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Entropic Communications, Inc. (NASDAQ:ENTR)

Q3 2012 Earnings Call

October 24, 2012; 04:30 p.m. ET

Executives

Patrick Henry - President & Chief Executive Officer

Dave Lyle - Chief Financial Officer

Debra Hart - Director of Investor Relations

Analysts

Ruben Roy - Mizuho Securities

Aalok Shah - D. A. Davidson

Anthony Stoss - Craig-Hallum

Sandy Harrison - Wunderlich

Krishna Shankar - Roth Capital

Gary Mobley - The Benchmark Company

Chris (ph) - Barclays

Tore Svanberg - Stifel Nicolaus

Rajvindra Gill - Needham & Company

Alex Gauna - JMP Securities

Ryan Carver - Credit Suisse

Operator

Good afternoon ladies and gentlemen. Welcome to the third quarter 2012, Entropic Communications Incorporated earnings conference call. My name is Chris and I will be your conference moderator for today.

Presently all participants are in a listen-only mode. Later we will facilitate a question-and-answer session. (Operator Instructions).

And at this time I would now like to turn the conference over to your presenter for today, Ms. Debbie Hart. Ma’am, you may proceed.

Debra Hart

Thank you Chris 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 third quarter 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 two for the periods reported in the release. We’ve also posted a schedule on the Investor section of our website, which includes our quarterly reconciliation of our GAAP to non-GAAP gross margins, operating expenses and taxes.

During this conference call we will make forward-looking statements regarding future events and anticipated operating or financial results of the company. Actual events or results could materially differ from those projected in the forward-looking statements. Please refer to our SoC filings, including our most recent 10-K and 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 the future events or circumstances.

And now it’s my pleasure to introduce Patrick Henry.

Patrick Henry

Thank you Debbie and thanks to everyone for joining the call today. We had record quarterly revenue in Q3 of $89.8 million, up 8% sequentially, both connectivity and set-top box SoC group showed revenue growth in the quarter. We delivered upside to revenue, net income and earnings per share and we see our product cycle momentum continuing into Q4. All in all it was a solid quarter.

I’ll provide some commentary before the turning the call over to Dave, who will review the specifics of the Q3 numbers and provide guidance for the fourth quarter. Then I’ll provide some closing comments before opening the call for your questions.

From an organizational standpoint we recently made an addition to our executive team. I am pleased to welcome Vahid Manian, our new Senior Vice President of Global Operations. With the acquisition of the set-top box SoC assets, the scale of scope of our global operations function has expanded significantly. We will benefit from Vahid more than 25 years of semi-conductor experience and bringing in a broad product line of high volume, complex silicon solutions to market cost effectively.

We also extended our Board of Directors by adding Bill Bock as an independent Director and member of our audit committee. Bill has a wealth of corporate leadership and board experience that should prove invaluable for both the Entropic board and our management team. He also brings semi-conductor industry expertise, having most recently served as CFO of Silicon Labs.

Moving to the business highlights, the integration of the set-top box SoC business is going extremely well. The supply issues we faced with the set-top box product line at the time of the acquisition have now been fully resolved. Our new SVP of Sales kicked off our sales team integration efforts for sharper focus on customers; our IC systems are now all running on the Entropic network; we completed the transition from NXPs enterprise resource planning system for set-top box SoCs and we continue to rationalize and optimize our supply chain.

We’ve also made substantial progress on aligning our product plans and now have a unified product road map for our customers that include our set-top box SoCs and connectivity products. I am very pleased with our integration progress so far.

Traffic has an expanding addressable market and we are benefiting from several service provider trends that should drive additional demand for our products. First, let me address the HD penetration and upgrade trend. HD penetration continued to increase both in the US and worldwide. IMS Research shows that the number of homes in the U.S. with at least one HD set-top box is around 57 million homes today, potentially growing over 92 million homes by 2015, and consumers are also adding second and third room HD TV sets as the cost of HD TVs decline. So nearly all new HD set-top boxes shipped in the U.S. include MoCA as the standard installation model for HD TV servers. The MoCA market opportunity grows as HD penetration increases.

In addition to new HD service installs, we see pent-up demand for existing HD TV subscribers with all the HD equipment to upgrade to advanced services enabled by MoCA. Advanced services include multi-room DVR and over the top video streaming to multiple devices in the home.

Shifting to the second trend, which benefits both our connectivity and SoC businesses, we are seeing many Pay-TV service providers adding IT based video streaming services with increased in-home connectivity to their offerings. With this move from Pay-TV, operators can bring new video services to market quickly, allowing for increases in average revenue per subscriber.

Initially the transition to IT is expected to center on gateways with muti-room DVR functionality network with IT clients. Our products are very well positioned to support this trend and we are in several of those new generation gateways now being deployed and clearly Liberty Global’s Horizon gateway, DirecTV’s HR34 or Genie and Comcast Xfinity X1 gateway.

Following the launch to the gateway solution, service providers will launch IP clients. As you may recall, a key part of our vision is to focus on IP client devices with our set-top box SoC product line. We estimate there could be as many as three IP clients deploying on average with each gateway device, yielding a strong long-term opportunity. We are certified and qualified support for security, traditional access systems and video decoding on our SoC solutions to meet global broadcasters requirements.

For example, we’ve already announced that our SoC and MoCA silicon solutions will be integrated with the Comcast RDK, to provide manufacturers an opportunity to quickly develop and commercialize IP client set-top boxes. Time Warner cable and other Tier 1 cable service providers have a similar strategy to Comcast and we expect to be a major supplier into the client devices for the IP video transition, especially as the market moves to MoCA 2.

In addition, we believe the deployment of high definition digital terminal adaptors or HD DTAs go hand in hand with the transition to IP video service delivery. Here in the U.S. Comcast, Time Warner cable and other cable MSOs are converting to digital platforms and multiple regions, turning off their analog TV servers. This strategy allows cable MSOs to reclaim analog bandwidth, which the cable MSOs can then use to launch new digital services, such as higher speed data services and new HD TV channels.

Our SoCs are currently ramping with leading OEMs supporting Tier 1 MSO HD DTA deployment and we are seeing initial ramp contributing to our revenue. This is one example of where Entropic is gaining market share in the set-top box SoC market.

Finally, the move from going from analog to digital globally has opened up new opportunities for us. Outside of North America there is a clear movement from analog to digital, as well as from standard definition to High Definition set-top boxes. We are seeing great momentum in Latin America and Eastern Europe for our silicon solutions. We are also seeing an increase for our technology in India for support of the analog sensor transition and in China for the next generation broadband initiative.

With today’s Pay-TV industry transforming, we are in a unique position with a focus product portfolio to capitalize on these exciting market opportunities.

Now Dave will review the third quarter results and provide our Q4 outlook. Dave.

David Lyle

Thanks Patrick. Third quarter revenue was $89.8 million, an 8% sequential increase and above the high end of our previous guidance range of $89 million. Both connectivity and set-top box SoC products contributed about equally to the revenue growth.

We had two customers who accounted for greater than 10% of our revenue during the quarter, WNC at 20% and Motorola at 12%. We supply WNC our MoCA and analog CSS products in support of the DirecTV deployment and MoCA into ODUs for Horizons LTE deployment. We supply Motorola our set-top box SoCs and MoCA products for cable and telecom service providers.

Our non-GAAP gross margin in Q3 was 51.5%. Excluded from Q3 non-GAAP gross margin was about $200,000 in stock based compensation expense and $2 million of amortization of purchased intangibles. Non-GAAP operating expense was as expected at $36.6 million.

Our non-GAAP operating expense excluded $4 million of stock based compensation expense, approximately $200,000 of transaction and integration costs associated with the set-top box SoC acquisition and $900,000 of amortization of purchased intangibles. Our non-GAAP operating margin came in at 11% in Q3.

Net interest income was about $300,000 for the quarter. Our Q3 non-GAAP results exclude charges of approximately $1 million relating to the fair value accounting treatment associated with our investment in privately held Zenverge of $800,000, and our acquisition of assets from PLX of approximately $200,000.

Our third quarter non-GAAP tax rate was 22%. Our GAAP tax rate for Q3 was 74%, well above the statutory rate, due mainly to an update in our tax provision estimates. The total tax provision estimate changes are only $400,000, but at large relative to our pre tax GAAP net income of about $1.6 million.

Non-GAAP net income was $7.8 million, resulting in earnings per share of $0.09, based on a fully diluted weighted-average share count of about 90.9 million shares. GAAP net income in the third quarter was about $400,000, and we were breakeven on a GAAP EPS basis.

With regard to our cash position, cash and investments were about $166 million at the end of Q3, a net cash increase of about $5 million. During the quarter we generated approximately $10 million of cash from our business operations. DSOs for the third quarter came in with solid 37 days. Inventory turns were about 4.4 times.

Now I’d like to provide our guidance for the fourth quarter of 2012.

In Q4, we expect Entropic’s top line revenue to be in the range of $89 million to $92 million, the mid point being a slight increase over Q3, with sequential growth expected primarily from our set-top box SoC products. Growing demand from new set-top box SoC design wins such as an HD DTA, are outpacing declines in our set-top box SoC products. We also see incremental demand coming from connectivity products internationally.

Moving on to gross margin, we expect non-GAAP gross margin for Q4 to be in the range of 50% to 51%. The expected decline in gross margin from 51.5% in Q3 is primarily due to a slight shift in product mix, as well as a production level take out cost for our high volume part, in connection with our overall product cost reduction effort. We will exclude from Q4 non-GAAP gross margin about $200,000 in stock-based compensation expense and $2.3 million in amortization of purchased intangibles.

We expect Q4 non-GAAP operating expense to be about $36.5 million, approximately flat with Q3. Our non-GAAP operating expenses will exclude $4 million of stock-based compensation expense and $1 million of amortization of purchased intangibles.

We expect interest income to be about $300,000. Our Q4 non-GAAP results will exclude a charge of approximately $1 million relating to the fair value accounting treatment associated with the investment in Zenverge and our acquisition of assets from PLX.

Our non-GAAP tax rate in Q4 will be about 22%, resulting in an annual tax rate of 20% for 2012. Our GAAP tax rate will be about 55% for Q4. Non-GAAP net income in Q4 is expected to be about $7.4 million at the midpoint of guidance, resulting in earnings per share of $0.08, based on a fully diluted weighted-average share count of about 91 million shares. GAAP net income is expected to be about $400,000, so we should be breakeven on a GAAP EPS basis.

We expect our cash and investments balance at the end of the fourth quarter to be about $175 million or $1.92 per share. We expect DSOs to be about 40 days and we expect inventory turns to be five times in Q4.

Looking out into 2013, we remain optimistic about our prospects for growth. Although we only provide guidance one quarter out, we thought it would be valuable to share some of our expectations for 2013.

With supply constraints now behind us and pressure from legacy set-top box SoC products slowing down this year, we believe set-top box SoC product revenue is at a new baseline for growth, with revenue stabilizing in the mid-20s in millions of dollars.

For our connectivity products, as HD penetration and upgrades, as well as international market expansion continue, we expect to more than offset share loss throughout 2013.

From a financial perspective in 2013, we expect that revenue growth from the set-top box SoC products will outpace revenue growth from connectivity products, which will put modest pressure on our gross margins.

We expect gross margins to stay around 50% throughout 2013, but could dip further into the high 40s if set-top box SoC revenue ramps more aggressively than planned. We will maintain our expense discipline and expect only low single digit percentage increases in OpEx per quarter on average. However there could be material fluctuations in quarter-to-quarter operating expense related to variable items like deep sub micron take out costs.

We expect our non-GAAP tax rate in 2013 to be about 20%. We expect to continue to add cash to the balance sheet throughout 2013. We believe we are still on track to hit our long-term model for operating margins of 18% to 20% by Q4 2014.

So now I’d like to turn it back to Patrick for some closing remarks.

Patrick Henry

Thanks Dave. As a broader platform company with world class SoC and connectivity products, we are strongly positioned to support the trends that are driving the connected home-entertainment market. We require the set-top box SoC and digital CFS assets to expand the reach of our connectivity products and all service providers more fully monetize home-entertainment.

We see new operatings such as HD DTA products ramping at Tier 1 cable MSOs as they expand their analog reclamation projects. This HD DTA ramp, as well as the launch of new IP clients for the transition of IP video delivery and increases in HD adoption internationally, should drive growth for our set-top box SoC products throughout 2013.

In connectivity we expect increases in HD penetration rates and upgrades, as well as international adoption that continue to provide growth for our connectivity products globally throughout 2013. We believe our strategy is playing out as planned, our platform technology approach is built on open standards and market leading silicon and software solutions that view our OEM and Pay-TV operators business.

We believe we implemented the right long term strategy and assembled the right team for our success. This coupled with the focused product road map will enable us to capitalize on the multi billion connected home-entertainment market and win new designs globally with both our bundled and discreet solutions.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Ruben Roy with Mizuho Securities. You may proceed sir.

Ruben Roy - Mizuho Securities

Thank you. Patrick, I was wondering if you could give us a little more detail, and thanks for all the detail around 2013, but on the set-top box business specifically, in terms of what your calling legacy, I’m just wondering, it sounds like the pressure, the legacy pressure is slowing down and you’ve got this baseline that your working with.

But are there new designs going into, I guess I want to call them kind of higher end set-top boxes with some of the SoCs that came over or do you expect as you look into maybe the second half of 2013 and beyond, do you think that the growth really for that business will turn over to DTAs.

Patrick Henry

Yes, thanks Ruben. I think it’s a combination of both. We are seeing design wins with DTAs already starting to ramp into production, but some of those same products are used in international cable opportunities, which the DTA and the U.S. market, which doesn’t have separable securities. Its like a normal non-DVR set-top box in the international market, so we are seeing some of those same products ramping in international, including both Asia and specifically in China. In Korea and Latin America we also have some opportunities as well.

Also winning design wins on IT based clients and some of those we’ve talked about. Comcast RDK as an example of something that we are focused on as a key target. So we got a number of different things that we are doing along those fronts and it will be a combination of things, not just HD DTAs.

Ruben Roy - Mizuho Securities

Thanks Patrick. What are the discussions like when you go in and kind of pitch the DTA products? Is it a discussion around price or is it a new supplier, technology, how are you winning in this market?

Patrick Henry

Well, those design wins really occurred a while ago and now they are ramping into production. So I think the key effort that was underway there is a desire for alternate sources to the incumbent that was doing traditional standard HD DTAs. We tried and did win a small amount of universal DTA business for standard up and I think our market share in HD DTA was going to be substantially higher. So it was really based on having an alternative to the incumbent supplier on our standard there.

Ruben Roy - Mizuho Securities

Great, and then just finally Patrick, it sounds like you guys have thought about market share on the connectivity side. Can you give us an update as to what you’re thinking in terms of market share exiting 2012 and then for 2013 please? Thank you.

Patrick Henry

Yes, so in MoCA specifically, we think that we are somewhere between 50% and 60% market share globally in MoCA and that includes both integrated and discreet. We think it kind of stabilizes in the 50% range. So we’ll probably see some incremental market share loss in 2013, especially in the North America market.

A lot of that will depend upon how robust the upgrade market is, where discreet MoCA adaptors continue to be used in a big way and retail MoCA is starting to take off as well with MoCA penetration in the U.S. now in the high teens, as far as household penetration. So actually a lot of interest around that as well.

So hard to call it exactly, but its in those kind of ranges and its not like after business our market share is much higher than that.

Ruben Roy - Mizuho Securities

Great. Thanks very much Patrick.

Patrick Henry

Sure. Thanks Ruben.

Operator

And the next question comes from the line of Aalok Shah with D. A. Davidson; you may proceed.

Aalok Shah - D. A. Davidson

Hi Patrick, Dave and Debbie; a couple of quick questions. Last night one of your competitors talked about MoCA and how they are never seeing up tick for their MoCA enabled boxes. I’m curious, have you guys seen any kind of major shifts in share in the last quarter that we should make note of right now or is there something out there that maybe going on unusual in the quarter.

And then secondly I guess, in terms of the DTA transition, I know you just spoke a little bit about it, but I’m curious, if we look into 2013 and beyond, do you think there’s an opportunity in international markets for the DTA markets that were left for you guys.

Patrick Henry

Yes, thanks Aalok. On the market share question, I think that specific comment was kind of a forex increase over the last year and MoCA attached rate and that’s really driven by a couple of different factors. One is among the HD and the fact that they are operating off a very small base a year ago. But in terms of overall market share, it’s about what we would have expected.

Probably the biggest up tick in the market share is really related to the EchoStar, Hopper and Joey which is the club by DISH Network, where they have significant presence in that and that really didn’t start to wrap until Q2, Q3 this year. So things are about as expected from the overall global market share in MoCA that what we thought would be historically.

In terms of HD-DTAs and the international market, the same types of boxes are used for HD-DTAs in the U.S. market. It can be used in international markets, Latin America, China, areas like that as just standard non-DVR step-up boxes. So we do see an opportunity that’s very large for our products in the international cable market. Well across the board we see things in Eastern Europe, we see opportunities in Latin America, we see opportunities in Asia.

Aalok Shah - D. A. Davidson

Patrice, is there a timeline you think we should be thinking about that international opportunity for DTA?

Patrick Henry

We are winning designs now. We actually ramped some designs already. We have some pretty significant android-based designs, which are hybrid boxes that support both IP streaming, as well as traditional broadcast in Korea. We have a pipeline of designs in Mainland China, we have some opportunities that are not ramping in volume yet, but they are already in the design pipeline for Latin America and Eastern Europe as well.

In addition to that, we are seeing a ramp in India around analog sunset, which is more of a move from analog to digital, so most of that is standard up today, not hideouts, so it’s a different set of products than what we are doing with HD-DTAs, but that’s also a growth driver for us.

Aalok Shah - D. A. Davidson

And then do you expect your margin profile to improve as we start to see some of these more hybrid type boxes or are these still older legacy Trident SoCs still that are being shipped today.

Patrick Henry

Well just at the corporate level, the gross margin on the business we acquired are substantial lower, so if that business ramps, it will put some pressure on corporate gross margins.

I think our peak was like a 55 or 56. As Dave guided we’re kind of trending towards the 50 range or may be even dipping in the high 40s depending upon how fast the setup box business ramps. But we are doing a lot of things across the board on our product line and specifically on the SoC product line to improve gross margins going forward.

Yes, probably it does in different initiatives under way. Some of those deliver short-term results. The things that deliver an even bigger bang for the buck are new products. Some of those new products are already ramping into production early next year and then we’ve got other new products that will be ramping their productions in later 2013 and then ‘14.

Aalok Shah - D. A. Davidson

That’s great. Thank you so much.

Patrick Henry

Sure thanks a lot.

Operator

Our next question comes from the line of Anthony Stoss with Craig-Hallum. You may proceed.

Anthony Stoss - Craig-Hallum

Hey guys. Two parts at Patrice; can you talk about – you mentioned your integration was tried and can you talk about from the product standpoint how far long you are, what you expect in terms of the timeframe for integrated products that with MoCA.

And also on MoCA 2, I know you talked about it. Can you give us a sense of kind of design activity and when you think we might start to see some revenue being bought from MoCA 2. Thanks.

Patrick Henry

Sure. Thanks Tony. In terms of integration with Trident, the overall corporate integration is going very well. We don’t have solutions SoCs with innovative MoCA today, so we have a bundling strategy and we’ve actually won some pretty substantial new designs selling our discreet MoCA along side the SoC products that we acquired with Trident. Those aren’t ramping the product yet, but we’ll see those ramping the production by mid-2013.

In terms of products that actually have MoCA integrated into the SoCs. We’ll see initial products sampling last 2013 and really ramping into product with operators and with OEM customer probably around mid-2014.

In terms of MoCA 2, we won substantial new designs. Most of the new design activity that is ongoing is around MoCA 2.0, not MoCA 1.1 anymore. Its still very small volume. We probably won’t see too much in terms of volume ramps with operators until kind of Q2 of next year, maybe a little bit in Q1, but primarily in Q2 and then ramping from that point forward.

Operator

And our next question comes from the line of Sandy Harrison with Wunderlich. You may proceed.

Sandy Harrison – Wunderlich

Thanks, good afternoon guys. So I appreciate the comments and sort of your thoughts of market share and others in the prepared remarkets Patrick, but if you can maybe take a second and look at the market where we are today, the market size, and how does that look on what you guys are looking like and expecting versus sort of where your market share, in other words is it a same size piece of the same size pie or is its a same size piece of a bigger or smaller pie.

Patrick Henry

In terms of the overall global market for connected home-entertainment that we are selling into, our serviced available market and not the total available market, but the part that we actually have products for; it’s about a $2.4 billion market. It’s growing about $3.5 billion over the next years. We are on a revenue run rate, around $90 million, so obviously we are not a huge market share player today.

We have very high market share in the outdoor unit business. We are the market leader in the MoCA business and we’re the number three guy globally and number two in the U.S. in the SoC business, although we’re a smaller player.

So I think that from that base the real opportunity for growth for us is in all three of those market opportunities, but especially in SoCs where we can not only grow with the market, but we can grow our market share. And we are already seeing us taking market share today and we see a pipeline of new designs where I think we’ll continue to take market share over these coming years.

Sandy Harrison – Wunderlich

And then sort of looking at some of the technologies our there, you talked a little bit about a number of the android opportunities that you’ve gotten wins in and my understand is that the arm based platforms might be a little more easily developed than the mid space platforms that you compete against. Are you seeing that playing field being leveled or is that still on the advantage as far as having an arm versus some of the competitive nips in other technologies.

Patrick Henry

I think generally in the SoC business, we’re used to both nips and arm, nips in our MoCA products, but more for a embedded processor. From an open application processor standpoint, we do used an arm-based architecture in our SoCs and we see the fact that we’ve used arm, we use open geographic and we are very open standards base.

It has been a big advantage to winning new designs really across the board and even in the case of like Comcast RDK, that’s a move by Comcast from more of a proprietary approach, more than an open standards based approach and I think that’s going to be a global trend and I think we have a very strong competitive position to continue to win business both in the non-DVR set-up box market, as well as in the IT client business.

The other trend that we are really seeing there is that digital rights management is moving more to a trend towards traditional conditional access systems in terms of the way they manage keys and security. So all the things that we’ve done historically in our traditional broadcast business has a big advantage even as you move to IP streaming and IT clients.

So I think its really us, the major competitor in this market that has the strongest position to move forward and not only traditional broadcast, but also in IP clients and that goes with android, as well as other subsets of android and HTML5 and all the different trends that are going on right now.

Sandy Harrison – Wunderlich

Got you, and then last one from me, your comments about your most likely to have more success in the IP homes selling in the clients and with the clients sort of at a three to one advantage over the gateway device, yes and then the gateway device many of the processor winners don’t posses MoCA technology. So if you looked at that gateway in areas where you are seeing processors players win, who are the ones that you are seeing more successful and how are your relationships with them.

Patrick Henry

Yes, so in the gateway market there’s only two approaches. One is more of a DVR set-up box type of thing, a video service and the other one is more of what we call a headless gateway, which doesn’t have a set-up box functionally, just has the broadband functionality.

We are dealing with a number of different broadband partners, the biggest of which in the cable world is Intel with their dox and stuff that they brought from TI a few years ago. So that’s our primary client on video. Our primary partner on Dox is we are not seeing too much opportunity in DSO upon which is the Horizon deployment, there’s a number of different partners we are working with there.

Also kind of as you move into kind of more of the router, a broadband home router market, we are partnered with guys like Haviam (ph) and Marvell, as well as WiFi suppliers like Qualcomm Atheros. So there are a variety of different partners there.

One of the things that we’ve done in the gateway side, whether its headed or headless is our partnership with Zenverge, where they are doing the trans county component and we are doing the MoCA component. So we are one business alongside of Intel and others with that kind of co-processor strategy and we think that’s going to play out for us.

Well we do have silicon contribution that we make in the gateways, but the bigger opportunity for us, both in terms of volume as well as having more of the complete solution is on non-DVR set-up boxes and on IP clients, which is where we are going to leverage our SoC business.

Sandy Harrison – Wunderlich

Great. Thanks for taking my questions.

Patrick Henry

Sure, thanks Sandy.

Operator

Our next question comes from the line of Krishna Shankar with Roth Capital. You may proceed.

Krishna Shankar - Roth Capital

Yes, congratulations on the solid Q3 results. Can you talk about, you mentioned again the MoCA market share that you have versus (inaudible). Can you repeat your kind of current market share trends in MoCA?

Dave Lyle

Yes we think our market share is kind of in the 50% to 60% range and that’s versus all other competitors, Broadcom being the largest and where they are primarily taking share in is areas where they’ve integrated MoCA into their SoCs.

We feel like we can fight back over time with that and now that we have our own SoC business, we already winning business today with the bundled strategy and we think as we have integrated solution going into next year, ramping into production in 2014, we’ll be able to rally back from that standpoint as well.

Krishna Shankar - Roth Capital

Okay and then can you comment on inventory levels in your setup customer and the distribution challenge and what do you see in terms of U.S. versus international strength for your products?

Patrick Henry

Yes, I mean in the kind of tough macro that we are in, I think inventories have been kept relatively lien. Earlier this year there was a pretty significant up-tick in the U.S. market around HD attach rates and upgrades, which did cause inventory fill that occurred, really starting in Q2, but primarily in Q3. That’s pretty much done now, so the inventory levels that are out there are probably at the right levels to support exiting run rate demand business. But we don’t feel like there is a massive over inventory position. We feel that they are about right.

Dave, do you have any other comments on that?

Dave Lyle

I agree. They defiantly were leaner near the beginning of the year and I think they are at the right level today given the demand that we are seeing.

Krishna Shankar - Roth Capital

And then international versus domestic, demand trends that you see both on the satellite and the cabal telco side.

Patrick Henry

Yes, I mean from a connectivity standpoint, still probably north of 90% of our business is U.S. from an end market perspective, and our SoC business a little more balanced, probably 50/50 international to domestic and yes, the international markets are relatively the same position in terms of inventories.

Krishna Shankar - Roth Capital

Okay. And then Dave now that you are making good progress and sort of fining up on the supply chain bottleneck and integrating the acquisition. Can you talk about your margin targets and whether they have changed in any way looking out 12 months?

Dave Lyle

Well, on the gross margin front in 2013, in some of the prepared remarks we are saying that we think we are gong to be kind of around the 50% gross margin range. That could dip into the high 40s if we see a more aggressive up-tick in demand for our set-top box SoC products during that timeframe, because it has a lower gross margin profile.

In general though, in terms of moving up our setup box SoC gross margins, we’ve done a lot of work there, made a lot of progress on both the kind of short term targets, as well as our longer term targets.

Krishna Shankar - Roth Capital

And your OpEx cost structure is kind of stabilized now. Any other major changes going forward?

Dave Lyle

No. I think we are at a pretty good level at OpEx. We are going to probably grow into 2013 as we invest incrementally on average per quarter next year. There maybe some fluctuations with your typical take-out type of expenses. But we feel pretty about maintaining some good expense discipline going to into 2013.

Krishna Shankar - Roth Capital

Okay, thank you

Patrick Henry

Thanks Krishna.

Operator

The next question comes from the line of Gary Mobley. You may proceed.

Gary Mobley - The Benchmark Company

Hi Guys, hi Deb. I was hoping to delve a little bit deeper into your comments regarding growth in the connectivity market, more than offsetting share loss in 2013. And I’m assuming that your comments regarding the $25 million per quarter for the set-top boxes SoC businesses is kind of shaping your fourth quarter guidance and connectivity is collectively $65 million in the quarter.

Should we expect a seasonal dip as normal in the connectivity business? Is any seasonality in the set-up box considered for first quarter and then should we then assume based on your comments that we can grow off of the first quarter base and post a new level of quarterly revenue for the connectivity business you progress through 2013.

Patrick Henry

Yes, that’s quite a few questions Gary, but I’ll try to handle all of them. The first one I think was about growth in our connectivity business. Look at the puts and takes, the main growth engines there are going to be continued increases in HD attached rate and upgrades globally, but especially in the U.S. markets and such where most of the business is today and that as well as international expansion.

We are seeing our new designs for the ODU business, for MoCA, as well as for broadband access ramping throughout 2013 from an international standpoint. U.S. market, I think if the market growth is really going to be dependant upon how much more of an up-tick we get in HD attach rates, which I think there is still room there and then there is also upgrades.

So the headwinds that we’ll get will be with market share loss, but we are kind of in a level where we are more status quo I think. We are below 60, probably still about 50. I think we’ll probably stay in kind of the 50 range, kind of going forward, and then maybe have the ability to build some of that back up as we get both bundled solutions, as well as integrated products around our SoC product line.

If you look at our overall business, both our SoC products and our connectivity products are sold into the same market. So the seasonality that exists to it historically and our connectivity business, its the same as it would be in the SoC business. So traditionally we get some seasonality in Q1, a little bit in Q2 and then the second half is bigger, Q3 typically being the strongest seasonally quarter and then Q4 pretty close to Q3.

So its still too early to call Q1, because we have new design wins ramping into the market. So could those design wins outpace what we are doing from a seasonality standpoint. Hard to tell, especially in the backdrop, a kind of a tough macro that we are looking at. So we’ll provide guidance for Q1 when we get there, but that would be my kind of qualitative comments around that.

Gary Mobley - The Benchmark Company

All right, thanks. That was my question. Thank you.

Patrick Henry

All right, thanks Garry.

Operator

Our next question comes from the line of Blayne Curtis with Barclays. You may proceed.

Chris (ph) - Barclays

Hi. This is Chris (ph). I’m in for Blayne, he had to jump off. Just one question about your 2013 guidance. I think you had mentioned you were expecting kind of mid-20s run rate for the set-top box business. I mean, it seems like its already kind of there. Are you expecting to hold there or grow from that point?

Patrick Henry

Yes, we expect to grow from that point. This is kind of where we think the set-top box SoC business, in general from the revenue perspective is kind of stabilizing at. So we think we can grow out that number and to 50,000 plus.

Dave Lyle

Yes, part of the reason why we mentioned that is just because we had supply constrains in that business when we acquired it. So this is without supply constrains. We’re kind of a new base line, kind of in the mid-20s growing from there.

Chris (ph) - Barclays

Okay, you expect to grow of that, okay.

Dave Lyle

Yes, the good news is that the upside versus the downside on that is a lot more on the upside, because a lot of the legacy products that we inherited with the acquisition have kind of blunt off at this point, so there is not as much downward pressure from continued, end of design, end of life of legacy products and a more upside in terms of the growth of new products that are ramping in production.

Chris (ph) - Barclays

Thanks very much and then just one other, I was wondering, are you baking in some share loss in connectivity or I guess are you aware of any particular platforms ramping for you guys?

Patrick Henry

Yes, we think that we are going to loose some share, probably continue in North America throughout 2013. We are winning designs, winning a lot of MoCA2 business. There’s some MoCA1, that one business that got awarded a while ago that we’re ramping the production throughout 2013. I think we’ll probably stay in that kind of 50% range from market share existing ‘13 I guess.

The think that can increase that is if upgrades really get very robust and then I think we have a higher market share into the street MoCA business around MoCA adapters, as well as MoCA retail for the after market. So that market really ignites, then our market share could be higher.

Chris (ph) - Barclays

Wonderful. Thanks very much for the time guys.

Patrick Henry

Sure, thanks Chris.

Operator

Our next question comes from the line of Tore Svanberg with Stifel Nicolaus. You may proceed.

Tore Svanberg - Stifel Nicolaus

Thanks for taking the questions. I just want to circle back you guys. Obviously you talked about making some progress with the SoC business and some of the challenges you face there. Now that you had nearly two quarters of that business, and you’ve made those improvements to the supply chain, any updates you can give us on when you think that business will be accretive. I know you mentioned the end of 2013 and then longer term may be by the end of ‘14 that could be profitably or at least at the corporate model I should say.

Patrick Henry

Yes, Dave you want to answer that one. Yes, I think this is Eric not Tore.

Dave Lyle

Yes, I think it is.

Tore Svanberg - Stifel Nicolaus

That’s right.

Dave Lyle

Yes, we had previously said Q4 ‘13 was our target for our set-top box SoC business to become accretive and we still think that we are on target for that. The other goal that we had set was Q4 ‘14 to be in their corporate operating margin, a long-term model basically, operating margins being at the 18% to 20% level.

Tore Svanberg - Stifel Nicolaus

Okay, so no changes still on track. MoCA 2.0, you have some modest designs now and do you think that it could be a ramp in Q2. Can you just maybe talk about what you think that ramp might look like and what could be holding this market back or is this on schedule. What you guys are originally thinking and I have one more thanks.

Patrick Henry

Yes, I mean. Its sort of (inaudible) marks that takes a long time. So a number of these designs have been under way for quite some time. We are wining new designs still today. Its going to be a while before from a volume standpoint MoCA 2 overtakes MoCA 1, because the product lifecycles are very long. I mean we are still shipping 0.13 MoCA that we got designed three of four years ago.

So I think that the likelihood that MoCA 2 probably surpasses MoCA 1.1 in volume sometime in late 2014, maybe early 2015, but all of the new design activity is MoCA 2 based. So people with MoCA 1.1 solutions are growing or winning any service provider business now.

Tore Svanberg - Stifel Nicolaus

Helpful thanks and just finally, can you comment on the Latin American market. Obviously its one of the emerging markets for you guys. What progress are you making there? Thanks.

Patrick Henry

We are actually making a lot of progress in design wins across the broad. Nothing we can announce specifically today about built in satellite and cable, we have key targets down there and when we kind of cross our product line with the upper unit business with our MoCA business as well as with our SoCs. So it’s a key target for us and we are wining business and we’ll see a ramp in volume in that later in ’13 and then continuing beyond that.

Debra Hart

We can go to the Next question.

Operator

The next question comes from the line of Rajvindra Gill with Needham & Company. You may proceed.

Rajvindra Gill - Needham & Company

Yes, thanks for taking my question and if you answered it, sorry about that, I just joined last. If you could talk about the ramp with Trident’s business fee, the Legacy business that’s going to fall off of some of the new design wins with the (inaudible) and the Trident. How do you see the cadence of that mix over the next several quarters?

Patrick Henry

Yes, in terms of the Legacy business, I think that the bigger part of the drop-off is in and will be there and its behind us. More to continue to see like in any semiconductor business that continue tail-off over a longer period of time. In the new products we are seeing the ramp really starting to occur now. I mean we saw a little bit of it in Q3, but Q4 we are starting to ramp, to pick up a little bit more and we got a lot of design activity that will be ramping throughout 2013 with the existing products.

We’ve also launched some new products. There were two new products in the pipeline when we did the acquisition with Trident. Both of those are in production as of this quarter. We’ve had another new product that will be launching early next year that we kicked off pretty much at the time that we did the acquisition and then we got a couple of other new products that will be launched late next year. So we got a good pipeline with new products and we are winning a lot of designs.

Rajvindra Gill - Needham & Company

If you could give kind of a rough percentage of how much of that mid-20s run rate of Trident is coming from still Legacy versus new product designs.

Patrick Henry

Yes, we are not going to break it our specifically, but its well less than half with Legacy.

Rajvindra Gill - Needham & Company

Okay, and this last question on the competitive landscape. Broadcom’s results and the connectivity in the broadband business were pretty good. They talked about kind of a 400% increase that increase in their tax rate for MoCA. You talked about loosing some share, kind of having that stock at 50%. What do you see are the risks that that could actually increase further down the road.

Dave Lyle

We’ve got pretty good visibility on what the pipeline looks like in the service provider business. We kind of know what designs we want, what designs they want and what the ramp schedules are. So our assumptions are our market share is going to be based on that. The 400% increase is typically based on somebody having a very amount of revenue at the starting point. So its pretty difficult, kind of what we expected.

Operator

Our next question comes from the line of Alex Gauna with JMP Securities. You may proceed.

Alex Gauna - JMP Securities

Thank you and good afternoon. I was wondering if you could give us an idea, now that you’ve hit somewhat of a steady state on your SoC business. What your end market MSO or carrier exposure might be? I know directly Verizon has historically been the largest. Does that bring in, does Trident bring in any other greater than 10% and mark your consumers and then also if you could look forward into 2013 based on that visibility you just spoke up. Do you see any other major carriers coming on line.

Patrick Henry

Yes, so in the SoC business, half is outside the U.S., half is in U.S. I think that’s kind of the exposure geographically and that business is going to ramp faster than the kind of activity business throughout 2013.

If you look at where most of the new design activity is initially, its in cable. So with cable on the service, both domestic and internationally, although we do see some pretty big design win opportunities in satellite as well, we’ll probably won’t see those ramping until the later part of 13, and rolling into ’14 as far as the SoC business goes.

So that’s where we will get additional exposure over time. If we look at our historically kind of activity business, 90% being the U.S., that’s going to come down from a percentage standpoint as we ramp international business throughout 2013. Now where does it land, I’m not exactly sure, but its welcomed down somewhat as we ramp in the international business throughout ’13.

Alex Gauna - JMP Securities

But is it correct that Direct TV and Verizon are still your largest end market drivers and greater than 10% or do you not know?

Patrick Henry

We know and Direct TV is defiantly our largest end customer, kind of for all our product lines. Verizon is smaller today. If you look at our total exposure in Verizon, they are under 20% in terms of in our overall exposure and then U.S. Cable aggregated is actually larger than Verizon, Comcast, those in by themselves.

Alex Gauna - JMP Securities

Yes, part of my question is within that US cable aggregate you got come pretty interesting design wins. Could any of those become big enough programs if they join the greater than 10% rank in 2013.

Patrick Henry

I think HD-DTA is an aggregate, that’s one thing, but that’s a big enough opportunity. Then we see China Cable been a big opportunity. The analog Sunset in India tried to call at this point, but I think there’s 65 million homes in India that will convert from analog to digital over the next three years and we have a pretty bid exposure there. So we’ve got a lot of big opportunities globally.

It’s a big market, we are relatively smaller player with very good solutions now, with the product lines attached to a much more stable company. So far we’ve seen Gregg, receptivity from customers as well as Pay-TV service riders who are doing business with us and we are going to need designs.

Alex Gauna - JMP Securities

Okay, unless I missed it, I haven’t heard you talking about channel switch opportunities within the go forward opportunity in 2013. What’s your exception on trends in that category?

Patrick Henry

Yes, we mentioned that we are following DTA 30 years. So we are seeing growth opportunity there. Both in the US market as we see continued increases in HD, attach rate and upgrades. I think that will drive revenue and volume in the U.S. market and we’ve also won a similar national business. We’ll see that ramping throughout next. Some of that is the early part of next year.

Alex Gauna - JMP Securities

Okay, one last one if I could, in terms of that market share trajectory you talked about, I was wondering, how does that incorporate – you work a long time beside Intel. Is that a risk of market share erosion as they go to SoC or they actually gain share and you do the transceiver with them you can gain share via them.

Patrick Henry

Yes, I’m not quite understanding the question there.

Alex Gauna - JMP Securities

I guess I believe that Intel has some integration roadmaps of its own, at least in part and I’m wondering if that comes into play in 2013, is either an opportunely or risk factor.

Patrick Henry

Yes, I think based on the design wins we are seeing alongside Intel from be transporting the MoCA standpoint, MoCA 2 standpoint. We are rolling up, seeing them having integrated products or in fact 13 or even 14 is a question mark from a volume standpoint.

So we see them as a key partner, we are working closely with them. (Inaudible) up to this point and we are doing the MoCA, actually the MoCA plus trans coding with our partnership. So we definitely see that there is a bigger upside opportunity than downside opportunity there. But this bigger volume opportunity is on clients, all the stuff we are doing with Intel on the gateway side.

Alex Gauna - JMP Securities

Okay, perfect. Thank you so much.

Patrick Henry

Sure, thanks Alex.

Operator

The next question comes from the line of Harlan Sur. You may proceed.

Unidentified Participant

Hey guys. This is (Inaudible). A quick question; going back to your Q4 guidance, it seems like your U.S. base connectivity business is not growing, which seems to be counter to what we’ve been seeing, continued aggressive promotional campaign and by Pay-TV service providers. Can you comment a little bit about what’s going on, perhaps slowdown in attach rate or upgrade cycle or maybe share loss.

Patrick Henry

Well, I think there was a big up tick going from Q1 to Q2 as we saw HD attach rates and upgrades really increase. We saw a pretty big jump in our business based on that. The primary headwind associated with that is some share loss, as well as the kind of tough macro that we are selling into.

So we still think that the overall trend is more connectivity. We think we are going to get our fair share of that business, both on the street basis and then overtime with bundled solutions with our SoCs and the rest of the integrated solutions with our SoCs.

So we still see that as a growth market opportunity and in fact, we are now going to start seeing growth outside the U.S. market, in addition to U.S. market growth with increases in HD attach rate and upgrades.

Unidentified Participant

Got it and I guess second quarter is, I mean a big part of your thesis has been your ability to provide complete platform solution and you’re determine to edit that with design wins at EchoStar, with three design wins. Can you help me understand what’s the dollar content and traffic at these boxes?

Patrick Henry

Yes, we really don’t break things out at that granularity.

Unidentified Participant

Okay. All right, thank you, a good job on the quarter.

Patrick Henry

Thanks a lot.

Operator

Our next question comes from the line of Daniel Amir with Lazard Capital Markets. You may proceed.

Debra Hart

Daniel, are you there? Chris, can you go to the next question please.

Operator

Our next question comes from the like of John Pitzer. You may proceed.

Ryan Carver - Credit Suisse

Yes, this is Ryan Carver in for John Pitzer. Just as you guys are thinking about the next generation of this integrated HD TV plus MoCA products, I guess what are your thoughts on the process to know that these products are going to be targeted towards and how do you guys think about sort of as you are looking at expenses for new devices, do you guys have thresholds in terms of business opportunities as the development costs go up as process notes go down and I have a couple of follow-ups.

Patrick Henry

Sure. Most of the new stuff that we are working on is 28 nanometer. We have a few 40 nanometer stuff that is still in development and they’ll be taking that out in the short term. But most of the new stuff beyond that is on 28 nanometer. We’ve been working on 28 nanometer from a development standpoint for well over a year now. The initial products we’ll have in those notes will be the MoCA 2 base, as well as transport across MoCA, but then from an SoC stand point we’ll see integrated MoCA with SoCs later next year.

Ryan Carver - Credit Suisse

Great.

Patrick Henry

Development costs, yes, of course we have eyes on our products. So we look at how much things cost. This is a massive market opportunity and we see really big volume opportunities for our new SoCs and its pretty easy to meet the thresholds from a development standpoint as we are able to carve out decent market share, which we think we can.

Ryan Carver - Credit Suisse

Got it, and then as you sort of look into 2013, your gross margin number is sort flat as you sort of get to the margin tail wind from cost improvements, but as you mix in two set-top boxes, sort of mixed headwinds.

One of your competitor hasn’t got margins since they are at the high end of their range and they talked about sort of getting price aggressive and not worried about sort of moving margins down a bit. I mean what are some of the levers that you guys can turn if some of your major competitors in your safe kit start become price aggressive, in a period of time where you are looking to just sort keep margins flat.

Patrick Henry

We have pretty aggressive price reductions, ASP reductions baked in for next year and believe that we can still maintain very attractive gross margins based on that. So we’ve competed with this competitor pretty much since the inception of the company and we think that we can continue to be with them very effectively over the longer term.

Our guys that we just hired to run operations, ran operations there from the time it was a zero revenue company to a $3 billion company. So I think we have a good understanding of what it takes to compete.

Ryan Carver - Credit Suisse

Got it. And then one quick last one if I could; so gross margin profile, I think between set-top box connectivity was between 20 to 25 bits, sorry 20 to 25 percentage points parts. Should we think about sort of Q4 as the trough of sort of the gross margin decline and gross margins were coming up within the STB business, so going forward.

Patrick Henry

We don’t really break out gross margins by product line Dave, do you kind of want to talk about kind of gross margins going forward?

Dave Lyle

Yes, we are of course constantly working on our product cost production plan, which will help us of course. But it also depends on mix of some newer products versus some older products, but certainly we expect to be able to make improvements throughout 2013.

Ryan Carver - Credit Suisse

Great, and last question, do you guys have any other thoughts on other potential acquisitions given the fact that you guys have acquired the set-top box side? Give you guys are partnering with a number of different people, any plans to look at other connectivity technologies that people make consider integrating through an SoC?

Patrick Henry

Yes, I mean our primary focus is to integrate what we already have. We are always looking at smaller technology things that could complementary, but we don’t see ourselves doing anything big for a while. We are primarily focused on continuing to integrate and monetize what we have under our belt, especially with the SoC business

Ryan Carver - Credit Suisse

Thanks a lot.

Patrick Henry

Sure, thanks Ryan.

Operator

And our last question comes from the like of Hamed Khorsand with BWS Financial. You may proceed.

Hamed Khorsand - BWS Financial

Thank you guys for squeezing me. Just really want to talk …

Patrick Henry

Hello?

Debra Hart

Hamed, did we loose you? Chris are there any other questions in the queue?

Operator

You have no questions at this time.

Debra Hart

All right. Well, thank you all for joining us. If you have any follow up questions, feel free to give me a call. Thank you so much.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you so much for your participation. You may now disconnect. Have a great day.

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