Welcome to the Q2 2018 Harmonic Earnings Conference Call. My name is Candice, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Nicole Noutsios, Investor Relations. Nicole, you may begin.

Thank you, operator. Hello, everyone, and thank you for joining us today for Harmonic's Second Quarter 2018 Earnings Conference Call. With me today are Patrick Harshman, our CEO; and Sanjay Kalra, our CFO. Before we begin, I'd like to point out that in addition to the audio portion of the webcast, we've also provided slides to this webcast, which you can see by going to our webcast on our IR website. Now turning to Slide 2. During this call, we will provide projections and other forward-looking statements regarding future events or future financial performance of the company. Such statements are only current expectations and actual events or results may differ materially. We refer you to the documents Harmonic files with the SEC, including our most recent 10-Q and 10-K reports, and the forward-looking statements section of today's preliminary results press release. These documents identify important risk factors, which can cause actual results to differ materially from those contained in our projections or forward-looking statements. And 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 on a reconciliation to GAAP, are contained in today's press release, which we've posted on our website and filed with the SEC on Form 8-K. We'll also discuss historical, financial and other statistical information regarding our business and operations and some of those information is included in the press release. But the remainder of information will be available on recorded version of this call or on our website. And now, I'll turn the call over to our CEO, Patrick Harshman.

Well, thanks, Nicole, and welcome, everyone, to our call today. We're pleased to again be reporting a positive quarter with solid year-over-year financial improvement enabled by the ongoing success of our strategic CableOS and video software and SaaS transformation. Specifically, continued CableOS progress delivered 70% year-over-year revenue growth for our Cable Access segment while the combination of solid over the top and ultra-high-definition sales drove 7.9% operating income for our Video segment. Other notable corporate financial highlights include year-over-year revenue up 21%, bookings up 18% as book-to-bill was again greater than 1 and operating income, 6.8%. Taking a closer look at our Cable Access segment. CableOS market momentum is driving a positive segment financial trajectory. Revenue was up 70% year-over-year and 9% sequentially and operating profit was 2.7%, our first Cable Access segment profit of the CableOS era, and we remain on track to reach our 2018 segment revenue target of approximately $100 million. Behind these numbers, CableOS is now delivering broadband service to over 400,000 cable modems, up 100% from last quarter. And over 100,000 of these modems are now being served through a distributed architecture, demonstrating that with CableOS, new more flexible access architectures really can be rolled out at scale. During the quarter, much of our CableOS focus was on working closely with a few global Tier 1 customers, preparing for scale deployment. And this Tier 1 progress has been good and underpins our second half guidance. However, we've also made progress expanding our overall customer base and now have over 20 line commercial deployments and advanced field trials, up from 15 reported last quarter. We're seeing this Tier 1 endorsement and broader market momentum because CableOS has introduced a powerful new architectural paradigm. Harmonic has done a tremendous amount of groundbreaking work inventing and productizing this…

Thank you, Patrick, and thank you all for joining our call this afternoon. Before I share with you my detailed quarterly remarks, I would like to remind you all that the financial results I'll be referring to are provided on a non-GAAP basis. As you just heard from Patrick, we delivered solid Q2 results and are pleased to return to profitability. In fact, we were profitable last quarter in both of our segments and delivered strong results across a number of financial metrics. Revenue and gross margins were better than anticipated while operating expenses execution was strong, resulting in a profitable quarter with EPS well above our guidance range. Our cash position also improved and we maintained a strong book-to-bill ratio of 1.1, enabling us to enter the second half of 2018 with a solid financial foundation. As we turn to Slide 6 to review our Q2 results, revenue was $99.4 million, above the high end of our guidance. This is compared to $90.2 million in Q1 '18 and $82.3 million in Q2 '17, resulting in a 21% year-over-year growth and 10% quarter-over-quarter growth. And importantly, we saw growth in both of our segments. Cable Access segment revenue was $20.2 million compared to $18.5 million in Q1 and $8.9 million in the year-ago period. Activity in our Cable Access segment has been making steady progress throughout 2018. We continue to believe that we will hit our target of approximately $100 million of revenue in 2018. As Patrick mentioned, we have more than 400,000 cable modems served worldwide by our CableOS technology, up 100% quarter-over-quarter. Video revenue was $79.2 million compared to $71.7 million in Q1 and $73.4 million in the same quarter last year. This sequential and year-over-year increase reflects improved demand and competitive success across almost all video product…

Okay. Thanks, Sanjay. We want to wrap it up by again highlighting our strategic priorities. For our Cable Access business, objective number one is to continue to successfully scale our first wave of CableOS deployments. Leveraging a growing CableOS market momentum, our second objective here is to secure new design wins with additional operators, both Tier 1 and midsized and smaller customers. And objective number three is to deliver on our $100 million 2018 segment revenue target, further positioning this business for long-term industry leadership and profitable growth. On the Video side of the house, our first objective is to further accelerate the growth of our over-the-top solutions across media and service provider verticals. Objective number two is to leverage our SaaS offerings to expand our addressable market, tapping into new higher-growth customers and business models. And objective number three is to continue to deliver consistent segment profitability just as we've done over the past 4 quarters. Our commitment to these priorities has enabled clear strategic and financial progress through the first half of the year and continuing confidence in driving renewed growth, profitability and shareholder value as we head into the remainder of the year. We're pleased by our business momentum. We want to take this opportunity to thank our talented and dedicated employees, our customers and our shareholders for their continued support. So with that, let's now open up the call for questions.

Thank you. [Operator Instructions] And our first question comes from George Notter of Jefferies. Your line is now open.

Hi. Thanks very much and nice to see the improving results here. I guess, I wanted to ask about CableOS. You mentioned you had 400,000 cable modems being served now out of that platform, up versus, I think, 200k last quarter, I think even 100,000 if you go back to Q4. So I guess, my question, it looks like the revenue in the Cable Access division is not scaling at quite that great rates. Can you just remind me how the economic model works on CableOS? Are you getting paid in terms of modems connected, in terms of software instances sold, throughput? Help us with that. And then I've got a follow-up also.

Yes. So thanks for the question, George. In general, the revenue should scale with capacity, so yes, with cable modems connected. Frankly, we're still in the realm of relatively small volumes. I think the quarter-over-quarter growth is important, and it's important to see that the technology is working out in the field at scale. That being said, some of the associated revenue was already recognized or is still in our backlog to be recognized, so I think it's a little bit early to tie a direct line between these, I'd say, relatively modest deployment numbers and the financial results of the quarter. I mean, the key point is that they are both starting to move in the right direction. The modems connected, of course, don't have the deferred revenue quality to them that some of the associated revenue has.

Got it. Okay, great. I'm sorry. And then just out of curiosity, what mixture of the 400k do you think has flowed through for revenue at this point? Is it a minority of those cable modems or how should we think about it? And then also, what's the trigger for bringing that -- those products through for revenue recognition?

Yes. George, so in terms of the 400,000 cable modems connected, there is around 30% or so of the piece for which we don't see revenue in the P&L yet. It does sit in our backlog and should be recorded in the next quarter or so. So -- and as Patrick mentioned, there is no real clear alignment, exact dollar to dollar versus the cable modem or cable modem, if I say. So I think there's going to be some difference in the way the modems -- connected modems pick up versus how we see the revenue. But overall, directionally, we see both, whether it's revenue or whether it's cable modems going more on deployment and more on revenue. So to get a precise percentage is hard but I will say, if you want to take a reasonable range, around 32%, 33% of the number we don't have in revenue but it will be in our backlog.

Okay. I’ll leave right there. Thanks a lot.

Thank you.

Thank you. And our next question comes from Simon Leopold of Raymond James. Your line is now open.

Great. Thanks for taking my question. First, I wanted to ask a couple. One is hopefully a simple modeling question. You provided a lot of detail so I appreciate that. And when I'm looking at the Q3 gross margin guidance, it seems a little bit lower than I would have expected just based on mix. I'm coming up with maybe about 100 basis point decline from the second quarter, but you're guiding for more than 200 basis point decline at the midpoint. So just if I could get a better understanding of whether there were factors in the second quarter or whether they -- maybe I don't appreciate volume variables or maybe I'm just getting the mix assumption wrong. Any additional color you can give us on that?

Yes, sure, Simon. In terms of overall margins, if you look for Q2 and H1, they are closer in the range of 54% to 55%, and I understand our guidance in H2 is lower, 52% to 53% and even full year is 51% to 52%. So if you look at both of our segments, our Video margins are consistently strong at the rates which we experienced in H1 in a very tight range. But if you look at the Cable Access, we believe the mix of CableOS hardware will increase in the second half compared to what we saw in first half, actually more in Q3 than in Q4 to be more precise, as we are expecting margins lower in second half versus the first half. But also please note that our overall margins for the full year have improved by 1% on both ends, low end and high end. So to net it out, it's a mix of the hardware and CableOS, which we are going to see more now in the second half versus what we are seeing so far.

That's helpful. Thank you. And the other thing I want to ask about was maybe to get a better understanding of the patent you were awarded, whether or not you see opportunities, whether it's licensing or whether you think that anybody has violated your patents, how you see your position competitively now that you've gotten that patent? Thank you.

Well, we think it's a -- as we said, it's a foundational patent, and it describes, we think, core technology that is going to be extremely relevant to the future of cable access networks. Exactly how we will use that intellectual property, patent to benefit the business, we have not and are not prepared to communicate our strategy. But I guess suffice it to say at this point, in the service of establishing a market-leading position, which is our overarching objective, we think having that recognition, having that in the bank, so to speak, is extremely advantageous. It speaks to the innovation that we've driven. It speaks to the leadership we've created. And we think it will be of value, one way or another, as we go forward.

I guess, one element of my question is number of competitors have all talked about products that would be comparable to yours. Do you have a sense of whether or not they may have violated your patent or you don't know at this point?

Well, frankly, you're right. We've heard a lot of talk. We have seen very little, anything specific. And we have yet to run into any -- we have yet to run into anything except for PowerPoint to be frank. And so I think that, that remains to be seen, Simon.

Great. Thank you for taking my questions.

Thank you.

Thank you. And our next question comes from Steven Frankel of Dougherty. Your line is now open.

Good afternoon. A follow-up on the CableOS discussion. What remained - happened with a couple of your major Tier 1s to get from where we are today in what seemed like very large [deal trial] to full-scale deployment?

It's difficult to generalize. The good news is, is our early Tier 1 customers, our impression is, are incredibly committed to high-volume rollout. And that has -- this is a pretty big architectural and technological shift so it has a number of implications that manifest themselves in different ways for different customers. Touching management systems, for example, the way this part of the system works with the broader IP switching and routing infrastructure, et cetera. So with our different customers, we are actively engaged, as we said, in preparing for this volume rollout. And increasingly, it's less about validating our technology, more about validating the end-to-end system that involves virtualized software and end-to-end new IP delivery network. And so our different customers are really, we believe, coming down the home stretch of getting these end-to-end systems worked and validated in a way that they're really ready to start to roll in higher volume in the field. So the progress has been good. The challenge has been complex, has been broader than just our technology. But based on the good progress, we're encouraged that things are really going to start moving more significantly here in the second half. And certainly, you can see that in the guidance that we've given. But to be clear, we see the second half as really just the on-ramp to even greater deployment in '19.

Great, Patrick. And on the Video segment. So the customer in SaaS that's turned off your offering, can you give us some background as to why you think they made that decision and maybe what the alternative was?

So let me clarify. They had -- this customer started off in one cloud location, in one cloud infrastructure. They decided to build up a second approach to their physical infrastructure on cloud, so they were operating two distinct physical cloud infrastructures. And they were using our SaaS. We had to return revenue while going on in both locations. Now we expected this at some point down the road to consolidate to just one location, and that's been their strategic plan. And what happened is they decided to turn down one of those locations and move all of the traffic to the second location more quickly than we anticipated. So they're still our customer. They're still actually among our largest SaaS customers right now. But we are -- actually, we have had a, I'd say, a temporary step down simply because of its consolidation from two sites to one.

I really appreciate that clarification. Thank you.

All right. Thank you.

Thank you. [Operator Instructions] And I'm showing no further questions at this time. I'd like to turn the conference back over to Patrick Harshman for closing remarks.

Okay. Well, thank you very much. As you've heard from us, we're encouraged by our first half performance. We're looking forward to and we're positioned for a strong second half and just as importantly, a great 2019 and beyond. We appreciate your continuing support, and we look forward to speaking with you all again soon.

Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.