Harmonic Inc (HLIT) 2010 Q2 法說會逐字稿

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  • Operator

  • Good afternoon.

  • My name is Phillip and I will be your conference operator today.

  • At this time, I would like to welcome everyone to the Harmonic second quarter 2010 earnings conference call.

  • All lines have been placed on mute to prevent any background noise.

  • After the speakers' remarks, there will be a question-and-answer session.

  • (Operator Instructions) Thank you.

  • I would now like to turn the call over to our host, Ms Carolyn Aver, Chief Financial Officer.

  • Ma'am you may begin your conference.

  • - CFO

  • Thank you very much and good afternoon everyone.

  • I am Carolyn Aver, the new CFO at Harmonic.

  • ,With me at our headquarters in Sunnyvale, California are Patrick Harshman, our CEO, and Michael Newman, our Investor Relations spokesman.

  • I would like to point out that in addition to the audio portion of this call, we have also provided slides which you can see by clicking on the front page of harmonicinc.com and going to the event section.

  • Thank you all for joining us.

  • Before I begin, let me remind you that 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 that actual events or results may differ materially.

  • We refer you to documents that Harmonic files 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, on this call, we will provide you with financial metrics determined on a non-GAAP or pro forma basis.

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

  • With that, let me turn things over to Patrick.

  • - President, CEO

  • Well thank you, Carolyn and thank you all for joining us today.

  • Turning to slide three of our presentation, let me begin by saying we are extremely pleased with the way our business is performing.

  • We delivered $95.5 million of revenue, up 18% year over year.

  • Our non-GAAP gross margins were 51%, reflecting the continuing success of our product strategy.

  • Non-GAAP earnings were $0.09, up from $0.03 a year ago.

  • Perhaps most indicative of how we are performing in the market, our bookings during the quarter were $104 million, up 28% from a year ago.

  • The key market dynamic underline these results as the continuing global expansion of high definition video services.

  • We see increasing investment in high definition services worldwide and across all customer segments and Harmonic has never been better positioned to take advantage of this growing HD opportunity.

  • Additionally, while HD is a locomotive driving business today, we continue to be encouraged by growing success in newer business areas, including converged multi-screen video services.

  • And of course we remain quite excited about the pending acquisition of Omneon.

  • I'm pleased to report that Omneon's business has continued to perform really well.

  • Customers around the world have provided strong positive feedback on the combination.

  • We now expect the deal will close in late Q3 or early in the fourth quarter.

  • Let's now move to slide four and take a closer look at how the market transition to HD is creating a range of growth opportunities for Harmonic.

  • We are excited to see all of our customers, broadcasters, cable operators, satellite direct to home operators, and telcos around the world expanding their HD channel lineups and investing in new encoding systems to do this.

  • We are also pleased to see video on demand content being increasingly migrated to HD formats, which of course drives the need for more edgeQAM capacity.

  • In cable networks.

  • Delivering this increasing live and on demand HD content is putting tremendous pressure on access networks.

  • In response to this bandwidth squeeze, our customers are investing in a range of bandwidth management technologies.

  • Across our customer base, we started to see a whole new encoder upgrade cycle where our latest generation, HD and standard definition encoders are being purchased to replace existing encoders.

  • Opening up bandwidth for new HD channels in the process.

  • This replacement cycle started to play out for us in the second quarter.

  • Will be a key opportunity for us going forward.

  • We are also seeing renewed cable industry focus on switch digital video rollouts and on HD network segmentation.

  • Trends that underline our continuing strong edge and access results and creates significant ongoing opportunities for Harmonic.

  • With events like the World Cup stimulating expansion of the HD experience around the globe and with new HD technologies such as 1080P at 60 frames a second and 3-D gaming market momentum, we see the trends I've just highlighted continuing to play out for the foreseeable future.

  • Turning now to slide five, I would like to highlight a couple of the reasons why Harmonic is successful at taking advantage of these market trends.

  • First, our technology position has never been stronger.

  • Our Electra 8000 encoding platform really has become the gold standard of the industry.

  • Winning numerous competitive shootouts conducted by our customers over the past several months.

  • Similarly in the edgeQAM area, we recently disclosed that we have now shipped over 1 million QAMs, a milestone that validates our clear market leadership position in this product category.

  • More generally, our sustained investments in maintaining our video technology leadership has paid dividends in the first half of this year and we are confident that our strong pipeline of new products and solutions will enable further opportunities.

  • In addition to developing great technology, we've also been doing a good job leveraging the sales and marketing investments we've been making to gain further market share.

  • Business with direct to home satellite operators represented 27% of revenue this quarter.

  • A result due in part to our strategic focus on gaining more International satellite customers.

  • I'm also very encouraged by the progress we've been making with new telco customers in emerging International markets.

  • And continuing progress with broadcasters around the globe.

  • Here I want to note the positive impact of the acquired scope of sales channels and broadcast products toward developing this broader customer base.

  • Turning now to slide six.

  • While HD is driving the biggest wave of customer spending with us today, we are also making positive strategic progress in developing additional growth engines for our business, which we believe will impact future growth.

  • First, I want to highlight the progress we are seeing with our growing technology portfolio that enables delivery of premium video programming over the Internet as part of converged multi-screen services.

  • We continue to win important seed projects in this area across our customer base, again with broadcasters, cable operators, satellite operators, as well as telcos.

  • We continue to believe that this area constitutes a significant growth opportunity for us.

  • I want to highlight here in particular increasing cable industry momentum towards converged IP video services.

  • Using the MPEG 4 AVC standard, a move that will create a new wave of video infrastructure investment that plays directly to our technology and IP system deployment strengths.

  • Another important market trend is that of distributing high-quality video content from content owners and origination sites to service provider locations.

  • During the quarter, the Comcast Media Center issued a press release announcing their new service in this area.

  • And Harmonic's role as a strategic technology partner.

  • As with the multi-screen area, we are well positioned from a technology perspective and we see this distribution trend opening up attractive opportunities across customer segments and across geographies.

  • Finally in new growth drivers, I want to highlight continuing success in International markets, and particularly in the emerging markets we have targeted for growth.

  • You've seen several recent press releases from us announcing our growing success in China and we also continue to be encouraged by the progress we are seeing in India and Latin America.

  • Another important step in the strategic evolution of our business is our proposed acquisition of Omneon.

  • Turning now to slide seven, I would like to provide a brief update on Omneon's business.

  • As you will recall, nearly three months ago we announced a definitive agreement to acquire Omneon, a significant step we believe will further accelerate our strategic develop into a category defining video market leader.

  • Similar to Harmonic, Omneon's business has been performing very well.

  • First half bookings were $57.8 million, up 19% year over year.

  • As Omneon has been doing a great job exploiting its newest products and solutions.

  • Both in traditional play out and in the newer production and software application areas.

  • As with Harmonic, the key driver of Omneon's business has been and will continue to be its market transition to high definition.

  • Also like Harmonic, Omneon has a strong focus on developing its International business.

  • Through the first half of the year, the Company has seen strong results from Asia in particular.

  • And has benefited from the rebound in advertising spending in the US and elsewhere.

  • Looking at the full year, on a standalone basis, Omneon now forecasts revenue in a range of $120 million to $125 million, up about 18% year over year.

  • Non-GAAP gross margins in the high 50s and non-GAAP operating margins of somewhere between 6% to 7%.

  • It is clear that Omneon's positive business momentum is continuing, driven by both strong technology and growing market opportunities.

  • Importantly, bookings in the second quarter were up from the first quarter as a strong market momentum has continued since our announcement of acquisition.

  • Indicative, I think, of a tremendous sort of confidence in the deal from Omneon's customers and employees.

  • To dig deeper in the feedback we've been receiving from customers, we will now turn to slide eight.

  • Since we announced the deal over 50 meetings have been held with both Omneon customers and joint Harmonic Omneon customers.

  • The feedback has been overwhelming positive.

  • There is no question that our customers are in agreement with our strategic vision, that the market is heading towards a convergence of video production, play out, and delivery.

  • Customers I've spoken to have been particularly excited by several integrated technology solutions the two companies plan to put together.

  • Examples of this include integrated content creation and delivery of workloads, where we can really streamline our customers operations and integrated solutions for live to on demand services.

  • Solutions that span content capture, storage, management, and multi-device streaming.

  • More generally, both companies are very well respected by our common customers around the globe.

  • They are excited to see two of the industries best players getting together.

  • Particularly in International markets, our customers appreciate the fact that we will now have more local presence and scale.

  • As an example, I recently visited Asia to meet with a number of our key customers and partners in the region.

  • These included SKY PerfecTV in Japan, one of our largest satellite customers in the region and also an Omneon customer .

  • JCOM also in Japan, and one of our key cable customers in the region and also Omneon customer and PCTW in Hong Kong, a strategic IPTV costumer of Harmonic and also an Omneon customer.

  • I can tell you I came back from this trip with even greater confidence in the value of what Harmonic plus Omneon can deliver in the global marketplace.

  • In addition to spending time with our customers, we've also been spending a great deal of time flushing out our integration plan.

  • And are very confident that we have a solid execution plan in place.

  • We've identified 2011 cost synergies of approximately $8 million to $10 million, spanning areas like product manufacturing costs, our two companies share a common contract manufacturer, as well as facilities and G&A.

  • Okay.

  • I'm now going to switch gears and bring Carolyn back into the call.

  • I think as all of you know, Carolyn joined Harmonic approximately eight weeks ago as our new Chief Financial Officer.

  • In the short amount of time Carolyn has done a great job rolling up her sleeves and making a difference in the business and we are really happy to have her on board.

  • Carolyn, I will now turn the call over to you to tell us more about Harmonic's second quarter, our financial outlook, as well as the pending integration of Omneon.

  • - CFO

  • Thanks, Patrick.

  • I am really delighted to be a part of the Harmonic team at this very exciting point of time for our Company.

  • Moving to slide 10, as Patrick said, this is a terrific quarter.

  • Driven by market demand for our products, we had a very strong bookings quarter, which combined with our backlog entering the quarter drove revenue margins and EPS.

  • In addition, we generated $10 million of cash and reduced DSOs.

  • As we've discussed, we saw a continuation of the strong momentum in revenue and bookings.

  • For the second quarter of 2010 we reported net revenues of $95.5 million, up 18% from the $81.3 million in the second quarter of 2009, and up 13% from the $84.8 million in the first quarter of 2010.

  • For the first six months of this year our net revenues were $180.4 million, up 21% from the $149 million in the same period last year.

  • Total bookings in the second quarter were $140 million, up 27% from $81 million for the second quarter of 2009.

  • Resulting in another quarter of building backlog.

  • Let's take a look at slide 12 where we can see our revenue mix.

  • Domestic customers represented 25% of total revenue for the second quarter and were a big factor in our bookings as well.

  • Revenue for Europe was up both your over year and sequentially.

  • And we have not yet seen signs of a slowdown among our customers there.

  • Cable customers accounted for 56% of revenue in the quarter, satellite customers 27%, and telcos and others were 17%.

  • The stronger than usual demand in the global satellite market was a result of both projects completed during the quarter, as well as new orders received and shipped in the quarter across all regions.

  • We would however expect to see the cable portion of this mix increase next quarter as a result of the strong cable orders we received during Q2.

  • Our largest customer was again Comcast representing 16% of total revenue in the second quarter.

  • By product category, video processing sales were particularly strong, representing 52% of revenue for the second quarter.

  • Edge and access products represented 35% and services and support 12%.

  • You will recall that we have revised our product categories to include software in the video processing category, rather than combining it with services support.

  • It has becoming increasingly difficult to clearly separate software and hardware in our video processing solution.

  • In addition, this presentation allows to show separately services and support, which now has exceeded 10% of our revenue.

  • On slide 13, we look at operating performance.

  • We continue to sustain strong gross margins this quarter.

  • Our non-GAAP gross margin was 51%, comparable with the previous quarter.

  • And up from 45% in the same period of 2009.

  • Operating expenses were $35.5 million, up about $0.5 million from last quarter and our operating margin was 13%.

  • Headcount remained relatively flat at 848 employees.

  • The year over year increase in revenue and margins had a positive impact on our net income as well.

  • Our non-GAAP net income for the second quarter was $9.1 million, or $0.09 per diluted share.

  • Up from non-GAAP net income of $3.1 million, or $0.03 per diluted share for the same period of 2009.

  • We have reported non-GAAP provision for income taxes of 30%, which we believe is the normalized tax rate given our current mix of International revenue and profitability.

  • We are pleased that our International reorganization in 2008 is paying off in lower taxes.

  • On slide 14 we will take a look at the balance sheet, which also continues to be strong.

  • At the end of the second quarter we have cash and cash equivalents short term investments of $278 million, up from $268 million at the end of Q1.

  • After closing the on the Omneon deal we expect to have cash in excess of $100 million.

  • Our inventory was $42.8 million, up from $39.6 million from the first -- from the end of the first quarter.

  • This inventory increase mainly reflects our preparations to fulfill the increases in our backlog and our forecast expectations as we move into the second half of the year.

  • Our receivables balance increased modestly to $71.4 million resulting in DSOs of 68 days, down from 75 days last quarter.

  • We are pleased to see this return to our target range as 60 to 70 days.

  • Finally, our capital spending was $2.9 million in the second quarter.

  • We expect CapEx to be in the range of $16 million $18 million for the remainder of 2010.

  • Which includes approximately $14 million for additional lease hold improvements and equipment for our new headquarters facility.

  • We begin moving into the new building tomorrow.

  • On slide 15 we will take a look at our outlook for the rest of this year.

  • We enter into the second half of the year with a very strong backlog.

  • Taking into account our backlog and business momentum, we expect net revenues for the third quarter of 2010 to be in the range of $95 million to $98 million.

  • For the full year of 2010 we are targeting net revenues in the range of $370 million to $375 million.

  • The planned introduction and continued development of a number of new important product releases in the second half of 2010, are expected to moderate gross margins and increase operating expenses.

  • Non-GAAP gross margins for the third quarter are anticipated to be in the range of 48% to 50%.

  • And non-GAAP operating expenses are expected to be $36 million to $37 million.

  • These anticipated results exclude any financial impact of, or related to, the proposed acquisition of Omneon.

  • In addition, they also do not include approximately $750,000 of move related expenses that we'll incur in the third quarter.

  • On slide 16, we want to take a look at what to expect from Omneon.

  • We believe the deal will be completed by the middle of the fourth quarter.

  • We have cleared any Hart-Scott-Rodino issues and are working through the regulatory approval process.

  • As some of you may know, I have considerable experience in acquisitions and the business modeling and integration planning for Omneon is the first thing I'd focus on since joining the Company.

  • The first phase of integration, is focused on integrating manufacturing and operations, co-locating the Sunnyvale employees and integrating the G&A functions.

  • Detailed integration plans are in place to achieve full integration in each of these areas within 60 days of close.

  • We have built a bottoms up combined company model that has identified $8 million to $10 million cost synergies for 2011, principally from these three areas.

  • We do expect additional acquisition related charges over proximately $5 million to $6 million in the Q3, Q4 timeframe.

  • We will provide specific guidance for the combined company after closing and once we have greater insight into the purchase accounting, including the potential reductions for Omneon deferred revenue balance, which would typical, of course, in a situation like this.

  • On slide 17 I would like to take a look at the 2011 business outlook.

  • We see a number of encouraging signs.

  • First of all, our core business has excellent momentum.

  • Excluding the impact of Omneon, we expect to see low double-digit revenue growth and operating margins of around 15%.

  • The addition of Omneon will extend our addressable market and further accelerate our growth.

  • With $58 million of first half 2010 bookings, we would anticipate Omneon to do between $120 million and $125 million in revenue for 2010, reflecting a continuation of their historical 18% growth rate.

  • Omneon has higher gross margins than Harmonic, so we expect the combination to have a positive impact on our gross margin over the long term.

  • With the target synergies identified, we anticipate the combined operating margins to be in the 15% range for 2011.

  • With that, I will turn the call back over to Patrick for some closing comments.

  • - President, CEO

  • Well thanks, Carolyn.

  • So, in summary, we believe the progress we've reported to today offers clear indication that our strategic direction that is focusing on the technology and services that enable HD and other next generation premium video services, while also addressing an ever broadening base of customers, is driving success for us.

  • We continue to see great opportunities for the Company and we continue to believe that the combination with Omneon further solidify our position as the leading provider of mission critical video delivery infrastructure to media companies around the world.

  • With that will and the formal part of our presentation and open up to your questions.

  • Operator?

  • Operator

  • (Operator Instructions) You do have a question.

  • Your first question is from the line of Mark Sue RBC Capital Management -- I'm sorry Capital Market.

  • - Analyst

  • Hello this is Chris for Mark Sue.

  • Can you give some color on the new financial model will look like after the integration of a Omneon?

  • - CFO

  • I think what we are trying to guide you to now, before we have all the details and disclose all of the numbers of Omneon.

  • Is that we would say that Harmonic for 2011, would see revenue growth in, as I said, the low double digits, we would expect that Omneon would likely continue to grow at their more historical growth rate.

  • And we don't have a gross margin target yet.

  • But we would say that after synergies, the combined companies could generate 50% operating margin.

  • We will move them to our tax structure over the course of the next several quarters.

  • That involves a series of things.

  • So, I'm not certain that we can achieve a 30% tax rate for thema beginning immediately.

  • But if you look at a 30 and 40% when a great moving to 30% over time.

  • That would give you a good sense of where it might be.

  • - Analyst

  • Okay great that's very helpful.

  • Just one more, you mentioned in your prepared remarks that cable segment would increase as a percent of revenues in the next quarter?

  • Can you give us a sense of where the segment is going past Q3?

  • - CFO

  • We take broad opportunities in cable.

  • As you know, it's the largest that that we address.

  • It's the largest opportunity in terms of breadth of our product line.

  • We continue to see opportunities in high definition encoding, stream processing.

  • I talked about the work with the Comcast Media Center moving content around national backbone fiber networks is an increasing opportunity.

  • I also mentioned growing activity around the convergence.

  • And of course on the edge and access area.

  • We see more pressure on access capacity.

  • We see continuing opportunities for the HSE access piece of that.

  • And we see good opportunities around our edgeQAM product, both in expansion of the traditional VOD footprint and, also as I mentioned, we see the continuing momentum around switched digital video.

  • For us to see, it's the full package, the full complement of technologies.

  • We think our cable customers are doing very well and we think they are increasingly turning to Harmonic to help them really right across their board

  • - Analyst

  • Great.

  • Thank you.

  • Operator

  • Your next question is from the line of Amir Rozwadowski of Barclays Capital.

  • - Analyst

  • Thank you very much and good afternoon, Patrick and Carolyn.

  • I was wondering if we could continue on the theme of cable side, Patrick.

  • It seems as though if we look at some of your larger customers in the cable arena.

  • There does seem to be a sense of restraint CapEx from a broader perspective for them.

  • Can you give us a little bit of color in terms of reconciling that what seems like, from your perspective as sort of healthy spending on your area versus where they are being more restrained in terms of their spending?

  • - President, CEO

  • Yes.

  • It's important to understand the cable CapEx pie is a big pie.

  • And Harmonic traditionally plays in a relatively small piece of that.

  • Historically, building new plants, digging up streets.

  • Set-top boxes, consumer electronics, the customer premises equipment.

  • Those are all major, major CapEx categories where Harmonic doesn't participate.

  • In our view, and I think the cable operators view, is a lot of that fundamental investment has happened.

  • What they have built is a fantastic platform.

  • Now the job, or the opportunity, is to roll out new services that ride on top of that platform.

  • New services like HD, like Internet video services, like video on demand.

  • HD on demand, 3-D et cetera.

  • We think that's where the opportunity is for their business, higher-margin, higher value services.

  • That's really where our products fit in.

  • I think if you look at the discussions of our large customers, you'll see that underneath flat or maybe even declining CapEx it actually shifts in where the investments are coming.

  • I think, as recently as yesterday, Comcast talked about their spending, and you saw, actually, an increase in planned spending and, what I think they call strategic areas.

  • - Analyst

  • If we think about sort of your own investments internally, it seems as though you mentioned that you are investing in some new product platforms that are going to temper some of your gross margins for at least the near term and then expand your OpEx.

  • What areas -- or should we consider that you're investing in right now, what types of products are these?

  • - President, CEO

  • We are investing right across the board.

  • We continue to push the edge on encoding, on transcoding.

  • A lot of the software-based applications.

  • As well as in edge and access.

  • Probably the most specific and significant driver of near term moderation and gross margins is our plan to roll out a new edgeQAM platform later in this quarter.

  • And as with the case when we rolled out the current platform, a year -- 18 months ago.

  • The initial shipments come with a lower margin.

  • We are putting new hardware and new platform and then over time, as we deployed blade into that platform, as we deployed new software applications on top of that platform, the margins significantly improved.

  • I think you've seen very strong margins for us in the edge and access category this year as we have really taken advantage of last generation platform.

  • So we're pretty excited about getting this next generation, edgeQAM platform out there.

  • - Analyst

  • Lastly, Carolyn if we look at sort of the cost synergies that you outlined, I guess the $8 million to $10 million, do yo have a sense of how much of that will fall into the COGS line versus OpEx?

  • - CFO

  • There is a good piece that falls into COGS because a component of that is on the manufacturing operations side.

  • We both use Plexus as our contract manufacturer.

  • We have the ability to achieve some important synergies in the combination of how we manage that and where we manage that.

  • So, there's certainly a significant chunk that is related to that.

  • There's another piece that is related to facilities cost and that gets spread equally across all areas.

  • And then I would say -- so I would say probably more than half in the COGS and the other piece in OpEx.

  • There's also a pretty good amount of synergies in the G&A line.

  • Really in auditors and insurance and all of the duplicate of costs that you have in it G&A areas.

  • There will be a few million in that area as well.

  • - Analyst

  • Perfect.

  • Perfect.

  • Thank you very much for giving the color.

  • Operator

  • Your next question comes from the line of Vivek Arya with Banc of America.

  • - Analyst

  • Thank you.

  • Hi.

  • A couple questions.

  • First from a guidance, it looks like fourth quarter would be sort of flattish versus the third quarter if my math is right.

  • Is it conservativism, is it based on any specific information, just in general what could be some of the upside or downside factors here?

  • - President, CEO

  • I think we are still getting a feel for what is going to happen later in the year.

  • Second quarter was exceptionally strong.

  • Frankly stronger than we anticipated and we are heading into Q3 with a lot of a momentum behind us.

  • We think we have got good visibility on the third quarter and good momentum.

  • I don't know if I would call it conservative, Vivek, but I think that we are really waiting to see how the fourth quarter will evolve.

  • I would point out that with this guidance, we are -- we have substantially increased our guidance for the full year.

  • We are quite pleased with our business if we do in fact end up where we predicted, which is something on the order of 16% growth year over year.

  • - Analyst

  • Patrick, can you remind us seasonally what trends have you seen in the fourth quarter versus the third quarter?

  • - President, CEO

  • It is a little bit all over the map.

  • Very often, last quarter -- last year, excuse me, we had a very strong fourth quarter.

  • Of course the previous year was very weak.

  • I think it can be either strong or we can -- at this point I think it is hard to predict.

  • - Analyst

  • Okay.

  • Secondly, I know you outlined some cost synergies at Omneon next year.

  • Any kind of top line synergies that you could perhaps point to that you may have started some work and that could be possible upside?

  • - President, CEO

  • Yes.

  • Absolutely.

  • We haven't quantify that.

  • I think it is premature to quantify it.

  • We definitely -- we definitely have been talking to a lot of customers and the response, as I mentioned in the prepared remarks, has been quite, quite positive.

  • I think that there is a lot of interest in doing business with the combined company, as I said, we're both really well liked by our customers.

  • Customers just like seeing us come together, have a lot of confidence in what the two companies can do in general.

  • In particular we see several solution areas that there's been a very strong response to.

  • So, I think -- I think we need to get a low bit closer, we need to let the companies come together before we start getting quantitative about that, but we're looking forward to getting this thing closed and really getting into our 2011 planning process in earnest.

  • - Analyst

  • Got it.

  • Just one last one.

  • If you could just give us a conceptual of gross margin range to model for the combined company.

  • I understand all the details have not been hammered, but just how should we think about combined gross margins including all the cost synergies that you mentioned before?

  • - CFO

  • Our gross margins, obviously are -- we target to be around the 50% range.

  • I think we've said that Harmonic's are in the high 50s and approaching 60%.

  • I think when you put that together and you look at the combined revenue contributions, you would imagine that they are going to start in the lowish 50 range.

  • For sure, as I think you know, Harmonic has had a roll over time to bring our gross margins up.

  • We have done that well over the last few years, we think we can continue to do that.

  • So, longer term, not modeling for next year, longer term we certainly want to see mid 50s or higher.

  • I don't think we are going to get there for 2011.

  • - Analyst

  • Got it.

  • And since you are on the topic of longer-term.

  • Is it unreasonable to expect high teens operating margin to even 20% at some point down the road, or is that too far to look out right now?

  • - CFO

  • I don't think we want to predict that at this point, but I think there are times in the past that we've been at that level and at scale, I think we certainly would like to achieve those.

  • - Analyst

  • Okay.

  • Thanks and good luck.

  • - CFO

  • Thank you.

  • - President, CEO

  • Thank you.

  • Operator

  • Your next question is from the line of Greg Mesniaeff with Needham & Company.

  • - Analyst

  • Yes.

  • Thank you and congratulations on a really solid quarter.

  • Question on the HD replacement cycle that you alluded to, Patrick, it appears to be a nice several quarter, perhaps longer growth driver for you.

  • Looking at that -- at your product set, how would you split that among MPEG 2 and MPEG 4?

  • Are you saying -- if you could just give us kind of your take on that?

  • - President, CEO

  • I don't know exactly what the breakdown is.

  • We are seeing a replacement cycle across both technologies.

  • I think it's important to remember, we often think about satellite and even IPTV as being MPEG 4.

  • I think that's true from an HD perspective, but actually if you step back worldwide, most of the satellite content, in particular that is delivered out there is actually standard definition MPEG 2.

  • Certainly in the cable world it is all standard definition and high definition MPEG 2.

  • The replacement cycle we are starting to see play out is not just replacing high definition decoders that have been deployed the last couple of years, it is also standard definition decoders there.

  • Squeeze the standard definition stuff down as much as you can to create room for additional HD channels.

  • We are seeing pretty good opportunities and pretty good activity across standard definition and high-definition and across MPEG 2 and MPEG 4.

  • - Analyst

  • So really you're seeing growth in the entire matrix , if you will, or

  • - President, CEO

  • That's right.

  • Most of the new incremental channels that are going on there, are MPEG 4 HD.

  • Except for in cable where it's high-definition and MPEG 2.

  • But in the service of those things and in the service of adding new channels, we see scrutiny right across the board in terms of squeezing down the already existing stuff.

  • Yes, from a replacement cycle, from getting more efficient on what is already up there, it is really hitting all four quadrants.

  • They are -- our 8000 product which simultaneously supports the same platform, same hardware supports is an MPEG 2, MPEG 4, HD and SD.

  • We've really hit the sweet spot with that product.

  • - Analyst

  • You also alluded to a new edgeQAM product to be released in the quarter.

  • I was wondering if you can give us a little bit of color on that, whether the focus is on density or on form factor, physical form factor or price or what other variables?

  • - President, CEO

  • We haven't -- haven't formally announced the product, Greg.

  • We thought it was the right thing to do to kind of give you give visibility that we are putting another platform out there from a gross margin point of view.

  • I prefer to hold off until we have the formal product launch to disclose the specific salient competitive advantages of the product.

  • - Analyst

  • Got you.

  • And just quickly if you can repeat what was the geographic revenue mix breakdown?

  • You mentioned US was 25%.

  • What were the other regions?

  • - CFO

  • No, geographic US was 52%.

  • - President, CEO

  • That's right and International was 48%.

  • - Analyst

  • Got it.

  • Okay.

  • Thanks a lot.

  • - President, CEO

  • All right thank you very much.

  • Operator

  • Your next question comes from the line of George Notter with Jefferies.

  • - Analyst

  • Hi.

  • Thanks very much.

  • I want to ask about if your guidance for 2011.

  • I guess number one, I'm trying to find out why guide for 2011 right now, traditionally the Company has been in the mode of guiding one quarter at a time, or even six months at a time.

  • Here we are still six months away from next year and you are putting some numbers out there.

  • I understand, there is a little bit different in the year because of be a Omneon acquisition.

  • I was wondering, has visibility really improved, or is there something else fundamentally that I'm missing about the business, or is it just simply the fact that we are getting ready to close the Omneon deal?

  • - CFO

  • I can't speak to history, obviously, although we've talked about it quite a bit.

  • I think it's a combination of, certainly the Omneon deal and secondly I think that the street is at a point now where they are starting to put out their 2011 numbers.

  • We would like to have some sort of help discrete in some way and get those numbers.

  • We don't them to get ahead given the strong growth, we don't want them to get ahead of where -- where we feel comfortable today.

  • Backlog obviously makes us have some more comfort as we get into the second half of this year.

  • We also do see some of these cycles having longer term impacts and are giving us some insight to the beginnings of where we think next year is going to be.

  • - Analyst

  • Got it.

  • And then just as a reminder, can you tell me what the operating margin guidance for Harmonic stand alone would be for next year?

  • I think you said 15%, but maybe I misheard that.

  • - CFO

  • I did.

  • 15% is correct.

  • - Analyst

  • Okay for heritage Harmonic and then as we layer in Omneon you also think the business would be 15% operating margin business?

  • - CFO

  • That's correct.

  • - Analyst

  • And then, just getting back to sort of the fundamentals of the business, we tend to think about your business as being a second derivative business, particularly on the video processing side, the pace of new HD channel additions on a second derivative basis is important.

  • The pace of upgrades, I guess I'm trying to figure out why now we are seeing a new acceleration in the rate of HD channel ads or the rate of upgrade activity.

  • Is there something fundamentally you see going on that is changing that -- that is creating an acceleration in the market?

  • - President, CEO

  • HD is certainly accelerating overseas.

  • So I guess is one important point.

  • Up until very recently it's been largely a US phenomenon.

  • We are very encouraged to see HD really starting to make a move overseas.

  • And secondarily, as I've tried to highlight, we think about the HD opportunity as broader than just new HD encoders for incremental channels.

  • What we are starting to see is some kind of ripple and follow on effects.

  • Switched digital video is getting a lot more attention now, I think as you know.

  • I think it is largely an out cropping of the fact that as more HD channels are being added in the cable environment, starting to run out of space.

  • The upgrade cycles.

  • I think that's also just an opportunity of the technology has afforded us.

  • Historically in encoding business, anytime that we can come up with significant enough advances in the compression efficiency, for a satellite operator to ad a couple more channels in an existing transponder, it pays dividends to replace those encoders.

  • Historically, even in the days of MPEG 2 standard definition, we went through several rounds of upgrade cycles simply because compression efficiency just got better and better.

  • The good news right now for us is that we have, both from a standard definition as well as a high definition, the state-of-the-art of the product is advanced to such a point that there is a material advantage now.

  • I think anytime that you can simply replace encoders to get better compression efficiency, it's always a winner to do that and clear out the additional bandwidth.

  • So, International effect, I think a number of derivative effects following on from the continuing growth of HD services here in the US.

  • Overall, really conspiring to lend -- I think underlying strength to the business right now.

  • - Analyst

  • Just one last housekeeping item.

  • I thought the deal was supposed to close in Q3, now you're saying mid Q4?

  • What exactly has changed there?

  • - CFO

  • We are just going through the sort of normal regulatory procedures.

  • We still think it certainly could close in Q3, but spillover in Q4 and we just wanted to update guidance on that.

  • On that -- I want to go back to your question sort of as I reflect on it on guidance versus target.

  • We aren't -- I don't want you to construe that what I am trying to do is give specific guidance for 2011.

  • I think that we are trying to help set an interim term targets of growth and margins that we think you all all to think about as you build your models.

  • But not prepare to sort of to call that specific guidance at this point.

  • - Analyst

  • Okay, thanks very much.

  • - President, CEO

  • Thank you.

  • Operator

  • Your next question comes from line of Blair King with Avondale Partners .

  • - Analyst

  • Thanks for taking the call.

  • Patrick, it's been probably several quarters since we have heard much out of Harmonic relative to the telco space.

  • You mentioned it in your remarks and obviously some pretty good sequential strength in that end market.

  • If you could give an update with regard to what's going on in the telco segment that would be really helpful.

  • - President, CEO

  • Yes.

  • The incremental activity that we are seeing is actually in a number of emerging markets where we are saying smaller telcos, perhaps tier two telcos, if you will.

  • Places like Asia, places like Eastern Europe.

  • The Middle East.

  • Start to get into IPTV.

  • And this is really a follow-on activity to a move a lot of tier ones Internationally made over the past couple of years.

  • We have seen kind of a second wave starting to happen among those smaller to medium sized telcos and some of these emerging markets.

  • And we have been fortunate enough to be able to pick up a lot of that business as it evolves.

  • Now of course there's a certain amount of ongoing business that has continued to happen with a number of the tier ones that we have won in other parts of Asia and Western Europe.

  • New HD ads, for example, early trials and activity around mobile work.

  • I think last quarter we announced a nice mobile video win with Swisscom, as an example.

  • It is a little bit of a balance of things, but I would say the extra lift that we are seeing right now with some of these telcos and emerging markets starting to get into the video game.

  • - Analyst

  • Lastly.

  • You had also made some comments about the converged multi-screen activity and some IPTV delivery activity within the cable space, I guess here in the United States.

  • Recognizing that, that's probably a relatively small piece of your business today, I'm certain that you have some confidence in that growing through 2011.

  • Really just anything you can give us that might help understand how that scales through 2011 relative to the size of your business would be also helpful.

  • - President, CEO

  • Look, frankly speaking there are still a lot of questions about how fast this segment will grow.

  • I think what is becoming increasingly clear is there is no question at all that converged services that deliver video, not only to the television set, but to iPads, and iPhones, and PCs, TV, anywhere kind of initiatives are continuing to bubble up really to the top of the strategic agenda or menu of our large customers, really across customer categories.

  • Certainly including cable and including cable operators here in the US.

  • Exactly how fast these services will be rolled out and the investment behind that.

  • I think we are still waiting to see.

  • Frankly, I don't see an explosion of activity in 2011, but I do see a steady ramp, I do see a growing contribution to our business in 2011.

  • Our main objective right now is to be to be right there, to be viewed as a business, as well as technology partner.

  • And so far I think we are doing a good job at that.

  • We will keep you posted on our progress in that area.

  • - Analyst

  • Thank you.

  • - President, CEO

  • Thank you, thank you, Blair.

  • Operator

  • (Operator Instructions) Your next question comes from the line of Simon Leopold with Morgan Keegan.

  • - Analyst

  • Hi.

  • This is Victor in for Simon Leopold.

  • I wanted to ask, another cable TV expo supplier reported last nigh a sharp slowdown in DOCSIS 3 that had a pretty material impact on their business.

  • I kind of wanted to ask you if you had a sense around this shift and if there's any impact in your business that you are seeing?

  • - President, CEO

  • I think we all know that the expanding in any particular category kind of waxes and wanes.

  • It's certainly true in video processing equipment.

  • I think none of us are surprised to see the fact that maybe CMTS spending is temporarily a little slower than it was in the past quarter.

  • I believe the CMTS and DOCSIS is a great business and we believe that cable operators will continue to spend strongly in that area.

  • All that being said on our side of the fence, if you will, I think video, new video services competing in terms of number of HDTV channels et cetera, continues to be very high on the agenda of our cable customers and we've continued to see a lot of strategic, and in fact investment focus, around the services that we're enabling.

  • - Analyst

  • Okay, great.

  • Also I noticed that there was a lot of upside from video processing this quarter, can you just give us a little color around specific allocations that were driving that this quarter?

  • - President, CEO

  • Video processing business is really doing well for us across customer categories.

  • Think you also noticed and we mentioned that a number of satellite products kind of converged, if you will, in the past quarter.

  • And those satellite -- our business with satellite is largely all about video processing, a little bit of our service business there.

  • I think you can -- you can certainly interpret the relative strength of our video processing in the second quarter to be somewhat correlated with the strength of the satellite direct to home business in the quarter.

  • - Analyst

  • Thank you.

  • - President, CEO

  • Thank you.

  • Operator

  • Your next question comes from the line of Jack Monti with UBS.

  • - Analyst

  • Hi.

  • Thanks for taking my question.

  • Just to dig in a little bit about gross margins.

  • I believe if I'm looking at it correctly that gross margin guidance got ticked down by about 100 basis points on a range.

  • I was just curious what the drivers of that change were.

  • - CFO

  • Certainly.

  • I think we talked a little bit about, we are coming into a new product cycle for one of our products.

  • And, that -- those cycles tend to be lower gross margin when they first come out because they have a larger hardware component.

  • Then over the life of that product cycle, we end up delivering more software and firmware into the appliance and therefore, getting higher gross margins.

  • So two things are happening, over the last couple of quarters we've clearly benefited from the back end of that cycle where we've had higher gross margins and more of a firmware software component.

  • Now we are moving into a phase where that's going to flip back again to a little bit more hardware component.

  • So, it's an estimate, we will -- it depends on the timing of the release and a number of things, but we just wanted to signal that there is -- if we left the range where it was I was worried everybody was going to end up at the high end of the range, and the reality is we think gross margins will be down a bit this quarter.

  • Where they land still depends on when the product comes out and how much we ship and a number of other factors.

  • We did want to signal that you should expect them to be a little bit lower this quarter.

  • - Analyst

  • I guess looking out further into the fourth quarter, I realize there's a lot of moving pieces, but with the organic business, do you think the launch will be sufficiently, far enough along that the margins will be able to improve a little bit at that point in time, or do you think there will still be a bit of a drag there?

  • - CFO

  • I suspect there could still be a bit of a drag.

  • That also depends on when in the quarter it gets released.

  • - Analyst

  • Okay.

  • And then shifting gears, cable is expected to tick up.

  • It sounds like satellite me tick down after a strong bit of -- strong bit of revenues and new projects recognizing revenues in the past quarter.

  • I was just curious if there is progress on the telco business that you want investors to think about?

  • Should that business be flattish or is that going to be down as well with cable being much stronger?

  • Thanks.

  • - President, CEO

  • I think we are encouraged by the activity around telco and in the short term we think that we will continue to see the level of business that we saw in this past quarter.

  • - Analyst

  • Great.

  • Thank you very much.

  • - President, CEO

  • Thank you.

  • I think we have time for one more question.

  • Operator?

  • Operator

  • Your next question comes from from the line of George Notter with Jefferies.

  • - Analyst

  • Hi.

  • Thanks a lot for the follow up.

  • I just wanted to ask about the sea map architecture.

  • It's getting more focused in the CMTS space.

  • There is two models, an integrated model, a modular model, both have implications for the edgeQAM space, obviously we are not pulling video into the IP domain.

  • How do you sort of parse that out in terms of how it impacts your business?

  • - President, CEO

  • I think there's a lot of interesting strategic discussions about -- about where and how these new services will be delivered.

  • I think that there is no question, but that the industry is eventually driving towards an IP delivery architecture.

  • I think that's a converged service.

  • I think definitely QAM is a big part of that.

  • How exactly it is packaged in the sea map architecture that you spoke to is certainly one-way of envisioning the way the future of the CMTS and the edgeQAM will come together.

  • I think as you know, and thos close to the industry know, we are very actively involved in all those conversations.

  • And, we continue to kind of work with one side of our brain, we are very involved in this long term strategic directionally thinking.

  • On the other hand we are very active making the business, making the services that need to be delivered today happen.

  • The thing is our position in the edge part of the network has never been stronger.

  • I think we as a company bring tremendous institutional knowledge, expertise in what it means to deliver IP services over access networks.

  • After all, we have really had unprecedented success with IPTV in the telecom sphere.

  • While I can't say we know for sure exactly how and where things are going to end up from an architecture and privatization point of view, we feel very good we stand from a core technology position, from a system expertise position and from a customer relationship position.

  • And it's just an exciting time to be working in the industry.

  • And, we all will continue to watch the evolution of some of these ideas and trends.

  • - Analyst

  • Got it, thanks very much.

  • - President, CEO

  • Thank you George.

  • With that, we'll wrap it up.

  • Just before we sign off here, I want to tell you again how good we feel about the way our business is going.

  • We are very excited about the results that we have been able to announce to you today.

  • More importantly, we are excited about the momentum that we see in business, the momentum we see in the marketplace.

  • The way our customers responding to our latest products and solutions, where customers are responding to our vision around the combination with Omneon.

  • We see a lot of good opportunities and we are really having a good time running this business.

  • So, we look forward to keeping you up-to-date on our latest projects.

  • Thanks everybody.

  • Operator

  • That does include today's conference call.

  • You may now disconnect.