Welcome to the Second Quarter 2016 Harmonic Earnings Conference Call. My name is Ana and I will 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 will now turn the call over to Blair King, Director of Investor Relations. Please go ahead.

Thank you, Ana. Hello, everyone and thank you for joining us today for Harmonic's second quarter 2016 earnings conference call. My name is Blair King, as Ana just mentioned. And with me here at our headquarters in San Jose today are Patrick Harshman, our CEO; and Hal Covert, our CFO. I’d like to point out that in addition to the audio portion of this call, we have also provided slides for this webcast, which you can see by going to the Investor Relations Page on harmonicinc.com and clicking on the second quarter 2016 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 reports and 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 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 and 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. So with all that said, I'll now turn the call over to our CEO, Patrick Harshman. Patrick?

All right. Thanks, Blair, and thank you all for joining us today. Turning to Slide 3. We executed well on Q2 reporting a quarter characterized by improved demand trends for video products and services, solid integration work with Thomson Video Networks and significant progress on our transformational product initiatives. Revenue were $110 million, was up 33% sequentially reflecting both our first full quarter of Thomson Video Networks contribution and improved Video products demand worldwide. Bookings were healthy at $117 million up 7% sequentially and 18% year-over-year. This was our third consecutive quarter of book-to-bill greater than one and consequently our backlog in differed revenues grew to a record $190 million. Gross margin for the quarter was 53% up 200 basis points sequentially reflecting a mix shift to more Video products relative to the first quarter. And finally EPS was breakeven with significant improvement over the first quarter but also reflecting that we're still in the early stages of our TVN related synergy program, and of course continuing to invest heavily in Cable-Edge R&D in anticipation of driving significant growth of that business. So putting it all together here, our strong order book, positive market demand trends, and strong internal execution enable us to remain confident in delivering the double digit operating profit we targeted in Q4 as we exit the year. So with that let's now turn to Slide 4, and take a closer look at our Video business. The first key message here is the demand momentum for Video infrastructure continued through the second quarter driven in particular by a resurgence of projects that spend traditional pay TV and live over the top services. Intense competition between global telecom, cable and satellite direct-to-home operators, as well as over the top business trends and growing Ultra HD market momentum, all…

Thank you, Patrick. We want to thank everyone for joining our call today. During my discussion I will cover two topics, first, our financial results for Q2, 2016 and then our financial goals for Q3 in the year of 2016. Before discussing our financial results, we would like to start with some opening comments. Q2, 2016 is the first quarter for Harmonic that reflects the full quarter's benefit of the TVN acquisition. TVN is performing in line with pre-acquisition expectations however since Harmonic is pursuing a path to operationally integrate TVN it is not possible to break out financial results for TVN on a standalone basis in typical detail. Even at the revenue level we are beginning to cross-sell and integrate product lines. We are on track with Harmonic plus TVN synergy goals for 2016 and our annual target for 2017 as well as related to restructuring and integration charges. I will provide more detail in this regard shortly. As Patrick indicated during the quarter we signed an engineering collaboration agreement with one of our customers. This agreement is focused on development initiatives that have been underway and extend into 2017. The agreement provides Harmonic with funding from our customer up to $10 million to offset associated engineering expenses upon achievement of agreed upon milestones. Payments will occur when these milestones are achieved in $2 million increments. We received our first payment in July, 2016. The aforementioned funding will flow through the R&D expense line in our income statement as a reduction in R&D expense in sync with related expenditures. In Q2, 2016 we recorded approximately $1.6 million of such expenses along with an offsetting reduction. Overall payments and expenditures related to engineering collaboration agreement are expected to offset each other and therefore will not increase our R&D expense one…

Okay, thanks Hal. Please turn to slide 12 where I want to conclude by emphasizing that we remain very focused on executing the strategic priorities was previously outlined. Our Video business is the market share leader in video encoding and related systems for the world leading pay TV and media companies. We’re increasing the value of this business by leading the industry transformation to software based video infrastructure and the next generation of high quality over the top services. Through our acquisition of Thompson Video Networks we’re accelerating the execution of the strategy combining innovative software approaches from Thompson and Harmonic into compelling customer offerings. Expanding our global footprint and driving greater profitability. From a stronger customer demand and competitive wins we’ve seen through the first half of the year to validate that we’re on track here. We’re also investing our Cable Edge business that is poised for significant growth with a release of our new CableOS platform. For most of 2016 will be spend - bringing this CableOS product to market, positive customer engagements and the pending cable architectural shift give us confidence in the growth potential of this business. And finally I want to confirm that our entire organization is focused on the execution of these strategic initiatives. Driving competitive wins that will translate into top line growth and margin expansion, delivering on approximately $20 million of annualized synergies, and positioning the company to exit 2016 with double digit operating profit and be poised for new phase of profitable growth. So with that let’s now open the call up for your questions.

[Operator Instructions] And we have a question from George Notter from Jefferies. Please go ahead.

Hi, guys. Thanks very much, and thank you for all the detail on the call. I guess I had a few questions. I guess maybe this is more housekeeping. But, on the $10 million nonrecurring engineering deal, I guess I'm curious if you could say anything about, which side of the business is that on? Is it on the Cable Edge side, or is it video? I guess I'm also curious if you could tell us what genre of customer that might be, a cable operator or otherwise. And I'm also curious about anything you can say on what technologies are involved or whether or not that technology would be exclusive to the partner there or something that you can leverage across other customers. Maybe I'll just start with that and come back for a follow up.

Well, I think all around the questions, George I'm very sorry at this point I can’t answer any of them. As I mentioned we are bound by a very strict confidentiality agreement. So at this point just have to - I guess trust us that this is a exciting a very positive for the business and very positive for shareholders. And we look forward to a point in the future when we can disclose more.

Can you at least…

George the only thing I would add to that - is that the payments are based on milestone and we did hit our first set of milestones in the July timeframe and received the first payment. So the activity is underway.

Got it. Okay. And can you just answer the one about exclusivity? Is there a way to leverage this technology across other customers as well?

We can’t answer in explicitly George I am sorry.

Okay.

But I would tell you we wouldn't do any deal that didn't make good sense for the business.

Got it. Okay. And then also, I was just curious about your comments about product discontinuances. Is that affecting revenue materially here? Is it -- did it show up in this quarter? Was it something that's more prospective looking? Is it in the full year guidance? How should we think about that?

Yes, I’ll tell you but it boiled down to quite simply was that as I indicated in my comments our revenue for Cable Edge is prior than our initial guidance by roughly 5 million. So we had some products that didn't have much activity and to sell those products in today’s environment we would had to put more R&D and sales opportunity thought was justified given the opportunity that we have with CableOS. So we made a decision to basically discontinue those products again and that didn’t have much activity to begin with. They had no impacts on our overall revenue generation at this point and going forward and the we don't think there’s any other costs related to those type of products. So that would have to be addressed at a later point.

All right. It sounds like we may have missed – lost George there so why don’t we move on.

Our next question is from Greg Mesniaeff from Drexel Hamilton. Please go ahead.

Yes, thanks. Besides breaking out revenues by video and Cable Edge, can you give us some color as to geographic mix and/or mix by type of customer? A – Harold Covert: Yes, I mean there is some geographic information that will be included in our 10-Q filing tomorrow. But we’re following our traditional pattern of roughly about half of our revenue and bookings in the Americas and then 30% or so in Europe and the balance in Asia. So I don't think there's any real changes to those patterns at this point.

Okay. And as far as cable operators versus broadcasters, any difference to your historical trends or patterns? A – Harold Covert: No, I would say that it's pretty much in line with our historical pattern, service provider is roughly about 60% or so and then the balance is media and broadcast. And again our patterns have held pretty consistent throughout the first half of the year.

Got it. Any greater than10% customer? A – Harold Covert: Not, not this quarter. No.

Okay, got it. Okay I'll stop there and I'll come back. Thanks.

Our next question is from Matthew Galinko from Sidoti. Please go ahead.

Hey, good afternoon, guys. Patrick, you highlighted pay -- I guess Ultra HD adoption as a catalyst for some of those trends maybe you're seeing in the video business. I was wondering if there's anything you could -- anything specific you could highlight, where that's -- whether geographically or any customers you could talk about that are -- that might be driving that.

It’s a good question. I want also to clarify that it's one of the several drivers that we see of the stronger video demand top of aggressive competition between tortious service providers, investment and over the top .And indeed we are starting to see slower than we had at one time expected but nonetheless a steady increase in 4K or Ultra HD activity. And we’ve had a couple of interesting press releases speaking about what we're doing there including a couple months back with a content producer I’d call Sneaky TV you'll probably also seeing some of the advertising some of our service providers talking about one or two channels better programming available in Ultra HD. And indeed what we’re seeing is really right across the globe we're seeing large service providers looking to add a couple of Ultra HD channels to their packages with our portfolios. So on one hand it’s a service providers on the other hand people like the broadcast to many companies we’ve mentioned in a couple of press releases starting to produce more of the content. So this is a little bit the pattern, we saw if you go back several years ago with HD it’s the flywheel starting to move, more content getting produced and for us that's an opportunity. And then more service provider starting to offer initially a couple of channels and then growing. As you may have also seen in our most recent press release about what we plan on showing at the upcoming big event in Amsterdam, the IBC Show over the top streaming of Ultra HD is becoming a theme for us and it’s a definitely an area where we’re seeing customer interest and we're doing some interesting early work. So in summary it's still a relatively modest contribution to the revenue but it's definitely starting to move and grow and it's part of why we’re optimistic about the sustained demand trends in video infrastructure in general.

Got it. And maybe if I could just ask a two-part follow on, you highlighted that 75% of your encoding business this quarter was in your VOS. So, I guess, can you single out or break out at all how much of that was hardware versus the software? And I guess secondly, I guess -- maybe we'll just stick with that one for now.

Okay. Let me first clarify that for us what we've developed is software and what we do is we offered a package to lever the customer likes. We can do a deal where we put that software onto the commercial off-the-shelf server and ship it as a box. But to be clear we didn't do a lick of hardware engineering there. We just package the software with the box. And then some customers are saying you know what I’ve got my own blade servers just ship me the software and I’ll take that and I'll install it myself. We're ready to go either way and that’s the great and the exciting news. As it turns out and I’ll tell you frankly a little surprising to us still the majority of customers are asking for us to package it with an off-the-shelf server. And I think our gross margin trend it's indicative of the fact that you see that that hardware box we're passing through being part of the revenue basically neutral from a gross margin dollar perspective. But I’ll tell you a couple of our largest customers are starting to tip towards just taking the software run on their own hardware, they’ve got volume purchasing on blade servers and they’ve also got the operational know-how. So I think it's going to be an interesting space to watch over the next several quarters of where they're ready to go as fast as the market will allow us. But I want to emphasize it's all the same code base for us. It's just a simply a matter of where and how it gets bound with off-the-shelf hardware. Did I answer your question?

Fair enough. It does. And if I could just get the follow up in there -- apologize for hogging, but in terms of the strength in VOS, again, this quarter and just terms of in the mix, is -- I guess you kind of alluded to it in your -- in my first question. But, is that kind of -- is it operationally driven, where customers are pushing towards the newer platform, or is it looking for features like being able to encode Ultra HD content, or what would you say the primary driver of strength in the VOS is at this point?

The primary driver is actually the functionality we're delivering on top of the platform. You are right. Everything from Ultra HD to amazingly well compressed standard definition and high-definition content. I think the real innovation here is that we’re now doing that on commercial off-the-shelf the Intel, Xeon and i7 chips which is really a revolution in the industry to deliver this kind of pristine compression on these off-the-shelf platforms. Now of course customers like the fact strategically that this is a running on Intel and even if they’re getting server from us today many of them have strategic plans to pivot to their own their own data center infrastructure going forward. So I’d say that that overall architecture is a secondary benefit but the first and foremost is just the great compression and the other functionality that we’re including in these offerings. So this is the highest performing platform regardless of what the underlying hardware chipset is in the industry that were delivering. And the fact that we can do it on these commercially available Intel chips is all the more amazing and I think call it more powerful in the marketplace.

Excellent, thank you.

And we have a question from Tim Savageaux from Northland Capital. Please go ahead.

Okay. I think that's me. Good afternoon. And some questions on the service provider front, if we can -- and pardon me if I missed some of this. I'm hopping on the call late. But, if you could talk to sort of organic trends on the cable spending side in particular across both your Edge and video businesses. You've seen pretty strong indications really through the first half here of kind of a pretty robust spending environment amongst North American cable operators. I wonder if kind of that's what you're seeing and if you have any outlook there. I ask because it's obviously tough to get kind of organic -- an organic sense of what's happening with your service provider business as you fold in Thomson. And I guess I'd ask the same question about kind of U.S. satellite providers. Thanks.

Okay, Tim I’ll take that perhaps Hal will jump in. The business is good with cable I guess is the headline there. The dynamics on the two sides of our business are indeed different. We’ve got the market leading EdgeQAM platform where EdgeQAM are needed we think we’re winning business and we had a modestly up quarter in legacy EdgeQAM. That being said cable operators are embarking on a big architectural transition and frankly we’re positive although looking ahead with their investments to this next generation CCAP and in our particular case as we get closer and closer to General: In no apparent distress. Awake, alert, and oriented x3. Mood and affect appropriate. Availability of our new cable less platform naturally we see customers pulling back a little bit and waiting looking ahead to that platform. So that’s what’s behind the commentary about softening Cable-Edge demand in the second quarter of year as we transition from legacy EdgeQAM to our new CableOS launch. On the other side of the equation things have been going well for us in the digital video front with cable operators. Frankly there was real slowdown last year but the combination of the Ultra HD we were just talking about and some real significant advancements that we’ve made around compressing high definition content and some of the interesting things we’re doing around over-the-top. We’ve got good momentum with cable operators in the video front worldwide. And of course the subscription numbers that you’ve seen for cable as well as the boarder pay TV space are not bad. I think it’s clear that while cord cutting is a threat I think it’s not one that is turning out in the short term to be that damaging to our service provider businesses, customer’s business and they are responding to the threat. So we’ve seen a resurgence actually in spending not only in cable but also in satellite direct-to-home as well as telecom and while our largest customers are notoriously reticent to allow publicity I think you can go to some of the press releases we’ve made over the past couple of months Claro in Chile, America Mobile operation, Airtel in India. In Finland a very significant over-the-top project et cetera. So we see satellite direct-to-home as well as telecom operators following sue with cable and making investments and expanding and upgrading the video infrastructure.

So I’ll just add a few numbers to Patrick’s comments. In quarter one and quarter two we did, quarter one we did 17, quarter two we did 19 in our Cable Edge business and our guidance is 12 to 14 in Q3 so we had a strong first half. Our initial guidance for the full year was 12 million to 14 million for the first three quarters so again the first half was stronger than we had initially anticipated and that’s why we boosted our guidance from up by $5 million from our initial goals. We do expect our Q4 cable edge business to tick back up again from the Q3 level that I just mentioned primarily driven by just again the legacy sales at a fairly flat level relative to Q3 and then we are anticipating shipments of our new CableOS products in Q4. So we’re looking for again an uptick as we exit the year in our Cable Edge business.

Okay, thanks.

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

Hi, this is Victor Chiu in for Simon Leopold. I'm sorry if I missed this before, but what's driving the lower gross margin and the higher operating expenses relative to your prior guidance? I'm just trying to reconcile the new guidance that you gave relative to what you gave last quarter.

Yes, I would say, let me just start with the operating expenses because it’s a little bit easier. We closed TVN earlier than we had anticipated, we closed in February as opposed to in Q2. That added about 4 million to our operating expense guidance for the full year. If you take that $4 million out of the equation we were essentially right in line with our initial guidance. So OpEx again I think is straightforward. On the gross margin side we do expect to get in line with our initial guidance for our video business, I mean it’s fundamentally tracking along that path now and as we get into the back half of the year and have full recognition of software revenue we think we’ll be again right in line with the initial guidance. On the CableOS side we gave guidance of 40% to 41% gross margin versus our initial guidance of 45% to 47% primarily due to the mix. The hardware mix is a bit stronger than we had anticipated although as I indicated during the prepared comments we believe that our license revenue will follow those hardware shipments as head into 2017 so we’re looking for an uptick from that standpoint again next year. So I would just summarize by saying that, our Video business is essentially right on track with our initial guidance again with the earlier closing of TVN taking into consideration and our Cable Edge business is tracking from a top line standpoint off slightly from a gross margin standpoint again due to the content of revenue I just mentioned.

Okay. And there is no impact to revenue from the discontinuation of the products that you spoke about.

No, actually those were products that we had not had much activity on in their current configuration and to change would have to put R&D and additional sales focus on it and it just didn’t make sense for us and it did not impact our overall plans for our Cable Edge revenue in 2016.

Okay. Thank you.

And we have a question from Greg Mesniaeff from Drexel Hamilton. Please go ahead.

Yes, thank you. On the somewhat higher OpEx levels we're going to see in the second half of this year, is that something we can expect as a kind of a stable benchmark going forward beyond into next year from the TVN integration, or is that something that's just really part of this year's transitional-related stuff?

Well I think there is a couple of different ways to look at it Greg. The first one is that as we execute forward we believe that we’ll have a lower level in OpEx than we had in Q2 and in Q3 so we’re going to have a lower level in Q4 as we exit the year first point. The second point, as a percent of revenue our OpEx in Q3 and Q4 will be lower and particular in Q4 we’ll be at probably I think the lowest point that Harmonic has had for OpEx as a percent of revenue in a number of years and I think the most important point is with the operating expense run rate that we expect to have we will be in a position to generate double-digit operating profit in 2017 without a significant increase in revenue. So I think the expenses are about where we targeted them to be and again with the exit rate that we’re planning for the year we’re going to be in great shape from a percent of revenue standpoint as well as generating double-digit operating profit heading into 2017.

Got it. Thank you.

Okay, well thank you all very much for joining us. We'll call it an afternoon there. Please know that we’re committed to continuing this momentum looking forward to a good Q3, a good rest of the year. We appreciate your continued interest and support. Good day everybody.

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