Harmonic Inc (HLIT) 2005 Q3 法說會逐字稿

Good day ladies and gentlemen and thank you for standing by.

Welcome to the Harmonic third quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to turn the presentation over to your host for today's conference Anthony Ley, Chairman, President and Chief Executive Officer, Please proceed sir.

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 all for joining us.

Today we announced our results for the third quarter of 2005.

The revenue is at the high end of our expectations of the second half and it was a very important quarter for us as we continue to roll out new technology and win new orders for our digital headend and fiber-optic systems across different markets.

We believe our exciting new products introductions will help shape the future of video, providing a variety of different operators with the ability to offer multi service,multi network, multi channel and multi resolutional video.

So we're growing [a way] of end points including mobile devices.

During the quarter we also extended our customer base in Europe and Latin America.

We continue to help our cable customers with digital simulcasting and network upgrade projects.

We shipped our systems to yet more international telco opera -- customers.

And we worked closely with your satellite customers in their planned migration to new compression technology and high [define] upgrades in 2006.

At this point I'm going to ask Robin to cover the financial aspects of the quarter.

And I'll then revue some of our progress during the period.

Robin.

Thank you Tony.

Good afternoon everyone.

During this call we may make projections or other forward-looking statements regarding future events of the future performance of the Company Please note that such statements are only predictions and actual events or results may differ materially.

We refer you to documents that we file with the SEC, including your most recent 10K and 10Q reports.

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

We will also provide you with financial metrics determined on a non-GAAP or pro forma basis, and these items together with the corresponding GAAP numbers and reconciliation to GAAP are contained it today's earnings press release which will be posted on our website and filed with the SEC on a form 8K.

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

Some of this the information is the press release and the remainder is available in a recorded version of this call on website.

Today we announced results for the quarter ending September 30th, 2005.

For the third quarter we reported net sales of $61 million up 20% from 50.6 million in the third quarter of '04 and up 2% sequentially from 59.8 million in the second quarter of this year.

Our conversion systems division which designs, manufacturers and markets digital headend systems had divisional sales of 35.8 million in the third quarter of '05 compared to 34.6 million in same period of 2004 and 43 million in the second quarter of 2005.

The sequential decline the conversion systems revenue is primarily in the cable segments and was most notably a result of reduced orders from Comcast in resent months.

However, during the third quarter as Time-Warner Cable initiated a number of digital simultaneously projects using Harmonic coders, encoders and other equipment.

Our Broadband Access Networks division, which designs, manufacturers and markets fiber-optic products, had divisional net sales of 25.2 million in the third quarter of '05 up from $16 million from the same period in '04 and from 16.8 million in the second quarter of '05.

The increase in -- in Band sales reflects substantially increased shipments to Tellabs, for the video infrastructure portion of Verizon's [SCTP] projects.

We also saw a healthy increase in sales into the international cable market.

By market segment, the cable revenue in the third quarter was 58% of our total revenue.

Our satellite customers represented 17% and Telco's and others represented 25%.

In spite of the much discussed transitions to new compression standards and it's somewhat negative affect on this year's capital spending by our largest satellite customers the satellite segment had it's best quarter of year.

I believe this demonstrates that the international market remains quite healthy.

Our recently announced deployment of Astra in Germany is a very good example .

In the telco segment we had our only 10% customer in the quarter.

At Tellabs, our channels of Verizon, each represented 13% of our total sales.

A side from Verizon, we continue to success in video over DSL deployments by international telcos.

Our telco revenue in Q3 included a new telco TV project in Latin America, an expansion from a European system.

We also booked orders for new European telco customers for delivery in subsequent quarters.

Our International sales represented 44% of total sales for third quarter of '05 compared to 41% in the second quarter.

Relative to the second quarter we saw particular strength in Europe in both divisions.

In addition to the Astra project, we participated in several video and demand rollouts and major network segmentation projects.

Our gross margins in the third quarter were down for two principle reasons.

First the product sold into the SCTP project carried margins substantially lower then the corporate average.

In addition we recorded a $1.6 million charge in excess inventory specifically related to product transitions in certain convergent systems product lines.

Within the last six months we have introduced several new convergement systems products including the MV3500 high definition encoder, the Ion, the Electro 1000 and 5000, as well as Digitrack over IP.

As many of our customers rapidly adopt these new products, we found it necessary to establish reserves against some of the previous versions of these products.

As a result of these reserves and the lower SCTP margins non-GAAP gross margins were 35% in the third quarter compared to 39% in Q2.

While gross margins were certainly disappointing we did make up some of the ground with operating expense control.

Our non-GAAP operating expenses excluding the amortization of intangibles were 24.6 million for the third quarter of 2005, down sequentially from 26.1 million.

This sequential decrease reflects a number of factors.

First we had much lower expenses for trade shows with only one major show in the third quarter compared to four events in the second quarter.

In addition of course, the third quarter is a relatively heavy vacation quarter.

And we have also been very tight on hiring.

At the end of September our head count was down by six in the quarter to 647 people in total.

Our GAAP net loss for third quarter was 2.9 million or $0.04 per share compared to a GAAP net loss of 4.4 million or $0.06 per share for the same period of 2004.

When we exclude the non-cash amortization of intangibles but still including the inventory charge, our non-GAAP net loss for the third quarter of 2005 was $2.6 million or $0.04 per share, compared to a non-GAAP net loss of 2 million or $0.03 per share for the same period of 2004.

As I turn to the balance sheet, our cash position improved in the third quarter with cash, cash equivalents, and short term investments of 1.49 million at the end of September, up from 98.2 million at the end of June.

Receivables were 48.2 million, the same as at the end of June with DSOs down slightly at 71 days.

Inventory was also relatively flat at $43.1 million.

Our capital spending was approximately 4.2 million in the first nine months of the year and expect it to be approximately $6 million for the full year.

With respect to the outlook we had stronger order input the third quarter than we did in the second quarter.

And we entered Q4 with healthier backlog than three months ago.

However at the same time we anticipate some of the usual seasonal slow down after Thanksgiving and we've also seen tighter CapEx spending by at least some of the MSOs in the second half.

And so in balance, we expect fourth quarter revenue to be similar to that of the third quarter.

This does include continuing SCTP shipments in the fourth quarter from current backlogs.

But we do not expect to make significant domestic SCTP shipments during 2006.

It has become fairly clear that the lower pricing requirements in this business, in the future, are simply uneconomic for us.

With respect to the rest of the outlook for 2006 the customers are still in the process of developing their detailed plans and budgets.

And it's a been [accure] to give any specific guidance for next year at this time.

So in summary, we are curtailing hiring in order to hold down our operating expenses and of course we are still assessing impacts of resent developments on our SCTP business.

However we remain focused on continuing new product development and introductions in order to drive our revenue and to improve our gross margins.

Our strong cash position allows us to continue to make these very necessary investments.

That's all for me.

Tony.

Well thank you, Robin.

Well we believe we significantly strengthened our competitive position during 2005 extending our technology leadership and penetrating new markets worldwide.

During this third quarter we introduced a number of ground-breaking new products to the marketplace.

Let me focus on three that we demonstrated at the resent IBC show in Europe.

Now to become MV3500 encoding platform is the first multi-format high definition encoder supporting the use of MPEG4 or VC1 or MPEG2.

It's the most powerful encoder of it's kind.

This fully featured encoding platform brings performance, video quality, and proven [interoperability] from the headend to the home.

It's precisely what operators need to offer a rich high definition experience [at low bit range].

And with one of the longest running and most extensive interoperability programs in the industry, Harmonic is facilitating the introduction of ready to -- to deploy solutions including MPEG4 HD set [inaudible] boxes which for the most part are only now slowly becoming available.

We also introduced our new [digicom] Electra 5,000 multi servicing coding platform that enables operators to simultaneously encode multiple channels in multiple formats using multiple compression standards.

In other words, the Electra 5,000 offers an unprecedented level of flexibility and multi service encoding, but gives operators the ability to broadcast video service to a variety of devices.

Going well beyond single Kodak multi-channel encoding, the Electra 5,000 also makes it possible to rapidly introduce new services such as advanced picture-in-picture, personalized mosaic program guides, high quality PC streaming and [CV] to the hand held, over all sorts of different kinds of networks.

This revolutionary product can help greatly expand the operator's geographical reach, customer base and revenue potential.

On the cable market we introduced a new coarse wave-division multiplexing digital transmission system that scales for being returned past bandwidths from the home.

In tandem with digital simulcasting initiatives designed to to reclaim downstream capacity for HDTV, VOD and other value-added services.

Cable operators are segmenting their hub-to-home networks to deliver more reliable higher speed bandwidth for internet access and next generation interactive services.

Our new return power solution helps cable operators fully leverage the established HFC infrastructure while minimizing the need for fiber-construction and supports redundant paths to increase network availability for telephony and other emerging services.

With the addition of our new digital CWDM systems we have one of the most comprehensive offerings of bandwidth reformation, segmentation and extension.

The MV3500HD encoder, Electra 5,000 multi service encoder, and CWDM return path solution are only a few of our important new innovations.

We strongly believe that our new products and technologies will help shape the future of video.

And the response by your customers has been remarkably positive.

Now we also continue to win new orders for digital headend and fiber-optic systems across different markets.

Despite a slight slow down of spending by some of our traditional cable customers during the second half of 2005, they continue moving towards the full triple player video, voice and data services.

As we said before, digital simulcasting is an important step for cable operators towards reclaiming bandwidth for more high definition channels, video on demand, and other services.

The simultaneous casting projects remained a major contributor to our revenue in the third quarter, As Time- Warner, in particular, began deploying our systems.

In coming periods we expect the most domestic cable operators will be rolling out digital simultaneously in one form or another and segmenting their networks as they migrate to all-digit networks.

During this quarter we announced that Telewest is deploying our Americast services gateway to deliver it's new TV on demand cable service in the UK.

And in 2006 we expect to see a renewed focus on VOD from domestic MSOs.

We also saw stronger demand worldwide during the quarter for fiber-optic solutions.

We announced that National Cable Networks, a leading cable operator in Russia, is deploying our transmission systems in scalable notes through up -- upgrade the performance, reliability, and capacity of existing infrastructure, as well as, expand it services.

Our satellite customers continue to work with us to provide more standard definition -- definition channels and increase the deployment of high definition and local channels.

Astra Platform Services, a leading Europe satellite distribution and DTH provider recently have deployed our MV100 encoding platform and DiviTrack Statistical Multiplexing Solution to enable it's Next Generation of satellite broadcast services.

APS's selection valid -- validates our video compression capabilities and market leadership.

Although we had a lower revenue from Satellite customers so far in 2005 we expect Satellite to remain a major business segment for us.

Satellite operators today are actively planning to migrate towards Next Generation compression standards and are carefully evaluating their options.

We believe the focus on planning and evaluation from migration to Next Generation compression has impacted our Satellite business in 2005.

However our encoders are for a built-in migration passed to impact 40VC1.

And this is a key competitor advantage.

In particular we believe your recent introduction of the first multi-format high definition encoder supporting both MPEG4 and MPEG2 represents a superior choice for many operators.

And we're fully expect increased Satellite business in 2006.

In the domestic telco market we made significant shipments of fiber-optic products to Verizon Communication for it's fiber [inaudible] deployment.

As Robin said, we expect additional SCTP shipments in the fourth quarter although it -- it appears shipments in 2006 will be lower as some of the Ford business is simply not profitable for us.

That said it's important to remember that today we are only in initial stages of the telco's entry into the new services with many opportunities and challenges ahead.

We believe we are well positioned over the long-term with one of the most comprehensive range solutions for enabling and delivering [rollcast] quality videos services over fiber [D] and DSL networks.

In fact at current count more than 25 telco customers worldwide are currently using our high performance encoders for IPTV.

During the third quarter new telco customers included operators in Europe and Latin America.

We also announced that VNL, a telco operator in the UK has completed the migration of it's broadcast lineup to MPEG4 becoming thus the words first revenue generating broadcast television service delivering -- delivered exclusively using an advanced compression technology.

Moving into the fourth quarter, given the [power] [inaudible] encoder product line we expect to continue to win new business for IPTV systems worldwide.

So in summary while 2005 has been a challenging year in many respects and timing of customer deployments remains difficult, the long-term industry trends and our business fundamentals remain positive.

We are encouraged by the continued diversification of our customer base worldwide and the tremendous potential of our new products.

We believe our new technology will help shape the future, where operators of all kinds are provide multi-dimensional video services through multiplicity of end user devices.

We believe that our cable, satellite, and telco customers see us as a key part in their -- in their future plans as a technology leader with breadth or breach systems that open the door to the extending their revenue streams in many directions.

We continue to invest in developing and introducing innovative products and remain very enthusiastic about our prospects over the longer term.

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

[ OPERATOR INSTRUCTIONS ] Robert Tango, Lazard

Hi, thank you.

Two questions one on the telco segment and on the MSOs.

Your, as you go into 2006, Tony, you're -- you know obviously the component that you're supplying to tellabs and ultimately to Verizon, obviously it's -- it's not being to profitable for you, as you indicated the margins are not going to be there.

Have they elected to choose someone else?

Was this a competitive situation where they've elected to go with a different component supplier?

And in question number two, the change in outlook regarding certain MSOs going into fourth calendar quarter, could you give us a little bit of help, what's what happened in the last three, four, five weeks that's sort of caused you to become a little more hesitant about their -- their spending or was this just a -- a Comcast specific situation?

Thanks.

Thank you, Robert.

Let's see.

This year in 2005 we were -- we believe so -- the sole source for the product that went through Tellabs and onto Verizon.

And of course, as you know, telco has tend to won multiple sources and in fact they have gone out for other sources and they selected, I don't know, the least one other.

And before pricing on this is such we don't find this very attractive so we think our business will be very much less going forward.

And you know that's just life.

It's been very good business so as far.

We will -- can certainly sell the products in other places but we think for your major customers at this time this is perhaps not the place to be given the -- the pricing that's now in the marketplace.

In terms of the MSO spend, certainly for us -- and I think, I believe Comcast said that their first half spend was -- was slightly greater than the second overall because we're a small part of Comcast whole spend.

We, in our particular sector, we think they did slow down a bit comp -- in the second half compared with the first and that does have quite an affect with us given the size of business we had with Comcast in the -- in the first six months.

Robert, it's Robin.

I -- I don't -- I don't necessarily agree that we've changed our tune on that.

I mean, I think our guidance we gave back in July for the second half of the year contemplated some amount of lower spending by the MSOs and by your major customers in particular.

So I think it's -- it's actually played out pretty much the way we -- we expected.

And another thing, next year, you know, but it's going to be -- should be a very good year right across the -- the digital video business in cable as well as the other sectors.

Is there -- just in terms of -- of some of the -- the decisions being made in the digital simultaneous cast arenas by some of the cable operators, obviously Time-Warner was there for you.

I guess I was just under the impression that maybe some other players -- some of that business is going to materialize and maybe offset some the -- the situation at Comcast.

I think that was probably a reasonable assumption but I think all of these companies are at a different stages and some got out of gate gate very quickly and some are taking much longer to decide really what to do.

But there's no question then in our minds that over the -- the next period of time all major operators are going to be moving into simulcast.

Sure.

Thank you very much.

Daniel Ernst, Hudson Square Research

Yes, good afternoon.

Thanks for taking the call.

A couple question, if I might.

First, just on your expectations for margins going into the -- the fourth quarter understanding that you still have the lower margin SCTP business and then, you know looking at the IPTV market with 25 telcos internationally using your encoding [gear].

Can you give us a sense of the -- the scale?

I mean to date a lot the -- the telco TV operations have been relatively small in scale, almost in trial form.

Are you seeing a form of moving that into a full-blown service where -- where they're getting excited about marketing this and we'll hear more about it?

And them just last question, you mentioned that VOD looked like it was going to have a come back in '06.

I'm just curious about what gave you confidence?

Thanks.

Let me handle the question in gross margins in Q4.

I think, overall we see Q4 being a -- a quarter with a relatively similar profile to Q3 in terms of certainly the top lines and even, to a large extent, the composition of the top by -- by -- by -- both by market segments and divisions.

I would certainly be hopeful that we -- we see some improvement in gross margins although the product mix will remain much the same as I think you observed.

I would certainly hope and expect that we would not have the 1.6 million inventory charge that we took in Q3 or certainly nothing on that -- on that scale.

So I would -- I would look to -- to see some marginal improvement on the assumes that we don't have anything along those lines.

And I -- on the operating expense front I -- expecting to see a -- a [inaudible] expenses pretty flat in -- in Q4 as well.

Okay, thanks.

And then in terms of the -- your other two questions, in IP TV, for most -- most telco operators this is a brand new adventure.

And not only have they got a fixed DSL network that [inaudible] headends they have to acquire content, they have to learn how to seel it.

It's an awful lot of stuff.

And so -- but if you look around the world, I think it's a pretty universal feeling in the telephone companies that their future is in multi-media.

And so the activity level is -- is very high and the brave ones as it were, are moving forward and building -- building their first systems.

Of course what they do is build the first major headend and then learned to get that working before they'll go on and build the others around the country [inaudible] they may need.

So I think there's a lot of seeding going on right now.

It's a nice business.

I believe it will grow substantially going forward.

And then, in terms of the Video in Demand in cable, I think al the - all the articles you read from the -- the -- the Chiefs of the -- of the MSOs very much on the lines that their future is going to be in on demand services.

And we supplied an awful lot of equipment about a year back and they have learned how to use this.

And we supply also monitoring systems that let's you see what the load is on the -- on the banks of NSG that they have in the -- in the hub supplying customers.

And from what they're saying and from what we know of their plans and what we see of the takeup of the demand, we believe that they will, indeed, be buying more equipment to scale with number of people who take the service and that is also set to increase.

Okay thanks for the color.

Marcus Coopersmith, Lehman Brothers.

Good afternoon guys.

Good afternoon.

Just to connect the dots on your response to the first question that I assume you're basically -- your looking for a sequentially a flat quarter of shipments in the Tellabs Verizon account in the fourth quarter?

Yes.

More or less, yes.

Okay.

I mean, can you give us a sense of what the book [will] looked like in the third quarter?

It was--it was quite healthy but you know which was quite a turn around from the -- from the second quarter.

You know it was probably 1.2 to 1.3, somewhere in that range.

And would you say those bookings were concentrated along the Verizon account or I mean is there strength within the -- within the business with both of them over one -- 1.1 or 1.0 to one.

It was not just -- it was not the verizon piece.

There were a number of projects some of the telco and new customers that we talked about.

Not all of those, of course, are deliverable or recognizable in the fourth quarter so some of the strength was certainly for business that not necessarily come into Q4.

So I don't want to overstate how good it was.

But it was certainly a much stronger quarter than -- than Q2.

All right and one other thing I wanted to clarify when you talked about the inventory write-off during the quarter here, should we -- can you give us a sense of what those products are?

I assumed it would be like [inaudible].

It was in the broadly in the number of areas in the encoding and multi-plexing product lines, yeah.

Sorry.

What were your third party sales also during the third quarter?

They were [backseat] where they normally are which is around roughly about 5% of total revenue.

And we expect that to stay that going forward?

Yes.

I don't see anything that's going to change that dramatically in the, certainly in the next couple of quarters.

All right, great thanks.

Alan Bezoza, AB consultants.

Hey guys I'm not dead yet.

It's good to hear from you I thought you'd go.

One more week.

One more week.

I want to -- [inaudible] -- thank you.

I wanted to ask you a question on pricing.

When we look at kind of the simulcasting efforts using MPEG2 and then also looking at what's going on with MPEG4 and HD encoders, as I call Next Generation, how would you characterize both the dependant dynamics and also pricing [inaudible] and how severe is it?

Sorry I understand the pricing.

What did you say about the dynamics?

Both the competitive dynamics as you go kind of up to the food change to MPEG4 and Hi Def what is is the competitive dynamics there?

We can talk hours about that.

Well first, the technology -- the so -- the silicon of course goes on down in price.

So in general, as we bring up new products, we get back to good margins so the dollar value goes down. [inaudible] but by redesigning the product we keep the margins where they should be.

And we'rew doing that, I think very successfully.

In terms of the competitive world, as we get into MPEG4 and HD we're see the phenomenon that you always have when -- when technology changes.

There's all sorts of new entrance in the market, new startups and so on.

My own view is that to survive ion this business you have to make greater systems and be able to support them.

And I think when the dust settles the traditional players are going to be the ones that survive and will go on competing in MPEG4 and the way that we've done in MPEG2.

So would you say the competitive dynamics are just as strong in MPEG4 as they are in MPEG2?

Yes I think they are -- they're exact -- they're very similar indeed.

Their the same players, more or less, and you know we're -- we're competing with each other as we've always done.

And then one last question on M&A.

There's no secret out there that Terayon's for sale including -- with your proximity [inaudible] as well as on a tech scale I'd tell you it sits very well any thoughts you can share with us?

I have general thoughts that the cus -- the operators tend to consolidate and even for base hasn't and there probably will be some -- there's certainly a need for it.

I think, many people are holding conversations in various directions pretty well all the time.

But I'm not at all sure anything's going to happen in the short term.

Okay.

Thanks a lot guys.

Good luck.

Tim Savageaux , Merriman

Good afternoon.

Question on new products I wonder if if you can talk about what your expectations for -- I gather you're probably in trial and evaluation phase for some of the new products you mentioned.

What your expectations are for kind of moving into revenue shipments for both the -- the high end encoding product and also the lower end product.

Yes, indeed.

Well we've always maintained that we would be -- we would have our hi definition MPEG4 MPEG2 machine available at the year end.

I'll very happy to say this -- this it's one of the major products in the Company.

It's been running for the last couple of months very consistently ahead of scheduled.

It looks an exceedingly solid product.

And we're very confident now that we'll be shipping by the year end. so we're really very pleased with the extraordinary progress our engineering department has -- has delivered on this one.

It's remarkable.

And of course it's in trails and evaluations as we speak.

The Electra 5,000 likewise, I believe our first shipments are scheduled in November.

So this is -- this is about to -- about to start shipping.

S we're both -- we're very confident that we have the product and we -- we're in tremendous shape.

Okay.

Good.

And if I could just follow-up on the numbers a bit.

In terms of the incremental decline and convergement systems can we contribute substantially all of that to to Comcast or is there -- or I see more than all of that given Time_Warner wrapping up?

Or how would you characterize the shift from quarter to quarter in the CS division?

Well I would say it was certainly an important factor but it's -- it's -- it's a certainly not accounting for all or -- all or more than the -- than the difference but it was an important factor.

Again perhaps not terribly surprising given what Comcast had said about their second half of capital spending and some of the areas of focus and non-focus.

So again it was not terribly unexpected.

And I'll just close with one more and understand in terms of revenue activity on the order front, you know, you mentioned orders for delivery perhaps in the future.

Any activity from Comcast there or is that you know pretty much closed for the rest of the year?

I'm fairly certain that Comcast will -- will order and take more equipment between now and the year end.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS] Nikos Theodosopoulos , UBS

Hi this is [inaudible] on behalf of Nikos.

A couple of quick question were there any other 10% customers beside ttele Verizon in the quarter?

No.

Are you able to disclose what percentage of the total sale is [inaudible]?

Yes it;s -- it's approximately, give me -- give me just one second to double-check the the numbers.

Sure.

Did you have another -- ?

No, that was it.

Yes, I was going to say 55%.

It's -- it's yes indeed in fact it is 55%.

Okay thanks.

Marcus Coopersmith, Lehman Brothers.

I just want to try to get a better sense in terms of the gross margin.

Can you give us a sense of what the drag was on the gross margin from the sales to Verizon for the quarter?

Well, as you--as we've talked about in the past, we don't -- we don't break out our divisional P&Ls publicly but as you know, we have certainly referred to in the past our conversion systems product margins are -- are generally above the corporate average and the broadband access are somewhat below and typically, that the 5% to 10% gap.

So the -- on the broadband access side just looking at that piece, the margins were down in -- from a product margin perspective we're down in the -- in the 20s which is unusual for us, I mean typically our product margins are 40, 50, 60%.

So that's sort of the order of magnitude.

I don't want to break it out in more detail than that but it was a -- it was certainly a drag.

Sorry. just to clarify, you said the band group average was around 20%.

No, no these particular products were in the 20s.

Alright and then the -- you seemed a little hesitant or maybe I misunderstood you in terms of the fourth quarter, why wouldn't the gross margins end up around near 38% which would be a level excluding the inventory charge?

That's what I think I did imply, that the profile of margins, let me [inaudible] clear.

The profile of gross margins in the fourth quarter should be similar to the third with the exception, I hope and expect, of not having similar inventory charges.

And you're right, that would then take the number up to around 38.

Okay.

That's what I intended to say.

All right, thank you.

Bill Choi, Kaufman Brothers,

Hi this is [SueAnne Roberts] on the line for Bill Choi .

I just have two questions, first given the fact that you said that composition of revenues would be similar in the fourth quarter as they were to the third quarter.

What is your level of the order flow going into fourth quarter and level of visibility in cable, specifically with Time-Warner?.

And then, second question I was hoping you could expand a bit on the gross margins for just the end division and just give us some color on where they were quarter-over-quarter if they were flat or down from -- in Q3 to Q2.

Thank you.

Well certainly, let me take the first part for Time-Warner for revenue in Q4 we have quite good visibility.

Just, I think on the margin for the band, I think Robin.

Yes, that [Sarah], what was the -- what was the whole question I missed part of it.

And speak up just a little bit.

You're a little faint.

I'm sorry can you hear me better now?

Yes that's better.

I just wanted to get color on -- you know for the CN division -- I'm sorry CS division specifically, if you could give some color on where the margins were on a quarter-over-quarter basis.

Were they, you know given the fact that you had order declines in Comcast and pick up in Time-Warner and your third party going to your normal level.

Yes, actually the margins and conversion systems -- the product margins were pretty consistent quarter-to-quarter, I mean there was -- there were some [inaudible] and takes depending on the customer mix and product mix and so on.

But in general, the margins were fairly stable with the second quarter.

The one big item, as we discussed, was the $1.5 million, $1.6 million in inventory charges that we took.

But if you take that out and look particularly at product margins there really wasn't a whole lot of change from Q2 to Q3.

Now clearly, for the Company as a whole the mix shifted to band division and in particular the Verizon piece.

So that brought down the -- the overall but CS was -- was fairly stable.

Okay, thank you.

L[OPERATOR INSTRUCTIONS] Paul McWilliams, Indie Research

Hi, guys.

Paul.

It looks like you guys generated cash flow this quarter.

Is that a reasonable assumption, positive cash flow?

Yes we -- we generated cash from operations although most of it did -- did relate to working capital movements.

In particular our payables were relatively low, lower than normal at the end of the second quarter and I think that had mostly to do with the particular time of inventory purchases and so on.

And they return to much more normal level in Q3.

So it was really the change in the payables which I think was from memory was at least--at least $5 or $6 million in the quarter.

That accounted for most of the change.

But you haven't done your cash flow statement yet, but you do think you're cash flow positive for the quarter?

Yes, yes.

Okay.

I notice inventory went up a little bit oh, if you take the reserve into consideration about a net of 2.9 million was that in preparation for an order that you were expecting that was maybe delayed or missed?

I think it was more of the case we built a forecast and the numbers fluctuate as we go through the quarter.

Okay.

Last question here, I've noticed one announcement from Lucent, that they said they were using your MV100 in their products.

I don't want to say -- they didn't say in any particular order and also an announcement that they have a deal going now with SBC.

Do you see anything involved in a SBC deal for you?

At the moment, no, not for us.

But we're very pleased to -- the way that we -- most of the channels to these large telcos particularly abroad is through big system integrators like Lucent and we're pleased, indeed now to have arrangements set up with -- with several of these -- these corporations.

Any input that all that you can give on BellSouth?

I think BellSouth is still deciding.

I mean I'm sure they're going to move.

I think that's still very much in the mode of deciding when they're going to do something and then what they're going to do.

I think decisions will not be made therefore -- I really don't know.

But we're not expecting any decisions in the short term.

Okay.

Thank you very much.

Thank you.

Tim Savageaux, Merriman

I just wanted to follow upon the Verizon business and just clarify a comment you made earlier or the [FTT] in the broadband access division.

You indicated the gross margins there were in the 20% range.

I gather that forward pricing requirements would have been in sort of advance of any cost reduction you may have been able to come up and margins would have been less than that or maybe even negative.

Is that sort of the scenario that caused you to -- to kind of back out there.

Could you comment on that?

I think you've got it exactly correctly.

Sir we have no further questions at this time back over to the group for any further remarks.

Thank you everybody for participating in today's call.

And we very much look forward to speaking to you again at the conference call in -- in January.

Thank you, and good day.

Ladies and gentlemen, we thank you for your participation in today's conference.

This concludes your presentation and you may disconnect.