Harmonic Inc (HLIT) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

I will be your conference operator.

At this time, I would like to welcome everyone to the Harmonic third quarter 2009 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).

(Operator Instructions) It is now my pleasure to turn the conference over to Mr.

Robin Dickson, Chief Financial Officer.

Sir, you may begin.

Thank you, Gerald.

Good afternoon, everyone.

I'm Robin Dickson, Chief Financial Officer of Harmonic.

With me in our headquarters in Sunnyvale, California are Patrick Harshman, our President and CEO, and Michael Newman, our Investor Relations spokesperson.

Thank you for joining us.

Before we start, let me remind you that during this call we may make projections or other forward-looking statements regarding future events or the future financial performance of the company.

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

We refer you to documents that Harmonic files with 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 that determine 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.

I'll now invite Patrick to give his introductory remarks and then I will address the financial details of the quarter before we open up to take your questions.

Patrick?

Well, thanks, Robin, and good afternoon, everyone.

Today we announced third quarter results that demonstrate Harmonic's continuing strong position in the marketplace, and in particular, very encouraging sales growth among our expanding base of international customers.

Compared to last year, we do continue to see cautious customer spending, and we've adjusted and focused our business execution accordingly.

We've continued to carefully manage our operating expenses, while at the same time, we've successfully continued to drive our strategy as aggressive technology leadership across a range of new video applications, customers, and geographies.

Geographic expansion and growth of our customer base has been a clearer strategic priority.

We're excited by our recent progress.

Having completed the full integration of the Scopus business, we began to see real sales synergy benefits.

With both an expanded product offering and strengthened local sales presence, our third quarter business in Europe rebounded sharply from what we saw in the first two quarters of the year.

Our business in Latin America is firmly on track for year-over-year growth and our third quarter bookings in China and India were both up significantly.

In fact, well above the levels seen during any prior period over the past several years.

While strength in local sales presence has certainly contributed to our success in these international markets, the impact of our industry-leading technology has also never been more important.

The move to high-definition video is now becoming a key market driver around the globe, and our high-definition encoder platforms continue to gain strong traction across markets.

This was certainly the case in recently announced wins with Deutsche Telekom and Sky Brazil, as well as with new wins in China, where HDTV is just now being introduced.

We're working closely with a number of existing cable, satellite, and telco customers, who will use our new Electra 8000 technology, not only for adding new channels, but also to efficiently compress existing HD channels.

While our domestic cable customers have been cautious about capital spending this year, our newest generation NSGF clump continues to gain important market share in video on demand, switch digital video, modular CMTS, and new IPTV over cable applications.

And looking ahead, we see compelling opportunities in each of these application areas.

Of course all these new video services are demanding bandwidth, and our cable customers also continue to respond positively to our new superlink WDM technology for provisioning more bandwidth into the cable network.

Also during the quarter, we introduced our new Media Prism Conversion Suite for multiscreen video delivery to iPhones and other mobile devices and PCs and we're very encouraged by recent progress with this new solution set.

We've been an important partner for two large customers who recently deployed new mobile video services and we're actively engaged in several other high potential mobile video trials.

While these mobile video solutions will not represent a significant portion of our revenue in 2009, our sustained investment in technological innovation for mobile video services and growing service provider confidence in the viability of mobile video business models caused us to be optimistic about our growth opportunities in this emerging space.

While we're still walking before we run with this new suite of software applications enabling mobile video, I do want to highlight our more general success in growing our software and services revenue, which is up 15% through the first three quarters of 2009 versus the first three quarters of 2008.

In this challenging economy, the strong growth is an impressive testament to our focus and success growing new revenue streams from services and software applications.

So with global spending continues to be softer than a year ago, we remain convinced that by continuing to innovate, by continuing to strengthen our competitive position with a growing base of global customers, and by keeping our internal business execution firmly on track, we're positioned extremely well for growth in 2010 and beyond.

I'll now ask Robin to cover the financial aspects of the quarter.

Thank you, Patrick.

Today we announced our results for the quarter ended October 2, 2009.

For the third quarter, we reported net sales of 83.9 million, up from 81.3 million in the second quarter of 2009.

Our lower year-over-year sales reflected continuing lower capital spending by most of our customers around the world.

However, during the third quarter of 2009, we saw sequential increases in quarterly revenue and bookings from our international customers.

On our earnings call three months ago, we noted a better tone in Europe.

We started late in the second quarter and this positive trend has continued into the third quarter.

More recently, as Patrick indicated, we've seen an improved environment in some of the larger emerging economies, particularly in China and India.

International sales represented 52% of revenue for the third quarter of 2009, up from 43% in the previous quarter and 39% in the third quarter of 2008.

We're encouraged to see this growing international activity and additional penetration of new customers.

This is a key part of our strategy and is due at least in part to the new sales channels and products we gained from the Scopus acquisition.

By market segment, cable customers accounted for 56% of revenue, satellite 21%, and telcos and others 23%.

This translates into sequential growth in both our satellite and telco businesses, but at the same time, we saw a sequential decline in revenue among our cable customers.

The third quarter decline may seem surprising following the strong performance of the cable market in Q2.

We think it's mainly due to the unpredictable nature of order timing from quarter to quarter, as we've now seen improved order input in October from several key cable customers.

In the third quarter, our largest customers was once again Comcast, representing 15% of total revenue, while EchoStar contributed 10%.

It's also worth noting that for both the third quarter and year to date, our top 10 customers represented less than 50% of our revenue, showing that our international growth and the Scopus acquisition are helping us to meet our strategic goal of custody verse fix.

By product category, edge and access products represented 39% of revenue for the third quarter.

The video processing, also 39%.

And software services and other, 22%, essentially unchanged from second quarter.

In the third quarter of 2009, our gross margins were somewhat lower than we expected, primarily due to a combination of product mix and some supply chain factors.

For example, in the edge and access category, we saw slightly lower sequential revenues from our edge devices compared to the previous quarter offset by improved revenues and Optical Access products, which carry lower margins.

Within the EdgeQAM product line, we saw increasing deployments of our new scalable multiport uptell platform.

As with previous generations of EdgeQAM , the new chassis itself carries low initial gross margins.

However, as more of the clam ports are activated in the future, we expect to see a more favorable margin impact at that time.

We also had a more back end loaded quarter than we expected.

In addition to the usual forecasting challenges that this brings, we ran into some lead time fluctuations in our supply chain.

As many other companies have experienced some component suppliers have run down inventories in response to the recession and had some difficulty in ramping up quickly to meet improving demand.

While we were able to overcome most of these supply issues without any serious customer consequences, we encouraged substantially higher freight costs, mainly as the result of expediting air shipments, both within the supply chain, as well as directly to end customers.

Until recently, our non-GAAP gross margins had been holding around 50%, driven by the continued success of new products and solutions, our sourcing strategy, and ongoing cost reduction efforts.

While we don't expect to get back to these margin levels this year, we do expect our gross margins to improve, as the short-term supply chain issues are resolved and our software mix and overall volumes increase over the longer term.

We continue to be pleased with our discipline in managing operating expenses, which are down very slightly from the previous quarter at $32.7 million.

Having completed the integration of Scopus into Harmonic, we're pleased that the anticipated cost synergies have now almost been fully realized.

We ended the third quarter with 849 employees, up by 7 from the end of Q2.

Our GAAP net income for the third quarter was $2.6 million, or $0.03 per diluted share compared to $12 million net income, or $0.12 per diluted share for the same period of 2008.

GAAP results in the third quarter of 2009 included modest restructuring charges related to the recent acquisition and continuing integration of Scopus.

Excluding these charges and noncash accounting charges for stock-based compensation, the amortization of intangibles and tax adjustments, non-GAAP net income for the third quarter of 2009 was $4.5 million, or $0.05 per diluted share compared to $15.9 million, or $0.17 per diluted share for the same period of 2008.

The non-GAAP net income includes a tax charge of 35% in 2009 compared to a nominal rate in 2008.

We continue to maintain a strong balance sheet.

We ended the quarter with cash, cash equivalents, and short-term investments of $253 million.

We are in a strong position to pursue further acquisitions, or other initiatives to achieve our strategic goals.

Our receivables increased to $70.3 million at the end of the third quarter, up from $64.5 million at the end of the second quarter.

Our DSOs were 77 days, also up from 72 days in the previous period.

The higher DSOs reflect the back end loaded quarter, with the high proportion of sales coming in September, as well as a richer mix of international sales where payment terms are typically longer.

Our inventory was 30.7 million, down approximately $3.5 million from the end of the second quarter and down about $7.5 million from the end of the first quarter.

The reduction in inventory levels and the improvement in terms reflect our success in integrating and streamlining Scopus production and procurement processes.

And finally, our capital spending was $2.3 million in the third quarter and we expect our CapEx to be approximately $8 million for the full year.

Turning to the outlook, the fundamental trends and competitive dynamics that have been driving our business remain in force, but are still muted considerably by the global economic slowdown.

While we want the terms of the annual sales levels of 2008 in this calendar year, we have seen sequential improvement in revenue during both Q2 and Q3.

We entered the fourth quarter with a total backlog and deferred revenue of approximately $70 million.

Q4, of course, is a short quarter, in part due to the holidays and in part because many of our customers have imposed deadlines for product deliveries in advance of the end of the year.

So while the short quarter and lingering components supply problems pose some distinct execution challenges, we believe that Q4 revenues will be at approximately the same level as Q3, within a range of 80 to $86 million.

We expect our non-GAAP gross margins for the fourth quarter of 2009 to be in a range of 47 to 49%.

While some of the factors which affected gross margins in Q3 may repeat to some extent in Q4, we believe that our longer margin trends, longer term margin trends are positive as the result of our new product introductions and the growing influence of software and services.

We believe our product strategy is on the right track and our medium-term gross margin target continues to be 50%.

With respect to operating expenses, we are pleased with our progress and cost control and executing on the cost synergy targets for the Scopus acquisition.

We expect that our non-GAAP operating expenses for the fourth quarter excluding charges for stock-based compensation and the amortization of intangibles remain relatively flat or slightly up from the third quarter in a range of 33 to $34 million.

So in summary, while our business in the third quarter had only modest sequential growth, it does show that the momentum is gradually heading in the right direction.

We are well placed with a strong balance sheet and a healthy operating model, allowing us operational flexibility and the opportunity to use our strong financial condition to our competitive advantage.

We continue to be successful at penetrating new international sales opportunities and demonstrating that our acquisition of Scopus is starting to get real traction on the sales front.

By investing in technology leadership and supporting our diversified and growing customer base, we believe that we will further strengthen our competitiveness and extend our global market presence in 2010 and beyond.

This concludes the formal part of our presentation.

Patrick and I are now pleased to open it up to your

(Operator Instructions) And your first question comes from Mark Sue with RBC Capital Markets.

Thank you.

Good evening, gentlemen.

I'm still trying to understand why the actual results were different from those projected.

was there a longer evaluation cycle with your customers in the US?

Was it a broad-based weakness in North America cable or was it just Comcast and did you recover some of the deals that had slipped into this current quarter.

Mark, our guidance for the quarter was $82 million to $88 million, and we are comfortably in that range -- we're comfortably in that range.

I think from a revenue perspective, if it was any surprise, it was perhaps the strength of the international business, which was very encouraging and admittedly, relative weakness of the domestic, of the domestic customers.

If I take 4 million from the high end of your guidance, can I say $2 million was due to North America being down sequentially and another $2 million related to supply chain, is that kind of how we can look at it?

No, as I said in the prepared remarks, we don't really believe that we missed any shipments as a result of supply chain problems.

It definitely caused us some additional costs, which are reflected in the gross margins, but from a revenue perspective, I don't want to give the impression that we saw that as a limitation on the top line.

I think you're right to observe that domestic sales were, as I said, relatively a little bit weaker than we expected, but commensurate with that, international sales were I think on the other hand a little stronger than we expected.

Got it.

Then by all accounts, the macro seems to be better in North America.

Cable CapEx seems to be healthy.

Is there something going on from a technology shift point of view?

Are they looking at other options when it comes to deployments, or any color on North American cable would be helpful.

Yes, Mark, we've not seen any meaningful change in the technology or competitive landscape in cable.

We believe that our technology competitive position is as strong as ever.

The response to our news products has been quite positive and we're quite confident we've not lost any market share and in some instances, we've regained market share.

I think we're still in the middle of the reporting season and there's a number of customers coming at this market with exposure to the US cable market.

But at least from what little I've seen, we're somewhat unique in that our third quarter revenue was up and, and I don't think that people are appointing to -- I have not seen any indication of tremendous strength in US cable in general in this third quarter.

So we, we feel that we still have just seen somewhat cautious spending from US cable operators.

We have continued to gain, we think, our fair share or somewhat more of what spending was there.

And we're really pleased that we've been, you know, focused on and executing a more general diversified global customer model that gives us exposure to a lot of other markets and customers around the globe.

Thank you, gentlemen, and good luck.

Thank you.

Your next question comes from Amir Rozwadowski with Barclays Capital.

Thank you very much, and good afternoon, Patrick and Robin.

Good afternoon.

Just trying to reconcile your commentary about the improved bookings in the month of October and the thought process of perhaps just slight sequential growth or sort of in line revenues for the fourth quarter.

How much of that is being impacted by some of these components supply problems and how should we think about sort of, you know, when, when will you be able to move past those supply problems?

So I think -- let me try to take that Amir.

I think we've -- perhaps we've left the wrong impression.

I think we wanted to point to the, to some of the supply chain challenges that we had in nonlinear demand throughout the third quarter is really trying to give you some granularity on where some of the gross margin went in the third quarter.

While, there still may be some issues in the fourth quarter, we see that as largely a third quarter event, and I think in any event, that is I think distinct for customer demand.

We did acknowledge that we've actually seen some pretty good order activity from some of our cable customers in the beginning of Q4, but frankly, we just chalk that up to the vagaries of timing of certain projects and we've seen some projects kind of moving forward here in October.

I think that's certainly an encouraging sign, but we don't necessarily take it as an indication of what's going to happen for the remainder of the quarter.

And in fact, we don't think it's going to be a down quarter, from a demand point of view.

But on the other hand, I would say our view is somewhat cautious, that it's probably not going to be dramatically different from a demand perspective than the third quarter.

Okay.

So the thought process is more along the lines that you've seen this pickup and certain take rates, but if we are to interpret your guidance, certainly it doesn't seem to carry over that pickup into your take rates into your guidance for the fourth quarter.

Yes, I think that's right.

I think by highlighting the early Q4 activity, I think we're trying to say we don't read into and we wouldn't suggest you read too much into the fact that, that domestic cable was light in Q3.

We had a pretty strong, actually quite strong bookings quarter in Q2 and we've seen some early activity in Q4.

So we chalk it up a little bit more towards just the natural timing and ebb and flow of spending around projects that we're positioned for.

That being said, I, I think given, given the overall tone of this year, and the cautious approach to spending, we're not expecting this quarter, unlike some in past years, to end with a big bang.

Okay.

That's very helpful.

Then lastly, if I may, I was wondering about sort of the reception on the Electra 8000 and some of the projects that you have going on there.

I mean, it seems as though you've already had some service providers that traditionally may not have looked at that product, but are now looking to work with the product and I was wondering if you could give us a little bit of color there.

Yes.

Well, we continue to be very excited about the product and I highlighted a couple of releases.

I think one of the really neat things about the product is within one hardware platform we brought together top notch HD encoding, as well as SD encoding or a mix of the two, both MPEG-2 and MPEG-4.

What that means is it's the same product that we're working with our top tier direct to home satellite operators with, who are delivering services in MPEG-4, same product is also being put to work in cable environments, where today it's going to be MPEG-2 and in a very dense fashion, we've been talking about four HD channels and one analog channel slot, and I think in addition to the video quality and the compression efficiency today, the other thing that the product brings to cable is a migration path to MPEG-4, which I think is increasingly viewed as something that's coming down the road by the cable industry.

And of course the product is also seeing good traction in telecom.

I highlighted a win that we were able to publicly disclose and discuss, which is with Deutsche Telekom.

We're pleased about that, and more generally we see this as a great product for IPTV telecom providers and we're getting the traction in that space as well.

I think that's part of the strength you see in the telco and other segments this past quarter.

Great.

Thank you very much for the incremental color.

Thank you.

Your next question comes from George Notter with Jefferies & Company.

Hi, guys, thanks.

This is actually James Kistner calling in for George Notter.

So I guess I was curious, is it safe to say that your cable business at this point, the vast majority of that is edge and access?

Is there any video processing, or I guess is there a way to give -- edge and access in there?

We don't break it out exactly that way, but I think if you do look at our numbers, you can see that the cable industry is, cable is quite a bit more than just edge and access.

I think edge and access we said was 39% of our business.

That's 100% in cable.

But of course cable was responsible for, Robin, 57?

56.

56% of the business.

So obviously another approximately 20% of the business of the revenue was non-edge and access business with cable.

And as just discussed in the last call, that spans a range of technologies, probably most prominently encoding, both high-definition and standard definition, but, looking forward, I also highlighted in the prepared remarks mobile video.

We certainly see a lot of cable interest in mobile video, video delivery to PCs.

That's becoming an interesting area for us, and on demand become -- is also an area of revenue contribution and we believe growth in the cable space.

I guess as a follow-up, you said the cable operators are doing a lot of work on -- obviously Comcast is very vocal about that and so -- another strategic area.

I'm sort of wondering, you know, at some point do we see sort of an in flexion point on the video processing side of cable?

Do we start -- could next year be a big growth year for cable as they expand their channel counts?

Seems to me that cable operators are still pretty far behind in terms of their widely available HD channel counts, or is there a reason to believe, given that there's less decoding and reencoding that perhaps it will be a trickle and sort of a slow, you know, roll for video processing equipment sales to cable?

I think it remains difficult to predict exactly when, but I think there's no doubt that there's a couple of areas where you're going to see substantial investment.

I think it's very clear that the, it's an overgeneralization but the industry is still trailing what direct to home satellite is doing in HD -- high-definition video.

Both broadcast, as well as on demand.

And we think that obviously drives several different of our opportunities for several different of our product lines.

Certainly another part of that is DOCSIS 3.0 and one of the things that will happen there is IPTV.

And we're, as I mentioned a moment ago, we're also excited about the associated video opportunities around that.

So I think it's -- I think I've held back from kind of predicting exactly when and if it will happen in kind of a big bang fashion that you'll see a wave of investment, but there's no doubt that the reason for provisioning all of this bandwidth, whether it be native impact bandwidth with all the digital analog reclamation, or pinning up more DOCSIS capacity, it's really all in the end so that more video can be delivered over the network and we think it's clear.

This is going to be a tremendous growth opportunities for companies like us delivering that video processing capability.

Thank you very much.

Thank you.

Your next question comes from Vivek Arya with Banc of America-Merrill Lynch.

Thank you.

Hi, Patrick.

Is it fair to think that for your cable customers DOCSIS 3.0 upgrades are becoming bigger priority than just expanding the number of HD channels?

I'm trying to see if the trends you are noting are because the spending is shifting -- or is it just a temporary sort of CapEx type issue that could be resolved as their spending resumes?

I think that this DOCSIS 3.0 clearly has been a key priority, and I think it's clear that the spending there has been good.

I think probably the number one competitive battle in the broader landscape, when you think not only about direct to home satellite, but in particular about telecom operators entering the video space, I think the number one battle field is, today, is high speed data.

And so it's not surprising to us to have seen relatively strong CapEx focus on DOCSIS 3.0.

However, we, we think in the history of our experience at least with cable operators is that you do see waves of investment and waves of focus.

And we were just talking a moment ago, we believe that focus on more HD, focus on expanded VOD platforms, and more generally, I would think the industry has taken strong note of the Cablevision court victory and we think there's going to be a lot of focus on Network-based PVR, time shifted, time delay TV, pushing video to other platforms once this DOCSIS infrastructure is replaced.

I said a moment ago I think it's premature to comment on the level of overall spending.

We believe we'll see spending slash back more to the video capability that will utilize a lot of this bandwidth that's been provisioned in the last year, 18 months.

Next, on the operating expense side, do you see any opportunity for cost cuts, or do you think that OpEx will probably stay around current levels for the next several quarters?

Vivek, it's our intention to keep it very flat over the next few quarters, assuming that there is no major change in the general macroeconomic environment.

But certainly for the foreseeable future, I think flat is the, flat is really the operating term, operating assumption.

All right, and also, I think on the positive side you guys still have a very solid balance sheet and I think right now it's over half of your market cap.

Why not take advantage of the weak stock price to do a buyback, or do you think that our other accretive uses of your cash?

Well, we're always reviewing opportunities to use the cash.

As we've said many times before, the prevailing sentiment here is that we use it, as you say, for accretive opportunities and we're certainly spending a fair amount of time and energy looking at a number of varied possibilities, and that is certainly our preference, is to use it for M&A purposes or similar.

Got it.

And just one final question.

Let's assume that next year there isn't a major recovery and I know you're not guiding for 2010, but let's say sales only grow mid to high single digit at best.

Do you think you can stay cash flow positive even with that kind of revenue trajectory?

Yes, I believe so.

If we see even modest sales growth and we do as we said we would, which is continue to contain our operating costs, I don't see why we wouldn't be generating at least a modest positive cash flow.

There is no pricing pressure or any other thing that could impact your gross margin.

I guess that's the way I should have asked the question.

Well, I mean pricing pressure is a constant I think in some product areas as we all know.

There is over time there is pricing pressure.

I mean it's often related to higher unit volumes at the same time and of course in our case we are usually able to keep ahead of the technology curve and keep introducing new and improved products with additional features and so on.

That's how we compete.

So I, I guess I would say I don't see anything extraordinary in the pricing environment, Patrick.

I think that's right.

Great.

Thanks.

Good luck.

Your next question comes from Blair King with Avondale Partners.

Yes, good afternoon.

I have just one question returning back to the gross margin topic.

Robin, I think in the recent quarters with the gross margin being depressed, one of the, one of the reasons that you've cited for gross margin compression has been volume related.

And now it appears that the volume is starting to improve and I understand you've got some short-term issues that you have to deal with, but as we think into 2010, should we still be thinking about gross margins in 49 to 50% range with your goal of potentially even exceeding 50%?

Yes, I think that's reasonable.

Given some improvement in overall volumes, what Patrick said, the -- changing positively in a direction of higher margin, software and services products.

So, again, hopefully with the resolution of the shorter term issue, like for example we saw in the third quarter, but with freight.

Yes, I'm comfortable, as I said, in the prepared remarks that we should be able to get back to a 50%, into the vicinity of 50% in the medium term, which I would certainly define as next year.

Okay, thank you.

Your next question comes from Greg Mesniaeff with Needham & Company.

Yes, thank you.

When you look at the US business and, you know, kind of the softness there, can you comment on the EdgeQAM environment in the quarter?

We have seen a fairly robust DOCSIS 3.0 upgrade level activity going on at the CMTS and various infrastructure points, and I can't help but wonder that, there clearly has been some activity at least in the EdgeQAM area, particularly with some of the MSOs.

So I'm just kind of wondering, has there been any changes to the previous, robust profile that you've seen in that activity and what has changed?

And then my other, the second part of my question is if you could maybe give us some color as to the initial uptake on the Electra 8000.

I know you've been in trials, and I'm wondering what currently the pipeline for that looks like.

Thanks.

Well, first of all, Greg, on the edge and access, our revenues in absolute dollars from edge and access were actually up in the third quarter over the second quarter, very modestly, but nevertheless were up.

And significantly up over the first quarter.

So we don't see any weakness or concern there with respect to edge and access.

One other thing perhaps we didn't point out, but you may remember in the second quarter, we had a fairly substantial chunk of revenue that came into the quarter as a result of completing a major project we had been working on.

That was a cable, a cable customer and if you were to -- in fact, if you were just to take that out of the numbers in Q2 and as a perhaps extraordinary type item, then in fact the third quarter, from the cable market perspective or the domestic perspective is really pretty flat with Q2.

So maybe, maybe we're, maybe you're overdoing perhaps the suggestion that US sales were weak.

I mean this is just one of the things that happens with some of the vagaries of revenue recognition.

And I think if you look at the underlying trends and were to either apply that over a number of quarters that the project took or just take it out of the numbers completely, then I think the trends look a lot more reasonable than the absolute numbers might suggest.

I think the second part of your question was around Electra 8000.

I think Patrick had already commented on that to some extent, but I'll pass that question over to him.

Yes, Greg, the 8000 continues to I think -- domestically, internationally and across the different customer segments.

We started shipping the product in earnest several months ago and it's, it's definitely flowing.

We have the product driving live systems today and we have a healthy pipeline of engagement, trials, demos, and discussions.

So we're, we're -- we continue to be quite excited about that product and, and we think it's really going to help us maintain and perhaps even extend our, our global market share lead in the encoding space.

Patrick, being that that product is both MPEG-2 and MPEG-4, do you foresee the opportunities for the product as more of a satellite refresh, sale, or more heavily skewed towards, the eventual changeover from MPEG-2 to MPEG-4 among the cable operators?

I would say the opportunities are comparable, Greg.

The coding efficiencies are such that they do provide on the MPEG-4 side anybody, satellite or telco, for example, who has deployed previous generation HD, this is an opportunity to really claw back some significant bandwidth at the same video quality by using much more efficient compression.

At the same time, I think the industry thinks that there's still a lot of HD work to be done in the cable environment and while I think the to transition to the fact the product can transition from MPEG-2 to MPEG-4 is a nice added feature, I think the right that's really selling it and really getting our cable customers excited is the fact that it's a fantastic quantum leap forward in MPEG-2 compression efficiency.

So just in an MPEG-2 cable world, customers are looking at it and realizing how many more HD channels they can fit in a fixed slot of bandwidth and we see that as a substantial opportunity as well.

Thank you, Patrick and Robin.

That was very helpful.

Thanks.

Your next question comes from Hasan Imam with Thomas Weisel Partners.

Hi, this is [Shibul Goosh] on behalf of Hasan Imam.

I was just wondering, do you break down at this point the percentage of revenues from Scopus and also, what's the margin impact on Scopus has been a little bit of a drag to overall margins and has that contributed to margin weakness in Q3?

We don't attract Scopus either products or customers separately.

There's just too much overlap and we've integrated Scopus completely into our existing organization and so it is not being run as a separate, as a separate unit.

I think the best thing I can point to is the growing momentum we seem to have in international sales.

And while clearly some of that can be attributed to perhaps an improving economic environment, at least in some countries and maybe a little bit more customer confidence, there's no question in our minds that some of it can be attributed to the fact that we're now getting some significant traction from the Scopus sales channels and products.

To your margin question, there's really no significant difference, and I certainly wouldn't want to attribute any margin fluctuations to the effect of the Scopus products, as you may remember from their stand alone days, Scopus margins were actually very comparable to Harmonic margins and we've seen no fundamental change in that relationship.

Thanks, Robin.

If I may have a quick follow-up, in that case, if I were to look at the reasons for the gross margin weakness this quarter, you mentioned product mix and supply chain issues regarding freight cost.

Could you perhaps quantify what caused it, what percentage came from product mix versus supply chain freight?

Well, if you look at our second quarter and take out that large project that I mentioned earlier, which was a very specific low margin project in Q2, if you take that out our adjusted non-GAAP margin was 48%, this quarter it's 47%.

So I mean first of all, in our view, we're not talking about really material differences.

Clearly that's not the direction we would have preferred to go, but we're talking about, 100 basis points.

I would say roughly, and this is very roughly, you could attribute perhaps a third to a half of it to the freight issue and most of the rest of it to the various product mix issues that I mentioned earlier.

Great, thank you.

Your next question comes from Simon Leopold with Morgan Keegan.

Great, thank you.

Just a quick follow-up on the discussion about gross margin issues.

Is your international business typically similar or lower gross margin than your US?

I'm not sure there's really any major differences.

I mean clearly in some parts, we see higher margins, but, we're also working with some very large customers and also to some degree with distributors and integrators as well where the margins can be lower.

I would say broadly speaking, and we don't break it down publicly, but broadly, there's no significant difference between domestic and international.

I think I recall the March quarter you talked about the relative strength of the dollar had pressured some of your international sales and that was one of the reasons for light sales in the March quarter.

And I'm just wondering if particularly the improvements we're seeing in international in this quarter, the strength there, could be relatively weaker dollar?

I don't remember the currency charts exactly off the top of my head, but I think the effect of dollar weakening has been most pronounced just in recent weeks, so I don't think it had an enormous effect on the quarter, but I do grant you that theoretically, you're right in that it's possible that we could see more, more favorable effects in the fourth quarter on the, on the revenue and the gross margins.

And then just looking out to the fourth quarter, what kind of assumptions in terms of your segments video processing edge and access software, what kind of assumptions are you making for mix shifts and customer shifts versus the third quarter?

Nothing too dramatic.

I think we see a fourth quarter profile that isn't too different from Q3.

It may be, maybe it gets a little closer back to 50/50 domestic/international, but we don't see substantial changes in any of the breakdowns that we provide to you, either products or geographies or markets.

I guess one aspect kind of puzzling to me, the third quarter is usually a good quarter for cable spending and then seasonally down in the fourth quarter.

So I guess what I'm struggling with, is okay, cable was weak for you guys in the third quarter.

Should it be up sequentially in the fourth quarter?

And if so, why the nonseasonal pattern?

Well, I think it's mainly just order timing.

I think customers in general, and this is not a particularly related to cable, but I think it's certainly true of many cable customers.

that the projects are being very carefully reviewed and only, released to purchase orders after some very tight scrutiny, and I think we've seen some of these processes that work all year.

Sometimes things happen, sometimes they don't.

And some of the things that do happen, happen later than either we think or even than the various divisions and systems think.

So it may not sound like a great explanation, but I think it's the best one we've got.

I would also say, again, don't forget that from a revenue perspective, we did have a big project come in in Q2 that really was taken way back in 2008 and so I think if you adjust the revenue for that or at least make some allowances for that, then you are really looking at a cable segment that was really a lot more like flat than, than weak or substantially down.

And is the project in Q2, was that primarily edge and access EdgeQAM business?

No, it was more on the video processing head end side.

Okay, great.

Thank you very much.

Okay.

Your next question comes from Larry Harris with CL King & Associates.

Yes, thank you.

I have a few questions, but they are not specifically related to the quarter.

First, the cable operators are certainly more interested in IP video and I was wondering if there were specific products that you have that could benefit from that deployment and if there are other products where you might have to upgrade or redesign based on an IP-type transmission.

There's a number of opportunities that IPTV and the cable environment presents us.

Maybe before I get into products, just highlight the fact that we've been so successful and active in IPTV with telecom, I think that just that company experience and expertise before we even get into a product I think is, puts the company in a particularly good position.

No particular order.

I mean I'll start with the EdgeQAM and some of the unique IPTV architectures that are so-called direct to edge solution based on our EdgeQAM enable.

You may recall last quarter we announced what we still believe to be the largest live deployment of IPTV in the world with SK Telecom in Korea based on our edge technology for delivering IPTV.

And so first area of opportunity is in the edge.

And then behind that is more, is variations of more traditional video processing and some of the new software capabilities.

I highlighted our media prism suite of solutions, which is really designed to deliver both broadcast and on-demand video to a variety of different screens, everything from a television to a PC to a mobile device.

And as our customers are thinking about IPTV, I think that's really a big part of the promise of it.

You're not going to use IPTV just to recreate the existing service, but in fact to deliver a richer service that is going to target multiple devices.

So I see a whole range of capture, startover capability, streaming capabilities, of course trans coding capabilities to render incoming video stream and different formats for different devices.

So there's a range of technologies there and all together we think it constitutes really exciting opportunity for the company.

Great.

And the other question that I have, it's been publicly reported that your EdgeQAMs are being installed in New York City in conjunction with Cisco CMTS equipment for Time Warner Cable.

And I was wondering if as we look ahead over the next 12 months or so, that you could see a significant increase or an increase in demand for edge as part of a modular CMTS solutions.

Well, first, I would emphasize you haven't heard that from us.

But more generally, specifically about New York City, so no comment on New York City, but generally, I think modular CMTS opportunities in general and with, in the context of a Cisco system in particular has been, it was a strong proponent of the EdgeQAM revenue we saw in 2008.

We continue to be active and quite successful this year and we continue to see it as an important element of the broader EdgeQAM opportunity that we have in front of us.

But you think it can increase?

It certainly can.

I think it, I think it remains to be seen.

I think that -- I don't want to oversell the modular CMTS architecture.

I think it makes sense for some network providers and not for others.

We've -- and I think the jury is really still out on how, how widely the architecture will be adopted.

So we think to the extent it's adopted, we're in a great position.

But I think we need to wait a little bit longer and see exactly what the penetration will be.

But I think as you, as you point out, there's a number of leading operators that, that are increasingly I think appreciating the advantages of the architecture.

Okay.

Thank you.

Thanks.

(Operator Instructions) And your next question comes from Paul McWilliams with Indie Research.

Hi, guys.

Thanks for taking my question.

I'm trying to put a finer line on some things and rather than looking at the sequential as you have through most of this, let's take a look at the year-over-year.

Year-over-year revenues are down $7.6 million, and I understand many things have changed in the economy worldwide.

Edge and access is down $10.3 million, so more than 100% of your total down.

Cable is down 10.8 and the US is down 15.4.

This would lead me to believe that had it not been for Scopus, we would see a fairly significant year-over-year total and I'm trying to put a finer line on what shareholders have gotten of value in this Scopus acquisition.

Can you give me something there?

I realize you don't track it as separate line item, but you have to have some degree and feel for it, and is it mostly, or all video processing, is my understanding, is that correct?

Yes, you are.

I mean look, I think you've, you have yourself just put a line under it.

I mean I think, I think you can take a look at it.

The video, relative strength of the video processing number compared to the edge and access number to which there is no contribution from Scopus, I think that, the difference there speaks for itself.

And I think it's clear that from a product perspective, you know, the contribution of Scopus is clear.

I, as we said as well in our prepared remarks, you look at the strength of international and while it's simply not possible to finely kind of attribute this win in India, this win in China, this win in Western Europe is attributable or not because we're selling these customers a mixed bag of products from Harmonic and what was Scopus, I think if you look at it in aggregate, which we do, you know, there's a clear marked strength there that although international sales has been a focus of ours, I think it's quite clear that we need to attribute a significant portion of that strength, particularly in the emerging markets to what Scopus has brought to us.

Well, carrying that thought forward then, edge and access is down year-over-year roughly 24%, so would it be anywhere near accurate to say that had it not been for Scopus aggregate might be down close to that 24%?

I don't think it's entirely unreasonable, Paul.

I think that, we have a somewhat concentrated collection of large cable operators.

Our video processing products in general go to a more diverse array of customers and is inherently more international.

So I think that even without Scopus, I think we would probably see our video processing numbers not quite as affected just because the statistics work better and we would be benefiting in any event from some of the recovery we're seeing in some international markets.

But with that being said, that's maybe a secondary consideration and I think your gross analysis is, is not unreasonable.

Okay.

Now, another large US provider to the cable market reported this week, without mentioning names, they reported their revenue down 7.4% year over year, and they're more integrated CMTS versus your modular CMTS and they spoke directly of great successes with CMTS.

Are you losing anything in your edge and access?

Are you seeing more deals go integrated than going modular?

I'm trying to understand what's going on here in these dynamics, and I want to get a fair understanding.

Yes, so for us, the CMT, the modular CMTS, it represents last year and this year represents less than 10% of our edge and access business, but it's an interesting but somewhat exciting new application, but in scale, we've been consistent about this.

It certainly is dramatically smaller than the Edge contribution to VOD, the HFC business, perhaps to digital TV and IP video in aggregate.

So, look, the CMTS business has been a great business to be in.

I think it's held up relatively well and I think we certainly think it's a great place to he be and that's not to take away anything from the execution of the companies who participate directly in that space.

I think if you look at companies, other companies out there who have reported or have provided forecasts for the quarter, kind of largely serving the cable industry who are not in CMTS, I think you see some much more significant changes to the overall revenue profile.

And so I think that, I think from that perspective, what we've seen is not out of sync with hearing from the broader industry about relative cable spending and/or the focus of that spending.

Now, backlog and deferred revenue, I believe it ended last quarter at $75 million, is that correct?

I think it was around 73, Paul.

Oh, okay.

So it's down just slightly.

Slightly, Yes.

Okay, and you mentioned your OpEx, you hoped to hold that flat going forward for a while now.

When do you expect that that would be in the mid 30% of revenue, which 35%, which is kind of the target that I believe you're going for?

Well, I think that is a function of how things turn out over the next, next few months.

I mean I think our view at the moment is that the business has at least stabilized and is showing certainly internationally in particular some signs of improvement.

I think if we continue to see that, that pattern, then our inclination will be to allow the revenues to grow, keep the expenses as flat as we can and allow things to come back into line naturally, if you, if you like.

Now, clearly if that does not happen, then we see continued signs of weakness in our customer base and customer spending well into 2010, I think it would be not unreasonable to look at the expense base and consider whether that's still the appropriate level.

But again, I'm optimistic that we're going to see the former rather than the latter and that at some point in 2010, things are going to come back more into line with our traditional operating model.

Real quick one here, do you have any senior sales or marketing executives depart during this year?

No, no.

Okay, good.

And last one here, this is general, I think you talked very clearly and very optimistic about some of the things that are going right, and I agree, I like what you're doing in software and like what you're doing in video processing.

I think you're probably best of breed and that's critical going forward.

But in light of the aggregate results that we're working with here today, what's not going so right?

What's weak?

Paul, I don't at all want to give the perception that we think that we do everything perfectly and right and there aren't any points of weakness.

That being said, the big difference between this year and last year is our customer spending.

Now, that doesn't mean that, if this is the new normal, we don't need to adjust and we've been working, we've adjusted quite significantly I think and we're prepared to continue to adjust with the market.

But that being said, we don't feel as though we've lost any significant market share.

Customer spending has simply been down.

And in fact, we're actually pleased in those areas where we've been able to grow, despite this, by expanding our customer base and by getting into new product lines, whether they are internally developed software solutions or some of the contribution, distribution products that we acquired from Scopus.

Thank you.

Generally speaking, are you more optimistic today than you were at this time last year?

Frankly, yes, I am.

I think at this time last year, the storm clouds were just kind of coming in, although the business was going quite well.

Now is maybe about the time we started to see some real warning signs out there in the macro economy.

So there was a fair amount of uncertainty that was starting to build.

I think right now, not that there's not uncertainty about the short-term, but I think that we've seen the worst and we're, while we don't know exactly what the level of spending will be, we think our customers are going to spend more and we know that we're even better positioned from a technology perspective, from a competitive position, and from a breadth of customer perspective.

So we, you know, we can't invent customer spending in 2010, but to the extent it's going to come back, and we believe it will, we just don't know how strongly, we think we're extremely well positioned to take advantage of it.

Thank you, and I appreciate your candor very much.

All right, thank you.

Your next question comes from Blair King with Avondale Partners.

Thanks for letting me back in.

My question was answered.

Thank you.

Okay, thanks.

Operator, I think unless there's maybe one last question, we're under some kind of time constraints here.

And that was your final question, sir.

That was the final question, great.

All right.

Well, with that, I would like to thank you all for your participation in the call today and we look forward to the fourth quarter and to speaking with you again also.

Good day.

Ladies and gentlemen, this does conclude the Harmonic third quarter 2009 earnings call.

You may now all disconnect.