Harmonic Inc (HLIT) 2003 Q3 法說會逐字稿

Ladies and gentlemen, please continue to stand by, your conference call will begin shortly.

Once again, please continue to hold, and thank you for your patience.

Ladies and gentlemen, thank you for standing by.

Welcome to the Harmonic, Incorporated third quarter conference call.

During the presentation, all participants will be in a listen only mode.

Afterwards we will conduct a question/answer session.

This conference is being recorded Thursday October 16, 2003.

I would now like to turn the conference over to Anthony Ley, chairman, president and CEO of Harmonic, incorporated.

Please, go ahead, sir.

Thank you.

Good afternoon, I'm Tony Ley, president and CEO 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 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 announced our results for the third quarter of 2003, as well as a public offering of 7.5 million shares of common stock.

While the worldwide market environment remains challenging, we are pleased to see a firmer industry capital spending environment, which we believe is having a positive impact on our business.

We're seeing intensifying competition between cable and satellite operators, to offer more channels of digital video and new interactive services such as Video-on-Demand, as well as the introduction of high definition television.

A number of our cable customers are also deploying our fiber-optic products to improve operational efficiency and configure their networks to support the new advanced services.

To address these needs, we've recently introduced new industry leading video products and we're developing products using next generation compression technology.

As is our custom, Robin will now review the financial results, and afterwards I'll discuss significant events that have occurred during the quarter.

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 to you documents that the company files with the SEC, including our most recent 10-K, and 10-Q reports and our prospectus supplement filed today.

These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Please also note that on this call we will provide you with several financial metrics determined on a non-GAAP or pro forma basis.

These items, together are with the corresponding GAAP numbers and the reconciliation to GAAP, are contained in today's earnings press release, which we have posted on our web site at www.HarmonicInc..com and filed with the SEC on form 8-K.

We will also discuss historical financial and other statistical information regarding our business and operations.

Some of this information is included in today's press release, and the remainder will be available in a recorded version of this call on our web site.

Today we announced our results for the quarter ending September 26th, 2003.

For the quarter, we reported net sales of 47.3 million, up from 41.7 million in the previous quarter, and up from 37,000,000 in the third quarter of 2002.

Our convergence system division which designs, manufactures and markets digital head end systems at divisional net sales of 29,000,000, up from 27.1 million in the previous quarter, and up from 23.8 million in the third quarter of 2002.

Our broadband access networks division, which designs, manufactures and markets fiber-optic products, had divisional net sales of 18.3 million, up from 14.5 million in the previous quarter, and up from 13.2 million in the third quarter of 2002.

In the third quarter, our largest customer was again Comcast, representing 38% of total sales.

We believe this reflects our very strong position as a supplier for Comcast, as they execute their plans for network upgrades in the former AT&T systems and aggressively roll out new services such as Video-on-Demand.

We also made shipments to Adelphia as they begin to spend again on capital equipment.

As well as to Cox and other domestic cable operators.

The satellite business is always lumpy on a quarter by quarter basis, our DBS customers continued their introduction of local channels to new markets, and are beginning to address the significant bandwidth requirements of new services such as high definition television.

By market segment, sales to our cable customers represented 79% of total revenue, in the quarter, sales to satellite customers represented 12%, and other sales principally to Telco and broadcast customers represented 9%.

Domestic sales were 71% of total sales for the third quarter, compared to 73% in the second quarter of this year.

Europe remains generally weak because of continued financial restructuring by many of the major operators, although we saw revenue from countries such as Spain and Portugal in the quarter.

In Asia, Japan, Korea, and China, continued to show good prospects for growth and all were solid contributors during the third quarter.

Gross margins on a non-GAAP basis were 34.5% in the third quarter, up on a sequential basis from 32% in the second quarter, mostly due to volume growth.

But we also continue to realize cost reductions both from our suppliers and in our own operations.

Non-GAAP operating expenses were 20.7 million, for the third quarter of '03, down from 25.1 million, in the third quarter of '02, and up slightly on a sequential basis from 20.2 million in the second quarter.

We remain committed to cost control and reduction efforts, and at the end of September our headcount was 558, down by one from the end of June, and down from 587 at the end -- I'm sorry, at the beginning of the year.

The non-GAAP loss for the quarter was $4.2 million, or 7 cents per share.

Compared to a non-GAAP loss of 13.3 million, or 22 cents per share for the third quarter of '02.

The non-GAAP loss excludes a non-cash charge for the amortization of intangibles of 3.5 million, a charge from an adjustment to the company's reserve for excess facilities of 900,000 dollars, and a credit relating to the sale of previously reserved inventory of $1.1 million.

Including these items, the GAAP net loss for the third quarter was $7.5 million, or 12 cents per share, compared to 38 million, or 63 cents per share for the same period of 2002.

And once again, a reconciliation between these GAAP and non-GAAP results, are in the press release on our web site and in our 8-K filing with the SEC.

Turning to the balance sheet, many of you may recall the receivables were higher than usual at the end of last quarter.

Partly because it was a more back end loaded quarter than is typical in the second quarter.

The linearity was much better in the third quarter and I'm pleased to report that our receivables decreased to 32.1 million at the end of September, down from 34.8 million at the end of June.

These sales outstanding were 62 days down significantly from 76 days at the end of June.

As a result we burned only $2 million in cash at the quarter and ended the third quarter with a total cash position of 34.2 million.

Inventory was 21.2 million at the end of September, also down, but slightly from 21.6 million at the end of June.

Our capital spending was about 800,000 dollars in the third quarter, $2.3 million year to date, and we now expect cap ex for the full year to be less than 4 million.

Also, as many of you are aware, we have tax liabilities remaining from our acquisition of DiviCom in 2000.

We paid less than $100,000 to a firm tax authority in Q3 and expect no significant payments in Q4.

The remaining balance will be due in a series of payments throughout 2004 and probably into 2005.

With respect to the outlook for the rest of the year, we are seeing positive developments.

In the fourth quarter, we expect to see continued revenue growth and a further move towards profitability.

We expect fourth quarter revenues to be in the range of 50 to 53 million, with our non-GAAP net loss in a range of a 3-cent net loss to break even.

On a GAAP basis, including the amortization of intangibles, we expect a net loss of 9 cents, to a net loss of 6 cents per share.

All of these per share numbers are based on the current share count, excluding our proposed offering.

With respect to that offering, we announced today that we filed a prospectus supplement with the Securities & Exchange Commission, related to a proposed offering of 7.5 million shares of common stock, all of which are to be sold by Harmonic.

The managing underwriters of the offering are expected to be UBS securities, sun view technology group, and Needham company.

In connection with the offering, we expect to grant the underwriters an option to purchase up to 1,125,000 additional shares to cover over allotments.

Because of applicable securities laws, we cannot make any further comment on the offering at this time.

But we direct you to the prospectus supplement that we filed today with the SEC, for more information.

That's all for me.

Tony.

Thanks, Robin.

We're very encouraged by the improved capital spending by many of our customers in both the fiber-optic and the digital video side of our business.

Although the worldwide market remains a challenge, there are signs of the recovery in the financial outlook of the operators we're seeing more competition between the cable, satellite and teleco companies, which is accelerating the transition to digital video and the roll-out of high definition TV.

This puts the capacity of the bandwidth of the poor path under pressure and is one of the driving forces for the increasing demand for low [Inaudible] coder, high definition encoders different -- high definition encoders and many of our other products.

At the same time, some of our cable customers are increasing their deployment of our fiber-optic technology.

The trend to consolidate head ends continues, which is being augmented by our new maxlink systems for greatly increased transmission distances.

In addition, many cable operators are further segmenting neighborhood optical modes in order to prepare their networks for the interactive services.

Especially Video-on-Demand, cable modems and IP telephony.

On the international cable front, many of our European cable customers are still working their way out to their financial problems.

However, we are seeing growing activity in some of the Asian markets.

During this third quarter, we announced that C and M, Korea's largest cable operator had deployed our digital video [inaudible] transport systems including our encoders, multiplexes, broadcast network gateway, and [inaudible] digital service manager.

In the domestic cable market, our business is being driven by the growing interest in our video systems solution, for Video-on-Demand, high definition TV and IP-based services.

To address these needs, we continue to roll out industry-leading products.

We recently introduced a third generation of our [inaudible] services gateway, a smart-edge device for Video-on-Demand solutions.

The new NSG 9,000 series will enable cable operators to cost effectively and reliably provision a broad range of America cast services from Video-on-Demand to HDTV, to switch broadcast.

We also introduced our new line of digital video encoders.

Our new MV450 is an advanced real timing coder for high definition TV, for which the demand is definitely increasing.

We believe our new MV100 encoder will enable to us gain further bit reductions in the case of MPEG2 compressions, but it also has the much increased computing power required for the implementation of the new compression standards, H 264 and windows media 9.

And our new MV30 is a low bit rate video encoder that [inaudible] in a cost-effective package.

We believe that the Harmonic range of digital encoders and those device is now very competitive.

At the recent international broadcasting convention in Amsterdam, we announced we were working with Microsoft to bring windows media 9 to broadcast TV marketplace in addition to our supporting edge 264 standard.

As many of you know, the digital television world of today is based almost entirely on MPEG-2.

We've made substantial progress with MPEG-2 such as being able to replace one Analog TV channel with 18--up to 18 high quality digital channels.

Giving an effective bit rate for high quality less than two megabits per channel.

While we continue to make advances with MPEG-2, we're starting to reach an area of diminishing returns.

We believe the new compression techniques should eventually reduce the bit rate by a factor of two.

Equivalent to doubling the bandwidth of the worlds infrastructure for TV transmission.

This capability is needed for a number of converging trends.

The advent of HDTV, a real hog, the desires of the Telcos to current transmit videos over DSL, and [inaudible]existing operators can make more money and retain their subscribers more easily with more channels and services such as Video-on-Demand.

In satellite, we've seen the market improve this year, both here and abroad.

Our deployment with DirecTV, echo star and other satellite broadcasters around the world, testify to our leadership in digital video technology for real time Mpeg-2 compression.

We are now engaged in discussions with our key satellite customers about the development and introduction of the new compression technologies.

In the Telco arena, we see rapidly growing worldwide interest in digital video.

Our encoders currently enable Telco's to provide television over DSL, using MPEG-2.

The DSL bandwidth is very limited and we believe the Telcos are anxious to move to the next generation conversion standards as soon as possible.

We are also following the development in fiber to the premises or FTP-based technology in domestic market very closely and believe the future deployments will create markets for both our fiber-optic and digital video products.

During the third quarter we also succeeded –we also scored a success in moving our digital video solutions upstream in the content delivery chain to the network distribution and program origination market.

We announced that the fox sports group had upgraded its Houston and Los Angeles uplink sites with our video encoder and statistical multiplexes to compress and combine regional and national content into multiple standard definition and high definition channels.

These channels are distributed via satellite, to cable direct to home satellite and other carrier networks head ends across the continent.

This application represents another new market opportunity for Harmonic.

In summary, the worldwide capital spending environment remains challenging, but we are pleased with our continued revenue growth and improved operation efficiencies.

We're excited about the introduction of our new products, our developmental work with H 264 and Microsoft windows media 9 and growing recognition for our technology across different markets.

We continue to believe broadband operators will need to upgrade their networks in order to keep pace with the demand for more digital video channels, video on demand, high definition video and IP-based services and we believe we remain strongly positioned to address the competitive needs of our cable, satellite and Telco customers.

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

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 a three-tone prompt to acknowledge your request.

If your question has been answered, and you would like to withdraw your registration, please press the 1 followed by the 3.

If you're using a speaker phone, please lift your handset before entering your request.

One moment, please for the first question.

Our first question comes from the line of Dennis Gallagher with SoundView technology group.

Please proceed with your question.

Good evening, and congratulations on the quarter.

I just had -- I guess I had multiple questions, but the one I wanted to start with is simply you talked several times on the call about high definition, and we're beginning to see volume deployments in that more MSOs are starting to widely distribute a greater number of high definition channels.

I wonder if you could talk about the opportunity for Harmonic there.

When it comes to -- it comes in two forms, really.

The first of course we sell high definition encoders and it's -- these are much more expensive products than the standard definition encoder, of course the volumes they're not tremendous at this stage but they're interesting and it's solid.

And then secondly, there is the problem of how do you multiplex high definition channel with standard channels and we do that, so it increases our ability to sell in a complete head ends or complete transponder lineups.

And not only are we seeing the interest by the operators in high definition, but in our discussions with set top box manufacturers and even going further back to semiconductor people, we do see that the market, and the consumer products people are going to roll out a great many offerings in the high definition television for people's houses.

So we do think this market is going to grow, and for us also it puts tremendous pressure on the bandwidth of the system because HD takes up more than the standard definition.

It's one of the drivers of our business.

Okay.

That's it, then, thank you.

Our next question comes from the line of Anton Wahlman with Needham & Company.

Please proceed .

Tony and Robin, can you hear me?

Yes.

Could you discuss a little bit the timing of availability of your H 264 as well as windows media player 9 functionalities of the new version of your MV encoder.

Yes, Anton.

We expect that to be making these compression technologies available, standard definition during the course of 2004, and probably high definition to follow the year after.

So, that goes for both Hdot 264 as well as windows media player in both standard definition and high definition, respectively?

It's quite likely, I think it's far from clear at the moment which one the market wants first, but Harmonic is certainly going to make both of those.

All right, thank you.

Our next question comes from the line of Daniel Ernst with Rodman and Renshaw.

Please proceed with your question.

Good afternoon.

Two questions.

One, on Comcast at 38% of revenues, what percent of that comes from the upgrade factor on the former AT&T properties, and what percent would come from new services like HD, and VOD, and I ask that because Comcast is saying that they're winding down their effort to upgrade and it's going better than expected, and they should be done within the next two quarters.

So, what does -- does it do to your Comcast revenues when the upgrade part is done and what's left with rolling out new services?

And second, or related to that is what is the growth outlook look like for next year, and what's the path of profitability?

I mean, there's a lot of these different rollouts of HD, VOD [inaudible] and then there's the European element, but what kind of path can we expect to see you guys break even and actually start turning a dime?

Let me address the questions about Comcast and the technology and I'll ask Robin to come in for the latter part.

But then, the generalized, there is the feeling, of course, the cable [inaudible].

That statement is true when you mean the upgrade is 750 megahertz and obviously tremendous progress is being made in Comcast as well as the other companies, in getting this part of the job done.

And of course, that affects greatly the capital budgets, but the interesting thing, though, is when you're done that, you still have the question, bandwidth, the question is [inaudible] still support the interactive services, and that leads you into the other side of the business which is how many houses do you have to [inaudible] starting to see more and more requirements in the market as people roll out the services and expecting that side of our business to increase.

And I think although capital -- although companies will say their upgrades may be done and capital budgets reducing, to do what we're talking about and, and the amount of money they spend with us is very small in the whole equation, and we do think that the -- the, if you like, the upgrade of the network for the new services, that is going to continue for a very long time to come.

I hope that answer that bit of the question.

Robin?

Dan, on the profitability question, I think first of all on the guidance we gave for Q4, I think I had at least thrown out at least the possibility of the high end of the range that we could be already at break-even on a non-GAAP basis, in the quarter.

I think the path there is holding our costs down, taking advantage of what we think is a firmer capital spending environment, delivering on -- delivering the new products that we've announced.

The margin impact, of which is very helpful, I think some of the things we've done with new versions of existing product and new products, allows us to continue on the path of margin expansion, so I think that is the path.

And as I say, I think we've already given you some idea that we think that is pretty close.

I don't want to go beyond that into the individual quarters of next year, but I think we're certainly well on our way.

Okay.

Tony, if I could back you up on the Comcast question, agreed that 750 is the first stair step up, and that over time they'll have to do more and it will be the hard to measure nodes splitting and additional capacity in particular places, but I would think that would be incremental compared to the big push they've been doing to upgrade.

The AT&T networks.

I guess it would be for your income statement perspective, it would be a question of timing, so one big push finishes portion and does this incremental upgrade make up for it.

Well, I can't comment on what Comcast is going to do and I shouldn't, but we do believe that the market for fiber optics will continue for very much longer than most people think.

Okay, fair enough.

Last question.

Did you have an involvement in cablevision's [inaudible] HD network jus launched this week?

We haven 't made any announcement about cablevision's network at all.

We are very interested in the fact they're talking about high definition, and Mpeg-4 in the future but we've made no announcement about cablevision.

Okay, thank you.

Our next question comes from the line of April Horace with Janco partners.

Please proceed with your question.

Hi, good afternoon, to dovetail off the cablevision question, in cablevision's announcement of their new service, they said they were going to upgrade to Mpeg-4 in Q3 of '04 and if I heard, you didn't think your Mpeg-4 was going to be ready until 2005.

Does that put you out of the running, or is there a disconnect between --

Perhaps I didn't put it clearly enough.

I said Harmonic will standard definition version of these new compression standards by 2004.

High definition probably won't be available or needed until 2005.

So the new encoders will be MPEG-4, correct?

I'm saying -- well, MPEG-4 covers -- [inaudible] so we will have encoders during the course of next year, that will do, if you like MPEG-4 or windows media 9.

Okay.

And these questions are probably for Robin.

With respect to the 10% customers, is Comcast the only 10% customer?

Yes, April, that's right.

Okay, and then I've noticed that the satellite contribution on a total dollar amount has been declining over the last couple of quarters.

Is that in part because DirecTV had the -- had to delay the launch of its satellite?

I think it's more that it's just a lumpy business.

It is dominated for the most part by the two large domestic players, and on any -- yeah, on a quarter by quarter basis it's just inevitably lumpy.

I think it's part of the swings and roundabouts.

The other thing, in the quarter, we didn't have any major international satellite business either, and that's unfortunately is equally lumpy.

So it was definitely a quarter in which cable was leading the way.

Okay.

And then, just as a kind of a housekeeping, where did you classify fox sports?

Is that cable, satellite or does that get lumped into the other?

We counted that as broadcast.

I mean, it is, I suppose, technically it's satellite application, but it's not direct to home, so we put it in the broadcast category.

Great, thanks, that's all I got.

Thank you

Our next question comes from the line of Erik Zamkoff, Independent Research Group.

Please proceed with your question.

Hi, good afternoon, great quarters, guys.

My question is related to Cox and their announced VOD deployment with C-change.

I was wondering if you're seeing an up tick in narrow cast server gateways, related to the impending deployment there, and I was also wondering if you could take an opportunity to talk about new services in general, and whether it is correct to assume that as new services proliferate there's a increase in bandwidth required to the end user and that could lead to continued out performance on the broadband network side of your business.

I would like to [inaudible] part of your statement there.

The interactive video services, interactivity require us to keep -- including the performance of the fiber side of the network and basically that's what's driving our fiber-optic business, and I think that will continue, as I said, for a very long time.

In terms of Cox, all I can tell you is that our NSG has a very significant share of the market in Video-on-Demand across North America.

and one other quick question.

Can you provide an update with respect to international cable operators, and if you're seeing a -- what the timing is on a return to spending for operators like UPC, and Telewest, teleuponica (ph), et cetera.

Asia is really coming -- is really coming along more strongly.

Europeans still taking their time, but I think it's fair to say, we are seeing signs of life where there was absolutely none before, and we're very optimistic.

In the next year we're going to start seeing revenues from the what you're talking about.

Telewest, the markets in Spain and Portugal, in fact, remained fairly consistent now and in better shape for some time.

Excellent, thank you.

Great quarter.

Thank you.

Our next question comes from the line of Greg Mesniaeff with Credit Lyonnais Securities .

Please proceed with your question.

Thank you.

Most of my questions have been answered.

Robin, if you can give a little bit more color on the satellite percentage contribution, which was I believe 12% of total sales in the quarter.

Any thought as to why, you know, DirecTV has scaled back its purchases there?

Does it have anything to do with the ownership of DirecTV, the pending ownership, and any delays associated with any decisions on that front?

I don't think we said anything about DirecTV scaling back purchases.

We certainly haven't said anything about that.

I mean, April's question earlier, I think there's not much more I can add to that.

The satellite business does have a lumpiness associated with it, just because there's generally a smaller number of customers, and two very large ones.

So, I think it's really more just the lumpy quarter to quarter business.

We see no indication on the ownership or pending ownership change, I guess it's not done yet.

We see no indication there is in the change of the competitive landscape.

Ok, that's my only question.

Thanks.

Our next question comes from the line of Steven Kamman with CIBC World Markets.

Please proceed with your question.

Likewise, most of my questions are answered.

But one question on Adelphia, what's your exposure there, and if you could characterize how much of that is going to be -- are they doing anything in terms of adding new channels or is this all going to be on the cable side and any additional color you could offer.

Yeah, I mean in terms of exposure, as we said the only 10% customer was Comcast and we're not going to break them down below that but Adelphia certainly has returned to the ranks of those who spend money in the third quarter, most of what we've seen to date has been on, as you suggested, on the network upgrade side.

Any potential there for further sales on the encoder side, or is this really more still in the network upgrade?

I think in due course.

I don't want to speculate, but logically it would be in due course once some of the networks upgrades have been completed.

Okay.

And then, would we assume that if that HDTV satellite is not up yet, that probably they have delayed a little bit on spending there, but obviously the satellite goes up, they will spend the money.

Is that how they run their business?

Are they going to build the encoding capacity in advance?

I'm not sure we're very well placed to comment on how they run their business.

I mean, generally, I think you'd see maybe I'd defer to Tony on this, but I think you generally see the satellite up before the encoder goes in.

I figured you were in better shape to comment than I was.

Thanks very much.

Our next question comes from the line of Michael Perica with Bean Murray.

Please proceed with your question.

Thank you, just want to follow up, Tony, on your earlier comments on fiber to the premises.

Kind of two-part question.

First, given that the Telcos aren't likely to offer video right away would they still install the video link overlay as the specifications calls, and if so, and if your partners advanced [inaudible] approved for winning this business, what would be sort of your participation kind of as a percentage of the equipment needed to do this?

Thanks.

It's not very clear to us, I think, or anybody else until Telco makes a statement much as to what they're going to be about rolling out television, but the fact of the matter is that to be competitive with the cable, you can make the justification for fiber to the premise, but I think it's clear you have to be selling television to make it all pay.

We're not privy to what they're thinking about, but we would expect to see significant rollouts of video when they do get going.

I guess the question I really have is, there's some initial preparation because there's a lot more factors that have to be sort of the CPE has to be figured out but initially are they going to put the lasers in right away even though they won't offer video services right away?

Again, until they -- until that's get going, you can never be sure, but our understanding is that they have very intense interest indeed in the video side of the network.

It is quite surprising, but I do think they're under the impression they have to roll out video, and so in the RFP that the industry received, video was a very large piece of it, and I'm quite sure they're looking at it very carefully indeed with intention of putting it out as early as possible.

Fair enough.

I guess, while I'm on the call, Robin, if you could comment on sort of the leverage to your financial model, especially on the operating expense side.

Can we still expect that to be rather flat in the December quarter, despite the up tick in revenues?

Yeah, that's certainly the game plan; to try to keep operating expenses pretty flat at around -- on a non-GAAP basis, about 20,million or so.

We did pick up a little in Q3, but as you also probably heard, the headcount was flat, actually down by 1.

So that's the game plan, is to take advantage of what appears to be a strengthening market.

Build the revenues, expand the gross margins, keep the operating expenses flat.

So we could see op EX come down?

I think flat.

Fair enough, thank you.

Our next question comes from the line of Mikkos (ph) [inaudible], with UBS.

Please proceed with your question.

Yeah, I had three very quick questions.

You know, Comcast was up sequentially as a customer in absolute dollars.

Can you talk about whether or not that was all on the band side or was it combination of the two businesses?

It was both.

I think somebody said earlier the upgrades were going well.

I certainly would say they seem to have hit their stride, but the same can be said of VOD rollouts.

So I think Comcast, at least as far as we're concerned, our business with Comcast is firing on both cylinders.

and the gross margin was up strongly, yet the mix kind of worked against, you know, the gross margin mix worked against the company there.

Can you talk about, you know, going forward as revenues increase, how much more you think the gross margin could go up, because I would have thought it wouldn't have gone up given as much of the mix of the two business this is quarter.

I think Mikkos, that's testimony to what we've been able to accomplish here in terms of cost reductions and redesigns of both existing products and of course designs of new products, there's a lot going on that we're beavering on here that we haven't been making headlines about.

But I think your point is a good one that normally you would expect that margins would be challenged by a somewhat richer mix of band products.

But that is not the case.

And so, hopefully that bodes well for margins as we go forward and certainly our guidance is based on further gross margin expansion.

One last question, I'm not sure if you commented on, this I didn't hear it.

But the other category, you know, almost 10% of sales, double sequentially, what -- was there anything that drove that, or was that just broad improvement in both Telco and broadcast, or was there anything specific there?

Well, as we mentioned and I think in response to I think it was April's question about where we put the fox sports deal, we did recognize most of the revenue on that in the third quarter.

We categorized that as a broadcast customer, and that's certainly -- that revenue has certainly had an impact on the broadcast or the Telco and broadcast segment.

All right, thank you.

Our next question comes from the line of Larry Harris with Openhimer(ph).

Please proceed with your question.

Yes, thank you.

Any signs of life at charter, you said you were seeing improvement in Adelphia.

Any signs of life at Charter, or do they still appear to be focusing on their finances at this point?

Yeah, we are seeing orders from charter . it's more on the video side of the world, but they're definitely back to spending money with us.

What do you mean on the video side of the world, would that be the convergence systems?

At the moment it is the convergence systems.

I'm sorry, yes.

Okay, great.

Well, thank you.

Ladies and gentlemen, as a reminder, to register for a question, please press the 1 followed by the 4 on your telephone at this time.

Our next question comes from the line of Alan Benzoa, with Friedman Billings Ramsay.

Please proceed with your question.

[inaudible] on international sales in Europe you said things were pretty weak, which seems to be across the board, but you did mention Portugal and Spain.

Is that going to be areas in like the O and O, properties or [inaudible], Portugal.

Yeah, we don't want to get into too much customer detail, but yes, I think we could say it would be some of the usual suspects, yes.

Okay, and then on the digital head end side, how big was that?

I understand you're selling to some of the Telecom providers and nontraditional providers in Asia.

Well, the breakdown -- could you give me the question again.

Are you talking about the segment or the geography?

More so the segment and digital head end and I'm going to ask about the NSG server as well.

Usually the case in the convergent systems area, the encoding product line is usually the biggest single contributor, and the NSG is pretty close behind, and that's pretty much the way it was also in the most recent quarter.

and as far as digital head ends in the broadband Nexis group.

What product are you talking about specifically?

Digital head ends into the Telecom space.

They would in convergent systems because if that is video over DSL video applications that would be mostly encoders and multiplexers. [inaudible] .

How big was that, then?

That was pretty small in the quarter, then?

No, I mean anything we did there would be in -- yeah, would be in our encoder product line.

I mean, we don't break out our product lines by particular market segment.

I mean, as you can probably figure out from the segment number, the -- there wasn't a big Telco contribution in the third quarter because the broadcast and Telco segment as a whole was dominated by the Fox deal.

Gotcha.

We didn't have any big Telco head end in the quarter.

Okay.

And my other question is on the balance sheet.

There's a line item called unrestricted cash.

I wanted to see what that is.

I haven't seen that in the past.

Well, actually restricted cash --

I'm sorry, restricted cash, sorry.

Well, under the terms of our guidelines we have certain restrictions on cash when we hit particular thresh holds and I believe in this case with a couple creditors standing, we triggered one of those thresholds, so a certain amount of crash cash is restricted by the bank.

No practical effect for operating purposes, but it's a disclosure item because we hit a particular threshold.

Great, thanks

Mr. Ley there are no further questions at this time.

I'll turn the conference over to you at this time for closing remarks.

Thank you, ladies and gentlemen, thank you for participating in today's conference call, and we look forward to speaking to you again next quarter.

Thank you and goodbye.

Ladies and gentlemen, that does conclude your conference for today.

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