Harmonic Inc (HLIT) 2010 Q1 法說會逐字稿

Good afternoon.

I will be your conference operator today.

At this time, I would like to welcome everyone to the Harmonic first quarter 2010 earnings conference call.

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

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

(Operator Instructions).

Thank you.

Mr.

Patrick Harshman, President and CEO, you may begin your conference.

Thank you very much, and good afternoon, everyone.

I am Patrick Harshman, President and CEO of Harmonic.

With me here in our headquarters in Sunnyvale, California are Robin Dickson, our Chief Financial Officer; Suresh Vasudevan, the CEO of Omneon; and Michael Newman, our Investor Relations spokesman.

Thank you all for joining us.

Today we are very pleased to announce both a strong first quarter and our agreement to acquire Omneon, a privately held Silicon Valley company that is a market leader in providing solutions for the production, management and distribution of digital media with a blue chip customer base that includes leading digital media companies around the globe.

Focusing first on our core business, Harmonic is executing well.

Our bookings were a first quarter record of 60% from the first quarter of 2009, and over 30% from the first quarter of 2008.

We also saw strong gross margins, and very positive progress on a range of our strategic initiatives.

We have found continuing indications of a healthier customer spending environment and we are very encouraged by the positive customer response to our latest innovations in our core video processing, cable edge and access product areas.

In the newer multiscreen area, we recently announced that both Swisscom and NBC have adopted our solutions to power their new Internet and mobile services demonstrating good forward progress in this important area.

Similarly, recently announced customer wins in Brazil, China, Cypress, Romania, the Middle East and elsewhere offer clear evidence that our strategy of expanding our geographic and customer footprint continues to succeed.

It is a great time to be driving innovative video technology and applications and we're entering the second quarter with strong market momentum worldwide.

For these reasons and more we believe it is also a great time for us to be joining forces with Omneon.

Omneon is a complementary market leader with great technology, great people, and a superb customer base.

The combination will enable us to further accelerate our strategy of video technology leadership, global sales and service expansion, customer base expansion, and strong revenue growth.

We will discuss the strategic rationale and benefits of this combination further, but first I will turn the call over to Robin to discuss the key results of our first quarter.

Robin?

Thank you, Patrick, and good afternoon, everyone.

Before I start, let me remind you that during this call, we may be making 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 Harmonic 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 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 Web site and filed with the SEC on Form 8-K.

On this call, and in our press release today regarding our definitive agreement to acquire Omneon, we discuss a number of uncertainties and assumptions regarding Omneon and the proposed combination.

This press release has also been posted on our Web site and will be filed in due course 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 Web site.

Today we announced our results for the quarter ended April 2, 2010.

For the first quarter of 2010, we saw strong year-over-year increases in both quarterly revenue and bookings.

We reported net sales of $84.8 million, up 25% from the first quarter of 2009.

Bookings in the first quarter of 2010 were $91 million, up 60% from the same period in 2009.

We saw continuing improvement in the customer spending environment across many geographies, and we were especially pleased with our $91 million bookings in the first quarter which is a very encouraging start to the year.

I should note, too that our total shipments also exceeded $90 million in Q1, although because of delays in revenue recognition on a few video processing projects, our reported revenues came in at just under $85 million.

Of that revenue, international sales represented 50%, consistent with the mix we have seen in recent periods.

The first quarter saw stronger than usual demand in the U.S.

cable market in a quarter that is typically weak.

This resulted in a revenue mix where cable customers accounted for 66% of revenue in the first quarter, satellite customers 18%, and telcos and all others 16%.

Our largest customer was again Comcast, representing 14% of total revenue in the quarter.

By product category, video processing represented 46% of our sales for the first quarter, edge and access products 42%, and services and support 12%.

I should point out that we have revised our product categories to include software in the video processing category rather than combining it with service and support.

It has becoming increasingly difficult to clearly separate software and hardware in our video processing solutions.

In addition, this presentation allows us to show separately services and support which are now typically exceeding 10% of revenue.

For comparative purposes, we have also reclassified the Q1 2009 product revenue in our press release today.

Compared to recent quarters, the first quarter of 2010 saw a higher percentage of edge and access revenue, and lower video processing revenue.

This quarterly mix reflects both the strong demand for our new edge products in a number of different applications as well as the delayed timing of revenue recognition on some video processing deployments as I mentioned earlier.

In the first quarter of 2010, we saw marked improvement in our non-GAAP gross margin which was 51%, up from 48.5% in the fourth quarter.

We're also pleased to see a return to gross margins at or above our target model of 50% and we do believe that the 50% level is sustainable, especially with the higher volumes we see ahead of us.

While we continue to focus on controlling operating expenses, we saw our first significant sequential increase since the second quarter of last year.

OpEx were $35 million, up about $2.3 million from the previous quarter, in part reflecting typical first quarter events, including the restart of payroll taxes, seasonally low vacation time, and a slightly longer quarter.

Also we are slowly hiring again as we have seen improving business conditions.

We ended first quarter with 850 employees, up by 10 from the end of last year.

The year-over-year increase in revenue and gross margins had a positive impact on our net income.

Excluding non-cash accounting charges for stock-based compensation expenses, the amortization of intangibles and tax adjustments, non-GAAP net income for first quarter of 2010 was $5.8 million, or $0.06 per diluted share, up from non-GAAP net income of $4.1 million or $0.04 per diluted share for the same period of 2009.

While on a GAAP basis we had a tax benefit for the quarter because of one-time discrete items we have reported a non-GAAP tax provision for income taxes of 30% which we believe is the normalized tax rate given our current mix of international and profitability in 2010 compared to 2009.

We are pleased that our international reorganization which took place in 2008 is now paying off in lower tax rates.

We continue to maintain a strong balance sheet.

At the end of the first quarter we had cash equivalents and short-term investments of $267.8 million, down $3.3 million from the end of Q4.

The decrease mainly reflects higher levels of receivables and inventory.

Inventory was $39.6 million, up $4.5 million from the end of the fourth quarter.

This increase mainly reflects our preparations to fulfill the increases in our backlog, and our forecast expectations as we moved into the second quarter, as well as address concerns about possible fluctuations in parts of the supply chain.

Our receivables increased to $70 million at the end of the first quarter, up from $64.8 million at the end of Q4.

The DSOs were 75 days, up from 68 days from the previous period.

This increase reflects back-end loaded shipments in the first quarter, and we expect to return to our target range of 60 to 70 days in the second quarter.

Finally, on the balance sheet our capital spending was $1.2 million in the first quarter, but we still expect CapEx for this year to be in a range of $13 million to $15 million, which includes approximately $4 million to $6 million for leasehold improvements and equipment for our new headquarters facility.

We expect to be moving into the new building in August.

Turning to the outlook, we moved into Q2 with a strong backlog and deferred revenue position, approximately $92.5 million.

The macroeconomic environment has been gradually improving and our customers appear more confident in moving forward with their capital spending plans.

So taking into account our strong backlog and our good business momentum entering the second quarter, we expect combined net sales for the second and third quarters of 2010 to be in a range of $180 million to $190 million.

For the full year 2010, we see the potential for revenue growth of 12% to 14% over 2009, an increase over the 10% to 12% revenue growth range we discussed three months ago.

We expect our non-GAAP gross margins for the second and third quarters of 2010 to be in a range of 49% to 51%.

While a number of factors can impact our gross margins from quarter to quarter, we believe that the success of our new products and solutions, an increase in video processing revenue, as well as benefits from higher volumes, allow us to view 50% non-GAAP gross margins as a sustainable target in 2010.

With respect to operating expenses, we will continue to invest in the long-term health of our business and we are in cautious hiring mode.

We expect non-GAAP OpEx for the second and third quarters of 2010, excluding charges for stock-based compensation and the amortization of intangibles, to be up slightly compared to current levels in a range of $70 million to $72 million.

This guidance excludes any financial impact of or related to the proposed acquisition of Omneon which we announced today and expect to close during the third quarter of this year.

We will provide guidance for the combined Company after closing, and once we have greater insight into the purchase accounting, including a potential for reductions in Omneon's deferred revenue balance which would be quite typical in a situation like this.

In summary, we see an improving customer spending environment, and a substantial increase to our backlog and deferred revenue in the last two quarters.

We're continuing to invest in next generation products and we've maintained solid profitability.

Now I will hand the call back to Patrick to provide more detail on the proposed acquisition of Omneon.

Patrick?

Thank you, Robin.

The cornerstone of our growth strategy has been aggressive technology leadership across a widening range of new video applications, customers and geographies.

Our recent results have substantiated the power of this strategy.

With the addition of Omneon, we believe we can accelerate the execution of our strategy, scaling our business faster, and taking advantage of several new and unique opportunities we see coming together in the marketplace.

To facilitate our discussion of this proposed combination, we will begin now walking through the slide deck that is running along side the audio webcast.

In particular, we will be turning to slide three.

What we announced today is a definitive agreement whereby Harmonic will acquire privately held Omneon for a net purchase price of approximately $274 million in cash and Harmonic stock.

We believe Omneon represents a unique and powerful asset.

It is a global leader in video production and playout technology with strong and growing potential in video optimized storage and associated media processing applications.

Harmonic will also gain most of Omneon's experienced management team and its exceptional employees.

This truly unique combination will make us the clear leader in next generation video infrastructure from video content acquisition to productions to delivery while expanding our customer relationships worldwide.

In 2011, we expect this transition to be accretive to our earnings.

We will now move to slide four.

In order to fully appreciate the potential of the combined Company, we need to understand the dynamics driving the market for both Harmonic and Omneon.

In recent years, the traditional video ecosystem has seen growing investment in both video production and delivery which have typically advanced as adjacent but separate sectors of the market.

We're seeing exploding video consumption which in turn is driving investment in more digital video in general and in particular, more HDTV, VOD, and new Internet and mobile services.

We continue to believe these dynamics are creating new business opportunities for our customers, global media players and service providers, and corresponding growing investment in the video delivery infrastructure, both Omneon and Harmonic provide.

Let's move to slide five.

Additionally, the video industry is now seeing a convergence of traditional content ownership and service provider business models illustrated by the recent combination of such major players as Comcast with NBC Universal, and this week's announced deal between Shaw and CanWest.

Other market developments such as the new national mobile content service recently announced by Fox and several other prominent U.S.

content owners and broadcasters and the tremendous success of the BBC iPlayer further underscore the important transformations that are happening in the market.

Underlying these realignments are Internet, wireless and multiscreen technology and any-time, any-where consumer trends that are altering the traditional business models and giving rise to new opportunities for converged content production and delivery.

We will move to slide six.

The convergence of content production and delivery creates a compelling strategic opportunity with no clear leader offering the full range of infrastructure solutions, and with Harmonic and Omneon positioned as clear market leaders in our respective adjacent domains this combination will make us uniquely positioned to deliver world class solutions for the conversion content production through delivery, a truly powerful combination for innovation and growth.

We will turn now to slide seven.

We are very pleased as I mentioned earlier that most of Omneon's talented executive management team will be joining Harmonic including Suresh Vasudevan who most recently before leading Omneon held several senior executive positions at NetApp.

Now to give you a brief overview of Omneon and his perspective on the opportunity this deal presents, it's my great pleasure to introduce Suresh.

Suresh?

Thank you, Patrick.

Good afternoon, everyone.

First of all, let me start by saying that I am thrilled at the prospect of Omneon and Harmonic coming together and the innovation that we can jointly bring to our customers.

Omneon was founded with a singular focus on helping television content producers move from a tape-based infrastructure to a file-based infrastructure.

To that end we brought our first playout video service to market in 2001.

Today, with our Spectrum service we are the global market leader with an estimated 22% market share, having consistently gained share year after year.

Over the last few years, we have broadened our product portfolio beyond servers.

We introduced MediaGrid, a clustered storage system optimized for video production and several media management applications.

With over 100 customer deployments and strong growth, we have seen rapid customer adoption in these newer areas as customers like Turner, NRK and ESPN STAR Sports have built their production and transmission workflows around MediaGrid.

Perhaps the best introduction to Omneon is in terms of the customers we serve and their perception of us.

We have built a very broad and global customer base with nearly 70% of our revenues in 2009 coming from outside of the U.S.

Among our core customers are eight of the top ten and 15 of the top 20 Fortune 2,000 media companies, as well as hundreds of local media companies and broadcasters.

We have an enormous amount of customer goodwill built around deep relationships and unparalleled customer support.

In a recent and comprehensive independent survey of media companies around the world, our customers rated our products and our ability to support them as the clear market leader, substantially ahead of our closest competitor.

From a financial perspective, we have closed 2009 with revenues of over $105 million, having gained significant market share.

Since 2005, we've had an average annual growth rate of about 18%, and in 2009, despite having one of the most difficult economic environments, we maintained a healthy gross margin of 58%.

Moving on to slide eight, the combination of the two companies strengthens the strategic opportunity ahead of us.

We now have the potential to bring dramatic improvements to the workflows that our customers deploy in going from raw content to finished video.

Today, in a large media facility, when you consider what it takes for camera content to reach an editor's workstation, the video asset will have gone through multiple compression steps, ultimately degrading video quality.

It would have gone through IP networks as well as baseband video networks, thus increasing costs, and the time involved is much longer than optimal.

Fundamentally, it takes a long number of processes that lead to inefficiencies and higher cost.

As the business models for content producers and service providers converge, the underlying infrastructure must also converge.

Today when you take a look at how media companies are adapting to deliver streaming video to the Web, and video to mobile devices, the production and delivery platforms are typically siloed.

In fact, for many of our customers, the infrastructure decisions are often made independently.

What excites all of us about the combination of the two companies is that now we have a comprehensive portfolio of technologies all the way from content acquisition to delivery, giving us the leadership position in many segments of this chain.

Together, we have an opportunity to tackle problems that go across the entire workflow and the capabilities to bring compelling new products to market in a way that few other companies can match.

We are very excited about this combination and the opportunities it creates for our customers and employees.

Now I will hand the call back over to Patrick.

Thank you, Suresh.

And we will move on to slide nine, where you can see that we believe, no other competitor today, including none of the major cable, networking or broadcast suppliers can offer this breadth of video infrastructure from acquisition to delivery.

Moreover, we believe our significant technology adjacencies will drive a whole new generation of innovative video solutions.

Together the combined Company will have a video focused R&D organization of approximately 450 engineers, a combined global sales and service organization of approximately 330 people and a network of approximately 250 global sales channel partners.

Turn to slide ten.

I think also very fundamental, from day one, the combination will benefit from a powerful footprint in the media world.

Today all of the top 20 Fortune 2,000 media companies rely on either Harmonic or Omneon for their mission critical infrastructure and in many cases both.

This includes 20 out of the top 20 global content providers and 19 out of 20 of the top pay TV service providers worldwide.

It is hard to overstate the value of our combined customer relationships around the globe.

We will turn now to slide 11.

While both companies have been independently and successfully diversifying their revenue over multiple markets and geographies, the combination will significantly advance this strategic goal.

Using 2009 results, the combined Company would have no single product category greater than 39%, international sales of around 54%.

And the top ten customers would have represented only 36% of sales.

That's precisely the kind of diversification and breadth of opportunity that both companies have been striving for.

I will now turn now to slide 12.

We will briefly review the terms of the deal.

Subject to certain purchase price adjustments, the net purchase price will be approximately $274 million, net of $32 million of cash at closing.

This includes about $158 million of net cash and 17.1 million shares of Harmonic stock.

Under the terms of our agreement, the equity of Omneon employees including unvested options and restricted stock units will be assumed by Harmonic.

The transaction is, of course, subject to customary closing conditions including Omneon's shareholders approval and regulatory approvals.

The target closing date is expected to be in the third quarter of 2010.

We do expect the combination to be accretive in 2011.

Finally, turning to slide 13.

I hope you can see this is a very exciting time for all of us here.

Harmonic is executing well, and increasingly well positioned to address an expanding array of geographies, markets and video applications.

Our agreement to acquire Omneon represents a major step in advancing our long-term strategic goals.

By bringing together two complementary video technology and market leaders we are accelerating our strategy of technology leadership, international sales and service expansion, and strong revenue growth.

The combination positions Harmonic to become the leading supplier of mission critical video infrastructure to the global digital media industry.

With that, we will conclude the formal part of our presentation.

Let me mention that we are planning to make a number of investor presentations in the coming weeks and we look forward to speaking with many of you in person about the proposed acquisition as well as our recent results.

Now, Robin, Suresh and I are pleased to open up the call to your questions.

Rebecca?

(Operator Instructions).

We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Mark Sue.

Thank you.

Gentlemen, maybe if you can talk to us about the potential customer synergies across the three customer segments, satellite, telco and cable, and also touch on operational synergies to drive the accretion in 2011?

And then separately, are there things that you might do differently with Omneon after the acquisition and the lessons learned from Scopus?

Okay.

I think there are three questions there, Mark.

You may have to come back and help us remember exactly what the question was.

I think the first one was around synergies, and, market synergies, and cross selling.

So, the biggest overlap in terms of customer base today is in the broadcast and direct-to-home satellite segments.

And they are, virtually all of Harmonic customers are also Omneon customers.

Companies like EchoStar and BskyB and SKY Perfect, and the business that we do today with NBC, et cetera, those are all common accounts.

And we're already there largely in the same [head-ins], et cetera.

We also have some important common customers across the other segments that we serve.

For example, Comcast, in particular the Comcast Media Center is an important customer of Omneon's.

And more generally, speaking to some of the trends that we talked about, as we see service providers get more active in content production, the upstream portions of the delivery food chain we see greater and greater opportunities.

We also see some pretty exciting opportunities for cross selling.

As you know, we have, Harmonic has recently entered the contribution and coding space.

These are products that are primarily targeted to the content owner, content originator market.

I think we have been very clear about our market aspiration to penetrate to content owners is an important growth area for us.

We see tremendous cross selling opportunities with the Omneon sales force there.

Somewhat similarly, Omneon's MediaGrid video storage platform has tremendous applicability in the world on on-demand television, VOD, Start Over, et cetera, and we see great opportunities for our current service providers with that product line as well.

And, of course, going forward, I think as we have just explained we see a lot of going forward synergies as this whole video chain converges and as service providers and content operators of all stripes get more involved in content on one hand and more involved with delivering content directly to consumers over a variety of networks.

Should we look at, Patrick, longer term some streamlining of operations then as you, since you do have a common customer base, you can use this --

Certainly, the primary thesis behind this deal is revenue synergies, and what we can really create in the market.

I think part of your question is are there also other cost synergies, and, of course, the answer is yes.

That's part of getting greater scale.

While we are not prepared today to talk quantitatively, I think we are confident in our statement about accretion in 2011.

I think at the close of the deal we will be able to provide more quantitative guidance around top line as well as bottom line.

Okay.

And, Robin, just to make sure, when the deal closes we should assume that the deferred revenues of Omneon goes to zero, is that correct?

No, not necessarily.

It's very likely there will be a haircut to the deferred revenues depending on the mix of software and hardware, and the specific reasons for deferred revenues.

So, no, I don't expect the dollars to go to zero, but I do expect some form of haircut and that's one reason we are just not in the position to be able to give any appropriate guidance at this stage, at this stage in the process.

Okay, that's helpful.

Thank you, gentlemen.

Good luck.

Thank you, Mark.

Your next question comes from the line of Greg Mesniaeff.

Thank you.

It is Needham and Company.

Two quick questions.

Given the size of this deal, is it fair to assume that this acquisition is pretty much it for now or are you actively pursuing other opportunities at this time?

Greg, I think that we have got our hands full with this, in the near term.

I think the resulting Company is extremely well and strongly positioned in the marketplace.

So we rule nothing out going forward.

But certainly for the time being, we've got a big and important job ahead of us.

Thank you.

Part two of my question is it fair to assume that this deal will perhaps accelerate Harmonic's deemphasis of the cable transmission segment?

Absolutely not.

We are pretty pleased with the way our cable edge and access business is going.

In fact, as you get a chance to take a closer look at our results you will see that Q1 was quite strong.

We are pleased with the market momentum that we have with the focus we have and with what's actually has come recently and is coming down the pipe.

So absolutely we remain as focused as ever on our cable edge and access business, and we think, frankly, there's a great synergy there as well as more and more of this content courses over cable networks.

We see good growing demand for our edge and access products.

Thanks.

I will come back to you later.

Thanks, Greg.

Your next question comes from Amir Rozwadowski.

Thank you very much.

And good afternoon, Patrick, Robin and Suresh.

Good afternoon.

Just turning to your organic business for a moment, just wanted to clarify a couple of points, if I may.

You had talked about some of the revenue recognition issues in the first quarter.

What was the size of the impact there?

Greg, sorry, Amir, it is -- it is probably on the order of $2 million to $3 million.

I wouldn't say it is substantial.

This is, frankly, one of the reasons we like to give six months guidance given that we have got the visibility because some of these outcomes are not as predictable as we would all like.

The good news is, of course, that this is revenue that will be recognized in a future period, most likely the second period.

So we are, again we don't view it as a big, as a big issue.

I'd really look to have people focus on the bookings for the quarter and the substantial and continuing improvement in backlog and deferred revenue.

Hi, Amir, are you still there?

Or -- so operator, it looks like we have lost Amir.

Okay.

Your next question comes from Simon Leopold.

Thank you.

Wanted to find out if you could give us the segments from the December 2009 quarter based on the restated definitions where you move the software over there?

I am, just would like to get a better handle on what the sequential patterns were?

Simon, it is Robin.

I am not sure I have got that with me, I can certainly follow up with that information.

In fact, we will plan to do is post that information on our Web site so that you can see the whole trend for 2009, it is a fair question and we will have to get back to you on that one.

Okay.

Super.

Yes, that was my follow-up was if I can get the, a little bit farther back in time, so we can look at the pattern.

So granted you don't have all of that detail, it does appear that the video processing, that core business was down pretty steeply sequentially, because kind of on an oranges-and-apples basis, they look flat without the software.

So I guess what I am trying to figure out is what disappointed in the quarter, relatively in the mix, was software lighter than you expected or was video processing lighter than you expected?

I think it is mainly the function, Simon, of the video processing business.

I mean as I think you know, a lot of our video processing projects are projects that are recognized over multiple quarters, they, unlike or less like the edge and access business which tends to have many more of the characteristics of traditional of book and burn where things turn in the same quarter.

Many of our video processing projects can take two or three quarters to fully realize, given that we are generally providing substantial integration services and support and maybe in some cases integrating third party equipment.

So it is really just part of the ebb and flow of those projects, and I think from a bookings perspective we are very, we are very comfortable with the way the video processing business is going.

In fact, the Electra 8000 Encoder in particular is, in our view, has been a great success and it continues to drive orders as you saw in fourth quarter, and continues to do so in Q1.

As I say, many of those orders we took in Q4, those projects are still in course of completion, and while we definitely picked up some of that revenue in Q1 there is other revenue that won't be recognized until Q2 or possibly Q3.

So the way to paraphrase that would be normal lumpiness and we should expect a good sequential move in the June quarter then?

Yes.

I believe so, yes.

There is certainly a number of projects I can think of that we are expecting to complete in Q2 and accordingly recognize revenue on.

Okay.

And then when we look at the edge and access business, unseasonably strong March, and a good sequential move in that one, was that a very diverse customer base, or relatively few projects that drove that, that sequential improvement?

Simon, it was pretty diverse.

We saw strength across domestic as well as international cable operators.

Okay.

Just one last one.

Looking at the balance sheet, your deferred revenues also took a nice rise, up roughly, I guess, $9 million or so, what's going on behind that?

Was that subject of the back end load to the quarter or something else?

No, it's really back to some of what we talked about earlier that many of the video processing projects inevitably are, the revenue or at least some of it is often deferred at a quarter end.

And, again, that's one of the things that gives me good confidence for the next couple of quarters that that deferred revenue is building and the vast majority of it came from the video processing segment.

Great,, thank you.

That's all I had.

Thanks.

Your next question comes from the line of Larry Harris.

Yes.

Thank you.

With respect to Omneon or for that matter, current Harmonic, we have seen, I guess, in the March quarter, a number of the broadcasters report on average about 15% year-over-year growth in terms of advertising revenues, have we seen an improvement in orders from the broadcasters as a result or is that something that might take quarter or two to surface?

I think we view that space, Larry, as I would characterize it as slowly improving, at least from the point of view of the Harmonic business and exposure to that segment.

I'll ask, maybe, Suresh, to give a comment from his side, but we view it as slowly improving.

I think we are very encouraged by some of the recent reports we have seen about strengthening ad revenues, et cetera.

So we look to that segment to continue to strengthen and come back to life over the course of the year.

Yes, what I would say, both from a results perspective as well as from the perspective of customers who have had projects, as I look at the pattern of how they behaved throughout 2009 versus sort of what their temperature seems to be over the last few months it certainly improved.

On a sequential basis, it's stronger than at any point in the last year.

And I suspect when you look at NAB which we just finished perhaps the best event to gauge where customer comfort feels like on capital spend, again, it was a very positive feedback from NAB.

So overall I would say certainty it is an improved environment.

Great.

And in terms of, who are some of Omneon's competitors, and I don't know if you mentioned what your market share is?

Sure.

Omneon really, we think of our markets as comprising two core segments, the first is our core product line, that's our video server product line.

And as I mentioned earlier, we have about a 22% global market share in that segment.

It is about a $0.5 billion market as measured by Frost & Sullivan, and our principal competitors there are the Grass Valley division of Thomson as well as Harris Broadcast.

And over the last several years against those competitors and others we have managed to gain share consistently every year.

So that is our first segment that we compete in.

The second segment really is around video optimized storage used by media companies for their content production.

That is a more recent segment for us in that our product there is more nascent, a growth area for us.

We have seen a large number of successes in that product line over the last couple of years, but we think of that as much more of a growth opportunity, our share is a lot more nascent against competitors like [Iceron], like Data Direct Networks.

Great.

I guess for Patrick, in terms of the 3-D TV, congratulations on your relationship with DirectTV, and is that tracking to your expectations or should we be looking for that as being a much greater opportunity in 2011 than 2010?

Well, I think Suresh just used the word nascent and I would certainly apply that word also to what is happening in 3-D.

I think the good news is that Harmonic is out front and has established a strong leadership position in the market, and I think you refer to the very nice demonstration we did at that NAB show together with Panasonic and DirectTV, two clear leaders in this space.

We see a lot of early activity, we're really at the middle of a lot of it.

So far the volume isn't so great.

But we see growing volume, certainly into 2011 and beyond.

And I think in terms of impact on our business this year, I think the whole 3-D environment is just raising awareness even further about video quality, and about the next generation HD standard, et cetera.

So we have found that the whole trend, even if the customer is not going to roll out a new 3-D channel, the whole direction and the strength that we have and the support we have for 3-D on our Electra 8000 platform, has kind of given us some additional wind at our back in terms of our strength in the, in the encoding space.

Great.

Okay.

Thank you very much.

Thank you.

Your next question comes from the line of Hasan Imam.

Hi.

This is Shubho Ghosh from Thomas Weisel Partners for Hasan.

Looking at the model for both the companies, you mentioned that it's accretive in 2011 and it's closing in Q3 of 2010.

Is there any reason why we shouldn't look at Q4 of 2010 from being accretive given the gross margin structure is certainly a lot higher for Omneon at 58% and you're at the 50%, 51%.

Frankly, Shubho, it is on the cusp.

We are really not far away from accretion.

I think we just wanted to take a fairly conservative position for the rest of this year.

We are uncertain as to when the deal will close, we're pretty sure it will be Q3, but we are not exactly sure when.

We are not certain around elements like, as I mentioned earlier, deferred revenue and so on.

So at the moment, what Patrick said will or what we said in our press release will be neutral to, neutral to 2010, and Q4 could be on the cusp but I don't want to go any further than that at this moment.

Got it.

And then just a quick follow-up on the gross margin structure, came in a lot higher than the guided 48% to 49%.

I think you had mentioned the reasons you're looking at 48% to 49% as basically being a mix off software being higher to account to the low margin [chassis] business.

And now this quarter saw strength in product design, new solutions and sourcing strategy, so, basically, is there a new kind of set of reasons you are seeing gross margins tick upwards versus what you had expected?

And going forward, what are you looking at as driving this strength?

Shubho, I don't think there's anything really new.

We have made commentary around the way we design products with very much gross margin opportunity in mind.

We have a continual effort to reduce costs, both in our own house and at our principal contract manufacturers.

And none of that is really, is really new.

We do, again, I think you know, we do have fluctuations, in fact, you mentioned that, in the mix of products both at the high, at the primary category level as well as within those categories and we did see some of that in Q1.

You mentioned edge and access and we were pleased with the mix there.

You may remember two or three quarters ago as we launched a new version of our narrow cast services gateway, we went the other way and we had significantly higher platform and chassis sales than we typically would have as we introduced that generation and I think now we are beginning to see some of the benefits as customers fill up those platforms to their capacity.

So inevitably there's going to be some fluctuation, but I think it is the fundamental trends I talked about earlier and our strong focus on value-added solutions that is driving an improving trend over time.

Great.

Thank you so much.

Your next question comes from Blair King.

Yes, hi, guys, how are you?

Good, Blair, we're doing well.

Yes, Suresh, I have a question for you.

I am not particularly familiar with Omneon, and so just a real thumbnail sketch of, what the, what the real sort of high level drivers for you have been in terms of achieving an 18% growth rate, and then is that a growth rate that you really feel is pretty sustainable as you head through 2011 and 2012?

Sure.

Let me start with what has driven our growth rate first, and then I will talk about sustainability.

The short answer is we absolutely see that as sustainable going forward as well.

But stepping back, I think, over the last several years there are two fundamental trends within our customer base that have driven our ability to grow fast.

The first trend is that most people that are producing media content, we sell to customers like Turner, like Discovery, like MTV and so on.

These are people essentially constantly seeing an increasing amount of video that's being deployed whether through traditional television channels or repurposed on to video over the Internet or video over mobile networks.

Fundamentally, in order to manage their video production and distribution process they used to use tapes and they are moving from using tape-based infrastructure to systems that are made up of file-based infrastructure.

When we entered the market, we have a product that's recognized as being the leading edge technology in how you send video and manage video as files in servers and now more recently in storage systems.

So our technology strength is really what's allowed us to capitalize both on the growth in the market, so the market grows historically to about 10% to 12%.

We have grown faster than that by being able to take share from our principal competitors.

So I would say those are the two factors, the fact that our market's growing inherently at about 10% to 12%, and we've been able to gain share consistently over the last several years.

Going forward, many of the drivers that have caused us to grow at that pace in the past remain very much in place, the adoption of High Definition TV, the increasing move from tape-based infrastructure to file-based infrastructure, the repurposing of content from traditional television to mobile and Internet devices, all of those really drive our systems growth, and so I feel very confident in saying that is a sustainable rate of growth.

Okay, that's fair enough.

I appreciate that.

One question, for Robin, you just touched on this, but if there's any way to give some sort of indication in terms of -- well not even an indication, but just talk a little bit about the mix in the EdgeQAM space, is there a heavy shift now towards your newly introduced narrow CAT server, or how is that -- relative to the NSG 9000 or, I'm just trying to parse out the gross margin improvement here in the quarter and then measure that against your comments going into next quarter potentially with higher mix of video processing but similar margins?

So I don't know if that's clear but basically --

Well, Blair, this is Patrick.

Let me try to take a crack at that.

We did, we did see, we don't break it out, it was a strong quarter in edge and access and we also saw strong gross margins.

So maybe what you are trying to get your head around is it is true, underneath that edge and access did actually pretty well from a gross margin point of view.

And I think what is driving that is our technology continue to be well received and I think carry additional value in the marketplace.

In particular, as we have explained before about our EdgeQAM product, that somewhat goes in kind of cycles.

When we first introduce a new chassis, we're putting out the whole chassis at somewhat lower margin and then as we populate that chassis with new blades, we are realizing, or software licenses turning on hardware that's already been deployed, we're realizing somewhat higher licenses.

We really see ourselves, in the first quarter, we're really in the sweet spot of the 9000 platform that we introduced, the middle of last year, or early last year.Z

So we saw some real continuing strong the activity around that product and we think that the differentiation of the product, as well as where we are in the cycle, more populating chassises kind of combined put us in a pretty good margin position.

Okay, so strong NSG 9000 software sales in the quarter is a good way to characterize it it sounds like?

Not purely software but, yes, strong sales in the quarter and those sales carried decent gross margins.

All right, thanks.

Thanks, Patrick.

(Operator Instructions).

The next question is from Simon Leopold.

Thanks for the follow-up.

Just want to see if you can talk about the Omneon business in terms of what kind of operating margin it's had most recently?

Thanks.

Well, Simon, Omneon is a private Company so there is some information out there.

We're not ready to go into the modeling and how we got there quite at this point.

I think I should say, Omneon, as you can see from the revenues and particularly gross margins, is a company with some lines of scale, and impressive, and impressive gross margins.

And as you might expect has been building its infrastructure to grow.

The Company has been profitable, and generated cash, even in 2009 which was a tough year for everyone.

So, I think we've got a great base to build upon there, as Patrick mentioned, there's clearly some operating synergies to be achieved as the Company -- now that we have a Company that it is potentially approaching $0.5 billion in revenue, and we are very confident we can get back into, back to our operating model and potentially beyond.

But I'd rather wait until we close until we get into more specific details on how we view the model and the progress from where we are at that point.

Your next question comes from Greg Mesniaeff.

Yes, just a quick follow-up.

I was wondering if you can focus a little bit on the particulars of the sales dynamics of Omneon and how they may differ from those of Harmonic?

In other words, we realize obviously the customer overlap here, but are sales cycles different for Omneon's products or are they rather similar and if they are different how so?

I'll call out a couple of dimensions on how they might differ.

The first comment I would make is that there is a fair degree of customer overlap, as you have pointed out, the strength is somewhat more distributed in that where most of our strength comes from is core content producers where most of the strength on the Harmonic side comes from its service providers and that creates a sales dynamic in that even when there are companies with both content creation and, let's say, distribution within the same umbrella often the decision maker is not the same person.

A lot of our sales, a lot of our deals, a lot of our transactions tend to have more of a, less of a deferred revenue characteristic to it.

They tend to turn much more quickly.

So what you will see is not a carry forward of backlog and deferred revenue from quarter-to-quarter for a long period of time.

Some differences certainly in the nature of the customer we're calling on, difference in the nature of the projects in that they don't tend to have very long life cycles.

They may have a long sales cycle but often get deployed and revenue gets recognized faster than you would imagine in the video processing project side that Robin mentioned.

Beyond that I think as we get more familiarity with each other there will be a lot more characterization.

That's very helpful.

And just as a quick follow-up, in terms of the R&D dynamics of the products, are products typically quicker to develop, or longer to develop, if you can give us some color there as well?

Thanks.

Greg, they're actually quite similar and quite analogous.

I think one of the exciting things to us is a great amount of similarity in the underlying technology building blocks.

Our teams, and we found out through the diligence process, are speaking really the same language and very often working with the same kind of chips, software modules, et cetera.

I think the end applications are slightly different, but, again, we are really actually part of that same video pipeline, content delivered from source to consumer.

And so, you shouldn't think about any significant difference.

In fact, a lot of commonality in terms of R&D processes, cycles, as well as skill sets and expertise.

And as I mentioned at the outset, for us that is one of the things that's truly exciting about this.

Video technology is difficult.

The combined Company, I think, has more critical mass of video expertise, of video intellectual property, video know-how than any other company on the planet.

I think it is really going to be powerful once we get this together and really harness it to solve not only today's problems, but the problems that we all see coming out of, from tomorrow, the opportunities coming at us from tomorrow.

Thank you.

That's very helpful.

Your next question comes from Jack Monti.

Hi.

Thank you for taking the question.

I am curious about, on the organic business, if we could switch back to that for a moment, and customer end market visibility, what is the, which customer end market do you feel like Harmonic has the best visibility into projects going into the next couple of quarters?

Jack, I wouldn't necessarily call out any particular growth.

I mean we were certainly pleased in Q1 that the U.S.

cable customers seemed to get off to a fast start, and honestly that was in stark contrast to what we saw last year at this time.

But beyond that, I think these, our service provider customers are for the most part competing with each other for the same sets of eyeballs and with many of the same applications.

And so I don't see one group or other particularly driving either our visibility or our revenues.

Yes, cable was a bit stronger in Q1 than normal, but as I have probably said many, many times before I don't pay too much attention to quarterly mix fluctuations.

And my suspicion is that, and we haven't really done a deep dive into the numbers, my suspicion is that will even out a little more in the second quarter as some of these deferred revenue projects come to fruition, many of which, not all of which, but many of which are more with our satellite, telco and other customers.

I know that's maybe not a satisfying answer but it really is, it's the reality.

Okay.

And I am curious, part of the commentary earlier in the call discussed the advertising budgets picking up and potentially more spend on the broadcast area.

I am just trying to think, is that an area that we can expect to maybe snap back a bit as we go further, progress towards the second half of the year?

Is that a fair characterization?

Certainly from the organic, our core Harmonic business that is our expectation.

As Suresh highlighted earlier, we had a fantastic NAB show, National Association of Broadcasters, in Las Vegas.

We saw more activity, more optimism and confidence on the part of our customers in that segment than we have seen, any time in the last 12 months.

We see a lot of activity out there, and that is a sector in particular, that although not the biggest part of our core business today, we expect to see continuing momentum build throughout the year.

I would echo that comment.

I mean we have seen the momentum build through the last two quarters and it seems to have a very solid foundation.

So I would echo that comment very much from what we see in our customer base as well.

And just one last one if I could, the $2 million to $3 million in revenues that can get recognized that are probably or likely to fall into the second quarter, any sense for what -- was that in the telco broadcast area as well?

Or was that more satellite?

It was actually a little bit of both, some, some are satellite projects, some are in our other telco and other category and they were mostly, mostly international.

Great.

Thank you very much.

Okay.

Well, thank you, Jack, and thank you, everyone.

We will wrap the call up.

Before we do that, I guess I would like to reiterate again how excited we are about our current business momentum, the success we are seeing in the marketplace, the success we see Omneon having in the marketplace, and the potential that we can unlock by putting these two companies together.

We look forward to talking with you a lot over the coming weeks and months, and until then, good day, and thanks for joining us.

This concludes today's conference call.

You may now disconnect.