Harmonic Inc (HLIT) 2017 Q3 法說會逐字稿

Welcome to the Third Quarter 2017 Harmonic Earnings Conference Call.

My name is Skyler and I will be your 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, Harmonic's Director of Investor Relations.

Blair King, you may begin.

Thank you, Skyler.

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

With me at our headquarters in San Jose, California are Patrick Harshman, our CEO, and Sanjay Kalra, our CFO.

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

Now 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 results or events may differ materially.

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

These documents identify important risk factors which 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 a reconciliation to GAAP are contained in today's press release, which we have posted on our website and filed with the SEC on Form 8-K.

We'll also discuss historical, financial and other statistical information regarding our business and operations.

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

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

Patrick?

Okay.

Thanks, Blair, and thank you all for joining the call today.

Let's get started by turning to our Slide 3, where you can see that third quarter revenue was $91.6 million, just above the high end of our guidance range.

Our video segment led the way, up 15% sequentially, powered by a growing demand for our live over-the-top platform.

As anticipated, Cable Edge revenue continued to decline in front of the major market and product transitions that we'll discuss shortly.

Book-to-bill was again greater than 1, as new orders came in at approximately $96 million, up 5% sequentially.

These new orders included a growing mix of video software and related services and material CableOS commitments, driving our backlog and deferred revenue to over $200 million, a record level for the company.

Gross margin in the quarter rose to 53%, driven by higher video segment gross margins, although offset slightly by lowered Cable Edge gross margin due to both declining legacy product volume and heavy new product introduction costs.

The result was a profitable video segment and an expected Cable Edge segment loss, resulting in a combined net non-GAAP EPS loss of $0.01.

So with that brief summary, let's turn to our video business on Slide 4. The key message here is that video revenue in the quarter was $84 million, up 15% sequentially, accompanied by expanded gross margin and over 8% segment operating income, as Sanjay will discuss shortly.

This rebound was driven by a resurgence of new project spending, particularly in the areas of media playout and premium-quality live over-the-top, and by competitive share gains.

A subset of this over-the-top business came in the form of new SaaS commitments.

Total contract value for new SaaS over-the-top deals accounted for of total company bookings, increase our over-the-top annual recurring revenue to approximately $7 million.

Now related to this portion of our over the top business that is being purchased as SaaS, I want to update an answer provided on our last earnings call.

Specifically, I was asked if our SaaS bookings could achieve 20% of total company bookings within a year.

With the caveat that it was still early days, I answered that 20% of bookings converting to SaaS was possible during 2018.

Now since then we've spent more time delving into the pace of SaaS bookings growth and speaking with leading customers and partners regarding their SaaS adoption plans.

With the benefit of this additional insight, we now anticipate a more gradual conversion of CapEx engagements to SaaS, such that over-the-top SaaS bookings are likely to remain a single-digit percentage of total company bookings through 2018.

That said, we remain excited to be growing our recurring revenue stream as part of our broader over-the-top strategy.

Which brings us to the second key message here, and that is that the video market we address is continuing to evolve from a traditional pay-TV model to a new over-the-top model, creating some transitional challenges that continue along with tremendous opportunities for our company.

Now while there's no question that investment in traditional pay-TV solutions is declining, this is still a $1-billion-plus global market, and here we remain focused on profitably capturing market share and strengthening our strategic relationships with the world's leading pay-TV operators and media companies.

And while the switch from traditional pay-TV to what we call OTT 2.0 -- that is, premium-quality live over-the-top services targeted to both the large family room screen and mobile devices -- it has certainly caused some pause in investment as customers formulate their over-the-top strategies.

It's increasingly clear that there is a growing wave of investment in these new live and premium over-the-top services, and that delivering these new over-the-top services with broadcast quality and reliability is becoming increasingly important to our customers.

And this view of the evolution of the market brings us to the third key message here, which is that Harmonic's OTT 2.0 growth strategy is gaining real traction in the market, positioning our video segment for greater stability and profitability.

Now core to our strategy is our technology innovation team that's unrivaled in the industry and has recently delivered breakthroughs in quality of over-the-top consumer experience; in low latency, which is particularly important for live sports; and in bit rate compression, which is increasingly important for mobile applications.

Now the second unique pillar of our over-the-top strategy is leveraging the combination of these new technology innovations and our broadcast expertise to enable traditional pay-TV operators and media companies to transition smoothly from linear broadcast to new OTT services; and behind that, from appliances to virtualized software in cloud, and for some from CapEx to SaaS, all while retaining the video service quality and reliability that is critically important to our customers' brands.

And finally, regarding our over-the-top strategy, the third pillar is expansion of our addressed market.

For example, through both traditional CapEx and new SaaS deals, Harmonic is playing a key enabling role for several of the so-called skinny bundles being rolled out in the U.S. We're also now targeting completely new direct-to-consumer services that are being launched by global media companies, brand-new international over-the-top services and leveraging our SaaS platform, growing live productions such as concerts and special sporting events.

And so in summary here, we've delivered a strong video segment quarter.

We're reiterating our fourth quarter guidance.

And looking ahead, we have an over-the-top growth strategy that positions this business to thrive as the market continues to pivot from traditional pay-TV to OTT 2.0.

So let's now turn to our Cable Edge business in Slide 5. As anticipated due to the ongoing cable network architectural transition, legacy EdgeQAM demand continues to be weak.

Revenue is approximately $7.5 million, down 27% year-over-year.

However, the real business headline here is that our new CableOS platform, which uniquely enables the coming cable access transformation, continues to gain tangible momentum in the marketplace.

First a word about the market itself.

As anyone who attended the recent Cable-Tec Expo in Denver can attest, it's quickly becoming industry consensus that the cable access network is going to be disrupted by the dual transformations of network function virtualization and distributed access.

Harmonic has clearly been the thought leader and innovation leader here, and customer feedback continues to be that we're way out in front of our competitors in the space.

The questions around virtualization coupled with distributed access have clearly shifted from "if" to "when," and we continue to contend that the "when" is coming sooner than many predict.

Now while most of our field activity remains customer-confidential, we can show the following data points that indicate continuing material progress in turning CableOS into a growing and profitable business.

First the number of CableOS commercial deployments in advanced field trials has now expanded to include over ten leading cable operators around the globe.

These deployments span centralized and distributed architectures and are decisively proving out the operational feasibility and benefits associated with our virtualized solution.

The largest of these deployments is now delivering DOCSIS services to over 40,000 paying high-speed-data subscribers, demonstrating the scalability, reliability and real-world interoperability of the platform.

And I'm particularly pleased to announce here that we've secured a new Tier 1 customer design win, so we've now received purchase orders from 2 of the top 5 global cable operators and grown our CableOS backlog to over $20 million.

While this backlog is only the tip of the iceberg in terms of the overall opportunity, it's nonetheless real money that speaks to the real confidence influential customers are placing in CableOS and Harmonic.

So putting it all together here, we see growing customer appreciation for virtualization and distributed access and the synergies between the 2; new customers wins, including a new Tier 1; expanding deployments; technical validation of scale deployments with tens of thousands of legacy cable modems, et cetera; and a growing backlog of new orders.

Consequently, we continue to believe that we're well-positioned to hit the $100 million revenue target we've established for 2018.

Looking further ahead, our vision continues to be growth well beyond this level by capturing significant share of approximately $3 billion [in the] CCAP and distributed access market.

So with that, I'll now turn the call over to you, Sanjay, for a more detailed look at our third quarter financial results and our outlook for the fourth quarter.

Thank you, Patrick.

I would also like to thank everyone for joining our call today.

During today's discussion I will cover 2 topics: first, our financial results for Q3 '17; and second, our financial guidance for Q4 '17.

Please note that the numbers I'll be referring to here are on a non-GAAP basis.

Let's turn to Slide 6 and start with our Q3 '17 results.

Revenue was $91.6 million, exceeding the upper end of our guidance range, compared to $82.3 million in Q2 and $101.7 million in Q3 '16.

Video segment revenue was $84.2 million, also above the high end of our guidance, and compares to $73.4 million in Q2 and $91.7 million in the same quarter last year.

Q3 Cable Edge segment revenue was $7.4 million, slightly below the low end of our guidance.

These results compare to $8.9 million in Q2 and $10 million in the year-ago period.

Our Cable Edge revenue is not expected to improve materially until CableOS shipments begin ramping, which is expected to begin late in the current quarter and pick up pace throughout 2018.

Gross margin was $49 million in Q3 compared to $39.4 million in Q2 and $53.4 million in Q3 '16.

Gross margin as a percentage of revenue was 53.4% in Q3, 47.9% in Q2 and 52.5% in Q3 '16.

Video segment gross margin was 57.4% in Q3, 51.4% in Q2 and 54.1% in Q3 '16.

The higher margin was the result of a favorable product mix, with higher composition of video products, with more software content shipped this quarter.

Cable Edge gross margin was 9.2% in Q3, 19% in Q2 and 37.3% in Q3 '16.

The sequential and year-over-year decline is a combination of declining legacy product volumes and new product introduction costs.

Operating expenses for Q3 were $47.7 million, just below the low end of our guidance.

Operating expenses are $55.8 million in Q2 and $52.9 million in Q3 '16.

The overall reduction in operating expenses was primarily driven by a 6% headcount reduction from 1,338 employees in Q2 to 1,258 employees in Q3, augmented by cost controls throughout all the functions of the company and realignment of our R&D investment with the company's business strategy and market opportunities.

Our reduced R&D expenses also reflect the reimbursement of engineering spend by one of our large customers which had been delayed from the prior quarter.

Looking ahead, we'll continue to balance our R&D investment strategy to capitalize on evolving market opportunities to expand our addressable market, satisfy customer trends and return the business to profitability.

Q3 operating income of $1.3 million was driven by a sequential and year-over-year improvement in our video segment, which contributed $7 million of operating income and 8.3% of margin in the quarter.

Q3's $1.3 million operating income compares to an operating loss of $16.4 million in Q2 and operating income of $400,000 in Q3 '16.

An EPS loss of $0.01 in Q3 compares to a loss of $0.20 in Q2 and a loss of $0.01 in Q3 '16.

We ended Q3 with a weighted average basic share count of 81.4 million compared to 80.6 million in Q2 and 78.1 million in Q3 '16.

Bookings were $96 million compared to $91.1 million in Q2 and $97.3 million in Q3 '16.

As Patrick mentioned, the sequential growth in our Q3 bookings reflect meaningful progress, advancing our CableOS financial agenda, which more than offset a seasonally weak service bookings quarter.

As a reminder here, a majority of our service level agreements are booked in the second and fourth quarters of the year.

The key takeaway for Q3 results is that, while we have a ways to go, these Q3 results, especially video revenue, gross margins and expense control, demonstrate tight focus on execution and establish a template for continuing strengthening of our business.

Moving to Slide 7, I would like to pause here and provide some additional context regarding our Q3 results and an update on our settlement with Avid, which we announced in our earnings release.

In addition, I will briefly comment on our Silicon Valley Bank credit facility established in the quarter.

First, with respect to our SaaS initiative, in Q1 about 5% of our bookings came in the form of SaaS, which, as Patrick explained, are a subset of overall OTT activity.

In Q2 about 8% of our bookings were SaaS-based.

For Q3, 6% of our bookings were SaaS-based, slightly higher than our 4% guidance.

Keep in mind that when a traditional CapEx booking comes in we typically recognize the vast majority of that bookings as revenue immediately or within a quarter or 2; but if that booking comes in as a SaaS order, revenue is instead recognized ratably over time, resulting in much less current revenue for the period but an expanded backlog which bolsters future revenue and profits as well as predictability.

Relative to our anticipated third quarter OTT SaaS mix of 4%, which was factored into our guidance, the effect of the actual higher 6% mix of TCV subscription bookings means that additional 2% of bookings cost us about $1.5 million in traditional video product revenue and about $900,000 of operating income in the quarter.

However, we are building a longer-term, higher-margin recurring revenue.

Looking ahead, as a general rule of thumb, on an annual basis each $1 million shift from a traditional CapEx purchase to SaaS will reduce total company revenue by $600,000 and total company non-GAAP operating margin by $400,000 in the initial period.

Keeping this in perspective, as Patrick mentioned, we expect only a modest single-digit percentage of bookings conversion of business from CapEx to SaaS for the coming quarters.

As SaaS bookings and revenue become more meaningful and begin to absorb our investments in R&D, we'll provide you an update to this model.

Regarding the Avid litigation, I am pleased to announce we recently executed a settlement and patent portfolio cross-license agreement with Avid, ending Avid's patent infringement action against Harmonic on mutually acceptable terms, without incurring trial expenses.

Under the agreement, we have agreed to pay Avid a total of $6 million over the next 3.5 years.

The first payment of $2.5 million was made in October of this year.

There will be no payment in 2018.

Two additional payments of $1.5 million and $2 million will be made in the second quarter of 2019 and the third quarter of 2020 respectively.

As a reference, the full $6 million expense is reflected in our third quarter GAAP results included in our general and administration expenses.

Finally, as announced last month, we put in place a $15 million working capital facility with Silicon Valley Bank in Q3 which was not used during the quarter.

We currently do not have any intention to access this facility.

Rather, with nominal facility fees on the undrawn amount, we see it as both good housekeeping and a means to access cash on favorable terms if needed at some point in the future.

Now turning to our balance sheet on Slide 8, we ended Q3 with $50 million in cash, matching the high end of our guidance.

This compared to $52.9 million at the end of Q2 and $52.7 million at the end of Q3 '16.

Following strong improvements to working capital metrics in Q3, we used approximately $8.6 million in cash from operating activities, of which $6.4 million was used for building working capital.

This was partially offset by $6.2 million of tax credit funding received in the quarter related to research and development activity in France.

Our days sales outstanding at the end of Q3 was 70 days compared to 66 days at the end of Q2 and 89 days at the end of Q3 '16.

The sequential increase reflects both the increase in accounts receivable and revenue, while the year-over-year decrease underscores the efforts we are making to drive working capital improvements throughout the organization.

Our days' inventory on hand were 67 days at the end of the Q3 compared to 74 days at the end of Q2 and 67 days at the end of Q3 '16.

The sequential decrease was due to good execution in operations and supply chain management and an associated inventory reduction.

At the end of Q3, we had a record $200.9 million of backlog in deferred revenue.

This compares to $194.4 million at the end of Q2 and $181.1 million at the end of Q3 '16.

Again, the sequential and year-over-year increase is primarily due to the receipt of material new orders for our new CableOS system, including commitments from 2 of the world's top 5 cable operators and an increase in backlog of our traditional video broadcast and OTT SaaS offerings.

Now turning to Slide 9, our non-GAAP guidance for Q4 '17 is unchanged from our prior Q4 guidance provided in July, despite a stronger than anticipated Q3: revenue in the range of $90 million to $100 million; video revenue of $80 million to $86 million; and Cable Edge revenue of $10 million to $14 million.

Gross margin of 52% to $53.5%, with video gross margin of 55% to 57%, and Cable Edge gross margins of 27% to 29%.

Operating expenses to range from $48 million to $50 million.

Operating profit to range from $3 million loss to $5.5 million profit.

EPS to range from $0.05 loss to $0.04 profit.

Effective tax rate of 15%, and weighted average basic share count approximately 82 million to a diluted share count of 82.5 million.

Finally, cash and short-term investments at the year-end are expected to range between $40 million to $50 million.

The implied full-year 2017 guidance as a result of our guidance for Q4 is contained in the table in our press release.

I will now turn the call back over to Patrick.

Okay.

Thanks, Sanjay.

Now turning to Slide 10, we want to close by reiterating our strategic priorities for the second half of the year.

For our video business, objective #1 is to capitalize on the ongoing market transitions to further accelerate the growth and success of our over-the-top platform.

Objective #2: maintain an alignment of our investments with customer demand to further improve the profitability of our traditional video broadcast product lines.

And objective #3 is to deliver a high-single-digit operating margin in our video business again in the fourth quarter, just as we did in the third quarter.

On the Cable Edge side of the house, objective #1 is to continue to successfully scale our CableOS deployments, encompassing both centralized and distributed architectures, leveraging growing CableOS market momentum and industry architectural transformation.

Objective #2 is to secure new design wins with additional Tier 1 operators.

And objective #3 is to exit the year with sufficient backlog, bookings and new customer momentum to meet or exceed our $100 million 2018 revenue target, positioning the business segment for return to the black and compelling growth well into the future.

Our focus on these priorities enabled solid Q3 execution, and together with our strong backlog and opportunity pipeline this gives us confidence as we head into the fourth quarter.

As I know many of you already appreciate, the major market transitions from traditional pay-TV traditional to over-the-top and from traditional cable access to NFV with distributed edge create both risk and opportunity.

The internal investment and strategic shifts Harmonic has made over the past several years have positioned our company to not only survive these crosswinds but to thrive as premium over-the-top video and related cable access transitions take hold.

The results we've presented today in both our over-the-top and CableOS areas make it clear that we're seeing real success in the marketplace and real progress toward driving renewed growth, profitability and shareholder value.

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

(Operator Instructions) Our first question comes from Timothy Savageaux with Northland Capital.

One -- questions on both sides of the business.

First on the kind of Cable Edge side, among other things you are guiding to a bit of a ramp here into Q4 and especially on the topline, as well as a pretty dramatic improvement in gross margin as well.

I wonder, if we look at that ramp, can that give us some indication of -- to the extent that revenues get more material, how that revenue should roll out, from whether it's kind of a headend versus node, hardware versus software-type perspective, implicit in your guidance I think is something like an incremental gross margin of 60%, if you just look at the revenue and margin guidance.

Is there any sort of notion of, kind of, what would lead and what would lag from a hardware and software margin perspective, or just the overall cadence of rollout on the Cable Edge side, headend versus node, or however you want to try to address it?

Thanks for the question.

In Q3 -- let me give a little bit more insight on the Cable Edge.

Q3 was a quarter of the year we were expecting the legacy product not to go down as quickly as it actually happened.

We were expecting a little bit more continuation from Q2, but we saw a slightly bigger dip than what we were expecting, and hence we came slightly below the low end of our range.

And Q3 did not have any expectation, or not an expectation for CableOS shipments.

They were expected to ramp and kick off starting Q4.

So I think, Q4, the ramp you'll see is more -- mainly coming from CableOS versus the legacy product decline, which also is factored in Q4.

Okay.

Well, then, to the extent that is CableOS-driven and we're talking about incremental margins certainly well above 50%, would you want to revisit or comment on kind of gross margin targets or prospects into 2018, having kind of reaffirmed that target of $100 million in revenue, realizing there are likely still some legacy in there as a drag?

But what sort of -- to the extent -- and you tell me whether this modest ramp in Q4 can be looked at as a microcosm of what we might expect when the ramp gets more significant.

But with that in mind, as -- realizing you've got some -- the law of small numbers here and it might not be that meaningful, any commentary on where you expect CableOS gross margins to sort out there, relative to what looks to be a pretty modest operating expense base that you're carrying right now on the cable side?

Yes, Tim.

So in Q3, as you said, there's -- it's the law of small numbers in Q3.

The revenues are small as well.

The margin is small.

The margin is like -- if you agree the margin is $0.5 million, the percentage kind of close to doubles of what it is.

So definitely it is a law of small numbers.

But in Q4 it's more on the CableOS side of shipments, which does include software as well as hardware, and software -- with the software the margins would be up again in Q4 compared to Q3.

Okay.

Great.

And moving on to the video side, you saw a nice uptick in the business here.

I guess my question is, maybe to dig into the drivers there, I think you mentioned over-the-top is kind of a key driver.

Is there any more metrics or big customers or deployments to put around that?

And in general, I think visibility both on the plus and minus side has been a challenge on the video side of the business.

Now that you seem to have some better visibility on the nature of the SaaS transition -- which makes me think you might have some better visibility kind of on the overall kind of quarterly pace on the business.

So question is about the specifics of the strength that you saw and also just your overall views on go-forward visibility in that business in general.

It's Patrick.

Maybe I'll take that one.

Indeed, we were encouraged by the quarter.

Frankly, the -- let me call it the legacy business, largely feeding into legacy pay-TV, was actually stronger than -- relatively stronger than we expected.

At the same time, we are seeing a more significant ramp in what I term -- well, we term OTT 2.0.

The initial wave of OTT was largely about video-on-demand, and frankly there isn't that much opportunity for Harmonic there.

But as OTT now pivots to include live services, sports, et cetera, that really does come back to our sweet spot.

And there's no question that there is a beginning wave of deployment and transition of what we call the legacy broadcast services to OTT 2.0 that's happening worldwide.

I think that transition is still early days.

We don't want to get too far out ahead of ourselves, but we were encouraged by what we saw in the third quarter.

We're encouraged by the -- not only the backlog but the pipeline that we have for the fourth quarter.

That's what informs our guidance and our continuing positive view on the video business for the fourth quarter.

And I think what we prefer to do is let's deliver a solid fourth quarter and then we'll assess and provide you an update.

We're, I'd say, cautiously optimistic that the -- that we've kind of rounded a corner in terms of this wave of OTT becoming more material and, correspondingly, our visibility improving.

But I think we'd like to see another quarter of that before we declare victory.

But it does feel encouraging, coming out of Q3 and into Q4.

Our next question comes from Simon Leopold with Raymond James.

This is Victor Chiu, in for Simon Leopold.

So you spoke a bit about the impact of OTT services impacting the pace of investments for cable operators, and given the commentary from some of the service providers this quarter, do you believe we're seeing an inflection point in terms of pay-TV investments?

And if that's the case, is there some sort of contrast there with regards to your outlook and your targets for CableOS and Cable Edge in 2018?

And I guess, just what specifically is driving your optimism and your confidence in hitting the target?

Let's see.

I think you -- Victor, you touched on 2 different things there.

They are in fact somewhat related.

I think one of the drivers for CableOS and frankly a new -- a transformation of the cable network is that the cable network is going to be under increasing pressure from over-the-top video services, delivered by both the cable operators themselves as well as third parties -- Hulu or MLB or what have you, as well as things like 5G mobile service, et cetera, a lot of which we heard about on the recent cable company conference calls.

So over-the-top is a driver of more bandwidth in the network, and I think that's part of what creates the nearly $3 billion opportunity, the growth that we see on the cable access side of the business.

So let's put that to one side.

So clearly there's going to be a lot of spend.

Clearly there's a need for a fresh look at the cable access architecture to handle all this traffic.

And in the video side of our business we deal with actually helping companies create that traffic, if you will.

And that's a combination -- actually, cable operators themselves are -- they're an important but a modest piece of the overall picture.

We deal with all manner of legacy pay-TV providers -- cable operators, satellite direct-to-home operators, telecom operators, brand-new over the top startups and a lot of media company who, for the first time, are getting into the act of direct-to-consumer services all on their own.

So that's a -- it's a pretty -- we're trying to do business with everybody on the video side of the house that is in the business of creating and launching and delivering a new over-the-top service, traditional or new-entrant.

And as mentioned in the answer to the last question, I think it is earlier to say, hey, we're -- too early to say we're at an inflection point.

But we've definitely seen a pause as some of our legacy customers have kind of slowed up spending on the traditional infrastructure and they've been kind of trying to figure out what their over-the-top plan is.

We've seen some of that spending on new over-the-top stuff start to happen in the third quarter.

The outlook for the fourth quarter looks pretty good.

But as I mentioned a moment ago, I think it is premature for us to give a view -- an overall view on 2018 but it -- and declare a firm inflection point, if you will.

But the key is that, while we all acknowledge that pay-TV is under a lot of pressure, those same people are -- or same customers are turning around to invest in over-the-top platforms.

I think what Harmonic does, particularly around live and premium-quality OTT, is unique in the market.

And the winds that we've been seeing and where we're lined up -- the deals we have lined up for the coming quarter give us additional confidence that we've got a leading role to play in this as the market pivots, both legacy traditional customers, if you will, as well as the new players.

I'll pause there.

I hope that answers the question.

That's definitely helpful.

And just off of that, would accelerating declines of the legacy business be a point of caution to your target, or does your target kind of incorporate that, and you see enough growth in your new products to kind of offset that?

That's -- your target kind of incorporates the impact of possible acceleration and decline in legacy products?

Yes.

So Simon (sic) [Victor], while we acknowledge, if you see the history of our video business, there is a decline every year; however, if you would now look at our backlog and the bookings, they are growing.

We have a record backlog of more than $200 million ending this quarter and we expect book-to-bill ratio more than 1 again in Q4.

We believe we will exit this year with a much higher backlog to underpin our confidence for 2018 success.

So even though historically we have seen the decline in video product revenue, at the same time the bookings do support and this transition to OTT Patrick just mentioned is all part of it, and that has all been factored into the bookings.

Our next question comes from Steven Frankel with Dougherty.

Patrick, maybe we'll start with just a high-level look at this goal of $100 million-plus from CableOS in 2018.

Does that require winning significantly more Tier 1s or, with the customers you have today, either firm or in trial, just having them roll out in '18 gets you to that $100 million number?

Steve, it's -- we need to have confirmed design wins with additional customers.

So we don't have every single dollar tied to -- let me call it an existing customer.

That being said, the visibility is pretty good compared to normal.

We've got a good pipeline, and that number comes from a -- the cable industry doesn't have that many players, so we're engaged with a lot.

I've talked about advanced trials or already deployments with ten.

We've got a pipeline that goes much larger than those.

So you can imagine kind of a typical statistical weighting kind of methodology.

Indeed, a couple of the largest gets us a big chunk of the money -- the forecast that we're making.

There is a difference to be made up, but we have more than ample pipeline or more than ample customer engagements to give us confidence in that number, based on the ongoing engagements we have.

Okay.

And that early European customer that you had -- has there been any material follow-on business from that customer?

The short answer is yes.

It depends on how we want to define "material" but there has been real follow-on business, and that deployment continues to expand.

Okay.

And if I dare to poke at this new Tier 1 CableOS customer, could you give us any more detail on maybe the -- where they're located -- U.S., Europe, Latin America -- and why you think you won?

Well, I'll respectfully decline on the first part.

(inaudible)

But why we won -- this is a case where actually, the -- not just that it's a good idea in principle, but the reality of the need for a distributed and virtualization really comes into play in a specific part of their network, frankly.

And we've been challenged on, hey, why does a cable operator need another supplier?

There's incumbents, et cetera, etc.

Well, this is a particular operator who I think actually came at it initially from that point of view.

They have a specific problem to solve that CableOS was able to solve uniquely, from both a technical point of view and from a commercial point of view.

And I wouldn't go as far as to say they were reluctant, but it was -- really, the proof was in the pudding of a -- of extensive technical testing and capability that uniquely solved a meaningful problem that made the difference.

And I think that goes to the broader point here.

These architectural changes we're talking about aren't just kind of this theoretical good idea kind of thing.

As mentioned just a moment ago, these networks are coming under unprecedented pressure with the amount over-the-top video traffic coursing across them, broader high-speed data consumption going up and up, and in many cases improving subscription.

There's a -- there's pressure on these networks and there's problems for our customers to solve.

Okay.

And then on the video business, how's the mix transferring -- transforming between proprietary hardware and customers doing their software, either bundled with pass-through hardware or virtualization?

I don't think we have exact numbers that we can share with you, but I'd say the percentage of our business that we're doing based on our traditional proprietary, which really means ASIC-based hardware, is much less than a half and probably less than a third of the overall video business that we're doing.

The lion's share of the business today is software that either we deliver on a white box server or the customer procures and installs on their own server infrastructure.

And the -- let's say the far end of the curve is either SaaS-deployed or on-premises but nonetheless cloud-native deployment that our customer's doing.

So we've -- we kind of have 3 buckets, if you will.

I don't know.

I've got a bell curve pictured in my mind.

I don't know if that works for you or not.

The middle is probably the software delivered on a white box server or installed on a server as a -- kind of a bare metal or virtual machine by our customer.

The fare end of the curve is cloud-native.

And the opposite end of the curve is -- let me call it traditional ASIC-based hardware.

It's -- so it's definitely become less than 40% or a third of the business.

But it's still there.

And maybe that relates to the broader point, Steve, where we're talking a lot about over-the-top, and there's no doubt that that transition is ongoing.

I don't want to make it sound as though -- we don't want to make it sound as though it's 100%, 1 or 0 kind of shift.

Particularly outside of the U.S., where things are somewhat -- can move a little bit more slowly, there's still a solid $1 billion-plus market for what I'll call traditional broadcast infrastructure, and continuing to fully exploit that market is absolutely important to the business for the foreseeable future.

Okay.

And one last quick one.

You've mentioned multiple times about the shift to OTT and live events, especially sports.

Are there any particular events you might point to in the last quarter or 2 that you believe you played a key role in their successful OTT implementation?

Well, I -- there's 2 parts to the highlighting of live sports.

Number one, any live -- any of these new over-the-top services that are carrying live events.

I mean, for example, you can see the World Series or football or whatever that's going on now.

Those services are delivered live to -- through these skinny bundles and other streaming services.

So one comment is that Harmonic is playing an increasing role in a number of these implementations behind the scenes.

That's really where the activity is now.

The second comment was -- is we think about where our business can possibly go, and we look at addressable market expansion opportunities.

We're starting to look at -- let me call them special events.

Don't attach too much specificity to this, but we're thinking about the Olympics, or the upcoming World Cup, if you will.

We see more opportunities around those kind of events, particularly given that people distributing those events are now targeting not only small screens, which is a relatively easier technology job, but in fact are thinking about delivering those signals over-the-top to a 60-inch screen.

And by the way, with super low latency that is no later than is being delivered through the traditional broadcast pipe, so the goal doesn't appear magically 12 seconds later.

Which, in the example of software, doesn't work.

So this is -- the second category is where we're starting to nibble around the edges, but as we think about our business and where we might go we see that as an intriguing addressable market expansion opportunity.

Our next question comes from George Notter with Jefferies.

I guess I wanted to ask about CableOS.

You mentioned the order from a second Tier 1 MSO.

I was curious about that.

Is that for commercial deployments or is that trial deployments?

I guess I'm just trying to understand kind of the nature and size of the commitment there.

And then also a broader question.

I guess I was thinking more about the move of HFC networks to distributed access architectures and the timing around that.

I guess I'm wondering if you guys see the adoption of CableOS as being tied to either DOCSIS 3.1 or DOCSIS Full Duplex or deep fiber deployment.

How do you see yourself in the realm of those sorts of initiatives with the cable operators?

Thanks.

Okay.

So thanks for the question, George.

The first part of the question is, in this -- in the design win that we have, it's an early order and we have to prove ourselves out and see that scale.

But the point is, we've received an initial order and we're excited to be moving forward with this.

It will be a process but we're in the door, I think is the key point.

The second point or question about architecture -- we're currently involved in trials and discussions that involve all variations of what you just spoke to.

And as I believe you were in the Denver event and you -- held last week or whenever it was, where the cable tech community got together.

There's a lot of different permutations of what people are looking at with distributed.

One is DOCSIS traffic is distributed just to the existing node locations.

Another variant is nodes are pushed further or fiber is pushed deeper.

And as you mentioned, there's a third variable there, which is the RF split changes so you've got a capability for higher upstream.

The bottom line is we can support all of those, and I'd go even further and to say, actually, that's part of the beauty of having a virtualized or all-software core is that you can very easily and flexibly support all of that, giving a huge amount of agility to a cable operator who may be looking at different versions of what you've just explained for different neighborhoods, different business opportunities, consumers versus small businesses, et cetera.

So we don't see ourselves tied to any one of those particular variants of the HFC architecture permutations.

We see ourselves as enabling all of them.

And indeed that's reflected in the engagements that we currently have ongoing.

Our next question comes from Greg Mesniaeff with Drexel Hamilton.

A question on CableOS.

Given the $100 million run rate bar that you guys set, how much of that is going to have to come from market share gains, given the current growth of the TAM, in your view?

Well, that's a tough one to answer exactly, because the market is transitioning.

So I think we'd be hesitant to call it just market share gain, because it's not a static market.

It's kind of not -- it's an imperfect analogy, Greg, but think about gasoline combustion engines moving to electric, and we're coming in with an electric version.

Is that market share gain or is that feeding into a new, growing part of the market?

I guess it's a little bit of both.

But I think that's one way to think about what's going on here with our technology, and we're clearly the innovator, and out way ahead in the -- in what we're -- in -- if you will, in the electric motor part of this.

Sure.

But I guess what I was trying to was that even with a robust pickup in the TAM growth, there's still going to have to be some gains in market share from direct competitors to kind of get you to that level, right?

Well, there's some piece.

But the market today is -- I think everyone thinks is well over $1.5 billion, and maybe close to $2 billion in the neighborhood.

So we're -- $100 million is a relatively modest portion of that.

And then you layer onto that the fact that some portion of that existing market is transitioning.

And to the last question, some of it is -- some of the market is expanding.

People are pushing fiber deeper.

Push -- people are upgrading their data handling capability.

So this is not necessarily a rip-and-replace of things that work fine, but this is part of an ongoing operator strategy of pushing more high-speed data deeper into the network.

So we're new to the market.

We have a sliver of market share today.

So from one perspective, I would agree that all of it is kind of market share, or we're going to see a part of the CCAP market, part of which is going to Harmonic.

But I think from another perspective, we will predominantly be going into applications where either virtualization and/or distributed access really make a difference for customers.

And from that perspective, I think that we're plowing into new territory.

I'm sorry for the -- it was a wishy-washy answer, but I think it's a little bit of both.

No.

Fair enough.

Fair enough.

I was -- my follow-up to that is, with all the inputs you're getting from your key customers, what's your best take on when we will see, for lack of a better term, a hockey stick here, in terms of growth?

In terms of, like, what -- is it first half of next year?

Is it middle of the next year?

Is it second half of next year?

So I think it's a little bit early.

We've stuck to and we've done kind of another bottoms-up in anticipation of this earnings release on our view -- our pipeline, as mentioned a moment that, for '18.

We still feel good about that number.

In fact, we probably feel a little bit better because of the expanding customer dialogues and relationships and lack of dependence on any 1 or 2 particular customers.

So the pipeline and the engagements are clearly there.

Other than sizing the bread basket for you, it's just too early for us to give you any kind of a quarter-by-quarter shape to how that'll play out.

I do hope that we're able to give you a little bit more color on our next call, Greg.

And we have a follow-up question from the line of Timothy Savageaux with Northland Capital.

I had a quick follow-up on the new Tier 1 customer announcement, though a lot of that's been covered.

Although I will just add the following, I suppose, which is, as you look at that opportunity, at least in what you've said thus far it sort of seems like, could be a solution to a specific problem and a relatively nichey opportunity.

But would you care to size that opportunity, given you've already noted it's a global Tier 1, or top-5 operator, sorry, relative to some of the bigger deals you already have in-house?

Or in any way sort of talk to whether that's kind of a network-wide opportunity for you or a pretty -- and understanding things will start in fairly targeted fashions.

Is there any way for you to relate the nature of this new Tier 1 win to your current Tier 1 win, number one?

And then, number two, at least based on some of the work I've done, coming out of the show and recently, it doesn't seem crazy to maybe assume that over time your initial Tier 1 customer could run at a $100 million a year run rate.

Are you kind of taking that off the table and not -- understanding that you might not want to have that degree of concentration, but any comment on that front either?

Difficult questions to answer, really, while at the same time respecting the confidentiality we have with our customers, frankly.

Let me answer it this way, and forgive me for more generalities on the first part.

But I think that what we've developed is an amazing platform that has unique advantages, either in a centralized or distributed approach.

The key for us is getting the foot in the door; as it is, I think, always for a new market entrant.

You've got to find the specific use case.

I'm thinking of a company in the switching area that had super-high-speed switching, and they found a niche with finance companies who needed super-low latency.

And that was their foot in the door, but then they get going, and then growth starts coming.

And so I believe that what we've developed is not at all a nichey product.

It's the product that the market [actually] not only wants but is going to need.

Our path in to different operators is going to come in different ways.

Some operators are going to embrace us and say, "Hey, philosophically we get it.

This is where we want to go." Others are going to say, "I'm not so sure yet, but if you can solve this specific problem for me, that's the way in the door." I expect we're going to come in the side door, the back door or the front door with different kind of operators.

But the key thing is, once we get in there, Tim, I think we're going to do an amazing job.

I think that the capabilities of the platform are going to become self-evident.

And our goal is to become not a niche but the predominant solution.

That certainly has to play out.

But that's our objective and that's the way we think about it.

But right now we're not worried too much whether it is the side door, the back door or the front door.

The key thing is get in.

Regarding -- and maybe that dovetails to the answer to the second part of your question.

I think any customer, in time, can be really big.

This is a space that's going to be approximately $3 billion.

I think that what we've developed is going to be an absolutely winning solution.

What does a winning solution in that kind of space look like?

I think it has great potential to be by -- the biggest part of our business; the fastest-growing part of our business.

We have work to do.

It's an incredibly important, profitable part of our customers' business.

It's understandable that they're taking one step at a time.

So we'll see how it goes.

And I -- we don't want to get any further ahead of ourselves than necessary.

We wouldn't be reiterating the $100 million target for '18 if we didn't feel a high level of confidence in that.

But I'd rather -- I think we'd rather not go any further than that until we notch up a couple of more wins and we have a little bit more specific progress that we can share with you.

But in the meantime, know that our confidence is high, or the excitement in the company is high, and we remain incredibly focused and committed to making the most out of this opportunity.

All right.

Well, thank you very much.

And I think that that brings us to the top of the hour and we should wrap things up.

Just in summary, let me reiterate that we're executing on our plan to capitalize on the new wave of global investments in both premium-quality OTT, as we discussed, virtualized CCAP and this distributed cable access architecture.

From an operating perspective, our third quarter results demonstrate that we've made good progress repositioning the business.

And looking ahead, we'll remain focused on both profitability and driving positive free cash flow, while of course continuing to deliver differentiated new technologies and services to the market that really will build long-term value.

We appreciate your support, and thank you all for joining the call today.

We look forward to speaking with you again soon.

Thank you.

Thank you.

Ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may now disconnect.