Harmonic Inc (HLIT) 2007 Q2 法說會逐字稿

Good afternoon.

My name is Kara, and I will be your conference operator.

At this time I would like to welcome everyone to the second quarter 2007 Harmonic earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session.

(OPERATOR INSTRUCTIONS) Thank you.

I would now like to turn the call over to our host, Patrick Harshman, President and CEO.

Please go ahead, sir.

Well, thank you, and good afternoon, everyone.

I'm Patrick Harshman, President and CEO of Harmonic.

With me at our headquarters in Sunnyvale, California are Robin Dickson, our Chief Financial Officer; and Michael Newman, our Investor Relations spokesman.

Thank you all for joining us.

Today, we announced our results for the second quarter and first half of 2007.

We're very pleased with our sales and earnings growth in the first half of the year.

Our continued improvements in gross margins and operating efficiencies and the strong business momentum we have heading into the second half of the year.

We've been strategically focused on the big movements in the video delivery marketplace.

The move from standard to high-definition, the move from broadcast television to OnDemand video delivery to any device and intensifying competition between video service providers.

In the first half of the year, these market trends have been driving strong business momentum with our industry leading high definition encoding, video on demand edge, and Optical Access solutions.

While we are very pleased with our strengthening leadership position in these core product areas, we're equally encouraged by the market's growing interest in our powerful range of new solutions encompassing switch digital video, time shift to television, video on demand content streaming and management, video-rich navigation, and higher speed Internet data and delivery, all of which take further advantage of the key video market drivers.

And with today's announcement of our agreement to acquire Rhozet Corporation, which provides industry leading video transcoding software.

We're making a significant additional step towards enabling our growing array of customers to deliver video on demand in any format to any device.

With that introduction, I will ask Robin to cover the financial aspects of the quarter and I'll then review some of our recent business developments and strategic initiatives in more detail.

Robin?

Thank you, Patrick, and good afternoon, everyone.

During this call, we may make projections or other forward-looking statements regarding future events or the future financial performance of the Company.

We must caution you that such statements are only predictions and that actual events or results may differ materially.

We refer you to documents that the Company files with the SEC, including our most recent 10-K and 10-Q reports.

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 on this call we will provide you with financial metrics determined on a non-GAAP or pro forma basis.

These items, together with the corresponding GAAP numbers and the reconciliation to GAAP are contained in today's earnings press release, which we have posted on our website and filed with the SEC on Form 8-K.

We will also discuss historical financial and other statistical information regarding our business and operations.

Some of this information is included in the press release and the remainder of the information will be available in a recorded version of this call on our website.

Today we announced results for the second quarter ended June 29, 2007.

We reported net sales of 71.3 million, up 34% from 53.3 million in the second quarter of 2006.

For the first six months of 2007, net sales were 141.5 million, up 29% from 109.5 million in the same period of 2006.

In the second quarter of 2007, domestic sales represented 54% of revenue compared to 60% in the first quarter and 51% in the second quarter of 2006.

Our largest and only 10% customer was Comcast, representing 16% of our total revenue.

By market, in the second quarter, cable accounted for 66% of total revenue.

Satellite customers represented 11%, and telcos and others, 23%.

Our cable business remains strong and in comparison to Q1, we also saw significantly higher revenue from our telco and other customers.

Although our satellite revenue was slightly down from Q1, first half satellite revenue was up strongly from the first half of last year.

Furthermore, we had strong bookings during the second quarter from both domestic and international satellite customers, and we expect these orders to have a very positive impact on our second half revenue.

By product category, we saw Edge and Access products representing 44% of revenue in the second quarter.

Video processing products 40%, and software and services, 16%.

This represents a more balanced mix than in Q1, when the lower margin Edge and Access products represented over 50% of our revenue.

As a result of this change in our product mix, and in line with our expectations, non-GAAP gross margins increased sequentially from the first quarter of 2007 from 42% to 45%.

Second quarter gross margins were also higher than in the same period of 2006 due to sales of new products and higher manufacturing volumes.

Forecasting our quarterly product mix remains challenging, given the variations that we see in the timing of orders, of shipments, and their subsequent conversion into recognizable revenue.

However, we expect to be able to maintain gross margins around the level of the second quarter for the second half of this year.

We continue to focus on controlling our operating expenses.

Our non-GAAP operating expenses in the second quarter were up $250,000, or about 1% on a year-over-year basis, reflecting successful cost reduction initiatives over the last year.

This compares to a 34% increase in sales in the same period.

Operating expenses are down about $800,000 on a sequential basis, principally reflecting cost reductions resulting from the shutdown of our UK R&D facility, and also lower than anticipated outside engineering costs.

In addition, in the second quarter, we had a reclassification of almost $200,000 from R&D expense to cost of sales, because we dedicated some of our R&D people to a very specific system integration task for a major satellite project.

Our total head count at the end of June was 604, up modestly from 594 at the end of March.

On the income tax line, we recorded a small benefit, resulting from the reversal of a prior year foreign tax provision.

This happened under the new FIN 48 accounting rules, but this unusual credit had no effect on our non-GAAP earnings per share.

Excluding non-cash accounting charges for stock-based compensation expense and the amortization of intangibles, our non-GAAP net income for the second quarter of 2007 was $9 million, or $0.11 per diluted share, compared to a non-GAAP net loss of $200,000, or $0.00 per share for the same period of 2006.

For the first six months of 2007, non-GAAP net income was 14.3 million, or $0.18 per diluted share, compared to a non-GAAP net loss of 3.5 million, or $0.05 per share for the same period of 2006.

Our GAAP net income for the second quarter was 6.2 million, or $0.08 per diluted share compared to a GAAP net loss of 2.9 million, or $0.04 per share for the same period of 2006.

Our balance sheet remains solid.

As of June 29, we had cash, cash equivalents, and short-term investments of 82.2 million, compared to 82.9 million at the end of March.

Our receivables were 62.5 million, with DSOs at around 79 days.

Our DSOs have run higher than historical levels for several quarters now, in large part due to the complex and expanded nature of many of our large satellite and telco projects, particularly those in international markets.

Net inventory was 42.5 million, down from 46.7 million at the end of March.

This reduction in inventory reflects our success in selling our new products, for which we have invested in up front inventory, as well as reflecting our improved management of our supply chain.

Our capital spending for the second quarter was $1.1 million, and we still expect our CapEx to be in the range of 5 million to $6 million for the full year.

We expect to close our acquisition of Rhozet within a week.

The $15.5 million purchase price is comprised of approximately $5.3 million in cash and a value of approximately 1.1 million shares of Harmonic common stock as determined in accordance with the terms of our definitive agreement.

Excluding charges for the amortization of intangibles, we expect the transaction to be neutral to our earnings per share for the remainder of 2007.

We go into the second half of this year with a strong backlog and good sales momentum.

We anticipate our combined net sales for the second half to be in a range of 150 million to 160 million.

On a non-GAAP basis, we expect gross margins to be in a range of 44 to 45%, subject, of course, to the vagaries of our product mix.

We also expect to see our operating expenses trend in an upward direction from the second quarter level.

In summary, we're pleased with our results for the first half of 2007 and optimistic about our opportunities for growth in coming periods.

We expect to maintain our gross margins at Q2 levels in the second half and we continue to focus on controlling costs and increasing our profitability.

Moreover, our strong cash position continues to give us plenty of operational and strategic flexibility, as demonstrated by today's acquisition.

That's all for me.

Patrick?

Well, thanks, Robin.

We are pleased with our results for the first half of the year and the fundamental strength of our business, as well as the continued diversification of our business across a broadening range of products and solutions, customers and geographies.

So what I would like to do now is walk you through some of the key developments and activities in each of our different customer segments.

In the cable market, our technology leadership position and long-standing customer relationships continue to grow stronger.

Cable operators continue to focus on various strategic transitions to more high-definition and more on-demand offerings.

And the associated bandwidth management technologies needed to enable the expansion of these services.

Correspondingly, we continue to see strong momentum for our traditional products, including our best of breed MPEG-2 high definition and standard definition encoders, our EdgeQAM for video on demand expansions and our Optical Access solutions for network segmentation and deep fiber extension.

We are also very encouraged to see growing momentum for our expanding range of new cable solutions.

Our switch digital video capability now encompasses IP distribution, stream processing, encryption, targeted ad insertion, as well as Edge processing, constituting a very compelling offering.

Throughout the second quarter, this new solution powered switch digital video trials with several key operators.

Today, I'm pleased to inform you that our universal EdgeQAM has now been formally selected by a major cable operator to enable their switch digital video and next generation VOD deployments beginning in the second half of the year.

Well, we know we will not be the sole supplier for this business.

Our superior product, extensive installed base, and deployment expertise position us for success.

A further compelling advantage of our new universal EdgeQAM is that it supports more than VOD and switch digital video.

During the quarter, we announced a customer deployment of the universal EdgeQAM and a significant modular CMTS trial in Korea and we publicly demonstrated innovative EdgeQAM software to enable DOCSIS bypass for IPTV applications on the cable network.

Another major cable market growth initiative this year has been the introduction of our new software-based asset creation, ingest, and distribution solution for VOD, time shifted TV, and network personal video recording.

While we have yet to report significant cable revenue from this initiative, we are very encouraged by our testing and integration progress with several leading cable operators.

We continue to look for this area to be a key incremental growth driver for our business.

This is an exciting time in the cable industry.

We're pleased to be at the center of so many new initiatives and to be seeing strong momentum across the growing portfolio of solutions we deliver to our cable customers.

Turning to the satellite direct to home market, our second quarter revenue does not fully underscore the progress we have made in regaining our leadership position in winning new business with leading domestic and international operators.

Our strong current backlog in deferred revenue and satellite business reflects significant wins with key satellite customers in the U.S., Asia, Europe, and Latin America, and makes us confident about this market in the second half of the year.

The cornerstone of our competitive success in this market continues to be our market-leading Electro 7000 MPEG-4 AVC high-definition encoder.

This product was recently honored by Broadband Gear Report with a perfect score, the first product ever to receive a perfect score from this organization.

And beyond capturing market share among satellite operators with our powerful new encoding capabilities, we're also seeing success with our strategy to extend our satellite solution footprint to include innovative new video on demand and video over IP networking solutions.

During the second quarter, we secured our first order from an international satellite operator for our recently introduced non-realtime version of our Streamliner VOD platform, enabling this operator to offer a competitive video on demand service over broadband Internet connections.

Turning to the emerging IPTV market, we've continued to strengthen our leadership position with new customer wins in Europe and Latin America, as well as significant follow-on orders from established customers in Europe and Asia, who are beginning to expand their video service.

While it remains difficult to predict the timing of new telco to customer deployments and subsequent service expansions, the power and breadth of our new solutions, our increasing experience with IPTV deployments and our close relationships with market-leading strategic partners put us in a very strong position to continue to win new business in this emerging market.

To remain at the forefront of the video delivery market, we continued to increase the focus and leverage of our internal research and development team and activities.

At the same time, we're keeping our eyes open for external video focused companies that possess complementary, best in class video delivery technology, and market position.

Our decision to acquire Rhozet is a natural extension of our market-leading IP-enabled compression, stream-processing, and OnDemand solutions, and our strategic focus on the market transition towards on OnDemand video delivery to any device anywhere.

Rhozet's software-based universal transcoding solutions enable service providers and broadcasters to deliver superior, multiformat video to virtually any device over any medium, including Internet and mobile applications where viewers are increasingly turning to watch an ever-expanding range of current and long tail video content.

Rhozet's software is already being used by leading broadcast and Internet video content providers, including Amazon.com, the BBC, Microsoft Networks, Comcast platform, and Yahoo!.

We see a great opportunity to marry this technology with our solutions to provide our cable, satellite, IPTV, and broadcast customers with the ability to seamlessly integrate Internet and user-generated video into their OnDemand service platforms.

At the same time, Rhozet's strong market position with leading content creators, Internet video service providers, and an array of strategic business partners provides a valuable opening for us to expand the addressed market for Harmonics products and solutions.

We also continue to strengthen our organization with the recent announcement of the appointment of Harold Covert to our Board of Directors and as Chairman of our Audit Committee.

We expect that Harold's experience and outstanding record with leading Silicon Valley technology companies will bring broad industry expertise and additional in-depth financial skills to our company.

So in summary, we continue to grow our sales and improve our operating performance, as we significantly strengthen our leadership position across different video delivery markets.

Moreover, a growing global customer base is steadily gaining a deeper understanding of how to fully leverage the breadth and power of our new products and solutions, which provides them with exciting opportunities for future growth.

Our strategy remains focused on the key market drivers transforming the business, the video service delivery.

The transition from broadcast to OnDemand, the transition to more high-definition programming, the transition towards video delivery over IP and new IPTV services and the more intelligent use of network bandwidth to support these new services.

We're very excited about our potential in the second half of the year and beyond.

This concludes the formal part of our presentation.

Rob and I would be pleased to entertain any questions that you might have.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Jason Ader of Thomas Weisel.

Great, great pronunciation.

Thank you.

I wanted to ask you about the Universal EdgeQAM win that you talked about.

Aris had their call at 5:00 and they mentioned a specific customer, Comcast and that they were one of two suppliers chosen and then you get on your call and you talk about a major win.

Is there anything you can shed light on there?

Is that the customer?

Jason, I regret that we did not, we did not secure approval from the customer to mention their name on this call.

Okay.

All right.

The timing is sort of interesting.

That's why I bring it up.

Perhaps the difference for us is that this is an existing customer.

We've got a large installed base for us, and we fully expected to be chosen for this business.

Okay.

Enough said.

That's great.

Haven't cleared it with the customer.

Thank you.

And then second question is, if I look at just sort of the breakdown between cable satellite and telco, I think the satellite explanation makes a ton of sense to me.

It was down, but you had strong bookings, so you think it will be up in the second half.

However, I guess I'm struggling to understand cable was down sequentially and telco and other was up, like 60% sequentially.

Could you add a little color there on why cable would have been down and what's normally a pretty good quarter?

Were the bookings much better than the revenue and just kind of any commentary there on bookings versus revenue in both those segments?

Okay.

Well, I mean Jason, the cable revenue is down a little bit.

I don't really view that as terribly, terribly significant.

I mean for the last, the last few quarters, we've been running cable up in the, around 50 million and, yes, sure, it's gone up and down and around 50 for the last three quarters.

I just don't view it as statistically significant.

I think as you may recall, we had some pretty strong bookings for cable in the fourth quarter and much of that was delivered in Q1 and we had some discussion about the impact of that on margins and I think we're pleased to see that the other impact on Q1 margins has been, has been rectified because we've, we have caught up on some of the telco revenue, which was admittedly, was lagging a bit in the first quarter and lagging, again, because of their ability to get projects completed and revenue recognized.

So this is a little bit of the puts and takes, yes, a little bit of a reversal of the first quarter, but I don't view it as being particularly significant.

The cable business remains very strong, and I think, the first part of your question, I think, there's increasing evidence that that is the case.

And the telco and other, Robin?

Yes, well, I think, in the revenue piece of it, there is some catch-up from Q1.

I mean there was some disappointment in Q1, that that number was down.

I think we've said before on many occasions, this is still an emerging market.

It's -- in fact, I think Patrick the last time said it wasn't even so much a market yet as it's a collection of customers doing a lot of different things, and I think we're just seeing a continuation of that.

And I think it will continue to be somewhat erratic quarter to quarter, just because we're still dealing with a relatively small number of customers, small, but growing number of customers.

And was some of it I guess revenue rec?

Yes, absolutely.

There were some projects we were just not able to complete and recognize revenue on in Q1 and we did manage to catch up on some of that in Q2.

Okay, and then just a last question, what type of gross margin impact should we expect from Rhozet?

I guess you said it was neutral at EPS in the second half.

And you guided gross margins sort of in the same range of where it's been, and it's a software product, so I would assume it's got higher gross margins.

Are you just not at the point right now where you have the visibility to say gross margins could be on an upward path because of Rhozet?

Well, I think at this point it's just too small to really have much difference.

I mean the Company has been shipping product for just over a year.

We're still sorting out the revenue accounting as you know, in software acquisitions.

We usually lose deferred revenue, so we're still sorting that out and frankly, I think it's just too small at this point and certainly for the next few months to have any really meaningful impact from a financial perspective.

As Patrick I think could probably address, some of the other aspects of the acquisition.

But I do want to be clear that we have not yet closed and it is not factored into our guidance.

Okay.

Great.

Thank you.

Your next question comes from the line of Eric Buck with Brean Murray.

Yes, good afternoon.

Thank you.

Back on the, on Jason's original question regarding the EdgeQAM business, can you kind of give us a sense of scope of that business relative to what you have been doing on a run rate or when you would see that start to ramp up and how you think the business will be allocated between you and the other competitor that won in that segment?

The -- we've been, we've been a strong player and the leading player in EdgeQAM's for VOD and we continue expect to lead that market.

As we've been saying throughout the year, we continue to see some good strength in that market and our second half outlook definitely contemplates continuing strength in the VOD Edge.

As we've been in several, I think quite successful switch digital video trials over the last several months, as I've mentioned, and this is the first customer I think to formally make a decision and choose us, but it's still relatively early days.

That decision just came down recently and we're still actually getting our arms around exactly what the incremental volume associated with the switch digital video component of that will look like.

So I regret it's a little early days to give more specific guidance.

I guess maybe one key thing to say is that our, the guidance therefore on the outlook that we've given for the second half of the year does not contemplate too significant of a contribution from that activity in the second half of 2007.

Great, and then secondly, can you talk a little bit more about what's going on here in the U.S.

satellite market in terms of HD, local HD deployment and whether you think you've made any further traction and maybe some accounts that you haven't had traction before?

Well, we've, while I regret I can't talk in any specifics about either of the two big U.S.

satellite guys, what I can say in general is we're very pleased with our progress in this market.

We think our new high-definition encoding technology has clearly risen to the top, and we've won the major pieces of business that have been available in front of us, and so we're executing against that business and we look forward to continue to execute and recognize some of the deferred revenue in the second half of the year and we're also looking forward to winning new opportunities in the second half of the year as well.

Okay, and then finally, on Rhozet, you said it wasn't incorporated in the guidance, but can you give us kind of a revenue run rate idea, if meaningful at all?

We're not quite ready to do that yet.

As I say, we're still -- we still need to go through the revenue accounting analysis and all that, and so I think at a later date we'll be in a better position to address that.

But it's, this is small.

We're not buying it for the existing numbers.

It's very compelling and exciting technology.

The product has been -- it's actually, the product has had great traction in roughly 12 months since it was launched.

The numbers are small, but growing quickly.

We like it very much because it's software and just as importantly as the stand-alone revenue, we're very excited about the synergies that are going to happen as we bind this together with our other video delivery solutions.

So as Robin says, give us a little bit more time to come out with a more fleshed out model for not only the continuation of the growth of their existing business, but also the synergy revenue that we think will come about as we bundle this together with our other solutions and as we bring this technology to our service provider customers, which Rhozet has not been focused on.

Okay, great.

Thanks.

Your next question comes from the line of Tim Savageaux with Merriman.

That's a new one.

Keeping that pronunciation streak going here.

Congratulations on the margin performance in the quarter, thought that was very strong both gross and operating.

And my first question is about the operating expense line.

You may have covered this in the text, but whether you have any guidance for whether OpEx is going to stay at this rather low and attractive level, so that's question number one.

And then it wouldn't be a Harmonic conference call unless we talked about doubling the satellite business year-over-year, so given the performance we saw on the quarter, that obviously seems like it's a little tougher to do.

I wonder if you have any updated thoughts on that?

Thanks.

Okay, Mr.

Tim, I think I can get that right.

Let's see, the operating expenses, we did have maybe a couple of unusual factors.

In particular, we saw some external engineering expenses delayed a little bit and those will get picked up in the second half of the year.

At the same time, we have done some cost reduction through the, as we announced last quarter, closing down the fairly modest operation we have in the UK, but that does save us some money.

We also reclassed about $200,000 out of R&D into cost of sales and that was in connection with some very specific integration activities that our R&D people were doing in connection with a major satellite project.

So it's a mixture of one-time and structural stuff.

At the same time, we are trying very hard to continue to strengthen our R&D effort and I think that, and just simply a combination of the higher sales that we're pointing to in the second half of the year mean that our operating expenses are going to trend back up in the second, in the second half.

I mean not dramatically, but I think they would trend up probably more on the order of where they, where they were, for example, in the first quarter, which was about $750,000 higher.

Right.

So 25 is the level you're comfortable at?

I would say 24.5, 25, in that range.

Okay.

I think is, is possible.

Yes, probable.

And then on the satellite?

Same question on the satellite revenue.

Yes, again, I think we did acknowledge that the second quarter was down, first half year-over-year was up quite a bit over last year, but more importantly, we had some very significant bookings in the second quarter, both, with both domestic customers and international customers, and those are very solid set of backlog in deferred revenue numbers that we think are going to give us a significantly higher second half number than the first half number.

Okay.

Thanks a lot.

Yes.

Your next question comes from the line of Greg Mesniaeff of Needham & Company.

Thank you.

Boy, I survived that one pretty well.

The question on -- to kind of shift gears a little bit from the product front to the expense side, how is the progress towards outsourcing of your final test and assembly progressing?

I know you've been involved with that process for a while now, and I'm wondering what kind of results we're seeing in terms of its impact on margins.

Well, as Robin spoke, at a high level, the supply chain and our manufacturing efficiencies has been a strong area of focus for us.

I would say over the last year, or at least the last nine months.

You may recall that we brought in some new executive leadership in November of last year to lead our supply chain and manufacturing operations.

And this isn't a thing where we've got to one particular milestone that we've been communicating or focused on.

It's really just an issue of continuous improvement.

And I would say qualitatively we're making good progress, but it's still, it's still less than a year into our, I would say intense focus on really reevaluating and strengthening our supply chain and manufacturing efficiencies.

So ongoing continuing improvements in this area, continuous improvements, incremental improvements is something that we're continuing to look for.

And I think it's just part of the, our broader focus on balance, having a strong balance between top line growth and close attention to profitability.

And as a follow-on, with your acquisition of Rhozet, do you plan to kind of keep that business as a quasi stand-alone unit, or are you planning to essentially embed the technology and the software into some of your current product lines?

Well, it's actually a little bit of both.

We do -- although they have been in existence not that long a period of time, they have actually got a great brand name and a great position with their core customers, most of whom do not know of or do not deal with Harmonic in the Internet space and some of the content creation space.

So we see a lot of value in maintaining the Rhozet brand and maintaining their tight organizational focus on that part of the market.

At the same time, as I mentioned, we see, we're very excited about the opportunities of leveraging the technology for our own traditional Harmonic customers, and so while from a commercial perspective and an organizational perspective, Rhozet will still be focused on their current market and therefore bringing exposure to that market to Harmonic.

We will be simultaneously leveraging that technology and embedding it in our traditional platforms and solutions to bring to our cable operators or our telcos and satellite operators as well.

Great.

Thank you.

Thanks.

Your next question comes from Robert Bovo of XI Asset Management.

Good evening, guys.

Thanks for taking the call.

Just a quick question, Robin, if you could, I wanted to flesh out a little more about the strength in telco this quarter.

I think a follow-up to the other question in regards to recognizing some deferred revenue and projects that came together.

Any new business or reacceleration given what seems to be a little bit more friendly regulatory environment, particularly in Europe and some discussion from others in the supply chain about the overall environment picking up some as we look out to the second half for IPTV?

Well, I think Patrick spoke a little bit to this earlier, that we did have some new, some new wins, so there is still new entrants into this business.

At the same time we were encouraged to see some expansion of existing systems that we had helped our customers deploy in previous years.

So I think it's -- we're seeing both.

At the same time this year we haven't seen any deals.

We're not aware of any deals on the scale of perhaps some some of the things we did last year.

So it's still, as I said earlier, it's a little bit of very much an emerging, an emerging market and numbers that I think are going to kind of go up and down for the next few quarters.

Okay.

So fair to say that we've moved from some initial deployment stages in existing customers and that's a piece of the strength in a couple of odds and ends in terms of new deals?

Yes, I think that's a fair characterization and we'll continue to obviously to work closely in this market.

Okay, great.

Thank you so much.

Your next question comes from the line of Brian Coyne with Friedman, Billings.

Hey, guys, good afternoon.

Good afternoon, Brian.

Just a couple things.

First of all, I was wondering if you could speak a little about your traditional sort of video on demand business vis-a-vis your NSG.

I'm guessing it was probably down quarter over quarter.

As we get a little bit of an MSO spending rebound on the VOD side, how much benefit do you really expect in the next quarter or so in this area?

I think you're right.

I think the NSG in particular was marginally down quarter over quarter, but at a marginal difference, Brian.

As we look forward, we actually see probably the spending picking up marginally around VOD and EdgeQAM for VOD applications in the second half of the year.

So we saw a fairly significant step-up around the end of 2006 and we basically have seen that step-up level be maintained and, maybe a little higher in Q1, a little lower in Q2, but as we look to the second half of the year, we don't see any appreciable change.

It still feels fairly robust and probably a little bit above the level that we saw in the second quarter.

Do you see, any, I guess significant variability from, is it sort of one customer, or is it the overall market where you saw the uptrend in 1Q and sort of a little bit of an erosion in 2Q?

I can't point to any specific customer, Brian.

I mean it really, at the top level it feels very much actually like the two quarters were basically flat or identical.

If there is a delta, and I haven't even looked at the specific number, I think it's down somewhat, but not appreciably.

I would say that the, one of the things that is happening, I mentioned we're involved in a number of switch digital trials, video trials, and I think what we'll see playing out over the next six months to twelve months is a redefinition of this space, as the market does more generally embrace the notion or the definition of a Universal EdgeQAM.

So I think we'll start to see buying decisions that are less VOD-specific, less reactive, gee, we've got to expand, we need four extra channels in this system to deal with the capacity issues and perhaps a little bit more integrated with more strategic expansions of putting up additional VOD capacity, as well as simultaneously in an integrated way, establishing switch digital video infrastructure capacity.

Great.

That's helpful.

One satellite question.

Obviously you talked about satellite bookings being solid.

Can you, I guess maybe give us a feel for the mix on the optics versus the encoding part of those bookings?

Optics within satellite?

Right.

I mean I think Robin may have commented on some, on some IP transports, or some optical--?

Okay.

I mentioned while encoding has been the lion's share of the revenue, one of the interesting things, and one of the things we've been strategically working on doing is expanding the breadth of solutions that we bring to satellite operators and we have really had two general initiatives.

And one is around IP networking, but in that case, it hasn't been optics.

It's been more our stream processing products.

We've introduced remote wide area network, statistical multiplexing, also some very sophisticated core error correction technology, which essentially allows our operators to aggregate their local channels so they are not over lower cost IP networks as opposed to very high quality, very expensive ATM networks, et cetera.

So we've integrated that functionality into our more general stream processing technology and so we've been working with operators to set up these wide area networks, both for direct, as well as wholesale applications.

So that's been one area of growth for us.

We've actually seen a pickup of our video stream processing and it's really been around this forward out correction, this remote statistical multiplex thing, et cetera, over native IP networks.

And the secondary that I mentioned, still very relatively slow financially, but strategically significant for us, is we've been engaged in a number of discussions with a number of operators about using our VOD capability.

You may recall we announced in April an adaptation of our VOD platform to be able to support non-realtime streaming, so you could offer VOD service or a very near VOD service over a broadband Internet connection.

We've got a number of satellite operators who are looking at that as a key competitive response to competitive VOD services from cable and IPTV operators and we closed the first piece of that business as well.

So that was more in the video software realm.

All right, great.

And then finally, just quickly, on -- maybe I missed this, but on the slight uptick that you're looking for in the coming quarter on OpEx, would you say it's -- kind of characterize it relative to your outlook for sequential sales growth and sort of what's the driver here?

Thanks.

Well, Brian, there is certainly a part of it that is tied to sales growth.

I mean as we pointed to higher revenue in the second half relative to the first half, that will inevitably drive some of the variable expenses higher.

In addition, as we said, we did have some delays in NOE expense that we expect will start to -- we will pick up in the second half, and although we're not hiring aggressively, we're certainly looking to beef up in some key areas.

So I think all of that together points to somewhat higher, but not dramatically higher OpEx in the second half.

Okay, great.

Thanks, guys.

Thank you.

Your next question comes from the line of Marcus Kupferschmidt with Lehman Brothers.

Thought I would give Tim a run for his money with that.

Thanks, guys.

So couple questions.

In terms of the exciting opportunity for your EdgeQAM, I guess looking forward wouldn't you expect EdgeQAM then to start growing as a percent of the total company, and if so, isn't that something that weighs on the gross margins all else equal, my guess is yes, so what else is going on that keeps gross margins in the 44, 45% range in the future?

Well, I think Marcus, as we tried to indicate earlier, we, despite the announcements today, we do not have very different expectations in our guidance for the second half yet, because simply it's a little too early to know the specifics of timing and quantities and actual deployments and so on.

So we've -- in the guidance we've given for the second half, we have really pretty much used the ongoing run rate of existing activity in the EdgeQAM space and we've not really factored into any significant extent any potential increase in volume from, again, from the announcements today.

So for the guidance we've given, because of the strong backlog that we come into the quarter with, and the mix that we expect to see for the second half, we're certainly pretty confident with the margin, the gross margin guidance we've given this afternoon.

And as we learn more about the specifics of, of the Universal EdgeQAM deployments, we'll certainly factor that into our thinking.

I think what that, I think you're right.

I mean that would, could lead to significantly higher revenue, but also might have some overall depressing effect on the gross margins.

But I think that's a trade we're happy to make.

Sure.

No incremental revenue is good.

Okay.

So then a separate subject, the OpEx, is going up.

I mean can you give us a sense of kind of where the operating margins for this company are going, maybe the end of this year and then looking out, 18 months from now?

Obviously all excluding this new acquisition that you have yet to close on?

Yes, I think structurally, I mean we've talked quite a bit about, and actually are executing on a desire to certainly to have more complete solutions and perhaps more software-intensive solutions for our customers, and the acquisition of Antone and today the acquisition of Rhozet are very much in that line of thinking.

And so over some period of time and maybe we should say over the next 18 months, I would expect that structurally we should be in a position to increase our gross margin from what we reported in the second quarter and what we're talking about from the, for the second half.

So that is, that is probably the biggest single driver of margin expansion and to that extent, think that would allow us to expand the operating margin somewhat.

I mean we are this quarter, in the 10 to 15% operating margin range that we have talked about.

Maybe we would like to get a little bit higher into that range and if that happens, that probably comes through improving gross margins, but at the same time, if we can be consistently in that range, I don't know that we would necessarily want to drive higher.

We may be more willing to invest at that point once we've established pretty consistent performance in that 10 to 15% range.

Okay.

So to clarify, doing 14, 15% operating margins on a 45% gross margin is pretty tough for what you know today?

I think so.

I would think if we're going to perform at that kind of operating margin level, that that would presume that the gross margins are probably in excess of 45%.

Okay, and then one last quick question just to ask a nitpicky question, the acquisition today sounds quite exciting.

I'm just curious, why not use all cash?

You guys generate a nice amount of EBITDA every year, working capital shouldn't keep going up, so why even use any equity here?

There's a number of reasons that go into these decisions, as you can probably well imagine.

Considerations of the buyer, considerations of the sellers, and so on, and while we -- I agree with you that this is the deal we could have done in cash, at the same time, as Patrick indicated, we are continuing to look for other types of opportunities in this area and so it seemed prudent not to, perhaps not to use all of our cash, or make this an all-cash deal in these particular circumstances.

So, each deal has its own particular metrics.

Thank you very much.

Thank you.

Your next question comes from the line of Nikos Theodosopoulos with UBS.

Hey, I just had some real quick questions.

Robin, it sounds like the book to bill was greater than 1 and deferred revenue was up sequentially.

Was all of that related to satellite, or was it more broad-based than across the business?

I would say it was very broad based, Nikos.

Certainly the satellite piece was particularly strong, but I think our orders were, the order performance in the second quarter was very broad based across all of the major segments.

Okay, and just lastly on the strength in telco broadcast, is it fair to say that this sequential increase was driven by telco or was there anything unique in the broadcast segment of customers?

Well, there were some -- there were some good things that happened in the broadcast space, but it's a relatively small piece for us and the majority of the increase was driven by these larger telco dealers that we have.

Okay, and the gross margin outlook, it doesn't sound like there's any mix shift that you would expect in the second half that would negatively effect what you accomplished this quarter.

Is that fair to say?

I think that's, that's fair to say, yes.

I think particularly given the pipeline of satellite opportunities, I think we're not, we're not looking for any significant mix shift.

I mean you never know, but, no, I think it's -- we are expecting something along the lines of what we saw in the second half -- in the second quarter.

Okay, great.

Thank you.

Your next question comes from the line of George Notter with Jefferies.

Hi, guys.

Thanks very much.

Just wanted to be clear on this Rhozet acquisition.

The revenue stream from Rhozet is not in the revenue guidance.

I assume it's also the expenses are not in the OpEx guidance and not in the gross margin guidance either?

Also, I would be curious to know how many people are at Rhozet and then when you say transcoding in software, I assume what you're doing is you're taking higher res video and taking it down to lower res video for mobile applications.

Is that the primary opportunity you see there, or any clarity there would be great.

Thanks.

Okay.

First, yes, you're correct.

It's the expenses, no other revenue -- none of it is in our guidance.

So it's a local company here in the Silicon Valley, in Santa Clara, just a couple miles away from where we are and it's about 15 people.

And about the product, no, it's actually not just for turning things down res.

It's an amazingly powerful tool, software capability, it's basically any format to any format, so we could be dealing with standard definition one format in, one format out.

A good example is I've got several existing customers who are actually providing VOD service going to TiVo boxes, televisions, on the Internet.

I mentioned Amazon and their own box service as a customer.

So there's a case where you've got a lot of input content that's coming in all different formats and you need to play it out in Amazon's desired format and in many cases to be played out on a specific set top box.

So certainly the mobile application, adapting things from mobile is one, I think very important application, but it's certainly not the driver or the lead application.

And really the power of the software is much more general than that and it really is about very fast format conversion, and that's one of the reasons why we see great opportunities for our existing customers as well, who may want to offer, for example, user-generated services on their own network.

Send us in your video file in whatever format it is and we're going to adapt it so it can be played out on your television over your set top box.

Got it.

Then just one last question, EdgeQAMs, obviously you were starting to see a number of deals and opportunities out there in the Universal EdgeQAM space.

You mentioned the one that you have won here, but any new impressions on the pricing environment for that space as we go forward and bid on Universal EdgeQAM deals?

Thanks.

Yes, certainly -- I mean we expect the pricing to be under pressure, as the volumes increase.

I mean certainly, this is -- I'm not sure how this will end up in the end, but certainly we do and our customers do expect the volumes to increase significantly, as you expand from just VOD to also switch digital video and then as you look out a little further, as you -- the same universal EdgeQAM will now start handling all DOCSIS traffic, so the volumes can be quite significant.

And I think our customers are no dummies.

They understand that if the volume is increasing significantly, there ought to be efficiencies there.

And I think that they are looking to us and others in the industry to share some of those efficiencies with them.

So we expect the volumes over the next year and a half to really increase quite significantly.

We expect correspondingly, ourselves to be able to make significant progress on the cost, and we expect to have to share some of that benefit with our customers.

I think it's a little early and as we said earlier, we're still getting our arms around how soon and how all of this will roll out.

We're there from a technology capability point of view and now it's really seeing how the market's going to evolve.

Great, thanks.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Paul McWilliams with Indie Research.

Hi, guys.

Congratulations.

Hi, Paul.

A couple of housekeepers here real quick.

On the OpEx trend, Robin, was that 24.5 to 25.0, basically what you're expecting for Q3 and Q4 on average?

Yes, we think it's somewhere in that range, yes.

Okay.

On the deal where you had your R&D guys working on that one job for satellite and you shipped at about 200 K for that, was that revenue recognized in Q2?

Yes, a portion, a portion of it was.

I mean basically the way the accounting works is the revenue and the expenses are recognized on a pro rata basis.

Okay.

On the major cable operator that selected the NSG 9000, is that application going to be using switch digital video?

Yes, so the selection, this particular RFP process was for a -- I think the first widespread Universal EdgeQAM application.

So it will be both the expansion of the VOD service, as well as switch digital video.

Okay, and will it be used in the modular CMTS, too?

Well, maybe ultimately, but that is not part of the short-term plan or buying or evaluation decision.

Okay.

Is the Cox deal that you announced, is that a NSG 9000 deal?

I don't think so, Paul.

I think that was our 9116, continued use of our 9116.

Okay.

How quickly do you expect cable companies to move to switch digital video?

As you probably know, there's a, there's I think a spectrum of interest and/or aggressiveness about this.

We saw the early, I think the early leaders start to do something last year and I think it's widely known in the industry that Time Warner has been quite aggressive and did quite a bit of work last year.

We're seeing strong interest, I guess, through all operators and including international operators.

I think when exactly they will deploy is just -- is a complex set of variables, depending on what their plans are for rolling out services that require the extra bandwidth and how they are prioritizing this against their other work.

So we see most operators with it in their future and I think the timing is still a little up in the air.

We certainly see at least the activity we'll participate in starting to happen in 2007 and probably starting to build up in more earnest in 2008.

Help me on understanding this one little thing here.

What is the driver that drives an application to move to a modular cable motion termination system versus just the ones that we're used to seeing out there?

Well, I think it's actually the beauty of this Universal EdgeQAM architecture.

Today we have different silos for the different services, if you will.

You've got a certain amount of bandwidth pinned up for VOD, another amount of bandwidth, a different pipe, if you will, pinned up for switch digital video and a third pipe, pinned up for DOCSIS traffic.

What the operators would like to do is unify those three pipes and at different times of the day be able to slosh or trade bandwidth back and forth between those different applications.

So in an ultimate Universal EdgeQAM application where you've got one unified Edge that's carrying video on demand traffic, switch digital video traffic, as well as DOCSIS traffic, then the operator ultimately has much more operational flexibility, as well as operational cost savings.

You've got this one Edge.

You've got different IP devices or channels coming into it, and at different times of the day, you may -- 10:00 Friday night, you may actually rattle down on the switch broadcast and you may ramp up on the amount of bandwidth you're going to allocate to VOD.

During the middle of the day, it may be higher, more DOCSIS data.

Today, the operators don't have the flexibility to kind of manage their network in that kind of way and I think -- well, I don't think, but what the industry wants to do is move to this unified architecture, which the Universal EdgeQAM enables so that they can have much more flexibility and control over these services.

Excellent.

Who are the players that can compete with you right now in the Universal EdgeQAM that offer all three things?

Well, I -- truthfully, I don't know, Paul.

There's a lot of noise out there and there's certainly a lot of people who have, I think, come to the realization this is an exciting opportunity, doing different things with different products.

And I certainly wouldn't want to go on record and say who has got what.

I mean I think from our perspective, the key point is is that we are the clear leader in EdgeQAM technology.

That's from a technology point of view, but perhaps just as importantly from a market share point of view.

And I think one of the important things to realize about our technology and maybe as people think about the way this EdgeQAM business evolves, I mean we also have the capability to go back to installed EdgeQAMs and bring along new software to enable some of these additional functionalities.

So we absolutely plan on leveraging, not only our strong technology, but leveraging our strong installed base to continue to lead this market.

So you won't need to do a forklift to do a current NSG user to a Universal EdgeQAM capability.

You can do that in software, maybe cards?

It depends on the, it depends -- certainly for our 9116, which is most of what's out there, we can support many of the applications we're talking about.

And certainly I think that's a big part of Harmonic's value proposition.

The way our new Universal EdgeQAM can actually work cooperatively.

I won't say that the 9116 can support everything, but we can do a great many things and I think that's of tremendous value to our customers who have a large installed base of 9116s and therefore I think it will really work to our advantage as we work to maintain a strong leadership position here.

Excellent.

Thank you very much for your time.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question is a follow-up from the line of Greg Mesniaeff with Needham & Company.

Just two very quick housekeeping questions, Robin.

What was your total percent of overseas revenues?

In the second quarter, 46%.

Okay.

And you gave us a breakdown not by satellite versus cable versus telco, but by the product categories.

Could you just run through that again real quick?

Yes, actually, Greg, just for the record, we've actually put an analysis of our revenue in the press release.

We've not previously done that.

We've usually just given the numbers on the call, so you will find it in the press release.

Oh, okay.

But the products, video processing, 40%.

Edge and Access, 44%.

And software and services, 16.

Got it, okay.

Great.

Thanks.

Your next question is a follow-up from the line of Marcus Kupferschmidt with Lehman Brothers.

Hi, guys, just wanted to be clear, since you guys said that you're looking forward to some better activity certainly on the NSG products in the second half of the year, should we interpret that you had, you expect that the cable business in the second half of the year to be up from the first half of the year for what you know today?

I think really just in proportion to the guidance that we've given, which is somewhat above the first half, so at the top level, we don't -- we're not trying to forecast or communicate a top level mix of change from customer segments.

But just, we see the tide rising across the markets that we serve.

Okay.

Thanks.

(OPERATOR INSTRUCTIONS) And it appears that there are no further questions, sir.

Do you have any closing remarks?

I would just like to thank everybody for participating in the call today, and we look forward to speaking with you again soon.

Good day.

This concludes today's conference call.

You may now disconnect.