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Harmonic Inc. (NASDAQ:HLIT)

Q1 2011 Earnings Conference Call

April 28, 2011 17:00 PM ET

Executives

Carolyn Aver – Chief Financial Officer

Patrick Harshman – Chief Executive Officer

Analysts

Mark Sue – RBC Capital Markets

William Stein – Credit Suisse

Simon Leopold – Morgan Keegan

James Kissner – Jefferies

Blair King – Avondale Partners

Shubho Ghosh – UBS

Amir Rozwadowski – Barclays Capital

Operator

Good afternoon. My name is David and I will be your conference operator today. At this time, I would like to welcome everyone to the Harmonic first quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to turn the call over to Ms. Carolyn Aver, Chief Financial Officer. Ma’am you may begin your conference.

Carolyn Aver – Chief Financial Officer

Thank you. Hi everyone. With me at headquarters today in San Jose, California is Patrick Harshman, our CEO.

I’d like to point out that in addition to the audio portion of this call, we also have provided slides, which you can see by going to the Harmonicinc.com website and clicking on the first quarter earnings call button in the events section on the home page.

Turning to Slide two, let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only current expectations and that actual events or results may differ materially. We refer you to the documents that Harmonic files with the SEC including our most recent 10-K. These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP or pro forma basis. Revenues described as pro-forma include Omneon as if they had been part of our results for the period stated. These items, together with corresponding GAAP numbers and a reconciliation to GAAP are contained in today’s earnings press release, which we have posted on our website and filed with the SEC on Form 8-K.

We will also discuss historical financial and other statistical information regarding our business and operations. Some of this information is included in the press release, and the remainder of the information will be available in the recorded version of this call on our website.

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

Patrick Harshman – Chief Executive Officer

Thank you, Carolyn. Thank you everyone for joining us today. Turning now to Slide four, we are very extremely pleased with the way our business is continued to perform in the first quarter of 2011.

We have strong revenue of nearly $133 million indicated of both generally healthy market and are very positive business momentum. Assuming a full contribution from Omneon last year, our consolidated pro forma revenues was up 19% year-over-year. Revenue from our video processing product area was particularly robust up 64% from Q1 last year.

We are also pleased with relatively strong first quarter bookings of $131.6 million, evidence that we continue to expand our market presence and capture market share across customers segments in geography and what is typically a slower seasonal quarter. We are also pleased with our continuing operational execution as we realized gross margin to 51% and delivered an operating margin of 10% in line with our expectation. A non-GAAP were $0.09 per share up from $0.06 in the first quarter of 2010.

Turning now to Slide five, let’s look at some of the business highlights that underlies these results, reviewing first the key drivers of our very strong video processing business. The proliferation of high definition service is world-wide, continue to be a major growth driver. As we won new customers and help our long-standing customer upgrade their HD offerings.

Our HD driven business in North America continue to be quite strong across customer segments and we are particularly pleased to see the HD opportunity, expanding internationally with recently announced win Kosovo being an good example of our expanded international footprint. Enabling this continuing success, our Electra 8000 recording platform continue to be the clear marketing leading solution for HD Encoding, transcoding and format conversion.

I should note that as we continue to rollout market share gains, in many cases we show that the higher costs as we penetrated new accounts. We are also signed instances particularly oversees from a space competitors did not go down without a fight, effectively putting pressure on pricing as we want new business and extended our global footprint.

Moving now to new media and multi-screen applications, I’m also very pleased to report that our newest solutions for both service provider managed and over the top internet applications continue to gain momentum at both traditional and new customers. In fact our largest single order received during the first quarter was for our new tablet driven application. Further strengthening our position, we recently released our newest ProStream 4000 transcoder product which incorporates a number of emerging system features required for these new multi-screen applications.

We are also beginning to leverage new unique solution synergies between our live and file based streaming product in our new production and play-out products, enabling our broadcast and media customers to streamline their new multi-screen workloads. Another important contributor to our positive video processing activity was our contribution and distribution product group. The core of this product category came to us via Scopus acquisition, completed approximately two years ago and we’re delighted to see the strongest revenue quarter yet for this product category. A combination of compelling new products in this area and our stronger corporate focus on broadcast customers led to growing success in this area.

And so summarizing the message of this slide, Harmonic is uniquely positioned with the best-of-class video processing product portfolio which spans HD to new media applications for service providers, content aggregators, broadcasters and media companies. The greater than 60% year-over-year growth we saw in video processing sales, which clearly indicative of our broadening industry leadership and the unique workflow and solution synergies we’re able to leverage as our customers look to rollout innovative new video services.

Let’s turn now to slide six. Armed with this powerful product portfolio, we’ve continued to expand and diversify our global customer base. Our top 10 customers in the quarter contributed only 35% of our total revenue and our international sales represented 55% of revenue with particularly a strong momentum in emerging markets. We continue to be bullish on growth opportunities overseas and investments in further strengthening our international sales presence will remain an important element of our strategy.

We’ve also seen excellent momentum with our newer broadcast and media customers. First quarter broadcast and media pro forma revenue increased 38% from the same period last year. Importantly, we are really just now beginning to leverage the cross selling benefits of our recent unified Harmonic Omneon sales team worldwide, and we see significant opportunities to further strengthen our strategic position of leading broadcasters and media companies around the globe.

This week's Wall Street Journal article on growing demand for TV advertising suggests a healthy ad sales environment for media companies, which is more positive news for the segment. As you will see in a couple of moments when Carolyn breaks down the numbers, cable also continues to be a key customer segment and very important part of our strategy, in fact our largest customer segment. We continue to be very well positioned with leading cable operators and believe our cable business will continue to grow in 2011. In this particular quarter year-over-year revenue from cable was approximately flat as we saw lower cable spending on internet access projects offset by growth in video processing and such.

Across cable, media, and other customers segments as the complexity of new video applications has increased, we've been increasing our strategic focus on the support and professional services we can offer our customers and we’re very pleased with the 28% year-over-year revenue growth in this area and you can expect us to continue to focus on expanding our support and service capabilities going forward.

Turning now to slide seven, I want to update you on our progress in integrating and leveraging Omneon. Revenue from our production and play-out products in the first quarter was down modestly from the same period in 2010. While we were targeting a better reserve, it’s not unusual to see such a dip in results given the significant integration issues we are working through during the quarter. The good news is that the integration activity is going well and our positive outlook for this business is fundamentally unchanged.

Over the past month we have announced several significant new Omneon product releases including our new rate based MediaGrid video storage system, our media centric video server, and our next generation video server I/O modules. These new product releases have been extremely well received by our customers both because of the operational and cost efficiencies they deliver and also because they offer clear evidence that the highly respected Omneon innovation and engineering capabilities alive and well.

I’m also pleased to let you know that our integration of Omneon supply chain and manufacturing operations is on track and we continue to expect to realize the associated cost benefits beginning this quarter and more fully in the latter half of the year. Additionally, integration of our two sales organizations commenced during the first quarter and is now well underway. As I mentioned just a moment ago, we’ve been seeing the beginning of cross-selling benefit particularly in the broadcast and media space. And then on that note, I’ve just returned from the large NAB show in Las Vegas and I was very encouraged by the very positive response from both existing customers and potential customers to Harmonic’s greatly expanding capabilities and market focus in this area. This recent and strong positive customer response, our overall company momentum with broadcast and media companies and our compelling new production and play-out products coupled with the increasingly healthy TV advertising market lead us to remain confident in the growth prospects for Harmonic products in our broadcast and media business in general.

Turning to slide eight, we’re moving into the second quarter of 2011 as a leading video infrastructure company and uniquely positioned to capitalize in a very dynamic marketplace. This fast moving, new video economy is being driven by consumer demand for more HDTV and multi-screen services. By growing reach and strength of media companies and by new business opportunities as well as intensifying competition among traditional and new video service providers. We believe our customers video service providers, global media companies and broadcasters are continuing to invest in order to advance their strategic position in this fast moving economy.

Our customers are looking for innovative technology and service enabling solutions as well as fast moving focused and capable business partners like us. Consequently, we see a great opportunity for Harmonic to build on our strengths and recent successes and help our customers do it in one.

Turning to slide nine, we continue to execute on our four strategic imperatives in 2011. First, we’re leveraging our increased scale, solution breadth and competitive strength to expand our brand and deepen our customer relationships in developed markets while also continuing to work aggressively to capture greater market share in emerging economy markets. Second, we expect to extend our leadership position in new applications and customer verticals, namely multi-screen, new media services over the internet and video production. Third, our objective is to continue to lead the market in technology innovation. And I remain very excited about the pipeline of new products and solutions we have scheduled to release over the course of the year. And finally, we are leveraging the value we’re creating in the marketplace. We intend to continuously improve our operational execution and business model.

And on that note, I’ll now turn the call back over to you Carolyn to talk more about the quarter and our financial outlook.

Carolyn Aver – Chief Financial Officer

Thanks Patrick. Turning to slide 11, while the first quarter is typically our slowest seasonal period this was indeed a strong start to 2011 driven by market demand for our products and the continued expansion of our leadership in many markets worldwide. Our net revenue grew 19% from the first quarter of 2010 on a pro forma basis including the 2.1 million of Omneon deferred revenue carved out. Note, this is the last quarter we’ll have a material carved out as deferred revenue.

Gross margin remain flat at 51%, the same as the previous quarter and the first quarter of 2010. Factors impacting gross margin this quarter include the relative mix of products and the reduction in the video processing gross margin related to certain competitive wins recognized in the quarter.

Operating expenses for Q1 2011 were $54 million compared to $35 million for the same period last year, reflecting the inclusion of Omneon this year. The increase from Q4 operating expenses of $52.3 million is primarily due to an increase in R&D resulting from increased headcount as well as cost associated with new production and play-out products and an increase in sales and marketing due to our Q1 kick off events for our sales force and our partners. These increases were partially offset by a decrease in G&A as we realized cost savings from our integration efforts. Our operating margin was 10% for the first quarter of 2011 compared with 13% for the fourth quarter and 10% a year ago. We recorded a one-time charge related to excess facility costs of $500,000. This was a true up of an estimate we made in Q4 as a result of subleasing a facility that we exited last quarter, as a result of integrating Omneon products into our international tax strategy. Our non-GAAP tax rate was 25%, down from 30% last year. Our reported non-GAAP net income per share for the first quarter was $0.09 per diluted share, up from $0.06 per diluted share for the same period of 2010.

Turning to slide 12, let’s look at our revenue and backlog in more detail. As noted, total net revenues for the quarter were $132.8 million, excluding the $2.1 million of deferred revenue carve-out. On a pro forma basis including the carve-out, our revenues were up 19% compared to the prior year’s first quarter. Total bookings for the first quarter of 2011 were $131.6 million, reflecting the strongest Q4 to Q1 sequential trend in five years.

Moving to slide 13, we have continued to significantly diversify our revenue mix across different geographies, products, and markets. International revenue made up 55% of net revenues in the first quarter showing our continued strength worldwide including emerging markets in China, India, the Middle East, Eastern Europe, and Latin America.

Our largest customer was again Comcast, representing 11% of revenue in the first quarter. Our top 10 customers represented only 35% of our revenue, reflecting our continuing diversification across the worldwide customer base. Cable customers accounted for 42% of revenue in the first quarter, satellite and telco is 26% with a strong showing from the satellite sector, and broadcast and media 32%.

Video processing revenues in the first quarter were exceptionally strong worldwide, representing 47% of our net revenues. Production and play-out represented 17%, edge and access products represented 23%, and service and support, excuse me, represented 13%.

As you can see on slide 14, we continue to maintain a strong balance sheet. We ended the quarter with a cash balance of $117.3 million, down slightly from a $120.4 million at the end of 2010. This decrease is due to the timing of payments for income taxes and the annual pay-out under our bonus plan. Our inventory was $58.8 million, up modestly from the fourth quarter and our inventory turns were down slightly to $4.4 million.

Our receivable balance increased to $111.9 million and our DSOs increased to 77 days. The increase in both the receivable balance and our DSOs are due to an increase in deferred revenue and the non-linearity of invoicing in the quarter. We do expect DSOs to decrease in Q2. Finally, our capital spending was $3.2 million in the first quarter and we expect our CapEx for the full year to be between $12 million and $16 million.

Turning to the outlook for next quarter on slide 15, the second quarter is typically up sequentially from the first as our customers begin to more fully execute their plans for the years. We also expect to benefit from our strengthening competitive position. Note that we will no longer have a material carve-out of deferred revenue related to the Omneon acquisition. As a result, we expect net revenue for the second quarter of 2011 to be in the range of $137 million to $141 million.

Non-GAAP gross margins for the second quarter of 2011 are anticipated to be in the range of 50.5% to 52.5%. Product and geographic mix will continue to influence gross margins. In addition, we expect to begin to see the benefit of consolidating production and play-out manufacturing with our traditional Harmonic manufacturer. As the year progresses, we expect the overall trend of gross margin to continue to increase gradually.

Our target for non-GAAP operating expenses for the second quarter is $54.5 million to $55.5 million. Note that our headcount was 1,121 at the end of the first quarter, up slightly from the end of the previous quarter, reflecting that we have begun selecting hiring of new talent. We will recall that we executed our international tax strategy on the Omneon IP in Q4. This strategy has resulted in the lower non-GAAP tax rate for Q1 and the year. We currently anticipate our non-GAAP tax rate for 2011 will be approximately 25%.

Looking at slide 16, as Patrick discussed, we continue to see a number of encouraging signs. Our business has excellent momentum and we continue to expect 12% revenue growth for the year. We also expect strong operating performance. We should gradually see an improvement in gross margins in the second half of the year. As expected, we had somewhat lower seasonal operating margins in Q1, but we anticipate improvement during the year. Our target for non-GAAP operating margins for the year is approximately 15%.

Turning to slide 17, I want to be sure that you were aware of the Analyst Day we’re holding on May 26, 2011 in the New York City from 8 AM to 12 PM Eastern Time. Key members of our senior management team will review in greater detail, our vision of market dynamics, our solutions portfolio and technology roadmap, and our go-to-market strategy. Keep in mind that the event will be webcast, if you were an analyst or an institutional investor please RSVP to hlit@stct.com. We look forward to seeing you there.

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

Patrick Harshman – Chief Executive Officer

Thank you, Carolyn. In summary, we’re very pleased with our strong start to the year. During the first quarter, we clearly continued to expand Harmonic’s leadership position in the marketplace. Our success was driven by growing worldwide investment in video services, our increasingly strong product portfolio, and our expanding go-to-market capabilities around the globe. The ongoing integration of Omneon has further extended the breadth of our solutions, our global broadcast and media customer base, and our international presence.

Going forward, we expect broadcasters, media companies, and video service providers around the globe to continue to invest in producing and delivering high value video programming and services. And you can expect us to continue to introduce innovative new technologies that enable this dynamic video marketplace. We’re very excited about the many opportunities ahead of us.

And with that, we’ll end the formal portion of the call and Carolyn and I would now be happy to open it up to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mark Sue of RBC Capital Markets.

Mark Sue – RBC Capital Markets

Thank you. Good afternoon. I was just hoping that if you can give us some sense of what’s behind the ramp in the video processing strength that you saw. And is that something that we can extrapolate to the subsequent quarters?

Patrick Harshman

We’ve been saying for quite a while Mark that we believe that this video theme is big. We see more video being produced, stored, repurposed and delivered around the globe by many different kinds of customers across different customer segments. And we’ve been hard at work trying to not only strengthen our position with an existing accounts, but open up new accounts and that’s new accounts from the traditional service provider markets base that we have addressed as well as in the new broadcast and media spaces that I have mentioned. I certainly not predicting and we wouldn’t predict continued 60% year-over-year growth. We think that new video services to new devices is a powerful theme. We think we’re well positioned and we think that the growth at this kind of business is something we can take advantage of for quite sometime.

Mark Sue – RBC Capital Markets

Okay. And then maybe if you just – as we understand the increasing opportunities for the multi- formatted coding that we’re seeing at the moment, help us understand your share gain opportunities that might help you grow fast in the market. And then separately, you didn’t reiterate your 15% operating margins, despite the near-term increase, maybe just trajectory of putting margin improvements for the balance of the year? Thank you.

Patrick Harshman

Okay. So I’ll take the first part and turn it back to you Carolyn to talk about the margins. Look, the multi-screen and new media space is still relatively new. It still feels a little bit like the Wild West and there is a lot of different players. And so I think it’s a little bit early as we don’t think about it as a market share gain paradigm per se, but we just think about – we think about identifying new opportunities and trying to be on the spot with the right products and solutions. Certainly, we think we are well-positioned with our historic service provider customers just about all of whom, whether they’re cable operators, satellite operators, or telco operators are developing their new media plans. And in fact it’s from a traditional customer base that we’ve actually started to see some larger size opportunities like the one I mentioned in my prepared remarks. So we’ve been investing quite a bit in this area. We’re very pleased to see continuing and growing success and we are certainly not alone and focused on this space, but we think we continue doing what we are doing leveraging the core strength and know-how of the company. We think we’ll be well-served as this market continues to grow.

Carolyn Aver

On your operating margin question, we only gave guidance one quarter at a time and – but having said that, certainly we would expect it to build over the year. Q1 is always both because it’s typically sequentially down as well as it’s the highest employee cost everybody’s tax rates reset. We have taxes on bonuses and other things that happen. So it always ends up being higher cost, lowest margin. And so we’d always expect to see a build over the course of the year. I think we saw that again. So if its 15% for the year, it’s probably somewhat under that for Q2, little over that for Q3, and then building into Q4 when the lot of those costs end up. The employee cost end up going away. So, I would just build as you get through the year.

Mark Sue – RBC Capital Markets

Okay. And just to be sure, it’s 15% before the year, not exiting the year?

Carolyn Aver

Correct. That’s our target.

Mark Sue – RBC Capital Markets

Okay. Thank you and good luck.

Carolyn Aver

Thank you.

Patrick Harshman

Thank you, Mark.

Operator

And your next question comes from the line of William Stein of Credit Suisse.

William Stein – Credit Suisse

Thanks. First, I’d like to just kind of stick to the operating margin target for a second. Carolyn, I think there is a higher goal for the longer term, can you remind us of that and how long do you think it takes to get there?

Carolyn Aver

We have not stated a higher goal for the longer term. So far our target is 15%. I think that as you ask Patrick and I do we think there is room for gross margin to continue to improve over the next short – few years, short-term years, whatever you want to – however you want to frame that. I think the answer is yes, we’ve grown over the last five years. Our gross margin is pretty significantly generally the higher growing areas we’re in have higher gross margins. And so as we go year-over-year, we would expect that to continue and then we expect to become more efficient in operating expenses as our revenues continue to grow. So there is certainly an opportunity to do better than 15%. We’ve not yet predicted what that is or at what timeframe that would be. It’s definitely when we continue to balance it with investment and the growth opportunity. That’s a decision we’ll make every year. So I think there is certainly opportunity. We haven’t committed to anything about 15%.

William Stein – Credit Suisse

Understood. Just must have been a bad note on my part. Bad note taking.

Carolyn Aver

With fault thinking.

William Stein – Credit Suisse

Perhaps, wasn’t trying to push you there.

Carolyn Aver

Okay.

William Stein – Credit Suisse

Maybe we can dig into production and play out for a minute, I think that’s the Omneon business mostly and that was down fairly significantly. I’m wondering if that was – whether you attribute that to sales force integration issues or product issues or manufacturing or component shortfalls, any color you can offer on that would be helpful?

Patrick Harshman

Well a couple of things. As I said in my prepared remarks, I do think that to some extent, the organization integration played a role. We are excited about the year and we went into the year quite excited about, and in fact increasingly excited about the synergy opportunities. So we made a decision right at the beginning of the year to move more aggressively with the integration of our sales force.

As Carolyn mentioned, I think from a cost perspective, we pulled our whole worldwide sales force together for really an unprecedented meeting that involved a lot of planning and lot of training. And so we made a conscious decision to really focus in Q1 on reorganizing our sales force. We consolidated under one senior manager doing the same thing with our service and support organization and I think that decision will the proof for us over the balance of the year and certainly going in to the future years. I think inevitably though it probably had an impact on the first quarter.

I also mentioned that we rollout some pretty exciting new products and the fact that these products were coming was not necessarily the best kept secret so we also think that they may have been some expectation or waiting for the newest products in this area. You asked about manufacturing component, no significant comprise on the business from that perspective.

Carolyn Aver

Although that probably played even more in to our linearity or non-linearity as which then impacted the receivables, but certainly not on the revenue side I think any material wise.

Patrick Harshman

That’s right. If I look at the year-over-year number I mean it was down about $2 million so while from a percentage basis that maybe large on kind of a mid 20s kind of number, actually not that big of a number from our perspective. So, we don’t feel while we took a substantial step backward when we think we positioned ourselves to really move forward and even stronger fashion going forward.

William Stein – Credit Suisse

That’s helpful. If I can just squeeze one more in quickly, the obligatory Japan question as it relates to component supply and demand, any effect from that?

Patrick Harshman

So far we have seen nothing. We can say that kind of all the information is in. But right now I give a really I pay a tribute to our commodities and supply chain group, but so far, we have not been impacted on the supply side and its really too early to say what on the customer side, what the impact will be? There’s been no canceled orders, but I think we are still waiting to see how the dust is going to settle on the customer side in Japan.

William Stein – Credit Suisse

Okay. Thank you very much.

Patrick Harshman

Thank you.

Operator

And your next question comes from the line of Simon Leopold of Morgan Keegan.

Simon Leopold – Morgan Keegan

Thank you. I wanted to see if we could go back to the trends of what’s happening in the production and play out segment. I think in the prepared remarks, made some mention of some pricing competition and pressure, I think that was a segment. I'm just wondering if you could quantify what kind of pricing pressure you are having in terms of what effect that had. And then given that this line of business was a bit lighter than we expected in the quarter, I am just wondering how things are trending coming off of this lower base in the March quarter from the production side of it. Thanks.

Patrick Harshman

Yeah. So, right across the product line I mean there is amount of pricing pressures this is part of the market, but actually the comments in our prepared remarks was steered more towards the video processing business, Simon where we think we really been picking up good market share and I think understandably running in to some competitive resistance particularly oversees.

Wasn’t our intention to highlight and in fact we don’t think there is any particular unusual or extraordinary pricing pressure in the production and play out area. And in fact with that product line we continue to feel very well situation from the competitive point of view particularly with the newer products that I mentioned that we rolled out.

So, look we are still getting to know the business as I said I just come back from the NAB Show on Las Vegas there has been a lot of time with both domestic and international customers. Wish we continue to see a lot of good opportunity, a lot of good appreciation for the Omneon brand, of the Omneon products and a lot of excitement in the newer products.

At least for now, we are chalking up the first quarter to kind of getting going integration kind of friction and we remain quite optimistic about the balance of the year.

Simon Leopold – Morgan Keegan

So, if I just want to focus on how to trend this in the June quarter, is it unrealistic to expect year-over-year growth for the Omneon business?

Patrick Harshman

Our goal is certainly to deliver year-over-year growth for the Omneon business in the June quarter.

Simon Leopold – Morgan Keegan

Okay. That’s very helpful. And then I wanted to touch on a little bit around the edgeQAM business for you. A number of companies have talked about building new form factors, chassis-based solutions, and I'm just wondering in terms of your portfolio, how you are thinking about that?

Patrick Harshman

It’s a competitive market. There is always a lot of happening and everyone is kind of always looking for angle. So, that’s definitely fast. And we have the benefit and the challenge of being the clear market leader in edgeQAMs. So we lead the market with our latest (indiscernible) product in density and actually in commercial flexibility with our licensing model that I think we really introduced to the industry. We feel very good competitively about the product as good as we’ve ever felt and about our technology. And competition and people kind of come in with new angles, there is nothing new to just based on them. So, it’s kind of status quo from our perspective and we continue to invest quite a bit and we continue to think we are well positioned.

Simon Leopold – Morgan Keegan

Thank you very much. That’s all I had.

Patrick Harshman

All right, thank you.

Operator

Your next question comes from George Notter of Jefferies.

James Kissner – Jefferies

Hi, this is James Kissner calling in for George. So, I just wanted to touch on this large order for the tablet application. I was wondering if you might be willing to dimentionalize, even in rough terms, how big that order was and how much of the revenue is recognized in this quarter, how it might roll out from here?

Patrick Harshman

We hadn’t planned to go there. I look less than 10 bigger than 3. So, I mean just to give you the kind of a rough red box. I mean the point is it’s reasonable size compared to any decent size encoder kind of deal. And in fact I guess as we've kind of long thought operators getting into this market it’s actually just provisioning additional encoding and video processing capability that in lot of ways mirrors, what they've done for television delivery services. So there's a rough red box. I believe none of the revenue was actually recognized during the quarter. It might be typical, it would be typical. And as you might expect these are new kinds of systems and projects and there is a fair amount of complexity and it also goes to my point more generally about the opportunities we see around services and support in this area.

Our customers want to run fast. They want to do new things and are looking to us not only for great technology but also our systems expertise and knowledge. And here I would point out that our IPTV expertise is a company really developing the context of a lot of the work we’ve done with telcos around the world. It’s really valuable and informative. Radio, cable or satellite or telco operator or media companies these kind of applications actually look and feel little bit more or like IPTV kind of deployments. And so I think we bring a lot to the party and we’re pleased to have one that deal. It’s probably the largest one that we've seen so far and as I said earlier we’re looking for more successes in this area as we go forward.

James Kissner – Jefferies

Did you say whether this was a cable operator or a content provider? Did you say who it was?

Patrick Harshman

I didn’t. What I said is that I didn’t want to be any more specific. Who can appreciate, these projects in particular have a lot of strategic sensitivity let's say and we are not going to be the ones to discuss. We are going to leave it to our customers to discuss their plans.

James Kissner – Jefferies

Related to that sort of – I won’t push you on that any more, thanks for the detail that you gave. But, do you think that there is sort of -- some folks now, there have been sort of a chilling effect, just given there's been a lot of contention around the various launches that we’ve seen already from the major operators. Do you think that there is some wait for effect for people waiting for that to resolve? And I'm also trying to wonder, sort of wondering what are the – how many sort of deals are out there? There are a lot of other operators exploring this, or is it just couple of large ones right now and then there's probably going to be a respite for a while. Can you give us a feel for sort of the outlook for the opportunity?

Patrick Harshman

Well, I think it’s a good question. And while we’ve certainly seen an increase in the number of real kind of revenue projects, it’s still, this whole market is still very much informative period. And while there has been a lot of press recently around some specific iPad applications, the more general issue of content rights delivered to mobile devices in general is not new to this space. I think we have said before publicly in a number of cases that actually these content right issues are pulling more than technology or key kind of factor in the development of this marketplace. So, by no means do we mean to suggest that the floodgates are opened and we’re being hit with 100 RFPs for these kinds of things kinds of things. We continue to participate in and support growing number of trails around the world and across customer segments and I’d say we’re seeing a small percentage of those. All though increasing still small kind of turn to real projects and so think that this market has long way to go in terms of maturation.

And I regret the kind of weaving answer, but the honest truth this is we don’t know. I mean we’re surprise by how fast this tablet stuff is going. If you’d have ask me year ago, I wouldn’t have told you it would be this far. But at the same time there are to your question a lot of questions out there in the market and many of our customers are still trying to feel the way. In terms of the business issues, in terms of their own strategy, the business model etcetera.

James Kissner – Jefferies

Okay. That’s very helpful. Thanks a lot.

Patrick Harshman

Thank you.

Operator

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

Blair King – Avondale Partners

Yeah. Hi, I’m just going to come back to the margin question that was asked a couple of times earlier and try to figure out if there is a way that you can help us kind of gain a little bit more insight into the magnitude of what the step up function on the margin might have to be if you guys to get to 15% operating margin for the full year sort of implying I guess pretty high-teens in the second half. So, just wanted to make sure that I was thinking about that right?

Carolyn Aver

Yeah. You obviously have to be at 15 mid-point for the year to get there on both side. And so where I think about it is Q1 and Q4 kind of average 15 in Q2 and Q3 kind of average 15. And part of that I don’t mean to be evasive part of that is why we get one quarter guidance because we are still working our way through that as well. And we are balancing our OpEx investments with the gross margin expansion that we see. So we’re working our way through it in the year sort of focusing on that is the 15% average margin, our guiding principle if you will as best we can.

Blair King – Avondale Partners

You haven't moved off in the top line number of 12% revenue growth, you are pretty clear about that so the balance have to really be coming from margin improvement, right?

Carolyn Aver

Right.

Blair King – Avondale Partners

I think Carolyn, you've mentioned in the past that, I think you just did again, that you're going to balance OpEx investment and gross margin improvements, which would basically imply. I think if you look at 4Q OpEx ramps over 2Q at least to 4% gross margin improvement just to get back even with the OpEx ramp through the back half of this year?

Carolyn Aver

I’m sorry that you lost me on the last part.

Blair King – Avondale Partners

Sorry. If you take the OpEx number in the second quarter measure that up against the full fourth quarter or that the fourth quarter, which was the first full quarter of Omneon, that's about a 5.5% OpEx bump versus of 1.5% gross margin bump over that same timeframe. So, my guess is that you're in the process of catching up on gross margin to that OpEx investment.

Carolyn Aver

Yes. There is that in the revenue ramp of course right. So, I think that the slope of the line of OpEx growth in absolute dollars moderate. In absolute dollars, revenues grow part of that is a mix issue for growth margin to increase and those things together get you to that blended operating margin, that make sense?

Blair King – Avondale Partners

Yes. I appreciate that. That helps a lot. And then the last question, just Patrick, you had mentioned in your remarks and there was another question about this as well, about the higher cost on the competitive replacement opportunity that obviously you had won. Can you give us an impact or just give us a sense as to what impact that might have on your cost structure this quarter?

Patrick Harshman

I was pointing to more from a gross margin perspective, when you move into new customer environment, a typical scenario is we win a deal because the customer loves our HD video quality. Very often the incumbent is it’s a system. And there is kind of integration hooks etcetera. So, customer will say dude, I like your product and actually I’m willing to pay a premium for it. But come in and help me to do some amount of customization and help me actually overcome the operational discontinuity of replacing the competitor with you. So, I’ve pointed to that kind of impact which has some, it has some OpEx impact it also has some above the line kind of support and service impact on us. And then the other thing I’ve pointed from a gross margin perspective is it’s not atypical with the incumbent supplier will fight back with price.

So I was frankly acknowledging that as we have really further expanded our market share particularly overseas that has been accomplished through the slightly lower gross margin than we’re used to with our video processing product line. I don’t necessarily see that as a long term or intrinsic trends of the market, I think that is really part of us capturing market share and enforcing some fundamental shifts in terms of our position relative to some of our competitors overseas. As I’m trying to give a little bit of a qualitative color for you, but acknowledging really that those kind of things were playing out and impacting our video processing gross margin as we continue to expand.

Blair King – Avondale Partners

Okay. Is there any way to put some quantitative number on that, instead of qualitatively in terms of what, how many basis points that might affected the margin this quarter?

Patrick Harshman

I mean you could think about it from your own model, but we’re not in the practice and we’re not going to breakout gross margin by product areas. I think in the past we’ve said that our video processing is 5 to 10 points above our corporate gross margin average and in select areas that’s probably than closer to the corporate average. The overall effect is to, is one of the factors that Carolyn spoke to as we think about the overall gross margin next.

Carolyn Aver

Right. And I guess I’d also say with the lower production and play-out revenue, we didn’t get all the uptick we thought we would get from the combination. So those things kind of offset each other a bit.

Blair King – Avondale Partners

Okay. Thank you very much.

Carolyn Aver

The last thing just on your OpEx question is I was thinking about and looking at our numbers. The other thing is as I’ve even mentioned in my comment Q4 OpEx is typically seasonally light, Q1 OpEx is typically, seasonally heavy because of all the cost. Q4 has less tax costs, more vacation and so you also get a little up, not only does it balance it in and sort of the growth of the year but reality is they tend to be more heavy expenses in Q1. o kick off a lot of that less traveling Q4 in a number of those things. So you get a little bit of an offset just naturally in OpEx in Q4 as well.

Blair King – Avondale Partners

Thank you very much.

Carolyn Aver

Sure.

Patrick Harshman

Thanks Blair.

Operator

(Operator Instructions) Your next question comes from Nikos Theodosopoulos of UBS.

Shubho Ghosh – UBS

Yeah. Hi this is Shubho Ghosh for Nikos. Given Comcast is down approximately 2 million quarter-on-quarter, can you give some more color on what is behind the sequential weakness in cable in general. Is it few select customers or is it more broad based weakness in the sector and also is this weakness more in the U.S. or international?

Patrick Harshman

As we think about cable we tend to think about it more on the product categories. And as you see the table in our press release and as I mentioned in my comments, our edge and access business is down year-over-year and frankly we saw in the first quarter less of those kind of infrastructure and edge build projects happening. On the other hand our video processing business, right across cable, was up despite of the same amount year-over-year, so nothing particular on any one customer and nothing that surprising given our history with cable. We’ve seen, just that we’ve seen more focus on video processing and we see what we think is a temporary slowdown in some of the edge and access spending.

Shubho Ghosh – UBS

Got it.

Carolyn Aver

Maybe if I could add to that. I mean a couple of other things I would say as one it was – we probably got more of the benefit in Q4 when we talked about budget availability and some of the upside we saw in Q4 in excess budget opportunity that probably also came from those customers. And so one that makes Q4 higher, two that probably absorbs a little bit of Q1 demand as well. So, there is some of that impact going. And then I think generally and a little bit I tried to talk about this in the telco and satellite members. I mean, I think historically, especially with more – are more historic customers or traditional customers, where there are larger orders, you might see in one quarter a big deal from a cable company. So, your revenues are up and then the next quarter might be a satellite company and so that sector was up.

And that over the past has caused our revenue to be somewhat less predictable, because those ups and down had more of an impact on kind of the overall revenue number. One of the strong benefits we have of diversifying our revenue base is it’s helping lessen the big impacts of our large order by one sector or another sector in a particular quarter. So, I don’t think we’d read a lot of trend into it other than some ebbs and flows, I guess in the product demand.

James Kissner – Jefferies

Got it. Thank you.

Operator

And your next question comes from the line of Amir Rozwadowski of Barclays Capital.

Amir Rozwadowski – Barclays Capital

Thank you very much and good afternoon Patrick and Carolyn.

Patrick Harshman

Hi.

Carolyn Aver

Hi.

Amir Rozwadowski – Barclays Capital

We are coming close upon a year since you announced the Omneon transaction. And what I was wondering, obviously your holdings for that 12% growth, top line growth numbers is steady, but I was wondering if you could give us a little bit more color in terms of whether or not you're starting to see some of the potential synergies for having both organizations under one roof and sort of an integrated sales force from that perspective and if some of those are either emerging along the lines that you had expected them to be or having different conversations with different sets of customers. Maybe a little bit of color there.

Patrick Harshman

So, the answer is yes. I mean frankly I couldn’t be more pleased is the way it’s trending so far. I mentioned in the prepared remarks and you can see in the numbers that we published that the overall business with broadcast and media company was quite strong and indicative of really asking considerable more market share with our video processing products in that sector.

And Amir remember that one of the strategic tenets of the deal was, broadcast and media companies are going to be doing more and more video processing, delivery of multi-screen services themselves probably and a great opportunity for Harmonic to penetrate to historic traditional video processing product base. The focus on that started over a year ago and through the time up until close deal upon Omneon. And we now actually see the discussions with the big media companies actually accelerated.

And again I’ll go back to the NAB Show, for all of us it was actually an extremely positive event in terms of really the first time. Although we started to see tractions here or there, we really have a kind of wider range and strategic conversations with large customers that really point to significant opportunities. Now these opportunities I’m talking about the things that again play out as we develop and deepen the relationship over multiple quarters. But nonetheless that’s where we wanted to go strategically. So we are pleased with the way things are evolving commercially. We are also starting to see some technical synergies first its our file based and its our streaming transcoding products in particular brought back married up with the Omneon products and particularly in the context of broadcast to media companies.

But we are also talking with customers across our base about, storage opportunities now, reproduction opportunities, and our engineering team are collaborating more and more around new ideas about things we can do middle to longer term strategically from the technology perspective. So, we see kind of synergies wide across the board everything in more at this point in time from a commercial and customer relationship and market penetration perspective good really evidence of kind of solutions putting our products together new bundles and some very encouraging signs in terms of some longer range new product category, R&D kind of stuff. So, strategically we are quite pleased.

Amir Rozwadowski – Barclays Capital

Great, thank you very much, Patrick for the incremental color.

Patrick Harshman

All right. Thank you very much Amir.

Operator

And there are no further questions in queue at this time.

Patrick Harshman

Okay. Well then, we’ll wrap it up. I very much appreciate everybody’s participation today and in closing again let me say on behalf of Carolyn, me and our entire company that we couldn’t be more pleased with the way we started the year. We think we clearly in leveraging our leadership position, we are expanding it. We are very excited about the new product pipeline that we have. The ways is coming together on the marketplace and about the opportunities we see ahead of us.

We appreciate all of your support and interest and we look forward to continuing and talk to you as we continue to execute in the marketplace. Thank you very much everyone.

Carolyn Aver – Chief Financial Officer

Thanks, we will see you in New York on May 26th.

Operator

Ladies and Gentlemen this does conclude today’s conference call. Thank you for your participation. You may now disconnect.

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