Harmonic Inc. (HLIT) Q3 2012 Earnings Report, Transcript and Summary

Hello, and welcome to the Third Quarter 2012 Harmonic Earnings Conference Call. My name is Maisha, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded. I will now turn the call over to Carolyn Aver, Chief Financial Officer, you may begin.

Thank you, hello everybody. With me at our headquarters in San Jose, California is Patrick Harshman our CEO. I would like to point out that in addition to the audio portion of this call; we’ve also provided slides, which you can see by going to investor relations page of harmonicinc.com and clicking the third quarter earnings call button. Now turning to slide two, let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only current expectations and actual events or results may differ materially. We refer you to the documents of Harmonic files with the SEC included our most recent 10-Q report and the forward-looking statement section of today’s earnings press release. These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis. These items together with corresponding GAAP numbers and a reconciliation to GAAP are contained in today’s earnings press release, which we’ve posted on our website and filed with the SEC on Form 8-K. We will also discuss historical, financial and other statistical information regarding our business and operation. 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 the call over to Patrick.

Thanks, Carolyn, and thank you everyone for joining us today. Turning now to our slide three, today we reported our results for the third quarter 2012, which were in line with our guidance issued a quarter ago and sequentially up from the second quarter. In the context to continuing macroeconomic challenges, these results reflect our focus on improving operation execution and gaining market share. We are also making the right strategic moves and investments to position the company for a stronger long-term growth. With that as background revenue was $136.7 million, driven by a healthy demand from our global cable customers. Good execution on services related international projects. Demand from cable operators was particularly strong for Edge and Access products, where we believe we continue to gain market share. Record services and support revenue reflected growing revenue recognized on multi period projects, booked in prior quarters. Reflecting continuing macroeconomic headwinds, new bookings were $128.7 million, down sequentially. In particular, new orders from Europe were down over 15% year-over-year. Yet despite this we believe we gained market share in Europe, particularly in Cable, Edge and Access and in multi-screen. We gained some of number of new customer wins. In contrast to Europe, we did see solid year-over-year growth in new orders from Asia, in other emerging markets. And as a result year-to-date book-to-bill is still greater than one and we head into the fourth quarter with a healthy backlog. Turning to operating performance our gross margins were 48%, slightly better than the second quarter, but still below our target, due to product mix, and geographic makeshift towards emerging markets. Operating expenses were approximately $55 million in the quarter, and non-GAAP earnings were $0.07 per share. We again had robust cash performance generating approximately $22 million in cash from operations during the…

Thank you, Patrick. Moving to FY ‘10, our net revenue for the third quarter was $136.7 million, an increase of 3% from the second quarter and 2% below last year’s third quarter. Our bookings were $128.7 million lower than the second quarter bookings by $10.8 million. However, our book-to-bill for the year is still over one to one. Non-GAAP gross margin improved from Q2 to 48%, but are still below last year’s gross margin of 50.6%. The decrease in the gross margin is largely due to product mix issues as well as the shifted revenue to emerging markets. Non-GAAP operating expenses for the third quarter of 2012 were $54.8 million, up 2% from the previous quarter and a year ago. Our head count was 1,155 at the end of the third quarter, up eight from the end of the previous quarter. Non-GAAP net income for the third quarter was $8.1 million or $0.07 per diluted share compared to the $7.2 million or $0.06 per diluted share in the prior quarter and $12.7 million or $0.11 per diluted share for the third quarter of 2011. Turning to slide 11. let’s look at our quarterly revenue and backlog in more detail. As noticed, net revenue for the third quarter was $136.7 million, an increase of 3% from the second quarter and 2% below last year’s third quarter. On the other hand, our backlog and deferred revenue at the end of Q3 was $137.7 million, a decrease from $146 million last quarter, but an increase from the $125.4 million a year ago. In the past two quarters, our bookings have exceeded revenue principally due to increased service booking. This quarter, we began to recognize some of those service projects. Moving to slide 12, our international revenue represented 58% of total revenue in the…

Well, thanks Carolyn. In summary we believe Harmonic is executing well, gaining market share in a challenging environment, making dibble investments in significant growth opportunities. Regardless of the near-term macro situation we continue to broaden our customer base across geographies and to our clear technology leadership including delivering on our new CCAP and HEVC initiatives, and driving market leading IP multiscreen solution capabilities. With the focused global staff and strengthening strategic relationships with industry leading service providers and media customers, we are confident in our ability to execute. With that we’ll end the formal portion of the call, Carolyn and I would be pleased to answer any questions which you have.

(Operator Instructions) First question is from James Kisner with Jefferies. Please go ahead with your question. James M. Kisner – Jefferies & Co. Inc.: Hi, guys. Thanks for taking my questions. Just generally, I just want to start with the big picture question here, so I can sort of understand that, what’s going on in the business right now, very generally high level. I mean your bookings were down and I appreciate year-to-date that the book-to-bill is above 1, but they are down this quarter, and you’re still guiding up sequentially, so obviously it sounds like you’re planning to burn some backlog here in a seasonally strong Q4. Mission is curious, is that all Europe, is there any chance for some budget for election with America, Comcast has implied a pretty strong ramp in the back half. could you just sort of elaborate a little bit more on that in the current business environment?

Look, it’s challenging in many parts of the world including Europe. And we don’t expect that to change in the fourth quarter, James. and I’d say more broadly, including in the U.S., we see a fair amount of conservatism and careful spending. So our guidance for the fourth quarter doesn’t contemplate that much budget cost activity. As you’ve pointed out, and as we’ve pointed out, bookings were sequentially down in the quarter, a little bit of that is around timing, but also reflecting continuing slow activity in Europe. That being said, as we also pointed out, we’re quite encouraged by the growth that we saw in Asia and in other markets, and we continue to see that whenever the cable operator spends, they’re spending and increasingly with us, particularly in the U.S. So it’s a little bit of a mix bag, I recognized that, but putting all the puts and takes together, we feel so we’re well positioned to deliver, let’s say another in line quarter and the extend that the market improves above and beyond that. We think we’re extremely well positioned.

Thank you. Next question is from Richard Ingrassia with Roth Capital. Please go ahead with your question. Richard Ingrassia – Roth Capital Partners LLC: Hi, good afternoon everybody. Patrick, can you say a little bit more about the CCAP opportunity. What do you think, you might have to must have product for that initiative, if it’s something other than being first to market, and maybe, if you could size the addressable opportunity over the next two or three years?

Yeah. So there’s a couple of things, Richard. first, we do think we have extremely a strong technology that positions us very well. Understand we’re not coming out of this market from out of the blue; we’re coming at it from being the market leader in edgeQAM technology. A key aspect, if not got key aspect and fill the CCAP value proposition or architecture is density of QAMs. Here we lead the market with our edgeQAM product and the product that we announced and will be shipping in the first quarter is significantly ahead of any other product that’s been announced or that the market currently anticipates. So we comment from the places having extremely strong QAM of credentials and the leadership and the response from our customers has been extremely positive. We are excited about the opportunity. We have a lot of work to do, but we see our customers very focused here and confident in our ability to succeed. We’ve been working closely with them from the beginning. We asked about the size of the opportunity, there is a number of market research studies out there, kind of the red boxes about $1.5 billion to $2 billion a year, incremental opportunity that we currently don't address, that is above and beyond a pure just QAM market. So it’s substantial opportunity for us it’s why we are investing as heavily as we are and why we are as focused as we're in this space. Richard Ingrassia – Roth Capital Partners LLC: Okay thanks for that. And a question on gross margin, if I can. You mentioned why the makeshift drove non-GAAP margins a little lower and your expectations for Q3, but Q4 hence actually suggests a decent increased over the last few years. Can you explain what's changing in your expectations, here in Q4 or is it backlog per annum or something more we should be watching?

So I think it’s I mentioned that Edge and Access we thought would be down sequentially, so that makeshift goes the other way. And so it’s a series of things we’ve had focused on cost initiatives, so we’ll see some of those begin to benefit in the Q4. In Q4 we do think the product mix will shift a little bit the other way. So those two things together are the drive slightly higher gross margins.

Next question is from Simon Leopold with Raymond James. Please go ahead with your question. Victor W. Chiu – Raymond James: Hi guys this is Victor Chiu in for Simon Leopold. I just wanted to go back to Europe really quickly for a second. Now on the last conference call you mentioned that you expected Europe to be relatively flattish, but it was actually a bit weaker. Is the weakness in Europe related to specific segment because it seems like video processing was a fair amount last quarter, but this quarter it was a bit weaker and the opportunity for Edge and Access?

Well Victor in general our European business tends to be tilted more strongly towards the video processing products than the U.S., simply because cable represents a lower percentage of our business in Europe. In Europe, well in the U.S. cable is a, it’s really a big piece of the business. And in Europe cable is an important segment, but actually no bigger than IPTV business we do with telcos, the business we do with satellite direct to home operators and as well as the business we do with media companies. So a down business in Europe disproportionally impacts both our video processing products and our production and playout products, because that’s where we really have the exposure in both those products. So what play not Edge and Access and satellite in media companies, et cetera? So indeed video processing was down this quarter and you got it correct. It was basically in line with the fact that Europe is weaker, on an absolute basis and in fact on a relative basis because we anticipate it. And also we have and as I pointed out domestically, satellite and media orders were down as well. Those two things together, drove the video processing number overall down to floor. Victor W. Chiu – Raymond James: Okay. And just very quickly on gross margin, can you give us an update on your cost reduction efforts, and may be some specifics around how that's reflected in your guidance and I think you mentioned that you're fine tuning some of the processes I think were particular markets, versus specific products. Instead of just flat cost, so you can mention how that is going to impact the results going forward?

So we have a qualified dollars of gross margin publicly, but we have initiatives that our beginning to be impacted in Q4 and really will impact next year, probably more significantly till they take (inaudible) and your standard cost if you will. So we are seeing a little of that benefit in Q4, and will now to get more of that in the next year. On the products for market, I think you are referring to Patrick's comment last quarter we are trying to focus the right product at the right market and also look at our broad portfolio of products and make sure we have the right products in the right places. And certainly that effort continues and there’s something we do on an ongoing basis.

Next question is form Amitabh Passi. Please go ahead with your questions. James F. Hillier – UBS Securities LLC: Thanks this is actually Jim Hillier for Amitabh. I guess not a follow-up question on the gross margin. Your Edge and Access business were both stronger in the quarter, and I did things typically lower margin, yet we did see a sequential improvement in the margin. So if you could talk about some of the puts and takes that would be helpful.

So it’s an overall mix, because the other thing is that P&P was up this quarter, which is our highest margin. So I think there was some offset between the increase that we got from the production on playout products and the impacts on Edge and Access and those two things I think balanced each other out. Does that make sense? James F. Hillier – UBS Securities LLC: Okay got it. And then may be another easy question with regard to the NSG core product and how you think that product can compete effectively or perhaps against some of the incumbent CMTS providers that are also pursuing the CCAP opportunity?

There is no doubt that we’ll have competition, but as I mentioned earlier, we have been working closely with our customers from the beginning, got some fantastic core technology that we’re building this around, which is best QAM technology in the market. As far as I know, we are the only ones to announce actually QAM density technology that meets the CCAP spec where we have the luxury of starting from scratch in terms of a new platform. and so we build this NSG Pro that we have announced really from the ground up to support CCAP specifically. And frankly, we’ve hired some top tier talent that also has some deep DOCSIS high-speed cable data experience to the team. so with complement of the existing team of people who have been there and done that. So it’s a recombination of all of those things, it’s not a slam dunk nothing in this world is, but we feel as confident as I think we could at this point, that we have a product that that’s going to be extremely compatible. And as I mentioned in the prepared remarks, we’ve already now deployed it with in customer lapse and your early returns on that testing has also been extremely positive, that’s bolstering our confidence as well as the confidence of our customers that this company and this product really has something to offer the specs. James F. Hillier – UBS Securities LLC: Okay. Thanks, again.

Sure. Thank you.

(Operator Instructions) Next question is from Greg Mesniaeff with Maxim Group. Please go ahead with your question. Greg Mesniaeff – Maxim Group LLC: Yes, thank you. Patrick, can you go over what some of your assumptions are on edgeQAM pricing in a post-CCAP environment. I mean do you see pricing getting more robust or more competitive after your edgeQAM products assume a CCAP form factor?

Well, I’m going to stay qualitative for obvious reasons, Greg. Individual QAM pricing will go down, but the volume is going to go through the roofs. I mean this is step-up, the whole thesis here, why this is being deployed, as the idea is to turn the entire cable award spectrum into QAM enabled spectrum over which IP traffic in particular IP video is traversing. That’s really a revolution in the infrastructure; it’s a revolution in the volume of QAMs that are out there. So the idea is, we see actually good win-win for the industry. We see the opportunity, industry to deliver, innovative IP based services and with this technology at a much lower cost than would be feasible with today’s DOCSIS technology. On the other hand, because the volume will be so grade and because of where the technology is progressing. we see an opportunity to realize not only substantial revenue gains, but also higher margin product that we’re investing a lot in this product; we’re delivering a lot of technology and value. and I think we’ll be appreciated by our customers. And so the price per QAM goes down, the volume goes up and we see a pretty attractive business opportunity. Greg Mesniaeff – Maxim Group LLC: Gotcha, and just a quick follow-up. what kind of a substitution slope do you see for the CCAP form factor, edgeQAMs versus – in other words, are the current non-CCAP edgeQAMs, is there a long tail for them or is the tail rather steepen to hands off pretty quickly to the CCAP?

Well, I think these transitions are always hard to forecast since one of the reasons we’ve adopted the strategy that we have. And what we’re going to be delivering to the market is a CCAP compatible chassis that holds just edgeQAMs to make sure. and with that, we expect to build footprint, and we expect that to be used the way edgeQAMs are today. But over time, when this is going to vary, I think from operator to operator and have some system to system, when they are prepared to move to CCAP infrastructure and where they’re with appeal hard in the platform, one that operationally they know how to use. So now, we’re hiring no fore clip upgrade et cetera, et cetera. I mean it’s a cliché and I clinched saying it, but as much as closest, it gets to in this space. This is a future going solution. And that’s really a big part of what our customers responding so positively too. Greg Mesniaeff – Maxim Group LLC: And I assume that’s the same network management so for that all control family.

Absolutely, it’s a unified platform and operating system for us. we’d call it Cable OS and it’s migrated from our QAM system and again, the early returns from the customers were taking close look at this very positive. So it’s common management software, and it’s part of the beauty of the solution. Greg Mesniaeff – Maxim Group LLC: Gotcha, Patrick. thank you for that color.

All right. Thanks, Greg.

We have a follow-up from James Kisner with Jefferies. Please go ahead with your follow-up. James M. Kisner – Jefferies & Co.: Thanks. I just want to quickly ask about Ultra HD, I mean you mentioned a couple of times before, I recognized you haven’t set a timeline, but I’m curious where do you think that might be rolled out first, I guess geographically or by segment also it would be helpful, if you have any idea?

Yes, I do. We talked about and have certainly been out there in the standards work companies in the camera space and some of the consumer electronic guys in TVs have been working on it, but what has changed materially from my perspective in the last three months, it has been the fact that several of our customers were starting to really take notice, and really think about how they differentiate themselves. And James, there isn’t a pattern. we have a cable customer, one geography who is extremely interested; another geography that I’d take the lead customers satellite direct-to-home operator. So there is not a – I think it’s down to the individual operator and kind of their vision of how they’re going to differentiate themselves. I’d say the common theme is in any market, it’s the operator who really wants to differentiate himself, is having the premier video technology, video viewing experience available. And increasingly, that’s a way that we see in different market verticals, different geographies, our customers are trying to differentiate themselves. So the televisions are coming and if you see one of these demos, it’s nothing short of stunning, I mean you put that together with the latest Dolby audio and I mean it just blows you away. I don’t think there’s any volume next year, but there may be initial things. but certainly I believe that we will start to see real volume in 2014. James M. Kisner – Jefferies & Co.: Okay, that helps. Thanks a lot.

Thank you.

We have no further questions at this time. I would now like to give the call to Mr. Harshman for closing comments.

All right. I simple like to thank you all for participating today. I hope it comes across that we’re excited about our business. we’re undaunted by the challenges that we see macroeconomically, we’re very encouraged by the progress that we see in several geographies as well as the excitement we see from our customers around our newest technologies. So we’re extremely focused on executing for the short-term as well as for the long-term. And we very much appreciate you continue to follow Harmonic. And we look forward to speaking with you again next quarter. Thank you.

Thank you.

Thank you, ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.