Harmonic Inc (HLIT) 2014 Q1 法說會逐字稿

Welcome to the Q1 2014 Harmonic earnings conference call.

My name is Heather, and I will be the operator for today's call.

(Operator Instructions)

Please note that this conference is being recorded.

I will now turn the call over to Blair King.

Blair, you may begin.

Thank you, Heather.

Before we begin, I'll take a moment to introduce myself.

My name is Blair King, and I joined Harmonic in early February as the Company's Director of Investor Relations.

I'm pleased to be here, and look forward to working with all of you.

And with that, welcome to Harmonic's first-quarter 2014 earnings call.

With me in our headquarters in San Jose, California, is Patrick Harshman, our CEO; Carolyn Aver, our CFO; and Peter Alexander, our CMO.

I'd like to point out that in addition to the audio portion of this call, we've also provided slides, which you can see by going to the Investor Relations page on Harmonicinc.com and clicking on the first-quarter earnings call button.

Now, turning to slide 2, let me remind you that during this call, we will provide projections and other forward-looking statements regarding future events or future financial performance of the Company.

We must caution you that such statements are current expectations, and actual events or results may differ materially.

We refer you to documents that Harmonic files with the SEC, including our most recent 10-K report and the Forward-Looking Statements section of today's earnings press release.

These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

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

These items, together with the corresponding GAAP numbers and our reconciliation to GAAP, are contained in today's earnings press release, which we have posted on our website, filed with the SEC, and on our Form 8-K.

We will also discuss historical, financial, and other statistical information regarding our Business and operations.

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

And with that, I'll turn the call over to Patrick.

Thank you, Blair, and thank you, everyone, for joining us today.

Turning now to our slide 3: Today we reported our results for the first quarter of 2014, which reflects solid progress in our strategic and financial growth agenda.

Revenue was $108 million, up 6% year over year.

International customers accounted for 50% of revenue, as US customers grew back at 50%.

Business from our cable customers contributed 41% of revenue, while broadcast and media customers represented 34%, following a record 42% in the fourth quarter.

And satellite, direct to home, and telco customers represented 25% of revenue in the quarter.

Our first-quarter bookings of $126.3 million were up an encouraging 15% year over year, representing the strongest bookings quarter we've had since the second quarter of last year.

And with that, book-to-bill was roughly 1.2, a level we haven't seen since 2010, and a positive indicator of our ability to return to mid-single-digit growth this year.

Our backlog and deferred revenue stands at a healthy $126.4 million as we enter the second quarter, supporting our confidence in the rest of the year.

Gross margin for the quarter was a strong 53.3%, reflecting continued healthy margin trends in the blended business.

Non-GAAP earnings were $0.03 per share, and cash from operations was $11.2 million, as we maintained our focus on both operating expense and cash management.

And significantly, regarding our buyback program, we repurchased 4.4 million shares in the quarter for approximately $29 million.

And Carolyn will provide further details and commentary on these operating results in just a few minutes.

But turning now to slide 4, I'll provide a little bit more business and market color on the quarter.

Driving our year-on-year revenue growth was growing momentum with cable providers, up 14%, and led, in large part, by our Edge business, which was up 40% year on year.

And in particular, by the early success of our NSG Pro CCAP platform.

We see these results as validation of our strategic focus in this market, and the increasingly competitive differentiation the NSG Pro platform offers.

In the first quarter, we also saw year-on-year improvement in the demand from satellite, direct-to-home, and telco pay TV service providers, up 15% from the first quarter of last year.

We're now seeing some of the fruits of our efforts in developing the next generation of industry-leading compression technologies, as some service providers begin refreshing their encoding base with our newest MPEG-2 and MPEG-4 encoders.

[Here, our nergstrom] strategy has been to bring significant bandwidth efficiency innovations to the market.

And with our total video processing sales up 9% year over year, we're increasingly making technical and commercial progress in this regard.

And turning to broadcast and media, after a record 2013, we experienced a slow start to 2014, with revenue down 7%, primarily due to softer demand in Europe.

In associated, production and playout product revenue was down in the quarter, also in part due to slower European order flow.

However, we were encouraged by a rebound in EMEA orders in March, enabling us to exit the quarter with a regional book-to-bill ratio greater than 1.

Also of note: Our production and playout products were core to NBC's successful highlights factory for the Sochi 2014 Olympic Games during the quarter.

And we continue to see growing market interest in our Spectrum ChannelPort Solution, following high-profile and successful deployments with customers such as FOX Sports 1 and British Telecom Sports.

We remain committed to leveraging the foundation we have created in broadcast and media to deliver future growth.

And finally here from a geographical perspective, our domestic business grew to 50% of revenue for the quarter, up 27% over the period a year ago.

As noted earlier, this relative strength was largely due to success with our cable Edge products, the NSG, and the new NSG Pro.

In contrast, our international business was down 8%, with EMEA proving challenging early in the quarter, as I noted just a moment ago.

So, let's turn to slide 5 now, where I want to return to our overarching objective of creating shareholder value.

As a reminder, our value-creation agenda is comprised of three components: executing on our strategic growth plan, continuing focus on capital structure optimization, and ensuring strong supporting corporate governance and management.

In capital structure, we remained focused on generating and returning cash to shareholders.

And during the quarter, we repurchased 4.5% of our shares outstanding.

And since the inception of our stock repurchase program in early 2012, we've reduced our share count by approximately 24%, repurchasing over 27 million shares for approximately $167 million.

With respect to corporate governance and management, we recently brought Blair on board as our Director of Investor Relations.

Blair brings extensive Wall Street experience as a senior sell-side research analyst, and he covered Harmonic for many years in this capacity.

And prior to his experience as an analyst, he worked in our industry for over a decade in a variety of disciplines, including finance, marketing and sales.

So, Blair, we're very pleased to welcome you on board, and I encourage all of you, our shareholders, to get to know Blair.

So, let's now turn to our progress executing on our strategic growth plan.

Moving to slide 6, let's first talk about our progress toward addressing what we see as roughly a $1.6-billion market opportunity for us at the converged cable Edge; notably, an opportunity representing more than 5 times the traditional edgeQAM market we've addressed with our legacy and market-leading product.

As some of you may already know, this large opportunity is driven by our cable customers' planned disruptive transition to a flexible all-IP converged video and data access network.

The phase I release of our entry into this larger adjacent market is our downstream converged cable access product, the NSG Pro CCAP platform and downstream line card.

The fourth quarter was our first volume production shipping quarter for the NSG Pro, and in February, Infonetics Research asserted that Harmonic captured nearly 19% of the total CCAP downstream ports shipped during the quarter.

We're encouraged by this early position in the market, and I'm pleased to report that the momentum for our NSG Pro accelerated throughout the first quarter, contributing to the upswing in our cable Edge business.

As we enter the second quarter, our pipeline of new cable Edge opportunities has continued to grow.

So, let me here highlight two drivers that are underpinning this early success.

The first is our competitive advantage from the technology and design perspective.

We believe the NSG Pro offers cable operators more downstream capacity than any other competitive product on the market today, fundamentally altering the economics of adding new revenue-generating services to their networks.

Our design's unique marriage of density and flexibility is critically important to cable operators, as they balance the cost of adding capacity with seemingly unabated increases in the consumption of bandwidth-intensive video services.

Of equal technical and operational importance is Harmonic's industry-leading capability in integrating downstream narrowcast to video, and modular CMTS or DOCSIS QAMs in the unified CCAP platform.

Our NSG Pro today uniquely enables allocation of unicast video and IP data traffic across the RF spectrum, as service flows and the network require.

Our technology and expertise here is unique, not easily duplicated by our competitors, and undoubtedly a strong contributor to our early success.

So, armed with a highly differentiated new product, the second important factor driving our early success is growing market demand.

On one hand, we see Internet-based over-the-top video delivered over the cable network growing.

And with cooperative agreements between cable operators and over-the-top service providers, the bit rates and quality of these streams increasing, creating accelerating demand for scalable modular CMTS Edge forms.

On the other hand, as cable operators deploy much more powerful and user-friendly content navigation guides for accessing their own content, we also see consumption of traditional video-on-demand services accelerating, and corresponding demand for video Edge QAMs growing.

And we see both of these effects driving a demand trend that can gain momentum throughout 2014.

That said, with our phase I product release now well underway, we no longer plan to provide detail on individual phase I orders.

So, looking ahead, phase II of our program adds CMTS-compliant DOCSIS upstream upgrade capability to the same NSG Pro platforms we're shipping today for downstream applications.

We plan to deliver phase II product into customer labs later this year, followed by commercial availability in 2015.

We anticipate this strategy will further alter the economics of deployment for our cable customers, and in turn, further accelerate the value proposition and margin performance of the NSG Pro.

And here, it's important to note that today's CMTS market dynamics make clear that historical market share positions held by incumbent CMTS providers are being revisited by cable operators as they evaluate their next-generation unified IP video service offerings.

So, summarizing our cable Edge business, we're pleased with our CCAP program results so far, and we see good near-term demand trends.

But in terms of the full potential of our initiative, we're really just getting going.

We remain focused on delivering the full CMTS functionality of our platform, and realizing the associated value for our customers and our shareholders.

So, let's turn now to slide 7, where I'll update you on the indicators we see catalyzing progress toward new video processing investments, driven by next-generation video encoding technology.

We've previously discussed the progress we're making toward significantly improving compression and video quality for legacy MPEG-2 and MPEG-4 AVC services.

We've also discussed the new HEVC encoding standard delivering up to 50% bandwidth savings versus MPEG-4, and our progress in delivering this HEVC capability.

Well, I'm really pleased to say that we've brought all of this together in the public forum at NAB just two weeks ago, where we launched Harmonic VOS, a virtualized software platform and architecture for the entire video processing ecosystem, running atop of virtual machines on standard IT server hardware.

Within VOS, we also announced our new pure compression engine, which enables significant new bandwidth efficiency improvements for MPEG-2 and MPEG-4 AVC, together with HEVC and all of its benefits.

The first orderable and [scentiation] of VOS is the Electra XVM product, the latest in our market-leading Electra series of video encoders, which contains the pure compression engine, as well as differentiated capabilities including graphics, branding and playout, and runs only in software as a virtual machine.

The Electra XVM product is available today, and has actually been in customer labs for several months.

Harmonic VOS and the Electra XVM won Best of Show awards at NAB from TV Technology Magazine.

And I can tell you: We really felt that customer reaction was overwhelmingly positive to what we're doing here.

And I realize I'm only scratching the surface in mentioning the broad capabilities and vision of Harmonic VOS, and the ongoing transition of our Business to be more software oriented.

But rather than take more time here, we propose to cover this in more detail in our upcoming investor conference.

So, turning now to slide 8, I'll wrap up this portion of the call by touching on still-anticipated technology cycles driven by 4K or ultra high-definition television and over-the-top multi-screens.

In ultra HD, we believe the market dynamics continue to gain steam with new television prices eroding further and consumer awareness rising.

Our broadcast and media customers tell us that their content is increasingly produced in 4K, and at NAB, we saw a continued wave of announcements of lower-cost 4-K cameras and production equipment.

Also at NAB, we demonstrated live HEVC encoding of ultra HD for the first time using VOS.

We also showed ultra HD at 30, 60 and 120 frames per second, and creation of ultra HD channels on-the-fly together with our technology partners Broadcom, ViXS, Sigma Designs and Vigor.

So, we're clearly innovating here, and I think we've clearly carved out a strong market leadership position.

Nonetheless, it remains unclear exactly when ultra HD channels will first go live and HEVC compression will be deployed in volume.

Nonetheless, I can tell you: Customer interest is clearly building, and we see growing potential for both of these new technology cycles over the coming quarters.

Turning lastly here to over-the-top and multi-screen video: We've previously discussed Harmonic's number-one position in the relatively small multi-screen transcoding market, and how we see this functionality becoming more consolidated within the rest of the video processing flow over time.

With NAB, we continued to demonstrate market leadership with the announcement of a new partnership with encoding.com, particularly focused on burst transcoding in the cloud, with them adopting our ProMedia technology.

And we also announced ProMedia integration with Adobe Primetime.

And we realized new customer wins in cable, telco and broadcast during the quarter.

So, Harmonic VOS and this new Electra XVM product also include multi-screen capability.

We've uniquely integrated with powerful graphics and digital video effects for creative and localized advertising, and social media personalization, setting a new benchmark of capability and performance in this market.

And demonstrating, for the first time, the powerful technology consolidation and video chain functions that we've been championing in the marketplace.

And again, we'll discuss this in more detail at our investor conference, but here, suffice it to say that we're quite encouraged about the game-changing potential of our latest innovations and announcements, and our overall continued strategic progress.

And with that, Carolyn, let me turn it over to you.

Thank you, Patrick.

Let's move to slide 9. Our net revenue for the first quarter was $108 million, seasonally down from the $120.2 million for the fourth quarter of 2013, and up 6% from the $101.7 million for the first quarter of 2013.

Our bookings were $126.3 million, up 11% from Q4, and up 15% compared to the same quarter of last year, led in large part by the strength in our cable Edge business, and in particular by the NSG and NSG Pro products.

Video processing, and service and support, also contributed to the strength of the quarter.

Our book-to-bill ratio for the quarter was 1.2.

Backlog and deferred revenue was $126.4 million at the end of Q1, compared to $114 million at the end of Q4 of last year.

The increase in deferred and backlog is principally due to the timing of recognition of deferred revenue, and a pickup in order flow toward the end of the quarter.

Our non-GAAP gross margin was 53.3% this quarter, a decrease from 54.3% in the previous quarter, and an increase from 51% in the first quarter of 2013.

The decrease in gross margin this quarter on a sequential basis is largely due to a greater portion of our revenues coming from our Edge product line in general, and an increase in the shipment of our NSG Pro product, as we move through the early production units more specifically.

The year-over-year improvement reflects healthy margin trends across all product categories, including cable Edge.

We continue to see growing license sales into our existing hardware, and the initiatives we have established to reduce costs through operational efficiencies and supply chain management are really paying off.

While many factors play into this transition, including strategically focusing on innovative products and solutions that deliver differentiated value to our customers, and the strategic decision to move away from commodity product categories, we have been focused on delivering more of our value in software, and see this trend continuing.

Non-GAAP operating expenses for this quarter were $54.1 million, down from $54.5 million in the fourth quarter of 2013, and $55.2 million in the first quarter of 2013.

The decrease in operating expenses reflect the strong focus on expense management, as we balance the needs of our Business with our commitment to drive operating leverage on mid-single-digit top-line growth in 2014.

Headcount was 1,042 in Q1, compared to 1,032 in Q4, and 1,096 a year ago.

Non-GAAP net income for this quarter was $2.8 million or $0.03 per diluted share, compared with net income of $8.3 million or $0.08 per diluted share in the prior quarter, and a net loss of $2.7 million or $0.02 per diluted share for the first quarter of 2013.

Moving to slide 10, let's take a look at our revenue category breakdowns for the quarter.

Our US business generated 50% of our revenue in the quarter, primarily driven by our cable Edge business.

International declined to 50%, principally a result of lower revenues in the Europe portion of our EMEA region.

Emerging markets remain generally healthy in the quarter.

From a product view, video processing as a percentage of revenues remained relatively flat at 43% compared to the first quarter of 2013.

Production and playout decreased as a percentage of revenue from 22% in the first quarter of 2013 to 16% in the current quarter.

This decline in production and playout is principally due to a slow start to the year in Europe, although, as Patrick noted earlier, our bookings in the region exiting Q1 were stronger than our revenue that was recorded in the period.

Our cable market, and our satellite and telco market, each increased 2% compared to the year-ago quarter, to 41% and 25% of revenue, respectively.

The broadcast and media market represented 34% of revenue in the current quarter, compared to 38% in the first quarter of last year.

Our only 10% customer for the first quarter of 2014 was Comcast, at 20% of revenue.

Now, turning to slide 11, you can see we continue to drive a strong balance sheet.

We ended the quarter with a cash balance of $147.7 million, down $22.9 million from the previous quarter, reflecting approximately $11.2 million of cash generated from operations in the quarter, offset by $29.1 million used for share repurchases, which I'll discuss in more detail momentarily.

Our receivable balance was $77.5 million, and our DSOs were 65 days, up from last quarter's 57 days.

Inventory was $30.3 million, down by $6.6 million from the prior quarter.

As a result, our inventory turns were 6.7 times for the quarter.

Capital expenditures for the first quarter of 2014 were $3.4 million.

Moving to slide 12, I'd like to update you on our share repurchase activities during the quarter.

In the quarter, we repurchased 4.4 million shares for a total of $29.1 million.

This brings our total shares repurchased from inception of the program to date to 27.7 million shares for a total of $167.3 million.

And brings our shares outstanding down to 95.7 million.

At the end of Q1, we had $52.7 million available from our Board-authorized program for continuing repurchases.

Turning to slide 13, as we look into the second quarter of 2014, we expect our revenue to be in a range of $113 million to $123 million.

While this represents only modest year-over-year increase over the second-quarter 2013 at the midpoint, we also want to provide a framework for you to think about revenue growth for the remainder of the year.

We believe the customer demand trends we saw in Q1, coupled with our backlog and deferred revenue, as well as our bookings forecast, provide a base for our target of mid-single-digit revenue growth this year.

Non-GAAP gross margin in the second quarter is expected to be in the range of 52.5% to 53.5%.

This range takes into consideration the margin impact we expect from increasing revenues of our new NSG Pro cable Edge platform.

As with previous generations of new QAM platforms, our initial shipments are more hardware-centric and lower margin.

Over time, we expect to sell increasingly high volumes of QAM licenses as network traffic scales.

We are also expecting ongoing manufacturing and supply chain cost reduction, as the new product matures and hits higher volume thresholds.

The NSG Pro margin improved in Q1 as expected, and we anticipate further improvement as we move into Q2 and beyond.

Due to this and other ongoing strategic initiatives, we continue to anticipate gross margins for the year to be in the 53% or better range.

As we bring the new strategic products Patrick discussed earlier to market, we are leveling off our R&D investment, and moving some investment focus into the go-to-market activities.

We also continue to focus on optimizing our general and administrative costs.

Our plan is to do all of this within a flat operating expense structure for the year.

We have targeted our non-GAAP operating expenses for the second quarter to be $54.5 million to $55.5 million.

Finally, we anticipate our non-GAAP tax rate for 2014 to be 21%, subject to our domestic versus international [split].

I'd like to direct your attention to slide 14.

In conjunction with our earnings release today, Harmonic separately announced our Analyst and Investor Day at the NASDAQ market site building in New York City on May 15 from 9:30 AM till 2 PM.

We look forward to sharing with you the most pressing trends, opportunities and technologies impacting our industry and markets, as well as our vision, strategy and product road map for transforming the way video is distributed and consumed on a global stage.

Before I turn the call back over to Patrick, I'd like to add my welcome to Blair to the Harmonic team.

I really believe his experience and enthusiasm for our Business will make him a valuable addition.

Patrick?

All right.

Thanks, Carolyn.

So, in summary, during the quarter, we delivered results that demonstrate clear progress in getting back to growth, advancing our strategy, and building shareholder value.

Our progress reflects both our focused execution and our customers' confidence in Harmonic, and our ability to continue to deliver industry-leading innovation and business partnership.

Looking ahead to the second quarter and the remainder of the year, we expect to continue to execute on our growth strategy, and innovate to capitalize on coming waves of cable Edge and video infrastructure market expansion, while also growing our market share and global customer base, and thereby driving expanded value for our customers and our shareholders.

And with that, we'll move to the question-and-answer portion of the call.

Heather, could you please instruct the audience on how to ask questions, please.

Thank you.

(Operator Instructions)

Our first question is going to come from Mark Sue from RBC Capital Markets.

Please go ahead with your question.

Thank you.

Good afternoon.

If we look at the interest and just the uptake of the new products, maybe if we could get a sense of how the year might trend as we progress through the quarters before the larger uptake in 2015, maybe as it relates to CCAP and the broader family.

That would be helpful.

And then just a separate question.

Just how we should think about the operating margin trends as we progress through the year, as well?

Thank you.

I'll take the first part on product trends.

We're encouraged by the response to our downstream CCAP platform, the NSG Pro.

It's clearly being well received, and clearly there's good demand trends out there on the market with more over-the-top video needing to be managed and growing success, I would say growing takes rates of the traditional video on demand streams.

So we see those demands continuing to move forward, and so we have a positive outlook for the cable Edge business throughout the rest of this year.

Although we'll be trialing and testing customer in labs, our two way CMPS device before the end of the year, we don't expect any revenues for that, say, a 2015 and beyond historic, Mark.

Patrick, any thoughts of the number of trials maybe that has expanded, and how we should think about the trials before revenues next year?

There's nothing really noteworthy there.

We have a habit with all of our major products to work closely with several of our largest customers, and I woulodn't expect to this to be any different.

We've received good coaching and guidance up to now with the phase II of our CCAP NSG Pro release, and we'll continue to follow the same path.

The (inaudible) to video, it's largely an analogous story.

We're encouraged by the uptake that we see the latest MPEG-2 and MPEG-4 compression activity there.

And candidly, we're -- relative to a year ago, we're disappointed that ultra HD and HEVC aren't further along, and we don't expect large amounts of revenue from those initiatives this year.

The growth that we see will largely be based off of the current encoding standards.

That being said, very much like two way CCAP, the potential and the customer interest and the thirst for this over time is very clear.

And in the beginning of this year at CES through this recent NAB show, becomes clearer and clearer in our minds.

And I think in the marketplace that ultra HD is for real, and is going to drive a very substantial investment in upgrade cycle.

We think we'll be seeing early deployments in the back half of this year, and probably not volume until 2015.

Okay.

That's helpful.

Thank you, and good luck.

Our next question is from Simon Leopold from Raymond James Financial.

Please go ahead with your question.

Hello, guys.

This is Victor Chu in for Simon Leopold.

You mentioned the introduction of the DOCSIS component with your new CCAP offering as part of the phase II.

Can you tell us a little more about this product, because I don't think you've spoken too much about this in detail before?

How does that look exactly?

Are you integrating the CMTS component into your EdgeQam product, or are you partnering with someone for this?

Can you just tell us a little more about that?

We're on the road to building a full two-way CMTS/CCAP, if you like, that will be introduced to the market in 2015.

The CCAP spec has got two dimensions.

One is a downstream spec, that's the first release that we've embarked on.

But our design, our strategy from the get-go has been to deliver a platform that can support two-way DOCSIS capability.

And that's still the path we're on, and we're pretty pleased with the progress we're making.

You asked about partnership, a big part of our ramp up in R&D expense last year was associating with funding for this program.

And we've certainly hired a number of the experts from outside of the industry in addition to drafting several of our own best and brightest into this initiative.

But it's a scaled up initiative that we've been investing in and working with our repeat customers on for some time.

The phase I of this program that we announced is being shipped now, we're delivering it now.

It's a chassis, the switching infrastructure, the downstream line cards are 100% CCAP compliant, and what remains to be delivered is the upstream functionality.

And that's what I spoke to earlier would be delivered into our customer's labs later this year.

So the product is going to compete directly with the incumbent CMTS vendors.

Is that correct?

That's correct.

Okay.

How do you view that going forward?

It seems like that market is pretty well established with some of these larger incumbents.

Do you see your penetration into that market as a challenge?

We see a great opportunity, Victor.

First of all, in terms of the size, the fluidity of the market, there is a big disruption coming as cable operators pivot to all IP video.

We see a lot of change out there.

I think even if you look at what's happening in the market today, you can see shifting market share going on, is one point.

The second point is, our architecture has some really unique differentiable advantages.

The downstream port density that we spoke to, we think we uniquely in the industry have a strong leadership position, and it's going to be crucially important to turn the entire cable plant into a unified IP delivery path.

We think we've got a very strong and unique position there.

And we've also, although endorsed by cable operators and cable apps now, we've also really innovated in helping the industry think about a new fundamental architecture in the way routing is handled.

And if you haven't seen it, I'd point you to the white paper posted on our website that we jointly published with Alcatel Lucent.

It talks about the very significant advantages to the cable operators with the routing piece of that.

And here, I would highlight that we are not endeavoring to become a routing player ourselves.

We think that this architecture makes much more sense for the industry, and we've been working closely with people like Alcatel Lucent, like JuniPore on a so-called forwarding CCAP architecture.

And the first thing I would say to you is I'd just go back to the comments in the opening part of our presentation.

Infonetics has started to track downstream CCAP ports and delivery.

And just in the fourth quarter of last year, they're already attributing 19% of the market to having been captured.

Early market, nascent days, but having captured by Harmonic.

I think it's a very early data point, but that, coupled with our historic strength in the edgeQam space, need us to be I think in no way over confident, but to be optimistic that this is a large $1.5 billion to $2 billion market that we can participate in and that we can capture a meaningful share of.

I just had one last question.

Does this imply that the industry is leaning towards one particular architecture, the integrated architecture, specifically, more so than the modular architecture?

Is that how things are -- ?

I wouldn't say so.

There's a lot of discussion about a variety of different architectures that are out there, and there are a number of different players espousing different points of view.

And look, we're talking all the time with our largest and closest cable customers.

They're looking at a variety of different architectures out there.

And suffice it to say, we feel this is a major investment that the Company is making.

We feel very strongly that the architecture we're pursuing gives us a great opportunity to participate.

Great, thank you.

Thank you.

Our next question is from Tim Quillen from Stephens Incorporated.

Please go ahead with your question.

Hello, good afternoon.

So cable Edge revenue was obviously up quite a bit year-over-year.

I think, I don't know if it was coincidence, but the amount that it was up quarter-over-quarter was roughly the same that revenue from Comcast was up quarter-over-quarter.

And I think you said that order flow was pretty good throughout the quarter, but how do I think about the sustainability?

I think if you extrapolate first quarter numbers across the year, you get to a record year in cable Edge or at least over the past several years.

Is that how you're thinking about the year?

Or was there something this quarter that was maybe more of an increase driven by a single customer that maybe won't be as strong throughout the year?

Tim, the visibility to the second half is far from perfect.

Nonetheless, the demand trends that we see are multi-customer, and we believe are sustainable for multi-periods.

I'll remind you that last year was not a strong year on the Edge, and so in part, we're seeing a return to focus and investment here.

But also, there's some very real dynamics that are playing out that I don't think are just a bubble or flash in the pan.

The transport of over-the-top video services, putting pressure on networks, the quality, the bit rate of those video services being delivered over the cable network, those are all, it's a very big effect.

On the other hand, we're still in early days in terms of the rollout of some of these new attractive, more powerful, more compelling user guides that are in our mind clearly going to drive a sustained increase in the on-demand track that we're seeing in the cable network.

And the third thing I'd layer on to that is that we're in the market with a pretty exciting and pretty compelling new product, the NSG Pro.

And while what we delivered in the first quarter was a mix of our previous generation, this new generation of product, it's very clear to us that there's a strong positive reaction to this new product.

And we believe that our competitive differentiation for this EdgeQAM or downstream capability is growing.

So on top of increased demand, we think our competitive situation, our competitive positioning is growing strong.

And then as customers deploy NSG Pro right now with downstream capabilities, and then you introduce upstream capabilities, can you talk about how seamless that is to an upgrade to the installed base?

So in other words, we won't necessarily see a lull in orders as people await phase II of CCAP?

Well, as a standalone device, downstream we see a lot of opportunity for not just this year, but for a while into the future.

That being said, delivering upstream capability opens up a whole new chapter if you will, or a whole new adjacent market of being able to [pop] and participate in the full two-way CMTS market as we just discussed.

So I see it as layering on of the opportunity, not really a replacement of the opportunity, and expansion of the opportunity.

And so from that perspective, I don't see any real disruption to our business.

I see an expansion of the business, and I think one that can be quite compelling to our cable customers, particularly as they more aggressively, over the next couple of years, pursue this vision of all IP video delivery.

Okay.

And then on production and playout, it sounds like there was a little bit of mixed signals in the market where Europe was weak but bookings came on stronger the end of the quarter.

Do you -- I don't think this is an area you would expect to grow this year, but do you see improved results over the course of the year from what we saw in 1Q?

I would expect so.

It was certainly a weak quarter from a production playout point of view.

And so as you just summarized, we see that at least in part due to timing and the way Q1 in certain geographies got off to a very slow start.

And so we don't expect that to be repeated, and therefore, we expect to be able to perform better in that production plant area in the coming periods.

Okay.

And then just a couple questions on the softwarization of your business, if that's a word.

But number one question is, do you have any changes to your long-term gross margin outlook, given the impact or potential impact of VOS and the slow introduction of products that will reside on that platform?

And then the second question is, is there any analogous trend that you might see on the cable Edge side?

So, is there some competitors talking about virtual CCAP and some competitors talking about software defined cable.

I'm wondering if there's a softwarization or a virtualization process that might go on in the cable Edge side as well over time, as well.

Thanks.

Tim, I'll take the first part of that.

Obviously, over many years as more business goes toward software, we can we can imagine even greater than mid $50 millions gross margin.

And our strategy certainly is over the years to continue on the video side for sure to continue to drive in that direction.

At this point, we're not changing that mid $50 millions target.

And certainly as we've been talking about that and the improvements, we've obviously known we're coming out with these products.

So at this point, no change in the long-term.

But, obviously, as more of our business turns that way, we would expect that to continue to increase.

And I'll come back to the second part of the question, Tim, it's regarding what's happening in the cable side.

There is a certain analogy there, we introduced actually what we call cable OS with the NSG Pro product when we first announced it at the end of 2012.

And we do see over time the ability to separate the control functionality from the underlying hard processing capability in RF hardware.

That being said, the cable access business is fundamentally at its core.

This is not software that's running on top of Intel.

This is the modulation RF technology, et cetera, optical interfaces, and so it's inherently -- it's got an inherent hardware aspect to it or quality to it.

So we certainly see gross margins also continuing to improve as they have in the Edge area, it's more a virtue of just the density of capability and the corresponding licensing strategy that we have associated with that hardware.

And it's a different technology or dynamic than the true ability to deliver product exclusively as software, as we are planning with this VOS announcement, where we'll deliver just purely software to our customers to have them run on their data centers.

I don't expect that to ever happen in the cable edging.

Yes, that makes sense.

Thank you very much.

All right.

Thank you.

Our next question is from James Kisner from Jefferies LLC.

Please go ahead with your question.

Thank you.

And, Blair, welcome to Harmonic.

So just turning to the questions, first on the softness you guys saw in EMEA.

I believe you just said and you characterized it as a slow start.

It looked like it was a pretty big down quarter for international, and production and playout.

It was a pretty precipitous decline there.

I'm just wondering can you point to anything do you think the unrest in the region around Ukraine had impact, or was it macroeconomic concerns entering the year?

Is there any way to characterize it, whether some large projects that may have slipped.

I think you mentioned deferred revenue.

Could you give us a little more color on that softness?

It would be helpful.

Yes, absolutely.

So a couple things we alluded to: one, the bookings in the quarter were more in line with what our listing business was, revenue is what was low, and there's a few reasons for that.

One is, as you mentioned, deferred revenue.

We tend to do more project work in Europe than we do in some other regions, and the way those projects happen to fall from a completion and the ability to recognize revenue this quarter, less of those fell in terms of the revenue we would recognize and more of the bookings had project basis to them, and so were deferred.

So a piece of it is just I wouldn't read anything into that, other than the way those deals happen to fall in or not.

And then there was definitely a more backend nature to their booking, and that just caused some of those orders to be pushed out into next quarter.

And we don't see any real macroeconomic issues that had impacted it.

Okay.

That's helpful.

And I don't know to the extent you attributed the Edge stream to both the NSG Pro and traditional video on demand.

And so, that traditional video on demand piece is pretty interesting just given what your large customers have been saying about VOD transactions going up with the improved user interface and recommendation engine.

I'm wondering if you might help us parse out the relative impact?

Maybe you customers are talking about 20% to 30% increase, but I'm just wondering, is more than half of the increase sequentially here in Edge, NSG Pro shipments, can you dimentionalize it in any way?

That would be helpful.

Well let me clarify something, James.

The NSG Pro and the downstream functionality we're delivering supports both modular CMTS and traditional VOD.

It does it in a dramatically enhanced, much denser fashion.

The hardware has the capability of supporting almost the entire cable spectrum with those services, which is a big climbing step forward.

That being said, the product in the downstream configuration supports both of those applications.

So the mix that we saw in the quarter between who went with NSG Pro and who went with the Legacy product, it was less to do with application and more it was just who is excited about the new platform and who is going with the new platform versus who was going, adding on with the existing platform.

Coming at it from a different dimension, I'd say roughly equal in terms of the increase in demand that we saw from the over-the-top video traffic, monitor CMTS activity as we saw from the traditional VOD.

So, they are both there, and at the top level an approximate equal proportion in terms of driving the demand.

Okay, that's helpful.

Also wondering, just let's turn to VOS again.

So, you guys have had software-based, I'd say more transcoding, I think, with ProMedia.

I just want to delineate to the extent possible just verses ProMedia software based I guess really transcoding.

Maybe this is the first that actually includes encoding.

But I just wanted to compare and contrast your prior software offering versus your VOS.

And I'm also just curious, do you envision all customers going there, or do you think primarily it will be a hosting application initially?

Just your thinking more detail on VOS would be helpful.

Thanks.

So you're right, we have had software products before.

Both products that we've shipped exclusively as a software, in particular our file-based transcoding product, our ProMedia carbon.

As well as products that we shipped on top of Intel appliances.

What's really different with VOS is that it's a platform encompassing not just specific product functionality, but the really whole end to end range of what we do in video.

Encompassing playout, graphics, visual video effects, captioning, encoding, transcoding, the whole end to end realm.

And it's specifically designed to be delivered as software to run on our customer's data centers.

And importantly, unlike the ProMedia carbon supporting both file, as well as live programming.

Particularly with our large customers, James, we see a growing interest in from an operational perspective in doing more and more of what they do the unified fashion on third-party servers that constitute a homogeneous data center environment.

So this is not for everybody, at least in the near term.

But I would say that there's a real resonance with certain of our larger customers who really have a broad vision of both capital, as well as operational efficiency advantages gained from driving more of the functionality in a virtualized environment.

When in announcing VOS, we had a press conference in Las Vegas at NAB, and it was attended by an executive from FOX.

And it's a good example of a larger key player in the industry who's speaking very eloquently, and I think forcefully about the vision of getting to a virtualized environment for really the end to end production and delivery aspect of what they're doing.

And truly, that vision that we're pursuing, and I think it's that vision that we're uniquely positioned as a Company to deliver.

Okay.

That's helpful.

All right, thanks a lot.

I'll pass it.

Heather, we have time for one more question.

Okay, great.

We have Brian Coyne from National Alliance.

Please go ahead with your question.

Hello, guys, good afternoon.

Thanks for taking my questions.

Two quick ones, and a little bit perhaps longer term focused.

You guys had talked a little bit about, certainly on the cable Edge, the opportunity very incremental as operators, cable operators move towards CCAP.

$1.5 billion, perhaps more per year versus, call it, maybe $300 million or $400 million a year on the traditional cable Edge.

Can you help us understand this, do you see that delta, maybe it's $1 billion, $2 billion, $3 billion.

Is that purely incremental to what your current addressable market is for cable Edge?

Or what happens to the existing, call it, the EdgeQAM business for lack of a better term as cable operators move toward that?

Obviously, you've got a big group of DBS customers and others as well, so if you could perhaps give us some context there.

I think it's a good question, and nobody knows exactly what's going to happen, Brian.

But we've got our own model, and also there's several, I think, possible industry analysts who have published a model.

And the one that we'd point you to in particular that we and I think much of the industry relies on is that of Infonetics.

And it kind of [immitates], yes, we believe that let's call it $1.2 billion whatever it is, is indeed incremental.

And that's not to say that the absolute value of the EdgeQAM piece or the CMTS piece doesn't change over time, but the way we look at it, today, there's a distinct EdgeQAM market and a CMTS market.

We just addressed the smaller EdgeQAM part.

These kits match together in some way over the next several years.

And with the direction we're headed, we have the opportunity to address the entirety of it.

And indeed we think that that's a substantially larger opportunity.

That's why we're as focused as we are, and why we're investing the way we are.

Okay, great.

That's helpful.

And then I guess just following up.

Obviously, you referenced a couple of times the flattish, perhaps even declining R&D as you shift more dollars toward go market.

Again, help us understand I think is that -- obviously you invested, you said last year in the second release of the NSG Pro.

How confident are you in that relative to the additional engineering that's got to go into completing, call it, full CCAP or at least the upstream line card?

We have an overall budget of nearly $100 million in R&D, and so I think we believe that as we focus our resources we have the ability to invest on the growth initiatives that we need to.

It's not to say that expenses will stay at this level forever.

We're trying to balance top line growth with operating margin leverage, and definitely continue to invest in the growth areas.

And so, I think we're doing all three of those things.

Okay.

That's good.

Then for last, and back on VOS.

Obviously, pretty meaningful in terms of big market shift here.

Can you give us a little color on what you're doing with customers?

It's obviously you said it's been in testing with customers, or rolled out at least initially your labs with customers, how is that going?

And what do you think the near-term prospects for customer adoption?

So, there's a lot of excitement, it's simply coming of the public announcement at NAB.

Frankly, we're juggling probably more near-term interest than we had anticipated, which is not to say that we think that there's a big spike in revenue.

Moving from managing a head end of stand-alone appliances to operating in a data center environment, it's a pretty big shift.

So what we're trying to do is we're trying to lead in the market, and particularly with those customers that have the wherewithal, the desire, capability on their side to really work their way through this kind of transition.

So I anticipate that we'll continue to work closely.

I anticipate that we'll have our first sales in the next couple of periods, and that we'll exit the year with some real good momentum and the first real revenue under our belts.

That's not say that I see a transformation in the business model before the end of the year, by any means.

I think because this is a pretty disruptive change to the model, it will take some time.

But I think that we have a real opportunity here to be leading not only from a core technology point of view, but also from a deployment expertise point of view.

And that's certainly one of our goals, and one of the reasons why we're working close as we are with some of the key thought leaders in the marketplace.

So we'll keep you posted on progress that we make.

Okay, great.

Thanks, Patrick.

Good luck.

All right.

Thank you, Brian.

Thank you.

Patrick, do you have any closing remarks?

I hope it comes across that we're excited about our business.

That we're happy to be back growing again, and that the outlook in the near-term is positive.

And the outlook in the longer term is also positive, as we think about the fundamental shifts in the marketplace and the investments that we're making really towards long-term growth and creating long-term shareholder value.

So we're appreciative of the support that you're giving us, and we're going to continue to work hard and innovate.

And we're very hopeful that you'll be able to join us at the Analyst Day in mid-May.

We look forward to delving into these topics in more detail.

So until then, thank you very much and good afternoon.

Thank you, ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may now disconnect.