Welcome to the Third Quarter 2014 Harmonic Earnings Conference Call. My name is Janet, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I would now turn the call over to Blair King. Mr. King, you may begin. .

Thank you, Janet. Hello, everybody. With me in our headquarters today in San Jose, California is Patrick Harshman, our CEO; and Carolyn Aver, our CFO..

I'd like to point out that in addition to the audio portion of this call, we have also provided slides, which you can see by going to the Investor Relations page on harmonicinc.com and clicking on the third quarter 2014 preliminary results call button..

Now turning to Slide 2, let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We must caution you that such statements are only current expectations and actual events or results may differ materially.

We refer you to documents that Harmonic files with the SEC, including our most recent 10-Q and 10-K report..

In the forward-looking statement section of today's preliminary results press release, these documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis..

These items, together with corresponding GAAP numbers and a reconciliation to GAAP, are contained in today's preliminary results press release, which we have posted on our website and filed with the SEC on Form 8-K. We will also discuss historical, financial and other statistical information regarding our business and operations.

Some of this information is included in the press release and the remainder of the information will be available in the recorded version of this call on our website..

With that, let me turn the call back over to you, Patrick. .

Thanks, Blair, and thanks, everyone, for joining us today. I'm turning now to our Slide 3..

Today, we reported our results for the third quarter of 2014. Plus, a continuation of the external market turbulence we discussed last quarter, but also the margin trajectory we expected as we entered the year.

With this in mind, I'll first review our results for the quarter then take a step back to discuss overall market dynamics, why we believe much of this market turbulence is in fact an encouraging sign of pending new infrastructure investment and why Harmonic is positioned with significant earnings upside as we look ahead at 2015..

Our revenue in the third quarter was just over $108 million, down 1% sequentially and slightly above the midpoint of our guidance range. The radio business improved modestly, up $3.5 million from the prior quarter while as expected, our cable edge business declined due to over $5 million off of a record second quarter.

In terms of customer verticals, business from our service provider customers represented 62% of revenue, while broadcasting media grew to 38%, reflecting the modest improvement in our video product business..

Third quarter bookings of $97.8 million were down 14% sequentially. Now some of you may recall, our third quarter has been and was again the seasonally lowest service renewal quarter. So as a result, we typically exit the third quarter with a book-to-bill slightly below 1 as we did again this quarter.

Nonetheless, year-to-date book-to-bill remains above 1. Backlog and deferred revenue is consequently a $116.6 million, down from last quarter again due largely to the seasonality in our service bookings. Gross margin for the quarter was a very solid 53.6%, reflecting healthy margin trends in both our video and cable edge businesses.

Earnings were $0.06 per share, aided not only by our gross margins but also by our continued focus on operating expenses. Cash from operations was just under $1 million due to the unusual timing of some payments, which are not expected to repeat in the fourth quarter.

Significantly, we have purchased just under 5 million shares in the quarter or nearly $32 million. In total, we've reduced our share count by over 30% as we began our buyback program in the second quarter of 2012. Carol will provide further details and commentary on these operating results in just a few minutes..

Returning now to Slide 4, let's take a closer look at our business and the market color that we saw in the fourth quarter. Our service provider revenue remains up 4% for the year, led by 50% -- a little over 50% growth on our cable edge business while service provider revenue for the quarter as a whole was down 10% when compared to the prior quarter.

In the third quarter turbulence in our video business caused by both macroeconomic issues and technology transition-driven pauses was compounded by the anticipated reduction in cable edge sales off of the record Q2 as I just mentioned.

Additionally, we did begin to see certain service provider customers slow some investment spending in connection with consolidation activities. And we anticipate these activities may intensify in the coming months and this therefore factors into our cautious outlook for the fourth quarter..

Turning to our broadcast and media vertical. In the third quarter, we were pleased to see revenue advance from the prior quarter up 17%, primarily due to stronger demand from several of the world's largest media companies. And here, we were encouraged by a sharp rebound in associated production plant product for us..

Finally, from geographical perspective, the Asia Pacific region was a clear bright spot in the quarter, growing about 15% further reflecting improved revenue contributions from our broadcast and media vertical.

Revenue from the Americas were flat -- was flat against the second quarter as improved video revenue, again, led by broadcast and media, offset the decline in our cable edge business, which has, again, for the year, driven the year-to-date growth we've seen in the Americas, about 3%..

While the EMEA region, again, remain very challenging. Revenues were down about 13% sequentially. Broadcast and media vertical here, too, performed well relatively well in the quarter. We also saw a modest improvement from our cable customers in the geography.

Importantly, we exit the quarter with slightly better bookings in the region and strong customer engagement following the sales organization in Europe, Middle East and Africa that we conducted in June. Nevertheless, Russia, Africa and the Middle East remain a big concern for us.

Year-to-date, we're down more than $20 million in 2013 in these 3 subregions, so we remain cautious of the softening macroeconomic and geopolitical climates in the broader EMEA region..

Despite these choppy business conditions, we believe our strategy remains sound. Technology and competitive fundamentals are positive. Our margin structure continues to improve. Cost structure is aligned and improving, generated cash and used this to significantly reduce our share count.

And consequently, we're very solidly positioned to accelerate earnings growth in 2015..

So let's turn to Slide 5 and I'll update you on what we're seeing going on in our related, but distinct, video and cable edge businesses. As many of you will recall, the video business was our problem child in the second quarter.

While we experienced modest sequential improvement throughout the third quarter, the overall market dynamics were largely unchanged. Domestically, we continue to see an industry coming off of the high definition MPEG-4 and tape to file waves and pause before investing in HEVC, Ultra HD, 4K and data center based video delivery infrastructure.

The past quarter, we've grown incrementally more confident that Ultra HD or 4K services will become real starting in 2015. And that these will be delivered through the adoption of HEVC compression..

We've also seen continued industry momentum toward network function virtualization, based on core video chain functions being reengineered and collapsed to run on Intel processors, leveraging industry standard servers and virtualized data center best practices.

Inspired by the vision of virtualized video infrastructure, very often their own IT network experiences, our customers around the globe are now grappling with the very real operational transition and technical staff training issues associated with making this video virtualization move a reality.

We see this work in associated investment pause as very much the calm before the storm. Let me be clear, we are a real driver here, very focused on pushing the market forward..

Related to this dynamic, over-the-top services are also a clear area of focus for our industry. In recent months, we've seen our vision of integrated over-the-top taking hold.

As the initial file of over-the-top infrastructure starts to give way to unified headends that enables simultaneous origination and delivery, the linear broadcast and multiscreen services. I've been spending a long road to whole with relatively modest revenue contributions to date in the over-the-top area for us.

We're encouraged by the over-the-top business and architectural trends we're seeing, and the significant operational efficiency gains were positioned to enable in the marketplace.

The growing focus on operational efficiencies is also driving more customers to broadly turn their attention to the notion of total cost of ownership of their entire video workplace.

And we see this reaffirming our long-held strategy of end to end solutions and horizontal function collapse, which we have enabled for both internal R&D and acquisition, waiting to our VOS announcement at NAB in April of this year..

Now finally, regarding the third quarter video market dynamics. Again, customer demand continues to be sluggish throughout much of the Europe, Middle East and Africa region. While we saw some improvement in pockets of Europe, other regions were geopolitical weakening macroeconomic conditions prevailed remain soft.

We anticipate these conditions to weigh on our near-term results. We remain actively engaged with our customers and believe we're well-positioned to capitalize on pent-up demand, the circumstances begin to normalize..

So with this in mind, let's now turn to our video business execution. The marketplace challenges have not slowed our focus on strategic progress. First, I'd like to take a moment to introduce you to Bart Spriester. Bart joined our team in September as Senior Vice President of our video business.

Previously, Bart was Executive Vice President and General Manager for North America and before that, Chief Technology Officer for Encompass, long time Harmonic customer and partner. He's also served in a number of capacities for Cisco, once recently as its Vice President and General Manager of Digital Media Networks.

Bart comes to us with a deep understanding of our industry inclusive of managed services, extensive customer relationships, and a solid track record of translating strategic vision into changeable results. Bart has already made tremendous strides ensuring a strong course toward exhibiting our strategies in the 2 months that he's been with us.

Now we look forward to taking our video business to the next level through Bart's leadership..

From a go-to market perspective, Bart joined at a time when our video business is reaching a key inflection point. Some of you might recall, the first orderable instantiation of VOS was Electra XVM.

Electra XVM is also the latest iteration of our market-leading Electra series of video encoders and contains our PURE Compression Engine as well as differentiated graphics, branding and play out capabilities.

And here we've made tremendous and now demonstrable video quality and compression gains, evidenced by a recent string of high-profile shootout wins expanding MPEG-4, MPEG-2 and HEVC compression against all of our key competitors, setting a new benchmark of capability and performance in the marketplace..

Additionally, at IBC in Amsterdam last month, we announced the second order of instantiation of VOS functionality, which we call ProMedia X, and this integrates our market-leading packaging and origin server capabilities for over-the-top into the VOS platform.

As a result, VOS is now uniquely capable of enabling linear broadcast and over-the-top media processing with production play out capabilities, running in software on virtual machines.

And also for those of our customers a little bit slow on their respective transition to data center operations, we installed on-servers by us for those more traditional deployment opportunities..

By adding or underlining this progress, I'm quite pleased to say we were able to announce Sky Italia as our first customer adopting VOS, this new Internet TV service, reaching the scale on total cost of ownership advantages of VOS as well as our powerful services support capabilities.

While Sky Italia is our only publicly announced customer on VOS, I can tell you we're actively driving the pace of adoption across the industry. But we still have much work to do. We do see customer adoption momentum accelerating throughout the balance of this year and into next year..

Also at IBC earlier this month, aligned with our strategic vision and increasingly important industry trend towards integrated systems and solutions, we announced the Polaris suite of play out management tools for our production and play out business, providing the first elements of the immediate orchestration that will be needed for dramatically simplified workflows in the future.

With Polaris, we aim to enhance the completeness, differentiation and growth of our production and play out suite of products. As part of this initiative, we announced a minority investment in Vislink [ph] key technology ingredient and go-to-market partner in the software control and orchestration area.

Along these same lines, we've also recently made 2 other monostrategic investments, partner companies VJU and Encoding.com, who are both leveraging our VOS technologies to offer innovative cloud-based services.

We're pleased to see our technology being leveraged by these innovative businesses as we advance our thought leadership into cloud-based managed services as we advance the scope of our addressable market..

So with that, on video, let's now pivot to our cable edge business. We really have driven strong growth for the first 9 months of this year.

Today, we remain in the very early innings of a multiyear investment cycle by cable operators worldwide to unleash much more powerful and user-friendly content navigation guide for accessing their own content, driving accelerated consumption of traditional video-on-demand services and by extension demand for Narrowcast Edge QAM [ph] where the advent of cooperative agreements between cable companies and over-the-top service providers, paired with the delivery of new 4K streaming services by the likes of Netflix, Amazon and others.

Stream quality and bit rates are increasing, creating further demand for scalable downstream edge bandwidth. And these trends continue to accelerate the shift to seek CCAP-enabled architectures. As many of you know, CCAP is a term used by the industry to describe a flexible all IP-converged video and cable network.

And here, Harmonic remains the forefront of this multiyear investment cycle. Representing an eventual addressable market of roughly $1.8 billion a year, more than 6x the traditional cable edge market we've historically addressed. And as a shift to CCAP occurs, we're also seeing growing momentum for distributed CCAP-based solutions.

Cable operators extend their fiber access networks, further enhancing the theme of enabling flexible, cost-effective network capacity..

In light of this momentum, we continue to find ourselves well positioned in the industry, particularly with the recently announced NSG Exo, specifically architected to leverage the virtues of deep fiber networks by simplifying operations and reducing cost for cable operators..

So all of that is background. Let's talk more specifically about our progress executing in our cable edge plan and our outlook for continued growth in this area. Over the past 2 years, we've strategically executed a well-defined road map to penetrate the centralized and distributed market opportunities inherent within the CCAP framework.

Today, we're uniquely addressing these architectures, the substantive new platforms developed in close collaboration with our customers. From a centralized perspective, we've successfully been seeding the market with our powerful new platform, the NSG Pro, which we started shipping late last year.

Here, the momentum in the market is strong, our product is unique and the demand trend associated with both VOD and over-the-top streaming service continue to fuel sustainable investments in Narrowcast swaps [ph]. Specifically, I'm very pleased to report our NSG Pro revenue was again strong in the quarter.

It continues to contribute meaningfully to the over 50% year-over-year growth in the cable edge business..

Our platform is a unique marriage of density and flexibility to clearly delivering value to cable operators as they balance the cost of adding network capacity with unabated increases in the consumption of bandwidth incentive services.

Now of equal technically of operational importance, its industry-leading capability of integrating downstream in VOD and DOCSIS Narrowcast services, the single unified CCAP platform. So again, I'm very pleased with the early footprint we've established in this market and remain quite optimistic about our centralized CCAP opportunity in this regard..

Now equally encouraging in the third quarter is the fact that we've sold our first software licenses on this platform, activate previously deployed hardware. This is the razor blade analogy we've discussed with you previously. Consequently, we saw our cable edge gross margins improve in the quarter..

Turning now to 2 CCAP, for those of you who did not attend the SCTE show in Denver last month, I'm also very pleased to inform you we successfully demonstrated DOCSIS upstream capability within our NSG Pro platform. And we remain on track to deliver this functionality to customer labs this year..

On the other hand, as I noted earlier, our new NSG Exo is a distributed CCAP platform equipped from initial deployment with full 2-way DOCSIS capability. This distributed approach to CCAP extends our ability to penetrate the CCAP market.

In doing so, the product provides the means for cable operators to cost-effectively add network capacity while further reducing operational complexities of more traditional DOCSIS deployment scenarios.

Today, we're actively engaged in trial activity with Tier 1 operators where we're seeing mounting customer interest, and limited involvement from computing technology companies resulting in a real opportunity to drive incremental share gain in the overall CCAP space.

In recent months, we've increased focus in the still small but fast-growing segment of the CCAP market. I now anticipate incremental revenue to ensue over the coming months..

In summary here, as I look across our video and cable edge businesses, I think it's clear that we're really raising the bar in innovation.

We're crisply focused on executing a road map strategically defined to extend Harmonic's technology leadership even further in advance of the powerful market transitions we've discussed in both in our video and cable edge businesses.

I freely acknowledge there's still plenty of work ahead of us, and I think we're encouraged by our early new innovation successes, and we continue to see meaningful progress being made every day..

On that note, and moving to Slide 6, I'd like to briefly review some of the tangible validations of our latest innovations we saw exiting the IBC show in Amsterdam and the SCTE cable show in Denver, both held in September.

I'm not going to go through all of this but importantly, VOS and it's associated Electra XVM we're recognize at both IBC and SCTE as Best of Show, CSI and Broadcast Product of the Year awards. The NSG Exo [ph] Will also receive the CSI award and the Multichannel News Innovator Award. So all these products are really yet to hit their full ramp.

The industry recognition they've received serves as a strong leading indicator of our innovation, competitive positioning and really, positioning for future success..

On that note, let's turn to Slide 7. Well, I'll conclude my comments by stepping back and highlighting for you my view of the fundamental value of our business. In my view, Harmonic is better positioned strategically at any of the time in the company's history. We stand tall with commanding share leads in nearly every market we serve.

Within video, new and existing customers are increasingly eager to impress -- embrace our virtualized video processing platform.

It uniquely encompasses media network functions from production all the way to distribution and thereby enable network elasticity and new service philosophy for our customers who are also representing the industry's lowest total cost of ownership proposition..

From the cable side, we are also uniquely armed with fresh, innovative, centralized and distributed CCAP solutions, the ultimate conversion to full IP-based service delivery.

In total, following several years of investment and close collaboration with both our media and service provider customers, we purposely find ourselves on solid technology and strategic ground. We believe we're merely scratching the surface of monetizing the full potential of these investments.

As we continue to unleash our unparalleled intellectual property and strategic focus to further collapse video processing functions, and also to further develop features and functionality on our CCAP platforms. Our overall value proposition and competitive position becomes even stronger in the marketplace..

Perhaps the most significant importance is to bring all of these to be bear under the umbrella of an exceptionally well-respected brand. And deep customer relationships with uniquely both the world's leading media and service provider companies.

As we reflect on '14, particularly, our financial performance, it's certainly not lost on us our video business is down over $40 million so far. That said, roughly half of this decline is attributable to specific market geographies experiencing extraordinary economic and geopolitical unrest.

As these conditions improve and we do believe they will over time, we're well-positioned to capitalize on the underlying demand trends in those specific geographies. On the other hand, technology-driven transitions account for the balance of the video business decline.

And here it is, my view that the shifts in technology historically amplifies future growth and economic gain. And let's just look back 18 months ago when we first announced our CCAP-enabled product to the market.

As a result, our cable customers paused purchases of Heritage Edge QAM [ph] products and many of you will remember that our cable edge business was depressed for most of 2013. Today, our cable edge business is back on track. We were in the very early innings of a multiyear investment cycle in the IP data network convergence.

Despite the turbulence in our video business, as we lead our customers through planning cycles and operational adaptations to incorporate our VOS, Ultra HD and HEVC technologies, we have a clear view to ensuing the success and strong demand trends ahead in the video business.

Our strategic direction remains focused and intact, and we're leading the marketplace with a competitively advantaged new and powerfully disruptive technologies that are paired with an outgrowing and real pipeline compelling business opportunities.

So therefore, looking ahead, we maintain a view for both our video and cable edge businesses and contribute meaningfully to our future success, and we see a clear path to deliver strong earnings growth in 2015 and beyond..

With that, Carolyn, let me now turn the call over to you to talk more about the results of the quarter and our financial outlook. .

Thank you, Patrick. Let's move to Slide 8..

Our net revenue for the third quarter was $108.1 million, in line with our expectations. Net revenue was down from $122.9 million for the third quarter of 2013 and from $109.6 million for the second quarter of this year. Our video business was up $3.5 million sequentially led by a rebound in our production of play out products.

This was offset by an expected decrease in our cable edge business of $5.4 million, which had a record quarter in the second quarter of this year..

Services were up modestly. Our bookings for the third quarter were $97.8 million, down 16% from a year ago and down 14% sequentially. Virtually, the entire sequential decrease in bookings is due to a reduction in service and support bookings.

Again, I'd like to remind you that the third quarter is always our seasonally lowest quarter for support renewal contracts, and that was again this quarter..

Our book-to-bill ratio was 0.9 in Q3 as it has been for each of the last 2 years. Our year-to-date book-to-bill remains above 1 at 1.04. Backlog and deferred revenue was $116.6 million at the end of Q3 compared to $123.6 million at the end of Q3 of 2013.

Gross margin was 53.6% this quarter, an increase from 50.1% in the previous quarter and from 50.8% in the third quarter of 2013.

The increase in gross margin on a sequential basis is principally due to a greater portion of our revenues coming from our video business in general and more specifically, an increase in revenue from our production and play out products.

Additionally, we had an continued improvement in the gross margin of our cable edge business led primarily by the NSG Pro, which has now reached its targeted standard costs. As well as our first firmware licenses into the NSG Pro footprint to enable new capacity in previously deployed hardware..

Operating expenses for this quarter were $51.2 million, down from $53.7 million in the third quarter of 2013 and $52.5 million in the second quarter of this year. We continue to prudently manage expenses in the quarter and came in slightly below the low end of our guidance range..

From a year-over-year perspective, the decline reflects a nearly $2 million reduction in R&D expenses as we have moved through 2 major platform transitions over the last year. Our headcount was 1,040 in Q3, matching the prior quarter and down from 1,063 in the third quarter of last year..

On a non-GAAP basis, net income for this quarter was $5.1 million or $0.06 per diluted share compared to $1.8 million or $0.02 per diluted share in the prior quarter and $7.1 million or $0.07 per diluted share for the third quarter of 2013..

Now moving to Slide 9, let's take a deeper look into our revenue. There are really 3 major trends that are impacting revenue for us this year. One positively and two negatively.

First, as Patrick mentioned, in cable, the worldwide demand for Narrowcast QAMs continues to gain momentum driven by strong increases in VOD usage and increasingly higher bit rates applied to OTT video services resulting from the cooperative agreement between carriers and over-the-top service providers.

This paired with our new NSG Pro has driven 52% year-to-date revenue growth in our cable edge business. The strength in our edge business drives our service provider revenue, which is up 4% year-to-date..

The second trend is a decline in our EMEA revenues of 21% for the first 9 months of this year compared to the same period a year ago. As you know, emerging markets have driven substantial growth for us over the last few years.

And while Latin America and APAC have performed in line with our expectations this year, Africa, the Middle East and broader Eastern Europe have been challenged. Each of these regions have experienced macroeconomic and geopolitical issues and their revenue has fallen significantly over the course of this year.

Having said that, we're at a point now where we believe we're skipping along the bottom in each of these regions..

The EMEA revenue decline significantly contributes to the 20% year-to-date decline in our video business revenue and is split almost evenly between video processing and production and play out on a percentage basis.

Also affected by Europe is revenue from our broadcast and media customers, which has declined 18% from the record high set in the same 9 months a year ago. As a result, through the first 9 months of this year, the broadcast and media vertical accounts for 34% of revenue down from 40% through the first 9 months of 2013..

Last factor impacting our revenue is the spending costs ahead of the industry's move to Ultra HD and HEVC compression. And this is undoubtedly compounded by our customer's transition to next-generation video processing corresponding with the launch of our software-based VOS platform in April of this year.

Here, we've seen both new and existing media and service provider customers delay projects to resync their video processing architecture on a global scale.

Further aggravating the year-to-date decline in our broadcast and media revenue, which while largely offsetting the success we've exhibited with our cable edge products and our service provider vertical..

Now turning to Slide 10. You could see we continue to drive a strong balance sheet. We ended the quarter with a cash balance of $97.2 million, down $37.2 million from the previous quarter reflecting $31.7 million used for share repurchases, which I'll discuss in more detail momentarily.

We generated just under $1 million of cash from operations in the quarter as we had the unusual timing of a number of payments..

The receivable balance was $75.6 million and our DSOs were a very low 64 days, down from last quarter's 67 days. Inventory was $32.5 million, up by $2.3 million from the prior quarter. As a result, our inventory terms was 6.2x in Q3 compared to 7.2x in the second quarter..

Now moving to Slide 11, I'd like to update you on our share repurchase activities. In the quarter, we repurchased 4.9 million shares. This brings our total shares repurchased from the second quarter of 2012 when the program began to 36.3 million shares, or a total of $225 million.

At the end of Q3, we had $75 million available from our board-authorized program for continuing repurchases. While we expect to continue our repurchase trend, we do anticipate our purchases will moderate in the fourth quarter.

Significantly, we returned approximately 160% of cash from operations to shareholders in the form of stock repurchases since the second quarter of 2012, bringing our shares outstanding at the end of the third quarter to $88.4 million..

Now turning to Slide 12. We believe the trends impacting our revenue this year will likely continue into Q4.

We continue to see both customer verticals pausing investment as they carefully evaluate transitioning to the next generation of video processing network, when the prevailing macroeconomic and geopolitical climate within the EMEA region remain a concern. We've also grown incrementally more cautious of customer consolidation activities.

So as we look into the fourth quarter of 2014, we expect our revenue to be in the range of $96 million to $106 million.

Gross margin in the fourth quarter is expected to be in the range of 52.5% to 53.5% based on a similar product mix to Q3, and for the fourth quarter of this year, we have targeted our operating expenses to be within the range of $50 million to $51 million as we continue to manage our expense levels..

Finally, we anticipate our non-GAAP tax rate for the fourth quarter to be 21% subject to our domestic versus international split. All this represents a disappointing disruption to our 2014 financial growth agenda. We want to provide a framework for you to think about 2015.

It's too early, especially with the current turbulent market conditions to give specific guidance beyond our usual 1 quarter. However, I will say we see 2015 as on up year for revenue. In fact, we anticipate each of our product categories to show revenue growth for 2015.

From a gross margin perspective, the NSG Pro margin has improved since we began shipping the product in late fourth quarter of 2013. It's been a full year at the current gross margin and our expectation for our software-based VOS platform to contribute to our revenue mix next year. We continue to anticipate gross margin improvements in 2015.

We have and will continue to balance the needs of our business with market opportunity, and we'll continue this activity into 2015..

Therefore, we anticipate operating expenses to be $10 million to $15 million lower for the full year 2015 than they will be for 2014.

That said, while these operating adjustments will drive improvement to the company's overall operating performance, we are largely geared to accelerate and expand our leadership in next-generation video and cable edge networking. And we look forward to bearing the fruits of these changes in the quarters ahead..

Finally, we anticipate our non-tax rate for next year to remain at 21%. We believe that this framework will enable us to provide meaningful year-over-year earnings growth and even modest revenue growth for 2015..

With that, I'll turn the call back over to Patrick for his closing remarks before we open to Q&A. .

Thank you, Carolyn. And just summarizing, as you just said, it's true that technologies transition and macro disruptions are impacting our top line performance. The near-term outlook for the fourth quarter are disappointing.

While we can't control the macroeconomic environment around us, we can control our competitive position and cost structure and that's exactly what were doing.

And I could tell you our internal execution and focused determination will ratchet up even higher in the months ahead as we exploit our competitive advantages to drive the top and bottom line growth..

What remains undoubtedly clear is that Harmonic's stand on solid strategic ramp. Equipped with innovative and competitively differentiated new technologies, positioned in areas where our customers plan to invest and are actively engage with us.

Internally, we're driving an operational framework that balances market opportunity with investment in support of the earnings growth we expect in 2015. We very much appreciate your support, and we're looking forward to continuing to deliver and continue to talk to you. On that note, let's open it up for your questions. .

[Operator Instructions] And our first question comes from James Kisner. .

So I guess, the first question I have was just on the European weakness. And just kind of wondering if this could be partially related or amplified by your kind of historical exposures? If I recall you've had some good business in Russia and Germany, 2 areas sort of highlighted as weak by just the macro indicators and just the news.

Is that fair? Is that the areas you're seeing more weakness?.

Certainly, yes, is the short answer, James. Certainly, Russia has been the most acute for us. Recall that Russia, Africa and the Middle East. And a little bit more broadly, Eastern Europe. And Russia has been the area of the most acute year-over-year decline. .

Okay, great. And I was just hoping to just probe a little bit on, you said that you're more cautious on customer consolidation activities.

I'm just wondering if that's a function of just your own judgment or customers saying to you that you should perhaps be ready for some disruption and just any kind of texture around that and perhaps how long that particular component might persist?.

We've got a big customer base worldwide, and we're exposed to several in-process mergers or acquisitions between different service provider customer stands. Although I wouldn't call the impact significant in the third quarter, we were exposed to certain delays on certain projects. So more than anything else, it's what we observed.

And we have observed and prior to that, we didn't observe anything, and to be fair, we have not seen any impact specifically in our cable edge business. But in the video area, we've seen a couple of things, situations play out that give us cause to be cautious as we had into the fourth quarter. .

I guess, I was just wondering, just as a follow-up there, I mean, what do think the prospects are sort of post these consolidation activities for there to either be a sort of snapback or perhaps a heightened level of investment? Is it fair to say that your acquisition targets perhaps are going to be receiving incremental investment by their perhaps better funded parents? Is that something you guys view as possible?.

We view it as possible, probable and we see it as a real opportunity. I mean, let's face it, a lot of these deals are around scale and consolidation very much related to content and who can negotiate, who can deliver most compelling content packages, who can negotiate the best deals. So a lot of this activity we see both in the U.S.

and in Europe revolves very much around video content, and we're well-positioned. And I'll note that we're fortunate in a number of situations that play out that we're incumbents with players on both sides of the equation.

And so we often in our history have sold to the consolidators as they up their game, as they up their ante in the competitiveness of the new combined entity. So I would say that we're optimistic about the other side of the balance, particularly [indiscernible].

And our next question comes from Simon Leopold. .

This is Victor Chiu in for Simon Leopold. Last quarter, you noted that the transition to virtualization was driving a slowdown in video.

Can you just give us an update regarding that trend and is this still a factor driving weakness? I know Patrick, you mentioned that the environment hasn't changed too much and that was an issue for you in 2Q but can you just give us maybe an update on what the impact is there?.

Yes, it's difficult to quantify, Victor, but it certainly is impacting us and the overall situation hasn't changed. So you talked to most Chief Financial Officers and Chief Technology Officers of our customers, they believe in the merits of virtualization.

I think how it plays out kind of on the ground is a little bit more complex and those discussions depending on the customer, it will take more or less time. We've got certain sophisticated customers who are ready to roll, and we're very pleased to be able to announce that Sky Italia and we think we're going to be seeing more wins in the near future.

On the other hand, there's some other customers who are intrigued. They kind of get it but they want to study it. They want to figure it out. It's a process.

I would point out though that through that process, we are developing capability, intellectual property around not only the core video technology but the operationalization of that technology, which I think is pretty important, pretty powerful, pretty valuable in the context of a broader communications landscape that is moving towards virtualized infrastructures over the next several years.

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Is the virtualization, is that more prevalent within certain geographies?.

Just from extent. It's more of a developed market phenomena or advance market. So definitely the U.S. is #1 and I'd say Western Europe is #2. But that's not to say that there isn't interest in other geographies but proportionately it's strong as in the U.S. and Western Europe. .

Okay.

And maybe just a general sense of how the transition impacts gross margin going forward?.

It's certainly a positive for gross margin. And we exposed at our Analyst Day where we really unveiled the strategy for the investor community that we saw this as a great opportunity to really capture more value and continue what has been a good track record of gross margin improvement over time.

We don't expect the entire product line to flip 100% to virtual machines overnight. We expect it to be a migratory process and through that process, we expect our gross margins to expand. .

Okay.

But that wasn't really a factor that drove upside in the gross margin this quarter, right?.

That's right. That's right. .

[Operator Instructions].

All right. It seems that there's no more questions. We know it's a busy day but we do very much appreciate everyone spending the time with us today. And I guess I'm hearing that there is 1 more.

We've got Brian?.

Yes, we have a question from Brian Coyne. .

Just a couple of ones. Patrick, I'm hoping you can clarify, I think, your response to James' earlier with regards to some of the softness you're seeing from potential M&A activity.

Did you say that you haven't really seen a change in the order trend on the cable edge side? And maybe just perhaps a little bit more detail of what you're seeing if in fact the delays or sort of the holdups seems to be coming more in the media and broadcast segment of your business, if I got that right. .

cable operators, satellite, telco operators, we're exposed to a number of different deals. And there, I don't want to overstate it by any means. I don't even want to suggest a meaningful impact to Q3. We saw a couple of instances across a couple of different of these pending mergers. Their deals where we put on ice, in the video domain in particular.

And that -- absorbing that, seeing that play out into Q3, has caused us to be incrementally more cautious as we head into Q4. .

Got it. That helps. I appreciate it.

Looking ahead a little bit further, if you put could take out your crystal ball for, say, the first half of 2015, I mean, I understand your view about revenue growth for the full year but let's say assuming that perhaps some of the delays from consolidation of results if, in fact, those might end up being sort of a more of a binary event from the first part of next year.

Do you think that your business might be a little bit flat year-over-year, in the first half of 2015?.

Absolutely. I mean, you're right. We don't have a crystal ball but we're hopeful to see growth in the first half of the year, Brian. And look, we've been battered around by the degradation of business in the certain geographies we talked about.

As Carolyn said in her remarks, we think we've hit bottom there so we don't see that there's any real further deterioration possible there. And frankly, we see much more upside or opportunity than downside elsewhere. Cable edge business is on a roll, our service and support business is continuing to grow.

On the video side, we're making strides every day around technologically and around the discussion process, the readiness of around virtualization. Every single day brings more announcements about Smart TVs that are capable of supporting Ultra HD. We're actively engaged in a number of HEVC trials and the like.

So we -- I don't want overstate it for you, I think that it's an evolutionary recovery here, but I think it is a recovery that will show demonstrable progress and sequentially, over the next 3 quarters. And so yes, we're -- we can imagine and quite in fact, we're hopeful to see growth in the first half of '15. .

Got it. That's great. Couple more if I could, I guess sort of along the same lines. On VOS, if you could maybe talk a bit more about your sales cycles there.

It's obviously an important part of your view toward 2015 and I know it's early, but how does that compare to maybe more traditional hardware, software solution sale? And then how is, VOS over time, I mean, do you think you can move the business toward being perhaps a little bit more recurring in nature and less project or buildout dependent?.

Okay. So let's take those 2 things separately. I mean, it's just stating the obvious, it very much depends on the customer. Just forgetting our specific underlying technology, Brian. When we engage on video opportunity with a customer, we see deals get closed in weeks and we see them get closed in 9 months. And it's everything in between.

So in that context, it's a little bit hard to assess out what kind of additional delay is a move to virtualization, introduce it. Certainly, we're not seeing any virtualization deals get closed in a matter of weeks. That being said, we see increasingly sophisticated customers. We're doing virtualization in other realms and they're ready.

And I think that -- so I think we'll see some fast-moving customers and I think we'll see the number of customers kind of ready to move more quickly, expand over the next couple of quarters. That being said, it's undoubtedly also true that a number of customers are really figuring it out.

And it's like kind of like a couple of moments ago I think that's creating an opportunity for us to bring additional value and we're really developing intellectual property there, the operationalization of this technology in addition to just the deployment of it.

So it's undoubtedly -- look, it caught the market by surprise when we came out and said we could do what we could do at the NAB Show in April. And it's been a process since then.

Last quarter we said, "Listen, for number of reasons not least of which is that, we expect a couple of choppy video demand quarters." We're very much in the midst of that but we don't see it lasting forever, and we're hopeful we are going to punch out the other side here in a quarter or 2.

To the second part of your question, we've not communicated a broader model or plan for getting into recurrent revenue but I would point of that part of our overarching strategy of moving to integrated, functionally collapsed software virtual machine platform is it does open the door for a number of new business models.

And whether that's us delivering a service or whether it's with a strategic partner, it creates the opportunity to participate in the market to expand the addressable market and to exchange -- interact with customers with different commercial approaches.

And we've got to walk before we run here, and I'd put that a little bit more in the run category but make no mistake, we're positioning ourselves to grow the business and to change the business for the positive in some very fundamental ways by engineering this overarching technology transition.

So we're focused on nailing the technology transition and getting that out of the field with the current business model today but you'll see us going forward, I think getting more creative and responding to our customers in the way they want to do business. .

Great. That's very helpful. Carolyn, one for you, if I could. It's really sort of question on cash and your share buyback. If I heard you right, you said you've got about $35 million remaining on the availability.

I believe you got just $100 million or so in cash on the balance sheet, and that, of course, of expected positive cash flow, can you talk maybe briefly about your strategy around cash management in 2015?.

Yes, I think to your point, we certainly expect that we'll continue to be strong generators of cash and so we think that will be a growth there. We have $75 million left. We anticipate that we'll consume that $75 million over the next many quarters. So we think both of those things will happen.

This quarter, given the investments that we made and where our cash balance is, is we expect it to be more moderate but we certainly think as we go into a cash generation over the next several quarters, we'll continue to buy. .

All right. Well, thank you very much, Brian, and we'll end it there. Thank you very much, everyone, for joining us. Please note that we're very focused on executing the business both in the fourth quarter and in 2015. We do think we're on very solid strategic ground.

We're excited by the strategic progress, balance that versus real challenges in the marketplace but on balance, this business has got a lot of growth capability. We put real leverage into the model from an earnings perspective. And we're committed and excited about getting after that.

Thanks very much for joining us today, and we look forward to our next opportunity to update you on our progress. Good afternoon. .

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