Harmonic's Management Presents at Barclays Select Series 2014 Emerging Cable Technologies Forum Conference (Transcript)

| About: Harmonic Inc. (HLIT)

Harmonic Inc. (NASDAQ:HLIT)

Barclays Select Series 2014 Emerging Cable Technologies Forum Conference Call

January 17, 2014 1:25 PM ET


Peter Alexander – Chief Marketing Officer & Senior Vice President

Unidentified Analyst

All right, let’s just move on now. So we have Peter Alexander, he is the Chief Marketing Officer at Harmonic and therefore we go back to the headend and get a little bit more about that from Peter and of course Harmonic is a lot beyond that as well. So, with that Peter on to you.

Peter Alexander

All right, thank you. Good afternoon everyone. Thanks for the introduction. My name is Peter Alexander, I’m Chief Marketing Officer at Harmonic. And I have been with the company about 18 months and excited about being here. And hope to share with you kind of where we fit in the whole video ecosystem that in relation to the cable business. And hopefully leave enough time for questions at the end, that’s certainly my intention. I will start by saying we are in a quiet period for Q4. So there are some things obviously that can answer questions on. And nothing yet that I will say it should be considered to be reflection on what happened in Q4. And so with that I’ll get to it.

So who is Harmonic? What does the company do? Well off course, I am the marketing guy. So I’m going to start by saying, we enable amazing video experiences. But really if you look at where we fit in the ecosystem, which I’ll go into, I very much believe that to be to true. And as we see everyone start to talk about ultra high definition and those kinds of things. Nothing will guarantee, you don’t have a good experience more than having poor video encoding, having poor transmission and so on. And so we do believe we are a big part of what’s going to make future experience in video, what it will be and there will be a big part of that.

Just to give you some perspective on our business and show you where we are and why we are relevant to cable and how that looks. You can see from this chart that we are about 55% to 60% international with the remainder being domestic. In terms of our products 47% in Q3 was video processing, which is things like encoding, transcoding, decoding and 17% was products specific to the Cable Edge. We are known for QAMs, which are essentially the modems on the cable, out-of-band that carry the video signal or the downstream data signal.

And I’ll go into that segment in particular of course because that’s highly relevant to this conference, but you can see between the pie chart in the middle and the one on the right that while 17% of our business with cable operators is for specific Cable Edge products, 39% on our business is with cable operators. So that goes to show, we clearly work with them beyond just at the headend from packaging the cable perspective and I’ll try to give you some perspective on that.

We are also a major supplier to the satellite and Telcos and broadcast and media companies. And we believe the broadcast and media component is also important in the context of Pay TV operators, because its always good for them to know what’s happening upstream, relatively compatible and further it will be the right steps of video quality as you go from the golden mask that that you might find in a production facility out to the home where you may have been through the couple of steps down in bit rates and maybe between MPEG 4 and MPEG 2 in the case of cable. So we believe this all plays together very synergistically, and works out well both for us and our customers and gives us some balance to our business.

In terms of what we help, our customers do really starts with the business challenges, everyone tends to gravitate immediately to absorption of new technology, and certainly at the moment there is a tremendous amount of new technology in video. However, there is also a very relevant aspect to the complexity and the cost of ongoing operations. Video is a very competitive business for our customers as well as for us and the ability to absorb new technology is often a function of the space and the complexity reduced in the legacy of what’s out there. And so we spend a lot of time talking about that with our customers. Lot of talk in our industry and then video in general today, about workflow, compressing workflows, simplifying workflows and we spend a lot of time working on that.

So as a company I think I’ve seen while I’ve been at the company, this been a long more of a conversion at the business level with our customers and lot more of a conversion in terms of overall video processed from production through delivery to the consumer. And we do play across the board in video, our jobs starts when these video signal leads the video or television camera with so called contribution encoding goes all the way through the production flow into the playout flow where a channel is sequenced out onto the air, or onto the net. Primary distribution, which is primarily from a broadcaster or content owner into the Pay TV operators.

Content and service delivery is carriage of that signal across the Pay TV network, multi-screen some people call that over the top or second screen is essentially taking the video signal over the Internet. In an environment where for the rest of the network the signal is in a constant bit rate or a variable bit rate that changes according to how the picture changes. In the multi-screen world the bit rate changes according to available throughput across the Internet. And that changes how you do the encoding and how you manage the quality. And then finally this is certainly not least and as I mentioned in the previous two slides ago 17% of our business today is this Cable Edge where you pack the downstream today aspect of the cable for delivery to the home. So we are truly an end-to-end or glass-to-glass provider as we say sometimes.

Our customers are blue-chip broadcast media Pay TV operator and new media company. If you don’t see them on here with the few exceptions likely just won’t let us, use their names, but we are a company that sells globally across the board to the leading companies in the video business. And this gives us good perspective and increasingly as I said an ability to provide a business perspective to these kinds of companies. Just in the last couple of quarters we had some notable wins both in the Pay TV operator space and in the broadcaster’s space. Our landmark win last quarter – last quarter that we’ve announced which was Q3 was Fox Sports where Fox Sports 1 is based on our latest technology in the integrated playout space or so called channel in a box.

So from a business point of view driving growth is top of our agenda, returning shareholder value and our plan falls in just three areas. Addressing larger markets then we are in today, growing market share which has been steadily part of what we have been doing.

And then thirdly addressing, and participating and leading in new technology cycles. I will cover all three, but I’ll start very importantly on the cable side with the expansion our TAM. In that today we see three big TAM expansion opportunities, one is multi-screen I talked about that somewhat comes at back to that emerging markets where the subscriber growth is primarily and so we are very active in the emerging markets, but the third one and very important in the cables space is CCAP, the Converged Cable Access Platform.

Today we play in QAMs downstream QAMs, the market for those is around $400 million, but the combined CCAP market we estimate or the analyst estimate to be around to $2 billion market and so that is an expansion of our TAM. And for that we have announced about a year ago our NSG Pro platform which is I’ll go into in a second are designed from the beginning CCAP platform. We announced in Q2 of 2013, we had our first orders and our first shipments, production shipments of the NSG Pro and in Q3 we announced we had our first multimillion dollar order for the NSG Pro. We also said that we tested CMTS capability with the service providers what some of this means I’ll explain in a second and I’ll also mention our joint white paper.

So bottom line CCAP for those of you not that familiar with the technology and to talk about our position in it, you really have to look at the logical elements of the headend, you have downstream data that goes on to the cable out to the consumer. You have video also carried over QAMs and then the third component is upstream data.

Today these systems and the router behind the upstream and downstream data, usually the router is integrated with the CMTS platform. So if you look at a typical deployment in a headend you would see say Cisco with the UBR and Harmonic historically with our NSG 9000 where we would be the transmission portion, the portion that puts all of the video signals and all of the downstream data signal onto the cable in our platform and Cisco would be the router and the upstream CMTS.

In an Arris deployment typically these days with E6000 we would be the video as E6000 does support downstream and upstream data, but also has an integrated router. So you can see that today the headend to build out of both kinds of systems. The video integrated QAM systems that can also carry downstream data and the CMTS platform in particular this speaks DOCSIS on the CMTS side particularly upstream where the protocol is fairly different.

Now I mentioned a joint white paper we did with Alcatel-Lucent and it really goes to the hard end, it is available on our website, also available through our IR from Blueshirt and the Alcatel-Lucent website. It goes into the shuffle, but important differences within the CCAP spec and CCAP architecture and let me bottom line it by saying it’s really very – just to network architecture from the rock point of view whether you route all the way through or whether you do switching and routing as a forwarding CCAP architecture, the CCAP platform looks a lot more like a switch connected to a site router.

Now why does that make a difference, well it comes down to network complexity and cost. In a routing CCAP architecture you have many instances of routing in the headend as each CMTS has its own integrated router. In a forwarding CCAP architecture you only have primarily the one router at the headend and not a small instance of routing in each of the QAM shelves and needless to say we consider ourselves to be distinguished in supporting the forwarding architecture that will work with any router behind us. The integrated routing architecture tend to be those favored by Cisco and Arris, but both fall within the strict definition of what CCAP is.

Now in terms of status today we are competing primarily with Cisco and Arris in headend and it’s fair to say that no one has complete CCAP. We will have the platform that we say is our host, but no one could delivers the complete capability. So in Cisco’s case, the CBR they’re talking with their customers they have not announced to our knowledge a specific release date.

On E6000 which we hear a lot about from a CCAP perspective actually does not have video support and backend video integration again we understand. On the NSG Pro side, which is our platform, we do not yet deliver the upstream capability. We have full downstream video and data and we support more narrowcast QAMs per service group than any of the other platforms where we’re up today.

So that’s our position from our CCAP perspective and where we fit and how our architecture works. From a market share perspective, as I mentioned earlier, our goal is to grow market share across our businesses. We’re number one in pay TV encoders, number one in broadcast playout servers, number one in IPTV headends. We are number one in Cable EdgeQAMs. In fact, the latest report from Infonetics came out in Q3. We were about 39% versus 26% for Cisco and Arris. And in Q4, this is public knowledge, not otherwise, we remain number one in multi-screen overall transcoding by Frost & Sullivan and in file transcoding by MRG. So these are very strategic markets. Multi-screen, relatively small, but we are number one in that respect.

From a growing market share perspective, again from the technology, we believe we’re in good shape to continue to gain share. In encoding we particularly gain from Ericsson. We also are picking up more customers on the pay TV side, particularly in international market, but many of our markets are very fragmented and quite competitive. Some in the fragmentation is reducing as we see consolidation and we believe very often we’re beneficiary of that from the point of view of the confusion that creates, gives us opportunities with customers who want to see stable product roadmaps.

Now another area of great interest to us is next-generation technology and encoding and in end user devices. And I’m sure there’s been a lot of talk today in here after CES about ultra high definition television. So let’s start on video compression and encoding. We really see there being two aspects to this. One, yes, is HEVC. I’ll come back to that. The other is the opportunity for improvements in MPEG-2 and MPEG-4. What’s unique about the MPEG standards is that within those standards, even though they specify how to do things there are areas where by using proprietary techniques and advanced hardware you can get more out of the protocol to get better video quality at less bandwidth. And that’s one of the things that Harmonic is best known for.

Well, at this point we’re showing our customers what we believe are significant gains and the ability to encode MPEG-2 and MPEG-4 at higher quality and lower bandwidth and we think part of the refresh cycle will start this year isn’t just moving to HEVC. It is also improvements in MPEG-2 and MPEG-4. Of course the big benefit of that is that it works with existing set-top boxes. And the decode part is fully standard. We can still make improvements on the encode and transcode part, which will play out to high-quality at lower bit rate that will work with the existing set-top boxes and we are demonstrating that today.

Now HEVC, High Efficiency Video Compression or coding, is definitely on the horizon. Everyone is talking about it. We’re starting to see some real deployments. We were showing HEVC at NAB this year in April and CES this year was the first time where we saw kind of the catching size of HEVC in terms of things that can decode it. In fact at CES we saw a smart televisions with HEVC decoders built into them. So, HEVC will happen, but it will happen first in software which means it will be more relevant in over the top kinds of applications to start with. And in fact Netflix is 4K or ultra demonstration in CES was HEVC encoded and decoded. And we cooperated with Broadcom with Sigma and with Samsung at CES around HEVC and ultra high definition encoding to be compatible with what they were doing.

In Q3 we also announced a cloud transcoding service HEVC enabled with Tata Communications. On the ultra high definition side because a lot of this very exciting about this from our perspective. Nothing drives demand for good encoding and transcoding like big televisions that show the weakness in the signal and the problems with the compression. And the bigger a television gets, the more you want high quality encoding and transcoding of course which is where we come in. And so in terms of ultra high def for us the things that really signal this is going to be a real market, one is the adoption of HDMI 2.0, which will allow an ultra high def signal into a television at 60 frames per second or higher, HDMI 1.4 limits up to 30 frames per second at a ultra high definition speeds.

The other one of course is price points in televisions, in the Black Friday sale in November Seiki televisions were on the cs.com, 55 inches $799 for an ultra high definition television. Earlier this week I was on Amazon.com Seiki 65 inch less than $2,000. Also at CES Vizio announced a $1,000 ultra high def at 50 inches and $400 per five inches after that. So the prices in ultra are coming down quickly, which means pretty much with Vizio in the picture we are going to start to see ultra’s in Cosco, we are going to start to see more adoption of new ultra high definition televisions at the consumer level. Then the question is, okay I’ve got this fancy new TV where do I get my content from. Well it’s pretty clear that this is going to be a disc less transition, there is no compelling case, no compelling technology for disc based ultra high def.

So it’s going to be streaming, it’s going to be channeled and going to be so called progressive download, this Sony Player, that looks like an oversized hockey puck. The black thing is a progressive download player, where you ask it to get your movie in the morning and by the time you get home from work, its downloaded it. But we believe that’s a temporary fix until there is more content out there.

Now let me qualify this by saying I maybe disappointed a little bit, in the same way that most of what you watch on your 1080p television at home, isn’t 1080p, its 720p or 1080i, so most of what you will watch on your ultra high def will be 1080p not much of the ultra. And two reasons for that. One is its economically viable to upgrade to 1080p on the existing infrastructure for many channels.

And secondly, 1080p looks pretty good on an ultra set, because either the set or the intermediary device like the set tops, does or will have fairly good up conversion. And we are giving demonstrations at the trade show showing up converted 1080p in the television environment and looks pretty good. Now, from our prospective that represents an opportunity because what you’re seeing today is 720p or 1080i. To go to 1080p is going to require an upgrade of the infrastructure, which we provide.

So, along with the ultra high def wave will come some channels in ultra high def, file transcoding ultra high def streaming and a broader upgrade to 1080p from many of the key channels. To help this along we’ve been doing a lot of demonstrations with third party vendors I mentioned once at CES. We’ve also been working on a number of industries first in terms of demonstration over different kinds of infrastructures. We help some cable MSOs. We also done joint demonstrations with SES and Sky Deutschland in Europe.

A final point I’ll make here is that for every new technology we’re about to adopt, there is always another one on the horizon that we may or may not adopt, across the one beyond 4K is 8K. And I think it’s important to note that with the Olympics in 2020 being in Japan and 8K being a technology very much being driven out of Japan. If you go to any of our industry shows an 8K there and then many of the Japanese vendors which showcase the 8-K technology. It’s fair to say that the 2020 Olympics will at least be mastered in 8K. We’ll see where they delivered in 8K.

Having said that, we’ve got the Winter Olympics coming up, we’ve got the World Cup and then the Summer Olympics in Brazil. Certainly by the Summer Olympics in Brazil, we estimate that ultra high def services over mainstream channels will be available carrying those kinds of sports events and these are often good catalysts for upgrades of televisions.

I mentioned this already, Fox Sports 1, this demonstrates the power of some of the integrated capabilities now available on the channel playout side that Harmonic is bringing to bear. What you’re looking out is two video feeds and light graphics on the same screen, all driven from a single platform. So compressing the workflow and the broadcaster, simplifying what it takes to put on a sophisticated channel.

Now Fox Sports 1 of course is a major investment by Fox and a major endorsement of the technology. We think what’s important about this technology that goes beyond that. And now there is that we are starting to see a proliferation of more personalized content, more personalized channels over the top in particular and to run a sophisticated channel over the top with this kind of technology, will cost a fraction of what it costs with the string of technologies that you see in the typical broadcaster today.

So, I use the music analogy, music had radio, television had broadcast channels, music has Hitchin [ph] and video has Netflix. Music has Pandora Rhapsody a lot of that semi personalized kind of content. Video still needs to get there. That’s where channel proliferation comes in, that’s where some of the more on-demand user configured kinds of video capability will happen. The difference with on-demand however is that for any kind of period of watching users just is why Pandora is important don’t want to choose every individual piece of content something that place content in general topics that they’re interested in, is of interest and this is where we see channel proliferations with these kinds of channels in the box, capabilities happening where there might be a cross channel or a scuba diving channel.

You can’t get it on the regular line up, but you can get it over the top and we’ll see more and more of that. So that’s my perspective on where we are in the industry and some of the trends and technologies. Again, I’m not reflecting on Q4 when I say that up to Q3, we had been making financial progress. A couple of things that we noted were our general trends was improving gross margins. We had two quarters in the last four of higher margins due to a mix shift towards software.

The other thing in Q3 was a notable management of operating expenses, and this I think reflects a very focused effort within the company on controlling what is in our control and by doing so giving ourselves a differentiation in the business model to compete in the market and grow at or beyond the market that we address. And on the balance sheet, again, different improvements, and in the last year if you look through our financial records a big focus on returning shareholder value including a significant stock buyback.

So I’ll close with a note of the shareholder value, continued focus on growth, I hope I’ve impressed on you. We’re very much involved in the key trends in this industry. We are constantly looking to accelerate our core market share leadership, and we’ve demonstrated market share gains on a consistent basis. We’re building an enhanced margin profile optimizing our balance sheet and certainly looking to drive long-term earnings accretion.

With that, we’ve left a few minutes for questions, I’d be happy to take them.

Question-and-Answer Session

Unidentified Analyst

So the way you described the CCAP approach that you guys are taking, I mean it looks like it’s more a higher density approach rather than an all IP approach. I mean if this is where that cable guys are hiding you towards, or is this an interim spare band [ph]?

Peter Alexander

So first of all it essentially isn’t all IP approach. In that – the interface – of the interfaces into the box are 10-gigabit Ethernet. But this is certainly the way in close conversations with our cable customers – they versus to architect the device. I think there is interest in the flexibility on the routing side that that our version of the architecture provide and a simplicity of the network architecture that they are very attractive to. So we believe that we built something is very much along the lines of what the operators are looking for. Please.

Unidentified Analyst

Can you talk about the fact that there is a 4K content [indiscernible] and can you comment on when you think, between the encoding and the quality of encoding, the size of the TV, when does the user say, hey, I can really tell the difference between native 4K and 1080p upscale, is that a 60-inch TV with the encoder set?

Peter Alexander

Yes, so something they get trained on, but the bigger the TV gets the easier is to tell that. I think if you compare 1080p television with a Ultra HD or 4K television, it doesn’t take much to be able to tell right now, even down to 55-inch. Now, that some people will say baloney, that’s fair enough, try this – the closer you stand to it, the more you can tell. And if you look even on Sony’s own website, they talk about how the typical viewing distance that you expect from a television is reduced in an ultra high-def environment, meaning more of a home cinematic experience broader field of view.

If you watch a 1080p television and it’s a 60-inch and you are just a few feet from it, you can the pixelation very much, that’s a lot less pronounced in an ultra high def environment. But the 1080p content does look good, the video experts and I walk around them all day would tell you it depends on the content, if you are watching high speed sports, a lot of changes, things like waterfalls and where there is a lot of, you are challenging the encoding and so on. If it’s encoded well, even then, you will still notice the differences pretty quickly.

So but I would say from 60 on, there is a pronounced difference and it’s all about how far you are from itself. There I saw an interesting video report and where they were saying, we can’t tell the difference, but they were watching 1080p on an ultra, and ultra on an ultra, try watching 1080p on a 1080p and ultra on a ultra next to it, you will immediately see the difference.

While we are thinking, I can add that, we have a ultra high def and 4K test clips on our website and we do sublicense content to other vendors for using in testing demonstration examples and with assuming [indiscernible], legal agreement, yes thank you.

Unidentified Analyst

Yeah, I just wanted to ask you very quickly on your analogy that we need a Pandora for video, actually we have video apps, some what we have YouTube, does exactly what it does, it forces you to do with ultra [indiscernible] next video for the YouTube apps on TVs. Apart from Google that I have so much knowledge on their customers and also huge database of videos, who do you expect will be bringing these kind of services to market?

Peter Alexander

Well, anyone with a content library, I think, so there is a lot. One of the challengers for lot of broadcasters and media companies and for the one of the drivers behind multi-screen has been the ability to access libraries of content, because if you are many media companies you have a few channels that playout 24 hours a day, but they are touching the only the very thin veneer of their content library and so access to a content library in a more automated way would make sense.

So I wouldn’t be surprised to see major media companies start to offer these kinds of personalized channel services, is that makes sense. And then of course that could be new media aggregators doing that to. Any questions?

Unidentified Analyst

Thanks for the time. Thanks.

Peter Alexander

Great, thank you for the invitation, it’s good to see everyone. Thank you.

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