Harmonic, Inc. Q4 2008 Earnings Call Transcript

Feb.22.09 | About: Harmonic Inc. (HLIT)

Harmonic, Inc. (NASDAQ:HLIT)

Q4 2008 Earnings Call

January 29, 2009 5:00 pm ET

Executives

Patrick Harshman – President and Chief Executive Officer

Robin Dickson – Chief Financial Officer

Analysts

George Notter – Jeffries & Co.

Vivek Arya – Merrill Lynch

Greg Mesniaeff – Needham & Company

Todd Cooper – Stephens, Inc.

Blair King – Avondale Partners

Jack Monte – UBS

Larry Harris – CL King & Associates

Amir Rozwadowski – Barclays Capital

Paul McWilliams – India Research

Mark Sue – RBC Capital Markets

Operator

I would like to welcome everyone to Harmonic's fourth quarter and yearend 2008 earnings conference call. (Operator Instructions) It is now my pleasure to turn the call over to Mr. Patrick Harshman, President and CEO, sir, you may begin.

Patrick Harshman

Thank you very much and good afternoon. I am Patrick Harshman, President and CEO of Harmonic. With me in our headquarters in Sunnyvale, California, are Robin Dickson, our Chief Financial Officer, and Michael Newman, our Investor Relations Spokesman. Thank you all for joining us.

Today, we announced our results for the fourth quarter and full year of 2008. It was an outstanding year for Harmonic, with record revenues, gross margins, earnings and cash flow. Underlying this operational success is the strongest product portfolio and competitive position the company has ever had, and a consistently growing number of video service providers around the globe, who rely on Harmonic to power their mission critical video services.

Looking ahead to 2009, Harmonic will continue to leverage this strong position across a growing range of video delivery technologies, customer segments, and geographies. In addition to aggressive organic execution, our business will be further strengthened by the upcoming acquisition of Scopus video networks with its powerful technology portfolio and extensive international customer base.

While we expect the global economic environment to undoubtedly impact some of our customers' nearterm capital spending, we remain convinced that the fundamental market and technology drivers that underpin our opportunities, the trends towards more video being delivered in more formats to more devices over more networks by competitive operators, will remain in force over the long term.

We believe that our technology leadership, diversified customer base, and strong financial position give us a great deal of operational and strategic flexibility and position us to further strengthen our competitive position and increase your global market share.

I will now ask Robin to cover the financial aspects of the quarter. I will then review some of our recent business developments and strategic initiatives in more detail, Robin.

Robin Dickson

Thank you, Patrick. Good afternoon everyone. During this call, we may make projections or other forwardlooking statements regarding future events or the future financial performance of the company. We 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 10K and 10Q reports. These documents identify important risk factors that could cause actual results to differ materially from those contained in projections or forwardlooking statements.

Please note that on this call, we will provide you financial metrics determined on a nonGAAP or pro forma basis. These items, together with the 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 Form 8K.

We will also discuss historical financial and other statistical information regarding our business and operations. Some of this information is included in the press release, and the remainder will be available in a recorded version of this call on our website.

Today, we announced the results for the quarter and year ended December 31, 2008. For the fourth quarter of 2008, we recorded net sales of $96.9 million, up 11% from $87.4 million in the fourth quarter of 2007. For the full year, net sales were $365 million, up 17% from $311.2 million in 2007.

Yearoveryear, both our domestic and international sales grew strongly, with international representing 44% of our annual revenue in 2008. For the full year, cable customers accounted for 62% of revenue; satellite customers, 20%; and telcos and others, 18%.

Our largest customers for the year were Comcast and EchoStar, representing 20% and 12%, respectively, of our revenue. By product category, video processing products represented 38% of revenue for the year; internet access products 45%; software services and other products, 17%. We were very pleased with the yearoveryear growth in revenue in all of our principal market segments, geographic regions, and product families.

Looking ahead, one of the primary benefits of the Scopus acquisition is the further diversification of our revenue streams by geography, market segment, and product category. Specifically, it will increase our international business and our revenues from markets other than cable. Moreover, Scopus has very little customer concentration with no recent 10% customers and revenue spread across a very wide range of customers.

We also improved our gross margins in 2008, reflecting the continued success of our new products and solutions, as well as our sourcing strategy and product design innovations. Our nonGAAP gross margins were 51% in the fourth quarter and 50% for the year. The improvement in Q4 was due in substantial part to a higher mix of software and services revenue in the quarter.

Our nonGAAP operating expenses in the fourth quarter were up significantly on a sequential basis to $33.3 million. Some of this increase reflects a full quarter's impact of our active hiring during last summer when we added 19 people during the third quarter. Some of the additional expense is due to our strong Q4 performance, with the consequent increase in variable compensation accruals in the quarter.

Additionally, we took a very close look at our customer receivables in the light of credit and currency markets and current general economic conditions. We concluded that a few of our international customers have fallen into some degree of financial difficulty and may not be in a position to pay us in full. Accordingly, in the fourth quarter, we took a $1.4 million charge to increase our bad debt reserve. Historically, we have had very good receivables experience and minimal bad debts. But we decided it would be prudent in these circumstances to increase our reserves.

In spite of this charge and a substantial increase in OpEx, we increased our nonGAAP operating margin sequentially to 17% for the quarter, which is 16.5% for the full year.

Our other income declined again sequentially, even though our cash balances have increased. Of course, this is mainly because of the very low interest rates which now prevail, particularly on treasury securities.

We recorded a tax benefit in Q4, principally due to an additional reversal of valuation allowance for deferred tax assets, which we have excluded from our nonGAAP results. However, the Q4 benefit was also in part due to the recent passage of the R&D tax credit for 2008 resulting in an overall lower tax rate for 2008, which is accounted for in our Q4 nonGAAP results.

Our GAAP net income for the fourth quarter was $13.2 million or $0.14 per diluted share, up from $6.6 million or $0.07 per diluted share for the fourth quarter of 2007. For the full year, GAAP net income was $64 million or $0.67 per share, up from $23.4 million or $0.28 per share in 2007.

Excluding a litigation charge and noncash accounting charges for stockbased compensation, the amortization of intangibles, and the reversal of the valuation allowance, our nonGAAP net income for the fourth quarter of 2008 was $19 million or $0.20 per diluted share, up from $16.9 million or $0.19 per diluted share for the same period of 2007.

For the full year 2008, nonGAAP net income was $66.4 million or $0.70 per diluted share, up from $43.1 million or $0.52 per share for 2007.

This strong operating performance further improved our balance sheet. As of the end of December 2008, we had cash, cash equivalents, and shortterm investments of $327.2 million, up by approximately $34 million from September.

As we recently announced, we plan to acquire Scopus for approximately $51 million in cash, net of Scopus' cash and shortterm investments and before transaction expenses. The acquisition is expected to close in March and will still leave our balance sheet very strong with proforma cash of at least $270 million, allowing us to continue to pursue further acquisitions or other initiatives to achieve our strategic goals.

One reason for the increase in cash in Q4 was our performance in receivables, which dropped from $75.9 million at the end of Q3 to $63.9 million at the end of Q4. This corresponds to DSOs of 60 days, down considerably from 76 days at the end of Q3. We believe this shows that the vast majority of our customers are paying us according to their usual terms; and where we have a few customers in financial difficulties, we have made appropriate reserves, as I discussed earlier.

Our net inventory was $26.9 million, down over $5 million from the previous quarter and over $7 million from the end of 2007. We're very pleased with our success in improving our inventory turns during 2008.

Finally, our capital spending was around $2 million in the fourth quarter and approximately $8 million for the full year as anticipated.

Turning to the outlook, we're moving into 2009 with fundamental trends and competitive dynamics that have been driving our business remaining very relevant. Our customers are at different stages of their annual planning processes. We understand that many have still not yet finalized their capital spending budgets for the year.

However, based on discussions with our customers and public announcements by some major telcos, we expect overall capital spending to be flat to down during the year in response to global economic conditions. Moreover, because of the slowdown in orders towards the end of the fourth quarter, we are moving into the first quarter with an order backlog and deferred revenue of around $74 million, lower than a year ago.

Now please keep in mind that historically the first quarter offers the least visibility with respect to our customers' capital spending plans. It is seasonally the slowest period of the year with sales generally building up as the year progresses. This pattern has been quite pronounced in the last few years. We are expecting this historical pattern to continue with sales growing sequentially during the course of 2009.

Yet, the current challenging economic situation creates substantial uncertainty. So, while we've been in the practice of providing rolling sixmonth guidance, making projections beyond the first quarter of 2009 is quite difficult. So taking these factors into consideration and excluding any impact of the anticipated Scopus acquisition in March, we expect that our net sales for the first quarter will be in a range of $72 million to $78 million.

NonGAAP gross margins for the same period, excluding stockbased compensation and the amortization of intangibles are anticipated to be in the range of 47% to 49% and nonGAAP operating expenses in a range of $30 million to $31 million. The corresponding GAAP numbers are 45% to 47% and $32 million to $33 million.

While our contract manufacturing model provides us with flexibility, we do have some internal fixed costs which take longer to adjust to lower revenue levels and which we expect will impact our Q1 gross margins. However, we believe that our strong and consistent gross margin performance throughout 2008 demonstrates that our product strategy is on the right track and our longterm gross margin targets continue to exceed 50%.

With respect to operating expenses, our strong performance in 2008 allowed us to add resources in the second half of last year. But we are now planning to hold head count flat or even lower it slightly in the short term. We ended the year with 698 employees. We have currently stopped hiring except for a handful of critical positions.

While we intend to maintain our R&D capability and capacity for competitive reasons, we are reducing spending in other areas where there is a lower volume of activity in the current environment. Additionally, we will have much reduced variable compensation expense in Q1 and expect no recurrence of the bad debt charge which we took in 2004. As a result of these measures, we believe we can reduce nonGAAP operating expenses to a range of $30 million to $31 million allowing us to remain very comfortably profitable, even with lower revenue that we've seen in recent quarters.

With respect to our tax rate for 2009, we're not yet in a position to update you with that in precision, mainly because of the uncertainty around the revenue and particularly the geographic mix expectations for the rest of 2009. However, as we have noted on previous calls, we have reversed our valuation allowance against our deferred tax assets during 2008; and we will become a regular taxpayer in 2009.

Once again, I underline these expectations exclude any impact of the Scopus acquisition. As we discussed in December, Scopus reported revenues of $55.4 million for the first 9 months of 2008, up 35% from the same period in 2007. Its gross margins are around 49%. Upon full integration, we expect to realize substantial synergies of between $8 million to $10 million on an annualized basis, including the integration of product lines and road maps, sales and marketing efforts, and public company costs. With these synergies, we still expect the transaction to be accretive to our nonGAAP earnings in 2009. After completion of the purchase accounting at closing, we plan to provide more financial guidance for the combined company.

In summary, we're very pleased with our execution and performance in the fourth quarter and throughout 2008. While there is significant global economic uncertainty in the near term, we have strong a balance sheet and a healthy operating model, allowing us operational flexibility and the opportunity to use our strong financial condition to our competitive advantage.

We like the diversification that the Scopus acquisition brings and the attractive business and cost synergies that come with this consolidation. Over the longer term, we are very optimistic about our industry and our opportunities for profitable growth. Patrick.

Patrick Harshman

Thanks, Robin. 2008 was clearly a very successful year for us. In addition to our excellent financial results, we're equally pleased with the underlying technology innovations and competitive positioning we've achieved. Throughout the past year, we continued to invest in both leading edge new product development and extending our market presence around the globe.

As a result, we've extended our technology leadership and market share across a broadening range of applications, customers, and geographies with both incumbent and emerging video service providers selecting our award winning systems and solutions to power their growing array of new video services.

Looking ahead, we continue to see significant growth opportunities across the worldwide broadcast, cable, satellite, and telco IPTV market segments that Harmonic has historically addressed, as well as with video content owners, programmers, and newer internet video players we're just beginning to address.

So far this week, we have heard from both Verizon and AT&T that their video services continue to gain market share. B Sky B, the large satellite player in the U.K. just announced solid subscriber gains, turn reduction, and acceleration of HD penetration. Netflix communicated strong subscriber gains driven by its new streaming service.

It's, therefore, clear that competition between video delivery service providers and platforms remains intense, despite the macro economic environment; and the new video delivery technology that we provide will continue to be a strategic enabler of this competitive marketplace.

High definition video is at the center of a lot of this competitive activity; and as was emphasized in a recently released market research report from In-Stat, the global transition to high definition viewing is still in the early innings. Our newest high definition products, an exciting product road map, continue to position us at the forefront of this market opportunity with all types of service providers.

We also see an intensifying market focus on multiformat video delivery to a growing array of wired and mobile enduser devices. Our newest softwarebased solutions and technology road map for these applications will continue to be a powerful incremental growth driver for us with both new and traditional customers.

We also expect to continue to see very strong growth of video streaming over the internet putting increasing stress on the edge and access portion of the network. Our market leading edgeQAM solutions for modular CMTS and IPTV over cable applications and our exciting new WDM transmission solutions for band width expansion will be key technologies for cable operators around the world seeking to scale their broadband infrastructure to accommodate this explosion of internet video.

And for all our customers, we also continue to see growing strategic importance of video delivery solutions that can support both real-time and ondemand consumption. Correspondingly, we expect requirements for new video capture, storage transcoding, streaming and catch up TV software applications. Inner VED edge processing solutions continue to be a growing part of our business.

While organic technology and solutions development is the centerpiece of our strategy, we're also using out strong financial position to extend our market leadership and worldwide customer base to a strategic acquisition. Our recent agreement to acquire Scopus represents an additional significant step forward in the growth and diversification of our business. Nearly half of Scopus' revenue is derived from contribution and distribution markets where Harmonic does not actively participate today. The contribution market calls for high quality delivery of news, sports, and other live events to broadcasters and other video programmers.

The distribution market involves the subsequent transmission of high quality video programming from these programmers to Harmonic’s traditional cable, satellite, and telco IPTV customers. With global transitions from standard to high definition, from MPEG2 to MPEG4, from DDBS to DDBS 2.0 modulation, and from single channel backhaul of live events to multi-channel all just getting under way, and with new applications such as multi-format and file-based delivery just beginning to emerge, we see significant additional growth opportunities for Harmonic in this space.

Furthermore, it remains a critical part of our strategic vision that international expansion will be a key growth driver for our business. We’ve been very successful in organically expanding our business in western Europe and select Asian markets. While Scopus has been very successful in emerging markets such as India, Russia, the former CIS countries, and several African nations, the addition of Scopus’ broad array of end customer and sales channel partner relationships will enable us to further accelerate the globalization and diversity of our business.

Finally, Scopus will also be adding powerful and complementary technology and associated video R&D talent. The addition of Scopus’ R&D team will enable Harmonic to remain the industry pacesetter for developing innovative new video delivery technology. In coming periods, you can expect Harmonic to announce a number of high impact new product introductions.

Moving into 2009, we intend to continue to extend our technology leadership in what remains a dynamic video delivery industry, despite the expected impact of seasonal slowing in the first quarter and of more general global economic conditions on our customers’ near-term capital spending. We remain focused on controlling costs and delivering outstanding operating results while making the necessary investments to grow our business over the long term.

With our technology leadership, diversified customer base, strong financial position, and operational and strategic flexibility, we feel excited and confident about our ability to further strengthen our competitiveness and extend our global market share in 2009 and beyond.

In closing, I want to take this opportunity to thank our outstanding employees, suppliers, and business partners for their dedication and contributions to our success during the past year. With that, we’ll conclude the formal part of our presentation and now Robin and I will be pleased to entertain any questions that you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of George Notter with Jeffries and Company.

George Notter – Jeffries & Co.

My question has to do with bookings. I calculate your bookings in the December quarter at about $71 million. I go back and look at the year ago quarter. You did about $96 million in bookings in December. I was trying to figure out how you guys are thinking about seasonality right now. Obviously, the bookings number was down a ton here in December. Even on a sequential basis and certainly year-on-year, how are you thinking about seasonality? Is it that the orders are coming in softer now in Q4 than they were in the past? Do you expect orders to come back in Q1? What’s the thought process?

Patrick Harshman

First, a couple things, going back to Q4, I think it’s important also to remember the bookings were hugely up in Q3. So there is an inherent ebb and flow to projects and orders. In this particular year, we saw a real burst of activity. In fact, we had a record bookings quarter in the third quarter; and that was actually driven by a huge amount of activity late in the quarter that we frankly had expected to take place in Q4.

When we look at the back end of the year, it was really in line with what we expected, although I would agree it was a little bit more in Q3 and a little less in Q4 than we had expected. That was some of what drove an upside in the results relative to our initial expectations in the back half of the year.

All of that being said, heading into this year, it remains true that the visibility is not too great. We don’t read too much into what happened in Q4. We do know from those customers who have made some decisions that, as Robin stated, we do expect CapEx among many of our customers to be flat to down. In many other cases, however, those CapEx discussions are still very much under way and not yet resolved.

So we find ourselves in a position where we’re in a historically slow quarter for capital expenditures, the first quarter of the year, and I would say the visibility is incrementally worse than what it normally is. We’re confident in the guidance we’ve given in the first quarter, but I think we still want to wait and see a little bit more what our customers have to say about the rest of the year before we get a better feel for what the remaining quarters will look like.

George Notter – Jeffries & Co.

Separately, I also wanted to ask about M&A. You’re acquiring Scopus here; the deal closes in March. I guess I was, based on your prepared remarks, you mentioned you have a significant cash balance pro forma for the Scopus deal and that you were still interested in pursuing M&A and other strategic initiatives. Could you give us more color there? Is it likely that Harmonic would go out and look to acquire, after the integration of Scopus, could you do something even sooner, what’s the thought there?

Patrick Harshman

We remain very interested in acquisition opportunities that make good sense technologically, from a customer basis, as well as financially. We have been and we will continue to keep our eyes open. We think the current environment, as well as our position, puts us in a good position to execute deals. In the six weeks between now and the close of the Scopus deal, I would say it’s probably unlikely to see anything else. On the other hand, you shouldn’t be surprised to see us do something else later in the year if and as the opportunities present themselves to us.

Operator

Our next question comes from Vivek Arya with Merrill Lynch.

Vivek Arya – Merrill Lynch

My question is really if you take a step back and people think generally consumption of video services goes up countercyclically. I am surprised why you are seeing the budgets on video turning down. Is it that customers are done with some of the upgrades they had in mind or what’s really going on? I thought video budgets would be more resilient to CapEx downturns.

Patrick Harshman

I’m sorry. Perhaps I wasn’t clear or I misspoke. Our discussions to date with customers who are still working through their plans or have settled on plans, those CapEx, the information we have is very top down. The numbers that I quoted are what our customers are telling us for their overall total CapEx. I should make that clear. Where we do have information, we have had communication, and people have told us that their CapEx is flat to down. That’s been the total pot.

Quite honestly, and somewhat regrettably, what we have less visibility on is the allocation of that CapEx. Of course, as I think your question points out, for us it’s really all in the mix. Our understanding is that many of the CapEx discussions are, however, being driven from the top down; and while our visibility of total CapEx is limited, I regret to say that our visibility on the underlying allocation of those CapEx’s is even more limited.

We have visibility into what’s going to be happening in the first quarter, but we’re still waiting to hear and understand how exactly the CapEx will be allocated over the remainder of the year. I would say we remain cautiously optimistic as your question suggests that we will see a growing portion of whatever CapEx there are going into new and competitive video services.

Vivek Arya – Merrill Lynch

Patrick, if you look at this ongoing digital TV transition, did Harmonic benefit from that in the second half of 08 and should that be seen as a one-time benefit? Now the transition is close to being over, that benefit goes away?

Patrick Harshman

I think perhaps there was a marginal benefit in coding business with the so-called ATSC channels in the U.S. who were perhaps scrambling to put up digital channels. Not a significant impact. I would agree that I think that small, incremental impact was probably a one-time with this transition. I do want to step back from that and say the ATSC and broadcast channels and video broadcasters in general is an important market segment that we feel strategically we have underserved and underaddressed.

It’s certainly part of our strategic rationale with the Scopus acquisition who has both the product line as well as relationships and a history of sales focus and activity in this market. We expect to raise the level of activity with broadcasters and we see a whole host of activities and ongoing spending initiatives there that go beyond the simple 2009 digital transition. That’s a market we’re learning more about, and I think you will see us over the coming year and years reporting more and more revenue from that segment, but not specifically associated with the transition to digital.

Vivek Arya – Merrill Lynch

As you look at 2009, I understand that visibility is limited and you’re not really giving guidance; but do you see the company actually growing organically this year? If yes, where will that growth come from? Would it be from your cable customers, from satellite, from telco, or do you think it’s all going to come from Scopus?

Patrick Harshman

We are uncertain. We made a decision not to give guidance beyond the first quarter. Really, as you might imagine, we see a range of scenarios; and we’re really uncertain. As we look at the opportunities and the prospects for investment from our customers, we do not see substantial change over the dynamics and the distribution of those opportunities from what we saw in 2008. We see a lot of activity that we think needs to happen within the cable space, more aggressive moves to HD, much more aggressive rollout of DOCSIS 3.0 and associated bandwidth expansion, as well as continuing to leverage the early head start and on-demand.

We continue to see good opportunities in satellite as well, not only new channels, but MPEG4 channels, the first ones have now been up there for several years. With some of our newest technology that’s been delivered or is in the pipeline, we see some pretty exciting opportunities to go back and do an even better job of compressing some existing HD content.

In short, we see good rationale and good opportunities across our customer segments and across geographies. How exactly that’s going to shake out and whether that affords the opportunity for substantial top line growth, we still have to wait to see. I think we will start to get a better idea later this quarter when more of our customers come out with their earnings and talk more concretely and publicly about their plans for 2009.

Vivek Arya – Merrill Lynch

One last one for Robin. You are suggesting that we should model tax at some statutory level. I am wondering, does Scopus offer any benefits on the tax rate that can the combined tax rate be below? For example, if we are more than 35%, can the combination with Scopus make that be below that rate?

Robin Dickson

Yes. I believe so. Clearly we have not completed all of the work we want to do. We have certainly done some top-down modeling, but there’s a lot more to be done. I think in general the profile of their revenue distribution across geographies and their tax loss attributes, and so on, certainly give us the opportunity, I believe, over time perhaps not so much this year, but certainly over time to enhance what we believe we can do, in addition to, Scopus will enhance what we can do organically.

As we have indicated in the past, we certainly have done some restructuring that should help us this year to lower the rate below the statutory rate. It’s simply that there’s still a lot of variables, particularly on the top line as Patrick has just discussed. So we don’t really feel in a position to update with the kind of precision that you would all like.

Operator

Our next question comes from the line of Greg Mesniaeff with Needham and Company.

Greg Mesniaeff – Needham & Company

If I may, I would like to dig a little deeper into this question of visibility in terms of the three customer segments that you guys address, namely cable, satellite, and telco. Clearly with notwithstanding the overall economic backdrop, Comcast continues to push ahead with DOCSIS 3.0 where quite a bit of your edgeQAM deployments seem to be tied to.

I can’t help but wonder, maybe Robin you can give us a little bit of color as to whether you’re seeing less certainty in the satellite business in the near term and maybe that’s what’s behind the increased caution that you’re putting out. Or is it more of an international telco-related situation?

Robin Dickson

I will let Patrick add more color in a minute, perhaps, if he chooses to; but we don’t see it as being particularly focused on any geography or market segment. That said, there’s no question that some of our international customers are perhaps doubly challenged, not only by conditions in credit markets, but also to some extent by recent substantial depreciations of their currencies.

If I were to try to pick out any particular group of customers, I would acknowledge that there are some, and it’s very case-by-case, country-by-country, but there are certainly some that are maybe with some greater challenges than others.

I think, particularly coming back to the North American, Western European markets, I think the general lack of visibility we have talked about is really across the board. And the customers that we have spoken to and the customers we’ve cited here in our discussions are of all shapes and sizes. We don’t see it as being particularly focused on one group.

Greg Mesniaeff – Needham & Company

Has Dish given you any particular color as to their targets for high definition at this point or is it still kind of a fairly unknown picture?

Patrick Harshman

I am sure you can appreciate that we are not in a position to discuss any specific discussions with any customers. I would just observe at the top level that all of our large customers, we think, are quite healthy and are looking at the market quite aggressively. As I said a couple moments ago, we are cautiously optimistic about the way things will unfold later in the year.

You mentioned cable in particular earlier. I think it bears remembering that we had a very slow start from a bookings perspective in Q1 of 2008 with cable. Of course, we turned out to have a great rest of the year. I think we have given appropriate guidance, therefore, for Q1 of this year; and thereafter we’re simply saying we want to wait and see what they say publicly about what they plan to do.

Greg Mesniaeff – Needham & Company

Just as a final follow-up, in addition to the $8 million to $10 million in terms of synergies from Scopus that you expect, could you comment on any potential for any supply chain management savings or component savings associated with realigning manufacturing and things of that nature.

Patrick Harshman

We’re certainly optimistic that over the medium to long term we can do even better, realizing even more operational benefits as well as top line synergies, which we have not really modeled at this point. I think, however, it’s prudent to wait until we’ve really got the integration of the companies well under way to be more specific and to really start to factor such benefits in.

Operator

Our next question comes from the line of Todd Cooper with Stephens, Inc.

Todd Cooper – Stephens, Inc.

Patrick or Robin, see if this question makes sense. If you look at the process you took to arrive at your guidance for the first quarter, how much of the guidance is based on true visibility given backlog bookings, that kind of thing, and what percentage is based solely on your perception that spending by your customers will be down for the year and maybe a little slow out of the gate?

Robin Dickson

Let me take a shot at that. We came into the year, as we said, with backlog and deferred revenue of around $74 million. Typically, and I don’t think this quarter is any different, we certainly almost every quarter see the majority of that convert into revenue in the current quarter.

Although our backlog is certainly down from where it was three months ago or even from the same period last year, we still have pretty decent visibility over revenue for Q1 simply because of the volume we have. There is the comfort that, as I say, at least half and some more of that will convert as well as business that we have seen materialize in the first weeks of this quarter.

Todd Cooper – Stephens, Inc.

Is there anything that your major customers could say about their CapEx spending plans when they announce them publicly that would make the revenue in the first quarter be better than you’re expecting right now?

Robin Dickson

I think ultimately it’s what they do rather than what they say. But this is not unusual to see a slow start to the year. If I looked back a year ago without the economic backdrop, and I think Patrick mentioned this earlier, the order intake in the first quarter was relatively light. Our customers took a while to get going and to put their plans in place. I think we’re just seeing that again this year with the added backdrop of the economy adding a further note of caution. At the end of the day, I think it’s what they do.

As Patrick pointed out, it really is mostly to do with the mix of what they are working on and the mix of projects they have rather than the absolute levels of CapEx. What I would expect to get from their conference calls is a sense of their confidence or lack of, perhaps, but their confidence in their businesses and how they see their businesses performing going forward.

Todd Cooper – Stephens, Inc.

You reminded us that you had beginning of the last quarter a very good book to fill [inaudible]. Patrick, you said that in a number of those wins, revenues would be recognized in and beyond first quarter. Are you seeing any change in those projects maybe earlier than expected revenue recognition thus the upside this quarter or any pushout and delays of some of those projects?

Patrick Harshman

I would say there’s no substantial deviation from the visibility we’ve had on projects. I think we’ve been executing quite well on our projects and programs, and I think we feel quite confident that they will go according to plan. To the extent there’s an upside, I would say it’s probably upside in terms of new business that materializes in a given quarter.

Todd Cooper – Stephens, Inc.

One last, if I may, there’s some intriguing language in the press release about we should expect important new product introductions. Should we look for new product categories from Harmonic that’s developed internally or are you thinking more in the terms like in a recent announcement for extending or improving the current product offerings?

Patrick Harshman

Certainly in the near term, it’s more the latter. We have an R&D team that’s executing better than ever before. As I mentioned earlier, we feel extremely good about our competitive and technology position. We have recently announced or expect to announce over the coming several months major extensions or new additions to our product line in just about every category. We are quite excited about our pipeline of activity and the impact that continually introducing these new products into the marketplace will have for us into 2009.

Operator

Our next question comes from the line of Blair King with Avondale Partners.

Blair King – Avondale Partners

One quick question, if I may. International sales were up pretty substantially in the fourth quarter relative to the third quarter, as were gross margin. Is it safe as we look into 2009 to assume that there’s not significant pricing pressure given the decline or I guess a significant decline in demand, despite the strength of the U.S. dollar for international opportunities?

Patrick Harshman

2008 was a great year overall for us outside of the United States. By and large, we expect those markets to continue to be good contributors for us. In fact, as we mentioned a couple times, a good portion of the logic behind the Scopus deal was their strength and depth of customer relationships overseas, particularly in some countries or markets where we have not historically participated.

Pricing pressure, I think, is a reality. It’s always there. But we’ve dramatically increased, I think, our presence, our execution, our credibility, our brand recognition overseas. We expect to continue to push the advantages that we created last year. I think the addition of Scopus will be an additional benefit and driver of us continuing to increase our success overseas in general.

Operator

Our next question comes from the line of Jack Monte with UBS.

Jack Monte - UBS

I want to follow up on something that was previously asked. When you look at the backlog, is there any particular customer segment that maybe has more strength or weakness than you expected at this point? Also, as far as orders through January, kind of the same question, if there’s any particularly customer segment that is stronger or weaker than you had anticipated coming into this quarter?

Robin Dickson

I don’t think so. As I tried to say earlier, with the exception perhaps of a few international customers in countries which have particular challenges, and those customers can be in any of our market segments, we don’t see any particularly different pattern either in the backlog or in the incoming orders that we’ve seen so far this year.

Jack Monte - UBS

As far as gross margins, you were pretty healthy in the fourth quarter. I was hoping you could help us understand the changes that you see in terms of the guidance for the first quarter. What’s changing there, at least the lower gross margin guidance?

Robin Dickson

I think the principal change is that we are looking, the guidance we’ve given in revenue is quite a bit lower then we’ve seen in recent quarters. Although we’ve got a contract manufacturing model which really helps us largely to have a largely variable cost model. I mean there are still some internal costs and overhead costs that just can’t be adjusted so quickly in the short terms, nor in fact do we necessarily want to adjust them if we do believe that the rest of the year is going to start to see some sequential growth. It’s mainly the law of having a certain amount of fixed costs to manage our supply chain.

Jack Monte – UBS

Just to be clear, there’s no significant change in mix, it’s mainly just volume related.

Robin Dickson

It’s mainly volume related. The only thing we did take into account is we do have one fairly significant project that we expect we will close out in Q1 where the margins are quite a bit lower than our typical margins. We took that into account because we expect that revenue is going to convert in the first quarter. Aside from that, I would say it’s mainly to do with the effects of the lower volume.

Operator

Our next question comes from the line of Larry Harris with CL King and Associates.

Larry Harris – CL King & Associates

Congratulations on the cash flow generation in the fourth quarter. Two questions. One, these new products that we expect to see, I guess, in the next few months. Could they have a significant impact or material impact say on revenues in the second half of the year?

The second question I have is it was announced by at least one of the trade press publications that you’re going to be supplying universal edgeQAMs or maybe already to Charter along with Cisco. I was wondering the decisions in terms of the purchase of universal edgeQAMs say in conjunction with CMTS deliveries, is that a decision that tends to be made by Cisco or is that a decision that tends to be made by the cable operator?

Patrick Harshman

I will take the second question first. I can’t place or I am not sure about the news that you spoke to, but I can address the more general question. Our edgeQAM activity, we have worked with a number of partners, including Cisco. Our relationship is ultimately with the end customer. The vast majority of our sales are to our end customers.

I think it’s important to remember that part of the strength of our positioning in the high speed data or DOCSIS 3.0 opportunity is the fact that our edgeQAMs already have such a large installed base for video and demand applications. In most cases, we already have deep existing relationships in general, and around edgeQAM deployments in particular, with leading cable operators around the world. The support of the DOCSIS 3.0 traffic is really an incremental service capability offered on a pre-existing edgeQAM relationship. I’m sorry, I have forgotten the first part of the question.

Larry Harris – CL King & Associates

The new products that you’re going to be introducing in the next few months, will they have a significant impact?

Patrick Harshman

I believe they will. In many cases, they will replace some existing products; but we think the performance, the value for our customers, the competitiveness, will be material, as well as we do expect them to come into play quite quickly. Therefore, be responsible for big pieces of the revenue that we might associate with these different product categories.

Larry Harris – CL King & Associates

So it could be as soon as the second quarter we could see some impact?

Patrick Harshman

I am speaking to a number of programs. We scaled up our R&D quite significantly, as you know, over the last six to nine months. We’re really excited about some of the things we’re doing and the capabilities. I don’t want to point or have anyone thinking about one particular product development program, but really across everything we do in video processing, software for on demand, our recently announced new HFC product as well as in the edgeQAM space, we’re quite excited about what we’re doing across all of these areas. I think over the next several months you will see exciting things from us in each of these areas.

Operator

Our next question comes from the line of Amir Rozwadowski with Barclays Capital.

Amir Rozwadowsky – Barclays Capital

Patrick, just following up on sort of your last comment. Certainly, you folks have seemed to scaled up R&D ahead of the launch of some of your new products. How should we think about sort of support for these new products in terms of operating expenses and perhaps are you folks looking now that these new products are coming to market to ratchet down R&D in 2009?

Patrick Harshman

In terms of support, I think the rest of the infrastructure of the company is very appropriate. We feel quite well placed. As a matter of fact, as Robin mentioned earlier, we do have some levers at our disposal to scale capacity up and down. I think one area that we feel very strongly about continuing at the current level is R&D. I think one of the themes of the success of the business, in addition to the revenue growth and I think the growing market share, has also been the growing gross margin expansion. We believe that’s very much been driven by innovative designs and really high value product innovations that we’ve brought to market.

As we continue in our long-term quest to continuously raise the gross margin profile of our products and solutions and we believe the way to do that is by continuing what’s been successful for us over the last two years, which is this continuing innovation from an R&D point of view. So that is one piece of the equation that we continue to press forward with, and we’ve seen very good financial results, returns on this investment to date. When we look at the combination of the opportunities in terms of both revenue as well as gross margin expansion, we think it makes a lot of sense.

Amir Rozwadowsky – Barclays Capital

Just touching on the gross margin expansion, certainly you folks have been very successful with expanding your gross margins. How should we think about some of the puts and takes there for 2009? Certainly the demand environment, at least visibility indicates, sort of a softening demand environment. Are there specific product areas that perhaps could impact sort of your gross margin progression over the course of the year, or how should we think about sort of the puts and takes from that perspective?

Patrick Harshman

I don’t think we expect any substantial, certain product lines will be under relative pressure or relatively unpressured. We expect and we’re planning to, over time, continue basically the steady quarter-to-quarter variations that will absolutely happen associated with product mix in a given quarter, etc.

I think over a slightly larger arc of time, I think you will continue to see us do what we’ve done. I think the mix of our products and the mix of our sales are slowly but relatively steadily moving towards higher margin products. We don’t see that general trend being substantially impacted or altered in the context of near-term capital spending pressure.

Amir Rozwadowsky – Barclays Capital

Do you folks anticipate any pricing pressure to perhaps impact, given some of the service providers may be ratcheting back?

Patrick Harshman

Certainly. This is undoubtedly has always been a very competitive space. We have some very strong competitors. Pricing is certainly one of the elements in that game. We don’t expect that to go away. Yet, in fact, I think it could be argued that the pricing pressure may be somewhat exacerbated in this environment.

All that being said, we think a lot about pricing pressure, and we think a lot about underlying costs in our product development programs. With our newer generations of products, we endeavor not only to raise the value proposition, but frankly also to reduce the cost. I think we continue to be well positioned from that point of view. As we think about gross margins, we think a little bit about pricing, we probably think a little bit more about some of the volume-related and overhead constraints or issues that Robin spoke to a minute ago, though.

Operator

Our next question comes from the line of Paul McWilliams with Indie Research.

Paul McWilliams – Indie Research

I have a couple of questions here. On the Scopus product line, how would that break out on what you estimate their sales to be this year between your three product group categories?

Robin Dickson

The vast majority of it will fit in what we currently define as video processing.

Paul McWilliams – Indie Research

Would that be 75%-80%?

Robin Dickson

Yes. In fact, it’s probably over 90% and the balance in what we define as software and services.

Paul McWilliams – Indie Research

Would it be fair to model them for about $65 million for the year, do you think?

Robin Dickson

For which year?

Paul McWilliams – Indie Research

I’m sorry. Calendar 2008.

Robin Dickson

I think Scopus is due to report their numbers in a week or two. I don’t think I would want to comment on their 2008 numbers until they report on them.

Paul McWilliams – Indie Research

You mentioned you were going to have a conference call after the close of the Scopus deal. Is that an implication that we’ll have a call in March or are you intending to wait until April?

Robin Dickson

I don’t think we specifically spoke to a conference call. I think what we would like to do is once the deal closes and once we get our arms around the level of detail that we need to get ourselves as comfortable as we want to be, we will get some updated guidance to the street. Exactly how and when we do that, I guess I would prefer to not to be specific about here. But obviously once we’re in control, we would want to update you as much as we can and as soon as we can.

Paul McWilliams – Indie Research

Any word as to whether Yaron Simler is going to come over with the deal?

Patrick Harshman

There’s a whole number of planning, integration, and organizational issues that we’re working through. Not to be cryptic, but we’re still very much working through those. I think we prefer to let all the dust settle before we start communicating how things are going to work out.

Paul McWilliams – Indie Research

I understand. I was just curious if there had been anything said on that subject. For Q4, who were the 10% customers? I think you gave full year, Robin, didn’t you?

Robin Dickson

Yes. Actually for Q4 it was the same line-up, Comcast and EchoStar, and both the percentages were actually very close to what they were for the year as a whole. If you just bear with me a second, I can probably quote these to you right now. Comcast was 19 for the quarter, 20 for the year. EchoStar was 12 for both the fourth quarter and the year as a whole.

Paul McWilliams – Indie Research

We’re all trying to crawl inside your head on this guidance issue here. I am not going to try to push you too much on this. What I am curious about is how much of your Q1 guidance this year is based on turns versus what you had based on turns last year?

Robin Dickson

Yes, my head is starting to hurt from all the crawling that’s going on. I don’t think, really, the mix, we don’t see as being that much different from last year. Our backlog contains, as it always does and as I said earlier, a significant amount of deferred revenue on various types of projects of all shapes and sizes in different places. I don’t see the mix as being particularly different with respect to what’s already in deferred and what’s coming from turns.

Paul McWilliams – Indie Research

Component companies quite often will establish what their turn assumptions are per quarter. I just thought I would ask to see if that’s something.

Robin Dickson

As I said earlier, the majority, and more than just a thin majority, is coming out of the existing deferred revenue and backlog that we had at the beginning of the year. The balance does come from turns business. Much or our access business, particularly, and even our edge business to a large extent tends to be more of a turns basis, whereas the video processing is very often in deferred revenue for some time.

Paul McWilliams – Indie Research

You guys did particularly well this year in edge and access. Would you attribute that to the universal edgeQAM primarily?

Patrick Harshman

We did see strength all the way around. Yes. It was a particularly strong year, I would say, for us in the edgeQAM space driven by both VOD activity where we continue to see solid expansion of VOD offerings and VOD transactions with cable operators around the world. Of course, as we’ve said before, we’re very pleased by the growing penetration of our edgeQAM into high-speed data applications as well.

Paul McWilliams – Indie Research

One last question. What products are driving your success in software and services?

Patrick Harshman

I’m hesitating a little bit, because in a lot of ways we’ve got a spectrum of small products that really work well together as a broader solution. Not to point at any one particular area, but software coming out, and what we’ve adapted out of our [intone] acquisition continues to do very well for us.

It was a very good year for us from a Rhozet point of view. I think you recall seeing a number of press releases. We’re really pleased with the way the market is accepting Rhozet technology and the way Rhozet is bringing us into some new customers.

Of course, on demand technology, transcoding technology, and some of the other things we’re doing around processing and video in the software domain, they all tend to work together for broader system solutions sitting behind, particularly filed-based video delivery platforms that we see increasingly being built up by both our existing customers as well as customers who are brand new to us.

Paul McWilliams – Indie Research

Thank you. Again, Patrick, congratulations on the marvelous success you have given us all with Harmonic over the last three years that you’ve been there.

Patrick Harshman

Thanks very much. We very much appreciate that recognition and, of course, we are pleased with the results. We have a little bit more time if there is one additional question after Paul. We will take that then wrap it up.

Operator

Our last question comes from Mark Sue with RBC Capital Markets.

Mark Sue – RBC Capital Markets

Patrick and Robin, if you look across your customer base of satellite, cable, and telco, any sense of what percentage of your revenues are project driven and what percentage may be maintenance driven? Then as you consider that question, maybe if you can give us a sense of with the moving dynamics, is $72 million, does that kind of settle, is that the bottom for you in terms of what you are seeing in terms of activity or is it still somewhat uncertain beyond the first quarter at the $72 million mark?

Robin Dickson

Maybe I could as you for a little clarification as to what you mean by maintenance. The way we think about our business from one angle is that we have projects which are almost always associated with the deferral of revenue and the recognition of revenue over some period of time.

Then what is commonly known as, and a couple of questioners have asked about, turns business. In addition to both of those, we have a modest level of maintenance and support contracts which we sell to all of our customers, or many of our customers, across all geographies and market segments. If you mean by that strict definition of maintenance, that’s bundled into our services and software number and is typically less than 10% of our overall revenue.

Mark Sue – RBC Capital Markets

Perhaps just the thought of new projects versus expansion of existing projects?

Robin Dickson

That’s tough, maybe Patrick has some better ideas, but what we see with our cable customers is that many projects are designed to be implemented in all or the majority of their systems around the country. If you are thinking of the overall level and the edgeQAMs for CMTS, for example, you could think of that as a project that our customers are going to undertake over some extended period of time.

But any particular installation in a particular system might be a one-quarter project. Again, I’m not trying to confuse you, I’m just saying it’s not that easy to think about it that way.

Mark Sue – RBC Capital Markets

Lastly, Robin, tax rate. Any bracket? Any thought? I understand it’s still kind of fluid, but will it be less than 30%, less than 20% for 2009?

Robin Dickson

We have talked in the past about for 2009 being maybe somewhere in the mid-30s and in 2010 and beyond becoming lower, probably closer to 30%. We’re certainly driving our tax strategy and our business in a direction that I think is consistent with that. We’re just a little uneasy, not being able to talk with great precision to revenue for the year. It gets a little hard to talk about tax because it is very dependent on the mix, particularly the geographic mix.

Maybe I can leave you with these thoughts. Those numbers are still broadly where we’re shooting for, but we’d like to come back once we get a little better visibility into the year and become more precise about the rate, particularly for 2009.

Patrick Harshman

I think with that we will wrap it up. I would like to thank everybody for participating in today’s call. We look forward to speaking with you again soon. Good day.

Operator

This concludes today’s Harmonic’s fourth quarter and yearend 2008 earnings conference call. We appreciate everyone’s participation. You may now disconnect your line.

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