Harmonic Inc (HLIT) 2017 Q1 法說會逐字稿

Welcome to the Q1 2017 Harmonic Earnings Conference Call.

My name is Candance, and I'll be your operator for today's call.

(Operator Instructions) Please note that this conference is being recorded.

I will now turn the conference over to Blair King, Harmonic's Director of Investor Relations.

Blair King, you may begin.

Thank you, Candance.

Hello, everyone, and thank you for joining us today for Harmonic's First Quarter 2017 Earnings Conference Call.

My name is Blair King, and with me at our headquarters in San Jose, California, are Patrick Harshman, our CEO; and Hal Covert, our CFO.

Before we begin, I'd like to point out that in addition to the audio portion of this call, we've also provided slides for this webcast which you can see by going to the Investor Relations page on harmonicinc.com.

Turning to Slide 2, during this call we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company.

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

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

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

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

These items together with corresponding GAAP numbers and reconciliation to GAAP are contained in today's press release, which was 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 will be included in the press release and the remainder of the information will be available on a recorded version of this call on our website.

So with that, I'll turn the call over to our CEO, Patrick Harshman.

Patrick?

All right.

Well, thanks, Blair, and thank you everyone for joining the call today.

Turning to our Slide 3, let's get started with an overview of our first quarter results.

Revenue was $83.5 million, down 27% sequentially following a strong fourth quarter, but up modestly from a year ago.

Video segment revenue performed below our expectations, down 29% sequentially, but up 13% year-over-year.

Our Cable Edge segment performed as expected given the major market and product transition now underway, with revenue unchanged from the prior quarter, down 46% year-over-year.

Combined bookings of $82 million reflect seasonally weak demand in the quarter, exaggerated following a strong fourth quarter order and several anticipated deals, which were delayed out of the quarter, a couple of which has since been closed in April.

Our bookings also include a growing mix of new cloud-based recurring revenue orders, which is advantageous over the mid-to long-term, but a headwind for near-term revenue conversion.

Underscoring the shift to our video -- of the shift in our video business to more software recurring revenue services, backlog and deferred revenue is $184 million, remaining at a near record level.

And nonetheless, fewer new orders that converted immediately to revenue during the quarter result in the higher mix of support revenue and a corresponding lower gross margin of 52% and a disappointing EPS loss of $0.14.

I want to emphasize that these results stem directly from a singularly weak Q1 video spending environment.

We do not believe we lost any market share during the period.

And following a just completed detailed business review, our sales pipeline and overall demand trends we saw entering the year are still very much intact.

And so with that brief summary, let's take a closer look at the video business and turn to our Slide 4. The first key message here is that following strong fourth quarter of video-on-demand, first quarter customer spending dropped materially.

In particular, our results reflect much softer-than-expected service provider spending in Europe, Middle East, and Africa.

This was most pronounced in the final month of the quarter when several anticipated projects were unexpectedly delayed.

And nothing we've seen from competitive data suggest the spending weakness was a unique Harmonic challenge.

In fact, we subsequently closed a couple of these key deals.

And as noted a moment ago, we've conducted a detailed sales pipeline review, which convinces us that the full year demand we anticipated remains intact.

Now that said, we're seeing some faster-than-expect shifts in demand trends, with several satellite Pay-TV operators reducing investments in traditional video infrastructure, offset by growing investments in over-the-top, in a particular cloud and SaaS-based over-the-top solutions.

Which brings us to the second key message about our video business, which is that customer adoption of our new video cloud and software-as-a-service solutions continues to gain encouraging momentum.

Year-to-date cloud and SaaS solutions represent over 5% of total video segment bookings.

And following a busy NAB Show last week in Las Vegas, it's now clear that serious customer interest in our cloud solutions is starting to gain steam.

Underpinning this momentum is on one hand, truly innovative new technology, we're the first to enable premium video quality video processing as cloud native applications that can run on private clouds or public clouds such as AWS.

And on the other hand, strong engagement with several Tier 1 operators who are looking to the cloud to enable more agile and efficient operations.

Our cloud solutions are now powering high-profile, live video over-the-top platforms from multiple blue chip service provider and media customers in both the U.S. and overseas.

We firmly believe we're creating a winning formula here, marrying the industry's most advanced video compression and qualitative experience technology with an innovative public and private cloud-based delivery platform that enables both broadcast and unicast services to mobile devices all the way up to the widescreen in the family room.

And this has been a major area of investment for us, and it's good to see the successful early deployments and expanding market buzz.

Although we must, again, caution that we expect the well-known issues associated with pivoting part of a revenue stream from a CapEx to a consumption business model.

So while we're not yet forecasting dramatic growth of recurring revenue contribution this year, we do expect to continue to report to you growing SaaS bookings and backlog throughout the balance of 2017.

And this brings me to the third key message, which is that our video business outlook for the remainder of 2017 remains healthy.

We have sufficient backlog, deferred revenue and solid sales pipeline to deliver a profitable second quarter.

Similarly, our full backlog, deferred revenue and pipeline data give us confidence that we're in a good position to deliver modest revenue growth for the balance -- excuse me, this year overall, despite the headwind of the partial transition to the recurring revenue model that I've just mentioned.

And as Hal will address momentarily, factoring in continuing programs to maximize our operating efficiencies, we remain positioned to deliver on the double-digit operating margin target we've established for the video business segment in aggregate to the balance of this year.

So with that, let's now turn to our Cable Edge business on Slide 5, where we continue to make real progress advancing our CableOS growth agenda.

First, early revenue shipments of CableOS to our first major customer are ongoing, enabling the delivery of DOCSIS broadband services to tens of thousands of paying European cable customers with further footprint expansion expected over the next several quarters.

Second, we achieved a major milestone with another key customer, who initiated critical DOCSIS 3.1 field trial activity to validate readiness for the large scale deployment and progress to date on this trial has also been good, validating not only our fully virtualized 3.1 technology, but also the broader operational aspects associated with running a fully horizontally scaled virtualized CMTS stack in the field.

Third, during the quarter, we materially expanded new customer engagement activity in the United States, Europe and Latin America, encompassing both centralized and Remote PHY CMTS architectures.

And fourth, associated with this work, we have started shipments of our new Remote PHY nodes powered by CableOS to multiple customers performing end-to-end converged testing.

Now it's really important to understand here that this story is not just about Harmonic having a new CMTS solution and some good customer relationships.

With dual disruptions of virtualization finally coming to the Cable Access network and the distributed access architectures that push processing to the network edge promise massive scalability and cost advantages for cable operators worldwide.

New SNL Kagan data says that over 50% of cable executives polled representing 35 top global operators now expect to be deploying new distributed access technology by the end of 2018.

The combination of growing customer appreciation for the power of virtualization and distributed access architectures, Harmonic's significant technology lead in these areas and now our growing credibility through several high-profile or retrials and deployments all underscore our continuing confidence in this business.

So turning back to the first quarter, financial results for the Cable Edge segment were in line with our low expectations as the combination of soft legacy product revenue and heavy new product investment again weighed on the bottom line.

And that's been a bad news for our Cable Edge segment for sometime, and we expect it will continue to be the case in Q2.

However, looking beyond Q2, I want to assure you that our CableOS outlook for the remainder of 2017 remains positive.

We've been working closely with our lead customers, not only on technical issues, but also on volume deployment plans and associated commercial forecasts.

And based on this work, we continue to anticipate commencing volume shipments in the second half of this year.

With this target firmly in mind, for the next few months we're focused on scaling existing commercial deployments and trials of both centralized, industry-related DOCSIS solutions, leveraging our deepening field experience, steadily expanding market awareness and credibility and securing additional customer design wins as we go forward.

We remain well positioned to turn the corner in the second half of this year and hit the $100 million annualized run rate target we set for ourselves.

And of course, looking further ahead, the ultimate goal remains to become a leading player in the $2 billion-plus CCAP in distributed access architecture market.

We're genuinely excited to be entering the countdown phase and successfully turning this CableOS business, our innovations, our investments into a powerful new growth engine for the business.

So with that, Hal, let me turn it over to you.

Thank you, Patrick.

We want to thank everyone for joining our call today.

During my discussion, I will cover 3 topics: First, our financial results for Q1; next, our financial goals for Q2; and then our financial goals for the year of 2017.

Before discussing our Q1 financial results, we would like to start with some opening comments.

In our February 2017 call, we mentioned that for Q4 2016, we achieved financial results for both revenue and EPS ahead of our financial guidance, primarily due to completing certain video projects that we recorded in the Q4 2016 that were initially planned for Q1 2017.

We went on to say that this event combined with Q1 typically being our weakest quarter from a seasonality standpoint and that was reflected in our financial guidance for Q1 2017.

Although our financial results for Q1 2017 were below our guidance, we do not believe that the softness in our business experienced in the quarter is representative of prospects going forward.

Most of the shortfall in Q1 was related to our North American and European geographies, for which we expect the timing of purchase decisions to improve.

Taking our Q1 financial results and Q2 financial guidance into consideration, we continue to believe that directionally our financial performance aspirations that we articulated for 2017 are fundamentally intact with the acknowledgment that additional time is needed for achievement.

Key aspects of our updated 2017 financial goals include increasing non-GAAP video revenue on a year-over-year basis in 2017, pursuing double-digit non-GAAP operating profit for our video operating segments starting with the second half of 2017, achieving Cable Edge bookings that will support $100 million of revenue run rate and double-digit operating profit as we exit 2017.

The momentum needed to reach this goal is dependent upon achieving projected shipments for our new CableOS products and services, managing our Cable Edge operating segment so that it will not be a non-GAAP drag on overall EPS starting in the second half of 2017.

To enhance the achievement of our operating profit goals, we plan to reduce our current operating expense run rate on a sequential basis over the remainder of 2017.

We believe that we can accomplish this task without impacting the momentum of our business.

Shortly, I will provide more details about our 2017 financial goals.

Now turning to our financial results.

Please note that our financial results and guidance discussed during this call are based on non-GAAP measurements.

A table reconciling GAAP and non-GAAP measurements is included in our earnings call presentation and in our earnings press release issued earlier today.

Bookings for Q1 2017 were $82.1 million compared to $116.9 million in Q4 2016 and $109.6 million in Q1 2016.

Our bookings level for Q1 2017 reflects my earlier comments about our soft quarter as well as typical seasonality.

Non-GAAP revenue for Q1 2017 was $83.5 million versus $113.8 million in Q4 2016 and $82.5 million in Q1 2016.

Non-GAAP video segment revenue for Q1 2017 was $74.5 million versus $104.8 million in Q4 2016 and $65.6 million in the same quarter last year.

The sequential and year-over-year comparisons reflect the soft Q1 revenue level that we reported as well as typical seasonality.

Non-GAAP Cable Edge segment revenue for Q1 2017 was $9 million versus $9 million in Q4 2016 and $16.8 million in the same quarter last year.

Our Cable Edge revenue has been relatively flat since Q3 2016 and is not expected to improve until the second half of 2017 when we begin shipping a meaningful amount of our new CableOS products and services.

In Q1 2017, we did not have any 10% customers.

Non-GAAP gross margin was $43.5 million for Q1 2017, $63.8 million for Q4 2016 and $42.1 million for Q1 2016.

Non-GAAP gross margin as a percent of revenue for Q1 2017 was 52.1% versus 56.1% in Q4 2016 and 51.1% in Q1 2016.

Q1 2017 video gross margin was $40.9 million or 54.9% of revenue versus $60.4 million or 57.7% of revenue in Q4 2016 and $34.9 million or 53.2% of revenue in Q1 2016.

The sequential decline was due to lower revenue and product mix.

Cable Edge gross margin was $2.6 million or 29.1% of revenue in Q1 2017 versus $3.3 million or 37% of revenue in Q4 2016 and $7.2 million or 43.1% of revenue in Q1 2016.

The current gross margin range which began in Q3 2016 will not improve until the second half of 2017 when we begin shipping a meaningful amount of our new CableOS products and services.

Non-GAAP operating expenses for Q1 2017 were $54.9 million compared to $54.2 million in Q4 2016 and $50.5 million in the same quarter last year.

Our operating expenses in Q1 2017 were approximately $2 million higher than expected due to the timing of sales commission expense, professional fees and accruals.

Sequentially, we believe that our operating expenses will be lower in each quarter of 2017 starting with Q2.

Q1 2016 operating expenses only included 1 month of TVN.

Our non-GAAP operating loss for Q1 2017 was $11.4 million compared to a profit of $9.6 million in Q4 2016 and a loss of $8.4 million in Q1 2016.

The sequential loss reflects the lower-than-planned revenue level experienced in Q1 as well as gross margin as a percent of revenue.

The year-over-year increase reflects higher operating expenses partially offset by higher gross margin.

Our non-GAAP EPS loss for Q4 2017 was $0.14 versus a profit of $0.08 in Q4 2016 and a loss of $0.11 in the same quarter last year.

These comparisons reflect the comments just highlighted.

We had 79.8 million shares of non-GAAP common stock outstanding as of the end of Q1 2017 versus 80.1 million as of the end of Q4 2016 and 77 million as of the end of Q1 2016.

Now turning to our balance sheet.

We ended Q1 2017 with $55.3 million in cash and short-term investments compared to $62.6 million at the end of Q4 2016 and $76.2 million as of the end of Q1 2016.

The sequential and year-over-year decline primarily reflects cash outflows related to the purchase and integration of TVN.

Going forward, cash outflows related to integration activities will have a materially reduced impact over the remainder of 2017.

Our day sales outstanding at the end of Q1 2017 were 76 days versus 69 days at the end of Q4 2016 and 105 days at the end of Q1 2016.

Our days inventory on hand were 90 days at the end of Q1 2017 compared to 74 at the end of Q4 2016 and 94 at the end of Q1 2016.

The sequential increase in days on hand reflect the softer-than-planned revenue previously discussed.

At the end of Q1 2017, we had $184.2 million of backlog and deferred revenue compared to $188.4 million as of the end of Q4 2016 and $180 million as of the end of Q1 2016.

Staffing at the end of Q1 2017 was 1,358 compared to 1,376 at the end of Q4 2016 and 1,418 at the same time last year.

The sequential and year-over-year decline is related to our TVN integration program.

The following are our Q2 2017 financial goals.

Non-GAAP revenue $95 million to $103 million, which includes video revenue of $86 million to $91 million and Cable Edge revenue of $9 million to $12 million.

Non-GAAP gross margin as a percent of revenue 52.5% to 53.5%, which includes video gross margin percent of 55% to 56% and Cable Edge gross margin percent of 33% to 34%.

Non-GAAP operating expenses $52.5 million to $53.5 million, non-GAAP operating loss $2.5 million ranging to a profit of $1.5 million, non-GAAP EPS loss of $0.04 ranging to breakeven, non-GAAP common shares of stock outstanding approximately $81 million.

Cash and short-term investments at quarter end $40 million to $45 million.

For the most part, the sequential decrease in cash on hand projected at the end of Q2 is related to the lower-than-planned level of accounts receivable that we entered the quarter with due to our Q1 revenue level.

Based on our current outlook, our cash balance should improve in Q3 2017 with higher accounts receivable collections and improved operating profit based on achievement of our Q2 2017 financial goals.

Non-GAAP effective tax rate 15%.

Now the following are our 2017 financial goals: Non-GAAP revenue $400 million to $420 million, which includes video revenue of $350 million to $360 million and Cable Edge revenue of $50 million to $60 million.

Non-GAAP gross margin as a percent of revenue 53.5% to 54.5%, which includes video gross margin percent of 56% to 57% and Cable Edge gross margin percent of 38% to 39%.

Non-GAAP operating expenses $206 million to $207 million.

Our projected operating expense level for 2017 reflects the favorable year-over-year impact of our $20 million synergy savings program related to the TVN, which was essentially complete -- completed in 2016.

Non-GAAP operating profit $8 million to $22 million.

Non-GAAP EPS $0.02 to $0.16; non-GAAP common shares of stock outstanding approximately 82 million.

Cash and short-term investments at year-end $50 million to $55 million; non-GAAP effective tax rate 15%.

I will now turn the call back over to Patrick.

Okay.

Thanks, Hal.

Let's finish up and turn to our Slide 10, where we want to close by again emphasizing that we have one overarching objective for the balance of 2017.

And that is to leverage our expanded video market leadership in CableOS software innovations to significantly improve the long-term profitability and cash flow of the business.

In video, objective number one is to increase value by driving revenue growth and margin expansion, catalyzed by the ongoing market transition to software-based platforms for Internet video services.

And supporting this is objective number two, we'll grow market share and strengthen our financial model by advancing our leadership in cloud, excuse me, Software-as-a-Service in 4k.

And objective number three, delivering aggregate double-digit operating margin in the business for the balance of the year.

On a stand-alone basis, we continue to believe our video segment is a strategic market-leading business with compelling upside.

On the Cable Edge side of the house, we have the industry's first modern virtualized CMTS on the launch pad.

So objective number one is to continue the momemtum for the first quarter into the second quarter to further scale commercial deployments and advance DOCSIS 3.1 and distribute access architecture field trials.

At the same time, there is growing industry buzz around the products we're making with key customers, and objective number two is to leverage this to secure new design wins with additional operators.

And objective number three continues to be to exit the year with both $100 million annualized run rate in a competitive market position that will enable our compelling growth business well into the future.

So look, while Q1 was softer than we expected following a strong fourth quarter, our business pipeline is strong, our backlog deferred revenue was strong and our overarching targets for 2017 are unchanged.

We're pushing full speed ahead, leading the charge in software-based video processing and virtualized cable broadband delivery, leveraging our strong customer relationships, this record backlog and growing innovation advantage.

Our entire organization is laser-focused on the continuing execution of our strategic video and Cable Edge growth initiatives, and on driving a sustainable new phase of profitable growth and shareholder value creation.

So with that, let's now open the call to your questions.

(Operator Instructions) And our first question comes from George Notter of Jefferies.

I guess, I wanted to dig in to some of the Q1 dynamics in the video business.

I think you said that you saw shift outs in business in the last month.

And yet at the same time, I think you also said that some of the softness was a result of the strength in Q4.

And I guess, I'm trying to under -- reconcile all this, I guess, I would have assumed that had you pulled a lot of business forward in to Q4, you would have seen softness right away in Q1, and I guess, I'm just trying to understand that.

And then also I want to understand how much of that video softness is really directed at satellite customers?

Or is it more a broader mix of customers?

Yes.

I'll start and then pass it to Patrick very quickly, George.

When we set the guidance for Q1, we actually took into consideration the projects that we closed in Q4 that we thought were going to actually be recorded in Q1.

So we did take that into consideration.

I think Q1, just -- we had things slip out at the end of the quarter due to timing that we talked about earlier that we did not count on.

So we did anticipate the impact from the Q4 overage so to speak, but nothing more than that.

That's fair.

I mean, the additional thing I would say is Q1 is always a somewhat backend-weathered quarter.

Many businesses take a little while to get going in the beginning of the year.

So we always expect a relatively strong March month, and this was no different with several key projects.

And as both Hal and I mentioned, we saw unfortunately a couple of those anticipated and frankly committed projects from customers get delayed.

And good news is a couple of them were subsequently then closed in April, but a couple of them are -- have drifted.

As I mentioned in my prepared remarks, from a geographical perspective Europe was -- and Middle East and Africa is where we saw the biggest or proportionately the largest concentration of that, George.

But it wasn't tied specifically to any particular customer vertical.

It was -- it certainly included demand from satellite operators, but we saw it across-the-board.

Just for whatever reason, and we don't think it's anything actually that looking at our pipeline, we don't think there is anything really at work, systemic at work here.

But just a confluence of events that we saw a pretty weak quarter, with just a number of customers for a variety of reasons pushing things that are relative to what our expectations had been.

Got it.

And then is this -- how broad is this?

Is this -- are we talking about 2 customers, 5 customers, 10 customers, I'm just curious, how broad this is across the customer base?

In terms of the significant deals that we anticipated, in the neighborhood of 5.

And our next question comes from Tim Savageaux of Northland Capital.

Just following up on that really quickly, so you mentioned EMEA is kind of a geographical area of weakness, but in your slides you did call out satellite Pay-TV softness.

Is that meant to refer to something separate that was also an issue?

Hal mentioned weakness in North America and we do know that they had an awfully tough quarter over there at DIRECTV, this quarter and probably changing some things around there.

So I wonder if we could infer anything there from that satellite remark?

Or because if you didn't mean to call out verticals -- and then you seem to have called out verticals.

So I just want to kind of clarify that.

Well, so there's 2 different things.

I think the point on the slide in there is to say that it's -- we saw and we say -- and we see going forward kind of a mix shift relative to what we thought.

As I just mentioned, biggest thing in Q1 was simply the delay of a handful of sizable deals.

And frankly, those were not exclusively with the satellite, those were kind of a cross customer verticals.

We typically concentrated in Europe just the way it worked out.

That being said, full transparency on the market as we sit back now and did our detail analysis for what the rest of the year looks like relative to the demand trends we saw when we put together our plan 3 or 4 months ago.

We do see -- for the balance of the year, we do see relatively less satellite spending, largely compensated for a -- relative increase and what we had expected in over-the-top.

So that was really meant to give a little bit more color on not so much the weakness in the quarter, but some of the event evolving demand trend changes that we've noticed.

Got it.

And then sort of continuing along that service provider focus, it doesn't sound like you've seen a whole lot of change and I don't know whether the quarter or you expect for the year out of the U.S. Cable vertical.

Clearly, you've got a bunch of trial activity going on, but just from a spending standpoint any commentary there?

Cable is positive.

In fact, one of the delayed deals we referred to was actually a U.S. cable deal that subsequently came in, in early April, really a timing thing more than anything else, Tim.

But in general, as we look at the full year, the demand trends that we anticipated on both the video side as well as the Cable Edge side of the house are largely intact.

We don't anticipate any real changes relative to our original view of the market in terms of cable.

And we're fully bullish on cable for this year.

Okay.

And you mentioned, you had a couple of deals that were pushed closed, is that as well as kind of overall kind of backlog and deferred metrics that really didn't change much from last quarter, I guess despite a pretty significant slowdown and a reduction in bookings.

Wondered if you can kind of discuss that dynamic, maybe just sort of mathematically?

And whether -- I think you discussed in the last call, having traded some revenue that normally would have come in either hardware or software license that turned into cloud and that had a certain impact, I wonder if you had a similar discussion there?

And just kind of the overall drivers of visibility to what remains a pretty steep ramp on the video side looking into Q2, understanding that some of these deals closings and the backlog situation probably contribute to that?

Yes.

So let me start and Patrick can certainly jump in whenever he wants to.

First of all on the bookings, our bookings and revenue were fairly close for Q1.

Our bookings were a little over $81 million, our revenue was $83.5 million, so pretty close.

And so we had a fairly consistent deferred revenue backlog at the end of the quarter, which is good.

The other thing I would say, Tim, is that when we did a deep dive on looking at the balance of the year for video, and we -- in our plan for the balance of the year, we have not put a catch up in there for Q1, primarily because of the -- some of the softness that we see in the market place.

We don't think that's going to happen over the balance of the year, which gets us in a position where we can actually grow our video revenue on a year-over-year basis, which is our goal now.

We thought we'd be a little bit higher, but again, we had a miss in the neighborhood of $10 million, $12 million in Q1 that we don't think we're going to make up, but again will still be a year-over-year positive growth.

Roughly, about $4 million or $5 million of our bookings in quarter 1 were related to cloud-based activity.

And that's $4 million or $5 million in revenue that would have happened in the old model in Q1.

In the new model, its a recurring stream that's going to happen over a couple of year period of time.

So although we didn't -- we did build that into our plan, we are building a recurring revenue stream as we go forward and that we have calculated than in our balance of the projection for Q2 through Q4 this year.

So we're still looking for a pretty healthy video environment over the balance of the year.

I don't know Patrick if you want to...

No, I think that captured it, Hal.

Okay.

Well, understood.

And 1 final question for me and I don't know that you've guided to this level of granularity before, But is there any change in your margin expectations over on the Cable Edge side, is that ramp exiting the year or you seem to be a little bit lower in Q2 maybe that's sort of having (inaudible) time...

Yes.

a couple of points, Tim.

Just to follow on.

First of all, let me start with the positive, our video margin is really looking good for the full year at around 56% to 57%, that's back to our historical level.

So we've compensated for the lower level we had by a couple of percentage points in 2016, because of TVN.

On the Cable Edge side, we expect to end the year with a margin that approaches the mid-50 as we start shipping our CableOS products.

The margin in quarter 1 and quarter 2 for the most part has been impacted by lower service levels, so we didn't have as much -- we have more professional services going on in those quarters and it has a lower-margin associated with it.

So it is a little lower in the first half of the year, but we expect it to pick up in the back half of the year.

And our next question comes from Greg Mesniaeff of Drexel Hamilton.

Patrick, you mentioned in your opening remarks that one of the factors affecting gross margin in the quarter was higher services and support revenues.

Can we drill down a little deeper on that.

Is that primarily tied to the business video in the quarter or the CableOS business and some of the opportunities you're working on right now in terms of the next-generation CCAP products leased up there?

Yes, as Hal mentioned a moment ago, Greg, that specifically it was a strong quarter from a services and support point of view, and it was particularly strong on the cable side.

I should explain that as we as a company kind of get geared up to really be able to support DOCSIS deployments in the field in earnest, in volume, one of our initiatives is to make sure that not only do we have a right product, but we do have the right to services capability.

So in fact starting a year ago, we started to get our services group involved even with third-party DOCSIS product offering services that we might not normally provide to cable operators just to make sure that we're -- our people out there in the field are fully capable, aware, trained on, working in the cable head environment around all of the high-speed data solutions.

So part of that is what you're seeing that.

A relatively higher mix of services and support in general, particularly around services for cable, and of course, from a mix perspective with lower product revenue in the quarter, you end up with a lower blended gross margin.

Okay.

And when do you think that ratio will turn more favorable for you as far as services versus products in the cable?

Yes.

I just mentioned a few minutes ago, Greg.

I think that in Q4 once we start shipping our new CableOS products and volume, we should see an improvement, and we actually believe we can really start pushing close to the -- hitting the 50% goal, which is our -- in total, which is our longer-term target as we exit the year.

You may recall that our old legacy business was more in the -- closer to 40%.

So we are looking for a nice uptick again, as we exit the year once we start shipping CableOS and volume.

Cable business (inaudible).

Business and aggregate simply higher video product and software mix will drive a higher composite gross margin, which is what we're anticipating for the next quarter.

Sure.

And would it be fair to say that the video business is really not requiring that -- as much or as much at all services revenues as the cable business?

Yes.

I think it fits the normal pattern that we've had in our video business in the past.

And again, I think the positive thing about our video business from a gross margin percentage standpoint.

Now as we're -- our target is to get back up to the 56% to 57%, which we historically experienced prior to the TVN acquisition last year.

And that includes associated services.

That's also (inaudible).

So we're in a pretty good track on the video side, gross margin percent-wise.

And our next question comes from Steven Frankel of Dougherty.

So the guidance for the rest of the year in terms of gross margins and we have been digging into that a little bit here with the CableOS side.

But it still looked like overall, it's a little lower than what was anticipated before.

Is that just the lower revenue run rate?

Or are there pricing pressures going on in the video business that's dinging gross margins?

Yes.

So I think you have to look at the 2 businesses.

So on the video side, it's primarily because of just the lower revenue that we experienced in Q1.

As I said before, we're not trying to catch that up.

From a gross margin percent-wise, we're right on target video-wise to get between 56% and 57%, and that part of it we're really happy with.

On the Cable Edge side, and again as we mentioned early on, we were kind of dragging in quarter 1 and quarter 2 to get a little bit better in quarter 3. But in quarter 4, we expected to get back up to the targeted level.

So essentially, it's driven more by revenue than anything else right now.

Initially on the video side, we thought our video revenue would be above $370 million range and now we're at $360 million at the high end of our guidance, essentially because of the miss that we had in quarter 1. So it's revenue-driven.

Okay.

And on the transition to cloud and SaaS, are there any more metrics that you would be willing to share with us in terms of size of that backlog or the number of cloud and SaaS deals you have today?

So Patrick and I over the last -- and Bart who runs the business have been talking about that and we're going through a fairly strategic review of the business over the next couple of months here and our plan is in the back half of the year to start giving you a lot more guidance on that.

It's starting to get to be a meaningful number.

I mean, for example, we talked about roughly about 5% of our bookings in quarter 1 were related to our SaaS business and that represents roughly about a $4 million revenue stream.

So we're at a point now where we need to give more guidance and direction on that and transparency, and we will be doing that.

Okay.

And do you think through this transaction in the next couple of quarters there is a lot more ASP pressure in the video side?

Or have hardware sales and hardware pull-through fallen to a low enough level that, that's not a headwind in the back half of the year?

We don't assume much change through the back half of the year.

You never kind of say never, but it's an interesting time what's happening competitively.

Let me -- let's just put it on the table, historically our largest competitor in this space, Ericsson, is going through some reconsideration of where they're going with the media business, and we see that as a positive thing.

Yet, there's others in the market applying pressures.

But on balance actually we think it's a relatively more benign competitive environment.

And looking outside of the company and inside of the company, we're pushing hard on the innovations and the move to software that we've discussed.

So I don't want to take the possibility of a continued price pressure off the table, but we think that from a couple of different perspectives, we're better positioned ever -- than ever to withstand that and it's one of the reasons why as Hal as mentioned a couple of times, we're confident about the gross margin in the video business bouncing back to the 56% to 57% level that we've talked about here.

Okay.

And you speak with a lot of confidence about the CableOS ramp, maybe if you could tell us what gives you that confidence, is that the detail of the discussions you're having with the customer?

Is it where you are in the trials?

Is it just your confidence in your company's ability?

It's the confluence of a couple of different things.

In no particular order, as I mentioned earlier, take Harmonic out of it, this industry is actually finally waking up to the fact, like much of the rest of tech has, is that the concept of virtualization can be extremely powerful.

The concept of Edge processing in the network can be extremely powerful.

By powerful, I mean, something that can open up tremendous scalability as well as cost efficiency.

So that kind of a high is hitting the industry.

I mean, we're certainly helping it, but it's not just coming from us.

That's extrapolation in this industry of things that have happened elsewhere.

And so we're confident that -- we're increasingly confident that cable is not going to be some kind of isolated part of the broader tech landscape that is immune to the power of virtualization and the power of Edge processing.

So I think that's one reason and the Kagan data that we cited earlier I think speaks to that.

Look, everyday that goes forward and everyday we move forward, we get more experience with our own technology, we become more excited about it, more convinced in powering capability and that comes out of our own lab.

But I think just as importantly it comes out of our customer's labs and their evaluations.

And then third by virtue of not just discussions, but the real substantive work that we're doing with early deployments and in the field not our CMTS solution isolation, but fully integrated with the broader ecosystem we're really seeing tremendous progress and the customers who are working with it are actually seeing validation of some of the promise that I alluded to earlier.

The benefit of virtualization, the benefits of Edge processing in a distributed scenario.

So I characterize this as more than just a discussion.

Customers are starting themselves to have a tangible aha moment, saying, "Wow, this stuff works.

This stuff is real.

Looks like my benefit -- my business is going to benefit in this way, that way and this way." So all of those things, I mean we've still got a long way to go and I don't want to make it sound likes it's done by any means.

But you look at all of those data points and yes, we are feeling increasingly comfortable and confident.

And there is -- I'm glad that (inaudible) let me add one more thing, which is that I also alluded to which is discussions are expanding now to be more customers and particularly with the earlier customers that are becoming more about what volume deployment looks like and what the forecast is going to look like.

So that's kind of a tangible data point, a tangible discussion that certainly also gives us confidence that what we're doing is real and it's something that we can -- with increasing confidence bake into our plan.

And could you give us a rough idea of how many live field trials you have ongoing today and maybe what that looked like last quarter?

Up until recently we've been focused on a number that's less than 5. And our strategy still becomes not to attack simultaneously 50 cable operators around the world.

But we're north of 5, south of 10 right now.

Okay.

And any update on the CFO transition?

We have a search ongoing.

We're pleased to be speaking seriously with a number of good candidates.

But there is no eminent announcement nor have we finalized or completed the search.

And has -- Hal staying until there is somebody else on board?

Or you will appoint somebody to take his place on an interim basis?

I'll tell you what my plan is and then Patrick can tell you his.

My plan is to stay fully engaged and active.

The business is going through a rough spot right now and I believe that we'll make it through the transition.

And again, I'm fully engaged until Patrick tells me to disengage.

So look, it's a -- it's been a pleasure and a privilege to have Hal on the staff and on the team for these past whatever it is been 18 months.

And I and the rest of the team and our board are deeply appreciative of his willingness to stay with us in a leadership capacity through the successful completion of the search.

And our next question comes from Matthew Galinko of Sidoti.

So is 5% of bookings the right level to think about for the full year in the video business?

And then in terms of how much is coming in on a SaaS basis?

Right now, Matthew, I would take that number and we'll give you more information when we announce the set of metrics or statistics that you can follow.

My guess is it's going to be higher than that.

But for right now, I think until we complete our strategic review over the next few months here, I'd go with the 5%, which even at that level it starts to build up a pretty interesting recurring revenue stream over the next few years.

But there's no doubt in anybody's mind here in the company that people are going to move to the cloud-based model, and it will take a few years for that to happen.

And again, we'll layout more of a game plan within the next few months here.

Sure.

I mean, maybe it might be helpful if you could share what your internal expectation might have been coming into the quarter and the year before that.

Is that all possible?

Well, I think right now we did have an internal expectation.

We're probably tracking slightly ahead of that right now, and we did have that built into the plan.

But again, I think in the next few months here when we complete our detailed strategic review, we'll provide more information that you can actually start tracking it.

We realize because of the transition the business is going to -- a very positive transition by the way, that we need to help with more transparency along that line, and we will do that.

Okay.

And last one for me, in terms of the $100 million run rate you're talking about or exit rate for Cable Edge business, does that anticipate any additional Tier 1 wins?

It does anticipate Tier 1 wins more than one, and we think it will happen again in the fourth quarter.

Now that's the game plan and that relates to the trials that Patrick highlighted earlier on.

And the next question comes from Simon Leopold of Raymond James.

This is Mauricio in for Simon.

Can you please talk about your competitive position in the next-generation CCAP products?

Sure.

We're the first to have a -- who have announced and released a fully virtualized solution.

You may recall we announced that at the Cable Show in Philadelphia in October of last year.

And this completely virtualized solution all the way down to the physical layer, everything but the physical layer has tremendous potential cost, flexibility of deployment and scalability advantages, not really different than the way you see virtualization being leveraged in other parts of the broader tech and communication space.

So I think that that's first.

While, that's a broader advantage.

The second thing it really leverages or enables quickly is the seamless support of both centralized as well as distributed architectures.

And here, again, many cable operators are gravitating to the ideas -- idea of distributed architectures as a way of within the constraints of existing real estate, head-ends, et cetera, power, budgets, et cetera, as a way of quickly scaling up broadband capacity in the access network.

So full virtualization, seamless within that -- under that umbrella, seamless in cooperation of both distributed and centralized architectures, tremendous cost scalability advantages and flexibility.

And as mentioned earlier, the response from the cable operators -- leading cable operators who are really ahead of the pack and thinking about this and working on it has been quite positive.

And then one more for me.

Last quarter you expressed optimism regarding the adoption of your new products in the second half of 2017.

Can we get an update on your view regarding these opportunities?

And are you basically -- are you feeling incrementally more or less optimistic today than you did on your last earnings call?

Yes, Sure.

We summarize that earlier, but I think it bears repeating.

We're feeling incrementally more confident simply because we've made good progress with the first quarter.

We have one scale deployment in Europe, and we have a couple of other significant field trials in the U.S. and elsewhere, all of which have gone quite well.

And that gives us more technical confidence.

It gives our customers confidence, not only in the technology in the standalone way, but the way it can be integrated into the broader operating environment.

And based on this positive progress, our discussions with our customers have now pivoted -- those customers have pivoted towards forecasting and planning for volume deployment.

And at the same time, those trials and tests are not really simply super well kept secrets in the industry, you're not hearing anything from us.

But nonetheless, other cable operators are aware that we're doing very interesting things in the market.

And so our credibility is -- of our technology, of our company in this area and the credibility of this kind of technological approach all of that is gaining momentum.

And so that's giving way to more customer discussions and more customer engagements, and it gives -- it leaves us confident that we will see additional design wins before the end of the year.

Thank you.

And that concludes our question-and-answer session for today.

I'd like to turn the conference back over to Mr. Harshman for any further remarks.

All right.

Well, thank you very much.

And just wrapping up, we want to emphasize that despite a slow first quarter, there's good reason to remain confident in our business.

On the video side of the house, the sales pipeline is solid, momentum behind our new cloud and SaaS capabilities as we've just discussed is strong, and we have near-record backlog in deferred revenue.

And we're continuing the necessary operating improvements to achieve double-digit operating margin for the balance of the year.

In Cable Edge, while the near-term financial outlook remains challenging, that's no surprise and the real story here is about our increasingly successful CableOS field trials in commercial deployments and our expanding customer engagements.

Again, as we've just discussed, all of which keep us on track for the start of a meaningful multiyear volume ramp in the second half of the year.

We are undeterred by the first quarter.

In fact, we're encouraged by what's happening strategically behind it and believe you -- me, we're hard at work on the second quarter and the rest of the year.

In that context, we very much appreciate your continued support.

And we look forward to providing you additional updates on our next second quarter or if we see you before that.

Thanks very much, everyone.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may now disconnect.

Have a great day everyone.