Harmonic Inc. (HLIT) Q4 2013 Earnings Report, Transcript and Summary

Welcome to the Fourth Quarter 2013 Harmonic Earnings Conference Call. My name is Ellen 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. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Carolyn Aver. Ms. Aver, you may begin.

Thank you. Hello, everybody. With me in our headquarters in San Jose, California, is Patrick Harshman, our CEO. I'd 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 the Investor Relations page on harmonicinc.com and clicking on the fourth quarter earnings call button. Now, turning to Slide 2. 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 documents that Harmonic files with the SEC, including 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 have 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 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 the call to over to Patrick.

Well, thanks, Carolyn, and thank you everyone for joining us today. Turning now to our Slide 3. We reported our results for the fourth quarter of 2013 today. And these results reflect continued progress on our strategic and financial growth agenda. Our revenue was $120.2 million, up 2% year-over-year. Business from our international customers contributed 60% or approximately $72 million, reflecting continued international market strength with Europe holding up and emerging markets still quite strong. Broadcast and media customers represented a record 42% of revenue this quarter, while cable customers represented 35%, and satellite direct-to-home and telco customers contributed 23% of revenue. Our fourth quarter bookings were $113.3 million, also up 2% year-over-year driven across all geographies. Our book-to-bill for the quarter was below 1. We did again see a substantial mix shift into higher margin software licenses, which drove a lower top line but higher profitability. Nonetheless, book-to-bill for the year was approximately 1 and our backlog and deferred revenues stands at a healthy $114 million. Gross margins for the quarter were very strong 54.3%, reflecting both the mix shift with software licenses and continued healthy margin trends in the blended business. Non-GAAP earnings were $0.08 per share and cash from operations was $18.6 million, as we maintained the tight focus on both operating expense and cash management. Carolyn will provide additional details on our operating results in just a few minutes. So let's now to Slide 4 and I'll provide a little bit more color on the quarter. Driving our year-on-year revenue growth was continued momentum of our business with global broadcast and media customers, up 8% year-over-year, the result of our strategic focus on this market and the increasing competitive differentiation of our contribution in coding, multiscreen streaming, and production and playout products. We continue to believe…

Thank you, Patrick. Let's move on to Slide 11. As a remainder we completed the sale of the HFC Access business on March 5th of this year, last year now. Accordingly, we have shown that business in the discontinued operation section of our P&L for all periods presented. Our net revenue for the fourth quarter was $120.2 million compared to $122.9 million for the third quarter of 2013, and $118 million for the fourth quarter of 2012. Our bookings were $113.3 million, up 2% compared to the same quarter of last year, and our book-to-bill ratio for the year was 1 to 1. Backlog and deferred revenue was $114 million at the end of Q4 compared to $123.6 million at the end of Q3, principally due to the timing of recognition of deferred revenue. Our non-GAAP gross margin was 54.3% this quarter, an increase from 50.8% in the previous quarter, and a decrease from 55.8% in the fourth quarter of 2012. This brought our non-GAAP gross margin to 52.6% for the full year of 2013 compared to 51.1% in 2012. The increase in gross margin this quarter and generally this year is due to three factors. First, improving gross margins in our edge product line, where we see growing license sales into existing hardware; second, a higher proportion of our video processing and production and playout revenue coming from license sales and new software products; and third, our initiatives to reduce cost through improved operational efficiencies and supply chain management. Over the last several years, our gross margins have moved from the mid to high 40s now on their way to the mid 50s. Well, many factors play into this transition, including strategically focusing on innovative products and solutions that's delivered differentiated value to our customers and a strategic decision…

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question is from Mark Sue with RBC Capital Markets. Please go ahead.

I understand the positive dynamics as it relates to the trends in multiple screen viewing, improved HD, converged architecture. Yet, if I look at the revenue outlook for the near term and also kind of how we should see things for 2014, we're not going to see any meaningful growth this year and I guess we have to wait till next year 2015. Are there things that the company can do to drive the software performance considering that we have been near this $500 million run rate for quite some time now? Thank you.

Well, Mark, thanks very much for the question. We are definitely targeting and we are confident we will achieve growth this year. We believe we will continue to take market share. We believe we will continue to do well with our new cable edge products as well as our new video, new products. From a market perspective, as you can see from our results, we're also very excited about the progress we are making global broadcast to media customers. Putting all that together, we've given you a first quarter guidance that is 8% up year-on-year and we've said that we are comfortable from where we sit today pointing to mid single digit growth. Certainly, we see that there is upside potential beyond that and certainly that's what we are striving for. That being said the bigger growth drivers that we have been investing in massive upgrade cycle on the conversion to ultra HD and HEVC compression, the broad market acceptance through CCAP kind of architecture, those are the things that are going to drive even stronger growth for us, that's what we have invested and positioned ourselves for. We're trying to say, yes, look some of those things could happen in 2014, that's upside on the view that we have given you. We have more confidence in them hitting later but the point is that when they mature in the marketplace, when our customers are ready to move on those initiatives we think we are extremely well position to capitalize it.

If I remove lower on the income statement and I look at the higher than normal cost structure considering the overhead post the HSC asset divestitures, are there things to protect the earnings outlook for 2014 before we see revenues accelerate in 2015? What are some of the things that you can do to reduce OpEx considering you also need to spend to drive and capture the growth opportunity in '15?

Yes, so Mark, we've made a number of large investments in R&D over the last few years. And at this point we see that R&D investment leveling off frankly in absolute dollars and perhaps even declining slightly. That's not because we have fewer people working on our initiatives, it is to say we have over the last year managed our work force and our work force growth so that we've benefited from a lower cost of development across the globe. So we continue to add resource but we're doing that more efficiently today than we were a year ago. So that allows us to free up effectively some dollars or at least dollar growth and move that to go-to market to really work on the initiatives that George is driving on the go-to market. And then lastly, across the board in G&A we continue to optimize there.

The next question is from Simon Leopold with Raymond James. Please go ahead.

I wanted to drill down a little bit on the ultra high def opportunity, so certainly you found sound very constructive on it is 2015 and suggested it might begin this year. So I want to drill down on the timeline specifically understanding your exposure to markets likes Japan and Korea that seem like early adopters, and then maybe if you could walk us in terms of what this means to your business, how material will it be or when does it reach a meaningful threshold that you can call it out? Thank you.

Sure. Well, I think probably the best analogy is to look back at the way the HD market rolled out and that didn't happen all on one year, it grew and it was sustained over several years. As your question indicates we'll see early adopters out there and that's both by geography. And indeed as you mentioned Japan and Korea are as countries quite aggressive in terms of the adoption these technologies, but we also see certain customers who are going to adopt the first mover strategy there. The announcement by Netflix we think is going to have an impact here in the US market. We also bundle together ultra HD and HEVC you may actually see these proceed independently, in particular we have some customers who are looking at HEVC compression even for HD today. So it's still a little bit hazy on the crystal ball, but we see activities starting in 2014. I think the comment here is that we don't see massive upgrades really commencing in 2014 and if we're looking for the wholesale growth opportunities the kind of which that we saw as a company in 2008, 2007, 2009 when HD was really in its prime, you probably see that more as a 2015 kind of initiative. That being said, we're positioned with product today, we expect to have material revenue in 2014 on our way to taking advantage that's going to play out over several years.

And can you anticipate some aspect that your video and coding business could pause ahead of that cycle in sort of classic like kind of I guess an Osborne effect if customers who know they want to invest in ultra high def will perhaps slow down purchases of the current generation, how do you prepare for that?

Generally, Simon, that has been happening in the US for a little while. I mean, if you look at our numbers you can see that our overseas market have been the prime driver of the video processing business that we have. It's not a black or white statement. And certainly in things like multiscreen it's been quite interesting here for us domestically. It's also true that as we outlined in the prepared remarks that we're doing some very innovative things running like 4 and MPEG-2 which are driving market activity in both the US as well as the international markets. That being said, I think we've tried to be quite clear and transparent for a number of periods that there is a little bit of a waiting period on the part of several of our big tier-1 customers looking forward to ultra high definition. So we really see upside, not downside, from where we sit today. We think we will continue to roll along nicely in overseas markets where frankly even HD is still kind of the new flavor. Digital video is very often the new flavor in some of the international markets we're participating in. And domestically, we don't see negative, we really see upside around a ramp up towards ultra HD and in fact, as I mentioned, souped up HD to look good on these ultra HD sets that consumers are starting to buy now.

(Operator Instructions) The next question is from Tim Quillin with Stephens Incorporated. Please go ahead.

Could you just give us a sense of how we should think about NSG Pro deployments in 2014? You've got a couple of customers right now. Are you seeing orders more for select QAM replacements or are you seeing broader upgrades that that might have a persistent trends over the next year or two?

Tim, right now the discussions we're seeing and the applications we're seeing are really everything under the sun. So far we've shipped into both video-on-demand as well as module CMPS applications. And as I highlighted we're pretty optimistic about the growth for both of those services areas for our cable customers worldwide. Certainly Comcast results today point to, as we said in our prepared remarks, a healthy overall video business and we think on demand, network PVR, cloud DVRs as it's called, they're all very important or increasingly important parts that of a resurging video strategy. We're also seeing customers starting to look at using this technology for converged downstream DOCSIS and on demand video traffic. So we see a fair amount of innovation out there, we're getting tested and now deployed in a variety of scenarios. And over the course of the year we see it becoming an increasingly big part of our edge revenue.

And then on the services and support business, why was that down a little bit, both quarter-to-quarter and year-over-year?

There were some large project revenue in particular in Q3 that we talked about that was more of a one-time, not a one-time, but an unusual increased I would say in Q3. Year-over-year probably the same in Q4 of last year, but definitely from Q3 to Q4 we had a big project we recognized with a lot of service revenue, professional service revenue in Q3.

And then on the gross margin so you outperformed your guidance in the fourth quarter. I think that your rationale at that time was kind of the same in terms of chassis shipment on NSG Pro and not having the scale in manufacturing. Is it fairly hard to predict the mix of business that you'll have in any given quarter? I mean, is your gross margin guidance for the first quarter a little bit of a place holder and you won't really know the true mix until the end of the quarter and could have some upside there?

There were multiple reasons that revenue were -- gross margins were higher in Q4. It's true that a piece of my guidance was a little hedging how quickly the NSG Pro was going to ramp, but offset by that were our highest margins ever in the edge business not NSG Pro. So more of the upside had to do with that all of our -- across all product lines gross margins were up this quarter and there was a mix shift towards higher gross margin products in the quarter. So a little bit of the improvement was the hedge and NSG Pro we were going to do in Q4, but the majority of the upside came from those other areas. In Q1, we have more visibility. As Patrick mentioned, we received already a multi-million dollar order this quarter. So we have more visibility into the fact that we are going to ship a meaningful amount of NSG Pro revenue this quarter. So I do know that is going to have an impact. What I don't know as much or I don't have as much visibility into is if we end up doing more software types of revenue in the quarter that's mostly the upside.

And then just one last question. I know you don't like to break out litigation costs specifically but maybe if you can give us a sense directionally how you're thinking about litigation cost in 2014 and what the update is on the timing of your Avid litigation?

Sure. We expect that to be resolved in Q1. So we don't expect the same level of litigation costs in the remainder of the year. And that would be on the order of several hundred thousand dollars a quarter that we're spending.

We have no further questions at this time. I will now turn the call back to Patrick Harshman for closing remarks.

Okay, well, I want to thank everyone for joining us today. I will summarize by saying that during the fourth quarter we delivered results that we believe demonstrate clear progress in advancing our strategy to both accelerate growth in the long term as well as build significant shareholder value. We believe we have more work to do to get all of our cylinders firing at the same time. Our progress reflects both our focused execution and our customers' confidence in Harmonic and our ability to continue to deliver industry-leading innovation support business partnerships. So looking ahead in 2014, as we have stated here, we will continue to execute on our growth strategy, innovating at current investments levels, capitalize on coming waves of cable edge and video infrastructure market expansion but also growing our market share and global customer base. As a result, we're firm and confident in our targeting of both top and bottom-line growth in the year and to see if there are opportunities to drive expanded value for customers and our shareholders. Thank you very much for your time today and we look forward to our next opportunity to speak with you.

Thank you, ladies and gentlemen. This concludes the fourth quarter 2013 Harmonic earnings conference call. Thank you all for participating. You may now disconnect.