Welcome to the Q3 2019 Harmonic Earnings Conference Call. My name is Chris and I will 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 call is being recorded. I would now turn the call over to Nicole Noutsios, Investor Relations. Nicole, you may begin.

Thank you, Chris. Hello everyone, and thank you for joining us today for Harmonic's third quarter 2019 earnings conference call. With me today are Patrick Harshman, our CEO; 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 with this webcast, which you'll see by going to our webcast section on our IR website. 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 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 on this call are determined on a non-GAAP basis. These items together with corresponding GAAP numbers and a reconciliation to GAAP are contained in today's press release which we posted on our website and filed with the SEC on Form 8-K. We will also discuss historical, financial, and other statistical information regarding our business and operations and some of this information is included in the press release. But the remainder of the information will be available on a recorded version of this call or on our website. And now I’ll turn the call over to our CEO, Patrick Harshman. Patrick?

Well, thanks Nicole and welcome, everyone to our third quarter call. Harmonic delivered a strong quarter, both financially and strategically. The financial headlines, a revenue of $115.7 million, up 14% year-over-year. Record gross margin of 67% and record non-GAAP EPS of $0.25. Our virtualized CableOS solution was the primary driver of this growth, demonstrating the operating leverage achievable as we scale our software based solutions.And scale as we’re headed as we start during the quarter a clear tipping point of industry consensus that virtualization is the future of Cable Access worldwide and the Harmonic CableOS is the industry leading platform driving this transformation. From a Video side of our business, we’re similarly seeing positive momentum from our transformation to live over the top, as we launch powerful new streaming capabilities and as new cloud based customer deployment accelerated. We also refinanced approximately two-thirds of our convertible debt during the quarter, taking advantage of favorable terms and confirming our confidence in paying down the remaining third of the original debt principle in cash by the end of 2020. Taking a closer look at our Cable Access segment, let’s start with the financial headlines. Revenue in the quarter was $55.7 million of which $42.9 million was gross profit, as virtualized CableOS software dominated the revenue mix. We also anticipate a solid fourth quarter and correspondingly raised our full year segment revenue and corporate operating profit guidance. With our Comcast relationships serving as the strong foundation, we’re making good progress expanding our customer base. At the end of the third quarter, CableOS had been commercially deployed by 19 cable operators globally and the associated number of served modems had grown to over 935,000, up 20% from the end of the second quarter. It's important to understand that these early deployments are generally still…

Thanks, Patrick, and thank you all for joining our call this afternoon. Before I share with you our quarterly results and outlook, I would like to remind you that the financial results I’ll be referring to are provided on a non-GAAP basis. For the third quarter of 2019, we delivered solid results. Revenue was a record $115.7 million and gross margin was a record 67%, resulting in a $0.25 EPS. We improved our balance sheet with the material improvement in working capital, reporting cash of $66.7 million, and we refinanced our convertible debt with significantly improved terms, positioning the Company for reduced interest expense and reduced potential dilution. Turning to Slide 11, Q3 revenue was $115.7 million compared to $84.9 million in Q2, 2019 and $101.4 million in Q3 2018, resulting in a 36% quarter-over-quarter growth and up 14% year-over-year growth. This growth was driven by our Cable Access segment. Cable Access revenue was $55.7 million compared to $13.3 million in Q2 and $28.1 million in the year ago period. Off note, in Q3, we recorded $37.5 million of the $175 million CableOS software license agreement, which we closed with Comcast in July. In our Video segment, we reported revenue of $60 million compared to $71.6 million in Q2 and $73.3 million in the year ago period. As a reminder, Q3 is typically a weak quarter seasonally due to summer vacation and specifically relative to the third quarter of few anticipated deals were booked in early Q4 instead of Q3. This resulted in lower Q3 Video revenue and commensurately higher Video guidance for Q4 which we will cover shortly. In Q3, Comcast was our only greater than 10% customer contributing 44% of total revenue. Gross margin was 67% in Q3 compared to 53.6% in Q2 and 52.1% in Q3, 2018.…

Okay, thanks Sanjay. Expecting of execution, we want to wrap it up by highlighting our strategic priorities for the remainder of the year and as we head into 2020. For Cable Access business, we’re focused on successfully executing on our existing Tier 1 customer engagements, securing new design wins with additional global cable operators and leveraging our market leading position to scale the business. For Video segments, our objectives are to continue to expand our base serve over the top streaming customers, to drive new growth through our expanded live streaming and network delivery solutions, and deliver segment profitability as we’re on track to do this year. We’re confident in our business and we’re looking forward to a strong fourth quarter. And we want to thank you all for your continuing support. With that, let’s now open it up the call for some questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] John Marchetti from Stifel. You are now open.

Thanks very much. I just wanted to touch real quickly on the, the Cable Access business here, obviously a very strong quarter here, driven by a lot of the software and I know you're not giving guidance for '20. But as we start to look out at some of these additional deals coming on and the mix shift changing a little bit, just thinking about gross margins here. How do we sort of account for a lot of the variability in their between the two different pieces? This was obviously primarily a big software core, but just thinking about how the remainder of that Comcast deal flows through as well as you know some of those other deals that you mentioned coming on? How we should think about maybe that mix either being more aligned? Or do we see a series of hardware shipments first and then expect a follow through of software, just trying to think about that as we're looking out over the intermediate term here?

Yes, John. Thanks for the question. So, yes, Q3 definitely is very strong quarter, reflective of a very strong mix of software as you see about 70% margin. Q4 our guidance entails a little bit less than 70% because it's more of a hardware mix is little higher than what we saw in Q3. But at the same time -- we do need a little more experience to understand how the proportion of software sales and hardware sales growth will evolve over time to get to a very precise measurement. However, overall, if you look at the chart which was earlier displayed today on the call, the mix of hardware and software over a longer period of time should result in a margin of 60% plus. We don't see that ability as we already experienced like Q3 more than 70% as I said, in the past, we have seen 50%. So, it needs to settle down but believe overall 60% plus is reasonable.

And then, if I could just follow up there for a second, Sanjay. When I go back to the announcement or when you talked about the announcement last quarter and then you mentioned the two international deals. Those deals, if I remember correctly anyway, were more sort of blended that 50% was not, the number that you quoted for those deals were not software specific. Just curious if that's still the case and when you talk about that $200 million or so that that's not yet included in backlog, if that's primarily software, if that's the mix of software and hardware. Just trying to get a sense from maybe the magnitude of this, because you show that, that Dell'Oro chart that you spoke to Eric and the presentation, just trying to get a sense for us were looking out into in '20 and '21? Just how big that opportunity it really is for CableOS here?

John, this is Patrick. I'll step in. So, in terms of those three deals, two international that we spoken about and Comcast. Comcast of course is a 100% software. So, we do think hardware there as an additional opportunity, but that's not part of 'the deal'. In contrast, the two international deals we spoke about are indeed as your question were blended deals where the contracts covered both the virtualized software as well as the Remote PHY element. So indeed, those two deals we see as blended margin deals, combination of lower margin hardware and high margin software where is the Comcast one in terms of it contracted is exclusively software.

And then just one last quick one and I'll jump back into the queue. When you talk about the size of these deals and obviously being multiyear all that, is the sense that these are when all is said and done that these represent 50% of the network build when all is said and done? Is it the full build? I'm trying, I guess, to get a sense if there is follow on opportunity even with these existing contracts that you've announced. Or if those really do essentially cover the entire footprint, if you will that they're looking to change over to DAA? Thanks very much.

The short answer is that there is follow on expansion opportunities in all three contracts that we've talked about publicly and in particular with the international ones only covering a portion of the of the potential opportunity of footprint.

Thank you. Rich Valera from Needham & Company is online with the question.

Another question on the Cable business. Just wondering what drove the upside relative to your prior guidance for the year? I noticed you're not expecting sounds like any rev rec from the second international, so just curious, if you could give any color on what drove the higher expectations for this year for cable?

Yes, I think so when we presented the initial expectation, there was a 34 million kind of software expectation, but that was at midpoint of a range of plus minus 10%, and we came a little bit higher towards our high end of 37.5 million. That was the primary reason for our marginal increase there.

And then in the Video business, nice to see some stability at least in the annual guidance there, I was hoping to get a little color on sort of what's going on under the covers. Patrick, you've talked about having some sort of teasing pains as you shifted the sales force from your traditional kind of hardware process to SaaS, and said, you are kind of having to educate them on that. I am wondering if you can give us an update sort of on where they are in that process? And then this new product you're talking about the CDN capability for live streaming and capacity is that having any near term impact on the numbers or is that more of a 2020 contributor do you think?

I'll start with the last question first. We think it's more of a 2020 contributor. I mentioned that we have a very successful kind of advanced field trial there is ongoing, I think we will probably see a little bit of revenue associated with that at the back end of this year. But the opportunity really starts to grow for us in 2020. So, the first part to your question, look the whole company is in a little bit of a learning mode, and frankly, I think if you look at the industry at large, I'll go to some of the earnings calls of some of our customers over the past several days. We're all in a in a big transition from traditional broadcast based services to streaming platforms. In our case indeed there is not only new technology, but as you said some amount of that business it's fairly modest, we're still in the five plus percent of total of our bookings being SaaS but that's a learning curve for our organization and our sales force in particular. And as I highlighted a couple of moments ago, we're also building I think very exciting relationships with new customers, but also for the Company and the sales force in particular getting out and discovering new up and coming streaming businesses that are not our historic customers is part of the challenge but of course part of the opportunity here. So I'd say work in progress Rich definitely have made improvement over the course of the year, but our plan is to really lean in more to these growth opportunities in 2020 and to do that our whole company including our sales force needs to continue to evolve and much the way as I said that we see the rest of the industry having to pivot.

And one more if I could. It looks like based on your percentage of revenue from Comcast that you did indeed have some hardware sales to them this quarter. I’m wondering, if could characterize kind of how that piece of the opportunity is going? I mean you’ve, I think been on record saying that you expected to share the node part of the Comcast deployment with other vendors. Can you give any color on how you feel like that’s going for you in terms of maintaining or keeping a share that you feel is kind of what you want?

Yes. I appreciate the question, because that is important for us, it’s not as high margin, but nonetheless we think that can be a very profitable business and in fact we’ve work extremely hard and invested quite a bit, and as we highlighted on our last call, we’ve actually been fortunate enough to file and have some approvals of patents granted in that space. So, we feel very strongly about our competitive position there and indeed we like what we’re seeing so far in deployment. So I won’t be specific about Comcast or any other customers, but let me say and what's deployed so far we believe that we have the line of share of the DAA notes that have been deployed worldwide. And we think that the performance as well as the operational advantages of our products are really distinguishing themselves in the marketplace. So, we’re excited our ability to lead not only in the software piece of these new architectures, but also on the hardware remote PHY piece.

Simon Leopold from Raymond James is online with the question.

Hi, guys this is Victor Chiu in for Simon. You've touched on this during the prepared remarks a little bit. Could you help clarify how the margins and profitability differ, if another cable operator adopts virtual and some other channels as you suggested versus making directly with Harmonic? And how might that type of strategy play out practically speaking?

We have a history of doing a lot of international business through sales channels, Victor. And historically, there is a sales channel provides some value add, value added reseller and so we may give up a sliver of margin, but at the same time the end price maybe higher. And if we think about CableOS going through an alternative channel or being offered by a service by alternative channel, we see largely the same. So, we’re pretty bullish on both or direct sales opportunities with CableOS as well as a variety of strategic partnership that can bring that technology to market all of it frankly is additive to the top as well as the bottom line. And if we can use those kind of channels to accelerate market share so much the better is our view.

Okay. That’s helpful. And at the Cable Trade Show last month, we got the impression that cable operators are fragmented to a certain degree in terms of sort of strategies that are pursuing regarding network Comcast is really the only major operator and is pitching hard towards virtual. Some of the others are making a more gradual transition. So, can you just help us understand your perspective on this dynamic and how that impacts our mind?

Well, I candidly have a somewhat different view as we’ve mentioned here we’re working with at least one other top five operators who we believe is pivoted hard to virtual. So, by no meaning we think Comcast is well and in fact as data shared by them as well as other operators we think at that event was quite eye opening for the broader community. So we see another bump in terms of momentum coming out of that show that’s for sure. Now look, not every operator is ready to go upgrade their plan to next year. So I think part of the dialogues that we heard at the cable shows is, what does the architecture look like four years from now and there is this whole DOCSIS 4.0 discussion. We're right in the middle of, but the silicon for those kind of technologies, they're still several years away and one of those technologies in fact we're the software based platform we think we're going to there before the rest of the market. But in the meantime, our view is that if an operator is feeling competitive pressure or has any other reason to be upgrading their network, a virtualized solution is increasingly clearly a winning strategy. So, it means every customer is going to pivot that way, no, but we think that the momentum is clearly swinging in the direction of virtualization.

The last thing I'd add Victor is. As you know, we're no strangers to kind of the naysayers and the positioning on the reasons why this market transition won't happen. And I think if you step back and look at the progress that's been made and the pivot made by the market over the last 6 to 12 months, it's pretty astounding, and our view is, we're going to continue to see that kind of a pivot in our broader market perception, and adoption over the coming 12 months.

And just very quickly. Some of the discussions we had raised questions about Cisco's commitment to the cable TV sector. So, do you have any opinions or results on that?

No, we have a couple of good competitors and they're doing their thing. We're doing our thing. Our customers continue to tell us, they see us substantially ahead and you know our head is down and we're doing all that bring our solution to market. We take nothing for granted and we believe that, we compete with companies that are capable of doing good things if they so choose.

Steven Frankel from Dougherty, he's online with the question.

Good afternoon Patrick. Maybe if you could start by giving me some color on what the pipeline looks like in CableOS? Now, that Comcast has made a commitment you had a couple other Tier1 companies make commitments. So, what's next? What should look like? And what's the tenor of those discussions and maybe how they changed since the Comcast announcement?

I think starting with the last piece of the question, how it's changing, that is real time. We have been talking about the advantages and I think having good resonance with some customers but the fact that now you've got multiple credible customers themselves talking about real tangible financial benefits that haven't deployed their solution, this is changing the conversation in the market and that's kind of real time. So, I think that the dialogue and the credibility and the understanding is changing real time in the market in a positive way from our perspective. That being said, you kind of got to take it operator by operator, we're investing and expanding our go-to-market capability. We're now involved in one way or another with more large and small operators than ever before. That being said, I'll be honest and tell you, we still have work to do to fully cover the market, but domestically as well as internationally, the number of conversations going on is significant. The number of our lab and field trials is also significant. So we kind of got all the full gamut of engagement underway. And look, our objective is 2020 is to put as much of that over the finish line is we can. And so our discussion, Sanjay earlier alluded to 2020 planning, it's just as much about our go-to-market activity here as it is the financial bottoms up. We think we've got the industry leading solution. We think we've got some wind at our back. We just need to get out there and have the conversations, find the customers who are motivated to invest and get on with it and that's increasingly happening across the cable landscape domestically and internationally.

And see I would just add that while this question is for pipeline, but I wanted to remind that we have over 200 million of demand associated with over three Tier 1 customers of CableOS, which is not yet included in our reported backlog and differed revenue number. So that helps see the full picture of growing business expectations we have.

And on this international DAA customer that you thought maybe you would get a little bit in Q3 it sounds like now it's Q4, could you maybe give us some insight as to why their timetable has stretched out a bit because you got that order a while ago? And what needs to change that to get that to revenue?

If I roll the clock back, we were kind of there with Comcast 3 or 6 months ago. So from some perspective at a higher level, I think we're just thinking right now, tier ones big tier ones are complicated beasts and they have processes organizations, etcetera. There is nothing fundamental standing in the way. So we are extremely confident in the rollout. I think we're becoming a little bit more experienced with the challenges and the read the on the ground realities and just getting it across the finish line. So taking a little longer we thought no particular, singular issue stands out to Steve it is just kind of painstaking work with punch less kind of items across complex organizations. So I think as we think about our business going forward on one hand we're more confident never we can land these tier ones we've got the credibility and we're going to win them. The time frame for deployment so a little bit challenging, so question, I think we're going to get better and better execution wise. I think we're already seeing that in this case and we're doing our best to accelerate but particularly this first wave of them it's going a little bit slower, but nothing fundamental and we while I said before and I'll say it again, we're confident in what we're seeing and we're confident in these engagements.

Okay, and then just quickly switching gears to the video business. Do you feel like you have a line of sight on the bottom in that segment with this transition to SaaS and new OTT products and the other things that you've talked about? Or do you think you're still kind of figure out where this business bottoms and starts to grow again?

We think of it as having two distinct components, we try to not to hide the SaaS that we've got a broadcast component that is declining. That being said we don't think at least for the foreseeable future, it's declining to zero. Broadcast particularly internationally is and will continue to be a very important means of getting live video to large numbers of our subscribers. So modest continuing decline there, but perhaps not as acute now that kind of the, a lot of the pain in the U.S. has been kind of worked through. On the other hand, the streaming thing is going to continue to grow. And again going back to the recent earnings calls of several prominent video service providers, I think on one hand they acknowledged their challenges with the existing model. On the other hand, I think you heard from them a commitment to continuing to invest in video particularly in streaming to stay relevant and keep that as a relevant part of their combined offerings. So, it’s a balancing act for us, it’s hard exactly to say when there is a cross over point, but we’re getting momentum on the streaming side and with particularly with some of our new technology developments we think the addressable market on the streaming side is getting larger. And as we look out over a multiyear period, time in fact we’ve seen net, net an expanding addressable market combining the two. And that’s very positive and yes, it’s challenging to forecast exactly in the short-term, but there is no doubt on our mind that this is ultimately a very interesting strategically important and profitable business for us and for our customers. And so, we’re continuing to innovate and we see good growth opportunities and we’ll continue to pursue.

Tim Savageaux from Northland Capital Markets is online with the question.

Hi, good afternoon and congrats on the results, a couple of questions here. I think I want to know, I know how I want to approach. The first is with regard to gross margin guidance for Q4 and given the magnitude of the rebound that you are forecasting for the video side and also the increasing mix you’ve noted around recurring revenues software SaaS. Is it fair to assume that you would expect video gross margins to increase in Q4? Or are there maybe some other mix factors involved with big deals there that might change that expectation?

So, Tim in terms of the gross margins for Q4, we’ve -- in this year we’ve had 57.5% approximately in every quarter, and based on how we are seeing the mix also software as well as our SaaS deals and hardware deals. Overall, we are ending up 57.5% and that’s reasonable margin to presume for Q4. We believe it’s going to be very similar of our guidance and deals range of 55% to 57% and that’s what we’ve seen and I think that’s going to continue.

Okay, so in the same ballpark. Well, even in a flat level it doesn’t apply Cable Access gross margins coming back down to levels you’re seeing previously. And assuming that Comcast software contribution goes back out of the run rate that you described in the past I think implies a pretty material step up on the hardware side in Q4. And I guess if you look at the just to eliminate the Comcast offer revenue recognition from Q3 and you’ve got the overall revenue going from close $19 million to the low to mid-30s. I wonder if you might be able to describe it in more detail kind of what's going on there from -- if I'm right to think that's very hardware-centric in Q4. And maybe you balance that against your comments about and I know you don't want to mention Comcast specifically, Patrick. But you seem to be discussing the hardware element as a potential future opportunity, although it does appear that's happening now. So, I guess the overall question is, do you expect material Comcast hardware shipments in Q4 or do you expect assuming that hardware uptick is what I'm seeing there or do you expect that to be more broad-based?

So, Tim I'll start, in terms of Q4 cable segment margins, our expectations is, you know, approximately 40% and that's what we baked in the guidance. And you are absolutely right. The mix in Q4 is more hardware-centric versus software-centric as we saw in Q3. And other Tier 1 as we briefly discussed earlier is going to start contributing revenue from Q4 as you know we experienced in the Comcast deal, hardware follows and then later on software follows. So, there is more of a hardware mix in Q4 and hence you see 40%, which is drop from Q3. But that reflects an full year gross margin of 55% to 57% for the entire cable segment.

Okay, a lot moving parts there. I'm sure I'll figure it out. Let me move. There was a competitive question before that I'd like to expand on and not include or actually to include both of your largest competitors to the extent that. I don't know if too pretty much to say, Cisco is exiting the business but it may not be and trying to get started with assume integration challenges on the part of CommScope and Arris as well. I mean, can you comment in any more detail on whether if you think either or both of those events or situations could result in material share gain opportunities for Harmonic, not tomorrow maybe but over time?

Tim, I think our biggest opportunity is really just to leverage the technology that we have and the lead that we have. As I mentioned a couple of moments ago, I personally continue to receive feedback from a healthy cross section of customers who're exposed to what's going on in the market, that we have a substantial lead and this isn't just on kind of our product but the operationalization of the product. And really leveraging cloud-native attributes, et cetera. So, you know, I hear your question, but the way we're thinking about it is, look, is to continue to invest, continue to innovate and to leverage our leadership position to drive success. And frankly, we don't want do is, lean back for a second, assuming that our competitors may be taking the foot off the gas. We don't know. We really don't know what's going on in either of those shops, both shops have a history of executing over time, and we have a lot of respect for them. But really we think we're in a position, we put ourselves in the driver seat. You are seeing the growth that, we think that not only we think that outside analysts think is associated with this new virtualization and remote PHY opportunity, we think we're well ahead. It's just incumbent on us to take advantage of the opportunity and whether or not competitor decisions somehow clear the way even more or not I don't know, but the main thing here is that we've created a lead, and we think it's incumbent on us and we're determined to take full advantage of it.

And last quick one from me would be. On the bookings for the quarter and again assuming that the Comcast software element is a bit of a wash, actually it seemed like there and your book-to-bill outside of that even a little bit higher and again given your guidance for video bouncing back to that degree, I would assume it first blush you saw some strong bookings there, but you also did mention a couple of big deals moving out into October. So with that in mind, I wonder. if you could characterize the strength in bookings in the quarter kind of extract Comcast software revenue recognition looking at the cable or video or if we assume biased in any particular fashion?

Yes, I think the booking for Q3 were strong 126.5 million again Q4 also I mean we are expecting strong bookings in Q4, Q4 generally is historically has been a very strong quarter seasonally and hence over video expectation has increased for Q4 at the same time of cable we are in terms of the plan we originally anticipated in terms of guidance you see as the same what we discussed earlier our Q4 for video we have increased. Our booking expectation is strong, and we believe that our expectation as we have continued to book-to-bill ratio 1.1 year-to-date we expect that to continue exiting this year as well.

Thank you. And George Notter from Jefferies is online with the question.

Hi guys this is Kyle on for George. I wonder if there's anything you can add and this is the question may have been asked in a different way earlier, but I'll ask it here in a different way. With regard to how many of your initial CableOS customers are deploying significant portions of their footprint as opposed to test markets in smaller areas? I know you have a mix of all, but is there something you can add in terms of how many of your initial customers have big parts of their footprint moving in the direction of being deployed?

Look, we reported 935,000 so that's actually a pretty modest number compared to the footprints of some of the customers we are working with. So clearly what has been deployed to date is a small fraction. We believe based on what we're told, as well as the success that's being achieved out there, we believe that the solution is not going to be used as a niche solution by any of our customers there in fact is going to be deployed broadly. Now, all of that I guess remains to be seen, but we are working towards broad deployments with all of our key customers and particularly as some of the operational and financial advantage data starts to flow in. And we think that there is more than ever there is compelling reasons to be deploying our technology as broadly as possible.

Thank you, ladies and gentlemen. And that concludes today's conference. Thank you for participating. You may now disconnect.

All right, well, thank you everybody. Good bye and we look forward to talking with you next time.