Welcome to the Fourth Quarter 2018 Harmonic Earnings Conference Call. My name is Carmen, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference call is being recorded. Now I will like to turn the call over to Avelina Kauffman, Investor Relations. Avelina, you may begin.

Thank you, Operator. Hello everyone, and thank you for joining us today for Harmonic's fourth quarter 2018 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 to this webcast, which you can see by going to our IR Web site. Now turning to slide two, during this call, we will provide projections and other forward-looking statements regarding future events or future financial performance of the company. Such statements are only current expectations and actual events or results may differ materially. We refer you to the documents Harmonic files with the SEC, including our most recent 10-Q and 10-K report, 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 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've posted on our Web site and filed with the SEC on Form 8-K. We will also discuss historical, financial and other statistical information regarding our business and operations, and some of this information is included in the press release, but the remainder of the information will be available on a recorded version of this call or on our Web site. And now, I'll turn the call over to our CEO, Patrick Harshman. Patrick?

Well, thanks, Avelina, and welcome everyone to our Q4 call. We're pleased to again be reporting a strong quarter with revenue growth and profitability driven by the ongoing success of our strategic transformation, CableOS, and video streaming software. Specifically, continued CableOS momentum delivered 79% year-over-year revenue growth for our Cable Access segment, while a combination of over-the-top streaming and ultra-high-definition wins drove a record 14.2% operating income for our Video segment. Putting it all together, combined corporate Q4 results were 12% year-over-year revenue growth, 11.2% operating income, $0.11 EPS, and $6.6 million cash generated from operations. So, taking a closer look at our Cable Access segment, we continue to expand the combined number of commercial deployments and field trials now with 29 global customers. Among these were a growing list of industry heavy hitters, including four of the top eight North American and European cable operators, and six of the named cable operators leading the new 10-G or 10 gigabit initiative announced recently at CES. Focusing first on our commercial deployments to date, CableOS is now powering high-speed data service for over 535,000 residential and business cable subscribers demonstrating that our fully-virtualized technology is being deployed at scale and enabling substantial operational benefits relative to traditional hardware-based solutions. These initial CableOS deployments are primarily in a traditional centralized CMTS architecture with a typical application as DOCSIS 3.1 upgrade, and virtualized software economics, and future distributed network migration flexibility underpinned our competitive advantage. We expect continued momentum during 2019 for these more traditional applications. Turning next to the heavy trial activity that we've been involved with. Based on challenging the groundbreaking progress made over the past several months, we expect the volume 2019 deployments of new Distributed Access Architecture or DAA networks with multiple tier 1 operators. During this quarter, Q1,…

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. As you just heard from Patrick, our fourth quarter performance was solid. We are pleased that we delivered another profitable quarter with strong results across a number of key financial matrices. Total revenue was within our guidance range. Gross margins exceeded the high-end, while our operating expenses came in at low-end of our guidance range. This resulted in a profitable quarter with stronger EPS than we have seen in several years. This was coupled with a strong balance sheet and working capital, and another sequential improvement in cash. This is the sixth consecutive quarter of solid financial and strategic execution. As we turn to slide six, to review our Q4 results, revenue was $113.6 million. This compares to $101.4 million in Q3 '18, and $101.1 million in Q4 '17, resulting in a 12% quarter-over-quarter and year-over-year growth. The sequential revenue growth was primarily driven by our Video segment and year-over-year growth was primarily driven by our Cable Access segment. Cable Access revenue was $24.1 million, compared to $28.1 million in Q3, and $13.5 million in the year-ago period, reflecting a 14% decrease quarter-over-quarter, but a 79% year-over-year growth. This quarter brings Cable Access segment revenue to $90.9 million for the full-year 2018, compared to $38.9 million for 2017, an increase of 92% after adjusting for segmental reporting change we made last year. As you have seen, we've been steadily ramping the activity of our Cable Access segment over the last four quarters, and are leading a fundamental capability upgrade in access architecture for cable operators. As Patrick discussed, the…

Okay. Thanks, Sanjay. And we want to wrap it up by reviewing our strategic priorities. For Cable Access business, objective number one is to further scale our first wave of CableOS deployment. Leveraging this growing CableOS market momentum, our second objective is to secure new design wins with additional operators with international expansion becoming a key theme in 2019. And as cable operator deployment plans and DAA solidify, objective number three is to leverage our DAA technology and market lead to further accelerate growth. Turning to our Video segment, our first objective is to continue to further grow our over-the-top streaming market share across both media and service provider verticals. Objective number two is to leverage our SaaS offerings to expand our addressed market, tapping into new higher growth customers and business models. And our third objective is to deliver consistent segment profitability just as we have done over the past six quarters. Our commitment to these priorities enabled material strategic and financial progress throughout last year, and we enter 2019 with continuing confidence in driving growth, profitability, and shareholder value. I want to close here by thanking our amazing team members and our customer partners for the results we drove together in 2018 and our stockholders for your continued support. With that, let's not open up the call for your questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question is from Simon Leopold with Raymond James.

Great. Thank you for taking the question. I wanted to see if maybe we could parse some of the trends in the Cable Access side of your business and maybe update what may or may not have changed, and just to sort of lay it out, I tend to think of the distributed access architectures in the virtual CCAP initiative as different, but sort of cousins kind of related, and my impression is DAA, you sound more upbeat, and that looks like it's ramping in the spring, whereas maybe virtual CCAP might take a little bit longer. That's part one. Part two, just by my rough math, your access business needs to deliver $25 million to $30 million per quarter in the second through fourth quarters. I'm wondering if you can give us some thoughts on what kind of linearity you expect -- I appreciate full-year guidance, but just looking for a little bit more detail on how it plays out. Thank you.

Well, thanks, Simon. Appreciate the thoughtful questions. First, yes, I would agree that the idea of virtualization and DAA are cousins. I mean, virtualization does not require DAA,. In fact, as we've noted several times, the majority of our deployments to date are not DAA, but they are all -- by definition with us virtualized. We actually see continued good momentum of -- let me call them centralized deployments just with the virtualized CMTS. I think the issue or the fact is, Simon, that the largest operators that we're involved with I'd say are turning their chairs hard towards DAA. So it's not a lack of good competitive momentum with just pure virtualized, it's just that right now, most of that activity, I would say is with the smaller, and medium-sized operators. Whereas the larger ones are really locked into, I'd say, the battle with 5G, and really pushing their broadband businesses further aggressively. You saw that in the so-called 10G Announcement at the CES show. And so indeed, just because of the nature of the tier 1 customers themselves and their increasing focus on DAA, we see -- let me say, over the next 24 months, probably greater volume opportunity with those kinds of deployments. To the second part of your question about ramp, I also appreciate you kind of doing the rough math, and indeed we anticipate a pretty busy year in total, and after a pretty slow start in Q1 a pretty good pick up. It remains to be seen exactly what the pace is. We're basing our full-year numbers on fairly detailed plans that multiple operators have shared with us, and we are involved intimately with crafting those plans, and the feasibility of the rollout. Exactly what Q2 looks like versus Q4, it's too soon for us to give that kind of detail, it will be a ramp, it will be an accelerating pace through the year. That being said, we don't see this as a big bang in Q4. We do see a ramp. A lot of this is outside plant work, but frankly needs to begin in earnest in Q2. So, I hope that helps a little bit with the qualitative picture, and all I can say beyond that is we'll certainly keep you posted as the next level of detail of these DAA deployment plans get more solidified.

That is helpful. Just as a very quick follow-up, then if there is more DAA and less virtual CCAP, I assume that's margin unfavorable in terms of just the mix for you?

Well, let me back up. I'm a little uncomfortable, I mean, you probably get it, but I'm a little uncomfortable with the characterization, "Less virtualized." All of this DAA stuff or everything we do has got a virtualized CCAP at the core, okay, and so from that point of view, I mean, think about our business in two distinct blocks. There’s centralized software piece or maybe we sell the servers with, so let's say, the pure software or let's say high north of 60% margin stuff if we sell servers with it. And that scales with bandwidth, and so whether it's DAA or centralized, that doesn't change. I'd say DAA brings additional revenue dollars admittedly at lower margin with these nodes. And so, yes, the blended margin goes down, but the revenue is kind of on a per subscriber or per gigabit basis, the revenue is up because we're delivering this hardware capability out into the field at a higher price, albeit at a lower margin than we are in a centralized scenario. So, yes, in DAA, blended gross margin is a little bit less, nothing what we've seen historically, we still think as Sanjay said, we're on an upward track there, but it's less than it would be if we were all exclusively centralized and shipping only pure software. Does that help?

It does, thank you very much.

All right, thank you.

Thank you. Our next question comes from Tim Savageaux with Northland Capital.

Hi, good afternoon. Maybe first question kind of addressing that margin issue from a different direction, you did have a very strong quarter in video and strong margins as well as in nodes, you know, very high operating margins, I wonder -- you look to be guiding sort of flat to down a bit from a revenue perspective, I wonder if you can comment on what sort of margin compression -- direction, sorry, not compression -- you might expect from a gross and operating perspective on the video side or what's contemplated in your annual guidance relative to what you did in '18?

Sure, Tim. So I'll start with video. Video margins, we ended at 56.8% for the whole year, but if you look at all the quarters, Q2 was 55% and Q4 you know, we got 57.5%. So, although the mix is improving, but you know there is a range we are seeing more recently, 55% to 57%, so that's in our guidance we baked, 55% as low-end and 57% as high-end for video, and that's similar to not only Q1, but for the whole year as well. Coming to cable, you know, this year for the full-year, we ended at 44% approximate margins on cables, and the mix -- and as Patrick has discussed, because of DAA and virtualization, so the mix could change quarter and for the whole year, so while we did end at 44% for the whole year, but we have seen, you know, mid 30s to mid 40s in the year. So for guidance purposes for Q1, we are keeping a range of mid 30s to 40s and for the whole year, we are keeping approximately 35 to 45. We believe by the end of the year, we'll catch up with what we saw this year. And you know blended both, if you see both the margins we end at 54.5% for the whole company for both segments for the whole year, and hence 52.5 to 54.5 for Q1 -- again, high-end is exactly what we found for the whole year. And for full-year 2019, the guidance is 50 to 53.5. I hope that provides a decent insight.

Got it. Yes. And any follow-up on -- you seem to have a fair number of tailwinds in the video side from streaming, from UHD, any comments on the growth potential there, the puts and takes driving that guide, can we assume that on the video side you would look to hold OpEx steady or maybe decrease it a little bit?

Well, maybe I'll jump in here, Tim, on the -- look, just taking the last part, yes, we think that we are scaled, and in good shape in terms of the amount of investment we're making in the business, and so, I wouldn't expect any material change in OpEx as we go forward. Regarding the overall trends, as you mentioned, there is favorable things happening, market dynamic wise, competitive positioning, technology trend, I'd say the one headwind though is to transition to SaaS, and to be clear, we think that overall this is a good thing. Frankly, it was a somewhat slower year than we expected in '18 in terms of seeing opportunities with the Saas although the number of customers grew. And here what's really interesting is we're bringing on customers that we never worked with before. So we really feel as though we're building almost to 20, we're really expanding the addressed market. And the other thing we've seen with each of those customers, although they're modest in size at the outset, we've seen almost across the board a rampant spending, we're kind of there on the ground floor with a lot of these guys as they're getting going with new business models, and so, we are committed to this as the right long-term strategic business direction. That being said, when we sign-up a new deal either with an existing customer or a new customer, the SaaS deal, that's less revenue upfront than it would have been in the past, and that's more in backlog that will be recognized ratably over the contract term. So, that creates a positive thing strategically, but indeed a little bit of a headwind, and we do expect the pace -- I don't want to overstate it, but we do expect the pace of business tipping over to SaaS, increase somewhat in '19. And I would say that is a consideration that plays out in the top line for us. So keep that in mind as you look at the year-over-year comparisons.

Yes…

Yes, I'll just add to that…

Okay.

- for video overall, the way our focus is shifting to manage the video business is not only purely top line, but together managing the SaaS transactions looking at -- there are two key metrics, which is the gross margin SaaS we discussed earlier, at the same time, the OpEx, so overall the profitability of video business is our focus. And as you saw this quarter, we achieved a very good operating margin on that video segment. Similarly, our plan is to -- over longer period of time we believe our operating margin should be in double-digit. And that's the path we are marching on towards. So I think the focus is not only just top line, but OpEx as well and margins and the right mix of both.

Got it. And last quick one from me, and I'll pass it on, it's been I think quite a while since we have seen Charter on the 10% list, wonder if you can comment -- I'm going to -- I would guess that's likely focused on the video side, but if you had any color on kind of what brought Charter up to join Comcast in the 10% customer list in the quarter?

We can't give any more color on the makeup of it, but let me just take the opportunity to concur that it's -- we are happy to see them there, it's certainly a critically important cable account, and I don't think one can overstate the importance of the value of having a strong strategic relationship with them as well as we do with Comcast. And it's been a little bit slow as we saw Charter and Time Warner go through a M&A process, and we stayed focused close to the account, and it's good to see the relationship paying dividends.

Thanks.

Thank you.

Thank you. And our next question comes from Steven Frankel with Dougherty. Please go ahead.

Good afternoon. Patrick, I wonder if you can give us any insight in how you get better visibility into the pace of these nodes getting installed in the past moving from no to high margin software, and in that vein I want to ask if the 2020 guidance assumes that this business does have a material software component in 2019, or do you expect that to come next year after you get through these installation issues?

Look, I want to acknowledge that it's been a road to get here that has had more twist and turns than we anticipated, and frankly, more of those out of our control than in our control. So we are little bit conflicted, primarily transparent. On one hand, we think we have quite good visibility and we think that the vast majority of issues are behind us and behind our customers. That being said, we are very cognizant of the appearance of the unexpected -- this is cognizant to hear. So I would acknowledge that we are startling the line, on one hand, we are confident that these things are going to move forward, but the exact pace and the exact volume is something that we don't want to get too far ahead of our skis. I think we have given pretty good full-year guidance, particularly when you consider the slow start in Q1. So we see even in a slow scenario, a pretty healthy ramp. And included in that ramp is probably with the volume DAA stuff is hardware first, but absolutely there is corresponding software, maybe not quite in proportion, but corresponding software that follows and gets deployed in the course of 2019. I think we have to wait and see a little further before we're more granular or more aggressive about the exact mix of that.

And this ramp that begins in Q2, is that driven out of backlog with better visibility on timing, or this is more about conversions of trial activity to deployments as we go through the year?

Well, it's a little bit of both. We have shipped several thousand nodes out there that do not have companion software licenses shipped with them, yes, yet. So those nodes are to be -- and there's no question as I think we discussed on this call last quarter, they're not much use without buying that software. So we see companion high margin revenue that is still to come with what's already been delivered, Steve, and we see that as kind of the first shoe to drop in terms of the next phase of substantial deployment. But frankly, we think of the several thousand that have been shipped to date is really the tip of the iceberg -- you think about the plans of multiple tier 1 operators. So behind that is additional hardware purchases and additional software purchases coming behind that kind of in a cycle. There's no doubt in our mind that flywheel starts to move in Q2 and picks up pace for the rest of the years. As discussed, a little earlier on this call, the exact pace of that and the timing, you know, we're not in a position to give precise second quarter guidance here, but we did feel comfortable giving a full-year view of what we think our customers are determined to achieve by the end of the year.

Okay. And then a look back quickly on Q4, you'd hoped to hit $100 million in Cable Access, you fell a little short of that, would you say that shortfall really related to this issue of some of the major customers are rolling out more slowly as they work on issues not directly related to your business, or your part of the puzzle?

Yes, so, essentially, yes. And again, I want to emphasize that the -- I think that they are very close, but as often is the case with very complex deployments with -- particularly with tier 1s who want things just so, and basically want to get something that is done right, and it's going to be scalable on a big -- reproducible on a massive scale. We have a couple customers who came across things, I noted one change, 40 gig to 100 gig hardware as an example that they decided kind of eleventh hour, you know what, we want to change this, and it's the better interest of the long-term scalability of the program. So, yes, that created a headwind on deployment in Q4. We expect that to continue through Q1 as that stuff gets worked through, but none of these things that I'm referring to the specific changes or decisions that have been made kind of late in the game regarding deployment, none of them involved real rocket science or -- so we're not praying that anything is going to work out. We wouldn't be able to give the guidance that we were giving if we didn't have a -- I think a very comprehensive understanding of the nature of the complexity and the -- basically, the confidence in achieving what is currently being worked through.

Okay. And in the margin improvement in video, how much of that is the transition of your traditional customers from a bundled hardware/software approach to licensing pure software, or is that benefit still to come as we work through this year and next year?

So, Steve, we have not really clearly broken out the margins that for which particular segment within video is improving, but I can tell you overall if you look at the mix for entire gambit of our video products, overall, we see that software mix in the entire product value is increasing composition, and marginally every quarter we are seeing that improvement, and we're glad to see a very high percentage in Q4 of 57.5%. But I'd say it's spread across all of our products, and we are able to actually demand market premium as I mentioned in the prepared remarks, and having a strong competitive position pricing and that's building up because of software mix.

Okay, great, thank you.

Thank you. Our next question is from Simon Leopold with Raymond James. Please go ahead.

Hey, I appreciate you letting me back in for -- and just a -- hopefully maybe a quick follow-up, and maybe you did explained in the prepared remarks, but I just wanted to look back at the actual fourth quarter, the gross margin in Cable Edge segment was particularly strong and you upside it in the quarter. So it does look like video has been very stable throughout 2018, but we've seen a lot of volatility in the Cable Edge. Could you just help us understand what actually happened in your December quarter to help the Cable Edge gross margin? Thanks.

Well, so you're right, Simon, we experienced margins in cable at the beginning of the year versus now. It's like, for example, Q1 47, Q2 50, Q3 we saw 39, and Q4 coming back 44. I think the mix the way is playing among various product lines in cable, which is a mix of the nodes, the mix of the software, together with services we provide to the cable customers. The mix is playing, and that is just the result of that, it's nothing, which is particularly exceptional to call out, I would say, it's purely mix, and that baked into our guidance as well.

Okay. Thank you for the follow-up.

Thank you. Our next question is from George Notter with Jefferies. Please go ahead.

Hi, this is Kyle in for George. Thanks for taking the question. Of the distributed access deployments that you're currently working on, I guess specifically those thousand DAA nodes that you should thank you for, is there any regional focus to that deployment activity, like, is this U.S., Europe, broad-based, any additional color you can add that will be great.

The biggest opportunities we see right now that we're working on are in the North America and Europe.

Okay. And the thousand nodes…

And to be clear, global cable industry is I think it's captured the imagination of the global cable industry, but in terms of those who are safe furthest along and pursuing it most aggressively that we think we'll see deployed first, it's in Europe and North America.

So there's some subset of those thousand nodes that were in each of those regions?

We don't want to go get that specific. I mean, we announced substantial nodes in Q3 as well. So we've shipped several thousand nodes to date, and we'll keep it there.

Fine, and then, do you see distributed access decisions across operators holding up the cycle or the opportunity for you. I appreciate the commentary that the virtualization aspect of your product is not necessarily tied to DAA, but big architecture decisions across your customers could understandably be something that takes some time. So, anything you're seeing there across your customer engagements would help.

Well, in my prepared remarks I noted that we're closely engaged with four out of the top eight operators in North America and Europe, and I would say, I mean the best of our understanding those four are -- if not working exclusively with Harmonic, or have decided to work very closely with Harmonic kind of at least a substantial part of what they're doing. That being said, the other four are still as you've suggested in a discussion, and a decision process and engaged I think with multiple potential technology suppliers. So we think we've carved out a very strong position, but it's not across the 100% of the customers where we are most involved. We think the choice has been made, and really, it's kind of operational and deployment planning that's going on, and the sequence of advanced lab and field trials to get ready for volume deployment. Elsewhere, I think theses customers who are just not as far along in the process, and yes, there's a lot of -- I'd say, the next wave of operators who are trying to make decisions about architecture as well as who the technology partner is going to be.

Okay, thanks. That's helpful. And one last one on the video side of the business, in terms of the full-year guidance, is there something you're expecting in terms of the headwind from the further transition to SaaS models, like is there a headwind that you have baked into that guidance?

Yes, Kyle we have. As you see the -- if you take the midpoint of our annual guidance range, we are marginally down than this year around 3% or 4%, and that's what we've experienced when we transitioned to SaaS. We experienced it a little bit in '18, and in '17 we did experienced it for sure in the first-half. So, yes, you are right, SaaS transition marginally impact the top line.

Okay, and consistent with the headwinds seen last year is essentially what you are expecting?

Yes.

Okay, all right, great. Thanks a lot. Thanks for taking the question.

Thank you.

Okay. Listen, I would like to thank everyone again for joining the call today, and for following our business. So, I hope it comes across, but we are pleased with the progress we have made last year, but we see good opportunity ahead, and we are excited about pursuing it. We look forward to talking with you all again soon. Thanks very much.

Okay, thank you.

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