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Executives

Patrick J. Harshman - President, Chief Executive Officer and Director

Robin N. Dickson - Chief Financial Officer

Michael Newman - Investor Relations

Analysts

Amir Rozwadowski - Barclays Capital

Unidentified Speaker

Mark Sue - RBC Capital Markets

George Notter - Jefferies & Company, Inc.

Vivek Arya - Banc of America, Merrill Lynch

Blair King - Avondale Partners LLC

Jack Monte - UBS

Unidentified Speaker

John Epstein - Morgan Keegan & Co.

Paul McWilliams - Indie Research

[Jeremy Helmond - Avenue T Fund]

Harmonic, Inc. (HLIT) Q2 2009 Earnings Call Transcript July 30, 2009 5:00 PM ET

Operator

Ladies and gentlemen, this is the operator. Today’s conference will begin momentarily. (Operator Instructions)

Good afternoon, my name is Jennifer and I will be your conference operator today. At this time I would like to welcome everyone to the Harmonic second quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

I would now turn the call over to Robin Dickson, Chief Financial Officer. You may begin.

Robin Dickson

Thank you and good afternoon everyone. I am Robin Dickson, Chief Financial Officer of Harmonic. With me in our headquarters in Sunnyvale, California are Patrick Harshman, our President and Chief Executive Officer and Michael Newman, our Investor Relations spokesperson. Thank you all for joining us.

Before we start let me remind you that during this call, we may make projections or other forward-looking statements regarding future events or the future financial performance of the Company. We must caution you that such statements are only predictions and those 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 our projections or forward-looking statements. Please note also that on this call we will provide you with financial metrics determined on a non-GAAP or pro forma basis.

These items together with the corresponding GAAP numbers and the reconciliation to GAAP are contained in today's earnings press release which we have posted on our website and filed with the SEC on Form 8-K. We will also discuss historical financial and other statistical information regarding our business and operations.

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

I would now like to invite Patrick to give his introductory remarks after that I will address the financial details of the quarter before opening up to take your questions. Patrick?

Patrick Harshman

Well, thanks Robin and good afternoon everyone. Today we announced second quarter results to demonstrate a significant sequential rebound in quarterly revenue and bookings, and Harmonic is continuing strong position in the marketplace. It was premature to declare for market recovery particularly in some of the international markets we addressed. We are encouraged by healthier domestic cable spending and strong customer interest across markets and geographies and our expanding portfolio of products and solutions.

We are also pleased with our internal execution as evidence by our continued discipline and managing operating expenses, realizing cost synergies from our focus acquisition. Improving our inventory management as well as excellent progress and delivering very compelling to products and solutions.

In our core application areas, this was a very successful quarter for our newest products. The high definition video continues to be a key market driver and our new Electra 8000 encoder platform is getting strong traction on the market. We saw our first revenue from the product in the second quarter and we are working closely with the number of our cable, satellites and Telco customers who used this technology, not only for adding new channels but also to more efficiently compressed existing digital channels.

We are also very pleased by recently published market research from [in staff] than in Harmonic as a global market share leader and encoding. Similarly, our newest generation NSG Edge QAM continues to gain important market share in video and demand, switched digital video, modular CMTS, and new IPTV over Cable applications. Our cable customers are also responding very positively to our new superlink WDM technology for segment and cable accessed and others. And we continue to be pleased by our gross margins in the edge and access product category, a clear indication of our continuing market leadership position.

We are equally excited by the progress we are making in the newer customer in application scenarios we have targeted for additional growth. The integration of the Scopus business is going well. For the past quarter, we saw a solid rebound in associated bookings and several new wins with video content originators and important customer group we targeted with this acquisition.

We are also seeing significant progress with our new solutions enabling deliver of on-demanding video content to mobile internet devices. During the past quarter, we were at three separate projects with large customers pursuing this merging mobile video area.

Going forward we see growing interest in mobile video applications from broadcasters, cable, satellite, and particularly our Telco customers. We are not extending our IPTV platform to encompass new wireless video services. We now expect these innovative multiple video delivery solutions will contribute significantly to our revenue in 2010 and beyond.

In so in summary, while global spending continues to be soft than a year ago, we remain convince that like to continuing to innovate, by continuing to strengthen our competitive position with the growing base of global customers and by keeping our internal business execution formally on-tract. We are positioned extremely well for further growth as market conditions improved.

I am going to give back to you Robin to cover the financial aspects of the quarter.

Robin Dickson

Thank you, Patrick. Today we announced the results for the quarter ended July 3rd, 2008. For the second quarter, we reported net sales of $81.3 million compared to $89.3 million in the second quarter of 2008 and $67.8 million for the first quarter of 2009.

The lower year-over-year sales continue to reflect lower capital spending by most of our customers around the world. And so while we have not yet returned to 2008 revenue levels, we are encouraged by our strong sequential growth in quarterly revenue and in orders.

You may recall that our bookings are fallen both Q4 of last year and began in the first quarter. But on our Q1 earnings call, we said we have started to see a recovery in the early part of Q2. These trends continue throughout the second quarter and bookings for Q2 were $81 million up from $57 million in Q1, while the sequential growth in Q2 bookings was stronger in the US than in international.

We were pleased to see a significant improvement in our European bookings, in part due to the additional sales channels we now have as a result of the Scopus acquisition.

Turning to the revenue breakdown, domestic sales represented 57% of revenue for the second quarter of 2009 compared to 48% in the first quarter. Here again, we saw a strong sequential revenue growth in the US. With international revenue marginally lower than in Q1.

By market segment, cable customers accounted for 66% of revenue in the second quarter, our satellite customers 14% and Telco and others 20%. As you see from our revenue data published in the press release on a year-to-date basis compared to last year, there is very little change in the mix of our market segments.

Our largest customer in the second quarter was Comcast, representing 19% of revenue and once again our only greater than 10% customer during the quarter. Additionally, we saw our sales to all of our US cable customers as an area of relative strength in Q2 echoed in large part by strong sequential growth in revenue from our edge and access products.

And by product category, edge and access represented 40% of revenue in the second quarter, video processing 39%, and software services and others 21%. In Q2, we saw a significant increase in revenues from our edge devices following a slow start to the year in Q1.

Now in recent periods, we have seen our non-GAAP gross margins holding at around 50% driven by the continued success of new products and solutions, a flexible sourcing strategy and ongoing cost reduction efforts.

In the second quarter of 2009, we recognized approximately $4.6 million in revenue related to the installation and deployment of a video headend project, which we have begun in 2008.

We had anticipated recognizing this revenue in the second half of this year, but received customer acceptance in June. The project was quite significant from a competitive and technological perspective but they generated no gross profit.

So, if we were to remove this project revenue in the associated costs from our second quarter results, our non-GAAP gross margins would have increased from the recorded 45.5% to 48%, which is right in the middle of our second quarter guidance.

We have more typical gross profit levels on project sitting in our backlog and then our pipeline and we expect our gross margins to rebound accordingly in the future quarters.

We are continued to be pleased with the discipline in managing our operating expenses. Our non-GAAP operating expenses in the second quarter were $32.7 million up approximately $4 million on a sequential basis. All of which reflects the full quarter of Scopus operations included in our results compared to only three weeks of Scopus in Q1.

During the second quarter, we substantially completed the integration of Scopus into Harmonic and we are pleased to see the anticipated cost synergies well underweighted being realized. In part, this is due to reduce headcount. We entered the second quarter with 905 employees and at the end of Q2 had reduced headcount to 842 people.

Our GAAP net loss for the second quarter to 2009 was $7.9 million or $0.08 per diluted share compared to net income of $25.5 million or $0.27 per diluted share for the same period of 2008. The second quarter of 2008 contained the large tax benefit of $15 million related to the reversal of evaluation allowance against our deferred tax assets. That results for the second quarter of 2009 include restructuring of excess facilities charges related to the recent acquisition and integration of Scopus.

Excluding these charges, non-cash accounting charges for aftermarket inventory accounting Scopus, stock based compensation, the amortization of intangibles and tax adjustments, the non-GAAP net income for the second quarter of 2009 was $3.1 million or $0.03 per diluted compared to $15 million or $0.16 per diluted share for the same period of 2008.

We continue to maintain a strong balance sheet and we entered the quarter with cash, cash equivalents and short term investments of $253 million. We are in the strong position to pursue further acquisitions or other initiatives to achieve our strategic goals.

Our receivables increased to $64.5 million at the end of the second quarter up from $52.7 million at the end of the previous quarter, reflecting our higher revenue levels. Our DSOs were 72 days essentially unchanged from the previous period.

Our inventory was $34.4 million that almost $4 million from the end of the first quarter and we are pleased to see this reduction in the inventory levels and the improvement in the inventory turns reflecting substantial progress in integrating and streamlining the Scopus production and procurement processes. And finally our capital expending was $2.3 million in the second quarter and we are still expecting CapEx for the year to be approximately $7 million to $8 million.

So, turning to the outlook, the fundamental trends on the competitive dynamics that have been driving our business remained enforced even though they have been muted by the effect of macroeconomic events on our customers and their businesses.

We said in April that we believe that Q1 represents at the low point for our business and we indeed did have a strong sequential rebound in our bookings and revenue during Q2. We enter the third quarter with total backlog in deferred revenue of about $73 million.

While the global economic situation still creates substantial uncertainty, recent seasonal patterns showed that the second half of the year is normally stronger than the first half. Based on our improved bookings and the seasonal patterns, we anticipate another sequential increase in net sales in the third quarter and a range of $82 million to $88 million.

We also expect our non-GAAP gross margins for the third quarter of 2009 to return the levels comfortable with recent periods in the range of 48% to 50%. While we will always see some pricing pressure, our margin trends are positive and our contract manufacturing model provides us with flexibility. We believe our product roadmap and strategy on the right track and our long term gross margin targets continue to exceed 50%.

With respect to operating expenses, we are pleased that the promised Scopus cost synergies are being delivered. Non-GAAP operating expenses for the third quarter excluding possible additional acquisition related charges and charges for stock based compensation and the amortization of intangibles are anticipated to remain relatively flat or slightly up from the second quarter in a range of $33 million to $34 million.

So, in summary, they remained significant global economic uncertainty and yet we are cautiously optimistic. Q2 shows that our business momentum is heading in the right direction or be it at the measured pace. Harmonic is well placed with a strong balance sheet at the healthy operating model, allowing us operational flexibility and the opportunity to use our strong financial condition to our competitive advantage.

We are focused in leveraging the sales opportunities provided by the acquisition of Scopus while delivering on cost synergies and other efficiencies. By continuing to invest in technology leadership, I am strongly supporting our diversified and growing customer base, we believe we will further strengthen our competitiveness and extend our global market presence in 2009 and beyond.

This now concludes the formal part of our presentation. Patrick and I will be pleased to open it up to your questions. Operator?

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from Amir Rozwadowski - Barclays.

Amir Rozwadowski - Barclays Capital

If we look at sort of the spending environment by end market and certainly it seems that you had some strength on the domestic cable market. I was wondering if you could talk a little bit about what you are seeing in terms of the DBS or satellite markets and sort of any outlooks you see in terms of spending from that perspective.

Patrick Harshman

Yes. As you pointed out and as we said, the domestic cable markets seem to rise above all other markets and among the other markets including the DBS market. There are no really appreciable differences. As Robin noticed in his comments, year-over-year our satellite revenue is about 18% of total, which is almost than what it was for the entirety of 2008. So, as a percentage of our overall business as a ratio, satellite is consistent.

We are encouraged by the response toward getting from satellite customers, not domestically and internationally in response to the newest products particularly the Electra 8000 that I spoke and we see good opportunities around supporting the addition of new channels, as well as I mentioned the upgrading of some previously deployed channels both MPEG-2 and MPEG-4, high definition as well as standard definition.

Robin Dickson

I was wanted to pointed out that as we have been saying over the past couple of quarters, while encoding I think is the main thrust of our historical business and probably for sometime going forward with satellite customers. We increasingly excited about and we see increasing activity around the first defying business models and deliver means coming from satellite operators specifically some of the internet and mobile activity that I spoke. We are seeing satellite operators around the world really leveraging their content relationships, their customer relationships to explore and in some cases begin to invest in these alternative video deliver mechanisms and we are really excited about that as a fundamental long term incremental driver of our satellite business.

Amir Rozwadowski - Barclays Capital

Should the way we think about it is, is sort of as the Electra 8000 being the acceptance in the marketplace that is where we could see some further stabilization and then in the satellite business from a product upgrade cycle?

Patrick Harshman

Yes. I mean I do not want to suggest that we think it is not stable. As I said earlier, the revenue is actually had hanged in there quite well. That being said, if you look over the history of Harmonic working to satellite operators, I am talking with the last 8 to 10 years. Actually, the lion share of the business is actually being around upgrading and replacing existing previous generation in quarters and looking forward we see great cycles, great opportunities to do that. The first high definition, MPEG-4 encoders were now in the field of upwards of three years. There is tremendous savings opportunities now associated with upgrading those encoders and the same kind of opportunities it goes around standard definition channels.

So, we do see. Without one operator, it is a cyclical, kind of investment cycle. As a whole, you get some smoothing and we continue to see a good future with satellite operators, domestically and internationally.

Amir Rozwadowski - Barclays Capital

Okay. And then last, if I may, obviously we have seen in March to pick up in your bookings and your deferred revenue on sequential basis this quarter. As we stand today, obviously the standing environment still remains challenge but how would you characterize your visibility going forward where we stand today versus where we were probably three months ago?

Patrick Harshman

It is certainly improved from three months ago; on the other hand it is not what it was a year ago. It should be saying too much in the gray. We do see study improvements. We have substantially better visibility but still not what we are accustomed to in terms of managing our business over the past couple of years.

So, we are really looking forward to seeing what is going to happen in the third quarter and then we are certainly cautiously optimistic that we will see continued improvement, if not only in the fundamental standing but also in the visibility.

Operator

Your next question comes from the line of Mark Sue - RBC Capital Markets.

Unidentified Speaker

This is [25.46] for Mark Sue. The datum for $82 million to $88 million how should be less at the Scopus contribution in the third quarter and if you could, can I tell, we should look at the trends by customer segment Telco, cable and satellite?

Patrick Harshman

We are not breaking out and we will not be reporting on Scopus [26.12]. But as I mentioned in the prepared comments, we are very pleased with the way the Scopus bookings are rebounded and actually progressively increased to the second quarter. Really, the rate of the quarter finished up and looking for the second of the year. We are seeing no appreciable different in kind of year-over-year comps and what was the core Harmonic business in the core Scopus business.

So there is nothing particularly no worthy about “Scopus contributions”. Let me ask you to restate the second part of the question. I was not sure if that was in general or where they were still kind of asking about Scopus related at contribution with those markets that you mentioned.

Unidentified Speaker

In general for the third quarter, I guess how we should look at the trends by customer segments in Telco, cable and satellite?

Patrick Harshman

Yes. We do not see any appreciable difference. We have mentioned a couple of times now that we certainly saw US cable in particular more aggressive in the second quarter than the rest of our customer universe as a whole.

We expect cable to continue on that track more or less. We are optimistic and in fact our guidance suggests incremental improvement in the remaining universe of our customers in markets. But in terms of quarter-to-quarter, other than that no appreciable difference and in different customer segments or geographies.

Mark Sue - RBC Capital Markets

That is a good smart to say. Just a follow up on that, what about currency impacting Europe anything that is crossing some prestigious dependent, what is the currency in particularly delay purchases?

Patrick Harshman

Well, I think that is certainly an aspect in parts of Europe, particularly Eastern Europe Mark and I think that is part of what if we look at as an overall region I think that is part of what behind. That is still being in somewhat challenge region from our perspective, frankly in Europe as well as in Asia as well as in parts of the America. You do have some economists that are relatively hard to hit.

So, those lingering issues are certainly part of our thanking and part of our continuing caution as we try to understand how all of our international markets will emerge from this current climate.

Mark Sue - RBC Capital Markets

And just lastly, just on the fourth quarter recognizing it is fairly, are you going to feel the pipeline overall to the balance not also be healthy considering your near term bookings in terms of the resumption in projects?

Patrick Harshman

We certainly help so much. But the truth is the visibility still is not great. The trends feel right. We are certainly telling positive by what we saw in the US and we cautiously optimistic to things will continue to improve throughout the second half and therefore that does not imply we hope a good Q4. But we really think it is prudent to wait to see exactly how Q3 tends out and then of course we will have a better feeling and just given the kind of the ups and the downs over the past three quarters. We continue to be a little bit reluctant to just speak with any great confidence about the fourth quarter at this point.

Operator

Your next question comes from the line of George Notter - Jefferies & Company, Inc.

George Notter - Jefferies & Company, Inc.

I guess just to be clear, the Scopus revenue in large part gets recognized to the video processing, revenue line, is that correct?

Patrick Harshman

Yes. That is correct, almost exclusively.

George Notter - Jefferies & Company, Inc.

I got it, okay. So, the thing that is confusing for me is that you had very small sequential bomb in the video processing business here in June, despite the fact that Scopus was in a number sort of entirety of the quarter only three weeks of the March quarter. What happened to all that we have new and it seems like it is really off relative to almost $20 million quarterly run rate they are doing at the end of your last year before the acquisition?

Robin Dickson

I think, George, look a little bit only the revenue versus the bookings. I mean there is no question. The revenue was tilted more towards the US in the second quarter reflecting as Patrick and I both said relative strength in US cable which tends to be not exclusively but tends to be more of quick turn business. The video processing products and solutions are often carried some of our deferred revenues. So, I think what I am really trying to say is that we saw strength in the bookings in the second quarter internationally and I think the conclusion that I draw from that is we are going to see stronger performance internationally and in video processing to some extent in the third quarter.

So, I think it is simply timing. I mean as you remember, the deal did not close until March and I think frankly as we admitted in the first quarter call that the first quarter was a difficult time as we are putting the deal together in the customers and distributors and so on. We are trying to figure out what would happen. I think all that is behind us and the affects are beginning to show when as we look at our orders in the second quarter.

George Notter - Jefferies & Company, Inc.

So, is it fair to say that the reason we had such a little lift in the video processing businesses quarter is because, Q1 or even Q4 from a booking’s perspective was super soft than Scopus and therefore they did not have the deferred revenue piece of the business. I guess I am still trying to understand what happened, I mean outside I am looking in. I mean it kind of feels like maybe those guys got a little aggressive and play their revenues in the back part of your last year and you got cut kind of holding the downside after the acquisition.

Robin Dickson

I think the focus in Scopus is not really the right focus here. Our first quarter revenue picture was actually very strong in the international and in video processing as well and a lot of that was coming from backlog and deferred revenue from the [color] Harmonic business which had been booked in the second half of last year.

So, I think it was more of the movement; the fact that the first quarter was actually relatively strong in video processing is the reason that the second quarter increase was relatively light. It is less to do with Scopus than it does with the absent flows of our regular video processing business or headend projects and delay.

Operator

Your next question comes from the line of Vivek Arya - Banc of America, Merrill Lynch.

Vivek Arya - Banc of America, Merrill Lynch

A couple of questions, now, first is on operating expenses. Do you see flattish OpEx trends from here or do you see you are going back to the historical range of OpEx being 33% to 34% or so of sales?

Robin Dickson

Well, I think Vivek our plan for the moment is to hold operating expenses relatively flat but the key to getting back to that kind of ratio I think has more to do with the top line than the revenue line. As Patrick said, we are cautiously optimistic with things are beginning to improve. We have made some significant reductions in operating expenses when you look at to combine Harmonic Scopus Company. And so we are relatively comfortable where the right level now and I think the ratio will start to get back in balance as the revenues build back, which is what we are going to do for Q3 and hopefully be on that.

Vivek Arya - Banc of America, Merrill Lynch

So, in absolute dollar is then Robin we should see OpEx on a whole to this, the third guidance that you have given, sort of that 34 million-ish type level.

Robin Dickson

Yes. The range recorded in the press release and earlier in the call was 33 million to 34 million. That compares to 32.7 million in the second quarter and I think is the way to think about it flat, maybe up a little bit of revenues increase though with some variable costs that increased as well.

Vivek Arya - Banc of America, Merrill Lynch

I got it. The second thing, the increase and bookings have been encouraging. Could you, Patrick, maybe give us some more color what is driving this trend with segment is providing this trend and which segments are still remaining lead or any comments on Scopus versus your organic booking trends would be very helpful?

Patrick Harshman

It is honestly a patchwork picture Vivek. From a customer point of view, the clearer pillar of strength was US cable and of course cable is we work with the range of our products in cable. So, we think cable, it was exactly strong quarter as Robin mentioned that originates accessed product line but I also did quite well with cable operators with our encoding and stream processing of products as well.

So, we saw, from a product point of view, broad strength in US cable. Stepping apart from US cable, I would say it is a little bit more a question of domestic versus international and in particular oversees we do not see a dramatic difference between the different customer segments rather that becomes down in the countries that are struggling or doing somewhat relatively better and as mentioned a couple of moments ago, we are still a number of countries, Eastern Europe, at some parts of Asia. For example, where we continue to see significant economic pressure and provide the reasons of slower spending or more cautious approach spending.

Vivek Arya - Banc of America, Merrill Lynch

And just the last thing, this weakness in video processing, going back to the last question, is that just the result of the vid satellite on sales and is that a secular trend or do you see it rebounding in the second half like a bit last year and it is year than why do not we see better gross margin that your guiding to.

Robin Dickson

Again, I think the issue with the point about weak satellite sales. During our satellite sales we are down compared to last year but then overall the market segments. As we said earlier, particularly when you look at on the year-to-date basis, there is really no appreciable difference in the mix at this time last year versus this time, this year. I think it is got more to do with the fact as I said earlier that we did a relatively strong first quarter performance in video processing with a lot of revenue being recognized from projects taken in the latter part of ’08 when things were still a lot more robust than they have been over the last six months.

Vivek Arya - Banc of America, Merrill Lynch

Just one last thing, Robin, to follow up, last year your satellite sales, I think in the second half grew 20% compared to the first time. Do you expect the similar trend in the second half this year?

Robin Dickson

I think it is possible with that. I think we are still waiting. As I mentioned earlier, one has to do with the exact timing. We have no doubt that over the next several quarters will see with several of our customers spending associated with some of the upgrade cycles that I have been talking about, a number of our satellite customers around the world are taking it post look over this technology and depending on where they are in many cases are deploying on technology.

So, we continued to be quite optimistic and quite confident about our position in satellites where our satellite operator customers are headed. Their aggression and their seriousness about continuing to compete in this market and I think the combination of where they are at together with the new technology whether would be encoding or whether in some of the new technology that I still need to enable than to deliver internet and mobile services. Altogether, we remain quite bullish in the long term on the satellite business.

How much of that is going to follow in to what the uptick will be in the second versus how much of that maybe it turns to be early 2010 business. I think we are still not sure.

Operator

Your next question comes from the line of Blair King - Avondale Partners.

Blair King - Avondale Partners LLC

Just a couple of quick ones, I just want to come back on the edge and access side, I was wondering if you guys could talk just a little bit about what is going on in the Edge QAM space today if you can clearly a lot talk about pricing pressure in the Edge QAM space and certainly I would imagine that is the case but I would be curious also to hear how that pricing pressure might be offset on increase volumes or if that is in the case and just general thoughts about marketplace today in where it seems to be going, if you do not mind.

Robin Dickson

Yes. It is an exciting space as when we feel very strongly about and when we continue to be very excited about and when we continue to invest them. I mean first, just addressing the pricing pressure. That whole is obviously accessed more generally. This was a price at a competitive area.

And I would say that relative to past years, the pricing pressure is not notably different this year than any other year and in fact as we mentioned we continue to be pretty pleased with the way our overall edge and access gross margins are hanging in there quite nicely.

In terms of broader trends which is nice about the area as we continue to find new applications and new opportunities. Video on-demand continues to be the cornerstone of our deployments, of the volumes today and really of the opportunity going forward. If you look back at the cable vision related remote storage DVR of rolling that happened during the past quarter, we are really excited about what that might mean in terms of more aggressive rollout in video on-demand over the next year or 18 months by cable operators as they perhaps take advantage and is willing to throughout from more aggressive network DVR kinds of services.

So, first and foremost, from an Edge QAM perspective I think we should lose the side of the fact that the VOD is a great market as when where we have commanding market share or lead and we continue to be very excited about the future prospects.

Additionally, we continue to see opportunities growing and into the other opportunity scenarios. The switched digital video, we have seen several nice wins in so far this year and looking forward to the second half of this year, in 2010 we see that as a nice incremental growth opportunity. We continue to win new customers and new accounts in the modular CMTS area and somewhat related to that so I want to highlight particularly international operators who are utilizing an Edge QAM base architecture that delivered IPTV services over cable network.

What is from my perspective, a very important press release with SK broadband in Korea this past quarter, talking about a really significantly in fact the world largest deployment of IPTV over cable in Korea and that is really powered by our Edge QAMs with some higher value of software on top to make the whole thing work. So, it is a dynamic area. It is an area and one where we continue to feel good about the opportunities as well as our competitive position.

Blair King - Avondale Partners LLC

Okay. Just one follow up to that, it sounds like a lot is going on in the Edge QAMs base. We are implying a lot of volumes and certainly I am sure there is a lot of volume. So, can you give us a sense in terms of what the price purpose is and just in general terms on a worldwide basis and where you see that going let us say from today two years from now and then how your margins actually stock up against that?

Robin Dickson

I think I disappoint but I would really rather no going to any specific pricing discussion, I just like to suffice to say ever since we have been in this category, prices have gone down. We have been able to a combination of delivering added value of capability on that cost reduction. But we have been able to do a very good job when keeping the gross margins strong, I mean over a period of years. We have been in this business since 2000 I think and I do not see any significant change in that dynamic going forward.

Operator

Your next question comes from the line of Jack Monte - UBS.

Jack Monte - UBS

Just trying to back into the Scopus revenues from a little different angle and I was curious if you could confirm which customer of vertical the Scopus revenues are in? I was thinking they are mainly Telco or the other segment and when I do the quick math here, it looks like first half 2009 Telco and other revenues are down about 12% and then we got the cable revenues down about 15%. So, I was curious if you could comment, are these organic Telco deployments or in cash slower than Harmonic as anticipated? It sounds like underperforming the cable space, but just trying to get a better idea of what is happening there with the organic business and if Scopus is entirely in that customer of vertical. Thanks.

Robin Dickson

So actually Scopus is spread out across a customer of verticals in fact we had some nice revenue out of cable has not involved Scopus product this past quarter. So, I think it is important to remember if I take a step back, we really get in two things with the Scopus acquisition.

One is a class of products that contribution encoding and distribution products and that technology will I think has got a particular residence and really open doors with content creators and broadcasters people like discovery in Disney and Turner. That technology is also applicable and purchased by all of our other verticals, satellite operators IPTV as well as cable operators. And in that kind of business so the sale of Scopus product across our customer base and to some of these content originators as well I think represented about half of the contribution that we saw in the past third quarter in terms of new orders.

The other thing we were looking from the other half of the bookings contribution from Scopus was just the fact that from a sales presence point of view particularly outside of the United States, they had channels and customers and they were in geographies where Harmonic just was not present. And so there the opportunity for us was to significantly step up our feet on the street, our sales channels on our presence and again these were up across territories.

For example, in India, India 2008 and I think 2007 with Scopus is largest market. Their sales in that market were the cable, satellite as well as IPTV and broadcast operators. We have leveraged that presence and not only to deliver historical traditional Scopus products but actually Harmonic products through the existing Scopus channels, direct sales with presence, direct sales and support presence as well as evaluated reseller networks.

Jack Monte - UBS

I guess just to follow up, so if I understand that correctly, it sounds like 50% of the Scopus revenue was in the Telco other vertical or is that the wrong way to think about that?

Patrick Harshman

I will try to get. I am sorry. It was not. Fifty percent of the bookings approximately were from the products. They are developed by the Scopus business across all of our customers in cable, IPTV, broadcast and satellite. And the other half actually came from particular international markets where Harmonic had net strong of a presence historically. Sales in the Eastern Europe, in Russia, in Africa, across the African content part of Southeast Asia including India.

Jack Monte - UBS

Okay. I guess I can follow up offline. The answer is so confusing for me.

Patrick Harshman

Well, I regret that. We would be happy to try to clear it with you.

Robin Dickson

I mean Jack it really goes back to the fact that we are not running Scopus as a separate unit. We have integrated it into the existing sales and product structure within Harmonic and we are simply not franking everything to the end as degree as to the details and it does fit mostly internationally but no exclusively from a geographic perspective and it is reasonably well spread across the market segment. I mean you are right in one sense that Telco and other is the place where many of the Scopus customers in what we would lose they call the broadcast space do it, but as Patrick’s pointed our ability to add the Scopus channels to our sales arms have helped also significantly in some of our cable and satellite customers as well.

Jack Monte - UBS

Okay. That is helpful. Thank you. And as far as the international revenues, they were at 52% last quarter. We knew they were going to be off a bit this quarter. When do we see them getting back to that 50% range? Is it still a long term goal or I guess vision for the Company that international revenues will be 50% of the business?

Patrick Harshman

Well, it is not the entire outfit for the most of the last several quarters and then we have isolated in the range of 45%, as you pointed out above 50% last year. I think, as we have said, some of the strengthened international bookings, we started to see later in the second quarter. I think we are going to closer apparently in Q3. I mean it is always stuff to call exactly but I think will be closed it apparently.

Operator

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

Unidentified Speaker

This is [49.51] calling in for Greg. How are you doing?

Robin Dickson

Doing well.

Unidentified Speaker

Just a quick question for you guys regarding the Electra 8000, just want to see some of the, how the order is trending with satellite business being [50.09] I was wondering if you are seeing a traditional at the order pattern of the 8000?

Robin Dickson

Well, it is still relatively know. The customers have been testing throughout Q2 and we had made our first shipments in the second half and do mentioned that we are able to recognize our first revenue but still very much just ramping up. So, I think it is still very early days. I do want to emphasis though that the discussion in the interest is across our customer segments certainly I think this tremendous value and we are consequently really excited about the opportunities in satellite but [50.48] compelling for IPTV customers and many of our first wave of IPTV deployments did not involve high definition as you know DSL networks are quite banned with constrained and the additional compression capability this product is very meaningful for Telco operators who are looking to add high definition and just significantly the opportunities were cable operators. Rather this is a product that supports both MPEG-2 and MPEG-4 and one of the exciting things about this product is that will enable four high definition channels in one channel slot in the cable network. This is, in other words, somewhere between 30% and 50% of better efficiency than it is currently being delivered in the cable network today.

So, our cable customers are among the most excited about this technology and we are consequently quite excited about the opportunities there. So, a lot of testing, a lot of evaluation going on, first orders, some of the first shipments and I think it is going to be a story for us over the second half of this year and throughout 2010 the ramp of this product.

Unidentified Speaker

Great and maybe this is earlier, do you expect the Scopus acquisition to be decreased exiting the year?

Robin Dickson

That is what we said as the beginning of year, we clearly in this environment, revenues are not quite what we expected than to be or anyone expected them to be. I guess what I can say and because I am not but to try to predict in that six months but I think what I can say is at least from an expense perspective we have put in place the actions that need to be taken to realize all of the cost synergies that we talked about when we announce the deal in December and I am very confident that we are well in the way to realizing the cost synergies piece.

The sales piece is a little more challenging again namely because of the current environment. But as we said earlier and I think we get starting to get some leverage out of the Scopus sales channels and I think there is still a possibility that that is the way it turns to be for the year.

Operator

Your next question comes from the line of Simon Leopold - Morgan Keegan.

John Epstein - Morgan Keegan & Co.

This is John Epstein calling in for Simon. Thanks for taking the question. You mentioned a number of wins in different product lines and that along with the expected recovery in gross margin. Can you help us to understand how the mix affects your blended gross margin? For example, what is the range from your best margin products to your lowest?

Patrick Harshman

John, typically if you assume the corporate margins to be around 50% generally what we find is our video processing it ranges 5 to 10 percentage points above that level with edge and access below to not quite the same extent but it is only about say 3 to 7 below the corporate average.

Software and services piece is the highest margin but that is relatively small component of revenue at this time. So, a video processing maybe 5 percentage points above and edge and access maybe 3 to 4 percentage points below in general.

John Epstein - Morgan Keegan & Co.

Thanks. That is very helpful. It seems like the government broadband stimulus is geared mostly towards Telcos but the [EC] in the opportunities for your customers and your business?

Patrick Harshman

We do. It is not a big part of our business and we do have some revenue when some sales activity among the tier 2 and tier 3 Telco as one of the smaller cable operators and we are talking about the US here, and so I would not say it is a huge opportunity for the Company but in fact there is some activity and increasing activity among that segment of the market and we do think it could present some additional spending and additional opportunity among those smaller carrier customers.

John Epstein - Morgan Keegan & Co.

Okay. And lastly, you mentioned about your customers, how would you characterize that diversity below the 10% line, maybe they can contribution from a top 5 or 10 customers?

Patrick Harshman

Yes. Our top 10 customers and that is the number we have published in our 10-Q. So we will through in a number from memory. I do not have any in front of me here but memory expect that for the year to date our top 10 customers will represent somewhere between 50% and 55% of revenue which is maybe a little lower than we have seen in the most recent periods.

Operator

(Operator Instructions) Your next question comes from the line of Paul McWilliams - Indie Research.

Paul McWilliams - Indie Research

It looks to me, just look at the numbers here that most of the Scopus OpEx is carrying forward would be R&D, is that correct?

Patrick Harshman

No, not really. I mean clearly Paul we are trying to protect the R&D efforts but it is not entirely we have retained the significant portion of the Scopus sales and service support team which is an important piece of the selling equation as we have talked about earlier. Scopus has channels and customers in many places that we have either not reached this effectively or not reached the toll and so we have retained quite a bit of the team there.

Paul McWilliams - Indie Research

I was just looking at the sequential changes there on the pro forma basis and it looked to so SG&A was down a little bit for non-GAAP and R&D was up noticeably non-GAAP.

Patrick Harshman

Well, I think Paul that maybe has more to do with the fact that you may remember going back a year, maybe a year or 15 months we said that with the very strong operating margins we had a bad sign that we were very anxious to invest maybe a little bit more aggressively in our R&D and so I think that is probably where that come from that we have been anxious to try to protect that investment and maintain that investment even in the more difficult environment that we have been facing for the last few years. So, I think it is probably got more, like a lot of things that we talked about this afternoon probably has more to do with what is going on in the core of Harmonic than the addition of the Scopus piece.

Paul McWilliams - Indie Research

On the $4.6 million that came over from 2008. I would like to dig into that just a little bi more. Were there OpEx charges associated with that?

Patrick Harshman

Yes, of course. There is always with any major project but I do not mean to suggest but that anything out of the ordinary and there were OpEx charges clearly in the sales people and sales support and so on but nothing I would not say anything out of the ordinary.

Paul McWilliams - Indie Research

So, consistent with your trend?

Patrick Harshman

Yes, yes. I think that is there, yes.

Paul McWilliams - Indie Research

Can you tell me anything more about that type of project? Why it was a zero GP project? Was that a proof-of-concept for you?

Patrick Harshman

Paul, I will be appreciated [59.10]. We do not too much data simply because it was not went off and you want to see overpaid it but maybe a little bit of background. There was a complex project that involved not only around project but a substantial amount of third party project as well as a substantial amount of our system integration work. I think it raiment the complications. It turned to be more than anybody to customer way or our third party partners back and forth and a big part of the challenge, the cost over run was associated with other products as well as a dramatic cost over run and our own service in integration cost.

The key thing is that I do not think it is an anyway indicative of a broader market trend or border trend within our business in terms of deals that we were seeking out and the reason no other they like that currently active or under consideration or on the horizon.

Paul McWilliams - Indie Research

What I was trying to get to was the proof-of-concept where the customer was then prudently to considerably orders.

Patrick Harshman

To a certainly aspects of that and in fact there has been already follow on business that did much help your margins from that customer. I do not want to overstate it but what your suggesting is certainly an aspect a piece of the equation and a piece of the original thinking and going up to that business.

Paul McWilliams - Indie Research

Was spread across than video processing software and services?

Patrick Harshman

Primarily video processing.

Paul McWilliams - Indie Research

Okay. Real quick here on the Edge QAM or early trends for CMTS, do you see modular CMTS becoming more popular or are you seeing over an integrated CMTS? What do you see there in that trend?

Patrick Harshman

We were frankly and I think we said we were surprised by the way modular CMTS kind of pop-up faster than we had predicted in 2008. So, it is kind of a pretty [stick lamp] last year and in terms of popularity and percentage adoption, we are not seeing a substantial since that time. So, I would not say that is becoming more popular than since nine months ago, Paul. It is the architecture choice for some number of customers and in fact we have added new customers who have adopted our projector just in 2009.

That being said, I do not want to suggest that we think it is becoming the predominant ISP data, the accessed architecture.

Paul McWilliams - Indie Research

Okay. [62.00], would you say and I think you have, I just want to make sure I ask you directly. Would you say that there you see an uptake in demand across the broad for video infrastructure equipment in the second half or the first half?

Patrick Harshman

We think so. I mean divide it into two pieces part. I mean there is a tremendous amount of strategic activity in thinking in competitive planning going on around video. I mean I do not think it could be in a more exciting place, but I will rely on top of that. The fact that our customers are still dealing with uncertainty of their own in a certain amount of caution include us.

So, there is no question in our mind and we see in terms of the amount of pre-sales activity and customer discussions. It has frankly never been busier. At the same time that translates directly or how that will translate directly into intellectual spending. So, that is one of the reasons why we are cautiously optimistic look for Q3 and for Q4 but we are still really waiting to see and I think that is prudent as we go for Q3.

Operator

Your next question comes from the line of [Jeremy Helmond - Avenue T Fund].

[Jeremy Helmond - Avenue T Fund]

For a minute, about your perspective on what you foresee with respect to the long term environment may be taking five years out in terms of cut and deliver, do you imagine in talking about Scopus there are some traffics with the [contact] creator, do you see any sort of a migration or larger opportunity with respect to your products landing at the doorstep of contact creators be it at to this like and have found that work and they will be in such, you might then kind of [63.58] for channel for you so to speak?

Robin Dickson

Yes. That is a clearer strategic goal of ours. We think with primary developer of video technology and we frankly as a whole that we are not delivering that technology or have not historically to that market segment. We want people, like the NSL network, like Disney, like Turner, like the BBC are to be using our product.

We do have exactly the right product to date acquiring Scopus was at first I think significant step in that direction we do additional work in that area through our [64.37] trends encoding technology and long term penetrate in that market and developing more products and solutions for as a clear strategic game of the business.

[Jeremy Helmond - Avenue T Fund]

If the challenge in doing that in the value add for them, the fact [64.55] then they found that work for example, they will have all these varying I guess delivering mediums to get bandwidth and management of delivering throughout those, the various mediums we have seen really to get some complexity and need for devices and management tools.

Robin Dickson

That is right. You can imagine, we think it is a very opportunity rich of scenario, multiple formats, multiple of times and less add insertion of possibility. We think that there are significant opportunities there.

[Jeremy Helmond - Avenue T Fund]

Okay. And just one last follow-up to that and then I will sign off. It sounds like you still might need a little bit more, like another arrow in your technology to deliver for that and if so, was that something like to be acquired or built?

Robin Dickson

We clearly I think do not have critical mass even with Scopus there but this is a case where I think I have rolled out before we run and we are learning more and more about the market in the opportunities and the way these models loss of coincide and convert with our service provide customer business model. So, I think it is pretty much sort to say what is exactly the next step will be. We are going to try to take full advantage of the technology we have today and use it to develop poster relationships and get better insights into the [66.22] market and we will figure out then the most prudent next step to us.

Operator

There are no further questions in queue sir.

Patrick J. Harshman

Alright, I would like to close simply by thanking everybody for participating in the call and we would look forward to talking with you all again soon. Thank you and good day.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Harmonic, Inc. Q2 2009 Earnings Call Transcript
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