Entropic Communications, Inc. Q2 2008 Earnings Call Transcript

Entropic Communications, Inc. (NASDAQ:ENTR)

Q2 2008 Earnings Call

August 5, 2008 5:00 pm ET

Executives

Patrick Henry – Chief Executive Officer

David Lyle – Chief Financial Officer

Analysts

Tim Luke – Lehman Brothers

Sandy Harrison – Signal Hill.

Krishna Shankar - JMP Securities

Gary Mobley - Piper Jaffray

John Pitzer - Credit Suisse

Aalok Shaw – D.A. Davidson

Eric Rasmussen – Roth Capital Partners

Operator

Welcome to the Entropic Communications conference call. (Operator Instructions) I would like to turn the program over to Debra Hart, Director of Investor Relations for Entropic Communications.

Debra Hart

Welcome to Entropic Communications Second Quarter 2008 Conference Call. Leading the call today are Patrick Henry, Chairman and CEO, and David Lyle, our Chief Financial Officer.

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

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

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

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

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

Patrick Henry

In Q2, we delivered sequential topline revenue growth of 2% reading $42.8 million. This is our 17th consecutive quarterly revenue growth and our fourth consecutive quarter of non-GAAP net income. Increased demand for our home networking products was tempered by a slower than expected ramp of our CSS product within our DBS outdoor unit product line. Despite the slower CSS ramp in Q2, we have confident that DIRECTV deployment will provide the material revenue ramp for us in the second half of 2008 and provide a growth engine for us throughout 2009. Although we remain optimistic about the longer term traction and momentum we are gaining in our end markets, our revenue expectations for Q3 are below our original operating plan. David will address this in more detail following my remarks.

The format we use for today’s call will be as follows. Dave and I will provide our financial quarterly overview and provide guidance for Q3. I’ll talk about what went well in the quarter, what we need to improve, and steps we’re taking in response to some near-term softness. I’ll also discuss industry trends and dynamics. In particular, I’ll give an update on service provider launch plan, and finally, we’ll open the call to your questions.

Now, I’ll turn the call over to Dave for a more detailed report on our financial results for the quarter.

David Lyle

Second quarter revenue of $42.8 million was up $800,000, or about 2% sequentially from $42 million in Q1. Topline revenue growth was driven primarily by our MoCA deployment with Verizon offset by a slower than expected ramp of our channel stacking switch products by DIRECTV and to a lesser extent continued softness in our EchoStar deployment of our band translation switch product.

Because of this product mix shift, non-GAAP gross margin for the quarter was 48.1%, down from 48.7% in Q1. Non-GAAP gross margin excludes $1.6 million of amortization of purchased intangibles associated with prior acquisitions.

Non-GAAP operating expense of $19.7 million was up by $2.3 million, or approximately 13% from $17.4 million in Q1. Q2 total headcount of 317 employees worldwide increased 36 heads from the first quarter, 17 of which came from our acquisition of Vatic Technologies which closed on April 3rd of this year. Our Q2 non-GAAP results exclude $3.4 million in stock-based compensation expense and approximately $700,000 in amortization of purchased intangibles from prior acquisitions, a non-recurring charge of $1.3 million for in-process R&D, and $700,000 for accrued retention bonuses related to the acquisition of Vatic Technologies.

With respect to income taxes, we recorded a benefit of $72,000 due to the uncertainty of our alternative minimum tax liability for 2008.

Non-GAAP net income was $1.2 million in Q2, down from Q1 on-GAAP net income of $3.2 million. Non-GAAP EPS was $0.02 per share based on diluted weighted average common share count of approximately 73.4 million shares.

Moving to our balance sheet, we ended the quarter with $29 million in cash and marketable securities and no bank debt. Excluding the cash payment of approximately $6 million for the acquisition of Vatic Technologies in early April, Entropic would have been at cash flow breakeven.

A slight improvement in the timing of billings across the three months of this quarter versus last quarter resulted in lower accounts receivable and therefore an improvement in DSO from 81 days in Q1 to 76 days in Q2. However, our DSOs are still higher than our target as we once again had much of our billings towards the back end of the quarter, resulting in a high accounts receivable balance.

Our inventory turns were 4.2 times on a non-GAAP basis, below the 6.1 times achieved in Q1. The primary reason for this was due to our inventory bills in preparation for the ramp of our channel stacking switch product into the DIRECTV deployment that was announced in our press release last week.

Now, I’ll provide our guidance for the third quarter of 2008. In Q3, we expect topline revenue to be in the range of $30 to $31 million, a decline of about $12 to $13 million from Q2. Softness in demand for our MoCA products in Q3 and high MoCA inventory levels specific to our Verizon FiOS deployment is the primary reason for this decline. There are two main issues we are facing. First, Verizon’s demand softened in Q2. Second, our direct OEMs continue to show strong demand and ordering patterns during the same period in order to keep up with Verizon’s demand forecast.

With regards to Verizon’s softened demand, in Verizon’s earnings call last week, they announced that they had added 187,000 net new FiOS internet customers in Q2, 75,000 fewer than they had in Q1, and they added 176,000 net new FiOS customers in Q2, 84,000 fewer than they added in Q1. As a reminder, Entropic sells 3 chips set into FiOS internet home and an additional 3 chips set into the average FiOS TV home. Verizon indicated that this sequential growth slowdown in FiOS net add was due primarily to a lower level of promotions, marketing, and advertising activities during the quarter, which they have since re-energized.

During the same period, we continued to receive orders from our OEMs to meet Verizon’s demand forecast. The combination of these events has created higher levels of inventory throughout the Verizon side of supply chain. Our lower Q3 revenue forecast reflects this inventory correction for our MoCA products. We expect that the revenue ramp related to the DIRECTV deployment, our CSS product, will offset some of the anticipated Q3 MoCA revenue shortfall.

Although it’s our policy to limit our outlook guidance to one quarter, we’re making an exception this time, with regard to our Q4 revenue prospects. In Q4, we believe we will show sequential revenue growth over our Q3 revenue estimate of $30 to $31 million, but revenue will not likely be greater than our Q2 actual of $42.8 million.

We believe non-GAAP gross margin in Q3 will be 49.5% to 50.5%, due to a richer mix of higher margin DBS outdoor unit products. We believe non-GAAP operating expense will decline in Q3 by approximately 10-11% sequentially, or close to $2 million to approximately $17.5 to $17.8 million through even more stringent cost containment efforts than we’ve had previously, and we will discontinue the accruals for our management bonus program. Those efforts will include pushing out noncritical projects, such as our international tax structure implementation and will also include tightening up controllable spending such as consulting and outside services. However, we are not sacrificing the future growth of the company by cutting into R&D projects critical to our long-term success.

Please note that we will exclude from our non-GAAP expense approximately $2.3 million of amortization of purchased intangibles from prior acquisitions and $3.1 million for stock-based compensation expense.

Moving to income tax expense, we do not expect to record any additional tax expense in Q3. We expect to approach our long-term effective tax rate of approximately 20% beginning early next year when we formally begin to utilize our new international structure. We estimate that our basic weighted average share count will be approximately 68 million shares for Q3.

For quarter-to-quarter comparison purposes, our non-GAAP fully diluted weighted average share count would have been approximately 73 million shares if we had projected a net income rather than a net loss. For EPS calculation purposes, the anti-dilutive basic weighted average share count will be used because of our anticipated net loss for the quarter.

Assuming the midpoint of the guidance, we expect a non-GAAP net loss per share of approximately $0.03.

Moving to our balance sheet, we expect to be a positive net generator of cash in Q3, as cash from heavy June shipment is collected in Q3, unless new material orders will be necessary as inventory levels are worked through. We expect DSOs to improve to less than 70 days in Q3. We expect inventory turns to continue to be a challenge in Q3, as we work off higher than normal inventory levels from Q2 and as parts ordered in Q2 for higher previously projected Q3 volumes are received into inventory.

Now, I’ll turn it back to Patrick.

Patrick Henry

Clearly, we’re disappointed with the guidance we’re providing today. As Dave mentioned, due to the sequential drop in Verizon’s FiOS subscriber growth in the second quarter and the resulting increase in inventory positions as MoCA-based customer premises equipment for Verizon and it’s associated supply chain, we expect significant softness in sales of our MoCA product line for the third quarter. We expect the situation to be partially mitigated by the anticipated ramp of our DBS outdoor business at DIRECTV. While we face these near-term challenges, we remain confident in our long-term business opportunity which I will discuss shortly.

First, I’d like to elaborate on our near-term plans to ensure that we’re managing the business prudently in light of our reduced revenue expectations for the third quarter. We’re taking steps to reduce our operating expenses during the current quarter by cutting discretionary spending and implementing general belt-tightening measures across the organization. These steps will allow us to preserve our cash while not sacrificing our long-term prospects for what we believe is short term softness compounded by an inventory correction. We still see a great opportunity in our serve markets and need to continue to invest in the company to support our market penetration. We’ll remain focused on product development efforts and driving new design activity.

In home networking, let me take you through the current status of service provider deployments and some recent OEM design wins. Recently, Westell and Actiontec both announced new broadband home router design wins for Verizon’s FiOS deployment. These recent customer wins are with our MoCA 1.1 solution. The move from MoCA 1.0 to MoCA 1.1 increases the performance and functionality of the MoCA solution and required Entropic to develop new silicon and software. Entropic’s MoCA 1.1 products are 100% backward compatible with our MoCA 1.0 solutions which is a requirement of the MoCA specification.

The new features of our MoCA 1.1 solutions include increased net throughput from 100 megabits to 175 megabits per second, a doubling of the supported MoCA device’s in-home network from 8 notes to 16 notes, enhanced network management functionality, and parameterized quality of service or PQOS, which provides reserved bandwidth for critical networking traffic like video on demand and multi-room DVR. All of these features were driven by service provider and OEM customer feedback. Spcifically, reserved bandwidth is critical to support coexistence of network traffic from retail after-market MoCA devices and premium network traffic from pay TV service providers such as video on demand. Entropic remains the only provider of MoCA compliant silicon, and these recent wins further extend our leadership in the market.

Verizon continues to roll out its FiOS internet and TV services. As we discussed, Verizon’s subscriber numbers for Q2 came in below Wall Street expectations. Verizon indicated that they intend to step up promotional activities this fall, and they are moving full steam ahead with their FiOS launch in New York City where there are over 3 million residents. Entropic continues to work on multiple strategic initiatives with Verizon, and we’re confident of our long-term position in this deployment.

Entropic is extending our lead in the market by winning new set-top box designs for future MoCA deployments by cable, telco, and satellite TV service providers. At the Cable Show in May, a number of OEMs demonstrated cable set-top boxes with MoCA functionality. These customers included Motorola, Cisco (formerly Scientific Atlanta), Panasonic, and Samsung. These new MoCA-ready products for our key customers are being developed for future MoCA operator deployments; however, despite the progress we are making on new MoCA deployments, we are disappointed that new service provider based deployments are taking longer than we would like. Historically, we believe that there will be additional service provider MoCA deployments by the end of 2008. Now, the projected launch timing of these new deployments is moving into the first half of 2009. Based on this delay and new MoCA deployments, to be conservative, we’re not forecasting a material contribution to revenue from new MoCA service provider deployments for the remainder of 2008. As the launch of new service deployments in mid 2009, we would expect to see modest volumes in Q1 2009 and ramped up volumes in Q2 2009 for these new deployments.

We seek continued progress on new design wins, technical trials by operators, growth in MoCA membership, and a firming up of deployment timelines for at least three tier one service providers in the US market. Base on these revised timelines, we expect a ramp of new MoCA deployment revenue in the first half of 2009 and a continued ramp for the next several years.

The service provider deployment model is an essential part of Entropic’s MoCA business. This is because the killer app for MoCA is its multi-room DVR, and about 90% of the TV homes in the US get their TV programming and their DVRs from its pay TV service providers, either cable, satellite, or telco. In the US, over one-third of pay TV households or about 35 million homes have DVRs, and the Yankee Group forecasts the number of DVR homes in the US will go to 56 million homes by 2011. Once consumers get used to watching TV with a DVR in one room in the house, they want that capability for every TV in the house. In addition, new DVR subscribers and most current DVR customers will upgrade their DVRs as they migrate to HDTV. Today, there are over 40 million homes in the US that have HDTV sets, but only about 10 million homes have subscribed HDTV service. Because of this data, there is a market potential over the next 4 to 5 years of over 200 million MoCA devices just in the US and just for the killer app. This is based on 59 homes x 4 MoCA chips. In an average home for multi-room DVR, there would be 3 MoCA chips for the TVs and one MoCA chip for the broadband connection that provides triple-play service routing. To put this into perspective, based on our first large scale deployment of MoCA with Verizon, Entropic has shipped about 10 million units over the first 2-1/2 years of the deployment.

In addition to multi-room DVR in the US, there are several other applications for MoCA technology. Both D-Link and NetGear have announced Ethernet to local bridges that will be available to retail consumers later this year. Further, there are MoCA opportunities in international markets that we are pursuing.

A large market opportunity like this is bound to attract competition. For the last few quarters, there has been a general concern about MoCA competition and a second source for MoCA entering the market. Specifically, there has been a concern about a competitive solution from Broadcom. Entropic has great respect Broadcom as a company and the connected home entertainment space. Although we take all competitive threats seriously, we think the current vibes regarding a competitive offering overstates the near-term and intermediate-term competitive situation for Entropic. We believe that Broadcom may initially gain a modest market share position in late 2009 or early 2010. We believe that other potential MoCA competition is at least 6 months or a year further behind Broadcom. Entropic continues to work very closely with our OEM customers and service provider partners to define next generation products. We feel confident that our product roadmap is very strong in the MoCA market and will allow us to compete effectively with the competition once they introduce MoCA-enabled chips into the market.

I am sure that all of you share my disappointment about the near-term issues associated with out MoCA sales. At the same time, I’m more optimistic than ever about Entropic’s longer term prospects due to the overall market size, the traction that I see MoCA gaining in the market, and the fact that Entropic is maintaining a substantial lead over competition in the MoCA market. I understand that all of you desire additional evidence and proof points about Entropic’s progress on the next wave of MoCA service provider deployments, and you have my commitment to deliver any news as soon as we are able to disclose it. I can tell you that the behind-the-scenes progress which is evident by the growth in MoCA membership, the demonstration of MoCA-enabled products, the ongoing lab and field trial of MoCA-enabled set-top boxes by a number of tier 1 pay TV service providers is significant.

Now, let’s turn to our DBS outdoor unit business. We continue to be encouraged by our opportunity within the DBS space. We recently expanded our relationship with EchoStar and announced that Entropic’s band translation switch product will be deployed in new EchoStar products available later this year. The ongoing product development collaboration between EchoStar and Entropic is creating technology that improves customer quality, value, and control. Entropic’s BTS chips are already in nearly all of DISH Network’s outdoor unit installs, and these BTS design wins at EchoStar secure our sockets in next-generation outdoor unit installations. DISH Network has about 800,000 gross ads per quarter, and Entropic gets one BTS per DISH install. This does not include the HDTV upgrade potential which can be substantial.

Last week, we announced DIRECTV has expanded their use of our CSS technology. As we discussed in our Q1 results call, DIRECTV launched their MFH2 incorporating their CSS technology late last year targeting multiple dwelling units. More recently, DIRECTV has launched an integrated single wire module or SWM, pronounced swim, for outdoor units for single family installations. This new SWM ODU contains 3 of our CSS chips.

By reducing the number of cables required to support multiple satellite tuners, CSS technology delivers savings to reduce installation costs. Additional benefits of CSS technology include greater customer acceptance, shorter installation times, satellite TV service, and the ability to support easy upgrades to new services without the need for new wires or new truck rolls. These capabilities together with other SWM ODU advantages play a critical role in helping DIRECTV execute its HDTV programming strategy. DIRECTV’s initial focus with their SWM ODU products is in new HDTV installs.

DIRECTV reports nearly 1 million gross additions per quarter, and we believe that about one-third to one-half of the gross adds are new HDTV installs. This represents about 350,000 to 500,000 outdoor units per quarter, which roughly translates to 1 million to 1.5 million CSS chips per quarter once DIRECTV reaches full run rate for HDTV new installs with the SWM ODU. Entropic has an opportunity to expand beyond this initial footprint and increase our penetration rate of CSS products via this ODU in 2009.

In addition to the US satellite TV market, our DBS outdoor unit solutions support global satellite TV applications. Entropic contributed to and is actively working with the standard body and we’ve also been working with Astra to ensure CSS compliance with their single-cable LNB specification. We believe these collaborations will position our CSS solutions to address the needs of European and other international markets. The total international market potential for our DBS products is approximately 7 million outdoor unit installs per year. With an average of two chips per household, that equates to about 14 million units of annual opportunity.

In addition to the overall market potential for BTS and CSS, there is also a MoCA market opportunity from satellite providers for the use of these technologies. An Entropic MoCA-enabled network can coexist on the same piece of cable with BTS or CSS. MoCA is a complementary technology and it offers significant benefits to satellite service providers.

As we look at the competitive landscape for our DBS outdoor unit product line, Entropic sees no near-term or intermediate term competitive threats that meet the price performance points of our CSS solutions. In other areas, Entropic remains focused on driving new deployment of our broadband access technologies in international markets with a specific focus in China. Broadband access revenues are still modest from a company perspective since these volumes are primarily based on large-scale trials but not large-scale deployments. Large-scale deployment timings for broadband access products will likely not be reached until late 2009. We still expect revenue from broadband access products to grow throughout 2009, but we don’t expect it to be a growth driver for the overall company topline until 2010. We still expect our tuner and interconnect products to contribute more materially to revenue in late 2009, and we still see these technologies as important building blocks for future products.

In closing, we are taking action to control operating expenses in the near term to match the realities of our near-term revenue expectations. We are focused on driving additional service provider deployments at MoCA and increasing our market penetration with our DBS outdoor unit products. We remain bullish about the long-term outlook for the industry and for Entropic. We will continue to invest in R&D and design wins which is essential for the longer term prospects of the company.

Now, we’ll open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Tim Luke with Lehman Brothers.

Tim Luke – Lehman Brothers

Just to clarify with respect to your lower revenue expectation, could you just give us some granularity on how you perceive your control of operating expenses and maybe some greater color on what the puts and takes may be for the gross margins going forward? Thank you.

David Lyle

I think there were a couple of different questions there. The first one was related to more color on the revenue. We’re not going to break out the details of it, but the product mix will shift obviously a little bit more towards the DBS outdoor unit product line given the expected ramp in the DIRECTV business for our channel stacking switch products, and in fact that is also driving a little bit of improvement on the gross margins in Q3, and we’re not going to go into details in terms of forecasting Q4 and beyond, so I’ll stick with just that. In terms of operating expense, there is really one main goal, and that’s cost containment. We’re pushing out, for instance, the implementation of our international tax structure which has long-term effective tax rate implications in terms of spending, but we’re still going to make progress on it without spending internally, so we still think that’ll be a positive thing for the company going forward.

Tim Luke – Lehman Brothers

Can you offer some color on how you can moderate…should we expect flattish affects? How do you see that? Are there significant opportunities to lower it and match the revenue break profile?

David Lyle

We kind of bracketed the expectation for revenue in Q4, with kind of not lower than what we’ll do in Q3, probably not higher than what we did in Q2, so we are expecting some improvement in Q3. The level of improvement will really be dependent upon Verizon sell-through and how quickly this inventory position gets worked through. From an internal control standpoint, we definitely are working on it, and we’re going to continue to monitor internally where we think revenues are going to be in Q4, so that we can get to a point where we’re basically break even. That’s what we are going to really try to work towards from a cash flow standpoint, until we start really seeing the revenues grow at a more accelerated rate again. So our primary focus is to really make sure that we preserve our cash while we work through this slowdown in inventory situation with Verizon.

Tim Luke – Lehman Brothers

Lastly, can you just elaborate, Patrick, what you were saying with respect to the revenue growth being oriented towards fiscal 2010 rather than ’09?

Patrick Henry

In the broadband access business, we had two major geographic focus areas that we started with since the beginning of this year, China and Korea, and then during the year, we started getting some deployment and early trial activity in Europe as well. The revenue growth that we really expected to kick in later this year and then throughout 2009 was really focused on Korea and mainland China. Our main OEM partner in Korea has had severe financial difficulties, and that has really hampered out ability to penetrate the Korean market, which probably has been at least a 6-month setback for us. In the Chin market, we are making reasonable progress there, where we’ve got some pretty large scale trials going on over the next couple of months. In order to get the broad-based endorsement within the cable industry there, they want to see more proof points before they go to large scale deployments, so that’s going to slow down the overall revenue growth. We still think it’s a big opportunity for us, but it’s slowing down the ramp of that business. The European market also provides some additional lift for us, but we really didn’t expect much from that from a revenue standpoint until ’09, or really late ’09, but that probably still remains about the same as where it was previously.

Tim Luke – Lehman Brothers

Operator

Our next question will come from Sandy Harrison with Signal Hill.

Sandy Harrison – Signal Hill

Patrick, in your prepared remarks, you had some comments about the competitive environment. Obviously you guys have looked at that. If you could share maybe a little bit more of a lot of the other talks and conversations that’s been had about the competitors as far as where you guys stand and what it is that has created some of that environment, and then just if you could update any other folks that with this market and the opportunity it presented, are there any other folks entering it or becoming added to?

Patrick Henry

I think the main buzz that we’ve heard recently is really related to this competitive solution that is slated from Broadcom. From our competitive analysis and talking to customers, their initial focus appears to be on a chip that would integrate the GPON system-on-a-chip functionality with MoCA. Up to this point, based on our competitive checks with customers, Broadcom still hasn’t delivered an engineering sample, which obviously you need an engineering sample before you can have a commercial sample, before you can have production, and then once that’s delivered, you still have to go through MoCA certification and an operator-based deployment. You have to go through system integration test which is a laboratory testing period with major operators, followed by first office application deployment followed by general availability launch. So, if you look at it end to end in that process, assuming that there were actually engineering samples in the market today, we probably wouldn’t see any market share loss to Broadcom until the very tail end of 2009, and as I just said, there aren’t engineering samples in the market today. Also, the GPON part of the markets for Entropic is only one of six sockets that we have within the Verizon FiOS deployment, and the other deployments that we’re pursuing don’t use GPON. The cable MSOs, the satellite service providers, and even the other telcos in the US don’t use GPON in terms of fiber to the premises. So the overall threat from that particular product is pretty limited in terms of the footprint that it has for revenue in 2010. Ultimately, if Broadcom has MoCA has as a building block, we would expect to share the market with them longer term and maybe avoid more substantial market share loss in late 2010 or 2011, assuming they get the product working here relatively soon.

Sandy Harrison – Signal Hill

What do you think are the advantages of a standalone chip versus an integrated chip, sort of the pluses and minuses, and what are your longer term plans to address the potential for multiple different applications?

Patrick Henry

I’m not going to break out our specific product portfolio, but what I can say from a competitive positioning standpoint, we’re really developing products on three fronts in the MoCA space. One is pure cost reductions of MoCA 1.1 functionality. We’re removing the 65-nm, and that’s kind of our basic next step. We are the incumbent supplier, so our software is already embedded into these products, so there are some built-in switching costs, and we’re partnered with best in breed other system-on-a-chip manufacturers, so in the case of a GPON socket, we’ve partnered with the incumbent GPON suppliers which are BroadLight and Freescale, and then we’re also working with AMC-Sierra on joint reference designs in the event that they penetrate that market, so we’re basically working with the incumbent suppliers where both parts of that socket already have pretty sticky software associated with it.

The next level of things we’re doing is a treadmill of higher performance. We’ve already demonstrated that we’re executing on the treadmill of performance by moving from MoCA 1.0 to MoCA 1.1. We have next generation functionality that we’re developing in products that’s been based on our collaboration with our OEM customers and the service providers.

The third area is we’ve our own products where we’re developing higher levels of integration based on some of the building block technologies that we’ve picked up from some of our acquisitions over the last year and a half, so we’ll see products related to that later this year in terms of announcement and then in production in 2009. So that’s kind of what we’re doing from that standpoint. The rationale for integrating MoCA is that if there was no more innovation available on MoCA and attach rate was near 100%, then it could be cost effectively integrated. I think the premise of MoCA being a standalone and fixed target technology is somewhat questionable.

I also think that we’ve continued to work with the best in breed system-on-a-chip manufacturers on most of these sockets, so it’s not clear that MoCA will be integrated as quickly in some of these products as some people think. The other thing is you’re not talking about one integrated system on a chip. There’s a different system on a chip you would need in GPON versus a cable set-top box that is DVR versus a cable set-top box that is non-DVR versus a satellite set-top box that is DVR versus non-DVR. High-def set-top boxes sometimes have different system on a chip than standard def boxes, so we’re really talking about a number of products where you have to integrate MoCA in order to be able to go after all of the market opportunity that we’re pursuing with our solution.

Operator

Our next question comes from Krishna Shankar with JMP Securities.

Krishna Shankar - JMP Securities

In your outlook for Q3, you had mentioned revenues potentially recovering to the Q2 level, and is that based on Verizon’s re-energizing its promotion activities again, and can you discuss the implications of your OEMs reducing inventory versus Verizon stepping up its promotions, and do you anticipate chip sales to your OEMs picking up in Q4 or is that more from the growth in the satellite TV business.

Patrick Henry

It’s a combination a couple of things. We don’t know what Verizon’s sell-through numbers are going to be until they actually publish them on their earnings call, so our most recent data point is their numbers for Q2. We know that they’re going to really focus their promotional efforts to try to get to a recovery back to their Q1 levels or maybe even better than that, but have some uncertainty around that, so there’s obviously inventory in the channel already. How quickly that inventory gets worked through depends upon how successful they are at selling things, so we believe that Q3 is a bottom for us. How quickly we recover from that bottom is really dependent upon how quickly we work through some of the inventory positions in the MoCA products. We do expect a ramp in the DIRECTV business moving from Q3 to Q4, but that will be insufficient to get back to the Q2 levels of revenue without some robustness in the MoCA business.

Krishna Shankar - JMP Securities

You did mention the pros and cons of integrated versus standalone solutions. It sounds like you’re shipping MoCA 1.1 chips now. When do you anticipate the next set of evolution for the MoCA standard, and when will chips for that category be out in the out in the market?

Patrick Henry

We’ve got products in development today that will be in the market with more enhanced features in the late 2009 timeframe and be in production in 2010. I think most of the 2009 volume will still be MoCA 1.1.

Krishna Shankar - JMP Securities

Taking a step back, Patrick, you did outline some of the longer term growth opportunities both internationally and the uptick of single DVR, with that sort of as a background, given the most likely scenario for one or two more deployments in the second half of ’09, the satellite business ramping up, as you look at calendar ’09, how should we look at the longer term outlook for calendar ’09 in terms of growth or plateauing out or how we should we look at the revenue growth outlook for 2009?

Patrick Henry

We’re really not going to provide guidance beyond the current quarter, and we’re kind of making an exception to give kind of a bracketing of Q4. If you look at the overall market potential, we’ve tried to provide some building block information for you. I think the way to look at it would be for the ramp and for potentially even up to three service providers in the first half of ’09 where they would reach more of a run rate in the second half of ’09, and maybe some additional service providers launching towards the tail end of ’09. We would start seeing some of these single DVR homes converting on a broad scale to multi-room DVR homes. So, we’ve tried to provide as much information as we can, but it’s our policy not to provide guidance beyond the current quarter.

Krishna Shankar - JMP Securities

A question for Dave. You have a nice enhancement in gross margins as the satellite business becomes a bigger portion of revenue. I know you won’t comment on revenue mix going out to Q4, but how should we look at gross margins in Q4 and beyond with Verizon maybe coming back a little bit? Do you anticipate gross margins dipping down to the Q2 level or will there be efficiency as you switch to 65-nm helping gross margins?

David Lyle

We’re going to continue to see it fluctuate in and around our long-term model of 50-52%, until we have multiple new operator deployments which create some more revenue engines for us.

Operator

We take our next question from Gary Mobley with Piper Jaffray

Gary Mobley - Piper Jaffray

It’s a question specific to your channel stacking switches and trying to size up the market opportunity with DIRECTV. Patrick, I think in your prepared remarks you identified maybe 350 outdoor units per quarter being installed by DIRECTV in new HD installs as you termed it. Does that translate to then about $6 million per quarter in potential revenue for Entropic, and then as well I’m wondering if that number includes HD upgrades.

Patrick Henry

We will break out the specific ASP for those products, and I think the way we’ve kind of talked about it historically is that these products end up being in kind of mid to high single-digit range, and we would get three chips per outdoor unit, so if we’re in the 350,000 to 500,000 outdoor unit range, that will translate roughly into between 1 million and 1.5 million outdoor units times three (the three chips that are already included in those numbers) on a quarterly basis. So you kind of get the basic idea there. That number does not include HD upgrades or DVR upgrades. That’s just HD new installs, so there is potential beyond HD new installs. DIRECTV has not made a commitment beyond HD new installs at this point, but they are doing the economic analysis around that, and we believe that there could be potential for us in the SWM ODU in 2009 and beyond the HD new install market.

Gary Mobley - Piper Jaffray

Specific to the new HD installs, when would you expect your tie ratio for the CSS products approach 100% for every new DIRECTV HD subscriber?

Patrick Henry

We don’t have a specific timeline on that. We think it’s probably going to take a couple of quarters, so as we get into Q1, we’ll probably be close to the penetration rate for HD new installs that would get us to the levels that we’re talking about. At that point in time, there could be continued growth based on attach rates and penetrating other parts of the DIRECTV footprint.

Operator

Our next question comes from John Pitzer with Credit Suisse

John Pitzer - Credit Suisse

As we try to make our own assessments on the length of the inventory workdown at MoCA, with the Q3 revenue down about $12 to $13 million sequentially, given the ramp in the DBS revenue, is it safe to assume that MoCA is down mid to high teens sequentially, or is it more than that?

Patrick Henry

We really can’t break it out to that level. We’ve tried to give enough information though. If you look at Verizon’s sell-through numbers in Q1 and the fact that Verizon would carry ordinary revenue levels, maybe even a little bit higher than ordinary revenue levels assuming you had a ramp in business off of the Q1 numbers and then the significant drop that they had into Q2, you can kind of get an idea of the order of magnitude of the inventory that’s out there.

John Pitzer - Credit Suisse

Patrick, I know that it’s difficult until we figure out what the new adds are for Verizon in Q3, but if they start to approach sort of the Q1 adds in Q3, is it your expectation that this is a one-quarter inventory workdown for you, so that they’ll be some sequential growth in MoCA in Q4, or are you assuming all the growth is coming from DBS again in Q4?

Patrick Henry

We are projecting even on the top end of the bracket for Q4 growth over Q2, so we basically are showing more of a recovery to Q2 as the best case scenario, so we think it really is a two-quarter issue even after we get run rates returning back to normal.

John Pitzer - Credit Suisse

But to be sure, there is sequential growth expected from Q3 to Q4 in MoCA?

Patrick Henry

Correct.

John Pitzer - Credit Suisse

And then my last question is as you try to diversify and bring on other service providers besides Verizon, again the target has been sort of a moving target. I’m just kind of curious from your perspective why you think the adoption rate hasn’t been faster outside of Verizon? Is it technical? Is it economic? What’s your view there?

Patrick Henry

I think it’s a combination of factors and it varies service provider to service provider. I think there’s a general concern about CapEx in certain segments of the industry and especially in the current economic environment, so there’s some cautiousness there. I think there’s been some technical delays not related to us in a couple of the service provider deployments, and then we’ve got some other things where things are done more serially instead of being more in a parallel fashion in terms of new technology initiatives with other operators. So, I don’t think there is one thing I can pinpoint across the operator base. What I do see is that there’s continued momentum and focus on getting this stuff deployed by the operators, at least the two to three that we think will launch in early 2009. So that’s kind of where we are at today.

John Pitzer - Credit Suisse

Patrick, at what point do you worry that the new service providers not launching opens up a window of opportunity for Broadcom and competition?

Patrick Henry

That’s actually a much more significant concern of ours. When we were doing the IPO roadshow, our belief was that potentially Broadcom competition was imminent, and now we’re sitting in kind of early August, and we still haven’t seen an engineering sample, so we believe that we’re in good shape for 2009, and we are continuing to work with our customers on designs that would be really deployed in production in 2010 over the next, say, 6 months to 9 months. So, we think that we’re extending our lead over competition, not to underestimate the potential of competition, but we’re continuing to focus on innovating and introducing new products to the market, and up to this point at least, we haven’t seen a real silicon from the competitors yet.

Operator

Our next question comes from with Aalok Shaw with D.A. Davidson.

Aalok Shaw – D.A. Davidson

Patrick, talking about the cable timings, you addressed them in your prepared remarks that the cable service providers are delaying their MoCA rollouts. I’m curious from your discussions with people there, does the Cable Vision decision with their lawsuit have anything to do with it? Is it just maybe they are waiting to see what time network-based DVRs are going to roll out and what the likelihood of that could be, or is it something maybe that’s causing them to be a little bit more cautious in terms of their MoCA deployment at this point?

Patrick Henry

I don’t think we can make a specific generalized comment about all cable as a service because I think there are different views within the MSO community around remote storage DVR versus in-home DVR, so I think the service providers that are proponents of in-home DVR continue to see MoCA for multi-room DVR as being important although they have got other technology initiatives that they are working on as well, but MoCA continues to be an important initiative. The other thing is even with remote storage DVR, there are still important applications for service providers for MoCA within the home around personal content sharing and triple-play service routing, so even with the ones that are more lenient towards the remote storage DVR model, we think there are still pretty significant MoCA opportunities, although a little bit more delayed than the folks that are focused on the in-home DVR portion of the market.

Aalok Shaw – D.A. Davidson

Is it fair to fair to say that there is no cable MSO at this point doing any trial activity with MoCA?

Patrick Henry

I can’t really comment specifically on that. I would violate our NDAs.

Aalok Shaw – D.A. Davidson

Earlier on, I guess we were all expecting to have at least some kind of deployment activity by the end of this year, and you said that’s pushed out to next year from a deployment standpoint, but from your discussions, I guess the bottom line question is is MoCA still relevant with the cable MSOs or are they starting to look at alternatives?

Patrick Henry

I believe MoCA is still well known with the cable MSOs in general, and there are some specific MSOs that are more bullish and more aggressive about deployment than others.

Operator

We take our final question from Eric Rasmussen with Roth Capital Partners.

Eric Rasmussen – Roth Capital Partners

Just quickly on the numbers, you talked about obviously the weakness going into Q3 and then tried to give us some guidance for Q4. You see a non-GAAP loss of $0.03 in Q3. When do you expect maybe to get to a breakeven again and when we can start to see the bottomline back into positive territory?

David Lyle

We’re not going to guide past what we’ve given you, but what we can tell you is that we’re going to be monitoring or at least maintaining our OpEx to some reasonable levels, and as Patrick said, we should start seeing growth again back in the first half of ’09, so I think it would be reasonable sometime in that period.

Eric Rasmussen – Roth Capital Partners

We’ve talked about the service provider market and maybe some pushout there. It seems like in Q1 of ’09, we might start to see some modest volumes. What do you think though that could change the minds of service providers or maybe lead to some sort of pulling of a surprise maybe into the fourth quarter that maybe you’re just not seeing today? Is there anything?

Patrick Henry

I don’t think there would be a pulling of deployments into calendar ’08. There could be some modest volumes in Q4 ’08 if there is a pull-in into the earlier part of ’09 versus more of the Q2 ’09 or middle of ’09, but from where we sit today with the current situation with the company, I think we would guide you guys to treat that as upside surprise as opposed to trying to bake anything of that into your model, but we really have to focus on, from a company standpoint, is controlling our costs right now, making sure we get our new products out, getting the new design wins into production as quickly as possible, and we can’t necessarily accelerate operator deployments, but we can make sure we support them in a way that gets them to market as quickly as they can based on their timelines.

Operator

That would conclude our question-and-answer session.

Patrick Henry

To summarize our call today, we are taking action to control our operating expenses in the near term to match the realities of our near-term revenue expectations. We are focused on driving additional service provider deployments to MoCA and increasing our penetration rates with our DBS outdoor unit products. We remain bullish about the long-term outlook for the industry and for Entropic. We continue to invest in R&D and design wins which is essential for the longer term prospect of the company. I want to close by thanking all of you for your time today. We look forward to updating you on our progress on our next call.

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