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Harmonic Inc. (NASDAQ:HLIT)

Q2 2008 Earnings Call

July 28, 2008 5:00 pm ET

Executives

Patrick J. Harshman – President and Chief Executive Officer

Robin N. Dickson - Chief Financial Officer

Analysts

Brian Coyne - Friedman, Billings, Ramsey & Co.

Vivek Arya - Merrill Lynch

Tim Savageaux - Merriman Curhan Ford & Co.

Mark Sue - RBC Financial Group

George Notter - Jeffries & Co.

Greg Mesniaeff - Needham & Company

Jack Monte - Lehman Brothers

Blair King - Avondale Partners

Amitabh Passi - UBS Securities

Larry Harris – C.L. King & Associates

Paul McWilliams – Indie Research

Operator

Welcome to the second quarter 2008 Harmonic earnings call. (Operator Instructions) Mr. Harshman, you may begin your conference.

Patrick J. Harshman

I am Patrick Harshman, President and CEO of Harmonic. With me in our headquarters in Sunnyvale, California, are Robin Dickson, our Chief Financial Officer, and Michael Newman, our investor relations spokesman. Thank you all for joining us.

Today we announced our results for the second quarter of 2008. We are pleased with our strong revenue growth, operating performance, and our momentum moving into the second half of the year. Our sales growth, strong gross margins, and increasing profitability not only demonstrate the strength of our products and business but also the ongoing success of our global strategy.

One of the key pillars of our long-term strategy is differentiated technology leadership for the dynamic video-delivery market place. We are pleased to see our technology continue to distinguish itself from our competitors for its ease of deployment, innovativeness, flexibility, cost effectiveness, scalability, and delivery of unmatched picture quality.

This renewed technology leadership has allowed us to execute another key component of our long-term strategy, namely to extend our customer base across different market segments and across different geographies. Our award-winning systems and solutions continue to be selected by both incumbent and emerging cable, satellite, telco, and broadcast operators around the world for many of their highest profile and most innovative visual-video deployments.

Moreover, our international business has been growing even faster than our domestic business and this quarter represented over half of our total sales. Going forward, we continue to see strong momentum for the deployment of compelling new video services worldwide. We continue to drive investments in innovative product development programs and we’re closet with our customers to roll out ground-breaking new products that address the major trends towards more high definition, on demand, and anytime-anywhere video.

We are also making the necessary investments to continue to successfully support our expanding global customer base, including a new support center in Europe. We are very excited about our strategic progress and the opportunities before us.

Now I will ask Robin to cover the financial aspects of the quarter and I’ll then review some of our recent business developments and strategic initatives in more detail.

Robin N. Dickson

During this call we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only predictions and that actual event or results may differ materially. We refer you to documents that Harmonic files with the SEC, including our most recent 10-K and 10-Q reports. These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Please note that on this call we will provide you with financial metrics determined on a non-GAAP or pro forma basis. These items, together with the corresponding GAAP numbers and the reconciliation to GAAP, are contained in today’s earnings press release, which we have posted on our website and filed with the SEC on 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.

Today we announced results for the second quarter ended June 27, 2008. For the second quarter of 2008 we reported net sales of $89.3 million, up 25% from $71.3 million in the second quarter of 2007. For the first six months of 2008, our net sales were $176.6 million, also up 25% from $141.5 million in the same period of 2007.

Our strong year-over-year revenue growth is reflected across all geographies, product lines, and markets. The international performance was particularly strong with international sales slightly exceeding domestic sales in the second quarter of 2008. During the second quarter we saw strengthening demand from our cable customers, both domestic and international, as they continue to expand and enhance their on-demand and high-speed data services, as well as their high-definition offerings.

Our largest customer for the quarter was Comcast, representing 18% of our total revenue. By market, cable customers in the second quarter accounted for 64% of total revenue, satellite 13%, and telcos and others were 23%.

As we expected, satellite revenue was lower and telco revenue was higher than the immediately preceding quarter. For both these markets the quarter-to-quarter fluctuations reflect the timing of complex deployments and revenue recognition considerations. On a year-over-year basis, however, we have seen revenue growth in both of these market areas and we expect to see revenue growth in both on a full-year basis.

And as we’ve discussed before, it’s becoming more difficult to neatly categorize our customers into these market segments. We have telco customers that also operate HFC cable networks, while other telcos are supplementing their DSL-based IPTV networks with direct-to-home satellite services.

By product category video processing products represented 38% of revenue in the second quarter, edge and access products 47%, and software, services, and other, 15%. The strength of our edge and access products underscores the fact that our newest edge devices are increasingly being used in advance configurations for on-demand, switch digital, and modular CMTS deployments, both in the U.S. and internationally.

We continue to maintain strong gross margins in the second quarter with non-GAAP gross margins again at 50%. The year-over-year improvement in gross margins reflects the success of our new products and solutions that provide exceptional value to customers.

Our newest edge QAMs for example, incorporate unique features as well as a redesigned platform, both of which have allowed us to expand margins in the key product line. Our small but growing software revenue has also strengthened our gross margins. Additionally, our margins have benefited from cost efficiencies as a result of our sourcing strategy, higher volumes, and product design innovations, as well as net benefits from the weakness of the U.S. dollar.

Our results for the second quarter of 2008 include charges of approximately $500,000 related to certain management changes and to some initial costs connected with planning the establishment of an international support center in Europe. This new center will help us better support our growing business with international customers as well as provide longer-term tax benefits in future years.

In part because of these costs, our non-GAAP operating expenses in the second quarter were up on a sequential basis by about $1.3 million. As is typical at this time of year, we also had heavy trade show activity during the second quarter. Our head count at the end of June was 674, up by only two from the end of March. And on a non-GAAP our operating margin was 16% for both the second quarter and the year-to-date.

One item that negatively impacted our bottom line results in Q2 was a significant drop in our interest income of about $900,000, or approximately $0.01 per share compared to Q1. Quite simply, our cash investments are rescinding to lower interest rates as they mature.

GAAP net income for the second quarter of 2008 was $25.5 million, or $0.27 per diluted share, up from $6.2 million or $0.08 per diluted share for the same period of 2007. The second quarter includes a tax benefit of $15.1 million arising from the reversal of the discrete portion of our valuation allowance against certain of our deferred tax assets. Excluding this tax benefit, as well as charges for stock-based compensation, the amortization of intangibles, and the charge for access facilities arising from a revised estimate of subtlies income, the non-GAAP net income for the second quarter of 2008 was $50.0 million, or $0.16 per diluted share, up from $9.0 million, or $0.11 per diluted share for the same period of 2007.

Our operating performance continues to strengthen our balance sheet. At the end of June we had cash, cash equivalents, and short-term investments of $288.2 million, up from $278.9 million at the end of March.

Our receivables were $59.2 million, with DSOs at 60 days, virtually the same as the previous quarter. We’re pleased with the positive trend we’ve seen in our DSOs this year, although we still continue to see some pressure from customers for longer payment terms. Additionally, our higher portion of international sales may also put some upward pressure on DSOs.

Net inventory was $32.1 million, down about $1.0 million in the quarter, with continuing improvements in terms. And finally, our capital spending was $2.3 million in the second quarter and we still expect to see CAPEX of approximately $8.0 million for all of 2008.

Now with respect to the outlook, we have healthy backlog and deferred revenue, totaling $84.0 million. This is up slightly from March and reflects a book-to-bill ratio of around 1 in the second quarter.

While the current global economic picture is certainly challenging, we’ve seen so far that the competitive dynamics among our customers is continuing to drive them invest in network operates and expanded services. We believe that our own competitive position remains very strong, with our diverse customer and product base as a significant source of that strength.

Taking all of these factors into consideration, we currently anticipate that our net sales for the second half of 2008 will be in a range of $175.0 million to $185.0 million. We expect to see non-GAAP gross margins in the 49% to 51% range for the next six months, and corresponding GAAP gross margins for the same period are anticipated to be in the range of 47% to 49%.

We anticipate some increase in operating expenses in the second half of the year as we look to increase headcount more substantially in order to accelerate some of our product development programs and to bolster our international sales effort, including our new support center in Europe.

We believe that it makes sense to take some of the benefits of our recent improvements in gross margins to reinvest more in our business, specifically in these areas I noted just earlier. However, we are going to be very careful to modulate these investments with our ability to sustain revenue growth and to at least maintain our gross margin performance so that our target for non-GAAP operating margin remains in a range of 15% to 17%, consistent with our 16% margin in the first half of this year.

Let me now turn to the tax impact of some recent developments. Because of our consistent profitability in recent periods and our expectations of continuing profitability, we are using up our net operating losses. In addition, as I noted earlier, we have decided to reorganize the way in which we conduct our international operations. As a result of our profitability, and taking in to account tax effects of this operational restructuring, we expect to use up virtually all of our remaining U.S. NOLs and the corresponding valuation allowance, during the remainder of 2008. In the second quarter we reversed the discrete portion of this discrete valuation allowance, resulting in a one-time benefit of $15.1 million.

The net result of all this is that we expect to have a continuing nominal tax rate for the remainder of 2008, similar to the rate in the first half of about 6% to 8%. In 2009 and beyond, we anticipate that this reorganization of our international operations will allow us to drive our tax rate lower than the combined federal and California statutory rate, which approximates 40%. At this point our estimates are still very preliminary but we are looking for a 2009 tax rate in the mid-30% with further reductions to the low-30% or possibly even as low as 30% in succeeding years.

We will give more precise guidance on this topic in future quarters, but reorganizing our international operations is expected to not only lower our effective tax rate over time but also to drive international revenue growth and provide enhanced support to our international customers.

In summary, we are pleased with our performance in the second quarter and in spite of the global economic uncertainty, we remain quite optimistic about our industry and our opportunities for continuing profitable growth.

That’s all for me. Patrick.

Patrick J. Harshman

Our strong financial results reflect a vibrant video-delivery market place and the continued strengthening of our business, allowing us to take advantage of exciting opportunities across a broadening range of applications, customers and geographies.

Let’s look at some of those opportunities and developments across these market segments we addressed and some of our newest technology developments. For cable operators around the globe there continues to be demand for new services and intensifying competition from direct-to-home satellite, telco IPTV, and new Internet-based video service providers.

Cable’s response is more high-definition programming, more and easier to access on-demand content, and higher speed Internet access to complexibly support IP-based video services. Our powerful new solutions for each of these applications continue to set up apart in the market enabling us to deepen our relationships with existing customers and penetrate new accounts with significant new customer wins recently in Europe and Asia.

A key driver of our global cable momentum is the growing deployment of our latest edge QAM-based solutions for VOD, switch digital video, and high speed data, with high speed data applications representing an important expansion of our addressable market opportunity.

A significant recently announced win in this area was with Hanaro Telecom, a leading and telco operator in Korea, who deployed our universal edge QAM for its wideband DOCSIS 2.0B modular CMTS service, capable of delivering 150 Mbps or more. In coming periods we expect DOCSIS 2.0 and 3.0 modular CMTS applications and universal edge QAM architectures that marry high speed data and video services to be important drivers of new business with cable operators worldwide.

Internationally we are also continuing to see select cable operators adopt our industry-leading MPG4 ABC technology to roll out premium quality HD channels. We recently announced HOT, Israel’s leading cable provider, implemented a full suite of our IP-based digital video solutions, including our HD MPG4 ABC encoders. This follows similar MPG4 adoption announcement with cable customers in Asia and Latin America. We expect our continually improving MPG4 and MPG2 technologies for high quality HD delivery will remain important growth drivers for us in the cable market.

In the satellite direct-to-home market we continue to extend our market share position with leading operators around the globe. The technology cornerstone of our success continues to be market leading MPG4 compression solutions for standard and high-definition video. We recently announced that ASTRA Platform Services in Germany and SKY Italia, two of the market leaders in Europe, have now deployed our market-leading encoders and statistical multi-plexing systems to extend their HD channel offerings.

These wins follow similar announcement we have made over the last several quarters about new our expanded relationships with leading satellite operators in France, The Netherlands, Norway, India, Indonesia, Japan, as well as here in the U.S. As more HD content becomes available and the satellite operator investment into HD and MPG4 grows, along with the deployment of new hybrid on-demand and IPTV services, our increasingly strong global market share position in satellite puts us in a great position.

We also continue to be very pleased with our expanding customer and technology footprint in the emerging global IPTV market. During the quarter we won both new IPTV customers and follow-on business from existing telco accounts, with HD programming and on-demand capabilities being key drivers.

With the Olympics almost upon us we are particularly excited by the innovative ways our latest software solutions for delayed TV and network personal video recording are being deployed by several leading Asian telcos to enable their customers to view the Beijing games in a more personalized and convenient way.

Underling all this positive market activity and our strengthening gross margins is our continuing drive to develop and deliver powerful and high-value new video technologies and solutions that have applications across the video delivery markets. For example, we recently announced new optical technology, which doubles the capacity of our market-leading universal edge clones. We also enhance our IP-enabled ProStream stream processing platform with the addition of support for MPG2 digital program and ad insertion.

Furthermore, our technology continues to receive industry awards. Broadband Gear Report recently recognized our direct edge cable IPTV solution, Media Prism on-demand content preparation software, new Powerlink optical transmitters, and Ion encoder for their technology excellence.

In summary, the second quarter was another very strong period for Harmonic. We are pleased with our continuing success and extending our customer base across an expanding range of domestic and international operators. Our powerful and growing portfolio of new video delivery products and solutions continue to sustain our market leadership and drive sales growth, strong gross margins, and profitability. We continue to invest in innovative product development programs as we help our customers address the key trends towards more high definition, on-demand, and anytime-anywhere video in new creative and cost-effective ways. As we move into the second half of 2008 we remain excited about our strong market position and the growth opportunities before us.

This concludes the formal part of our presentation. Robin and I will be pleased to entertain any questions that you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian Coyne with Friedman, Billings, Ramsey.

Brian Coyne - Friedman, Billings, Ramsey & Co.

Could you maybe just describe a bit of what you’re seeing in terms of video processing at domestic cable customers. I mean, HD still seems to be a pretty intense battlefield among cable and satellite, and increasingly on the telco side. Just wondering if you give us an update. It seems like you shifted your focus perhaps a little bit on the edge QAM side, but maybe if you could go back and run through that a little bit.

Patrick J. Harshman

Brian, I would say there is no substantial change in what’s happening in video processing. As I mentioned in the prepared remarks, high-definition video is certainly a big driver for the market. There’s more content, there’s more consumers with wide screens looking to view that content in the highest quality way possible and we see all of our customers, and certainly including the cable operators, making great strides in delivering high-quality services. And we’re certainly benefiting from that.

You also mentioned the activity in the edge QAM space. That’s particularly exciting for us just because we see the range of applications we’re addressing expanding. Of course, the home base of edge QAM is supporting on-demand content and certainly continued to adding on-demand assets is another key driver of cable operator strategy.

And we see the edge QAM volume scaling with more on-demand content and more on-demand transactions. We also see switch digital video and, as I noted, high-speed data is starting to drive consumption of QAM channels as well. And the latter is a particularly important and exciting development and has been a big key driver, not only of our success with edge QAM here in the States, but overseas where we see a lot of focus on next-generation high-speed data services over the cable network.

Brian Coyne - Friedman, Billings, Ramsey & Co.

I was just kind of looking year-over-year. Your video processing sales obviously have come up about $6.0 million over the June quarter last year and given the greater success that you’ve had on the satellite side, it seems like maybe what you’re saying is there hasn’t been probably too much change year-over-year on the cable front. Is that the right way to interpret it? Would that lead you to believe that there might be another sort of push from the cable operators coming perhaps in 2009 on this front?

Patrick J. Harshman

In broad strokes, we see all of our customers, both satellite and cable, I think, making a concerted push. Now as a practical matter, you don’t see all these programs proceeding perfectly linearly. And very often there is kind of a push, a deployment cycle, and then another push. And certainly more than cable, satellite business is characterized by cycles of investments, across different operators and across different geographies.

I would say that we see the cable focus on HD as being a little bit more consistent, relative to last year. We see relatively more activity and video processing. And going forward, we continue to see a lot and probably growing activity in the cable space around processing, encoding, and personalizing video content in general and high-definition content in particular.

Brian Coyne - Friedman, Billings, Ramsey & Co.

And, Robin, you talked a little bit about some OPEX investments. I was wondering if you could us a better sense of how you see those rolling through over the next couple of quarters. And on top of that, can you hazard a kind of a qualitative outlook for 2009? There’s got to be something that gives you confidence right now to invest perhaps a little more aggressively. What are maybe the two or three kind of big opportunities that you might be targeting?

Robin N. Dickson

I don’t think, Brian, we want to speak to specific R&D programs that we plan to invest more aggressively in. But let me address a couple of the other points you raised.

I think we feel, as I said in my prepared remarks, that we’ve made a lot of headway in gross margins and I think over time we can continue to make some headway and I think it’s appropriate to reinvest some of the fruits of that performance in accelerating R&D programs. I think we found over the last couple of years that that formula works pretty well. So we’re certainly looking at it from that perspective, that there is a return to be made from accelerating these investments, both on the top line and I think, also, in gross margin growth. So I think that’s really what’s underlying the thinking.

With respect to specific numbers, the other thing we’re going to be very careful about is, again, as I said in the script, you know, this is not an intention to push the operating margins out any. We are absolutely committed to keeping that to where it’s been most recently, in the range of 15% to 17%. And so, as I said, we’re going to modulate any spending we do as carefully as we can, with commensurate growth and revenue and gross margins.

On the numbers, in a way I don’t really expect to see a whole lot change in the third quarter. In fact, in the second quarter we had a couple of unusual items, including, as you know, the very heavy trade show activity that goes on in Q2, and so actually for Q3 I don’t’ see necessarily any major increase in OPEX but I do think that by Q4 they could snap up.

So if you think about the first half and our spending just under $60.0 million on a non-GAAP basis, I’m thinking maybe the second half ends up being somewhere in the $61.0 million to $62.0 million range.

Brian Coyne - Friedman, Billings, Ramsey & Co.

And just finally, bigger picture. You didn’t mention any update on your script regarding you thoughts on M&A. I was wondering if there was any update on the thoughts there. And also you said your preference in the past might be for perhaps a smaller deal, one that might extend technology towards different customers, different verticals. Could you maybe compare and contrast that with the opportunity, if one were to present itself, maybe to do a bigger deal perhaps, you know, to add some additional technology and something where you already have an existing presence that might benefit from perhaps rounding out a solution?

Patrick J. Harshman

First and foremost, business priorities on driving the business organically, and I think that’s going quite well. We have publicly stated that we have stepped up our interest in keeping our ear to the ground and looking out for interesting and intriguing opportunities that we think are complementary with the way we’re driving the business.

And while we are pleased with the couple of smaller deals that we’ve done over the past 18 months and we like the way they’re contributing to the business from a solution point of view, from a margin point of view, and that probably is our initial bias as we look for other opportunities, we certainly don’t rule out anything larger.

And that’s not to say that we’re looking for something larger but if the question is would be open to something that’s a little bit larger, that makes good sense, from a financial sense point of view as well as from a strengthening solution point of view, absolutely.

Just our experience and the way we’ve looked at the market so far, our perception is that there is probably more opportunities for us in the realm of smaller companies with focused technology editions. But we continue to look at all possible angles and opportunities.

Operator

Your next question comes from Vivek Arya with Merrill Lynch.

Vivek Arya - Merrill Lynch

I think my question is really about the sales growth that you are projecting for the second half. If I look at last year, you’re second half sales grew roughly 20% compared to the first half. This year you are guiding second half sales to be roughly flattish even though you’re not really seeing any major weakness in spending. So is it conservatism, is it related to any deceleration on the satellite side? Can you please help us understand why you are expecting sales to be just flattish for the next couple of quarters?

Patrick J. Harshman

Going back, you started off talking bout 2007 and we think 2007 was a little perhaps unusual with the way the business stepped up as dramatically as it did in the second half of the year. And there was really a flood of activity in the second half of the year that was really out of balance with the first half. As we head into 2008, our perception right now is that the spending environment, the investment environment, to be a little bit more balanced. We’ve had a fairly strong first half of the year. We see this strength continuing, but right now at least, we don’t see a dramatic step up in the second half of the year the way we did a year ago.

Of course, we have to wait and see and in the past we’ve had upside surprises. On the other hand, as I think Robin mentioned in his comments, there are some higher level global questions about where the economy is going. So pulling all those things together, we have to just back up and rely a little less on history and a little more about what we see immediately in front of us. And right now, at least, we see by and large a continuation of the kind of spending, maybe just slightly stepped up, from what we’ve seen in the first half of the year.

Vivek Arya - Merrill Lynch

I just wanted to drill down as to, you could be conservative because you see headlines being weak or you see the order trends being weak? I’m just trying to differentiate between what you’re really seeing in terms of order trends versus just the macro headlines.

Patrick J. Harshman

Our guidance is based on what we’re seeing in terms of orders and our discussions with our customers. And frankly, we don’t think it’s really that conservative. There’s a lot of market activity going on, we’re very pleased with the way the businesses unfolded this past quarter, and continuing this business stepping up slightly, it seems where the market is right at this moment. What we see, we think a lot of the trends have long basis, and we see investment in many of these areas continuing to not only be sustained, but growing into 2009 as we take our initial look at 2008.

Well, the guidance we provided is our best assessment of where we think the spending is going to be specifically over the next six months.

Vivek Arya - Merrill Lynch

On your satellite sales, there was obviously a big down tick in the second quarter. How should we read that? Does it mean the cycle is over or is that just a temporary blip? I believe Robin said that it was perhaps related to the timing of spending activity so does that mean we see the satellite spending growth resume from the third quarter onwards or how should we read that?

Robin N. Dickson

I tried to stress that looking at the satellite, and indeed, too, the telco business, on a quarter-over-quarter basis can be confusing. And I don’t deny the number dropped quite a bit from Q1. As I think we’ve been pretty clear about for some time that that was going to happen. Nevertheless, we are still confident that we are going to show year-over-year growth in the satellite business, which implies a second half certainly stronger than we saw in the second quarter and at least comparable to what we did in the first half. It is subject to deployment cycles and deployment delays and revenue recognition considerations, as I’ve said, and any particular quarter can sway quite a bit based on those factors.

So, I think trend-wide, as I say, we’re still expecting to see growth over last year.

Vivek Arya - Merrill Lynch

Patrick, how do you balance this need for making acquisitions versus, for instance, considering stock buyback, do you think you have the flexibility to perhaps do both, or right now the focus is just on making some small acquisitions?

Patrick J. Harshman

I think there are really two thought processes. In addition to just strengthening the overall position of the company as another means of establishing our credibility and strength as we pursue business overseas, the other main reason why we strengthened the balance sheet and raised money last fall, was to give ourselves the fire power to execute acquisitions.

We continue to be very bullish about this over market and the macro trends around video delivery. We continue to see a lot of opportunities, a lot of need from our customers, needs that we think we can provide in principal. And so looking for complimentary technology-based acquisitions is a priority of the business.

Now, that being said, we’re not determined to do a deal regardless. It has to be a deal that is very good financially, a deal that is very good technologically, etc. And as we follow that process wherever it takes us, in parallel, in due time, if we decide that our balance sheet is in a place where we don’t have a better use for the funds, I suppose that we could also consider paying part of the money back, buying some shares back.

That’s currently not forefront in our thinking but we don’t rule that out at some point in the future.

Operator

Your next question comes from Tim Savageaux with Merriman Curhan Ford & Co.

Tim Savageaux - Merriman Curhan Ford & Co.

Last quarter you noted that the cable industry, especially in the U.S., kind of got off to a slow start from an order stand point. Your performance and your commentary looks pretty strong across both U.S. and international markets. I wonder if you could sort of update that commentary with regard to how the cable industry is looking in the U.S in particular? It seems to have improved.

Patrick J. Harshman

Yes, cable demand has rebounded quite nicely, in our view. Both domestically as well as internationally.

Tim Savageaux - Merriman Curhan Ford & Co.

Just kind of getting the engine running throughout the first quarter into the year, are there any particular drivers to that? Sort of product-specific from your standpoint or would you characterize it as just an overall increased level?

Patrick J. Harshman

I characterize it as overall strength. As you know, we bring to bear a broad array of technologies and solutions to cable. Perhaps the area of strength that we highlighted in particular, if nothing else simply because it’s an addition from the past, is the strength of the edge QAM space, in particular the contribution we’re seeing from high speed data applications. In addition to everything else we’re doing, which encompasses edge QAM for switch digital video, VOD, encoding of both standard and high definition content, increasing work around on-demand applications. And of course our HFC access business, which has continued to do quite well in an environment where bandwidth is at a premium.

Tim Savageaux - Merriman Curhan Ford & Co.

And to follow up, it was previously mentioned, obviously the satellite business did come down a bit, yet gross margins’ performance was pretty strong and toward the high end of your guidance range, nearly what you did last quarter despite an increasing cable mix and some weakness in satellite. I gather that’s a result of a little more telco and software business. But I wonder if you could give us a little more color and as an aside, in mentioning Comcast, I assume there are no other 10% customers in the quarter. If you can give us a little more color on what’s happening in telco, what drove that strength and where the margin profile is relative to the rest of the business. Or more broadly, how you were able to maintain that margin performance with such a dramatic drop in satellite?

Robin N. Dickson

I will address, briefly, the margin piece of it and then let Patrick expand.

On the margins, yes, in general the business we do with telcos does carry good gross margins with it. I think we’ve historically seen that in most of the deployments that we’ve been involved in. So to the extent that satellite falls off and telco picks it up, really that doesn’t have any significant overall effect on the business. This is maybe a small part, but also in the other category of telco and other, that is a fertile area for some of our newer software products and although the revenues are still relatively small the margins there are usually pretty good.

The telco business, geographically, was really all over the place. We had revenue in Europe and Asia, and Canada and Latin America, and I think even, maybe not significant revenue but even orders from tier-two and tier-three players in the U.S. So, it continues to be geographically very dispersed.

Tim Savageaux - Merriman Curhan Ford & Co.

Regardless of how we move from quarter to quarter here at the middle of your guidance range, you’re really toward the high end of your guidance range, which is where you’ve been for the last several quarters, you look to close out the year at something, 15, 16, mid-teens type growth. And that with , as you mentioned, a very strong kind of ramp with EcoStar last year so arguably that’s kind of a below-trend number.

We haven’t had this conversation for a couple of quarters so I thought I would bring it up. But from an overall growth-rate-perspective, as we start to think about 2009, coming off that kind of mid-teens growth here, I wonder if you could talk about, with all the risks and opportunities in mind and mindful of your decision to step up spending here, what sort of growth rate do you think remains reasonable for Harmonic? I think you’ve talked sort of in the 15% to 20% range in the past.

Patrick J. Harshman

And Tim, I think that’s still the rough ball park that we see as reasonable. Given everything we know about the way the market is evolving and the specific opportunities that we think that we can actually address. And maybe just to highlight, we’re talking here about revenue growth. I think equally important is the fact that we’re going to continue to push strong on strengthening the gross margins.

And when we talk and we think about R&D investments, we think about the fruits that that investment has recently delivered in terms of really delivering products that deliver a higher gross margin. And so I think it is too early for us to talk too specifically or quantitatively about 2009.

But we continue to see opportunities to grow the base business organically in the range that we’ve spoken about previously. And we additionally see the opportunity to grow some of the higher margin products under that umbrella at an even faster rate. So we’re certainly targeting to continue what we’ve been doing on all fronts. Not only the revenue growth but also the continued strengthening of the gross margins.

Operator

Your next question comes from Mark Sue with RBC Capital Market.

Mark Sue - RBC Financial Group

Just on customers, in your assessment, how long will the digestion take for your satellite customers before the ordering resumes? Should it be another quarter or are we thinking more of the later part of the year?

Patrick J. Harshman

One of the points I made in the prepared remarks is with the addition of customers like Telecom Italia and other ones that we’ve been mentioning and announcing over the last six months, we’re really working on executing on our strategy of making the satellite segment for us one that’s comprised of not a couple but actually tens of significant customers.

Now, some of the trends that have been playing out here in the U.S., particularly the heavy adoption of HD, I think are trailing a little bit internationally, but we continue to see great and growing opportunity around this transition of MPG2 to MPG4, standard definition to high definition, in international markets. Additionally, we do see continuing growth opportunities here in the Americas with a number of operators.

So, as we look to the next couple of periods, on average, we see the satellite sector revenue driving for both domestic as well as international customers, to step up from the level that we saw here in Q2. On balance we expect the second half of the year to be equal to or greater than the total first half. And of course, that puts us modest growth relative to last year.

Mark Sue - RBC Financial Group

And the split between the third and fourth quarter, is the satellite business the major swing, considering that you should have steady cable growth and also strong telco growth that makes the third quarter slightly lower than the fourth quarter?

Patrick J. Harshman

One of the reasons, I think, we’re giving six month guidance is we don’t have perfect visibility on that. So if there is a significant difference between Q3 and Q4, I would agree that where satellite revenue falls could be part of that equation. And I wouldn’t be surprised to see a significant contribution from satellite in Q3, or on the other hand, a bigger contribution in Q4. I think we don’t quite have that level of resolution yet but in terms of broader strokes, the six month period, we’re quite confident that we’ll see strong contributions from the satellite sector in Q3 an Q4 combined.

Robin N. Dickson

And I would add that the other thing that’s always hard to predict is exactly what happens in the fourth quarter. I mean, we’ve seen years with budget flushes, we’ve seen years where spending tails off pretty quickly after Thanksgiving and so it’s always a little bit hard to call. We’ve got pretty good visibility into Q3 right now on all fronts and so if there are question marks it’s just about Q4 in general. And some of it is just typical suspending the questions around spending patterns that we will see.

Mark Sue - RBC Financial Group

And historically what’s been the book-to-bill going into the September quarter?

Robin N. Dickson

To be honest, Mark, I can’t really remember off the top of my head. Do you mean the book-to-bill of the second quarter?

Mark Sue - RBC Financial Group

Going into the third quarter. Because you said book-to-bill would be approximately 1.

Robin N. Dickson

It was about 1. I don’t think that’s wildly out. To be honest I don’t remember all the numbers off the top of my head, but I don’t think that’s wildly out of line with what we’ve seen in previous years. Last year we did have a very strong second half performance but I do think much of that actually happened within the boundaries of the second half as opposed to sitting in backlog at the end of June.

Mark Sue - RBC Financial Group

And just on interest income going forward, I guess this is a new level we could kind of model?

Robin N. Dickson

I admit we may not have paid as much attention to that as perhaps we should have done on the last call three months ago. But clearly with interest rates having come down as our investments mature, they are rescinding across the board at lower interest rates and that really had quite an effect in Q2. So, yes, I would say in general, that going forward the level we’re at in the second quarter, of somewhere around $2.0 million, maybe a little less maybe a little more, is probably about the right number.

Operator

Your next question comes from George Notter with Jeffries & Co.

George Notter - Jeffries & Co.

I wanted to ask a question about your MCMPS opportunity on the edge QAM side. It is certainly an increase in the size of the edge QAM market place and I think it’s probably really improved the profitability of your edge QAM business, also, but can you put any math around that? Any sense for how much it increases your overall market opportunities as we pull edge QAMs out of CMPS systems and how much extra margin you can get in that business going forward? Just ballpark.

Patrick J. Harshman

George, to be honest, we’re still getting our arms around the DOCSIS-related opportunity. It’s a relatively new area from a market perspective and an overall spending perspective for us. Although I think we’re a great job of mastering the technology and taking advantage of opportunities that we’ve seen right in front of us. In all candor, we’re, I think, a little further behind in really understanding the longer term ramifications. And to some extent it is associated with how quickly we’re going to see the industry move to modular CMTS and DOCSIS 3.0 application.

In very broad strokes, I ultimately see the opportunity being at least comparable to the size that we’ve seen heretofore for edge QAMs around VFD service. And certainly looking forward, the customer demand for higher speed data, for video that’s going to be moving over cable at a length seems to be almost insatiable. So it’s truly an exciting opportunity and it’s one that has had a material positive impact on the business.

I think both the top line and, I think you’re right, for us, we’ve brought new technology to bear, running on the same edge QAM hardware, which does help the margin profile of that business. Unique capabilities there.

Other than that kind of high-level qualitative view, though, I think we’re not quite prepared to model the incremental opportunity.

George Notter - Jeffries & Co.

Just to paraphrase, at last trim on size to the overall VOD opportunity you have on edge QAM.

Patrick J. Harshman

That’s what we see in the mid-term, yes.

George Notter - Jeffries & Co.

On Comcast, obviously there’s an STD roll out going on there, you guys are involved. I think last quarter, if memory serves, you said it was a modest contributor to your Q1 results. Has that grown for you here in Q2 and what’s the outlook for that opportunity going forward?

Patrick J. Harshman

We leave it to Comcast to speak specifically about what they’re up to, but in broader strokes, we have identified switch digital as something that’s of interest to both domestic and international operators alike. And it’s one where we have seen modest contribution to revenue. And we continue to see that modest contribution in Q2. Much similar to what we saw in the first quarter.

Or put differently, the contribution is still fairly well below that from edge QAM applications and VOD as well as the modular CMTS applications.

Operator

Your next question comes from Greg Mesniaeff with Needham & Company.

Greg Mesniaeff - Needham & Company

I wanted to refocus on the satellite questions, the sequential delta from Q1 to Q2, which as you said, Robin, was not unexpected. But I’m wondering when you gave the guidance of $175.0 million to $185.0 million for the second half, I’m assuming you’re kind of modeling a baseline contribution from satellite kind of in that, you know, 10% to 15% range. Is that a fair assumption?

Robin N. Dickson

Yes, Greg. I think maybe you’re underestimating a little bit. We see a lot of activity in the satellite market. We still have a number of projects in progress where we haven’t either recognized any revenue or only part of the revenue so there is a pretty decent pipeline. I would say we are looking for a number more, maybe even a little closer to 20%. I mean, I did say, after all, that we still expect to see satellite growth this year so that implies a dollar number somewhere approaching $70.0 million, which again, based on the mid-point of the guidance we’ve given, we would be closer to 20% of revenue. So I think it’s somewhere in that 15% to 20% range.

Greg Mesniaeff - Needham & Company

And I guess we could also assume that the satellite business will follow the overall trend towards lesser dependency on the U.S. obviously that with dish.

Robin N. Dickson

I think that’s right. Patrick has already highlighted a couple of significant wins in Europe. We have had actually more than that. I think two press releases we’ve had recently in Europe as well as a number of other wins, including the emerging markets. We’ve talked about that before.

I will admit in the second quarter, from a revenue perspective, we didn’t have an enormous contribution from some of these emerging markets but I think over time we will see more revenue flowing through. So again, you’ve really got to look at these kinds of numbers on a year-over-year basis. Quarter-to-quarter is just too difficult.

Greg Mesniaeff - Needham & Company

If you focus on the recent sort of rebound, if you will, of the cable revenue segment and you kind of look ahead towards the second half of 2008, could you talk a little bit about the high definition MPG to encoder opportunity there? You know, we’re talking a lot about MPG4 obviously but with cable still firmly entrenched in the MPG2 world, I’m kind of wondering if you could just give us some time line scenarios and how that’s going to continue and what you’re seeing in the MPG2 HD encoder space.

Patrick J. Harshman

We expect the U.S. cable industry to be working with MPG2 technology for at least the next several years. Perhaps not exclusively. I think there is some thought or some discussion that MPG4 technology may start to move in in certain places. I think most people in the industry will tell you that operators will start to receive boxes that support both MPG2 and MPG4 later in the year.

But you’re absolutely right, that by and large, the HD services in the U.S. over cable networks will be delivered in MPG2. And for that reason Harmonic continues to invest quite significantly into a lot of, I think, very innovative work around very high-quality, next-generation HD encoding in the MPG2 domain. MPG2 encoding, as well as more general stream processing and networking.

And there really is a lot of continuing room for innovation there and a lot of good resonance with our customers, who are looking to get the most out of their current investment in MPG2 boxes.

Operator

Your next question comes from Jack Monte with Lehman Brothers.

Jack Monte - Lehman Brothers

I just wanted to touch upon the seasonality that, you know, on the visibility you have into the cable segment going into the second half of the year. I think there are times in the past it’s been seasonally down in the fourth quarter. I was curious if that was a scenario you viewed as being highly probably as we go into the second half of 2008?

Robin N. Dickson

I tried to address a little bit of this earlier, Jack. There’s always some level of uncertainty about the fourth quarter and perhaps cable spending. Or I would say it more generally, our customer spending, but often cable in particular. As I said, we’ve seen budget flushes in some years and we’ve seen the spending turn off at some point during the quarter. So that was the uncertainty over that. And it’s too early, really, to have any good visibility over that. It’s certainly one factor that we considered as we put the guidance together. We just really simply don’t know it at this point.

What is comforting is that we’ve seen a strong rebound in bookings in the second quarter, after what was, my our own admission, a relatively light first quarter and that seems to be continuing, at least from what we can see in July. So that’s comforting. But it’s just a little early to be speculating on what happens in late November and December.

Jack Monte - Lehman Brothers

And I just wanted to touch upon the satellite segment again. Is some of the up tick in the second half satellite revenues tied to some late second quarter orders or would you quantify it as saying that there’s a lot of finished good inventory for satellite waiting customer acceptance to be able to recognize that revenue? How should we think about that?

Robin N. Dickson

Well, our satellite business for most of our customers is a business that we recognize revenue typically over a number of quarters. Most of these, to use our own definition, are projects and typically recognized revenue over several quarters, and we have a number of those in the pipeline. So I would say we tend to have more future satellite revenue sitting in deferred revenue than we do in our standard book-and-ship backlog. Although we do have both. It is very customer-dependent and sometimes even product-dependent. But as I mentioned earlier, we have a number of satellite projects in process at the moment and that’s one of the things that gives us comfort about growth for the full year in the satellite business, growth for the full year 2008 over 2007.

Jack Monte - Lehman Brothers

And there were some currency remarks made in the prepared comments. I think 50% of the revenues was international. How much of that is priced in dollars versus other currencies? And also if you could just touch on the cost of materials there that are U.S. dollar-based, just to give us a sense of how we should think about that going forward.

Robin N. Dickson

We still have a relatively small but a growing portion of our international revenues denominated in currencies other than dollars, so the dollar is still our primary billing currency but that is changing pretty rapidly in Europe and as we move our European support center in place, I mentioned that is going to accelerate. So we’re certainly getting some benefit on the top line. Most of our material costs are denominated in dollars but clearly inflation in some countries and the rising cost of freight and fuel and some of the other inflationary pressures are having some impact on our contract manufacturers.

But at this point I would say that currency has been so far a net benefit to us. Maybe not a huge one, but at least it has been a net benefit to us.

Jack Monte - Lehman Brothers

Also in the prepared remarks, I don’t think it was mentioned. Is ASTRA in Germany and SKY Italia, they’re already ordering or they’re going to begin ordering in 2009? Or when are those projects expected to start?

Robin N. Dickson

As Patrick has indicated, SKY Italia is a new customer for us and we’ve already recognized some of the revenue from that. ASTRA is an ongoing customer and this particular project was noteworthy, but they’re an ongoing customer and they have been ordering from us for some time. But much of the project that was discussed in the press release, I believe most of that revenue has already actually been recorded.

Operator

Your next question comes from Blair King with Avondale Partners.

Blair King - Avondale Partners

I just want to touch on a question that was previously asked and that has to do with the edge QAM space. There was some discussion around how you sort of prioritized the edge QAM sales relative to VOD, switch digital video, and MCMTS platform. Patrick, I was wondering if you might be able to just put that in order? In terms of what you’re seeing today in terms of edge QAM upgrades and then maybe a year out. Do you see that mix changing at all or is it still the same mix, in terms of how you would classify the opportunity?

Patrick J. Harshman

All I’m saying is today, certainly the VOD application continues to be number one in terms of the volume of edge QAMs that are deployed. But coming up behind that, and frankly faster than we had perhaps initially anticipated, we see these modular CMTS applications coming. And I would say third, in terms of volume of QAMs deployed, is the switch digital video application.

I didn’t mention it earlier, but I think it’s important to clarify that by design these applications are, and can, somewhat meld together. The industry coined a phrase called the universal edge QAM and part of the idea is, is rather than have three side-by-side edge QAMs, each dedicated to those specific applications I just mentioned, why not have edge QAMS that can flexibly support any of these services.

So, as we think about the overall opportunity, we think not only about these discrete applications and opportunities, but we think about the evolution of the architecture to flexibly support all of these services. And I think it is our unique support of all three applications that is putting us in a particularly strong competitive position today. And one of the reasons why we’re pretty excited about the opportunity around this technology and these architecture directions going forward.

Blair King - Avondale Partners

If I could just make up a number, if I were to say that the edge QAM space today were in aggregate worth $1.0 million, next year is it a $1.0 million or next year is it $2.0 million?

Patrick J. Harshman

From our perspective we think it’s growing in 2009. I’m a little reluctant to put a number or a percentage on it, but it’s clearly growing. I mean, we’ve talked for a long time and we think more on-demand content, more content viewed on demand, it’s just a fundamental driver of this overall business.

Additionally, more high-speed data. Frankly, that’s just another means of accessing personalized on-demand content. And increasingly streamed video is also an application and technology that is going to do nothing but scale. So put those two things together, more and more on-demand content, high-quality video, more and more broadband access, that modular CMTS kind of stuff, we definitely see the volume and the amount of activity in this space growing in 2009 relative to 2008.

Blair King - Avondale Partners

Is it fair to assume that the edge and access business, in your view, would outpace the video processing segment?

Patrick J. Harshman

No, I’m not comfortable saying that. I think the growth will be there but we’re also quite bullish on what’s going to happen around video processing. Continue to invest a lot. Not only our HD streaming and processing but splicing, add insertion. A lot of the on-demand capabilities on the front end actually feed into these same applications.

I talked about some of the exciting work we’re doing in Asia right now, around the Olympics. That’s all software-based related to video processing capabilities that are allowing us to take video, reformat that video, store the video, play it back out in a number of PBR or delayed TV, catch-up TV, kind of scenario. We’re seeing a whole lot of activity on that front as well.

So I think as we get a little closer to 2009 we perhaps will be able to give you a little bit more nuance guidance about the relative opportunity we see around some of these things. But in broad strokes, we’re excited about both areas. As we look forward, we extrapolate the current trends in 2009, we continue to see a lot of good opportunity.

Blair King - Avondale Partners

There was a little bit of talk on the software and other segment and obviously that has some pretty strong sequential growth there this quarter. So is there any more detail you can give us on just an update in those two business units that you have there? I guess Entone and Rosette.

Patrick J. Harshman

More and more, particularly the Entone piece, is kind of merging into what we do in blending into what we do in blending into what we do around video processing. I just gave you a couple of examples. A lot of the delay TV and catch up stuff that I mentioned is a hybrid solution, depending on both what was Entone and evolved versions of that software, together with some of the hardware-based encoding and stream processing that we’re doing. And so that piece of things continues to go very well for us and we’re seeing a lot of success around bundled solutions there.

And similarly, the Rosette business continues to move forward. We’ve had a couple of nice announced deals, again with operators in the U.S. as well internationally. And we continue to be excited about that business. It’s still relatively small relative to the mother ship but it continues to make good progress and it’s one that we continue to be quite excited about.

Operator

Your next question comes from Amitabh Passi with UBS Securities.

Amitabh Passi - UBS Securities

Patrick, as we look into the back half of 2008, wondering how we should think about trends in your two major categories, edge in access and video processing. More specifically, do you think the edge in access business can grow quarter-over-quarter, and if so it almost seems by implication that the video processing segment could show a year-over-year decline from the back half. Just wondering how to thing about the two segments for the rest of the year.

Patrick J. Harshman

We have to wait and see how things materialize. We’re excited how the edge in access business has stepped up. I probably don’t envision sequential quarter-over-quarter kind of growth. Similar to that. But six months as a whole, back half, front half, I think we’ll see edge in access a little larger.

On the video processing piece I definitely expect a stronger second half than we saw in the first half. A little bit of uncertainty about how big that step up will be.

Amitabh Passi - UBS Securities

And just wondering if you could provide a little more color, particularly on the access sub-segment of your edge in access. Just very high level, what sorts of trends did you see in the quarter. I believe you said in the first quarter there was sort of modest year-over-year growth. I’m wondering if anything changed in the second quarter?

Patrick J. Harshman

No dramatic change. You’re talking about the HFC access, it continues to be a solid contributor. I think we’ve acknowledge in the past, from a macro or a time perspective, we probably don’t see quite the same growth opportunities we do elsewhere. That business tends to be a little bit flatter than other pieces of our business. But it continues to move along and it continues to be an important part of our overall portfolio for cable customers and a solid contributor. But not the fastest growing product.

Amitabh Passi - UBS Securities

This quarter, first time, you had the 50/50 split, international versus domestic. Curious if you see this as being sustainable or do you think we should revert back to being skewed more towards a higher proportion of domestic revenues versus international?

Patrick J. Harshman

Again, it’s a bit like some of our market segment data. These numbers tend to move around on a quarterly basis, depending on which projects we’ve made progress on and/or completed. So, my guess is that international is going to run domestic pretty close in the second half. I’m not sure that it’s going to be 50/50 but my sense is it’s going to run pretty close. At least 45% and maybe closer to 50%.

Amitabh Passi - UBS Securities

And Robin, did you say anything about the tax rate in the back half of 2008?

Robin N. Dickson

We basically said no change from what we’ve been doing in the first half of 2008, which is pretty nominal rate. I used a range of 6% to 8% for the remainder of this year.

Amitabh Passi - UBS Securities

And finally, if you’re looking to 2009, just wondering if you can give us some sense, as you look at your business model. Should we expect OPEX, in light of all the comments you made, to grow generally at the same rate of revenues? Do you think there’s enough leverage that perhaps it grows at some portion of revenue growth?

Robin N. Dickson

I’ll give you my perspective on it and then Patrick may want to add something. I think we see investment in operating expenses really in two major directions. One is in accelerating certain of our R&D programs and clearly we’re not doing that without the expectation that at some point that’s going to pay off in the future in some combination of higher revenue growth and higher gross margins. That is definitely underlying what we’re trying to do. And so I could see that perhaps, maybe not in the first half, but maybe in the second half of 2009 that that could begin to pay off in terms of a higher revenue growth rate.

The other thing we’re doing is the establishment of an international support center in Europe, which has double benefits, I think, again, by providing better support to both our internal people as well as to our customers, internationally. I think that’s going to be good for revenue growth in due course. And as we’ve said, also again, over time it probably provides us with some pretty worthwhile tax benefits.

So I don’t see fundamental changes to the model in 2009. I could see some improvement in gross margins, as we continue to roll out new products and new products with a major focus on improved gross margins. And we were asked the question earlier about revenue growth, and I think, as Patrick said, 15% to 20% is possible next year. And we’re going to do everything we can to keep that operating margin about 15%.

Operator

Your next question comes from Larry Harris with C.L. King & Associates.

Larry Harris – C.L. King & Associates

Today we had an announcement from both Direct TV and also Verizon in New York relative to offering 100 or more HD channels. Certainly it appears that the U.S. cable offerings are lagging the likes of Direct TV and Verizon. Even EcoStar dish. Are you seeing increasing interest in HD from the U.S. cable operators in terms of their purchases or is a pretty consistent purchasing pattern?

Patrick J. Harshman

We agree with the top-level assessment, that the market is doing nothing but getting more competitive. I think cable customers are very aware of what’s happening in the market. I think they’re very shrewd as well as prudent in what they’re going after and we don’t see any marked adjustments in their strategy in their approach to HD. But we believe that they are fully cognizant and fully prepared to respond to what’s happening competitively. Directly with HD content as well as marrying up HD content with some of their on-demand offerings, which are perhaps a unique differentiation for differentiating applications that they bring to the market place.

Everything that they’re doing as well as others are doing are not necessarily evident publicly and I think we’ll all look forward to the conference calls from the leading cable operators over the next week or two here.

But our belief is this is kind of unfolding as we’ve envisioned for quite some time. We’ve expected to see a heavy push around HD and we expect all the players, satellite, telco, and cable, to be fully in the game.

Operator

Your next question comes from Paul McWilliams with Indie Research.

Paul McWilliams – Indie Research

Patrick, I asked you a question at the last conference call. Basically it was, how do you see the aggregate demand for products by Harmonic, the same, better, or worse than it was at the beginning of the year. And your response was the same or a little bit better. How do you feel now about that, if asked the same question?

Patrick J. Harshman

I guess we’re feeling modestly better than we were after the first quarter. We’ve definitely seen demand pick up. We’ve talked about a one-to-one book to bill ratio. And we feel relatively good about the demand for our products across the spectrum of what we’re doing.

Paul McWilliams – Indie Research

I need to ask some other questions that will pertain to the second half growth and then looking at 2009. But in prefacing those questions, I don’t want them to take anything away from what you’ve accomplished in the couple of years that you’ve been there and doing this job. You’ve pulled off miracles. But if we look at what you’re saying for second year, at the mid-point, it implies that we’re looking at 14.6% year-over-year growth, full 2008 over full 2007, which is just slightly below the range of that 15% to 20%. And then as you were talking here, you said that edge in access should be a little larger and the video processing should definitely be larger in the second half. Although second half is just marginally up from first half. Should I take it that telecom [sic] is going to soften in the second half, telecom [sic] and other?

Patrick J. Harshman

Well, that’s probably a space where we have the least amount of visibility, as we’ve been saying I think for the last couple of quarters and it is frustrating. But this is still the least mature market and we had a particularly good quarter this past quarter and we’re pleased about that. Adding some new customers, closing some business with existing customers. But as we look out at the second half of the year, I would acknowledge that business around IPTV and with telcom operators, we’ve got the least visibility of all the markets that we serve.

Paul McWilliams – Indie Research

You’ve developed a very good reputation of promising conservatively and then over-delivering on your promise and it sounds to me as though you’re doing that again. Not that it’s a bad thing, just that is just kind of what the second half sounds like to me.

Robin, operating profit margin, non-GAAP for the second half. What do you see there?

Robin N. Dickson

It’s is very much our goal to keep that in a 15% to 17% range. I don’t see it really coming out all that much differently from the first half of the year. Hopefully the gross margins tick up a little bit, that’s certainly suggested by our guidance. Maybe the operating expense ratio also ticks up a little bit as we’ve suggested, most of that probably coming in the fourth quarter. But overall, as I said, the 16% we did in the first half seems very doable in the second half and I think consistent with the various elements of the P&L that we’ve discussed.

Paul McWilliams – Indie Research

In the second quarter, out of the increase in OPEX, how much of that was a one-time investment to set up a new tax policy for the international office?

Robin N. Dickson

It’s a relatively small piece at this point. We’re still very much, at least in the second quarter, we’re very much in the planning stages. We talked about $500,000 related to management changes and initial costs, so it’s a fairly modest number at this point. But we will bear some more costs in the second half as we go forward with implementing the program. But that’s factored into the guidance that we’ve already given.

Paul McWilliams – Indie Research

But you’ve not taken that out in your pro forma?

Robin N. Dickson

No, we have not taken that out in the pro forma. That is an ongoing cost of doing business and we don’t think it’s justified to take it out in pro forma.

Paul McWilliams – Indie Research

In 2009 you said that you would be recording tax rate probably in about the mid-30%s. What do you think you’ll be paying in your taxes in 2009, at what rate?

Robin N. Dickson

Something less than that but with this structure in place it will be a higher proportion than we had originally thought. So, it’s still very early to speak in detail to these numbers. But I think it’s fair to say that probably somewhere in the 20% to 25% of that number ends up being cash. So, again, I wouldn’t want to present this as anything other than the regular cost of doing business. And I think our real focus is to get the tax rate down over time using a number of avenues that are open to us.

Paul McWilliams – Indie Research

What was your backlog and deferred revenue at the close of Q1?

Robin N. Dickson

It was around $82.0 million and it grows slightly in the second quarter and we ended the quarter with $84.0 million.

Paul McWilliams – Indie Research

And to cap off 2009 and put together the comments that you’ve made throughout this Q&A, we’re looking at , just for modeling purposes, top line growth, somewhere around 15% to 20%, improvement in GP and operating income somewhere in the 15% to 17% window.

Robin N. Dickson

It’s early days for 2009 but I think that’s a reasonable summary of some of the discussion that’s come out of the last hour or so.

Operator

There are no further questions at this time.

Patrick J. Harshman

Thank you all for joining us and we look forward to talking to you next quarter.

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Source: Harmonic Inc. Q2 2008 Earnings Call Transcript
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