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Operator
Welcome to the first quarter 2007 Harmonic earnings conference call.
My name is Eric.
I'm your coordinator for today.
At this time, all participants are in a listen-only mode.
(OPERATOR INSTRUCTIONS) We will facilitate a question-and-answer session towards the end of the conference.
As a reminder, your conference is being recorded for replay purposes.
I'd like to turn the presentation over to Patrick Harshman.
President and CEO.Please proceed sir.
- CEO
Thank you.
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 first quarter of 2007.
We're pleased with solid sales performance in the first quarter which is typically the slowest period of the year.
We saw strong demand from our domestic cable customers and our powerful new products continue to win in competitive evaluations, reinforcing our leadership in the IPTV market and helping us regain our leadership position with direct to home satellite operators both domestically and internationally.
Our gross margins did not meet our expectations in the first quarter and we'll take you through the details behind this and why we're confident in gross margin improvements in the coming periods.
With that I'll turn it over to Robin, to cover the financial aspects of the quarter and then I'll review some of our progress during the period.
Robin?
- CFO
Thank you, Patrick.
Good afternoon, everyone.
During this call we may make projections or other forward-looking statements regarding future events or future financial performance of the Company.
We must caution you that such statements are only predictions and actual events or results may differ materially.
We refer you to documents that the Company files with the SEC, including our most recent 10-K and 10-Q reports.
They identify important risk factors that could cause actual results to differ materially from those contained in projections or forward-looking statements.
On this call we will also provide you with financial metrics determined on a non-GAAP or pro forma basis.
These items together with the corresponding GAAP numbers and reconciliation to GAAP are contained in today's earnings press release which we posted on our website and filed with the SEC on Form 8K.
We will also discuss historical financial and statistical information regarding our business and operations.
Some of this information is included in the press release and the remainder of the information will be available in a recorded version of this call on our website.
Today we announced results for the quarter ending March 30, 2007.
For the first quarter of 2007 we reported net sales of 70.2 million.
Up 25% from 56.2 million in the first quarter of 2006.
Our domestic cable business was stronger than we expected.
Perhaps somewhat surprising given the slow start of the year that we usually see in U.S.
cable.
We also continued to add new customers in TELCO and satellite markets world wide, although many of our TELCO installations are taking longer to complete than we expected.
Mainly as a result of the strong U.S.
cable business domestic sales represented 60% of revenue in the first quarter compared to 46% in the same period of 2006, and 59% in the fourth quarter.
By market segment cable revenue in the first quarter was 72% of total revenue, our satellite customers represented 13%, and TELCO and others, 15%.
Our largest and only 10% customer was ComCast representing 21% of our total revenue.
Revenue from our U.S.
cable customers in the first quarter included significant volumes related to video-on-demand deployments, as well as continued spending for bandwidth and network expansion.
By contrast our TELCO revenue was relatively light in the quarter.
Reflecting slow progress on a number of ongoing IPTV projects.
Well we remain optimistic about the IPTV opportunity and we have found that execution and completion of these projects is quite challenging for all involved.
Gross margins in the first quarter of 2007 were significantly higher than in the same period of 2006, due to more favorable margins from the sale of our newer products and increased volume.
However, gross margins were lower than we anticipated in the first quarter of 2007.
As a result, of the product mix, which was skewed heavily towards edge and access products.
By product category we saw edge and access products representing 51% of our revenue in the first quarter.
Video processing products 37% and software and services 12%.
As I mentioned previously, we saw significant VOD deployments using our current NSG or edgeQAM device.
The pricing on this product come down over the last few years and this is one reason they we developed and recently launched its successor product the NSG-9000.
We started to see revenue from the 9000 in Q1 and we expect it will constitute a greater portion of edgeQAM sales in coming quarters.
In addition, because both orders for and shipments of our video processing products in Q1 were actually higher than for edge and access, we believe that this should lead to gross margin improvements in coming quarters as these video processing orders and shipments convert to revenue.
Forecasting our quarterly product mix remains challenging given the variations that we see in the timing of orders, shipments to customers, and subsequent conversion of those shipments into recognizable revenue.
We continue to focus in controlling operating expenses.
Our non-GAAP operating expenses in the first quarter were essentially flat on a sequential basis.
As you may recall, our cost reduction initiatives in 2006 resulted in an approximately $3 million reduction in non-GAAP operating expenses on a year-over-year basis.
In a continuing effort to control costs and improve operating efficiencies, we decided to shut down our UK R&D facility in the first quarter.
Following our earlier decision in the fourth quarter of last year to close manufacturing.
As a result, we incurred a charge of $1.8 million in the first quarter, related to severance costs, excess facilities charges and inventories of discontinued products.
Apart from one building which was still occupied at the end of March we expect no further restructuring costs from our UK operations.
Following these actions our head count at the end of March dropped to 594, down by 45 people from 639 at the end of December.
Despite our solid sales performance, our lower than expected gross margins impacted our net income in the first quarter of 2007.
Excluding the UK charge and accounting charges for stock-based compensation and the amortization of intangibles, non-GAAP net income for the first quarter of '07 was $5.3 million or $0.07 per diluted share compared to a non-GAAP net loss of $3.3 million or $0.04 loss for the same period of 2006.
GAAP net income for the first quarter of 2007 was $1 million or a $0.01 per diluted share compared to a GAAP net loss of $5.1 million or $0.07 per share for the same period of 2006.
Although we once again reported a nominal tax charge we are now subject to the FIN 48 tax accounting rules which could lead to more significant quarterly fluctuations in the future.
Our balance sheet remains solid.
As of March 30th, we had cash, cash equivalents and short term investments of $82.9 million, compared to $92.4 at the end of 2006.
During the first quarter of '07 we utilized some of our cash to increase inventories of new products and to reduce by $2.4 million the merger awaited obligations from our DiviCom acquisition in 2000.
Approximately, $6.7 million of these obligations remain outstanding.
Receivables were $58.4 million with DSOs down slightly to 76 days.
This is still running higher than we would like and we intend to bring DSOs down to a normal range of 60 to 70 days.
Net inventory was $46.7 million, up from $42.1 million at the end of December, reflecting increased production of new products to address our customer demand.
Capital spending was $1.4 million in the first quarter and we expect it to be in the range of 5 to $6 million for the year.
While the first quarter is historically the slowest period in the year, we saw pretty respectable bookings and good sales momentum.
We go into Q2 with combined backlog and deferred revenue, only a few million dollars lower than the $71 million we reported at the ends of last year.
We anticipate our combined net sales for the second and third quarters of 2007, to be in a range of 140 to $150 million.
On a non-GAAP basis we expect gross margins to improve to be in a range of 44 to 45%, subject, of course to (inaudible) of product mix.
We expect to continue to hold our operating expenses relatively flat with Q1 levels.
In summary, we're pleased with our solid sales results for the first quarter, and optimistic about the opportunities for growth in coming quarters.
We expect our gross margins to improve from Q1 levels and continue to focus on controlling costs and increasing profitability.
Our strong cash position continues to give us plenty of operational flexibility.
That's all for me.
Patrick?
- CEO
Thanks, Robin.
As you can see we're encourage by improved performance and fundamental strengthening of our business compared to this time last year.
Across different market segments we continue to successful drive the reexertion of our technology leadership and the expansion of our business.
Underlying this progress is our strategic focus on the key market drivers transforming the business of video service delivery.
Transition from broadcast to On-Demand, the transition to more high definition programming, the transition toward video delivery over IP and new IPTV services and the more intelligent use of network bandwidth to support these new services.
In the cable market, our market position is strong and getting stronger.
We saw significant new shipments as cable operators moved forward on new deployment on Video-on-Demand, time shifted TV, high definition programming and associated bandwidth enhancement to their HFC networks.
Cable operators are driving toward the triple cast of high definition, standard definition and analog video and as part of this initiative there is great focus on increasing the picture quality and the quantity of HD programming.
We're seeing this market direction drive strong demand for newest high definition and standard definition encoding solutions.
During the quarter we also saw good demand for our post stream video stream processing solutions for new applications such as delayed TV, switch digital broadcast, and video rich navigation.
And we close our first VOD service software deal with the cable operator.
This is the VOD service software we acquired from Entone in December and going forward we will exploiting the industry move to open VOD server and software architectures to drive growth that this area.
We are also pleased with the growing deployments of our NSG edgeQAMs, while VOD service expansion continue to drive the majority of NSG demand, our new NSG 9000 universal edgeQAM has been selected for new switch digital broadcast and modular CMTS, high speed data applications.
With the adoption of newest generation edgeQAM, we aim to both enable top line growth through entry into these new cable edge applications and at the same time improve our gross-margins in this edge product category.
With new deployments of On-Demand and high definition services consuming HFC network bandwidth, we also continue to see robust demand for our HFC optical access products.
This is an exciting time in the cable industry and pleased to be at the center of multiple new and important initiatives.
In the emerging IPTV market we continued to be successful in strengthening our leadership position with several new customer wins.
We have been at the forefront of innovation with our electra platform having introduced the first integrated encoder to simultaneously support full resolution and picture-in-picture and the first multi channel encoder used in the Live Microsoft TV service.
We are also please to have recently announced that Harmonic is recognized as the leader in providing video head end solutions and Microsoft TV environments.
With our growing leadership position in IPTV, our continuing innovations in MPEG-4 encoding, stream processing, delivering video over an IP infrastructure and full line of IP based VOD solutions we expect to continue to win new IPTV business world wide.
In the satellite direct to home market, we're making excellent progress in regaining our leadership position by winning new business with leading domestic and international operators.
Our new electra encoders and unique video over IP networking capabilities, are proving to be a winning combination.
Often in the face of intense competition.
Since we released are new electra 7000 high definition MPEG-4 AVC encoder last fall, we've won and shipped this product into over 25 new projects around the globe.
We're very pleased with our recent wins, which include key satellite customers in the U.S., Asia, Latin America and Europe.
Our new products are also helping us win important new projects with video broadcasters,.
We recently announced that Hearst Arkile Television, on e of the leading television groups in the U.
S.
reaching nearly 20 million households, has deployed the first IP-based (inaudible) multi-plex in a ATFC broadcast environment using our MV500 MPEG-2 high definition and MV100 MPEG- 2 standard definition encoders as well as post-stream 1000 stream processing platform.
We announced public broadcasting service, the largest digital satellite television distributor in the U.S.
reaching more than 75 million viewers nationwide has applied our MPEG-2 high definition and standard definition encoders for its next generation enter connection system.
Having just returned from an exciting national association of broadcasters trade show in Las Vegas, I can tell you we have the right high definition solution at the right time for broadcasters around the world.
In addition to growing a world wide customer base we're also continuing to expand our technology leadership in new and important ways.
New software based products and solutions continue to be an area of strategic focus for us.
We recently introduced several significant new enhancements to On-Demand solution capabilities.
Used in combination with our (Arlota) intelligent asset manager our new streamliner 2000 server family can support dynamic content demand profiles easily scaling to accommodate (Inaudible) software enables service providers to automate the capture of broadcast video content for video-on-demand, time shift to television or network video personal video recording.
Altogether these new software products provide a powerful suite of solutions that enable service providers to reduce the cost and complexity of when they are implementing scalable on-demand content preparation and delivery.
This integrated suite of on-demand solutions is generating significant interest among our customers, creating strong solution synergy and pull through sales opportunities for our traditional products and represents an important growth factor for the company.
Also in the area of new video delivery technology, we announced our groundbreaking prostream 1000 video stream processing platform, now includes forward error correction support, which is a critical requirement for high quality video transmission over wide area IP networks.
We also introduced powerful new any-to-any service management technology.
The capability that enables dynamic management of an operator's video program lineup by automating the way services are moved across IP based transports and multi plexies.
These new innovations means Harmonic continues to lead the way in driving the integration of video delivery and IP networking technologies.
In summary, we continue to significantly strengthen our leadership position across a variety of video delivery markets we address.
We expect these developments to enable us to continue to grow our top line while strengthening our gross-margins and profitability.
Going forward, we will continue our focus on profitable growth while offering the most advanced and compelling solutions that enable our customers to provide more on-demand video services, more high definition programming and more multi platform multi service delivery of video..
This concludes the formal part of our presentation, and Robin and I will be pleased to entertain any questions that you may have.
Operator
(OPERATOR INSTRUCTIONS) Your first question comes from the line of Marcus Kupferschmidt with Lehman Brothers.
Please proceed.
- Analyst
Good afternoon, guys.
- CEO
Good afternoon.
- Analyst
Could you clarify, Robin, what you think the future tax rate looks like and what your tax NOL status is today?
- CFO
Yes, I think it's best to think of our tax provision at least in the immediate future and I would say for this year and next, as an absolute dollar number as opposed to a particular percentage.
We have significant operating losses available to us.
I don't remember the exact number off the top of my head, but it's I believe it's to the order of $180 million and so I don't expect to be paying any significant amount of U.S.
taxes at least in the next couple of years.
So we will have a modest rate of a few hundred thousand dollars that is really a combination of some foreign taxes and alternative minimum taxes.
The--we're still like a lot of other companies getting our arms around the new FIN 48 requirements and that will mean that it is possible we may see some fluctuations in given quarters as particular countries or states roll in and out of the provision.
(Inaudible).
I have to open up this line if he is next.
(Operator speaking)
- Analyst
Hello?
I can hear you.
You think 2 or $300,000 a quarter.
- CFO
Possibility of fluctuations that can provide credits in some quarters and maybe larger debit.
- Analyst
That's great.
That's no problem.
I guess what I would like to understand a little differently is in terms of the first quarter the cable mix, yes, when I see the results I guess I assumed you would have thought you would have sold more encoders than what you did in the first quarter, or trying to think about the difference in the gross margin or is the flip side you thought you might have sold more encoders on the IP-TV side that would help you to stabilize your gross margin.
If you could help us understand that, that would be great.
- CFO
I think it is more of the latter, that we found that our TELCO business, in particular, was a little bit slow in the first quarter.
When I say slow, I really mean more in the execution of a number of projects that we're working on, and so it's really was our inability, if you like, in some projects to recognize as much revenue as we expected to, and much of that revenue, as you know, in the TELCO space, is centered a around our encoding products, both standard and high definition.
So I think it was more of that mix, whereas cable in my view is stronger than we expected and TELCO perhaps a little bit weaker, so overall the revenues were kind of where we thought they would come in, but it was the stronger cable mix on the upside and TELCO mix on the down side that I think has caused some of the margin shift.
- Analyst
And if I could, what is Harmonic, what are you guys focusing on to try and approve your ability to recognize revenues for the TELCOs, or is it the function of you have to wait and see the customers do whatever they need to do.
- CFO
Well it is a bit of both, to the extent that we can--we can drive particular terms, that help us, we do that, but that is not always--that is not always possible.
I think a lot of it really simply comes down to execution on not only on our part, but by some of the other vendors involved and indeed the customers themselves.
Video is a relatively new--new world for TELCOs, and there is a fairly steep learning curve for everyone involved and I think that is part of it.
So I think it is mostly on the execution side that we can--that hopefully we can recognize revenue more quickly.
- Analyst
Great.
Thank you.
Operator
Your next question comes from the line of Tim Savageaux with Merriman.
Please proceed.
- Analyst
Hi, good afternoon and I'm jumping on a little late.
I apologize if I'm redundant in any way.
But you had mentioned strength on the cable side.
I wonder if you have given any indication as to kind of where precisely you're seeing that in various parts of the network, outside plant upgrade infrastructure, versus the digital side.
More importantly what kind of trends you see throughout the balance of the year?
You obviously raised your guidance range a bit at least on a two quarter rolling basis.
Does that reflect stronger than expected cable results are there other factors driving that?
Thanks.
- CEO
So on cable we see strength really across the board.
I think probably what stands out in terms of the revenue that we recognized in Q1, the edge and access area for cable, our edgeQAM and HFC optical access equipment really was the strong performer from a revenue point of view.
That being said, we saw good demand for our high definition and standard definition encoding products and perhaps more interestingly and directly to the longer-term growth part of the question, although the revenues were not huge, we're very encouraged by the new revenue streams coming by a variety of new applications and opportunities within cable.
We're pleased to see our edgeQAM being picked up but not only VOD but for switch digital broadcast and wide band docksis modular CMTS applications.
We're pleased to see some our stream processing product being picked up for switch digital broadcast again as well as part of emerging delay TV applications.
And, it is really those kind of new applications and opportunities for our technology that probably create the greater long term growth driver the back end of the year into 2008, are--our guidance for the next two quarters is really based on continuing strength and let me call it our core products and continuing getting market share and good penetration with our edgeQAM devices and optical access products and encoding products.
- Analyst
If I could follow up with one more question.
I wonder if with the closure of the Tamburg deal here over at Ericsson, I wonder if you could update us on anything you're seeing positively or negatively from a competitive standpoint coming out of that combination.
Thanks.
- CEO
I think early obviously.
What I will say is that--I think as you know Harmonic made a living in the beginning competing against a variety of large and small competitors.
I think historically focus and exclusion has been the key, and we increasingly like our competitive position in the market, from a technology and market presence point of view.
And in particular obviously I think the--that combination will be geared towards I PTV, and, we couldn't be happier than we are with the success of our new MPEG-4 encoding products and the success that we continue to see in penetrating IPTV accounts world wide.
- Analyst
Great.
And congrats on a nice quarter.
- CEO
Thank you.
Operator
Ladies and gentlemen, your next question comes from the line of Jason Kim with Thomas Weisel Partners.
Please proceed
- Analyst
Hi, guys thanks for taking the question here.
I was hoping to go get a little more color.
I know at the end of last year you guys had talked about sort of a early shipments to a domestic satellite operator with your MPEG-4 HD encoder and I wonder if we can get insight as far as the revenue you guys have seen there and sort of the ramp moving forward with that particular customer?
- CEO
Well, we are very pleased with the progress we're making with satellite operators in the U.S.
and around the world.
I think we broke it out.
Our satellite revenue for the quarter was about $9.5 million, I think, which is the largest we've seen in any quarter for quite some time.
Certainly we didn't see anything like that in 2006.
So I think it speaks to our overall strength, both domestically and internationally.
We did say last--late last year we had been awarded a piece of business from a major U.S.
domestic player, and part of the revenue story in Q1 was associated with that.
And we've actually since then won additional new business in the U.S., so the momentum is good and I think that the numbers are definitely moving in the right direction.
We think we're going to see more success as the year goes on, both in the U.S.
and outside of the U.S., and the growth and the strengthening of the satellite segment for us is in fact an important part of our story, and the strengthening of the business in 2007.
- Analyst
Okay.
Hey, thanks a lot, guys.
- CEO
Thank you.
Operator
Ladies and gentlemen, (OPERATOR INSTRUCTIONS) Your next question is a follow-up question from the line of Marcus Kupferschmidt with Lehman Brothers.
Please proceed.
- Analyst
Hi, guys.
Could you give us a sense of what kind of soft savings you would expect from shutting down the UK plant?
- CFO
Yes, I think on a full-year basis it's probably somewhere approaching a couple million dollars.
- Analyst
Okay.
- CFO
1.5 to $2 million and we bake that into our expectations about keeping operating expenses relatively flat over the next couple of quarters flat as a whole, with reduction in the UK but some increases in other places.
- Analyst
Okay.
And can you give us a sense in the inventories your work--finished goods versus work in progress and raw materials?
- CEO
Yes, I don't have a detailed breakdown with me.
I think I said earlier definitely the focus has been on building inventories of some of our--some of our newer products.
I think I would say that's focussed quite heavily on the encoding space and also in the edgeQAM areas where we're in the midst of a product transition towards our newest edgeQAM device, NSG9000 and so we put quite a bit of focus there.
I think one other area that is worth highlighting is the--on the fiber optic products that we do have some pretty steady business there now.
It's--that space has been quite resilient.
There is good business and we've got back out into most of the rest of the year for some products.
In the area we've been building up the deal with that as it rolls out over the year.
- Analyst
Okay.
How much of your inventory build is IPTV product sitting at sites waiting for our (Inaudible)
- CEO
There is certainly some of that.
The accounting is complicated, some of it sits in inventory, some of it goes into deferred costs of sales, so it is not all necessarily in the inventory.
That 's a factor, It is certainly a factor I don't want to overemphasize it, but it is certainly a factor that we have a lot of product somewhere between us and the end customer acceptance and that is most definitely a factor but again I don't particularly want to overemphasize that.
It is not huge.
It is really more the buildup for business that's on its way.
- Analyst
So the point--I guess the point, too, is then there is not a lot of IPTV products sitting at customers sites waiting for our [wreck] it more the customer are not yet taking IPTV products from you to really get things going?
- CEO
Well, no, it is a bit of both.
Actually some of the--expect the accounting, some of the inventory that is sitting at customers that is awaiting acceptance or completion or whatever, is actually sitting in deferred cost of sales, so it is actually not on the inventory line.
It depends--it depends upon the complexity of what the billing schedule is, and so forth, and way too complicated to get into here.
There is a portion in inventory, a portion in deferred cost of sales and probably some sitting here waiting for shipment on TELCO-- TELCO projects that we've just been awarded.
- Analyst
That's great.
If I could ask one other thing.
Can you quantify roughly some of the deferred cogs in the inventory for these projects, kind of what is shift and waiting for revenues?
- CEO
I can't off the top of my head.
I think there is probably several million dollars in deferred cost of sales.
But that would not be just IPTV, that could be for other projects and satellite world, for example.
I don't have that level of granularity with me.
- Analyst
Okay.
Maybe another time.
Thank you.
Operator
Your next question comes from the line of Paul McWilliams with Indie Research.
Please proceed.
- Analyst
Hi, guys, thank you for taking the call.
Third party business during the quarter, was that above or below your typical level?
- CEO
It was around the normal level, Paul.
It was, a variety of different vendors for a variety of different project s but it is not a particularly significant number these days, and I don't think the quarter was particularly unusual in that respect.
It's a fairly--a fairly modest piece of our overall revenues now.
- Analyst
3, 5% s that a reasonable model for that?
- CEO
Probably on the low end of that, yes.
- Analyst
Okay.
Time Warner has gotten quite a bit of publicity lately on their start-over and now their look-back program.
I know you're heavily involved in the start-over program.
Are you equally involved in the look-back?
- CEO
Well, I think all--I'm comfortable saying is we're involved in a variety of interesting and new initiatives with Time Warner, and I--don't mean to be evasive but I'm not sure what we're saying and not we're not saying and what they've approved to be disclosed.
We enjoy a good position and a good relationship with Time Warner.
They're an important customer, and they're currently a leader in this space.
Staying close to what they're doing in participating and what they are doing is certainly an area focus for us.
- Analyst
You shared an Emmy with them on the start-over.
- CEO
We did share an Emmy with the start-over service.
That is correct.
- Analyst
Could you say as to whether that market share in that application has changed at all?
- CEO
I think we're doing well my gut says that we're doing well, Paul.
I don't have a number and I probably couldn't, I don't have any quantified--quantifiable data for you.
- Analyst
Okay.
You mentioned you did get other order from a U.S.
satellite provider, is that one of the major providers?
- CEO
Well, we're trying to be actually a little bit vague because we don't, again, regrettably have an agreement from from the parties involved to discuss what is going on.
We have in fact, yes, received another order, and we're pleased with that, and we're pleased with the strengthening position in the U.S.
What we will say is we received another significant order beyond what we disclosed late last year.
- Analyst
Okay.
On OpEx modeling, Robin, you suggested and I want to make sure I understand this correctly, dollars would be relatively flat over the next two quarters.
- CFO
Yes, I'm sorry if I did not make that clear.
Talking absolute dollars, yes.
- Analyst
And for Q4, so I can model the rest of the year, can you give me any inkling there?
- CFO
Well, I think, assuming that the business stays healthy, I think it would be reasonable to assume maybe a little bit of trending up.
I mean, not in a big way, but I think that we'll, again, if the business remains healthy I think we'll devote a little bit of that to increasing, increasing expenses.
- Analyst
Okay.
One more housekeeper here, and that is on inventory reserves with some products being replaced by new versions.
Did you take any inventory reserves about what wouldn't be normal on a quarter?
- CFO
We were probably a bit above where we have been.
I mean, that is a number that fluctuates a lot depending on, depending on what's going on, product transitions in particular have an impact and, we have always got some kind of product transition going on.
It was--yes, I would acknowledge it was a little bit higher than perhaps normal.
- Analyst
Might have that though eaten into GP by a percent or two?
- CFO
No, not by that much.
And there are all kinds of offsetting, other things at work, as well, in cost of sales and gross profits, as you know.
There is a lot of puts and takes, as you know.
That one was a little bit on the debit side, if you like, but there were others on the credit side, so I think overall I would say that stuff was--was really not that significant.
- Analyst
Okay.
Last question here, and you brought up on the node activity, so you're seeing more node-splitting or reemergence of node-splitting going on, or another cycle going on?
I don't know what you want to call it.
- CEO
Yes, we are.
It is not a start-stop thing, but we've seen a fairly consistent, although maybe somewhat gradual, a definite trend of strengthening of that part of the business over the last nine months, and as we said, we think it goes hand in hand with everything else, all the content that is being pushed down these agency networks as well as intensifying competitive dynamic that you see out there, with deep fiber DSL, coming hard from one direction and I think ever improving HD product offerings coming from the sky.
So we definitely see expansions of band width in the HFC networks being a key part of what is happening out there.
- Analyst
Okay.
I did have one last little one here.
Do you expect for the balance of the year to have a more typical split of domestic and international?
- CFO
Well, the last year--last year was closer to 50-50.
We started off this year roughly 60% in the U.S.
I do think with some of the--some of what we're seeing in the domestic cable market and some of the satellite business that Patrick has alluded to, that perhaps this is the year where the U.S.
is back in the majority.
I think the domestic business is going to be somewhere between 50 and 60, but it is hard to--it is hard to project out at very easily over the rest of the year.
So I would say it's somewhere in that--somewhere in that range.
- Analyst
Okay.
Thank you very much for your time.
- CFO
Thank you.
Operator
Your next question comes from the line of Alan Bezoza with Oppenheimer.
Please proceed.
- Analyst
Good afternoon.
Sorry about jumping back and forth.
(Inaudible) Demonstrated your 6-meg bit encoder for HD and it sounded to me from a couple of guys I talked to in the industry that there is pretty good demand for that kind of product, people on deliver HD and lower bit rates but still high quality.
Is there anything that you're seeing as far as the next couple quarters after some hold-outs waiting for this product to become tested before they roll out anything?
Is there anything out there that says we'll wait for the next generation products?
- CEO
Well, I think everyone who is in the space, both domestically and internationally and who has an intention, either mid-or near longer term, is keeping their finger very much on the pulse of what is happening with the technology.
This product that you've referred to is actually the 7000 hardware product that we announced and released and we started shipping late last year.
For us, the name of the game is really continuing to improve the software and the algorithmic efficiency on that hardware engine.
With our close customers and with other key interested parties we share not only where we are today but of course our road map.
And it is a story of continuing improvements and I tell you, there is a lot of power under the hood of this product, and not only the performance today, but the roadmap of the performance, particularly one our key customers understand the capabilities of this product, I think that is very key to the wins that we had in IP-TV and direct to home satellite.
As you point out, it is really a case where these customers desperately need both--both dimensions, top-quality video and really at absolute minimum bit rates and we are finding that 6 meg bits below and really awesome looking video is a pretty sweet spot and it's really catching the attention of the industry, and it is one of the reasons we continue to be excited about this area.
- Analyst
A follow-up on that.
Do you feel like there is more tweak to get even lower than 6 megs and go back to my original question, do you think there is anyone waiting for continued-- as you looking at a road map and discussing road map with your customers, are people waiting, okay, let's wait until we get the new super-charged version, that way we can more efficiently use the bandwidth that we have?
- CEO
I can thing be of anybody who is completely sitting on the side lines.
I think it is absolutely true, particularly in DSL, there are business models that say to be competitive you to deliver two HD signals to a home, so one can be watched realtime and one can be recorded on a digital video recorder at home.
So, there are, I would say business models that come into full bloom once these bit rates start going lower and you can deliver.
Not unlike what were doing in the ATSC space with MPEG-2 when you can deliver multiple HDs and maybe 1 or 2 SDs on top of that in the allocated bandwidth.
So is there anyone who is really sitting on the sideline?
I can't think of anyone who is completely sitting on the side line, but having video is increasingly a requirement, but I would agree that there are people who are maybe pacing their trials or their rollouts and really thinking about maybe more importantly about the expansion of their systems, depending on continuing innovations and improvements in the space.
- Analyst
And then again to follow up on, other people waiting, look at AT&T, do you think there is a lot of pressure on AT&T to get this right, lot of pressure for the industry, in other words a lot of European and Asian carriers.
- CEO
I'm more comfortable referring to the overall industry.
I think there are some common trends that we see world wide.
And yes I think there is a lot of pressure to get it right.
Whether they're a strong incumbent video competition, there is a common sentiment we see world wide, saying there is not a point in rolling out an inferior or me-too project.
- Analyst
That's not what I mean't, what I mean AT&T has a lot pressure on the industry in other words a lot people waiting to see if AT&T success and failure and wait for them to fix it before they roll it out themselves?
- CEO
I don't know, Alan, maybe maybe that is somewhat true in the U.S., I suppose.
As you know, we're doing a lot of work internationally where we've been a part of very successful rollouts including on a Microsoft platform in Western Europe and Asia, and there outside of the U.S.
we see operators going forward full force, and pretty aggressively.
The last quarter we announced our--PCTW had chosen us, for MPEG-4 largely on the strength of the products and there is an example of an operator with three quarters of a million subscribers.
So the rule looks different outside of the U.S.
and we see IPTV moving forward in earnest.
There is a slightly different feel here in the U.S.
but I think that's simply a matter of time.
I think as the theme of the overall IPTV discussion, judging the time here, continues to be a challenge.
- Analyst
Okay.
Thanks a lot guys.
I appreciate it.
Operator
Your next question comes from the line of with Amit Tse with UBS.
Please proceed.
- Analyst
My first question was for Robin.
Robin, I just want to clarify the gross margin in the quarter.
Outside of the impact of a product mix shift, was any adverse movement within product categories?
It seems like gross margin might have declined in a couple of categories outside of just mix shift.
- CFO
No, I don't think so.
I think a lot of it was really due to mix.
In fact, on the contrary we were actually reasonably pleased with the way that in general pricing held up.
I did make the observation that within the edge and access segment, there was a pretty--or product line--there was a pretty significant impact of our NSG were mostly VOD deployments and the pricing on that has declined over the years.
We've introduced new versions of it, denser versions and so on, that reduce cost and cost per stream and price per stream.
So we're working away at that.
We have the new generation NSG9,000, which we began to ship in the first quarter.
So certainly with that--possibly with that exception, I would say overall we were reasonably pleased with pricing and their own costs, as well.
- Analyst
Okay.
- CFO
I mean, the mix, just to go back on the mix, I mean, the software and service piece was down a bit and I think a lot of that is in the service area where and that's kind of linked to some of the TELCO--particularly TELCO deals that moved a bit more slowly than we had hoped, clearly not just hardware gets delayed there, but service gets delayed as well.
And that is the software and service piece together is definitely the highest margin of the three groups that we've--that we speak to.
But I think overall with the possible exception of pricing and video-on-demand on the NSG side, we are comfortable with the way margins were.
- Analyst
Got it.
The book-to-bill for the quarter?
- CFO
Yes, it was just below one.
I said that we were down a few million dollars in backlog.
The combination of backlog and deferred revenue we reported $71 million in the last quarter, that was in our 10-K, and it dropped a few million dollars, so it is in the high 60's.
It positions us quite well going into Q2.
The challenge for us is to get many of these projects moving more quickly, which is not always within our control, but get these moving more quickly and to get many of them finished.
- Analyst
Thanks.
And then I guess I think it was on the call last quarter where there is some talk about your satellite business possibly growing two or three times over last year's levels in 2007.
I just want to confirm that is a range or goal that you're still fairly comfortable for 2007?
- CFO
As I recall the discussion, we were asked whether those kinds of numbers were possible, and I--I think we certainly acknowledged that some significant increase year-over-year in our satellite business would be quite plausible, and I think we're starting to see that already.
I mean, last year it was just over 10% of revenue, so a run rate of somewhere around 6.5 to $7 million a quarter, this quarter, Q1, that just finished, it was actually about $9.5 million or 13% of revenue.
So clearly the run rate has stepped up.
That doesn't clearly at that rate we still don't get to two times, but as Patrick indicated, we keep on winning new business, and I'm fairly confident we could see that number be quite a bit bigger than last year.
- Analyst
Got you.
And on the last question I guess for either Patrick or yourself, around switch digital video, I was just wondering if you could comment in terms of the competitive landscape and how you see yourself positioned relative to some of your other competitors, and who you most often see and sort of some of the RFPF activity.
- CEO
It is still a relatively new space, and we would acknowledge that we're not the first in the space.
But what we see right now in the market is a transition in the way the operators are looking at it.
I think the first deployments, that was kind of a one-stop shop of vertically integrated solutions for switch digital video.
And now what we see is a move to a different kind of architecture.
Switch digital video is one of many applications.
It is a unified infrastructure for dealing with switch digital video, VOD and even high speed data.
And in this new kind of architecture, relies on one common edgeQAM and service is coming through the different paths, and so the way the operators are looking at it going forward, I think, is rather than a stand alone silo for VOD and a silo for switch digital video and silo for docksis data, they are bring these things together and for us this is discontinuity or a disruption that provides a great opportunity to step in and we think there is no other company better positioned to take advantage of it, than us, because we have by far and away the largest deployed base of edgeQAMs out there by virtue of our hugh VOD footprint.
Our strategy is to take that same edgeQAM capability, and adapt for both module CMTS docksis traffic as well as switch digital video traffic and allow our customers to build on what is there for VOD.
And the customers, cable operator s cable industry is looking to separate that data path, what is happening at the physical layer with the bits from the control software.
So our strategy is not to do high level control software but to control all of the products, systems, solutions, that actually process and transport the data and video signals through the network.
So the edgeQAM is kind of a home base and one of the reasons why despite some challenging margins we really stuck to a strategy of being the clear market share leader and as we said a larger footprint than anybody else out there.
And we're trying to build on top of that, our stream processing solutions are now part of what people are using for switch digital video as well as delay TV and VOD applications our new Entone software comes into all of that.
So it's becoming less of a stand alone application and more of an integrated solution.
We know this is the way the operators are driving and we positioned ourselves to strategically take advantage of this changing approach.
- Analyst
Got it.
Thank you.
- CEO
All right.
Thank you.
Operator
Your next question comes from the line of Brian Horey with Aurelian Management.
Please proceed.
- Analyst
I was wondering if you could provide any more color on the IP-TV deployments and the issues that are kind of making those drag out.
Is it possible to generalize over a bunch of different operators, is it really software issues, network engineering issues?
Integration issues between different vendors.
If you could provide any more color, that would be helpful.
- CFO
I made the comment earlier that most telecom operators that we're working with at least look at it.
Coming out with a simple me-too video solutions is not the objective.
When you see one of these systems working as I have, I mean, it is pretty awesome.
That being said, there is kind of a layer upon layer of new technology complexity.
New middle wares, new capabilities.
MPEG-4, even though we do the encoding, brand new MPEG-4 set-top boxes, that's a new level of complexity for all involved.
And then on top of that you've got a lot of system integrators and customers who are actually new to working with video.
Below that it is hard to generalize, but at the blanket level we're dealing with new technology.
Many players who are new to working with video in general and of course new technology and underneath that, it is a whole host of issues.
In some places we see technical in operability issues and in other places it's there are software, middle ware issues, set-top box issues.
There is no one kind of key problem or obstacle we see anywhere.
It just feels like it is a new market, a complex technology, and it's probably all very reasonable and natural.
I think if anything, we and others, were just a little naive to think that this new industry, built upon really new and innovative technology could spring up really quickly.
We have to remember cable operators and satellite operators have been delivering video and digital video for years and years and years, and we see operators trying to catch up and leap-frog over the course of a year, and it is a tall order and it is taking longer.
- Analyst
Okay.
I mean, do you have any ability to handicap when generally those things might start to get resolved?
I mean, is there a middle ware or software coming up that may deal with some of those?
What does your gut say as to how, what the duration of this problem looks like?
- CFO
There is no silver bullet.
Look, I don't think we want to overstate it.
At the end of the day we actually a good part of our revenue that was recognized was from IPTV.
There are successful deployments and projects out there.
What we're finding is that we're still in the first phase of the business.
I don't see any technical silver bullet.
What I see is everyone involved, Harmonic, end customers, I think more knowledge basically being available and present out in the market, and so I see a gradual, but steady maturation of the overall technology, and growing up with the experience base, and I think we'll, you know, this is going to be a very good market.
It was a good market for us last year, and I think it's going to be a good market for us this year and I do think coming the ends of this year in 2008 we'll see things moving much more quickly.
- Analyst
Okay.
Thank you.
- CFO
Thank you.
Operator
Your next question comes from the line of Tim Savageaux.
With Merriman, please proceed.
- Analyst
My questions on OpPex and satellite have been answered.
I assume you disclosed 10% customers up front when I was not here.
But in case you diidn't, I'll ask the question and leave it here.
- CEO
We had 110% customer, that was Comcast which represented 21% of revenue.
- Analyst
Great.
Thanks, guys.
Operator
(OPERATOR INSTRUCTIONS).
Your next question comes from the line of Paul McWilliam with Indie research.
- Analyst
You mentioned earlier and I read your press release in regards to 6-meg bit at HD and 264, in MPEG-4.
Now, that's statistically multiplexing in a number of channels, isn't it, to realize that as the average per channel?
- CEO
No, not necessarily.
Look, what people--what I should explain is that, there is no one kind of setting or sweet spot.
In general there is a trade-off between video quality and bandwidth and I think in a particular demo we were showing publicly and at the recent show and what we've been showing for quite some time in private to our customers, is that in a particular configuration, when we ramp down to 6 meg bits including a constant bit rate, you see decent quality.
But there is a spectrum of opinion and we have some customers who say, gee, it is good enough even below that level.
And we have other customers that say, gee, I'm really more comfortable with it at seven.
Going back to your specific question, Paul, the product looks quite well in those ranges, even with constant bit rate.
- Analyst
Oh, okay.
Is there a measurement standard where you can have a quality measurement and a bandwidth measurement so it can be comparable.
- CEO
No, there isn't.
It is one of the maddening things.
In our prepared comments we talked about competitive evaluations.
In this industry there is literally something called a shoot-out where a customer comes in with their so called golden eye employees and take a look at how different video looks.
It is subjective by people who have a lot of experience looking at video.
- Analyst
Okay.
Thank you.
Operator
Your next question comes from the line of Brandin Peoples with XI Asset.
Please proceed.
Mr.
Peoples, your line is open.
I'm showing no more questions in queue at this time.
- CEO
Okay.
Well, let me close by thanking you all for participating in today's conference call, and we look forward to speaking with you again.
Good day.
Operator
Thank you for your participation in today's conference.
This concludes our presentation.
You may now disconnect.
Have a good day.