Scientific Atlanta Q4
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Scientific Atlanta Q4
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(FOOL CONFERENCE CALL SYNOPSIS)* By Debora Tidwell (MF Debit)
Scientific Atlanta Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SFA)") else Response.Write("(NYSE: SFA)") end if %> UNION CITY, Ca., August 13, 1996/FOOLWIRE/ --- Scientific Atlanta released their Q4 and Fiscal Year 1996 results on August 8th, after the market close. Q4 sales were $272.7 million, compared to last year's $314.3 million which was an all-time record for the company. They anticipated a continued softness in their revenue compared to 1995. Sequentially, revenues were flat with $271.9 million in Q3. Comparisons with last year are made more difficult by the exceptional 4th quarter they had last year, due in part to the end-of-volume shipments under their Orbit direct-to-home contract in the Middle East and the initial customer inventory build-up of Sega game adapters. If it were not for Orbit and Sega, revenues would have been flat versus the 4th quarter of FY 1995.
If you strip out the one-time programs from last year and last quarter the company seems to be at a $270 million a quarter run rate, but margins on that $270 million are increasing. They are creating good leverage situation as volumes pick up. The real difference between Q4 this year and last year is around $40 million in profitable non-recurring programs last year. At the time, they said it would be difficult to replace these programs and their 47% growth for fiscal year 1995 versus fiscal year 1994 would create problems for comparison purposes for FY 1996.
Overall, the company feels that they had a good quarter, and in many respects a very good quarter. They are beginning to see favorable trends in their industry as domestic cable operators begin once again to upgrade their networks in response to new competition. They are very pleased with the Q4 results in their broadband distribution business where they had record bookings and the second highest sales in their history, and with the continued success of their 8600x advanced desktop terminal.
Bookings for the quarter were $250.3 million versus $275.6 million last year. They think that bookings, which have been soft in recent quarters, are beginning to turn. If you exclude telcos from last year's bookings, they are about flat for the quarter. Telcos continue to assess their options under the new Telecommunications Act and they remain somewhat of a question mark going forward as far as spending is concerned.
Net earnings from continued operations showed a loss of $15 million due to the previously announced one-time charges associated with their acquisition of ATx Telecom and an arbitration award and associated costs relating to the company's electronic program guide. Excluding the one-time charges their EPS was $0.19 which was close to most expectations. If you include the one-time charges, they had a net loss of $0.20 per share.
They are particularly pleased with their continued improvement in gross margins. Gross margins in the quarter were 30.1%. This is a 1.3% improvement compared to last year's Q4 and a 2.4% improvement compared to last year's Q3, which is in itself 1.8% higher than Q2. They hope to see continued improvements in gross margins over time. They still think that getting gross margins up into the mid-30s is possible and that is their goal. They are seeing the margin impact of new internal processes and management systems they have been discussing for a number of quarters. They are firmly committed to these internal changes as a means to improve the way they conduct their business, not only because of costs because they also help improve quality. Quality improvement initiatives throughout the company from order entry to the products they ship, to sales, service, and support is a top priority for them. During the quarter they established the position of VP Quality Assurance and brought on board an experienced Quality Executive from Motorola who had done an exceptional job at work in this area over the last 8 years. She will be working with their management team to focus on several important areas such as design verification testing, manufacturing verifications testing, standards compliance, fiscal method and overall process improvements.
Their gross margins are no longer negatively affected by the yen. Margin improvement over last year came from reduced manufacturing costs. Manufacturing costs are directly attributable to their new plant and increased emphasis on purchased components. Operating income, excluding the write-off of in-process R&D, was down $9.2 million versus last year, but up $4.3 million from last quarter. The year-to-year decline was driven by reduced revenues and higher R&D, offset by lower SG&A expenses. R&D expenses of $24.6 million was about 9% of revenue, somewhat higher than their target because of reduced volumes. The increase this quarter was due to the ramping up of their coax and cable telephony systems, high-speed cable modems, and digital satellite communications products. They also increased their R&D in transmission businesses as well, to develop new optical electronics and RF distribution products. They will continue to invest in digital headend, digital set-tops, cable telephony, cable modems, as well as advanced analog. Continued investments in digital technology are very important to them if they are going to maintain their leadership in digital systems.
International sales were 34% of total sales and international bookings were 35%. This percentage is slightly below last quarter because domestic sales were up, though the general trend toward greater volumes of international business still prevails. One would expect to see some quarter-to-quarter fluctuations as these percentages are based on domestic versus international mix. They saw continued growth in Asia where their PowerVu set tops saw significant bookings and sales for distribution and subscriber products. Build-out by the Australian Broadcasting Corporation and Italy Telecom continue. Latin America is not a major contributor yet in cable but is becoming more important. Europe, overall, is an area of great promise because the companies are positioning themselves to take advantage of total deregulation which goes into effect January 1, 1998.
The company's balance sheet remains strong. Inventories were down by $20.3 million from last quarter and down by $51.3 million since the beginning of the fiscal year. Inventory turns were up slightly from last quarter. They generated more than $25 million in cash from the operations in the quarter, which was used for the acquisition of ATx. So, their margins continue to improve and their revenues are about flat. Days Sales Outstanding was up about 6 days during the quarter and they expect to see that come back down in the next quarter due to a number of shipments late in the quarter which drove the days up. But, receivables are in excellent shape. They have had an outstanding receivable from Saudi Arabia, like a number of other companies, and that is now starting to be paid.
Organizations they have been implementing over the past several quarters continue to show favorable results. They are becoming more efficient and are reducing their costs which will help them strengthen their future competitiveness. They continue their long-standing commitment to digital technology because they think that eventually we will all live in a much more digital world. In the meantime, they have a very successful 8600x home communications terminal.
Turning to the year as a whole, fiscal year revenues were $1,047.9 million, compared to $1,118.1 million last year. Operating income was $52.4 million, excluding the write-off of purchased in-process R&D of ATx. Net earnings from continuing operations were $36.6 million or $0.48 per share, excluding the acquisitions and charges for the arbitration award. Bookings were $985.5 million, compared to $1,171.2 million last year. If you exclude Orbit and Sega from yearly sales, their business grew 5%.
OPERATIONS
They have four stories to communicate this quarter -- distribution, subscriber, satellite, and new products. They have moved from a group structure to a customer-focused product and geographic organization. Their goal is to achieve consistent group growth by product and by customer, so they won't talk about the company in terms of groups in the future.
Results of their distribution business were very strong. They had record bookings and the second-highest sales ever during the quarter. Bookings were up 37% overall, with international bookings up 48%. Sales were up 34% overall and 55% internationally. This represented about 30% of total company sales.
In the US, bookings and sales were strong across the board with most of their leading MSOs customers taking part. They think this indicates that domestic operators have begun to increase their spending on network upgrades. They are taking initial steps to meet their competition by preparing their infrastructure to offer new services to their subscribers. Investment in distribution, of course, is somewhat of a leading indicator for the industry. However, it is still premature to assume that we are at the start of a major surge in overall spending. Bookings began to pick up late in the quarter so they would like to see several more months go by before they make any firm conclusions.
Overseas, Optis and ItaTel continue their aggressive build-out programs following deregulation in Australia and Italy.
Deployments of their 8600x advanced analog set-top continued in the quarter with approximately 200,000 units shipped. They shipped a total of about 500,000 set-top boxes in the quarter. They now have about 1.2 million units in the field. A number of their customers are now in the process of converting from standard products such as the 8600 to the advanced features of the 8600x. So they saw a decline in shipment of their standard analog products in the quarter. One interesting development in the quarter is the fact that smaller cable systems are beginning to employ the 8600x in addition to the larger cable companies that were already doing so. This development indicates an increasing acceptance and a broadening of the market.
In their satellite business, they saw strong revenues in their satellite networks and communications and tracking area, offset to some extent by the effect of the final shipments of Orbit in last year's fourth quarter. On the booking side, their PowerVu digital compression video system is fully released and enjoying a strong demand. They are beginning to replace other providers because of the breadth of the applications offered by the PowerVu system.
Several contracts were mentioned in the company's press releases. Overall, satellite bookings were down due to a number of large contracts in last year's Q4. In summary, satellite is performing well, but by nature is a lumpy business. Long-term it continues to provide many opportunities for profitable growth.
NEW PRODUCTS
Their CoAxiom development program is on track and scheduled for release to manufacturing in early Fall. It is becoming increasingly apparent that this product has an international appeal. They are viewing it as a global product and are pursuing a number of specific opportunities in the US and abroad. Both Scientific Atlanta and their partner, Siemens, will be manufacturing the product. Scientific Atlanta is capitalizing on Siemens' expertise in telephony and switching and they are capitalizing in Scientific Atlanta's expertise in digital modulation and broadband transmission technology.
They continue to invest in a family of cable modem products. Their first product will be introduced this calendar year with shipments to begin in the first quarter of 1997. Their price point will be under $260 which is significantly below any other product in the market. This first offering will have a telephone return. It will have an RF return a few months later at the same price range.
SCARLET COMES TO ATLANTA FOR THE OLYMPICS
One of the more interesting and significant stories in the quarter was Scientific Atlanta's involvement in the Centennial Olympic Games. They provided the essential video technology for the games and their systems functioned flawlessly. They gave the network an appropriate name, SCARLET, which stands for Synchronous Communications Accessing Real-time Live-Event Television.
SCARLET was a state-of-the-art video distribution system that provided 60 channels of live video accompanied by data channels of the results of medal standings from the International Broadcasting Center. This was sent to 40 Olympic venues, athletic villages, hospitality suites, and Olympic locations including Centennial Park. Access to SCARLET was through 10,000 viewing stations accompanied by their 8600x set-tops.
The significance of SCARLET is that, by using existing products and available metropolitan fiber backbone structure -- in this case BellSouth's SONET network -- they were able to integrate digitized video and data, and distribute them to many locations on the network simultaneously. Reporters at individual sports venues could use SCARLET to view many other sports as they were occuring and receive up-to-the-minute data on results and medal standings. In fact, some of their customers preferred to watch SCARLET at their hospitality suite rather than attending live events because they could watch many events simultaneously on different screens.
Lessons learned about the integration of video and data and the transmission over an existing metropolitan fiber network will have real commercial significance in the future, especially since the products and systems they used in SCARLET are commercially available today. Video and data clearly dominated the information distribution at the Olympics more than ever before. Most people receive their news from TVs or Internet, not from daily newspapers. All future Olympics will be video and data oriented and the feasibility of showing multiple video images supported by multiple data channels will likely play an important role. SCARLET was possible because of the R&D investments Scientific Atlanta has made in digital video products and systems and the experience that they have acquired in implementing digital video networks for Time Warner in their full service network in Orlando, for US West, for PacTel, and most recently with BellSouth in their digital video trial that is now rolling out in Atlanta.
DIGITAL VIDEO SYSTEMS
There are essentially two philosophies or approaches to digital video. The first is simply a channel expander. This is so-called broadcast video enhanced in some cases by one-way services such as near video-on-demand, sports scores, school lunch menus, and weather reports. They think that is a more limited and short-term approach. The second approach provides a true interactive client-server platform that, in addition to providing expanded channels, lets you move to new services such as Web browsers with high-speed Internet access via cable boxes, true video-on-demand, interactive games, multimedia applications, and electronic commerce. This is Scientific Atlanta's approach.
They followed this approach with Time Warner in Orlando, with US West in Omaha, with PacBell and BellSouth in Atlanta. They've learned from each of these programs and have fed that experience back into the system design and have enhanced the software. They've gone to higher and higher levels of system integration in their digital products.
They are now deploying their third generation digital products with BellSouth and their fourth generation is well down the road in development. They have had digital interactive set-tops in consumer homes for over two years and currently have thousands working in homes every day. Their third and fourth generation products incorporate power TV operating system, which has an open API for third party application development and chip graphic accelerators to make more compelling graphical user interfaces that display video, graphics, photographic images, and sound bites that are becoming a way of life for Internet applications. Also, the price point for their digital set-top boxes have moved from multiple thousands of dollars in the Orlando Time Warner trial, to the $400 range for volume production roll-out in mid-calendar year 1997.
They have also established a licensing program for their digital set-top technology to provide multiple sources for set tops. Toshiba, Pioneer, and Thompson are the first companies to take advantage of this opportunity. They have received a very positive industry reaction to the performance and functionality of their digital video approach. Subscribers in their customer trials are enthusiastic about the true interactive services. And, of course, any home communication terminal supplier that ignores high-speed Internet application will have a very difficult time in the future.
Their digital video products provide a platform to build a variety of applications that interact with TV or computers. It represents the coming together of the TV and the computer over client-server networks, much like SCARLET represented the integration of video and data over high-speed fiber backbones.
In contrast to the limited approach of a digital channel expander such as MMDS, DBS, or Central Digital Broadcast, their approach provides both the technical platform and a satisfactory financial model for real digital video interactivity to either the TV or to the computer. Technology will continue to reduce the cost of these systems over time, but committing to a basic two-way architecture is critical. Scientific Atlanta's is modeled after a client-server architecture similar to that of computer architectures. Therefore, it will fit in both worlds. The coming together of PCs and TVs will require this approach. Other architectures simply will not work.
THE RECENT ARBITRATION AWARD IN CALIFORNIA
The company was disappointed by the decision because they firmly believe they did not violate the terms of the 1992 license and technical system agreement between themselves and StarSight Telecast. However, they do not feel that the decision will have any long-term material impact on them because they have a number of rather attractive options to pursue. Their most likely course of action will be to develop on an accelerated basis a new, more advanced, interactive programming guide with much greater functional capability and features. The technology has evolved a great deal in recent years and their plan is to employ a totally new technology in their 8600x set-top platform. This would involve a software implementation that would not require a lot of redesign and would be backward compatible. Essentially, they would create a virtual API to allow MSOs or third party developers to create program guides and other applications. In other words, the program guide would just simply be another application on the device. * A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. |
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Copyright 1996, The Motley Fool |