e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended September 28, 2007
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No. 0-25826
HARMONIC INC.
(Exact name of Registrant as specified in its charter)
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Delaware
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77-0201147 |
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(State or other jurisdiction of incorporation or
organization)
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(I.R.S. Employer Identification Number) |
549 Baltic Way
Sunnyvale, CA 94089
(408) 542-2500
(Address, including zip code, and telephone number, including area code, of Registrants principal executive offices)
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 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.
Yes þ No
o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
(Check one):
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
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 outstanding of the Registrants Common Stock, $.001
par value, was 80,973,812 on October 26, 2007.
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
HARMONIC INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
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(In thousands, except par value amounts) |
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September 28, 2007 |
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December 31, 2006 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
40,993 |
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$ |
33,454 |
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Short-term investments |
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58,038 |
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58,917 |
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Accounts receivable, net of allowances of $7,192 and $4,471 |
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69,339 |
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64,674 |
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Inventories |
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36,341 |
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42,116 |
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Prepaid expenses and other current assets |
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11,911 |
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12,807 |
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Total current assets |
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216,622 |
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211,968 |
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Property and equipment, net |
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14,084 |
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14,816 |
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Goodwill |
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46,222 |
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37,141 |
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Intangibles, net |
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19,522 |
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16,634 |
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Other assets |
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3,903 |
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1,403 |
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Total assets |
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$ |
300,353 |
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$ |
281,962 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Current portion of long-term debt |
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$ |
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$ |
460 |
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Accounts payable |
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15,583 |
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33,863 |
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Income taxes payable |
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726 |
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7,098 |
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Deferred revenue |
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30,794 |
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29,052 |
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Accrued liabilities |
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43,904 |
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44,097 |
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Total current liabilities |
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91,007 |
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114,570 |
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Accrued
excess facilities costs, non-current |
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11,126 |
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16,434 |
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Income taxes payable, non-current |
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8,243 |
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Other non-current liabilities |
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8,968 |
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5,824 |
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Total liabilities |
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119,344 |
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136,828 |
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Commitments and contingencies (Notes 16 and 17) |
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Stockholders equity: |
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Preferred stock, $0.001 par value, 5,000 shares
authorized; no shares issued or outstanding |
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Common stock, $0.001 par value, 150,000 shares authorized;
80,798 and 78,386 shares issued and outstanding |
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81 |
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78 |
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Capital in excess of par value |
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2,100,059 |
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2,078,863 |
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Accumulated deficit |
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(1,919,025 |
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(1,933,708 |
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Accumulated other comprehensive loss |
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(106 |
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(99 |
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Total stockholders equity |
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181,009 |
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145,134 |
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Total liabilities and stockholders equity |
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$ |
300,353 |
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$ |
281,962 |
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The accompanying notes are an integral part of these consolidated financial statements.
2
HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three Months Ended |
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Nine Months Ended |
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September 28, |
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September 29, |
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September 28, |
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September 29, |
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(In thousands, except per share amounts) |
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2007 |
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2006 |
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2007 |
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2006 |
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Product sales |
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$ |
74,995 |
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$ |
56,815 |
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$ |
205,017 |
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$ |
155,260 |
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Service revenue |
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7,300 |
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6,041 |
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18,797 |
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17,086 |
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Net sales |
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82,295 |
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62,856 |
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223,814 |
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172,346 |
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Product cost of sales |
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43,131 |
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30,866 |
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121,547 |
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94,109 |
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Service cost of sales |
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3,521 |
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2,193 |
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8,907 |
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6,955 |
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Total cost of sales |
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46,652 |
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33,059 |
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130,454 |
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101,064 |
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Gross profit |
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35,643 |
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29,797 |
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93,360 |
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71,282 |
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Operating expenses: |
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Research and development |
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11,018 |
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10,021 |
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31,615 |
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29,554 |
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Selling, general and administrative |
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14,911 |
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16,931 |
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46,357 |
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48,623 |
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Write-off of acquired in-process
technology |
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700 |
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700 |
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Amortization of intangibles |
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143 |
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45 |
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365 |
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179 |
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Total operating expenses |
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26,772 |
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26,997 |
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79,037 |
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78,356 |
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Income (loss) from operations |
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8,871 |
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2,800 |
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14,323 |
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(7,074 |
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Interest income, net |
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1,238 |
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1,182 |
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3,224 |
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3,349 |
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Other income, net |
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58 |
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137 |
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42 |
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173 |
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Income (loss) before income taxes |
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10,167 |
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4,119 |
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17,589 |
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(3,552 |
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Provision for income taxes |
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750 |
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103 |
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807 |
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482 |
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Net income (loss) |
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$ |
9,417 |
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$ |
4,016 |
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$ |
16,782 |
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$ |
(4,034 |
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Net income (loss) per share |
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Basic |
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$ |
0.12 |
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$ |
0.05 |
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$ |
0.21 |
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$ |
(0.05 |
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Diluted |
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$ |
0.12 |
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$ |
0.05 |
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$ |
0.21 |
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$ |
(0.05 |
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Weighted average shares |
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Basic |
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80,371 |
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74,588 |
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79,570 |
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74,286 |
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Diluted |
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81,642 |
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75,050 |
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80,743 |
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74,286 |
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The accompanying notes are an integral part of these consolidated financial statements.
3
HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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Nine Months Ended |
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September 28, |
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September 29, |
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(In thousands) |
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2007 |
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2006 |
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Cash flows from operating activities: |
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Net income (loss) |
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$ |
16,782 |
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$ |
(4,034 |
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Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities: |
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Amortization of intangibles |
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3,661 |
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672 |
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Write-off of acquired in-process technology |
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700 |
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Depreciation |
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5,089 |
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5,719 |
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Stock-based compensation |
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4,475 |
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4,376 |
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Net loss (gain) on disposal and impairment of fixed assets |
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(31 |
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55 |
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Changes in assets and liabilities, net of effect of acquisitions: |
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Accounts receivable, net |
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(4,234 |
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(9,314 |
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Inventories |
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5,777 |
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2,877 |
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Prepaid expenses and other assets |
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799 |
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(8,133 |
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Accounts payable |
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(18,217 |
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3,486 |
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Deferred revenue |
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3,714 |
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2,474 |
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Income taxes payable |
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(271 |
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366 |
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Accrued excess facilities costs |
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(5,661 |
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683 |
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Accrued and other liabilities |
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(3,242 |
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764 |
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Net cash provided by (used in) operating activities |
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9,341 |
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(9 |
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Cash flows from investing activities: |
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Purchases of investments |
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(70,584 |
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(58,061 |
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Proceeds from sales of investments |
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71,578 |
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71,030 |
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Acquisition of property and equipment |
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(4,193 |
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(3,677 |
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Acquisition of Rhozet Corporation, net of cash received |
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(1,370 |
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Purchase of Entone, Inc. convertible note |
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(2,500 |
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Acquisition costs related to the merger of Entone Technologies, Inc. |
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(2,466 |
) |
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Net cash provided by (used in) investing activities |
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(9,535 |
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9,292 |
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Cash flows from financing activities: |
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Proceeds from issuance of common stock |
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8,292 |
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4,017 |
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Repayments under bank line and term loan |
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(460 |
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(615 |
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Repayments of capital lease obligations |
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(65 |
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(61 |
) |
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Net cash provided by financing activities |
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7,767 |
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3,341 |
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Effect of exchange rate changes on cash and cash equivalents |
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(34 |
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(38 |
) |
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Net increase in cash and cash equivalents |
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7,539 |
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|
12,586 |
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Cash and cash equivalents at beginning of period |
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33,454 |
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|
37,818 |
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Cash and cash equivalents at end of period |
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$ |
40,993 |
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$ |
50,404 |
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Supplemental disclosure of cash flow information: |
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Income tax payments, net |
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$ |
1,132 |
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$ |
177 |
|
Interest paid during the period |
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$ |
66 |
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$ |
94 |
|
Non-cash
investing and financing activities |
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Issuance of restricted common
stock for Rhozet acquisition |
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$ |
8,424 |
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$ |
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Liability
for future issuance of common stock for Rhozet acquisition |
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$ |
1,870 |
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|
$ |
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The accompanying notes are an integral part of these consolidated financial statements.
4
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, the Company or we) 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 Companys audited consolidated financial statements contained in the Companys Annual
Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2007.
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, 2007, or any other future period.
The Companys fiscal quarters end on the Friday nearest the calendar quarter end, 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.
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.
Note 2: Recent Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value
Measurements (SFAS No. 157). This statement clarifies the definition of fair value, establishes a
framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS
No. 157 is effective for fiscal years beginning after November 15, 2007. We have not determined the
effect, if any, the adoption of this statement in the first quarter of fiscal 2008 will have on our
consolidated results of operations or financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial LiabilitiesIncluding an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159
expands the use of fair value accounting but does not affect existing standards which require
assets or liabilities to be carried at fair value. Under SFAS 159, a company may elect to use fair
value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities,
equity method investments, accounts payable, guarantees and issued debt. Other eligible items
include firm commitments for financial instruments that otherwise would not be recognized at
inception and non-cash warranty obligations where a warrantor is permitted to pay a third party to
provide the warranty goods or services. If the use of fair value is elected, any upfront costs and
fees related to the item must be recognized in earnings and cannot be deferred, e.g., debt issue
costs. The fair value election is irrevocable and generally made on an instrument-by-instrument
basis, even if a company has similar instruments that it elects not to measure based on fair value.
At the adoption date, unrealized gains and losses on existing items for which fair value has been
elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the
adoption of SFAS 159, changes in fair value are recognized in earnings. SFAS 159 is effective for
fiscal years beginning after November 15, 2007 and is required to be adopted by Harmonic in the
first quarter of fiscal 2008. Harmonic currently is determining whether fair value accounting is
appropriate for any of its eligible items and cannot estimate the impact, if any, which SFAS 159
will have on its consolidated results of operations or financial condition.
The Company adopted Financial Standards Accounting Board Interpretation No. 48, Accounting for
Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109 (FIN 48) on January 1,
2007. FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. FIN 48
prescribes a comprehensive model for the financial statement recognition, measurement, presentation
and disclosure of uncertain tax positions taken or
5
expected to be taken in income tax returns. See Note 10 for additional information, including the
effects of adoption on the Companys condensed consolidated financial statements.
In June 2007, the FASB also ratified Emerging Issues Task Force (EITF) Issue No. 07-3, Accounting
for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and
Development Activities (EITF No. 07-3). EITF No. 07-3 requires that nonrefundable advance
payments for goods or services that will be used or rendered for future research and development
activities be deferred and capitalized and recognized as an expense as the goods are delivered or
the related services are performed. EITF No. 07-3 is effective, on a prospective basis, for fiscal
years beginning after December 15, 2007. We are currently evaluating the effect that the adoption
of EITF No. 07-3 will have on our consolidated results of operations and financial condition.
Note 3: Acquisitions
Rhozet Corporation
On July 31, 2007, Harmonic completed its acquisition of Rhozet Corporation, a privately held
company based in Santa Clara, California.
Rhozet develops and markets software-based transcoding solutions that
facilitate the creation of multi-format video for internet, mobile
and broadcast applications. With Rhozets products, and
sometimes in conjunction with other Harmonic products,
Harmonics existing broadcast, cable, satellite and telco
customers can deliver traditional video programming over the Internet
and to mobile devices, as well as expand the types of content
delivered via their traditional networks to encompass web-based and
user-generated content. The acquisition also opens up new customer
opportunities for Harmonic with Rhozets customer base of
broadcast content creators and online video service providers and is
complementary to Harmonics video-on demand networking software
business acquired in December 2006 from Entone Technologies. These opportunities were significant factors to the establishment
of the purchase price, which exceeded the fair value of Rhozets
net tangible and
intangible assets acquired resulting in the amount of goodwill we have recorded
with this transaction.
Management has made a preliminary allocation of the
estimated purchase price to the tangible and intangible assets
acquired and liabilities assumed based on various preliminary
estimates. The allocation of the estimated purchase price is
preliminary pending finalization of various estimates and
analyses.
Under the terms of the merger agreement, Harmonic paid or
will pay an aggregate of approximately $15.5 million in total merger consideration, comprised of
approximately $2.5 million in cash, approximately
$10.3 million of common stock issued and to be issued, consisting of
approximately 1.1 million shares of Harmonics common stock, in
exchange for all of the outstanding shares of capital stock of Rhozet, approximately $2.8
million of cash which will be paid, at such time as provided in the merger agreement, to the
holders of outstanding options to acquire Rhozet common stock plus
approximately $0.7 million in transaction costs. Pursuant to the merger agreement,
approximately $2.3 million of the total merger consideration, consisting of cash and shares of
Harmonic common stock, are being held back by Harmonic for at least 18 months following the closing
of the acquisition to satisfy certain indemnification obligations of
Rhozets shareholders. As of September 28, 2007, $ 3.9 million in
merger costs, cash consideration payable to Rhozet shareholders and
cash consideration payable to holders of Rhozet stock options remains
unpaid and has been recorded in either accounts payable or current
liabilities. In addition, as of September 28, 2007, approximately $1.9
million of purchase consideration, which based on the terms of the
merger agreement will be settled through the issuance of
approximately 0.2 million shares of Harmonics common stock, has
been recorded as a non-current liability.
The Rhozet acquisition was accounted for under SFAS No. 141 and certain specified provisions of
SFAS No. 142. The results of operations of Rhozet are included in Harmonics Consolidated
Statements of Operations from July 31, 2007, the date of
acquisition. The following table summarizes the preliminary allocation of the purchase price based on the estimated fair value of
the tangible assets acquired and the liabilities assumed at the date of acquisition:
|
|
|
|
|
|
|
(in thousands) |
|
Cash acquired |
|
$ |
657 |
|
Accounts receivable |
|
|
457 |
|
Fixed assets |
|
|
133 |
|
Other tangible assets acquired |
|
|
59 |
|
Intangible assets: |
|
|
|
|
IP technology |
|
|
169 |
|
Software license |
|
|
80 |
|
Existing technology |
|
|
4,000 |
|
In-process technology |
|
|
700 |
|
Core technology |
|
|
1,100 |
|
Customer contracts |
|
|
300 |
|
Maintenance agreements |
|
|
600 |
|
Tradenames/trademarks |
|
|
300 |
|
Goodwill |
|
|
8,989 |
|
|
|
|
|
Total assets acquired |
|
|
17,544 |
|
Deferred revenue |
|
|
(174 |
) |
Other accrued liabilities |
|
|
(1,165 |
) |
Net assets acquired |
|
$ |
16,205 |
|
|
|
|
|
The purchase price was allocated as set forth in the table above. The Income Approach which
includes an analysis of the markets, cash flows and risks associated with achieving such cash
flows, was the primary method used in valuing the identified intangibles acquired. The Discounted
Cash Flow method was used to estimate the fair value of the acquired existing technology,
in-process technology, maintenance agreements and customer contracts. The Royalty Savings Method
was used to estimate the fair value of the acquired core technology and trademarks/trade
6
names. In the Royalty Savings Method, the value of an asset is estimated by capitalizing the
royalties saved because the Company owns the asset. Expected cash flows were discounted at the
Companys weighted average cost of capital of 18%. Identified intangible assets, including existing
technology and core technology are being amortized over their useful lives of four years; trade
name/trademarks are being amortized over their useful lives of five years; customer contracts are
being amortized over its useful life of six years and maintenance agreements are being amortized
over its useful life of eight years. In-process technology was written off due to the risk that the
developments will not be completed or competitive with comparable products. Existing technology is
being amortized using the double declining method which reflects the future projected cash flows.
The core technology, customer contracts, maintenance agreements and trade name/trademarks are being
amortized using the straight-line method.
The residual purchase price of $9.0 million has been recorded as goodwill. The goodwill as a result
of this acquisition is not expected to be deductible for tax purposes. In accordance with SFAS No.
142, Goodwill and Other Intangible Assets, goodwill relating to the acquisition of Rhozet is not
being amortized and will be tested for impairment annually or whenever events indicate that an
impairment may have occurred.
Entone Technologies, Inc.
On December 8, 2006, Harmonic acquired Entone Technologies, Inc., or Entone, pursuant to the terms
of an Agreement and Plan of Merger (the Merger Agreement) dated August 21, 2006. Under the terms
of the Merger Agreement, Entone spun off its consumer premise equipment business, or CPE business,
to Entones existing stockholders prior to closing. Entone then merged into Harmonic, and Harmonic
acquired Entones VOD business, which includes the development, sale and support of head-end
equipment (software and hardware) and associated services for the creation, distribution and
delivery of on-demand television programming to operators who offer such programming to businesses
and consumers. Harmonic believes Entones software solution, which facilitates the provisioning of
personalized video services including video-on-demand, network personal video recording,
time-shifted television and targeted advertisement insertion, will enable Harmonic to expand the
scope of solutions we can offer to cable, satellite and telco/IPTV service providers in order to
provide an advanced and uniquely integrated delivery system for the next generation of both
broadcast and personalized IP-delivered video services. These opportunities, along with the
established Asia-based software development workforce, were significant factors to the
establishment of the purchase price, which exceeded the fair value of Entones net tangible and
intangible assets acquired resulting in the amount of goodwill we have recorded with this
transaction. Management has made a preliminary allocation of the estimated purchase price to the
tangible and intangible assets acquired and liabilities assumed based on various preliminary
estimates. The allocation of the estimated purchase price is preliminary pending finalization of
various estimates and analyses.
The purchase price of $49.0 million included $26.2 million in cash, $20.1 million of stock issued,
consisting of 3,579,715 shares of Harmonic common stock, $0.2 million in stock options assumed, and
$2.5 million of transaction costs. Stock options to purchase Harmonic common stock totaling 175,342
shares were issued to reflect the
7
conversion of all outstanding Entone options for continuing employees. The fair value of Harmonics
stock options issued to Entone employees were valued at $925,000 using the Black-Scholes options
pricing model of which $697,000 represented unearned stock-based compensation, which is being
recorded as compensation expense as services are provided by optionholders, and $228,000 was
recorded as purchase consideration. As part of the terms of the Merger Agreement, Harmonic was
obligated to purchase a convertible note with a face amount of $2.5 million in the new spun off
private company subject to closing of an initial round of equity financing in which at least $4
million is invested by third parties. This note was funded in
July 2007. See Note 15.
The Entone acquisition was accounted for under SFAS No. 141 and certain specified provisions of
SFAS No. 142. The results of operations of Entone are included in Harmonics Consolidated
Statements of Operations from December 8, 2006, the date of acquisition. The following table
summarizes the preliminary allocation of the purchase price based on the estimated fair value of
the tangible assets acquired and the liabilities assumed at the date of acquisition:
|
|
|
|
|
(in thousands) |
|
|
|
|
Cash acquired |
|
$ |
|
|
Accounts receivable |
|
|
297 |
|
Inventory |
|
|
184 |
|
Fixed assets |
|
|
313 |
|
Other tangible assets acquired |
|
|
22 |
|
Amortizable intangible assets: |
|
|
|
|
Existing technology |
|
|
11,600 |
|
Core technology |
|
|
2,800 |
|
Customer relationships |
|
|
1,700 |
|
Tradenames/trademarks |
|
|
800 |
|
Goodwill |
|
|
32,412 |
|
|
|
|
|
Total assets acquired |
|
|
50,128 |
|
Accounts payable |
|
|
(855 |
) |
Deferred revenue |
|
|
(166 |
) |
Other accrued liabilities |
|
|
(146 |
) |
|
|
|
|
Net assets acquired |
|
$ |
48,961 |
|
|
|
|
|
The purchase price was allocated as set forth in the table above. The Income Approach which
includes an analysis of the markets, cash flows and risks associated with achieving such cash
flows, was the primary method used in valuing the identified intangibles acquired. The Discounted
Cash Flow method was used to estimate the fair value of the acquired existing technology and
customer relationships. The Royalty Savings Method was used to estimate the fair value of the
acquired core technology and trademarks/trade names. In the Royalty Savings Method, the value of an
asset is estimated by capitalizing the royalties saved because the Company owns the asset. Expected
cash flows were discounted at the Companys weighted average cost of capital of 18%. Identified
intangible assets, including existing technology and core technology are being amortized over their
useful lives of three to four years; tradename/trademarks are being amortized over their useful
lives of five years; and customer relationships are being amortized over its useful life of six
years.
The residual purchase price of $32.4 million has been recorded as goodwill. The goodwill as a
result of this acquisition is not expected to be deductible for tax purposes. In accordance with
SFAS No. 142, Goodwill and Other Intangible Assets, goodwill relating to the acquisition of
Entone is not being amortized and will be tested for impairment annually or whenever events
indicate that an impairment may have occurred.
Unaudited
Pro Forma Financial Information
The following unaudited pro forma financial information presented below summarizes the combined
results of operations as if the acquisitions of Rhozet and Entone had
been completed as of the beginning of the fiscal years presented. The unaudited pro forma financial information for the three and nine months ended September 29, 2006 combines the
results for Harmonic for the three and nine months ended September 29, 2006, and the historical
results of Rhozet and Entone for the three and nine months ended
September 29, 2006. The unaudited pro forma financial information
for the three and nine months ended September 28, 2007 combines the
results of Harmonic for the three and nine months ended September 28,
2007 with the results of Rhozet for the respective periods
through July 31, 2007, the acquisition date. 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 mergers actually been completed on such date or of
results which may occur in the future.
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Three Months |
|
Nine Months |
|
Nine Months |
|
|
Ended |
|
Ended |
|
Ended |
|
Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except per share data) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Net sales |
|
$ |
82,553 |
|
|
$ |
63,473 |
|
|
$ |
226,550 |
|
|
$ |
175,255 |
|
Net income (loss) |
|
$ |
8,981 |
|
|
$ |
309 |
|
|
$ |
12,397 |
|
|
$ |
(13,823 |
) |
Net income (loss) per share basic |
|
$ |
0.11 |
|
|
$ |
0.00 |
|
|
$ |
0.15 |
|
|
$ |
(0.18 |
) |
Net income (loss) per share diluted |
|
$ |
0.11 |
|
|
$ |
0.00 |
|
|
$ |
0.15 |
|
|
$ |
(0.18 |
) |
Note 4: Cash, Cash Equivalents and Investments
At September 28, 2007 and December 31, 2006, cash, cash equivalents and short-term investments are
summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
September 28, |
|
|
December 31, |
|
(in thousands) |
|
2007 |
|
|
2006 |
|
Cash and cash equivalents |
|
$ |
40,993 |
|
|
$ |
33,454 |
|
|
|
|
|
|
|
|
Short-term investments: |
|
|
|
|
|
|
|
|
Less than one year |
|
|
48,376 |
|
|
|
54,724 |
|
Due in 1-2 years |
|
|
9,662 |
|
|
|
4,193 |
|
|
|
|
|
|
|
|
Total short-term investments |
|
|
58,038 |
|
|
|
58,917 |
|
|
|
|
|
|
|
|
Total cash, cash equivalents and
short-term investments |
|
$ |
99,031 |
|
|
$ |
92,371 |
|
|
|
|
|
|
|
|
The following is a summary of available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
(in thousands) |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
September 28, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government debt securities |
|
$ |
17,056 |
|
|
$ |
48 |
|
|
$ |
|
|
|
$ |
17,104 |
|
Corporate debt securities |
|
|
37,420 |
|
|
|
74 |
|
|
|
(30 |
) |
|
|
37,464 |
|
Other debt securities |
|
|
3,470 |
|
|
|
|
|
|
|
|
|
|
|
3,470 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
57,946 |
|
|
$ |
122 |
|
|
$ |
(30 |
) |
|
$ |
58,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government debt securities |
|
$ |
17,187 |
|
|
$ |
|
|
|
$ |
(36 |
) |
|
$ |
17,151 |
|
Corporate debt securities |
|
|
38,678 |
|
|
|
38 |
|
|
|
(25 |
) |
|
|
38,691 |
|
Other debt securities |
|
|
3,075 |
|
|
|
|
|
|
|
|
|
|
|
3,075 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
58,940 |
|
|
$ |
38 |
|
|
$ |
(61 |
) |
|
$ |
58,917 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of Investments
We monitor our 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, we evaluate,
among other factors: the duration and extent to which the fair value has been less than the
carrying value; our financial condition and business outlook, including key operational and cash
flow metrics, current market conditions and future trends in our industry; our relative competitive
position within the industry; and our intent and ability to retain the investment for a period of
time sufficient to allow any anticipated recovery in fair value.
9
In accordance with FASB Staff Position Nos. 115-1 and FAS 124-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (FSP FAS 115-1), the
following table summarizes the fair value and gross unrealized losses related to available-for-sale
securities, aggregated by investment category and length of time that individual securities have
been in a continuous unrealized loss position, as of September 28, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months |
|
|
Greater than 12 months |
|
|
Total |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
Unrealized |
|
|
|
|
|
|
Unrealized |
|
|
|
|
|
|
Unrealized |
|
(in thousands) |
|
Fair Value |
|
|
Losses |
|
|
Fair Value |
|
|
Losses |
|
|
Fair Value |
|
|
Losses |
|
Corporate debt
securities |
|
|
11,557 |
|
|
|
(30 |
) |
|
|
|
|
|
|
|
|
|
|
11,557 |
|
|
|
(30 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
11,557 |
|
|
$ |
(30 |
) |
|
$ |
|
|
|
$ |
|
|
|
$ |
11,557 |
|
|
$ |
(30 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decline in the estimated fair value of these investments relative to amortized cost is
primarily related to changes in interest rates and is considered to be temporary in nature.
Note 5: Inventories
|
|
|
|
|
|
|
|
|
|
|
September 28, |
|
|
December 31, |
|
(in thousands) |
|
2007 |
|
|
2006 |
|
Raw materials |
|
$ |
10,475 |
|
|
$ |
12,845 |
|
Work-in-process |
|
|
2,923 |
|
|
|
3,759 |
|
Finished goods |
|
|
22,943 |
|
|
|
25,512 |
|
|
|
|
|
|
|
|
|
|
$ |
36,341 |
|
|
$ |
42,116 |
|
|
|
|
|
|
|
|
Note 6: Goodwill and Identified Intangibles
The following is a summary of goodwill and intangible assets as of September 28, 2007 and December
31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 28, 2007 |
|
|
December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
Net |
|
|
|
|
|
|
|
|
|
|
Net |
|
|
|
Gross Carrying |
|
|
Accumulated |
|
|
Carrying |
|
|
Gross Carrying |
|
|
Accumulated |
|
|
Carrying |
|
(in thousands) |
|
Amount |
|
|
Amortization |
|
|
Amount |
|
|
Amount |
|
|
Amortization |
|
|
Amount |
|
|
Identified intangibles: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Developed core technology |
|
$ |
49,489 |
|
|
$ |
(33,493 |
) |
|
$ |
15,996 |
|
|
$ |
44,322 |
|
|
$ |
(30,160 |
) |
|
$ |
14,162 |
|
Customer relationships/contracts |
|
|
33,913 |
|
|
|
(32,152 |
) |
|
|
1,761 |
|
|
|
33,611 |
|
|
|
(31,929 |
) |
|
|
1,682 |
|
Trademark and tradename |
|
|
5,341 |
|
|
|
(4,381 |
) |
|
|
960 |
|
|
|
5,031 |
|
|
|
(4,241 |
) |
|
|
790 |
|
Supply agreement |
|
|
3,549 |
|
|
|
(3,549 |
) |
|
|
|
|
|
|
3,532 |
|
|
|
(3,532 |
) |
|
|
|
|
Maintenance agreements |
|
|
600 |
|
|
|
(14 |
) |
|
|
586 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Software license and intellectual
property |
|
|
249 |
|
|
|
(30 |
) |
|
|
219 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal of identified intangibles |
|
|
93,141 |
|
|
|
(73,619 |
) |
|
|
19,522 |
|
|
|
86,496 |
|
|
|
(69,862 |
) |
|
|
16,634 |
|
Goodwill |
|
|
46,222 |
|
|
|
|
|
|
|
46,222 |
|
|
|
37,141 |
|
|
|
|
|
|
|
37,141 |
|
|
|
|
|
|
|
|
|
|
|
|
Total goodwill and other
intangibles |
|
$ |
139,363 |
|
|
$ |
(73,619 |
) |
|
$ |
65,744 |
|
|
$ |
123,637 |
|
|
$ |
(69,862 |
) |
|
$ |
53,775 |
|
|
|
|
|
|
|
|
|
|
|
|
10
The
changes in the carrying amount of goodwill and intangibles for the nine months ended September 28, 2007 are as
follows:
|
|
|
|
|
|
|
|
|
(in thousands) |
|
Goodwill |
|
|
Intangibles, net |
|
|
|
|
Balance as of January 1, 2007 |
|
$ |
37,141 |
|
|
$ |
16,634 |
|
Acquisition of Rhozet Corporation |
|
|
8,989 |
|
|
|
6,549 |
|
Purchase price adjustments |
|
|
|
|
|
|
|
|
Intangible amortization |
|
|
|
|
|
|
(3,661 |
) |
Foreign currency translation adjustments |
|
|
92 |
|
|
|
|
|
|
|
|
Balance as of September 28, 2007 |
|
$ |
46,222 |
|
|
$ |
19,522 |
|
|
|
|
For the three and nine months ended September 28, 2007, the Company recorded a total of $1.5
million and $3.7 million of amortization expense for identified intangibles, of which $1.3 million
and $3.3 million was included in cost of sales, respectively. For the three and nine months ended
September 29, 2006, the Company recorded a total of $0.2 million and $0.7 million of amortization
expense for identified intangibles, of which $0.2 million and $0.5 million was included in cost of
sales, respectively. The estimated future amortization expense of purchased intangible assets with
definite lives for the next five years is as follows:
|
|
|
|
|
(in thousands) |
|
|
|
Years Ending December 31, |
|
Amounts |
|
|
2007 (remaining 3 months) |
|
$ |
1,678 |
|
2008 |
|
|
6,191 |
|
2009 |
|
|
5,821 |
|
2010 |
|
|
4,441 |
|
2011 |
|
|
790 |
|
2012 |
|
|
436 |
|
2013 |
|
|
115 |
|
2014 |
|
|
50 |
|
|
|
|
|
Total |
|
$ |
19,522 |
|
|
|
|
|
Note 7: Restructuring and Excess Facilities
In 2001 and 2002 excess facilities charges totaling $44.3 million were recorded due to the
Companys reduced headcount, difficult business conditions and a weak local commercial real estate
market.
As of September 28, 2007, accrued excess facilities cost totaled $17.0 million, of which $5.9
million was included in current accrued liabilities and $11.1 million in other non-current
liabilities. The Company incurred cash outlays of $4.9 million during the first nine months of 2007
principally for lease payments, property taxes, insurance and other maintenance fees related to
vacated facilities. Harmonic expects to pay approximately $1.6 million of excess facility lease
costs, net of estimated sublease income, for the remainder of 2007 and to pay the remaining $15.4
million, net of estimated sublease income, over the remaining lease terms through September 2010.
Harmonic reassesses this liability quarterly and adjusts as necessary based on changes in the
timing and amounts of expected sublease rental income. In the fourth quarter of 2005 the excess
facilities liability was decreased by $1.1 million due to subleasing a portion of an unoccupied
building for the remainder of the lease.
During the second quarter of 2006, the Company streamlined its senior management team primarily in
the U.S. operations and recorded severance and other costs of approximately $1.0 million. We expect
the remaining payments related to these actions to be paid by the end
of the fourth quarter of 2007.
During the third quarter of 2006, the Company recorded a charge in selling, general and
administrative expenses for excess facilities of $3.9 million. This charge relates to two buildings
which were vacated during the third quarter in connection with a plan to make more efficient use of
our Sunnyvale campus in accordance with applicable provisions of FAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities. In addition, during
11
the third quarter of 2006 the Company revised its estimate of expected sublease income with respect
to previously vacated facilities and recorded a credit of $1.7 million in accordance with
applicable provisions of EITF 94-3 Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).
During the first quarter of 2007, the Company recorded a charge in selling, general and
administrative expenses for excess facilities of $0.4 million. This charge primarily relates to two
buildings in the UK which were vacated during the first quarter of 2007 in connection with the
closure of the manufacturing and research and development activities of Broadcast Technology
Limited, or BTL, in accordance with applicable provisions of FAS No. 146. The Company expects to
record an additional charge in the fourth quarter of 2007 for an additional building in the UK
which will be vacated in connection with the closure of BTL.
During the third quarter of 2007, the Company recorded a net credit in selling, general and
administrative expenses for excess facilities of $1.4 million for its Sunnyvale campus. The Company revised its estimate of
expected sublease income due to the extension of a sublease of a building to the lease expiration and
recorded a credit of $1.8 million. This was partially offset by a charge of $0.4 million on a
reduction in estimated sublease income for another building that is vacant and available for
sublease.
The following table summarizes restructuring activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Management |
|
|
Excess |
|
|
Campus |
|
|
BTL |
|
|
|
|
(in thousands) |
|
Reduction |
|
|
Facilities |
|
|
Consolidation |
|
|
Closure |
|
|
Total |
|
|
|
|
Balance at December 31, 2006 |
|
$ |
394 |
|
|
$ |
17,184 |
|
|
$ |
5,514 |
|
|
$ |
|
|
|
$ |
23,092 |
|
Provision/(recoveries) |
|
|
(18 |
) |
|
|
(1,792 |
) |
|
|
637 |
|
|
|
353 |
|
|
|
(820 |
) |
Cash payments, net of sublease income |
|
|
(298 |
) |
|
|
(3,274 |
) |
|
|
(1,533 |
) |
|
|
(52 |
) |
|
|
(5,157 |
) |
|
|
|
Balance at September 28, 2007 |
|
$ |
78 |
|
|
$ |
12,118 |
|
|
$ |
4,618 |
|
|
$ |
301 |
|
|
$ |
17,115 |
|
|
|
|
Note 8: Credit Facilities and Long-Term Debt
Harmonic has a bank line of credit facility with Silicon Valley Bank, which provides for borrowings
of up to $20.0 million that matures on March 5, 2008. In March 2007, Harmonic paid in full the
outstanding balance of its secured term loan for equipment and canceled its term loan facility as
part of the renewal process for the bank line of credit. As of September 28, 2007, other than
standby letters of credit and guarantees (Note 16), there were no amounts outstanding under the
line of credit facility and there were no borrowings in 2006 or 2007. This facility, which was
amended and restated in March 2007, contains financial and other covenants including the
requirement for Harmonic to maintain cash, cash equivalents and short-term investments, net of
credit extensions, of not less than $30.0 million. If Harmonic is unable to maintain this cash,
cash equivalents and short-term investments balance or satisfy the additional affirmative covenant
requirements, Harmonic would be in noncompliance 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 and disposing of the collateral if obligations were not repaid. At September 28, 2007,
Harmonic was in compliance with the covenants under this line of credit facility. The March 2007
amendment resulted in the Company paying a fee of $10,000 and requiring payment of approximately
$20,000 of additional fees if the Company does not maintain an unrestricted deposit of $20.0
million with the bank. Future borrowings pursuant to the line bear interest at the banks prime
rate (7.75% at September 28, 2007). Borrowings are payable monthly and are collateralized by all of
Harmonics assets except intellectual property.
Note 9: Benefit Plans
Stock Option Plans. Harmonic has reserved 11,324,000 shares of Common Stock for issuance under
various employee stock option plans. The 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.
Stock options are granted at the fair market value of the stock at the date of grant. Beginning on
February 27, 2006, option grants had a term of seven years. Certain option awards provide for
accelerated vesting if there is a change in control. Certain option awards granted to former Entone
employees in 2006 had a term of ten years from the original Entone date of grant and are fully
12
exercisable at the date of grant and, to the extent not vested, become restricted shares subject to
repurchase. At September 28, 2007 there were no restricted shares outstanding.
Director Option Plans. In May 2002, Harmonics stockholders approved the 2002 Director Option Plan
(the Plan), replacing the 1995 Director Option Plan. The Plan provides for the grant of
non-statutory stock options to certain non-employee directors of Harmonic pursuant to an automatic,
non-discretionary grant mechanism. Options are granted at fair market value of the stock at the
date of grant for periods not exceeding ten years. Initial grants generally vest monthly over three
years, and subsequent grants generally vest monthly over one year. In June 2006, Harmonics
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 option granted under the Plan to seven years. Harmonic has a
total of 678,000 shares of Common Stock reserved for issuance under the Plan.
The following table summarizes activities under the Plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares Available |
|
|
Stock Options |
|
|
Weighted Average |
|
|
for Grant |
|
|
Outstanding |
|
|
Exercise Price |
|
|
(In thousands, except exercise price) |
|
Balance at December 31, 2006 |
|
|
3,632 |
|
|
|
9,249 |
|
|
$ |
11.50 |
|
Options granted |
|
|
(2,335 |
) |
|
|
2,335 |
|
|
|
8.42 |
|
Options exercised |
|
|
|
|
|
|
(837 |
) |
|
|
6.05 |
|
Options canceled |
|
|
820 |
|
|
|
(820 |
) |
|
|
12.21 |
|
Options expired |
|
|
|
|
|
|
(34 |
) |
|
|
35.64 |
|
|
|
|
|
|
|
|
Balance at September 28, 2007 |
|
|
2,117 |
|
|
|
9,893 |
|
|
|
11.09 |
|
|
|
|
|
|
|
|
Options vested and
exercisable as of September
28, 2007 |
|
|
|
|
|
|
6,062 |
|
|
|
13.43 |
|
|
|
|
|
|
|
|
|
|
|
|
Options vested and
expected-to-vest as of
September 28, 2007 |
|
|
|
|
|
|
9,186 |
|
|
|
11.39 |
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average fair value of options granted for the nine months ended September 28, 2007 was
$4.50.
The following table summarizes information regarding stock options outstanding at September 28,
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options Outstanding |
|
|
Stock Options Exercisable |
|
|
|
|
|
|
Weighted-Average |
|
|
|
|
|
|
|
|
|
|
Number Outstanding |
|
Remaining |
|
|
|
|
|
Number |
|
|
Range of Exercise |
|
at September 28, |
|
Contractual Life |
|
Weighted-Average |
|
Exercisable at |
|
Weighted Average |
Prices |
|
2007 |
|
(Years) |
|
Exercise Price |
|
September 28, 2007 |
|
Exercise Price |
(In thousands, except exercise price and life) |
|
$ 0.19 5.66 |
|
|
1,210 |
|
|
|
5.5 |
|
|
$ |
3.79 |
|
|
|
909 |
|
|
$ |
3.67 |
|
5.67 5.87 |
|
|
1,830 |
|
|
|
6.2 |
|
|
|
5.86 |
|
|
|
820 |
|
|
|
5.86 |
|
5.88 8.20 |
|
|
2,281 |
|
|
|
5.9 |
|
|
|
7.91 |
|
|
|
486 |
|
|
|
7.07 |
|
8.21 9.29 |
|
|
2,061 |
|
|
|
5.2 |
|
|
|
8.96 |
|
|
|
1,509 |
|
|
|
9.06 |
|
9.44 14.50 |
|
|
1,077 |
|
|
|
4.7 |
|
|
|
10.59 |
|
|
|
904 |
|
|
|
10.67 |
|
15.00 25.50 |
|
|
1,037 |
|
|
|
2.4 |
|
|
|
23.41 |
|
|
|
1,037 |
|
|
|
23.41 |
|
25.81 121.68 |
|
|
397 |
|
|
|
2.3 |
|
|
|
56.08 |
|
|
|
397 |
|
|
|
56.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,893 |
|
|
|
5.1 |
|
|
$ |
11.09 |
|
|
|
6,062 |
|
|
$ |
13.43 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average remaining contractual life for all exercisable stock options at September 28,
2007 was 4.3 years. The weighted-average remaining contractual life of all vested and
expected-to-vest stock options at September 28, 2007 was 5.0 years.
Aggregate pre-tax intrinsic value of options outstanding and exercisable at September 28, 2007 was
$14.4 million. The aggregate intrinsic value of stock options vested and expected-to-vest net of
estimated forfeitures was $24.4 million at September 28, 2007. Aggregate pre-tax intrinsic value
represents the difference between our closing price on the last trading day of the fiscal period,
which was $10.61 as of September 28, 2007, and the exercise price
13
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
$0.7 million and $3.0 million during the three and nine months ended September 28, 2007,
respectively.
Employee Stock Purchase Plan. Harmonics 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. In May 2004, Harmonics stockholders approved an
amendment to the 2002 Purchase Plan and increased the maximum number of shares of common stock
authorized for issuance over the term of the 2002 Purchase Plan by an additional 2,000,000 shares.
In June 2006, Harmonics stockholders approved an amendment to the 2002 Purchase Plan to increase
the maximum number of shares of common stock available for issuance under the 2002 Purchase Plan by
an additional 2,000,000 shares to 5,500,000 shares and 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 of the offering period or end of the purchase period, whichever is lower.
Offering periods and purchase periods generally begin on the first trading day on or after January
1 and July 1 of each year. The 2002 Purchase Plan is intended to qualify as an employee stock
purchase plan under Section 423 of the Internal Revenue Code. During the first nine months of 2007
and 2006, the number of shares of stock issued under the purchase plans were 669,871 and 811,565
shares at weighted average prices of $4.82 and $4.04, respectively. The weighted-average fair value
of each right to purchase shares of common stock granted under the purchase plans were $2.38 and
$1.44 for the first nine months of 2007 and 2006, respectively. At September 28, 2007, 1,813,624
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
makes 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. Such amounts totaled
$0.1 million and $0.3 million in the three and nine months periods ended September 28, 2007.
Stock-based Compensation
The following table summarizes stock-based compensation costs on our Condensed Consolidated
Statements of Operations for the three and nine months ended September 28, 2007 and September 29,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
(In thousands) |
|
September 28,
2007 |
|
|
September 29,
2006 |
|
|
September 28,
2007 |
|
|
September 29,
2006 |
|
Employee stock-based compensation in: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales |
|
$ |
255 |
|
|
$ |
184 |
|
|
$ |
719 |
|
|
$ |
727 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expense |
|
|
563 |
|
|
|
331 |
|
|
|
1,438 |
|
|
|
1,304 |
|
Sales, general and
administrative expense |
|
|
822 |
|
|
|
729 |
|
|
|
1,979 |
|
|
|
2,342 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total employee stock-based
compensation in operating
expense |
|
|
1,385 |
|
|
|
1,060 |
|
|
|
3,417 |
|
|
|
3,646 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total employee stock-based
compensation |
|
|
1,640 |
|
|
|
1,244 |
|
|
|
4,136 |
|
|
|
4,373 |
|
Amount capitalized as inventory |
|
|
(5 |
) |
|
|
38 |
|
|
|
9 |
|
|
|
38 |
|
Total other stock-based compensation(1) |
|
|
48 |
|
|
|
|
|
|
|
339 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation |
|
$ |
1,683 |
|
|
$ |
1,282 |
|
|
$ |
4,484 |
|
|
$ |
4,413 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Other stock-based compensation represents charges related to non-employee stock
options. |
As of
September 28, 2007, total unamortized stock-based compensation cost was $12.3 million, with the weighted
average recognition period of 2.8 years.
14
The fair value of each option grant is estimated on the date of grant using the Black-Scholes
multiple option pricing model with the following weighted average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Stock Options |
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
|
|
Expected life (years) |
|
|
4.75 |
|
|
|
4.75 |
|
|
|
4.75 |
|
|
|
4.75 |
|
Volatility |
|
|
56 |
% |
|
|
69 |
% |
|
|
59 |
% |
|
|
76 |
% |
Risk-free interest rate |
|
|
4.6 |
% |
|
|
4.9 |
% |
|
|
4.7 |
% |
|
|
4.6 |
% |
Dividend yield |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Stock Purchase Plan |
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
|
|
Expected life (years) |
|
|
0.5 |
|
|
|
0.5 |
|
|
|
0.5 |
|
|
|
0.5 |
|
Volatility |
|
|
50 |
% |
|
|
56 |
% |
|
|
51 |
% |
|
|
56 |
% |
Risk-free interest rate |
|
|
4.9 |
% |
|
|
5.1 |
% |
|
|
4.9 |
% |
|
|
5.1 |
% |
Dividend yield |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
The expected term for stock options and the ESPP represents the weighted-average period that the
stock options are expected to remain outstanding. We derived the expected term using the SAB 107
simplified method. As alternative sources of data become available in order to determine the
expected term we will incorporate these data into our assumption.
We use the historical volatility over the expected term of the options and the ESPP offering period
to estimate the expected volatility. We believe that the historical volatility, at this time,
represents fairly the future volatility of its common stock. We will continue to monitor relevant
information to measure expected volatility for future option grants and ESPP offering periods.
The risk-free interest rate assumption is based upon observed interest rates appropriate for the
term of our employee stock options. The dividend yield assumption is based on our history and
expectation of dividend payouts.
Note 10: Income Taxes
We adopted the provisions of Financial
Standards Accounting Board Interpretation No. 48, Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement
No. 109 (FIN 48)
on January 1, 2007. The effect of this pronouncement on the Companys retained earnings as of
January 1, 2007 was a decrease in retained earnings of $2.1 million for interest and penalties. At
the date of adoption we had $7.1 million of unrecognized tax benefits which included $0.7 million
of unrecognized tax benefits that were fully offset by a valuation allowance. The Company
historically had a $6.4 million balance in current taxes payable. As a result of the adoption of
FIN 48, the liability of $6.4 million was reclassified to long-term taxes payable.
For the nine months ended
September 28, 2007, the Company has accrued $0.5 million of interest and
reversed $0.8 million of FIN 48 liability due to the expiration of the statute of limitation in two
foreign jurisdictions. The cumulative balance as of September 28, 2007 of interest and penalties
related to uncertain tax positions is approximately $2.5 million. The Company does not anticipate a
significant change in unrecognized tax benefits within the next twelve months.
We
anticipate the unrecognized tax benefits may increase during the year for items that arise in the
ordinary course of business. Such amounts will be reflected as an increase in the amount of
unrecognized tax benefits and an increase to the current period tax expense. These increases will
be considered in the determination of the Companys annual effective tax rate. The amount of the
unrecognized tax benefit classified as a long-term tax payable, if recognized, would reduce the
annual income provision.
The tax years 2001-2006 remain open to examination by the major taxing jurisdictions to which we
are subject.
15
As of September 28, 2007, we maintained a full valuation allowance against our net deferred tax
assets because we expect that it is more likely than not that all deferred tax assets will not be
realized in the foreseeable future. We continuously monitor the circumstances impacting the
expected realization of our deferred tax assets for each jurisdiction. We consider all available
evidence, both positive and negative, including historical levels of income in each jurisdiction,
expectations and risks associated with estimates of future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for the valuation allowance. If we determine
it is more likely than not that some or all of our deferred tax assets will be realized in the
foreseeable future, we will adjust our valuation allowance accordingly. A change in our assessment
regarding the realization of our deferred tax assets will impact our effective tax rate in the
period we revise our assessment and in subsequent periods. As of December 31, 2006 our valuation
allowance totaled $120.0 million. As of December 31, 2006, the Company had $184.0 million of
federal and $60.4 million of state net operating loss carryforwards available to reduce future taxable
income which will begin to expire in 2021 and 2012 for federal tax purposes and for state tax purposes, respectively. As of December
31, 2006 the Company had foreign net operating loss carryforwards of $23.7 million which do not
expire.
Our effective tax rate for the three and nine months ended September 28, 2007 differs from the U.S.
statutory rate primarily due to utilization of unbenefited net operating loss carryforwards.
Note 11: 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
nine months ended September 29, 2006 because potential common shares, such as common shares
issuable upon the exercise of stock options, are only considered when their effect would be
dilutive.
The following table shows the potentially dilutive shares, consisting of options, for the periods
presented that were excluded from the net income (loss) computations because their effect was
antidilutive:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Potentially dilutive options outstanding |
|
|
5,464 |
|
|
|
8,929 |
|
|
|
7,196 |
|
|
|
11,008 |
|
|
|
|
|
|
Following is a reconciliation of the numerators and denominators of the basic and diluted net loss
per share computations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except per share data) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Net income (loss) (numerator) |
|
$ |
9,417 |
|
|
$ |
4,016 |
|
|
$ |
16,782 |
|
|
$ |
(4,034 |
) |
Shares calculation (denominator): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
basic |
|
|
80,371 |
|
|
|
74,588 |
|
|
|
79,570 |
|
|
|
74,286 |
|
|
|
|
|
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Potential common stock relating to
stock options |
|
|
1,139 |
|
|
|
462 |
|
|
|
1,129 |
|
|
|
|
|
Potential common stock relating to
Rhozet acquisition |
|
|
132 |
|
|
|
|
|
|
|
44 |
|
|
|
|
|
|
|
|
|
|
Average shares outstanding diluted |
|
|
81,642 |
|
|
|
75,050 |
|
|
|
80,743 |
|
|
|
74,286 |
|
|
|
|
|
|
Net income (loss) per share basic |
|
$ |
0.12 |
|
|
$ |
0.05 |
|
|
$ |
0.21 |
|
|
$ |
(0.05 |
) |
|
|
|
|
|
Net income (loss) per share diluted |
|
$ |
0.12 |
|
|
$ |
0.05 |
|
|
$ |
0.21 |
|
|
$ |
(0.05 |
) |
|
|
|
|
|
16
Note 12: Comprehensive Income (Loss)
The Companys total comprehensive income (loss) was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 28, |
|
|
September 29, |
|
|
September 28, |
|
|
September 29, |
|
(in thousands) |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
|
|
Net income (loss) |
|
$ |
9,417 |
|
|
$ |
4,016 |
|
|
$ |
16,782 |
|
|
$ |
(4,034 |
) |
Change in unrealized gain (loss)
on investments, net |
|
|
92 |
|
|
|
83 |
|
|
|
71 |
|
|
|
173 |
|
Foreign currency translation |
|
|
(11 |
) |
|
|
19 |
|
|
|
(78 |
) |
|
|
125 |
|
|
|
|
Total comprehensive income (loss) |
|
$ |
9,498 |
|
|
$ |
4,118 |
|
|
$ |
16,775 |
|
|
$ |
(3,736 |
) |
|
|
|
Note 13: Segment Information
We operate in one reportable segment, which is the design, manufacture and sale of versatile and high performance video products and system solutions
that enable service providers to efficiently deliver the next generation of broadcast and on-demand
services, including high-definition television, or HDTV, video-on-demand, or VOD, networked
personal video recording and time-shifted TV. Historically, the majority of our sales have been
derived from sales of video processing solutions and edge and access systems to cable television
operators and from sales of video processing solutions to direct-to-home satellite operators. We
also provide our video processing solutions to telecommunications companies, broadcasters and
Internet companies that offer video services to their customers. 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 geographic region, based on the location at which each
sale originates, is summarized as follows:
Geographic Information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 28, |
|
|
September 29, |
|
|
September 28, |
|
|
September 29, |
|
(in thousands) |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Net sales: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
$ |
44,638 |
|
|
$ |
29,265 |
|
|
$ |
125,447 |
|
|
$ |
81,968 |
|
Canada |
|
|
6,953 |
|
|
|
7,408 |
|
|
|
11,002 |
|
|
|
12,216 |
|
International |
|
|
30,704 |
|
|
|
26,183 |
|
|
|
87,365 |
|
|
|
78,162 |
|
|
|
|
Total |
|
$ |
82,295 |
|
|
$ |
62,856 |
|
|
$ |
223,814 |
|
|
$ |
172,346 |
|
|
|
|
In the third quarter of 2007, sales to Comcast and Echostar
accounted for 16% and 15% of net sales, respectively. In the third
quarter of 2006, sales of the Cox Communications accounted for 13% of net sales.
In the first nine months of 2007, sales of Comcast accounted for 18% of net sales, and in the first nine months
of 2006, no customer had sales that accounted for more than 10% of sales. As of September 28, 2007, one customer had a balance of 17% of our net accounts receivable.
The
Companys assets are primarily located within the United States of America.
Note 14: Related Party
A director of Harmonic is also a director of JDS Uniphase Corporation, from whom the Company
purchases products used in the manufacture of our products. Product purchases from JDS Uniphase
were approximately $0.3 million and $0.7 million for the three and nine months ended September 28,
2007, respectively. As of September 28, 2007, Harmonic had liabilities to JDS Uniphase of
approximately $0.1 million.
Note 15: Convertible Note Receivable
On July 5,
2007, Harmonic purchased an unsecured convertible promissory note
from Entone, Inc. with a face amount of $2.5 million. Interest accrues
on the note at the rate of 4.95% per annum and will be due with
principal at the earlier of August 21, 2011 or upon a Change of
Control Transaction of Entone, Inc, unless the note is
otherwise converted. The principal amount of $2.5 million and all
accrued interest will automatically convert into preferred stock of
Entone when it closes its next preferred stock equity financing of at
least $8.0 million prior to the due date of the note. Upon the next
preferred stock equity financing, Harmonic will be entitled to
receive shares of such series of preferred stock equal to the
principal amount of the note and all accrued interest up to the date
of conversion divided by the greater of (i) 80% of the per share
purchase price of the such preferred stock or (ii) the original
purchase price of Entones Series A preferred stock. Upon a
Change of Control Transaction, Harmonic will be entitled to receive
Series A preferred stock equal to the $2.5 million principal amount
of the note and all accrued interest up to the date of conversion
divided by the greater of (a) 80% of the amount received by a holder
for a share of Series A preferred stock in connection with such
Change of Control Transaction, assuming conversion of the note, or
(b) the original purchase price of the Series A Preferred Stock.
As of
September 28, 2007 the Company had accrued $29,000 of interest
and all accrued interest is deferred. The Convertible Note will be
tested for impairment quarterly or whenever events indicate that
impairment may have occurred. The note is included in Other Assets on
the Balance Sheet as of September 28, 2007.
Note 16: 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 adjusts
based on the terms of warranties
17
provided to customers, historical and anticipated warranty claims
experience, and estimates of the timing and cost of specified warranty claims. Activity for the
Companys warranty accrual, which is included in accrued liabilities is
summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 28, |
|
|
September 29, |
|
|
September 28, |
|
|
September 29, |
|
(in thousands) |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Balance at beginning of the period |
|
$ |
6,056 |
|
|
$ |
6,018 |
|
|
$ |
6,061 |
|
|
$ |
6,166 |
|
Accrual for current period warranties |
|
|
1,120 |
|
|
|
1,383 |
|
|
|
2,700 |
|
|
|
3,404 |
|
Adjustments for preexisting warranties |
|
|
(148 |
) |
|
|
|
|
|
|
274 |
|
|
|
|
|
Warranty costs incurred |
|
|
(1,208 |
) |
|
|
(985 |
) |
|
|
(3,215 |
) |
|
|
(3,154 |
) |
|
|
|
Balance at end of the period |
|
$ |
5,820 |
|
|
$ |
6,416 |
|
|
$ |
5,820 |
|
|
$ |
6,416 |
|
|
|
|
Standby Letters of Credit. As of September 28, 2007, the Companys financial guarantees consisted
of standby letters of credit outstanding, which were principally related to customs bond
requirements and state requirements imposed on employers. The maximum amount of potential future
payments under these arrangements was $0.7 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 September 28, 2007.
Guarantees. As of September 28, 2007, Harmonic had no other guarantees outstanding.
Note 17: Legal Proceedings
Between June 28, 2000 and August 25, 2000, several actions alleging violations of the federal
securities laws by us and certain of our officers and directors (some of whom are no longer with
us) were filed in or removed to the United States District Court for the Northern District of
California. The actions subsequently were consolidated.
A consolidated complaint, filed on December 7, 2000, was brought on behalf of a purported class of
persons who purchased our publicly traded securities between January 19, 2000 and June 26, 2000.
The complaint also alleged claims on behalf of a purported subclass of persons who purchased C-Cube
securities between January 19, 2000 and May 3, 2000. In addition to us and certain of our officers
and directors, the complaint also named C-Cube Microsystems Inc. and several of its officers and
directors as defendants. The complaint alleged that, by making false or misleading statements
regarding our prospects and customers and our acquisition of C-Cube, certain defendants violated
Sections 10(b) and 20(a) of the Securities Exchange Act. The complaint also alleged that certain
defendants violated Section 14(a) of the Exchange Act and Sections 11, 12(a)(2), and 15 of the
Securities Act by filing a false or misleading registration statement, prospectus and joint proxy
in connection with the C-Cube acquisition.
On July 3, 2001, the District Court dismissed the consolidated complaint with leave to amend. An
amended complaint alleging the same claims against the same defendants was filed on August 13,
2001. Defendants moved to dismiss the amended complaint on September 24, 2001. On November 13,
2002, the District Court issued an opinion granting the motions to dismiss the amended complaint
without leave to amend. Judgment for defendants was entered on December 2, 2002. On December 12,
2002, plaintiffs filed a motion to amend the judgment and for leave to file an amended complaint
pursuant to Rules 59(e) and 15(a) of the Federal Rules of Civil Procedure. On June 6, 2003, the
District Court denied plaintiffs motion to amend the judgment and for leave to file an amended
complaint. Plaintiffs filed a notice of appeal on July 1, 2003. The appeal was heard by a panel of
three judges of the United States Court of Appeals for the Ninth Circuit on February 17, 2005.
18
On November 8, 2005, the Ninth Circuit panel affirmed in part, reversed in part, and remanded for
further proceedings the decision of the District Court. The Ninth Circuit affirmed the District
Courts dismissal of the plaintiffs fraud claims under Sections 10(b), 14(a), and 20(a) of the Exchange Act with prejudice,
finding that the plaintiffs failed to adequately plead their allegations of fraud. The Ninth
Circuit reversed the District Courts dismissal of the plaintiffs claims under Sections 11 and
12(a)(2) of the Securities Act, however, finding that because those claims did not allege fraud,
they met the applicable pleading requirements. Regarding the secondary liability claim under
Section 15 of the Securities Act, the Ninth Circuit reversed the dismissal of that claim against
Anthony J. Ley, our Chairman and former Chief Executive Officer, and affirmed the dismissal of that
claim against us, while granting leave to amend. The Ninth Circuit remanded the surviving claims to
the District Court for further proceedings.
On November 22, 2005, both the defendants and the plaintiffs petitioned the Ninth Circuit for a
rehearing of the appeal. On February 16, 2006 the Ninth Circuit denied both petitions. On May 17,
2006 the plaintiffs filed an amended complaint on the issues remanded for further proceedings by
the Ninth Circuit, to which the defendants affiliated with Harmonic responded with a motion to
dismiss certain claims and to strike certain allegations. On December 11, 2006, the Court granted
the motion to dismiss with respect to the Section 12(a)(2) claim against the individual director
and officer defendants affiliated with Harmonic and granted the motion to strike, but denied the
motion to dismiss the Section 15 claim. A case management conference was held on January 25, 2007,
at which the Court set a trial date in August 2008, with discovery to close in February 2008. The
Court also ordered the parties to attend a settlement conference with a magistrate judge or a
private mediation before June 30, 2007. A mediation session was held on May 24, 2007 at which the
parties were unable to reach a settlement.
A derivative action purporting to be on our behalf was filed against its then-current directors in
the Superior Court for the County of Santa Clara on September 5, 2000. We were also named as a
nominal defendant. The complaint is based on allegations similar to those found in the securities
class action and claims that the defendants breached their fiduciary duties by, among other things,
causing us to violate federal securities laws. The derivative action was removed to the United
States District Court for the Northern District of California on September 20, 2000. All deadlines
in this action were stayed pending resolution of the motions to dismiss the securities class
action. On July 29, 2003, the Court approved the parties stipulation to dismiss this derivative
action without prejudice and to toll the applicable limitations period pending the Ninth Circuits
decision in the securities action. Pursuant to the stipulation, defendants have provided plaintiff
with a copy of the mandate issued by the Ninth Circuit in the securities action.
A second derivative action purporting to be on our behalf was filed in the Superior Court for the
County of Santa Clara on May 15, 2003. It alleges facts similar to those previously alleged in the
securities class action and the federal derivative action. The complaint names as defendants our
former and current officers and directors, along with former officers and directors of C-Cube
Microsystems, Inc., who were named in the securities class action. The complaint also names us as a
nominal defendant. The complaint alleges claims for abuse of control, gross mismanagement, and
waste of corporate assets against the defendants affiliated with Harmonic, and claims for breach of
fiduciary duty, unjust enrichment, and negligent misrepresentation against all defendants. On July
22, 2003, the Court approved the parties stipulation to stay the case pending resolution of the
appeal in the securities class action. Following the decision of the Ninth Circuit discussed above,
on May 9, 2006, defendants filed demurrers to this complaint. The plaintiffs then filed an amended
complaint on July 10, 2006, which names only the defendants affiliated with Harmonic. The
defendants filed demurrers to the amended complaint and the parties have stipulated to several
continuances of the hearing on the demurrers, which currently is set for December 14, 2007.
Based on its review of the surviving claims in the securities class actions, Harmonic believes that
it has meritorious defenses and intends to defend itself vigorously. There can be no assurance,
however, that Harmonic will prevail. No estimate can be made of the possible range of loss
associated with the resolution of this contingency, and accordingly, Harmonic has not recorded a
liability. An unfavorable outcome of this litigation could require that we pay substantial damages.
In addition we may decide to settle the litigation, which could cause us to incur significant
costs. A settlement or an unfavorable outcome in these shareholder actions could have a material
adverse effect on Harmonics business, operating results, financial position or cash flows.
On July 3, 2003, Stanford University and Litton Systems filed a complaint in U.S. District Court
for the Central District of California alleging that optical fiber amplifiers incorporated into
certain of our products infringe U.S.
19
Patent No. 4859016. This patent expired in September 2003. The complaint sought injunctive relief, royalties and
damages. On August 6, 2007, the District Court granted our motion to dismiss. The plaintiffs have
appealed this motion.
An unfavorable outcome of any of these litigation matters could require that we pay substantial
damages, or, in connection with any intellectual property infringement claims, could require that
we pay ongoing royalty payments or could prevent us from selling certain of our products. In
addition, we may decide to settle any litigation, which could cause us to incur significant costs.
A settlement or an unfavorable outcome of these litigation matters could have a material adverse
effect on our business, operating results, financial position or cash flows.
Item 2. MANAGEMENTS 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 the acquisition of
Entone will enable us to expand the scope of solutions we offer to cable, satellite and IPTV
providers; our expectation that the majority of our net sales will be to relatively few customers
for the foreseeable future; our expectation that international sales will continue to account for a
significant portion of our net sales for the foreseeable future; our expectation regarding a potential
reversal of all or part of the valuation allowance we hold against
our deferred tax assets; our expectation that the
closure of the facilities we occupied in the UK will be complete in
the fourth quarter of 2007; our expectation that we will record approximately $1.5 million in
amortization of intangibles in cost of sales in the remaining three months of 2007 due to the
acquisitions of Rhozet and Entone; our expectation that we will record a total of approximately $0.2 million in
amortization of intangibles in operating expenses in the remaining three months of 2007 due to the
acquisitions of Rhozet and Entone; our expectation that capital expenditures will be in the range of $5 million
to $6 million during 2007; 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 condition and liquidity; our belief that a 10% change in interest rates would not have a
material impact on our financial condition, results of operations or cash flows; our expectation
that sales to cable television, satellite and telecommunications operators will constitute a
significant portion of net sales for the foreseeable future; our expectation that SFAS 123(R) will
continue to negatively impact our earnings and may affect our ability to raise capital on
acceptable terms; our expectation that our operations will be affected by new environmental laws
and regulations on an ongoing basis; our expectation that the
effective tax rate may fluctuate in future periods; our belief that any ultimate liability of Harmonic with
respect to certain litigation arising in the normal course of business would not, in the aggregate,
have a material adverse effect on us or our operating results, financial position or cash flows;
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 Harmonics filings with the Securities and Exchange
Commission.
Overview
Harmonic designs, manufactures and sells versatile and high performance video products and system
solutions that enable service providers to efficiently deliver the next generation of broadcast and
on-demand services, including high-definition television, or HDTV, video-on-demand, or VOD,
networked personal video recording and time-shifted TV. Historically, the majority of our sales
have been derived from sales of video processing solutions and edge and access systems to cable
television operators and from sales of video processing solutions to direct-to-home satellite
operators. We also provide our video processing solutions to telecommunications companies,
broadcasters and Internet companies that offer video services to their customers.
In the third quarter and first nine months of 2007, Harmonics net sales increased 31% and 30%
compared to the third quarter and first nine months of 2006, respectively. The increases in sales
in the third quarter and the first nine months of 2007 compared to the corresponding periods in
2006 were primarily due to stronger demand from our domestic and international satellite customers
for products and solutions related to HDTV, stronger demand from
our domestic cable customers for HDTV and VOD deployment, and sales of our new products and software. Gross
margins increased in the third quarter and first nine months of 2007 compared to the corresponding
periods in 2006 due to favorable margins from the higher proportion of sales of higher margin video processing
20
solutions and software and services partially offset by an increase in expense for excess and
obsolete inventories.
Historically, a majority of our net sales have been to relatively few customers, and due in part to
the consolidation of ownership of cable television and direct broadcast satellite systems, we
expect this customer concentration to continue for the foreseeable future. In the third quarter of
2007, sales to Comcast and Echostar accounted for 16% and 15% of net sales, respectively. In
the third quarter of 2006, sales to Cox Communications accounted for 13% of net sales. In the first
nine months of 2007, sales to Comcast accounted for 18% of net sales, and in the first nine months
of 2006, no customer had sales that accounted for more than 10% of sales.
Sales to customers outside of the U.S. in the third quarter and the first nine months of 2007
represented 46% and 44% of net sales, respectively, compared to 53% and 52% for the comparable
periods in 2006. 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. Sales denominated in foreign
currencies were approximately 7% in the first nine months of 2007
compared to 9% for the comparable
period of 2006. We expect international sales to continue to account for a significant portion of
our net sales for the foreseeable future.
Harmonic often recognizes a significant portion, or the majority, of its revenues in the last month
of the quarter. Harmonic establishes its expenditure levels for product development and other
operating expenses based on projected sales levels, and expenses are relatively fixed in the short
term. Accordingly, variations in timing of sales can cause significant fluctuations in operating
results. Harmonics expenses for any given quarter are typically based on expected sales and if
sales are below expectations, our operating results may be adversely impacted by our inability to
adjust spending to compensate for the shortfall. In addition, because a significant portion of
Harmonics business is derived from orders placed by a limited number of large customers, the
timing of such orders can also cause significant fluctuations in our operating results.
In 2001 and 2002 excess facilities charges totaling $44.3 million were
recorded due to the Companys reduced headcount, difficult business conditions and a weak local
commercial real estate market. In the fourth quarter of 2005, the excess facilities liability was
decreased by $1.1 million due to subleasing a portion of the unoccupied portion of one building for
the remainder of the lease. In the third quarter of 2006, we completed our facilities
rationalization plan resulting in more efficient use of our Sunnyvale campus and vacated several
buildings, some of which were subsequently subleased. This resulted in a net charge for excess
facilities of $2.1 million in the third quarter of 2006. In the third quarter of 2007, we recorded
a net credit of $1.4 million resulting from a revision to
expected sublease income. In the event we are unable to achieve expected levels of sublease rental
income, we will need to revise our estimate of the liability, which could materially impact our
financial position, liquidity, cash flows and results of operations.
In the fourth quarter of 2006, we discontinued a decoder product line and announced the closing of
our manufacturing operations in the UK. In the first quarter of 2007 we decided to shut down our UK
research and development operations and to abandon the facility in which such operations were
conducted which resulted in an excess facility charge of $0.3 million for two buildings. We expect
to complete the closure of the facility in the fourth quarter of 2007 which we expect will result
in an additional charge to excess facilities, which is estimated to
be approximately $0.2 million.
As of
December 31, 2006, we maintained a
full valuation allowance against our net deferred tax assets because we expect that
it is more likely than not that all deferred tax assets will not be realized in the foreseeable future.
Each reporting period we evaluate both positive and negative evidence
and, as of September 28, 2007, we considered our history of losses and volatility of earnings to represent sufficient
negative evidence to require us to maintain a full valuation allowance against our net
deferred tax assets. We expect to maintain a valuation allowance on future tax benefits until an
appropriate level of profitability, primarily in the U.S., is sustained and we are able to develop tax
planning strategies that enable us to conclude that it is more likely than not that our deferred tax
assets would be realizable. However, if our income projections for future periods are realized, it is
reasonably possible that these earnings could provide sufficient positive evidence to require release
of all, or a portion, of these valuation allowances in the future. In the quarter that we release all
or part of the valuation allowance, it will have a material impact on our effective tax rate.
As of December 31, 2006, our valuation allowance was
$120.0 million. In periods following the release of our valuation allowance we anticipate that our effective
tax rate will increase.
On December 8, 2006, Harmonic completed its acquisition of the video networking software business
of Entone for a total purchase price of $49.0 million. The purchase price consisted of a payment of
$26.2 million, the issuance of 3,579,715 shares of Harmonic common stock with a value of $20.1
million, the issuance of 175,342 options to purchase Harmonic common stock with a value of $0.2
million, and $2.5 million of transaction costs. Prior to the closing of the acquisition, Entone
spun off its consumer premises equipment, or CPE, business into a separate private company. As part
of the terms of the acquisition agreement pursuant to which Harmonic acquired the video networking
software business of Entone, Harmonic was obligated to purchase a convertible note with a face
amount of $2.5 million in the new spun off private company subject to its closing of an initial
round of equity financing in which at least $4 million is invested by third parties. This note was
funded in July 2007.
21
On July 31, 2007, Harmonic completed its acquisition of Rhozet Corporation, a privately held
company based in Santa Clara, California. Under the terms of the merger agreement, Harmonic paid
or will pay an aggregate of approximately $15.5 million in total merger consideration, comprised of
approximately $2.5 million in cash, approximately
1.1 million shares of Harmonics common stock in
exchange for all of the outstanding shares of capital stock of Rhozet, approximately $2.8
million of cash which will be paid, at such time as provided in the merger agreement, to the
holders of outstanding options to acquire Rhozet common stock plus approximately $0.7 million in transaction costs. Pursuant to the merger agreement,
approximately $2.3 million of the total merger consideration, consisting of cash and shares of
Harmonic common stock, are being held back by Harmonic for at least 18 months following the closing
of the acquisition to satisfy certain indemnification obligations of Rhozets shareholders.
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 the annual consolidated financial
statements as of and for the year ended December 31, 2006, included in our Annual Report on Form
10-K filed with the SEC on March 15, 2007 and notes to condensed consolidated financial statements
as of and for the three month period ended September 28, 2007, included herein. Our most critical
accounting policies have not changed since December 31, 2006 and include the following:
|
§ |
|
Revenue recognition; |
|
|
§ |
|
Allowances for doubtful accounts, returns and discounts; |
|
|
§ |
|
Valuation of inventories; |
|
|
§ |
|
Impairment of long-lived assets; |
|
|
§ |
|
Restructuring costs and accruals for excess facilities; |
|
|
§ |
|
Assessment of the probability of the outcome of current litigation; |
|
|
§ |
|
Accounting for income taxes, and |
|
|
§ |
|
Stock-based compensation. |
Our accounting policy for income taxes was recently modified due to the adoption of FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109, or FIN 48, see Note 10 to the Condensed Consolidated Financial Statements on
Income Taxes.
22
Results of Operations
Harmonics historical consolidated statements of operations data for the third quarter and first
nine months of 2007 and the third quarter and first nine months of 2006 as a percentage of net
sales, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Product sales |
|
|
91 |
% |
|
|
90 |
% |
|
|
92 |
% |
|
|
90 |
% |
Service revenue |
|
|
9 |
|
|
|
10 |
|
|
|
8 |
|
|
|
10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
100 |
|
|
|
100 |
|
|
|
100 |
|
|
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product cost of sales |
|
|
52 |
|
|
|
49 |
|
|
|
54 |
|
|
|
55 |
|
Service cost of sales |
|
|
5 |
|
|
|
4 |
|
|
|
4 |
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales |
|
|
57 |
|
|
|
53 |
|
|
|
58 |
|
|
|
59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
43 |
|
|
|
47 |
|
|
|
42 |
|
|
|
41 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development |
|
|
13 |
|
|
|
16 |
|
|
|
14 |
|
|
|
17 |
|
Selling, general and administrative |
|
|
18 |
|
|
|
27 |
|
|
|
21 |
|
|
|
28 |
|
Write-off of acquired in-process technology |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangibles |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
32 |
|
|
|
43 |
|
|
|
35 |
|
|
|
45 |
|
Income (loss) from operations |
|
|
11 |
|
|
|
4 |
|
|
|
7 |
|
|
|
(4 |
) |
Interest income, net |
|
|
1 |
|
|
|
2 |
|
|
|
1 |
|
|
|
2 |
|
Other income, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
12 |
|
|
|
6 |
|
|
|
8 |
|
|
|
(2 |
) |
Provision for income taxes |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
11 |
% |
|
|
6 |
% |
|
|
8 |
% |
|
|
(2 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales Consolidated
Harmonics consolidated net sales in the third quarter and first nine months of 2007 compared with
the corresponding periods in 2006 are presented in the table below. Also presented are the related
dollar and percentage
23
changes in consolidated net sales in the third quarter and first nine months of 2007 compared with
the corresponding periods in 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands, except percentages) |
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 28, |
|
|
September 29, |
|
|
September 28, |
|
|
September 29, |
|
Sales Data: |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Video Processing |
|
$ |
38,623 |
|
|
$ |
26,116 |
|
|
$ |
92,790 |
|
|
$ |
66,363 |
|
Edge and Access |
|
|
29,156 |
|
|
|
25,143 |
|
|
|
95,891 |
|
|
|
77,029 |
|
Software and Other |
|
|
7,216 |
|
|
|
5,556 |
|
|
|
16,336 |
|
|
|
11,868 |
|
Service and Support |
|
|
7,300 |
|
|
|
6,041 |
|
|
|
18,797 |
|
|
|
17,086 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
82,295 |
|
|
$ |
62,856 |
|
|
$ |
223,814 |
|
|
$ |
172,346 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Video Processing increase |
|
$ |
12,507 |
|
|
|
|
|
|
$ |
26,427 |
|
|
|
|
|
Edge and Access increase |
|
|
4,013 |
|
|
|
|
|
|
|
18,862 |
|
|
|
|
|
Software and Other increase |
|
|
1,660 |
|
|
|
|
|
|
|
4,468 |
|
|
|
|
|
Service and Support increase |
|
|
1,259 |
|
|
|
|
|
|
|
1,711 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total increase |
|
$ |
19,439 |
|
|
|
|
|
|
$ |
51,468 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Video Processing percent change |
|
|
47.9 |
% |
|
|
|
|
|
|
39.8 |
% |
|
|
|
|
Edge and Access percent change |
|
|
16.0 |
% |
|
|
|
|
|
|
24.5 |
% |
|
|
|
|
Software and Other change |
|
|
29.9 |
% |
|
|
|
|
|
|
37.6 |
% |
|
|
|
|
Service and Support change |
|
|
20.8 |
% |
|
|
|
|
|
|
10.0 |
% |
|
|
|
|
Total percent change |
|
|
30.9 |
% |
|
|
|
|
|
|
29.9 |
% |
|
|
|
|
Net sales increased in the third quarter of 2007 compared to the same period of 2006 principally
due to stronger demand from our domestic and international satellite operators, and sales of our
recently introduced products. In the video processing product line,
the sales increase in the third quarter of 2007 compared to the same period in the prior
year was primarily due to higher spending by domestic and international satellite operators. The edge
and access product line experienced an increase in net sales in the third quarter
of 2007 compared to the same period in 2006 due to continuing sales
of VOD and video transmission products for deployments from cable operators. Software and other revenue increased in
the third quarter of 2007 compared to the same period of 2006 primarily due to sales of recently
introduced software products, including products from the recent acquisitions of Entone and Rhozet,
partially offset by a reduction in other revenue. Service and support revenue, primarily
consisting of maintenance agreements, system integration and customer repairs, increased in the
third quarter of 2007 compared to the same period of 2006 principally due to an increased customer
base.
Net sales increased in the first nine months of 2007 compared to the same period of 2006
principally due to stronger demand from our domestic and
international satellite operators and our domestic cable operators, and
sales of our recently introduced products. In the video processing
product line, the sales increase in the first nine months of 2007 compared to the same period in the
prior year was primarily due to higher spending across all types of customers
except telco. The increase in the edge and access product lines was
principally attributable to an increase of approximately $27.7 million in sales of VOD and video
transmission products for deployments for domestic and international cable operators, offset by
a decrease in sales of lower margin FTTP products of $9.6 million. Software and other revenue increased in
the first nine months of 2007 compared to the same period of 2006 primarily due to sales of
recently introduced software products, including products from the recent acquisitions of Entone
and Rhozet. Service and support revenue, consisting of maintenance agreements, system integration
and customer repairs, increased in the first nine months of 2007 compared to the same period of
2006 principally due to an increased customer base.
24
Net Sales Geographic
Harmonics domestic and international net sales in the third quarter and first nine months of 2007
compared with the corresponding periods in 2006 are presented in the table below. Also presented
are the related dollar and percentage changes in domestic and international net sales in the
third quarter and first nine months of 2007 compared with the corresponding periods in 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands, except percentages) |
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 28, |
|
|
September 29, |
|
|
September 28, |
|
|
September 29, |
Geographic Sales Data: |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
U.S. |
|
$ |
44,638 |
|
|
$ |
29,265 |
|
|
$ |
125,447 |
|
|
$ |
81,968 |
|
International |
|
|
37,657 |
|
|
|
33,591 |
|
|
|
98,367 |
|
|
|
90,378 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
82,295 |
|
|
$ |
62,856 |
|
|
$ |
223,814 |
|
|
$ |
172,346 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. increase |
|
$ |
15,373 |
|
|
|
|
|
|
$ |
43,479 |
|
|
|
|
|
International increase |
|
|
4,066 |
|
|
|
|
|
|
|
7,989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total increase |
|
$ |
19,439 |
|
|
|
|
|
|
$ |
51,468 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. percent change |
|
|
52.5 |
% |
|
|
|
|
|
|
53.0 |
% |
|
|
|
|
International percent change |
|
|
12.1 |
% |
|
|
|
|
|
|
8.8 |
% |
|
|
|
|
Total percent change |
|
|
30.9 |
% |
|
|
|
|
|
|
29.9 |
% |
|
|
|
|
The increased U.S. sales in the third quarter and first nine months of 2007 compared to the
corresponding periods in 2006 were principally due to stronger demand from our domestic satellite
and cable operators, partially offset by lower sales of FTTP products
to a domestic telco customer.
International sales in the third quarter and the first nine months of 2007 increased compared to
the corresponding periods in 2006 primarily due to stronger demand from satellite and cable
customers for network expansion, primarily in the South American and
Asian markets, partially offset by lower sales in Europe. We expect that
international sales will continue to account for a significant portion of our net sales for the
foreseeable future.
Gross Profit
Harmonics gross profit and gross profit as a percentage of consolidated net sales in the third
quarter and first nine months of 2007 as compared with the corresponding periods of 2006 presented
in the tables below. Also presented are the related dollar and percentage changes in
gross profit in the third quarter and first nine months of 2007 as compared with the corresponding
periods of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except percentages) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Product gross profit |
|
$ |
31,864 |
|
|
$ |
25,949 |
|
|
$ |
83,470 |
|
|
$ |
61,151 |
|
Service gross profit |
|
|
3,779 |
|
|
|
3,848 |
|
|
|
9,890 |
|
|
|
10,131 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross profit |
|
|
35,643 |
|
|
|
29,797 |
|
|
|
93,360 |
|
|
|
71,282 |
|
Products
gross profit as a % of net product sales |
|
|
42.5 |
% |
|
|
45.7 |
% |
|
|
40.7 |
% |
|
|
39.4 |
% |
Service
gross profit as a % of net service sales |
|
|
51.8 |
% |
|
|
63.7 |
% |
|
|
52.6 |
% |
|
|
59.3 |
% |
Total gross
profit as a % of net sales |
|
|
43.3 |
% |
|
|
47.4 |
% |
|
|
41.7 |
% |
|
|
41.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
gross profit increase |
|
|
5,915 |
|
|
|
|
|
|
|
22,319 |
|
|
|
|
|
Service
gross profit decrease |
|
|
(69 |
) |
|
|
|
|
|
|
(241 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross
profit increase |
|
$ |
5,846 |
|
|
|
|
|
|
$ |
22,078 |
|
|
|
|
|
Products
gross profit percent change |
|
|
22.8 |
% |
|
|
|
|
|
|
36.5 |
% |
|
|
|
|
Service
gross profit percent change |
|
|
(1.8 |
)% |
|
|
|
|
|
|
(2.4 |
)% |
|
|
|
|
Total percent change |
|
|
19.6 |
% |
|
|
|
|
|
|
31.0 |
% |
|
|
|
|
The increase in gross profit in the third quarter of 2007 as compared to the corresponding period
of 2006 was primarily due to increased sales, partially offset by an
increase in net expense of $3.8
million from the writedown of excess and obsolete inventory, which included a charge of $1.8
million for excess inventory of two older product lines, and an
increase in cost of sales of $1.2 million
from amortization of intangibles. The gross margin percentage of 43.3% in the third quarter of 2007
compared to 47.4% in the third quarter of 2006 was lower primarily due to higher
25
expenses for the writedown of excess and obsolete inventory in the third quarter of 2007, increased
cost of sales from the amortization of intangibles in the third quarter of 2007 and a one-time benefit
in the third quarter of 2006 from successful progress on a European telco project, partially offset
by increased gross margins on recently introduced products. Additionally, in the third quarter of
2006, our gross margin percentage increase included a benefit of $1.0 million related to products sold for which the cost basis
had been written down in prior years.
The increase in gross profit in the first nine months of 2007 as compared to the first nine months
of 2006 was primarily due to increased sales, partially offset by increased expense from the
net writedown of excess and obsolete inventory of $5.5 million and an increase in expense of $2.7 million from
amortization of intangibles. The gross margin percentage of 41.7% in the first nine months of 2007
compared to 41.4% in the first nine months of 2006 was higher primarily due to higher gross margins
on recently introduced products, partially offset by increased expense from the writedown of excess
and obsolete inventory and amortization of intangibles.
In the first nine months of 2007, $3.3 million of amortization of intangibles were included in cost
of sales compared to $0.5 million in the first nine months of 2006. The higher amortization in the
first nine months of 2007 was primarily due to the amortization of intangibles arising from the
Entone acquisition, which was completed in the fourth quarter of 2006, and the amortization of
intangibles arising from the Rhozet acquisition, which was completed in July 2007. We expect to
record approximately $1.5 million in amortization of intangibles in cost of sales in the remaining
three months of 2007 due to the acquisitions of Entone and Rhozet.
Research and Development
Our research and development expense and the expense as a percentage of consolidated net sales in
the third quarter and first nine months of 2007, as compared with the corresponding periods of
2006, are presented in the table below. Also presented are the related dollar and
percentage changes in research and development expense in the third quarter and first nine months
of 2007 as compared with the corresponding periods of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except percentages) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Research and development expense |
|
$ |
11,018 |
|
|
$ |
10,021 |
|
|
$ |
31,615 |
|
|
$ |
29,554 |
|
As a % of net sales |
|
|
13.4 |
% |
|
|
15.9 |
% |
|
|
14.1 |
% |
|
|
17.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase |
|
$ |
997 |
|
|
|
|
|
|
$ |
2,061 |
|
|
|
|
|
Percent change |
|
|
9.9 |
% |
|
|
|
|
|
|
7.0 |
% |
|
|
|
|
Research and development expense increased in the third quarter of 2007 as compared to the same
period in 2006, primarily due to increased compensation costs of $1.0 million and increased
stock-based compensation costs of $0.2 million, partially offset by lower consulting expenses of $0.2 million. The
increased compensation costs in the third quarter of 2007 were related to the increased headcount
associated with the acquisitions of Entone and Rhozet in December 2006 and July 2007, respectively,
and higher incentive compensation expenses.
The increase in research and development expense in the first nine months of 2007 as compared to
the first nine months of 2006 was primarily the result of increased
compensation costs of $2.8 million and depreciation expense of
$0.3 million, which was
partially offset by lower facility and overhead expenses of
$0.6 million and lower prototype materials expenses
of $0.5 million
associated with the development of new products. The increased compensation costs in the first nine
months of 2007 were related to the increased headcount associated with the acquisitions of Entone
and Rhozet in December 2006 and July 2007, respectively, and higher incentive compensation
expenses.
Selling, General and Administrative
Harmonics selling, general and administrative expense and the expense as a percentage of
consolidated net sales in the third quarter and first nine months of 2007, as compared with the
corresponding periods of 2006, are presented
26
in the table below. Also presented
are the related dollar and percentage changes in selling,
general and administrative expense in the third quarter and first nine months of 2007 as compared
with the corresponding periods of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except percentages) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Selling, general and administrative expense |
|
$ |
14,911 |
|
|
$ |
16,931 |
|
|
$ |
46,357 |
|
|
$ |
48,623 |
|
As a % of net sales |
|
|
18.1 |
% |
|
|
26.9 |
% |
|
|
20.7 |
% |
|
|
28.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease |
|
$ |
(2,020 |
) |
|
|
|
|
|
$ |
(2,266 |
) |
|
|
|
|
Percent change |
|
|
(11.9 |
)% |
|
|
|
|
|
|
(4.7 |
)% |
|
|
|
|
The decrease in selling, general and administrative expense in the third quarter of 2007 compared
to the same period in 2006 was primarily a result of a decrease in excess facilities expenses of
$3.4 million consisting of a net credit of approximately $1.4 million for excess facilities in the
third quarter of 2007 mainly from the extension of a sublease to a building through the end of the
lease term compared to a charge of approximately $2.1 million in the third quarter of 2006 from the
campus consolidation. Partially offsetting the lower excess facilities expenses were higher
compensation expenses of $0.8 million primarily due to increased incentive compensation and higher
legal and accounting expenses.
The decrease in selling, general and administrative expense in the first nine months of 2007
compared to the first nine months of 2006 was primarily a result of a decrease in excess facilities
expenses of $3.4 million as noted above, lower evaluation material expenses of $0.3 million,
partially offset by higher compensation expenses of $0.9 million and higher legal expenses of $0.5
million.
Amortization of Intangibles
Harmonics amortization of intangible assets and the expense as a percentage of consolidated net
sales in the third quarter and first nine months of 2007 as compared with the corresponding periods
of 2006 are presented in the table below. Also presented are the related dollar and percentage
changes in amortization of intangible assets in the third quarter and first nine months of 2007
as compared with the corresponding periods of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except percentages) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Amortization of intangibles |
|
$ |
143 |
|
|
$ |
45 |
|
|
$ |
365 |
|
|
$ |
179 |
|
As a % of net sales |
|
|
0.2 |
% |
|
|
0.1 |
% |
|
|
0.2 |
% |
|
|
0.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase |
|
$ |
98 |
|
|
|
|
|
|
$ |
186 |
|
|
|
|
|
Percent change |
|
|
217.8 |
% |
|
|
|
|
|
|
103.9 |
% |
|
|
|
|
The increase in the amortization of intangibles in the third quarter and first nine months of 2007
compared to the corresponding periods in 2006 was primarily due to the acquisitions of Entones and
Rhozets intangible assets during the fourth quarter of 2006 and July 2007, respectively. Harmonic
expects to record a total of approximately $0.2 million in
amortization of intangibles in operating
expenses in the remaining three months of 2007 due to the amortization of intangible assets
resulting from the acquisitions of Entone and Rhozet.
27
Interest Income
Harmonics interest income, net, and interest income, net, as a percentage of consolidated net
sales in the third quarter and first nine months of 2007 as compared with the corresponding periods
of 2006, are presented in the table below. Also presented are the related dollar and percentage
changes in interest income, net, in the third quarter and first nine months of 2007 as compared
with the corresponding periods of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except percentages) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Interest income, net |
|
$ |
1,238 |
|
|
$ |
1,182 |
|
|
$ |
3,224 |
|
|
$ |
3,349 |
|
As a % of net sales |
|
|
1.5 |
% |
|
|
1.9 |
% |
|
|
1.4 |
% |
|
|
1.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) |
|
$ |
56 |
|
|
|
|
|
|
$ |
(125 |
) |
|
|
|
|
Percent change |
|
|
4.7 |
% |
|
|
|
|
|
|
(3.7 |
)% |
|
|
|
|
The increase in interest income, net in the third quarter of 2007 compared to the corresponding
period of 2006 was primarily due to payments received from a customer
on a financing arrangement partially offset by lower interest income
resulting from a lower portfolio
balance during the third quarter of 2007. The decrease in interest income, net, in the first nine
months of 2007 compared to the corresponding period of 2006, was due primarily to a lower portfolio
balance during the first nine months of 2007 which was partially offset by lower interest expense
on debt.
Other Income, Net
Harmonics other income expense, net, and other income expense, net, as a percentage of
consolidated net sales in the third quarter and first nine months of 2007 as compared with the
corresponding periods of 2006, are presented in the table below. Also presented is the related
dollar and percentage changes in other income expense, net, in the third quarter and
first nine months of 2007 as compared with the corresponding periods of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except percentages) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Other income, net |
|
$ |
58 |
|
|
$ |
137 |
|
|
$ |
42 |
|
|
$ |
173 |
|
As a % of net sales |
|
|
0.1 |
% |
|
|
0.2 |
% |
|
|
|
% |
|
|
0.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease |
|
$ |
(79 |
) |
|
|
|
|
|
$ |
(131 |
) |
|
|
|
|
Percent change |
|
|
(57.7 |
)% |
|
|
|
|
|
|
(75.7 |
)% |
|
|
|
|
The decreases in other income, net, in the third quarter and first nine months of 2007
compared to the corresponding periods of 2006 were primarily due to
lower foreign exchange gains, net.
28
Income Taxes
Harmonics provision for income taxes, and provision for income taxes as a percentage of
consolidated net sales in the third quarter and first nine months of 2007, as compared with the
corresponding periods of 2006, are presented in the tables below. Also presented are the related
dollar and percentage changes in income taxes in the third quarter and first nine months of 2007
as compared with the corresponding periods of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 28, |
|
September 29, |
|
September 28, |
|
September 29, |
(in thousands, except percentages) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Provision for income taxes |
|
$ |
750 |
|
|
$ |
103 |
|
|
$ |
807 |
|
|
$ |
482 |
|
As a % of net sales |
|
|
0.9 |
% |
|
|
0.2 |
% |
|
|
0.4 |
% |
|
|
0.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase |
|
$ |
647 |
|
|
|
|
|
|
$ |
325 |
|
|
|
|
|
Percent change |
|
|
628.2 |
% |
|
|
|
|
|
|
67.4 |
% |
|
|
|
|
The increases in the provision for income taxes in the third quarter
compared to the same period in 2006 was primarily due to higher
Federal alternative minimum tax, greater state income taxes and the
accrual of interest on uncertain tax positions. The increase in the
provision for income taxes in the first nine months of 2007 compared
to the same period in 2006 was primarily due to higher Federal
alternative minimum tax, greater state income taxes, accrual of
interest on uncertain tax positions partially offset by a reversal of a prior
year foreign tax provision.
Liquidity and Capital Resources
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
(in thousands) |
|
September 28,
2007 |
|
September 29,
2006 |
Net cash provided by (used in) operating activities |
|
$ |
9,341 |
|
|
$ |
(9 |
) |
Net cash provided by (used in) investing activities |
|
$ |
(9,535 |
) |
|
$ |
9,292 |
|
Net cash provided by financing activities |
|
$ |
7,767 |
|
|
$ |
3,341 |
|
As of September 28, 2007, cash, cash equivalents and short-term investments totaled $99.0 million,
compared to $92.4 million as of December 31, 2006. Cash provided by operations in the first nine
months of 2007 was $9.3 million, resulting from net income of $16.8 million, adjusted for $13.9
million in non-cash charges and a $21.3 million net change in assets and liabilities. The non-cash
charges included depreciation, amortization, write-off of acquired in-process technology and
stock-based compensation expense. The net change in assets and liabilities included a decrease in
accounts payable primarily from the payment of inventory purchases, a decrease in accrued excess
facilities costs, a decrease in accrued and other liabilities primarily from the payment of
merger-related obligations from our DiviCom acquisition in 2000 and the payment of incentive
compensation, an increase in accounts receivable primarily from increased sales, which was
partially offset by a decrease in inventories and an increase in deferred revenue.
To the extent that non-cash items increase or decrease our future operating results, there will be
no corresponding impact on our cash flows. After excluding the effects of these non-cash charges,
the primary changes in cash flows relating to operating activities resulted from changes in working
capital. Our primary source of operating cash flows is the collection of accounts receivable from
our customers. Our operating cash flows are also impacted by the timing of payments to our vendors
for accounts payable and other liabilities. We generally pay our vendors and service providers in
accordance with the invoice terms and conditions. In addition, we usually pay our annual incentive
compensation to employees in the first quarter.
Net cash used in investing activities was $9.5 million for the nine months ended September 28,
2007, resulting primarily from the payment of $2.5 million in merger costs related to the Entone
acquisition in December 2006, the purchase of a convertible note
from Entone, Inc. for $2.5
million, a payment of $2.0 million to Rhozet shareholders, the net
proceeds from investments of $1.0 million and the payment of $4.2 million of capital expenditures primarily for
test equipment. Harmonic currently expects capital expenditures to be in the range of $5 million to
$6 million during 2007.
29
Net cash provided by financing activities was $7.8 million for the nine months ended September 28,
2007, resulting primarily from proceeds received of $8.3 million from the exercise of stock options
and the sale of our common stock under our ESPP, less the repayment of $0.5 million of the
remaining outstanding balance under our term loan facility.
Under the terms of the merger agreement with C-Cube, Harmonic is generally liable for C-Cubes
pre-merger liabilities. As of September 28, 2007, approximately $6.7 million of pre-merger
liabilities remained outstanding and are included in accrued liabilities. We are working with LSI
Logic, which acquired C-Cubes spun-off semiconductor business in June 2001 and assumed its
obligations, to develop an approach to settle these obligations, a process which has been underway
since the merger in 2000. These liabilities represent estimates of C-Cubes pre-merger obligations
to various authorities in 9 countries. Harmonic paid $2.4 million in January 2007, but is unable to
predict when the remaining obligations will be paid. The full amount of the estimated obligations
has been classified as a current liability. To the extent that these obligations are finally
settled for less than the amounts provided, Harmonic is required, under the terms of the merger
agreement, to refund the difference to LSI Logic. Conversely, if the settlements are more than the
remaining $6.7 million pre-merger liability, LSI Logic is obligated to reimburse Harmonic.
As of
September 28, 2007, $3.9 million in merger costs, cash consideration
payable to Rhozet shareholders and cash consideration payable to
holders of Rhozet stock options remains unpaid and has been recorded
in either accounts payable or current liabilities. In addition,
approximately $1.9 million of purchase consideration, which based on
the terms of the merger agreement will be settled through the issuance
of approximately 0.2 million shares of Harmonics common stock,
has been recorded as a non-current liability.
Harmonic has a bank line of credit facility with Silicon Valley Bank, which provides for borrowings
of up to $20.0 million that matures on March 5, 2008. In March 2007, Harmonic paid in full the
outstanding balance of its secured term loans and canceled its term loan facility as part of the
renewal process for the bank line of credit. As of September 28, 2007, other than standby letters
of credit and guarantees (Note 16), there were no amounts outstanding under the line of credit
facility and there were no borrowings in 2006 or 2007. This facility, which was amended and
restated in March 2007, contains financial and other covenants including the requirement for
Harmonic to maintain cash, cash equivalents and short-term investments, net of credit extensions,
of not less than $30.0 million. If Harmonic is unable to maintain this cash, cash equivalents and
short-term investments balance or satisfy the additional affirmative covenant requirements,
Harmonic would be in noncompliance 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 and
disposing of the collateral if obligations were not repaid. At September 28, 2007, Harmonic was in
compliance with the covenants under this line of credit facility. The March 2007 amendment resulted
in the company paying a fee of $10,000 and requiring payment of approximately $20,000 of additional
fees if the company does not maintain an unrestricted deposit of $20.0 million with the bank.
Future borrowings pursuant to the line bear interest at the banks prime rate (7.75% at September
28, 2007). Borrowings are payable monthly and are collateralized by all of Harmonics assets except
intellectual property.
Harmonics cash, cash equivalents and investment balances at September 28, 2007 were $99.0 million.
However, we may need to raise additional funds if our expectations are incorrect, to fund our
operations, to take advantage of unanticipated strategic opportunities or to strengthen our
financial position. We believe that our existing liquidity sources will satisfy our cash
requirements for the next 12 months. On October 23, 2007,
we filed a preliminary prospectus supplement to an effective registration statement on Form S-3 with the SEC related
to the proposed sale of 12.9 million shares of our common stock.
There is no assurance that we will complete this offering of common
stock.
In addition, we actively review potential acquisitions that would complement our existing product
offerings, enhance our technical capabilities or expand our marketing and sales presence. Any
future transaction of this nature could require potentially significant amounts of capital or could
require us to issue our stock and dilute existing stockholders. If adequate funds are not
available, or are not available on acceptable terms, we may not be able to take advantage of market
opportunities, to develop new products or to otherwise respond to competitive pressures.
Our ability to raise funds may be adversely affected by a number of factors relating to Harmonic,
as well as factors beyond our control, including market uncertainty surrounding the ongoing U.S.
war on terrorism, as well as conditions in capital markets and the cable and satellite industries.
There can be no assurance that any financing will be available on terms acceptable to us, if at
all.
30
Off-Balance Sheet Arrangements
None as
of September 28, 2007.
Contractual Obligations and Commitments
Future payments under contractual obligations, and other commercial commitments, as of September
28, 2007, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
Total |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Committed |
|
|
1 year or less |
|
|
2 - 3 years |
|
|
4 - 5 years |
|
|
Over 5 years |
|
|
|
(in thousands) |
|
Contractual Obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Leases(1) |
|
$ |
39,135 |
|
|
$ |
13,065 |
|
|
$ |
26,070 |
|
|
$ |
|
|
|
$ |
|
|
Inventory Purchase Commitments |
|
|
19,650 |
|
|
|
19,650 |
|
|
|
|
|
|
|
|
|
|
|
|
|
C-Cube Pre-Merger Liabilities |
|
|
6,657 |
|
|
|
6,657 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency forward exchange contracts |
|
|
10,992 |
|
|
|
10,992 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital lease obligations |
|
|
7 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Contractual Obligations |
|
$ |
76,441 |
|
|
$ |
50,371 |
|
|
$ |
26,070 |
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
Total |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Committed |
|
|
1 year or less |
|
|
2 - 3 years |
|
|
4 - 5 years |
|
|
Over 5 years |
|
|
|
(in thousands) |
|
Amount of Commitment Expiration Per Period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Commercial Commitments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Standby Letters of Credit |
|
$ |
728 |
|
|
$ |
728 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Indemnifications(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Guarantees |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Contractual Obligations |
|
$ |
728 |
|
|
$ |
728 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1. |
|
Operating lease commitments include $26.3 million of accrued excess facilities costs. |
|
2. |
|
Harmonic indemnifies some of its suppliers and customers for specified intellectual
property rights pursuant to certain parameters and restrictions. 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 for
indemnification and, accordingly, no amounts have been accrued in respect of the
indemnification provisions at September 28, 2007. |
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the operating results, financial position,
or liquidity of Harmonic due to adverse changes in market prices and rates. Harmonic is exposed to
market risk because of changes in interest rates and foreign currency exchange rates as measured
against the U.S. Dollar and currencies of Harmonics subsidiaries.
Foreign Currency Exchange Risk
Harmonic has a number of international customers each of whose sales are generally denominated in
U.S. dollars. Sales denominated in foreign currencies were approximately 7% and 9% of net sales in
the first nine months of 2007 and 2006, respectively. In addition, the Company has various
international branch offices that provide sales support and systems integration services.
Periodically, Harmonic enters into foreign currency forward exchange contracts, or forward
contracts, to manage exposure related to accounts receivable denominated in foreign currencies.
Harmonic does not enter into derivative financial instruments for trading purposes. At September
28, 2007, we had a forward contract to sell Euros totaling $11.0 million that matures during the
fourth quarter of 2007. While Harmonic does not anticipate that near-term changes in exchange rates
will have a material impact on Harmonics operating results, financial position and liquidity,
Harmonic cannot assure you that a sudden and significant change in the value of local currencies
would not harm Harmonics operating results, financial position and liquidity.
Interest Rate Risk
Exposure to market risk for changes in interest rates relate primarily to Harmonics investment
portfolio of marketable debt securities of various issuers, types and maturities and to Harmonics
borrowings under its bank line of credit facility. Harmonic does not use derivative instruments in
its investment portfolio, and its investment portfolio only includes highly liquid instruments with
an original maturity of less than two years. These investments are classified as available for sale
and are carried at estimated fair value, with material unrealized gains and losses reported in
other comprehensive income. There is risk that losses could be incurred if Harmonic were to sell
any of its securities prior to stated maturity. A 10% change in interest rates would not have had a
material impact on financial conditions, results of operations or cash flows.
Item 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
We maintain disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under
the Exchange Act, that are designed to ensure that information required to be disclosed by us in
reports that we file or submit under the Securities Exchange Act of 1934, as amended (the Exchange
Act) is recorded, processed, summarized and reported within the time periods specified in SEC
rules and forms, and that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and evaluating our disclosure controls and
procedures, management recognized that disclosure controls and procedures, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of
the disclosure controls and procedures are met. Additionally, in designing disclosure controls and
procedures, our management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible disclosure controls and procedures. The design of any
disclosure controls and procedures also is based in part upon certain
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assumptions about the likelihood of future events, and there can be no assurance that any design
will succeed in achieving its stated goals under all potential future conditions.
Based on their evaluation as of the end of the period covered by this Quarterly Report on Form
10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures were effective.
Changes in internal controls.
There was no change in our internal control over financial reporting that occurred during the
period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Shareholder Litigation
Between June 28, 2000 and August 25, 2000, several actions alleging violations of the federal
securities laws by us and certain of our officers and directors (some of whom are no longer with
us) were filed in or removed to the United States District Court for the Northern District of
California. The actions subsequently were consolidated.
A consolidated complaint, filed on December 7, 2000, was brought on behalf of a purported class of
persons who purchased our publicly traded securities between January 19, 2000 and June 26, 2000.
The complaint also alleged claims on behalf of a purported subclass of persons who purchased C-Cube
securities between January 19, 2000 and May 3, 2000. In addition to us and certain of our officers
and directors, the complaint also named C-Cube Microsystems Inc. and several of its officers and
directors as defendants. The complaint alleged that, by making false or misleading statements
regarding our prospects and customers and its acquisition of C-Cube, certain defendants violated
Sections 10(b) and 20(a) of the Securities Exchange Act. The complaint also alleged that certain
defendants violated Section 14(a) of the Exchange Act and Sections 11, 12(a)(2), and 15 of the
Securities Act by filing a false or misleading registration statement, prospectus and joint proxy
in connection with the C-Cube acquisition.
On July 3, 2001, the District Court dismissed the consolidated complaint with leave to amend. An
amended complaint alleging the same claims against the same defendants was filed on August 13,
2001. Defendants moved to dismiss the amended complaint on September 24, 2001. On November 13,
2002, the District Court issued an opinion granting the motions to dismiss the amended complaint
without leave to amend. Judgment for defendants was entered on December 2, 2002. On December 12,
2002, plaintiffs filed a motion to amend the judgment and for leave to file an amended complaint
pursuant to Rules 59(e) and 15(a) of the Federal Rules of Civil Procedure. On June 6, 2003, the
District Court denied plaintiffs motion to amend the judgment and for leave to file an amended
complaint. Plaintiffs filed a notice of appeal on July 1, 2003. The appeal was heard by a panel of
three judges of the United States Court of Appeals for the Ninth Circuit on February 17, 2005.
On November 8, 2005, the Ninth Circuit panel affirmed in part, reversed in part, and remanded for
further proceedings the decision of the District Court. The Ninth Circuit affirmed the District
Courts dismissal of the plaintiffs fraud claims under Sections 10(b), 14(a), and 20(a) of the
Exchange Act with prejudice, finding that the plaintiffs failed to adequately plead their
allegations of fraud. The Ninth Circuit reversed the District Courts dismissal of the plaintiffs
claims under Sections 11 and 12(a)(2) of the Securities Act, however, finding that because those
claims did not allege fraud, they met the applicable pleading requirements. Regarding the secondary
liability claim under Section 15 of the Securities Act, the Ninth Circuit reversed the dismissal of
that claim against Anthony J. Ley, our Chairman and former Chief Executive Officer, and affirmed
the dismissal of that claim against us, while granting leave to amend. The Ninth Circuit remanded
the surviving claims to the District Court for further proceedings.
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On November 22, 2005, both the defendants and the plaintiffs petitioned the Ninth Circuit for a
rehearing of the appeal. On February 16, 2006 the Ninth Circuit denied both petitions. On May 17,
2006 the plaintiffs filed an amended complaint on the issues remanded for further proceedings by
the Ninth Circuit, to which the defendants affiliated with Harmonic responded with a motion to
dismiss certain claims and to strike certain allegations. On December 11, 2006, the Court granted
the motion to dismiss with respect to the Section 12(a)(2) claim against the individual director
and officer defendants affiliated with Harmonic and granted the motion to strike, but denied the
motion to dismiss the Section 15 claim. A case management conference was held on January 25, 2007,
at which the Court set a trial date in August 2008, with discovery to close in February 2008. The
Court also ordered the parties to attend a settlement conference with a magistrate judge or a
private mediation before June 30, 2007. A mediation session was held on May 24, 2007 at which the
parties were unable to reach a settlement.
A derivative action purporting to be on our behalf was filed against its then-current directors in
the Superior Court for the County of Santa Clara on September 5, 2000. We were also named as a
nominal defendant. The complaint is based on allegations similar to those found in the securities
class action and claims that the defendants breached their fiduciary duties by, among other things,
causing us to violate federal securities laws. The derivative action was removed to the United
States District Court for the Northern District of California on September 20, 2000. All deadlines
in this action were stayed pending resolution of the motions to dismiss the securities class
action. On July 29, 2003, the Court approved the parties stipulation to dismiss this derivative
action without prejudice and to toll the applicable limitations period pending the Ninth Circuits
decision in the securities action. Pursuant to the stipulation, defendants have provided plaintiff
with a copy of the mandate issued by the Ninth Circuit in the securities action.
A second derivative action purporting to be on our behalf was filed in the Superior Court for the
County of Santa Clara on May 15, 2003. It alleges facts similar to those previously alleged in the
securities class action and the federal derivative action. The complaint names as defendants our
former and current officers and directors, along with former officers and directors of C-Cube
Microsystems, Inc., who were named in the securities class action. The complaint also names us as a
nominal defendant. The complaint alleges claims for abuse of control, gross mismanagement, and
waste of corporate assets against the defendants affiliated with Harmonic, and claims for breach of
fiduciary duty, unjust enrichment, and negligent misrepresentation against all defendants. On July
22, 2003, the Court approved the parties stipulation to stay the case pending resolution of the
appeal in the securities class action. Following the decision of the Ninth Circuit discussed above,
on May 9, 2006, defendants filed demurrers to this complaint. The plaintiffs then filed an amended
complaint on July 10, 2006, which names only the defendants affiliated with Harmonic. The
defendants filed demurrers to the amended complaint and the parties have stipulated to several
continuances of the hearing on the demurrers, which currently is set for December 14, 2007.
An unfavorable outcome of this litigation could require that we pay substantial damages.
In addition we may decide to settle the litigation, which could cause us to incur significant
costs. A settlement or an unfavorable outcome in these shareholder actions could have a material
adverse effect on Harmonics business, operating results, financial position or cash flows.
Other Litigation
On July 3, 2003, Stanford University and Litton Systems filed a complaint in U.S. District Court
for the Central District of California alleging that optical fiber amplifiers incorporated into
certain of our products infringe U.S. Patent No. 4859016. This patent expired in September 2003.
The complaint sought injunctive relief, royalties and damages. On August 6, 2007, the District
Court granted our motion to dismiss. The plaintiffs have appealed this motion.
An unfavorable outcome of any of these litigation matters could require that we pay substantial
damages, or, in connection with any intellectual property infringement claims, could require that
we pay ongoing royalty payments or could prevent us from selling certain of our products. In
addition, we may decide to settle any litigation, which could cause us to incur significant costs.
A settlement or an unfavorable outcome of these litigation matters could
33
have a material adverse effect on our business, operating results, financial position or cash
flows.
Item 1A. RISK FACTORS
We depend on cable, satellite and telecom industry capital spending for a substantial portion of
our revenue and any decrease or delay in capital spending in these industries would negatively
impact our operating results and financial condition and cash flows.
A significant portion of our sales have been derived from sales to cable television, satellite and
telecommunications operators, and we expect these sales to constitute a significant portion of net
sales for the foreseeable future. Demand for our products will depend on the magnitude and timing
of capital spending by cable television operators, satellite operators, telecommunications
companies and broadcasters for constructing and upgrading their systems.
These capital spending patterns are dependent on a variety of factors, including:
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access to financing; |
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annual budget cycles; |
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the impact of industry consolidation; |
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the status of federal, local and foreign government regulation of telecommunications and
television broadcasting; |
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overall demand for communication services and consumer acceptance of new video, voice
and data services; |
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evolving industry standards and network architectures; |
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competitive pressures, including pricing pressures; |
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discretionary customer spending patterns; and |
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general economic conditions. |
In the past, specific factors contributing to reduced capital spending have included:
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uncertainty related to development of digital video industry standards; |
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delays associated with the evaluation of new services, new standards and system
architectures by many operators; |
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emphasis on generating revenue from existing customers by operators instead of new
construction or network upgrades; |
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a reduction in the amount of capital available to finance projects of our customers and
potential customers; |
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proposed and completed business combinations and divestitures by our customers and
regulatory review thereof; |
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economic and financial conditions in domestic and international markets; and |
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bankruptcies and financial restructuring of major customers. |
The financial difficulties of certain of our customers and changes in our customers deployment
plans adversely affected our business in recent years. An economic downturn, tightening of credit,
or other factors could also cause
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additional financial difficulties among our customers, and customers whose financial condition has
stabilized may not purchase new equipment at levels we have seen in the past. Financial
difficulties among our customers would adversely affect our operating results and financial
condition. In addition, industry consolidation has, in the past and may in the future, constrained
capital spending among our customers. As a result, we cannot assure you that we will maintain or
increase our net sales in the future. If our product portfolio and product development plans do not
position us well to capture an increased portion of the capital spending of U.S. cable operators,
our revenue may decline and our operating results would be adversely affected.
Our customer base is concentrated and the loss of one or more of our key customers, or a failure to
diversify our customer base, could harm our business.
Historically, a majority of our sales have been to relatively few customers, and due in part to the
consolidation of ownership of cable television and direct broadcast satellite systems, we expect
this customer concentration to continue in the foreseeable future. Sales to our ten largest
customers in the first nine months of 2007 and the years 2006 and 2005 accounted for approximately
51%, 50% and 54% of net sales, respectively. Although we are attempting to broaden our customer
base by penetrating new markets such as the telecommunications and broadcast markets and expand
internationally, we expect to see continuing industry consolidation and customer concentration due
in part to the significant capital costs of constructing broadband networks. For example, Comcast
acquired AT&T Broadband in 2002, thereby creating the largest U.S. cable operator, reaching
approximately 22 million subscribers. The sale of Adelphia Communications cable systems to Comcast
and Time Warner Cable has led to further industry consolidation. NTL and Telewest, the two largest
cable operators in the UK, completed their merger in 2006. In the direct broadcast satellite, or
DBS, market, The News Corporation Ltd. acquired an indirect controlling interest in Hughes
Electronics, the parent company of DIRECTV, in 2003. News Corporation announced its intention to
sell its interest in DIRECTV to Liberty Media in December 2006. In the telco market, AT&T completed
its acquisition of Bell South.
In the first nine months of 2007 and the years 2006 and 2005, sales to Comcast accounted for 18%,
12% and 18%, respectively, of our net sales. In the three months
ended September 28, 2007, sales to Comcast
and Echostar accounted for 16% and 15%, respectively. The loss of Comcast or Echostar or any other
significant customer or any reduction in orders by Comcast, Echostar or any significant customer, or our
failure to qualify our products with a significant customer could adversely affect our business,
operating results and liquidity. In this regard, sales to Comcast declined in 2006 compared to
2005, both in absolute dollars and as a percentage of revenues. The loss of, or any reduction in
orders from, a significant customer would harm our business.
In addition, historically we have been dependent upon capital spending in the cable and satellite
industry. We are attempting to diversify our customer base beyond cable and satellite customers,
principally into the telco market. Major telcos have begun to implement plans to rebuild or upgrade
their networks to offer bundled video, voice and data services. While we have recently increased
our revenue from telco customers, we are relatively new to this market. In order to be successful
in this market, we may need 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 are subject to delays in completion, as video
processing technologies and video business models are 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 the recognition of
revenue by Harmonic. As a result of these and other factors, we cannot assure you that we will be
able to increase our revenues from the telco market, or that we can do so profitably, and any
failure to increase revenues and profits from telco customers could adversely affect our business.
Our operating results are likely to fluctuate significantly and may fail to meet or exceed the
expectations of securities analysts or investors, causing our stock price to decline.
Our operating results have fluctuated in the past and are likely to continue to fluctuate in the
future, on an annual and a quarterly basis, as a result of several factors, many of which are
outside of our control.
Some of the factors that may cause these fluctuations include:
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the level and timing of capital spending of our customers, both in the U.S. and in
foreign markets; |
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changes in market demand; |
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the timing and amount of orders, especially from significant customers; |
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the timing of revenue recognition from solution contracts, which may span several
quarters; |
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the timing of revenue recognition on sales arrangements, which may include multiple
deliverables; |
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the timing of completion of projects; |
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competitive market conditions, including pricing actions by our competitors; |
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seasonality, with fewer construction and upgrade projects typically occurring in winter
months and otherwise being affected by inclement weather; |
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our unpredictable sales cycles; |
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the amount and timing of sales to telcos, which are particularly difficult to predict; |
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new product introductions by our competitors or by us; |
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changes in domestic and international regulatory environments; |
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market acceptance of new or existing products; |
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the cost and availability of components, subassemblies and modules; |
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the mix of our customer base and sales channels; |
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the mix of products sold and the effect it has on gross margins; |
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changes in our operating expenses and extraordinary expenses; |
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impairment of goodwill and intangibles; |
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the outcome of litigation; |
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write-downs of inventory; |
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the impact of SFAS 123(R), an accounting standard which requires us to record the fair
value of stock options as compensation expense; |
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changes in our tax rate, including as a result of changes in our valuation allowance
against our deferred tax assets and our expectation that we would experience a substantial
increase in our effective tax rate in periods following a potential release of our
valuation allowance; |
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the impact of FIN 48, a recently adopted accounting interpretation which requires us to
expense potential tax penalties and interest; |
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our development of custom products and software; |
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the level of international sales; and |
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economic and financial conditions specific to the cable, satellite and telco industries,
and general economic conditions. |
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The timing of deployment of our equipment can be subject to a number of other risks, including the
availability of skilled engineering and technical personnel, the availability of other equipment
such as compatible set top boxes, and our customers need for local franchise and licensing
approvals.
In addition, we often recognize a substantial portion of our revenues in the last month of the
quarter. We establish our expenditure levels for product development and other operating expenses
based on projected sales levels, and expenses are relatively fixed in the short term. Accordingly,
variations in timing of sales can cause significant fluctuations in operating results. As a result
of all these factors, our operating results in one or more future periods may fail to meet or
exceed the expectations of securities analysts or investors. In that event, the trading price of
our common stock would likely decline. In this regard, due to a decrease in gross profit percentage
in 2005, and lower than expected sales during the first and second quarters of 2006, we failed to
meet our internal expectations, as well as the expectations of securities analysts and investors,
and the price of our common stock declined, in some cases significantly.
Our future growth depends on market acceptance of several emerging broadband services, on the
adoption of new broadband technologies and on several other broadband industry trends.
Future demand for our products will depend significantly on the growing market acceptance of
several emerging broadband services, including digital video, VOD, HDTV, IPTV, mobile video
services, very high-speed data services and voice-over-IP, or VoIP.
The effective delivery of these services will depend, in part, on a variety of new network
architectures and standards, such as:
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new video compression standards such as MPEG-4 ACV/H.264 for both standard definition
and high definition services; |
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fiber to the premises, or FTTP, and digital subscriber line, or DSL, networks designed
to facilitate the delivery of video services by telcos; |
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the greater use of protocols such as IP; |
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the adoption of switched digital video; and |
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the introduction of new consumer devices, such as advanced set-top boxes and personal
video recorders, or PVRs. |
If adoption of these emerging services and/or technologies is not as widespread or as rapid as we
expect, or if we are unable to develop new products based on these technologies on a timely basis,
our net sales growth will be materially and adversely affected.
Furthermore, other technological, industry and regulatory trends will affect the growth of our
business. These trends include the following:
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convergence, or the desire of certain network operators to deliver a package of video,
voice and data services to consumers, also known as the triple play service; |
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the entry of telcos into the video business; |
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growth in HDTV, on-demand services and mobile video; |
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the use of digital video by businesses, governments and educators; |
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efforts by regulators and governments in the U.S. and abroad to encourage the adoption
of broadband and digital technologies; and
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the extent and nature of regulatory attitudes towards such issues as competition between
operators, access by third parties to networks of other operators, local franchising
requirements for telcos to offer video, and new services such as VoIP. |
We need to develop and introduce new and enhanced products in a timely manner to remain
competitive.
Broadband communications markets are characterized by continuing technological advancement, changes
in customer requirements and evolving industry standards. To compete successfully, we must design,
develop, manufacture and sell new or enhanced products that provide increasingly higher levels of
performance and reliability. However, we may not be able to successfully develop or introduce these
products if our products:
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are not cost effective; |
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are not brought to market in a timely manner; |
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are not in accordance with evolving industry standards and architectures; |
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fail to achieve market acceptance; or |
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are ahead of the market. |
We are currently developing and marketing products based on new video compression standards.
Encoding products based on the MPEG-2 compression standards have represented a significant portion
of our sales since our acquisition of DiviCom in 2000. New standards,
such as MPEG-4 AVC/H.264 have
been adopted which provide significantly greater compression efficiency, thereby making more
bandwidth available to operators. The availability of more bandwidth is particularly important to
those DBS and telco operators seeking to launch, or expand, HDTV services. We have developed and
launched products, including HD encoders, based on these new standards in order to remain
competitive and are devoting considerable resources to this effort. There can be no assurance that
these efforts will be successful in the near future, or at all, or that competitors will not take
significant market share in HD encoding. At the same time, we need to devote development resources
to the existing MPEG-2 product line which our cable customers continue to require.
Also, to successfully develop and market certain of our planned products for digital applications,
we may be required to enter into technology development or licensing agreements with third parties.
We cannot assure you that we will be able to enter into any necessary technology development or
licensing agreements on terms acceptable to us, or at all. The failure to enter into technology
development or licensing agreements when necessary could limit our ability to develop and market
new products and, accordingly, could materially and adversely affect our business and operating
results.
Broadband communications markets are characterized by rapid technological change.
Broadband communications markets are relatively immature, making it difficult to accurately predict
the markets future growth rates, sizes or technological directions. In view of the evolving nature
of these markets, it is possible that cable television operators, telcos or other suppliers of
broadband wireless and satellite services will decide to adopt alternative architectures or
technologies that are incompatible with our current or future products. Also, decisions by
customers to adopt new technologies or products are often delayed by extensive evaluation and
qualification processes and can result in delays in sales of current products. If we are unable to
design, develop, manufacture and sell products that incorporate or are compatible with these new
architectures or technologies, our business will suffer.
The markets in which we operate are intensely competitive.
The markets for digital video systems are extremely competitive and have been characterized by
rapid technological change and declining average selling prices. Pressure on average selling prices
was particularly severe during the most recent economic downturn as equipment suppliers competed
aggressively for customers reduced capital
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spending. Our competitors for fiber optic products include corporations such as Motorola, Cisco
Systems and C-COR, which has recently agreed to be acquired by Arris. In our video processing and
edge and access products, we compete broadly with products from vertically integrated system
suppliers including Motorola, Cisco Systems, Thomson Multimedia and Tandberg Television, which was
recently acquired by Ericsson, and, in certain product lines, with a number of smaller companies.
Many of our competitors are substantially larger and have greater financial, technical, marketing
and other resources than us. Many of these large organizations are in a better position to
withstand any significant reduction in capital spending by customers in these markets. They often
have broader product lines and market focus and may not be as susceptible to downturns in a
particular market. These competitors may also be able to bundle their products together to meet the
needs of a particular customer and may be capable of delivering more complete solutions than we are
able to provide. Further, some of our competitors have greater financial resources than we do, and
they have offered and in the future may offer their products at lower prices than we do, which has
in the past and may in the future cause us to lose sales or to reduce our prices in response to
competition. In addition, many of our competitors have been in operation longer than we have and
therefore have more long-standing and established relationships with domestic and foreign
customers. We may not be able to compete successfully in the future, which would harm our business.
If any of our competitors products or technologies were to become the industry standard, our
business could be seriously harmed. For example, new standards for video compression are being
introduced and products based on these standards are being developed by us and some of our
competitors. If our competitors are successful in bringing these products to market earlier, or if
these products are more technologically capable than ours, then our sales could be materially and
adversely affected. In addition, companies that have historically not had a large presence in the
broadband communications equipment market have begun recently to expand their market share through
mergers and acquisitions. The continued consolidation of our competitors could have a significant
negative impact on us. Further, our competitors, particularly competitors of our digital and video
broadcasting systems business, may bundle their products or incorporate functionality into existing
products in a manner that discourages users from purchasing our products or which may require us to
lower our selling prices resulting in lower gross margins.
If sales forecasted for a particular period are not realized in that period due to the
unpredictable sales cycles of our products, our operating results for that period will be harmed.
The sales cycles of many of our products, particularly our newer products and products sold
internationally, are typically unpredictable and usually involve:
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a significant technical evaluation; |
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a commitment of capital and other resources by cable, satellite, and other network
operators; |
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time required to engineer the deployment of new technologies or new broadband services; |
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testing and acceptance of new technologies that affect key operations; and |
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test marketing of new services with subscribers. |
For these and other reasons, our sales cycles generally last three to nine months, but can last up
to 12 months. If orders forecasted for a specific customer for a particular quarter do not occur in
that quarter, our operating results for that quarter could be substantially lower than anticipated.
In this regard, our sales cycles with our current and potential satellite and telco customers are
particularly unpredictable. Orders may include multiple elements, the timing of delivery of which
may impact the timing of revenue recognition. Additionally, our sales arrangements may include
testing and acceptance of new technologies and the timing of completion of acceptance testing is
difficult to predict and may impact the timing of revenue recognition. Quarterly and annual results
may fluctuate significantly due to revenue recognition policies and the timing of the receipt of
orders. For example, revenue from two significant customer orders in the third quarter of 2004 was
delayed due to these factors until the fourth quarter of 2004, and delays in the completion of
certain projects underway with our international telco customers in the second quarter of 2006
resulted in lower revenue.
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In addition, a significant portion of our revenue is derived from solution sales that principally
consist of and include the system design, manufacture, test, installation and integration of
equipment to the specifications of our customers, including equipment acquired from third parties
to be integrated with our products. Revenue forecasts for solution contracts are based on the
estimated timing of the system design, installation and integration of projects. Because solution
contracts generally span several quarters and revenue recognition is based on progress under the
contract, the timing of revenue is difficult to predict and could result in lower than expected
revenue in any particular quarter.
We must be able to manage expenses and inventory risks associated with meeting the demand of our
customers.
If actual orders are materially lower than the indications we receive from our customers, our
ability to manage inventory and expenses may be affected. If we enter into purchase commitments to
acquire materials, or expend resources to manufacture products, and such products are not purchased
by our customers, our business and operating results could suffer. In this regard, our gross
margins and operating results have been in the past adversely affected by significant charges for
excess and obsolete inventories.
In addition, we must carefully manage the introduction of next generation products in order to
balance potential inventory risks associated with excess quantities of older product lines and
forecasts of customer demand for new products. For example, in the nine months ended September 28, 2007, we
wrote down approximately $5.5 million for obsolete and excess inventory with a significant portion
of the write down being due to product transitions. We also wrote down $1.1 million in 2006 as
a result of the end of life of a product line. There can be no assurance that we will be able
to manage these product transitions in the future without incurring write-downs for excess
inventory or having inadequate supplies of new products to meet customer expectations.
We may be subject to risks associated with acquisitions.
As part of our business strategy, from time to time, we have acquired, and continue to consider
acquiring, businesses, technologies, assets and product lines that we believe complement or expand
our existing business. For example, on December 8, 2006, we acquired the video networking software
business of Entone Technologies, Inc. and, on July 31, 2007, we completed the acquisition of Rhozet
Corporation, and we expect to make additional acquisitions in the future.
We may face challenges as a result of these activities, because acquisitions entail numerous risks,
including:
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the diversion of managements attention from other business; |
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difficulties in integrating acquired companies systems controls, policies and
procedures to comply with the internal control over financial reporting requirements of the
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adverse effects on existing business relationships with suppliers and customers; |
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risks associated with entering markets in which we have no or limited prior experience; |
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the potential loss of key employees of acquired businesses; |
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difficulties in the assimilation of different corporate cultures and practices; |
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substantial charges for the amortization of certain purchased intangible assets,
deferred stock compensation or similar items; |
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substantial impairments to goodwill or intangible assets in the event that an
acquisition proves to be less valuable than the price we paid for it; and |
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delays in realizing or failure to realize the benefits of an acquisition. |
For example, we recently closed all operations and product lines related to Broadcast Technology
Limited, which we acquired in 2005 and we have recorded charges associated with that closure.
Competition within our industry for acquisitions of businesses, technologies, assets and product
lines has been, and may in the future continue to be, intense. As such, even if we are able to
identify an acquisition that we would like to consummate, we may not be able to complete the
acquisition on commercially reasonable terms or because the target is acquired by another company.
Furthermore, in the event that we are able to identify and consummate any future acquisitions, we
could:
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issue equity securities which would dilute current stockholders percentage ownership; |
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incur substantial debt; |
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assume contingent liabilities; or |
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expend significant cash. |
These financing activities or expenditures could harm our business, operating results and financial
condition or the price of our common stock. Moreover, even if we do obtain benefits from
acquisitions in the form of increased sales and earnings, there may be a delay between the time
when the expenses associated with an acquisition are incurred and the time when we recognize such
benefits. We expect to utilize at least some of the proceeds from this offering to acquire
businesses, technologies, assets and products lines that we believe complement or expand our
existing business, and our failure to apply these proceeds from this offering effectively could
harm our business.
If we are unable to successfully address any of these risks, our business, financial condition or
operating results could be harmed.
We face risks associated with having important facilities and resources located in Israel.
We
maintain a facility in Caesarea in the State of Israel with a total of 72 employees as of
September 28, 2007, or approximately 11% of our workforce. The employees at this facility consist
principally of research and development personnel. In addition, we have pilot production
capabilities at this facility consisting of procurement of subassemblies and modules from Israeli
subcontractors and final assembly and test operations. Accordingly, we are directly influenced by
the political, economic and military conditions affecting Israel. Any recurrence of the recent
conflict in Israel and Lebanon could have a direct effect on our business or that of our Israeli
subcontractors, in the form of physical damage or injury, reluctance to travel within or to Israel
by our Israeli and foreign employees, or the loss of employees to active military duty. Most of our
employees in Israel are currently obligated to perform annual reserve duty in the Israel Defense
Forces and several have been called for active military duty recently. In the event that more
employees are called to active duty, certain of our research and development activities may be
adversely affected and significantly delayed. In addition, the interruption or curtailment of trade
between Israel and its trading partners could significantly harm our business. Terrorist attacks
and hostilities within Israel, the hostilities between Israel and Hezbollah, the election of Hamas
representatives to a majority of the seats in the Palestinian Legislative Council and the recent
conflict between Hamas and Fatah in Gaza have also heightened these risks. We cannot assure you
that current or future tensions in the Middle East will not adversely affect our business and
results of operations.
We depend on our international sales and are subject to the risks associated with international
operations, which may negatively affect our operating results.
Sales to customers outside of the U.S. in the first nine months of 2007 and the years 2006 and 2005
represented
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44%, 49% and 40% of net sales, respectively, and we expect that international sales will continue
to represent a meaningful portion of our net sales for the foreseeable future. Furthermore, a
substantial portion of our contract manufacturing occurs overseas. Our international operations,
the international operations of our contract manufacturers and our efforts to increase sales in
international markets are subject to a number of risks, including:
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import and export license requirements, tariffs, taxes and other trade barriers; |
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fluctuations in currency exchange rates; |
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difficulty in collecting accounts receivable; |
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potential tax issues; |
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the burden of complying with a wide variety of foreign laws, treaties and technical
standards; |
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difficulty in staffing and managing foreign operations; |
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political and economic instability, including risks related to terrorist activity; and |
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changes in economic policies by foreign governments. |
Certain of our international customers have accumulated significant levels of debt and have
undertaken reorganizations and financial restructurings, including bankruptcy proceedings. Even if
these restructurings are completed, we cannot assure you that these customers will be in a position
to purchase new equipment at levels we have seen in the past.
While our international sales and operating expenses have typically been denominated in U.S.
dollars, fluctuations in currency exchange rates could cause our products to become relatively more
expensive to customers in a particular country, leading to a reduction in sales or profitability in
that country. A significant portion of our European business is denominated in Euros, which may
subject us to increased foreign currency risk. Gains and losses on the conversion to U.S. dollars
of accounts receivable, accounts payable and other monetary assets and liabilities arising from
international operations may contribute to fluctuations in operating results.
Furthermore, payment cycles for international customers are typically longer than those for
customers in the U.S. Unpredictable sales cycles could cause us to fail to meet or exceed the
expectations of security analysts and investors for any given period. In addition, foreign markets
may not further develop in the future. Any or all of these factors could adversely impact our
business and results of operations.
Changes in telecommunications legislation and regulations could harm our prospects and future
sales.
Changes in telecommunications legislation and regulations in the U.S. and other countries could
affect the sales of our products. In particular, regulations dealing with access by competitors to
the networks of incumbent operators could slow or stop additional construction or expansion by
these operators. Local franchising and licensing requirements may slow the entry of telcos into the
video business. Increased regulation of our customers pricing or service offerings could limit
their investments and consequently the sales of our products. Changes in regulations could have a
material adverse effect on our business, operating results, and financial condition.
In order to manage our growth, we must be successful in addressing management succession issues and
attracting and retaining qualified personnel.
Our future success will depend, to a significant extent, on the ability of our management to
operate effectively, both individually and as a group. We must successfully manage transition and
replacement issues that may result from the departure or retirement of members of our senior
management. For example, in May 2006 we announced that our then Chairman, President and Chief
Executive Officer, Anthony J. Ley, had retired from his position as
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President and Chief Executive Officer effective immediately, and that he was being succeeded by our
then Executive Vice President, Patrick J. Harshman. In addition, in November 2006, we announced
that our Senior Vice President of Operations and Quality, Israel Levi, retired from his position
and was succeeded by Charles Bonasera as Vice President of Operations. We also recently announced
the appointment of Matthew Aden as our new Vice President of Worldwide Sales and Service. We cannot
assure you that changes of management personnel will not cause disruption to our operations or
customer relationships, or a decline in our financial results.
In addition, we are dependent on our ability to retain and motivate high caliber personnel, in
addition to attracting new personnel. Competition for qualified management, technical and other
personnel can be intense and we may not be successful in attracting and retaining such personnel.
Competitors and others have in the past and may in the future attempt to recruit our employees.
While our employees are required to sign standard agreements concerning confidentiality and
ownership of inventions, we generally do not have employment contracts or non-competition
agreements with any of our personnel. The loss of the services of any of our key personnel, the
inability to attract or retain qualified personnel in the future or delays in hiring required
personnel, particularly senior management and engineers and other technical personnel, could
negatively affect our business.
Accounting standards and stock exchange regulations related to equity compensation could adversely
affect our earnings, our ability to raise capital and our ability to attract and retain key
personnel.
Since our inception, we have used stock options as a fundamental component of our employee
compensation packages. We believe that our stock option plans are an essential tool to link the
long-term interests of stockholders and employees, especially executive management, and serve to
motivate management to make decisions that will, in the long run, give the best returns to
stockholders. The Financial Accounting Standards Board (FASB) issued SFAS 123(R) that requires us
to record a charge to earnings for employee stock option grants and employee stock purchase plan
rights for all periods from January 1, 2006. This standard has negatively impacted and will
continue to negatively impact our earnings and may affect our ability to raise capital on
acceptable terms. For the nine months ended September 28, 2007, stock-based compensation expense
recognized under SFAS 123(R) was $4.5 million, which consisted of stock-based compensation expense
related to employee and consultant equity awards and employee stock purchases.
In addition, regulations implemented by the Nasdaq Stock Market requiring stockholder approval for
all stock option plans could make it more difficult for us to grant options to employees in the
future. To the extent that new accounting standards make it more difficult or expensive to grant
options to employees, we may incur increased compensation costs, change our equity compensation
strategy or find it difficult to attract, retain and motivate employees, each of which could
materially and adversely affect our business.
We are exposed to additional costs and risks associated with complying with increasing and new
regulation of corporate governance and disclosure standards.
We are spending an increased amount of management time and external resources to comply with
changing laws, regulations and standards relating to corporate governance and public disclosure,
including the Sarbanes-Oxley Act of 2002, SEC regulations and the Nasdaq Stock Market rules.
Particularly, Section 404 of the Sarbanes-Oxley Act requires managements annual review and
evaluation of our internal control over financial reporting and attestation of the effectiveness of
our internal control over financial reporting by management and the Companys independent
registered public accounting firm in connection with the filing of the annual report on Form 10-K
for each fiscal year. We have documented and tested our internal control systems and procedures and
have made improvements in order for us to comply with the requirements of Section 404. This process
required us to hire additional personnel and outside advisory services and has resulted in
significant additional expenses. While our assessment of our internal control over financial
reporting resulted in our conclusion that as of December 31, 2006, our internal control over
financial reporting was effective, we cannot predict the outcome of our testing in future periods.
If we conclude in future periods that our internal control over financial reporting is not
effective or if our independent registered public accounting firm is unable to provide an
unqualified opinion as of future year-ends, investors may lose confidence in our financial
statements, and the price of our stock may suffer.
We may need additional capital in the future and may not be able to secure adequate funds on terms
acceptable to us.
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We have generated substantial operating losses since we began operations in June 1988. We have been
engaged in the design, manufacture and sale of a variety of video products and system solutions
since inception, which has required, and will continue to require, significant research and
development expenditures. As of September 28, 2007 we had an accumulated deficit of $1.9 billion.
These losses, among other things, have had and may have an adverse effect on our stockholders
equity and working capital.
We believe that our existing liquidity sources will satisfy our cash requirements for at least the
next twelve months. However, we may need to raise additional funds if our expectations are
incorrect, to take advantage of unanticipated strategic opportunities, to satisfy our other
liabilities, or to strengthen our financial position. Our ability to raise funds may be adversely
affected by a number of factors relating to us, as well as factors beyond our control, including
conditions in capital markets and the cable, satellite and telco industries. There can be no
assurance that such financing will be available on terms acceptable to us, if at all.
In addition, we actively review potential acquisitions that would complement our existing product
offerings, enhance our technical capabilities or expand our marketing and sales presence. Any
future transaction of this nature could require potentially significant amounts of capital to
finance the acquisition and related expenses as well as to integrate operations following a
transaction, and could require us to issue our stock and dilute existing stockholders. If adequate
funds are not available, or are not available on acceptable terms, we may not be able to take
advantage of market opportunities, to develop new products or to otherwise respond to competitive
pressures.
We may raise additional financing through public or private equity offerings, debt financings or
additional corporate collaboration and licensing arrangements. To the extent we raise additional
capital by issuing equity securities, our stockholders may experience dilution. To the extent that
we raise additional funds through collaboration and licensing arrangements, it may be necessary to
relinquish some rights to our technologies or products, or grant licenses on terms that are not
favorable to us. For example, debt financing arrangements may require us to pledge assets or enter
into covenants that could restrict our operations or our ability to incur further indebtedness. If
adequate funds are not available, we will not be able to continue developing our products.
If demand for our products increases more quickly than we expect, we may be unable to meet our
customers requirements.
If demand for our products increases, the difficulty of accurately forecasting our customers
requirements and meeting these requirements will increase. For example, we had insufficient
quantities of certain products to meet customer demand late in the second quarter of 2006 and, as a
result, our revenues were lower than internal and external expectations. Forecasting to meet
customers needs and effectively managing our supply chain is particularly difficult in connection
with newer products. Our ability to meet customer demand depends significantly on the availability
of components and other materials as well as the ability of our contract manufacturers to scale
their production. Furthermore, we purchase several key components, subassemblies and modules used
in the manufacture or integration of our products from sole or limited sources. Our ability to meet
customer requirements depends in part on our ability to obtain sufficient volumes of these
materials in a timely fashion. Also, in recent years, in response to lower sales and the prolonged
economic recession, we significantly reduced our headcount and other expenses. As a result, we may
be unable to respond to customer demand that increases more quickly than we expect. If we fail to
meet customers supply expectations, our net sales would be adversely affected and we may lose
business.
We purchase several key components, subassemblies and modules used in the manufacture or
integration of our products from sole or limited sources, and we are increasingly dependent on
contract manufacturers.
Many components, subassemblies and modules necessary for the manufacture or integration of our
products are obtained from a sole supplier or a limited group of suppliers. For example, we depend
on a small private company for certain video encoding chips which are incorporated into several new
products. Our reliance on sole or limited suppliers, particularly foreign suppliers, and our
increased reliance on subcontractors involves several risks, including a potential inability to
obtain an adequate supply of required components, subassemblies or modules and reduced control over
pricing, quality and timely delivery of components, subassemblies or modules. In particular,
certain optical components have in the past been in short supply and are available only from a
small number of
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suppliers, including sole source suppliers. While we expend resources to qualify additional
component sources, consolidation of suppliers in the industry and the small number of viable
alternatives have limited the results of these efforts. We do not generally maintain long-term
agreements with any of our suppliers. Managing our supplier and contractor relationships is
particularly difficult during time periods in which we introduce new products and during time
periods in which demand for our products is increasing, especially if demand increases more quickly
than we expect. Furthermore, from time to time we assess our relationship with our contract
manufacturers. In 2003, we entered into a three-year agreement with Plexus Services Corp. as our
primary contract manufacturer, and Plexus currently provides us with a substantial portion of the
products that we purchase from our contract manufacturers. This agreement has automatic annual
renewals unless prior notice is given and has been renewed until October 2008.
Difficulties in managing relationships with current contract manufacturers, particularly Plexus,
could impede our ability to meet our customers requirements and adversely affect our operating
results. An inability to obtain adequate deliveries or any other circumstance that would require us
to seek alternative sources of supply could negatively affect our ability to ship our products on a
timely basis, which could damage relationships with current and prospective customers and harm our
business. We attempt to limit this risk by maintaining safety stocks of certain components,
subassemblies and modules. As a result of this investment in inventories, we have in the past and
in the future may be subject to risk of excess and obsolete inventories, which could harm our
business, operating results, financial position and liquidity. In this regard, our gross margins
and operating results in the past were adversely affected by significant excess and obsolete
inventory charges.
Cessation of the development and production of video encoding chips by C-Cubes spun-off
semiconductor business may adversely impact us.
Our DiviCom business, which we acquired in 2000, and the C-Cube semiconductor business (acquired by
LSI Logic in June 2001) collaborated on the production and development of two video encoding
microelectronic chips prior to our acquisition of the DiviCom business. In connection with the
acquisition, we have entered into a contractual relationship with the spun-off semiconductor
business of C-Cube, under which we have access to certain of the spun-off semiconductor business
technologies and products on which the DiviCom business depends for certain product and service
offerings. The current term of this agreement is through October 2008, with automatic annual
renewals unless terminated by either party in accordance with the agreement provisions. On July 27,
2007, LSI announced that it had completed the sale of its consumer products business (which
includes the design and manufacture of encoding chips) to Magnum Semiconductor, and we expect, but
cannot be certain, that the agreement providing us with access to certain of the spun-off
semiconductor business technologies and products will be assigned to Magnum Semiconductor. If the
spun-off semiconductor business is not able to or does not sustain its development and production
efforts in this area, our business, financial condition, results of operations and cash flow could
be harmed.
We need to effectively manage our operations and the cyclical nature of our business.
The cyclical nature of our business has placed, and is expected to continue to place, a significant
strain on our personnel, management and other resources. We reduced our work force by approximately
44% between December 31, 2000 and December 31, 2003 due to reduced industry spending and demand for
our products. If demand for products increases significantly, we may need to increase our
headcount, as we did during 2004, adding 33 employees. In the first quarter of 2005, we added 42
employees in connection with our acquisition of BTL, and in connection with the consolidation of
our two operating divisions in December 2005, we reduced our workforce by approximately 40
employees. Following the closure of our BTL operations in the first quarter of 2007, we reduced our
headcount by 29 employees in the UK. Our purchase of the video networking software business of
Entone in December 2006 resulted in the addition of 43 employees, most of whom are based in Hong
Kong, and we added approximately 15 employees on July 31, 2007, in connection with the completion
of our acquisition of Rhozet. Our ability to manage our business effectively in the future,
including any future growth, will require us to train, motivate and manage our employees
successfully, to attract and integrate new employees into our overall operations, to retain key
employees and to continue to improve our operational, financial and management systems.
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We are subject to various environmental laws and regulations that could impose substantial costs
upon us and may adversely affect our business, operating results and financial condition.
Some of our operations use substances regulated under various federal, state, local and
international laws governing the environment, including those governing the management, disposal
and labeling of hazardous substances and wastes and the cleanup of contaminated sites. We could
incur costs and fines, third-party property damage or personal injury claims, or could be required
to incur substantial investigation or remediation costs, if we were to violate or become liable
under environmental laws. The ultimate costs under environmental laws and the timing of these costs
are difficult to predict.
We also face increasing complexity in our product design as we adjust to new and future
requirements relating to the presence of certain substances in electronic products and making
producers of those products financially responsible for the collection, treatment, recycling, and
disposal of certain products. For example, the European Parliament and the Council of the European
Union have enacted the Waste Electrical and Electronic Equipment (WEEE) directive, effective August
13, 2005, which regulates the collection, recovery, and recycling of waste from electrical and
electronic products, and the Restriction on the Use of Certain Hazardous Substances in Electrical
and Electronic Equipment (RoHS) directive, effective July 1, 2006, which bans the use of certain
hazardous materials including lead, mercury, cadmium, hexavalent chromium, and polybrominated
biphenyls (PBBs), and polybrominated diphenyl ethers (PBDEs) that exceed certain specified levels.
For some products, substituting particular components containing regulated hazardous substances is
more difficult or costly and redesign efforts could result in production delays. Selected
electronic products that we maintain in inventory may be rendered obsolete if not in compliance
with the new environmental laws and we may have unfulfilled sales orders, which could negatively
impact our ability to generate revenue from those products. Legislation similar to RoHS and WEEE
has been or may be enacted in other jurisdictions, including in the United States, Japan, and
China. Our failure to comply with these laws could result in our being directly or indirectly
liable for costs, fines or penalties and third-party claims, and could jeopardize our ability to
conduct business in such countries. We also expect that our operations will be affected by other
new environmental laws and regulations on an ongoing basis. Although we cannot predict the ultimate
impact of any such new laws and regulations, they will likely result in additional costs or
decreased revenue, and could require that we redesign or change how we manufacture our products,
any of which could have a material adverse effect on our business.
We are liable for C-Cubes pre-merger liabilities, including liabilities resulting from the
spin-off of its semiconductor business.
Under the terms of the merger agreement with C-Cube, we are generally liable for C-Cubes
pre-merger liabilities. As of September 28, 2007, approximately $6.7 million of pre-merger
liabilities remained outstanding and are included in accrued liabilities. We are working with LSI
Logic, which acquired C-Cubes spun-off semiconductor business in June 2001 and assumed its
obligations, to develop an approach to settle these obligations, a process which has been underway
since the merger in 2000. These liabilities represent estimates of C-Cubes pre-merger obligations
to various authorities in nine countries. We paid $2.4 million to satisfy a portion of this
liability in January 2007, but are unable to predict when the remaining obligations will be paid.
The full amount of the estimated obligations has been classified as a current liability. To the
extent that these obligations are finally settled for less than the amounts provided, we are
required, under the terms of the merger agreement, to refund the difference to LSI Logic.
Conversely, if the settlements are more than the remaining $6.7 million pre-merger liability, LSI
Logic is obligated to reimburse us.
The merger agreement stipulates that we will be indemnified by the spun-off semiconductor business
if the cash reserves are not sufficient to satisfy all of C-Cubes liabilities for periods prior to
the merger. If for any reason, the spun-off semiconductor business does not have sufficient cash to
pay such taxes, or if there are additional taxes due with respect to the non-semiconductor business
and we cannot be indemnified by LSI Logic, we generally will remain liable, and such liability
could have a material adverse effect on our financial condition, results of operations or cash
flows.
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We rely on value-added resellers and systems integrators for a substantial portion of our sales,
and disruptions to, or our failure to develop and manage, our relationships with these customers
and the processes and procedures that support them could adversely affect our business.
We generate a substantial portion of our sales through net sales to value-added resellers, or VARs,
and systems integrators. We expect that these sales will continue to generate a substantial
percentage of our net sales in the future. Our future success is highly dependent upon establishing
and maintaining successful relationships with a variety of VARs and systems integrators that
specialize in video delivery solutions, products and services.
We have no long-term contracts or minimum purchase commitments with any of our VAR or system
integrator customers, and our contracts with these parties do not prohibit them from purchasing or
offering products or services that compete with ours. Our competitors may be effective in providing
incentives to our VAR and systems integrator customers to favor their products or to prevent or
reduce sales of our products. Our VAR or systems integrator customers may choose not to purchase or
offer our products. Our failure to establish and maintain successful relationships with VAR and
systems integrator customers would likely materially and adversely affect our business, operating
results and financial condition.
Our failure to adequately protect our proprietary rights may adversely affect us.
We currently hold 39 issued U.S. patents and 19 issued foreign patents, and have a number of patent
applications pending. Although we attempt to protect our intellectual property rights through
patents, trademarks, copyrights, licensing arrangements, maintaining certain technology as trade
secrets and other measures, we cannot assure you that any patent, trademark, copyright or other
intellectual property rights owned by us will not be invalidated, circumvented or challenged, that
such intellectual property rights will provide competitive advantages to us or that any of our
pending or future patent applications will be issued with the scope of the claims sought by us, if
at all. We cannot assure you that others will not develop technologies that are similar or superior
to our technology, duplicate our technology or design around the patents that we own. In addition,
effective patent, copyright and trade secret protection may be unavailable or limited in certain
foreign countries in which we do business or may do business in the future.
We believe that patents and patent applications are not currently significant to our business, and
investors therefore should not rely on our patent portfolio to give us a competitive advantage over
others in our industry. We believe that the future success of our business will depend on our
ability to translate the technological expertise and innovation of our personnel into new and
enhanced products. We generally enter into confidentiality or license agreements with our
employees, consultants, vendors and customers as needed, and generally limit access to and
distribution of our proprietary information. Nevertheless, we cannot assure you that the steps
taken by us will prevent misappropriation of our technology. In addition, we have taken in the
past, and may take in the future, legal action to enforce our patents and other intellectual
property rights, to protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or invalidity. Such
litigation could result in substantial costs and diversion of resources and could negatively affect
our business, operating results, financial position or cash flows.
In order to successfully develop and market certain of our planned products for digital
applications, we may be required to enter into technology development or licensing agreements with
third parties. Although many companies are often willing to enter into technology development or
licensing agreements, we cannot assure you that such agreements will be negotiated on terms
acceptable to us, or at all. The failure to enter into technology development or licensing
agreements, when necessary or desirable, could limit our ability to develop and market new products
and could cause our business to suffer.
Our products include third-party technology and intellectual property, and our inability to use
that technology in the future could harm our business.
We incorporate certain third-party technologies, including software programs, into our products,
and intend to utilize additional third-party technologies in the future. Licenses to relevant
third-party technologies or updates to those technologies may not continue to be available to us on
commercially reasonable terms, or at all. In addition, the
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technologies that we license may not operate properly and we may not be able to secure alternatives
in a timely manner, which could harm our business. We could face delays in product releases until
alternative technology can be identified, licensed or developed, and integrated into our products,
if we are able to do so at all. These delays, or a failure to secure or develop adequate
technology, could materially and adversely affect our business.
We or our customers may face intellectual property infringement claims from third parties.
Our 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. In particular, leading
companies in the telecommunications industry have extensive patent portfolios. From time to time,
third parties have asserted and may assert patent, copyright, trademark and other intellectual
property rights against us or our customers. Our suppliers and customers may have similar claims
asserted against them. A number of third parties, including companies with greater financial and
other resources than us, have asserted patent rights to technologies that are important to us. Any
future litigation, regardless of its outcome, could result in substantial expense and significant
diversion of the efforts of our management and technical personnel. An adverse determination in any
such proceeding could subject us to significant liabilities, temporary or permanent injunctions or
require us to seek licenses from third parties or pay royalties that may be substantial.
Furthermore, necessary licenses may not be available on satisfactory terms, or at all.
On July 3, 2003, Stanford University and Litton Systems filed a complaint in U.S. District Court
for the Central District of California alleging that optical fiber amplifiers incorporated into
certain of our products infringe U.S. Patent No. 4859016. This patent expired in September 2003.
The complaint sought injunctive relief, royalties and damages. On August 6, 2007, the District
Court granted our motion to dismiss. The plaintiffs have appealed this motion. At this time, we are
unable to determine whether we will be able to settle this litigation on reasonable terms or at
all, nor can we predict the impact of an adverse outcome of this litigation if we elect to defend
against it. No estimate can be made of the possible range of loss associated with the resolution of
this contingency and accordingly, we have not recorded a liability associated with the outcome of a
negotiated settlement or an unfavorable verdict in litigation. A settlement or an unfavorable
outcome of this matter could have a material adverse effect on our business, operating results,
financial position or cash flows.
Our suppliers and customers may receive similar claims. We have agreed to indemnify some of our
suppliers and customers for alleged patent infringement. The scope of this indemnity varies, but,
in some instances, includes indemnification for damages and expenses (including reasonable
attorneys fees).
We are the subject of securities class action claims and other litigation which, if adversely
determined, could harm our business and operating results.
Between June 28, 2000 and August 25, 2000, several actions alleging violations of the federal
securities laws by us and certain of our officers and directors (some of whom are no longer with
us) were filed in or removed to the United States District Court for the Northern District of
California. The actions subsequently were consolidated.
A consolidated complaint, filed on December 7, 2000, was brought on behalf of a purported class of
persons who purchased our publicly traded securities between January 19, 2000 and June 26, 2000.
The complaint also alleged claims on behalf of a purported subclass of persons who purchased C-Cube
securities between January 19, 2000 and May 3, 2000. In addition to us and certain of our officers
and directors, the complaint also named C-Cube Microsystems Inc. and several of its officers and
directors as defendants. The complaint alleged that, by making false or misleading statements
regarding our prospects and customers and its acquisition of C-Cube, certain defendants violated
Sections 10(b) and 20(a) of the Securities Exchange Act. The complaint also alleged that certain
defendants violated Section 14(a) of the Exchange Act and Sections 11, 12(a)(2), and 15 of the
Securities Act by filing a false or misleading registration statement, prospectus and joint proxy
in connection with the C-Cube acquisition.
On July 3, 2001, the District Court dismissed the consolidated complaint with leave to amend. An
amended complaint alleging the same claims against the same defendants was filed on August 13,
2001. Defendants moved to dismiss the amended complaint on September 24, 2001. On November 13,
2002, the District Court issued an opinion granting the motions to dismiss the amended complaint
without leave to amend. Judgment for defendants was
48
entered on December 2, 2002. On December 12, 2002, plaintiffs filed a motion to amend the judgment
and for leave to file an amended complaint pursuant to Rules 59(e) and 15(a) of the Federal Rules
of Civil Procedure. On June 6, 2003, the District Court denied plaintiffs motion to amend the
judgment and for leave to file an amended complaint. Plaintiffs filed a notice of appeal on July 1,
2003. The appeal was heard by a panel of three judges of the United States Court of Appeals for the
Ninth Circuit on February 17, 2005.
On November 8, 2005, the Ninth Circuit panel affirmed in part, reversed in part, and remanded for
further proceedings the decision of the District Court. The Ninth Circuit affirmed the District
Courts dismissal of the plaintiffs fraud claims under Sections 10(b), 14(a), and 20(a) of the
Exchange Act with prejudice, finding that the plaintiffs failed to adequately plead their
allegations of fraud. The Ninth Circuit reversed the District Courts dismissal of the plaintiffs
claims under Sections 11 and 12(a)(2) of the Securities Act, however, finding that because those
claims did not allege fraud, they met the applicable pleading requirements. Regarding the secondary
liability claim under Section 15 of the Securities Act, the Ninth Circuit reversed the dismissal of
that claim against Anthony J. Ley, our Chairman and former Chief Executive Officer, and affirmed
the dismissal of that claim against us, while granting leave to amend. The Ninth Circuit remanded
the surviving claims to the District Court for further proceedings.
On November 22, 2005, both the defendants and the plaintiffs petitioned the Ninth Circuit for a
rehearing of the appeal. On February 16, 2006 the Ninth Circuit denied both petitions. On May 17,
2006 the plaintiffs filed an amended complaint on the issues remanded for further proceedings by
the Ninth Circuit, to which the defendants affiliated with Harmonic responded with a motion to
dismiss certain claims and to strike certain allegations. On December 11, 2006, the Court granted
the motion to dismiss with respect to the Section 12(a)(2) claim against the individual director
and officer defendants affiliated with Harmonic and granted the motion to strike, but denied the
motion to dismiss the Section 15 claim. A case management conference was held on January 25, 2007,
at which the Court set a trial date in August 2008, with discovery to close in February 2008. The
Court also ordered the parties to attend a settlement conference with a magistrate judge or a
private mediation before June 30, 2007. A mediation session was held on May 24, 2007 at which the
parties were unable to reach a settlement.
A derivative action purporting to be on our behalf was filed against its then-current directors in
the Superior Court for the County of Santa Clara on September 5, 2000. We were also named as a
nominal defendant. The complaint is based on allegations similar to those found in the securities
class action and claims that the defendants breached their fiduciary duties by, among other things,
causing us to violate federal securities laws. The derivative action was removed to the United
States District Court for the Northern District of California on September 20, 2000. All deadlines
in this action were stayed pending resolution of the motions to dismiss the securities class
action. On July 29, 2003, the Court approved the parties stipulation to dismiss this derivative
action without prejudice and to toll the applicable limitations period pending the Ninth Circuits
decision in the securities action. Pursuant to the stipulation, defendants have provided plaintiff
with a copy of the mandate issued by the Ninth Circuit in the securities action.
A second derivative action purporting to be on our behalf was filed in the Superior Court for the
County of Santa Clara on May 15, 2003. It alleges facts similar to those previously alleged in the
securities class action and the federal derivative action. The complaint names as defendants our
former and current officers and directors, along with former officers and directors of C-Cube
Microsystems, Inc., who were named in the securities class action. The complaint also names us as a
nominal defendant. The complaint alleges claims for abuse of control, gross mismanagement, and
waste of corporate assets against the defendants affiliated with Harmonic, and claims for breach of
fiduciary duty, unjust enrichment, and negligent misrepresentation against all defendants. On July
22, 2003, the Court approved the parties stipulation to stay the case pending resolution of the
appeal in the securities class action. Following the decision of the Ninth Circuit discussed above,
on May 9, 2006, defendants filed demurrers to this complaint. The plaintiffs then filed an amended
complaint on July 10, 2006, which names only the defendants affiliated with Harmonic. The
defendants filed demurrers to the amended complaint and the parties have stipulated to several
continuances of the hearing on the demurrers, which currently is set for December 14, 2007.
49
On July 3, 2003, Stanford University and Litton Systems filed a complaint in U.S. District Court
for the Central District of California alleging that optical fiber amplifiers incorporated into
certain of our products infringe U.S. Patent No. 4859016. This patent expired in September 2003.
The complaint sought injunctive relief, royalties and damages. On August 6, 2007, the District
Court granted our motion to dismiss. The plaintiffs have appealed this motion.
An unfavorable outcome of any of these litigation matters could require that we pay substantial
damages, or, in connection with any intellectual property infringement claims, could require that
we pay ongoing royalty payments or could prevent us from selling certain of our products. In
addition, we may decide to settle any litigation, which could cause us to incur significant costs.
A settlement or an unfavorable outcome of these litigation matters could have a material adverse
effect on our business, operating results, financial position or cash flows.
We are subject to import and export controls that could subject us to liability or impair our
ability to compete in international markets.
Our products are subject to U.S. export controls and may be exported outside the United States only
with the required level of export license or through an export license exception, in most cases
because we incorporate encryption technology into our products. In addition, various countries
regulate the import of certain technology and have enacted laws that could limit our ability to
distribute our products or could limit our customers ability to implement our products in those
countries. Changes in our products or changes in export and import regulations may create delays in
the introduction of our products in international markets, prevent our customers with international
operations from deploying our products throughout their global systems or, in some cases, prevent
the export or import of our products to certain countries altogether. Any change in export or
import regulations or related legislation, shift in approach to the enforcement or scope of
existing regulations, or change in the countries, persons or technologies targeted by such
regulations, could result in decreased use of our products by, or in our decreased ability to
export or sell our products to, existing or potential customers internationally.
In addition, we may be subject to customs duties and export quotas, which could have a significant
impact on our revenue and profitability. While we have not encountered significant difficulties in
connection with the sales of our products in international markets, the future imposition of
significant increases in the level of customs duties or export quotas could have a material adverse
effect on our business.
The terrorist attacks of 2001 and the ongoing threat of terrorism have created great uncertainty
and may continue to harm our business.
Current conditions in the U.S. and global economies are uncertain. The terrorist attacks in the
U.S. in 2001 and subsequent terrorist attacks in other parts of the world have created many
economic and political uncertainties that have severely impacted the global economy, and have
adversely affected our business. For example, following the 2001 terrorist attacks in the U.S., we
experienced a further decline in demand for our products. The long-term effects of the attacks, the
situation in Iraq and the ongoing war on terrorism on our business and on the global economy remain
unknown. Moreover, the potential for future terrorist attacks has created additional uncertainty
and makes it difficult to estimate the stability and strength of the U.S. and other economies and
the impact of economic conditions on our business.
We rely on a continuous power supply to conduct our operations, and any electrical and natural gas
crisis could disrupt our operations and increase our expenses.
We rely on a continuous power supply for manufacturing and to conduct our business operations.
Interruptions in electrical power supplies in California in the early part of 2001 could recur in
the future. In addition, the cost of electricity and natural gas has risen significantly. Power
outages could disrupt our manufacturing and business operations and those of many of our suppliers,
and could cause us to fail to meet production schedules and commitments to customers and other
third parties. Any disruption to our operations or those of our suppliers could
result in damage to our current and prospective business relationships and could result in lost
revenue and additional expenses, thereby harming our business and operating results.
The markets in which we, our customers and our suppliers operate are subject to the risk of
earthquakes and other natural disasters.
Our headquarters and the majority of our operations are located in California, which is prone to
earthquakes, and some of the other locations in which we, our customers and suppliers conduct
business are prone to natural disasters. In the event that any of our business centers are affected
by any such disasters, we may sustain damage to our operations and properties and suffer
significant financial losses. Furthermore, we rely on third-party manufacturers for the production
of many of our products, and any disruption in the business or operations of such manufacturers
could adversely impact our business. In addition, if there is a major earthquake or other natural
disaster in any of the locations in which our significant customers are located, we face the risk
that our customers may incur losses, or sustained business interruption and/or loss which may
materially impair their ability to continue their purchase of products from us. A major earthquake
or other natural disaster in the markets in which we, our customers or suppliers operate could have
a material adverse effect on our business, financial condition, results of operations and cash
flows.
Some anti-takeover provisions contained in our certificate of incorporation, bylaws and stockholder
rights plan, as well as provisions of Delaware law, could impair a takeover attempt.
We have provisions in our certificate of incorporation and bylaws, each of which could have the
effect of rendering more difficult or discouraging an acquisition deemed undesirable by our Board
of Directors. These include provisions:
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authorizing blank check preferred stock, which could be issued with voting, liquidation,
dividend and other rights superior to our common stock; |
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limiting the liability of, and providing indemnification to, our directors and officers; |
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limiting the ability of our stockholders to call and bring business before special
meetings; |
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requiring advance notice of stockholder proposals for business to be conducted at
meetings of our stockholders and for nominations of candidates for election to our Board of
Directors; |
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controlling the procedures for conduct and scheduling of Board and stockholder meetings;
and |
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providing the Board of Directors with the express power to postpone previously scheduled
annual meetings and to cancel previously scheduled special meetings. |
These provisions, alone or together, could delay hostile takeovers and changes in control or
management of us.
In addition, we have adopted a stockholder rights plan. The rights are not intended to prevent a
takeover of us, and we believe these rights will help our negotiations with any potential
acquirers. However, if the Board of Directors believes that a particular acquisition is
undesirable, the rights may have the effect of rendering more difficult or discouraging that
acquisition. The rights would cause substantial dilution to a person or group that attempts to
acquire us on terms or in a manner not approved by our Board of Directors, except pursuant to an
offer conditioned upon redemption of the rights.
As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203
of the Delaware General Corporation law, which prevents some stockholders holding more than 15% of
our outstanding common stock from engaging in certain business combinations without approval of the
holders of substantially all of our outstanding common stock.
Any provision of our certificate of incorporation or bylaws, our stockholder rights plan or
Delaware law that has the effect of delaying or deterring a change in control could limit the
opportunity for our stockholders to receive a
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premium for their shares of our common stock, and could also affect the price that some investors
are willing to pay for our common stock.
Our common stock price may be extremely volatile, and the value of your investment may decline.
Our common stock price has been highly volatile. We expect that this volatility will continue in
the future due to factors such as:
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general market and economic conditions; |
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actual or anticipated variations in operating results; |
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announcements of technological innovations, new products or new services by us or by our
competitors or customers; |
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changes in financial estimates or recommendations by stock market analysts regarding us
or our competitors; |
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announcements by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital commitments; |
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announcements by our customers regarding end market conditions and the status of
existing and future infrastructure network deployments; |
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additions or departures of key personnel; and |
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future equity or debt offerings or our announcements of these offerings. |
In addition, in recent years, the stock market in general, and the Nasdaq Stock Market and the
securities of technology companies in particular, have experienced extreme price and volume
fluctuations. These fluctuations have often been unrelated or disproportionate to the operating
performance of individual companies. These broad market fluctuations have in the past and may in the future materially and adversely affect our stock price, regardless of our operating results.
If securities analysts do not continue to publish research or reports about our business, or if
they downgrade our stock, the price of our stock could decline.
The trading market for our common stock relies in part on the availability of research and reports
that third-party industry or financial analysts publish about us. Further, if one or more of the
analysts who do cover us downgrade our stock, our stock price may decline. If one or more of these
analysts cease coverage of us, we could lose visibility in the market, which in turn could cause
the liquidity of our stock and our stock price to decline.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On July 31, 2007, Harmonic completed the acquisition of Rhozet Corporation by a merger transaction.
In connection with the acquisition, Harmonic paid an aggregate consideration of approximately $15.5
million, which was comprised of (i) approximately
$2.53 million in cash and approximately 1,105,656
shares of Harmonics common stock in exchange for all of the issued and outstanding capital stock
of Rhozet, and (ii) approximately $2.76 million of cash to be paid, at such time as provided in the
definitive agreement related to such acquisition, to the holders of options to acquire Rhozets
common stock that were outstanding immediately prior to the effective time of the merger. In
connection with such sale of its common stock, Harmonic relied upon the exemption from registration
provided by Section 4(2) of the Securities Act of 1933, as amended.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS
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Exhibit Number |
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Exhibit Index |
31.1
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Section 302 Certification of Principal Executive Officer |
31.2
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Section 302 Certification of Principal Financial Officer |
32.1
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Section 906 Certification of Principal Executive Officer |
32.2
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Section 906 Certification of Principal Financial Officer |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the
Registrant, Harmonic Inc., a Delaware corporation, has duly caused this Quarterly Report on Form
10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of
Sunnyvale, State of California, on October 30, 2007.
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HARMONIC INC.
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By: |
/s/ Robin N. Dickson
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Robin N. Dickson |
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Chief Financial Officer
(Principal Financial and Accounting Officer) |
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Exhibit Number |
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Exhibit Index |
31.1
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Section 302 Certification of Principal Executive Officer |
31.2
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Section 302 Certification of Principal Financial Officer |
32.1
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Section 906 Certification of Principal Executive Officer |
32.2
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Section 906 Certification of Principal Financial Officer |