Harmonic's (HLIT) CEO Patrick Harshman on Q4 2015 Results - Earnings Call Transcript

| About: Harmonic Inc. (HLIT)

Harmonic Inc. (NASDAQ:HLIT)

Q4 2015 Results Earnings Conference Call

February 16, 2016, 05:00 PM ET

Executives

Blair King - Director of Investor Relations

Patrick Harshman - CEO

Hal Covert - CFO

Analysts

George Notter - Jefferies

Tim Savageaux - Northland Capital

Greg Mesniaeff - Drexel Hamilton

Victor Chiu - Raymond James

Matthew Galinko - Sidoti

Jeff Bernstein - Cowen Prime Advisors

Robert Moses - RGM Capital

Operator

Welcome to the Q4 2015 Harmonic Earnings Conference Call. My name is Danielle, and I will be your operator for today's call. (Operator’s Instructions) Please note this conference is being recorded.

I will now turn the call over to Blair King. Blair, you may begin.

Blair King

Thank you, Danielle. This is Blair King at Harmonic and I appreciate everyone being here today. With me here in our headquarters is Patrick Harshman, our CEO; and Hal Covert, our CFO.

I’d like to point out that in addition to the audio portion of this call, we have also provided slides for this webcast, which you can see by going to the Investor Relations Page on harmonicinc.com and clicking on the fourth quarter 2015 preliminary results call button.

Now turning to slide two, let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only current expectations and actual events or results may differ materially.

We refer you to the documents that Harmonic files with the SEC, including our most recent 10-Q and 10-K reports and the forward-looking statement section of today's preliminary results 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 press release, which we have also been 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 said, I'd now turn the call over to our CEO Patrick Harshman. Patrick?

Patrick Harshman

Well, thanks Blair and thank you everyone for joining us today. I’ll begin with a brief summary of our fourth quarter results and then turn to updates and outlook for our Video and Cable Edge businesses. Hal, will then discuss our financial results and outlook for the quarter and the year, and I’ll conclude by summarizing our key strategic priorities for 2016.

So with that, let’s turn now to our slide four, where we see that our fourth quarter revenue was approximately $87 million, up 4% sequentially. The financial highlight of the quarter was bookings of $101 million, up 35% sequentially and our strongest bookings quarter of the year.

Relative to the third quarter, the rebound in bookings occurred across all geographies and product categories, but with strongest overseas and for our video business. Gross margin was 55%, our second highest margin quarter ever, a percentage point below the record 56% gross margin attained in the third quarter and continuing evidence of the shift to software underway in our video business.

EPS was a $0.01 just ahead of the breakeven result of the third quarter. So let’s now turn to slide five and take a closer look at our video business. The first key message here is that we are seeing improving video infrastructure demand trends globally. As you know for most of 2015, we saw hesitance to spend in the face of evolving television business dynamics, significant service provider M&A, and significant technology transitions. So it was good to see some of this pent up demand break loose in the fourth quarter driven in particular by global telco, cable, and satellite operators.

Looking ahead to the balance of 2016, where customer M&A are transforming pay TV business environment and associated technology transformations will continue, and we forecast improving demand and resulting growth of our organic video business.

The second key video segment message is that we are continuing to steadily transition our business to be more software centric with converged traditional pay TV and over the top services playing an increasingly central role in our business.

Our VLS platform which is enabling ground breaking video compression delivered to our customers as software is gaining strong market momentum and was the key to several competitive IPTV and over the top wins in the fourth quarter.

As Hal will discuss, this ongoing video business transition to software results and our expectation for compressed top line growth but expanding gross margins and operating profit.

And the third key message of our video business is our market position, technology differentiation, and financial performance will all be enhanced through the Thomson Video Networks acquisition.

So let’s turn now to slide six and take a closer look at the TVN deal. Since announcing the acquisition in December, global customer reaction has been overwhelmingly positive. Now as a reminder, TVN is an approximately $75 million revenue per year video compression competitor with strong presence in Europe, Middle East, and Africa, Asia Pacific and Latin America and a key supplier to blue chip customers such as the BBC, BSkyB in the U.K., DirecTV Latin America, Foxtel in Australia, and Telefonica.

And through this deal, Harmonic will become one of only two global suppliers of video solutions that have product breadth, scale, and leading market share, and the other competitor being Ericson. And through this combination, we expect to further strengthen our technology and product innovation capabilities to move even faster to address emerging customer challenges and opportunities.

And TVN is a well run company with very talented employees, and we expect the acquisition to be accretive within the first year and strongly accretive thereafter, and we now anticipate the deal will be closed by the end of March, and Hal will provide corresponding financial guidance shortly.

So let’s now turn to our Cable Edge business on slide seven. Our Cable Edge strategy is to become a major player in the approximately $2 billion CCAP market by delivering truly innovative new DOCSIS 3.1 CMTS technology and what we call CableOS.

Since our last update to you, we’ve made significant progress, and are confidence in the ultimate success of our CableOS program continues to grow. So let me now provide a couple of specific updates.

First, in addition to continuing to hit our internal development milestones, during the fourth quarter we successfully demonstrated full DOCSIS 3.1 interoperability at CableLabs. Second, I’ve been telling you that we’ve been working closely with a couple of lead customers. I am now pleased to report that we have received our first multimillion dollar financial commitment from a tier 1 international operator.

And third, we remain firmly on track to release CableOS and make our first shipments in the second half of this year. Now in the meantime we expect global demand for our legacy EdgeQAM technology to be steady, but similar to the depressed level that we saw in the back half of 2015 meaning that our CableEdge business will weigh on our total company financial results until CableOS revenues starts to really take off.

Now stepping back, you know for this segment of our business, it really is all about CableOS. And this is a major program that frankly carries real risk but also tremendous upside. And we are determined to turn this into a growing several hundred million dollar per year business with full product launch and further strategic wins later this year.

With that, Hal, let me turn the call over to you.

Hal Covert

Thank you, Patrick. I want to thank everyone for joining our call today. During my discussion, I would like to cover two topics. First, our financial results for Q4, 2015 and then our financial goals for Q1 and the year of 2016.

Since this is my first earnings call as our Harmonic’s Chief Financial Officer and we just wrapped up a difficult year from a financial results standpoint, I would like to make two opening comments.

First, based on fact patterns that we have experienced over the last several quarters in our video product segment, the management team has done a good job in 2015 maintaining our market leadership position as our customers have explored and in some cases taken the first steps in the transition to software based video solutions.

While still in its early stages, it is our view supported by customer feedback that this transition will accelerate over the next year and beyond. We believe we are in a solid position with our current VOS product offering to take full advantage of this opportunity to expand our market share and gross margin as a percent of revenue.

In addition, the acquisition of TVN clearly solidifies our market leadership position in the video market, enhances our revenue generation momentum, and positions the company to achieve approximately $20 million of synergies on a global basis, $18 million related to operating expenses with the remaining $2 million accounted for by cost of revenue.

We expect to record $5 million of these synergies in 2016, which equates to approximately $10 million on an annual run rate basis and complete implementing programs for the remaining $10 million late in 2016. By doing this, the company will be in a position to enter 2017 with a benefit of $20 million of synergies fully implemented.

Turning to our Cable Edge product segment, based on feedback from our customers who are working with us in the development process of our planned converged product offering, we will be in a good position to become a meaningful player in a large and growing market place in the second half of 2016 when we expect to start shipping our new products.

Second, the management team clearly recognizes that we need to improve our financial performance. We believe that with continued strong marketplace acceptance of our customer value proposition in both of our product segments, improving market place momentum, and solid operational execution, we will achieve continuous financial performance improvement throughout 2016.

With that said, I will now discuss our Q4 2015 financial results and our 2016 financial guidance. Please note that our financial results and guidance are based on non-GAAP measurements. The table reconciling GAAP and non-GAAP measurements is included in our Q4 2015 earnings press release issued earlier today.

Bookings for Q4, 2015 were $101 million compared to $4.6 million in Q3, 2015 and $121.1 million in Q4, 2014. Our book-to-bill ratio for Q4, 2015 was $1.2. Our bookings for the quarter were in line with expectations on a geographic and product segment basis and there was no single customer order or geographic performance that skewed our bookings results.

Total revenue for Q4, 2015 was $86.6 million versus $83.3 million in Q3, 2015 and $107.9 million in Q4, 2014. For Q4, 2015 video revenue was $72.4 million compared to $71.9 million in Q3, 2015 and $86.9 million in Q4, 2014.

Cable Edge revenue in Q4, 2015 was $14.2 million versus $11.4 million in Q3, 2015 and $20.9 million in Q4, 2014. The sequential increase was in line with expectations for both of our product segments. On a year-over-year basis, the decrease in revenue was due to delays in customer purchase decisions related to product transitions and M&A activity in both of our product segments.

There were no 10% customers in Q4, 2015. Gross margin for Q4, 2015 was 55% versus 56.3% in Q3, 2015 and 54.1% in Q4, 2014. Operating expenses for Q4, 2015 was $46.7 million compared to $47.3 million in Q3, 2015 and $51.6 million in Q4, 2014. The year-over-year decrease is a result of continuing effort to tightly control and reduce operating expenses.

Operating profit for Q4, 2015 was $1 million compared to a loss of $0.4 million in Q3, 2015 and profit of $6.7 million in Q4, 2014. The sequential improvement was essentially due to higher revenue while the year-over-year decrease was due to lower revenue.

Non-GAAP EPS for Q4, 2014 was $0.01 versus break even in Q3, 2015 and $0.06 in Q4, 2014, again the difference in both cases was a result of revenue, higher revenue in Q4, 2015 when compared to Q3, 2015 and lower revenue in Q4, 2015 when compared to Q4, 2014.

We had $85.6 million weighted average shares of diluted common stock outstanding as of the end of Q4, 2015 versus $88 million as of the end of Q3, 2015 and $89.3 million as of the end of Q4, 2014. I will discuss our financial results for 2015 from an income statement standpoint when I cover our 2016 financial guidance.

Now turning to our balance sheet, we ended 2015 with $152.8 million in cash compared to $87.6 million as of the end of Q3, 2015 and $104.9 million as of the end of Q4, 2014. Our cash balance as of the end of Q4, 2015 included net proceeds of $74.1 million from the issuance of $128.3 million in convertible notes, less related fees and the purchase of $50 million of our common stock.

Taking this into consideration in Q4, 2015 we used $8.9 million of cash. Accounts receivable represents approximately $5 million of the cash usage while the balance was accounted for by the purchase of our common stock.

During Q4, 2015 we purchased approximately 0.5 million shares of our common stock at an average price of $5.95 as part of our authorised common stock repurchase program and 11.1 million shares as part of our convertible notes issuance at $4.49 per share.

As a result of these purchases, we reduced our outstanding common stock share count by approximately 11.6 million shares during the quarter. Our days sales outstanding at the end of Q4, 2015 was 73 days versus 70 days at the end of Q3, 2015 and 63 days at the end of Q4, 2014.

Our day’s inventory on hand were 91 at the end of Q4, 2015 100 at the end of Q3, 2015 and 59 at the end of Q4, 2014. We have the opportunity to improve working capital management in 2016 and that will be a key area of focus for us throughout the year.

At the end of Q4, 2015 we had 120.1 million of backlog and deferred revenue versus $110.8 million as of the end of Q3, 2015 and $128.7 million as of the end of Q4, 2014. Staffing at the end of Q4, 2015 was 989 versus 1,012 at the end of Q3, 2015 and 1,028 at the end of Q4, 2014.

Now I will discuss our financial guidance. Since the acquisition of TVN is not expected to be finalized until the end of the first quarter of 2016, our financial guidance for Q1, 2016 only includes projections for Harmonic on a standalone basis.

For Q1, 2016 we estimate that total revenue will be between $82 million to $86 million. This compares to total revenue of $86.6 million in Q4, 2015 and $104 million in Q1, 2015. Our video product segment revenue for 2016 is projected to be in the range of $70 million to $72 million compared to $72.4 million in Q4, 2015 and $69.3 million in Q1, 2015.

The sequential decline is essentially due to seasonality. On a year-over-year basis in 2015, our average quarterly revenue was $73 million. In addition to the ongoing shift of software to some extent our video revenue on a quarterly basis is subject to closing large projects in a particular quarter. This attribute can cause some lumpiness in our quarterly revenue profile.

Our Cable Edge product segment revenue for Q1, 2016 is projected to be in the range of $12 million to $14 million compared to $14.2 million in Q4, 2015 and $34.7 million in Q1, 2015. The year-over-year decline is a result of customers putting off major video edge purchase decisions until the next generation of our converged Cable Edge products begin shipping which is planned in the second half of 2016.

Our new products will ship with DOCSIS 3.1 the next generation operating system. Gross margin for Q1, 2016 is projected to be 54% to 55% compared to 55% in Q4, 2015 and 53.9% in Q1, 2015.

Operating expenses for Q1, 2016 are projected to be in the range of $46 million to $48 million compared to $46.7 million in Q4, 2015 and $49.9 million in Q1, 2015. Again, the year-over-year decrease in operating expenses is a result of our ongoing effort to slightly control and reduce operating expenses.

And operating loss for Q1, 2016 is projected to be in the range of $1 million to $2 million compared to operating profit of $1 million in Q4, 2015 and $6.1 million in Q1, 2015. The sequential difference is due to the mix of lower revenue and potentially higher operating expenses related to payroll taxes while the year-over-year decline is due to lower revenue.

Non-GAAP EPS for Q1, 2016 is anticipated to be a loss of $0.02 to $0.03 compared to non-GAAP EPS of $0.01 in Q4, 2015 and $0.05 in Q1, 2015. The sequential decline is due to lower operating profit as just discussed, and approximately $1.3 million of non-GAAP interest expense related to our convertible notes.

Q1, 2016 is the first quarter that will reflect a full quarter of interest expense for our convertible notes. On a year-over-year basis, a reduction in non-GAAP EPS is due to lower Cable Edge revenue and interest expense somewhat offset by lower operating expenses. In future quarters, Harmonic plus TVN synergies will more than offset interest expense.

We expect to have approximately 79 million shares of our stock outstanding as of the end of Q1, 2016. For the full year of 2016, our financial guidance is as follows. Please note that our annual guidance includes three quarters of financial projections for TVN Q2 through Q4.

Starting with revenue, Harmonic’s organic video product segment revenue in 2016 is anticipated to be $290 million to $295 million as opposed to $292 million in 2015. During 2016, we believe that the transition to our VOS software platform will accelerate. We expect that TVN will result in adding approximately $55 million to $60 million of video revenue in 2016.

Cable Edge revenue in 2016 is projected to be $55 million to $60 million as compared to $85 million in 2015. In the first half of 2015, Cable Edge revenue was $59.6 million and it was $25.6 million in the second half of the year. In the first three quarters of 2016 we anticipate that Cable Edge revenue will generate between $12 million to $14 million in each quarter and an increase in the fourth quarter as we expect to start recognizing revenue for the next-generation of our converged Cable Edge products.

Given the aforementioned revenue elements, our projected revenue for 2016 is $345 million to $355 million on an organic basis as compared to $377 million in 2015 and $400 million to $415 million for 2016 including TVN.

Turning to gross margin as a percent of revenue. Harmonics organic video gross margin percent is anticipated to be 57% to 58% as compared t o 57.4% in 2015 as a result of higher VOS revenue.

TVNs non-GAAP gross margin percent is expected to be 47% to 50%. We expect that TVNs gross margin percent will increase in 2017 by approximately 200 basis points as we take advantage of the leverage that our combined supply chains offer.

Cable Edge gross margin percent is projected to be 45% to 47% as compared to 44.4% in 2015. We expect that our gross margin percent will increase in 2017 by approximately 200 to 300 basis points as our converged Cable Edge products become a larger part of our overall shipments.

Given the aforementioned gross margin percent elements our projected gross margin percent for 2016 on a Harmonic plus TVN basis is projected to be approximately 55%. Operating expenses for 2016 including TVN are projected to be between $208 million and $212 million compared to $193.5 million for Harmonic in 2015 on a standalone basis.

This projection includes approximately $5 million of synergies that are expected to be obtained in 2016. And taking together, with overall global cost cutting initiatives are part of projected annual synergy savings of $16 million to $18 million. The full annual benefit of the aforementioned synergies is expected to be obtained in 2017.

Operating profit for 2016 including TVN is projected to be between $14 million to $16 million. This compares to $12 million in 2015 for Harmonic on a standalone basis. With the attainment of the aforementioned synergies we will be in a position to generate double digit operating profit in 2017.

Non-GAAP EPS including TVN is projected to be in the range of $0.09 to $0.12 for 2016 as compared to $0.10 in 2015 for Harmonic on a standalone basis. This projection includes approximately $5 million of non-GAAP interest expense in 2016 related to our convertible notes.

In summary, by achieving our 2016 financial guidance we will clearly demonstrate the accretive benefit of the Harmonic plus TVN combination. There are four other data points that we would like to provide as part of our 2016 financial projections.

First, after taking the payment for the TVN acquisition and related restructuring charges into consideration, our goal is to end each quarter of 2016 with $50 million to $60 million of cash including capital expenditures and changes in working capital.

To summarize, we ended 2015 with approximately $153 million in cash. In 2016 we expect to use approximately $80 million in cash for the acquisition of TVN, incur approximately $20 million in restructuring charges and use approximately $15 million for capital expenditures.

Second, for 2016 we expect that our non-GAAP tax rate will be approximately 15% versus approximately 21% in 2015 as a result of more revenue being generated in international markets for both Harmonics organic business as well as an impact of TVN.

Third, during 2016 we currently do not plan to purchase any of our outstanding shares of common stock. At the end of 2016 we anticipate having approximately 80 million shares of common stock outstanding as compared to 85.6 million at year end 2015.

Finally, starting with Q2, 2016, our financial results will include the impact of the TVN acquisition as part of Harmonics’ overall financial results. To be clear, TVN’s financial impact will not be identified as individual elements in our financial statements. Certain aspects of TVNs 2015 and 2016 pro forma financial results will be included in most of our financial statements. This presentation format is in accordance with GAAP.

I will now turn the call back over to Patrick.

Patrick Harshman

Okay, thanks very much Hal. Turning now to our slide 11, let me conclude by summarizing our key strategic priority. We have a video business that is the market share leader in video encoding and related systems for the world leading television and media companies.

We are very focused on increasing the value of this business by leading the industry transformation to software based video infrastructure from a next generation of high quality over the top services.

Through our acquisition of TVN our objective is to accelerate this technology strategy, expand our global footprint, and drive greater profitability sooner. Now in addition to our video business, we are also investing in the Cable Edge business that is poised for breakout growth with the release of our innovative CableOS platform.

For most of 2016 we’ll be bringing this new CableOS product to market, increasingly positive customer response, collaboration and now financial commitment cause us to remain optimistic about the growth and profitability outlook for this business and were aiming to secure several tier one customer wins by year end.

And finally, I want to stress that our entire organization is focused on the execution of this strategic initiative. Driving topline growth and margin expansion and realizing approximately $20 million of annualized cost synergies to the Harmonic terms and combination position in the company as Hal has just explained to exit 2016 with double digit operating margin and a truly compelling future.

And with that we would like to open the call for your questions.

Question-and-Answer Session

Operator

Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] And I’m showing our first question is going to be coming from George Notter of Jefferies.

George Notter

Hi, guys. Thanks very much. I wanted to ask about the TVN revenue assumption for 2016, and I think you guys said $55 million to $60 million. I know that business was a $75 million, $78 million upon the announcement of the deal. So it feels like you are assuming some bigger revenue synergies here than you previously talked about. Can you walk us through what you are assuming there, and why the change versus the prior thoughts?

Patrick Harshman

Yes, first of all just to point out George that the $55 million to $60 is for three quarters. And you know if you look back at 2014 and 2015, revenue for TVN was roughly in the $75 million to $76 million range for each one of the years. And we’re looking at you know as we again head out of 2016 to be at or above that level. So, the revenue in 2016 is relatively flat compared to 2015, but that includes any dis-synergies – from customers who may require more than one vendor who they buy from.

In terms of the cost reduction synergies, first of all, we are talking on a global basis and we haven’t really disclosed about the detail about those in the past, but $20 million has essentially been our target from our early planning stages for the combination of Harmonic and TVN.

George Notter

Got it, okay. Fair enough. Great, that makes sense. And then I wanted to ask also you guys had talked -- going back to last quarter, you talked a lot about some of the mergers that were going on in the industry on the cable side, and bookings were certainly better this quarter. You did not really talk a lot about disruption from those situations. Can you kind of talk about what you are seeing now? Are they still having an impact on your business? Are we kind of getting beyond the impact of those mergers? Kind of walk us through what you are seeing there?

Patrick Harshman

George, first, the fourth quarter, we saw a little bit of catch-up in the fourth quarter. We saw a couple of deals that had been pushed out, closed. But it certainly wasn’t the totality of what did get pushed out related to M&A activity. Looking ahead, we’re still clearly at in an environment where M&A among our customers is ongoing. I mean, there’s no secret that we’re all waiting to see what’s going to happen with the charter and Time Warner.

Just today, two of our key customers in Europe, Vodafone and LGI announced a merger of source of their Dutch operations. So, our guidance contemplates 2016 continuing to be like we saw in 2015 with a number of deals going on. Some announced some not yet announced. And with those having, I think creating, a mid to long term opportunity for the company, but creating some choppiness in terms of demand as those companies work through the complexities of putting their businesses together.

George Notter

Got it. Great. Thanks very much.

Patrick Harshman

Thank you.

Operator

And our next question comes from Tim Savageaux of Northland Capital.

Tim Savageaux

Hello. Good afternoon.

Patrick Harshman

Good afternoon.

Tim Savageaux

Couple of questions here, first on that kind of last topic talking about some improvement in service provider demand globally, would you say that sort of a catch-up or kind of M&A was the primary driver or was there any element there of kind of adoption or decisions to move ahead with new technologies whether it would be new encoding technologies, 4K video, what have you – is there any sense of that logjam breaking up a bid or really just kind of a tactical impact of less near term M&A activity? Then I’ll have a follow-up.

Patrick Harshman

Thanks for asking that question. I certainly did not intend to suggest Tim that the strength of bookings that we saw in the fourth quarter to be due primarily to some M&A related catch-up. That was an element. But to your question, I would actually say a stronger element is the number of customers getting off the fence. And we saw customers on the fence for variety of reasons, currency issues, trying to wrap their heads around what’s coming next technologically et cetera.

And we’ve been pushing hard with our new VOS platform. For us, the real highlight on the video front was not only the rebound of a number, but the fact that’s much higher mix than ever before was associated with the VOS platform.

And frankly, we exceeded VOS demand. We exceeded in the fourth quarter what we had done in the first three quarters of 2015. So, as you see from our guidance in 2016, it’s a little bit early for us to kind of call the knee and the curve, but we definitely saw people get off the fence. We definitely saw more than ever people wrapping their heads around and embracing software. And when they’re making that decision we saw more than ever embracing this VOS platform, and so all those things were encouraging to us in the context of our video business.

Tim Savageaux

Great. And if I could maybe follow-up with sort of another M&A but different M&A driven question, which is to say, have you seen anything kind of meaningful from a market or competitive perspective, I guess most notably with Elemental going into Amazon or that is sort of impaired -- kind of call it merchant supplier or change behaviour at all, and I guess perhaps to a lesser extent with Ericsson and Envivio, but have you seen any changes in competitive behaviour as a result of those recent deals?

Patrick Harshman

I think it’s too early call, but I think it’s an important question, something they were watching carefully. I mean, this has been a crowded and probably too crowded than competitive space. And as your question points out over the last 20 months of the year there were about – we saw Ericsson making acquisition to acquire a software strategy within video.

We saw Elemental go into Amazon. And of course, we announce the TVN deal that we’ve been working on for a while. So, it’s going to be a very different kind of marketplace as we go into 2016. I think we really want to – we’re optimistic about what that could mean. Our guidance really does not contemplate significantly more benign environment, but we’re going to wait and see. Maybe one last to say, Elemental is a good company with good technology, but I would tell you a number of our larger customer do look at Amazon from a little bit of competitive point of view. And that will certainly be interesting to see how it plays out for us.

Tim Savageaux

Okay. Thanks. I’ll pass it along for now.

Patrick Harshman

All right. Thank you.

Operator

And our next question comes from Greg Mesniaeff of Drexel Hamilton.

Greg Mesniaeff

Yes. Thanks. Good evening. This is Greg Mesniaeff. Question on the $20 million in cost synergies, with TVN you alluded to earlier. Was most of that really focused on sales and marketing side or the R&D organizations of the two entities?

Hal Covert

First of all, Greg, just let me point it is $20 million on is really a global basis which will include Harmonic and TVN, and we think there is opportunities in each of the three primary operating expense line, R&D, sales and marketing and G&A. and our goal is really to try to optimize both organizations and as we’re doing that to pick low cost areas of doing business on a global basis.

Patrick talked about earlier and we indicated I think in a couple of different points during the call. Our international business is really growing at fairly significant rates; so it’s all about optimization and using the best capabilities of both organizations.

Greg Mesniaeff

Okay. But there’s really not going to be a situation where you’ve got concurrent sales forces operating for in tandem for a while. There’s going to be a pretty steep ramp by the end of which the two should be integrated?

Hal Covert

Let me start to answer the back part of your question and then I’ll Passover to Patrick on the sales side. Keep in mind that we’re actually not planning on closing the TVN transaction until the end of the first quarter as we indicated. We’re doing a lot of planning right now. Lot of those plants will start to get implemented in Q3 and Q2, so Q2 and Q3 will be major implementation efforts. And then we’ll have another primary implementation plan that will go in late in the fourth quarter, so it’s going to happen throughout the year, but our goal is to exit the year with all those synergies fairly well locked down in place so we can get the full benefit in 2017. Now relative to the sales organization, I’ll pass it over to Patrick.

Patrick Harshman

Well, I’ll answer is just to explain that this is a business that we competed with historically. So we know each other’s customer based solutions et cetera. Our largest customer [Indiscernible] companies I highlight got extremely positive feedback from our largest customers. And frankly the marketplace is eager to see what we can do working together.

So, as we’ve indicated our operational plan is not to run two separate businesses, but to bring the businesses together as quickly as possible without slowing ourselves down and without missing any commitments in the marketplace, but really to take advantage of the synergies as quickly as possible. Not only the cost synergies, but this is importantly the innovation synergies, the solution energy, the customer support, opportunities that we have.

In general, go-to-market capabilities, and we think really is volume and this goes back to last question were asked, is it a consolidating space. Our customers have seen a number of businesses being acquired or changes et cetera and they’re really around and say who is going to be strong and standing and we’re delivering, I think a compelling message to the marketplace that says two very capable, well respected technologically leading companies in the space are joining forces and we’re going to hit it very hard. And that’s where the message our customers are responding positively to and that really is what’s driving the idea of where to put these businesses together as quickly as we can.

Hal Covert

Just one point on the cost synergies, again to Greg, keep in mind that you know out of the $20 million, we think there’s at least $2 million above the gross margin line that we’re focused on to supply chain efficiencies.

Greg Mesniaeff

Sure, great. That’s very helpful. Thank you.

Hal Covert

Thank you.

Operator

And our next question comes from Simon Leopold of Raymond James.

Victor Chiu

Hi, guys. This is Victor Chiu for Simon Leopold. I just wanted to circle backup on synergies for one second. Did you say that it is about $5 million of synergies in 2016 on a prorated basis for the three quarters and then about $20 million for 2017, is that correct?

Hal Covert

I mean, basically our plan is to – we think we can in fact record $5 million worth of synergies during 2016 to be able to be in the position to do that we have to really drive $10 million of run rate synergies. So, roughly half of the $20 million will be implemented and it will start receiving the benefits in 2016.

Remaining $10 million of synergies we plan implementing late in the year and we have not included those synergies in our earlier guidance. We might be able to obtain some of those in the fourth quarter, but our plan more importantly is to exist 2016 with the $20 million of synergy programs in place so that we can get the full benefit in 2017. And by doing that we think we can generate double-digit operating profit during 2017 compared to the single digits over the last couple of years. So we think we have a major opportunity. We want to make sure that we’re ready to go after that.

Victor Chiu

Okay. So, what I guess for 2017 given that target for about $20 million, what’s the assumption or the basis approach for 2017 I guess basing off from the topline perspective?

Hal Covert

We don’t have any guidance for 2017 right now. I mean the first thing to do to get 2016 lock down in place. We do feel that we have opportunities with our software platform and we think the market will continue to show momentum. So, we believe that if we can go in through 2017 with the right operating infrastructure in a very efficient manner again we’re going to have major opportunity that really drive EPS in 2017.

Victor Chiu

Okay. So assuming that sales are flat in 2017 than you would expect your cost to be down to about $20 million roughly I guess it’s kind of…?

Hal Covert

Yes. I think we would not assume that sales are going to be flat, but if they were we’re still in a very good position because we have a – by that time with our successful implementation of our program we’ll have a very efficient operating infrastructure from an execution as well as a cost standpoint.

Victor Chiu

Okay. And then secondly, I just want to drill down a little more on the Thompson acquisition. Can you just from a high level perspective, can you speak some as to what drove the decision from a strategic standpoint, because it seems as if on one hand you’re acknowledge rapid shift with software base solutions per coding, but Thompson deals seems to imply kind of a different attitude and that its mostly hardware based. So can you kind of just speak to that and give us some color around that?

Patrick Harshman

Yes. I appreciate your raising that. I’m not sure where the misperception has arisen but it is a misperception about hardware and software. Thompson has fantastic engineering. We’ve long consider than really our leading competitor from a video compression point of view. And that kind of algorithm plays out that kind of technology can be deployed or employed on any kind of platform hardware or software.

Like the rest of the industry, including Harmonic, Thompson came from a place of deploying that their technology and so called hardware platform and appliance, but they are latest R&D efforts much like ours have really starting couple of years have tilted toward new Intel based platforms. Now it’s true that the U.S. leads the way really in any adoption of data enter kind of architectures of these applications and even here in the U.S. it’s still early days. So it’s a mix of the Thompson video networks business, I would say software is even less than Harmonic, that’s really your reflection of where the customers are.

One of the things we’re quite impressed with as we studied Thompson and then did our due-diligences is the majority in the sophistication and capability of their software Intel based platform. So, we’re quite excited about getting the Top Tier engineers from both sides under one roof and getting both teams running twice as hard on the convert software platform. But the addition of that team and if that team is a historic, Victor, their historic innovation is quite well aligned with our push towards software.

Victor Chiu

Okay. And just I guess really quickly, if you’re looking at the business as a whole including Thompson I guess just going forward how do you envision the mix of the business going forward in terms of software and hardware, is it the vision kind of at some point shifting Thompson’s customer based toward the software base platform or you’d envision them moving towards that and you adapting to that and is that happening?

Patrick Harshman

Okay. So, another good question. You know, it’s less about their customers or Harmonic customers and really it’s more about the geographic and the orientation. As I mentioned a moment ago, if you go overseas you see a little bit more caution at least in this and the media field in terms of employing datacenter kind of approaches, but I belief is that we will see the entire market tip [ph] that way over the next three years. Maybe what we consider developed markets first, but arguably the opportunity, the cost synergy advances are even greater in developed market, so really going to datacenter or cloud architectures.

So I think that we will see the entire market for Harmonic and TVN today separately, tomorrow together address and tilting towards software and datacenter. I think that – probably on a 50/50 kind of run rate as we exit 2016 and driving towards 100% software as I said over the following 24 months.

And I see that adoption is really as I said being more dependent on different customer orientation, how comfortable they are and how mature they perceive the technology to be et cetera. It’s a transition that’s has created a little bit slowness in the market that we’ve talked about over the past year and we’re really looking forward to getting that tipping point in the U.S. and then seeing that expand more rapidly overseas.

Victor Chiu

Thank you.

Hal Covert

Victor just one other thing to keep in mind that the guidance we provided for revenue for 2016 only includes three quarters of TVN. So, even if you added four years worth of revenue in 2017 and keep in mind that we’re transition to more and more software, so even on a flat revenue base our gross margins we believe that the percent of revenue will [Indiscernible] and then if you take the expenses based on the $20 million taken out, we run to the calculation, you’ll see even that delivers a pretty good bottom line performance. And again as we indicated early, we think we can actually grow revenue in 2017, so it’s too early to talk about that now, again we want to lock down 2016 first.

Patrick Harshman

Victor, I think that’s right, but it does help their emphasizing that we see the opportunity for a very profitable video business. And I think to the context to this conversation has been video and do step back and remind everybody that on the other hand that we’ve got the CableOS business. We are going to be releasing the market our CCAP product in the second half of the year, strong customer feedback continues and while again its pre mature for us to offer 2017 guidance, suffices to say that we think 2017 is going to be a very excited year on the Cable Edge side of our business.

Victor Chiu

Thanks. That’s very helpful. Thank you.

Patrick Harshman

Thank you.

Operator

And our next question comes from Matthew Galinko from Sidoti.

Matthew Galinko

Hey, guys. Thanks for taking my questions. I think you mentioned stronger uptake in last fourth quarter and really the rest of the year, so I just wanted to make sure I understood that correctly and that if that is the case what do you see in that indicate deeper adoption curve versus maybe seasonality in the business or benefits that you’re seeing from consolidation in the rest of video processing industry?

Patrick Harshman

So, number one, just to validate the fact, indeed we’ve had number of customers who through the course of 2015, we’re carefully evaluating our VOS platform, looking at what other customers were doing et cetera. We did see fair amount of that break loose in the fourth quarter, and that was exciting. Now, I do want to emphasize that most of that software was delivered package with an Intel based server, this is why you haven’t yet seen the margins really go up. But actually we saw the first piece of a couple of Tier 1 customers taking pure software to run on their own datacenter environment and that’s where we run into the -- I’d say accelerating gross margin, but top line headwind kind of scenario that we’ve alluded to you here.

Now turning to the market trends, Matthew the thing to remember is that we just saw a lot of volatility. We had a pretty good Q2. We had a very slow Q3. We saw the demand really bounce back stronger in Q4, so we’ve kind of gives you an outlook that does not assume that we’re riding that curve from Q4. We simply want to collect more data from the marketplace before we draw too many conclusions about a fundamental rebound in their demand. But certainly the trend in the fourth was encouraging. And it was encouraging that when customers had money to spend as I turn to our U.S. platform.

Matthew Galinko

Got it. And I guess terms of customer sort of kicking the tires on initial path with the platform, I mean is that still something that’s fairly active or is everybody somewhat familiar with it in terms of North American market. Where do you see that trial activity at this point?

Patrick Harshman

We deal with hundreds, if not thousands of customers every quarter, so its – our Tier 1 customers in the U.S. have certainly I would say, we passed through the tire kicking phase and that’s quite positive. But there are we cal them Tier 2 and Tier 3 customers in North America and customer of all size overseas who are only now just starting to check out the platform. So it’s a process and we’re still in midst of, but we think over the course of this year the platform is going to gain more and more momentum.

Matthew Galinko

Great. And one last one just on the TVN acquisition, is there any risk for the timing of the late Q1 close at this time or you fairly confident that its worth will come in?

Patrick Harshman

Based on everything you know right now it will close at the end of Q1. We’ve actually had a very discussions with TVN, their works, comps or group and so forth of reviewed and we’re on to the next step and we’re just simply now waiting for some French government approvals that based on feedback from our advisors and everyone else should happen and we’re hopeful that everything will be wrap up so we can close before the end of Q1. So, we viewed as low risk at this point in time, but until you get the final approvals there’s still risk.

Matthew Galinko

Fair enough. Thank you.

Patrick Harshman

Thank you.

Operator

And our next question comes from Jeff Bernstein from Cowen Prime Advisors

Jeff Bernstein

Hi. Thanks for taking my questions. Just a quick question -- the cash restructuring cost number you gave for 2016 was what?

Hal Covert

Approximately $20 million.

Jeff Bernstein

$20 million, okay. And then a couple of competitive questions, so I guess, the compression as a service as maybe personified by Amazon, is that been a market share type headwind or a mindshare headwind at this point and where are we in resolving that and in whatever direction it gets resolved and I think you guys had a lot of coupled service bureaus in that space and what kind of attraction are you getting there?

Patrick Harshman

Jeff, we made a very small investments in San Francisco based company that does some file based encoding as a service, so it’s a cloud-based software and service, and really that was to get our foot in the water and understand that business. Its relatively small and indeed compression as a service is still a very small part of the overall global spend. I don’t have a precise number for you but I would estimate less than 5%.

That being said, it is a segment where we think growth will happen over time. Many of our larger customers don’t anticipate completely, let me say outsourcing their operations, but using such a services for burst capacity or for variable capacity on top of the fixed capacity that they know they need day-to-day, so we see compression as a service being a –we see compression as a service being an interesting growth opportunity for the industry and for the company,. Over the next couple of years it’s still a relatively small part of the picture but you can expect to see us do more on this space over the course in 2016 as the sectors starts to mature.

Jeff Bernstein

So six to nine months ago were you spending lot of time really discussing that kind of thing or is really the software transition that’s been the big subject?

Patrick Harshman

For us internally it’s really been the software transition I mean frankly, we didn’t have to look for in the broader IT space to see the move to SaaS, so we’ve hypothesis for several years here that the path can be an important part of the market. For us, first necessary part of the transition was move the technology platform to software, to applications really that can be run on off the shelf of blade [ph] server infrastructure or indeed third cloud infrastructure, that’s what we’ve done now. So we’re actually in a place where we can deliver our technology and a box as software to run on someone’s blade or indeed to run on Amazon Rackspace or anything else.

And that’s been a huge technological frankly over the last couple of years, but we think we’ve largely scale that hill [ph]. And now we’re at the point of commercially monetizing that and figuring out where the market wants to go. Most of the customers are today are large ones, they are still saying hey I want to take is capital sale but we do think to your question and we’re starting to have increasing number of conversations where are people are looking at service offering is part of the whole.

Jeff Bernstein

Okay. So its sounds like customers are starting to actually release sort of stuff out and be able to make some decision. And then on the CCAP side you underscored both the risk and opportunity there. Can you just go back over the competitive environment, you guys Cisco, Casa and anybody else and I know there’s a couple iterations of CCAP product architectures that people have been considering what is it about your offering that you think as a winner that gives you confident but we’re going to actually see the fruit of the opportunity as suppose to the risk here?

Patrick Harshman

Okay. So, the competitive landscape in the market today are two publicly held companies Arris and Cisco who were the dominant legacy CMTS providers as you mentioned is private company Casa that is also a player. And whether there maybe some very small players I think between the three of them had accounts over 99% of global broadband infrastructure spent made by global cable operators.

This is a space that we think is poised for tremendous growth but also has some real challenges. Bandwidth needs to growth fast to keep up with video services that are being rollout over them as well as the competitive push by companies like AT&T and Google et cetera. And as we talked to customers there is a fundamental scalability and flexibility issues that they’re struggling with.

By coming with a brand new architecture we’ve really have the opportunity to build something really creative from the ground up and candidly Jeff we have now gone public with all of the key differentiators that we have and for us frankly it’s been a little bit of learning in an evolutionary process, but we’ve done some things that customers are telling us that are fundamentally different, that have really solved their fundamental scalability issues in particular when it comes to pumping multiple gigabit down to small areas of homes [ph].

And nothing is certain we believe that the way we implemented the technology, the way the technology can be packaged and the way it can be deployed particularly in the distributed cable architecture is quite unique and quite well suited to address the challenges that their largest customers have told us that they really concerned about addressing over the next two to five years.. And I don’t want to make too much out of this stage is just an important step in data point. I did mention in my prepared remarks that we’ve received your first several million dollars of financial commitment from an international cable operator who really is dealing head on with some heavy duty fiber to the home competition. And this is a customer who uses competitive product today, and the fact that they would make that kind of commitment to us in this technology, I think speaks to the fact that we’ve got something here.

Jeff Bernstein

That’s terrific. Thanks so much. Good luck.

Patrick Harshman

Thank you.

Operator

And our next question comes from Robert Moses from RGM Capital. Please go ahead.

Robert Moses

Good afternoon guys.

Patrick Harshman

Good afternoon.

Robert Moses

Just had -- thanks for the additional clarity on the synergies and the numbers, just good information work with. So I guess, and I understand your reluctance to talk about 2017 at this point, we’re just I guess six weeks into 2016, but just trying to understand kind of when the dust settles on this, and just want a clarification if I’m thinking about this correctly. So for 2016 if you pro forma the acquisition, you’d have revenue closer to about $425 million if it was in for the full year or something like that?

Patrick Harshman

Yes I’d probably say it would be a little bit more than that Rob, probably and may be 430 or so. So I’d add roughly another $15 million or $20 million.

Robert Moses

Okay. Got it. And you also mentioned while it won’t be in there for the quarter or even for the year kind of a 10% operating margin, I believe depreciation has been running what about $13 million, $14 million a year, would that be incremental to that 10% number?

Patrick Harshman

Our depreciation is roughly $13 to $14 per year, yes.

Robert Moses

Okay. And would that include the acquisition or could we see that number increase just given the full year of that transaction?

Patrick Harshman

No, the number will increase.

Robert Moses

Okay. So if we think about a 10% non-GAAP operating margin in that I don’t know $15 million to $20 million of depreciation for combined entities, we should be more than operating EBITDA margin sorry kind of in the 13%, 14%, 15% range. Does that math seem reasonable?

Patrick Harshman

It does, yes. Now just to be clear, what time frame are you talking about now?

Robert Moses

I’m just talking about as we get into 2017, really just trying to understand…

Patrick Harshman

No, you’re right. Yes.

Robert Moses

No I mean shareholders obviously we felt the brunt of the downturn as well as the converts and everything else and kind of lack of information. So I think we’re just trying to get an understanding of kind of when the dust settles earnings power of the business and I think at the same time, the other nuance would be your implications for the fourth quarter would be for the Cable Edge business to be more like $15 million to $20 million in quarterly revenue exiting the year as opposed to $12 to $14.

Patrick Harshman

You are fairly close on that also.

Robert Moses

Okay. So 2017 we’ll get passed this cash restructuring, the cash flow for 2017 unless we get a major downturn in our markets, which you don’t expect at this point should be quite significant.

Patrick Harshman

It should.

Robert Moses

Great. Thank you.

Patrick Harshman

You know and depends how quickly we get the remaining half of our synergies implemented in the fourth quarter of 2016, I mean there could be potentially benefit there too, but again you have our guidance.

Robert Moses

Thanks.

Patrick Harshman

Okay. Thank you. Danielle, this will be -- we have time for one more question if that’s okay.

Operator

Excellent. Our next question comes from Tim Savageaux of Northland Capital.

Tim Savageaux

Okay, great. Made it for a quick follow-up. Wanted to ask about the kind of hardware versus software discussion and you know to what extent at least short term that’s a proxy for kind of streaming over the top versus service provider from a customer standpoint. And you mentioned the pace of that transition might be dictated to some degree by the movement of certain customer segments in that direction.

Would it be fair to assume kind of and understanding this could be different parts of the same customer, right in certain cases. Now your understanding that is it fair to kind of think about it that way than kind of the streaming guys might be early adopters of that and then more broadly you know that the kind of a rebound demand amongst the service providers, I wonder if you could talk about kind of the demand trends and the streaming over the top kind of the part of the market and it looks like you did see an uptick in broadcasting media revenue in the quarter, if not bookings.

And maybe discuss your kind of share and competitive position there relative to the kind of the more linear part of the market.

Patrick Harshman

Okay, several things there and all good questions. I mean, first yes whether it’s a standalone, brand new over the top streaming company or whether it’s a streaming group within a larger let’s call legacy Media Company or service provider. Those people tend to be a little bit more data center oriented, think in terms of rolling out software applications on servers. And so, yes, there the push or the orientation for our software products is probably greatest.

You know that being said, I don’t want to give you the impression it’s limited to that. I mean, look at AT&T’s demand 2.0 initiative just as an example. A lot of press over the weekend about their big push to -- only imperative for the employees to get on the bandwagon with cloud and software etcetera. I mean, it is where our larger telecommunication customer companies are going for all applications. And that’s new streaming as well as legacy.

And maybe that dovetails to the next major point which is that, actually for us we’re seeing a real convergence of what I call the legacy linear applications and the streaming applications. You know the streaming opportunity increasingly is about live, live sports live everything else and I think more and more of customers are saying, hey, why will I have two separate operations or infrastructure, let me get to one platform that can deliver things seamlessly to the television living room as well as to the iPad and the bedroom.

And that’s part of what I think both the technological aspects of that as well the business aspects of that is part of what a lot of our large customers have been wrestling with over the last year, and to some extent still going forward.

So while I mentioned and we’re quite excited about over the top and streaming, I would tell you the biggest opportunities we see with what you might call legacy or traditional customer base and those are people who are looking at a next generation converged video service where convergence means a single platform delivering both the legacy linear as well as over the top.

And of course we think we know that we as well as does Thomson have a great entrenched position with most of the legacy service provider and large media players globally. So we think it’s a good place to be. It has been choppy in terms of demand as is the business model from technological transformations have been getting figured out and you know as our guidance indicates we don’t think we are out of the woods yet, but things are moving. And I think that they are moving in a way that’s favourable and aligned with where we are investing in technologically and where we are installed historically.

Tim Savageaux

Okay. Thanks very much.

Patrick Harshman

Okay. Well thank you Tim again, and let me thank everyone for joining us. Hope it comes across. So we have challenges in front of us but we are excited about the things we are doing in our organic video business the way that business is going to get even strong with the addition of TVN and then separately everything that’s going on with our CableOS business which we think is tremendous growth opportunity for the company over the next several years. We are incredibly focussed on execution. You can count on that and we look forward to providing you updates as we go forward over the course of 2016. Thanks very much everyone.

Operator

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

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