For those who think my summary of the conference call was suspect, here is the transcript below. Notice the size of the two COX systems. One is 400,000 plus and the other 500,000 plus. Notice the companies mentioned as providing VOD. Notice the description of the technology and roll out. There was a lot more to the call. This was just the opening remarks, but it is all that is now available to be posted. Enjoy!
January 28, 1999
Q2 FY99 Earnings
President and CEO James F. McDonald remarks
Good evening. Thank you for joining us.
Tonight, I will give you a summary of our financial results for the quarter, then review the status of our digital deployments.
I am pleased to report that Q2 was an excellent quarter. It represented a major step on the digital front for us, and we are more convinced than ever that by being first to market with interactive systems we are establishing a firm foundation for profitable growth.
Results for the quarter were in line with our January 7, 1999 pre-announcement. In fact, the numbers were above Wall Street's revised view which was based on our pre-announcement. We were reluctant to report earnings based on a short close, but our final results ended up where we initially thought they would.
Our bookings for the second quarter, which ended January 1, were $290.5 million. New bookings totaled $302 million, offset by approximately $12 million of debookings in our Satellite sector associated with orders that were delayed due to the international economic downturn. This compares to $313 million last year and $302 million last quarter. Bookings were very strong in North America and reflect solid growth in our core cable business.
In North America, broadband momentum continued across most MSOs. Bookings were up $22 million year-over-year to $222 million with significant growth in both our Transmission and Subscriber businesses as cable operators continue to upgrade networks in preparation for their digital deployments. Transmission bookings increased 18% year-over-year in North America and 7% sequentially. In our subscriber business, North American bookings were up 7% year-over-year and were flat sequentially.
International bookings of $58 million were down $24 million year-over-year from $82 million last year. Twelve million dollars was associated with the debookings. The remainder is due to reductions in our international Transmission business.
Overall, 80% of our bookings came from North America, and 20% were international.
Sales for the second quarter were $311 million, a record for any second quarter. This was compared to $294.5 million last year, and was considerably above Wall Street expectations prior to our pre-announcement which were $263 million. Sequentially, our sales were up 21% from last quarter's $257.5 million.
In North America, sales were up 37% year-over-year to $245 million. We continued to enjoy strong sales growth in our Broadband businesses driven by network upgrades and digital set-tops. North American Transmission sales increased 61% to $94 million year-over-year and were up 18% sequentially. Subscriber sales increased 51% year-over-year to $127million and 26% sequentially. Satellite sales in the region declined by16% year-over-year to $23 million and were flat sequentially.
Overall US sales accounted for 77% of our sales in the quarter and International was 23%.
International sales of $72 million declined $46 million, year-over-year. All businesses were impacted: Transmission was down $26M, Subscriber was down $6M and Satellite was down $14M. Sequentially, however, international sales increased.
Our backlog was $510 million, a record for any second quarter, compared to $460 million at the end of last year's second quarter, and down from last quarter's $532 million.
Gross margins for the quarter were 28.3%, compared to 27.3% last quarter and 29.2% a year ago. The sequential improvement in margins was due to increased volumes combined with cost reduction efforts. The year-over-year decline was due largely to the impact of digital set-tops in the product mix and the satellite volume shortfall which impacted manufacturing costs. As with almost any new product, initial margins on our Explorer 2000 interactive digital set-tops are below the company average. As volume picks up and we see the benefits of scale in coming quarters, costs will continue to decline.
Last fall, we completed our RF product line transfer to Juarez ahead of schedule. This move generated significant cost improvements during the second quarter
We continued to focus attention on below the line costs during the quarter. Increases in operating expenses relative to last year and last quarter are due in part to the fact that our second quarter of FY99 included 14 weeks as opposed to the normal 13 week quarter and to increased marketing expenses associated with our rollout of digital products. Quarterly operating expenses were $72.6 million, up 10% year-over-year and 7% from last quarter, which was in line with expectations. R&D expenses were $29.8 million, up $3.1 million year-over-year due to capitalization of R&D in Q2 ‘98 and flat sequentially.
Net earnings were $19.2 million, or $0.25 per share, a record for any second quarter. This number includes a net $0.09 per share gain resulting from the increased Broadcom share value and our sale of 1 million shares during the quarter.
Additionally, we made investments in our own stock, which we believe will add long-term value to our shareholders. We purchased 4 million shares of our common stock during the quarter at an average price of $13.30 per share.
Our balance sheet continues to remain very strong with cash and marketable securities of $198 million at the end of the quarter. Cash and marketable securities declined $63 million sequentially from $261 million due primarily to the $54 million we spent to purchase shares of Scientific-Atlanta stock. Accounts Receivable were up $35 million over last quarter and increased $35 million over last year due to shipments of digital set-tops. DSO improved by 10.3 days from last quarter, down to 79.8 days, due to improved collections. Inventories at the end of the quarter were $196.5 million, down $5.8 million year-over-year and up $14.6 million sequentially. Inventory turns improved to 4.7 from 4.4 last quarter as we rolled out digital set-tops. The company continues to have no significant debt.
Now I would like to turn to the subject of our digital strategy as it relates to our customers' strategic choices.
Our customers have seen the competitive future. They know that the consolidations of the satellite direct broadcast industry represents the greatest competitive threat they have ever faced. And those threats are expanding as evidenced by EchoStar's purchase of Rupert Murdoch's satellite slots and the purchase of PrimeStar by DirectTV. The DirectTV purchase gives them the advantage of larger scale and incremental low-power slots to complement their high-power capability.
Our customers know that interactivity is the only way to compete with DBS, and that just going to digital broadcast is at best a me-too strategy -- and that in the meantime DBS will continue to skim the high value customer base. Our customers have chosen to future-proof their businesses by selecting Scientific-Atlanta's two-way digital networks.
Some operators, on the other hand, believe they can use a broadcast-only approach now and go to interactive later. This approach will require a change out or add-on of interactive later. We believe that path has a lot of technical and competitive risk .
DBS already offers hundreds of channels, a central uplink, centralized billing and retail distribution today. They are gaining share. Plans to increase their capacity even more and to provide access to local digital broadcasting of off-air channels with an integrated DBS and DTV home terminal will increase their ability to deliver a complete service offering. As a result, DBS has some real advantages with low operating costs.
In contrast, MSOs have localized delivery systems with personnel distributed throughout their many systems, with local facilities, local billing and customer service and, of course, truck rolls. As a result, they don't enjoy the cost benefits of centralized operations.
Given this environment, how does the cable operator compete? The answer lies in delivering more, differentiated, interactive services—such as video on demand—that are not possible over satellite. While broadcast-only offerings can provide short term revenue and cash flow benefits, they fail to provide an attractive long term competitive positioning. Operators must ask themselves "can I afford not to future proof my network today?" Our view is that if they wait, they risk losing their most profitable customers.
We have commitments for 89 sites from 17 MSOs, with a footprint covering over 17 million subscribers and 25 million homes passed. That's because these customers understand the competitive implications of the current landscape. Our view is obviously in line with theirs.
Some customers either have already or are considering change out of first generation digital broadcast-only boxes. One customer, for example, is in negotiations to change out 70,000 first generation broadcast boxes Another customer is currently changing out digital broadcast-only boxes in favor of the Explorer 2000 in multiple cities.
Now, what needs to be done to offer interactivity today?
To offer interactive digital services, operators must do several things:
First, they need to upgrade their networks to enable two-way, IP packet delivery capability. That involves installing modems, routers, switches and activating the two-way plant.
Second, they need to install headend computers with integrated software to manage the subscriber information, manage the network itself, link to the billing system, interface to the local IP network, manage the security and conditional access function, control the broadcast network, control the interactive applications and interface to the applications servers.
Third, they must have a terminal in the home that has the following capabilities: a user-friendly consumer interface, 2-way cable modem, powerful microprocessors, advanced graphics functions, sufficient memory, and a real-time operating system with open interfaces to standard programming languages like HTML and Java -- so that future applications and new services can be downloaded with software.
Scientific-Atlanta's expertise in these areas, in end-to-end system design and integration uniquely positions us to help our customers be successful as competition from satellite continues to intensify.
In summary, today, cable operators must choose between two alternatives: whether to go interactive now or later. We offer our customers the ability to upgrade their networks today, before direct satellite takes advantage of their recently acquired expanded capabilities.
Now I will update you on our progress with digital deployments.
Initial subscriber reaction in areas where commercial deployments have begun has been very positive. The data to this point is early, but very upbeat. Customers like the video scaling function which allows them to use the interactive program guide while continuing to watch a movie in a window on the screen. They appreciate the speed of the interactive program guide and the brilliant graphics which are related to the speed of the processor we use and our 16-bit graphics. Our customers like the marketing data that is generated automatically as subscribers use the system. One customer told us that the interactive program guide and movies are so popular that it is not uncommon for subscribers who have one or two analog boxes to say they would like one Explorer 2000 and then call back within a day or two for a second box for their other TV. In one major system, the take rate was more than 80% where the Explorer was marketed to existing analog subscribers. Early market data currently available suggests that digital services will initially increase overall TV viewing by 10% and that results in $18 per month of incremental spending from the digital tier, additional premiums and higher pay-per-view buy rates.
We have shipped 63 systems to MSO customer sites and an additional 22 to customer labs, partners and applications developers. Thirty-three systems have been completely installed at customer locations. We anticipate installing another 30 to 40 systems this quarter.
Eight systems have begun commercial deployments to paying subscribers. Some of you who attended the Western Show in Anaheim CA last month had an opportunity to visit the Cox Communications system in San Diego, which began their commercial launch yesterday. As you will recall, this site has 490,000 subscribers. They launched Phoenix, last month. That's their largest system, with 580,000 subscribers and the fifth largest in the country. Their next launch is scheduled for Oklahoma City.
On Monday, Adelphia announced Tom's River, New Jersey, their second system launch. Buffalo was launched in December. They plan to launch several more systems by mid-February and additional systems in March.
In total, we have shipped more than 207,000 digital interactive set-tops. At the start of the fiscal year we estimated we would ship 400,000 to 500,000 digital interactive set-tops this fiscal year, of which we have shipped more than 180,000 year to date. We expect the digital rampup to continue to accelerate in the second half of the fiscal year.
I hope you saw the announcement on January 7 that Time Warner Cable took delivery of 100,000 Explorer 2000 digital set-tops in preparation for launches in multiple systems early this year.
Even more important, was the announcement of the Time Warner purchase of 32 Scientific-Atlanta digital network systems, so far. This is a major step towards Time-Warner's national rollout of their Pegasus real-time digital network and constitutes an unprecedented rollout of product for our industry. These systems represent about 70% of all Time-Warner subscribers.
The number of systems sold, shipped and installed is an important measure, because they are the leading indicator of future business for Scientific-Atlanta – both for set-tops, for additional head-end equipment and for software as interactive services are rolled out.
A further validation of our strategy is the rich array of companies we are working with:
IBM, who is developing an Internet based cable commerce application which was on display in our booth at the Western Show.
Microsoft, who announced at the Western Show our joint plans to offer the WebTV service on the Explorer 2000.
NCI, the Oracle/Netscape joint venture, who is providing a suite of Internet-based interactive applications that will operate on the Explorer 2000.
Sun Microsystems, who had agreed to port personal Java to the Explorer 2000.
PowerTV, our subsidiary in Silicon Valley, provides the PowerTV OS for the Explorer and is also an applications company with web-based services including e-mail, web browsing and web casting.
Seachange and Concurrent, who provide servers for video-on-demand applications.
Now I would like to turn for a moment to advanced analog networks. We had a very good quarter in advanced analog. This is consistent with the expectations we have articulated in the past, that advanced analog offers a strong value proposition to consumers and operators complementing digital. We had a book-to-bill greater than one in the quarter which gives us confidence that we will remain at current levels during the second half. During Q2 we shipped more than 530,000 analog set-tops.
Turning now to our Transmission Network System business, we had improving results in the quarter, with revenue exceeding our own projections. Sales increased 10% year-over-year to $118 million and increased 20% sequentially. The success was driven by the North American rebuild cycle, which we expect to continue for the foreseeable future.
The RF product manufacturing transfer to Mexico was a key element in our success. The transfer was smooth, and ahead of schedule, allowing us to achieve nearly a full quarter of benefits in Q2.
In fiber-optics, we increased our customer base and had record shipments of 1310 transmitters. This was driven by the Prisma family of transmitters that have industry-leading performance and include overlay applications which complement our new high power 1550 optical amplifier products.
A highlight for us was our announcement that we are developing a breakthrough technology to increase hybrid fiber/coax reverse path capacity and improve performance. The benefits to operators will be a four-fold increase in the reverse path capacity in the fiber portion of their network and a concurrent reduction in costs. These benefits will be critical as operators use their networks for the interactive and multimedia applications that we believe are required for our customers' overall competitiveness.
Our Satellite Television Networks division plays an important role in our video strategy because of its essential role in the distribution of programming to cable operators and other service providers. During the quarter we worked with Time Warner on the installation and launch of its AthenaTV project which offers a packaged program service to cable operators. AthenaTV will provide numerous multiplexes of digital programs to cable headends which will seamlessly pass them through to digital set-tops.
We also worked closely with Public Broadcasting television, PBS, as they launched their inaugural and subsequent HDTV broadcast specials. PBS has selected our PowerVu Plus system for satellite distribution of HDTV programming. PBS services 350 TV stations.
Before my conclusion, I would like to say a few words about our progress in addressing the issues in our satellite network business. Those of you who have been following the situation are aware that we have been implementing a program to reduce costs to match current and projected business levels. We have been successful and should get a significant uplift in profitability in Q3 as satellite approaches a break-even quarter.
We have successfully consolidated several satellite network operations including the transfer to Atlanta of our satellite data business including our Network Operations Center and associated personnel from Melbourne, Florida. We have reduced our total satellite networks workforce by more than 35% since the beginning of this fiscal year.
In conclusion, I would like to leave you with these thoughts.
First, the increasing business level in North America is offsetting the decline in our international business.
Second, after 5 ½ years of investment, we have now reached the stage where we are rolling out true digital interactive networks. We've completed the integration, we have begun commercial launches, and our customers think the system is clearly the best in the market. Each quarter we are shipping, installing and launching more systems and will shortly start to launch applications.
That is why we are so confident and optimistic about the future.
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