Welcome to the Q2, 2019 Harmonic Earnings Conference Call. My name is Brian and I will 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. 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; 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 with this webcast, which you'll see by going to our webcast section on our IR website. Now turning to Slide 2. 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 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 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 to GAAP are contained in today's press release which we posted on our website and filed with the SEC on Form 8-K. We’ve 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 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 operators. In our Video segment, live over-the-top sales channel deployments continue to grow up 10% sequentially and we deliver a 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 four year software license agreement, priced at $175 million, covering CableOS head end 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 a win-win arrangement through which future additional purchases above the Harmonic products, such as DAA hardware and CMTS shelves earn credits, which can be deducted from a software license fee. The remaining bill highlights that we can't disclose are the Comcast will pay us the first $50 million of cash in 2019, and the rest of the remaining 5.8 million in change warrant shares granted when the original partnership agreement was signed. In a couple of…

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 of 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 2019 and 99.4 million in Q2, 2018. 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 2019 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 to 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 certainty deals to later this year and as Patrick just mentioned, growing customer…

Okay. Thanks, Sanjay. And on that topic of execution, we want to wrap it up by summarizing our strategic priorities for the remainder of the year. For our Cable Access business it’s all about taking advantage of the opportunities in front of us [indiscernible]. Our near term objectives of a further scale or current CableOS deployments secure new design wins with additional global operators, and to ensure our Tier 1 customers volume DAA deployments through the second half are successful. Our video segments objectives are to continue to grow are 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 our last eight quarters. We want to close by thanking our strategic customers and partners, our talented team members and our stockholders, all of whom and stay 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. Your line is now open.

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 weren't being included. I 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 early in 2018, when we signed this international customer contract more than 50 million 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 similar to Comcast, and that there's an enterprise license agreement for a given amount and then the ability to sell remote fine nodes 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 and 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.

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? Thank you.

So Simon, you've seen the guidance we gave for Q3 and Q4, well Q3 definitely has a one-time, 34 million revenue. So based on that, the margins are 76 to 78, approximately build in the guidance, but Q4 does not have any one-time pickup. So Q4 I believe, which is early I would say 41%, 42% kind of margins for our 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 targets 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 of few years as generally trending higher from the 2019 level. You've guided 2019 in a 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. Your line is now open.

I wanted to go back to the comment that you made Sanjay, about the credits associated with the Comcast deal as well. And just made sure that I understand what you’re alluding to there. The 175 I understand the 20 million that has come out of there, bringing the total to 155. But then you mentioned that there might be some credits that work that value down even lower. I just wanted to make sure, I understood how that sort of balances of - against at least my expectation that we may see additional hardware sales and things like that may - drive the total value up above the 175. 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 three 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 credit defined by the deal. This structure was defined this way up front to encourage a win-win approach of doing business together.

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

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

And then when you talk about the concentration on video and where do you hope that goes Patrick over time. As I look out into 2020 or 2021, 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 2020. 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 timeframe 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 - 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 - would have otherwise been an appliance deal now becomes a SaaS deal it puts effectively more in backlog. So we expect for - in 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 two quarters, is it four quarters? We don't see this as a five-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 book 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 re-converge. 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 the - this video market the streaming market is headed in general. And where the dialogues that we're having with customers give us continued confidence that - that 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, so the revised full year guidance, particularly on the cable side, with the high end of that range now coming down from 130 to 113. 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, that change down from the high end, what's really caused that to come out a little bit?

Yes, John. I'd say it's a confluence of all these things which you mentioned, all the three 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 maybe coming a little lower than what we anticipated, but the gross margins and the overall profitability for that year has solidified 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 line of Rich Valera with Needham & Company. Your line is now open.

Patrick, I was hoping you'd find 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. I 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, 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, if that timing changes or if there is 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 -- other the Comcast deals, this is already highlighted in the…

The new international deal.

The new or international deal. So, look, I think what we've learned is that, let me take a step back first, which although, most of the deployments we've done to date are on the so-called centralized architecture, the big volume with the big Tier 1s that we're seeing right now is really associate 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 three 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. But 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 the snap of a finger -- the fingers, subsequent large DAA deployments look to be able to be executed more quickly. 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 timeframe than we've seen heretofore with other deployments. So specifically asking -- 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 up throughout to 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 cost frequently recognized 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.

Then just sort of a follow up on that. Not to cut to find 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.

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. You know the convert, the price of conversion to 575, 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 is just a simple formula which we use basically whatever is the trading price. And we take all 575 from that, i.e. whatever is in the money amount, multiply that by 22.3 million shares, which is a basic dilution when we did the deal five 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 seven, the amount will be 4 million shares or suppose the price goes to nine, it will be 8.1 million shares. It's a very safe formula. You can actually also share that with everybody.

Any update in terms of potential options for that convert, in terms of refinancing or anything to talk about their.

Well, so, we definitely that is something which is being actively taught off on how to address that. I believe what recently has happened in terms of what stock price gives us much more options or alternatives to look at. We are looking at it and that the deal still matures in December 2020. So we have a lot of time to address it. We would 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 confirm plan on how to execute on it.

And our next question will come from the line of Steven Frankel with Dougherty. Your line is now open.

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 -- to say it definitively. What I will say Steve, is 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 or to let some of the kinks get worked out, if you will. There's no question that Comcast is viewed, I think worldwide is 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.

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 is happening on the trial side now?

That numbers has -- that has gone up as well, Steve. I think there was always this ambiguity about, well, at least we got off line 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. Well, we got into this whole thing. I think it 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 one, 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 up 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 three years?

Well, when you say roughly yeah, it will form - 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.

And regarding this whole discussion about credits and hardware. Is that because Comcast has gotten to the point where they just assume buy 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, 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, sincerity provide a real win-win opportunity here. So I view, we may think credit is a minus. But I mean I view this is all is nothing but goodness 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 pre-structured way is a discount if you will, or alternatively a credit. I think the real takeaway here is that there is an incentive and a desire going back to the date of the original agreement to do additional business together. And it 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 - because of related the products.

Let me 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 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 the announcements around people doing this our DAA hardware. I think it’s all goodness for our virtualize, CMTS strategy and business. It’s endorsement of the DAA model and I think that what we've done with CableOS from a head in perspective is truly unique in terms of enabling this 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 head in software, that's also pretty good.

And our next question will come from George Notter with Jefferies. Your line is now open.

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 won't 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 is 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 onset. 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 cost syndication deals, that's if I understand what you mean by that, that would be outside of their footprint. So that would - 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 deployment. Indeed as I mentioned a moment ago, the majority of our field deployments today - are actually in the so called centralized architecture. So they've got, they purchased a license that they can use it however, they like within their footprint. We've made - 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 - we're certainly not predicting or authorized to discuss anything about the Comcast 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.

And then so the upside here for you above and beyond the 175 is really focused on, optical node and RPB sales, in terms of the credit?

I'm sorry just let me interrupt. I also highlighted centralized deployments. I mean, again most of our deployments to-date involve a centralized CMTS architecture, which also includes the 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 anyway you would use the software to deliver DOCSIS service to subscribers, either deep PHY or remote PHYSICIAN. 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 datacenter, 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. Your line is now open.

Good afternoon 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 two a little bit or maybe the European MSO deals and the aggregate 100 million plus. And the sort of profile you might expect there from a hardware revenue to software, and it seems kind of more, once a traditional 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 a - almost sort of a two to one 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 five shelf and it doesn't have all the trappings of a -- of what you would hang out in a poll 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 or Edge qualm 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 five module that goes in a third party node. So we go to market with hardware and 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 five module that will plug into some third party node where the local requirements are such that…

Absolutely. A little more complex, but still understandable and appreciated. And here's a question more kind of follows on that a little bit. Sanjay, you mentioned I think $34 million in license be contribution anticipated for Q3. I don't know. I'll 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 pickup in Q4. That would -- that would seem to imply another decent smaller chunk of license revenue in Q4. And I'm really just trying to understand, how the business is scaling exComcast and what sort of 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 one-time 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 sale, but it is going to be a revenue piece from this contract and it's going to be coming to the bottom line as 100%margin. So for purposes of clarity, even though this agreement of a Comcast rev rec we just discussed is a preliminary view, but at the same time, our expectation is going forward after this one-time pick up 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.

Okay. So we're on the run rate starting in Q4. It does help and it doesn't play a pretty significant scaling in the business outside of Comcast. In Q4 I assume that the European stuff and maybe some other things. Final question for 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, eight 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 on top of the hour to wrap up the call. So let me thank everybody for joining us today for your continued support. We're certainly encouraged about the business and are 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.