HARMONIC INC - Quarter Report: 2010 October (Form 10-Q)

TABLE OF CONTENTS

PART I			3
ITEM 1. FINANCIAL STATEMENTS			3
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			32
ITEM 4. CONTROLS AND PROCEDURES			33
PART II			34
ITEM 1. LEGAL PROCEEDINGS			34
ITEM 1A. RISK FACTORS			34
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			52
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			53
ITEM 5. OTHER INFORMATION			53
ITEM 6. EXHIBITS			53
SIGNATURES			54
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HARMONIC INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

(In thousands, except par value amounts)		October 1, 2010				December 31, 2009
ASSETS
Current assets:
Cash and cash equivalents		$	70,523			$	152,477
Short-term investments			39,595				118,593
Accounts receivable, net of allowances of $5,528 and $5,163			92,438				64,838
Inventories			57,176				35,066
Deferred income taxes			39,923				26,503
Prepaid expenses and other current assets			24,873				20,821
Total current assets			324,528				418,298
Property and equipment, net			38,752				25,941
Goodwill			212,475				63,953
Intangibles, net			125,461				25,265
Other assets			1,989				22,847
Total assets		$	703,205			$	556,304
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	28,465			$	22,065
Income taxes payable			2,808				609
Deferred revenue			41,412				32,855
Accrued liabilities			40,045				37,584
Total current liabilities			112,730				93,113
Accrued excess facilities costs, long-term			—				58
Income taxes payable, long-term			41,768				43,948
Financing liability, long-term			—				6,908
Deferred income taxes, long-term			15,633				—
Other long-term liabilities			4,473				4,804
Total liabilities			174,604				148,831
Commitments and contingencies (Notes 15 and 16)
Stockholders’ equity:
Preferred stock, $0.001 par value, 5,000 shares authorized; no shares issued or outstanding			—				—
Common stock, $0.001 par value, 150,000 shares authorized; 111,816 and 96,110 shares issued and outstanding as of October 1, 2010 and December 31, 2009, respectively			112				96
Capital in excess of par value			2,392,101				2,279,945
Accumulated deficit			(1,863,130	)			(1,872,533	)
Accumulated other comprehensive loss			(482	)			(35	)
Total stockholders’ equity			528,601				407,473
Total liabilities and stockholders’ equity		$	703,205			$	556,304

The accompanying notes are an integral part of these condensed consolidated financial statements.

HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

		Three Months Ended								Nine Months Ended
		October 1,				October 2,				October 1,				October 2,
(In thousands, except per share amounts)		2010				2009				2010				2009
Product revenue		$	90,597			$	72,553			$	249,292			$	202,973
Service revenue			14,187				11,308				35,857				29,936
Net revenue			104,784				83,861				285,149				232,909
Product cost of revenue			53,019				44,477				140,086				126,617
Service cost of revenue			4,233				3,304				11,044				11,281
Total cost of revenue			57,252				47,781				151,130				137,898
Gross profit			47,532				36,080				134,019				95,011
Operating expenses:
Research and development			19,002				15,879				52,946				45,825
Selling, general and administrative			25,999				19,405				70,917				61,431
Amortization of intangibles			959				1,367				2,026				3,289
Total operating expenses			45,960				36,651				125,889				110,545
Income (loss) from operations			1,572				(571	)			8,130				(15,534	)
Interest income, net			165				583				974				2,764
Other expense, net			(405	)			(212	)			(903	)			(893	)
Income (loss) before income taxes			1,332				(200	)			8,201				(13,663	)
Provision for (benefit from) income taxes			1,693				(2,777	)			(1,202	)			10,523
Net income (loss)		$	(361	)		$	2,577			$	9,403			$	(24,186	)
Net income (loss) per share
Basic		$	(0.00	)		$	0.03			$	0.10			$	(0.25	)
Diluted		$	(0.00	)		$	0.03			$	0.10			$	(0.25	)
Weighted average shares
Basic			100,246				96,104				97,975				95,742
Diluted			100,246				96,732				98,672				95,742

The accompanying notes are an integral part of these condensed consolidated financial statements.

HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

		Nine Months Ended
		October 1,				October 2,
(In thousands)		2010				2009
Cash flows from operating activities:
Net income (loss)		$	9,403			$	(24,186	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Amortization of intangibles			8,904				9,222
Depreciation			6,696				6,299
Stock-based compensation			10,180				7,637
Net loss on disposal of fixed assets			73				191
Deferred income taxes			(57	)			—
Other non-cash adjustments, net			1,344				1,995
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable, net			(10,531	)			(303	)
Inventories			(11,088	)			12,098
Prepaid expenses and other assets			(1,786	)			9,064
Accounts payable			(1,898	)			(1,279	)
Deferred revenue			994				(887	)
Income taxes payable			(104	)			2,156
Accrued excess facilities costs			(5,230	)			(4,446	)
Accrued and other liabilities			(5,688	)			(27,332	)
Net cash provided by (used in) operating activities			1,212				(9,771	)
Cash flows used in investing activities:
Purchases of investments			(39,035	)			(101,221	)
Proceeds from maturities of investments			83,689				119,001
Proceeds from sales of investments			32,609				27,240
Acquisition of property and equipment			(29,837	)			(6,105	)
Acquisition of Rhozet			—				(453	)
Acquisition of Scopus, net of cash acquired			—				(63,053	)
Acquisition of Omneon, net of cash acquired			(153,254	)			—
Net cash used in investing activities			(105,828	)			(24,591	)
Cash flows from financing activities:
Proceeds from lease financing liability			18,833				—
Proceeds from issuance of common stock, net			3,918				4,239
Net cash provided by financing activities			22,751				4,239
Effect of exchange rate changes on cash and cash equivalents			(89	)			207
Net decrease in cash and cash equivalents			(81,954	)			(29,916	)
Cash and cash equivalents at beginning of period			152,477				179,891
Cash and cash equivalents at end of period		$	70,523			$	149,975
Supplemental disclosure of cash flow information:
Income tax payments, net		$	984			$	2,598
Non-cash investing and financing activities:
Issuance of restricted common stock for Rhozet acquisition		$	—			$	1,870
Issuance of restricted common stock for Omneon acquisition		$	95,938			$	—
Fair value of vested portion of stock options and restricted stock units assumed in connection with the Omneon acquisition		$	2,125			$	—

The accompanying notes are an integral part of these condensed consolidated financial statements.

HARMONIC INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: BASIS OF PRESENTATION

Basis of Presentation. The accompanying unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) which Harmonic Inc. (“Harmonic,” or the “Company”) considers necessary for a fair presentation of the results of operations for the interim periods covered and the consolidated financial condition of the Company at the date of the balance sheets. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 1, 2010. The interim results presented herein are not necessarily indicative of the results of operations that may be expected for the full fiscal year ending December 31, 2010, or any other future period. The Company’s fiscal quarters are based on 13-week periods, except for the fourth quarter which ends on December 31.

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The year-end condensed balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Use of Estimates. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications. The Company has reclassified certain prior period balances to conform to the current year presentation. These reclassifications have no impact on previously reported total assets, total liabilities, stockholders’ equity, results of operations or cash flows.

NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS

In October 2009, the FASB issued revised guidance for revenue recognition with multiple deliverables. This guidance impacts the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, this guidance modifies the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. This revised guidance is effective beginning in the first quarter of fiscal year 2011; however early adoption is permitted. The Company is currently evaluating the potential impact, if any, of the adoption of the revised accounting guidance on its consolidated results of operations, financial condition and cash flows.

In October 2009, the FASB issued revised guidance for the accounting for certain revenue arrangements that include software elements. This guidance amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. This revised guidance is effective beginning in the first quarter of fiscal year 2011; however early adoption is permitted. The Company is currently evaluating the potential impact, if any, of the adoption of the revised accounting guidance on its consolidated results of operations, financial condition and cash flows.

In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for

fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the interim reporting requirements by the Company in the first quarter of 2010 did not have a material impact on its consolidated results of operations or financial condition.

NOTE 3: ACQUISITIONS

Omneon

On September 15, 2010, Harmonic completed the acquisition of 100% of the equity interests of Omneon, Inc., a privately-held company organized under the laws of Delaware and headquartered in Sunnyvale, California. Omneon develops and supports a range of video servers, active storage systems and related software applications that media companies use to simultaneously ingest, process, store, manage and deliver digital media in a wide range of formats. When used for television production and on-air operations, the products are designed to provide continuous real-time record and playback capabilities as well as file-based access to and delivery of digital media content. Omneon’s products include Spectrum video servers, MediaGrid active storage systems, Media Application server and other software applications which were initially designed for, and have been deployed mostly by, broadcasters that use Omneon’s products for the production and transmission of television content.

The acquisition of Omneon is intended to strengthen Harmonic’s competitive position in the digital media market and to broaden the Company’s relationships with customers who produce and distribute digital video content, such as broadcasters, cable channels and other major owners of content. The acquisition is also intended to broaden Harmonic’s technology and product lines with digital storage and playout solutions which complement Harmonic’s existing video processing products. In addition, the acquisition provided an assembled workforce, the implicit value of future cost savings as a result of combining entities, and is expected to provide Harmonic with future unidentified new products and technologies. These opportunities were significant factors to the establishment of the purchase price, which exceeded the fair value of Omneon’s net tangible and intangible assets acquired resulting in goodwill of approximately $147.8 million that was recorded in connection with this acquisition.

The purchase price, net of $40.5 million of cash acquired, was $251.3 million, which consisted of (i) approximately $153.3 million in cash, net of cash acquired, (ii) 14.2 million shares of Harmonic common stock with a total fair value of approximately $95.9 million, based on the price of Harmonic common stock at the time of close, and (iii) approximately $2.1 million representing the fair value attributed to shares of Omneon equity awards which Harmonic assumed for which services had already been rendered as of the close of the acquisition. The cash portion of the purchase price was paid from existing cash balances and is subject to a post-closing adjustment based on Omneon’s working capital. The Company also incurred a total of $5.7 million of transaction expenses, which were expensed as selling, general and administrative expenses in the second and third quarters of 2010.

The assets and liabilities of Omneon were recorded at fair value at the date of acquisition. The Company will continue to evaluate certain assets and liabilities as new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. Changes to the assets and liabilities recorded may result in a corresponding adjustment to goodwill and the measurement period shall not exceed one year from the acquisition date. Further, any associated restructuring activities will be expensed in future periods and not recorded through purchase accounting as previously done under prior accounting guidance. There are no contingent consideration arrangements in connection with the acquisition.

The results of operations of Omneon are included in Harmonic’s Consolidated Statements of Operations from September 15, 2010, the date of acquisition. The following table summarizes the allocation of the purchase price based on the fair value of the assets acquired and the liabilities assumed at the date of acquisition:

(In thousands)
Cash acquired		$	40,485
Accounts receivable (Gross amount due from accounts receivable of $17,760)			17,055
Inventory			11,010
Fixed assets			12,391
Deferred income tax assets			17,960
Other tangible assets acquired			2,653
Intangible assets:
Existing technology			50,800
In-process technology			9,000
Patents/core technology			9,800
Customer contracts and related relationships			29,200
Trade names/trademarks			4,000
Maintenance agreements and related relationships			5,500
Order backlog			800
Goodwill			147,756
Total assets acquired			358,410
Accounts payable			(6,829	)
Deferred revenue			(6,399	)
Deferred income tax liabilities			(42,052	)
Other accrued liabilities			(11,328	)
Net assets acquired			291,802
Less: cash acquired			(40,485	)
Net purchase price		$	251,317

The purchase price set forth in the table above was allocated based on the fair value of the tangible and intangible assets acquired and liabilities assumed as of September 15, 2010. The Company used an overall discount rate of 15% to estimate the fair value of the intangible assets acquired, which was derived based on financial metrics of comparable companies operating in Omneon’s industry. In determining the appropriate discount rates to use in valuing each of the individual intangible assets, the Company adjusted the overall discount rate giving consideration to the specific risk factors of each asset. The following methods were used to value the identified intangible assets:

	•		The fair value of the existing technology assets acquired was established based on their highest and best use by a market participant using the “Income Approach.” The Income Approach included an analysis of the markets, cash flows and risks associated with achieving such cash flows to calculate the fair value;
	•		As of the acquisition date, Omneon was developing new versions and incremental improvements to its 3G MediaPort product, which is expected to be used in the Spectrum product line once completed. The in-process project was at a stage of development that required further research and development to determine technical feasibility and commercial viability. The fair value of the in-process technology assets acquired was based on the valuation premise that the assets would be “In-Use” using a discounted cash flow model;
	•		The fair value of patents/core technology assets acquired was established based on a variation of the Income Approach called the “Profit Allocation Method”. In the Profit Allocation Method, we estimated the value of the patents/core technology by capitalizing the profits expected to be saved because Harmonic owns the technology;
	•		The fair value of the customer contracts and related relationships assets acquired was based on the Income Approach;
	•		The fair value of trade names/trademarks assets acquired was established based on the Profit Allocation Method;
	•		The fair value of the maintenance agreements and related relationships assets acquired was based on the Income Approach; and
	•		The fair value of backlog acquired was established based on the Income Approach.

Identified intangible assets are being amortized over the following useful lives:

	•		Existing technology is estimated to have a useful life of four years;
	•		In-process technology will be amortized upon completion over its projected remaining useful life as assessed on the completion date. The completion of the in-process project is expected within the next twelve months;
	•		Patents/core technology are being amortized over their estimated useful life of four years;

	•		Customer contracts and related relationships are being amortized over their estimated useful life of six years;
	•		Trade name/trademarks are being amortized over their estimated useful lives of four years;
	•		Maintenance agreements and related relationships are being amortized over their estimated useful life of six years; and
	•		Order backlog is being amortized over its estimated useful life of three and one half months.

The existing technology, patents/core technology, customer contracts and related relationships, maintenance agreements and related relationships, trade name/trademarks and backlog are being amortized using the straight-line method which reflects the future projected cash flows.

The residual purchase price of $147.8 million has been recorded as goodwill. The goodwill resulting from this acquisition is not deductible for federal tax purposes.

Substantially all unvested stock options and unvested restricted stock units issued by Omneon and outstanding at closing were assumed by Harmonic. The exchange of stock-based compensation awards was treated as a modification under current accounting guidance. The calculation of the fair value of the exchanged awards immediately before and after the modification did not result in any significant incremental fair value. The fair value of Harmonic’s stock options and restricted stock units issued to Omneon employees was $17.3 million, which was determined using the Black-Scholes option pricing model, of which $2.1 million represents purchase consideration and $15.1 million will be recorded as compensation expense over the weighted average service period of 2.5 years.

For the period from closing through October 1, 2010, Omneon products contributed revenues of $5.6 million and a net operating loss of $0.9 million.

Scopus

On March 12, 2009, Harmonic completed the acquisition of 100% of the equity interests of Scopus Video Networks Ltd., or Scopus, a publicly traded company based in Israel. Scopus was engaged in the development and support of digital video networking products that allowed network operators to transmit, process, and manage digital video content. Scopus’ primary products included integrated receivers/decoders (“IRD”), intelligent video gateways (“IVG”), and encoders. In addition, Scopus marketed multiplexers, network management systems (“NMS”), and other ancillary technology to its customers.

The acquisition of Scopus strengthened Harmonic’s technology and market leadership, particularly in the broadcast contribution and distribution markets. The acquisition extended Harmonic’s diversification strategy, providing it with an expanded international sales force and global customer base, particularly in video broadcast, contribution and distribution markets, as well as complementary video processing technology and expanded research and development capability. In addition, the acquisition provided an assembled workforce, the implicit value of future cost savings as a result of combining entities, and is expected to provide Harmonic with future unidentified new products and technologies. These opportunities were significant factors to the establishment of the purchase price, which exceeded the fair value of Scopus’ net tangible and intangible assets acquired resulting in goodwill of approximately $22.8 million that was recorded in connection with this acquisition.

The purchase price, net of $23.3 million of cash acquired, was $63.1 million, which was paid from existing cash balances. The Company also incurred a total of $3.4 million of transaction expenses, which were expensed as selling, general and administrative expenses in the first quarter of 2009.

The assets and liabilities of Scopus were recorded at fair value at the date of acquisition. Further, any associated restructuring activities will be expensed in future periods and not recorded through purchase accounting as previously done under prior accounting guidance. Subsequent to the acquisition, the Company recorded expenses of $8.2 million in the year ended December 31, 2009, primarily for excess and obsolete inventories related to product discontinuances and severance costs.

The results of operations of Scopus are included in Harmonic’s Consolidated Statements of Operations from March 12, 2009, the date of acquisition. The following table summarizes the allocation of the purchase price based on the fair value of the assets acquired and the liabilities assumed at the date of acquisition:

(In thousands)
Cash acquired		$	23,316
Investments			1,899
Accounts receivable (Gross amount due from accounts receivable of $6,977)			6,308
Inventory			15,899
Fixed assets			4,280
Other tangible assets acquired			2,312
Intangible assets:
Existing technology			10,100
In-process technology			2,400
Patents/core technology			3,500
Customer contracts and related relationships			4,000
Trade names/trademarks			2,100
Maintenance agreements and related relationships			1,000
Order backlog			2,000
Goodwill			22,847
Total assets acquired			101,961
Accounts payable			(2,963	)
Deferred revenue			(336	)
Other accrued liabilities			(12,293	)
Net assets acquired			86,369
Less: cash acquired			(23,316	)
Net purchase price		$	63,053

The purchase price set forth in the table above was based on the fair value of the tangible and intangible assets acquired and liabilities assumed as of March 12, 2009. The Company used an overall discount rate of 16% to estimate the fair value of the intangible assets acquired, which was derived based on financial metrics of comparable companies operating in Scopus’ industry. In determining the appropriate discount rates to use in valuing each of the individual intangible assets, the Company adjusted the overall discount rate giving consideration to the specific risk factors of each asset. The following methods were used to value the identified intangible assets:

	•		The fair value of the existing technology assets acquired was established based on their highest and best used by a market participant using the “Income Approach.” The Income Approach included an analysis of the markets, cash flows and risks associated with achieving such cash flows to calculate the fair value. As of the acquisition date, Scopus was developing new versions and incremental improvements to its IRD, encoder and IVG products;
	•		The in-process projects were at a stage of development that required further research and development to determine technical feasibility and commercial viability. The fair value of the in-process technology assets acquired was based on the valuation premise that the assets would be “In-Use” using a discounted cash flow model;
	•		The fair value of patents/core technology assets acquired was established based on a variation of the Income Approach called the “Profit Allocation Method”. In the Profit Allocation Method, we estimated the value of the patents/core technology by capitalizing the profits saved because Harmonic owns the technology;
	•		The fair value of the customer contracts and related relationships assets acquired was based on the Income Approach;
	•		The fair value of trade names/trademarks assets acquired was established based on the Profit Allocation Method;
	•		The fair value of the maintenance agreements and related relationships assets acquired was based on the Income Approach; and
	•		The fair value of backlog acquired was established based on the “Cost Savings Approach.”

Identified intangible assets are being amortized over the following useful lives:

	•		Existing technology is estimated to have a useful life between three years and five years;
	•		In-process technology is being amortized upon completion over its projected remaining useful life as assessed on the completion date. Three of the in-process projects were completed in the fourth quarter of 2009 and the remaining three projects were completed in the first quarter of 2010. The completed technology is estimated to have useful lives between three and six years;
	•		Patents/core technology are being amortized over their useful life of four years;
	•		Customer contracts and related relationships are being amortized over their useful life of between four years and five years;
	•		Trade name/trademarks are being amortized over their estimated useful lives of five years;
	•		Maintenance agreements and related relationships are being amortized over their useful life of four years; and
	•		Order backlog was amortized over its estimated useful life of six months.

The existing technology, patents/core technology, customer contracts, maintenance agreements and related relationships, trade name/trademarks and backlog are being amortized using the straight-line method which reflects the future projected cash flows.

The residual purchase price of $22.8 million has been recorded as goodwill. The goodwill as a result of this acquisition is not deductible for federal tax purposes.

For the three month period ended October 2, 2009, Scopus products contributed revenues of $6.9 million and a net operating loss of $1.5 million. For the period from March 12, 2009 to October 2, 2009, Scopus products contributed revenues of $14.5 million and a net operating loss of $13.7 million.

Pro Forma Financial Information

The unaudited pro forma financial information presented below for the 2009 periods summarizes the combined results of operations as if the Scopus and Omneon acquisitions had been completed on January 1, 2009. The unaudited pro forma financial information for the three months ended October 2, 2009 combines the results for Harmonic for the three months ended October 2, 2009 and the historical results of Omneon for the three months ended September 30, 2009. The unaudited pro forma financial information for the nine months ended October 2, 2009 combines the results for Harmonic for the nine months ended October 2, 2009, the historical results of Scopus through March 12, 2009, the date of acquisition and the historical results of Omneon for the nine months ended September 30, 2009.

The unaudited pro forma financial information presented below for the 2010 periods summarizes the combined results of operations as if the Omneon acquisition had been completed on January 1, 2010. The unaudited pro forma financial information for the three and nine months ended October 1, 2010 combines the results for Harmonic for the three and nine months ended October 1, 2010 and the historical results of Omneon through September 15, 2010, the date of acquisition.

The pro forma financial information is presented for informational purposes only and does not purport to be indicative of what would have occurred had the merger actually been completed on such dates or of results which may occur in the future.

		Three Months Ended								Nine Months Ended
(In thousands, except per share data)		October 1, 2010				October 2, 2009				October 1, 2010				October 2, 2009
Net revenue		$	128,198			$	107,229			$	368,709			$	314,235
Net income (loss)		$	(2,852	)		$	(6,694	)		$	(4,940	)		$	(60,851	)
Net income (loss) per share — basic		$	(0.03	)		$	(0.06	)		$	(0.04	)		$	(0.55	)
Net income (loss) per share — diluted		$	(0.03	)		$	(0.06	)		$	(0.04	)		$	(0.55	)

NOTE 4: FAIR VALUE

The applicable accounting guidance establishes a framework for measuring fair value and expands required disclosure about the fair value measurements of assets and liabilities. This guidance requires the Company to classify and disclose assets and liabilities measured at fair value on a recurring basis, as well as fair value measurements of assets and liabilities measured on a nonrecurring basis in periods subsequent to initial measurement, in a three-tier fair value hierarchy as described below.

The guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The guidance describes three levels of inputs that may be used to measure fair value:

	•		Level 1 — Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.
	•		Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company primarily uses broker quotes for valuation of its short-term investments.

•

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company uses the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. During the nine months ended October 1, 2010, there were no nonrecurring fair value measurements of assets and liabilities subsequent to initial recognition.

The following table sets forth the fair value of the Company’s financial assets measured at fair value on a recurring basis as of October 1, 2010 and December 31, 2009 based on the three-tier fair value hierarchy:

(In thousands)		Level 1				Level 2				Level 3				Total
October 1, 2010
Money market funds		$	38,976			$	—			$	—			$	38,976
Corporate bonds			—				15,038				—				15,038
U.S. federal government bonds			—				11,122				—				11,122
State, municipal and local government agencies bonds			—				13,435				—				13,435
Total assets		$	38,976			$	39,595			$	—			$	78,571

(In thousands)		Level 1				Level 2				Level 3				Total
December 31, 2009
Money market funds		$	114,898			$	—			$	—			$	114,898
Corporate bonds			—				35,707				—				35,707
U.S. federal government bonds			—				46,536				—				46,536
State, municipal and local government agencies bonds			—				30,381				—				30,381
Other debt securities			—				5,969				—				5,969
Total assets		$	114,898			$	118,593			$	—			$	233,491

At October 1, 2010 and December 31, 2009, maturities of short-term investments are as follows:

(In thousands)		October 1, 2010				December 31, 2009
Short-term investments:
Less than one year		$	35,595			$	84,771
Due in 1-2 years			4,000				27,821
Due in 3-27 years			—				6,001
Total		$	39,595			$	118,593

The following is a summary of available-for-sale securities:

						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
(In thousands)		Cost				Gains				Losses				Fair Value
October 1, 2010
U.S. federal, state, municipal and local government agencies bonds		$	24,508			$	50			$	(1	)		$	24,557
Corporate debt securities			14,997				42				(1	)			15,038
Total		$	39,505			$	92			$	(2	)		$	39,595
December 31, 2009
U.S. federal, state, municipal and local government agencies bonds		$	76,712			$	214			$	(9	)		$	76,917
Corporate debt securities			35,655				74				(22	)			35,707
Other debt securities			5,744				234				(9	)			5,969
Total		$	118,111			$	522			$	(40	)		$	118,593

Impairment of Investments

Harmonic monitors its investment portfolio for impairment on a periodic basis. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, an impairment charge is recorded and a new

cost basis for the investment is established. In order to determine whether a decline in value is other-than-temporary, the Company evaluates, among other factors: the duration and extent to which the fair value has been less than the carrying value; the Company’s financial condition and business outlook, including key operational and cash flow metrics, current market conditions and future trends in the industry; and the Company’s relative competitive position within the industry. At the present time, the Company does not intend to sell its investments that have unrealized losses in accumulated other comprehensive loss. In addition, the Company does not believe that it is more likely than not that it will be required to sell its investments that have unrealized losses in accumulated other comprehensive loss before the Company recovers the principal amounts invested. The Company believes that the unrealized losses are temporary and do not require an other-than-temporary impairment, based on our evaluation of available evidence as of October 1, 2010.

As of October 1, 2010, there were no individual available-for-sale securities in a material unrealized loss position and the amount of unrealized losses on the total investment balance was insignificant.

NOTE 5: INVENTORIES

		October 1,				December 31,
(In thousands)		2010				2009
Raw materials		$	13,352			$	8,633
Work-in-process			2,858				3,072
Finished goods			40,966				23,361
		$	57,176			$	35,066

NOTE 6: GOODWILL AND IDENTIFIED INTANGIBLES

The following is a summary of goodwill and intangible assets as of October 1, 2010 and December 31, 2009:

		October 1, 2010												December 31, 2009
		Gross								Net				Gross								Net
		Carrying				Accumulated				Carrying				Carrying				Accumulated				Carrying
(In thousands)		Amount				Amortization				Amount				Amount				Amortization				Amount
Identified intangibles:
Developed core technology		$	126,051			$	(54,859	)		$	71,192			$	64,864			$	(48,013	)		$	16,851
In-process technology			9,000				—				9,000				600				—				600
Customer relationships/contracts			67,099				(34,612	)			32,487				37,900				(33,541	)			4,359
Trademarks and tradenames			11,367				(5,656	)			5,711				7,369				(5,136	)			2,233
Supply agreements			3,423				(3,423	)			—				3,427				(3,427	)			—
Maintenance agreements and related relationships			7,100				(695	)			6,405				1,600				(405	)			1,195
Software license, intellectual property and assembled workforce			309				(300	)			9				309				(282	)			27
Order backlog			2,800				(2,143	)			657				2,000				(2,000	)			—
Subtotal of identified intangibles			227,149				(101,688	)			125,461				118,069				(92,804	)			25,265
Goodwill			212,475				—				212,475				63,953				—				63,953
Total goodwill and other intangibles		$	439,624			$	(101,688	)		$	337,936			$	182,022			$	(92,804	)		$	89,218

The changes in the carrying amount of goodwill for the nine months ended October 1, 2010 are as follows:

(In thousands)		Goodwill
Balance as of December 31, 2009		$	63,953
Acquisition of Omneon			147,756
Adjustment to deferred tax liability associated with the Scopus acquisition			786
Foreign currency translation adjustments			(20	)
Balance as of October 1, 2010		$	212,475

For the three and nine months ended October 1, 2010, the Company recorded a total of $3.7 million and $8.9 million of amortization expense for identified intangibles, of which $2.7 million and $6.9 million, was included in cost of revenue, respectively. For the three and nine months ended October 2, 2009, the Company recorded a total of $3.6 million and $9.2 million of amortization expense for

identified intangibles, of which $2.2 million and $5.9 million was included in cost of revenue, respectively. The estimated future amortization expense of purchased intangible assets with definite lives is as follows:

(In thousands)

						Operating
Years Ending December 31,		Cost of Revenue				Expenses				Total
2010 (remaining 3 months)		$	5,635			$	2,887			$	8,522
2011			19,364				8,907				28,271
2012			17,991				8,715				26,706
2013			16,719				8,096				24,815
2014			11,231				6,775				18,006
2015 and after			261				9,880				10,141
Total		$	71,201			$	45,260			$	116,461

NOTE 7: RESTRUCTURING AND EXCESS FACILITIES

The Company has recorded restructuring and excess facilities charges beginning in 2001 and throughout subsequent years as a result of changing conditions in the use of its facilities in the United States and the United Kingdom. The initial expenses that had been recorded to selling, general and administrative expense and the related liabilities have been adjusted periodically for changes in sublease income estimates.

In the first quarter of 2009, the Company recorded a total of $7.4 million of expenses related to activities resulting from the Scopus acquisition, including the termination of approximately 65 Scopus employees. A charge of $6.3 million was recorded in cost of revenue, consisting of excess and obsolete inventories expenses from product discontinuances and severance expenses for terminated Scopus employees. Research and development expenses were $0.6 million for terminated Scopus employees. Selling, general and administrative expenses totaled $0.5 million consisting primarily of severance expenses for terminated Scopus employees. Substantially all of the severance was paid during the three months ended April 3, 2009.

As of October 1, 2010, accrued excess facilities cost totaled $0.1 million, which was included in current accrued liabilities and is expected to be substantially paid in the remainder of 2010. The Company incurred cash outlays of $5.0 million during the first nine months of 2010 principally for lease payments, property taxes, insurance and other maintenance fees related to vacated facilities.

Harmonic reassesses this liability quarterly and adjusts as necessary based on changes in the timing and amounts of expected sublease rental income.

The following table summarizes the activities in the restructuring accrual during the first nine months of 2010:

		Excess				Campus				BTL				Scopus
(In thousands)		Facilities				Consolidation				Closure				Facilities				Total
Balance at December 31, 2009		$	3,117			$	1,715			$	276			$	224			$	5,332
Provisions/(recoveries)			(157	)			(2	)			(71	)			4				(226	)
Cash payments, net of sublease income			(2,960	)			(1,713	)			(205	)			(127	)			(5,005	)
Balance at October 1, 2010		$	—			$	—			$	—			$	101			$	101

NOTE 8: CREDIT FACILITIES

Harmonic has a bank line of credit facility with Silicon Valley Bank, which provides for borrowings of up to $10.0 million that matures on March 2, 2011. As of October 1, 2010, other than standby letters of credit and guarantees (Note 15), there were no amounts outstanding under the line of credit facility and there were no borrowings in 2009 or 2010. This facility, which was amended and restated in March 2010, contains a financial covenant with the requirement for Harmonic to maintain unrestricted cash, cash equivalents and short-term investments, net of credit extensions, of not less than $35.0 million. If Harmonic were unable to maintain this cash, cash equivalents and short-term investments balance, Harmonic would not be in compliance with the facility. In the event of noncompliance by Harmonic with the covenants under the facility, Silicon Valley Bank would be entitled to exercise its remedies under the facility which include declaring all obligations immediately due and payable. At October 1, 2010, Harmonic was in compliance with the covenants under this line of credit facility. Future borrowings pursuant to the line would bear interest at the bank’s prime rate (4.0% at October 1, 2010). Borrowings are payable monthly and are not collateralized.

NOTE 9: FINANCING LIABILITY FOR CONSTRUCTION IN PROGRESS

The lease for the building at the Company’s Sunnyvale location ended in September 2010. In December 2009, the Company entered into a lease for a building in San Jose, California, which was intended to become the Company’s new headquarters. In January 2010, the Company began a build-out of this facility and during the construction incurred approximately $18.9 million in structural leasehold improvements. Under the terms of the lease, the landlord reimbursed $18.8 million of the construction costs. Because certain improvements constructed by the Company were considered structural in nature and the Company was responsible for any cost overruns, the Company was considered to be the owner of the construction project for accounting purposes under applicable accounting guidance on the effect of lessee involvement in asset construction.

As a result, the Company capitalized the fair value of the building of $6.9 million with a corresponding credit to financing liability. The fair value was determined as of December 31, 2009 using a combination of the revenue comparison approach and the income capitalization approach. During the nine months ended October 1, 2010, the liability increased by $18.9 million due to additional structural leasehold improvements, by $0.2 million due to land lease expense and by $0.2 million due to capitalized interest expense.

Construction was completed in September 2010 at which time the Company relocated to the new building. Upon completion of construction in September 2010, the Company assessed and concluded that it qualified for sale-leaseback accounting under applicable accounting guidance since the Company has no form of continuing involvement other than the leaseback. In connection with the sale-leaseback of the building the Company removed from its books the carrying value of the building, the structural leasehold improvements and the financing liability.

NOTE 10: BENEFIT PLANS

Stock Option Plans. Harmonic has reserved 22,809,000 shares of Common Stock for issuance under various employee stock option plans. Stock options are granted for periods not exceeding ten years and generally vest 25% at one year from date of grant, and an additional 1/48 per month thereafter. Beginning on February 27, 2006, option grants had a term of seven years. Restricted stock units have no exercise price and generally vest over four years with 25% vesting at one year from date of grant or the vesting commencement date chosen for the award, and either an additional 1/16 per quarter thereafter, or 1/8 semiannually thereafter. In May 2010, Harmonic stockholders approved amendments to the 1995 Stock Plan (the “1995 Plan”) and increased the maximum number of shares of common stock authorized for issuance by an additional 10,600,000 shares, decreased the maximum term of stock options to seven years and changed the share counting provisions to provide that each award with an exercise price below 100% of the fair market value on the grant date (or no exercise price) would decrease the 1995 Plan reserve 1.5 shares for every unit or share granted and any forfeitures of these awards due to their not vesting would increase the 1995 Plan reserve by 1.5 shares for every unit or share forfeited. Previously, restricted stock units granted reduced the number of shares reserved for grant under the plans by two shares for every unit granted. Stock options are granted having exercise prices equal to the fair market value of the stock at the date of grant. Certain awards provide for accelerated vesting if there is a change in control. In the three and nine months of 2010, employees received restricted stock units valued at $10.2 million and $19.7 million, respectively. In the three and nine months ended October 2, 2009, employees received restricted stock units valued at $2.0 million and $9.3 million, respectively.

Director Option Plans. In May 2002, Harmonic’s stockholders approved the 2002 Director Option Plan (the “Plan”), replacing the 1995 Director Option Plan. In June 2006, Harmonic’s stockholders approved an amendment to the Plan and increased the maximum number of shares of common stock authorized for issuance over the term of the Plan by an additional 300,000 shares to 700,000 shares and reduced the term of future options granted under the Plan to seven years. In May 2008, Harmonic stockholders approved amendments to the Plan to, among other things, increase the maximum number of shares of common stock authorized for issuance by an additional 100,000 to 800,000 shares, and to rename the Plan the “2002 Director Stock Plan.” In May 2010, Harmonic stockholders approved amendments to the Plan and increased the maximum number of shares of common stock authorized for issuance by an additional 400,000 shares and changed the share counting provisions to provide that each award of restricted stock units would decrease the 2002 Plan reserve 1.5 shares for every unit granted and any forfeitures of unvested restricted stock units would increase the 1995 Stock Plan reserve by 1.5 shares for every unit forfeited. Harmonic had a total of 752,000 shares of Common Stock reserved for issuance under the Plan as of October 1, 2010. The Plan provides for the grant of non-statutory stock options or restricted stock units to certain non-employee directors of Harmonic. Restricted stock units, or RSUs, have no exercise price and vest either after one year or the vesting date chosen for such award. Previously, restricted stock units granted reduced the number of shares reserved for grant under the Plan by two shares for every unit granted. Stock options are granted at fair market value of the stock at the date of grant for periods not exceeding seven years. Initial option grants generally vest monthly over three years, and subsequent

grants generally vest monthly over one year. In the first nine months of 2010 and 2009, there were 87,367 and 99,463 units granted to non-employee directors, respectively.

A summary of share-based award activity during the nine months ended October 1, 2010 is as follows (in thousands):

		Shares
		Available
		for Grant
Balance at December 31, 2009			4,054
Shares authorized			11,000
Options granted			(2,466	)
Restricted stock units granted			(5,327	)
Restricted stock units canceled			223
Options canceled			510
Options expired			103
Balance at October 1, 2010			8,097

The following table summarizes restricted stock unit activity under the Plans:

						Weighted
		RSUs				Average Fair Value				Aggregate Fair
(In thousands except exercise price)		Outstanding				Per Share				Value (1)
Balance at December 31, 2009			1,637			$	5.88
Restricted stock units granted			3,092				6.53
Restricted stock units released			(757	)			5.88			$	4,599
Restricted stock units canceled			(112	)			6.23
Balance at October 1, 2010			3,860			$	6.36

The following table summarizes stock option activity under the Plans:

		Stock Options				Weighted Average
(In thousands except exercise price)		Outstanding				Exercise Price
Balance at December 31, 2009			10,499			$	9.44
Options granted			2,466				3.78
Options exercised			(167	)			4.82
Options canceled			(510	)			8.40
Options expired			(685	)			35.01
Balance at October 1, 2010			11,603			$	6.84
Options vested and exercisable as of October 1, 2010			7,501			$	7.66
Options vested and expected-to-vest as of October 1, 2010			11,453			$	6.87

The weighted-average fair value of options granted for the nine months ended October 1, 2010 was $4.18 The weighted-average fair value of options granted for the nine months ended October 2, 2009 was $2.80.

The following table summarizes information regarding stock options outstanding at October 1, 2010:

		Stock Options Outstanding												Stock Options Exercisable
						Weighted-
						Average
		Number				Remaining								Number				Weighted
Range of Exercise		Outstanding at				Contractual Life				Weighted-Average				Exercisable at				Average
Prices		October 1, 2010				(Years)				Exercise Price				October 1, 2010				Exercise Price
		(In thousands, except exercise price and life)
$        0.19 --   3.46			1,794				7.7			$	2.31				300			$	2.64
3.73 --   5.86			1,776				4.6				5.53				1,158				5.46
5.87 --   6.93			1,729				4.2				6.18				963				5.97
6.94 --   8.17			2,571				4.5				8.12				1,661				8.11
8.20 -- 8.79			1,714				3.5				8.26				1,495				8.25
8.80 -- 11.94			1,971				2.1				9.66				1,876				9.64
12.10 -- 16.73			48				1.2				13.94				48				13.94
			11,603				4.4			$	6.84				7.501			$	7.66

The weighted-average remaining contractual life for all exercisable stock options at October 1, 2010 was 3.2 years. The weighted-average remaining contractual life of all vested and expected-to-vest stock options at October 1, 2010 was 4.3 years. The weighted-average remaining contractual life of all vested and expected-to-vest restricted stock units at October 1, 2010 was 1.3 years.

Aggregate intrinsic value of options exercisable at October 1, 2010 was $4.1 million. The aggregate intrinsic value of stock options vested and expected-to-vest net of estimated forfeitures was $12.1 million at October 1, 2010. Aggregate intrinsic value represents the difference between our closing price on the last trading day of the fiscal period, which was $7.00 as of October 1, 2010, and the exercise price multiplied by the number of options outstanding or exercisable. The intrinsic value of exercised stock options is calculated based on the difference between the exercise price and the current market value at the time of exercise. The aggregate intrinsic value of exercised stock options was $0.1 million and $0.3 million during the three and nine months ended October 1, 2010, respectively.

Employee Stock Purchase Plan. In May 2002, Harmonic’s stockholders approved the 2002 Employee Stock Purchase Plan (the “2002 Purchase Plan”) replacing the 1995 Employee Stock Purchase Plan effective for the offering period beginning on July 1, 2002. As a result of the adoption of the 2002 Purchase Plan and subsequent stockholder-approved amendments, a total of 7.5 million shares have been approved for issuance pursuant to the 2002 Purchase Plan. In addition, in June 2006, the Company’s stockholders approved an amendment to the 2002 Purchase Plan to reduce the term of future offering periods to six months which became effective for the offering period beginning January 1, 2007. The 2002 Purchase Plan enables employees to purchase shares at 85% of the fair market value of the Common Stock at the beginning or end of the offering period, whichever is lower. Offering periods generally begin on the first trading day on or after January 1 and July 1 of each year. The 2002 Purchase Plan is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. During the first nine months of 2010 and 2009, the number of shares of stock issued under the purchase plans was 864,800 and 705,206 at weighted average prices of $4.90 and $5.24, respectively. The weighted-average fair value of each right to purchase shares of common stock granted under the purchase plans during the first nine months of 2010 and 2009 was $1.70 and $2.19, respectively. At October 1, 2010, a total of 1,775,073 shares were reserved for future issuances under the 2002 Purchase Plan.

Retirement/Savings Plan. Harmonic has a retirement/savings plan which qualifies as a thrift plan under Section 401(k) of the Internal Revenue Code. This plan allows participants to contribute up to 20% of total compensation, subject to applicable Internal Revenue Service limitations. Harmonic can make discretionary contributions to the plan of 25% of the first 4% contributed by eligible participants up to a maximum contribution per participant of $1,000 per year. This employer contribution was suspended during the first quarter of 2009.

Stock-based Compensation

The following table summarizes stock-based compensation costs in our Condensed Consolidated Statements of Operations for the three and nine months ended October 1, 2010 and October 2, 2009:

		Three Months Ended								Nine Months Ended
		October 1,				October 2,				October 1,				October 2,
(In thousands)		2010				2009				2010				2009
Employee stock-based compensation in:
Cost of revenue		$	516			$	376			$	1,521			$	1,086
Research and development expense			1,169				972				3,435				2,771
Selling, general and administrative expense			1,833				1,346				5,224				3,780
Total employee stock-based compensation in operating expense			3,002				2,318				8,659				6,551
Total employee stock-based compensation			3,518				2,694				10,180				7,637
Amount capitalized as inventory			(14	)			8				11				12
Total stock-based compensation		$	3,504			$	2,702			$	10,191			$	7,649

As of October 1, 2010, total unamortized stock-based compensation cost related to unvested stock options and restricted stock units was $36.5 million. This amount will be recognized as expense using the straight-line attribution method over the remaining weighted-average amortization period of 2.6 years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes single option pricing model with the following weighted average assumptions:

		Employee Stock Options
		Three Months Ended								Nine Months Ended
		October 1, 2010				October 2, 2009				October 1, 2010				October 2, 2009
Expected life (years)			3.52				4.75				4.00				4.75
Volatility			55	%			60	%			56	%			58	%
Risk-free interest rate			1.1	%			2.6	%			1.6	%			1.7	%
Dividend yield			0.0	%			0.0	%			0.0	%			0.0	%
		Employee Stock Purchase Plan
		Three Months Ended								Nine Months Ended
		October 1, 2010				October 2, 2009				October 1, 2010				October 2, 2009
Expected life (years)			0.5				0.5				0.5				0.5
Volatility			43	%			78	%			46	%			76	%
Risk-free interest rate			0.4	%			0.5	%			0.4	%			0.5	%
Dividend yield			0.0	%			0.0	%			0.0	%			0.0	%

The expected term for stock options and the 2002 Purchase Plan represents the weighted-average period that the stock options are expected to remain outstanding. Our computation of expected life was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The issuance of Harmonic stock options in the third quarter of 2010 due to the assumption of the unvested Omneon stock options had the effect of reducing the expected life due to a shorter remaining vesting period.

We use the historical volatility over the expected term of the options and the 2002 Purchase Plan offering period to estimate the expected volatility. We believe that the historical volatility, at this time, represents fairly the future volatility of our common stock.

We will continue to monitor relevant information to measure expected volatility for future option grants and 2002 Purchase Plan offering periods.

The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our employee stock options and employee stock purchase plan awards. The dividend yield assumption is based on our history and expectation of dividend payouts.

NOTE 11: INCOME TAXES

The income tax provision includes U.S. federal, state and local, and foreign income taxes and is based on the application of a forecasted annual income tax rate applied to the current quarter’s year-to-date pre-tax income (loss). In determining the estimated annual effective income tax rate, the Company analyzes various factors, including projections of the Company’s annual earnings, taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, the Company’s ability to use tax credits and net operating loss carryforwards, and available tax planning alternatives. Discrete items, including the effect of changes in tax laws, tax rates, and certain circumstances with respect to valuation allowances or other unusual or non-recurring tax adjustments are reflected in the period in which they occur as an addition to or reduction from, the income tax provision, rather than being included in the estimated annual effective income tax rate.

For the three and nine months ended October 1, 2010, our effective tax rate, in thousands, was a provision of $1,693 and a benefit of $(1,202), respectively, compared to a benefit of $(2,777) in the third quarter of 2009 and a provision of $10,523 for the first nine months of 2009, inclusive of discrete items.

For the three months ended October 1, 2010, the difference between our effective tax rate provision of 127.1% and the federal statutory rate of 35% was primarily attributable to various discrete items, the differential in foreign tax rates, non deductible stock-based compensation expense, non deductible transaction costs, and California research and development credits. The discrete items recorded in the third quarter of 2010 principally related to translation adjustments and accrued interest on uncertain tax positions and a reallocation of expenses between legal entities.

For the nine months ended October 1, 2010, the difference between our effective tax rate benefit of 14.7% and the federal statutory rate of 35% was primarily attributable to various discrete items, the differential in foreign tax rates, non deductible stock-based compensation expense, non deductible transaction costs and California research and development credits. The discrete items recorded for the nine months ended October 1, 2010, principally related to a benefit associated with the reversal of previously provided foreign income taxes due to expiration of the statute of limitations, translation adjustments and accrued interest on uncertain tax positions, a reduction in the valuation allowance on the California deferred tax assets due to an increase in the estimated amount of income that will be apportioned to California, based on anticipated changes in the geographic mix of sales, and a reallocation of expenses between legal entities.

On February 20, 2009, California enacted legislation, which among other things, provides for the election of a single factor apportionment formula beginning in 2011. As a result of our anticipated election of the single sales factor, we are required under applicable accounting guidance on accounting for income taxes to compute our deferred taxes at the end of any reporting period taking into account the reversal pattern and the expected California tax rate under the elective single sales factor. For the first quarter of 2009, the impact of the new legislation resulted in a change to the state effective tax rate used to compute the Company’s California deferred tax assets resulting in a corresponding reduction to the amount of previously recorded California deferred tax assets. Any future changes to the estimate may result in an adjustment to the amount of the California deferred tax assets recognized.

In compliance with applicable guidance for accounting for uncertainty in income taxes, the Company had gross unrecognized tax benefits, which include interest and penalties, of approximately $52.3 million as of December 31, 2009, and approximately $48.9 million as of October 1, 2010. If all of these unrecognized tax benefits were recognized, the entire amount would impact the provision for income taxes. We anticipate the unrecognized tax benefits to decrease by $2.4 million in the next 12 months due to statute of limitation expirations.

We recognize interest and penalties related to uncertain tax positions in income tax expense. During the quarter ended October 1, 2010, we recorded a net increase of $0.5 million for interest and penalties related to uncertain tax positions resulting in a balance at October 1, 2010 of $5.2 million.

The tax years 2002-2009 remain open to examination by various federal, state and foreign taxing jurisdictions.

NOTE 12: NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share is computed by dividing the net income (loss) attributable to common stockholders for the period by the weighted average number of the common shares outstanding during the period. The diluted net loss per share is the same as basic net loss per share for the three months ended October 1, 2010 and the nine months ended October 2, 2009 because potential common shares, such as common shares issuable under the exercise of stock options or the employee stock purchase plan, are only considered when their effect would be dilutive.

The following table shows the potentially dilutive shares, consisting of options, restricted stock units and ESPP shares, for the periods presented that were excluded from the net income (loss) computations because their effect was antidilutive:

		Three Months Ended								Nine Months Ended
		October 1,				October 2,				October 1,				October 2,
(In thousands)		2010				2009				2010				2009
Potentially dilutive equity awards outstanding			16,529				8,645				15,036				13,280

Following is a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share computations:

		Three Months Ended								Nine Months Ended
		October 1,				October 2,				October 1,				October 2,
(In thousands, except per share data)		2010				2009				2010				2009
Net income (loss) (numerator)		$	(361	)		$	2,577			$	9,403			$	(24,186	)
Shares calculation (denominator):
Weighted average shares outstanding — basic			100,246				96,104				97,975				95,742
Effect of dilutive securities:
Potential common stock relating to equity awards outstanding			—				628				697				—
Average shares outstanding — diluted			100,246				96,732				98,672				95,742
Net income (loss) per share — basic		$	(0.00	)		$	0.03			$	0.10			$	(0.25	)
Net income (loss) per share — diluted		$	(0.00	)		$	0.03			$	0.10			$	(0.25	)

NOTE 13: COMPREHENSIVE INCOME (LOSS)

The Company’s total comprehensive income (loss) was as follows:

		Three Months Ended								Nine Months Ended
		October 1,				October 2,				October 1,				October 2,
(In thousands)		2010				2009				2010				2009
Net income (loss)		$	(361	)		$	2,577			$	9,403			$	(24,186	)
Change in unrealized gain (loss) on investments, net of tax			5				(90	)			(339	)			601
Change in unrealized gain (loss) on foreign exchange contracts, net of tax			43				(205	)			(19	)			—
Foreign currency translation			567				(122	)			(88	)			178
Total comprehensive income (loss)		$	254			$	2,160			$	8,957			$	(23,407	)

NOTE 14: SEGMENT INFORMATION

We operate our business in one reportable segment, which is the design, manufacture and sale of video infrastructure solutions, spanning content production to multi-screen video delivery. Harmonic’s products enable customers to create, prepare and deliver video services over broadcast, cable, Internet, mobile, satellite and networks. Operating segments are defined as components of an enterprise that engage in business activities for which separate financial information is available and evaluated by the chief operating decision maker in deciding how to allocate resources and assessing performance. Our chief operating decision maker is our Chief Executive Officer. The acquisition of Omneon resulted in an additional product line, production and playout, but did not impact our reportable segments.

Our revenue by product type is summarized as follows:

Revenue Information:

		Three Months Ended								Nine Months Ended
		October 1,				October 2,				October 1,				October 2,
(In thousands)		2010				2009				2010				2009
Revenue by type:
Video processing products		$	51,005			$	39,880			$	139,893			$	113,841
Production and playout			4,880				—				4,880				—
Edge and access products			34,712				32,673				104,519				89,132
Service and support			14,187				11,308				35,857				29,936
Total		$	104,784			$	83,861			$	285,149			$	232,909

Our revenue by geographic region, based on the location at which each sale originates, and our property and equipment, net by geographic region is summarized as follows:

Geographic Information:

		Three Months Ended								Nine Months Ended
		October 1,				October 2,				October 1,				October 2,
(In thousands)		2010				2009				2010				2009
Net revenue:
United States		$	54,538			$	40,282			$	146,387			$	118,932
International			50,246				43,579				138,762				113,977
Total		$	104,784			$	83,861			$	285,149			$	232,909
		October 1, 2010				October 2, 2009
Property and equipment:
United States		$	31,213			$	11,547
International			7,539				7,776
Total		$	38,752			$	19,323