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Harmonic Inc. (NASDAQ:HLIT)

Q3 2011 Earnings Call

October 27, 2011 5:00 PM ET

Executives

Carolyn Aver – Chief Financial Officer

Patrick Harshman – Chief Executive Officer

Analysts

Mark McKechnie – ThinkEquity

Simon Leopold – Morgan, Keegan

Blair King – Avondale Partners

Larry Harris – CL King & Associates

James Kissner– Jefferies & Co.

William Stein – Credit Suisse

Mark Sue – RBC Capital Markets

Paul McWilliams – Next Inning Technology Research

Operator

Good evening. My name is [Vivian], and I will be your conference operator today. At this time, I would like to welcome everyone to the Harmonic Third 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. Ma’am, you may begin your conference.

Carolyn Aver

Thank you, Operator, and good afternoon, everyone. I’m Carolyn Aver, the CFO at Harmonic. With me at our headquarters 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 and clicking on the third quarter earnings call button in the Event section on the home page.

Let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or the future performance of the company. We must caution you that such statements are only current expectations and that actual events or results may differ materially.

We refer you to the documents that Harmonic files with the SEC, including our most recent 10-Q report and the forward-looking statement section of today’s earnings press release. 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. Revenue described as pro forma include Omneon as if they have 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 a recorded version of this call on our website.

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

Patrick Harshman

Thank you, Carolyn, and thank you, everybody for joining us today. Turning now to our slide number three, today we reported third quarter revenue of approximately $139 million, up 7% from the same period last year and up 4% sequentially from the second quarter. In the second quarter you will recall that we saw some delays in expected domestic business.

In the third quarter we were pleased to see our domestic business rebound, up 24% sequentially, as we recognize revenue from several key projects. With these third quarter results our year-to-date business in aggregate was up approximately 10% from the same period in 2010 on a pro forma basis. That is assuming a full contribution from Omneon last year.

Third quarter bookings were approximately $141.4 million as we awarded several strategic deals and more generally as we continue to see strong competitive momentum across a growing base of global customers and media applications.

We realize gross margins of 51% and delivered an improved operating margin of 12%. Our non-GAAP earnings were $0.11 per share and we generated approximately $6.6 million of cash during the period.

Turning now to slide four, let’ look at the business dynamics that underlie these results. During the third quarter the rebounded domestic demand was powered principally by a number of new video processing wins spanning high-definition television to mobile and web applications. As we noted last quarter many of our U.S. customers are still thoughtfully planning their next steps toward unifying the delivery of traditional video services with next-generation mobile and web services.

However, the healthier demand during the third quarter is indicative that many media, cable, satellite and telco customers are moving forward on a variety of new video initiatives and that they are increasingly turning to Harmonic as a strategic partner.

As you know international expansion is also a key strategic priority for us and we’re very pleased to see our international business continue to deliver results. Well, not quite as robust in the third period, international revenue for the year-to-date 2011 was up 16% from the same period in 2010, again on a pro forma basis and our international bookings remained quite healthy. New international projects span a wide range of video applications from traditional standard definition TV production and origination and fast growing emerging markets to cutting-edge mobile video wins.

Looking ahead, our international business outlook remains healthy across geographies, market segments and product categories. However, as we discussed last quarter, the consequence of our rapid international expansion and market share gains continues to be competitive pricing pressure and the associated impact on gross margins.

Turning now to slide five, another area of strategic focus is our expanding customer base of media and broadcast companies. Year-to-date, media and broadcast sales have generated 31% of our total revenue and have grown an impressive 19% year-to-date from the same period of 2010 on a pro forma basis. This excess span traditional video production and delivery, as well as new medial application driven by powerful new solutions built from a combination of historic Harmonic, Scopus and Omneon technologies.

Surveying market dynamics more broadly over the past three months, it’s clear to us that our growing relationships with the world’s leading media companies is a significant strategic advantage for Harmonic.

While Omneon acquisition has been a very successful catalyst of this strong overall growth with leading broadcasters and media companies, growth of our Production and Playout products from Omneon is progressing more modestly than anticipated. Production Playout product revenue was up 2% from the third quarter of 2010 and 5% from last quarter. However, we have made good progress and our new media storage products in particular are performing quite well.

And for example, we recently announced that BBC Sport will use our MediaGrid active storage system to support its London 2012 Olympic Games coverage. We also announced new MediaGrid deployments with Crawford Media Services here in the U.S., Dubai Media, London Studios and Sichuan TV in China.

During the quarter, we also won our first significant multiscreen application project involving both MediaGrid and our new ProMedia products, indicative of the unique broader look for solutions we’re beginning to bring to the market. We expect to continue to make progress and realizing the full strategic synergies in our cross-selling efforts and introducing such new integrated solutions.

Turning now to slide six, our Cable Edge and Access business remain strong, with revenue in the third quarter up 10% from the third quarter of 2010. The continuing healthy demand for our EdgeQAM solutions was driven by the continuing growth of narrowcast services being delivered across cable networks and Harmonic industry leading dense HectoQAM technology. We’re also receiving very positive and collaborative customer response to our CCAP vision and development program, which we believe solidifies our near-term market position and expands our longer term opportunities.

And turning to our video processing business, as noted a couple moments ago, we continue to achieve strong growth worldwide with our video processing products, up 23% year-to-date from the first three quarter of 2010. Building on our market leadership position here, we introduce powerful new products during the quarter that will enable our global customers to move forward on a range of new mobile and web, as well as traditional video services.

We announced the new Electra 9000, a follow-on to our very successful Electra 8000 in the industry’s first multi-coded, multi-format video encoder and transcoder that simultaneously supports very high quality broadcast, mobile and web formats. And complementing the Electra 9000, we also introduced our we ProMedia family of software solutions, designed to run on Intel based platforms and optimized for live and filed based trancoding, adapted data rate packaging and origination for production and streaming of high quality video content to IP connected devices, all of which enabling us to play increasingly vital role in our customers’ multi-screen plans.

Turning to slide seven, let’ delve into this multi-screen topic, a little bit more deeply. Armed with this increasingly powerful portfolio of new processing tools and our broader workflow solutions, we’ve continued to see our multiscreen business opportunities and customer activity grow.

The biggest near-term opportunity we see in this area is in assisting our media and video service provider customer to deliver very high quality video by both managed networks and over-the-top to an expanding range of devices in the context TV anywhere and video-on-demand business models.

While this is still a relatively nascent market, characterize more by planning and smaller deals than large scale initiatives. During the third quarter, we did have several wins expand media companies delivering their own content over-the-top, service provider customers, rolling out new services targeted at mobile devices, a new internet only service providers offering growing libraries of on-demand content.

Harmonic’s unique ability to support both managed network delivery and internet delivery coupled the with our unique ability to enable simultaneous and integrated delivery of super high quality 1080p, high definition television for wide screen living room television viewing together with pristine iPad video at amazingly low bit rate are key differentiators in the market.

As this market continues to develop, we believe that both our existing and new customers will demand the exceptional video quality and underlying compression technology, as well as the broader media management and storage solutions with the hallmarks of Harmonic’s capabilities. Consequently, we continue to invest strongly in this space and we have a rich pipeline of exciting new products to fuel growth.

Turning now to slide eight, we continue to execute our key strategic imperatives. First, we’re leveraging our increased sale, solution breadth and competitive strength to deepen our new relationships with leading media companies. As we expand our brand and deepen our existing customer relationships in developed markets, we’re also continuing to work aggressively to capture greater market share in emerging economy markets.

Second, we’re successfully extending our leadership position in new applications and customer verticals namely high-quality, multiscreen and new internet media services, dense EdgeQAM and IP-over-cable delivery and video production and post production work flows. Our objective is to continue to lead the market and helping our customers deliver valuable new services and I remain confident that our pipeline of new products and solutions 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 in business model. We target R&D investments in the high growth areas of our business and to continue to carefully manage our operating expenses with a focus on profitable growth.

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

Carolyn Aver

Thank you, Patrick. Turning to slide 10, as Patrick just said our third quarter net revenue of $138.9 million was driven by particularly strong growth in the U.S. Total bookings in the third quarter were approximately $141.4 million, up 7% from last quarter. Unlike last quarter, we did receive new orders for a few large projects, as well as recognized revenue on one significant project that was previously deferred.

Non-GAAP gross margins remained essentially flat at 51%, the same as the previous quarter and up 180 basis points from the third quarter of 2010. While we continue to focus on gross margin improvement, we do see pricing pressure both as we penetrate into certain new markets and occasionally in competitive situations.

In addition, sales of our Production and Playout product which tend to have the highest gross margins have grown slower than anticipated. Operating expenses for Q3 were $53.7 million comparable to the previous quarter.

Non-GAAP operating margin was 12% for the third quarter of 2011, up from 11% in the previous quarter and comparable to the third quarter of 2010. Our non-GAAP net income per share for the third quarter was $0.11 per diluted share, up from $0.09 in the previous quarter and the third quarter of 2010.

Turning to slide 11, let’ look at our revenue and backlog in more detail. As noted, total net revenue for the third quarter was $138.9 million. On a pro forma basis net revenue for the third quarter of 2011 was up 7% from the third quarter of 2010 and our year-to-date revenue was up 10% compared to the first nine months of 2010.

Our backlog and deferred revenue at the end of Q3 2011 was $125.4 million, up 3% from the previous quarter, reflecting an increase in backlog offset by a decrease in deferred revenue.

Moving to slide 12, we have continued to significantly diversify our revenue mix across different geographies, product categories and markets. International revenue represented 51% of net revenues in the third quarter. During the third quarter, we were pleased to see our domestic business rebound, up 24% from the previous quarter.

On a year-to-date basis, however, International sales have grown 16% as we continue to show strength worldwide in both traditional and emerging markets. Our largest customer was again Comcast representing 12% of revenue in the third quarter. Our top 10 customers represented 45% of revenue reflecting the timing of a number of large deals.

We saw continued strength in Q3 from our growing base of satellite and telco customers, which represented 25% of sales. For the third quarter our broadcast and media customers rented 30% of sales. Year-to-date, broadcast and media revenue has grown 19% on a pro forma basis.

Video Processing revenues rebounded in the third quarter, representing 41% of our net revenues. Edge and Access revenue also remained strong, representing 28% of total. Our Production and Playout revenue represented 19% of total revenue and services and support 12%. Despite quarter-to-quarter fluctuation in overall revenue mix, our strategy of continuing diversification across different geographies and market is succeeding.

As you can see on slide 13, we continue to maintain a strong balance sheet. We ended the quarter with cash of $140.9 million, up $6.6 from the end of the prior quarter. Our receivables balance was $116.4 million and our DSO decreased to 76 days. Our inventory was $65.2 million, up from the second quarter, but reflecting increased sales activities in the second haft of the year. Our inventory turns were up slightly to $4.2.

Finally, our capital spending was $3.5 million in the third quarter and we still expect our CapEx for the full year to be between $14 and $16 million.

Moving to slide 14, we are encouraged by our bookings and the U.S. customer demand in Q3. Additionally, Q4 is generally our strongest quarter and often includes year end spending by some of our large customers, having said that, the global economic environment was continued caution.

We are also keeping our eyes on the floods in Thailand and it’s a fact on our global supply chain. There is an impact on one of our suppliers of optical components that we currently believe will have up to a $2 million adverse impact on our revenue in the fourth quarter.

Taking all of this into consideration we expect net revenue for the fourth quarter of 2011 to be in the range of $135 million to $145 million. We believe the floods in Thailand will also have an impact on the cost of disk drives which will adversely impact our gross margins in the fourth quarter.

Non-GAAP gross margins are anticipated to be in the range of 49.5% to 51.5%. Product and geographic mix will continue to influence whether we are on the high or low end of that range of gross margin. Our target for non-operating expense – non-GAAP operating expense for the fourth quarter is $51 to $53 million. We typically enjoy slightly lower operating costs in the fourth quarter due to an increase in vacation days and because of the timing of large tradeshows. Our headcount was 136 employees at the end of third quarter, down slightly from the end the previous quarter.

Finally, we currently anticipate our non-GAAP tax rate for 2011 will remain at approximately 25%.

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

Patrick Harshman

Thank you, Carolyn. Before we open up to questions let me just summarize a couple of the key points. First, Harmonic delivered a good quarter, actually the highest revenue and bookings quarter ever for the company.

Our domestic business bounced back strongly after a slower second quarter and our International business continues to demonstrate strong growth. Our new product announcements make clear that we continue to be relentlessly focused on innovating and further strengthening our competitive position.

Particularly noteworthy this quarter, our newest video processing products, which position Harmonic even more strongly to lead in the colliding world of traditional and new media. And our broadening customer base continues to enhance our strategic position. While we are pleased to deliver 12% operating income during the quarter, we believe we can perform even better. We remain focused on leveraging our expanding customer relationships and product advancements to deliver even great value to the marketplace and further strengthen our financial performance.

And, with that, we will end the formal portion of the call and Carolyn and I would now be pleased to open up to any questions that you might have. [Vivian]?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question is from the line of Mark McKechnie with ThinkEquity.

Mark McKechnie – ThinkEquity

Yeah. Congrats on a solid quarter in this macro environment. So a couple questions. Carolyn, can you comment on – just general visibility going forward here into the fourth quarter relative to your guidance and kind of relative to the last couple quarters?

Carolyn Aver

Yon know, Mark, I think frankly it’s the same. We had a good bookings number, backlog increased and so, I think that we would say we have relatively the same visibility as we would any other quarter.

Mark McKechnie – ThinkEquity

Okay. No change one way or the other. That’s helpful. And then second is, clearly, I saw your deferred revenue came down and I know your guidance range was upper end, if you’re able to recognize the one big deal. But could you give me a sense that – was all that decline in the deferred revenue from the one announcement, so was it about $10 million that you got from this big deal or is there any other factors in there that I should think about?

Carolyn Aver

Yeah. There is actually other factors, so thanks for asking that question. We did recognize one deal that actually wasn’t the big deal. The other thing that happened is in the prior quarter, our prior quarter ended on July 1st and so that quarter included in deferred revenue a months of maintenance billings, because we bill on the first day of the month.

So last quarter’s deferred revenue was inflated if you will not incorrectly, but last quarter’s deferred maintenance – deferred revenue had four months of billings in it instead of three and one of those only had one day of revenue that was recognized. So about half of the decrease in deferred revenue comes from that one month of billings that goes away and the other half came from the recognition of a project.

Mark McKechnie – ThinkEquity

Okay. Great. Thank you. One last question and I’ll let it back to the floor. But can you characterize how much monthly channel you actually -- you did in the business or what can you quantify on that in terms of may be the number of deals, the sizes and just the overall mix and multi-channel? Thanks.

Patrick Harshman

The multi-channel business continues to increase. It’s still a relatively small piece of our overall video processing business. But increasingly the worlds are becoming intertwine and certainly, with our new product announcements, we think we’re playing a role in driving that for the industry.

As I mentioned in the prepared remarks, we saw multiscreen activity expanding media companies, traditional service provider, their customers, as well as some new guys out there. So it’s still relatively modest, still a lot of the experimentation, still a lot of thinking and planning going on. But it is growing and it’s becoming an increasingly important part of the strategic discussions we have with our customers and with the new product announcements we made in the quarter we feel even more strongly positioned to really be a strong leader here.

Mark McKechnie – ThinkEquity

That’s great. Thanks, guys.

Patrick Harshman

Thank you.

Operator

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

Simon Leopold – Morgan, Keegan

Great. Thank you. Just a couple quick clarifications first. One is the interest and other income improved a bit and I just want to see if there’s anything one-time-ish going on in there?

Carolyn Aver

Yeah. There’s – I think it was $250, about $150 was foreign currency impact that I wouldn’t project going forward.

Simon Leopold – Morgan, Keegan

Okay. And in the third quarter the gross margin was a little bit below the mid-point and just a tad softer than we expected. And I just would like to get a sense of how much of that was an element of the product mix versus other factors and maybe, I’m wondering if the disappointment you mentioned in the playout business is part of the contributing factor. So I’m just trying to get a sense of kind of the levers here?

Carolyn Aver

Yeah. Simon, it’s all three of the things I mentioned in this quarter. A little bit product mix, a little bit – and maybe a little bit less this quarter International because we had more domestic this quarter and a little bit of a deal that had some pricing pressure on it if you will. So it’s a combination, but certainly if we had more higher margin revenue that offset some of that. So really in each quarter this year it’s been some of each of those that impacts us.

Simon Leopold – Morgan, Keegan

Okay. And then the video processing business took a nice improvement this quarter on the back of last quarter’s kind of surprise and I guess, I’m trying to figure out how much to think of this is lumpiness versus a recovery and maybe help me understand where we’re going from this point on in terms of video processing?

Patrick Harshman

Look, in broad strokes, we clearly think we’ve carved out the leading position of the market Simon in video processing business and as we grow the number customers, we think the statistics around the growth of the business will become better or better or smoother and smoother.

That being said, we still have some very large customers and we’re still vulnerable to shifts on whether a deal gets done on, July 28th or I mean, on June 28th or July 2nd, right? So, I think, that still will be an aspect of the business, but if you have longer than a one quarter view on the business, I think you will certainly see continuing strength and growth out of video processing. We see more customers, more applications and more geographies.

Simon Leopold – Morgan, Keegan

And just one last one on video processing. I think in the past I have not differentiated really much between encoding and transcoding and I think that was a mistake on my part. I’d like to see if you could kind of set some context for us in terms of the contributions from transcoding and where you see that going as a contributor to your business? Thanks.

Patrick Harshman

We haven’t – I’ll take the response to that. We haven’t done a good job breaking it out and I, frankly, I’m not sure how much it is important. Over the last couple of years, an increasing portion of what we call our encoding business is actually transcoding. I mean, just indulge me for a moment. I mean, encoding is when you take something that it is -- video that’s not compressed and you compress it into one format or another, transcoding is when you’re receiving video already compressed somewhere else and you’re going to recompress it or put it into a new compression format.

For example, most of cable head-end business over the past couple years is, which we’ve characterize as encoding, I guess technically speaking is actually transcoding. HBO pitches something out in one resolution and MPEG 4 and a cable head-end get its and converts it to MPEG 2 at a better rate that make sense for that cable network and off they go, using our "endcoder" there as a transcoder. So whether there is a pretty fuzzy line, all of our video processing encoding, transcoding products increasingly support this capability.

And I would say though, as we go forward in increasing number of those applications will be transcoding, that is service providers receiving something that’s already been, endcoded originally somewhere upstream and reformatting it and this particularly as we see more, more different devices, et cetera. Is that helpful?

Simon Leopold – Morgan, Keegan

It is. No. I appreciate it. I guess the one other thing and I don’t know if you’re able to even do it, its just – if there’s some quantification and really where I’m going is the transcoding opportunity around multiscreen you talked about, I’d like to kind of be able to size it.

Patrick Harshman

Okay. So, I break – break it apart into two separate things, Simon. So transcoding, as I said is, is a big part of our encoding business even for video delivered to television sets and I gave you a prime example of that. Certainly, for smaller screen devices, multiscreen devices, it’s almost all of that is involved in transcoding that is you’re taking something that was originally encoded for TV and now you’re reformatting it for a smaller screen.

So in aggregate today, I’d say that over half of the business and the opportunity that we’re doing and what we call the video processing space is actually associated with transcoding functions either for TVs or smaller devices. Hence why you see us rolling out a product like the Electra 9000 that can do encoding or transcoding for big screens, as well as little screens. But the other thing I would say is that video processing whether it be encoding or transcoding for big screens on our live television still dominates very much the size of the business that’s getting transacted for small screens.

Simon Leopold – Morgan, Keegan

Thank you. That’s very helpful. Thanks.

Patrick Harshman

All right. Thanks.

Operator

The next question is from the line of Blair King with Avondale Partners.

Blair King – Avondale Partners

I might follow-up on that (inaudible) a little bit, it think Patrick, with some of the comments that you had made in your prepared remarks. Given the sort of watershed of announcements coming out of the Microsoft over the course of the quarter surrounding live HD video streaming throughout Xbox. I mean, there just seems to be so much activity around multiscreen these days or at least a lot of talk and then just trying to figure out sort of how that filters through into Harmonic’s business and perhaps you can talk a little bit about that?

And then maybe it follows into the ProMedia software solution products that you’ve recently announced and what applications those actually serve? And then, just the last piece of that question would be, how the Electra 9000 actually helps address some of those applications? It’s a lot.

Patrick Harshman

Okay. So we’ll -- I’ll do my best, Blair, right. So, first you talked about the Xbox stuff, I think that that’s quite interesting and quite exciting. And I think what it actually does is it helps emphasize a point that we’ve been trying to make, which is that, we don’t believe there is two separate universes out there, one of television viewing and one of iPad and iPhone viewing that are disparate markets. We in fact think that this is same market and in fact, I would actually broaden the definition of multiscreen to encompass, a 52-inch HD viewing. I mean in a way HD was the original multiscreen as oppose to standard definition viewing.

So now we see a variety -- we see a variety of different kind of media and service operator companies trying to deliver content to a whole range of devices from small BlackBerry Apple screens all the way up to widescreens. They’re trying to do over managed networks if they on a managed network and/or over the top. If I don’t own a managed network or to get to customers who are wandering off the managed network. And but certainly multiscreen no longer means just small screens, in your example, getting content over the top to an Xbox, for example, well, that’s very often feeding a widescreen television.

And here from our perspective the key thing is, is that particularly as you deal with a range of screens how efficiently you can compress that video, how do deliver exceptional quality video with the minimum amount of bandwidth is a key factors in all these networks and so where we think Harmonic value shines.

Now, depending on different applications like most things, there’s horses for courses in terms for different technology. In some cases, video processing that’s software running on a Intel based hardware platform, it offers some good advantages. Much -- and you see a number of high-tech products out there that run often Intel servers and this is where we’re really -- this is the market space that we’re addressing with you our ProMedia products.

At the same time, really for the most intense video processing applications, particularly those that involve a lot of widescreen HDTV processing, solutions based on video application specific processing platforms tends to be more prevalent in the market and that’s really the piece of the market that we’re addressing with our Electra 9000 product. So, just stepping out of our space you look at a number of products run on Intel kind of servers. On the other hand, you look at your iPad that’s running on a process that’s designed specifically for those kind of applications.

So very similarly in our world, we were addressing the market with both classes of products just because we see opportunities and customer inclination for both. Our goal is to cover the broader space from a screen point of view, from a managed network, as well as an over the top point of view and in this kind of broad approach to solving problems is resonating extremely well with our customers.

Blair King – Avondale Partners

Thank you very much, Patrick.

Patrick Harshman

Thank you, Blair.

Operator

And the next question is from the line of Larry Harris with CL King & Associates.

Larry Harris – CL King & Associates

Yeah. A few questions here. You mentioned that there was pricing pressure, I think in International markets. Is the pricing pressure that you’re seeing or the competitive pricing is that in the video processing area or is it in other segments of the business?

Carolyn Aver

What -- internationally – what -- so there’s two things we said. One was International and there we mean emerging markets and in those cases, it’s probably broadly across product lines. I also mentioned individual competitive situations and those depend – they’re situational. There aren’t a lot of those. There’s one a quarter or so, it’s not a time and that just depends on what the engagement is, but that could be Edge and Access, it could be Video Processing, it could be in any area.

Larry Harris – CL King & Associates

And I was wondering if you’re seeing any changes here in terms of cable operator spending. It looks like your sales to cable and of course, you’re now much more than cable, we’re down slightly sequentially in year-over-year. Motorola Mobility tonight reported that their home sales were down about 10% year-over-year. I assume a good portion of that was set top related. But what are you seeing in terms of demand from cable operators?

Patrick Harshman

No real shift, Larry. Our business I would characterize our business with cable is pretty good. And to the extent we see some slowdowns, frankly in our area we think more to do with strategic planning and what comes next than any other issue. I mean, it’s clear that cable operators have a great strategic opportunity. I think that they’re focused on innovating and investing to retain and then grow their customer base and that they’re going to do that with innovative technology. I think they’re trying to answer a lot of tough strategic problems that go beyond technology, contents rights, et cetera.

And so, as we noted last quarter there is a fair amount of strategic thinking and working going on and I think that that does perhaps has caused a little slower pace of activity than we had anticipated, but in general we see a good know of activity from cable operators both domestically and internationally.

Larry Harris – CL King & Associates

Finally, the Electra 9,000 when can we expect initial shipments, do you think it will have the same kind of impact to your results that we saw over the past couple years with the Electra 8,000?

Patrick Harshman

We’re very excited about that product. It’s being trialed now and the first shipments will happen by or around the start of next year. But the customer dialogue, et cetera is happening now and we really think that this is a real breakthrough for the industry. We rolled that out at the recent IBC show in Amsterdam. It won a I think a pretty new prestigious new product award and its really the right product at the right time in terms of the way operators were thinking about these colliding worlds of their traditional media services and their new video services.

Larry Harris – CL King & Associates

All right. Great. Thank you.

Patrick Harshman

Thank you, Larry.

Operator

Next question is from the line of George Notter with Jeffries & Co.

James Kissner– Jefferies & Co.

Hi. It’s actually James Kissner calling in for George. Thanks. Just quickly a clarification on...

Carolyn Aver

George?

James Kissner– Jefferies & Co.

Can you hear me?

Operator

Excuse me, Mr. Notter. Your line is open.

James Kissner– Jefferies & Co.

Can you hear me?

Carolyn Aver

Let’s move on.

Operator

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

William Stein – Credit Suisse

Hi. Can you hear me? Hey, guys. Can you hear me?

Operator

Mr. Stein, your line is open.

William Stein – Credit Suisse

Yeah. I’m talking, can you hear me?

Operator

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

Mark Sue – RBC Capital Markets

Hi. Its Mark Sue, RBC. Just a question on operating margin targets.

Patrick Harshman

Are you sure your lines are working?

Operator

Mr. Sue?

Mark Sue – RBC Capital Markets

I think we’re all trying to get -- having a tough time getting through.

Patrick Harshman

All right. Let’s keep going.

Operator

Your next question is from the line of Paul McWilliams with Next Inning Technology Research. Mr. Paul?

Paul McWilliams – Next Inning Technology Research

Yeah. I’m here.

Carolyn Aver

Well, good.

Paul McWilliams – Next Inning Technology Research

We’re live. Really. I wasn’t expecting that. Congratulations on a good quarter and getting the conference call back on.

Patrick Harshman

Thank you, Paul.

Paul McWilliams – Next Inning Technology Research

I’ve got -- on Q4, I think that earlier in the year we were kind of modeling Q4 to end up around 15% non-GAAP operating profit, weren’t we?

Carolyn Aver

We were. Yeah.

Paul McWilliams – Next Inning Technology Research

Okay. Now, I understand that you’ve got a little pinch here from hard to strive prices at least anticipating that and then I think that’s good to do. How much impact is that?

Carolyn Aver

We think it’s maybe a half a percent.

Paul McWilliams – Next Inning Technology Research

Okay. I was guessing that by your gross profit margin, but that seemed awfully high. I just didn’t realize that was such a big procurement item for you.

Carolyn Aver

Well, it’s included in the production and playout products.

Paul McWilliams – Next Inning Technology Research

Okay. So, I’ve got a 0.5% there and I’m looking at when I model this out you’re at the mid point of guidance here about 13.4%, is that correct?

Carolyn Aver

I’m -- I think it depends on which parts of the guidance you’re looking at, but we certainly model a view that gets us to 15% so if you run down the middle, yeah, it might be at 13.5 or 14 and that is tweaked a little bit by the gross margin impact of these parts.

Paul McWilliams – Next Inning Technology Research

Well, when I was running down the middle at $140 million, 50.5% gross profit and then OpEx at $52 million.

Carolyn Aver

Right.

Paul McWilliams – Next Inning Technology Research

Would that be correct?

Carolyn Aver

Yeah.

Paul McWilliams – Next Inning Technology Research

With 18.7 million in operating profit and then dividing that by 140, I came out to 13.4 so I’m just wondering if I’m doing something wrong there.

Carolyn Aver

No. I think down the middle that’s probably right. I think it would certainly still be our goal to get to 15%. There is obviously in the last 48 hours this breaking news on the floods that have some impact, but I think our goal certainly is to be close to 15.

Paul McWilliams – Next Inning Technology Research

Okay. Now, we were modeling next year I think growth range of 12% to 15% on top line. Is that still valid?

Carolyn Aver

We, as you can tell we specifically didn’t give next year direct guidance and we’re not really prepared to do that. I think that we have for sometime said it’s our target to grow. We have said 12%, not 15, but it’s our target to grow 12% given all of the things happening sort of in the environment right now, we’re not prepared to put a 2012 number out specifically.

Paul McWilliams – Next Inning Technology Research

Okay. Do you think just by the state of the industry in looking at it the state of your customers that they are prepared to take this next up in spending or do you think that the macro-economic environment could really slow that up? It just seems as though they’re positioned to where that next step seems awfully logical for them.

Patrick Harshman

It does Paul, so you’ve got -- I mean, I think you see it clearly in the way we see it which is we’ve got competing forces here. I think that there is a fair amount of uncertainty. In our customers’ minds and consequently in our minds at the same time there is -- it’s a competitive market and I think there is a strategic imperative for our customers to invest in the development of their products to retain and tag new customers.

I think this will playout slightly differently in different parts of the world. We were a little bit surprised by the fact that overall the U.S. market was a little bit slower than we anticipated this year and so we have learned from that.

At the same time, we were equally surprised by the fact that parts of our International markets, Europe for example was actually more robust than we had anticipated once some of the activity -- some of the challenges there came to light.

So I -- we don’t have a clear -- none of us have -- as you know have a clear crystal ball. I see competing forces out there and as we articulated a quarter ago when we kind of adopted, I would say a somewhat more conservative stance on the market we are waiting to see really how this whole thing place out.

We remain convinced in the long-term strategic drivers that we do see a number of macro-economic headwinds that we’re uncertain as how they will playout.

Paul McWilliams – Next Inning Technology Research

Okay. I’ve got two more here and I will keep them as brief as I can. Now, on this -- are there still more operating synergies that you expect to bring into the model during this over, say next six, nine, 12-months that you weren’t able to get into it this year.

Carolyn Aver

I think there is two answers to that. We targeted 8 to 10 million of cost synergies sort of specifically from bringing the companies together and we achieved that. On the other hand, as we continue to leverage our new size and the growth we have. I think there are opportunities to continue to do things more efficiently.

And, there by improve margin or free up spending for other areas. And that’s in a number of areas both above and below the gross margin line. So I might not call them specific deal synergies any more, but I certainly think with our scale and as we grow we have more operating leverage.

Paul McWilliams – Next Inning Technology Research

You’re probably aware Cisco and Alcatel are doing a major, major installation in coastal China building an optical network and from what I’ve read it’s specifically to support IBTV. Do you see that as a hot bed of opportunity for you next year as they go ahead and put in the video equipment? I’m presuming they will next year. They did most of the install second half here at the base network.

Patrick Harshman

Paul, we’ve been pleased with our overall growth this year in emerging markets, which certainly includes China. And we don’t see that changing going into next year. Unlike other parts of the world we just see a steady growth opportunity as more and more people mover into the middle is class and get television more and more just kind of plain vanilla TV services rolled out. We see continuing good opportunity.

So I would say more broadly in the emerging markets and specifically, yeah, we’re focused on China that’s one of the reasons why we have a an office in Beijing, as well as a separate office in Hong Kong and we think our brand, our market reputation is extremely strong in mainland China and we think we’re positioned to take advantage of opportunities there and elsewhere in the emerging market world.

Paul McWilliams – Next Inning Technology Research

Excellent. Excellent. That sounds very similar to the drivers that Intel has talked about benefiting their business which is logical. Thank you, guys. I appreciate you taking so much time with me, may lines are working here.

Carolyn Aver

Sure, Paul. Thanks. Paul, if I go back to the question just for a minute back on operating margins the other thing that’s impacting our numbers we talked about the gross margin piece, but the other thing that’s impact be the number is potentially $2 million decrease in revenue, so if you drive that through that has another impact on the 15%. So both of those components may impact depending on where we end on that range.

Paul McWilliams – Next Inning Technology Research

Absolutely.

Carolyn Aver

Right.

Paul McWilliams – Next Inning Technology Research

On other income interest and such how should I model that for Q4?

Carolyn Aver

Of the other income line about 100,000 is interest and the rest was foreign gain. I wouldn’t -- I would focus just on the interest component of that.

Paul McWilliams – Next Inning Technology Research

Okay. So just add a 100,000 in there and be on the operating profit?

Carolyn Aver

Yeah.

Paul McWilliams – Next Inning Technology Research

Thank you again.

Carolyn Aver

Okay.

Patrick Harshman

Thank you, Paul.

Operator

Your next question is from the line of George Notter with Jefferies & Company.

James Kissner– Jefferies & Co.

Hi, guys, this is James calling in for George, can you hear me now this time?

Carolyn Aver

George.

James Kissner– Jefferies & Co.

You are kidding me. I am still here hello.

Operator

The next question is from the line of William Stein with Credit Suisse.

William Stein – Credit Suisse

Can you hear me, hey guys can you hear me.

Carolyn Aver

Well, there must be some.

William Stein – Credit Suisse

Hello.

Carolyn Aver

All right. One more.

Operator

The next question is from the line of Mark Sue with RBC Capital Markets.

Patrick Harshman

Mark?

Mark Sue – RBC Capital Markets

I am freaking here. Hello.

Carolyn Aver

Yeah. There must be something wrong on the call with those guys because they’re telling us they’re there. Do we have anybody else on the call?

Operator

Yeah. We have a follow-up from Mark McKechnie.

Carolyn Aver

Okay. Can we take him and can you check on George, Will and Mark.

Operator

Yeah. Ma’am. Absolutely.

Carolyn Aver

Thank you.

Operator

You’re welcome.

Mark McKechnie – ThinkEquity

So hopefully it works for me but it’s not going to do too much because my question was asked and answered so thanks.

Carolyn Aver

Oh, all right. Thanks.

Operator

Okay. And we have Mr. William Stein with Credit Suisse.

William Stein – Credit Suisse

Third time is a charm. Can you hear me?

Carolyn Aver

We can.

William Stein – Credit Suisse

Wow. All right. So you’re guiding Q4 up maybe half a percentage point or so essentially flat. I think normal seasonality is for increased sequentially and I guess you talked about a potential shortfall in revenue from supply chain issues. I assume that’s optics. Is that fair to say? And which product category would that affect?

Patrick Harshman

Yeah. The revenue shortfall that we think we’re not going to be able to plug is in the optical access area.

William Stein – Credit Suisse

And so that’s your -- sorry. If I look at the -- at it on a product basis, it’s.

Patrick Harshman

Part of the Edge and Access group so within Edge and Access we have some optical transmission products. The Access piece of Edge and Access and while that whole product line is certainly not run through Thailand a couple of products rely on a couple of components that come from [Fabranet] actually and we don’t think that we’re going to be able to solve that problem in the quarter.

William Stein – Credit Suisse

So do you have other source -- well, [Fabranet] is the contract manufacturer or so. Is there someone else you can make that product for your component supplier or...

Patrick Harshman

Well, in this case we’re not getting a whole product. We are actuality getting some small sub-assemblies and yeah, we think over a longer term, it’s possible to secure products from other suppliers. We just don’t think that that will get done to cover all of the demand that we see in the fourth quarter. So look, we’re not overstating this. I mean, it’s a relatively modest impact that we’re -- that our supply chain team is forecasting at this point, but we do see up to $2 million of impact, specifically on the revenue side.

William Stein – Credit Suisse

And then you’re also contemplating weakness related to the macro is that right? Maybe if you didn’t see that, you now how much do you think that’s impacting the way you’re guiding?

Carolyn Aver

We wouldn’t put dollars on it, but I would say that, that we -- we’re certainly cautiously optimistic and so at the high end of the guidance range we think that maybe we some impact of budget dollars offset by a little bit of revenue impact from this problem. On the lower end, we see more -- certainly more impact and less benefit from seasonality.

William Stein – Credit Suisse

Okay. And then just so I understand from the optical side you’re assuming it’s a supply chain impact to revenue, but from the perspective of disk drives you’re assuming you can pay more, it’ll be a 50 basis point hit to grow...

Carolyn Aver

Exactly.

William Stein – Credit Suisse

But you can source where you need to?

Carolyn Aver

Right. We feel -- we, given the situation, we feel comfortable with our sourcing there, but it’s a cost issue.

William Stein – Credit Suisse

Okay. The other questions were asked and answered. So I’ll stop there. Thank you.

Carolyn Aver

Thanks.

Operator

And next question is from George Notter with Jeffries & Company.

James Kissner– Jefferies & Co.

Now can you hear me?

Carolyn Aver

We can.

James Kissner– Jefferies & Co.

Oh, my gosh. Okay. This is actually James Kissner, calling in for George. Thank you for giving me a third shot. So the first question, I just want to clearly a little bit on the guidance. I mean, you mentioned that sometimes there is budget flush in Q4, but I wasn’t really clear on what, what your guidance assumes for that, is it completely out of the guidance or is it the high end of guidance this budget flush or how do we think about budget flush in context to the I guidance?

Carolyn Aver

All of these things are a range of course and there’s no, there is no specifics. I think at the high end of guidance, especially given the fact that at the high end of guidance and with impact on revenue from the optical, that would assume some budget flush, not necessarily historic high budget flushes by any stretch of the imagination but certainly would assume some orders came in.

I would say at the low end of guidance I would assume, the higher end impact on the product revenue and relatively little budget flush or budget flush but some impact internationally, some combination of that.

James Kissner– Jefferies & Co.

Okay. Perfect. So another question for you here. I guess I want to sort of understand, last quarters you guys said that the cable operators kind of paused given the dramatic potential architectural changes that are coming down the pike and that don’t make sense to me, but its kind of -- I mean here we’re just one quarter away and you guys saying -- I mean, do you think everything kind of better all of sudden.

And I am just wondering is that because other customers are coming in and fill the gap or is it because those sort of ambiguities about architectural choices have been cleared up. But can you just sort of help me understand the progression of that issue relative to your good results now?

Patrick Harshman

So, James, we didn’t at all intend suggest that issue is all better or resolved. In particular several of the deals that we had initially anticipated in Q2 transpired in Q3 thus, contributing to a stronger third quarter. At the same time a couple of other deals that we anticipated in the second quarter are still floating out there.

So the overall perspective on what’s happening in the market and in fact the overall arc on our outlook of revenue for the second half of the year being down from what we saw early during the year is still very much impacted by that issue.

James Kissner– Jefferies & Co.

Okay.

Patrick Harshman

We strive to say that it wasn’t kind of one or the other. We said we see this over arching, a slower pace of decisions and activity, that doesn’t mean nothing is going to happen, but we just see a slower space.

So things that were initially anticipated in the second quarter, some transpired in the third quarter, maybe some are going to transpire in the fourth quarter, some are actual going – get pushed to 2012 and that’s still very much the way we see it.

So I think there was a little bit of catch-up on stuff that actually did transpire in the third quarter but in the end of the day our fourth quarter guidance is still lower than we anticipated if you go back to the spring.

James Kissner– Jefferies & Co.

Perfect, That’s it...

Patrick Harshman

Does that make sense?

James Kissner– Jefferies & Co.

Level of activity yeah, it definitely does. Yeah. That’s very help. Just a couple quick ones and I’ll pass it on maybe to Mark, if he is still there. So the -- I’m wondering what you guys are thinking about the east, I’m sorry about the converged Edge products that are coming out. I mean, you obvious had competitors, another one of your competitors on the Edge here, (inaudible) deal and now they are going to have two offerings.

And is this something that you’re going to continue to chase, are you going to be competitive here when these guys to ship their first product into a lab like can you have any on the EdgeQAM space and where it would go in the context of that?

Patrick Harshman

So, yeah. We believe today, tomorrow and in the further officer future we are and will be extremely competitive in this area. There’s no doubt James that we’re the EdgeQAM leader in the market space today and frankly we think we have picked up market share in 2011.

We’re doing that through a combination of the technology and we’re delivering to the market today as well as the roadmap and the vision we have for what comes next. As I mentioned in the prepared remarks, we’re working closely with our large and key customers. They have a clear view into where we’re headed technologically and we’re receiving very positive feedback from them.

So, we expect to continue do well with the current evolution progression of our products and technology and we see longer-term growing opportunities in this space. The fact that two competitors have combined and our view is more positive than negative. Frankly, it’s just one less competitor out there in the market and I think it further emphasizes the importance of the video technology that we bring to the Edge space.

James Kissner– Jefferies & Co.

Any thought on when you could actually ship a project now to similar milestone, ship your product to a customer?

Patrick Harshman

You mean -- are you talking about -- I assume you’re talking about CCAP per product?

James Kissner– Jefferies & Co.

CCAP

Patrick Harshman

So as I mentioned earlier we do have a CCAP per development program, our belief is that such products will not -- will only be deployed in volume out around -- not for several years and we think we’re going to be in position to develop us a product at that time.

Now, we think actually the industry kind of there evolve there and we have a carefully thought out product evolution that we really think is going to work hand-in-hand with the way the operators are evolving their network towards that. And so it’s not -- in our mind, it’s not a bright line, but it’s an evolution.

Frankly, the very dense EdgeQAM technology that we’re delivering today is in our mind a key underpinning of this technology. It’s where a lot of the cost and the operational efficiency comes from a high number much QAMs in per port -- per RF port and we think we’re leading the market in that space today.

And we I think that this product and then what comes next and what comes next after that in our product evolution plan, we think it’s very much in line with what the operators are look for and what they’re actually going do deploy over the next couple of years as they move towards this full fledged CCAP vision a couple years out.

James Kissner– Jefferies & Co.

Okay. Very helpful. Last yeah or no question was this deal that flowed though are doing you referenced, was that the multi opportunity that you discussed earlier this year?

Patrick Harshman

No.

James Kissner– Jefferies & Co.

Okay. That’s it. Thanks a lot.

Carolyn Aver

All right. Let’s see if we can go three for three with Mark.

Operator

And the next question is from Mr. Mark Sue with RBC Capital Markets.

Mark Sue – RBC Capital Markets

Carolyn, since I waited so patiently. Do you think -- can you just -- can you just exceed 15% operating for me next year?

Carolyn Aver

Next year? Let’s talk next quarter.

Mark Sue – RBC Capital Markets

I mean but the business with the scale that you will have next year, what kind of long-term operating margins do you think the business can support?

Carolyn Aver

I think back at the Analyst Meeting, we said that our target for actually ‘11 and ‘12 was 14% and 16% and again while we’re not confirming or -- we don’t want to give formal guidance for next year. I think that that is a near-term goal next few years is still right and I think over -- we would strive to improve that kind of on an annual basis. I think there’s leverage in our business and so we purposefully are trying to stay away from guidance for next year, but for sure we want to make improvements.

Mark Sue – RBC Capital Markets

Got it. That’s helpful. Well, I think this concludes today’s conference call. Thank you for your participation everyone.

Carolyn Aver

Okay. I guess it really did. Operator?

Operator

Yeah. I’m here.

Patrick Harshman

Okay. We thought we lost you. Just before sign off, let me thank everybody for hanging with us particularly through some of those technical difficulties and more generally we appreciate your continuing interest and support of the business.

I hope it comes across that while there are certainly are challenges out there, we think the opportunities outweigh the challenges, we think the company continues to be extremely well-positioned. We like our competitive positions. We’re excited about our new products.

We’re excited about the business we’re doing really all corners of the globe. And we’re very committed to pushing this business forward adhering to the strategic tenants as well as the financial goals that we’ve laid out. And we’re going to continue to work extremely hard and we believe deliver good results.

So, with that Carolyn and I thank you all for joining us and we’ll look forward to talking to you soon. Bye-bye.

Operator

And thank your participation in today’s call. You may now disconnect.

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