HARMONIC INC - Quarter Report: 2011 July (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

HARMONIC INC.

(Exact name of registrant as specified in its charter)

Delaware		77-0201147
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

The number of shares of the registrant’s Common Stock, $.001 par value, outstanding on July 29, 2011 was 115,703,050.

 

 

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			23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			33
ITEM 4. CONTROLS AND PROCEDURES			33
PART II			35
ITEM 1. LEGAL PROCEEDINGS			35
ITEM 1A. RISK FACTORS			35
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			54
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			54
ITEM 5. OTHER INFORMATION			54
SIGNATURES			56
EX-10.46
EX-10.47
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)

		July 1, 2011				December 31, 2010
		(In thousands, except par value amounts)
ASSETS
Current assets:
Cash and cash equivalents		$	70,370			$	96,533
Short-term investments			63,928				23,838
Accounts receivable, net of allowances of $5,950 and $5,897 at July 1, 2011 and December 31, 2010, respectively			117,861				101,652
Inventories			61,064				58,065
Deferred income taxes			39,849				39,849
Prepaid expenses and other current assets			26,399				28,614
Total current assets			379,471				348,551
Property and equipment, net			39,678				39,825
Goodwill			212,210				211,878
Intangibles, net			102,979				118,070
Other assets			2,023				2,062
Total assets		$	736,361			$	720,386
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	30,594			$	26,300
Income taxes payable			126				6,791
Deferred revenue			47,617				46,279
Accrued liabilities			39,486				51,283
Total current liabilities			117,823				130,653
Accrued excess facility costs, long-term			1,769				1,153
Income taxes payable, long-term			48,622				48,883
Deferred income taxes, long-term			15,635				14,849
Other non-current liabilities			6,082				4,645
Total liabilities			189,931				200,183
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; 115,670 and 112,360 shares issued and outstanding at July 1, 2011 and December 31, 2010, respectively			116				112
Capital in excess of par value			2,422,468				2,397,671
Accumulated deficit			(1,875,962	)			(1,876,868	)
Accumulated other comprehensive loss			(192	)			(712	)
Total stockholders’ equity			546,430				520,203
Total liabilities and stockholders’ equity		$	736,361			$	720,386

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 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
		(In thousands, except per share amounts)
Product revenue		$	117,156			$	84,261			$	233,023			$	158,695
Service revenue			16,840				11,283				33,808				21,671
Net revenue			133,996				95,544				266,831				180,366
Product cost of revenue			65,315				46,058				130,066				87,069
Service cost of revenue			6,853				3,804				13,082				6,810
Total cost of revenue			72,168				49,862				143,148				93,879
Gross profit			61,828				45,682				123,683				86,487
Operating expenses:
Research and development			25,662				16,977				51,811				33,943
Selling, general and administrative			32,543				24,074				66,107				44,919
Amortization of intangibles			2,230				534				4,459				1,067
Total operating expenses			60,435				41,585				122,377				79,929
Income from operations			1,393				4,097				1,306				6,558
Interest income, net			74				425				166				809
Other expense, net			(299	)			(126	)			(406	)			(497	)
Income before income taxes			1,168				4,396				1,066				6,870
Provision for (benefit from) income taxes			778				(49	)			160				(2,894	)
Net income		$	390			$	4,445			$	906			$	9,764
Net income per share:
Basic		$	0.00			$	0.05			$	0.01			$	0.10
Diluted		$	0.00			$	0.05			$	0.01			$	0.10
Weighted average shares:
Basic			114,939				96,998				114,387				96,845
Diluted			116,298				97,570				116,143				97,529

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 1, 2011				July 2, 2010
		(In thousands)
Cash flows from operating activities:
Net income		$	906			$	9,764
Adjustments to reconcile net income to net cash used in operating activities:
Amortization of intangibles			15,092				5,231
Depreciation			6,824				4,404
Stock-based compensation			11,094				6,663
Net loss on disposal of fixed assets			103				27
Deferred income taxes			76				(1,422	)
Other non-cash adjustments, net			322				1,076
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable, net			(16,209	)			(6,529	)
Inventories			(2,994	)			(7,724	)
Prepaid expenses and other assets			2,783				90
Accounts payable			4,780				(1,616	)
Deferred revenue			788				4,595
Income taxes payable			(6,925	)			(2,211	)
Accrued excess facility costs			556				(3,398	)
Accrued and other liabilities			(8,056	)			(3,467	)
Net cash provided by operating activities			9,140				5,483
Cash flows from investing activities:
Purchases of investments			(62,009	)			(39,035	)
Proceeds from maturities of investments			11,267				66,127
Proceeds from sales of investments			10,327				—
Acquisition of property and equipment			(8,502	)			(13,175	)
Other acquisitions			(250	)			—
Net cash provided by (used in) investing activities			(49,167	)			13,917
Cash flows from financing activities:
Proceeds from lease financing liability			—				12,385
Proceeds from issuance of common stock, net			13,703				3,833
Net cash provided by financing activities			13,703				16,218
Effect of exchange rate changes on cash and cash equivalents			161				(202	)
Net increase (decrease) in cash and cash equivalents			(26,163	)			35,416
Cash and cash equivalents at beginning of period			96,533				152,477
Cash and cash equivalents at end of period		$	70,370			$	187,893
Supplemental disclosures of cash flow information:
Income tax payments, net		$	6,414			$	770

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 AND SIGNIFICANT ACCOUNTING POLICIES

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 statement 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, 2011 (“2010 Form 10-K”). 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, 2011, 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 (“US GAAP”).

Use of Estimates. The preparation of the consolidated financial statements in conformity with US GAAP 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.

Significant Accounting Policies. The Company’s significant accounting policies are described in Note 1 to its audited Consolidated Financial Statements included in its 2010 Form 10-K. With the exception of revenue recognition discussed below, there have been no significant changes to these policies and no recent accounting pronouncements or changes in accounting pronouncements, during the six months ended July 1, 2011, that are of significance or potential significance to the Company.

Revenue Recognition. Harmonic’s principal sources of revenue are from hardware products, software products, solution sales, services, and hardware and software maintenance contracts. Harmonic recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the sale price is fixed or determinable, and collectability is reasonably assured.

Revenue from product sales, excluding the revenue generated from service-related solutions, which is discussed below, is recognized when risk of loss and title have transferred, which is generally upon shipment or delivery, or once all applicable criteria have been met. Allowances are provided for estimated returns and discounts. Such allowances are adjusted periodically to reflect actual and anticipated experience.

In October 2009, the Financial Accounting Standards Board (FASB) amended US GAAP for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. US GAAP for multiple deliverable revenue arrangements were also amended to:

	•		provide updated guidance on how deliverables in a multiple element arrangement should be separated and how the consideration should be allocated;
	•		require an entity to allocate revenue in an arrangement using the best estimate of selling price (BESP) if a vendor does not have vendor-specific objective evidence (VSOE) of selling price or third-party evidence of selling price (TPE); and
	•		eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

Harmonic elected to adopt this accounting guidance prospectively, beginning with the quarter ended April 1, 2011, for applicable transactions originating or materially modified after December 31, 2010. Certain of Harmonic’s hardware products contain software components that function together to provide the essential functionality of the product. Therefore, such product sales are removed from the industry-specific software revenue recognition guidance and, instead, are governed by the amended guidance described above.

For product sales subject to the amended guidance, the Company allocates the arrangement consideration to each unit of accounting on the basis of each such products’ relative selling price (the “relative selling price method”). When applying the relative selling price method, the Company first considers VSOE of the selling price, if it exists; otherwise TPE of the selling price. If neither VSOE nor TPE exists for a deliverable, the Company uses BESP for that deliverable.

Harmonic has established VSOE for certain elements of its arrangements based on either historical stand-alone sales to third parties or stated renewal rates for maintenance. The Company has VSOE of fair value for maintenance, training and certain professional services.

TPE is determined based on competitor prices for similar deliverables when sold separately. The Company is typically not able to determine TPE for their products or services. Generally, the Company’s go-to-market strategy differs from that of their peers and the Company’s offerings contain a significant level of differentiation, such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, the Company is unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.

When the Company is unable to establish fair value of non-software deliverables using VSOE or TPE, the Company uses BESP in their allocation of arrangement consideration. The objective of using BESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. The Company determines BESP for a product or service by considering multiple factors, including, but not limited to, pricing practices, market conditions, competitive landscape, internal costs, geographies and gross margin. The determination of BESP is made through consultation with Company’s management, taking into consideration the Company’s go-to-market strategy.

The Company regularly reviews BESP and maintains internal controls over establishing and updating these estimates. There has been no material impact during the current quarter, and the Company does not anticipate a material impact in the near term, from changes in BESP. However, the Company may modify pricing practices in the future, which could result in changes in selling prices, including BESP. Accordingly, the impact on future revenue recognition for multiple deliverable arrangements could differ materially from the results in the current period.

Total revenue, as reported, and pro forma total revenue that would have been reported for the three and six months ended July 1, 2011 if the transactions entered into after December 31, 2010 had been subject to previous accounting guidance, are shown in the following table:

		Three months ended July 1, 2011								Six months ended July 1, 2011
		As Reported				Pro Forma				As Reported				Pro Forma
		(In thousands)
Net revenue		$	133,996			$	129,870			$	266,831			$	261,539

The impact of the revised accounting guidance on net revenue during the three and six months ended July 1, 2011 was attributable to the ability to assign a relative selling price to undelivered elements, which previously required VSOE (such as undelivered firmware updates on hardware products), and the reallocation of consideration from revenue deliverables.

Sales of stand-alone software that are not considered essential to the functionality of the hardware continue to be subject to the industry-specific software revenue recognition guidance. The Company uses the residual method to recognize revenue for the delivered elements in stand-alone software transactions. Under the residual method, the amount of revenue allocated to delivered elements equals the total arrangement consideration, less the aggregate fair value of any undelivered elements, typically maintenance, provided that VSOE of fair value exists for all undelivered elements. VSOE of fair value is based on the price charged when the element is sold separately or substantive renewal rates for maintenance.

Solution sales for the design, manufacture, test, integration and installation of products, including equipment acquired from third parties to be integrated with Harmonic’s products, that are customized to meet the customer’s specifications are accounted for in accordance with applicable guidance on accounting for performance of construction/production contracts. Accordingly, for each arrangement that the Company enters into that includes both products and services, the Company performs a detailed evaluation to determine whether the arrangement should be accounted for under guidance for construction/production contracts or, alternatively, for

arrangements that do not involve significant production, modification or customization, under other applicable accounting guidance. The Company has a long-standing history of entering into contractual arrangements to deliver the solution sales described above and such arrangements represent a material part of the operations of the Company.

At the outset of each arrangement accounted for as a single arrangement, the Company develops a detailed project plan and associated labor hour estimates for each project. The Company believes that, based on its historical experience, it has the ability to make labor cost estimates that are sufficiently dependable to justify the use of the percentage-of-completion method of accounting and, accordingly, utilizes percentage-of-completion accounting for most arrangements that are determined to be single arrangements. Under the percentage-of-completion method, revenue recognized reflects the portion of the anticipated contract revenue that has been earned, equal to the ratio of actual labor hours expended to total estimated labor hours to complete the project. For contracts that include customized services for which labor costs are not reasonably estimable, the Company uses the completed contract method of accounting. Under the completed contract method, 100% of the contract’s revenue is recognized upon the completion of all services under the contract. If the estimated costs to complete a project exceed the total contract amount, indicating a loss, the entire anticipated loss is recognized.

Maintenance services are recognized straight-line over the maintenance term, which is typically one year. The unrecognized revenue portion of maintenance agreements billed is recorded as deferred revenue. The costs associated with services are recognized as incurred.

Deferred revenue includes billings in excess of revenue recognized, net of deferred cost of revenue, and invoiced amounts remain deferred until applicable revenue recognition criteria are met.

Revenue from distributors and system integrators is recognized on delivery, provided all other revenue recognition criteria have been met. The Company’s agreements with these distributors and system integrators have terms which are generally consistent with the standard terms and conditions for the sale of the Company’s equipment to end users and do not provide for product rotation or pricing allowances, as are typically found in agreements with stocking distributors. The Company accrues for sales returns and other allowances based on its historical experience.

Shipping and handling costs incurred for inventory purchases and product shipments are recorded in cost of revenue in the Company’s Consolidated Statements of Operations.

NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS

In May 2011, the Financial Accounting Standards Board (“FASB”) issued additional guidance on fair value disclosures. This guidance contains certain updates to the measurement guidance, as well as enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for “Level 3” measurements, including enhanced disclosure for: (1) the valuation processes used by the reporting entity; and (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any. This guidance is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. The Company does not expect the adoption of these reporting requirements to have a material impact on its consolidated results of operations or financial condition.

In June 2011, the FASB issued guidance on the presentation of comprehensive income. This guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The guidance allows two presentation alternatives; present items of net income and other comprehensive income in (1) one continuous statement, referred to as the statement of comprehensive income, or (2) in two separate, but consecutive, statements of net income and other comprehensive income. This guidance is effective as of the beginning of a fiscal year that begins after December 15, 2011. Early adoption is permitted, but full retrospective application is required under both sets of accounting standards. The Company is currently evaluating which presentation alternative it will utilize.

NOTE 3: OMNEON ACQUISITION

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 servers and other software applications that 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 was intended to strengthen Harmonic’s competitive position in the digital media market and to broaden the Company’s relationships with customers that produce and distribute digital video content, such as broadcasters, satellite operators, content owners and other media companies. The acquisition was also intended to broaden Harmonic’s technology and product lines with digital storage and playout solutions that complement Harmonic’s existing video processing products. In addition, the acquisition provided an assembled workforce and the implicit value of future cost savings as a result of combining entities, and is expected to provide Harmonic with future, but presently 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 $147.5 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 and 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. The Company also incurred a total of $5.9 million of transaction expenses, which were expensed as selling, general and administrative expenses in the year ended December 31, 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 and, 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 will 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			17,250
Other tangible assets acquired			3,294
Intangible assets:
Existing technology		$	50,800
In-process technology			9,000
Patents/core technology			9,800
Customer contracts and related relationships			29,200
Trademarks and tradenames			4,000
Maintenance agreements and related relationships			5,500
Order backlog			800
			109,100
Goodwill			147,452
Total assets acquired			358,037
Accounts payable			(6,829	)
Deferred revenue			(6,399	)
Deferred income tax liabilities			(41,804	)
Other accrued liabilities			(11,203	)
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 was 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 being amortized over its estimated useful life of four years;
	•		In-process technology is being amortized, upon completion, over its projected remaining useful life, as assessed on the completion date. The completion of the in-process project was in the first quarter of 2011. The completed technology was estimated to have a useful life of four years;
	•		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 names/trademarks are being amortized over their estimated useful life of four years;
	•		Maintenance agreements and related relationships are being amortized over their estimated useful life of six years; and
	•		Order backlog was 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 names/trademarks and backlog are amortized using the straight-line method, which reflects future projected cash flows.

The residual purchase price of $147.5 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 $15.2 million will be recorded as compensation expense over the weighted average service period of 2.5 years.

Pro Forma Financial Information

The unaudited pro forma financial information presented below for the three and six months ended July 2, 2010 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 six months ended July 2, 2010 combines the results for Harmonic for the three and six months ended July 2, 2010 and the historical results of Omneon for the three and six months ended June 30, 2010.

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.

		Three months ended				Six months ended
		July 2, 2010				July 2, 2010
		(In thousands, except per share amounts)
Net revenue		$	127,473			$	240,512
Net loss			(1,986	)			(4,441	)
Net loss per share — basic and diluted			(0.02	)			(0.04	)

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 1, 2011, 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 July 1, 2011 and December 31, 2010, based on the three-tier fair value hierarchy:

		Level 1				Level 2				Level 3				Total
						(In thousands)
July 1, 2011
Cash equivalents:
Money market funds		$	27,616			$	—			$	—			$	27,616
Commercial paper			—				1,200				—				1,200
Corporate bonds			—				1,130				—				1,130
Short-term investments:
State, municipal and local government agencies bonds			—				32,261				—				32,261
Corporate bonds			—				22,849				—				22,849
Commercial paper			—				4,796				—				4,796
U.S. federal government bonds			—				4,022				—				4,022
Total		$	27,616			$	66,258			$	—			$	93,874
December 31, 2010
Cash equivalents:
Money market funds		$	68,395			$	—			$	—			$	68,395
Short-term investments:
State, municipal and local government agencies bonds			—				11,931				—				11,931
Corporate bonds			—				11,907				—				11,907
Total		$	68,395			$	23,838			$	—			$	92,233

At July 1, 2011 and December 31, 2010, maturities of short-term investments are as follows:

		July 1, 2011				December 31, 2010
		(In thousands)
Short-term investments:
Less than one year		$	35,890			$	21,174
Due in 1 - 2 years			7,736				2,664
Due in 3 - 30 years (1)			20,302				—
Total short-term investments		$	63,928			$	23,838

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

						Gross Unrealized				Gross Unrealized				Estimated Fair
		Amortized Cost				Gains				Losses				Value
						(In thousands)
July 1, 2011
State, municipal and local government agencies bonds		$	32,237			$	25			$	(1	)		$	32,261
Corporate bonds			22,851				5				(7	)			22,849
Commercial paper			4,796				—				—				4,796
U.S. federal government bonds			4,017				5				—				4,022
Total		$	63,901			$	35			$	(8	)		$	63,928
December 31, 2010
State, municipal and local government agencies bonds		$	11,915			$	20			$	(4	)		$	11,931
Corporate bonds			11,894				20				(7	)			11,907
Total		$	23,809			$	40			$	(11	)		$	23,838

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 included 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 included 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 July 1, 2011.

As of July 1, 2011, 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

The following is a summary of inventory as of July 1, 2011 and December 31, 2010:

		July 1, 2011				December 31, 2010
		(In thousands)
Inventories:
Raw materials		$	12,759			$	10,378
Work-in-process			4,610				2,324
Finished goods			43,695				45,363
		$	61,064			$	58,065

NOTE 6: GOODWILL AND IDENTIFIED INTANGIBLES

The following is a summary of goodwill and intangible assets as of July 1, 2011 and December 31, 2010:

		July 1, 2011												December 31, 2010
		Gross Carrying				Accumulated				Net Carrying				Gross Carrying				Accumulated				Net Carrying
		Amount				Amortization				Amount				Amount				Amortization				Amount
		(In thousands)
Identifiable intangibles:
Existing and core technology		$	136,210			$	(71,146	)		$	65,064			$	127,146			$	(60,453	)		$	66,693
In-process technology			—				—				—				9,000				—				9,000
Customer relationships/contracts			67,100				(39,132	)			27,968				67,098				(36,117	)			30,981
Trademarks and tradenames			11,371				(6,890	)			4,481				11,361				(6,060	)			5,301
Supply agreements			3,431				(3,431	)			—				3,414				(3,414	)			—
Maintenance agreements and related relationships			7,100				(1,634	)			5,466				7,100				(1,008	)			6,092
Software license, intellectual property and assembled workforce			309				(309	)			—				309				(306	)			3
Order backlog			2,800				(2,800	)			—				2,800				(2,800	)			—
Subtotal of identifiable intangibles			228,321				(125,342	)			102,979				228,228				(110,158	)			118,070
Goodwill			212,210				—				212,210				211,878				—				211,878
Total goodwill and other intangibles		$	440,531			$	(125,342	)		$	315,189			$	440,106			$	(110,158	)		$	329,948

The changes in the carrying amount of goodwill for the six months ended July 1, 2011 are as follows:

	(In thousands)
Balance at December 31, 2010		$	211,878
Adjustment to deferred tax asset associated with the acquisition of Omneon			244
Foreign currency translation adjustment			88
Balance at July 1, 2011		$	212,210

For the three and six months ended July 1, 2011, the Company recorded a total of $7.7 million and $15.1 million of amortization expense for identified intangibles, of which $5.5 million and $10.6 million was included in cost of revenue, respectively. 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. The estimated future amortization expense of purchased intangible assets with definite lives is as follows:

		Cost of				Operating
		Revenue				Expenses				Total
		(In thousands)
Years ending December 31,
2011 (remaining 6 months)		$	10,869			$	4,449			$	15,318
2012			20,504				8,715				29,219
2013			19,232				8,096				27,328
2014			13,745				6,775				20,520
2015			714				5,783				6,497
2016			—				4,097				4,097
Total		$	65,064			$	37,915			$	102,979

NOTE 7: RESTRUCTURING AND EXCESS FACILITIES

In the second quarter of 2009, the Company recorded an excess facilities expense of $0.3 million in selling, general and administrative expenses related to the closure of the Scopus New Jersey office. The lease term expired in April 2011.

In the fourth quarter of 2010, the Company recorded an excess facilities expense of $3.0 million in selling, general and administrative expenses related to the closure of the Omneon headquarters in Sunnyvale, California. The charge was based on future rent payments, net of expected sublease income, to be made through the end of the lease term in June 2013. In the first quarter of 2011, the Company recorded an additional expense of $0.5 million in selling, general and administrative expenses related to changes in expected sublease income for this property. Harmonic reassesses this liability quarterly and adjusts it, as necessary, based on changes in the timing and amounts of expected sublease rental income.

As of July 1, 2011, accrued excess facilities costs totaled $3.5 million, of which $1.7 million was included in current accrued liabilities. During the six months ended July 1, 2011, the Company incurred cash outlays of $1.0 million related to vacated facilities, principally for lease payments, property taxes, insurance and other maintenance fees, and received sublease income of $1.1 million.

The following table summarizes the activity in the restructuring accrual during the six months ended July 1, 2011:

		Excess
		Facilities
		(In thousands)
Balance at December 31, 2010		$	2,920
Provisions			517
Sublease income			1,050
Cash payments			(1,011	)
Balance at July 1, 2011		$	3,476

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 September 2, 2011. As of July 1, 2011, 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 the six months ended July 1, 2011. 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, including declaring all obligations immediately due and payable. At July 1, 2011, 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 1, 2011). Borrowings are payable monthly and are not collateralized.

NOTE 9: FINANCING LIABILITY FOR CONSTRUCTION IN PROGRESS

The lease for the buildings at the Company’s Sunnyvale, California 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, in December 2009 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 year ended December 31, 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 concluded that it qualified for sale-leaseback accounting under applicable accounting guidance because the Company has no form of continuing involvement other than under its lease. Accordingly, 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 Based Incentive Plans. The Company has three active stock based incentive plans; the 1995 Stock Plan (the “Stock Plan”), the 2002 Director Stock Plan (the “Director Plan”), and the Employee Stock Purchase Plan (the “ESPP”). As of July 1, 2011, (a) an aggregate of 19,134,221 shares of common stock are reserved for issuance under the Stock Plan, 7,998,875 of which remained available for grant, 7,171,074 of which were subject to outstanding stock option grants and 3,964,272 of which were restricted stock units (“RSUs”) subject to vesting, (b) an aggregate of 619,162 shares of common stock are reserved for issuance under the Director Plan, 163,317 of which remained available for grant, 380,000 of which were subject to outstanding stock option grants and 75,845 of which were RSUs subject to vesting, and (c) an aggregate of 2,829,786 shares of common stock are reserved for issuance under the ESPP. In addition, the Company has various inactive stock based incentive plans, such as the assumed Omneon plans described below. As of July 1, 2011, an aggregate of 2,169,412 shares of common stock are reserved for issuance under the inactive plans, all of which were subject to outstanding stock option grants.

Stock Plan. Under the Stock Plan, both stock options and RSUs may be granted to employees and consultants of Harmonic. Stock options have a maximum term of seven years and generally vest 25% at one year from date of grant and an additional 1/48 per month thereafter. Stock options are granted with exercise prices equal to the fair market value of the common stock at the date of grant. Restricted stock units (“RSUs”) 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 or 1/8 semiannually thereafter. In May 2010, Harmonic stockholders approved amendments to the Stock Plan that (a) increased the maximum number of shares of common stock authorized for issuance by an additional 10,600,000 shares, (b) decreased the maximum term of stock options to seven years, and (c) 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 Stock 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 Stock Plan reserve by 1.5 shares for every unit or share forfeited. Previously, RSUs granted reduced the number of shares reserved for grant under the Stock Plan by two shares for every unit granted. In the six months ended July 1, 2011, 1,570,300 RSUs, with an aggregate grant date fair value of $14.9 million, were granted to employees. In the six months ended July 2, 2010, 1,501,100 RSUs, with an aggregate grant date fair value of $9.5 million, were granted to employees. Certain stock option and RSU awards provide for accelerated vesting if there is a change in control and a subsequent involuntary termination of the award holder.

Upon acquisition of Omneon in September 2010, the Company assumed substantially all unvested stock options and RSUs outstanding, as of the date of closing, under Omneon’s 1998 Stock Option Plan and 2008 Equity Incentive Plan, resulting in the assumption of stock options to purchase approximately 1,522,000 shares of Harmonic common stock and the assumption of RSUs for 1,455,000 shares of Harmonic common stock. 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 RSUs 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 $15.2 million will be recorded as compensation expense over the weighted average service period of 2.5 years from the September 15, 2010 closing date.

Director Plan. In May 2002, Harmonic’s stockholders approved the Director Plan. Under the Director Plan, both non-statutory stock options and RSUs may be granted to certain non-employee directors of Harmonic. In May 2010, Harmonic stockholders approved

amendments to the Director Plan, (a) increasing the maximum number of shares of common stock authorized for issuance by an additional 400,000 shares, and (b) changing the share counting provisions to provide that each award of RSUs would decrease the Director Plan reserve 1.5 shares for every unit granted and any forfeitures of unvested RSUs would increase the Director Plan reserve by 1.5 shares for every unit forfeited. Previously, RSUs granted reduced the number of shares reserved for grant under the Director Plan by two shares for every unit granted. RSUs have no exercise price and vest either after one year from the grant date or on the vesting date chosen for such award. Stock options are granted at the fair market value of the common stock on the date of grant and have a maximum term of seven years. Initial option grants generally vest monthly over three years, and subsequent grants generally vest monthly over one year. In the six months ended July 1, 2011, 75,845 RSUs, with an aggregate grant date fair value of $0.7 million, were granted to non-employee directors. In the six months ended July 2, 2010, 87,367 RSUs, with an aggregate grant date fair value of $0.5 million, were granted to non-employee directors.

A summary of share-based award activity under the Stock Plan and Director Plan during the six months ended July 1, 2011 is as follows:

		Shares
		Available for
		Grant
		(In thousands)
Balance at December 31, 2010			10,449
Options granted			(833	)
Restricted stock units granted			(2,469	)
Options cancelled			384
Restricted stock units cancelled			591
Options expired			40
Balance at July 1, 2011			8,162

The following table summarizes RSU activity under the Stock Plan and Director Plan during the six months ended July 1, 2011:

						Weighted
		RSU’s				Average Fair				Aggregate Fair
		Outstanding				Value Per Share				Value(1)
		(In thousands, except per share data)
Balance at December 31, 2010			4,507			$	6.43
Restricted stock units granted			1,646				9.50
Restricted stock units vested			(922	)			6.31			$	8,250
Restricted stock units cancelled			(718	)			6.80
Balance at July 1, 2011			4,513				7.51

The following table summarizes stock option activity under the Stock Plan and Director Plan during the six months ended July 1, 2011:

						Average
		Stock Options				Exercise Price
		Outstanding				Per Option
		(In thousands, except per option data)
Balance at December 31, 2010			11,020			$	6.90
Options granted			833				9.63
Options exercised			(1,714	)			6.33
Options cancelled			(507	)			7.55
Options expired			(384	)			9.11
Balance at July 1, 2011			9,248				7.12
Options vested and exercisable at July 1, 2011			6,492
Options vested and expected-to-vest at July 1, 2011			9,122

The weighted-average fair value of options granted for the six months ended July 1, 2011 and July 2, 2010 was $4.55 and $3.09, respectively.

The following table summarizes information regarding stock options outstanding at July 1, 2011:

		Stock Options Outstanding												Stock Options Exercisable
						Weighted
						Average				Weighted								Weighted
		Number				Remaining				Average				Number				Average
		Outstanding at				Contractual Life				Exercise Price				Exercisable at				Exercise Price
		July 1, 2011				(In Years)				Per Option				July 1, 2011				Per Option
						(In thousands, except per option data)
Range of Exercise Prices
$0.19 - 5.14			1,467				5.9			$	2.77				866			$	3.12
5.18 - 5.87			1,483				3.6				5.76				1,097				5.79
5.88 - 8.12			1,036				4.8				6.65				509				6.72
8.17 - 8.17			1,895				3.7				8.17				1,523				8.17
8.20 - 8.65			1,332				2.7				8.25				1,313				8.25
8.69 - 9.69			1,398				5.0				9.39				555				9.04
9.74 - 16.73			637				1.2				10.63				629				10.63
			9,248				4.0			$	7.12				6,492			$	7.31

The weighted-average remaining contractual life for all exercisable stock options at July 1, 2011 was 3.2 years. The weighted-average remaining contractual life of all vested and expected-to-vest stock options at July 1, 2011 was 4.0 years. The weighted-average remaining contractual life of all vested and expected-to-vest RSUs at July 1, 2011 was 1.4 years.

Aggregate intrinsic value of options exercisable at July 1, 2011 was $6.0 million. The aggregate intrinsic value of stock options vested and expected-to-vest, net of estimated forfeitures, was $10.1 million at July 1, 2011. Aggregate intrinsic value represents the difference between our closing price on the last trading day of the fiscal period, which was $7.46 as of July 1, 2011, and the exercise price multiplied by the number of options outstanding and exercisable. The intrinsic value of exercised stock options is calculated based on the difference between the exercise price and the market value of the common stock at the time of exercise. The aggregate intrinsic value of exercised stock options during the six months ended July 1, 2011 was $4.9 million.

ESPP. In May 2002, Harmonic’s stockholders approved the ESPP. In June 2011, Harmonic’s stockholders approved an amendment to the ESPP which increased by 2.0 million shares the maximum number of shares authorized under the ESPP. The ESPP enables employees to purchase shares at 85% of the fair market value of the common stock at the beginning or end of each six month 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 ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. During the six months ended July 1, 2011 and July 2, 2010, the number of shares of stock issued under the ESPP was 945,287 and 864,800, at weighted average prices of $5.54 and $4.90, respectively. The weighted-average fair value of each right to purchase shares of common stock granted under the ESPP during the six months ended July 1, 2011 and July 2, 2010 was $2.02 and $1.91, respectively.

Retirement/Savings Plan. Harmonic has a retirement/savings plan that 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. The employer contribution has been suspended since 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 1, 2011 and July 2, 2010:

		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
						(In thousands)
Employee stock-based compensation in:
Cost of revenue		$	762			$	527			$	1,509			$	1,006
Research and development expense			1,771				1,158				3,607				2,266
Selling, general and administrative expense			2,559				1,734				5,978				3,391
Total employee stock-based compensation in operating expense			4,330				2,892				9,585				5,657
Total employee stock-based compensation			5,092				3,419				11,094				6,663
Amount capitalized in inventory			(14	)			(5	)			—				25
Total stock-based compensation		$	5,078			$	3,414			$	11,094			$	6,688

As of July 1, 2011, total unamortized stock-based compensation cost related to unvested stock options and RSUs was $41.1 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								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
Expected life (in years)			4.75				4.75				4.75				4.75
Volatility			52	%			55	%			54	%			56	%
Risk-free interest rate			2.5	%			2.2	%			2.1	%			2.4	%
Dividend yield			0.0	%			0.0	%			0.0	%			0.0	%

		Employee Stock Purchase Plan Awards
		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
Expected life (in years)			0.50				0.50				0.50				0.50
Volatility			43	%			50	%			43	%			50	%
Risk-free interest rate			0.3	%			0.4	%			0.3	%			0.4	%
Dividend yield			0.0	%			0.0	%			0.0	%			0.0	%

The expected life for stock options and ESPP awards represents the weighted-average period that the stock options or ESPP awards are expected to remain outstanding. Our computation of expected life for stock options 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 ESPP offering period to estimate the expected volatility.

The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our stock options and ESPP 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 months ended July 1, 2011, the Company recorded a provision for income taxes of $0.8 million, compared to a benefit from income taxes of $49,000 for the same period a year ago, inclusive of discrete items. For the six months ended July 1, 2011, the Company recorded a provision for income taxes of $0.2 million, compared to a benefit from income taxes of $2.9 million for the same period a year ago, inclusive of discrete items.

For the three and six months ended July 1, 2011, the difference between the recorded provision for income taxes and the tax provision, based on 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 amortization on foreign intangibles, and federal research and development credits. The discrete items recorded in the six months ended July 1, 2011 principally related to accrued interest on uncertain tax positions, a benefit associated with the reversal of previously provided foreign income taxes due to statute of limitation expirations, and foreign currency translation adjustments.

For the three and six months ended July 2, 2010, the difference between the recorded benefit from income taxes and the tax provision, based on 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 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, a benefit associated with the release of a portion of the valuation allowance on certain California deferred tax assets, foreign currency translation adjustments, and accrued interest on uncertain tax positions.

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 $53.4 million as of December 31, 2010, and approximately $54.0 million as of July 1, 2011. 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 $4.4 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 six months ended July 1, 2011, we recorded a net increase of $0.5 million for interest and penalties related to uncertain tax positions, resulting in a balance at July 1, 2011 of $5.5 million.

The tax years 2003-2010 remain open to examination by various federal, state or foreign taxing jurisdictions.

The Company’s income tax returns for 2007, 2008 and 2009 are currently under examination by the U.S. Internal Revenue Service.

NOTE 12: NET INCOME PER SHARE

Basic net income per share is computed by dividing net income for the period by the weighted average number of the common shares outstanding during the period.

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 computations because their effect was antidilutive:

Three months ended

Six months ended

July 1, 2011

July 2, 2010

July 1, 2011

July 2, 2010

(In thousands)

Potentially dilutive equity awards outstanding

10,671

11,755

9,103

11,715

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

		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
		(In thousands, except per share amounts)
Net income (numerator)		$	390			$	4,445			$	906			$	9,764
Shares calculation (denominator):
Weighted average shares outstanding — basic			114,939				96,998				114,387				96,845
Effect of Dilutive Securities:
Potential common stock relating to stock options, restricted stock units and ESPP			1,359				572				1,756				684
Weighted averages shares outstanding — diluted			116,298				97,570				116,143				97,529
Net income per share — basic		$	0.00			$	0.05			$	0.01			$	0.10
Net income per share — diluted		$	0.00			$	0.05			$	0.01			$	0.10

NOTE 13: COMPREHENSIVE INCOME

The Company’s total comprehensive income was as follows:

		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
						(In thousands)
Net income		$	390			$	4,445			$	906			$	9,764
Change in unrealized gain (loss) on investments, net			8				(128	)			(3	)			(344	)
Change in unrealized gain (loss) on foreign exchange contracts, net of tax			—				(62	)			—				(62	)
Foreign currency translation			69				(518	)			523				(655	)
Total comprehensive income		$	467			$	3,737			$	1,426			$	8,703

NOTE 14: SEGMENT INFORMATION

The Company operates its 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 in September 2010 resulted in an additional product line, production and playout, but did not impact our reportable segments.

The Company’s revenue by product type is summarized as follows:

		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
						(In thousands)
Video processing products		$	51,525			$	49,998			$	115,283			$	88,888
Production and playout products			25,453				—				46,386				—
Edge and access products			40,178				34,263				71,354				69,807
Service and support			16,840				11,283				33,808				21,671
		$	133,996			$	95,544			$	266,831			$	180,366

Our revenue by geographic region, based on the location of our customer, and our property and equipment, net by geographic region, is summarized as follows:

		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
		(In thousands)
Net revenue:
United States		$	55,578			$	49,259			$	114,532			$	91,850
International			78,418				46,285				152,299				88,516
		$	133,996			$	95,544			$	266,831			$	180,366

		July 1, 2011				December 31, 2010
		(In thousands)
Property and equipment, net:
United States		$	31,875			$	32,104
International			7,803				7,721
		$	39,678			$	39,825

Major Customers. For both the three and six months ended July 1, 2011, revenue from Comcast accounted for 11% of net revenue. For the three and six months ended July 2, 2010, revenue from Comcast accounted for 16% and 15% of net revenue, respectively. For the three months ended July 2, 2010, revenue from Echostar accounted for 10% of net revenue. As of July 1, 2011, Comcast accounted for 14% 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
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
						(In thousands)
Balance at beginning of period		$	5,263			$	3,426			$	4,811			$	4,186
Accrual for current period warranties			2,171				1,020				4,433				1,470
Warranty costs incurred			(1,856	)			(1,252	)			(3,666	)			(2,462	)
Balance at end of period		$	5,578			$	3,194			$	5,578			$	3,194

Standby Letters of Credit. As of July 1, 2011, the Company’s financial guarantees consisted of standby letters of credit outstanding, which 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 amounts accrued in respect of the indemnification provisions through July 1, 2011.

Guarantees. As of July 1, 2011, Harmonic had no other guarantees outstanding.

NOTE 16: LEGAL PROCEEDINGS

In March 2010, Interkey ELC Ltd, or Interkey, filed a lawsuit in Israel alleging breach of contract against Harmonic and Scopus Video Networks Ltd. (now Harmonic Video Networks Ltd. or “HVN”), which was acquired by Harmonic in March 2009. The plaintiffs are seeking damages in the amount of 6,300,000 ILS (approximately $1.7 million). Although, as is the case with all litigation, no assurances can be given as to the outcome of the Interkey lawsuit, Harmonic believes Interkey’s and its shareholders’ claims are without merit and Harmonic and HVN intend to vigorously defend themselves against these claims. Based on the foregoing, Harmonic has not recorded a provision for this claim.

In April 2010, Arris Corporation filed a complaint in United States District Court in Atlanta, alleging that our Streamliner 3000 product infringes four patents held by Arris. The complaint sought injunctive relief and damages. In connection with this matter, we recorded a $1.3 million liability in the fourth quarter of 2010, based on a tentative agreement of Arris and Harmonic with respect to settlement of the action. In April 2011, this matter was settled on essentially the same terms as the tentative agreement, the Company paid Arris $1.3 million, and the action was dismissed.

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 of, or an unfavorable outcome on, any of the above referenced or other litigation matters could have a material adverse effect on Harmonic’s business, operating results, financial position and cash flows.

Harmonic’s industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. From time to time, third parties have asserted, and may in the future assert, exclusive patent, copyright, trademark and other intellectual property rights against us or the Company’s customers. Such assertions arise in the normal course of the Company’s operations. The resolution of any such assertions and claims cannot be predicted with certainty.

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

The terms “Harmonic,” the “Company,” “we,” “us,” “its,” and “our,” as used in this Quarterly Report on Form 10-Q, refer to Harmonic Inc. and its subsidiaries and its predecessors as a combined entity, except where the context requires otherwise.

Some of the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements that involve risk and uncertainties. The statements contained in this Form 10-Q that are not purely historical are 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, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. In some cases, you can identify forward-looking statements by terminology such as, “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “intends,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other comparable terminology. These forward-looking statements include, but are not limited to, statements regarding:

•		developing trends in the broadcasting and television business;
•		continuation of customer concentration;
•		capital spending of our customers in the balance of 2011 and beyond;
•		our strategic direction, future business plans and growth strategy;
•		increases in our international revenue;
•		industry and customer consolidation;
•		anticipated changes in economic conditions or the financial markets, and the potential impact on our business;
•		the expected demand for, and benefits of, our products and services;
•		concentration of revenue sources;
•		anticipated benefits of recent acquisitions;
•		potential future acquisitions;
•		statements regarding anticipated results of potential or actual litigation;
•		our competitive environment;
•		the impact of governmental regulation;
•		the impact of conditions in, and changes to, economies and markets;
•		anticipated revenue and expenses, including the sources of such revenue and expenses;
•		expected impacts of changes in accounting rules;
•		use of cash, cash needs and ability to raise capital; and
•		the condition of our cash investments.

These statements are subject to known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements. Important factors that may cause actual results to differ from expectations include those discussed in “Risk Factors” beginning on page 35 of this Form 10-Q. All forward-looking statements included in this Form 10-Q are based on information available to us on the date thereof, and we assume no obligation to update any such forward-looking statements.

Overview

Harmonic designs, manufactures and sells versatile and high performance video infrastructure products and system solutions that enable our customers to efficiently create, prepare and deliver broadcast and on-demand video services to televisions, personal computers and mobile devices. Historically, the majority of our sales have been derived from sales of video processing solutions and network edge and access systems to cable television operators and from sales of video processing solutions to direct-to-home satellite operators. More recently, we have been providing our video processing solutions to telecommunications companies, or telcos, broadcasters and other media companies that create video programming or offer video services. In September 2010, we acquired Omneon, Inc., a private, venture-backed company specializing in file-based infrastructure for the production, preparation and playout of video content typically deployed by broadcasters, satellite operators, content owners and other media companies. The acquisition of Omneon, which is further described below, is complementary to Harmonic’s core business, expanding our customer reach into content providers and extending our product lines into video servers and video-optimized storage for content production and playout.

Harmonic’s revenue increased by 40% and 48% in the three and six months ended July 1, 2011, respectively, compared to the same periods in 2010. The increase in revenue in the three months ended July 1, 2011 was due, in part, to stronger worldwide customer demand for edge and access solutions, which grew 17% compared to the same period in 2010. The increase in revenue in the six months ended July 1, 2011 was due, in part, to stronger worldwide demand for video processing solutions primarily during the three months ended April 1, 2011, which grew 30% compared to the same period in 2010. In addition, Harmonic’s revenue also increased in the three and six months ended July 1, 2011 as a result of the acquisition of Omneon in September 2010. Omneon’s product revenue, which for the three and six months ended July 1, 2011 was $25.5 million and $46.4 million, respectively, is included in the production and playout product line under “Net Revenue — Consolidated” below. The growth in edge and access revenue in the three months ended July 1, 2011, the growth of video processing revenue in the six months ended July 1, 2011, and the addition of Omneon product revenue in both periods also contributed to the growth in service and support activity related to the associated product solutions, resulting in services and support revenue growth of 49% and 56% in the three and six months ended July 1, 2011, respectively, when compared to the same periods in 2010.

Financial difficulties of certain of our customers and changes in our customers’ deployment plans have adversely affected our business in the past. In 2008 and 2009, economic conditions in many of the countries in which we sell products were very weak, and global economic conditions and financial markets experienced a severe downturn. The downturn stemmed from a multitude of factors, including adverse credit conditions, slower economic activity, concerns about inflation and deflation, rapid changes in foreign exchange rates, increased energy costs, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions and liquidity concerns.

Although there was an increase in global economic activity in 2010 and in the first six months of 2011, economic growth may be sluggish during the balance of 2011 and possibly beyond. The severity or length of time that these adverse economic and financial market conditions may persist, or whether such adverse conditions may return in the U.S. and in other countries, is unknown. During challenging or uncertain economic times, and in tight credit markets, many customers may delay or reduce capital expenditures, which in turn often results in lower demand for our products.

Sales to customers outside of the U.S. in the three and six months ended July 1, 2011 represented 59% and 57% of net revenue, respectively, compared to 48% and 49%, respectively, for the same periods in 2010. A significant portion of international sales are made to distributors and system integrators, which are generally responsible for importing the products and providing installation and technical support and service to customers within their territory. We expect international sales to continue to account for a substantial portion of our net revenue for the foreseeable future, and expect that, partially as a result of the acquisitions of Scopus in 2009 and of Omneon in 2010, our international sales may continue to increase as a percentage of net revenue from year to year.

Further, we have a number of international customers to whom sales are denominated in U.S. dollars. Sales denominated in foreign currencies were approximately 9% of net revenue in the six months ended July 1, 2011, compared to 6% for the same period in 2010. The value of the U.S. dollar fluctuates significantly against many foreign currencies, which includes the local currencies of many of our international customers. If the U.S. dollar appreciates relative to the local currencies of our customers, then the prices of our

products correspondingly increase for such customers. Such an effect could adversely impact sales of our products to such customers and result in longer sales cycles, difficulties in collection of accounts receivable, slower adoption of new technologies and increased price competition in the affected countries. Further, if the U.S. dollar were to weaken against many major currencies, there can be no assurance that a weaker dollar would lead to growth in capital spending.

In addition, industry consolidation has in the past constrained, and may in the future constrain, capital spending by our customers. Also, if our product portfolio and product development plans do not position us well to capture an increased portion of the capital spending of customers in the markets on which we focus, our revenue may decline.

Historically, a majority of our revenue has been derived from relatively few customers, due in part to the consolidation of the ownership of cable television and direct broadcast satellite system companies. However, in the last two years, revenue from our ten largest customers has decreased as a percentage of revenue, due to our growing customer base, in part as a result of the acquisitions of Scopus and Omneon. Sales to our ten largest customers in the three and six months ended July 1, 2011 accounted for approximately 37% and 35% of revenue, respectively, compared to 51% and 48%, respectively, for the same periods in 2010. Although we are attempting to broaden our customer base by penetrating new markets and further expanding internationally, we expect to see continuing industry consolidation and customer concentration.

In both the three and six months ended July 1, 2011, sales to Comcast accounted for 11% of net revenue, respectively, compared to 16% and 15%, respectively, for the same periods in 2010. In addition, sales to Echostar accounted for 10% of net revenue in the three months ended July 2, 2010. The loss of Comcast, or any other significant customer, any material reduction in orders by Comcast, or any significant customer, or our failure to qualify our new products with a significant customer could materially and adversely affect our operating results, financial condition and cash flows. In addition, we are involved in most quarters in one or more relatively large individual transactions, including, from time to time, projects in which we act much like a systems integrator. A decrease in the number of the relatively larger individual transactions in which we are involved in any quarter could adversely affect our operating results for that quarter.

In addition, historically, we have been dependent upon capital spending in the cable and satellite industries. We are attempting to further diversify our customer base beyond cable and satellite customers, including to the telco and broadcast and media markets. Several major telcos have rebuilt or are upgrading their networks to offer bundled video, voice and data services. In order to be successful in this market, we may need to continue to build alliances with telco equipment manufacturers, adapt our products for telco applications, take orders at prices resulting in lower margins, and build internal expertise to handle the particular contractual and technical demands of the telco industry. In addition, telco video deployments, including recent trials of mobile video services, are subject to delays in completion, as video processing technologies and video business models are relatively new to most telcos and many of their largest suppliers. Implementation issues with our products or those of other vendors have caused, and may continue to cause, delays in project completion for our customers and delay our recognition of revenue.

We often recognize a substantial portion of our quarterly revenues in the last month of the quarter. We establish our expenditure levels for product development and other operating expenses based on projected revenue levels for a specified period, and expenses are relatively fixed in the short term. Accordingly, even small variations in timing of revenue, particularly from large individual transactions, can cause significant fluctuations in operating results in a particular quarter.

On September 15, 2010, Harmonic completed the acquisition of Omneon, Inc., a private, venture-backed company organized under the laws of Delaware and headquartered in Sunnyvale, California. 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 and 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. The Company also incurred a total of $5.9 million of transaction expenses, which were expensed as selling, general and administrative expenses in the year ended December 31, 2010. Substantially all unvested stock options and unvested restricted stock units issued by Omneon and outstanding at closing were assumed by Harmonic.

We have expanded our international operations and staffing to better support our expansion into international markets. This expansion included the implementation of an international structure that involved, among other things, an international support center in Europe, a research and development cost-sharing arrangement, and certain licenses and other contractual arrangements by and among the Company and its wholly-owned domestic and foreign subsidiaries. Our foreign subsidiaries have acquired certain license rights to use our existing intellectual property and intellectual property that will be developed or licensed in the future, including Omneon’s

existing and future intellectual property. As a result of these changes and an expanding customer base internationally, we expect that an increasing percentage of our consolidated pre-tax income will be derived from, and reinvested in, our international operations. We anticipate that this pre-tax income will be subject to foreign tax at relatively lower tax rates when compared to the United States federal statutory tax rate in future periods.

Critical Accounting Policies, Judgments and Estimates

The preparation of financial statements and related disclosures requires Harmonic to make judgments, assumptions and estimates that affect the reported amounts of assets and liabilities, the disclosure of contingencies, and the reported amounts of revenue and expenses in the financial statements and accompanying notes. Material differences may result in the amount and timing of revenue and expenses if different judgments or different estimates were made.

Our significant accounting policies are described in Note 1 to our Consolidated Financial Statements as of and for the year ended December 31, 2010, included in our 2010 Form 10-K and the notes to the Condensed Consolidated Financial Statements as of and for the three and six months ended July 1, 2011, included in this Form 10-Q. Critical accounting policies, judgments and estimates which we believe have the most significant impact on Harmonic’s financial statements have not changed since December 31, 2010, except as described in Note 1 to the Condensed Consolidated Financial Statements included herein, and are set forth below:

•		Revenue recognition;
•		Allowances for doubtful accounts, returns and discounts;
•		Valuation of inventories;
•		Impairment of goodwill or long-lived assets;
•		Restructuring costs and accruals for excess facilities;
•		Assessment of the probability of the outcome of litigation;
•		Accounting for income taxes, and
•		Stock-based compensation.

Results of Operations

Harmonic’s condensed consolidated statements of operations data for the three and six months ended July 1, 2011 and July 2, 2010, as a percentage of net revenue, is as follows:

		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
Net revenue			100	%			100	%			100	%			100	%
Cost of revenue			54				52				54				52
Gross profit			46				48				46				48
Operating expenses:
Research and development			19				18				19				19
Selling, general and administrative			24				25				25				25
Amortization of intangibles			2				1				2				—
Total operating expenses			45				44				46				44
Income from operations			1				4				—				4
Interest and other income, net			—				1				—				—
Income before income taxes			1				5				—				4
Provision for (benefit from) income taxes			1				—				—				(1	)
Net income			—	%			5	%			—	%			5	%

Net Revenue — Consolidated

Harmonic’s consolidated net revenue in the three and six months ended July 1, 2011, compared with the corresponding periods in 2010, are presented in the table below. Also presented are the related dollar and percentage changes in consolidated net revenue in the three and six months ended July 1, 2011, from the corresponding periods in 2010.

		Three months ended								Six months ended
		July 1, 2011				July 2, 2010				July 1, 2011				July 2, 2010
						(In thousands, except percentages)
Revenue by type:
Video processing products		$	51,525			$	49,998			$	115,283			$	88,888
Production and playout products			25,453				—				46,386				—
Edge and access products			40,178				34,263				71,354				69,807
Service and support			16,840				11,283				33,808				21,671
Net revenue		$	133,996			$	95,544			$	266,831			$	180,366
Increase:
Video processing products		$	1,527							$	26,395
Production and playout products			25,453								46,386
Edge and access products			5,915								1,547
Service and support			5,557								12,137
Total increase		$	38,452							$	86,465
Percent change:
Video processing products			3	%							30	%
Production and playout products			—								—
Edge and access products			17								2
Service and support			49								56
Total percent change			40	%							48	%