Harmonic Inc (HLIT) 2002 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Harmonic first quarter results conference call. During the presentation all participants will be in the listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the "1" followed by the "4" on your telephone. As a reminder, this conference is being recorded Wednesday, April 24, 2002. I would now like to turn the conference over to Mr. Tony Ley, CEO. Please go ahead.

Good afternoon. I'm Tony Ley, president and chief executive of Harmonic. With me in our headquarters in Sunnyvale, California, are Robin Dickson our chief financial officer and Michael Newman our investor relations spokesman. Thank you all for joining us.

As most of you know, Harmonic designs, manufactures and markets fiber optic and digital head-end systems for delivering video, voice and data over cable, satellite and telco networks. Today we released our results for the first quarter ended March 29, 2002. We're pleased with our performance in the quarter, and we're seeing a variety of promising initiatives in a number of broadband markets. In particular, we saw greater activity in plant upgrades by most of the major domestic cable customers to increase their network capacity and to lay the foundation for the introduction of advanced services such as video on demand and digital television.

Throughout the quarter we also continued to extend our strong customer base across a range of broadband markets and to maintain our technology leadership. As is our custom, Robin will now review our financial results. After that, I'll discuss other significant events that occurred during the quarter and our outlook in future periods. So Robin.

Thank you, Tony, and good afternoon everyone. During the course of this call we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only predictions and that actual events or results may differ materially. We refer you to documents that the company files with the SEC including our 10K and 10Q reports. These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Today we announced our results for the first quarter ended March 29, 2002. For the quarter, we reported revenue of $54 million, up 34 percent from $40.3 million for the first quarter of 2001, but in line with our guidance down sequentially from $56.7 million in Q4. Our Convergent Systems Division which provides digital headend systems to a variety of broadband service operators accounted for 60 percent of our total revenue. For the first quarter, our CS Division reported sales of $32.2 million up 50 percent from divisional net sales of $21.5 million in the first quarter of 2001 and down from $39.3 million in Q4.

During the quarter, convergent had strong demand for our NFG product line, for new video on demand deployments by several major cable operators in the United States. We also saw solid demand for our line of digital encoders and increasing interest in high-definition solutions which Tony will expand upon later. Our Broadband Access Networks Division, which provides fiber optics systems principally for cable networks, accounted for 40 percent of our total revenue. And for the first quarter our BAN sales were $21.8 million, up 16 percent from sales of $18.8 million in the first quarter of 2001 and up sequentially from $17.4 million in Q4.

We're pleased with the rebound in BAN sales which reflected an increased level of activity in network upgrades by several MSOs in the United States.

Domestic sales represented 69 percent of revenue for the first quarter compared to 44 percent for the first quarter of 2001 and 60 percent for 2001 as a whole. Our geographic sales in Q1 reflected the relative strength in US broadband, particularly in comparison to Europe. The domestic business was driven principally by cable due to a combination of network upgrades and new service launches, especially in VOD.

CableVision and Charter were both 10 percent customers in the quarter. Of course many of you will also want to know how much business Adelphia represents. For all of last year and also in Q1, our business with them was no more than 5 percent of sales. They have been a good customer for many years, but we don't have any particular insight into the situation and cannot add any more at this time.

In the DBS market we believe that the FCC delays in the Echo Star and DIRECTV merger process are beginning to hold back some spending decisions. So as a result of the strength of our cable business, cable represented 69 percent of our worldwide sales in Q1 compared to 50 percent in 2001 as a whole. Just as our presence in various market segments provide diversity to our business, we also believe that our international reach is an important strength and that broadband markets abroad will grow again in the future.

However, at this time many of our customers in Europe have severely restricted capital expenditures for a variety of reasons which have been well-documented in the media. While Asia remains fairly robust, the effect of the European situation was to reduce our international business in Q1, both in absolute dollars and as a percentage of revenue relative to Q4.

The gross margins in the first quarter were 35 percent, up sequentially from 33 percent in the fourth quarter. While we're pleased with our progress in improving gross margins over the past few quarters, we believe that further improvements will depend more upon volume growth than cost reductions.

Operating expenses for the first quarter were $26.4 million, down slightly on a sequential basis. We have completed the major restructuring efforts of last year, but we continue to trim costs in certain selected areas. Our headcount at the end of March was essentially unchanged from the end of December at just over 700 people.

Excluding the effects of noncash accounting charges for the amortization of intangibles, our pro forma net loss for the quarter was $8.2 million or 14 cents per share compared to a pro forma net loss of $44.9 million or 77 cents per share for the first quarter of 2001. Including these charges, net loss for the first quarter of 2002 was $14 million or 24 cents per share.

Turning to the balance sheet, our cash balance at the end of the first quarter was about $52 million, down slightly from $54 million at the end of the fourth quarter. We're very pleased that our cash balance held fairly steady despite an operating loss. Our capital spending in the first quarter was less than $1 million, and we expect capital spending to be no more than $10 million for the full year of 2002.

While we believe that our cash resources are sufficient for our current needs, we're pleased to tell you that our recently filed shelf registration statement has been declared effective by the SEC. Under this registration statement, we may issue various types of securities from time to time up to an aggregate of $150 million over a two-year period to meet future business needs.

Receivables were $46 million at the end of the first quarter, up from $34 million at the end of 2001. However, you may remember at the end of the last two quarters of 2001 we sold certain receivables to our bank, and at the end of December this reduced receivables by $7 million. We did not make use of this facility at all at the end of March. Day sales outstanding were approximately 76 days compared to 65 days at the end of the fourth quarter.

Inventory was $26 million, down from $31 million at the end of the fourth quarter, which reflected our continuing efforts to work down levels and to improve our product mix.

In summary, we're pleased with our operating results for the first quarter. Demand for our new products in the Convergent Systems Division continue to be strong, and we began to see a rebound in the BAN Division. At the same time, our financial performance continues to show improvement. We increased gross margins, reduced operating expenses and inventory, slightly narrowed our quarterly loss, and maintained our cash balances.

With respect to our financial outlook, we're encouraged that many major cable operators in the U.S. are spending more with us on plant upgrades and are launching and expanding new services such as video on demand, Internet access, and cable telephony. Our domestic cable business is strong. Though we expect the domestic satellite and in particular the European cable markets to be challenging in the near term, we continue to expect increasing sales during 2002 and the return to profitability later in the year. In essence, the strength in U.S. cable offsets the current weakness in domestic satellite and the European markets. We expect to see increasing sales in Q2 and a range of $56 to $60 million with a smaller pro forma net loss than in Q1 in a range of 6 to 9 cents per share.

Although in recent quarters we've demonstrated our ability to manage our cash resources very effectively, you should also anticipate a cash burn of perhaps up to $5 million during the second quarter.

That's all for me. Tony.

Thanks, Robin. During the quarter our Conversion Systems Division continued to be very engaged in a number of broadband markets. There was a great deal of interest in both video on demand in the cable industry and in high definition encoding in a range of our markets. In U.S. cable, video on demand has now been launched by several of the major MSOs with every indication that it is well-received by subscribers. Our Narrowcast Services Gateways, or NSGs, are used between the radio service and the HFC transmission network. Each NSG supports

transport streams and thus typically 80 independent video channels so that the demand for this product line increases the number of subscribers.

The NSGs work with all the video-on-demand servers on the market. We recently announced an important extension of the NSG product line that enables the use of gigabit-Ethernet between the video servers and the NSGs. The new NSG 8200 can be deployed in both the open standard and the proprietary conditional access systems present in North America. And this use of gigabit-Ethernet in the headends increases scalability and capacity of the VOD network.

In the television broadcast industry, our digital encoders and also our high definition or HD encoders are playing a key role in the migration to digital television. We recently announced that Capital Broadcasting is using our DiviTrack XC system and standard anti-definition encoders to deliver multiple VV programs simultaneously at two stations in North Carolina. The DiviTrack XC system is used through statistically multiplex, high-definition and standard-definition television programs permitting two standard definition and one high definition in the bandwidth normally occupied by only one high definition channel. In the future, this system will also be used to offer data services as an enhancement.

During the Olympics our digital video encoding and remultiplexing systems were used by KSL-TV in Salt Lake City to manage the digital spectrum for broadcasts of the winter games. Among the services provided were high definition of standard definition television, interactive television, and digital radio. Recently, our digital encoders were also chosen by PAX-TV to upgrade its network operation center.

We're very pleased with the recognition we're gaining in the broadcast industry for our encoding technology including our high definition technology. In this context, we recently introduced our broadcast network gateway, known here as the BNG, as a cost-effective solution for operators for digital turnaround to source both high definition and standard definition content while preserving the picture quality within the digital domain.

In the domestic satellite market, MV encoder sales were very strong last year as domestic satellite operators introduced local channels and set up to meet must-carry channel requirements. This year, given the pending directive Echo Star merger, we expect domestic satellite sales to be read to be flat. These customers remain of great importance to us in developing our business. At the same time, we expect that the total number of satellite customers worldwide using our new encoders will continue to increase.

Finally, in the telco market we introduced our encoding solution to enable video over DSL with a

and

in Canada last year. As telco service providers strive to meet competitive threats and increased revenues by bundling voice, video and data over their existing coupled wires, we are finding that interest in video over DSL is growing worldwide. Although it's a very early-growth stage of this market, we're optimistic about its future potential.

In our BAN Division this quarter, we began to see a rebound in capital spending by some domestic MSOs for upgrades. We're seeing real interest in increasing network capacity to handle the bandwidth demand created by the new interactive services. Eventually this will lead to demand for more modes and more transmission equipment. We also had considerable interest in our base-BAN VWDM optical transmission system known as GIGALight. This is a high-capacity system optimized for the transmission of video and other digital traffic. It's specifically designed to provide the transport between video servers and our NSG products when the NSGs are distributed in the hubs in the transmission network.

The combination of GIGALights in the industry demonstrates some of exciting synergies between our CS and BAN Divisions and gives cable operators great economy and flexibility when designing their interactive networks.

One of the most exciting developments for Harmonic today is the overlay of gigabit-Ethernet on the HFC architecture. Using the existing infrastructure it's very economical to bring gigabit Ethernet to the node from which we can run fiber to the business or to the home. The key element here is the CURBswitch which is installed in our standard nodes. We're shipping our units with our CURBswitch to cable operators worldwide and we expect to have production orders in the second half of this year. The initial market domestically is for businesses. Abroad, it's a combination of business and multiple dwelling unit applications.

As Robin stated earlier, we believe the international reach of Harmonic in all our markets is an important strength. While we have a growing customer base worldwide and some strong demand from parts of Asia. Our market in Europe has been affected by the difficulties of certain broadband customers. Despite this however, there remain significant opportunities for us in Europe.

In summary, we are pleased with our performance in the first quarter and see a variety of new promising opportunities developing in different broadband markets. We saw greater activity in plant upgrades by a number of our major domestic cable customers to increase their network capacity and to lay the foundation for the introduction of the BAN services such as video-on-demand and high definition television. In coming periods we expect to continue to extend our strong customer base across a range of broadband markets, maintain our technology leadership and improve our operating performance.

We anticipate growing sales throughout 2002 and a return to profitability in the second half of the year.

This now concludes the formal part of our presentation, and Robin and I will be pleased to entertain any questions that you may have. Thank you.

Thank you. Ladies and gentlemen, if you would like to register a question please press the "1" followed by the "4" on your telephone. You will hear three-tone prompt to acknowledge you request. If your question has been answered and you wish to withdraw your registration, please press the "1" followed by the "3." If you're using a speakerphone, please lift your handset before entering your request. Robert

with William

, please go ahead.

Thank you. Robin, during the quarter it seems as if, it was pretty obvious that the demand for some transmission equipment may have been a little bit stronger than expected, and the satellite business had been a little bit weaker than expected. Did the surprise on the BANside, do you think it's legitimate and consistent and it will continue? And is it based on several MSOs across the board?

Question number two is, given the gateway business, the NSG business is probably going to be health this year and the encoder business may be a little soft in the near-term. But do you expect some sort of sequential growth or continuous growth in CS as well? Thank you.

I think Tony and I can share some of that question. I think from my perspective we are pleased to see what we think is a rebound of the first quarter in BAN. I think there are good signs that we'll see a good a continuation of that. There are a couple of levels. One is the continuation of the traditional network upgrades by certain customers and others who are moving to specifically support some of the new services like video-on-demand where some of those products also play into our BAN Division. So that's the first part.

Secondly, with respect to the future, I think we'll see growth. We would expect the growth we've pointed to for the second quarter will have both the BAN component and a CS component to it.

I think on the other part of your question, the NSGs, we see that as growing substantially during the course of the year, and typically in encoding particularly in the US in our major customers here which you're very familiar with -- they're great accounts -- they tend to in their procurement pattern it tends to more in the second half of the year. So it's not a surprise either that the BAN business grew in its first quarter because I think we were all expecting that. And typically our CST business in encoding tends to be a big slow to take off the first part of the year. But we think it will be a good business throughout the year.

Tony, do you think that some of the NSG business can more than offset a little bit of the weakness in the satellite business?

We're waiting to see how the satellite business develops. We're very confident the totality of our CST business will grow in subsequent quarters.

OK, thank you. Congratulations.

The next question comes from

with CIBC World Markets. Please go ahead.

Hi, Tony, Robin. A couple customer questions. First, I was surprised to see Cablevision a 10 percent customer and surprised to see DirecTV is not a 10 percent customer. At Cablevision, is it mostly NSGs for video-on-demand or is it also some digital headends you're selling there and there may be some traditional transmission equipment? Then on DIRECTV side, do you expect them to just fall off completely,

, while they figure out their merger potential with Echo Star? Are they still ordering maintenance? How is that actually panning out here?

I'll just answer the customer questions. I'll let Tony expand on the satellite one. With respect to Cablevision, no it's not just NSGs but it's for the most part certainly our Convergent Systems products. So there was some digital headend equipment in there as well. I'll let Tony talk to the satellite business.

On DirecTV as I suggested we would expect our satellite business to be stronger the second half, but I think one of us indicated that the effects of the merger may be to slow things down a bit. That being said, we do believe because of the desire of DirecTV and Echo Star to move into local channels, the must-carry rules, whatever, there will be substantial demand.

Then at AT&T, some of your competitors have talked about orders picking up the last several weeks of the quarter and even last several weeks from now. Have you seen that same order pickup at AT&T?

I'd say that our business is probably in line with AT&T. We're seeing the same percentage increases as other people have indicated. We are back in business with AT&T and it's a pleasure.

The last thing I want to ask you is on the new NSG server, the 8200. You talked about in your press release the other day that you're able to provide

and up-converters for SFA platforms. I guess really what you're doing is the up-converter side and you're still needing a core modulator from

that's selling SFA platform. How does that help? How does that sale cycle work? Is it a combination sales effort with UNSFA or are you buying the equipment from SFA? How does that actually work? Is it a pain in the neck for these guys to try to do that rather than just deal with one vendor for the product?

I don't think this is the time to get into the technology into great depth. But what we said in the press release is that using our product, and the sale is quite independent of SFA I should hasten to add. But in the headend one of these proprietary encryption systems we can install gigabit Internet and the Internet switches and so on between the video servers and we can provide the product of the edge of the network all in conjunction with SA. It is not a problem for the operation.

There's still the core modulator that has to be bought from SFA though. Is that correct?

I'm not so sure that it has to be, but we'll need to check. I don't -- the answer is I don't think so, no.

OK, thanks.

Other than this application.

The next question comes from

with

Brothers. Please go ahead.

Thank you very much. Good afternoon, guys. The first question, sorry to make you repeat this, but you said that some of the cable business in Europe had fallen off. Could you just remind us who the major customers are in Europe?

Well, I think you're very familiar with the sort of people who are in trouble in Europe, and these are the people like NTL and Telewest and UPC.

Fair enough. And then with respect to AT&T did you actually have new backlog at the end of the March quarter?

Yes.

You did. So you actually were receiving purchase orders in the March quarter?

Yes.

OK, thank you. And the NSGs, is that a 10 percent product at this point?

Consistent with prior practice we don't like to break down our product lines in that level of detail. But I think you should assume that given what we said earlier about the strength that we're seeing in customers preparing to launch and launching VOD services that it was definitely an important piece of the CS picture.

Let me ask the question this way. From customer to customer, would I expect this product to be lumpy going quarter to quarter?

Yeah. I think on a -- yeah. If you look at individual customers, yes, these deployments tend to be done for specific geographic regions or systems, and so they do tend to buy for one or other of those at given times. So in a customer-by-customer basis I think we're beginning to see several customers launching service, and so that's beginning. I think during the year that will have the effect of smoothing out some of the lumpiness that we had last year.

Any chance you'd give us the number of customers you're selling this to now?

There are several major MSOs in the U.S. At this point it's mostly the U.S. gray: Two last questions. Linearity. Obviously DSOs went up even without the sold receivables last quarter. Could you give us some sense of what linearity looked like in the quarter?

Yeah. I think what we're seeing is the fact that the Q4 really is the odd quarter where the linearity tends to be more smooth than others, and that really has mostly to do with the depletion of budgets of customers and particularly of course the holiday schedule in the U.S, Thanksgiving and Christmas, New Year holidays. So Q4 is very linear, and has often in the past been the period when our DSOs have been at their lowest. So I think you've seen a little bit of a rebound to maybe a more normal situation in Q1.

So the current, the DSOs in the March quarter would be more normal to look at if I modeled the balance sheets stuff going forward?

Yeah. I mean, ideally I like them a few days lower, but I think somewhere 70 days or so would be where we'd like to be.

OK, fair enough. And last question for Tony, could maybe you just provide some insight on how large the market size looks for the HD encoder product? I just sent out a letter to members of Congress asking, requesting, it's a proposal to require operators to carry certain numbers of HD channels. There's been a lot of press about HD recently. How do we look at the market size for this product?

I think it's always going to be a niche market compared with the standard TV. But from our point of view of course, a high definition encoder costs somewhere between two and three times a standard definition encoder. So that's good when we sell them. But you tend to sell them in relatively small numbers compared with the SD. But the interesting thing is that we've been -- I think it's fair to say just a little surprised by the number of requests we're getting for HD in cable and broadcasting. I believe even, I'm pretty sure about this, even in satellite. So it tends to be small numbers, but in a great many places and they're fairly expensive units.

Fair enough. Thanks a lot, guys.

The next question comes from Jason

, Thomas Weisel Partners. Please go ahead.

Yes, thanks. Hey, guys. So Clifton just stole my question about HD and quarters, so it sounds like you're selling that into a variety of markets, not just the broadcast market. Is that correct?

Yeah, that's correct.

OK. And then second question has to do with gigabit Ethernet, architectures for the NSG. Are you actually selling into architectures now where you're using this gigabit Ethernet architecture to the hubs where you're basically have your NSGs?

Absolutely. That's the real application, and we're finding -- we have shipped the product for that purpose, and we're finding great interest as the operators realize the benefits of going basically to Ethernet transmission of these high speeds.

OK, and this is in both Motorola and Scientific Atlanta based systems?

Yes.

OK, great. And then the third question, on the NSG, when you win deals with the NSG who are you beating today and why?

I'm sorry. Could you rephrase the last bit?

With the NSG I was just asking when you win contracts with these MSOs who are you beating and why are you beating them?

I think the alternative to the NSG really has been coming from the video on demand of the server manufacturers trying to incorporate either crams or various transmission devices in their servers. I think we have a much more appealing architecture to the operators. Basically I think we're getting a great deal of the business.

Great. Then finally, Robin, I got the call late. Who did you say your 10 percent customers were?

Cablevision and Charter.

Could you give combined number there?

No. No, I didn't. They're both over 10 percent, but not dramatically over 10 percent.

And Charter is both on the BAN and the CS side?

Yes.

OK. Thanks a lot, guys.

The next question comes from Seth Spalding with Goldman Sachs. Please go ahead with your question.

Thank you. My questions have already been answered. Thanks.

The next question comes from Anton

with

and Company. Please go ahead with your question.

Robin, on other income I think it was actually negative this quarter, and if you could just explain a little bit about what unusual item may have been in there beyond the interest in your cash balances that may have pushed that down?

Nothing really to speak of, Anton. Obviously in these days our cash -- it's a combination of lower cash balances than perhaps sometime in the past and also particularly low interest rates really don't, in the kind of conservative securities we invest in, really doesn't throw off a lot of interest income these day. We also have some modest amount of interest expense. We have about a couple million dollars of term debt, $2.5 million or so of term debt. Plus we did have some, as I said the sale of receivables, although that was mostly in the end of last year, beginning of this year. So there's really nothing unusual. I would expect that we won't see any significant numbers on that line, either positive or negative for the next couple quarters or so.

OK. On the Ethernet architectures, the CURBswitch version not the gigapiece and that hub to headend transport. But you said, production volumes in the second half of the year. That would imply that you are currently in some relatively advanced stages of field trials. Could you discuss -- obviously you're not going to name any names, but could you discuss the number of field trials you're currently in or the approximate size of the field trials? In other words, are we talking about 10s of customers or maybe more customers than that that are in field trials without any given system?

I'd say worldwide we're really active in about six, and we have purposely limited what we can do because you'll appreciate this stage with the new technology and new application it requires a fair amount of support to make sure these work. But they're widely diversified geographically and they are in what we think are the key places.

Now when we say we're in production this year, we will be in production which means the trial units have come mainly from R&D and our early purchase, our facility here, manufacturing. But it will be, the equipment will be released quite soon in fact, so it gets into full production later of every year, but we expect of course -- this is, we're just at the very beginning of an embryonic market, so we expect volumes to be quite modest of course this year. But if we're successful then we'll expect to see obviously more substantial results next year.

So there are six customers that are in advanced stages of trial in the product?

That's correct.

Final question then. On the NSG and its compatibility with non-Motorola-based encryption, how long has that been available at this point in time? In other words, for awhile you were only able to ship into VOD systems that were run on Motorola

for encryption, and now of course you do the power keys/power V to encryption. When did that start?

Toward the end of the quarter. It's very recent.

OK. Thanks Tony and Robin.

The next question comes from James

with Adams, Harkness and Hill. Please go ahead.

Hi, Robin and Tony. A couple of questions. Both of you mentioned AT&T. Given what you see in their orders and your backlog and the plans they discussed a little on their conference call today, could they potentially return to a 10 percenter for you by late this year?

I think it's too early to tell. I mean, the signs are encouraging, but I just think it's too early, Jim, to speculate. There's no question, as Tony said they've returned to be an active customer. We are shipping product. We do have backlog. I think it's just too early to say whether they could get back to that.

Could you recognize anything in Q1?

Yes, we did.

What are they ordering?

You'll recall that ...

Is it the WDM or ...

Well, it's equipment of the same sort we supplied before, so it's basically WDM transmission and I believe they provide, they take some standard product and nodes and with the nodes in particular the digital return capability which in our case is very good.

Secondly, anything in the R&D line that boosted that number, or was I just looking for too low of a number this quarter?

Which number?

On the expenses?

Yea, in the research and development expense.

No. I think -- we of course have had to bring our R&D in line with our business over the last year and a half since the time of the acquisition. And I think we're running our machine now in terms of headcounts and so forth. It's in a very stable situation. So I wouldn't expect that number to be changing significantly -- there are always small changes up and down, but I would think it has reached a stable position.

OK. And you talked about the NSG, and could you mention when you may be recognizing revenue on the curb switch?

What we said was that it will be in our manufacturing facility in the second half. We would expect to see modest revenues this year, but this is the beginning of a growth market, and for the customers it's a whole new experience as they learn to cope with providing 100 megabyte or whatever they're going to do with their customers. It's going to take a little time for the industry to sort of learn how to use this and get going.

So whereas we're convinced in the long haul this is very large worldwide, in the short term it's going to take quite some time to get going.

OK. Great. Thank you very much.

The next question comes from Larry Harris with H.C. Wainwright. Please go ahead.

Yes. Thank you. It's good to see the BAN Division coming back again. I was wondering about one of the applications, the capital broadcasting in terms of the statistical multiplexing and the ability to broadcast multiple signals. Are you seeing interest from some of the PBS stations and maybe some of the commercial stations as well in terms of that solution?

Yes. I think the package we've put together is generating both orders and really a lot of interest. In fact, I don't know if you saw, if you were at the recent NAB show in Vegas, the National Association of Broadcasting, where we were present of course. And we put a system and a small rack together which amazed people both in the small physical size and the capability for what it cost.

We believe that's going to be quite an interesting business for us over the next year or two.

Great. Also with respect to the HD encoding for the broadcast stations, looks like the FCC is going to grant a lot of the stations just six-month waivers. If that's the case, could we see a concentrated level of HD encoder sales for the broadcasters, say, in the next couple of quarters?

I'm not sure how it's going to play out, but what we are seeing, we're engaged in discussions with a significant number of accounts, and we believe many of them will place orders over the next 18 months.

Great. All right. Well, thank you very much.

Ladies and gentlemen, as a reminder, if you do have a question please press the "1" followed by the "4" at this time. Kevin

with Soundview Technology Group. Please go ahead.

I guess these are kind of nit-picky and more aimed in your direction, Robin. Was NSG up sequentially from the fourth quarter?

Yes. Yes, it was.

Was it material? "Material" being more than 10 percent?

You mean the increase or the absolute?

The increase.

The increase? Yes. I think I could say that. Yes. I think we saw, like I said in response to an earlier question it was a somewhat lumpy business last year just because of the number of operators and number of deployments were so relatively small. But I think we're beginning to see some smoothing. Yes it was often. It was one of the strengths of the quarter.

So should I assume that the vast majority of the decline was the change in momentum on the satellite side of the business?

Not entirely. I think there's a couple of things going on. I think many of the international markets were weak, particularly -- you know, it may be a somewhat overlooked fact, but we sell our encoders and multiplexers all over the world, and some of that goes to places that are having some difficulties right now. So I don't think it's fair to say it's all the domestic satellite business by any means. I think some of it just what we saw as a general slowdown and a particularly slowdown in Europe as a result of some of the well-publicized difficulties.

As I look at gross margin -- and I do want to circle back on the satellite TV piece -- should I look at the positive sequential performance on gross margin which was more than I would have guessed given the volume activity in the business? Should I attribute that to a shift from convergent systems to BAN, or ...

Help me out from a mixed standpoint.

I think there's no question the improvement in BAN is helping us from a margin perspective because we are getting a little bit more efficiency out of the factory and the factory overhead we have. So there are some efficiencies helping to contribute. We also have -- we haven't done a lot of dramatic cost reduction in the last few months. We're just continuing to keep the squeeze on overhead and costs in general, so there's a little bit from there as well. So the BAN rebound is certainly helping. I don't think it's the whole story, but it's one of the key parts.

I did want to circle back on Jim's question about R&D because I think maybe he and I were sort of on the same planet as far as that line was concerned. It's my recollection that you had told us not to assume that we'd see anywhere near the kind of decline that had materialized in the fourth quarter, but that the number would be flatish with the number that we saw. Instead, up a million and a quarter or so. At the bottom line, that's two cents and a difference between a penny below consensus and an upside surprise. So I'm just curious if there could have been prototyping type expense that went through there vis-a-vis this new product announcement, anything unusual at all?

Nothing I can think of. You know, I must admit as I look at the -- you know, I tended to look at the overall operating expense numbers which have come down because there are offsetting reductions on the SG&A line. There's nothing immediately that comes to mind, but certainly you pointed to something that could often be a driver on the R&D line, out of pocket type costs for prototypes and so forth. We certainly are having some of that in BAN particularly as we work through these field trials.

But nothing that comes to mind. I probably should go back and do a little bit of digging on that one.

Now last question, circling back on the satellite front. We've sort of picked up in our own checks that assuming this combination goes forward that not only could there be business opportunity tied to sort of the convergence of the two different networks to a single architecture that might actually require more uplink capacity than what's currently out there when you look at the two separately. But also that there is the possibility of an upgrade cycle within the installed equipment base -- i.e. a need to replace. So the idea that things are a little slow here because we have a combination, I'm just sort of wondering what kind of feel you are getting because it's going to be much more of an inclination to look through it if it's just sort of a temporary delay followed by some nice opportunity as opposed to, oh my God, we only need one of these networks and we've gone from two customers to one.

I think, Kevin, we share your point of view. We think long-term, over a reasonable period of time there's a considerable demand. The benefit for these customers if you can, for the same bandwidth on the satellite, go from shall we say 10 channels to 11 to 12 to 13 -- is enormous compared with the cost of putting up another bird. So that is the business we're engaged in.

I think it's very hard for us, given the situation of this emergence and even to know whether it's going through or not -- to feel confident on any very short-term predictions. But over any long period of time, we are very confident that this is a very interesting business for us to be in.

I think it's worthwhile to add too that maybe not to focus too much on this, both the bit U.S. players were still among our top ten customers for the quarter. So it's certainly not as if they've gone away.

Everybody's looking at the BAN number, and they know it's the best number we've seen out of that group in probably a year and a half or something like that, so that's very encouraging. You just don't want to have the other piece undermining you.

That's the great benefit of diversity. You can be caught both ways. But look, we're delighted too. We think the BAN business is clearly going to have an interesting year. And we're fairly confident that the CSD business as a total is going to be where it should be.

OK, great. Thanks for that.

The next question comes from Alan Bezoza with CIBC World Markets. Please proceed with your follow-up question.

I have just one question on gross margins, kind of following up with what Kevin was asking. The gross margins on the NSG service I recall were very high, closer to 50 percent plus. And given the strength this quarter I would have expected gross margins to be higher. I know the convergent system typically has a higher margin as well. Can you kind of walk through the mix a little clearer? Is there maybe pricing pressures on the NSG server that's causing those margins to go down, or has the BAN growth not also helped margins?

I think we're getting to the point where in NSG we're starting to get into some pretty significant volumes, and usually they're, with volumes go some amount of price reduction. I wouldn't say price pressure, but price reduction. So I think that's perfectly normal as we start to move the meter on the NSG.

So would you say they're still higher than company average, maybe over 40 still?

Yeah. They're around the company target is they're right where we'd like them to be.

Any comments then on the broadband group?

Again, it's really just to repeat what I said to Kevin that we do have the current volume levels we still have some, if you like, inefficiencies in our factory, and as we move into higher levels of production we'll squeeze those out, and those tend to have a fairly quick and effective pass-through to benefit the gross margin line. I think we saw some of that also in Q1. But there's probably more to come assuming that BAN does continue to improve, which is our expectation.

It's how you describe inefficiency, but the BAN production part has a fairly high level effects cost and so it's a practical utilization issue.

OK, great. Thanks, guys.

The next question comes from Clifton Gray with Kaufman Brothers. Please proceed with your follow-up.

Thank you. How should we be thinking about gross margins, operating expenses and taxes? You mentioned your interest you should basically not see too much either positive or negative. But how should we think about other items in the P&L for the GM quarter?

We think with the benefit of some revenue increases as we talked about for second quarter that we should get some corresponding margin benefit from that. But from the fact that the volume is increasing -- it goes back to the preceding questions about factory utilization. As we move the BAN meter I would expect we'll see some corresponding improvement in gross margins. So as I think about the second quarter and assuming the revenue guidance we gave you holds up, then I would expect to see some improvement in gross margins.

I think operating expenses are about where we'd like them to be. We're going to continue to trim here and there, and we'll keep -- we're certainly keeping the lid on headcount. So you may see maybe possibly some modest improvement there, not much. Interest in other income we've dealt with and in taxes I expect we'll continue to provide half million as we have been doing, as we did in the first quarter and for most of last year. It takes care of your foreign taxes and other items we have, even though we happen to be in a loss position right now.

OK, thank you.

There are no further questions. Please continue with your presentation or any closing remarks.

Thank you very much for participating in today's conference call. We look forward to speaking to you again at the end of the next quarter. Thank you, and good bye.

That concludes the conference call today. Thank you for your participation.

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