Harmonic's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Harmonic Inc. (HLIT)

Harmonic, Inc. (NASDAQ:HLIT)

Q4 2013 Earnings Call

January 28, 2014 5:00 p.m. ET


Carolyn Aver - CFO

Patrick Harshman - CEO


Mark Sue - RBC Capital Markets

Simon Leopold - Raymond James

Tim Quillin - Stephens Incorporated


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.

Carolyn Aver

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.

Patrick Harshman

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 content is king, we're pleased to see that our strategic focus on market leading broadcast and media players is delivering growth.

In cable, after a very weak first half of 2013, we're pleased to see increased demand for edge products; sustained through both the third and the fourth quarters, the second half Cable Edge revenue up 28% over the first half of the year. But the top line was only part of the Cable Edge store in the fourth quarter.

More strategically was significant was the mix shift towards software licenses to activate previously deployed QAM hardware. This is the razor and razor based analogy we've discussed with you previously. But consequently, the Cable Edge top line was more modest than expected. But we had record Cable Edge gross margins, strongly validating our strategy to leveraging our industry-leading DENs EDGE QAM technology.

Although fourth quarter Cable Edge highlights included recognition of a first revenue for the new NSG Pro Platform and the release of new Infonetics Research showing that we strengthened our number one Edge core market share position through the first three quarters of 2013.

Also in the fourth quarter, we saw sequential uptick in demand from satellite direct-to-home and telco pay-TV service providers, and so we have 4% from the fourth quarter of 2012. Here our near term strategy is to bring dramatic bandwidth efficiency innovations to the market. We are making good technical and commercial progress. Our newest encoding innovations are now in running in several key customer labs, and during the fourth quarter we received an early order from a tier 1 satellite direct-to-home operator.

And finally from a geographical perspective, our international business grew again to 60% of revenue for the quarter and up 17% in the second half over the first half of the year, if you're holding steady and emerging markets being the primary growth drive.

So let's now turn to Slide 5 and take a step back and look at the whole of 2013. With revenue of approximately $462 million and bookings only slightly stronger, we're disappointed with our top line performance. However an important part of the story here is our strategic focus on higher value deals and more software rich new products. Of course, finally gross margins were up to 52.6%, a substantial step up year-over-year.

New product investments to enable strategic change in growth were the key things for us in 2013. In particular as we ramped hiring and spending on our NSG Pro CCAP initiative. The bottom line result was non-GAPP earnings of $0.17 per share coupled with significant progress on our targeted new growth initiatives.

Before we turn into the strategic progress, I also want to highlight here our continued strong cash generation approximately $54 million from operations, and associated stock buyback program with over 18 million shares repurchased during the year.

So turning now to our strategic progress during 2013, a clear highlight was the growth of our business with global broadcast and media customers. Up approximately 11% year-on-year and accounted for over 40% of our 2013 revenue. With announcements of customers like Fox and with leading media companies from Turkey to Thailand and new solutions like our spectrum channel port and multiscreen streaming capabilities gaining real momentum and market share, we created in 2013, a strong foundation for continued growth in broadcast media.

A second strategic highlight was the progress we made during the year on major new product initiatives. Initiatives we believe will be transformative for our business over the next two to three years. Among these are NSG Pro CCAP platform, next generation video encoding innovations, and an expanded multiscreen offering, all of which I will review in more detail shortly.

During the year we also divested our HFC Cable Optical Access business as we made the strategic decision to focus our business on higher growth and higher margin CCAP and DOCSIS Access Systems.

And finally, we've brought in new worldwide sales leadership with George Stromeyer joining us from Cisco at the end of the second quarter.

Well, it's never easy to change the engines of an airplane while in flight; George has managed to drive continued strategic lengths, gross margin improvements, and market share gains, while in parallel undertaking a significant reengineering of our sales operation. And under George's leadership we are encouraged to see second half 2013 revenue up 11% from the first half.

So look, well 2013 was not a banner top line year for us. We head in the 2014 having established strong gross margin and cash flow trends, positive top line momentum in the second half, and a renewed customer technology and go-to-market foundation for profitable growth and value creation.

On the subject of creating shareholder value on Slide 6, we return to the value creation agenda we set for the year. Now, as a remainder, our value creation agenda was comprised of three components; executing on our strategic growth plan, continuing focus on capital structure optimization, and ensuring strong supporting corporate governance and management.

With respect to the last component we added two new senior sales executives to George's team during the fourth quarter. Both as it turns out joining from Cisco. Spencer Hodson joined us to run global sales operations and Frank Montalto joined us to run North America Cable and telco sales.

On capital structure optimization Carolyn will update you on our cash generation and stock repurchase progress in just a few minutes. Well I'll now focus on progress and our strategic growth initiatives. Our key programs to capitalize on upcoming technology transitions and associated customer spending cycles.

So let's move to Slide 7 and first talk about our progress toward addressing what will be a major new $1.5 billion to $2 billion annual business opportunity for us at the Converged Cable Edge. An opportunity driven by our cable customers planned transition to a flexible, all-IP converged video and data network.

During the past four quarters, the phase 1 release of our converged cable access product, the NSG Pro, completed integration testing with key North American cable operators for downstream video-on-demand, switch digital video and modular CMTS data services. That also passed challenging physical and environmental testing demonstrating both wire speed throughput and the most narrow cast downstream qualms of any platform in the marketplace today.

And as a result, the fourth quarter was our first quarter of multimillion dollar revenue recognition for the NSG Pro and during the quarter we secured our second NSG Pro customer and already in the first quarter this year we've received a second multimillion dollar order. Well generally we believe we are competing very effectively versus our major Cable Edge competitors. And this was confirmed in November when Infonetics Research released their edge qualm report, which showed Harmonic to have 37% market share versus 26% to each for Cisco and Arris, a turnaround from the fourth quarter of 2012 when Cisco had edged ahead.

So looking ahead to Cable Edge demand trends a positive sign from the fourth quarter with Comcast highly publicized success with its new XFINITY TV store. In December Comcast had notable success outselling Amazon, Apple, and Wal-Mart voodoo and just released sales of Despicable Me 2 and Hunger Games: Catching Fire. And much of this was delivered through XFINITY on demand.

And more recently we have also seen ABC and Fox make policy changes driving video-on-demand access to their pay-TV partners notably cable operators. This is important because the more successful cable on demand service has become the more the cable MSOs will need expanded narrowcast qualm capacity and flexibility and the more opportunity we see for our new downstream NSG Pro platform. And we like the way the market seems to be trending as we head into 2014.

Well parallel with this downstream phase 1 activity, we continue to make good progress on phase 2 of our progress that is adding CCAP compliant two way DOCSIS upgrade capability to the same NSG Pro platforms that are now been deployed in the field for downstream applications. During the cable industry's Cable-Tec show in October Harmonic published a joint white paper with Alcatel-Lucent highlighting the merits of our new CCAP architecture. The paper was called transforming the network edge of the cable hub.

This approach has been very well received and the white paper which also includes a forward from Time Warner Cable is available on both our and Alcatel-Lucent websites. And we continue to make good progress executing on this innovative two way CCAP architecture. We now successfully conducted cable modem and provisioning back office interoperability testing at a key customer lab and we are on track for expanded two way traffic testing and initial qualifications midyear.

Our continued execution and close collaboration with our customers cause us to remain confident in our ability to become a player and ultimately a category leader in this transforming Cable Edge space. And we will continue to update you on our progress throughout 2014.

So let's now switch gears, let's turn to Slide 8 and talk about the progress we see towards upgrade cycles driven by next-generation video compression and Ultra HD encoding technologies. Looking first at encoding of today's standard definition and high definition services, we previously discussed the progress we've made towards significantly improving compression and video quality for legacy MPEG-2 and MPEG-4 AVC services. Our new MPEG-2 and MPEG-4 compression innovations are of particular interest to our service provider customers, because they enable significantly wireline and wireless bandwidth efficiencies without requiring costly set-top box upgrades.

In the fourth quarter, we moved one step closer to productization by taking these innovations into several key customer labs for evaluation. And the feedback so far has been very encouraging. As I mentioned earlier a key customer placed an order in the fourth quarter for valuation units containing this new technology and more generally we will see growing potential with this technology to be a catalyst for new encoding system upgrades by several of our key customers.

So turning now to the new ultra HD formats and the new HEVC compression standard that will make ultra HD practical, we continue to see industry developments that we affirm I believe that this technology will over time drive significant infrastructure refresh in our industry. For example, a Chinese brand Seiki and video recently hit new sub $1000 price points for Ultra HDTV sets. Several TV manufacturers demonstrated HEVC Ultra HD clients in new smart TVs, and Netflix announced that it will begin streaming HEVC included 4K later this year. And of course, we at Harmonic brought interest in Ultra HD coming to provision.

At CES, a few weeks ago we showcased the amazing picture quality made possible through our in development Ultra HD technologies, with joint demonstrations with BroadCom, Samsung, and Sigma Designs.

And additionally, well the volume Ultra HD encoder upgrade wave probably crest only in 2015, we're starting to see growing consumer purchase of Ultra HDTV sets this year backed the question could today's HD channels be made towards better when displayed on Ultra HDTVs. And consequently we're beginning to see broad potential for today's HD infrastructure, primarily broadcast at 720P or 1080i for the upgraded the 1080P encoding with the resulting picture up converting nicely on these new Ultra HDTV sets. So we continue to watch that space too and keep you appraised on how it's developing.

Let's now turn to Slide 9 and talk about the other technology transition that we've discussed with you also in the past, which is multiscreen video. You may recall that on our last call we announced that industry analyst Frost & Sullivan have named Harmonic as the number one market share leader in multiscreen transcoding, which is the core of the multiscreen marketplace, adding to our verifiable market share leadership in each of our key business and technology segments. Well on the fourth quarter MRG reaffirmed this view by also naming Harmonic as the multiscreen leader, this time specifically in multiscreen file transcoding. So it would be clear we're still waiting for the multiscreen market to really take off. However the second data point shows you that we're focused and winning in an area of strategic importance in which our customers will undoubtedly be increasing investment over time.

So let's turn now finally for me at least here to Slide 10, where I want to give some color on 2014 and where we see investments more or less likely to meet the growth enabling market demand during the year. So break things into two categories, high probability for traction where there is strong indicators that our strategic initiatives will drive growth and then upside trends where 2014 impact remains subject to broader market dynamics.

On the higher probability side building on the momentum we've created in 2013, we expect to grow by further expanding our base with global broadcast and media customers, and expanding the breadth of technologies and solutions we're deploying in these accounts. We also expect international markets to remain healthy, but the emerging markets continuing to drive growth overseas.

Turning to products. We believe our NSG Pro downstream CCAP platform will continue to gain traction through the year. Well true cable operators have multiple CapEx priorities. We expect the strategic importance they place on scalable, revenue generating on-demand video, and high speed data services, enabled by the NSG Pro, to drive resurgent Cable Edge demand relative to what we saw in 2013.

Similarly we believe our video processing business will also remain healthy. Our new encoding innovations for driving high customer interest and we will be productized in time to have an impact this year. We've also seen our service and support business grow steadily over the past few years and with new service level offerings coming to market this quarter we believe the progress will continue.

And finally we've invested in new sales and marketing leadership and practices, and we believe that these changes will bear incremental market share fruit for 2014.

So on the other hand Ultra HD, HEVC compression, and higher volume rollout of multiscreen services remain wildcards for now. We're confident in our position and strategy in each of these areas and continue to see compelling market potential. While we're quite convinced each of these areas will become an incremental growth driver by 2015 as will be the case for two-way CCAP initiatives. The extent to which we see material 2014 revenue upside remains a question. And again of course we will keep you updated as the timing and scale of these opportunities comes into sharper focus, and as we continue to position ourselves to fully leverage these transitions for stronger growth.

With that, Carolyn I will pass it back over to you.

Carolyn Aver

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 to move away from commodity product categories we have been focused on delivering more of our value in software. And you see this trend continuing. As we make this transition we are driving the growth of our gross margin dollars and consequently you may see compressed top line growth as was the case this quarter.

Non-GAAP operating expenses for this quarter were just higher than expected at $54.5 million, up from $53.7 million in the third quarter of 2013, and roughly flat with $54.6 million in the fourth quarter of 2012. The increase in operating expenses is due in part to higher sales expense as we invest in our go-to-market activity and in part to cost associated with the added litigation. However, our headcount was 1,032 down from a 1,063 at the end of the previous quarter and the 1,081 a year ago.

Non-GAAP net income from continuing operations for this quarter was $8.3 million or $0.08 per diluted share compared to a net income of $7.1 million or $0.07 per diluted share in the prior quarter, and net income of $8.3 million or $0.07 per diluted share for the fourth quarter of 2012.

Moving on to Slide 12, let's take a look at our revenue category breakdown for the quarter and the year. International continues to represent a growing percentage of our revenue at 60% of the total this quarter and 57% for the year. With the increasing international contribution is driven principally by emerging market and to a lesser extent some recovery in our European revenues from 2012.

From a product view, video processing, production and playout, and service revenues, maintained or increased as a percentage of revenue for the year at 48%, 19%, and 18% respectively. Cable Edge decreased as a percentage of revenue from 18% in 2012 to 15% in 2013, as customers paused their downstream Edge QAM projects in the first half of 2013.

As Patrick mentioned our Cable Edge business increased 28% in the second half of 2013 compared with the first half holstered in part by the release of our new NSG Pro platform. The broadcast and media market represented the largest growth in our revenues in 2013 comprising 42% of revenue in Q4 and over 40% of our revenue for the year.

Our cable market represented 35% of our revenue in the quarter and 37% for the year. And our satellite and telco market is relatively flat representing 23% of our revenue for both the quarter and year. Our largest and only 10% customer for the fourth quarter of 2013was Comcast, at 12% of revenue for both the quarter and the year.

Now, moving on to Slide 13, you can see, we continue to drive a strong balance sheet. We ended the quarter with a cash balance of $170.6 million, up $1.3 million from the previous quarter, reflecting approximately $18.6 million of cash generated from operations in the quarter, offset by $13 million used in our share repurchase and $7.5 million for an advance payment made to one of our contract manufacturers.

We do expect cash to decrease in Q1 due to an increase in DSOs back to our mid 60 day target. The seasonality of payments in Q1 and our continued share repurchase.

Our receivable balance was $75.1 million and our DSOs were 57 days, down from 63 days last quarter. Inventory was $36.9 million, down by $3.4 million from the prior quarter. As a result, our inventory turns were six for the second quarter in a row. Capital expenditures for the fourth quarter were $3.3 million.

Moving to Slide 14, I'd like to update you on our share repurchase activities during the quarter. We repurchased 1.8 million shares for a total of $13 million. This brings our total shares repurchased in 2013 to18.3 million shares and our shares outstanding down to 99.4 million. At the end of Q4, we had $81.8 million available from our board authorized program for continuing repurchases.

Turning to Slide 15, let's look into the first quarter of 2014, based on our backlog and expecting a seasonally normal modest decline in sale, we expect our revenue to be in a range of $105 million to $115 million. This represents 8% growth over Q1 '13 at the midpoint of the range. Beyond our first quarter guidance, we also want to provide a framework for you to think about revenue growth for 2014.

As Patrick mentioned in his 2014 outlook, we believe there are several growth drivers that we expect to continue from 2013 or gain momentum in 2014. We believe these drivers will provide a base for growth in the mid single digit. Well there are also some additional trends that we believe will drive even faster growth, the timing of those is less certain and therefore not included in our 2014 outlook at this time.

Non-GAAP gross margin in the first quarter is expected to be in the range of 51% to 52%. This range takes into consideration the margin impact we expect from increasing revenues from our new NSG Pro, cable edge platform. We will still be shipping from our first group of units which do not benefit from fully cost optimized production and therefore carry a lower gross margin.

Additionally, as with previous generations of new qualm platform, with our initial shipments, we are shipping chassis with powers supplies and few chords like razors, lightly populated with razor blades. And of course we then expect to ship a high volume of additional chords for razor blades overtime.

The NSG Pro margin is improving modestly in Q1 and expected to improve more significantly as we move into 2Q and beyond. Due to this and our other ongoing strategic initiatives, we expect gross margins for the year to be in the 53% or better range.

As we bring these new strategic products to market, we are leveling off our R&D investments and moving some investment focus in the go-to-market activities. We also continue to focus on optimizing our general and administrative cost. Our plan is to do all of this within a flat operating expense structure for the year.

We've targeted our non-GAAP operating expenses for the first quarter to be in $54 million to $55 million range.

Finally, we anticipate our non-GAAP tax rate for 2014 to be 21%, subject to our domestic versus international split.

In summary, I think we have accomplished a number of our value creation objectives in 2013. While we did have some revenue challenges we made a meaningful improvement in our gross margin profile, we effectively managed our operating expenses, while delivering on strategic product initiatives and embarking on a go-to-market transition.

We improved our balance sheet management by significantly improving our cash conversion cycle and investing that benefit and more in an aggressive stock repurchase program. As we move into 2014, we expect to return to revenue growth, continue our improvement in gross margin, and our focus on operating expense control. We believe these activities will drive earnings growth and more value for you, our shareholders.

With that, we are ready for questions.

Question-and-Answer Session


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.

Mark Sue - RBC Capital Markets

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.

Patrick Harshman

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.

Mark Sue - RBC Capital Markets

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?

Carolyn Aver

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.

Simon Leopold - Raymond James

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.

Patrick Harshman

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.

Simon Leopold - Raymond James

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?

Patrick Harshman

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.

Tim Quillin - Stephens Incorporated

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?

Patrick Harshman

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.

Tim Quillin - Stephens Incorporated

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

Carolyn Aver

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.

Tim Quillin - Stephens Incorporated

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?

Carolyn Aver

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.

Tim Quillin - Stephens Incorporated

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?

Carolyn Aver

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.

Patrick Harshman

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.

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