Harmonic Inc (HLIT) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second quarter 2006 Harmonic earnings conference call.

My name is Jennifer, I will be your coordinator for today.

[OPERATOR INSTRUCTIONS].

As a reminder this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Patrick Harshman, President and Chief Executive Officer.

Please proceed, sir.

Well, thank you, and good afternoon.

I'm Patrick Harshman, 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 second quarter of 2006.

While the second quarter revenue was impacted by supply chain constraints and delays in the completion of certain IPTV projects we had very strong bookings as the quarter progressed and are seeing strong market momentum as we move into the third quarter.

Our market success has been fueled by increasing customer diversity as we continue to send leadership with a number of new customers wins in Europe and Asia, and by a succession of important new product introductions, including our next generation high definition MPEG4 ABC encoder.

We're very encouraged by improvements in our operating performance and we continue to aggressively pursue further cost reductions.

Focusing on profitability, while further strengthening our competitive position in the market.

At this point, I'll ask Robin to cover the financial aspects of the quarter and I will then review some of our progress during the period.

Robin?

Thank you Patrick.

Good afternoon, everyone.

During 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 the documents that we filed with the SEC, including our most recent 10-K and 10-Q 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.

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

These items, together with the corresponding GAAP numbers, and a reconciliation to GAAP are contained in today's earnings press release, which we have posted on our Website and is being 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 the press release, and the remainder will be available in a recorded version of this call on our Website.

Today we announced our results for the quarter ended June 30th, 2006.

For the second quarter, we reported net sales of $53.3 million, compared to $56.2 million in the previous quarter and $59.8 million in the second quarter of '05.

Our revenue was lower than anticipated.

Primarily, as a result of supply chain constraints.

In certain product lines, we simply did not have enough of the right products available to ship before the end of the quarter.

We have seen lengthening component lead times and component shortages which seriously affected delivery schedules from our contract manufacturers.

In addition to this, we saw delays in completion of certain of the projects that we have underway with our international telco customers.

As many telcos have found, IPTV is still relatively new as implementation challenges and delays are quite common.

For us, this combination of product shortages and project delays caused the second quarter shortfall that represented approximately $6 million in revenue.

At the same time, our new order bookings strengthened significantly in the second quarter, At a level well above the revenue run rate in the first half.

International markets continued to be very active, and international sales represented 49% of our total sales in the second quarter, compared to 54% in the previous quarter, and 41% in the second quarter of '05.

Europe was particularly strong, but we also had significant new telco wins in Asia.

By market segment, our cable revenue in the second quarter was 62% of revenue.

Satellite customers represent 12%, and telcos and others, the remaining 26%.

Our largest customer was Cox, representing 13% of our total revenue.

While the U.S. cable market picked up only modestly in the second quarter, we have begun to see sharply-increased orders for our video-on-demand products.

In the U.S. telco market we continue to wind down our FTTP activity but the number of new customer wins in the international IPTV market continues to increase.

Our satellite revenue during Q2 was relatively flat, but marked by continuing MPEG 2 wins in the U.S., Australia and Eastern Europe.

Below the revenue line, we are particularly pleased with our improved operating performance.

In the second quarter, our non-GAAP gross margins were 42%, up from 36% in the previous quarter.

The increase was largely due to a higher mix of digital video and service revenue, last slow margin FTTP business as well as more favorable gross margins from our new products.

And I believe that this significant increase in gross margins is sustainable.

While we will undoubtedly see quarterly fluctuations, a fundamental shift has taken place.

With our new products now making significant contributions and our lower margin FTTP and third-party business at relatively low levels.

Turning to operating expenses, our non-GAAP operating expenses in the second quarter were down sequentially by about $600,000.

Despite the fact that the second quarter, as usual, involved a great deal of trade show activity and related marketing expense.

Our organizational consolidation at the end of 2005 is paying off in the form of lower expenses, and we expect additional reductions from the streamlining of our management team in second quarter.

These management changes, which resulted in the approximately $1 million of severance costs in the second quarter, were implemented following Patrick's appointment as President and Chief Executive Officer in May.

Finally, our headcount at the end of June was 594, down slightly from 601 at the end of March.

Our non-GAAP loss for the second quarter was $231,000, or break even on a per share basis.

Excluding noncash accounting charges for stock-based compensation expense as well as the amortization of intangibles and the severance charges.

This compares to a non-GAAP loss of $3.3 million, or $0.04 in Q1.

The GAAP net-net loss for the second quarter of 2006 was $0.05 per share compared to $0.07 in Q1.

As we continue to explore ways to further reduce costs, we are currently executing on a facilities plan following our reorganization at the end of the last year.

This plan will allow us to make more efficient use of our Sunnyvale campus and free up additional space.

While this will result in a significant charge for excess facilities in the third quarter, we expect to realize significant ongoing reductions in our occupancy costs.

Our balance sheet remains very strong.

We were cash flow positive in the second quarter of 2006.

At the end of the quarter, we had cash, cash equivalents and short-term investments of $113.5 million.

An increase of approximately $5 million from the end of March.

Our receivables were $35.5 million, with DSOs at 60 days, down from 69 days in Q1.

Net inventory was $31 million, this is down significantly from $38.6 million at the beginning of this year.

Our capital spending year-to-date was $2.9 million, and we continue to be on track for CapEx to be around $6 million for the full year.

With respect to the outlook, we continue to expect stronger revenues in the second half, based on the bookings trends we have seen and the opportunity pipeline.

However, the supply constraints present some continuing challenges and we have also seen that many of the IPTV projects have encountered delays in completion.

As a result, it remains difficult to predict the timing of our quarterly revenue.

However, for the second half, we anticipate net-net sales to be in the range of 130 to $140 million.

As you have seen, we have made progress in improving our gross margins and reducing our operating expenses, and we remain committed to continue to intelligently reduce our costs.

We expect a GAAP loss for the year, mainly because of the pending facilities charge, but we expect to be profitable in both the third and fourth quarters, and for the full year on a non-GAAP basis.

To summarize, our improving performance, coupled with our strong cash position gives us plenty of operational and strategic flexibility.

That's all for me.

Patrick?

Well, thanks, Robin.

While the supply chain constraints and project completion delays during the second quarter were disappointing, we're very pleased with our progress in all other fundamental areas of the business.

Our gross margins and operating performance are significantly improved.

We've generated cash, our bookings have been very strong, we have strong momentum across market segments and geographies.

Our outlook for the second half of the year remains positive and we've extended our technology leadership position on many fronts.

One of those fronts is high definition encoding, where I can tell you our customers worldwide are extremely excited about our new electra 7000 high definition MPEG-4 ABC encoder.

This encoder provides a dramatic improvement in high definition video quality and bandwidth efficiency and is the world's first multi-channel, multiservice high definition MPEG 4ABC encoder, supporting four full-resolution HD channels and simultaneously creating low resolution services for picture in picture or multi-channel Mosaics.

The Electra 7000's high definition compression, multiservice and native IP capabilities greatly extend the business model possibilities for satellite and telco operators, and we're pleased that five operators have already selected the product for deployment.

With this next-generation system, we're building upon Harmonic's longstanding tradition of technology, excellence and innovation, leapfrogging the competition and taking HD compression to a whole new level.

Regarding the satellite market, it is important no note that we maintain close relationships and have continued to drive new business with satellite operators around the world.

For example, we recently announced that select TV in Australia deployed our Electra 1,000 multi-channel encoders and statistical multiplexing solution for its direct to home satellite service.

As a result of our strong customer relationships, and our superior MPEG 4 and MPEG 2 technology, we expect increased satellite business in coming quarters.

We also continue to be very successful in the growing international IPTV market, we recently announced the T online France a subsidiary of Deutsche Telekom deployed our Electra 5,000 multiservice native IP encoders to power its new Club Internet digital television service.

This is a comprehensive video, voice and data triple play offering available throughout France and the first video service to be commercially launched in Europe using the Microsoft IPTV software platform.

With wins such as T-Online in France, HanseNet in Germany and several other as yet unannounced wins in Europe, Asia and the Americas, we have established an early leadership position in IPTV.

With this early leadership position, our intimate and successful experience with the Microsoft platform and our continuing fundamental innovations and MPEG four encoding, we expect to continue to win new telco business worldwide.

Turning to the cable market, we saw modest increase in quarterly cable revenue and more significantly, we began to see the expected pickup in video-on-demand and high definition activity.

In particular, we saw significant increase in new orders for our NSG solution for video-on-demand, and during the quarter, we announced that Insight Communications is deploying our NSG with privacy mode realtime encryption to protect on-demand content.

In coming periods, we expect growing shipments of our VOD solutions.

We also see cable operators moving to appropriate appropriate some of the IPTV value proposition by deploying advanced video navigation capabilities.

During the quarter, we announced that Cox Communications is utilizing our ProStream 8,000 digital video mosaic solution to deliver interactive multi-channel mosaics to select subscribers.

Cable operators are also beginning to look harder at the expansion of their high definition channel offering.

We believe that our new MV500 high definition encoder, which was released in Q2, will be a growth catalyst for our cable business in coming periods.

Although we tend to focus these discussions on our cable, satellite and telco business, it's also important to point out that we've also seen good progress in the broadcasting market.

During the quarter, we announced that Hearst Argyle television, one of the largest owners of affiliate TV stations in the U.S. is upgrading with our standard and high definition encoders, statistical multiplexors, and NMX digital service manager to do more multicasting, delivering more programming options over the air as well as via carrier networks and the Internet.

We also announced that Nosema, the largest terrestrial broadcaster in the Netherlands is supplying our multiservice encoding platform and multiplexing solutions.

With our help, the Netherlands is expected to become the first country in Europe to discontinue transmission of analog over the air television allowing spectrum to be reclaimed for our communication services.

Turning now to products and technology, Q2 saw us reassert our technology leadership through the development and introduction of a series of outstanding new products.

In addition to today's announcement of the new Electra 7,000 high definition encoder, we have recently introduced four significant new products that expand our solution portfolio for delivery of on-demand video services.

Our new ProStream 1,000, is an entirely new category of product, the first integrated digital video re-encoding solution for processing pre-compressed video content for storage and subsequent play-out for video-on-demand, network personal video recording and Swiss broadcast TV services.

We also released a new version of our CLEARcut storage encoding software that enables preparation of standard definition and now high definition content for ad insertion, VOD and other on-demand applications.

Our new NSG9000 is the fourth generation of our industry leading IP enabled device for on-demand services.

In addition to video, this platform includes support for DOCSIS 3.0, further solidifying our leadership position in the cable network edge.

Finally, we also introduced our new FLXLink solution for transporting emerging mobile digital video and high speed data services to and from the wireless edge.

After two months on the job at CEO, I can tell you that our growth strategy will directly address the major trends that span across different video delivery markets.

You can expect us to continue to provide the most advanced and compelling solutions that enable our cable, satellite, telco, and broadcast customers worldwide to provide four on-demand video services, more high definition programming and more multiplatform, multiservice delivery of video.

I also believe the company is becoming better focussed on the execution of this strategy, and more mindful of bottom-line results.

In addition to the recent consolidation of our organization and the streamlining of our management team we continue to aggressively pursue further cost reductions and improvements and operating efficiencies, driving a balanced focus on profitability and revenue growth.

In summary, despite supply chain problems and project completion delays in the second quarter, we're very encouraged by the fundamental strengthening of our business.

The continued diversification of our customer base worldwide, our improving operational efficiencies, the impact of our new products, and the strong business momentum going into the second half of the year.

With our deep customer relationships, outstanding technologies, a strong balance sheet and a proven financial performance, we believe Harmonic is an increasingly strong strategic position to capitalize on the emerging opportunities ahead.

This concludes the formal part of our presentation.

Rob and I will be pleased to entertain any questions you may have.

[OPERATOR INSTRUCTIONS] And your first question comes from Jason Ader with Thomas Weisel Partners.

Please proceed.

Good afternoon, guys.

I had a few questions.

First, Robin, just a clarification, you said well above the run rate in the first half for the orders.

Do you mean the average between Q1 and Q2?

Yes.

Okay.

All right.

And second question is Tamberg, on their recent call talked about some pricing pressure in encoders.

Are you guys seeing any of that?

No, we haven't.

We expect, as I think they do with the introductor of our new product, a high definition MPEG4 ABC encoding will become a more competitive space.

I can't speak to exactly what they were talking about.

We do expect with our entry into the market, the competitive situation will intensify significantly.

But you're still feeling confident about the margin profile of that product?

Yes.

Very much so.

Okay.

And I think it would be helpful for people, Patrick, if could you provide a little bit of history in terms of why you guys fell behind and now how you've leap frogged from a technical standpoint?

It seems like you're claiming you leap frogged the competition on the HD MPEG-4 side. but I think it would be helpful for me and probably others to maybe give a little background on what happened when you sort of had a false start at the end of last year with your product and now it's taken you six to nine months to get back on your feet here, and it seems like what you have is pretty interesting, but could you do at that for us?

Sure.

In my opinion, Harmonic has the top R&D team working in the industry.

We have been the clear industry leader in MPEG 2 standard definition and high definition encoding.

To some extent, we're off winning the MPEG 2 business and servicing our customers in that market, and I think by our own admission, we were, therefore, late entrants into the MPEG 4 space.

We did enter that space and we've done exceptionally well, standard definition part of that, our numerous wins in the IPTV space as well as our announcement of pretty good deal with DirecTV and standard definition MPEG-4 ABC encoding late last year are all a test amount to the fact that western able to move quickly and capture leadership position.

I will say, however, that high definition encoding is a little bit of a different animal and we did indeed start working and announced an early product last fall.

We very quickly realized that by virtue of what was happening in our R&D labs and looking elsewhere in the marketplace, that there was an opportunity and, in fact, we realized that if we didn't do it, someone else would, an opportunity for a leap-frog technology.

It was just becoming available about that time.

We looked at the market opportunities out there, there were two large deals that went down late last year, we were too late for those deals and frankly we saw a fairly not a tremendous or huge spending profile for HD encoding in the interleaving months.

We made what is -- what was a difficult decision at the time, but what I think is very much the right decision, to go straight for the second-generation product.

We were the first to market with what I would call second-generation technology and we think we're arriving in the market in time for significant new buying decisions that will go down in the second half of this year.

So your confidence level on being able to win U.S. satellite business right now, how would you characterize it?

I'm very confident that we have an excellent chance of winning business.

We believe, particularly in the U.S., satellite customers are quite sophisticated.

They're intimately aware of what we've been doing as well as what our competitors have been doing, and we think that the timing of their second-half decisions was all along synced up to be in line with their expectation of significant breakthrough and performance the second half of the year.

This product release, is this ahead of your expectations or railroad expectations or is this what you were planning?

This is about on schedule with our internal plan which was aggressive but it's about on schedule with our internal plan.

Last question, just on digital simulcast, you didn't mention that in the call, it's been a strong area for you in the past.

What do you think's happening in that space?

Do you think things have slowed down?

Do you think there's been a shift towards switch digital which slow down digital simulcast?

Give us a sense of the tone of that market.

We haven't seen very much digital simulcast activity.

There's been a small amount and it's been a portion of the cable revenue that we've had in the first half of the year.

However, there has been actually less activity than we expected in the first half, some of that has moved to the second half.

And but it's just one of many activity, video related activities that we think the cable operators will be pursuing in the second half.

Why do you think it slowed down or why do you think it's not lived up to the expectations?

I think that there's a lot of operational focus within the MSO area on the deployment of the voice over IP activity.

And beyond that, Jason, I don't have good answer for why it -- why the timing has shifted to what we originally understood in the first half of the year.

Thanks very much.

[OPERATOR INSTRUCTIONS].

And your next question comes from Nikos Theodosopoulos from UBS.

Please proceed.

Thanks, I had a couple of questions.

You mentioned how the gross margin improvement part of it was due to the new products.

Could you quantify, roughly speaking, what percentage of your business in the second quarter was quote/unquote, new products versus where it was in the first quarter?

I don't have specific numbers at my fingertips, Nikos.

I think from my perspective it was mainly in the encoder area where we've seen margins, as I think you know, we've rolled out a number of new platforms and encoding products over the last year or so, and it's gradually all of that is coming together and products like our Electra, for example, and our ion encoders are representing a much bigger share of the encoding business today than, say, a year ago when products like our NB50 and NB100 were the major sellers.

So I don't have hard numbers at my fingertips.

My sense is that certainly in the encoding space we've had a pretty significant shift in the types of encoder that we're selling.

Okay.

And, you know, just --

Also, I mean, I would say also as we pointed out in the press release, our service revenue has picked up as well, while that's clearly not a new product, that's had some, we are perhaps putting more emphasis on services than we have in the past.

Okay.

Given the comment that you think the 41%, 42% gross margin is somewhat sustainable -- assuming your gross margin stay in the 40, 45% range, what is the target operating margin?

Historically the operating margin has been quite volatile.

But if you can keep a gross margin steady in that range, how are you going to manage operating expenses to get to a target operating margin?

Can you comment on that?

Yes.

It's-- it's a little bit of everything.

I mean, clearly at least on a non-GAAP basis, we have got our breakeven point on the evidence at least in the second quarter, I admit that's not a lot of time but on the evidence of the second quarter it's getting pretty close to break even.

I think of the types, the levels of revenue that we are looking to in the second half, assuming, again, that we can sustain, which I believe we can sustain our gross margins in the low towards the mid-40s, then I think our operating expenses are moving in the direction, downwards, that are going to allow us to be generating at least something in the range of 5 to 10% of operating income fairly quickly.

The operating expenses were down in the second quarter.

As I mentioned, we've made some changes in the second quarter and we've got other changes in the works that will happen during the second half of the year that should drive the level of expenses down.

So again, at these revenue level in the second half, that's what I think lets us say that we're confident that we can be profitable in each of those quarters and I think that translates into decently profitable.

The plan is the revenues grow in the second half, gross margins stabilize and you're going to manage operating expenses down, somewhat downward.

Yeah, I think that's the essence of it.

Okay.

And on the back -- I'm sorry, the bookings, is your backlog higher than where it was when you entered the year?

Yes.

Okay.

And on IPTV, you mentioned the delays and I guess that's not surprising.

I'm just curious, given your exposure to many of these projects, would you say that the delays that the customers are facing are similar in each case or are they different in every case and, we're really in the early stage of this?

Or is there one or maybe two common problems or delay factors that once they're common problems or delay factors that once they're resolved, we could see a broader, quicker deployment or the delays just different in every account and it's not clear when that market will be poised to take off from a technology comfort level?

Every case is indeed unique, Nikos.

At a high level, I think that it's a new market, the technologies are somewhat new and we're dealing with operators.

Sometimes system integrators, et cetera who are new to video and new to pay television.

Each case is indeed unique.

The T-Online France project we spoke about, I think, is a great example of how it all can come together making things work on a Microsoft TV environment.

We've seen business-related issues, we've seen software set top box issues, we've also seen frankly, as I mentioned, issues associated with the team at the customer really coming up to speed.

So at a high level, I think it's all just kind of a new business, at a lower level, there's a variety of business and technical issues.

I see none of them as fundamental.

There's a lot of learning going on.

And certainly every time we're involved with a new project we bring more to bear in terms of experience and expertise to the next project.

We're getting our arms around it and we see it's just a little bit of growing pains as this thing starts to move.

My last question, you may have commented on this and I missed it, but did you give a date for the actual general availability of the MPEG-4 high definition encoder?

We said we'd be shipping it by the end of September.

Okay.

All right, thank you.

Thanks, Nikos.

[OPERATOR INSTRUCTIONS].

I would now like to turn the call back to Mr. Harshman for any closing remarks.

Only to say thank you for participating in today's conference call and we look forward to speaking with you again.

Good-bye.

Thank you for your participation in today's conference.

This concludes the presentation and you may now disconnect.

Have a great day.