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

TABLE OF CONTENTS

PART I			4
ITEM 1. FINANCIAL STATEMENTS			4
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			21
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			51
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			51
ITEM 5. OTHER INFORMATION			52
ITEM 6. EXHIBITS			53
SIGNATURES			54
EX-10.39
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)		July 2, 2010				December 31, 2009
ASSETS
Current assets:
Cash and cash equivalents		$	187,893			$	152,477
Short-term investments			90,028				118,593
Accounts receivable, net of allowances of $5,182 and $5,163			71,363				64,838
Inventories			42,816				35,066
Deferred income taxes			26,503				26,503
Prepaid expenses and other current assets			25,234				20,821
Total current assets			443,837				418,298
Property and equipment, net			42,962				25,941
Goodwill			64,603				63,953
Intangibles, net			20,033				25,265
Other assets			23,742				22,847
Total assets		$	595,177			$	556,304
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	28,694			$	22,065
Income taxes payable			2,583				609
Deferred revenue			40,049				32,855
Accrued liabilities			30,720				37,584
Total current liabilities			102,046				93,113
Accrued excess facilities costs, long-term			—				58
Income taxes payable, long-term			39,884				43,948
Financing liability, long-term			24,323				6,908
Other long-term liabilities			2,228				4,804
Total liabilities			168,481				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; 97,529 and 96,110 shares issued and outstanding as of July 2, 2010 and December 31, 2009, respectively			98				96
Capital in excess of par value			2,290,463				2,279,945
Accumulated deficit			(1,862,769	)			(1,872,533	)
Accumulated other comprehensive loss			(1,096	)			(35	)
Total stockholders’ equity			426,696				407,473
Total liabilities and stockholders’ equity		$	595,177			$	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								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands, except per share amounts)		2010				2009				2010				2009
Product revenue		$	84,261			$	70,513			$	158,695			$	130,420
Service revenue			11,283				10,780				21,671				18,629
Net revenue			95,544				81,293				180,366				149,049
Product cost of revenue			46,058				43,458				87,069				82,140
Service cost of revenue			3,804				4,288				6,810				7,977
Total cost of revenue			49,862				47,746				93,879				90,117
Gross profit			45,682				33,547				86,487				58,932
Operating expenses:
Research and development			16,977				15,450				33,943				29,946
Selling, general and administrative			24,074				20,735				44,919				42,026
Amortization of intangibles			534				1,534				1,067				1,922
Total operating expenses			41,585				37,719				79,929				73,894
Income (loss) from operations			4,097				(4,172	)			6,558				(14,962	)
Interest income, net			425				823				809				2,181
Other expense, net			(126	)			(188	)			(497	)			(682	)
Income (loss) before income taxes			4,396				(3,537	)			6,870				(13,463	)
Provision for (benefit from) income taxes			(49	)			4,382				(2,894	)			13,300
Net income (loss)		$	4,445			$	(7,919	)		$	9,764			$	(26,763	)
Net income (loss) per share
Basic		$	0.05			$	(0.08	)		$	0.10			$	(0.28	)
Diluted		$	0.05			$	(0.08	)		$	0.10			$	(0.28	)
Weighted average shares
Basic			96,998				95,703				96,845				95,563
Diluted			97,570				95,703				97,529				95,563

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

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

		Six Months Ended
		July 2,				July 3,
(In thousands)		2010				2009
Cash flows from operating activities:
Net income (loss)		$	9,764			$	(26,763	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Amortization of intangibles			5,231				5,645
Depreciation			4,404				4,090
Stock-based compensation			6,663				4,943
Net loss on disposal of fixed assets			27				187
Deferred income taxes			(1,422	)			—
Other non-cash adjustments, net			1,076				1,563
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable, net			(6,529	)			5,573
Inventories			(7,724	)			8,415
Prepaid expenses and other assets			90				8,214
Accounts payable			(1,616	)			(2,419	)
Deferred revenue			4,595				274
Income taxes payable			(2,211	)			4,200
Accrued excess facilities costs			(3,398	)			(2,806	)
Accrued and other liabilities			(3,467	)			(24,237	)
Net cash provided by (used in) operating activities			5,483				(13,121	)
Cash flows from investing activities:
Purchases of investments			(39,035	)			(70,221	)
Proceeds from maturities of investments			66,127				64,839
Proceeds from sales of investments			—				27,240
Acquisition of property and equipment			(13,175	)			(3,775	)
Acquisition of Rhozet			—				(453	)
Acquisition of Scopus			—				(63,053	)
Net cash provided by (used in) investing activities			13,917				(45,423	)
Cash flows from financing activities:
Proceeds from lease financing liability			12,385				—
Proceeds from issuance of common stock, net			3,833				4,185
Net cash provided by financing activities			16,218				4,185
Effect of exchange rate changes on cash and cash equivalents			(202	)			145
Net increase (decrease) in cash and cash equivalents			35,416				(54,214	)
Cash and cash equivalents at beginning of period			152,477				179,891
Cash and cash equivalents at end of period		$	187,893			$	125,677
Supplemental disclosure of cash flow information:
Income tax payments, net		$	770			$	2,414
Non-cash investing and financing activities:
Issuance of restricted common stock for Rhozet acquisition		$	—			$	1,870

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 for us 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 May 6, 2010, Harmonic entered into a definitive agreement to acquire Omneon Inc., a privately-held company headquartered in Sunnyvale, California and organized under the laws of Delaware. Under the terms of the Agreement and Plan of Reorganization, Harmonic would acquire Omneon for (i) $190 million in cash plus the aggregate exercise price of vested stock options of Omneon, and subject to further adjustment based on Omneon’s cash, cash equivalents and restricted cash position and working capital position at the time of closing, and (ii) 17.1 million shares of Harmonic common stock. This represents a total purchase value of approximately $274 million, based on the closing price of Harmonic common stock on May 5, 2010, net of cash to be acquired of approximately $32 million. The cash portion of the purchase price is subject to adjustment in the event that Omneon’s cash, cash equivalents and restricted cash are more or less than $32 million at closing and is also subject to a working capital adjustment. All unvested stock options and unvested restricted stock units issued by Omneon and outstanding at closing will be assumed by Harmonic. The proposed acquisition is subject to the approval of Omneon’s stockholders, and Harmonic has entered into voting agreements with holders of approximately 66% of Omneon’s outstanding shares of capital stock, pursuant to which such Omneon stockholders agree to vote in favor of the transaction. The proposed acquisition is also subject to other customary closing conditions and regulatory approvals and is expected to close in the second half of 2010.

The Company has incurred a total of $2.4 million of transaction expenses, which were expensed as selling, general and administrative expenses in the second quarter of 2010.

The proposed 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 play-out solutions which complement Harmonic’s existing video processing products.

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. There were no contingent consideration arrangements in connection with the acquisition.

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
Order backlog			2,000
Maintenance agreements and related relationships			1,000
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 weighted average cost of capital of 16% 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 the maintenance agreements 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; 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;
	•		Maintenance agreements and related relationships are being amortized over their useful life of four years;
	•		Trade name/trademarks are being amortized over their useful lives of five years; and
	•		Order backlog was amortized over its 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.

The following unaudited pro forma financial information presented below summarizes the combined results of operations as if the merger had been completed on January 1, 2009. The unaudited pro forma financial information for the six months ended July 3, 2009 combines the results for Harmonic for the six months ended July 3, 2009, and the historical results of Scopus through March 12, 2009, 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 date or of results which may occur in the future.

		Six Months Ended
(In thousands, except per share data)		July 3, 2009
Net revenue		$	153,377
Net loss		$	(37,328	)
Net loss per share — basic		$	(0.39	)
Net loss per share — diluted		$	(0.39	)

For the three month period ended July 3, 2009, Scopus products contributed revenues of $5.9 million and a net loss of $3.9 million. For the period from March 12, 2009 to July 3, 2009, Scopus products contributed revenues of $7.4 million and a net loss of $12.1 million.

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 six months ended July 2, 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 and liabilities measured at fair value on a recurring basis as of July 2, 2010 and December 31, 2009 based on the three-tier fair value hierarchy:

(In thousands)		Level 1				Level 2				Level 3				Total
July 2, 2010
Money market funds		$	146,256			$	—			$	—			$	146,256
Corporate bonds			—				31,515				—				31,515
Corporate commercial paper			—				5,198				—				5,198
U.S. federal government bonds			—				25,151				—				25,151
State, municipal and local government agencies bonds			—				25,958				—				25,958
Total assets		$	146,256			$	87,822			$	—			$	234,078

(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 July 2, 2010 and July 3, 2009, short-term investments are as follows:

(In thousands)		July 2, 2010				December 31, 2009
Short-term investments:
Less than one year		$	65,814			$	84,771
Due in 1-2 years			18,414				27,821
Due in 3-27 years			5,800				6,001
Total		$	90,028			$	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
July 2, 2010
U.S. federal, state, municipal and local government agencies bonds		$	51,041			$	78			$	(10	)		$	51,109
Corporate debt securities			36,697				38				(22	)			36,713
Total		$	87,738			$	116			$	(32	)		$	87,822
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 income (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 income (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 July 2, 2010.

As of July 2, 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

		July 2,				December 31,
(In thousands)		2010				2009
Raw materials		$	7,675			$	8,633
Work-in-process			1,822				3,072
Finished goods			33,319				23,361
		$	42,816			$	35,066

NOTE 6: GOODWILL AND IDENTIFIED INTANGIBLES

The following is a summary of goodwill and intangible assets as of July 2, 2010 and December 31, 2009:

		July 2, 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		$	65,367			$	(52,068	)		$	13,299			$	64,864			$	(48,013	)		$	16,851
In-process technology			—				—				—				600				—				600
Customer relationships/contracts			37,897				(34,118	)			3,779				37,900				(33,541	)			4,359
Trademarks and tradenames			7,353				(5,440	)			1,913				7,369				(5,136	)			2,233
Supply agreements			3,401				(3,401	)			—				3,427				(3,427	)			—
Maintenance agreements and related relationships			1,600				(573	)			1,027				1,600				(405	)			1,195
Software license, intellectual property and assembled workforce			309				(294	)			15				309				(282	)			27
Order backlog			2,000				(2,000	)			—				2,000				(2,000	)			—
Subtotal of identified intangibles			117,927				(97,894	)			20,033				118,069				(92,804	)			25,265
Goodwill			64,603				—				64,603				63,953				—				63,953
Total goodwill and other intangibles		$	182,530			$	(97,894	)		$	84,636			$	182,022			$	(92,804	)		$	89,218

The changes in the carrying amount of goodwill for the six months ended July 2, 2010 are as follows:

(In thousands)		Goodwill
Balance as of December 31, 2009		$	63,953
Adjustment to deferred tax liability associated with the Scopus acquisition			786
Foreign currency translation adjustments			(136	)
Balance as of July 2, 2010		$	64,603

For the three and six months ended July 2, 2010, the Company recorded a total of $2.6 million and $5.2 million of amortization expense for identified intangibles, of which $2.1 million and $4.2 million, was included in cost of revenue, respectively. For the three and six months ended July 3, 2009, the Company recorded a total of $3.7 million and $5.6 million of amortization expense for identified intangibles, of which $2.2 million and $3.7 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 6 months)		$	3,930			$	1,067			$	4,997
2011			4,214				2,124				6,338
2012			2,840				1,932				4,772
2013			1,569				1,313				2,882
2014			500				283				783
2015			261				—				261
Total		$	13,314			$	6,719			$	20,033

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 July 2, 2010, accrued excess facilities cost totaled $1.9 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 $3.4 million during the first six 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 six 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)			—				—				—				—				—
Cash payments, net of sublease income			(2,101	)			(1,152	)			(62	)			(83	)			(3,398	)
Balance at July 2, 2010		$	1,016			$	563			$	214			$	141			$	1,934

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 July 2, 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 July 2, 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 July 2, 2010). Borrowings are payable monthly and are not collateralized.

NOTE 9: FINANCING LIABILITY FOR CONSTRUCTION IN PROGRESS

In December 2009, the Company entered into a lease for a building in San Jose, California that will replace its current facility as corporate headquarters. In January 2010, the Company began a build-out of this facility and expects to incur approximately $21.5 million in construction costs. Under the terms of the lease, the landlord will reimburse up to $18.8 million of these construction costs. Because certain improvements constructed by the Company were considered structural in nature and the Company is responsible for any cost overruns, the Company is 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.

Therefore, 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. For the six months ended July 2, 2010, the liability increased by $17.1 million due to additional leasehold improvements, by $0.2 million due to land lease expense and by $0.1 million due to capitalized interest expense. Each major construction element will be capitalized and amortized over its useful life.

Upon completion of construction, the Company will assess whether or not it qualifies for sale-leaseback accounting under applicable accounting guidance. At that time, the Company will determine whether the lease will be treated as a capital or operating lease.

NOTE 10: BENEFIT PLANS

Stock Option Plans. Harmonic has reserved 24,207,000 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 first six months of 2010 and 2009, employees received restricted stock units valued at $9.5 million and $6.8 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 July 2, 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 ten years. Initial option grants generally vest monthly over three years, and subsequent grants generally vest monthly over one year. During the six months ended July 2, 2010 and July 3, 2009, there were 87,367 and 99,463 units granted to non-employee directors, respectively.

A summary of share-based award activity during the six months ended July 2, 2010 is as follows (in thousands):

		Shares
		Available
		for Grant
Balance at December 31, 2009			4,054
Shares authorized			11,000
Options granted			(945	)
Restricted stock units granted			(3,072	)
Restricted stock units canceled			116
Options canceled			278
Options expired			39
Balance at July 2, 2010			11,470

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			1,589				6.29
Restricted stock units released			(595	)			5.81			$	3,582
Restricted stock units canceled			(58	)			6.08
Balance at July 2, 2010			2,573			$	6.12

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			945				6.26
Options exercised			(113	)			4.62
Options canceled			(278	)			8.63
Options expired			(136	)			76.55
Balance at July 2, 2010			10,917			$	8.40
Options vested and exercisable as of July 2, 2010			7,847			$	8.85
Options vested and expected-to-vest as of July 2, 2010			10,808			$	8.41

The weighted-average fair value of options granted for the six months ended July 2, 2010 was $3.09. The weighted-average fair value of options granted for the six months ended July 3, 2009 was $2.86.

The following table summarizes information regarding stock options outstanding at July 2, 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		July 2, 2010				(Years)				Exercise Price				July 2, 2010				Exercise Price
		(In thousands, except exercise price and life)
$           0.19 -- 5.73			1,634				4.8			$	4.93				924			$	4.38
5.79 -- 6.41			2,135				4.4				6.07				1,457				5.92
6.45 -- 8.17			2,754				4.9				8.06				1,536				8.09
8.20 -- 8.93			2,058				3.8				8.36				1,716				8.38
8.95 -- 10.62			1,558				1.9				9.63				1,480				9.64
10.70 -- 13.67			206				3.4				11.44				162				11.52
14.50 -- 33.50			572				0.1				24.22				572				24.22
			10,917				3.8			$	8.39				7,847			$	8.85

The weighted-average remaining contractual life for all exercisable stock options at July 2, 2010 was 3.2 years. The weighted-average remaining contractual life of all vested and expected-to-vest stock options at July 2, 2010 was 3.8 years. The weighted-average remaining contractual life of all vested and expected-to-vest restricted stock units at July 2, 2010 was 1.6 years.

Aggregate intrinsic value of options exercisable at July 2, 2010 was $1.1 million. The aggregate intrinsic value of stock options vested and expected-to-vest net of estimated forfeitures was $1.1 million at July 2, 2010. Aggregate intrinsic value represents the difference between our closing price on the last trading day of the fiscal period, which was $5.60 as of July 2, 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 $0.2 million during the three and six months ended July 2, 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 six 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 six months of 2010 and 2009 was $1.91 and $2.22, respectively. At July 2, 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 six months ended July 2, 2010 and July 3, 2009:

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2010				2009				2010				2009
Employee stock-based compensation in:
Cost of revenue		$	527			$	373			$	1,006			$	710
Research and development expense			1,158				929				2,266				1,799
Selling, general and administrative expense			1,734				1,267				3,391				2,434
Total employee stock-based compensation in operating expense			2,892				2,196				5,657				4,233
Total employee stock-based compensation			3,419				2,569				6,663				4,943
Amount capitalized as inventory			(5	)			(18	)			25				4
Total stock-based compensation		$	3,414			$	2,551			$	6,688			$	4,947

As of July 2, 2010, total unamortized stock-based compensation cost related to unvested stock options and restricted stock units was $25.0 million. This amount will be recognized as expense using the straight-line attribution method over the remaining weighted-average amortization period of 2.4 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								Six Months Ended
		July 2, 2010				July 3, 2009				July 2, 2010				July 3, 2009
Expected life (years)			4.80				4.75				4.76				4.75
Volatility			55	%			60	%			56	%			60	%
Risk-free interest rate			2.2	%			2.3	%			2.4	%			1.7	%
Dividend yield			0.0	%			0.0	%			0.0	%			0.0	%
		Employee Stock Purchase Plan
		Three Months Ended								Six Months Ended
		July 2, 2010				July 3, 2009				July 2, 2010				July 3, 2009
Expected life (years)			0.5				0.5				0.5				0.5
Volatility			50	%			82	%			50	%			78	%
Risk-free interest rate			0.4	%			0.6	%			0.4	%			0.6	%
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.

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 effective annual income tax rate.

For the three and six months ended July 2, 2010, our effective tax rate was a benefit of 1.1% and 42.1%, respectively, compared to a provision of 123.9% and 98.8% for the same periods a year ago, inclusive of discrete items.

For the three months ended July 2, 2010, the difference between our effective tax rate benefit of 1.1% 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, and California research and development credits. The discrete items recorded in the second quarter of 2010 principally related to a benefit associated with the reversal of previously provided foreign income taxes due to the expiration of the statute of limitations.

For the six months ended July 2, 2010, the difference between our effective tax rate benefit of 42.1% 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, and California research and development credits. The discrete items recorded for the six months ended July 2, 2010, principally related to a benefit associated with the reversal of previously provided foreign income taxes due to expiration of the statute of limitations, and a benefit associated with the release of a portion of the valuation allowance on certain California deferred tax assets. The reduction in the valuation allowance on the California deferred tax assets was 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.

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 taking into account the reversal pattern and the expected California tax rate under the elective single sales factor at the end of any reporting period. 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. In the first quarter of 2010, the Company recorded a reduction in the valuation allowance on the California deferred tax assets due to an increase in the estimated amount of income that would be apportioned to California, based on anticipated changes in the geographic mix of sales. 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 $46.3 million as of July 2, 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 $2.3 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 July 2, 2010, we recorded a net reduction of $0.6 million for interest and penalties related to uncertain tax positions resulting in a balance at July 2, 2010 of $4.7 million.

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

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 and six months ended July 3, 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

Six Months Ended

(In thousands)

July 2, 2010

July 3, 2009

July 2, 2010

July 3, 2009

Potentially dilutive equity awards outstanding

11,755

9,618

11,715

10,132

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

		Three Months Ended								Six Months Ended
(In thousands, except per share data)		July 2, 2010				July 3, 2009				July 2, 2010				July 3, 2009
Net income (loss) (numerator)		$	4,445			$	(7,919	)		$	9,764			$	(26,763	)
Shares calculation (denominator):
Weighted average shares outstanding — basic			96,998				95,703				96,845				95,563
Effect of dilutive securities:
Potential common stock relating to equity awards outstanding			572				—				684				—
Average shares outstanding — diluted			97,570				95,703				97,529				95,563
Net income (loss) per share — basic		$	0.05			$	(0.08	)		$	0.10			$	(0.28	)
Net income (loss) per share — diluted		$	0.05			$	(0.08	)		$	0.10			$	(0.28	)

NOTE 13: COMPREHENSIVE INCOME (LOSS)

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

		Three Months Ended								Six Months Ended
(In thousands)		July 2, 2010				July 3, 2009				July 2, 2010				July 3, 2009
Net income (loss)		$	4,445			$	(7,919	)		$	9,764			$	(26,673	)
Change in unrealized gain (loss) on investments, net of tax			(128	)			355				(344	)			690
Change in unrealized gain (loss) on foreign exchange contracts, net of tax			(62	)			205				(62	)			205
Foreign currency translation			(518	)			448				(655	)			300
Total comprehensive income (loss)		$	3,737			$	(6,911	)		$	8,703			$	(25,478	)

NOTE 14: SEGMENT INFORMATION

We operate our business in one reportable segment, which is the design, manufacture and sale of products and systems that enable network operators to efficiently deliver broadcast and on-demand video services that include digital audio, video-on-demand and high definition television as well as high-speed internet access and telephony. 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.

Our revenue by product type is summarized as follows:

Revenue Information:

		Three Months Ended								Six Months Ended
(In thousands)		July 2, 2010				July 3, 2009				July 2, 2010				July 3, 2009
Revenue by type:
Video processing products		$	49,998			$	38,297			$	88,888			$	73,961
Edge and access products			34,263				32,216				69,807				56,459
Service and support			11,283				10,780				21,671				18,629
Total		$	95,544			$	81,293			$	180,366			$	149,049

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								Six Months Ended
(In thousands)		July 2, 2010				July 3, 2009				July 2, 2010				July 3, 2009
Net revenue:
United States		$	49,259			$	46,532			$	91,850			$	78,650
International			46,285				34,761				88,516				70,399
Total		$	95,544			$	81,293			$	180,366			$	149,049
		July 2, 2010				July 3, 2009
Property and equipment:
United States		$	35,386			$	11,644
International			7,576				8,115
Total		$	42,962			$	19,759

Major Customers. For the three and six months ended July 2, 2010, revenue to Comcast accounted for 16% and 15% of net revenue, respectively. For the three and six months ended July 3, 2009, revenue to Comcast accounted for 19% and 17% of net revenue, respectively. As of July 2, 2010, two customers individually accounted for 16% and 11% of net accounts receivable.

NOTE 15: GUARANTEES

Warranties. The Company accrues for estimated warranty costs at the time of product shipment. Management periodically reviews the estimated fair value of its warranty liability and records adjustments based on the terms of warranties provided to customers, historical and anticipated warranty claims experience, and estimates of the timing and cost of specified warranty claims. Activity for the Company’s warranty accrual, which is included in accrued liabilities, is summarized below:

		Three Months Ended								Six Months Ended
(In thousands)		July 2, 2010				July 3, 2009				July 2, 2010				July 3, 2009
Balance at beginning of the period		$	3,426			$	6,919			$	4,186			$	5,360
Scopus acquisition			—				—				—				2,379
Accrual for current period warranties			1,020				613				1,470				1,246
Warranty costs incurred			(1,252	)			(1,421	)			(2,462	)			(2,874	)
Balance at end of the period		$	3,194			$	6,111			$	3,194			$	6,111

Standby Letters of Credit. As of July 2, 2010, the Company’s financial guarantees consisted of standby letters of credit outstanding, which were principally related to performance bonds and state requirements imposed on employers. The maximum amount of potential future payments under these arrangements was $0.9 million.

Indemnification. Harmonic is obligated to indemnify its officers and the members of its Board of Directors pursuant to its bylaws and contractual indemnity agreements. Harmonic also indemnifies some of its suppliers and customers for specified intellectual property matters pursuant to certain contractual arrangements, subject to certain limitations. The scope of these indemnities varies, but in some instances, includes indemnification for damages and expenses (including reasonable attorneys’ fees). There have been no claims against us for indemnification pursuant to any of these arrangements and, accordingly, no amounts have been accrued in respect of the indemnification provisions through July 2, 2010.

Guarantees. As of July 2, 2010, Harmonic had no other guarantees outstanding.

NOTE 16: LEGAL PROCEEDINGS

On March 4, 2010 Interkey ELC Ltd, or Interkey, filed a lawsuit in Israel alleging breach of contract against Scopus Video Networks Ltd. (now Harmonic Video Networks Ltd. or “HVN”), which was acquired by Harmonic Inc. on March 12, 2009, and Harmonic Inc. (“Harmonic”). HVN responded by filing a motion to remove the proceedings to arbitration as required by the contract. This motion was granted on May 13, 2010. On May 24, 2010, Interkey filed a motion for the provision of an ex-parte judgment against Harmonic although Harmonic maintains that it was not properly served and therefore was not a party to the proceedings. On July 4, 2010, the court ruled against Harmonic and provided an ex-parte judgment in the amount of NIS 6,350,000, or approximately $1.7 million. On July 14, 2010, Harmonic filed a motion to set aside the ex-parte judgment and delay execution of the judgment along with a Statement of Defense. The Court has given Interkey 20 days to respond. Based on advice from counsel Harmonic believes it is likely to prevail on the motion to set aside the ex-parte judgment. Further, Harmonic believes Interkey’s claims are without merit and Harmonic intends to vigorously defend itself against these claims. Based on the foregoing, Harmonic has not recorded a provision for this claim.

On April 19, 2010, Arris Corporation filed a complaint in United States District Court in Atlanta, alleging that Harmonic’s Streamliner 3000 product infringes four patents held by Arris. The complaint seeks injunctive relief and damages. Harmonic has not been served in the case. Harmonic is currently evaluating its position with respect to these patents. At this time, we cannot predict the outcome of this matter. An unfavorable outcome of this matter could adversely affect our business, operating results, financial position and cash flows.

An unfavorable outcome on the above referenced or any other litigation matters could require that Harmonic pay substantial damages, or, in connection with any intellectual property infringement claims, could require that the Company pay ongoing royalty payments or could prevent the Company from selling certain of its products. As a result, a settlement or an unfavorable outcome on the above referenced or any other litigation matter could have a material adverse effect on Harmonic’s business, operating results, financial position and cash flows.

Harmonic may be subject to claims that have arisen in the normal course of business. In the opinion of management the amount of ultimate liability with respect to these matters in the aggregate will not have a material adverse effect on the Company or its operating results, financial position or cash flows.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements related to:

•		Our expectation that customer concentration will continue for the foreseeable future;
•		Our expectation that international revenue will continue to account for a significant portion of our net revenue for the foreseeable future;

•		Our belief that adverse economic conditions and tight credit markets may reduce capital spending by our customers, which could have a material and adverse affect on sales of our products;
•		Our expectation that we will record a total of approximately $3.9 million in amortization of intangibles in cost of revenue in the remaining six months of 2010, excluding the impact of any amortization related to the potential Omneon acquisition;
•		Our expectation that we will record a total of approximately $1.1 million in amortization of intangibles in operating expenses in the remaining six months of 2010, excluding the impact of any amortization related to the potential Omneon acquisition;
•		Our expectation that our capital expenditures will be in the range of $16 million to $18 million during 2010, net of reimbursed building improvements from our landlord;
•		Our belief that the net proceeds from our previously completed public offering of common stock will be used for general corporate purposes, including payment of existing liabilities, research and development, the development or acquisition of new products or technologies, equipment acquisitions, strategic acquisitions of businesses, general working capital and operating expenses;
•		Our belief that our existing liquidity sources, including our bank line of credit facility, will satisfy our requirements for at least the next twelve months;
•		Our belief that near-term changes in exchange rates will not have a material impact on our operating results, financial position and liquidity;
•		Our expectation that revenue from cable television, satellite and telecommunications operators will constitute a significant portion of net revenue for the foreseeable future;
•		Our expectation that we will successfully complete the announced acquisition of Omneon and will be able to achieve the anticipated benefits of the acquisition;
•		Our expectation that we will make additional acquisitions in the future;
•		Our expectation that our operations will be affected by new environmental laws and regulations on an ongoing basis;
•		Our expectation that an increasing percentage of our consolidated, pre-tax income will be derived from and reinvested in our international operations and our expectations regarding the associated tax rates;
•		Our expectation that any ultimate liability of Harmonic with respect to certain litigation arising in the normal course of business will not, in the aggregate, have a material adverse effect on us or our operating results, financial position or cash flows;
•		Our expectation that the proposed acquisition of Omneon will close in the second half of 2010, if at all;
•		Our expectation that the acquisition of Omneon would strengthen Harmonic’s competitive position in the digital media market and broaden our relationships with customers who produce and distribute digital video content, such as broadcasters, cable channels and other major owners of content, and that it would broaden Harmonic’s technology and product lines with digital storage and play-out solutions which complement its existing video processing products; and
•		Our expectation that operating results are likely to fluctuate in the future.

These statements involve risks and uncertainties as well as assumptions that, if they were to never materialize or prove incorrect, could cause actual results to differ materially from those projected, expressed or implied in the forward-looking statements. These risks and uncertainties include those set forth under “Risk Factors” below and elsewhere in this Quarterly Report on Form 10-Q and that are otherwise described from time to time in Harmonic’s filings with the Securities and Exchange Commission.

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