Harmonic Inc (HLIT) 2011 Q2 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the Harmonic Inc.

second-quarter 2011 earnings conference call.

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

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

(Operator Instructions).

Thank you.

Ms.

Carolyn Aver, you may begin your conference.

Thank you.

I am Carolyn Aver, the CFO of Harmonic.

With me here at our headquarters in San Jose is Patrick Harshman, our CEO.

I'd like to point out that, in addition to the audio portion of this call, we have also provided slides which you can see by going to the harmonicinc.com website and clicking on the second-quarter earnings call button in the events section on the Investor Relations section of the About Us tab.

Turning to slide 2, let me remind you that, during this call, we will provide projections and other forward-looking statements regarding future events or the future performance of the Company.

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

We refer you to the documents that Harmonic files with the SEC, including our most recent 10-Q Report.

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 unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP and pro forma basis.

Revenues described as pro forma include Omneon, as if they had been part of our results for the period stated.

These items together with the corresponding GAAP numbers and a 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.

The remainder of the information will be available in a recorded version of this call on our website.

With that, let me turn the call over to Patrick.

Thank you, Carolyn.

And thank you, everyone, for joining us today.

Turning now to slide 4 of the presentation.

Today we reported second-quarter revenue of approximately $134 million, about $5 million below the midpoint of our guidance range.

I want to be clear that we are not satisfied with the financial results of this quarter.

Having said that, though, the delta between our previous guidance and the final result is modest and while our near-term outlook has been affected by the marketplace issues we will discuss on this call, our strategic direction remains very much on track and our medium to longer term growth outlook remains positive.

And I also want to be clear that once we confirmed we do not reach our revenue goals, we exonerate the process of determining and communicating to our revenue, earnings, and, importantly, updated outlook for the remainder of the year.

Turning to the results themselves.

One of our key strategic imperatives has been to develop our business overseas.

And in the second quarter, our international business contributed 59% of total revenue, up 26% year-over-year on a pro forma basis.

However, our domestic business declined 15%.

And I'll discuss the reasons for this in a few moments.

In aggregate, our business in the first half of the year was up 12% year-over-year, again on a pro forma basis.

And that is assuming a full contribution from Omneon last year.

Second-quarter bookings were approximately $132 million.

As with revenue, strong orders from our growing base of international customers were offset by weaker domestic demand during the quarter.

While our revenue was lower than anticipated and the product mix relatively less favorable in terms of margins, we still realize gross margins of 51% and delivered an operating margin of 11%.

Our non-GAAP earnings were $0.09 per share and we generated $17 million of cash during the period.

Turning to slide 5, let's look at the business dynamics that underlie these results.

As you know, we have been clear that international expansion is a key strategic priority, and we are very pleased to see our international business delivering results.

International revenue in the first half of the year was up 22% on a pro forma basis from the first half of 2010.

This quarter saw us win projects spanning a wide range of video applications from traditional standard definition television and fast-growing emerging markets to a very strategic mobile video win with a leading industry player and historic Omneon customer in Western Europe.

The deals we were able to recently announce with GlobeSat Network, the largest pay-TV operator in Brazil and with Vietnam TV, the national broadcaster of Vietnam, are good examples of our strengthening international market position.

We also see expanding cable business overseas, as we won significant new edge and access business with a leading international cable operator.

Looking ahead, our international business outlook for the second half of the year remains very healthy across geographies, market segments, and product categories.

One final note on our international business.

A consequence of our rapid international expansion in market share gains is competitive pricing pressure, and associated impact on our gross margins.

While high definition continues to be a defining trend for video delivery worldwide and was a key driver of our overseas business during the quarter, the critical aspect of the quarter was the fact that in our domestic business we did not see a single large encoding project.

We believe this is primarily the result of timing issues, as we are actively working several of our domestic customers who are planning a larger scale encoding projects which we have already won or in very good position to win and will recognize revenue from incoming periods.

So we are [now] impacting our view of the longer term growth opportunity, the timing of these projects in our pipeline as we now understand that does have an impact on our near-term revenue outlook.

Additionally, after very recent and detailed assessments of our current domestic market activity, we believe the delays in larger encoding projects are indicative of the fact that many of our domestic customers are engaged in complex strategic planning of their next wave of video services, services that span integrated high definition to lower resolution services that will be delivered both over the top and over their own networks to a variety of new IP connected displays.

To be clear, this is not to say that the magnitude of the domestic opportunity is in any way diminished.

To the contrary, we believe such new services will come to dominate the marketplace and will demand the exceptional video quality and compression technology that are the hallmarks of Harmonic solutions.

With just one example, we see the opportunity to assist our domestic cable customers to deliver very high-quality, high definition video, over-the-top to Internet-connected televisions as a significant opportunity and an initiative that will require substantial industry investments and high-performing new MPEG-4 encoding technology.

So while we are extremely confident that Harmonic is uniquely positioned to benefit from the rollout of such new services, we also realize the timing of these major initiatives remain somewhat uncertain.

In several cases, they are playing out slower than we had anticipated just one month ago, again, impacting our revenue forecast for the second half of this year.

While we see domestic customers pausing before embarking on larger scale next-generation coding projects, smaller Internet and new media initiatives from mobile applications such as for iPhones and iPads are proceeding, both domestically and internationally.

Although this application area is still characterized by smaller-sized deals and experimentation, as well as by evolving business model and content licensing issues, we have continued to see our associated current period revenue and longer-term opportunities grow.

As I mentioned previously, this past quarter saw very strategic international win for delivering video to iPads and iPhones and, although still modest, our revenue for such applications was up significantly from a year ago.

Harmonic continues to invest only in this space and you will soon see us launch some really exciting new products that we think will further fuel growth and create particularly compelling solutions when bundled together with our high-definition offerings, thereby bolstering our competitive position in this area.

Turning now to slide 6.

In support of the coming new video services, we saw strong domestic and international demand for bandwidth optimizing cable edge and access products.

In particular, we saw strong demand from multiple cable operators for our EdgeQAMs to address both on-demand video and modular CMTS broadband applications.

These second-quarter results emphasize not only robust demand from cable operators, but also Harmonic's continuing industry-leading position in the cable edge and access category.

Our powerful HectoQAM technology is truly unique in the industry and is providing strong competitive differentiation as are our latest DWDM access products.

We are also very pleased to see the Production and Playout product revenue from around the Omneon acquisition bounce back nicely.

Up 14% from a slower first quarter.

Enabling this was a combination of positive market response to our newest server and media storage products, as well as continuing positive progress integrating our global sales force.

While the integration has gone well overall, I will acknowledge it proceeded somewhat slower than we initially anticipated with respect to both cross-training and cross-selling.

However, we have made important progress.

For example, the two largest media storage opportunities we are currently pursuing in Europe; that is, opportunities for the Media Storage Solution acquired from Omneon with service providers who are historical Harmonic customers addressed by legacy Harmonic sales people and part of a broader system solution bundle.

I expect us to continue to make progress on realizing such strategic synergies through the second half of the year.

An area of strategic focus is we already see benefit from our combination with Omneon is in our expanding and increasingly diversified customer base.

Our top 10 customers in the second quarter contributed only 37% of revenue; and for the first time we saw market-leading media and broadcast players among our largest customers in the period.

Turning to slide 7, fundamental dynamics driving our marketplace remain unchanged.

We continue to see a new video economy being driven by consumer demand for more video services by growing rates and strengths of video companies as well as by intensifying competition among traditional and new video service providers.

We, Harmonic, continue moving into the second half of 2011 as the leading video infrastructure company and very well-positioned to capitalize on opportunities as they unfold.

Turning to slide 8.

Despite a slower-than-expected near-term domestic market, we continue to execute our four strategic imperatives for the year.

First, we are leveraging our increased scale, solution breadth and competitive strength to expand our brand and deepen our customer relationships in developed markets, while continuing to work aggressively to capture greater market share in emerging economy markets; and our strong second-quarter international results are a great move in that direction.

Second, we are successfully developing a leadership position in new applications in customer verticals.

Namely multiscreen, new Internet media services, and video production.

Third, our objective is to continue to lead the market in technology innovation.

And I remain very confident that the pipeline of new products and solutions we have scheduled for release over the course of this year will further differentiate Harmonic in the marketplace.

And finally, leveraging the value we are creating in the global market, we intend to continuously improve our operational execution and business model.

And on that note, I will now turn the call back to you Carolyn to tell us more about the quarter and our financial outlook.

Thank you, Patrick.

Turning to slide 10, as Patrick has said, our total revenue in the second quarter of $134 million was below our expectations.

This was primarily a result of the timing of revenue on large encoding products in the domestic market.

Given the projects we are currently working on and are included in our deferred revenue, and the activities we see on new projects, we believe this to be a short-term effect and not a change in the overall long-term market outlook.

Net revenue in the second quarter of 2011 was down 1% from Q1 and up 5% from for net revenue of Q2 2010.

Also the second quarter of 2011 was marked by very strong international revenue growth across many different geographies with international sales up 26% year over year.

Non GAAP gross margin essentially remained flat at 51%, the same as the previous quarter and the second quarter of 2010.

While we continue to focus on gross margin improvement, the second quarter of 2011 had a relatively high percentage of Edge and Access products and international revenue, both of which generally have lower gross margins.

Sales of Edge and Access products increased 29% from the previous quarter.

Operating expenses for Q2 of 2011 were $53.9 million comparable to the previous quarter.

Even with lower-than-expected revenue, our operating margin was 11% for the second quarter of 2011 compared to 10% in the previous quarter and 13% a year ago.

Our reported non-GAAP net income per share for the second quarter was $0.09 per diluted share comparable to the previous quarter and the second quarter of 2010.

Turning to slide 11, let's look at our revenue and backlog in more detail.

As noted, total revenue for the second quarter was $134 million, up 5% from the prior -- the same quarter in the prior year.

Our backlog at the end of Q2 2011 was $122 million comparable to recent quarters.

Total bookings in the second quarter were approximately $131.7 million also comparable to last quarter.

Moving to slide 12, we have continued to significantly diversify our revenue mix across different geographies, products, and markets.

International made up 59% of our net revenue in the second quarter, showing continued strength worldwide in both developed and emerging markets.

In Q2 2010 by contrast, international revenue represented 49% of our total sales.

Our largest customer was again Comcast, representing 11% of revenue in the second quarter.

Our top 10 customers represented only 37% of our revenue, reflecting our continuing diversification across a worldwide customer base.

Cable customers accounted for 48% of revenue in the second quarter with a very strong contribution from our growing base of international cable customers.

Broadcast and media customers represented 31% of sales, satellite and telco, 21%.

Video Processing revenues in the second quarter were exceptionally low relative to recent quarters, representing only 38% of our net revenue.

On the other hand, Edge and Access revenue was up strongly representing 30% of the total.

We're pleased to see our Production and Playout revenue rebound from last quarter, representing 19% of total revenue, while Services and Support remain at 13%.

As you can see on slide 13, we continue to maintain a strong balance sheet.

We ended the quarter with a cash balance of $134.3 million, up $17 million from the end of the prior quarter.

Our receivables balance increased to $117.9 million and our DSOs increased to 80 days.

The increase in both the receivable balance and our DSOs are due to the nonlinearity of invoicing in the quarter.

Our inventory was $61.1 million up modestly from the first quarter as a result of lower than expected shipments in the quarter.

Our inventories were down slightly to (technical difficulty) [4.1].

Finally, our capital spending was $3.6 million in the quarter and we expect our CapEx for the full year to be between $14 million and $15 million.

Moving to slide 14, we do have a couple of significant projects underway that we expect to recognize in the coming quarters.

Yet the timing on when we will recognize that revenue remains uncertain.

We also have a number of significant potential new projects in the sales pipeline.

Yet the precise timing for closing and then ultimately recognizing revenue on those deals is also unclear.

Taking all this into consideration, we expect net revenue for the third quarter of 2011 to be a the range of $130 million to $140 million.

Non GAAP gross margins for the third quarter of 2011 are anticipated to be in the range of 50% to 52%.

Product and geographic mix will continue to influence whether we are on the high or low end of that range for gross margins.

Our target for non GAAP operating expense for the third quarter is $53 million to $54 million.

Our head count was 100 -- was 1,144 at the end of the second quarter, up slightly from the previous quarter.

We will continue to manage our operating expenses closely.

We currently anticipate our non GAAP tax rate for 2011 will remain at 25%.

Looking at slide 15, as Patrick discussed, while we remain very positive on our mid- to long-term opportunities, the short-term domestic market issues cause us to be more cautious for the remainder of the year.

At this time, we expect revenue for the full year to be in the $540 million to $550 million range.

We expect gross margin to be in the 50% to 52% range with the product and geographic mix continuing again to influence whether we are on the high or low end of the range for gross margins.

We expect expense management as well as seasonality to deliver sequentially lower operating expenses in Q4 by as much as a couple million dollars.

We do continue to target a 14% to 16% annual operating margin goal.

Although given the Q2 results, we won't achieve that goal for 2011.

With that, I will turn the call back over to Patrick for some closing comments.

Thank you, Carolyn.

Before moving to questions, let me just summarize the key points as I see them.

First, domestic spending on new large-scale encoding projects is proceeding more slowly than we anticipated.

As our customers work through a variety of strategic and planning issues, we believe these projects will get back on track and Harmonic will benefit as originally anticipated.

In the meantime, however, the slowdown and timing uncertainty has affected our near-term outlook, but not our long -- medium to longer term growth prospects.

The second key point, beyond this issue, Harmonic is executing well on all of our other key strategic initiatives, and these include driving international growth, overseeing well over 20% growth overseas, extending our customer base to include global media and broadcast companies who now account for over 30% of revenue.

Developing new revenue streams from new products that enable video services to target iPad, iPhones, and the like.

And successfully integrating and leveraging the Omneon business, where we saw the storage and server revenue bounce back strongly in the quarter.

And the final point, I want to assure you that we are extremely focused on further strengthening our operational execution and profitability.

We delivered 12% growth through the first half of the year, returned our operating margin to double digits, and we are committed to leveraging our expanded customer base and product portfolio to further strengthen our financial performance.

And with that, we will end the formal portion of the call and Carolyn and I would be pleased to answer any questions that you might have.

Operator?

(Operator Instructions).

Simon Leopold from Morgan Keegan.

This is Victor Chu in for Simon Leopold.

Can you guys just discuss some of the factors that make you guys confident that this is a timing issue and not more of a structural shift in the market?

Yes, Victor, I mean, the main reason for that is because there's very real projects that we are discussing with our customers.

We have seen for some time our view on the projects themselves, the strategic scope, the financial scope has not changed.

I think what has changed is our understanding and I think our customers' understanding of some of the broader complexities and implications.

If you are an operator, going to build a new head end, you know you need to further compress your channels.

You've got whatever it is, 200 channels, you need to upgrade that, that's fine.

Now what you're thinking, wait a minute, before I make that investment, I need to future proof that.

It needs to also be able to address a variety of different devices, maybe connect to TVs as well.

That whole rethink process.

We don't see the initial project being questioned by any means, but we do think that the broader business context is falling under -- and I think appropriately -- greater business scrutiny.

And we think working through those issues is taking a little bit longer.

So but fundamentally going back to the answer to your question is, we see very real projects we are discussing with our customers.

Our pipeline hasn't changed.

I think the strategic imperative from our customer's perspective has certainly not changed.

The competitive imperative has not changed.

So we see a very real and tangible market plan and budgets out there.

Are you thinking about the timeline, I guess, in terms of when you might see more normal run rates, I guess?

Look, let me back off and make sure we agreed we are talking just about the domestic business.

I mean, we are seeing -- we are actually -- we are very pleased with the way business is rolling overseas.

So within the domestic space, we have been surprised that things have slowed down.

That being said, there's a current projects which we have one, we are actually it is a little bit of a slower of a project completion and, correspondingly, revenue recognition process.

We do think that we will close some of those in the third quarter.

And we think that a number of our customers and projects we are talking about are relatively close.

That being said, we have been surprised by some of the slowdown, so we are being a little cautious and prognosticating how quickly some of our customers will make decisions and move forward.

Look, I expect several of the projects, most of the projects that we are talking about actually to be decided and to get rolling as projects in the second half of the year.

I think the other point though is that we are seeing a longer time to project completion and to revenue recognition.

Hence, I can imagine a scenario in the second half of the year where bookings are relatively strong.

But we have a positive book to bill ratio as maybe the completion of some of these projects rolls into 2012.

William Stein from Credit Suisse.

Good afternoon.

Regarding the lower revenue level, how much do you think this is demand or, as you say, maybe a timing issue versus a sales forecasting and execution issue?

Do you think that is it something that you could have predicted when you look back and maybe there was some internal issue to the Company?

Do you have any view on that at all?

I guess my answer is maybe.

The -- we acknowledged the last call and again in my prepared remarks, that we've been working, we have been -- we have a great sales force, but we've had change management, change organization, and that creates some amount of distraction.

It clearly had some impact on our Omneon results in the first quarter.

And I think on our last call we acknowledged and, it is true, it had some impact, I think, in the terms of the way things proceeded in the second quarter.

But I think it's a secondary or tertiary effect, really.

And to step back, I don't see a significant difference in the dynamic overseas and domestically, right?

We are enjoying our global sales force.

And frankly our -- internationally our sales teams are knocking the cover off the ball from my perspective.

So it's hard to see that the dynamic between our domestic, international sales force could be so different.

I think what is true is that the domestic market situation is always further advanced.

We have many international customers.

Actually I think internationally our standard definition channels shipped exceeded HD.

We have a lot of business in emerging markets which is just the initial rollout of pay television, etc.

I hate to use the term, but it is just a little more of a vanilla kind of business.

It is a very different situation than a leading company in the US, really plotting its strategy.

Are we moving away from set top boxes?

Are we going to go all over the top?

I mean there's not a question about more HD channels and broadening services to more devices, but exactly how it is going to get done, I think that these are a different kind of strategic issue and probably a little bit more complex and time-consuming for our large domestic customers than we had originally anticipated.

So when we think about the delay in these encoding projects, it sounds like at least partly this is your customers contemplating more over-the-top or maybe not your customers contemplating more over-the-top, but the market moving in that direction and your customers evaluating how they deal with that.

Is that a reasonable way to think about it?

Every single one of our domestic customers is developing an over-the-top strategy.

I don't mean that to say site they are replacing their over their own network strategy, but as a new strategic plank.

Every single one of our customers who owns a network is thinking about services over their own network to a variety of devices as well as services kind of over-the-top, over the open Internet outside of their footprint.

(multiple speakers)

And I think we talked about this in some depth at the Analyst Day that we did recently.

It is a pretty exciting opportunity.

Customers, the competition is going to increase.

There is a multiplication of the number of services times the number of screens that is going on, but this is complicated stuff and, in retrospect, I think neither we nor some of our customers fully grasp some of the complexities of plotting this out.

Is that part of the delay in the revenue recognition or the [delaying] these projects, the planning for over-the-top strategy?

No.

The projects that are hanging out there or that we see, I think that is a little bit more just with newer technology.

You know, the first high-definition projects we did took a little bit longer.

It's kind of the front end of an industry.

So the first complex deployments where people are looking at an integrated head end to serve both televisions as well as iPads, you know, a little side experiment is one thing.

We are finding some of the larger -- I talked in the first quarter, let me back up.

Let me give you a specific example.

I talked in the first quarter of the largest deal that we did was associated with a kind of a multiscreen deal, but it was tightly coupled into the legacy head end.

We've still not recognized the revenue from that project.

It is still ongoing.

It is complex work.

We think we will recognize that project in the third quarter but we haven't yet.

And so that's less of a strategic planning.

This operator has decided to go for it, and they are doing it, but it is actually technically some new problems are being solved from a system integration and rollout point of view.

Thanks.

Mark Sue from RBC Capital Markets.

This is Joe on for Mark.

I just wanted to know what is behind the lack of large encoding projects?

Is it the macro, is it share loss?

Typically there's a predictable timing to a lot of these.

And with the new integrated HD and multiscreen initiatives, are they evaluating competitive solutions, or is that part of the delay?

We feel strongly that we are not losing any share on the marketplace.

The competitive landscape is not too much different internationally than it is domestically.

Admittedly some of the solutions and the emphasis is slightly different, particularly in emerging markets.

If we were losing it a little bit competitively, I think we would be seeing that in our international results.

When I say we didn't see any significant encoding projects in the second quarter, I meant we didn't see any, period.

Not that we didn't win any.

And so first of all, the first part of your question, we don't think we are losing any share.

Now certainly, any time any bid that is going on, I mean, let's just go back a year ago in HD opportunity.

Almost everyone of our -- I mean all of our customers do competitive evaluations.

So certainly we have competitors and certainly they are being evaluated.

We don't see that part as the long pole in the tent, by any means.

Our customers know how to compare different subsets of solutions.

What we're pointing to is is that we think our customers are in many cases grappling with more complicated business arrangements.

I think you know that licensing; the way you store content for On Demand to a television set.

I mean there's been well-publicized issues about iPad services, etc.

There is very complex business issues that actually have implications for the technology side of the equation.

We see those kinds of issues as being a little bit the longer pole in the tent and on some of the planning and the initiation of some of the projects that we're talking about.

Thank you and good luck.

Thank you.

George Notter from Jefferies & Company.

This is actually James [Grzinic] calling in for George.

I just want to clarify, Ken, not to kick a dead horse here, but on, just on what happened that was that you didn't expect, I guess what didn't happen that you expected?

And I'm looking at satellite and telco being down sequentially and it looks like Video Processing for cable operators was kind of flattish.

I'm wondering like do you expect satellite and telco to be stronger or was it more centered around cable or both?

Could you give us a little more color in terms of like what customer groups may have contributed to the weakness in some of the encoding?

Well, let's separate the revenue of the current quarter, the second quarter with the outlook for the second half of the year.

You know, there was a $5 million delta between the midpoint of our guidance range and what we reported.

While significant that's not the whole market trend or anything.

That is a symptom of a couple of things moving more slowly than we initially anticipated.

I think, for my perspective, there is a bigger issue really here is that -- is that seemed to be the front edge of broader industry delays.

So we expect now projects that we thought might have been booked, but not show up as revenue in the second quarter and then subsequently recognized in the second or third quarter.

Well, now, we expect such a project to be perhaps booked in the third quarter and maybe recognized in Q4, but maybe in Q1 of 2012.

So as you look at the revenue numbers, I guess we don't break down and we are not going to break down our bookings, but I would say that the second-quarter bookings is not necessarily a proxy -- excuse me, the second-quarter revenue is not necessarily a proxy for the bookings.

And frankly, we've talked about large customers.

I don't really -- increasingly there isn't much of a strategic difference.

A large cable operator or a large satellite operator or a large telco in the US really all from a video perspective have the same strategic priority and at a high level from what we can see the same strategic direction.

They are going to roll out services over their own network to a lot of devices.

They are going to roll out services over the top to leverage their brand and content relationships.

So the issues we're talking about really transcend these traditional service provider categories.

Okay.

Could you maybe perhaps tell us what you think maybe the trajectory of the various businesses might look sequentially?

Like, for example, EdgeQAM's are pretty strong this quarter.

I'm wondering if that would be starting to decline sequentially and I guess, also, I'd just love it if you could briefly address, did you see a pretty strong uptick in software in EdgeQAMs?

Or I guess the Edge and Access business is -- that's part of, is that part of what drove your originally good margins given the unexpected mix?

So, we do see cable operators continuing to spend; and I think it's for us a little of an indication that we are not really looking at macro issues here.

We did see good spend in the Edge and Access area.

I think our new HectoQAM product in particular, as well as our DWDM products, are really unique in the marketplace, and I think as customers better understand that, as we get better articulating our competitive advantage to our customers, we are seeing ourselves not only retain market share, but gain new market share and I think benefit from that.

So I -- we feel -- look, there's always a little bit of an up-and-down variation in cable CapEx, but the trend certainly seems positive and we are very pleased with the second-quarter results in the Edge and Access space.

And I think it comes down to demand is there and we have got some very strong differentiated new products.

And, yes, there was a fair amount of software licensing as part of that or a component of it that -- for that helped those margins, you are right.

Okay.

Thanks for (multiple speakers).

Totally unexpected.

I mean remember that is part of the strategy is we went to an [Octo] (multiple speakers) and now we are at HectoQAM.

So we are either -- we are almost always now when we ship new hardware into the field it is not fully licensed.

So on a going forward basis, we expect a mix of new hardware sales as well as licenses to turn on hardware that was previously shipped in a preview period.

I suppose over quarter to quarter the relative mix should change.

But it is expected and it's much part of the strategy for strengthening the gross margin in this product line to have increasingly capable hardware.

We did that with the Octo product and now with the HectoQAM product, we are really doing it.

And that is why we see particularly good potential for this product and why we are particularly excited about gaining more market share.

Okay.

One quick last one before I go.

I just have to ask you mentioned --.

I think you mentioned your DWDM product.

Should I infer from some the quarter-over-quarter growth was coming from access?

Was that meaningful contribution?

Thanks a lot.

The last two quarters have been good access quarters for us.

We expect our access business to grow this year.

All right.

Thank you very much.

Blair King of Avondale Partners.

Thanks for taking the question.

Patrick, you made some -- actually didn't make much of a comment at all about some of the emerging market activity.

I was wondering if we could just turn the page a little bit and talk about how that might have progressed for you this year, especially in the content and distribution area?

We remain, we continue to be quite bullish about emerging markets.

It is definitely, I wouldn't say it's dominant in the international story, as we did well and good in developed markets with the exception of Japan, which is very slow.

But emerging markets is doing quite well for us.

I highlighted in my prepared remarks, press releases, we had -- many of our customers don't allow us to do press releases, but we had two very significant ones in the past quarter in my view.

We were able to announce a relationship with Globo in Brazil.

I mean they are a giant company addressing a giant market.

Real market leader down there as well as Vietnam TV.

So while we don't break out and report numbers for emerging markets, specifically, I would say we are our growth, look, our international growth clearly is outpacing our domestic growth and we have projected that for quite some time.

We are very pleased with overall international growth of about 20% and I would tell you that our growth in what I would call emerging markets, which includes Eastern Europe, Russia, the Middle East, India, China, and Latin America let us say is growing at a clip even faster than that.

We've been investing quite a bit in strengthening our local channel network as well as our local sales and support infrastructure in these markets.

And we have been seeing good success across customer types, both service providers as well as the media companies.

The two examples I just gave you are in fact broadcasters or media companies.

So we've -- frankly we couldn't be more pleased with the way our international and, particularly, our emerging market business is going.

And then, lastly, it is not often that you see US contribution, revenue contribution down and cable up.

And so obviously the international business is strong.

But is there something that you are doing internationally in the cable space now that hadn't been taking place in the past?

I think we've just stuck to it.

We admitted that our market share across the board and including in cable was lower internationally and we have just been hammering away.

And you know if you got great products, which I believe we do, and you kind of keep at it, you break through.

And I think that we've been doing that, we've been doing that over time?

And we are very placed and in particular protector I highlighted in the prepared remarks that with one particular I'd say leading international cable operator we really broke through in a kind of meaningful way for the first time with both Edge and Access products.

And so we are pleased with the success there.

If you remember at the beginning of the year when we talked about our strategies, one of the strategies was to take our leadership position and extend that into account for customers that perhaps we didn't have before and invest in sort of those sales processes.

And I think this is a good example of where you see some of that bearing fruit.

Then last question for Patrick is can you just give us an update on how the cross-selling activities are happening between the Omneon and Harmonic distribution forces?

I would give us a B or thereabouts.

It is proceeding slower than we had hoped.

I think at the beginning of the year we did say, hey, don't expect too much in terms of revenue this year.

Unfortunately, that is turning out to be the case.

That being said, we are seeing a number of projects.

One of the larger Production and Playout -- that is, Omneon deals that we did close in the last quarter was actually a hybrid Omneon contribution distribution deal that we did with a major broadcaster internationally.

I mentioned in the prepared remarks that actually the two largest media storage opportunities that we are currently pursuing in Europe, are actually not in that historic Omneon space of media and broadcast, but they are actually two -- were two service providers, historic Harmonic customers that our Harmonic sales force brought forward.

And there we are kind of bundling a lot of our new media transcoding and streaming solutions together with storage as a broader and a pretty powerful new media real-time and on-demand offering.

So, look, we have got a long way to go to close those deals and to the discussion earlier even though this was international, recognize that.

It is a pretty -- it's really breaking new ground.

But we are starting to see these deals, I would say we have closed a couple and we are starting to see more and more show up in our pipeline.

So I think we've got it to exactly right strategically.

I think that the opportunity is very much there, but I think that the --.

I mean, look, we are cautious.

I will tell you we were hoping it would go a little bit more quickly.

I think it is taking time.

Okay.

Thank you very much.

Thanks, Blair.

Larry Harris from CL King and Associates.

Thank you.

Good evening.

I came onto the call a little late, so I apologize if these questions were asked.

But at least, relative to what I was looking at in the Video Processing, came in a little bit below expectations at least what I was looking at and the same thing was true with Satellite.

I'm assuming that those two variances are connected.

Is that a correct assumption?

They are connected.

There is not 100% overlap.

What we did say is that, look, in general, although not internationally but domestically, we saw relatively light encoding demand across our customer base.

Our service provider customer base.

So, certainly, that includes satellite operators.

And I assume that is going to continue into the third quarter?

I can imagine the mixed changing a little bit.

I mean the overall comment is as we see the projects coming a little bit more slowly is all of our large customers, whether they are cable, satellite or telco, are being a little bit more thoughtful.

They are pausing and really getting the strategy right before they put their money down for the next generation head end.

Projects are on our pipeline, we are going to close new projects in this coming quarter.

We will recognize them sometime in the second half of the year or early year 2012.

And as has been in the case in the past, I think you know this from our satellite number, never been monotonically upper down.

Satellite in particular has been a project-oriented business and I think you'll see in the coming several quarters, you'll see both strong satellite quarters as well as lighter satellite quarters.

Then just one other question.

In the past you've indicated that you've done some software work with Amazon and Amazon, I believe, announced the last couple of days expanded relationship carrying more CBS programming.

Customers like Amazon or others expand their programming offerings or add more subscribers, does that have an impact, say, upon your transcoding software sales?

While I won't comment specifically on Amazon, I will tell you that our transcoding business while relatively modest numbers is doing quite well.

And we are pleased to see it continuing to gain traction with what I would call new media customers such as Amazon, as well as with service providers who are getting into that business.

We had an interesting win this past quarter with a traditional service provider who themselves are setting up a Netflix/Amazon kind of storefront, using our technology.

So that kind of application, yes, is of growing importance and relevance and it actually is beginning to span, as we see all of these different service provider models starting to meld, kind of -- we are seeing that opportunity cross traditional boundaries.

Great.

Thank you.

William Stein of Credit Suisse.

Thanks.

Couple of quick follow-ups.

Carolyn, you previously provided a margin outlook for the full year.

Can you give us an update on your view on that?

In terms of an operating margin?

Yes.

You know I -- because the revenue guidance is so big, I didn't give a specific operating margin.

I mean, our target was certainly 15%.

Given where we ended this quarter, it is going to be hard to achieve that.

We are managing our operating expenses very closely and we expect them to be relatively flat this quarter and then down next quarter.

I think it would be hard for us to get to 15% for the year at this point.

That is generally still our target.

And so at Analyst Day, I said 14% to 16%.

Whether it is 14% to 16% or 15%, we certainly expect that to be kind of our annual target.

I would expect Q4 to be above 15% with revenue continuing to grow.

But I'm not prepared to give a whole range for the year yet.

That's fine.

And then, one other one.

So, you've spoken about the change in the dynamic in the encoding business in particular in the US, that its customers are pausing, they are thinking more, maybe the revenue is going to be more lumpy, especially for these bigger deals.

Does your guidance for the rest of the year on the revenue, because you are guiding for the full year on revenue, does that derisk these larger deals, essentially taking them out?

Or is it more of a fair middle of the road kind of view, relative to your current pipeline that has kind of equal risk to upside and downside?

How should we think about that?

You know what?

I think that one of the reasons range for this quarter is so big is to cover the risk of one of these large projects either being in or out.

We are fairly confident that it will be completed in the year.

We expect and are hopeful that it will be completed in the quarter, but we have given ourselves hopefully enough of a range so that we have some flexibility there.

As Patrick said, this guidance would assume that maybe bookings would be stronger than revenue because of the nature of the projects.

We haven't obviously taken every risk out of the range.

We have tried to think cautiously about the guidance.

Okay.

Helpful.

Thank you.

Paul McWilliams of Next Inning Technology Research.

Thank you for taking my call.

There were a couple of interruptions by the conference call operator, so I missed some of the Q&A, so excuse me if I am redundant in some of my questions.

On the OpEx for Q4, did you suggest that would be down $2 million to $3 million was it, Carolyn?

I said a couple.

You know that would -- I think of that as 2-ish.

Okay, fine, I wasn't trying to put words in your mouth there.

Last conference call, you had mentioned that you expected the average operating profit for Q4 plus Q1 to be about 15%.

Do you think that is still achievable?

I think that depends on where revenue -- where we see revenue in Q4 and where gross margin is.

So depending on the mix of revenue as well.

So it's certainly possible, but you know that really has more to do with revenue and gross margin at this point.

Okay.

I understand.

Now what was Omneon for Q2 in millions?

We don't break out Omneon as a company.

We do break out Production and Playout as product.

So what that -- that includes their products, but not the service component of the business.

And that was $25.5 million.

You mentioned that there were up I think 14% sequentially -- (multiple speakers).

Correct.

And I looked back and I didn't see where you provided a Q1 number.

(multiple speakers) Playout as you mentioned and there is a service component.

Yes.

There is a -- at the back of every press release we have been giving out pro forma consolidated revenue as if we had been combined with Omneon both this year and last.

And that also adds in the deferred revenue carve-out that we were actually not able to take so that you could get the truest view of what their real business was.

And so for last -- for Q1 that number would have been $22.4 million and for Q2 it is $25.5 million.

Okay, but that's just on the Playout part of it.

That doesn't include their service?

That's production -- yes, that's their products, not their Support Services and Services.

Support and Services are consolidated.

We don't break those out.

But they are roughly [15]% of their total and are roughly in line with revenue.

Okay.

Let's see here.

Now on deferred revenue, you don't have any noncurrent deferred revenue, do you?

We do.

Okay, how much is that?

One second and I'll look that up.

I'm not sure I actually have it in the room with me.

It is combined on our balance sheet and so I'm not -- I don't have that in the room.

Oh, okay, I showed the current as being $47.6 million down from $49.8 million last quarter, which left me a little bit curious as to -- I took from the comments made that no direct statement that you had an increase in deferred revenue that I recall, that it seemed as though deferred revenue was one of the issues for the lower revenue realized this quarter.

So, bookings and revenue were both roughly flat with last quarter and roughly the same.

So there is not a big change in deferred revenue either.

There was revenue that they are included in deferred revenue from prior quarters are a couple of large projects that we -- that we expect to take the second half of this year.

A little bit to Patrick's comments, if you segregate those quarters revenue from that trend, two things happened.

There were projects that were in deferred revenue that we would have or might have expected to take.

We also expected bookings to be higher, which would have fueled future quarters' revenues.

Both of those things, not unrelated, slow down.

Okay.

Now, Patrick, you were talking about market share and such and I just want to make sure that I understand correctly that you are not aware of any major deals, domestic deals specifically that you lost to competition?

That's right.

Well and what I would -- look we don't have 100% market share, but we have done extremely well on what I termed and what I've called the high end in encoding.

And there hasn't been a period in the last two years where either a satellite, a telco customer or a cable customer hasn't done some kind of larger scale encoding project with us.

Yes and I know very well (multiple speakers).

So we are not aware of any project kind of that ilk that transpired.

Certainly you know there are small things that happen here or there and, yes, there's smaller projects that happen and certainly there's a number of companies out there doing things.

So we wouldn't have gotten to this result if we can do some amount of smaller kind of deals.

But this deal this quarter for us was characterized, I think, by no domestic deal larger than a couple million dollars, which is very unusual.

And so my comment is, is we weren't aware of anything larger than that that transpired.

Period.

Are you maintaining share in the universal EdgeQAM deal that you had been working with one of your major cable customers?

We think we have gained share in the last quarter.

As you see we had a very strong Edge and Access quarter and while the Access business is certainly part of that, our HectoQAM product is doing quite well in a marketplace.

It really offers I think compelling operational as well as financial benefit to our customers and we see it gaining momentum, both domestically and internationally.

We saw that product not only continue to fuel our presence with existing accounts and deployments, but actually break into some new locations.

So we are -- we are pleased with the way that technology is working out for us.

I've got two more here just real quick.

China Telecom announced fairly recently they are installing the Cisco ASR 9000 edge routers to support IPTV for the coastal cities.

Do you expect that you will have involvement in that project?

I hope so.

And the truth is I don't know exactly what's going to happen.

IPTV has been a winding road in China for some time.

We have deployment and we have relationships with the historic players who have the licenses on the content side.

And we continue to have those relationships.

And my belief is, my understanding is that we will be a beneficiary going forward.

I should highlight that, historically, that has been a very small portion of our revenue in China.

Most of our Chinese revenue has been derived from the cable operators who are the primary owners of the video delivery licenses in that country.

Oh yes and you have done well there.

That's what kind of made me curious as to what your thoughts were on this China Telecom.

Because like you, I take that as new event moving into Telecom and getting IPTV rolling and it's their (multiple speakers).

There are a couple of companies, for instance like the Shanghai Media Group who have owned IPTV licenses and there's been a couple of modest deployments in certain cities of Shanghai Media Group in cooperation with the Telecom network.

And what you just referred to, we read as really a gradual kind of extension of that model.

Excellent.

Now my last question here is a little bit general, but I think it speaks to what we are really all curious about.

This over-the-top model that is really just coming together now and people are understanding it, how does that impact your competitive position?

Bear with me, Paul.

It justifies kind of a one-liner, you know.

So, look, a year ago over-the-top meant delivering small resolution video to a small screen on your PC, right?

Or maybe to an iPhone.

That is kind of a new market and there's a number of players in that space.

You can do some of that in coding and software or you can do it very efficiently on hardware.

Harmonic is definitely a player in there, but there's also a whole lot of other companies that are playing an air.

In general, I would concede that that kind of market was more competitive than the way the high-end HD market had kind of shaken out.

We certainly believe in our long-term ability to win in that market just the way we think we have really come out by a long margin on top in the high-resolution HD market.

But, so that's going on and I think we're doing well, although, I will admit it's a more competitive space right now.

Band, the HD to television market, okay.

However, what's interesting and what has really happened over the last six months is the definition of over-the-top and what people want to do is really evolving in real time.

Look at now, you think about a Samsung 50 inch television screen that is designed to be connected and people want to watch Netflix on that -- streaming Netflix on that screen.

Well guess what, that little encoding system that plays just fine a little 5 inch screen or a 9 inch screen or whatever, no longer cuts it on a 50 inch thing.

So my view is although Harmonic was playing well and investing quite a bit and was poised to be quite successful in the smaller resolution thing, as the definition of over-the-top has opened up and now we are talking about delivering to much larger formats, that's really tilted the playing field actually much more strongly back in our favor.

There is nobody that knows how to live or compressed high-quality video to a 50 inch screen the way Harmonic does.

And that's certainly true over a provider network.

Now you talk about over-the-top where actually bandwidth is even more of a premium and the importance of compression is even more important because the operator doesn't control that network.

I think that puts an even greater emphasis on the compression of the quality.

So we like more than ever our competitive opportunity.

But this kind of goes -- I know we are getting into technology here, but this kind of goes to the heart of some of the things our customers are dealing with.

Six months ago the over-the-top platform was kind of the separate from how you get to 50 inch televisions.

We have got a little deployment for iPhones and that is distinct from our head end that is going to serve the televisions.

Now that is being rethought.

Well, wait a minute, maybe it is the same kind of -- it is the same kind of head end that has to hit all kinds of different screens.

So this is complicated.

It is moving very quickly and we think particularly as larger formats have come into the mix, into an expanded definition of what is over-the-top, we think Harmonic is positioned more strongly than ever from a technology point of view.

So on one hand, we're frustrated.

There's complexity, it's delayed.

We are not happy about sitting here as I emphasized at the beginning of the call.

We are not happy about the results nor are we happy about the financial forecast.

Nonetheless, at the same time, I hope you can hear it in my voice, we are as excited as ever about the opportunity.

We see these investments have to happen.

We see that our customers will roll out these services.

I think this is going to be the predominant model in this country, five years from now, and I think it constitutes a tremendous opportunity that goes right to the sweet spot of our technology.

So, sorry for the long-winded answer.

I hope that addressed it, but that is how we see it.

Well, no, I very much appreciate you taking the time and patience with me on that and I think it is something that a lot of your investors are interested in.

That wraps it up for me, but, Carolyn, could you put me on your call list so I can touch base on those housekeeping things with you later?

Absolutely.

Thank you very much.

All right, well, thank you very much, Paul.

And I think with that we will end the call.

Just a final word, I thank you very much for being with us today and more importantly thank you for your support and the company.

I hope it comes across that Carolyn, that I, that our management team, all of our employees have a tremendous conviction in our technology, our ability to succeed and we are incredibly focused on getting back on track from an operating perspective and back on track from a growth perspective.

We see the opportunity there.

We are heads down to make it happen.

And we look forward to talking with you next quarter, if not before.

Thank you very much, everyone.

This concludes today's conference call.

You may now disconnect.