Entropic Communications' (ENTR) CEO Patrick Henry on Q2 2014 Results - Earnings Call Transcript

Entropic Communications (NASDAQ:ENTR)

Q2 2014 Earnings Call

July 30, 2014 4:30 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 Wade Mobley - The Benchmark Company, LLC, Research Division

Joshua Buchalter

Erik Rasmussen - Stifel, Nicolaus & Company, Incorporated, Research Division

Hamed Khorsand - BWS Financial Inc.

Operator

Good day, ladies and gentlemen, and welcome to the Entropic's Second Quarter Results Conference Call. My name is Philip, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Debbie Hart. Please proceed.

Debra Hart

Thank you, Philip, 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 second quarter 2014 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 margin, 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-Q, which contain important factors that could cause actual results to differ materially from the forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statement to reflect future events or circumstances.

Finally, please be aware that we are located in the flight path of the Marine Corps Air Station in Miramar and cannot predict the timing of flights. If we do have a flight coming overhead, we'll just pause and then continue once the jet noise has passed.

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 Q2, revenue was $50.2 million, and our non-GAAP net loss for the quarter was $0.12 per share. Revenue was within our revised guidance range, and we were able to slightly beat guidance for EPS due to lower operating expenses. Dave will take us through the Q2 numbers and discuss guidance for the current quarter a little later in the call, but first, I'd like to provide a brief update on our business and our long-term objectives.

In Q2, we took some steps to improve our overall financial performance. In early June, we implemented a plan to lower our operating expenses. This plan consisted of an organizational restructuring and site consolidation to better align the cost structure of the company with near-term revenue and drive deeper engineering and operational efficiencies throughout the organization in order to accelerate our path to profitability. As we noted on our June 9 call, the financial benefits of this action will be realized in Q4.

On the design win front, we have secured a number of design wins that we expect to ship later this year, and we continue to win new designs based on products we are just now bringing to market. These design wins will enable Entropic to gain share in the overall connected home entertainment market as the industry continues to transition to IP video delivery. To this end, our focus remains on driving our existing design wins into revenue-generating deployments; commercializing our new products, including our latest 28-nanometer solutions; securing new designs based on these new products; and ultimately, returning the company to profitability in 2015.

With respect to converting design wins into revenue, we expect to begin shipping products into multiple service providers in support of their IP video platforms later this year. For example, our design win with Humax for our bundled SoC plus MoCA solution for an RDK-based IP client will deploy by Time Warner and remains on track, and we expect to see revenue from this product in Q4.

We expect the Tier 1 satellite service provider will begin to deploy our bundled solutions by year end, as well. We are seeing strong progress on this deployment, but we're not able to talk specifics about the service provider at this time. And we believe we will start to see our initial orders from design wins supporting deployments of Xfinity advanced services at Comcast later this year.

On the MoCA discrete side, we believe both traditional service provider and over-the-top players recognize MoCA as the technology of choice for delivering a robust and highly reliable backbone to distribute multimedia content throughout the home. For example, we're seeing interest in our MoCA 2 discrete solutions from multiple OEMs for new Wireless Ethernet-to-Coax Adapters or WECAs. These WECAs are adapters that extend the wireless coverage in a home, leveraging the MoCA backbone network. Operators are interested in deploying WECAs to drive all-home data and video coverage. We are also seeing more requests for data gateways that support higher data speeds where MoCA is the interface of choice for in-home networking.

In the direct broadcast satellite space, our Channel Stacking Switch or CSS technology continues to enjoy a dominant market position worldwide. Our analog CSS products continue to generate a significant revenue stream for Entropic, and we continue to win designs internationally with our analog CSS products.

With regard to digital CSS, we are currently working with multiple Tier 1 operators to design in our industry-leading next-generation solutions. Our digital CSS technology is recognized as the industry's smallest-sized, highest-performance and lowest-power solution on the market, using approximately half the power of competitive solutions.

From a product development standpoint, we have a group of newly developed next-generation core platform products across our product line, including our 28-nanometer integrated set-top box SoC with MoCA 2, HEVC decoding and Full-Band Capture front-end capabilities, our low-power second-generation MoCA 2 solution on 28-nanometer and our industry-leading second-generation digital CSS solution.

We have strong customer interest in each of these next-generation offerings. Design win momentum is solid, and we expect to see early volume ramps from these newer-generation platform solutions in 2015.

While we see opportunity for us to grow top line revenue over the next several years, we are currently in a transition period where legacy product revenue erosion is not yet being fully offset by new product developments and deployments. Therefore, we have taken critical steps to lower our breakeven revenue by significantly reducing our operating expenses.

Looking forward, we're confident we'll see initial product deployments, albeit on a smaller scale, towards the end of this year. These deployments, coupled with recent design win activity from our newer platform solutions and continued execution on our product roadmap, will allow us to transition the company to the next stage of growth.

Now Dave will review the second quarter results and provide our Q3 outlook. Then I'll make some brief closing remarks before we open the call for your questions. Dave?

David Lyle

Thanks, Pat. Second quarter revenue was $50.2 million, a 10% sequential decline consistent with previous guidance. We saw typical seasonal softness in Q2 in our DBS ODU revenue and set-top box SoC revenue, as well as a decline in discrete MoCA revenue at Verizon.

We had 4 customers who accounted for greater than 10% of our revenue during the quarter: WNC, a supplier into DIRECTV and other satellite service providers at 25%; Cybertan, a subcontractor for Cisco at 14%; Actiontec, a supplier to Verizon at 14%; and MTI, a supplier of DBS ODUs to multiple satellite operators at 11%.

Our non-GAAP gross margin in Q2 was 52.5%, at the midpoint of previous guidance. Excluded from Q2 non-GAAP gross margin was about $100,000 in stock-based compensation expense and $2.7 million of the amortization of purchased intangibles.

Non-GAAP operating expense in Q2 was $36.8 million, which is about $1.2 million lower than previous guidance due mainly to additional savings resulting from our expense-reduction effort and incremental cost decreases related to our restructuring activities.

Our Q2 non-GAAP operating expense excluded $5.5 million of stock-based compensation expense, $300,000 of amortization of purchased intangibles, $900,000 related to IP litigation defense and $1.8 million in restructuring charges. Other income was about $200,000 for the quarter.

Our second quarter non-GAAP tax expense was $150,000. Our GAAP tax expense was $300,000. Q2 non-GAAP net loss was about $10 million, resulting in a net loss per share of $0.12 based on a basic share count of about 90 million shares. GAAP net loss in the second quarter was about $22 million, and GAAP loss per share was $0.24.

With regard to our cash position, cash and investments at June 30, were approximately $121 million, a net cash decline of about $16 million during Q2. This includes $2.3 million used for share repurchases during the quarter, which equates to 659,000 shares repurchased at an average share price of $3.41.

During the quarter, cash used in our business operations was about $9 million. DSOs for the second quarter came in at 56 days, and inventory turns remained strong at about 7x.

Now I'd like to provide guidance for the third quarter of 2014. In Q3, we expect Entropic's top line revenue to be about $49 million to $51 million, approximately flat with Q2 at midpoint as seasonal strength in our DBS ODU revenue is offset by softness in legacy SoCs.

Moving on to gross margin. We expect non-GAAP gross margin for Q3 to be 53% to 54%, up slightly from Q2 mainly due to product mix. We will exclude from Q3 non-GAAP gross margin about $100,000 in stock-based compensation expense and $2.8 million in amortization of purchased intangibles. We expect Q3 non-GAAP operating expense to be approximately flat with Q2 at $36 million to $37 million.

Our non-GAAP operating expense will exclude $5.4 million of stock-based compensation expense, $300,000 of amortization of purchased intangibles, $900,000 related to IP litigation defense and $2.5 million in restructuring charges. We expect other income to be about $200,000. We expect our GAAP and non-GAAP tax expense in Q3 to be about $200,000 due mainly to foreign tax.

Based on this guidance, we expect a non-GAAP loss per share of $0.11 based on a basic share count of about 89 million shares. And our GAAP loss per share is expected to be $0.24. We expect our cash and investments balance at the end of the third quarter to decline sequentially by about $16 million to $105 million based on an expected cash use from operations, capital expenditures and costs associated with the restructuring. Further cash use -- used in the quarter will be dependent on share repurchase activity.

We expect DSOs to be up slightly from Q2 at about 60 days and we expect inventory turns to be about 7x in Q3.

Now I'd like to give an update on our restructuring effort. On June 9, we announced that we have implemented a restructuring plan with the goal of reducing quarterly non-GAAP operating expense to about $32 million per quarter by Q4, which would provide $24 million in savings on an annualized basis once fully implemented, subject to fluctuations related to non-recurring items such as tape-out expense. These measures should allow us to lower our quarterly non-GAAP breakeven revenue from about $71 million today to about $60 million once fully implemented.

The restructuring activities are going as planned. Our goal of reaching $32 million in operating expense by Q4 of this year remains intact, and we are still targeting to return to non-GAAP profitability on a quarterly basis sometime in calendar 2015. Related to this restructuring, we currently expect to record total charges through our GAAP P&L of about $6.4 million, all of which will be recorded by year end.

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

Patrick C. Henry

Thanks, Dave. In summary, we have successfully brought several new products to market, and we remain confident in our ability to build a pipeline of design wins to drive long-term growth. We have taken the necessary steps to improve our financial performance via restructuring and reducing our breakeven revenue, which is expected to provide substantial earnings leverage as our revenue grows with new service provider deployments.

This concludes our prepared remarks. Now Dave and I will take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Gary Mobley from Benchmark.

Gary Wade Mobley - The Benchmark Company, LLC, Research Division

Based on your comments, in particular the comments just made by Dave a minute ago, you obviously expect revenue to grow about 20% from your guided September quarter revenue over the next 12 months. Could you give us some sense of what drives that revenue growth? I know in your prepared remarks, you talked about a couple of SoC plus MoCA design wins with Time Warner and a Tier 1 satellite operator and some other opportunities as well. Is that 20% revenue growth dependent on those SoC plus MoCA design wins you have in place? Or is it dependent on success of the 28-nanometer integrated solution?

Patrick C. Henry

Thanks, Gary. Not much is really dependent upon 28 nanometer other than the 28-nanometer discrete MoCA. We do see discrete MoCA opportunities ramping throughout 2015. Some in traditional service providers, some in potentially over-the-top opportunities. We'll see growth in our broadband access -- high-speed broadband access business, as well as in bundled MoCA plus SoC opportunities. Right now, we're seeing pretty consistent headwinds based on legacy dropping off without the new ramp in deployments. That slows down and then the new ramp in deployment starts being an additive in Q4 and then throughout 2015.

Gary Wade Mobley - The Benchmark Company, LLC, Research Division

Okay. Could you give us an update on the development of the 28 nanometer? Would you characterize the development as being on target with where you intended to be, say, when you first introduced the product last year?

Patrick C. Henry

I think we actually announced it at CEF this year. You're talking about the integrated MoCA plus SoC, correct?

Gary Wade Mobley - The Benchmark Company, LLC, Research Division

Yes, the Full-Band Capture HEVC.

Patrick C. Henry

Yes. So it's on track. We have design win momentum with that solution, and we're basically on track with what we intended. Really, we're looking at initial volume from that device in the second half of '15, really kind of towards the tail end of '15. But we do have pretty good design win momentum underway with that product.

Gary Wade Mobley - The Benchmark Company, LLC, Research Division

All right. The last question I have relates to protection of your Channel Stack Switch business. I know it's widely discussed, the transition from analog to digital. And I'm just wondering where you stand with the development of your digital channel stack switch, whether or not you have the design wins in place, and whether or not you intend to maintain the same market share in the Single Wire Module market that you have today versus looking out 12 months into 2015? That's it for me.

Patrick C. Henry

Okay. So I mean, our current market share between BTS and analog CSS is extremely high. It's in probably the 95% range. So as the market migrates to digital CSS, we do think we'll share that market with 1 or 2 competitors, but we also see a potential market expansion opportunity currently with our analog CSS products internationally, but eventually with digital CSS and international markets as well. So kind of net-net, we don't see that as being a growth business for us. But we do expect to kind of maintain revenue at kind of in a flattish range over the next couple of years. I think the market size will expand. ASPs will come down a little bit, and I think we'll still maintain a pretty healthy market share there. We're already shipping our first-generation digital CSS, and our second-generation digital CSS is in development. And we do have design wins in place with that product that we'll ramp into production in 2015.

Operator

And our next question comes from the line of Raji Gill from Needham.

Joshua Buchalter

This is Josh Buchalter in for Raji. A major competitor mentioned strength in emerging markets acting as a nice tailwind in set-top boxes. Are you seeing a similar trend? And could you maybe speak to the dynamic between emerging markets versus developing countries?

Patrick C. Henry

We've got exposure in China and to some extent, in Eastern Europe. We do see our business having modest growth there. I think the bigger opportunities for us is share gains in North America and Latin America, and that's been our primary focus from a product development and design win standpoint. We really don't see too much exposure for us in India or some of the other parts of Europe. So I think our growth opportunities are definitely -- and that's a C business at least, more focused on North America and Latin America where we can see share gains. In some of our other product lines, for example, broadband access, we do have bigger exposure to China, but I think your question was specifically around SoCs.

Joshua Buchalter

Okay. That's very helpful. And I know you mentioned everything is on track with the restructuring. Could you maybe give us a little more color on the engineering site consolidation? And any more specifics would be helpful. That's it for me.

David Lyle

Yes, this is Dave. Nothing else has changed since we first announced on June 9 in terms of site closures. We said that most of them would wind down near the end of Q3 and probably into Q4 with most of the headcount reductions being done by the time we leave Q3. So all that's pretty much on track.

Operator

[Operator Instructions] And our next question comes from the line of Tore Svanberg with Stifel.

Erik Rasmussen - Stifel, Nicolaus & Company, Incorporated, Research Division

It's Erik calling in for Tore. You -- I wanted to talk about the legacy discrete MoCA and SoC. It seems like that continues to be kind of a headwind for you guys. Has that bottomed? If not, when do you expect it to bottom and be less of an impact for you guys?

Patrick C. Henry

On the discrete MoCA, there's 2 areas that have been -- continue to wind down a little bit: the DECA business; the DIRECTV; and then as Verizon converts from traditional, their first generation of products to VMs-related products, Verizon media server. We still see some -- a little bit of headwinds there, but that's pretty much done by the end of the year. I guess the SoC, that's kind of an ongoing thing where we've got older-generation products ramping down. I think that will probably last through the end of the year, maybe even through Q1. But we do see ramping of new businesses, IP set-top boxes, as well as HD-DTA, remains a growth business for us. So those are kind of offsetting each other to some extent. And then as we get into 2015, maybe even in Q4, we'll see some growth outpacing some of the legacy declines.

Erik Rasmussen - Stifel, Nicolaus & Company, Incorporated, Research Division

Okay. That's helpful. Can you comment on seasonality? I know based on some of the historical patterns, the second half of the calendar year is typically a little bit stronger following we'll call it first-half seasonality. But this year, it appears that the seasonal headwinds were somewhat worse. Is there any shift in seasonal patterns that you've noticed that would impact this trend or even your outlook?

Patrick C. Henry

Not so much from an end market perspective. I mean, Latin America had more substantial growth in the last couple of years. It's kind of slowing a little bit. I think we're just generally kind of in a slow-growth economy right now globally. But from an overall end market seasonality perspective, we don't see much of a change.

Erik Rasmussen - Stifel, Nicolaus & Company, Incorporated, Research Division

Okay. Maybe finally, one question. Cash has been on kind of a steady decline. What do you expect in your -- you gave some guidance for the next quarter, but where do you see it bottoming?

David Lyle

We only guide 1 quarter out, as you know, so all we can give at this point is the guidance that we gave around Q3-end cash, which is around the $105 million range. Clearly, if we will continue to burn cash until we get to breakeven, which we said would be sometime in 2015.

Patrick C. Henry

And one thing I would say is, I mean, we feel like we have a very healthy cash balance in the company. And we're not even close to having any kind of liquidity concerns, and it's definitely our job as managers to make sure we never get into that kind of a range. So we're going to closely monitor that and make sure that we're in good shape from a liquidity standpoint. We have plenty of cash to run the business, way more than enough, and I think enough cash to signal to our end customers that we're around for the long term.

Operator

And our next question comes from the line of Hamed Khorsand from BWS Financial.

Hamed Khorsand - BWS Financial Inc.

Just a couple of questions here. One, on the outlook you've been providing as far as the service provider launches, that really hasn't changed from your commentary standpoint, but it seems like, though, you got to have some confidence that this is going to happen, but service providers have been lumpy with what they want to do.

Patrick C. Henry

Yes. I mean, you're right. The outlook hasn't really changed in terms of timing. In terms of magnitude of the ramp, that's always uncertain. But we do have a pretty good sense that Q4 we are going to see a ramp in those 3 platforms we mentioned. It's really a matter of how quickly they do ramp and how quickly they become really substantial.

Hamed Khorsand - BWS Financial Inc.

Okay. And does the restructuring have any change as far as your roadmap on the R&D side?

Patrick C. Henry

The thing I think we mentioned on the June call was that we are getting more leverage out of our HEVC, SoC solutions, and although we do see initial market opportunities for 4K ultra high def, we've kind of pared back our productization effort there. We're still developing core IP, but we don't see that we want to be one of the first guys out there with ultra high def before there's really a volume market. So that's probably the most significant change that we made in our product roadmap as a result of the restructuring.

Hamed Khorsand - BWS Financial Inc.

Okay. But there isn't any change as far as having an integrated solution?

Patrick C. Henry

Yes. I mean, we have an integrated solution today, and we're leveraging that platform into additional derivatives that have integrated MoCA plus SoC.

Hamed Khorsand - BWS Financial Inc.

Okay. Anyway, I thought that was a bundled solution that's why I was asking.

Patrick C. Henry

The current product that we have, design wins that will start ramping in Q4 is bundled, but we have a product that has integrated MoCA, Full-Band Capture front-end and HEVC that it's not fully commercialized but it's sampling, and we have design wins around that product as well. That's the one that we would see really material revenue from in the second half of 2015.

Operator

Ladies and gentlemen, this will conclude the question-and-answer portion of today's call. Now I would like to turn it back over to Debbie Hart for closing remarks.

Debra Hart

Thanks, Philip, and thanks, everyone, for joining us tonight. Please feel free to call or e-mail me with any additional questions you might have. Thanks, and have a good evening.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you all for your participation, and you may all now disconnect. Have a wonderful day.

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