazard Capital Markets.

Daniel Amir – Lazard Capital Markets

Thanks and congratulations on a good quarter.

Dave Lyle

Thanks.

Patrick Henry

Hi, Daniel.

Daniel Amir – Lazard Capital Markets

Couple of questions. In terms of the service providers, the non-Verizon, I mean, is there an increase in the number of service providers or is there still large, either 3 cable MSOs that you talked about in terms of the ramp in Q4?

Patrick Henry

We are not going to break out Q4 by service provider, but there are the three announced deployments in our Cox, Time Warner and Bright House, and we are continuing to focus on DIRECTV and Comcast as additional targets. We are also starting to see a little bit of momentum in second tier cable as well, and all of those are contributing in some way to the Q4 ramp, at least the announced deployments. So, we are just seeing good momentum as we have historically talked about. Cable MSOs, they typically go slow before they go fast, but even a slow ramp, when you are talking about tens of thousands and those kinds of homes can be pretty substantial in term of revenue for a company of our size. So, we are seeing all the early signs of things are going well and that we should see expansion in those as we get into the early part of next year and really throughout next year.

Daniel Amir – Lazard Capital Markets

Is the ramp here in Q3, was it better than you had expected three or four months ago in terms of the cable MSOs or is this pretty much the slow ramp or the accelerated ramp that you actually expected it to be?

Patrick Henry

Q3 numbers came in a little bit higher above the high end of our guidance range. So, we did a little bit better generally and most of the growth in Q3 was driven by the MoCA business, so it came in a little bit higher. And then, as we get into Q4, we are seeing kind of what we expected, the new deployments are kind of kicking in, but again, going slow before they go fast. But the great news for us is that more than made up for any kind of slowdown that we are expecting to see in Verizon during the quarter. So, we feel great about the diversification playing out that has taken us a while to get there, but it’s finally starting to play out for us.

Daniel Amir – Lazard Capital Markets

In regards to Verizon, do you think the slowness is related to just the lack of promotional activities, I mean is that the real driver here, so I was kind of just a couple of quarter [ph] low in the market I guess in terms of that?

Patrick Henry

I think Verizon on their call this morning talked about their goal is to add a million subs per year. Some quarters are going to be a little bit better than that, maybe some quarters are going to be a little bit softer than that. They did, I think 300,000 or close to 300,000 sub adds in Q2 and they did about 200,000 in Q3. So, they did mention that they were a little bit weaker on some of the promotional stuff in Q3 and they plan to step it up and kick it in a little bit in a bigger way in Q4, but generally, they are kind of on track to be adding 250,000 subs per quarter, but it kind of bounces around that range. That would be more of an issue for us if Verizon were still our primary source for our MoCA revenue, but as we are starting to see a diversified revenue base from new Pay-TV service providers, that helps us quite a bit to kind of balance that a little bit.

Daniel Amir – Lazard Capital Markets

Okay. And then to follow one more question before I go back into the queue. In this quarter, we have seen a couple of acquisitions in the home networking space, can you comment how do you view in terms of landscape, does that change anything for Entropic in terms of the way you do business, or in terms of potential partnerships?

Patrick Henry

Well, the two suspects you are talking about are Intellon and CopperGate. Both Intellon and Atheros are key partners of ours, they provide complementary technologies in the MoCA in the markets that we service, and Wi-Fi, Ethernet, power line technologies, especially HomePlug AV, which is the dominant standard in power line are all important complementary technologies to MoCA. So, the fact that Intellon and Atheros are getting together we see as a great thing, two already great partners for us, become a single partner with a broader base set of products to kind of service the market. With respect to CopperGate, which provides the HPNA technology for the AT&T deployment, they are so much more narrow product offering. We really don’t see HPNA outside of the AT&T deployment. Their acquisition by Sigma Designs, where Sigma provides the MPEG SOC into that same piece of business in the IPTV market, makes a lot of sense for both of those companies, but it’s more of a – we see that more of a point solution as opposed to a broad based offering like MoCA or Wi-Fi or HomePlug AVR. So, we won’t really partner with them. They were somewhat – to us in the first place. So, we are kind of indifferent to that particular transaction.

Daniel Amir – Lazard Capital Markets

Okay. Thanks a lot.

Patrick Henry

Sure.

Operator

We will take our next caller, Tore Svanberg with Thomas Weisel.

Tore Svanberg – Thomas Weisel

Yes, thank you, a few questions. Great quarter. First of all, as far as the deployments that are starting here in Q4 from the players you mentioned, how should we model those going forward? Are these going to be gradual or some of this going to ramp fast than others? I am just trying to get a sense of, you know, once Verizon comes back from a seasonality perspective, would you still see that continuous trend towards diversification?

Patrick Henry

Yes, I would say generally cable MSOs, they go slow before they go fast where they would typically deploy a couple of geographies and see how it goes, make sure there aren’t any customer support calls, installation issues, things like that, then they would gradually ramp their business and then deploy it on a broad basis and more regions at a time. So, I think that there’s a good growth rate from an attach rate standpoint and the MoCA products under the cable MSO area for all of 2010 and probably even into 2011. If we do end up being able to probably the satellite service provider, typically they don’t make any major product new admissions during the hot seasons. So, we will probably see slow ramp there until after we get into the first part of next year, with an opportunity to ramp beyond that. So, to kind of summarize that, I would that if Verizon bounces back, that provides some additional opportunity for growth versus the current quarter, and then we should see growth in the new service provider deployments generally is throughout all of next year and even into 2011. Then we have a follow-on opportunity of these IP-based video delivery opportunities where that would mean that MoCA goes into every device, every set-up box, which should provide additional ways of growth even beyond 2011.

Tore Svanberg – Thomas Weisel

Sounds good, and then you mentioned Comcast and DIRECTV potentially rolling out MoCA-based solutions in 2010, should we assume that as a possible sort of first-half opportunity, will it be more of a second half?

Patrick Henry

There is no announced launch plan in terms of specific timelines from either Comcast or DIRECTV, although they both committed to using MoCA into networks, they made public statements around that and both have announced and intend to deploy multi-room DVR in 2010, there’s really no public information out there beyond that general timeline.

Tore Svanberg – Thomas Weisel

Okay, very good. And if I look at – it looks like 2010 could also be a growth year for both silicon tuner and the DBS business. Between the two of them, which one should we really assume seeing the strongest momentum in 2010?

Patrick Henry

Both of them provide a big opportunity. Obviously the percentage growth on tuners could be a lot larger because it’s growing off as a smaller base, but I think from an overall revenue standpoint, satellite provides the biggest revenue opportunity from a growth standpoint throughout next year.

Tore Svanberg – Thomas Weisel

Okay, and then specifically on silicon tuner and as we look at 2010 and I mean, this is going to be a business that’s going to be millions of dollars or could it be potentially be in the double digits?

Patrick Henry

Well, we are already kind of breaking into the millions of dollars. So, it has the potential to go into the double digits for the full calendar of 2010.

Tore Svanberg – Thomas Weisel

Okay. Very good. And just a question for Dave, do you have the cash flow from operations number in the quarter?

Dave Lyle

Yes, let me give it to you in a second, I will get back to you.

Tore Svanberg – Thomas Weisel

Okay, and then last question and this question is for both of you. When you look at your guidance, pretty strong sequential growth, is there something that you feel you already have sort of in the backlog on the books, should we classify this as pretty conservative guidance?

Patrick Henry

Yes, as we typically have within a quarter, we have really good visibility in the current quarter and decent visibility one quarter out. So, we feel very good about the guidance we are providing for Q4.

Tore Svanberg – Thomas Weisel

Okay. And actually, just one last question on Verizon, since it’s kind of spotty, do you think they will already come back in Q1 or will this sort of be softer for more than a quarter?’

Patrick Henry

I think based on their conference call, they are going to be stepping up their promotions in Q4. So, we should be able to be back on track I would think in Q1. And I think a good way to model that business going forward is that more than 250,000 sub adds per quarter and it’s going to be above or below that range quarter-to-quarter based on Verizon’s guidance is. So, I think historically to make sure that they can view that and there is no reason to think they can’t do that on a go-forward from a penetration standpoint looking at the number of homes they are marketing into and the number of homes they are past. So, difficult to predict the exact timing on that. The good news for us is that we are diversifying away from that being kind of such a big component of the overall business and we are entering a new product cycle for the new MoCA deployments as well as the new products cycle in some of the satellite business and the tuner business. So, we provide some other growth engines to help us there as well.

Tore Svanberg – Thomas Weisel

Sounds good again, great quarter.

Patrick Henry

Thanks Tore.

Debbie Hart

Peter, can you queue for the next question?

Operator

Let’s move on to Ruben Roy with Pacific Crest Securities.

Ruben Roy – Pacific Crest Securities

Hi thanks, hi guys.

Patrick Henry

Hi, Ruben.

Ruben Roy – Pacific Crest Securities

Patrick, can you give us a little bit more detail about growth for Q4 kind of, which areas are potentially providing more of a growth, the CSOs versus the new OEMs planning for the MoCA launches?

Patrick Henry

Yes, we are not going to break it out specifically, but I would say generally we are seeing a lot bit of growth in MoCA even though we are seeing some softness in Verizon, we are seeing really strong strength in the new deployments there, more than making up for that. And we are seeing even more growth in the satellite business, and as Dave talked about, gross margins creeping up a little bit because of mix. So, both of those are growing and in fact, we are seeing growth in both end axis in the tuner business forecast in Q4 as well, although that’s not a much smaller dollar base. So, percentage is good, but we are on a small base there. So, that’s why Dave didn’t really highlight those in his comments.

Ruben Roy – Pacific Crest Securities

Okay. And on the broadband access topic, the discussion around the collaboration of TMCS, is that a new product for Entropic, and would you be able to – if that works, kind of go out into other geographies, Japan for instance?

Patrick Henry

Yes, right now, most of the stuff that we are doing is with GPON and EPON solutions, the 10-gig EPON solution from PMC is really the next generation which does provide us potentially an opportunity in other geographies given outside of Asia, but we are in the early stages on that stuff, and it does leverage off of our existing broadband access product, but we are also moving our product to 65-nanometer just like we moved the MoCA product to 65. So, those leverage off of each other as you know.

Ruben Roy – Pacific Crest Securities

Okay. And then just one for Dave, on the inventory, Dave, moved up just a little bit, but it’s still well below levels you have had in the past year-on-year for instance, and revenues are moving up. Can you just comment on how you feel about the inventory level anything going on in supply chain etcetera?

Dave Lyle

Yes, the inventory levels are actually we feel pretty good about, the pretty clean. We expect them to go up as we start preparing for these new ramps with operator-based deployments with our MoCA as well as some of the other product lines. So, we will see that increase, but we are keeping our inventory turns about where they are and we feel pretty good about that. In term of the supply, the supply chain has tightened up a little bit from where it was just a couple of quarters ago. I think that’s true for everybody, but we have really good relationships with our suppliers and feel good about being able to supply into the ramp.

Ruben Roy – Pacific Crest Securities

Okay, great. Thanks guys.

Patrick Henry

Thanks Ruben.

Operator

From D.A. Davidson with Aalok Shah.

Aalok Shah – D.A. Davidson

Hi guys. A couple of quick questions, 10% customers, Dave that you mentioned to us?

Dave Lyle

I have mentioned those. We had really two this quarter, both related to the MoCA product line. One was Motorola and that was about 38%, and then the other was Actiontec, which was about half of that.

Aalok Shah – D.A. Davidson

And I guess going, I know you just talked about your margin profile going into Q4, given a little bit better on the gross margin side because of mix, but are we starting to read into maybe that we are seeing some seasonal factors going into the CSS business, so Q4, Q1 a little bit more stronger for CSS and maybe we should think about that as how we think about starting to model Q1, maybe the margins would be better also in Q1?

Patrick Henry

Yes, typically, you know, in the run rate portion of the CSS business, we see some seasonality in Q4, Q1 as far as strength. But the other thing that we are seeing in the satellite outdoor business generally right now is an increase in attach rate at DIRECTV. We are starting to see a portion of that kick in and then as we get into 2010, we are also seeing an opportunity of our new product cycle developing with international satellites. So, yes, Q1 should be strong, but we may not see the strong seasonal drop-off that we saw last year in Q2. We don’t want to provide specific guidance out there far bit kind of from a general trend standpoint, I think that would be the way I would think about it. Do you have anything to add there, Dave?

Dave Lyle

No, I think that’s right.

Aalok Shah – D.A. Davidson

And then, Patrick, if we look at the two major customers for CSS or outdoor switches, I know that DIRECTV is still ramping up, but can you quantify or give us a sense maybe some color as to where you think that, that launch is still with those guys in regards to you?

Patrick Henry

Well, we have been deploying with DIRECTV for a while. Most of this year, we have been really deploying into high-end HD installs, we are seeing an uptick from our OEM customers, which indicate that we are getting increased attach rate over and above what we have efficiently called high end, and we still have a goal to get to 100% HD installs sometime next year. So, that provides a pretty good revenue growth opportunity for us, and then also the international opportunity with CSS.

Aalok Shah – D.A. Davidson

And on the EchoStar, I know there is flow in start kind of fixing scratch from a bit, but where do you think you are now with them?

Patrick Henry

They are having a seasonal strong quarter and they are also running a lot of new promotions. I don’t know what their subscriber numbers are going to be, but it seems like their business is pretty strong right now.

Aalok Shah – D.A. Davidson

And are we moving beyond just new installs with these customers into more existing customers and they are pricing some outdoor units there?

Patrick Henry

When the EchoStar business, we were in a very high percentage, high 90s percentage of the dish antennas of new dishes which is both for new customers as well as upgrades and churn and pretty much of everything. In the case of DIRECTV, we are still in the new install part of the market, new high-end HD and moving beyond that. The opportunity for upgrades is still potentially in front of us. We are seeing that kick in yet. But that’s definitely a longer term goal for us is to penetrate beyond new subscriber installs.

Aalok Shah – D.A. Davidson

Okay. And then lastly on the MDU front, I know you signed a couple of deals now with some of the international companies, but have we started to see kind of real meaningful revenue from the MDU business?

Patrick Henry

It’s still real modest. You know, on a raw company standpoint, we feel like we are hitting our modest goals that we set for ourselves this year. These broadband access markets take a while to develop as you know, so we are making that kind of proper staged investment in those with a real heavy focus on them on China, and there’s nothing there’s potentially a big opportunity there although we wouldn’t see it be a meaning for contributor to overall company revenue until late 2010.

Aalok Shah – D.A. Davidson

Okay. And sorry, one more quick question. On the competition side, are you seeing any design wins trying to move away from you guys at this point?

Patrick Henry

Yes, we haven’t really seen any news after report that’s changed since our last quarterly conference call, some, I guess some product announcements, sort of brought around the satellite space. But that’s really too much new to report there.

Aalok Shah – D.A. Davidson

On that satellite business, I mean, is that something which should be aware of they going into 2010 or is it something that he has lost?

Patrick Henry

There are product announcements or more in the MPEG-SOC space for satellite set-top boxes. So, I think what that indicates is that the MoCA potential market opportunity is moving beyond Verizon, cable MSOs and also into the satellite market, analyze why would they develop MPEG-SOCs for the satellite market. In terms of satellite outdoor business, we really don’t see any meaningful competition there.

Aalok Shah – D.A. Davidson

Okay, great. Congratulations.

Patrick Henry

Thanks a lot.

Dave Lyle

Thanks.

Operator

Let’s move on to Hamed Khorsand with BWS Financial.

Hamed Khorsand – BWS Financial

Hi good afternoon guys. Just a couple of questions. Could you give me some details there on the second-tier MSOs, what’s making them move? Are you doing the marketing effort or are the OEMs doing the marketing effort, what’s causing that?

Patrick Henry

Most of the marketing effort to second-tier cable MSOs is really coming from our direct customers, the set-top box OEMS, that has developed products for the Tier 1 and now they are starting to push those products into the Tier 2 channel. So, we are really benefiting from our customers, doing some more intensive marketing around their MoCA product lines.

Hamed Khorsand – BWS Financial

Okay, and then on the DIRECTV side, you guys were running at around 10% of their new installs. Could you give me a range of where you guys are at now? Is this near 20%, near 50%?

Patrick Henry

Yes, we are really not going to break that out in that level of detail. It’s higher than where it was historically in the 10%. So, we are starting to see penetration beyond the high-end HD and we think there’s an opportunity to maybe penetrate anywhere from 30% to 50% overtime from an all HD install standpoint. So, that’s been our historical goal, and that’s still a goal. There may be an opportunity to penetrate even beyond that overtime if we start getting upgrades, but there’s no commitment from DIRECTV around that. So, we just continue to focus on increasing attach rate as much as we can as quickly as we can.

Hamed Khorsand – BWS Financial

Okay. And then last question, with China, have you seen any activity from the government, as the regulatory body, all we are seeing is MDU deployment certification process?

Patrick Henry

Yes, a couple of major Chinese government regulatory bodies, MII really focus somewhat on the telco side, and SARF really regulates the cable operators. So, SARF is heavily involved in some of the broadband access selection, Ethernet-over-coax technologies which is the specific category that we service.

Hamed Khorsand – BWS Financial

Okay. And, do you guys, with this announcement from yesterday, are you guys getting (inaudible) products on the market now?

Patrick Henry

We have product on the market already, although it’s pretty modest revenues for us, because it’s really these large-scale trials, small-scale deployments. So, there is heavy focus right now in China in the analog to digital TV conversion, kind of the next follow-up to that is interactive services, which is the opportunity for the Ethernet-over-coax products that we service into that market. So, we are meeting our modest goals for this year. Assuming things go well, this could be a decent size opportunity for us quite next year and beyond.

Hamed Khorsand – BWS Financial

Okay, thank you.

Patrick Henry

Thanks Hamed.

Dave Lyle

Thanks Hamed.

Operator

Our question is now from John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yes, good afternoon guys, congratulations.

Patrick Henry

Thanks John.

John Pitzer – Credit Suisse

First guys, on the Verizon weakness, did they say in the calendar third quarter or is that what you expect in the calendar fourth quarter, and as we try to model that, is this far that they will be down for you guys in the calendar fourth quarter by about as much than net adds were down in September, is that the best way to look at it?

Patrick Henry

Yes, I think that’s the way to look at it. We saw a sell-through in Q3 relative to Q2 down by about 30% to 35%. That’s going to impact us really this quarter, but see, kind of what happens, the sub growth this quarter, they are saying they like to be about 1 million sub adds a quarter. So, kind of on the go-forward if you model it, it’s 250,000 a quarter, you will kind of be around the right range I would think as they are already having promotions, and maybe there’s some seasonality or less promotions to be able to lessen that. But that’s kind of a good way to look at it.

John Pitzer – Credit Suisse

And then you guys gave us some good figures on chips per deployment from Verizon. Should we use some other numbers as we look at the other service providers ramping?

Patrick Henry

Yes, I think within a cable MSO deployment, if it’s purely multi-room DVR, it’s somewhere between 2 and 3 set-top boxes per home. They don’t always have a set-top box at every TV the way that Verizon does. Although as they move to all digital they will. But so maybe to model out, let’s say 2.5 set-top boxes per home for multi-room DVR. If they decide to add over-the-top-services on top of that we get an additional MoCA node at the cable modem, the broadband access connection. Within a satellite deployment, since they don’t offer triple-play, inherently they do when they bundle with the telco, whereas the stand-alone service for multi-room DVR, again it’s coupled somewhere between 2 and 3 set-top boxes per home. Now, if they also offer an over-the-top service, there could be an additional MoCA opportunity there, like these are online or downloadable movie type of things from the Internet. So, kind of multi-room DVR, somewhere maybe, 2.5 set-top boxes and then a favorable broadband access on top of that, that could add more MoCA node per home.

John Pitzer – Credit Suisse

And then, Patrick, given some of the experience you had with inventory management around the Verizon ramp, can you help us understand what you might be doing differently as the other service providers begin to ramp or – maybe at some point, you are going to have to worry a bit that (inaudible)?

Patrick Henry

I think generally service provider deployments you get to apply where they get to a run rate, and we just have to make sure we manage that closely when we get to a run rate. I think the good news for us right from the short intermediate term is we are just entering these new product cycles and they usually take six to eight quarters before they get to a more run rate status. And then we are seeing the emerging opportunity around IP-based video delivery, which could extend that run rate, potentially upgrade the MoCA 2, potentially penetrate into international markets. So, as we become more diversified, even though a particular service provider might get into more of a leveling off situation, in the case of Verizon, it wasn’t even leveling off, a little bit of subscriber drop there. But in the diversified business model, we are much less susceptible in some of the stuff that happened to us middle of last year.

John Pitzer – Credit Suisse

Got it. And then, I know you don’t want to give guidance more than one quarter off, but I guess with the new deployments, with the potential for Verizon coming back and some of the new businesses wrapping up by the MoCA, how should we think about Q1 normal seasonality versus what you might be able to expect this year?

Patrick Henry

Yes, we really can’t provide guidance for you on the current quarter. I would just say generally any quarter, we are in the new growth phase of our overall business, and a bounce back in Verizon can only help that. So, we feel really good about our short-term, intermediate term, and long-term growth prospects.

John Pitzer – Credit Suisse

And then, Patrick, my last question on the competitive front, actually away from Broadcom, you have Cavium starting to ramp this new chip, but high-def of Wi-Fi, I guess can you help me understand how that plays into the whole connected home and the MoCA vision?

Patrick Henry

Yes, we really view Wi-Fi as the complementary technology as opposed to competitive technology in the space that we service. Really you need MoCA data rates and MoCA quality of service for streaming video applications especially if you are streaming a lot of video in the home or in the room. These Wi-Fi products compete with us more in the retail aftermarket where it’s kind of a best efforts class of service instead of a true quality of service delivery of video. I think in this over-the-top service providers, if they eventually move to a real quality of service model and serve just the best efforts, opportunity, I think that MoCA is now continuing to penetrate those markets in a bigger way, just like we have done really well historically in the Pay-TV markets. So, we really don’t see it really competing with us very much, and if there’s a trend towards more HD content including Blu-Ray quality content online, and a move to providing quality of service as opposed to best efforts, I think that all bodes well for MoCA.

John Pitzer – Credit Suisse

Perfect. Thanks, Patrick; that was helpful.

Patrick Henry

Thanks John.

Operator

And it looks like our final question does come from Tim Luke with Barclays Capital.

Tim Luke – Barclays Capital

Thank you. David, I was wondering if you could just touch on what you feel the framework should be for thinking about gross margins as you leave into next year. I was also just wondering if you could just remind us, Patrick, on the 65-nanometer transition, when we should start thinking about production? And then, Patrick, maybe lastly I was just wondering if you could touch on industry dynamics around consolidation, how you see some of the things that have taken place impacting your positioning and just for your expectations for consolidations and its space? Thank you.

Patrick Henry

Okay, Dave in here, first.

Dave Lyle

So on the gross margin front, we have got a long-term target of 50% to 52%. We kind of have been in and around that target for some period of time now. We feel pretty good about being in and around that target due 2010.

Patrick Henry

And then 65-nanometer were in production now. And our 65-nanometer MoCA 1.1 product, we have initial orders already, we are going to be shipping some modest quantities in Q4, this quarter, but most of the real volume of that is late next year, you know, we will see it ramping in a more significant way in the second half of 2010, and then maybe actually in 2010, that’s where we will see kind of a crossover plan where that becomes a more dominant volume for us. So, we will be shipping the 0.13-micron stuff all of next year, and it will be a significant part of the overall volume for most of next year. As far as kind of broad based industry consolidation, we are going to continue this year, you know, specifically in the consumer electronics space, I think you will also see it in the analog space, and we start seeing some improvements in the macro economy especially even if it’s like a slow growth economy, some of the large cap companies get past some of these rationalization efforts that they have underway. I think it continue to see some trends towards us. Still some opportunities for some best-in-class providers, but as it’s always been the case, scale matters in the semiconductor business. You are going to see additional partnerships and probably additional consolidation overtime in my guess.

Tim Luke – Barclays Capital

Thank you so much guys, good luck.

Patrick Henry

Thanks Tim.

Operator

That concludes the question-and-answer session. I would like to turn the conference over to Debbie Hart for closing comments.

Debbie Hart

Right, thank you. Actually, Dave, I think wanted to make one final comment.

Dave Lyle

Yes, I wanted to respond to Tore’s question about cash flow for operations in Q3, the number is $1.8 million.

Debbie Hart

Thank you all for joining us today. Feel free to call me if you have any other questions. We will be presenting at the TechAmerica AeA Classic early next week. So, we hope to see some of you there. Thanks again and have a nice evening.

Operator

Once again, we now conclude today’s conference call. Thank you for your participation.

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Source: Entropic Communications, Inc. Q3 2009 Earnings Call Transcript
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