Harmonic Inc (HLIT) 2019 Q2 法說會逐字稿

Welcome to the Q2 2019 Harmonic Earnings Conference Call.

My name is Brian, and I will be your operator for today's call.

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

I would now turn the call over to Nicole Noutsios, Investor Relations.

Nicole, you may begin.

Thank you for joining us today for Harmonic's Second Quarter 2019 Earnings Conference Call.

With me today are Patrick Harshman, our CEO; and Sanjay Kalra, our CFO.

Before we begin, I'd like to point out that in addition to the audio portion of the webcast, we've also provided slides of this webcast, which you can see by going to our webcast section on our IR website.

Now turning to Slide 2. During this call, we'll provide projections and other forward-looking statements regarding future events or future financial performance of the company.

Such statements are only current expectations, and actual events or results may differ materially.

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

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

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

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

We will also discuss historical, financial and other statistical information regarding our business and operations, and some of this information is included in the press release.

But the remainder of the information will be available in a recorded version of this call or on our website.

And now, I'll turn the call over to our CEO, Patrick Harshman.

Patrick?

Well, thanks, Nicole, and welcome, everyone, to our second quarter call.

Starting with the financial headlines.

We had a solid quarter.

Revenue was $84.9 million, book-to-bill was 1.1%, gross margin was 53.6%, and EPS was minus $0.04.

However, the real story today is further evidence that our strategic growth initiatives are winning in the marketplace, positioning the company for clear market leadership and long-term profitable growth.

In our Cable Access segment, we signed a strategic CableOS software license deal with Comcast.

And in July, we signed a new greater than $55 million CableOS contract with another international cable operator.

In our Video segment, live over-the-top SaaS channel deployments continued to grow, up 10% sequentially, and we delivered our eighth consecutive quarter of video segment profitability.

Taking a closer look now at our Cable Access segment, let's start with the Comcast agreement.

First and foremost, this agreement is a powerful validation and endorsement of both our CableOS technology and Harmonic's ability to execute.

As described in our 8-K filing, the deal was a 4-year software license agreement priced at $175 million, covering CableOS headend software for use within Comcast-owned footprint.

The amount does not cover hardware appliances like DAA nodes and centralized architecture CMTS shelves.

Such additional use of our complementary technology is upside.

And to that point, the deal also includes a win-win arrangement through which future additional purchases of other Harmonic products, such as DAA hardware and CMTS shelves, earn credits which can be deducted from the software license fee.

The remaining deal highlights that we can disclose are that Comcast will pay us the first $50 million of cash in 2019 and has vested the remaining 5.8 million and change warrant shares granted when the original partnership agreement was signed.

In a couple of minutes, Sanjay will walk you through the expected accounting treatment for this agreement.

We believe this is a fantastic deal for Harmonic.

The baseline financial terms speak for themselves.

There are substantial incentives for our companies to do additional business together.

And as I stated previously, this is a powerful validation of our CableOS innovations, of Harmonic's ability to execute and of our vision of where the market is headed.

While succeeding with Comcast has and will continue to be mission-critical for us, we're also increasingly focused on expanding our customer base.

As we anticipated during our last earnings call, our previously announced large international customer, with whom we signed in 2018 a greater than $50 million multiyear deal, is on track to begin volume deployment this quarter.

We're pleased to also announce that earlier in July, we closed a new agreement with a different international cable operator for a projected 5-year DAA deployment, with an estimated total contract value over $55 million.

We expect this new project will get rolling around the end of the year or in the first quarter.

In total, CableOS is now commercially deployed by 16 cable operators, with 780,000 connected cable modems at the end of the second quarter, which is up 16% sequentially from the number we shared with you at the end of the first quarter.

While scaling early deployments and securing new design wins has been our primary focus, we've also continued to extend our technology advantage through focused and creative R&D.

During the quarter, we made 4 new unique patent filings, further strengthening our already strong intellectual property position in both virtualized CMTS and distributed access architectures.

To date, we've made 35 unique patent filings.

Big picture, it's increasingly clear that the Cable Access market is beginning to make a major pivot towards these virtualized CMTS and distributed access architectures.

It's also clear that this is not just a U.S. phenomenon.

We're seeing the trend beginning to unfold across all regions, driven by those operators who are most aggressive about strengthening their competitive position.

Our pioneering innovations and strategic customer engagements have put us in a unique position to take advantage of this global wave.

Now let me be clear, Harmonic is determined to take advantage of this opportunity not only by leading technologically, but to be the global market share leader.

We're doing this by leveraging our position as the first cloud native CMTS supplier, our associated unique solution for new distributed access architectures, our strong intellectual property position and foundational wins with now several of the world's largest and most influential cable operators.

Make no mistake, we've still got a ton of work ahead of us, but the CableOS train is clearly now leaving the station.

We're looking forward to a solid second half of 2019 and an exciting future for CableOS.

So turning now to our Video segment.

Here also execution of our strategic transformation is showing real progress.

As a reminder, our video transformation is about moving from our historically broadcast-centric appliance business to a more efficient, predictable and profitable over-the-top streaming business, where we provide our technology as either software running on COTS servers or a Software as a Service running on public, private or hybrid cloud.

As was the case during the first quarter, Q2 was characterized by a continued increase in both over-the-top and SaaS-based customer engagement, deal pipeline creation and deployments.

Specifically, we saw the number of cloud-based live over-the-top channels deployed grow 10% sequentially and the number of SaaS customers grew to 28, up 65% year-over-year.

Our SaaS platform and DevOps team continued to ensure 24/7 delivery of premium live video service to over 6.5 million consumers worldwide, demonstrating our ability to take on expanded mission-critical services for our customers and thereby expanded our addressable market opportunity.

As was the case last quarter, our SaaS deal pipeline has continued to grow in terms of both absolute dollars and percentage of our total video business pipeline.

Well, this growth trend is good news from a strategic point of view and expanding SaaS deal pipeline also creates, as we've discussed before, our short-term booking and revenue headwind.

We continue to see the SaaS sales cycle taking roughly twice as long as traditional appliance sales.

This phenomenon has been seen in other technology verticals pivoting to SaaS.

And based on the lessons from these other technology industries, we remain confident that our SaaS sales cycle times will return to normal.

Despite these strategic transition headwinds, our second quarter video segment financial performance remains solid.

The combined SaaS and service revenue, that is the recurring portion of our Video segment revenue, was $27.2 million, up 13% sequentially.

Total segment gross margin was a strong 57.9%, up from 55% a year ago.

And we delivered a segment profit for the eighth consecutive quarter with 6.2% operating income.

In summary, in both our Cable Access and Video business segments, we've invested and innovated for the future, transforming our business with industry-leading cloud-native technologies and services that are directly relevant to the competitive trends and operational objectives driving our customers' businesses.

It's gratifying to see growing success in the marketplace, success that is opening the door to even greater opportunity, positioning Harmonic for sustained growth and value creation.

I'll now turn the call over to you, Sanjay, for a more detailed discussion of our financial results and outlook.

Thanks, Patrick, and thank you all for joining our call this afternoon.

Before I share with you my detailed quarterly remarks, I would like to remind you that the financial results I'll be referring to are provided on a non-GAAP basis.

For the second quarter of 2019, we delivered solid results across a number of financial metrics.

Revenue was $84.9 million, gross margins were strong at 53.6%, and operating expenses were lower than projected at $48.3 million, resulting in a $0.04 EPS loss.

These results were coupled with cash of $58.1 million and book-to-bill ratio of 1.1%, enabling us to enter the second half of 2019 with a solid financial foundation.

Turning to Slide 6. Q2 revenue was $84.9 million compared to $80.1 million in Q1 '19 and $99.4 million in Q2 '18.

The sequential increase reflects typical seasonality in the Video business, while the year-over-year decline reflects product and customer transitions in both segments.

Turning to our segment revenue and results.

Cable Access revenue was $13.3 million compared to $12.9 million in Q1 '19 and $20.2 million in the year-ago period.

As you will recall, our first half guidance anticipated a pause by a couple of Tier 1 customers who are temporarily slowing to implement trial-informed improvements to their system architectures before volume deployment.

This played out largely as expected through the first half, and now, as anticipated, we are seeing growing deployment momentum in Q3 and Q4.

In our Video segment, we reported revenue of $71.6 million compared to $67.2 million in Q1 and $79.2 million in the same quarter last year.

The sequential comparison reflects typical seasonality while the year-over-year comparison reflects the combination of a shift in timing of certain deals to later this year and, as Patrick just mentioned, growing customer interest in SaaS.

In Q2, Comcast contributed 10% of total revenue.

As we put more emphasis on SaaS, we are pleased that our SaaS pipeline is building, and we understand that initial revenue delays are an inherent short-term impact of managing a SaaS transition journey.

As mentioned on prior earnings calls, we continue to see that SaaS opportunities are taking more time to close relative to traditional appliance-based video processing opportunities, thereby creating a near-term impact on bookings, backlog and upfront revenue.

Corporate gross margin was 53.6% in Q2 compared to 54.5% in Q1 and 54% in Q2 '18.

Cable Access gross margin was 30.8% in Q2 compared to 39.3% in Q1 and 50.3% in Q2 '18.

The sequential decline was a result of product mix.

Video segment gross margin was strong at 57.9% in Q2 compared to 57.5% in Q1 and 55% in Q2 '18.

We are pleased to see execution of our strategy continuing to deliver consistent improvements in video margins, despite software revenues, as we execute our video strategy to grow SaaS and service.

As a reminder, in the prior quarter, we made a revenue classification change.

Up until 2018, we have classified our total revenue in 2 categories: products and services.

To better reflect the nature of our business and sharpen the focus on our revenue priorities, starting in 2019, we updated our revenue categories to appliance and integration and SaaS and service.

The appliance and integration revenue category is comprised of nonrecurring hardware, software licenses and professional services revenue.

The SaaS and service category consists of ongoing usage-based fees from our SaaS subscription offerings and support revenue from our appliance-based customers and reflects our recurring revenue streams.

We have been consistently growing our recurring revenue base, focusing on expanded support services for our traditional appliance-based solutions and, as just mentioned, expanding our new cloud-based SaaS offerings.

During the second quarter, our SaaS and service revenue represented 35.9% of total revenue compared to 34.6% in Q1 '19 and 30.9% in Q2 '18.

Our recurring revenue category has higher gross margins than our appliance and integration category, thereby setting the stage for long-term margin expansion as we expand our SaaS and service revenue.

Our total SaaS and service gross margins were 62.6% in Q2 '19, 61.3% in Q1 '19 and 65.6% in Q2 '18, demonstrating solid margins for this category.

The year-over-year decline in SaaS and service margins was primarily the result of timing delays of closing certain high-confidence renewals.

Going forward, we may experience similar fluctuations between quarters as we go through our transition.

We made good progress expanding our SaaS customer base with a growth of 12% quarter-over-quarter and 65% year-over-year.

In Q2 '19, our SaaS customer count was 28 compared to 25 in Q1 '19 and 17 in Q2 '18.

We are still in the early stages of our SaaS evolution and expect to continue to expand our installed base.

We also consider the new SaaS customers as design wins and expect recurring revenue to grow as they expand their services.

Coming back to the income statement on Slide 7. We maintained strong expense control during the quarter end.

And as a result, our Q2 operating expenses were $48.3 million compared to $47.5 million and $47 million in Q1 '19 and Q2 '18, respectively.

The sequential increase is primarily reflective of incremental sales and marketing activity across both segments.

Our Q2 operating loss was $2.8 million.

This is a net result of our Video segment, which contributed $4.4 million of operating income, offset by our investment in our CableOS program, which resulted in a segment operating loss of $7.2 million.

Our Q2 operating loss of $2.8 million compares to an operating loss of $3.8 million in Q1 and $6.8 million operating income in Q2 '18.

We ended with a weighted average share count of 88.9 million compared to 88.2 million in Q1 and 85.8 million in Q2 '18.

The marginal sequential increase is primarily due to issuance of employees' restricted stock units.

The year-over-year increase in the shares is primarily due to performance-based compensation shares and RSUs.

Resultant Q2 EPS was a loss of $0.04 compared to Q1 loss of $0.05 and a profit of $0.05 in Q2 '18.

Q2 bookings were $92.6 million compared to $81 million in Q1 and $107.9 million in Q2 '18, resulting in a book-to-bill ratio of 1.1 in Q2 compared to 1.0 in Q1 and 1.1 in Q2 '18.

Bookings were down modestly year-over-year for the reasons mentioned previously: our efforts to convert historically appliance-based video customers to cloud-based SaaS and an anticipated temporary fall in virtual CMTS and DAA rollout activity by a couple of Tier 1 cable customers.

We are looking forward to seeing bookings rebound as SaaS deals' time to close reduces and as CableOS deployments pick back up again.

We will now move to our liquidity position and balance sheet on Slide 8. We ended Q2 with a cash of $58.1 million.

This compares to $69.9 million at the end of Q1 and $54.1 million at the end of Q2 '18.

The decrease in cash of $11.8 million is a reflection of cash used in operations primarily in working capital of $8.8 million and cash used in investing and financing activities of $3 million.

Our days sales outstanding at the end of Q2 was 75 days compared to 66 days in Q1 and 75 days at the end of Q2 '18.

Our days inventory on hand was 63 days at the end of Q2 compared to 72 days at the end of Q1 and 45 days at the end of Q2 '18.

At the end of Q2, backlog and deferred revenue was $194.7 million.

This compares to $187.2 million in Q1 and $230.4 million in Q2 '18.

Backlog and deferred revenue has increased sequentially by 4%.

Please note that the Comcast CableOS $175 million agreement and the new more than $55 million international cable contract Patrick mentioned are not included in our backlog.

Also a substantial portion of more than $50 million contract with a different international cable customer we announced in 2018 is not included in our backlog.

Although these are signed contracts, we will only record associated bookings as constituent project purchase orders are received.

We will now move to Slide 9 to discuss our revenue, margin and cash expectations from Comcast CableOS software license agreement, which we included in our guidance.

For the CableOS software license agreement with Comcast, we preliminarily expect the total license revenue to be net of a warrant vesting charge of approximately $20 million, resulting in a net GAAP revenue of approximately $155 million over a period of 4 years.

This will entail a onetime recognition of software licenses of approximately $34 million in the third quarter and approximately $121 million over the remaining period of 4 years.

Please note that historically, we have considered any warrant-related stock compensation charge as a non-GAAP adjustment to revenue.

However, as this volume charge of $20 million is material from a GAAP perspective, we have chosen an accounting policy to consider this as a charge even for non-GAAP purposes so as to align our GAAP and non-GAAP revenues and not create a material variability between the 2.

In terms of margins, the revenue on software license of $155 million is expected to be 100%.

In terms of cash, the total cash expectations on software license is $175 million less potential credit.

Credit can be earned by Comcast through additional purchases of CableOS-related products.

Please note that we will collect $50 million in cash in the second half of 2019 from this contract.

Remaining cash will be collected approximately ratably from 2020 through 2023.

Now let's turn to Slide 10 for our Q3 '19 non-GAAP guidance.

Considering recent business development and market dynamics, we expect revenue in the range of $110 million to $120 million, with Video revenue in the range of $63 million to $68 million and Cable Access revenue in the range of $47 million to $52 million.

This Cable Access revenue guidance includes the onetime license revenue of approximately $34 million, which I explained a moment ago.

Gross margin in the range of 64% to 66.5%; operating expenses to range from $48 million to $50 million; operating income to range from $20 million to $32 million; EPS to range from $0.16 to $0.26; an effective tax rate of 12%; a weighted average share count of 101.5 million.

The significant increase in share count reflects the dilutive effect of 6.3 million convertible note shares, 2.9 million shares for Comcast warrants and 1.7 million shares of employee-related RSUs.

Please note, this calculation assumes our currently trading stock price of approximately $8 per share.

And finally, cash at the end of Q3 is expected to range from $65 million to $75 million.

Now turning to Slide 11.

We also want to provide you our non-GAAP guidance for Q4, where we expect revenue in the range of $100 million to $110 million, with Video revenue in the range of $70 million to $75 million and Cable Access revenue in the range of $30 million to $35 million.

Gross margin in the range of 51% to 52.5%; operating expenses to range from $48 million to $50 million; operating income to range from $1 million to $10 million; EPS to range from a loss of $0.01 to a profit of $0.07; an effective tax rate of 12%; and a weighted average basic share count of 90.3 million to a diluted share count of 102.3 million.

The significant increase in share count, again, reflects the dilutive effect of 6.3 million convertible note shares, 3.2 million shares for Comcast warrants and 1.9 million shares for employee-related RSUs.

Please note, this calculation again assumes our currently trading stock price of approximately $8 per share.

Finally, cash at the end of Q4 is expected to range between $90 million to $100 million.

Moving to Slide 12.

Combining this Q3 and Q4 guidance, we provide the corresponding updated full year 2019 guidance.

Specifically, for the full year, we now expect revenue in the range of $375 million to $395 million, with Video revenue in the range of $272 million to $282 million and Cable Access revenue in the range of $103 million to $113 million.

As you can see, for our Cable segment, our original full year expectations have solidified as we have greater visibility through year-end with the Comcast CableOS contribution.

Regarding Video, we are continuing to see more than expected traditional opportunities moving to our SaaS pipeline.

Therefore, we are taking the Video guidance down by $13 million at low end and $18 million at the high end.

Gross margin in the range of 56% to 57.5%, significantly improved from our prior guidance of 50% to 53.5% primarily due to Comcast CableOS contract.

Operating expenses to range from $192 million to $196 million, improved from our prior guidance of $195 million to $205 million primarily due to strong expense management.

Operating income to range from $15 million to $35 million, significantly improved from our prior guidance of operating loss of $12.5 million to an operating income of $34.6 million primarily due to improved gross margins and reduced operating expenses.

EPS to range from $0.07 to $0.26, materially improved from our prior guidance of a loss of $0.19 to a profit of $0.27.

An effective tax rate of 12%; a weighted average share count of approximately 96.5 million shares; year-end cash to range from $90 million to $100 million.

In summary, this is a critical year for our business, and we remain very focused on continued execution.

So with that, thank you, and back to you, Patrick.

Okay.

Thanks, Sanjay.

And on that -- on the topic of execution, we want to wrap it up by summarizing our strategic priorities for the remainder of the year.

For Cable Access business, it's all about taking advantage of the opportunity in front of us to become the market leader.

Our near-term objectives are to further scale our current CableOS deployments, to secure new design wins with additional global operators and to ensure our Tier 1 customers' volume DAA deployments through the second half are successful.

For our Video segment, our objectives are to continue to grow our live over-the-top streaming revenue and market share, to leverage our SaaS to expand our addressed market and to deliver consistent segment profitability, just as we've done over each of the last 8 quarters.

We want to close by thanking our strategic customers and partners, our talented team members and our stockholders, all of whom had stayed by our side as we've taken risks and invested significant time and resources to transform our business.

Your support is very much appreciated.

With that, let's now open the call up to questions.

(Operator Instructions) Your first question comes from Simon Leopold with Raymond James.

Great.

A couple of things.

I wanted to clarify, first, Sanjay, your comments about the accounting for backlog, why the, I guess, Comcast and the other international warrant being included.

Just if you could explain the accounting of that real quick.

Sure, Simon.

So our accounting policy for counting backlog is when we receive purchase orders from our customers.

We do not count signed agreements only as a part of our backlog or bookings.

So earlier in 2018 when we signed this international customer contract, more than $50 million of that till date has not been included in the backlog, except for the amount of purchase orders we have received against that.

So we just wanted to clarify that the backlog number which we disclosed is not inclusive of these contracts which we talk about as well.

And then in terms of these international awards that you've talked about, should we think of the values and the structure as similar to Comcast in that there's an enterprise license agreement for a given amount and then the ability to sell remote fine node is above and beyond that.

In other words, you talked about in excess of $55 million.

Is that a mixture of software and hardware?

Or is that the software license, and then hardware is above and beyond?

If you could just clarify the structure of the international awards as a comparison to Comcast.

Yes, Simon, the Comcast structure is unique.

Everywhere else, we're working in, let me call it, a more traditional mode.

And when we mentioned contract values there, it's a combination of software and hardware.

And in general, that's how we're going to market elsewhere.

Okay.

Sure.

And then one last one.

Given, I'll say, the volatility of margins based on the mix of software versus hardware, how should we think about your long-term targets in terms of gross margin?

What will it look like in a few years from now?

So Simon, you've seen the guidance we gave for Q3 and Q4, where Q3 definitely has a onetime $34 million revenue.

So based on that, the margins are 76% to 78% approximately, built in the guidance.

But Q4 does not have any onetime pickup.

So Q4, I believe, which is early, I would say, 41%, 42% kind of margins for cable, which are baked into our guidance, that is kind of representative, at least in the initial year or so as we ramp.

But going forward, our long-term target for gross margins for cable are to catch up with the corporate margins of close to 50% -- between 50% and 55%.

And so we should think about the margins for the overall company out a few years as generally trending higher from the 2019 level.

You've guided 2019 in the range of 56% to 57.5%.

And so we should think about 2021, 2022 as values above that.

Is that a fair conclusion?

Well, thinking long-term in terms of percentages, I would say that's a fair conclusion.

And our next question will come from John Marchetti with Stifel.

I wanted to go back to the comment that you made, Sanjay, about the credits associated with the Comcast deal as well and just make sure that I understand what you were alluding to there.

The $175 million, I understand the $20 million that has come out of there, bringing the total to $155 million.

But then you mentioned that there might be some credits that worked that value down even lower.

And I just wanted to make sure I understood how that sort of balances off against at least my expectation that we may see additional hardware sales and things like that, that may drive the total value up above the $175 million.

Just wanted to make sure I understood the puts and takes around those, the way you articulated that.

Sure, John.

So our arrangement with Comcast has 3 major components: number one, $175 million software license deal; number two, the stock warrants; and number three is this additional confidential incentive to do more business together.

Total cash will be a combination of $175 million plus cash from additional business, minus credits defined by the deal.

The structure was defined this way upfront to encourage a win-win approach of doing business together.

And when you say that there's incentives to do more, is that both on the software and the hardware side?

Or is that primarily just on the hardware side?

Well, the incentives could be on other business opportunities which could entail other things, hardware and software, both.

Okay.

Okay.

And then when you talk about the concentration on Video and where you hope that goes, Patrick, over time.

As I look out into '20 or '21, where do you think we sort of hit that inflection point for the Video transition where SaaS stops being the headwind?

Do we need to get to a certain percentage of the total revenue?

Or as we get into '20, can we get far enough along in this transition that it stops being a headwind, and we can start to see that business at least flatten out, if not grow a little bit?

Yes.

It's difficult to put an exact time frame on it, John.

But our belief about this market as well as what we've observed in other tech verticals that have gone through a similar transition is it is something that we get through.

It's still a relatively small piece of the revenue.

So as that continues to grow, new booking, a new deal that would have otherwise been an appliance deal now becomes a SaaS deal, it puts effectively more in backlog.

So we expect for, let's say, the next several periods to continue to grow our pipeline and bookings around SaaS.

But indeed, and I hesitate to put a number on it, is it 2 quarters, is it 4 quarters?

We don't see this as a 5-year kind of thing.

We think that the end market is starting to tip pretty quickly.

But if you'll allow me, I'll call it several quarters through which we see growth, and then we see the backlog from previously booked SaaS deals starting to come in and help us out here.

People talk about a so-called -- a fish model where you actually do see, in the broader industry literature, you do see the revenue dip while the backlog grows.

And then these things reconverge.

And then it's a stickier model.

We think it's a more profitable model, and then you're off to the races in terms of something looks better.

That's the journey we're on.

We're convinced not only is it positive for our business, but it's the right thing for where the -- this video market -- the streaming market is headed in general.

And we're -- the dialogues that we're having with customers give us continued confidence that it is not a question of if but just when.

And then if I could, just one last question.

When I look at the full year guidance, the revised full year guidance, particularly on the Cable side, with the high end of that range now coming down from $130 million to $113 million, I'm just curious relative to where you were maybe a quarter or so ago.

Is that largely due now to having visibility on the exact timing of how Comcast rolls through?

Is it some of the international deals that you've highlighted here maybe starting a little bit later in the year and not providing as much potential upside as you thought they might have been able to when you were sitting in the -- sitting back in the first quarter?

I'm just curious with that change down from the high end, what's really caused that to come in a little bit?

Yes, John, I'd say it's a confluence of all these things that you mentioned, all the 3 significant contracts, at the same time, other activities we see and for the DAA nodes as well.

So it's a confluence of everything.

But one thing I'll point out is that although the high end may be coming a little lower than what we anticipated, but the gross margins and overall profitability for the year help solidify it to a very significant extent and has actually taken away the downside on EPS, which we were expecting earlier.

And our next question will come from the line of Rich Valera with Needham & Company.

Patrick, I was hoping you could provide a little more color on the new international deal, if you could give us any color around your expectations for rev rec on that timing of first revenue and how that might roll out into 2020.

And then on your prior international deal, you've been waiting to hit some sort of rev rec milestones, as I understood it, and you're expecting to hit them, I believe, sort of early in the third quarter.

Just wanted to clarify if in fact you've hit those rev rec requirements for that first international deal.

Well, I'll go with the second part of your question first, Rich.

The rev rec milestones are planned and expected to hit later in the second half of this year.

And that's how we are coming up with our guidance.

And yes, as -- if that timing changes or if there's a variability, we will definitely keep everybody updated, but that's the expectation as of now.

And in terms of the earlier part of your question on the rev rec for the Comcast deal, this is already highlighted in the...

No, the new international deal.

The newer international deal.

So look, I think what we've learned is that -- let me take a step back first, Rich.

Although most of the deployments we've done to date are in the so-called centralized architecture, the big volume with the big Tier 1s that we're seeing right now is really associated with these DAA architectures.

And a lot of groundbreaking work, frankly, more groundbreaking work than any of us anticipated has taken place over the past year.

So the bad news is I think the front-running projects have gone a little bit more slowly than were originally anticipated.

And we're still not out of the woods, although we're really starting to see stuff starting to scale.

Really, our view today is unchanged from what it was on our call 3 months ago in terms of the way our lead customers would be scaling in the second half of the year.

I'll put questions of exact timing of revenue recognition aside.

In terms of what's happening in the field, it's pretty much going as anticipated.

So that's been kind of a challenge here.

I'd say the good news is on the back of a lot of the lessons learned there, our belief is that while it won't happen in a snap of a finger -- the fingers, subsequent large DAA deployments look to be able to be executed more quickly.

And so we've just signed this deal that I mentioned.

And we expect that to really start getting going in either Q4 or Q1.

So a much faster time frame than we've seen heretofore with other deployments.

So specifically answering your question, I'd expect maybe the first dribs of revenue late this year or in Q1, and we expect that to begin to ramp throughout 2020.

And if I take a somewhat broader view, I think we're going to continue to learn.

And I think that the time to close, the time to provision, the time to deploy and consequently recognize revenue on these deals is going to only improve from here.

But we're still, as an industry, I'd say, on a learning curve.

Got it.

And then just sort of a follow-up on that.

Not to put too fine of a point here, but in the guidance for Q3, does that embed you achieving the acceptance criteria for that international customer, the original one?

There -- well, there is a piece of it, I would say.

And it's a small piece of it in Q3, but it largely ramps towards the later part of the year.

Got it.

And then just wanted to understand the share count increase.

In particular, it sounds like you're now including the dilutive shares from the convert in the share count.

Can you just explain the mechanics around that, Sanjay?

Sure.

So the convert -- price of conversion is $5.75, and we have not reached that trigger point by the end of the quarter.

But subsequent to the quarter, we definitely did.

And in Q3, for the first time, we will be counting the diluted impact of the convert.

So it's just a simple formula which we use, basically, whatever is the trading price, and we take out $5.75 from that, i.e., whatever is in-the-money amount, you multiply that by 22.3 million shares, which is basic dilution when we did the deal 5 years ago, and you divide that by the stock price.

So at $8, for example, the dilution amounts to 6.3 million.

Suppose the price goes to $7, the amount will be 4 million shares.

Or suppose the price goes to $9, it will be 8.1 million shares.

It's a very straight formula.

We can actually also share that with everybody.

Understood.

Any update in terms of potential options for that convert in terms of refinancing or anything to talk about there?

Well, so we -- definitely, that is something which is being actively thought of on how to address that.

I believe what recently has happened in terms of our stock price gives us much more options or alternatives to look at.

We are looking at it, and the deal still matures in December 2020.

So we have a lot of time to address it.

We will see how best it makes sense for the stockholders, for the debt holders and for the company.

So we are going to address it sooner than later.

But as of now, we haven't made a confirmed plan on how to execute on it.

And our next question will come from the line of Steven Frankel with Dougherty.

Patrick, could you give us some color on how this Comcast enterprise agreement has impacted your discussions with other customers that are either in field trials today or in the pipeline, thinking about doing a trial with you?

Have you seen any impact from the publicity around this launch?

I think it's too early to say it definitively.

What I will say, Steve, is it's certainly our expectation.

I think we've said it before, that there's a lot of eyes in the industry on this.

It's been no secret about what's been going on, in the work.

And I think a lot of people have been waiting to see -- to gauge the success, and to some of the commentary earlier, to let some of the kinks get worked out, if you will.

There's no question that Comcast is viewed, I think, worldwide as the leader here.

And it's why we think that the endorsement is so critically important.

So I think it's not been that much time since we filed the 8-K, but we're confident that as we go forward, the endorsement that is implied by this deal, the experience that we're getting, is going to be only positive for us as we interact with other operators around the world.

Okay.

And you previously had given out a combined number of deployments and trials.

And this quarter, you only gave out the number of live customers.

What's happening on the trial side now?

That number has -- that has gone up as well, Steve.

I think there was always this ambiguity about, well, at least we got offline questions about what does the number mean exactly.

So the purpose is certainly not to obfuscate anything here.

But -- so -- and look, let me take a step back.

When we got into this whole thing, I think there was a fair number of questions, skepticism, if you will.

And it was important to show, I think, to try to garner credibility in a number of different ways.

And our feeling is now, well, maybe not 100% put to rest.

I think it's increasingly clear that what we've been talking about is the way the industry is going.

And that what -- we're going to play a key role in this, and we're dead serious about our intention to lead here.

So in that context, we thought maybe it's appropriate for a couple of reasons to drop off the disclosure of the number of trials.

I will tell you that those are growing.

And maybe to take a step back and focus just on the number of commercial deployments, which is what we've done here.

Okay.

It makes sense.

And let me just make sure, Sanjay, that I understand the accounting treatment on the remaining Comcast.

So that's roughly $40 million a year, and that's going to be recognized $10 million a quarter over the next 3 years.

Well, when you say roughly, yes, it will fall, I mean in a rough fashion, yes, I would agree.

But there is some variability within certain amounts.

But I think if you are doing a rough estimation, I think it's reasonable to presume that.

Okay.

And we got into this whole discussion about credits and hardware.

Is that because Comcast has gotten to the point where they just assumed buying nodes from somebody else to ramp up a second source, and they may or may not come back to you in the future for hardware?

Well, remember, this deal -- the original deal was put together a couple of years ago.

And I think both parties wanted to afford ourselves the opportunity to be successful together if it made sense.

And in that context, this construct, I think, gave the right incentive as well as flexibility to do additional business together.

And so that's really -- I think in retrospect, it was a -- it's a great agreement.

And it really does, in all sincerity, provide a real win-win opportunity here.

So I view -- you may think credit is a minus.

But I mean I view this, as always, is nothing but good news in terms of upside.

I think that there is a real incentive to do additional business together.

And to the extent more volume business is done together, well, then some of that comes back in a prestructured way as a discount, if you will, or alternatively a credit.

But I think the real takeaway here is that there is an incentive and a desire, going back to this date of the original agreement, to do additional business together.

And it's certainly our intention to -- nothing is guaranteed, let me be clear.

But we're excited about the innovations we're making not only in the software area, but in the hardware area.

We're absolutely determined to differentiate ourselves there.

And to the extent we do, we think we're going to do very well across the cable industry and at Comcast and everywhere else with the other related products.

Maybe I'll ask it in a slightly different way.

Could you see in the medium term new CableOS customers come in as basically software-only customers at this point, if they're confident that the third-party hardware gets the job done that you wouldn't necessarily have to be the hardware supplier of choice?

Yes.

And I -- yes, absolutely.

I mean we think we've done -- we think the hardware piece is going to be good business.

We think we're going to see the margins go up in that area over time.

And as I mentioned, we're bringing new innovations to that space.

But our idea -- and frankly, the mandate from our largest cable customers from the beginning was one of interoperability.

So indeed, if there's a better mousetrap out there on the hardware side, our software will work with it.

And to some extent, I mean I look at announcements around people doing this and that in DAA hardware.

I think it's all good news for our virtualized CMTS strategy and business.

It's endorsement of the DAA model.

And I think that what we've done with CableOS from a headend perspective is truly unique in terms of enabling these DAA architectures.

So our idea from the beginning is exactly what you said.

DAA is a winner for us either way.

If we can sell the hardware, get additional profit, that's great.

If someone else sells it and we sell the enabling headend software, that's also pretty good.

And our next question will come from the line of George Notter with Jefferies.

And I never said congratulations on this Comcast deal, so congrats.

It's great.

I guess my question is more around, again, the software license agreement.

So I guess I want to understand what Comcast can do on a go-forward basis.

For example, I know that they had significant development resources also applied to the development of the product.

And I know there's talk about Comcast looking to syndicate the virtual CCAP product to other cable operators.

Can you just help me understand exactly what Comcast can and cannot do with the software and also where your technology starts and stops and where their developments start and stop and who owns what?

So any help there would be great.

Look, I want to be clear, we've never discussed, and we're not privy to all of their internal plans, what exactly their business plans are and what they're doing.

So I just want to be clear about that from the outset.

From our side, we've given them, through this agreement, a license to use the software that we developed within their footprint.

So you mentioned so-called syndication deals.

That's -- if I understand what you mean by that, that would be outside of their footprint.

So that would be extraordinary to this deal that we've just discussed.

That being said, within their footprint, they have latitude to use the software as much, as little and as broadly as they would like.

So I think it's important to understand this software can be used not only for DAA deployment but for traditional centralized deployments.

Indeed, as I mentioned a moment ago, the majority of our field deployments to date are actually in this so-called centralized architecture.

So they've got -- they purchased a license so they can use it however they like within their footprint.

We've made the core -- the headlines of that deal public here and work with other operators that Harmonic is going to pursue or that perhaps Harmonic and Comcast might pursue together or whatever.

That's all additional incremental business that we can consider.

But we're certainly not predicting or authorized to discuss anything about Comcast's intentions regarding -- either exactly what they're going to do within their footprint or any business development ideas they might have beyond their own footprint.

Got it.

Okay.

And then so the upside here for you above and beyond the $175 million is really focused on optical node and RPD sales.

In terms of the credit...

Let me -- I'm sorry, just let me interrupt.

I also highlighted centralized deployments.

I mean we -- again, most of our deployments to date involve a centralized CMTS architecture, which also includes a so-called shelf.

In other words, it's not just the PHY out in the field, it's the kit centralized.

So our upside within the Comcast footprint is any way you would use the software to deliver DOCSIS service to subscribers, either deep fiber, remote PHY, standard business as usual, centralized architecture or anything in between, where we would provide the enabling, so-called physical layer that converts the gigabit Ethernet, the gigabit IP from a data center or blade server architecture into something that can be delivered over a cable network.

And our next question will come from the line of Tim Savageaux with Northland Capital.

And my congratulations as well on both Comcast and the new European win you announced.

And I'll start kind of, I guess, trying to relate those 2 a little bit or maybe the European MSO deals in the aggregate, $100 million plus.

And the sort of profile you might expect there from hardware revenue to software seems kind of more, I won't say traditional in nature, but along the lines we've discussed here in the last few years and then looking at absolutely higher levels of revenue on the node side but lower margins.

And I've been using kind of almost sort of a 2:1 metric for hardware to software revenue but about 50-50 for margins.

Is that still reasonable to talk about?

And is there any reason to believe that Comcast would be any different than that over time kind of on a run rate basis?

I think it's reasonable, Tim.

And I think at a high level, the answer is no.

We certainly don't want to be evasive.

But going back just to the discussion a moment ago, part of the complexity comes in when we talk kind of in a generalized way because there is a difference in margin profile and actually dollars for different hardware configurations.

The risk of making it more complex, just to summarize, with our hardware, we can either do a very dense PHY shelf, and it doesn't have all the trappings of what you would hang out on a pole or put on a pedestal.

So in fact, that turns out to be a higher-margin product than the very lower-margin node that goes out in the field.

So that's kind of an intermediate margin product that looks like -- a lot like the NSG EdgeQAM that we provided for years.

And then you get to the node, and that's indeed a lower-margin product.

However, again, to the previous conversation.

In some markets, our strategy is some international markets that have kind of unique local node form factors, we actually just provide the PHY module that goes in a third-party node.

So we go-to-market with hardware in a number of configurations, kind of somewhat, let me call it, intermediate margin shelf traditional CMTS shelf, kind of lower margin, where we do the whole node and the whole wrapper.

It's kind of how we're going to do things in the U.S. And this intermediate, let me call it somewhere in the between them on the margin point, where we provide just a fine module that will plug into some third-party node, where the local requirements are such that just doesn't make sense for us to build such a node.

So I don't mean to make this overly complex, but there's a mix of different scenarios there.

And so you'll see kind of a basket of hardware margins that will shake out over time.

And part of our uncertainty and difficulty in answering the question is we're just not yet exactly sure how that's going to shake out.

And maybe one more thing to the last caller's question.

Indeed, there are -- or 2 before.

There is cases where we may not provide the hardware at all, just the headend software.

So we've got kind of this high-margin software business and this lower-margin hardware.

I think if we provide the whole kit, and we're doing the node, it's exactly the ratios or approximately the ratios you've discussed.

But as we get into discussions with Comcast or a European customer, everywhere else, where we're going to do some centralized with our shelf products, some remote node, maybe some third-party nodes, in general, those other scenarios point to a slightly higher-margin scenario.

But we don't yet have enough mileage under our belt to really give a crisper forecast.

And I'm sorry for that long speech, but I hope that gives a little bit more color in terms of this.

Really, all of which we see is upside in our business.

Absolutely.

A little more complex but still understandable, and appreciate it.

And here's a question more -- well, it kind of follows on that a little bit.

Sanjay, you mentioned the, I think, $34 million in license fee contribution anticipated for Q3.

I don't know -- I still have to work on this GAAP versus non-GAAP treatment.

But you mentioned $50 million in cash for the year, but yet no big software pick-up in Q4.

That was -- that would seem to imply another decent, though smaller chunk, of license revenue in Q4.

And I'm really just trying to understand sort of how the business is scaling ex Comcast and what sort of, at least, license revenue contribution is implied in your Q4 guide assuming kind of minimal hardware from Comcast.

So Tim, I can provide that in the -- we provided that in Q3.

We are picking up $34 million as a onetime license revenue, and that's how the new revenue recognition works.

But at the same time, for Q4 also we have around approximately $6 million which we will be picking up.

It will not go into the license revenue line per se, but it's going to be a revenue piece from this contract, and it's going to be coming to the bottom line at 100% margin.

So for purposes of clarity, even though this agreement of Comcast rev rec we just discussed is a preliminary view, but at the same time, our expectation is going forward, after this onetime pickup of Q3 is behind us, there is a run rate we can expect of approximately $6 million a quarter that should come in.

I hope that helps providing that.

Okay.

So we're on the run rate starting in Q4.

It does help.

And it does imply a pretty significant scaling of the business outside of Comcast in Q4.

I assume that's the European stuff and maybe some other things.

Final question from me, do you expect the Video business to be profitable in Q3?

Yes.

We are -- we have been profitable in Video business for a lot of quarters, 8 quarters, I believe.

And also we are planning to be profitable in Q3 and Q4.

All right, thank you very much.

And it's a good time, top of the hour, to wrap up the call.

So I -- let me thank everybody for joining us today, for your continued support.

We're certainly encouraged about the business and looking forward to talking with you again soon.

Goodbye.

Thanks.

Bye.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for your participation.

You may now disconnect.