Welcome to the Third Quarter 2014 Harmonic Earnings Conference Call. My name is Janet, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I would now turn the call over to Blair King. Mr. King, you may begin.

Thank you, Janet. Hello, everybody. With me in our headquarters today in San Jose, California is Patrick Harshman, our CEO; and Carolyn Aver, our CFO. I'd like to point out that in addition to the audio portion of this call, we have also provided slides, which you can see by going to the Investor Relations page on harmonicinc.com and clicking on the third quarter 2014 preliminary results call button. Now turning to Slide 2, let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only current expectations and actual events or results may differ materially. We refer you to documents that Harmonic files with the SEC, including our most recent 10-Q and 10-K report. In the forward-looking statement section of today's preliminary results press release, these documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis. These items, together with corresponding GAAP numbers and a reconciliation to GAAP, are contained in today's preliminary results press release, which we have posted on our website and filed with the SEC on Form 8-K. We will also discuss historical, financial and other statistical information regarding our business and operations. Some of this information is included in the press release and the remainder of the information will be available in the recorded version of this call on our website. With that, let me turn the call back over to you, Patrick.

Thanks, Blair, and thanks, everyone, for joining us today. I'm turning now to our Slide 3. Today, we reported our results for the third quarter of 2014. Plus, a continuation of the external market turbulence we discussed last quarter, but also the margin trajectory we expected as we entered the year. With this in mind, I'll first review our results for the quarter then take a step back to discuss overall market dynamics, why we believe much of this market turbulence is in fact an encouraging sign of pending new infrastructure investment and why Harmonic is positioned with significant earnings upside as we look ahead at 2015. Our revenue in the third quarter was just over $108 million, down 1% sequentially and slightly above the midpoint of our guidance range. The radio business improved modestly, up $3.5 million from the prior quarter while as expected, our cable edge business declined due to over $5 million off of a record second quarter. In terms of customer verticals, business from our service provider customers represented 62% of revenue, while broadcasting media grew to 38%, reflecting the modest improvement in our video product business. Third quarter bookings of $97.8 million were down 14% sequentially. Now some of you may recall, our third quarter has been and was again the seasonally lowest service renewal quarter. So as a result, we typically exit the third quarter with a book-to-bill slightly below 1 as we did again this quarter. Nonetheless, year-to-date book-to-bill remains above 1. Backlog and deferred revenue is consequently a $116.6 million, down from last quarter again due largely to the seasonality in our service bookings. Gross margin for the quarter was a very solid 53.6%, reflecting healthy margin trends in both our video and cable edge businesses. Earnings were $0.06 per share, aided…

Thank you, Patrick. Let's move to Slide 8. Our net revenue for the third quarter was $108.1 million, in line with our expectations. Net revenue was down from $122.9 million for the third quarter of 2013 and from $109.6 million for the second quarter of this year. Our video business was up $3.5 million sequentially led by a rebound in our production of play out products. This was offset by an expected decrease in our cable edge business of $5.4 million, which had a record quarter in the second quarter of this year. Services were up modestly. Our bookings for the third quarter were $97.8 million, down 16% from a year ago and down 14% sequentially. Virtually, the entire sequential decrease in bookings is due to a reduction in service and support bookings. Again, I'd like to remind you that the third quarter is always our seasonally lowest quarter for support renewal contracts, and that was again this quarter. Our book-to-bill ratio was 0.9 in Q3 as it has been for each of the last 2 years. Our year-to-date book-to-bill remains above 1 at 1.04. Backlog and deferred revenue was $116.6 million at the end of Q3 compared to $123.6 million at the end of Q3 of 2013. Gross margin was 53.6% this quarter, an increase from 50.1% in the previous quarter and from 50.8% in the third quarter of 2013. The increase in gross margin on a sequential basis is principally due to a greater portion of our revenues coming from our video business in general and more specifically, an increase in revenue from our production and play out products. Additionally, we had an continued improvement in the gross margin of our cable edge business led primarily by the NSG Pro, which has now reached its targeted standard costs.…

Thank you, Carolyn. And just summarizing, as you just said, it's true that technologies transition and macro disruptions are impacting our top line performance. The near-term outlook for the fourth quarter are disappointing. While we can't control the macroeconomic environment around us, we can control our competitive position and cost structure and that's exactly what were doing. And I could tell you our internal execution and focused determination will ratchet up even higher in the months ahead as we exploit our competitive advantages to drive the top and bottom line growth. What remains undoubtedly clear is that Harmonic's stand on solid strategic ramp. Equipped with innovative and competitively differentiated new technologies, positioned in areas where our customers plan to invest and are actively engage with us. Internally, we're driving an operational framework that balances market opportunity with investment in support of the earnings growth we expect in 2015. We very much appreciate your support, and we're looking forward to continuing to deliver and continue to talk to you. On that note, let's open it up for your questions.

[Operator Instructions] And our first question comes from James Kisner.

So I guess, the first question I have was just on the European weakness. And just kind of wondering if this could be partially related or amplified by your kind of historical exposures? If I recall you've had some good business in Russia and Germany, 2 areas sort of highlighted as weak by just the macro indicators and just the news. Is that fair? Is that the areas you're seeing more weakness?

Certainly, yes, is the short answer, James. Certainly, Russia has been the most acute for us. Recall that Russia, Africa and the Middle East. And a little bit more broadly, Eastern Europe. And Russia has been the area of the most acute year-over-year decline.

Okay, great. And I was just hoping to just probe a little bit on, you said that you're more cautious on customer consolidation activities. I'm just wondering if that's a function of just your own judgment or customers saying to you that you should perhaps be ready for some disruption and just any kind of texture around that and perhaps how long that particular component might persist?

We've got a big customer base worldwide, and we're exposed to several in-process mergers or acquisitions between different service provider customer stands. Although I wouldn't call the impact significant in the third quarter, we were exposed to certain delays on certain projects. So more than anything else, it's what we observed. And we have observed and prior to that, we didn't observe anything, and to be fair, we have not seen any impact specifically in our cable edge business. But in the video area, we've seen a couple of things, situations play out that give us cause to be cautious as we had into the fourth quarter.

I guess, I was just wondering, just as a follow-up there, I mean, what do think the prospects are sort of post these consolidation activities for there to either be a sort of snapback or perhaps a heightened level of investment? Is it fair to say that your acquisition targets perhaps are going to be receiving incremental investment by their perhaps better funded parents? Is that something you guys view as possible?

We view it as possible, probable and we see it as a real opportunity. I mean, let's face it, a lot of these deals are around scale and consolidation very much related to content and who can negotiate, who can deliver most compelling content packages, who can negotiate the best deals. So a lot of this activity we see both in the U.S. and in Europe revolves very much around video content, and we're well-positioned. And I'll note that we're fortunate in a number of situations that play out that we're incumbents with players on both sides of the equation. And so we often in our history have sold to the consolidators as they up their game, as they up their ante in the competitiveness of the new combined entity. So I would say that we're optimistic about the other side of the balance, particularly [indiscernible]

And our next question comes from Simon Leopold.

This is Victor Chiu in for Simon Leopold. Last quarter, you noted that the transition to virtualization was driving a slowdown in video. Can you just give us an update regarding that trend and is this still a factor driving weakness? I know Patrick, you mentioned that the environment hasn't changed too much and that was an issue for you in 2Q but can you just give us maybe an update on what the impact is there?

Yes, it's difficult to quantify, Victor, but it certainly is impacting us and the overall situation hasn't changed. So you talked to most Chief Financial Officers and Chief Technology Officers of our customers, they believe in the merits of virtualization. I think how it plays out kind of on the ground is a little bit more complex and those discussions depending on the customer, it will take more or less time. We've got certain sophisticated customers who are ready to roll, and we're very pleased to be able to announce that Sky Italia and we think we're going to be seeing more wins in the near future. On the other hand, there's some other customers who are intrigued. They kind of get it but they want to study it. They want to figure it out. It's a process. I would point out though that through that process, we are developing capability, intellectual property around not only the core video technology but the operationalization of that technology, which I think is pretty important, pretty powerful, pretty valuable in the context of a broader communications landscape that is moving towards virtualized infrastructures over the next several years.

Is the virtualization, is that more prevalent within certain geographies?

Just from extent. It's more of a developed market phenomena or advance market. So definitely the U.S. is #1 and I'd say Western Europe is #2. But that's not to say that there isn't interest in other geographies but proportionately it's strong as in the U.S. and Western Europe.

Okay. And maybe just a general sense of how the transition impacts gross margin going forward?

It's certainly a positive for gross margin. And we exposed at our Analyst Day where we really unveiled the strategy for the investor community that we saw this as a great opportunity to really capture more value and continue what has been a good track record of gross margin improvement over time. We don't expect the entire product line to flip 100% to virtual machines overnight. We expect it to be a migratory process and through that process, we expect our gross margins to expand.

Okay. But that wasn't really a factor that drove upside in the gross margin this quarter, right?

That's right. That's right.

[Operator Instructions]

All right. It seems that there's no more questions. We know it's a busy day but we do very much appreciate everyone spending the time with us today. And I guess I'm hearing that there is 1 more. We've got Brian?

Yes, we have a question from Brian Coyne.

Just a couple of ones. Patrick, I'm hoping you can clarify, I think, your response to James' earlier with regards to some of the softness you're seeing from potential M&A activity. Did you say that you haven't really seen a change in the order trend on the cable edge side? And maybe just perhaps a little bit more detail of what you're seeing if in fact the delays or sort of the holdups seems to be coming more in the media and broadcast segment of your business, if I got that right.

So let me, yes, I do need to clarify. I was referring to the cable edge product area. In the cable edge product area, Brian, we've seen pretty healthy demand and no visible, one way or another, impact to demand for our cable edge products. In our video product category, which we sell into all service providers: cable operators, satellite, telco operators, we're exposed to a number of different deals. And there, I don't want to overstate it by any means. I don't even want to suggest a meaningful impact to Q3. We saw a couple of instances across a couple of different of these pending mergers. Their deals where we put on ice, in the video domain in particular. And that -- absorbing that, seeing that play out into Q3, has caused us to be incrementally more cautious as we head into Q4.

Got it. That helps. I appreciate it. Looking ahead a little bit further, if you put could take out your crystal ball for, say, the first half of 2015, I mean, I understand your view about revenue growth for the full year but let's say assuming that perhaps some of the delays from consolidation of results if, in fact, those might end up being sort of a more of a binary event from the first part of next year. Do you think that your business might be a little bit flat year-over-year, in the first half of 2015?

Absolutely. I mean, you're right. We don't have a crystal ball but we're hopeful to see growth in the first half of the year, Brian. And look, we've been battered around by the degradation of business in the certain geographies we talked about. As Carolyn said in her remarks, we think we've hit bottom there so we don't see that there's any real further deterioration possible there. And frankly, we see much more upside or opportunity than downside elsewhere. Cable edge business is on a roll, our service and support business is continuing to grow. On the video side, we're making strides every day around technologically and around the discussion process, the readiness of around virtualization. Every single day brings more announcements about Smart TVs that are capable of supporting Ultra HD. We're actively engaged in a number of HEVC trials and the like. So we -- I don't want overstate it for you, I think that it's an evolutionary recovery here, but I think it is a recovery that will show demonstrable progress and sequentially, over the next 3 quarters. And so yes, we're -- we can imagine and quite in fact, we're hopeful to see growth in the first half of '15.

Got it. That's great. Couple more if I could, I guess sort of along the same lines. On VOS, if you could maybe talk a bit more about your sales cycles there. It's obviously an important part of your view toward 2015 and I know it's early, but how does that compare to maybe more traditional hardware, software solution sale? And then how is, VOS over time, I mean, do you think you can move the business toward being perhaps a little bit more recurring in nature and less project or buildout dependent?

Okay. So let's take those 2 things separately. I mean, it's just stating the obvious, it very much depends on the customer. Just forgetting our specific underlying technology, Brian. When we engage on video opportunity with a customer, we see deals get closed in weeks and we see them get closed in 9 months. And it's everything in between. So in that context, it's a little bit hard to assess out what kind of additional delay is a move to virtualization, introduce it. Certainly, we're not seeing any virtualization deals get closed in a matter of weeks. That being said, we see increasingly sophisticated customers. We're doing virtualization in other realms and they're ready. And I think that -- so I think we'll see some fast-moving customers and I think we'll see the number of customers kind of ready to move more quickly, expand over the next couple of quarters. That being said, it's undoubtedly also true that a number of customers are really figuring it out. And it's like kind of like a couple of moments ago I think that's creating an opportunity for us to bring additional value and we're really developing intellectual property there, the operationalization of this technology in addition to just the deployment of it. So it's undoubtedly -- look, it caught the market by surprise when we came out and said we could do what we could do at the NAB Show in April. And it's been a process since then. Last quarter we said, "Listen, for number of reasons not least of which is that, we expect a couple of choppy video demand quarters." We're very much in the midst of that but we don't see it lasting forever, and we're hopeful we are going to punch out the other side here in a quarter or 2. To the second part of your question, we've not communicated a broader model or plan for getting into recurrent revenue but I would point of that part of our overarching strategy of moving to integrated, functionally collapsed software virtual machine platform is it does open the door for a number of new business models. And whether that's us delivering a service or whether it's with a strategic partner, it creates the opportunity to participate in the market to expand the addressable market and to exchange -- interact with customers with different commercial approaches. And we've got to walk before we run here, and I'd put that a little bit more in the run category but make no mistake, we're positioning ourselves to grow the business and to change the business for the positive in some very fundamental ways by engineering this overarching technology transition. So we're focused on nailing the technology transition and getting that out of the field with the current business model today but you'll see us going forward, I think getting more creative and responding to our customers in the way they want to do business.

Great. That's very helpful. Carolyn, one for you, if I could. It's really sort of question on cash and your share buyback. If I heard you right, you said you've got about $35 million remaining on the availability. I believe you got just $100 million or so in cash on the balance sheet, and that, of course, of expected positive cash flow, can you talk maybe briefly about your strategy around cash management in 2015?

Yes, I think to your point, we certainly expect that we'll continue to be strong generators of cash and so we think that will be a growth there. We have $75 million left. We anticipate that we'll consume that $75 million over the next many quarters. So we think both of those things will happen. This quarter, given the investments that we made and where our cash balance is, is we expect it to be more moderate but we certainly think as we go into a cash generation over the next several quarters, we'll continue to buy.

All right. Well, thank you very much, Brian, and we'll end it there. Thank you very much, everyone, for joining us. Please note that we're very focused on executing the business both in the fourth quarter and in 2015. We do think we're on very solid strategic ground. We're excited by the strategic progress, balance that versus real challenges in the marketplace but on balance, this business has got a lot of growth capability. We put real leverage into the model from an earnings perspective. And we're committed and excited about getting after that. Thanks very much for joining us today, and we look forward to our next opportunity to update you on our progress. Good afternoon.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participating you may now disconnect.