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Harmonic Inc. (NASDAQ:HLIT)

Q2 2011 Earnings Call

July 21, 2011 5:00 PM ET

Executives

Carolyn Aver – CFO

Patrick Harshman – President and CEO

Analysts

Victor Chiu – Morgan Keegan

William Stein – Credit Suisse

Mark Sue – RBC Capital Markets

James (ph) – Jefferies & Company

Blair King – Avondale Partners

Larry Harris – CL King & Associates

Paul McWilliams – Next Inning Technology Research

Operator

Good afternoon. My name is Nikkia and I will be your conference operator today.

At this time, I would like to welcome everyone to the Harmonic Inc. second quarter 2011 earnings conference call.

All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Ms. Carolyn Aver, you may begin your conference.

Carolyn Aver

Thank you. I’m Carolyn Aver, the CFO of Harmonic. With me here at our headquarters in San Jose, is Patrick Harshman, our CEO.

I’d like to point out that in addition to the audio portion of this call we have also provided slides, which you can see by going to the Harmonicinc.com website and clicking on the “Second Quarter Earnings Call” button in the “Event” section on the “Investor Relations” section of the “About Us” tab.

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 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 filed with the SEC including our most recent 10-Q report. These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

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

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

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

Patrick Harshman

Well, thank you, Carolyn, and thank you everyone for joining us today.

Turning now to slide four of the presentation, today we reported second quarter revenue approximately a $134 million, about $5 million below the midpoint of our guidance range. I want to be clear that we’re not satisfied with the financial results of this quarter. Having said that though the delta between our previous guidance and the final result is modest. And while our near-term outlook has been affected by the marketplace issues, we’ll discuss on this call. Our strategic direction remains very much on track and our medium-to-longer-term growth outlook remains positive. I also want to be clear that once we confirmed we did not reach our revenue goals, we accelerated the process of determining and communicating to our revenue, earnings, and importantly updated outlook for the remainder of the year.

Turning to the results themselves, one of our key strategic imperatives has been to develop our business overseas. And in the second quarter our international business contributed 59% of total revenue, up 26% year-over-year on a pro forma basis. However, our domestic business declined 15%. And, I’ll discuss the reasons for this in a few moments. In aggregate, our business in the first half of the year was up 12% year-over-year, again on a pro forma basis, and that is assuming a full contribution from Omneon last year.

Second quarter bookings were approximately $132 million. As with revenue, strong orders from our growing base of international customers were offset by weaker domestic demand during the quarter. While our revenue was lower than anticipated and the product mix relatively less favorable in terms of margins, we still realized gross margins of 51% and delivered an operating margin of 11%. Our non-GAAP earnings were $0.09 per share and we generated $17 million of cash during the period.

Turning to slide five, let’s look at the business dynamics that underlie these results. As you know, we’ve been clear that international expansion is a key strategic priority, and we’re very pleased to see our international business delivering results. International revenue in the first half of the year was up 22% on a pro forma basis from the first half of 2010.

This quarter saw us win projects expanding a wide range of video applications from traditional standard definition television in fast-growing emerging markets to a very strategic mobile video win with a leading industry player and historic Omneon customer in Western Europe. The deals we were able to recently announce with Globosat Network, the largest pay-TV operator in Brazil; and with Vietnam TV, a national broadcaster of Vietnam are good examples of our strengthening international market position. We also see expanding cable business overseas as we won significant new edge and access business with a leading international cable operator.

Looking ahead, our international business outlook for the second half of the year remains very healthy across geographies, market segments, and product categories. One final note on our international business, a consequence of a rapid international expansion and market share gains as competitive pricing pressure and associated impact on our gross margins.

High-definition continues to be defining trend for video delivery worldwide and was a key driver of our overseas business during the quarter. The critical aspect of the quarter was the fact that in our domestic business we did not see a single large encoding project. We believe this is primarily the result of timing issues as we’re actively working with several of our domestic customers who are planning larger scale encoding projects which we have already won or in very good position to win, and we’ll recognize revenue from incoming periods. So with not impacting our view of the longer-term growth opportunity, the timing of these projects in our pipeline as we now understand them does have an impact on our near-term revenue outlook.

Additionally, after very recent and detailed assessments of our current domestic market activity, we believe the delays in larger encoding projects are indicative of the fact that many of our domestic customers are engaged in complex strategic planning of their next wave of video services, services that span integrated high-definition to lower resolution services that will be delivered both over-the-top and over their own networks to a variety of new IP connected displays. To be clear, this is not to say that the magnitude of the domestic opportunity is in anyway diminished. To the contrary, we believe such new services will come to dominate the marketplace and will demand the exceptional video quality and compression technology that are the hallmarks of Harmonic solutions.

Just one example. We see the opportunity to assist our domestic cable customers to deliver very high-quality, high-definition video, over-the-top to internet connected televisions is a significant opportunity and an initiative that will require substantial industry investment and high performing new MPEG 4 encoding technology. So while we’re extremely confident that Harmonic is uniquely positioned to benefit from the rollout of such new services, we also realize the timing of these major initiatives remains somewhat uncertain. In several cases, they’re playing out slower than we had anticipated just one month again impacting our revenue forecast for the second half of this year.

While we see domestic customers pausing before embarking on larger scale next-generation coding projects, smaller internet and new media initiatives for mobile application such as for iPhones and iPads are proceeding both domestically and internationally. Although this application area is still characterized by smaller sized deals and experimentation as well as by evolving business model and content licensing issues, we’ve continued to see our associated current period revenue and longer-term opportunities grow.

As I mentioned previously, this past quarter saw a very strategic international win, for delivering video to iPads and iPhones. And [inaudible] modest, our revenue for such applications was up significantly from a year-ago. Harmonic continues invest strongly in this space and you will soon see us launch some really exciting new products that we think will further fuel growth and create particularly compelling solutions and bundle together with our high-definition offerings, thereby by bolstering our competitive position in this area.

Turning now to slide six, in support of the coming new video services, we saw strong domestic and international demand for bandwidth optimizing cable edge and access products. In particular, we saw strong demand from multiple cable operators for edgeQAMs to address both on-demand video and modular CMTS broadband applications. These second quarter results emphasize not only robust demand from cable operators, but also Harmonic’s continuing industry leading position in the cable edge and access category. Our powerful HectoQAM technology is truly unique in the industry and is providing strong competitive differentiation as are our latest TWDM access products.

We are also very pleased to see the production in Playout product revenue from our Omneon acquisition bounce back nicely, up 14% from a slower first quarter. Enabling this was the combination of positive market response to our newest server and media storage products, as well as continuing positive progress integrating our global sales force. While the integration has gone well overall, I will acknowledge it proceeded somewhat slower than we initially anticipated with respect to both cross-training and cross-selling. However, we have made important progress. For example, the two largest media storage opportunities we’re currently pursuing in Europe led us opportunities for the media storage solution acquired from Omneon with service providers who are historic Harmonic customers addressed by legacy Harmonic sales people and part of a broader system solution bundle. I expect us to continue to make progress and realizing such strategic synergies through the second half of the year.

In the area of strategic focus, we already see benefit from our combination with Omneon, is in our expanding and increasingly diversified customer base. Our top 10 customers in the second quarter contributed only 37% of revenue. And for the first time we saw market leading media and broadcast players among our largest customers.

Turning to slide seven, the fundamental dynamics driving our marketplace remain unchanged. We continue to see a new video economy being driven by consumer demand for more video services by growing reach and strength of media companies as well as by intensifying competition among traditional and new video service providers. We, Harmonics, continue moving into the second half of 2011 as the leading video infrastructure company and very well positioned to capitalize on opportunities as they unfold.

Turning to slide eight, despite a slower than expected near-term domestic market, we continued to execute our four strategic imperatives for the year.

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

Second, we’re successfully developing a leadership position in new applications and customer verticals, namely multi-screen, new internet media services, and video production.

Third, our objective is to continue to lead the market in technology innovation. And I remain very confident the pipeline of new products and solutions we have scheduled for release over the course of this year will further differentiate Harmonic in the marketplace.

And, finally leveraging the value we’re creating in the global market, 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 tell us more about the quarter and our financial outlook.

Carolyn Aver

Thank you, Patrick. Turning to slide 10, as Patrick has said, our total revenue in the second quarter of a $134 million was below our expectation. This was primarily a result of the timing of revenue on large encoding projects in the domestic markets. Given the projects we are currently working on and are included in our deferred revenue and the activities we see on new projects, we believe this to be a short-term effect and not a change in the overall long-term market outlook.

Net revenue in the second quarter of 2011 was down 1% from Q1 and up 5% from net revenue of Q2 2010. Also, the second quarter of 2011 was marked by very strong international revenue growth across many different geographies with international sales up 26% year-over-year.

Non-GAAP gross margin essentially remained flat at 51%, the same as the previous quarter and the second quarter of 2010. While we continue to focus on gross margin improvement, the second quarter of 2011 had a relatively high percentage of edge and access product and international revenue, both of which generally have lower gross margins. Sales of edge and access products increased 29% from the previous quarter.

Operating expenses for Q2 of 2011 were $53.9 million comparable to the previous quarter. Even with lower than expected revenue, our operating margin was 11% for the second quarter of 2011 compared to 10% the previous quarter and 13% a year-ago. Our reported non-GAAP net income per share for the second quarter was $0.09 per diluted share comparable to the previous quarter and the second quarter of 2010.

Turning to slide 11, let’s look at our revenue and backlog in more detail. As noted, total revenue for the second quarter was a $134 million, up 5% from the same quarter in the prior year. Our backlog at the end of Q2 2011 was a $122 million comparable to recent quarters. Total bookings in the second quarter were approximately a $131.7 million also comparable to last quarter.

Moving to slide 12, we have continued to significantly diversify our revenue mix across different geographies, products and markets. International made up 59% of our net revenue in the second quarter, showing continued strength worldwide in both developed and emerging markets. In Q2 2010 by contrast, international revenue represented 49% of our total sales. Our largest customer was again Comcast, representing 11% of revenue in the second quarter. Our top 10 customers represented only 37% of our revenue, reflecting our continuing diversification across the worldwide customer base.

Cable customers accounted for 48% of revenue in the second quarter was a strong contribution from our growing base of international cable customers. Broadcast and media customers represented 31% of sales, satellite and telco 21%. Video processing revenues in the second quarter were exceptionally low relative to recent quarters, representing only 38% of our net revenue. On the other hand, Edge and Access revenue was up strongly representing 30% of the total. We’re pleased to see our production in Playout revenue rebound from last quarter, representing 19% of total revenue, while services and support remained at 13%.

As you can see on slide 13, we continued to maintain a strong balance sheet. We ended the quarter with a cash balance of a $134.3 million, up $70 million from the end of the prior quarter. Our receivable balance increased to a $117.9 million and our DSOs increased to 80 days. The increase in both the receivable balance and our DSOs are due to the non-linearity of invoicing in the quarter. Our inventory was $61.1 million, up modestly from the first quarter as a result of lower than expected shipments in the quarter. Our inventories were down slightly to 4.1. Finally, our capital spending was $3.6 million in the quarter and we expect our CapEx for the full year to be between $14 million and $16 million.

Moving to slide 14, we do have a couple of significant projects underway that we expect to recognize in the coming quarters, yet the timing on when we will recognize that revenue remains uncertain. We also have a number of significant potential new projects in the sales pipeline, yet the precise timing for closing and then ultimately recognizing revenue on those deals is also unclear. Taking all this into consideration, we expect net revenue for the third quarter of 2011 to be in the range of a $130 million to a $140 million.

Non-GAAP gross margins for the third quarter of 2011 are anticipated to be in the range of 50% to 52%. Product and geographic mix will continue to influence whether we are on the high or low end of that range for gross margins. Our target for non-GAAP operating expense for the third quarter is $53 million to $54 million. Our headcount was 1144 at the end of the second quarter, up slightly from the previous quarter. We will continue to manage our operating expenses closely. We currently anticipate our non-GAAP tax rate for 2011 will remain at 25%.

Looking at slide 15, as Patrick discussed, while we remain very positive on mid-to-long-term opportunities, the short-term domestic market issues cause us to be more cautious for the remainder of the year. At this time, we expect revenue for the full year to be in the $540 million to $550 million range. We expect gross margin to be in the 50% to 52% range with the product and geographic mix continuing again to influence whether we’re on the high or low end of the range for gross margins. We expect expense management as well as seasonality to deliver a sequentially lower operating expenses in Q4 by as much as a couple of million dollars. We do continue to target a 14% to 16% annual operating margin goal. Although, given the Q2 results, we won’t achieve that goal for 2011.

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

Patrick Harshman

Well, thank you, Carolyn. Before moving to questions, let me just summarize the key points as I see them. First, domestic spending on new large scale encoding projects is proceeding more slowly than we anticipated. As our customers work for a variety of strategic and planning issues, we believe these projects will get back on track and Harmonic will benefit as originally anticipated. In the meantime, however, the slowdown and timing uncertainty has affected our near-term outlook but not our medium-to-longer-term growth prospects.

Second key point, beyond this issue, Harmonic is executing well on all of our other key strategic initiatives, and these include driving international growth, we’re seeing over 20% growth overseas; extending our customer base to include global media and broadcast companies, who now account for over 30% of revenue; developing new revenue streams for new products that enable video services targeted at iPads, iPhones and the like; and successfully integrating and leveraging the Omneon business, where we saw the storage and server revenue bounced back strongly in the quarter.

And the final point I want to assure you that we are extremely focused on further strengthening our operational execution and profitability. We delivered 12% growth through the first half of the year, returned to operating margins to double-digits and we are committed to leveraging our expanded customer base and product portfolio to further strengthen our financial performance.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Simon Leopold from Morgan Keegan.

Victor Chiu – Morgan Keegan

Hi, this is Victor Chiu in for Simon Leopold. And I guess can you guys just discuss some of the factors that you are confident that this is timing issues and not more of the structural shift in the market?

Patrick Harshman

Yeah, Victor I mean the main reason for that is because there is very real project that we are discussing with our customers. We’ve seen for some time our view on the projects themselves was strategic scope, the financial scope has not changed. I think what has changed is our understanding and I think our customers understanding of some of the broader complexities and implications.

And if you are an operator you are going to build a new head-end you know you need to further compress your channels you got whatever it is 200 channels you need to upgrade that that’s fine. Now, what you are thinking wait a minute before doing that investment I need a future proof that a news to also be able to address a variety of different devices maybe connect a TV as well. That how we think process, we don’t see the initial project being questioned by any means, but we do think that the broader business context is falling under and I think appropriately greater business scrutiny.

And we think working to those issues is taking a little bit longer. So but fundamentally going back to the answer to your question is we see very real projects that we are discussing with our customers. A pipeline hasn’t changed I think the strategic imperative from our customer’s perspective has certainly not changed; the competitive imperative has not changed. So we see a very real intangible market plans and budgets up.

Victor Chiu – Morgan Keegan

How are you thinking about the timeline I guess in terms of when you might seem a normal run rates I guess?

Patrick Harshman

Look let me back up to make sure we agree we are talking just about the domestic business. Yeah, I mean what we are seeing we are actually – we are very pleased with the way the business is rolling overseas. So within the domestic space we have been surprised with things of slowdown that being said there is a current projects which we have won were actually to a little bit of a slower of a project completion and correspondingly revenue recognition process.

We do think that will close some of those in the third quarter and we think that the number of our customers that Patrick was talking about are relatively close that being said we’ve been surprised by some of the slowdown. So we are being little cautious and prognosticating how quickly some of our customers will make decisions and move forward.

Look I expect several of the projects, most of the projects that we are talking about actually will be decided and to get rolling this projects in the second half of the year. I think the other point though is that we are seeing a longer time to project completion and to revenue recognition hence I can imagine a scenario in the second half of the year where the bookings are relatively strong. But we have a positive book-to-bill ratio as maybe the completion of some of these projects rose into 2012.

Victor Chiu – Morgan Keegan

Thank you.

Operator

Your next question comes from William Stein from Credit Suisse.

William Stein – Credit Suisse

Thanks, and good afternoon. Regarding the lower revenue level, how much do you think this is demand or as you say maybe a timing issue versus the sales forecasting and execution issue? Do you think that is it something that you could have predicted Patrick, when you kind of look back and maybe there were some internal issue to the company with view on that at all?

Patrick Harshman

Well, I guess my answer is maybe the – we have knowledge of last call and again in my prepared remarks, this is that we’ve been working even, we have a great sales force. But, we had change management change organization and that create some line of distraction, it clearly had some impact on our results in the first quarter and I think on our last call, we acknowledged and it’s true. It had some impact I think in terms of the way things preceded in the second quarter.

But, I think it’s a secondary or tertiary effect really. And the step back, I don’t see a significant difference from the dynamic overseas and domestic right. And we are integrated in our global sales force. And frankly or internationally our sales team is – are not going to cover up above from my perspective. So it’s hard to see that that the dynamic between our domestic international sales force could be so different.

William Stein – Credit Suisse

Okay, okay.

Patrick Harshman

I think what is true is that the domestic market situation is, in lot of ways further advanced, we have many international customers. I think internationally our standard definition channels shift exceeded HTV we have a lot of business in emerging markets, which is just initial low out of pay television, et cetera. IT is the turn but it just a little bit more of kind of business. It’s a very different situation then a leading company in the US, really plotting its strategy and moving away from set-top-boxes.

So we again go all over the time, I mean, that is not a question about more HT channels and broadening services to more devices, but exactly how it’s going to get done, I think that these are a different kind of strategic issue and probably little bit more complex in time consuming forward or domestic customers and we had originally anticipated.

William Stein – Credit Suisse

So when we think about the delay and he is including projects, it sounds like at least partly this is your customer is contemplating more over the top or maybe not your customer is contemplating more over the top. But, the market moving in that direction in your customers evaluating how they deal with that, is that a reasonable way to think about it?

Patrick Harshman

Every single one of our domestic customers just developing and over the top stuff strategy, I don’t mean that to say that they replacing wrong network strategy. But, as a new strategic plan every single one of our customers who owns the network is thinking about services over their own network to a variety of devices as well as services kind of over the top, over the open internet outside of their footprint.

And I think we talked about this is in some depth at the Analyst Day that we did recently, so it’s a pretty exciting opportunity customers, I mean competition is going to increase. There is a multiplication of the number of services at times the number of strings that’s going on but this is complicated stuff and in retrospect I think neither we know some of our customers fully grasp some of the complexities of plotting this out.

William Stein – Credit Suisse

Is that part of the delay in the revenue recognition or to plan these projects is the planning for over top strategy?

Patrick Harshman

No, the projects that are hanging out there or that we see I think that’s a little bit more just with newer technology. The first high definition projects we did took a little bit longer kind of the front-end of an industry so the first complex deployments where people are looking at an integrated head and they serve both televisions as well as iPad, a little side experiment is one thing, defining some of the large, I talked in the first quarter I mean that’s how we’ll give a specific example I talked in the first quarter the largest deal that we did was associated with a kind of multi screen deal that was tightly coupled into the legacy end.

We still not recognize the revenue from that project. It’s still ongoing. It’s complex work. We think we will recognize that project in the third quarter but we haven’t yet and so that’s less of a strategic planning they this operators decided to go forward they are doing it but it’s actually technically some new problems are being solved from the system integration and rollout point of view.

William Stein – Credit Suisse

Okay, thanks. I’ll get back in queue.

Patrick Harshman

Thank you.

Operator

The next question comes from Mark Sue from RBC Capital Markets.

Mark Sue – RBC Capital Markets

Hi, this is Joe on for Mark, I just wanted to know what’s behind the lack of large encoding projects, is it the macro, is it share loss, typically there is a predictable time into lot of these and with this new integrated HT and multi-screen initiative are they evaluating competitive solutions or is that part of the delay.

Patrick Harshman

We feel strongly that we are not losing any share in the market place. The competitive landscape is not too much differently internationally than it was domestically. Well, admittedly some of the solutions and emphasis is slightly different particularly in emerging markets. If we were losing it a little bit competitively I think we would be seeing that in our international results. When I say we didn’t see any significant encoding projects in the second quarter, I meant we didn’t see any, not that we didn’t win. And so first of all, as the first part of your question, we don’t think we are losing any share.

And certainly, any time anything that’s going on I mean let’s just go back a year ago and HD opportunity almost every one of our – all of our customers do competitive evaluations. So certainly we have competitors and certainly they are being evaluated. We don’t see that part is the long form by any means. Our customers know how to kind of compare different subset of solutions. What we are planning to is that we think our customers are – in many cases, grappling with more complicated business arrangements. I mean I think you know, that licensing – the way you store content, for on-demand to a television set, I mean there is a – there has been well published issues about iPad services et cetera.

There is very complex business issues that actually have implications for the technology side of the equation. We see those kinds of issues as being a little bit of longer pole and the tad some of the planning and the initiation of some of the projects that we are talking about.

Mark Sue – RBC Capital Markets

Thank you and good luck.

Patrick Harshman

Thank you.

Operator

The next question comes from George Notter from Jefferies & Company.

James – Jefferies & Company

Hi, this is actually James calling in for George. I just wanted to clarify then, not to be a dead horse here, but I am just, what happened that wasn’t that you expect I guess didn’t happen that you expected and I am looking at satellite and telco being down sequentially, and it looks like the video processing for cable operators is kind of flattish. I am wondering like do you expect satellite and telco to be stronger or was it more centered around cable or both, could you give us a little more color in terms of like what customers contributed to the weakness in some of the encoding.

Patrick Harshman

Well, that separates the revenue of the current quarter, second quarter with the outlook for the second half of the year. There is a $5 million delta between the midpoint of our guidance range and what we reported. Well, significant that’s not a whole market trend or anything that is a symptom of a couple of things moving more slowly than we initially anticipated. I think from my perspective the bigger issue really here is that seem to be the front edge of broader industry delays.

So we expect kind of now projects that we thought might have been booked but I’ll show off this revenue in the second quarter and then subsequently recognizing the second and third quarter, but now we expect such a project to be perhaps booked in the third quarter and maybe recognize in Q4 but maybe in Q1 of 2012. So as you look at the revenue numbers I guess, we don’t break out and we’re not going to breakdown our bookings. But I would say that the second quarter bookings is not a necessarily a proxy, excuse me the second quarter revenue is not necessarily a proxy for the bookings.

And frankly we talked about large customers, I don’t really increasingly there isn’t much of a strategic difference. Our large cable operator, our large satellite operator, our large Telco in the U.S. really all from a video perspective, have the same strategic priority. And a high level from what we can see the same strategic direction. They are going to rollout services over their own network to a lot of devices they are going to rollout services over the top to leverage their brand and content relationships. And so the issues we’re talking about really transcend these traditional service provider categories.

James – Jefferies & Company

Okay. Could you perhaps tell us, what you think needed the trajectory of the various businesses, it looks like sequentially edgeQAM. For example edgeQAM are pretty strong this quarter, I am wondering if that would lead certainly to declines sequentially and, I guess it also just lowered, could you briefly address, did you see a pretty strong uptick in software in edgeQAM or I guess the internet access business is, is that part of what drove you, you recently give margins given the unexpected mix?

Patrick Harshman

So we do see cable operators continuing to spend and I think it’s, for us it’s a little if an indication that we’re not really looking at macro issues here, we did see good spend in the Edge and access area. I think our edgeQAM project the product in particular as well as our DWDM products are really unique in the marketplace.

And I think as customers better understand that as we get better in articulating our competitive advantage to our customers, we’re seeing ourselves not only retain market share but gain new market share and I think benefit from that. So we feel – look there’s always a little bit of up and down, a variation in cable CapEx but the trend certainly seems positive and we’re very pleased with the second quarter results in the Edge and access space. And I think it comes down to, demand is there and we have got some very strong differentiated new products.

Carolyn Aver

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

James – Jefferies & Company

Okay, thanks a lot.

Patrick Harshman

And that was totally unexpected, I mean remember that’s part of a strategy, as we’ve went to an offshore, and now that we are HectoQAM, so we’re either, we’re almost always now when we ship new hardware into the field it’s not fully licensed. So on a going forward basis we expect a mix of new hardware sales as well as licenses to turn on hardware that was previously shipped in a previous period. I suppose over, quarter-to-quarter the relative mix should change. But it’s expected and is very much part of the strategy.

For strengthening the gross margin to this product line to have increasingly capable hardware, we did that with the Octo (ph) product and now that with the HectoQAM product we are really doing and that’s what we see particularly good potential for this product while we are particularly excited about gaining more market share.

James – Jefferies & Company

Okay. One quick last one before I go – I think you mentioned your end product should I improve some of the quarter over to growth was coming from access was that an equal contribution? Thanks a lot.

Patrick Harshman

Last two quarters have been – have been good access quarter for us, we expect our access business to grow on the show.

James – Jefferies & Company

Thank you very much.

Operator

The next question comes from Blair King of Avondale Partners.

Blair King – Avondale Partners

Yes, thanks for taking the question. Patrick you would need some actually didn’t make much of comment that all about some of the emerging market activity one of you can just turn the page a little bit and talk about how that might of progress for you this year, especially in the content distribution area?

Patrick Harshman

We remain – we continue to be quite bullish about emerging market, it’s definitely I wouldn’t say its dominant in the international story as we did well and good in developed market with the exception of Japan which is very slow, but emerging market is doing quite well for us, I highlighted in my prepared remarks press releases we had – many of our customers don’t allow press release but we had two very significant once in the past quarter my view, we are able to announce relationship with Global in Brazil, I mean there a giant company addressing a giant market, real market leader down there and as well as Vietnam (ph) TV.

So what we don’t break out report numbers for emerging market specifically I would say our growth – look, our international growth clearly outpacing our domestic growth and we projected that for quite some time. We are very pleased with overall international growth about 20% and I would tell you that our growth in, what I call emerging markets, which includes eastern Europe, Russia, the Middle East, India, China and Latin America let us say, is growing at a clip even faster than that.

We’re investing quite a bit in strengthening our local channel network as well as our local sales in support infrastructure on these markets. And, Blair, we have been seeing good success across customer types both service providers as well as the media companies and the two examples I just gave you are in fact a broadcaster or media companies. So we are frankly we couldn’t be more pleased with international in particular emerging marketing business is going.

Blair King – Avondale Partners

Right. And then, lastly, it’s not often that you see US revenue contribution down and cable up. And so obviously the international business is strong. But is there something that you’re doing internationally in the cable space is now that hadn’t been taking place in the past?

Patrick Harshman

No, I think we’ve just stuck to it, Blair. We admitted that our market share across the Board and including in cable was lower internationally. And we’ve just spent hammering away and if you’ve gotten great products, which I believe we do. And you kind of keep at it, you break through. And I think that we’ve been doing that, we’ve been doing that overtime. And we’re – we’re very pleased in particular I highlighted in the prepared remarks that one particular I would say a leading an international cable operator, we really broke through in a kind of meaningful way for the first time with both edge and access products. And so we’re pleased with the success there.

Carolyn Aver

If you remember in the beginning of the year when we talked about our strategies, one of the strategies was to take our leadership position and extend that into accounts for customers that perhaps we didn’t have for an invest and sort of those sales processes. And I think this is an good example of where you see some of that that bearing through.

Blair King – Avondale Partners

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

Patrick Harshman

Look I would give it say a B or thereabout. It’s proceeding slower than we had hoped. I think at the beginning of the year, we did say hey; don’t expect too much in terms of revenue this year. Unfortunately that’s turning to out to be the case. That being said, we’re seeing a number of projects. One of the larger production and play out that is Omneon deals that we did close in last quarter was actually a hybrid.

Omneon contribution distribution deal that we did a major broadcaster and internationally. I mentioned in the prepared remarks that actually the two largest media storage opportunities that we’re currently pursuing in Europe has actually not in the historic Omneon space at medium broadcast, but they’re actually too with two service provide to our Harmonic customers that are Harmonic sales forces bought forth. And they were kind of bundling a lot of on new media trans coding and streaming solutions together with storage as a broader and a pretty powerful new media real time and on-demand offering. So look we’ve got a long way to go to close those deals and to the discussion early, if there was an international recognized status it’s pretty exist, it’s really breaking new ground.

But we’re starting to see these deals I would say we’ve closed a couple and we’re starting to see more and more shops in our pipeline. So I think we got exactly like strategically, I think that the opportunity is very much there. But I think that the – we are cautious, I’ll tell we were hoping we would go little bit more quickly, I think it’s taking time.

Operator

The next question comes from Larry Harris from CL King & Associates.

Larry Harris – CL King & Associates

Yes, thank you. Good evening. I came on to the call little late I apologize if these questions were asked. But at least relative to what I was looking at with the video processing, came out little bit below expectations that is what I was looking at, the same thing which are true with satellite, I’m assuming that those two variances connected, is that a correct assumption?

Patrick Harshman

They are connected, there is not a 100% overlap, what we did say is that looking general although not internationally but domestically we saw relatively light and coding demand across our customer base, our service provider customer base. So certainly that includes satellite offerings.

Larry Harris – CL King & Associates

Okay. And I assume that’s going to continue into the third quarter?

Patrick Harshman

I can imagine the mix changing a little bit, Larry. I mean the overall comment is that, as we see the projects coming a little bit more slowly is all of our large customers, whether that cable satellite or Telco or bring a little bit more thoughtful for pausing and really get in the strategy right before they put the money down for the next generation head in. Projects are in our pipeline, we are going to close the new projects in this coming quarter, we’re recognized them sometime in the second half of the year and its early 2012.

And that has been in the case in the past and I think you know this is from our satellite number, we never been monotonically up or down. Satellite in particular has been a project oriented business and I think you will see in the coming several quarters, you’ll see both strong satellite quarters as well as lighter satellite quarters.

Larry Harris – CL King & Associates

Then just one other question, in the past you’ve indicated that you’ve done some software work with Amazon, Amazon I believe announced in the last couple of days an expanded relationship carrying more CVS programming, if customers like Amazon or others, expand their programming offerings or add more subscribers, does that have an impact to stay upon your trans coding software sales?

Patrick Harshman

Well, I feel won’t comment specifically on Amazon, I will tell you that our transcoding business on a relatively modest numbers is doing quite well and we are pleased to see continue and gain traction with what would I call new medium customers such as Amazon as well as with the service provider for getting into that business.

But we had an interesting win this past quarter with a traditional service provider who themselves are setting up a Netflix/Amazon kind of store fund, using our technology. So that kind of application yes, is of growing importance and relevance and actually it’s beginning to expand as we see all of these different service provider models starting to melt and kind of we are seeing that opportunity across traditional mandates.

Operator

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

William Stein – Credit Suisse

Thanks. A couple of quick follow-ups, Carolyn, you previously provided a margin outlook for the full year, can you give us an update on your view on that?

Carolyn Aver

In terms of an operating margin?

William Stein – Credit Suisse

Yeah.

Carolyn Aver

You know, I – because the revenue guidance is so big I didn’t give a specific operating margin, I mean our target was certainly 15% given where we ended this quarter it’s going to be hard to achieve that we are managing our operating expenses very closely and we expect them to be relatively flat this quarter and then down next quarter I think it would be hard for us to get to 15% for the year at this point that is generally still our target and so at Analyst Day, Feb 14th to 16th, whether its 14 to 16 or 15 we certainly expect that to be kind of our annual target. I would expect Q4 to be above 15% with revenue continuing to grow, but I’m not sort of prepared to give a whole range for the year yet.

William Stein – Credit Suisse

That’s fine. And then one other one, so you’ve spoken about the change in the dynamic in the encoding business in particular in the US that its customers are pausing, they are thinking more, maybe the revenue is going to be more lumpy especially for these bigger deals? Does your guidance for the rest of the year on the revenue because you are guiding for the full year on revenue? Does that de-risk these larger deals essentially taking them out or is it more of a fair middle of the road kind of view relative to your current pipeline that has kind of equal risk to upside and downside, how should we think about that?

Carolyn Aver

I think that one of the reasons range for the quarter is though is Chuck covered the rest, because one of these large projects either being in or out. We are fairly confident that it will be completed in the year we expect and are hopeful that it will be completed in the quarter but we’ve given ourselves hopefully enough of a range so that we have some flexibility there. As Patrick said, this guidance would assume that maybe bookings would be stronger than revenue because of the nature of the projects. We haven’t obviously taken every risk out of the range. We’ve tried to think cautiously about the guidance.

William Stein – Credit Suisse

Okay, that’s helpful. Thank you.

Patrick Harshman

Thank you.

Operator

The next question comes from Paul McWilliams of Next Inning Technology Research.

Paul McWilliams – Next Inning Technology Research

Hi guys, thank you for taking my call.

Patrick Harshman

Hi, thanks for joining us Paul.

Paul McWilliams – Next Inning Technology Research

There were a couple of interruptions by the conference call operators, so I missed some of the Q&A, so excuse me if I’m redundant with some of my questions. On the OpEx for Q4, did you suggest that would be down $2 million to $3 million, was it fair one?

Carolyn Aver

I said a couple, that would – I think of that is twoish.

Paul McWilliams – Next Inning Technology Research

Last conference call you had mentioned that you expect to be average operating profit for Q4 plus Q1 to be about 15%, do you think that that’s still achievable?

Carolyn Aver

I think that depends on where revenue – where we see revenue in Q4 and where gross margin is still depending on the mix of revenue as well. So it’s certainly profitable, but that really has more to do with revenue and gross margin at this point.

Paul McWilliams – Next Inning Technology Research

Okay, I understand. What was Omneon for Q2 in values?

Carolyn Aver

We don’t break out Omneon as a company. We do break out production and play out as products, so what that – that includes their products but not the service component of those other business and that was $25.5 million.

Paul McWilliams – Next Inning Technology Research

Well, you mentioned that they were up I think 14% sequentially?

Carolyn Aver

Correct.

Paul McWilliams – Next Inning Technology Research

And I looked back and I didn’t see where you’ve provided a Q1 number those they play out as you mentioned and there is a service component.

Carolyn Aver

Yes, there is a – it’s at back of every press release. We’ve been giving out pro-forma consolidated revenue at this we had been combined with Omneon both this year and last, and that also adds in the deferred revenue carve out that we were actually not able to take, so that you could get the truest view of what their real business was and so for last for Q1 that number would have been $22.4 million and for Q2 it’s $25.5 million.

Paul McWilliams – Next Inning Technology Research

Okay, but that’s just on the play out part of it, that doesn’t include their service?

Carolyn Aver

That’s production, yeah, that’s their products not their support and services. Support and services are consolidated. We don’t break those out. But they are roughly 15% of their total and are roughly in line with revenue.

Paul McWilliams – Next Inning Technology Research

Okay. Let’s see here now on deferred revenue, you don’t have any non-current deferred revenue, do you?

Carolyn Aver

We do.

Paul McWilliams – Next Inning Technology Research

Oh! Okay how much was that?

Carolyn Aver

One second, I’ll look that out.

Paul McWilliams – Next Inning Technology Research

Thank you.

I’m not sure I actually have it in the room with me. It’s combined on our balance sheet and so I’m not – I don’t have that in the room.

Paul McWilliams – Next Inning Technology Research

Okay. I showed the current has been 47.6 down from 49.8 last quarter which left me a little bit curious as to – I took from the comments made, there is no direct statement that you had an increase in deferred revenue that I could recall. But you’ve seen there is deferred revenue was one of the issues for the lower revenue realized this quarter.

Carolyn Aver

And so bookings and revenue were both roughly flat with last quarter and roughly the same. So there is not a big change in deferred revenue either, there was revenue that they are included in deferred revenue from prior quarters or a couple of large projects that we expect to take the second half of this year, a little bit to Patrick’s comment, if you segregate this quarter’s revenue from the trend two things happen, there were projects that were in deferred revenue that we would have – or might have expected to take. We also expected bookings to be higher which would have fueled future quarter’s revenues. Both of those things not unrelated slowdown.

Paul McWilliams – Next Inning Technology Research

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

Patrick Harshman

That’s right. Well, and what I – look we don’t have a 100% market share Paul, but we’ve done extremely well and what I termed when I called high end encoding and there hasn’t been a period in the last two years where either a satellite or telco customer or a cable customer hasn’t done some kind of larger scale encoding project with us.

Paul McWilliams – Next Inning Technology Research

Yes. And I know it works very well.

Patrick Harshman

So we are not aware of any project kind of in that field that transpired. Certainly there are small things that happened here or there and yeah so the smaller projects that happen and certainly there is a number of companies out there doing things. So look we wouldn’t have gotten this result if we didn’t do some amount of smaller kind of deals. But this deal, this quarter for us was characterized I think by no domestic deal larger than a couple of million dollars which is very unusual. And so my comment is we weren’t aware of anything larger than that transpired period.

Paul McWilliams – Next Inning Technology Research

Now, are you maintaining share in the universal edgeQAM deal that you’ve been working with one of your major cable customers?

Patrick Harshman

We think we gained our share in the last quarter. As you see we had a very strong edge and access quarter and while the access business is certainly part of that, our HectoQAM product is doing quite well in the marketplace. It really offers I think compelling operation as well as financial benefit to our customers and we see it gaining momentum, both domestically and internationally we saw product not only continued to fuel our presence with existing accounts and deployments, but actually break into some new locations. So we are very pleased with the way that technology is working out for us.

Paul McWilliams – Next Inning Technology Research

I’ve got two more here just real quick. China Telecom announced very recently that they are installing the Cisco ASR9000 edge routers to support IPTV for the coastal cities. Do you expect that you will have involvement in that project?

Patrick Harshman

I hope so and the truth is that I don’t exactly what’s going to happen. IPTV has been a winding kind of road in China for some time. We have deployments and we have relationships with the historic players who have the licenses on the content side. And we continue to have those relationships Paul and my belief is, my understanding is that will be a beneficiary going forward. I should highlight that historically that’s been a very small portion of our revenue in China. Most of our Chinese revenue has been derived from the cable operators who are the primary owners of the video delivery licenses in that country.

Paul McWilliams – Next Inning Technology Research

Oh, yes indeed you have done well there, that’s what kind of made me curious as to what your thoughts were on the China Telecom, because like you I take that as new event moving into telecom and getting IPTV rolling and –

Patrick Harshman

There’s a couple of companies, for instance like the Shanghai Media Group who have owned IPTV licenses and there has been a couple of modest deployments in certain cities of Shanghai Media Group in cooperation with the telecom network. And what you have just referred to, we read is really a gradual kind of expansion of that model.

Paul McWilliams – Next Inning Technology Research

Excellent. Now my last question here it’s a little bit general, but I think speaks to what we’re really all curious about. This over the top model, that is really just coming together now and people are understanding it, how does that impact your competitive position?

Patrick Harshman

Bear with me, Paul. I mean it justifies kind of the one liner. So look, a year ago over the top meant delivering small resolution video to a small screen on your PC, right, or maybe to an iPhone, that’s kind of a new market and there’s a number of players in that space. You can do some of that encoding and software or you can do it very efficiently on hardware. Harmonic is definitely a player there, but there is also a whole lot of other companies that are playing in there. In general I would concede that, that kind of market was more competitive than the way the high-end HD market had kind of shaken out. We certainly believe that our long term ability to win in that market just the way we think we have really come out, by long margin on top in the high resolution HD market.

So that’s kind of going on and I think we’re doing well, although it’s all admitted to more competitive space right now than the HD to television market, okay. However what’s interesting, what’s really happened in the last six months is the definition of over the top and what people want to do is really evolving in real time Paul. Look at now I think about Samsung 50-inch television screen that is designed to be connected and people want watch NetFlix, on that – streaming NetFlix on that screen. Guess what, that little encoding system that plays just fine on a little 5-inch screen or 9-inch screen or whatever no longer cuts it on a 50-inch thing. So my view is although Harmonic was paying well and investing quite a bit and was poised to be quite successful in the smaller resolution thing, as the definition over the top has kind of opened up and now we are talking about delivering to much larger formats that’s really tilted the playing field actually much more strongly back in our favor. There is nobody that knows how to deliver compressed high quality video to 50-inch screen the way Harmonic does. And that’s certainly through over a provider network.

Now you talk about over the top where actually bandwidth is even more of a premium and the importance of compression is even more important because the operator doesn’t control that network. I think that puts an even greater emphasis on the compression or the quality. So we like more than ever our competitive opportunity. But this kind of goals I know we are getting in the technology here. But this kind of goes to harder set of things our customers are dealing with. Six months ago the over the top platform was kind of separate from how you get to 50-inch television maybe we’ve got a little deployment for iPhones and that’s distinct from our – serve the televisions, right?

Now that’s being refund, wait a minute maybe it’s the same kind of head in that has to hit all kinds of different screens. So this is complicated. It’s moving very quickly. And we think particularly as larger formats have come into the mix into an expanded definition of what is over the top, we think Harmonic is positioned more strongly than ever from a technology point of view. So on one hand we are frustrated, its complexity is delayed. We are not happy about sitting here as I emphasized at the beginning of the call, we are not happy about the results nor we are happy about the financial forecast.

Nonetheless, at the same time, I hope you can hear my voice. We are excited as ever about the opportunity, we see these investments have to happen. We see that our customers will allow these services. I think that this is going to be the predominant model in this country five years from now. And I think it constitute a tremendous opportunity that goes right to the sweet spot of our technology. So sorry long answered Paul, I hope that addressed it, but that’s how we see it.

Paul McWilliams – Next Inning Technology Research

Well, I very much appreciate you’ve taken the time and patience with me on that. And I think it’s something that a lot your investors are interested in. That wraps it up for me, but Carolyn could you put me on your call list, so I could touch based on those housekeeping things with you later.

Carolyn Aver

Absolutely.

Paul McWilliams – Next Inning Technology Research

Thank you very much.

Patrick Harshman

All right, well, thank you very much Paul and I think with that we will end the call. Just a final word, I thank you very much for being with us today, and more importantly thank you for your support in the company. I hope it comes across to Carolyn that I that our management team all of our employees have a tremendous conviction in our technology, our ability to succeed and we’re incredibly focused on getting back on track from an operating perspective, back on track from a growth perspective. We see the opportunity there. We are heads down to make it happen. And we look forward to talking with you next quarter, if not before. Thank you very much everyone.

Operator

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

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