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Harmonic Inc. (NASDAQ:HLIT)

Q2 2012 Earnings Call

July 24, 2012 5:00 pm ET

Executives

Carolyn V. Aver – Chief Financial Officer

Patrick Harshman – President and Chief Executive Officer

Analysts

James Kisner – Jefferies & Co

Richard Ingrassia – Roth Capital Partners

Blair King – Avondale Partners LLC

Greg Mesniaeff – Maxim Group

Victor Chiu – Raymond James

Operator

Welcome to the Q2 2012, Harmonic Earnings Conference Call. My name is Monica, and I’ll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

Please note that this conference is being recorded. I’d now turn the call over to Carolyn Aver, Chief Financial Officer. Ms. Aver, you may begin.

Carolyn V. Aver

Thanks Monica, hello everybody. With me at our headquarters in San Jose, California is Patrick Harshman our CEO. I would like to point out that in addition to the audio portion of this call, we’ve also provided slides which you can see by going to harmonicinc.com and clicking on the second quarter earnings call button on the event section of our home page.

Now turning to slide two, let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only current expectation and actual events or results may differ materially. We refer you to documents that Harmonic filed with the SEC including our more 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 statement.

Please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis. These items together with corresponding GAAP numbers and a reconciliation to GAAP are contained in today’s earnings press release which we’ve 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 operation. 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 everyone for joining us. Turning now to our slide three, today we reported our results for the second quarter of 2012, which were broadly in line with our guidance issued a quarter ago. Reflecting healthy U.S. demand and our overall strong competitive position, our bookings were $139.5 million dollars up 6% from the second quarter of last year and in line with our expectations.

To the first half of the year, bookings outside Europe had grown 11%, although orders from Europe were down 5% year-over-year. A key driver of our strong order book across most geographies has been an increasing number of IP video project win, underscoring healthy IP video demand trends success of newest video delivery products and momentum leveraging our system expertise, top of high-value professional services as part of these project wins.

Revenue was $132.6 million, driven by 10% year-over-year growth of our business in the U.S., which slowed by 9% year-over-year decline in our international business, with Europe being our principal challenge. As with new bookings, year-over-year revenue performance was strongest for video processing product line in our services business. One of the consequences of strong resistance and project based order book is a move to more multi-period revenue recognition. Consequently, our book-to-bill ratio was again greater than one, and we have a record backlog of $146 million.

Turning to operating performance, our gross margins were 48%, but the first quarter was slightly lower than forecast due to both product mix and continuing competitive pricing environment market.

Operating expenses were approximately $54 million in the quarter. And non-GAAP earnings were $0.06 per share from last quarters $0.03. We also have robust cash performance, generating approximately $20 million cash from operations during the quarter, resulting in to cash balance increase of approximately $9 million after using $7 million for a share repurchase program.

Carolyn will provide additional details and is operating results and our repurchase activity in just a few months.

Turning now to slide 4, to provide context to these results and our opportunities going forward. I'd like to review three important topics, our strategic priorities in focus, our key new product initiatives, and important changes and additions we recently made to our corporate leadership team.

Let's turn to slide 5, to begin with an update on our strategic priorities. At the beginning of the year I laid out three areas of strategic focus for 2012, continuing to broaden our global customer base, extending our product leadership position, and driving continuous improvements of our operational execution. We've remained very focused on these initiatives and despite marketplace challenges, mainly in Europe, making meaningful progress in each of these areas. Broadening our global customer base has been a key strategic priority to which we remain committed, despite current European headwinds.

If we don't control macroeconomic conditions and our revenues are lower than we're aiming for. We do control a competitive positioning. Our strong bookings growth outside of Europe, demonstrates our solid competitive momentum worldwide. Specifically, during the quarter we gained market share by expanding our footprint and a number of existing accounts. By adding new customers across geographies, including here in the U.S., in Latin America and other emerging economy markets and even within Europe.

Although we continue to have a relatively large exposure to Europe, our growing customer base in other geographies has enabled us to mitigate the risks and of course we're confidently well positioned to participate in the European rebound, when it occurs. Harmonic is known for it's engineering acumen, and refreshing and extending our product leadership is also core to our strategy.

One key area of focus is the industry move to IP and internet delivering video. As we'll discuss in more detail in just a moment, we're seeing very positive market response to our newest IP video products and solutions and increasing competitive wins in this area. We are similarly focused on the next generation of converged cable edge technology. In a couple of moments, I will also update you on our very encouraging progress in this area.

Our third key highlight of the quarter is the continuing growth of our services and support revenue, up 13% from the second quarter 2011. Next to customers, we know their networks better than anyone else. The fact that our customers are increasingly turning to us not only for technology, but also for systems expertise is very strategically significant.

On the operational front, we are making good progress in a number of areas, but we also have work to do. Our bookings momentum and record backlog speaks to sales execution and the success of our global customer expansion initiatives. Our strong cash generation speaks to our attention to collections and DSO management. And we are closely managing operating expenses focusing our investment on our highest return opportunity. And however, we are not satisfied with our gross margin performance. We are driving several initiatives to improve our performance in this area.

And turning now to slide 6, IP and multi-screen video represents a key growth opportunity for the company. While global spending and IP video technology is still much less than our traditional television delivery, we are seeing more customer investments in IP and OTT delivery and more success for our newest products addressing this area. During the quarter, we had over 25 new over-the-top wins that span both existing and new customers across cable, media, satellite, and telco markets.

We are pleased to be able to announce key wins with Alpha, a Belgian telco operator rolling out a converged IP TV to television and over-the-top to mobile devices platform; now TV, the leading telco and video player in Hong Kong, and with ZON the leading cable operator and also a satellite player in Portugal who is using our new products to roll out its new ZON Online service.

Enabling these wins as well as a longer list of tier 1 wins during the quarter, we are not yet able to publically announce, is the fact that Harmonic is uniquely differentiated in offering both new IP, multiscreens or systems, and systems which are multiscreen capable, yet deployed in more conventional applications today.

For example, we also saw several new IPTV wins during the quarter where the initial deployment provisions traditional television delivery only with a plan for a Phase II extension of the platform, to accomplish second screen internet delivered service system mobile devices.

We believe such converged systems will represent a large part of this market as it matures. The combination of our deployed base and newest technology puts us in a strong position to capitalize from this convergence. And one final comment on IP delivered video, is that we think mid to longer-term market and technology trends, very much play to our core strengths, that is the ability to optimize bandwidth while providing exceptionally high video quality.

For in-home wide screen viewing, the marketplace is starting to look ahead to new 2K and 4K screens that represents what comes next, after HD. And for mobile delivery, the growing tension between increasingly high-resolution screens and video oriented tablet devices, and wireless bandwidth constraints, has the industry looking to a next generation codec called HEVC, which we believe will spurn the industry investment cycle, at least as big as the industry move to MPEG 4 AVC technology that began several years. Harmonic is very focused on these new initiatives, and we see tremendous opportunity as they become embraced by industry.

Turning now to slide 7, cable EDGE is also an area of significant opportunity and strategic focus for Harmonic. During the second quarter, our Edge and Access revenue was 25% of total revenue, driven in large part by investment in our industry-leading Dense edgeQAM technology for rapidly growing high definition Video on Demand and network PVR application, as well as by continuing switched digital video and modular CMTS deployments.

As cable services become more personalized in on demand, the cable delivery model is moving to an increasing percentage of unicast traffic, which drives the need for more and more capacity and QAM ports at the edge of the cable networks. Very pleased to see both existing customers and new customers adopt our new HectoQAM technology as they evolve their networks to support this growth in unicast video traffic.

And looking little further ahead, we’re also making a substantial investment in our closely related strategic CCAP initiative. We’re receiving very positive customer response to our innovative CCAP architecture.

In summary, this new architecture, which is also being championed by several strong edge router partners enables cable operators to scale converged IP services, much more flexibly and efficiently. During the past quarter, we’ve been revealing the details of our program to increasing number of key customers and response has been overwhelmingly positive.

Over the past year, we scaled up our development team adding a number of skilled DOCSIS experts. We made amazing development progress, but we still have important work to do. We’re increasingly confident in our ability to hit our projected platform delivery in the first half of next year.

There are certainly execution risk ahead, but the reward upside for addressing a substantially expanded market opportunity, one Infonetics believes to be an approximately $2 billion opportunity by 2015. It’s very compelling and we’re committed to success in this area.

With that focus on success in mind, and moving out to slide nine, we’ve made some important changes and additions to our corporate leadership team. Many of you know Nimrod Ben-Natan, who has been our Senior Vice President of Product Management, Solutions & Strategy. And in the industry he’s known as one of thought leaders in the edge and access space.

Given the tremendous potential and strategic importance of the CCAP initiative, Nimrod has change in roles to be solely focused on leading our edge and access business. He’ll play a direct role in driving the success of our CCAP program. With Nimrod moving to his new position, we took the opportunity to expand our leadership team and that experience in both marketing and video product leadership. I’m also very pleased to announce that Krishnan Padmanabhan has joined Harmonic as senior Vice President of video products. Krish come to us from NetApp, he most recently served as Vice President and General Manager of Manageability and Ecosystem Integration business. Prior to NetApp Krish held key positions with Philips and McKenzie.

I’m excited to have Krish joined as he brings the vision, management and analytical skill set and deep product experience, which will further sharpen our ability to move aggressively and efficiently as we scale our video business. I’m also excited about the addition of Peter Alexander as our Chief Marketing Officer. Peter joined Harmonic with more than three decades of experience in sales, marketing and engineering hardware and software solutions for the telecommunications industry. Having spent 15 years with CISCO Systems, where he served most recently as Vice President of Worldwide Field Marketing. Peter is a proven marketing executive with broad experience in managing multi billion dollar product lines, as well as executing global marketing strategies. As we look to extend and further leverage our brand in our products and to strengthen our go to market capabilities. I believe Peter is going to have a very significant positive impact on our business.

And finally we are also pleased to announce that Mitzi Reaugh, Senior Vice President of Strategy and Business Development at Miramax; joined our Board of Directors. Having previously held leadership roles with NBCU and Nielsen, Mitzi brings a wealth of media and entertainment industry perspective and expertise to our Board and we are pleased to welcome him.

So in summary through these changes and additions, we further enhanced our focus on our key growth initiatives. We’ve added tremendous new talent and experience to our leadership team.

And on that note, I’ll now turn the call back over to you Carolyn, to talk more about the results of the quarter and our financial outlook. And then I’ll wrap things up with some final thoughts.

Carolyn V. Aver

Thanks, Patrick. Moving to slide nine, our net revenue for the second quarter was $132.6 million, an increase of 4% from the first quarter and relatively flat with last year. However, our bookings on a year-over-year basis show continued strength and were $139.5 million in the second quarter, up 6% from the same period in 2011.

As Patrick mentioned, excluding Europe, our bookings were up 11% for the first half of 2012. Non-GAAP gross margin improved 100 basis points from Q1 to 48%, but are still below last year's gross margin of 51%. The decrease in gross margin is largely due to product mix issues, as well as competitive pricing pressures particularly in emerging markets.

Operating expenses for the second quarter of 2012 was $53.9 million, a sequential decrease of 4% from the previous quarter and flat from a year ago. Our headcount was 1,147 at the end of the second quarter, down 17% from the end of the previous quarter, and up 3% from the end of Q2 of 2011.

Non-GAAP net income for the second quarter of 2012 was $7.2 million or $0.06 per diluted share compared to $3.2 million or $0.03 per diluted share in the prior quarter and $10.5 million or $0.09 per diluted share for the second quarter of 2011.

Turning to slide 10, let’s look at our quarterly revenue and backlog in more detail. As we noted, net revenue for the second quarter was $132.6 million, an increase of 4% from last quarter and a decrease of 1% for that same period a year ago.

On the other hand, our backlog and deferred revenue at the end of Q2 2012 was $146 million, an increase from $135.7 million last quarter and an increase from $122 million a year ago. The largest component of the increase in backlog from a year ago is due to service booking, which will be recognized over the next several quarters.

Moving to slide 11, while we have continue to expand our revenue base across different geographies, product categories and markets, our revenue mix has shifted in the last two quarters. Our international revenue represented 54% of total revenue in the second quarter of 2012 compared to 59% in that same period of 2011. This decline is primarily a result of softness in Europe and a stronger U.S. market. The weakness in Europe particularly impacted our production and playout revenue.

For the second quarter, video processing represented 45% of total revenue and production and playout represented 16% similar to last quarter, but down from recent quarters. Our edge and access revenue represented 25% of our total revenue. Services represented 14% of our total revenue and grew in absolute dollars.

As Patrick mentioned, we’ve also had strong service bookings. These bookings will be recognized as revenue in future periods and indicate the growing activity levels surrounding complex deployments and the competitive importance of our unique video experience. Our largest customer for the quarter was again Comcast with 18% of revenue. None of our other customers were over 10% of revenue.

Our cable customers represent 48% of our business, reflecting our strong edge and access sales and relative softness in Europe where cable represents a smaller portion of our business. Our satellite and telco customers represented 21% of sales, and our broadcast and media customers represented 31% of sales in the second quarter.

As you can see on slide 12, we continue to maintain a strong balance sheet. We ended the quarter with a cash balance of $177.8 million, up about $9 million from the end of the prior quarter and up $43.5 million from the second quarter of 2011. Our receivable balance was $102.7 million; our DSOs were 70 days, reflecting a strong collections effort.

Inventory was $68 million, up slightly from the prior quarter and inventory turns were flat at 4.1%. Capital spending was $2.9 million in the second quarter and we expect CapEx for 2012 to be in the $12 million to $18 million range as we have capital related to new product releases planned for the second half of the year.

Finally, we repurchased 1.6 million shares for approximately $7 million on a share repurchase plan that was implemented in the second quarter.

Turning to slide 13, while we are encouraged by the solid bookings and customer demand in most regions, moving into Q3, we still faced uncertain visibility regarding Europe. Taking this into consideration, we expect net revenue to be in a range of $130 million to $140 million in Q3.

Non-GAAP gross margins in the third quarter are anticipated to be in the range of 47.5% to 49.5%. We generally expect the pressure on gross margin to continue. However, as Patrick mentioned, we’ve kicked off a series of initiatives to drive down cost and improve gross margins. These initiatives will likely take a few quarters to impact our actual results and are therefore not reflected in Q3’s quarterly guidance.

Our target for non-GAAP operating expense for the third quarter is $55 million to $56 million, reflecting increased investment in R&D for the product initiatives that Patrick discussed, as well as increased legal costs related to defending few losses. Finally, we currently anticipate our non-GAAP tax rate for 2012 to be in the 25% to 26% range depending on the amount of international versus U.S income. This rate also assumes that the R&D tax credit will not be extended.

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

Patrick Harshman

Okay, thanks, Carolyn. Let now turn to our last slide, slide 14. In summary, we’re incrementally more positive on the fundamentals of the business in spite of continuing headwinds in Europe. We believe we’ve made the right strategic decisions to position the company to benefit from the growth and proliferation of video. And we continue to make improvements in the execution of our strategy and the operations of the company. And continue to broaden our customer base across geographies, and drive clear technology leadership, including delivering on our new CCAP initiative and driving market leading IP multiscreen video technologies. With a fantastic global staffs and our further strengthened senior management team, we’re well positioned, confident in our ability to execute, and very excited about the future.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from James Kisner of Jefferies & Co. Please go ahead.

James Kisner – Jefferies & Co

Hi guys, good afternoon. Can you hear me?

Patrick Harshman

Yes, we can.

James Kisner – Jefferies & Co

Great, thank you. So on, just the topic is Europe, you said, I believe that Europe bookings were down 5% year-over-year whether that right, I was wondering, if you could provide that number for Q1 to give us a sense to sort of the second derivative there, and are you (inaudible) additional picture on Europe and do you see any slope in the lines, is this being, is it stabilizing, is it unclear, is there any kind of feeling that perhaps Europe is done declining for the near term or not?

Carolyn V. Aver

Sure. I think that generally I’d say that it was relatively flattish in Europe from Q1 to Q2. And that the underlying sort of, I guess our sense of the business would say flattish. There are timing issues of certain deals that come in or come out that might move the numbers, but in terms of churn and demand and all of those things, we had a pretty precipitous drop in Q1. And I would say right now, we think that flat, and (inaudible) to our outlook, we that sort of what we would expect going forward, although we think visibility there is challenged.

James Kisner – Jefferies & Co

That’s fair. Okay, and just one of the question, now let’s also ask one. On pricing, you mentioned that numerous times in emerging markets, can you talk about what product theory is or verticals you’re really seeing that pricing pressure and is that just a result of just low demand or is it really – is there more competition, can you just elaborate on that?

Patrick Harshman

James, we see an aggressive pricing environment really across product lines particularly in emerging markets. I think a lot of people view that as beachfront property if they’re in Brazil or India or wherever. And so it’s just in high demand to get in on the foundation as new operators launch services and begin to expand. And so we don’t see it particularly related to any one product line. More to, I think the broader markets perspective and the strategic importance and long-term growth potential in these markets. And certainly, our strategy is to take the long view. We believe that being present as we are and as increasingly in places like Southeast Asia, in Brazil, in India, we think it’s very strategically significant.

So, well, we’re not pleased with the gross margin, and as we mentioned, we got a number of initiatives to kind of address when we move on basing on gross margins products up, our business decision right now is to take that business, because we believe the strategic value of the footprint that we’re establishing in these markets is quite valuable and important.

James Kisner – Jefferies & Co.

One quick follow-up, on the margins, is it fair to say the multiscreen initiatives are helping margins or already in them?

Patrick Harshman

Well, helping in general. I mean multiscreen is part of our broader video processing in fact we’re building more and more multiscreen capabilities into our traditional and mainline video processing products, and like our overall video processing business, the gross margins associated with our multiscreen solutions are substantially higher than the corporate average.

James Kisner – Jefferies & Co.

But I guess really the other video processing solutions are they – is it more software intensive, I guess it was my intuition therefore maybe positive for margins or was just very competitive and you don’t really see that?

Patrick Harshman

Maybe incrementally, I mean we’ve not broken it out in the past. We have in the past, I think the video processing in general is kind of high 50s and I would allow that multiscreen solutions are probably incrementally above that, but not dramatically.

James Kisner – Jefferies & Co

Okay, thanks a lot. I appreciate the clarification.

Patrick Harshman

Thank you.

Operator

Our next question comes from Richard Ingrassia of Roth Capital Partners. Please go ahead.

Richard Ingrassia – Roth Capital Partners

Thanks. Good afternoon, everybody.

Patrick Harshman

Good afternoon.

Richard Ingrassia – Roth Capital Partners

Patrick, can you say a little bit more about the scope of the announced Tier 1 over-the-top wins that were mentioned in the slides?

Patrick Harshman

We are quite excited about the momentum and what’s nice is we are seeing it right across the customer categories that we address. I think most of the Tier 1 wins that I spoke to are actually preexisting Harmonic customers, although we were necessarily previously involved in their internet activities. So it’s a combination of customers ramping up what we are doing for in home delivery that is creating the capability to hit iPads inside the home, as well as through over-the-top services outside of the traditional service delivery footprints to a variety of mobile devices.

Richard Ingrassia – Roth Capital Partners

Okay, thank you. Yes, thank you. And how do you access the penetration in the Omneon customer base so far and cross sell of Harmonic products there, vice versa?

Patrick Harshman

Candidly, it’s still a work in process. I think as I may have mentioned in prior calls, we've been more successful getting the Omneon sales force to take the historic Harmonic product line. You may recall that last year we saw our business in broadcast and media grew 17% year-over-year, and broadcast and media continues to be, I think Carolyn this quarter 31% of the business. So, we’re seeing actually very good traction of bringing our video processing including multi-screen products into the media and broadcast accounts and the Omneon sales force is doing a great job there. I will acknowledge that we are doing somewhat less of a good job kind of cross selling the Omneon products the other way. That’s our work-in progress and we continue to make progress there and we are quite optimistic about the potential as we really get that machine going, but it’s still work-in progress.

Richard Ingrassia – Roth Capital Partners

Okay, I appreciate that. And finally, maybe just some specifics on the efforts being made to cut cost, to cut cogs and increase gross margins across the board.

Patrick Harshman

Cost reduction is always something we’re doing in and of itself and also fundamentally part of the design process, you know introducing more features that are delivering more value, hopefully associate with less cost. In particular for emerging markets we find that sometimes the requirements aren’t exactly the same. In many cases some of the products that we have let’s say to the U.S., may be in some way over kill for some of the emerging market, applications. So, it’s just as much about tuning the products and delivering what’s needed by the market as it is kind of raw reduction of the existing products. It’s a portfolio of action, but we’re incredibly focused on it and we are confident in our ability to drive results.

Richard Ingrassia – Roth Capital Partners

Okay, thank you.

Patrick Harshman

All right. Thank you, Rich.

Operator

Our next question comes from Blair King of Avondale Partners. Please go ahead.

Blair King – Avondale Partners LLC

Thank you very much. A couple of questions, Patrick, maybe this one is for you. Is it possible – is it at all possible for you to break out what percentage of revenue the multiscreen business is today?

Patrick Harshman

It’s possible, but frankly, Blair, it’s something we prefer not to do. In fact the multiscreen applications are becoming increasingly intertwined with our mainline revenue. Frankly, the largest multiscreen deal that we’ve done in the last 12 months has been actually capability delivered on a heretofore non-multiscreen product. So we’ve been very aggressively, not only building our ProMedia product line, which is specifically targeted on multiscreen, but we’ve also been developing multiscreen capabilities enabled through our new software licenses that run on the historical product.

And that’s why I really want to emphasize the point that a number of the investments that we see being made today, even if our customers are buying product for traditional television applications, actually the platform they are investing in is really also simultaneously investment in multiscreen down the road. And so this is core to our strategy and core to the way that we are approaching the market. And I think that this trend, Blair, is just going to continue.

So my own view is that we’re going to be sitting here 12 months from now not even really talking about multiscreen anymore because by definition the video business is going to be multiscreen whether that’s a new 4K super high resolution screen down in your – I’m sure that fabulous movie viewing room you have in your basement to your new retina display iPad that you’re carrying around with you. I think the business of video delivery fundamentally is about infrastructure to hit all of those screens. The business of our customers is not to differentiate them into different silos, but basically to have that a connection with the consumer wherever they are, up in the bedroom, down in the screening room, out on a business trip, certainly the way we are thinking about the business.

Blair King – Avondale Partners LLC

All right, maybe just a follow up to that question, Patrick, appreciate the explanation here but, for it may be – in the quarter, obviously there seemed to be a lot of activity around the multi-screen phenomenally, you are referring to with 25 wins, is much of that business services or could you break down the percentage as – kind of service oriented versus product oriented, that was actually shipped in the quarter?

Patrick Harshman

Yeah. I think it's a mixed question, it's incrementally, there is more service associated with it. A lot of our customers are – and there’s still a fair amount of small-scale deployments and trials as you know, Blair. So kind of the name of the game very often is, hey, let’s run quick. And so in that context securing our services, I say it's incrementally more part of the mix.

But honestly we’re seeing more services which are part of the mainline business as well, so I wouldn't draw a bright line and say, hey, multi-screen services traditional businesses, non-services. I think the key point is that we’re increasingly, for all these applications being viewed as a strategic adviser, or consultant to our customers. And for me, above and beyond the services revenue, that's the part that I like to see strategically.

Blair King – Avondale Partners LLC

All right.

Carolyn V. Aver

If I can just add there, Blair, on a relative basis in our total revenue and even in our revenue here, you know professional services is still a relatively small percentage of the total deal or certainly the total product category.

Blair King – Avondale Partners LLC

Right.

Carolyn V. Aver

We’re making big strides, and a lot of the growth in our service bookings and some professional services, so we’re really very pleased, but it’s still a small piece.

Blair King – Avondale Partners LLC

All right, point taken. And then the last question, Patrick, just on the CCAP initiative, I was wondering if you could just address your strategy competitively. It almost feels like the next-gen edgeQAM from Harmonic might be behind some of the other edgeQAMs that are already starting to hit the market now. And so maybe do you feel like you’re coming into it a little late or do you feel like you’re right on time with where your customers are telling that you need to be?

Patrick Harshman

We feel that we’re not late at all. We feel, we’re right on time, and forgive the strong tone. but I guess, I vigorously disagree with the idea that we’ve lost a step in the historic edgeQAM business. I think we clearly continue to gain market share in the traditional edgeQAM business. And our technology there is, I believe second to none, and I think that’s why we’re winning market share. And certainly that position is a springboard to where we’re going with our CCAP initiative. CCAP is much more than that, but certainly our dense QAM technology, which we introduced as part of our HectoQAM product, I think it stands alone in the industry. And I think the wins that we’re racking& up, the greater footprints that we’re accumulating with both existing QAM customer – cable customers as well as having our new footprint, I think speaks to the power of this technology.

So we’re winning business today with I think the strongest edgeQAM product in the market. And we’re getting great feedback on architecture direction and our development progress on our CCAP initiatives. So we’re into competitive space, I’ll give you that. But we’re ready for the battle and we like our chances.

Blair King – Avondale Partners LLC

All right, thank you very much for your time. I appreciate it.

Patrick Harshman

Thank you, Blair.

Operator

Our next question comes from Greg Mesniaeff from Maxim Group. Please go ahead.

Greg Mesniaeff – Maxim Group

Yes, thank you, and good evening. I have one or two quick questions. One is regarding the gross margin commentary that you gave today vis-à-vis the what appears to be a rather significant shift towards service and support. I’m curious whether the fact that you’ve seen some change in your gross margin profile is directly attributable to that shift to customer service and support, and whether that will require a whole new way of managing costs going forward?

Carolyn V. Aver

So, that’s a good question, Greg. And certainly the professional services, part of services has a much lower gross margin. That is the part of our – a part of our bookings that has been growing. Not a lot of that is reflected in our revenue yet, although services were up about a $1.5 million sequentially, and a good chunk of that is professional services. So, on a year-over-year basis, when we look at why margins are down, a piece of that is mix, and that’s definitely related in part to higher professional services revenue.

Greg Mesniaeff – Maxim Group

And I guess as a part two of my question, when you look at professional services being offered domestically versus professional services being offered in overseas markets, there must certainly be a cost differential there and I am wondering, if you could may be give us a little bit of color on that too.

Carolyn V. Aver

Well, I think like our product pricing in different markets, our service pricing, it's probably on a relative base, that has the same impact, and therefore sort of as Patrick says on cost initiatives, you then have to find a service solution that allows you to do that for lower price. And so that’s part of driving into some of these emerging markets and building our ability to do business there at a price that’s competitive.

Greg Mesniaeff – Maxim Group

And now that you’re servicing not only your traditional pre-Omneon products, but the Omneon products as well, presumably there is a new component to the service and support, professional services aspect related to that as well, right?

Patrick Harshman

Yes, absolutely. We have a broader portfolio to support, Greg, and I think we have a broader footprint of possible services, not just talking about new service provider related opportunities, but also work that we can do directly with the media and content companies.

Greg Mesniaeff – Maxim Group

So, I guess managing the cost of good sold is up kind of a work in progress as the mix continues to change?

Patrick Harshman

I think that's right. I make one more just comment, I think in some cases our success in some of the emerging markets has outstripped our local presence there. So we do find ourselves servicing some of these opportunities with resources from more higher cost geographies.

Greg Mesniaeff – Maxim Group

Right, yeah okay.

Patrick Harshman

So over time as we continue to grow, I certainly imagine us further scaling our in-region service and support capabilities getting those train, which will naturally made to lower cost goods.

Greg Mesniaeff – Maxim Group

Got it, I just have one quick follow-up. Can you talk about any product refreshes that have recently occurred or will occur in the Omneon product line?

Patrick Harshman

Well, the biggest reset one is just about three months ago, we announced something called ChannelPort, which is a very significant step forward. It’s an extension of our media part of our Spectrum server product line now supports branding capability. And this is very significant from both a CapEx as well as an OpEx perspective for broadcasters and media companies. And we think really differentiable, because it actually doesn’t require a forklift upgrade to implement it, it’s directly compatible with the very large actually industry leading install base that we have with Spectrum video server product line. So this is – in terms of recently announced initiatives and the most significant thing we’ve announced over the last couple of months.

You haven’t asked about it, Greg, but it will pivot now and look a little further ahead. One of the kind of the apples in our eyes in terms putting Harmonic and Omneon together was to really to develop a whole next generation of – a new class of products that actually married or integrated historically desperate technologies. And well we are not prepared here to announce to anything yet. We are working in earnest on new products that really break down some barriers and we will really deliver I think exceptional, operational as well as capital saving to our customers that unify and integrate historically Harmonic and Omneon technologies. I think this is going to be really unique and powerful for us as well as our customers and well, we’re pretty excited about that

Greg Mesniaeff – Maxim Group

Thank you for that, Patrick.

Patrick Harshman

All right. Thank you, Greg.

Operator

Our next question comes from Simon Leopold of Raymond James. Please go ahead.

Victor Chiu – Raymond James

Hi. This is Victor Chiu in for Simon Leopold. Just going back to the multi-screen business, is there more gradual ramp of the multi-screen business relative to the coding business in the past more a function of the complexity of the technology or more aggressive competitive environment or maybe a combination of both I guess, you know kind of what's the biggest challenge to Harmonic in accelerating growth in that particular cycle?

Patrick Harshman

I think the biggest challenge is just the size of the overall market and spend. Well, there certainly there is a lot of noise about it. The overall spend is still substantially less in the spend on any given day in what we would call traditional television delivery. And this has a number of reasons; I mean we all just watched a big high-profile, a content that will playout on the front page of the Wall Street Journal. People are still sorting through a lot of the business rules, Victor allow the business models et cetera. There are some legitimate questions about how shall you make money off of these new services.

So, I think just about everyone of our customers has a foot in the water and I'm pretty pleased with the extent to which we are expanding our footprints and supporting these kind of foot in the water initiatives, but for this really to – really start to kicking the high gear, we need the scale in the size of these projects to really expand dramatically and I think the biggest limitation or the same kind of holding the market back is doing what exactly is the right business model there. There was no question in my mind or our minds that the future very much is this kind of flexible multi-screen universe. It's – there is just some pretty natural business issues that have to be worked out between now and then.

Victor Chiu – Raymond James

That's very helpful. Just one quick question, I think most of my questions have been answered, can you just give a little color around the shift in the product mix, this quarter it seems like the video processing business was particularly weak last quarter in Europe, and then not so much this quarter could you just kind of speak some about the shift in the mix kind of dynamic behind that in the geography I guess?

Patrick Harshman

We don’t actually breakdown products by geography, so in general we’re giving little bit more color on Europe, because obviously it is essential to what’s happening I think with our business in more generally. And it is true that Europe historically is a little less cable oriented, little bit more video processing and production and playout oriented.

But look, answer to your question, I think it’s just more the vagaries of timing of certain orders better than any underlying trends. So we just happen to see, I think somewhat your video processing deals fall in the first quarter, and some of those kind of flip to the second quarter.

Victor Chiu – Raymond James

Okay.

Patrick Harshman

I mean, I think there is a real thing to take away is that the – this is historically you know a factor of our business. I think you come back to the breath of our products, or the breath our customer base that will bring our products to the breath of the geography (inaudible) I think really helps us mange that. So last quarter worked out pretty well for us that was a relatively stronger edge and access quarter. That somewhat softer the video processing quarter, and we seen that kind flip, and I think that’s – is no underlying trend other than that just timing of certain orders.

Victor Chiu – Raymond James

Okay. Would you characterize your visibility in your business about same as last quarter of any better?

Patrick Harshman

I characterize it is about the same, and that’s worse than normal.

Victor Chiu – Raymond James

Okay, that’s helpful, thank you

Operator

(Operator instructions) Our next question comes from [Andrew Storm of Cortina]. Please go ahead.

Unidentified Analyst

Hey guys, thank you. As one of you help me understand just and thinking about billings versus revenue, in the first quarter your billings were up 5%, in the first quarter they were up 8%, and the second quarter they were up 6%. The revenues in fact were negative since then in your guidance for next quarter also implies the midpoint flat to negative, and your deferred revenues only up about 600 million since the end of fourth quarter which is about 2% a year throughout that house. So what is the differential there, and you had that slide that showed your revenue, I understand it can be lumpy kind of bouncing around and your bookings have been flat and really accelerate in the last two quarters. So can you just kind of help us understand is there a big revenue acceleration down the line, is there something else that has been kind of termed out. How should we think about that?

Carolyn V. Aver

Sure, let me try to take it in pieces and I might, you ask several questions in there, so let me try get a few of those. So the first is the difference between deferred and backlog. So our…

Patrick Harshman

No, just billing and why it’s not translating into revenue really.

Carolyn V. Aver

Right, so, it’s not billing that’s not translating in the revenue, it’s billing and bookings. There are combined right , we combined those two things, so there is a number of thinks that are book some of those are services that – they performed over a period of time of projects, that you book a project this quarter, it gets planned, it begins to be delivered in a quarter or so and then gets delivered over a series of quarters. And that may or may not be a billing, and tells upon the project completed around the percentage of completion days.

Patrick Harshman

Right. can you just before (inaudible) Carolyn, the point I was trying to get out with going to the last several quarters was, you’ve seen mid single digit increase in bookings and your deferred revenue has also been increasing. So, I understand the – one or two quarters move around, however this has been almost a year or long and normally now we’re – revenue and bookings have materially diverse, so maybe it’s an accounting issue, we can discuss afterwards but it seems like there is something there going on. And maybe it’s huge project, they are longer times.

Carolyn V. Aver

Yeah, so certainly for the last couple of quarters, however a bigger piece of our booking or services, two pieces services about additional support agreements as well as for sure there has been a pretty big increase in professional services bookings that’s what we are talking about, were we’re doing professional services work with the customers and those get delivered over a series of quarters.

Unidentified Analyst

Okay, so that makes sense and to kind of rethrew on to that as a result mixed single digit growth in billing does not really – that has been implied and we just think that single digit revenue growth in next couple of quarters right, it’s one year contract, something like that?

Carolyn V. Aver

Right, I mean that all should – generally I would say, all of that should turn within a year.

Unidentified Analyst

Okay. and then can you just talk about the sort of acceleration of the last two quarters that you’ve seen is that just (inaudible) tracking up?

Carolyn V. Aver

Yeah. those are for press, yeah we’ve sort of – if you remember last year, one of our big initiative was to build our professional services organization and so we are quite focused on that. I’d say the first half of last year that really went to working with our sales force, even to begin to how do you sell services? How do we get value for services? And then the second half of last year, we really begin to do a lot of proposals and more work around that, those are now converting to orders as you get into the latter part of last year and certainly the first half of this year, which should then convert into revenue as you move forward. So that pro services fees again I don’t how the percentage share, but it’s up significantly. It’s somewhat smaller base, but it’s up significantly.

Unidentified Analyst

Great, okay. And just to make sure I fully understand some services revenue has grown a fair amount of course being of a small base – smaller as I look at your bookings, does that imply because the rest of business has more negative even if marginally? Are your bookings for the rest of your business negative as well or is that seeing acceleration that hasn’t flown to the P&L yet?

Carolyn V. Aver

Yeah. No, the product revenue was not negative. The thing I should mention is that with some of the pro services work, the product revenue gets connected to the pro services and all of it gets deferred. So there are some projects where the services are deemed as essential, that they get tied up with the product revenue and both of those get deferred.

Unidentified Analyst

Right, okay. Interesting like this has been a recurring conversation for several quarters now, because you had some of these and I guess I’m wondering when some of this gets unlocked.

Carolyn V. Aver

Right. so I think it’s really two quarters, last quarter and this quarter I’m happy to go back and look at that more details. But I really think its two quarters where we’ve had phenomenon and I think it begins to get on mark over the next few quarters.

Unidentified Analyst

Okay, that’s very helpful. And then a last question I have just on your guidance. As you were contemplating that, you said you were assuming, I think Europe remains flat and you weren’t assuming it to get worse, is I correct? And how much of that revenue that Europe was just go to ship business versus bookings that you already had in? Thank you.

Carolyn V. Aver

I don’t want to be as specific as to say, it assumes this thing particularly, it presumes a range of outcomes. I think what I was trying to indicate though is that it doesn’t presume really or covering in Europe. Was there some nominal decrease in Europe that it’s probably presumed in there, if Europe takes another whole step down, I don’t think we’re contemplating that at this point. I don’t have the direct, well we do track in any given quarter, how much of our revenue comes from backlog and deferred, and how much comes from book and burn, I don’t have that specifically for Europe while it changes from quarter-to-quarter, I would roughly say it’s somewhere around 50/50, and sometimes it might be a little bit more on one way and sometimes in the other. I have no reason of the top of my head to think Europe is much different than that. But I haven’t looked at that specifically.

Unidentified Analyst

Okay, great. Thank you.

Operator

You have no further questions in queue. I will now turn the call to Patrick Harshman for closing comments.

Patrick Harshman

First of all like thank everybody for joining us today. we very much appreciate your attention and your support and the time with us. we’re confident in our ability to further strengthen this business. we’re excited about what we’re doing, and we look forward to talking with you next time. Thanks very much everybody.

Operator

Thank you, ladies and gentlemen, this concludes today’s conference. Thank you for participating. and you may now disconnect.

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