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Executives

Robin Dickson

Patrick Harshman

Analysts

Simon Leopold - Morgan Keegan

Mark Sue - RBC Capital Markets

Brian Coyne - Wedge Partners

George Notter - Jefferies & Company, Incorporated

Amir Rozwadowski - Barclays Capital

Blair King - Avondale Partners

Larry Harris - CL King

Greg Mesniaeff - Needham & Company

Brian Coyne - Wedge Partners

Presentation

Harmonic Inc. (HLIT) Q4 2009 Earnings Call February 2, 2010 5:00 AM ET

Operator

Good afternoon ladies and gentlemen. My name is Sarah and I will be your conference operator today. At this time I would like to welcome everyone to the Harmonic fourth quarter 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. Mr. Robin Dickson, Chief Financial Officer. You may begin your conference.

Robin Dickson

Thank you Sarah and good afternoon everyone. I'm Robin Dickson, Chief Financial Officer of Harmonic. With me in our headquarters in Sunnyvale, California are Patrick Harshman, our President and CEO, Michael Newman our Investor Relations spokesman. 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 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-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. 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 a Form 8-K.

We will also discuss historical, financial and other statistical information regarding our business and operations. Some of this information is included in the press release and the remainder of the information will be available in a recorded version of this call on our website. I will now invite Patrick to give his overview of the quarter and year. Then, I will address the financial details of the quarter before we open up to take your questions. Patrick?

Patrick Harshman

Thanks Robin, and good afternoon everyone. Today we announced fourth quarter and full year results that demonstrate solid operational execution in a challenging environment. Our results also provide encouraging signs of a recovering market and very positive customer response to our newest products and solutions. During the past year we remained focused on our strategy of aggressive technology leadership across a range of new video applications, customers and geographies. As a result we're entering 2010 with improving visibility and a stronger technology portfolio, more customer relationships and more opportunities.

Geographic expansion and diversification of our customer base has been a clear strategic priority and we're pleased by our progress in 2009. Our sales in Europe rebounded sharply in the second half of the year and our business in Latin America and Asia, particularly in China and India was up significantly as well. International sales represented half of our total sales for the year and we see good opportunities to grow our international business further in 2010.

While strength in global sales presence aided by our acquisition of Scopus has clearly contributed to our success in these international markets, the impact of our industry leading technology has an equally important success factor. The move to high definition video continues to be a key market driver around the globe and our high definition encoding and stream processing platforms. Particularly our new Electra 8000 continue to gain share across customers markets.

We're working closely with a growing number of cable, satellite and Telco customers around the world who are using our technology to add and upgrade an ever increasing number of standard and high definition channels. Our recently announced deployments with Insight Communications where we are powering a state of the broadcast and on demand cable video network with the island of (inaudible) where we are powering a new broadcast and on demand IPTV service are great examples of the breadth of solutions we're bringing to the global marketplace.

Turning now to the cable market, we saw a strong finish to the year as our newest video processing EdgeQAM and HFC access products powered mission critical applications such as expanded high definition and video on demand offerings start over and catch up TV services, high speed data capacity expansion and switch to little video.

We have some exciting new cable video, Edge and access products in the pipeline and as market recovery progresses we expect to see growing cable operator demand in each of these application areas. We're also very pleased to see our cable customers as well as our satellite and Telco customers starting to look to TV everywhere type service delivery to PCs and mobile devices.

Our media press and product suite from multi screen video delivery has enabled us to provide innovative solutions to several customers who are beginning to deploy new internet and mobile video services. Our sustained investment and technological innovation for mobile and internet video, the rapid proliferation of iPhones and other video capable mobile devices and growing service provider confidence and a viability of underlying multi screen business models cause to be increasingly optimistic about our growth opportunities in this emerging space. We expect mobile solutions will represent a modest but growing portion of our revenue in 2010.

An additional area of strategic focus in 2010 is video contribution and distribution where we are enabling the delivery of high quality news, sports and entertainment programming from content traders and broadcasters to service providers. We entered this market through the acquisition of Scopus and we're seeing some very positive progress. During the fourth quarter we announced new business with KT who is using our technology to distribute video content to over 160 cable operators throughout Korea and we recently announced a similar deal India.

Looking ahead, we see further business model and technology innovation driving this video contribution and distribution market with the initial roll outs of new video formats and delivery models, spanning technologies such as 1080p 60 high definition, 3-D and adapted bit rate video for all manner of emerging wide screen and mobile internet devices. And with Comcast's pending deal for NBC Universal, we remained convinced the creatively addressing the video delivery requirements of leading broadcasters and content creators represents a significant long term opportunity for Harmonic.

Summing up, Harmonic is executing well and is positioned well to address an increasing array of geographies, markets, and video applications. Although we face continued economic uncertainty we're confident in our ability to take advantage of growth opportunities to present themselves in 2010 and beyond. And on a final note, I'd like to take this opportunity to thank Robin for his many years of outstanding financial and business leadership at Harmonic. Robin has announced his plans to retire but will continue to serve until we complete our search and a smooth transition to a new CFO.

And with that Robin, I'll pen it back over to you to cover the financial aspects of the last quarter.

Robin Dickson

Thank you, Patrick. Today we announced the results for the quarter and year ended December 31, 2009. For the fourth quarter of 2009, we saw sequential increases in both quarterly revenue and bookings from our customers world wide. We reported net sales of $86.7 million, up from $83.9 million in the previous quarter. Bookings in the fourth quarter of 2009 were $107.6 million, up from $79.9 million in the third quarter with very good diversification across most geographies and markets.

For the full year 2009, net sales were $319.6 million compared to $365 million in 2008. Our lower year-over-year sales reflected to global economic recession and the lower capital spending by most of our customers around the world, particularly in the first half of last year. In the second half of 2009 we saw an improving environment in Europe and in the larger emerging economies, particularly China and India. Throughout 2009 we continue to diversify our revenue base. International sales represented 50% of revenue for the fourth quarter and 49% for the full year of 2009, up from 47% and 44% respectively for the same periods in 2008.

By market segment cable customers accounted for 60% of revenue in 2009, satellite customers 19%, and Telcos and others were 21%. This sales mix by market segment is comparable to 2008 but with an increase in the other category. This is due to higher sales to broadcasters and content providers mainly as a result of our Scopus acquisition in March of 2009.

In the fourth quarter we saw strong sequential growth in our cable market after a relatively light quarter for cable revenue in the third quarter. Our largest customer was Comcast representing 16% of total revenue in both the fourth quarter and for the year. Perhaps most significantly in 2009, our ten largest customers contributed 47% of total revenue compared to 58% in 2008.

Both our international growth and the Scopus acquisition contributed to our significant progress in furthering our strategic goal of customer diversification. We're encouraged to see this trend towards reduced dependence on a small number of large customers. By product category, video processing represented 42% of our sales for the year, Edge and Access products, 37% and software services and other 21%. Compared to 2008, we saw a higher percentage of video processing product sales and a lower percentage of Edge and Access products.

The shift in mix reflects a number of factors, the continued diversification of the customer base, the acquisition of Scopus, our increasing emphasis on software and services and the success of our Electra 8000 encoder in the second half of the year following its launch in the summer. In the fourth quarter of 2009, we saw sequential important in our non-GAAP gross margins which were 48.5%, up from 47% in Q3.

This improvement was driven in part by revenue growth and in part by the more favorable product mix although we have continued to see some pricing pressures particularly in the Edge and Access product lines. During 2010, we expect to rollout important new next generation products, which should contribute to improvement of our gross margins over the longer term.

We continue to be pleased with our discipline in managing operating expenses, which are essentially flat with the previous quarter at $32.7 million. Having completed the integration of Scopus into Harmonic during 2009, we're pleased to see that the anticipated cost synergies have been fully realized. We ended the fourth quarter with 840 employees, down by 9 from the end of the third quarter.

As we recently announced, we plan to move from our current corporate headquarters in Sunnyvale, California to 188,000 square foot facility in nearby San Jose in August of 2010. We expect the new facility to provide an outstanding work environment for our employees as well as cost savings and business efficiencies which should begin to positively impact our results in the fourth quarter of 2010.

Our sequential improvements in revenue and gross margins had a positive impact on operating margin and our net income. Our non-GAAP operating margin returned to double digits, 11% in Q4, still short of our desired 15% target, but a significant improvement over our earlier periods in 2009. GAAP net income for the fourth quarter of 2009 was $47,000 or breakeven on a per share basis compared to $2.6 million or $0.03 per diluted share in the previous quarter.

Excluding restructuring charges as well as non-cash accounting charges for stock-based compensation, the amortization of intangibles and tax adjustments, non-GAAP net income for the fourth quarter of 2009 was $6.3 million or $0.07 per diluted share, up from $4.5 million and $0.05 in the previous quarter. Our non-GAAP net income includes a tax charge of 35% for the fourth quarter of 2009. We continue to strengthen our balance sheet.

We generated significant cash from operations in the fourth quarter and ended the year with the cash, cash equivalents and short-term investments of $271.1 million, up from $253 million at the end of the third quarter. We continue to be in a strong position to pursue further acquisitions or other initiatives to achiever our strategic goals. Our receivables decreased to $64.8 million at the end of the fourth quarter, down from $70.3 million at the end of the previous quarter. Our DSOs were 68 days, also down from 77 days in the previous period.

We're very pleased with this improvement in DSOs and the return to our desired range of 60 to 70 days. Our inventory was $35.1 million, up almost $5 million from the end of the third quarter. This inventory increase mainly reflects our preparations to fulfill a substantial increase in our backlog as we were moving into 2010 as well as to address concerns about possible fluctuations in parts of the supply chain.

Finally, on the balance sheet, our capital spending was $2 million in the fourth quarter and $8.1 million for the full-year. We expect CapEx to be in the range of $13 million to $15 million in 2010, which includes approximately $4 million to $6 million for lease hold improvements and equipment for our new headquarters facility.

Turning to the outlook, we move into 2010 with a much improved backlog and deferred revenue position approximately $86 million. While the macro economic environment has strengthened since a year ago, our customers are generally still in a conscious mood and we expect to see the usual seasonal slowdown in bookings during the first quarter.

So with good backlog entering the year, but with the expectation of slower bookings in Q1, we expect to see revenues more or less flat in the first two quarters of 2010 at a level similar to that of Q4. So taking all of this into account, we believe that our improved backlog and visibility allows us to return to our previous practice of providing six months of rolling guidance.

We also expect that our net sales for the first half of 2010 will be in the range of $170 million to $180 million. For the full-year 2010, we see the potential for revenue growth of 10% to 12% over 2009 with growth of up to 15% perhaps possible in the event of a very robust recovery. But while we have confidence in our revenue outlook for the first half we strongly urge analysts and investors not to revise upwards the revenue expectations for the second half of the year. There is still too much uncertainty about the course of the economic recovery.

We expect our non-GAAP gross margins for the first half of 2010 to be in the range of 48% to 49%. While a number of factors can impact our gross margins from quarter-to-quarter, we believe that the success of our new products and solutions, our ongoing sourcing strategy and cost reduction efforts and the gradual increase in our video processing and software sales mix will have a favorable impact on gross margins.

We continue to see a return to 50% non-GAAP gross margins as an achievable target, perhaps as early as in the second half of 2010. With respect to operating expenses, we're pleased with our progress in controlling costs even while we continue to invest in the long-term strength of our business. We expect non-GAAP operating expenses for the first half excluding charges for stock-based comp and the amortization of intangibles to be up slightly compared to current levels in a range of $66.5 million to $68.5 million.

In summary, 2009 was a challenging year. We completed a significant acquisition. We continue to invest in next generation products. We maintained solid non-GAAP profitability and generated positive cash flow from operations. Our business strengthened in the second half of the year and we ended the year with increased momentum. Harmonic is well positioned with a strong balance sheet and a healthy operating model. These allow us operational flexibility and the opportunity to use our strong financial condition to our competitive advantage.

Finally, on a personal note, after 18 years in this position, I believe it's now an appropriate time for me to hand over the reins to a new CFO. Harmonic has successfully navigated a very difficult 2009 and the outlook for 2010 appears to be heading in the right direction. We have a very capable and increasingly experienced management team, a strong balance sheet and competitive position and our future prospects are bright, and in the meantime I want you to know that I will remain fully committed and engaged until my successor is in place and we have completed a smooth transition.

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

Question-and-Answer Session

(Operator Instructions). Your first question comes from the line of Simon Leopold with Morgan Keegan.

Simon Leopold - Morgan Keegan

First of all, Robin just want to wish you well and you will certainly be missed. You've been a great help in managing, and explaining what's going on for Wall Street. So spend some thanks. And on sort of dive into kind of the first question, certainly very pleasant guidance here being able to return to six month view and I guess, I'm trying to put this into some context relative to the commentary from Comcast about its capital spending plans, Time Warner suggesting that their spending would be down, so not only are you forecasting good sales trends, its better than seasonal patterns for that March quarter so could you help give us a little bit of context here relative to the macro.

Patrick Harshman

Simon this is Patrick why don't you take a crack at that. I mean I think the first thing to remember about at least the first quarter as we are coming in with the strong deferred revenue and backlog by virtue of the fact a very strong fourth quarter. Second although it is true that some of our larger cable customers are talking about reduced overall CapEx we've always said and either up or down CapEx environment what really matters most to us is the mix and we at least in the first half of the year we are cautiously optimistic that we are going to see actually more of that mix move towards video centric kind of projects and investments.

And the third thing I would say is that certainly Comcast has been our largest customer and cable and domestic cable is a very important part of our business I think it's worth again underlying the growing importance of customers outside the US cable community to our overall business. I mean last year 50% of our business came from outside of US. Also as sighted by Robin, our top ten customers last year contributed only 47% of our overall revenue. You know these are pretty important shifts and I think real evidence of the success of our growing strategy of diversifying and expanding our customer base. So as we think about our guidance we are thinking about global customers across customer market segments and across geographies.

Simon Leopold - Morgan Keegan

And just a follow up on the Comcast opportunities on their call yesterday they suggested that they are going to take a fresh look at Switch digital video. You had been awarded a contract some time ago what's your thought on that particular opportunity.

Robin Dickson

You know I would rather Simon not comment specifically on any one opportunity with any one customer but I would say that we've got a great leadership position in the market with our EdgeQAM product as you know. Its number one in video on demand applications and we think it's increasingly the product of choice particularly for our existing EdgeQAM customers for a switched digital video roll out. So we believe switched digital video is quite greater attention on that across the industry in 2010 you know as the race for more high definition channels continues pretty much unabated and we like our chances to compete for that business across operators with our market leading EdgeQAM platform.

Simon Leopold - Morgan Keegan

One last just housekeeping question what was the backlog.

Patrick Harshman

Simon the sum of backlog in deferred revenue which is the best way to look at it was $86 million at the end of the year.

Simon Leopold - Morgan Keegan

86?

Patrick Harshman

86, yeah.

Operator

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

Mark Sue - RBC Capital Markets

This is (inaudible) for Mark Sue. The fact that you are reverting back to six months guidance does that mean overall better visibility and how should we factor in seasonality for the first and second quarter and do your near term projects indicate continued strength in the second half.

Robin Dickson

(Inaudible) I think the way to think about it is that we had a very strong bookings quarter. We did over a $100 million in bookings and a substantial amount of that of course has carried over into 2010 with our revenues of around $86 to $86. So we certainly got a good head of steam coming into the first half of the year.

Nonetheless I mean as you know historically Q1 is often the lightest quarter of the year for our customer spending and you know we don't see this year as being any different so we have a good head of scene from the backlog but with the prospects of relatively lighter bookings in Q1. We see a kind of a flat six months honestly when you put it altogether. And that's really what we are suggesting here at mid point of our guidance is 175 which is roughly two times the number for Q4.

Mark Sue - RBC Capital Markets

Okay and for the fourth quarter I think like your Edge and Access business was down sequentially almost 12% if you could comment a little bit on that that would be great.

Robin Dickson

We don't see any underlying big trend. I think it's just the vagaries of what projects are happening and we do expect to see relatively stronger and relatively weaker quarters in any one given product category. I would say additionally though that we have found the new video processing products acquired from Scopus early in the year you know increasing coming into their own over the course of the year and from that point of view we have been expecting and witnessing a mix in revenue more towards video processing just by the injection of those new products.

Operator

Your next question comes from the line of Brian Coyne with Wedge Partners.

Brian Coyne - Wedge Partners

No surprise and no wonder that you skipped the ribbon cutting ceremony. Just wanted to say thanks again for all your help all of the years and I am sure I am not the only one to say that you are being missed. I do want to go on to your guidance to see the six months outlook and you mentioned in that looking obviously for seasonality in the first quarter do you think that that ought to be sort of a normal historical range around may be high single digits as a percent and on a sequential change and then you know if that's the case should your margins and sort of the OpEx follow roughly the same legal pattern that we would expect of that. Or do you have anything built in there that might you know in terms of perhaps an R&D increase just how much that might change that.

Robin Dickson

On I think our view on operating expenses is that it's pretty much steady as you go with the moment. We've had a tough you know we've been sitting for the last few quarters and in the range of $32 to $33 million and we don't have any immediate plans to change that significantly. We will do I am sure a little bit of selective hiring here and there but I think its still you know its still a cautious outlook at least around our spending plans.

Brian Coyne - Wedge Partners

Got it and the only other question I really have was you know you talked a bit about new products into 2010 that should be coming out and help support possibly expand the gross margin you know as things roll out in assuming small volumes that we saw first would this have the sort of typical low margin contribution that we expect and then if you would tie that back a bit into your view about being able to keep OpEx growth in check.

Patrick Harshman

Brian I will take the product part of that question. I think you referred to perhaps in our EdgeQAM area it is true there is a little bit of a razor blade idea there and usually when we come out with a new platform when its fully occupied its achieving higher gross margin but initially getting a new platform out there as often a slightly lower gross margins and that's certainly is the case around the EdgeQAM product and indeed that is one product area where we expect to what we are doing some pretty interesting innovations and you can expect to see some pretty exciting new product announcements from us and deliveries to the field later in 2010.

On the other hand on our video processing side of the house there we expect to see gross margin advantage right out of the gate. And that touches a whole range of product traditional and coding transcode extreme processing contribution distribution etcetera and just about every product category we are participating in you will see some kind of new announcement and development over the course of the year. And in most of those cases in video processing as I said you will see and we will see higher gross margins at the outset.

Brian Coyne - Wedge Partners

Got it and then last one can you comment a little bit more on just a brief and certainly if not dollar value may be just in terms of sort of the nominal sizes or increases that you are seeing on the Electra 8000 and a little bit of color on that front.

Patrick Harshman

It's been moving it's our expectation so frankly and as you may recall this is a pretty multifaceted product. It's working at MPEC 2 or MPEC 4. Handling both either standard definition or high definition or combinations thereof. And so we've actually seen it going to a wide range of applications across different customer segments and certainly across geographies. So beyond that I mean I think that basically captures the picture. We are very pleased with the way its going. It's been accepted extremely well, both from a functionality point of view as well as from a video quality point of view, from both perspectives it's positioned extremely well competitively. And right now we couldn't ask anymore from that platform.

Operator

Your next question comes from the line of George Notter with Jefferies & Company, Incorporated.

George Notter - Jefferies & Company, Incorporated

I wanted to ask about budget flush, we thought and evidence the budget flush from any given number of players in the cable couldn't factor and I guess I was wondering if that was a factor in the quarter and speaking more about the cable operator piece any comments there?

Robin Dickson

Yes, George I mean I think undoubtedly we saw some of that as well and some of it flowed into Q4 revenue but a significant amount of it has carried forward into 2010 and again our booking exceeded our revenue in the quarter by roughly $20 million. So, we do get the benefit of taking some of that with us. There wasn't flash I don't think it was particularly significant in our case.

Patrick Harshman

Let me just add one thing for that, I think it's also very important as Robin mentioned in his prepared comments that the contribution to the bookings was extraordinary from a number of customers, this was not driven largely by one or two customers. We saw basically that the sea rising across the global, across countries across customer segments and that's well undoubtedly true that there have been some budget flush activity happening in all corners of the markets we addressed. The fact that the bookings improved were so broad based we are just feeling pretty good about it.

George Notter - Jefferies & Company, Incorporated

Got it. So when I think about the upside in Q4 and then the strength in bookings into Q1, I mean is the story here just the strength on the Electra 8000 is that the biggest source of upside in your mind or was that budget flash or something else that drove that?

Unidentified Company Speaker

Incredibly there isn't one single headline. As I have said a couple of times here we all are quite pleased with the Electra 8000 and that was certainly important, but George we did see from the bookings perspective strength really right across our product offering. I have highlighted in my prepared comments a couple of important contribution, distributions links that we had overseas.

We also I think in the fourth quarter had a very nice HSE announcement to run some of the new technology we are delivering the cable there. We saw booking strength really right across the product offering. And as we have said absolutely some piece of that was probably extra pint-up budget that was on hand. I think its one of the reasons why we are a little bit reticent to get too far ahead of ourselves and as we go deeper in 2010. But the breath of the customers and the breadth of the customer interest across our product line both we think are quite positive signs.

Operator

Your next question comes from the line of Amir Rozwadowski with Barclays Capital.

Amir Rozwadowski - Barclays Capital

Just Robin tackled previous comments best of luck in your next steps and certainly thank you for all of your help over the years and working with Wall Street we certainly appreciate your help.

Robin Dickson

Thank you, Amir and thank you to everyone else who has echoed the same sentiments. Thanks.

Amir Rozwadowski - Barclays Capital

If we think about the traction with the Electra 8000 it seems like you folks have been gaining material threshold how should we think about a sort of adoption across the different end markets. Previously when the product was announced the goal was to not only spread it within the typical end markets for the product platform but to drive further adoption across other end markets. Can you give us a little bit of color in terms of how that's going?

Patrick Harshman

Well, I think we have to admit that the main progress has been in the core end customer markets and applications. So that is cable, satellite and IPTV Telco, that's been the bulk of the business. Although, we have actually started to see some success out of the broadcast space, we have highlighted a couple of times that broadcasters and concentrators are in additional area of customer that we were focused on for growth as you know last year was kind of tougher that segment with the massive hit the ad revenue talked. But I think as many other companies has commented there seems to have been some recovery and ad spending in the fourth quarter and we certainly saw some more amount of business including Electra 8000 sales to customers in that category as well in the fourth quarter.

Amir Rozwadowski - Barclays Capital

And then Robin you had mentioned that sales for the full year could be in the 10% to 12% range. Am I mistaken in that comment?

Robin Dickson

No, that's correct. That's what I said, that's our best expectation at this point and again suggesting a first half that's pretty flat this fourth quarter of 2009 and I am talking of revenue here. And then the second half of that's up a bit and then probably roughly inline with the consensus that's out there on Wall Street at least as of this morning.

Amir Rozwadowski - Barclays Capital

If we think about a sort of the higher end of that range, I mean what drives you to the higher end of the range. Is it new product announcements, is it improve spending trends, is that further adoption of some of the top platforms like the (inaudible) and what should we monitor to sort of gauge, sort of progress towards the higher end of that range?

Patrick Harshman

Well, from my perspective it's really all about the customer spending and underlying that the health of the economy. We think our customers are very well aware, and very excited about our newest products and technology including the 8000. The question is, will large scale projects be going forward. Last year, it was characterized by a lot of activity; a lot of our customers took lot of time looking very closely to our technology. We just didn't see that as much spending as we saw in 2008 and as we hoped to, and it really comes down to that, if there is spending there, we feel there is going to upside in the business.

Operator

(Operator Instructions). And your next question comes from the line of Blair King with Avondale Partners.

Blair King - Avondale Partners

I'll just go to the question. I guess Patrick with respect to the software segment in your business, obviously there is all kinds of visible trends everywhere about rollouts of online video and mobile video services. I am hoping that you might be able to give us some sort of sense as to where the software segment is heading as a percent of Harmonics overall total revenue and then ultimately how you scale that business and would it ultimately impact the P&L at any point during this year from the scaling perspective?

Patrick Harshman

I think as you have noticed in over the past couple of quarters, so actually this so called software piece of our business has actually been growing absolutely and totally relatively in a fairly healthy way, and we're quite excited to see that. We think we've got an exciting portfolio product, we're certainly doing a lot from an R&D perspective in that area and we've got high expectations over the next several years.

I think the biggest thing that's going to drive that sector is less on us and it's more about how quickly some of these new services accelerate, how quickly we see more widespread and mainstream video offerings to mobile devices, how quickly TV anywhere and similar kind of initiatives really take hold and how aggressively service operators get out there with those kind of offerings and as you know, its quite less the technology and more some of the underlying business issues which are somewhat of an impediment there.

Nonetheless, we are involved in several deployments and many more trials in the second half of last year and heading into this year, we see a lot of activity. All of that means that we do things that we will be able to talk about continued growth throughout the year in 2010. At the end of the day, at the end of 2010 I think it will still be a relatively modest contribution to revenue, certainly in the single digits. Very high margin products, so perhaps a little bit more contributions to our bottom line. And so some contribution 2010, but I have to say in 2010 we're probably looking at it from the longer term strategic growth perspective than we are an immediate impact on our financial statements.

Blair King - Avondale Partners

One last question, if it's okay. Clearly the satellite pay-TV guys seem to be retooling their efforts to drive additional HD channels more so now than it seems than last year. So I am wondering if you could just broadly outline the pipeline where the Electra 8000 is in the satellite domain and then alternately, do you see a sort of a product refresh and kind of a refresh on the horizon just on the larger satellite guys?

Patrick Harshman

Right so, perhaps there is just probably two main applications I think you just hit on the one and one is adding more channels both standard definition, high definition and the other is going back to encoders that were deployed two or three more years ago and actually are replacing the dose encoders to achieve significantly higher balanced efficiency. And we see that playing our both in the US and internationally. I would say that in the US, well there certainly are more channels going up. The bigger opportunity for us over the next year or two is probably ultimately about the refresh cycle.

On the other hand outside of the US support remedies, I think there is over 100 direct-to-home satellite operators around the world. In those markets in general we're still in the very early days of a high definition roll out, although high definition really is starting to take hold in all corners of the globe and there the bigger opportunity for us is really the initial population and well out of those high definition channels.

Blair King - Avondale Partners

So you would expect the satellite segment to continue its trend here through 2010?

Patrick Harshman

Yes but we continue to be very strong supporters and quite bullish on the satellite segment, both domestically and internationally.

Operator

Your next question comes from the line of Larry Harris with CL King

Larry Harris - CL King

And if I could add my thoughts are regarding Robin, excellent job working with Wall Street over the years. Thank you. With respect to 3D TV going to the Consumer Electronics Show you couldn't go anywhere without seeing a 3D TV monitor and I guess like all things with initial excitement and then reality and then the service gets rolled out. From a technological capacity point of view, is the Electra 8000 3D capable? What are the requirements say of a 3D signal, what is involved additional encoding beyond say what one might see with a typical HD type channel

Patrick Harshman

So Larry as you might understand that there is a lot of technology involved here, but I'll try to keep it at the headlines and you tell me where you need it to dive deeper. The top level, the good news is the Electra 8000 is very much 3D capable and in fact in several trials today it's actually delivering, powering 3D delivery, and in fact at the CES show the Electra 8000 was used to drive a couple of the 3D demonstrations that you perhaps saw.

It was going to be a couple of iterations of the technology and with technology we'll use simple one encoder. I think with sophisticated technology, we'll use two encoders since one of the great things about the Electra 8000 platform has many multiple encoders in the same box and future generations of the encoder from a hardware prospective were situated ideally to also deliver in the next generation of 3D technology that's envisioned that together with televisions an/or set top boxes will allow for example 3D delivery that will not require the funny glasses.

I think its also very important to point out that I think as we think about 3D, we just think about this as continuing to push the envelope of video quality experience and as you along the road map on 3D 1080p at 60 frames a second becomes very important and that's another important differentiating capability that we in the Electra 8000. So we are looking for 3D to drive demand not just from exclusively from 3D, but actually to raise the bar right across with the realm of video quality including things like greater penetration of 1080p services.

Larry Harris - CL King

You think you can create opportunities with satellite operators as well as cable operators or maybe more so with one type versus the other?

Patrick Harshman

From our prospective I mean it's our opportunities across the board. As I look out a little bit further, I think having at least a couple of channels, a competitive 3D offering is going to become a requirement and just like delivering some HD content was three years ago. So we see a cycle very much like that. I don't want to suggest a revolution in 2010, but it's a same kind of cycle that we see and we see that requirement basically playing equally to 12 different flavors of video service provider. It does seem that not unlike with in the case of HD. We're seeing direct-to-home satellite operators kind of take the early lead from an aggressiveness point of view.

Larry Harris - CL King

Understood, well I'll going to find out for Direct (inaudible). Okay. Thank you very much. Good explanation.

Operator

Next question from the line of Greg Mesniaeff with Needham & Company.

Greg Mesniaeff - Needham & Company

I have a question on the brief comment you made in your prepared remarks about pricing pressure and the access area. Can you give us a little more color on that? Are you referring to the edgeQAM product specifically?

Patrick Harshman

No not specifically Greg and there is nothing really new. The entire edge accessory, edgeQAMs as well as HFC, they are both very competitive spaces and pricing pressure (inaudible) cycles of product innovation and cost reduction is just part of the game and I think as we commented several times over the course of 2009 where we saw that pressure continue, that dynamic continue, and in some ways in the context of slightly reduced spending, its true that it seemed that pricing pressure dynamically was probably exacerbated a little bit.

Greg Mesniaeff - Needham & Company

And also, you clearly have been gaining market share with the Electra 8000 product and yet when you look at your distribution of sales by type of customer, satellite was down as a percentage, MSO cable keeps going up. So is it fair to say that the mix of customers may have surprised you, the percentage that were cable customers?

Patrick Harshman

No I don't think so. I think we've always expected that the Electra 8000 would be a hit with all of our major customer segments and we are certainly seeing a go into cable customers that there is a number of cable customers I think some of which we publicly announced, some of which we haven't, but it has a broad reach. Especially pointed out earlier it's capable of MPEG-2, MPEG-4, high definition, standard definition, so it fits virtual all needs of our customers.

So a portion of our cable revenue certainly coming from video processing products more broadly not just Electra 8000, but broadly as well as of course perhaps what you're more familiar with, which as an access area.

Greg Mesniaeff - Needham & Company

And just to wrap up, with DSOs down in the quarter, is it fair to assume that linearity was better in the fourth quarter than previously?

Patrick Harshman

Perhaps to some degree, I think we commented three months ago, some of customers and I think particularly in the cable space close down the receiving areas relatively early before the end of the quarter and so in come cases we did have to accelerate shipments in order to get in under the wire, but I would say that's part of it, but it was such a strong quarter for orders that we were basically pretty much through the entire quarter. I think frankly some of the DSO reduction probably has more to do with the fact that we now really got our arms around the scope as when we took over the company and obviously having a more diversified and very international customer base that it took us a little while to really get our arms around the customer base and the collections and all of that and that I think is one reason we stated before that Q2 and Q3 DSOs maybe a little higher than we would have liked and I think now that we comfortably got our arms around all of that.

Operator

Your next question is a follow-up question from the line of Brian Coyne with Wedge Partners.

Brian Coyne - Wedge Partners

I was wondering if you could just briefly talk about your involvement in any targeted advertising trials and your outlook for this and do you think its going to be impactful to your P&L this year? Thanks.

Patrick Harshman

Brian we are involved in a number of activities touching on advertising across different customer segments, but no I don't expect any meaningful impact on our revenue in 2010.

Brian Coyne - Wedge Partners

Anything in particular (inaudible) but also of the EBIT related it sort of depend on something going on in the set-top box side that you need to integrate with them down the road or I just wondered if you could give us a sense to how far along that process might be?

Patrick Harshman

Well, there are a couple of different scenario in which we are involved, touching both adding (inaudible) into the live programming as well as on-demand programming. In general everything that we're touching and the subset of a solution that we're providing is on a head end and or in the network and not touching the set top box.

Operator

(Operator Instructions). And at this time there are no further questions.

Patrick Harshman

Okay, well thank you very much Sera and thank you everyone who participated today. We appreciate the questions and discussion and we look forward to talking with you all again soon. Good day.

Operator

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

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Source: Harmonic Inc. Q4 2009 Earnings Call Transcript
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