HLIT-2014.09.26-10Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________________________
Form 10-Q
_____________________________________________________
(Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 26, 2014
 
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File No. 000-25826
_____________________________________________________
HARMONIC INC.
(Exact name of registrant as specified in its charter)
_____________________________________________________
Delaware
77-0201147
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
4300 North First Street
San Jose, CA 95134
(408) 542-2500
(Address, including zip code, and telephone number, including area code, of registrant’s 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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
¨
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares of the registrant’s Common Stock, $.001 par value, outstanding on October 17, 2014 was 88,059,028.


Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
 
 

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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARMONIC INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
September 26, 2014
 
December 31, 2013
 
(In thousands, except par value amounts)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
42,028

 
$
90,329

Short-term investments
55,151

 
80,252

Accounts receivable, net
75,640

 
75,052

Inventories
32,512

 
36,926

Deferred income taxes
2,631

 
24,650

Prepaid expenses and other current assets
26,852

 
21,521

Total current assets
234,814

 
328,730

Property and equipment, net
30,814

 
34,945

Goodwill
198,007

 
198,022

Intangibles, net
12,740

 
31,119

Other assets
13,347

 
13,268

Total assets
$
489,722

 
$
606,084

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
21,377

 
$
22,380

Income taxes payable
307

 
331

Deferred revenue
35,095

 
27,020

Accrued liabilities
31,043

 
35,349

Total current liabilities
87,822

 
85,080

Income taxes payable, long-term
4,199

 
15,165

Other non-current liabilities
17,554

 
11,673

Total liabilities
109,575

 
111,918

Commitments and contingencies (Note 16)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value, 5,000 shares authorized; no shares issued or outstanding

 

Common stock, $0.001 par value, 150,000 shares authorized; 88,408 and 99,413 shares issued and outstanding at September 26, 2014 and December 31, 2013, respectively
88

 
99

Additional paid-in capital
2,264,422

 
2,336,275

Accumulated deficit
(1,883,393
)
 
(1,841,999
)
Accumulated other comprehensive loss
(970
)
 
(209
)
Total stockholders’ equity
380,147

 
494,166

Total liabilities and stockholders’ equity
$
489,722

 
$
606,084

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

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HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
 
(In thousands, except per share amounts)
Product revenue
$
84,583

 
$
98,713

 
$
259,371

 
$
277,965

Service revenue
23,478

 
24,205

 
66,311

 
63,753

Net revenue
108,061

 
122,918

 
325,682

 
341,718

Product cost of revenue
41,802

 
52,747

 
134,336

 
146,916

Service cost of revenue
12,831

 
13,379

 
35,789

 
33,953

Total cost of revenue
54,633

 
66,126

 
170,125

 
180,869

Gross profit
53,428

 
56,792

 
155,557

 
160,849

Operating expenses:
 
 
 
 
 
 
 
Research and development
22,803

 
24,560

 
70,176

 
75,631

Selling, general and administrative
32,114

 
32,527

 
98,640

 
100,220

Amortization of intangibles
1,661

 
2,001

 
5,329

 
6,099

Restructuring and related charges
388

 
259

 
821

 
925

Total operating expenses
56,966

 
59,347

 
174,966

 
182,875

Loss from operations
(3,538
)
 
(2,555
)
 
(19,409
)
 
(22,026
)
Interest income, net
47

 
47

 
191

 
141

Other income (expense), net
(261
)
 
230

 
(376
)
 
(70
)
Loss from continuing operations before income taxes
(3,752
)
 
(2,278
)
 
(19,594
)
 
(21,955
)
Provision for (benefit from) income taxes
(4,830
)
 
(38,953
)
 
21,800

 
(45,723
)
Income (loss) from continuing operations
1,078

 
36,675

 
(41,394
)
 
23,768

Income from discontinued operations, net of taxes (including gain on disposal of $14,813, net of taxes, for the nine months ended September 27, 2013)

 
91

 

 
15,619

Net income (loss)
$
1,078

 
$
36,766

 
$
(41,394
)
 
$
39,387

Basic net income (loss) per share from:
 
 
 
 
 
 
 
Continuing operations
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.22

Discontinued operations
$
0.00

 
$
0.00

 
$
0.00

 
$
0.14

Net income (loss)
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.36

Diluted net income (loss) per share from:
 
 
 
 
 
 
 
Continuing operations
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.22

Discontinued operations
$
0.00

 
$
0.00

 
$
0.00

 
$
0.14

Net income (loss)
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.36

Shares used in per share calculation:
 
 
 
 
 
 
 
Basic
90,618

 
101,144

 
94,113

 
108,695

Diluted
91,800

 
102,723

 
94,113

 
109,879

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

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HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
 
(In thousands)
Net income (loss)
$
1,078

 
$
36,766

 
$
(41,394
)
 
$
39,387

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(670
)
 
462

 
(440
)
 
(8
)
Gain (loss) on investments
(308
)
 
52

 
(333
)
 
11

       Other comprehensive income (loss) before tax
(978
)
 
514

 
(773
)
 
3

       Income tax expense (benefit) related to items of other comprehensive income (loss)
(7
)
 
17

 
(12
)
 
5

       Other comprehensive income (loss), net of tax
(971
)
 
497

 
(761
)
 
(2
)
Comprehensive income (loss)
$
107

 
$
37,263

 
$
(42,155
)
 
$
39,385

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

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HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(41,394
)
 
$
39,387

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Amortization of intangibles
18,378

 
20,569

Depreciation
12,641

 
12,365

Stock-based compensation
12,720

 
11,953

Gain on sale of discontinued operations, net of tax

 
(14,813
)
Loss on impairment of fixed assets

 
149

Deferred income taxes
31,782

 
(10,647
)
Provision for excess and obsolete inventories
2,013

 
2,813

Allowance for doubtful accounts, returns and discounts
(116
)
 
1,161

Excess tax benefits from stock-based compensation
(194
)
 

Other non-cash adjustments, net
1,108

 
1,220

Changes in assets and liabilities:
 
 
 
Accounts receivable
(472
)
 
(310
)
Inventories
2,401

 
10,509

Prepaid expenses and other assets
(5,321
)
 
8,522

Accounts payable
(786
)
 
(5,418
)
Deferred revenue
7,770

 
5,127

Income taxes payable
(8,292
)
 
(39,209
)
Accrued and other liabilities
(4,717
)
 
(8,244
)
Net cash provided by operating activities
27,521

 
35,134

Cash flows from investing activities:
 
 
 
Purchases of investments
(26,599
)
 
(54,773
)
Proceeds from maturities of investments
43,236

 
50,681

Proceeds from sales of investments
7,408

 
31,506

Purchases of property and equipment
(8,859
)
 
(11,249
)
Purchases of long-term investments
(5,867
)
 

Proceeds from sale of discontinued operations, net of selling costs

 
43,527

Net cash provided by investing activities
9,319

 
59,692

Cash flows from financing activities:
 
 
 
Payments for repurchase of common stock
(86,407
)
 
(103,496
)
Proceeds from common stock issued to employees
1,241

 
5,355

Excess tax benefits from stock-based compensation
194

 

Net cash used in financing activities
(84,972
)
 
(98,141
)
Effect of exchange rate changes on cash and cash equivalents
(169
)
 
(25
)
Net decrease in cash and cash equivalents
(48,301
)
 
(3,340
)
Cash and cash equivalents at beginning of period
90,329

 
96,670

Cash and cash equivalents at end of period
$
42,028

 
$
93,330

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

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HARMONIC INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1: BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) which Harmonic Inc. (“Harmonic,” or the “Company”) considers necessary for a fair statement of the results of operations for the interim periods covered and the consolidated financial condition of the Company at the date of the balance sheets. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on February 28, 2014 (“2013 Form 10-K”). The interim results presented herein are not necessarily indicative of the results of operations that may be expected for the full fiscal year ending December 31, 2014, or any other future period. The Company’s fiscal quarters are based on 13-week periods, except for the fourth quarter, which ends on December 31.
The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The year-end condensed balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“US GAAP”).
Discontinued Operations
In the first quarter of fiscal 2013, the Company completed the sale of its cable access hybrid-fiber coaxial ("HFC") business to Aurora Networks (“Aurora”). The results of operations associated with the cable access HFC business were presented as discontinued operations in its unaudited condensed consolidated financial statements as described in Note 3, "Discontinued Operations". There were no operating activities associated with the cable access HFC business after December 31, 2013. Unless noted otherwise, all discussions herein with respect to the Company’s unaudited condensed consolidated financial statements relate to the Company’s continuing operations.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Variable Interest Entities
From time to time, the Company may enter into investments in entities that are considered variable interest entities under Accounting Standards Codification (ASC) Topic 810. If the Company is the primary beneficiary of a variable interest entity ("VIE"), it is required to consolidate it. To determine if the Company is the primary beneficiary of a VIE, the Company evaluates whether it has (1) the power to direct the activities that most significantly impact the VIE's economic performance, and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. The assessment of whether the Company is the primary beneficiary of its VIE requires significant assumptions and judgments.

Investments in Equity Securities
The Company accounts for its investments in entities that it does not have significant influence under the cost method. Investments in equity securities are carried at fair value if the fair value of the security is readily determinable. Equity investments carried at fair value are classified as long-term investments and included in "Other assets" in the Company's Condensed Consolidated Balance Sheet. Unrealized gains and losses, net of taxes, on the long-term investments are included in the Company's Condensed Consolidated Balance Sheet as a component of accumulated other comprehensive income (loss). Investments in equity securities that do not qualify for fair value accounting or equity method accounting are accounted for under the cost method. In accordance with the cost method, the Company's initial investment is recorded at cost and the Company reviews all of its cost method investments quarterly to determine if impairment indicators exist. Cost method investments are classified as long-term investments and included in "Other assets" in the Company's Condensed Consolidated Balance Sheet.


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Segment Reporting
The Company operates its business in one reportable segment, which is the design, manufacture and sale of versatile and high performance video infrastructure products and system solutions. 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 (which for Harmonic is the Chief Executive Officer) in deciding how to allocate resources and assess performance. More recently, the Company has started to view its business through two market segments: Video and Cable Edge. As part of its annual year-end financial planning process, the Company expects to develop internal processes, policies and controls to enable timely and reliable measuring of operating profits by these segments. The Company expects the chief operating decision maker will apply this information in deciding how to allocate resources and assess the Company's performance. As such, the Company anticipates reporting the operating results for the Video and Cable Edge business in its segment reporting in the fourth quarter of 2014.

Significant Accounting Policies

The Company’s significant accounting policies are described in Note 2 to its audited Consolidated Financial Statements included in its 2013 Form 10-K. There have been no significant changes to these policies during the nine months ended September 26, 2014.
NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
In March 2013, the FASB issued ASU 2013-05, “Parent’s Accounting for the Cumulative Translation Adjustment upon De-recognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity”. The ASU addresses accounting for a cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The new guidance became effective for the Company beginning in the first quarter of fiscal 2014 and it did not have a material impact on the Company’s Consolidated Financial Statements.
In July 2013, the FASB issued ASU 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”. Under certain circumstances, unrecognized tax benefits should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The new guidance became effective for the Company beginning in the first quarter of fiscal 2014 and it did not have a material impact on the Company’s Consolidated Financial Statements.
On April 10, 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity". This guidance raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. The guidance is effective for the Company beginning in the first quarter of fiscal 2015. The Company does not expect the adoption of ASU 2014-08 will have a material impact on its financial position, results of operations or cash flows.
On May 28, 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers", requiring an entity to recognize the amount of revenue that reflects the consideration to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for the Company in the first quarter of fiscal 2017. We have not yet selected a transition method and we are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.

NOTE 3: DISCONTINUED OPERATIONS
In February 2013, the Company entered into an Asset Purchase Agreement with Aurora pursuant to which the Company agreed to sell its cable access HFC business for $46.0 million in cash. On March 5, 2013, the sale transaction closed and the Company received gross proceeds of $46.0 million from the sale and recorded a net gain of $15.0 million in connection with the sale in the first quarter of fiscal 2013, adjusted by ($0.2) million in the second quarter of fiscal 2013, primarily related to adjustments on inventory and fixed assets sold to Aurora, for a net gain of $14.8 million. The gain was included in income from discontinued operations, net of tax in the Condensed Consolidated Statement of Operations for the nine months ended September 27, 2013.
In March 2013, the Company entered into a transition services agreement (‘TSA”) with Aurora to provide contract manufacturing and other various support, including providing order fulfillment, taking warranty calls, attending to product

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returns from customers, providing cost accounting analysis, receiving payments from customers and remitting such payments to Aurora. The TSA fees were a fixed amount per month and were determined based on the Company’s estimated cost of delivering the transition services. In addition, in April 2013, the Company and Aurora signed a sublease agreement for the Company’s Milpitas warehouse for the remaining period of the lease.
The TSA ended in October 2013 and the billing to Aurora was recorded in the Condensed Consolidated Statements of Operations under income from continuing operations as an offset to the expenses incurred to deliver the transition services. The table below provides details on the income statement caption under which the TSA billing was recorded (in thousands):
 
Three months ended
 
Nine months ended
 
September 27, 2013
Product cost of revenue
$
41

 
$
577

Research and development

 
21

Selling, general and administrative
7

 
379

Total TSA billing to Aurora
$
48

 
$
977

The Company recorded a gain of $14.8 million in the nine months ended September 27, 2013 , in connection with the sale of the cable access HFC business, calculated as follows (in thousands):
Gross Proceeds
 
 
$
46,000

Less : Carrying value of net assets
 
 
 
Inventories, net
$
10,579

 
 
Prepaid expenses and other current assets
612

 
 
Property and equipment, net
1,180

 
 
Goodwill de-recognized
14,547

 
 
Deferred revenue
(4,499
)
 
 
Accrued liabilities
(939
)
 
 
Total net assets sold and de-recognized
 
 
$
21,480

Less : Selling cost
 
 
2,473

Less : Tax effect
 
 
7,234

Gain on disposal, net of taxes
 
 
$
14,813

Since the Company has one reporting unit, upon the sale of the cable access HFC business, approximately $14.5 million of the carrying value of goodwill was allocated to the cable access HFC business based on the relative fair value of the cable access HFC business to the fair value of the Company. The remaining carrying value of goodwill was tested for impairment, and the Company determined that goodwill was not impaired as of March 29, 2013.
The results of operations associated with the cable access HFC business are presented as discontinued operations in the Company’s Condensed Consolidated Statements of Operations for fiscal 2013. There were no operating activities associated with the cable access HFC business after December 31, 2013. Revenue and the components of net income related to the discontinued operations for the three and nine months ended September 27, 2013 were as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 27, 2013
Revenue
$
161

 
$
9,717

Operating income
$
154

 
$
669

Less : Provision for (benefit from) income taxes
57

 
(137
)
Add : Gain (loss) on disposal, net of taxes
(6
)
 
14,813

Income from discontinued operations, net of taxes
$
91

 
$
15,619


NOTE 4: INVESTMENTS IN EQUITY SECURITIES

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On September 26, 2014, the Company acquired a 19.8% interest in VJU iTV Development GmbH ("VJU"), a software company based in Austria, for $2.5 million. Since VJU's equity is deemed not sufficient to permit it to finance its activities without additional support from its shareholders, VJU is considered a variable interest entity ("VIE"). The Company determined that it is not the primary beneficiary of VJU because its financial interest in VJU's equity and its research and development agreement with VJU do not empower the Company to direct VJU's activities that will most significantly impact VJU's economic performance. VJU is accounted for as a cost method investment as the Company does not have significant influence over the operational and financial policies of VJU. As of September 26, 2014, the carrying value of VJU was $2.5 million and it is included in “Other assets" in the Condensed Consolidated Balance Sheet. As of September 26, 2014, the Company's maximum exposure to loss from investment in VJU was limited to the investment cost and research and development fees paid to VJU in the amount of $2.5 million and $0.1 million, respectively.
On September 2, 2014, the Company acquired a 3.3% interest in Vislink plc ("Vislink"), a U.K. public company listed on the AIM exchange, for $3.3 million, and also made $3.3 million prepayment for future software license purchases. The investment in Vislink is being accounted for as a cost method investment as the Company does not have significant influence over the operational and financial policies of Vislink. The Vislink investment is marked to market for the difference in fair value at period end, and as of September 26, 2014, the carrying value of Vislink was $3.1 million and is included in “Other assets" in the Condensed Consolidated Balance Sheet. The $3.3 million prepayment for future software license purchases is included in "Prepaid expenses and other current assets" in the Condensed Consolidated Balance Sheet.
The Company reviews all of its cost method investments quarterly to determine if impairment indicators exist.
NOTE 5: SHORT-TERM INVESTMENTS
The following table summarizes the Company’s short-term investments (in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
As of September 26, 2014
 
 
 
 
 
 
 
State, municipal and local government agencies bonds
$
25,719

 
$
26

 
$
(31
)
 
$
25,714

Corporate bonds
26,150

 
5

 
(17
)
 
26,138

Commercial paper
3,299

 

 

 
3,299

U.S. federal government bonds

 

 

 

Total short-term investments
$
55,168

 
$
31

 
$
(48
)
 
$
55,151

As of December 31, 2013
 
 
 
 
 
 
 
State, municipal and local government agencies bonds
$
40,426

 
$
38

 
$
(15
)
 
$
40,449

Corporate bonds
33,483

 
20

 
(7
)
 
33,496

Commercial paper
2,299

 

 

 
2,299

U.S. federal government bonds
4,004

 
4

 

 
4,008

Total short-term investments
$
80,212

 
$
62

 
$
(22
)
 
$
80,252

The following table summarizes the maturities of the Company’s short-term investments (in thousands):
 
September 26, 2014
 
December 31, 2013
Less than one year
$
44,452

 
$
55,278

Due in 1 - 2 years
10,699

 
24,974

Total short-term investments
$
55,151

 
$
80,252

These available-for-sale investments are presented as Current Assets as they are available for current operations. Realized gains and losses from the sale of investments for the three and nine months ended September 26, 2014 and September 27, 2013 were not material.
Impairment of Investments
The Company monitors its investment portfolio for impairment on a periodic basis. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis for the investment is established. A decline of fair value below amortized costs of debt securities is considered other-than-temporary if the Company has the intent to sell the security or it is more likely than not that the

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Company will be required to sell the security before recovery of the entire amortized cost basis. At the present time, the Company does not intend to sell its investments that have unrealized losses in accumulated other comprehensive loss. In addition, the Company does not believe that it is more likely than not that it will be required to sell its investments that have unrealized losses in accumulated other comprehensive loss before the Company recovers the principal amounts invested. The Company believes that the unrealized losses are temporary and do not require an other-than-temporary impairment, based on its evaluation of available evidence as of September 26, 2014.
As of September 26, 2014, there were no individual available-for-sale securities in a material unrealized loss position and the amount of unrealized losses on the total investment balance was insignificant.
NOTE 6: DERIVATIVES AND HEDGING ACTIVITIES
The Company enters into foreign currency forward contracts to minimize the short-term impact of foreign currency exchange rate fluctuations on cash and certain trade and inter-company receivables and payables, primarily denominated in Euro, British pound, Japanese yen and Israeli shekel. These contracts reduce the exposure to fluctuations in foreign currency exchange rate movements as the gains and losses associated with foreign currency balances are generally offset with the gains and losses on the forward contracts. These contracts are not designated as hedges that are eligible for hedge accounting treatment and are marked to market through earnings every period and generally range from one to three months in original maturity. The Company does not enter into foreign currency forward contacts for trading purposes. The balance sheet location and net fair value of each of the Company’s derivatives are as follows (in thousands):
 
 
 
 
Fair Value of Asset (Liability)
Derivatives not designated as hedging instruments
 
Balance Sheet Location
 
September 26, 2014
 
December 31, 2013
Foreign currency contracts
 
Prepaid expenses and other current assets
 
$
19

 
$
196

Foreign currency contracts
 
Accrued liabilities
 
(331
)
 
(195
)
The effects of the changes in the fair values of non-designated foreign currency forward contracts are summarized as follows (in thousands) :
 
 
Three Months Ended
 
Nine months ended
 
 
September 26, 2014
 
September 27, 2013
 
September 26, 2014
 
September 27, 2013
Gain (loss) recorded in other income (expense), net
 
$
(95
)
 
$
(157
)
 
$
(201
)
 
$
658


NOTE 7: FAIR VALUE MEASUREMENTS
The applicable accounting guidance establishes a framework for measuring fair value and requires disclosure about the fair value measurements of assets and liabilities. This guidance requires the Company to classify and disclose assets and liabilities measured at fair value on a recurring basis, as well as fair value measurements of assets and liabilities measured on a nonrecurring basis in periods subsequent to initial measurement, in a three-tier fair value hierarchy as described below.
The guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date.
Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The guidance describes three levels of inputs that may be used to measure fair value:
Level 1 — Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.
Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company primarily uses broker quotes for valuation of its short-term investments. The forward exchange contracts are classified as Level 2 because they are valued using quoted market prices and other observable data for similar instruments in an active market.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

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The Company uses the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. During the nine months ended September 26, 2014, there were no nonrecurring fair value measurements of assets and liabilities subsequent to initial recognition.
The following table sets forth the fair value of the Company’s financial assets and liabilities measured at fair value based on the three-tier fair value hierarchy (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
As of September 26, 2014
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
4,292

 
$

 
$

 
$
4,292

Short-term investments
 
 
 
 
 
 
 
State, municipal and local government agencies bonds

 
25,714

 

 
25,714

Corporate bonds

 
26,138

 

 
26,138

Commercial paper

 
3,299

 

 
3,299

U.S. federal government bonds


 

 

 

Prepaids and other current assets
 
 
 
 
 
 
 
Derivative assets (1)

 
19

 

 
19

Other assets
 
 
 
 
 
 
 
Long-term investment
3,101

 
 
 
 
 
3,101

   Total assets measured and recorded at fair value
$
7,393

 
$
55,170

 
$

 
$
62,563

Accrued liabilities
 
 
 
 
 
 
 
Derivative liabilities (1)
$

 
$
331

 
$

 
$
331

   Total liabilities measured and recorded at fair value
$

 
$
331

 
$

 
$
331

 
Level 1
 
Level 2
 
Level 3
 
Total
As of December 31, 2013
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
51,014

 
$

 
$

 
$
51,014

Short-term investments
 
 
 
 
 
 
 
State, municipal and local government agencies bonds

 
40,449

 

 
40,449

Corporate bonds

 
33,496

 

 
33,496

Commercial paper

 
2,299

 

 
2,299

U.S. federal government bonds
4,008

 

 

 
4,008

Prepaids and other current assets
 
 
 
 
 
 
 
Derivative assets (1)

 
196

 

 
196

Total assets measured and recorded at fair value
$
55,022

 
$
76,440

 
$

 
$
131,462

Accrued liabilities
 
 
 
 
 
 
 
Derivative liabilities (1)
$

 
$
195

 
$

 
$
195

Total liabilities measured and recorded at fair value
$

 
$
195

 
$

 
$
195

(1) Derivative assets and liabilities represent forward currency exchange contracts. The Company enters into these contracts to minimize the short-term impact of foreign currency exchange rates fluctuations primarily from trade and inter-company receivables and payables.


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NOTE 8: BALANCE SHEET COMPONENTS
The following tables provide details of selected balance sheet components (in thousands):
 
September 26, 2014
 
December 31, 2013
Accounts receivable, net:
 
 
 
Accounts receivable
$
81,988

 
$
83,266

Less: allowances for doubtful accounts, returns and discounts
(6,348
)
 
(8,214
)
Accounts receivable, net
$
75,640

 
$
75,052


Inventories:
 
 
 
Raw materials
$
1,805

 
$
2,389

Work-in-process
1,780

 
976

Finished goods
28,927

 
33,561

 
$
32,512

 
$
36,926

Property and equipment, net:
 
 
 
Furniture and fixtures
$
8,796

 
$
8,227

Machinery and equipment
117,765

 
114,178

Leasehold improvements
8,386

 
7,888

Property and equipment, gross
134,947

 
130,293

Less: accumulated depreciation and amortization
(104,133
)
 
(95,348
)
 
$
30,814

 
$
34,945


NOTE 9: GOODWILL AND IDENTIFIED INTANGIBLE ASSETS
The changes in the carrying amount of goodwill for the nine months ended September 26, 2014 are as follows (in thousands):
Balance at beginning of period
$
198,022

Foreign currency translation adjustment
(15
)
Balance at end of period
$
198,007

The following is a summary of identified intangible assets (in thousands):
 
 
 
September 26, 2014
 
December 31, 2013
 
Range of Useful Lives
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
Identifiable intangibles:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed core technology
4-6 years
 
$
136,145

 
$
(134,731
)
 
$
1,414

 
$
136,145

 
$
(121,681
)
 
$
14,464

Customer relationships/contracts
5-6 years
 
67,098

 
(57,568
)
 
9,530

 
67,098

 
(53,772
)
 
13,326

Trademarks and tradenames
4-5 years
 
11,361

 
(11,361
)
 

 
11,361

 
(10,565
)
 
796

Maintenance agreements and related relationships
6-7 years
 
7,100

 
(5,304
)
 
1,796

 
7,100

 
(4,567
)
 
2,533

Total identifiable intangibles
 
 
$
221,704

 
$
(208,964
)
 
$
12,740

 
$
221,704

 
$
(190,585
)
 
$
31,119


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Amortization expense for the identifiable purchased intangible assets for the three and nine months ended September 26, 2014 and September 27, 2013 was allocated as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Included in cost of revenue
$
3,851

 
$
4,763

 
$
13,049

 
$
14,470

Included in operating expenses
1,661

 
2,001

 
5,329

 
6,099

Total amortization expense
$
5,512

 
$
6,764

 
$
18,378

 
$
20,569

The estimated future amortization expense of purchased intangible assets with definite lives is as follows (in thousands):
 
Cost of Revenue
 
Operating
Expenses
 
Total
Year ended December 31,
 
 
 
 
 
2014 (remaining 3 months)
$
695

 
$
1,446

 
$
2,141

2015
719

 
5,783

 
6,502

2016

 
4,097

 
4,097

Total future amortization expense
$
1,414

 
$
11,326

 
$
12,740


NOTE 10: RESTRUCTURING AND RELATED CHARGES
The Company accounts for its restructuring plans under the authoritative guidance for exit or disposal activities. The restructuring and related charges are included in “Product cost of revenue” and "Operating expenses-restructuring and related charges” in the Condensed Consolidated Statements of Operations. The following table summarizes the restructuring and related charges (in thousands):
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Restructuring and related charges in:
 
 
 
 
 
 
 
Product cost of revenue
$
15

 
$
324

 
$
94

 
$
530

Operating expenses-Restructuring and related charges
388

 
259

 
821

 
925

 
$
403

 
$
583

 
$
915

 
$
1,455

Harmonic 2013 Restructuring
In the first quarter of fiscal 2013, the Company committed to a restructuring plan to reduce costs and improve efficiencies. This restructuring plan extended to actions taken through fiscal 2014. In fiscal 2013, the Company recorded $2.2 million of restructuring charges under this plan consisting of worldwide workforce reductions, writing down leasehold improvements and furniture related to its Milpitas warehouse to estimated net realizable value, and obsolete inventory at its Israel facilities. Of the $2.2 million restructuring charges in fiscal 2013, $1.5 million was recorded in the nine months ended September 27, 2013. For a complete discussion of the restructuring actions related to the 2013 restructuring plan, please refer to Note 9 of the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

The Company recorded restructuring charges of $403,000 and $915,000 under this plan, in the three and nine months ended September 26, 2014, respectively. The restructuring charges in the nine months ended September 26, 2014 consisted of severance and benefits related to the termination of twenty-five employees worldwide, costs associated with exiting from a research and development project, as well as costs associated with vacating from an excess facility in France. The following table summarizes the activity in the restructuring accrual under this plan during the nine months ended September 26, 2014 (in thousands):

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Severance
 
Termination of a research & development project
 
Excess facilities
 
Total
Balance at December 31, 2013
$
179

 
$

 
$

 
$
179

2013 Plan restructuring charges
829

 
63

 
32

 
924

Adjustments to restructuring provisions
(9
)
 

 

 
(9
)
Cash payments
(715
)
 

 
(32
)
 
(747
)
Balance at September 26, 2014
$
284

 
63

 
$

 
$
347

The Company anticipates that the remaining restructuring accrual balance of $347,000 will be substantially paid out by the end of the fourth quarter of fiscal 2014.
HFC Restructuring
As a result of the sale of the cable access HFC business in March 2013, the Company recorded $600,000 of restructuring charges under "Income from discontinued operations" in fiscal 2013 consisting of severance and benefits and contract termination costs. For a complete discussion of the restructuring actions related to the HFC restructuring plan, please refer to Note 9 of the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

The remaining restructuring accrual balance of $13,000 as of December 31, 2013 was fully paid in the first quarter of fiscal 2014.

NOTE 11: CREDIT FACILITIES
Harmonic has a bank line of credit facility with Silicon Valley Bank that provides for borrowings of up to $10.0 million and matures on December 31, 2014. This facility, which became effective in August 2011 and was amended in August 2012, and further amended in August 2013, contains a financial covenant that requires Harmonic to maintain a ratio of unrestricted cash, accounts receivable and short term investments to current liabilities (less deferred revenue) of at least 1.75 to 1.00. On August 22, 2014, a third amendment was made to extend the maturity date to December 31, 2014 and the LIBOR margin was reduced from 1.75% to 1.50%.
There were no borrowings during the nine months ended September 26, 2014. As of September 26, 2014, the amount available for borrowing under this facility, net of $0.2 million of standby letters of credit, was $9.8 million.
As of September 26, 2014, the Company’s ratio under that covenant was 3.26 to 1. In the event of noncompliance by Harmonic with the covenants under the facility, including the financial covenant referenced above, Silicon Valley Bank would be entitled to exercise its remedies under the facility, including declaring all obligations immediately due and payable. As of September 26, 2014, Harmonic was in compliance with the covenants under the line of credit facility. Borrowings pursuant to the line would bear interest at the bank’s prime rate (3.25% at September 26, 2014,) or at LIBOR for the desired borrowing period (an annualized rate of 0.15% for a one month borrowing period at September 26, 2014) plus 1.50%, or 1.65%. Borrowings are not collateralized.

NOTE 12: EMPLOYEE BENEFIT PLANS
Harmonic grants stock options and restricted stock units (“RSUs”) pursuant to stockholder approved equity incentive plans. These equity incentive plans are described in detail in Note 12, “Employee Benefit Plans”, of Notes to Consolidated Financial Statements in the 2013 Form 10-K.
Stock Options and Restricted Stock Units
The following table summarizes the Company’s stock option and RSU unit activity during the nine months ended September 26, 2014 (in thousands, except per share amounts):

15

Table of Contents

 
 
 
Stock Options Outstanding
 
Restricted Stock Units Outstanding
 
Shares
Available for
Grant
 
Number
of
Shares
 
Weighted
Average
Exercise Price
 
Number
of
Units
 
Weighted
Average
Grant
Date Fair
Value
Balance at December 31, 2013
8,752

 
7,885

 
$
6.92

 
3,018

 
$
6.34

Authorized
350

 

 

 

 

Granted
(3,477
)
 
1,450

 
6.52

 
1,352

 
6.55

Options exercised

 
(329
)
 
4.91

 

 

Shares released

 

 

 
(1,589
)
 
6.32

Forfeited or cancelled
1,753

 
(1,592
)
 
8.15

 
(232
)
 
6.13

Balance at September 26, 2014
7,378

 
7,414

 
$
6.67

 
2,549

 
$
6.49

The following table summarizes information about stock options outstanding as of September 26, 2014 (in thousands, except per share amounts):
 
Number
of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
Vested and expected to vest
7,095

 
$
6.68

 
3.6
 
$
3,118

Exercisable
4,760

 
6.84

 
2.5
 
2,519

The intrinsic value of options vested and expected to vest and exercisable as of September 26, 2014 is calculated based on the difference between the exercise price and the fair value of the Company’s common stock as of September 26, 2014. The intrinsic value of options exercised is calculated based on the difference between the exercise price and the fair value of the Company's common stock as of the exercise date. The intrinsic value of options exercised during the three and nine months ended September 26, 2014 was $0.3 million and $0.7 million, respectively. The intrinsic value of options exercised during the three and nine months ended September 27, 2013 was $1.1 million and $2.0 million, respectively.
The following table summarizes information about restricted stock units outstanding as of September 26, 2014 (in thousands, except per share amounts):
 
Number of
Shares
Underlying
Restricted
Stock
Units
 
Weighted
Average
Remaining
Vesting
Period
(Years)
 
Aggregate
Fair
Value
Vested and expected to vest
2,365

 
0.7
 
$
15,114

The fair value of restricted stock units vested and expected to vest as of September 26, 2014 is calculated based on the fair value of the Company's common stock as of September 26, 2014.
Employee Stock Purchase Plan
The 2002 Employee Stock Purchase Plan (“ESPP”) provides for the issuance of common stock purchase rights to employees of the Company. The ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. The ESPP enables employees to purchase shares at 85% of the fair market value of the common stock at the beginning or end of the offering period, whichever is lower. Offering periods generally begin on the first trading day on or after January 1 and July 1 of each year. Employees may participate through payroll deductions of 1% to 10% of their earnings. In the event that there are insufficient shares in the plan to fully fund the issuance, the available shares will be allocated across all participants based on their contributions relative to the total contributions received for the offering period.
There was a shortage of approved shares in the ESPP to fund the total employee contributions from January 2, 2013 to June 30, 2013. The shares available in the plan were sufficient to fund approximately 53% of the total contributions. As a result, the shares available were issued ratably to the participants based on each of their contributions during the offering period, relative to the total contributions received from all participants. The participants were refunded the remaining 47% of their contributions and the ESPP was suspended for the second half of 2013. The Company’s stockholders approved a 1,000,000

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Table of Contents

share increase in the authorized shares for the ESPP during the Company’s annual meeting on August 14, 2013, and contributions under the ESPP resumed in January 2014. In anticipation of another potential future shortfall of approved shares in the ESPP, the Company’s stockholders approved an additional 1,000,000 share increase in the authorized shares for the ESPP during the Company’s annual meeting on July 29, 2014.
401(k) 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 the applicable Internal Revenue Code limitations under the plan. Harmonic has made 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. Harmonic contributed $354,000 and $387,000 for the nine months ended September 26, 2014 and September 27, 2013, respectively.

NOTE 13: STOCK-BASED COMPENSATION
Stock-based compensation expense consists primarily of expenses for stock options and restricted stock units granted to employees and shares issued under the ESPP. The following table summarizes stock-based compensation expense (in thousands):
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Stock-based compensation in:
 
 
 
 
 
 
 
Cost of revenue
$
612

 
$
605

 
$
1,751

 
$
1,838

Research and development expense
1,219

 
1,076

 
3,589

 
3,400

Selling, general and administrative expense
2,521

 
2,264

 
7,380

 
6,628

Total stock-based compensation in operating expense
3,740

 
3,340

 
10,969

 
10,028

Total stock-based compensation
$
4,352

 
$
3,945

 
$
12,720

 
$
11,866

Stock Options
The Company estimated the fair value of all employee stock options using a Black-Scholes valuation model with the following weighted average assumptions:
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Expected term (years)
4.70

 
4.70

 
4.70

 
4.70

Volatility
40
%
 
46
%
 
40
%
 
51
%
Risk-free interest rate
1.8
%
 
1.5
%
 
1.7
%
 
0.8
%
Expected dividends
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
The expected term represents the weighted-average period that the stock options are expected to remain outstanding. The computation of the expected term was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The Company uses its historical volatility for a period equivalent to the expected term of the options to estimate the expected volatility. The risk-free interest rate that the Company uses in the Black-Scholes option valuation model is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term. The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
The Company is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and records stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

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Table of Contents

The weighted-average fair value per share of options granted was $2.48 and $3.02 for the three months ended September 26, 2014 and September 27, 2013, respectively. The weighted-average fair value per share of options granted was $2.36 and $2.51 for the nine months ended September 26, 2014 and September 27, 2013, respectively.

The fair value of all stock options vested during the three months ended September 26, 2014 and September 27, 2013 was $0.6 million and $0.8 million respectively. The fair value of all stock options vested during the nine months ended September 26, 2014 and September 27, 2013 was $2.6 million and $2.8 million respectively.
The total realized tax benefit attributable to stock options exercised during the nine months ended September 26, 2014, in jurisdictions where this expense is deductible for tax purposes, was $194,000. The Company did not recognize any tax benefit attributable to stock options exercised during the nine months ended September 27, 2013.
Restricted Stock Units
The aggregate fair value of all restricted stock units issued during the three months ended September 26, 2014 and September 27, 2013 was $2.7 million and $2.8 million respectively. The estimated fair value of all restricted stock units issued during the nine months ended September 26, 2014 and September 27, 2013 were $10.0 million and $10.2 million respectively.
Employee Stock Purchase Plan
The value of the stock purchase rights under the ESPP consists of: (1) the 15% discount on the purchase of the stock; (2) 85% of the fair value of the call option; and (3) 15% of the fair value of the put option. The call option and put option were valued using the Black-Scholes option pricing model. The weighted average fair value of the Company's ESPP shares at purchase dates was estimated using the following weighted average assumptions during the nine months ended September 26, 2014 and September 27, 2013:
 
Purchase Period Ending
 
December 31,
2014
 
June 30,
2014
 
June 30,
2013
Expected term (years)
0.50

 
0.50

 
0.49

Volatility
33
%
 
28
%
 
30
%
Risk-free interest rate
0.1
%
 
0.1
%
 
0.2
%
Expected dividends
0.0
%
 
0.0
%
 
0.0
%
Estimated weighted average fair value per share at purchase date
$1.84
 
$1.70
 
$1.23
The expected term represents the period of time from the beginning of the offering period to the purchase date. The Company uses its historical volatility for a period equivalent to the expected term of the options to estimate the expected volatility. The risk-free interest rate that the Company uses in the Black-Scholes option valuation model is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term. The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
The ESPP was suspended for the second half of 2013 due to all authorized shares under the plan having been issued through the offering period ended June 30, 2013. The Company’s stockholders approved a 1,000,000 share increase in the authorized shares for the ESPP during the Company’s annual meeting on August 14, 2013, and contributions under the ESPP resumed in January 2014. As a result, the Company did not have any stock-based compensation expense in the second half of fiscal 2013 related to the ESPP.
Unrecognized Stock-Based Compensation
As of September 26, 2014, total unamortized stock-based compensation cost related to unvested stock options and restricted stock units was $17.1 million. This amount will be recognized as expense using the straight-line attribution method over the remaining weighted-average vesting period of 1.7 years.


18

Table of Contents

NOTE 14: INCOME TAXES
The Company reported the following operating results for the periods presented (in thousands):
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Loss from continuing operations before income taxes
$
(3,752
)
 
$
(2,278
)
 
$
(19,594
)
 
$
(21,955
)
Provision for (benefit from) income taxes
(4,830
)
 
(38,953
)
 
21,800

 
(45,723
)
Effective income tax rate
128.7
%
 
1,710.0
%

(111.3
)%

208.3
%
The Company's quarterly income taxes reflect an estimate of the corresponding fiscal year's annual effective tax rate and include, where applicable, adjustments for discrete tax items.
The Company's effective rate for the nine months ended September 26, 2014 was different from the U.S. federal statutory rate of 35%, primarily due to a $28.7 million increase in the valuation allowance against both U.S. federal, California and other state deferred tax assets, as a result of a history of operating losses in recent years that has led to uncertainty with respect to the Company’s ability to realize certain of its net deferred tax assets, of which $4.2 million and $24.5 million were recorded in the third and second quarter of 2014, respectively. This unfavorable impact was offset partially by $8.5 million of net tax benefit, recorded in the third quarter of 2014, associated with the release of tax reserves for uncertain tax positions as a result of the expiration of statues of limitations.
The Company's effective rate for the nine months ended September 27, 2013 was different from the U.S. federal statutory rate of 35%, primarily attributable to the net of various discrete items, non-deductible amortization on foreign intangibles, the differential in foreign tax rates, federal research and development tax credit, and non-deductible stock-based compensation expense. The discrete items included primarily the $38.4 million tax benefit associated with the reversal of previously recorded federal and, to a lesser extent, foreign income taxes as a result of the expiration of the applicable statues of limitations in the U.S. for 2008 and 2009 and in foreign jurisdictions for various years, and the benefit associated with the reinstatement of the prior year's federal research and development tax credit, offset partially by a higher valuation allowance on California research and development tax credit and accrued interest on uncertain tax positions.
The Company files federal, state, and foreign income tax returns in jurisdictions with varying statutes of limitations during which such tax returns may be audited and adjusted by the relevant tax authorities. The U.S. Internal Revenue Service has concluded its audit for the 2008, 2009 and 2010 tax years. The statute of limitations on the Company's 2008 and 2009 U.S. corporate income tax returns expired in September 2013, and the 2010 corporate income tax return expired in September 2014. As a result, the Company released $38.4 million of related tax reserves, including accrued interest and penalties, for the 2008 and 2009 tax years in the third quarter of 2013 and, additionally, the Company released $8.5 million of related tax reserves, including accrued interest and penalties, for the 2010 tax year in the third quarter of 2014.
The 2011 through 2013 tax years generally remain subject to examination by U.S. federal and most state tax authorities. In significant foreign jurisdictions, the 2006 through 2013 tax years generally remain subject to examination by their respective tax authorities.
The Company's operations in Switzerland are subject to a reduced tax rate under the Switzerland tax holiday which requires various thresholds of investment and employment in Switzerland. The Company has met these various thresholds and the Switzerland tax holiday is effective through the end of 2018.
As of September 26, 2014, the total amount of gross unrecognized tax benefits, including interest and penalties, was approximately $16.8 million, that if recognized, would affect the Company's effective tax rate. The Company recognizes interest and penalties related to unrecognized tax positions in income tax expense. The Company had $0.3 million of gross interest and penalties accrued as of September 26, 2014. The Company will continue to review its tax positions and provide for, or reverse, unrecognized tax benefits as issues arise. As of September 26, 2014, the Company anticipates that the balance of gross unrecognized tax benefits will decrease up to approximately $0.6 million due to expiration of the applicable statues of limitations over the next twelve months.


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NOTE 15: INCOME (LOSS) PER SHARE
The following table sets forth the computation of the basic and diluted net income (loss) per share (in thousands, except per share amounts):
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Numerator:
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
1,078

 
$
36,675

 
$
(41,394
)
 
$
23,768

Income from discontinued operations

 
91

 

 
15,619

Net income (loss)
$
1,078

 
$
36,766

 
$
(41,394
)
 
$
39,387

Denominator:
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
Basic
90,618

 
101,144

 
94,113

 
108,695

Effect of dilutive securities from stock options, restricted stock units and ESPP
1,182

 
1,579

 

 
1,184

Diluted
91,800

 
102,723

 
94,113

 
109,879

Basic net income (loss) per share from:
 
 
 
 
 
 
 
Continuing operations
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.22

Discontinued operations
$
0.00

 
0.00

 
$
0.00

 
$
0.14

Net Income (loss)
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.36

Diluted net income (loss) per share from:
 
 
 
 
 
 
 
Continuing operations
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.22

Discontinued operations
$

 
$

 
$

 
$
0.14

Net Income (loss)
$
0.01

 
$
0.36

 
$
(0.44
)
 
$
0.36

The following table sets forth the potentially dilutive shares from stock options, restricted stock units and the ESPP, for the periods presented, that were excluded from the net income (loss) per share computations because their effect was anti-dilutive (in thousands):
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Potentially dilutive equity awards outstanding
5,196

 
6,144

 
9,321

 
10,681


NOTE 16: COMMITMENTS AND CONTINGENCIES
Leases
Future minimum lease payments under non-cancelable operating leases as of September 26, 2014, after giving effect to $0.3 million of future sublease income from Aurora, are as follows (in thousands):
Years ending December 31,
 
2014 (remaining three months)
$
2,622

2015
10,307

2016
8,600

2017
7,795

2018
7,650

Thereafter
13,731

Total
$
50,705


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Warranties
The Company accrues for estimated warranty costs at the time of product shipment. Management periodically reviews the estimated fair value of its warranty liability and records adjustments based on the terms of warranties provided to customers, historical and anticipated warranty claims experience, and estimates of the timing and cost of warranty claims. Activity for the Company’s warranty accrual, which is included in accrued liabilities, is summarized below (in thousands):
 
Three months ended
 
Nine months ended
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Balance at beginning of period
$
3,532

 
$
3,228

 
$
3,606

 
$
4,292

Transfer to Aurora as part of the sale of discontinued operations

 

 

 
(939
)
Accrual for current period warranties
2,028

 
1,991

 
5,383

 
5,333

Warranty costs incurred
(1,629
)
 
(1,705
)
 
(5,058
)
 
(5,172
)
Balance at end of period
$
3,931

 
$
3,514

 
$
3,931

 
$
3,514

Purchase Commitments with Contract Manufacturers and Other Suppliers
The Company relies on a limited number of contract manufacturers and suppliers to provide manufacturing services for a substantial majority of its products. In addition, some components, sub-assemblies and modules are obtained from a sole supplier or limited group of suppliers. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, the Company enters into agreements with certain contract manufacturers and suppliers that allow them to procure inventory based upon criteria defined by the Company. The Company had approximately $17.6 million of non-cancelable purchase commitments with contract manufacturers and other suppliers as of September 26, 2014.
Standby Letters of Credit
As of September 26, 2014, the Company’s financial guarantees consisted of standby letters of credit outstanding, which were principally related to performance bonds and state requirements imposed on employers. The maximum amount of potential future payments under these arrangements was $0.2 million as of September 26, 2014.
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 most of its customers for specified intellectual property matters pursuant to certain contractual arrangements, subject to certain limitations. The scope of these indemnities varies, but, in some instances, includes indemnification for damages and expenses (including reasonable attorneys’ fees). There have been no amounts accrued in respect of these indemnification provisions through September 26, 2014.
Guarantees
The Company has $0.4 million of guarantees in Israel as of September 26, 2014, with the majority relating to rent obligations for buildings used by its Israeli subsidiaries.
Legal proceedings
From time to time, the Company is involved in lawsuits as well as subject to various legal proceedings, claims, threats of litigation, and investigations in the ordinary course of business, including claims of alleged infringement of third-party patents and other intellectual property rights, commercial, employment, and other matters. The Company assesses potential liabilities in connection with each lawsuit and threatened lawsuits and accrues an estimated loss for these loss contingencies if both of the following conditions are met: information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. While certain matters to which the Company is a party specify the damages claimed, such claims may not represent reasonably possible losses. Given the inherent uncertainties of litigation, the ultimate outcome of these matters cannot be predicted at this time, nor can the amount of possible loss or range of loss, if any, be reasonably estimated.

In October 2011, Avid Technology, Inc. (“Avid”) filed a complaint in the United States District Court for the District of Delaware alleging that Harmonic’s Media Grid product infringes two patents held by Avid. A jury trial on this complaint commenced on January 23, 2014 and, on February 4, 2014, the jury returned a unanimous verdict in favor of Harmonic, rejecting Avid's infringement allegations in their entirety. Avid filed a post-trial motion asking the court to set aside the jury’s

21

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verdict.  Briefing is complete and the parties are awaiting an order on Avid’s motion.  Harmonic believes it is unlikely the judge will grant Avid’s motion.  Avid has indicated it intends to appeal the verdict if its motion is not granted.

In June 2012, Avid served a subsequent complaint in the United States District Court for the District of Delaware alleging that Harmonic’s Spectrum product infringes one patent held by Avid. The complaint seeks injunctive relief and unspecified damages. In September 2013, the U.S. Patent Trial and Appeal Board ("PTAB") authorized an inter partes review to be instituted as to claims 1-16 of the patent asserted in this second complaint. A hearing before the PTAB was conducted on May 20, 2014. On July 10, 2014, the PTAB issued a decision finding claims 1 - 10 invalid and claims 11 - 16 not invalid. Harmonic filed an appeal with respect to the PTAB’s decision on claims 11 - 16 and the appeal has been docketed with the Federal Circuit.

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

NOTE 17: STOCKHOLDERS’ EQUITY
Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss were as follows (in thousands):
 
September 26, 2014
 
December 31, 2013
Foreign currency translation adjustments
$
(682
)
 
$
(242
)
Unrealized gain (loss) on investments
(288
)
 
33

Accumulated other comprehensive loss
$
(970
)
 
$
(209
)
Common Stock Repurchases
On April 24, 2012, our Board of Directors (the "Board") approved a stock repurchase program that provided for the repurchase of up to $25 million of our outstanding common stock. During 2013, the Board approved $195 million of increases to the program, increasing the aggregate authorized amount of the program to $220 million. On February 6, 2013, the Board approved a modification to the program that permits the Company to also repurchase its common stock pursuant to a plan that meets the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934. On May 14, 2014, the Board approved an increase to the aggregate amount authorized under the repurchase program of $80 million and extended the repurchase period through the end of 2016.
As of September 26, 2014, we had purchased 36.3 million shares of common stock under this program at a weighted average price of $6.19 per share for an aggregate purchase price of $224.6 million, excluding fees. The remaining authorized amount for stock repurchases under this program was $75.4 million as of September 26, 2014. For additional information, see "Item2 - Unregistered sales of equity securities and use of proceeds" of this Form 10-Q.
NOTE 18: SUBSEQUENT EVENT
On October 22, 2014, the Company acquired an approximately 18.4% ownership interest on a fully diluted basis in Encoding.com, Inc., a San Francisco-based provider of cloud-based transcoding and other media processing services, through an investment in Encoding.com's Series B financing round.


22

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The terms “Harmonic,” the “Company,” “we,” “us,” “its,” and “our,” as used in this Quarterly Report on Form 10-Q (“Form 10-Q”), refer to Harmonic Inc. and its subsidiaries and its predecessors as a combined entity, except where the context requires otherwise.
Some of the statements contained in this Form 10-Q are forward-looking statements that involve risk and uncertainties. The statements contained in this Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. In some cases, you can identify forward-looking statements by terminology such as, “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “intends,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other comparable terminology. These forward-looking statements include, but are not limited to, statements regarding:
developing trends and demands in the markets we address, particularly emerging markets;
economic conditions, particularly in certain geographies, and in financial markets;
new and future products and services;
capital spending of our customers;
our strategic direction, future business plans and growth strategy;
industry and customer consolidation;
expected demand for and benefits of our products and services;
economic conditions, particularly in certain geographies, and in financial markets;
seasonality of revenue and concentration of revenue sources;
the potential impact of our continuing stock repurchase plan;
potential future acquisitions and dispositions;
anticipated results of potential or actual litigation;
our competitive environment;
the impact of governmental regulation;
the impact of uncertain economic times and markets;
anticipated revenue and expenses, including the sources of such revenue and expenses;
expected impacts of changes in accounting rules;
use of cash, cash needs and ability to raise capital; and
the condition of our cash investments.
These statements are subject to known and unknown risks, uncertainties and other factors, any of which may cause our actual results to differ materially from those implied by the forward-looking statements. Important factors that may cause actual results to differ from expectations include those discussed in “Risk Factors” beginning on page 35 of this Form 10-Q. All forward-looking statements included in this Form 10-Q are based on information available to us on the date thereof, and we assume no obligation to update any such forward-looking statements.
OVERVIEW
We design, manufacture and sell versatile and high performance video infrastructure products and system solutions that enable our customers to efficiently create, prepare and deliver a full range of video services to consumer devices, including televisions, personal computers, laptops, tablets and smart phones. We sell video processing and production and playout solutions and services worldwide to broadcast and media companies, streaming new media companies, cable operators, and satellite and telecommunications (telco) Pay-TV service providers. We also sell cable edge solutions and related services to cable operators globally.

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In the first quarter of fiscal 2013, we completed the sale of our cable access HFC business to Aurora Networks (“Aurora”) for $46.0 million in cash. The results of operations associated with the cable access HFC business were presented as discontinued operations in our unaudited condensed consolidated financial statements as described in Note 3, "Discontinued Operations". There were no operating activities associated with the cable access HFC business after December 31, 2013. Unless noted otherwise, all discussions herein with respect to the Company’s unaudited condensed consolidated financial statements relate to the Company’s continuing operations.
Historically, a majority of our revenue has been derived from relatively few customers, due in part to the consolidation of the ownership of cable operators and satellite Pay-TV service providers. Sales to our ten largest customers in the three and nine months ended September 26, 2014 accounted for approximately 36% and 37%, respectively, of our revenue, compared to 38% and 33%, respectively, for the same periods in 2013. While we continue to seek to broaden our customer base by penetrating new markets and further expanding internationally, we expect to see continuing industry consolidation and customer concentration. During the three and nine months ended September 26, 2014, revenue from Comcast accounted for approximately 15% and 18%, respectively, of our revenue, compared to 16% and 12%, respectively, for the same periods in 2013.
In the three and nine months ended September 26, 2014, we recognized revenue of $108 million and $326 million, respectively, compared to $123 million and $342 million in the same periods in 2013. The decreases in revenue in the three and nine months ended September 26, 2014, were primarily due to decreased video products revenue, primarily, we believe, as a result of some of our customers delaying their purchase decisions until products based on our new VOS software platform, as well as new UltraHD and high efficiency video coding (HEVC) technologies, become available. During the second quarter of fiscal 2014, the Company announced its new VOS solution, a software-based, fully virtualized platform that we are developing to unify the entire media processing chain, from ingest to delivery, and which is designed to operate on common server hardware in IT data center environments. Typically, a service provider or broadcast and media customer transitioning to these kinds of new technologies requires extensive planning and preparation. The decrease in our video processing and production and playout revenue was partially offset by increased revenue from our cable edge products, including our new NSG Pro product.
Our international revenue decreased 19% and 11%, respectively, in the three and nine months ended September 26, 2014, as compared to the same periods in 2013, primarily due to softer demand in the Europe, Middle East and Africa ("EMEA") region, across all our products. In particular, Africa, Russia and eastern European regions experienced softness in demand due in part to macro-economic and geopolitical issues over the course of this year. Domestic sales decreased by 4% in the three months ended September 26, 2014, as compared to the same period in 2013 and increased 3% in the nine months ended September 26, 2014, as compared to the same period in 2013. The increase in our domestic sales in the nine months ended September 26, 2014, as compared to the same period in 2013, was primarily driven by increased cable edge product sales in the U.S. to cable operators. We expect that international sales will continue to account for a significant portion of our net revenue for the foreseeable future, and expect that, due to sales in emerging markets in particular, our international revenue may increase as a percentage of our total net revenue from year to year.
Historically, our revenue has been dependent upon capital spending in the cable, satellite, telco and broadcast industries. More recently, we also have derived revenue from media companies, including streaming media providers. Industry consolidation has in the past constrained, and may in the future constrain, capital spending by our customers. If our product portfolio and product development plans do not position us well to capture an increased portion of the capital spending of customers in the markets on which we focus, our revenue may decline. As we attempt to further diversify our customer base in these markets, we may need to continue to build alliances with other equipment manufacturers and content providers, adapt our products for new applications, take orders at prices resulting in lower margins, and build internal expertise to handle the particular contractual and technical demands of the media market, which could result in higher operating costs. Implementation issues with our products or those of other vendors have caused in the past, and may cause in the future, delays in project completion for our customers and delay our recognition of revenue.
Our quarterly revenue has been, and may continue to be, affected by seasonal buying patterns. Typically, revenue in the first quarter of the year is seasonally lower than other quarters, as our customers often are still finalizing their annual budget and capital spending projections for the year. Further, we often recognize a substantial portion of our quarterly revenues in the last month of each quarter. We establish our expenditure levels for product development and other operating expenses based on projected revenue levels for a specified period, and expenses are relatively fixed in the short term. Accordingly, even small variations in timing of revenue, particularly from large individual transactions, can cause significant fluctuations in operating results in a particular quarter.
As part of our business strategy, (1) from time to time we have acquired, and continue to consider acquiring, businesses, technologies, assets and product lines that we believe complement or may expand our existing business, and (2) from time to time we consider divesting a product line that we believe may no longer complement or expand our existing business. In September 2010, we completed the acquisition of Omneon, Inc., a company specializing in file-based infrastructure for the

24

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production, preparation and playout of video content typically deployed by broadcasters, satellite operators, content owners and other media companies. Omneon’s business was complementary to Harmonic’s core business, and expanded our customer reach into content providers and extended our product lines into video servers and video-optimized storage for content production and playout. In March 2013, we sold our cable access HFC business to Aurora Networks. See Note 3, “Discontinued Operations” of our Condensed Consolidated Financial Statements.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
There have been no material changes to our critical accounting policies, judgments and estimates, during the nine months ended September 26, 2014, from those disclosed in our 2013 Form 10-K.

RESULTS OF OPERATIONS
Net Revenue
Net Revenue by Product Line
Harmonic’s consolidated net revenue, by product line, for the three and nine months ended September 26, 2014, compared to the same periods in 2013, are presented in the table below. Also presented are the related dollar and percentage change in consolidated net revenue, by product line, in the three and nine months ended September 26, 2014, as compared to the same periods in 2013.
 
Three months ended
 
Nine months ended
 
September 26, 2014
 
September 27, 2013
 
September 26, 2014
 
September 27, 2013
 
(In thousands, except percentages)
Product
 
 
 
 
 
 
 
Video products(1)
$
60,668

 
$
78,023

 
$
181,882

 
$
226,905

Cable edge products
23,915

 
20,690

 
77,488

 
51,060

Service and support
23,478

 
24,205

 
66,312

 
63,753

Total
$
108,061

 
$
122,918

 
$
325,682

 
$
341,718

Increase (Decrease):
 
 
 
 
 
 
 
Video products
$
(17,355
)
 
 
 
$
(45,023
)
 
 
Cable edge products
3,225

 
 
 
26,428

 
 
Service and support
(727
)
 
 
 
2,559

 
 
Total decrease
$
(14,857
)
 
 
 
$
(16,036
)
 
 
Percent change:
 
 
 
 
 
 
 
Video products
(22
)%
 
 
 
(20
)%
 
 
Cable edge products
16

 
 
 
52

 
 
Service and support
(3
)
 
 
 
4

 
 
Total percent change
(12
)%
 
 
 
(5
)%
 
 
(1) Video products now includes video processing products and production and playout products. As new technologies continue to evolve, the functionality of the Company's video processing and production and playout products are increasingly converging onto a single platform. The distinction between the two product groups is becoming less identifiable and as a result, management has decided to report these two product groups together as one product group. The information for the prior periods have been reclassified to conform to the presentation of the current periods.
Video products net revenue decreased 22% and 20%, respectively, in the three and nine months ended September 26, 2014, compared to the same periods in 2013. We believe the decrease in video products revenue was principally attributable to the decision by some of our larger customers to delay their purchase decisions until products based on our new VOS virtualized media processing software platform, as well as new Ultra HD format and new HEVC compression technologies, become available. In addition, in the third quarter of 2014, we believe the consolidation efforts of some of our key customers negatively impacted their spending patterns and project plans, as they approached their capital allocation plans more conservatively.

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Cable edge net revenue increased 16% and 52%, respectively, in the three and nine months ended September 26, 2014, compared to the same periods in 2013, primarily due to our NSG products, including the new NSG Pro converged cable access platform ("CCAP") product that was launched in the fourth quarter of 2013. We believe the growth in our NSG Pro product was driven by the acceleration of the shift to CCAP architectures by the cable industry.
Service and support net revenue decreased 3% in the three months ended September 26, 2014, compared to the same period in 2013, primarily due to the recognition of service revenue from a multi-million dollar, long-term European contract in the third quarter of 2013. Service and support revenue increased 4% in the nine months ended September 26, 2014, compared to the same period in 2013, mainly driven by increased maintenance revenue across all regions, partially offset by a decline in our professional and integration services as we benefited from the recognition of service revenue from a multi-million dollar, long-term contract in the third quarter of 2013.
Net Revenue by Geographic Region
Harmonic’s net revenue by geographical region for the three and nine months ended September 26, 2014, compared with the corresponding periods in 2013, are presented in the table below. Also presented are the related dollar and percentage change in the regional revenue, in the three and nine months ended September 26, 2014, from the corresponding periods in 2013.
 
Three months ended
 
Nine months ended
 
September 26, 2014
 
September 27, 2013
 
September 26, 2014
 
September 27, 2013
 
(In thousands, except percentages)
Geography
 
 
 
 
 
 
 
Americas (1)
$
60,007

 
$
61,674

 
$
184,959

 
$
179,045

EMEA
27,430

 
37,736

 
83,136

 
105,069

APAC
20,624

 
23,508

 
57,587

 
57,604

Total
$
108,061

 
$
122,918

 
$
325,682

 
$
341,718

Increase (Decrease):
 
 
 
 
 
 
 
Americas
$
(1,667
)
 
 
 
$
5,914

 
 
EMEA
(10,306
)
 
 
 
(21,933
)
 
 
APAC
(2,884
)
 
 
 
(17
)
 
 
Total decrease
$
(14,857
)
 
 
 
$
(16,036
)
 
 
Percent change:
 
 
 
 
 
 
 
Americas
(3
)%
 
 
 
3
 %
 
 
EMEA
(27
)
 
 
 
(21
)
 
 
APAC
(12
)
 
 
 

 
 
Total percent change
(12
)%
 
 
 
(5
)%
 
 
(1) Americas include U.S., Canada and Latin America. The information for the prior periods have been reclassified to conform to the presentation of the current periods.

Americas net revenue decreased 3% in the three months ended September 26, 2014, compared to the same period in 2013, primarily due to a slowdown in demand for our video products, which we believe was caused largely by technology transitions to virtualized architectures. We believe that these customers have delayed their purchase decisions for several anticipated projects until products based on our new VOS virtualized media processing software platform, as well as new Ultra HD format and new HEVC compression technologies, become available. We also experienced some disruptions in our service provider customers' capital spending plan in the third quarter of 2014. This decrease was offset partially by increased sales to U.S. cable operators, primarily for our cable edge products, including our new NSG Pro product.

Americas net revenue increased 3% in the nine months ended September 26, 2014, compared to the same period in 2013, primarily due to increased sales to U.S. cable operators, primarily for our cable edge products, including our new NSG Pro product. The increase was offset partially by a slowdown in demand for our video products in the second and third quarters of 2014, which we believe was primarily due to our customers' growing consideration of our new VOS solution as well as the new Ultra HD format and new HEVC compression technologies.


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EMEA net revenue decreased 27% and 21% in the three and nine months ended September 26, 2014, compared to the same periods in 2013, primarily in Africa, Russia, and eastern European geographies in the third quarter of 2014. The decrease was principally due to a decrease of our video products sales, including encoders and video servers, as it appears that some of our larger customers are looking ahead to our new products and new technologies, as well as softening of demand due to the macroeconomic and geopolitical climate in that region. In addition, we benefited from the recognition of service revenue from a multi-million dollar, long-term contract in the third quarter of 2013.

APAC net revenue decreased 12% in the three months ended September 26, 2014, and was relatively flat in the nine months ended September 26, 2014, compared to the same periods in 2013, primarily due to decreased sales of our video products, particularly production and playout products, offset partially by increased sales of cable edge products, including NSG Pro.

Gross Profit
Harmonic’s gross profit and gross profit as a percentage of net revenue (“gross margin”) in the three and nine months ended September 26, 2014, as compared to the corresponding periods in 2013, are presented in the table below. Also presented are the related dollar and percentage changes in gross profit in the three and nine months ended September 26, 2014, from the corresponding periods in 2013.
 
Three months ended
 
Nine months ended
 
September 26, 2014
 
September 27, 2013
 
September 26, 2014
 
September 27, 2013
 
(In thousands, except percentages)
Gross profit
$
53,428

 
$
56,792

 
$
155,557

 
$
160,849

As a percentage of net revenue (“gross margin”)
49.4
 %
 
46.2
%
 
47.8
 %
 
47.1
%
Decrease
$
(3,364
)
 
 
 
$
(5,292
)
 
 
Percent change
(6
)%
 
 
 
(3
)%
 
 
Our gross margins are dependent upon, among other factors, achievement of cost reductions, product mix, customer mix, product introduction costs, and price reductions granted to customers.

The improvement in gross margin in the three and nine months ended September 26, 2014, compared to the corresponding periods in 2013, was primarily due to higher margin trends for our video products and service revenue, primarily resulting from a low margin project that was recognized as revenue in the third quarter of 2013, as well as efficiencies from manufacturing and overhead spending and lower amortization of intangibles. These positive impacts were partially offset by decline in the margin of our cable edge products, which benefited from particularly strong firmware sales in the third quarter of 2013.

In the three and nine months ended September 26, 2014, $3.9 million and $13.0 million of amortization of intangibles was included in cost of revenue, compared to $4.8 million and $14.5 million in the corresponding periods in 2013. The decrease in amortization of intangibles expense in the three and nine months ended September 26, 2014, compared to the corresponding periods in 2013, was primarily due to certain purchased intangible assets becoming fully amortized.
Research and Development
Harmonic’s research and development expense consists primarily of employee salaries and related expenses, contractors and outside consultants, supplies and materials, equipment depreciation and facilities costs, all associated with the design and development of new products and enhancements of existing products. Harmonic's research and development expense and the expense as a percentage of net revenue in the three and nine months ended September 26, 2014, as compared with the corresponding periods in 2013, are presented in the table below. Also presented are the related dollar and percentage changes in research and development expense in the three and nine months ended September 26, 2014, from the corresponding periods in 2013.

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Three months ended
 
Nine months ended
 
September 26, 2014
 
September 27, 2013
 
September 26, 2014
 
September 27, 2013
 
(In thousands, except percentages)
Research and development
$
22,803

 
$
24,560

 
$
70,176

 
$
75,631

As a percentage of net revenue
21
 %
 
20
%
 
22
 %
 
22
%
Decrease
$
(1,757
)
 
 
 
$
(5,455
)
 
 
Percent change
(7
)%
 
 
 
(7
)%
 
 
The $1.8 million or 7% decrease in research and development expenses in the three months ended September 26, 2014, compared to the corresponding period of 2013, was primarily due to reduced headcount and related expenses, including contractors, of $1.6 million, as a result of restructuring programs implemented in fiscal 2013 and the increased shift of research and development resources to lower cost facilities.
The $5.5 million or 7% decrease in research and development expenses in the nine months ended September 26, 2014, compared to the corresponding period of 2013, was primarily due to decreased headcount and related expense, including contractors, of $5.9 million, decreased prototype material costs of $0.6 million and $0.6 million of decreased facilities and other expenses. The decrease in headcount related expenses was mainly a result of restructuring programs implemented in 2013 and a decrease in accrual for employee time off benefits. These decreases in research and development expenses in the nine months ended