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EARNINGS CALL TRANSCRIPT
EARNINGS CALL TRANSCRIPT 2017 - Q1
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Executives

Blair King - Director of Investor Relations Patrick Harshman - Chief Executive Officer Hal Covert - Chief Financial Officer.

Analysts

George Notter - Jefferies Tim Savageaux - Northland Capital Greg Mesniaeff - Drexel Hamilton Steven Frankel - Dougherty Matthew Galinko - Sidoti.

Operator

Welcome to the Q1 2017 Harmonic Earnings Conference Call. My name is Candace 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 is being recorded.

I will now turn the conference over to Blair King, Harmonic’s Director of Investor Relations. Blair King, you may begin..

Blair King

Thank you, Candace. Hello, everyone and thank you for joining us today for Harmonic’s first quarter 2017 earnings conference call. My name is Blair King and with me at our headquarters in San Jose, California are Patrick Harshman, our CEO; and Hal Covert, our CFO.

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

Turning to Slide 2, during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements are only current expectations and actual events or results may differ materially.

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

These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis.

These items, together with corresponding GAAP numbers and a reconciliation to GAAP, are contained in today’s press release, which was posted on our website and filed with the SEC on Form 8-K. We will also discuss historical, financial and other statistical information regarding our business and operations.

Some of this information will be included in the press release, and the remainder of the information will be available on a recorded version of this call on our website. So with that, I’ll turn the call over to our CEO, Patrick Harshman.

Patrick?.

Patrick Harshman

Thanks, Blair, and thank you everyone for joining the call today. Turning to our Slide 3, let’s get started with an overview of our first quarter results. Revenue was $83.5 million, down 27% sequentially following a strong fourth quarter, but up modestly from a year ago.

Video segment revenue performed below our expectations, down 29% sequentially, but up 13% year-over-year. Our Cable Edge segment performed as expected given the major market and product transition now underway. With revenue unchanged from the prior quarter, down 46% year-over-year.

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

The bookings also included growing mix of new cloud-based recurring revenue orders, which was advantageous over the mid-to-long term but a headwind for near-term revenue conversion. Underscoring the shift in our video business to more software recurring revenue services, backlog and deferred revenue is $184 million remaining at a near record level.

Nonetheless fewer new orders that converted immediately to revenue during the quarter resulted in a higher mix of support revenue and a corresponding lower gross margin to 52% and a disappointing EPS loss of $0.14. I want to emphasize that these results stem directly from our singularly weak Q1 video spending environment.

We do not believe we lost any market share during the period and following the just completed detailed business review, our sales pipeline and overall demand trends we saw entering the year are still very much intact. So with that brief summary, let's take a closer look at the video business and turn to our Slide 4.

The first key message here is that following strong fourth quarter of video on demand first quarter customer spending dropped materially. In particular our results reflect much softer than expected service provider spending in Europe, Middle East, and Africa.

This was most pronounced in the final month of the quarter when several anticipated projects were unexpectedly delayed. Nothing we have seen from competitive data suggest this spending weakness was a unique Harmonic challenge.

In fact, we subsequently closed a couple of these key deals and as noted a moment ago, we’ve conducted a detailed sales pipeline review which convinces us that the full-year demand we anticipated remains intact.

So that said, we’re seeing some faster than expected shifts in demand trends with several satellite pay-TV operators reducing investment in traditional video infrastructure, offset by growing investments in over the top, in a particular cloud and SaaS based over-the-top solutions which brings us to the second key message about our video business, which is that customer adoption of our new video cloud and software as a service solutions continues to gain encouraging momentum.

Year-to-date cloud and SaaS solutions represent over 5% of total video segment bookings. And following a busy NAB show last week in Las Vegas it is now clear that serious customer interest in our cloud solutions is starting to gain stain. Underpinning this momentum is, on one hand truly innovative new technology.

We are the 1st to enable premium video quality video processing as cloud native applications that can run on private clouds or public roads such as AWS. And on the other hand, strong engagement with several Tier 1 operators who are looking to the cloud to enable more agile and efficient operations.

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

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

And this has been a major area of investment for us and it’s good to see the successful early deployments and expanding market buzz although we must again caution that we expect the well-known issues associated with pivoting part of a revenue stream from a CapEx to a consumption business model.

So, while we are not yet forecasting dramatic growth of recurring revenue contribution this year, we do expect to continue to report to you growing SaaS bookings and backlog throughout the balance of 2017. So this brings me to the third key message, which is that our video business outlook for the remainder of 2017 remains healthy.

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

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

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

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

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

Second, we achieved a major milestone with another key customer who initiated critical DOCSIS 3.1 field trial activity to validate readiness for the large-scale deployment.

And the progress to date on this trial has also been good, validating not only our fully virtualized 3.1 technology, but also the broader operational aspects associated with running a fully horizontally scaled virtualized CMTS stack in the field.

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

And fourth, associated with this work we have started shipments of our new Remote PHY nodes powered by cable OS to multiple customers performing end-to-end converged testing. Now it’s really important to understand here that this story is not just about Harmonic having the new CMTS solution and some good customer relationships.

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

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

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

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

And that has been the bad news for our Cable Edge Segment for some time and we expect it will continue to be the case in Q2. However, looking beyond Q2, I want to assure you that our CableOS outlook for the remainder of 2017 remains positive.

We have been working closely with our lead customers not only on technical issues, but also on volume deployment plans and associated commercial forecasts. And based on this work, we continue to anticipate commencing volume shipments in the second half of this year.

With this target firmly in mind, for the next few months we are focused on scaling existing commercial deployments and trials of both centralized and distributed DOCSIS solutions. We are leveraging our deepening field experience, steadily expanding market awareness and creditability and securing additional customer design win as we go forward.

We remain well positioned to turn the core on the second half of this year and hit the $100 million annualized run rate target we set for ourselves. And of course looking further ahead, the ultimate goal remains to become a leading player on the $2 billion plus CCAP in distributed asset architecture market.

We are genuinely excited to be entering the countdown phase and successfully turning with CableOS business, our innovations, our investments into a powerful new growth engine for the business. So with that Hal, let me turn in over to you..

Hal Covert

Thank you, Patrick. We want to thank everyone for joining our call today. During my discussion, I will cover three topics. First, our financial results for Q1, next our financial goals for Q2 and then our financial goals for the year of 2017. Before discussing our Q1 financial results we would like to start with some opening comments.

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

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

Although our financial results for Q1 2017 were below our guidance we do not believe that the softness in our business experienced in the quarter is representative of prospects going forward. Most of the shortfall in Q1 was related to our North American and European geographies for which we expect the timing of purchase decisions to improve.

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

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

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

To enhance the achievement of our operating profit goals we plan to reduce our current operating expense run rate on a sequential basis over the remainder of 2017. We believe that we can accomplish this task without impacting the momentum of our business. Shortly, I will provide more details about our 2017 financial goals.

Now turning to our financial results, please note that our financial results and guidance discussed during the call are based on non-GAAP measurements. The table reconciling GAAP and non-GAAP measurements is included in our earnings call presentation and in our earnings press release issued earlier today.

Bookings for Q1 2017 were $82.1 million, compared to $116.9 million in Q4 2016 and $109.6 million in Q1 2016. Our bookings level for Q1 2017 reflects my earlier comments about our soft quarter, as well as typical seasonality. Non-GAAP revenue for Q1 2017 was $83.5 million versus $113.8 million in Q4 2016 and $82.5 million in Q1 2016.

Non-GAAP Video Segment revenue for Q1 of 2017 was $74.5 million, versus $104.8 million in Q4 2016 and $65.6 million in the same quarter last year. The sequential and year-over-year comparisons reflect the soft Q1 revenue level that we reported, as well as typical seasonality.

Non-GAAP Cable Edge Segment revenue for Q1 2017 was $9 million versus $9 million in Q4 2016 and $16.8 million in the same quarter last year. Our Cable Edge revenue has been relatively flat since Q3 2016 and is not expected to improve until the second half of 2017 when we begin shipping a meaningful amount of our new CableOS products and services.

In Q1 2017, we did not have any 10% customers. Non-GAAP gross margin was $43.5 million for Q1 2017, $63.8 million for Q4 2016 and $42.1 million for Q1 2016. Non-GAAP gross margin as a percent of revenue for Q1 2017 was 52.1%, versus 56.1% in Q4 2016 and 51.1% in Q1 2016.

Q1 2017 video gross margin was $40.9 million or 54.9% of revenue versus $60.4 million or 57.7% of revenue in Q4 2016 and $34.9 million or 53.2% of revenue in Q1 2016. The sequential decline was due to lower revenue and product mix.

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

The current gross margin range, which began in Q3 2016 will not improve until the second half of 2017 when we began shipping a meaningful amount of our new CableOS products and services. Non-GAAP operating expenses for Q1 2017 were $54.9 million, compared to $54.2 million in Q4 2016 and $50.5 million in the same quarter last year.

Our operating expenses in Q1 2017 were approximately 2 million higher than expected, due to the timing of sales commission expense, professional fees, and accruals. Sequentially, we believe that our operating expenses will be lower in each quarter of 2017, starting with Q2. Q1 2016 operating expenses only included one month of TBN.

Our non-GAAP operating loss for Q1 2017 was $11.4 million, compared to a profit of $9.6 million in Q4 2016 and a loss of $8.4 million in Q1 2016. The sequential loss reflects the lower than planned revenue level experienced in Q1, as well as gross margin as a percent of revenue.

The year-over-year increase reflects higher operating expenses, partially offset by higher gross margin. Our non-GAAP EPS loss for Q4 2016 was $0.14 versus a profit of $0.08 in Q4 2016 and a loss of $0.11 in the same quarter last year. These comparisons reflect the comments just highlighted.

We had 79.8 million shares of non-GAAP common stock outstanding as of the end of Q1 2017, versus 80.1 million as of the end of Q4 2016 and 77 million as of the end of Q1 2016. Now turning to our balance sheet.

We ended Q1 2017 with $55.3 million in cash and short-term investments, compared to $62.6 million at the end of Q4 2016 and $76.2 million as of the end of Q1 2016. The sequential and year-over-year decline primarily reflects cash outflows related to purchase and integration of TVN.

Going forward, cash outflows related to integration activities will have a materially reduced impact over the remainder of 2017. Our days sales outstanding at the end of Q1 2017 were 76 days versus 69 days at the end of Q4 2016 and 105 days at the end of Q1 2016.

Our days inventory on hand were 90 days at the end of Q1 2017, compared to 74 at the end of Q4 2016 and 94 at the end of Q1 2016. The sequential increase in days on hand reflect the softer than planned revenue, previously discussed.

At the end of Q1 2017, we had 184.2 million of backlog and deferred revenue, compared to 188.4 million as of the end of Q4 2016 and a $180 million as of the end of Q1 2016. Staffing at the end of Q1 2017 was 1,358, compared to 1,376 at the end of Q4 2016, and 1,418 at the same time last year.

The sequential and year-over-year decline is related to our TVN integration program. The following are Q2 2017 financial goals. Non-GAAP revenue $95 million to $103 million, which includes; video revenue of $86 million to $91 million; and Cable Edge revenue of $9 million to $12 million.

Non-GAAP gross margin as a percent of revenue 52.5% to 53.5%, which includes video gross margin percent of 55% of the 56%, and Cable Edge gross margin percent of 33% to 34%. Non-GAAP operating expenses $52.5 million to $53.5 million, non-GAAP operating loss $2.5 million ranging to a profit of $1.5 million.

Non-GAAP EPS loss of $0.04 ranging to breakeven. Non-GAAP common shares of stock outstanding approximately $81 million. Cash and short-term investments at quarter-end $40 million to $45 million.

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

Based on our current outlook, our cash balance should improve in Q3 2017 with higher accounts receivable collections and improved operating profit based on achievement of our Q2 2017 financial goals. Non-GAAP effective tax rate 15%. Now the following are our 2017 financial goals.

Non-GAAP revenue $400 million to $420 million, which includes video revenue of $350 million to $360 million and Cable Edge revenue of $50 million to $60 million. Non-GAAP gross margin as a percent of revenue 53.5% to 54.5%, which includes video gross margin percent of 56 to 57% and Cable Edge gross margin percent of 38% to 39%.

Non-GAAP operating expenses $260 million to $207 million. Our projected operating expense level for 2017, reflects the favorable year-over-year impact of our $20 million of synergy savings program related to the TVN, which was essentially completed in 2016. Non-GAAP operating profit $8 million to $22 million. Non-GAAP EPS $0.02 to $0.16.

Non-GAAP common shares of stock outstanding approximately 82 million. Cash and short-term investments at year-end 50 million to 55 million. Non-GAAP effective tax rate 15%. I will now turn the call back over to Patrick..

Patrick Harshman

Okay. Thanks Hal. Let's finish up and turn to our Slide 10. We are very close by again emphasizing that that we have one overarching objective for the balance of 2017. That is to leverage our expanded video market leadership and CableOS software innovations to significantly improve the long-term profitability and cash flow of the business.

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

We grow market share and strengthen our financial model by advancing our leadership in cloud software as a service and forecast. And objective number three, delivering aggregated double-digit operating margin in the business for the balance of the year.

On a standalone basis, we continue to believe our video segment is a strategic market leading business with compelling upside. On the Cable Edge side of the house, we have the industry's first modern virtualized CMTS on the launch pad.

So objective number one is to continue the momentum through the first quarter and to the second quarter to further scale commercial appointments and advance DOCSIS 3.1 and distributed DOCSIS architecture field trials. But the same time, we are growing industry buzz around the progress we are making with key customers.

Objective number two is to leverage this to secure new design wins with additional operators. And objective number three continues to be to exit the year with both $100 million annualized run rate and a competitive market position that will enable a compelling growth business well into the future.

So look, well Q1 was softer than we expected following a strong fourth quarter. Our business pipeline is strong, our backlog deferred revenue is strong, and our overarching targets for 2017 are unchanged. We're pushing full speed ahead, leading the charge on software-based video processing and virtualized cable broadband delivery.

Leveraging our strong customer relationships, this record backlog and growing innovation advantage. Our entire organization is laser focused on the continuing execution of our strategic video and Cable Edge growth initiatives, and on driving a sustainable new phase of profitable growth and shareholder value creation.

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

Operator

Thank you. [Operator Instructions] And our first question comes from George Notter of Jefferies. Your line is now open..

George Notter

Hi there. Thanks very much. I guess I wanted to dig into some of the Q1 dynamics in the video business.

I think you said that you saw a shift out in business in the last month and at the same time, I think you also said that some of the softness was a result of the strength in Q4 and I guess I’m trying to under reconcile all this, I guess I would have assumed that had you pulled a lot of business forward into Q4 you would have seen softness right away in Q1 and I guess I was trying to understand that.

And then also I want to understand how much of the video softness is really directed at satellite customers or is it more a broader mix of customers? Thanks..

Hal Covert

Yes, I will start and pass it to Patrick very quickly George. When we set the guidance for Q1 we actually took into consideration the projects that we closed in Q4 that we thought were going to actually be recorded in Q1. So we did take that into consideration.

I think Q1, just, we had things slip out at the end of the quarter, due to the timing that we talked about earlier that we did not count on. So we did anticipate the impact from the Q4 over it so to speak, but nothing more than that..

Patrick Harshman

That's fair. I mean, the additional thing I would say is, Q1 is always a somewhat back end loaded quarter, many businesses take a little while to get going at the beginning of the year. So, we always expect a relatively strong March month, and this is was no different with several key projects.

And as both Hal and I mentioned, we saw unfortunately a couple of those anticipated and frankly committed projects from customers get delayed. Good news is a couple of them were subsequently then closed in April, but a couple of them have drifted.

As I mentioned in my prepared remarks from a geographical perspective, Europe was - and Middle East and Africa is where we saw the biggest or proportionately the largest concentration of that George. But it wasn’t tied specifically to any particular customer vertical.

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

Just for whatever reason and then we don’t think it is anything actually that looking at our pipeline, we don't think there is anything - really it works systemic at work here, but just a confluence of events that we saw a pretty weak quarter, with just a number of customers for a variety of reasons, pushing things out relative to what our expectations have been..

George Notter

Got it.

And then how broad is this, is this - are we talking about two customers, five customers, 10 customers, I’m just curious how broad this is across the country base?.

Patrick Harshman

In terms of the significant deals that we anticipated; in the neighborhood of five..

George Notter

Got it. Fair enough. Thank you..

Patrick Harshman

Thanks..

Operator

Thank you. And our next question comes from Tim Savageaux of Northland Capital. Your line is now open..

Tim Savageaux

Hi good afternoon.

Just following up on that really quickly, so you mentioned EMEA is kind of a geographical area of weakness, but in your slides you did call out satellite Pay-TV softness, is that meant to refer to something separate that was also an issue, I know Hal mentioned weakness in North America and we do know that they had an awfully tough quarter over their DirecTV this quarter and probably changing some things around there.

So I wonder if we can infer anything there from that satellite remark or because if you didn't mean to call out verticals, then you seem to have called out verticals. So, I just want to kind of clarify that..

Patrick Harshman

So there is two different things. The point on the slide in there is to say that it’s - we saw and we see going forward kind of a mixed shift relative to what we thought. As I just mentioned, biggest thing in Q1 was simply the delay for a handful of sizable deals.

And frankly those were not exclusive to satellite, those were kind of a cross customer verticals, particularly concentrated in Europe. Just the way it worked out.

That being said full transparency on the market as we sit back now and did out detailed analysis for what the rest of year looks like, relative to the demand trends we saw when we put together our plan three or four months ago, for the balance of the year we do see relatively less satellite spending, largely compensated for and relative increase in what we had expected in over the top.

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

Tim Savageaux

Got it.

And then sort of continuing along that service provider focus that doesn't sound like you’ve seen a whole lot of change in - I don't know whether the quarter or what you expect for the year out of the US Cable vertical, clearly you have got a bunch of trial activity going on, but just from a spending standpoint any commentary there?.

Patrick Harshman

Cable is positive. In fact one of the delayed deals we referred to was actually our US Cable deal that subsequently came in, in early April.

Really a timing thing than more than anything else Tim, but in general as we look at the full-year the demand trends that we anticipated, on both the video side, as well as the Cable Edge side of the house are largely intact. We don't anticipate any real changes relative to our original view of the market in terms of cable.

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

Tim Savageaux

Okay and then you mentioned you’d a couple of deals that were pushed close, is that and as well as the overall kind of backlog and differed metrics it really didn't change much from last quarter, I guess despite a pretty significant slowdown or reduction in bookings wondering if you can kind of discuss that dynamic maybe just sort of mathematically and whether - I think you discussed in the last call having traded some revenue that normally would have come in either hardware or software license that turned into cloud and that had a certain impact, I wonder if you have a similar discussion there and just kind of the overall drivers of visibility, so what remains a pretty steep ramp on the video side looking into Q2, understanding that some of these deal closings and backlog situation probably contribute to that..

Hal Covert

So let me start and Patrick can certainly jump in whenever he wants to. First of all on the bookings, our bookings and revenue were fairly close for Q1. Our bookings were a little over 81, our revenue was 83.5. So pretty close. And so we had a fairly consistent deferred revenue and backlog at the end of the quarter which is good.

The other thing I would say Tim is that when we did a deep dive on looking at the balance of the year for Video, and in our plan for the balance of the year we have not put a catch up in there for Q1, primarily because of the - some of the softness that we have seen in the marketplace, we don't think that’s going to happen over the balance of the year, which gets us in a position where we can actually go our video revenue on a year-over-year basis, which is our goal now.

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

Roughly about $4 million or $5 million of our bookings in quarter one were related to cloud-based activity and that’s $4 million of $5 million in revenue that would have happened in the old model in Q1 and a new model it’s a recurring stream that’s going to happen over a couple year period of time.

So, although we didn't - we did build that into our plan, we are building a recurring revenue stream as we go forward. And then we have calculated that in our balance of the projection for Q2 through Q4 this year, so we're still looking for a pretty healthy video environment over the balance of the year. Patrick if you want to….

Patrick Harshman

I think that should help..

Tim Savageaux

Okay. Understood. And one final question from me.

I don't know if you guided to this level of granularity before, but is there any change in your margin expectations over on the Cable Edge side as that ramps exiting the year or is, you seem to be a bit lower in Q2 maybe that’s sort of time?.

Hal Covert

A couple of points Tim, just to follow on. First of all let me start with the positive. Our video margin is really looking good for the full year round 56% to 57% that’s back to our historical level. So we’ve compensated for the lower level we had by couple percentage points in 2016 because of TVN.

On the Cable Edge side, we expect to end the year with a margin that approaches the mid-50s as we start shipping our CableOS products. The margin in quarter one and quarter two for the most part has been impacted by lower service levels.

So, we didn't have as much, we have more professional services going on in those quarters and has a lower margin associated with it. So, it is a little lower in the first half of the year, but we expected to pick up in the back half of the year..

Tim Savageaux

Got it. Thanks very much. I’ll pass it on..

Hal Covert

Thank you..

Operator

Thank you. And our next question comes from Greg Mesniaeff of Drexel Hamilton. Your line is now open..

Greg Mesniaeff

Yes, thank you.

Patrick you mentioned in your opening remarks that one of the factors affecting gross margin in the quarter was higher services and support revenues, can we drill down a little deeper on that, is that primarily tied to the video business in the quarter or the CableOS business in some of the opportunities you are working on right now in terms of the next generation CCAP Products? Let me stop there..

Patrick Harshman

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

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

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

So part of that is what you are seeing there, a relatively higher mix of services and support in general, particularly around services for Cable and of course from a mix perspective with lower product revenue in the quarter, you end up with a lower blended gross margin..

Greg Mesniaeff

Okay, and when do you think that ratio will turn more favorable for you, for services versus product in the Cable world? Thank you..

Patrick Harshman

Yes I just mentioned a few minutes ago Greg, I think that in Q4 once we start shipping our new CableOS parts of volume we should see an improvement and then we actually believe we can really start pushing close to the - hitting the 50% goal, which is our - in total, which is our longer-term target as we exit the year.

You may recall at our old legacy business was more in - closer to 40%, so we are looking for a nice uptick again as we exit the year once we start shipping CableOS and volume..

Hal Covert

The business in aggregate they simply higher video product and software mix will drive a higher composite gross margin, which is what we are anticipating for the next quarter..

Greg Mesniaeff

Sure.

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

Hal Covert

Yes I think it fits the normal pattern that we’ve had in our video business in the past and again I think the positive thing about our video business from a gross margin percentage standpoint now is, you know our target is to get back up to the 56% to 57%, which we have historically experienced prior to the TVN acquisition last year..

Patrick Harshman

And that includes associated service..

Hal Covert

That is also [indiscernible]. So, we are in a pretty good track on the video side. Gross margin percent wise..

Greg Mesniaeff

Thank you..

Operator

Thank you. And our next question comes from Steven Frankel of Dougherty. Your line is now open..

Steven Frankel

Good afternoon so the guidance for the rest of the year in terms of gross margins and we’ve been digging into that a little bit here with the CableOS side, but it still looked like the overall it’s a little lower than what we’ve anticipated before is that just a lower revenue run rate or are there pricing pressures going on in the video business that’s bringing gross margins?.

Hal Covert

I think you have to look at the two businesses. So, on the video side, it’s primarily because of just lower revenue that we experienced in Q1. As I said before, we are not trying to catch that up. From a gross margin percent wise, we are right on target video wise to get between 56% and 57% and in that part we are really happy with.

On the Cable Edge side, again as we mentioned earlier on we were kind of dragging in quarter one and quarter two to get a little bit better in quarter three, but in quarter four we expect it to get back up to the targeted level. So, essentially it is driven more by revenue than anything else right now.

And initially on the video side, we thought our video revenue would be above the 370 range and now we are at, up 360 at the high end of our guidance essentially because of the miss that we had in quarter one. So it is revenue driven..

Steven Frankel

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

Hal Covert

Patrick and I over the last and [indiscernible] runs a business and have been talking about that, we're going through a fairly strategic review of the business over the next couple of months here. And now plan is, in the back half of the year to start giving you a whole lot more guidance on that. It’s starting to get to be a meaningful number.

For example we talked about - roughly about 5% for bookings in quarter one where we are related to our SaaS business. And that represents roughly about $4 million revenue stream. So, we are at a point where we need to get more guidance and direction on that and transparency and we will be doing that..

Steven Frankel

And do you think through the transaction in the next couple of quarters there is a lot more ASP pressure in the video side or hardware sales and hardware pull through fall into low enough level that that’s not a headwind in the back half of the year?.

Patrick Harshman

We don't assume much change through the back half of the year. I mean, you can never say never, but it is an interesting time what is happening competitively.

Let me just put it on the table, you know historically our largest competitor in this space Ericsson is going through some reconsideration of where they are going with the media business and we see that as a positive thing, yet there is others in the market applying pressures, but on balance actually we think it is a relatively more benign competitive environment, and looking outside of the company and inside of the company we're pushing hard on the innovations and the move to software that we’ve discussed.

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

Steven Frankel

Okay, and you speak with a lot of confidence about the CableOS ramp, maybe if you could tell us what gives you that confidence, is that the detail of the discussions you're having with the customer, is it where you are in the trials, or it is just your confidence in your company's ability?.

Patrick Harshman

It is a confluence of a couple of different things. In no particular order, as I mentioned earlier, take Harmonic out of it, this industry is actually finally waking up to the fact like much of the rest of tech has, the combs that have a virtualization can be extremely powerful. The concept of Edge processing and the network can be extremely powerful.

And by powerful I mean, something that can open up tremendous scalability, as well as cost efficiency. So that kind of a hard is hitting the industry, I mean we are certainly helping it, but it is not just coming from us. That's extrapolation in this industry of things that have happened elsewhere.

So, we are confident that - we are increasingly confident that Cable is not going to be some kind of a isolated part of the broader tech landscape, but that is immune to the power of virtualization and the power edge processing. So, I think that is one reason and the Kagan data we cited earlier, I think speaks to that.

Look, every day that goes forward and every day we move forward - we get more experienced with our own technology. We’ve become more excited about it, more convinced in inspiring capability. That comes out of four on lab, but I think just as importantly it comes out of our customer’s labs and their evaluations.

And then third, by virtue of not just discussions, but the real substantive work that we are doing with early deployments and in the field, not our CMT solutions isolation, but fully integrated with the broader ecosystem.

We are really seeing tremendous progress and the customers are working with that are actually seeing validation of some of the promise that it was alluded to earlier. The benefit of virtualization, the benefits of Edge processing in a distributed scenario.

So, I characterize it is more than just discussion, customers are starting themselves to have a tangible aha moment saying wow, this stuff works. This stuff is real. Looks like my benefit, my business is going to benefit in this way that way and this way.

So all of those things, I mean we have still got a long way to go and I don’t want to make it sound like it is done in by any means, but you look at all of those data points and yes we are feeling increasingly comfortable and confident.

The risk I am gathering on, let me add one more thing, which is what I also alluded to which is discussions are expanding now to be more customers and particularly with the earlier customers they are becoming more about what volume deployment looks like. And what the forecast is going to look like.

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

Steven Frankel

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

Patrick Harshman

Up until recently we have been focused on a number that is less than five. And our strategy still becomes not to attack simultaneously 50 cable operators around the world, but we are north of five, south of 10 right now. .

Steven Frankel

Okay, and any update on the CFO transition?.

Patrick Harshman

We have a search ongoing, we are pleased to be speaking seriously with a number of good candidates, but there is no imminent announcement and nor have we finalized or completed the search..

Steven Frankel

And is Hal staying until there is somebody else on board, or you will appoint somebody to take his place on an interim basis?.

Hal Covert

I will tell you what my plan is, and then Patrick can tell you his. My plan is to stay fully engaged and active. The business is going through a rough spot right now and I believe that we will make it through the transition and again I am fully engaged until Patrick tells me to disengage..

Patrick Harshman

So, look it has been a pleasure and a privilege to have Hal on the staff and on the team for these past whatever it has been 18 months and I and the rest of the team and our board are deeply appreciative of his willingness to stay with us in leadership capacity through the successful completion of the search..

Steven Frankel

Okay great. Thank you..

Patrick Harshman

Thank you..

Operator

Thank you. And our next question comes from Matthew Galinko of Sidoti. Your line is now open..

Matthew Galinko

Hi good afternoon, so it's 5% of bookings the right level to think about for the full year in the video business in terms of how much is coming in on a SaaS basis?.

Hal Covert

You know right now Matthew I would take that number and we will give you more information when we announce a set of metrics or statistics that you can follow my guess is, it is going to be higher than that, but for right now, I think until we complete our strategic review over the next few months here, I’d go with the five.

Even at that level is first to build up a pretty interesting recurring revenue stream over the next few years, but there is no doubt in anybody's mind here in the company that people are going to move to the cloud base model and it will take a few years for that to happen and again we will lay out more of a game plan within the next few months here..

Matthew Galinko

Sure.

Maybe it might be helpful if you could share what your internal expectation might have been coming into the quarter and the year for that? Is that all possible?.

Hal Covert

I think right now, we did have an internal expectation. We are probably cracking slightly ahead of that right now, and we did have that built into the plan, but again I think in the next few months when we complete our detailed strategic review, we will provide more information that you can actually start tracking.

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

Matthew Galinko

Okay, and last one from me, in terms of the 100 million run rate you are talking about or exit rate for Cable Edge business, does that anticipate any additional Tier 1 wins?.

Hal Covert

It does anticipate Tier 1 wins more than one, and we think it will happen again in the fourth quarter and that’s the game plan and that lights the trials that Patrick highlighted earlier on..

Matthew Galinko

Got it. Thank you..

Operator

Thank you. And the next question comes from Simon Leopold of Raymond James. Your line is now open..

Unidentified Analyst

Thank you for taking my question. This is [indiscernible] in for Simon.

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

Patrick Harshman

Sure with the first two who announced and released a the fully virtualized solution, you may recall we announced that in the cable show in Philadelphia in October of last year and this completely virtualized solution all the way down to the physical layer, everything but the physical layer has a tremendous potential cost flexibility of deployment and scalability advantages.

Not really different than the way you see virtualization being leveraged in other parts of the broader tech and communications space. So, I think that’s first. And that is a broader advantage. The second thing it really leverages or enables quickly is the seamless support of both centralized, as well as distributed architectures.

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

So full virtualization, seamless within that - under that umbrella seamless incorporation of both distributed and centralized architectures, tremendous cost scalability advantages and flexibility and as mentioned earlier, the response from the cable operators, leading cable operators who were really ahead of the rest of the pack and thinking about this and working on it has been quite positive..

Unidentified Analyst

Thank you. And then one more from me, last quarter you expressed optimism regarding the adoption of your new products in the second half of 2017, can we get an update on your view regarding these opportunities and are you basically, are you seeing incrementally more or less optimistic today then you did on your last earnings call? Thank you..

Patrick Harshman

Yes sure. We summarized that earlier, but I think it bears repeating. We are feeling incrementally more confident simply because we’ve made good progress to the first quarter. We have one scale deployment in Europe and we have a couple of other significant field trials in the US and elsewhere, all of which have gone quite well.

And that gives us more technical confidence, it gives our customers confidence, not only in the technology and the standalone way, but the way it can be integrated into the broader operating environment. And based on this positive progress our discussions with our customers have now pivoted.

Those customers have pivoted towards forecasting and planning for volume deployment. And at the same time those trials and tests are not really, particularly super well kept secrets in the industry.

You are not hearing anything from us, but nonetheless other cable operators are aware that we are doing very interesting things in the market and so our credibility - it is - , of technology of our company in this area and the credibility of this kind of technological approach, all that is gaining momentum.

And so that is giving way to more customer discussions and more customer engagements and it leaves us confidence that we will see additional design wins before the end of the year..

Unidentified Analyst

Okay, thank you..

Patrick Harshman

Thank you..

Operator

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Mr. Harshman for any further remarks..

Patrick Harshman

All right. Well thank you very much. And just ramping up, we want to emphasize that despite a slow first quarter there is so good reason to remain confident in our business.

On the video side of the house, the sales pipeline is solid, momentum behind our new cloud and SaaS capabilities as we just discussed is strong, and we have new record backlog and deferred revenue, and we're continuing the necessary operating improvements to achieve double-digit operating margin for the balance of the year.

In Cable Edge, while the near-term financial outlook remains challenging that’s no surprise, and the real story here is about our increasingly successful CableOS field trials and commercial deployments, and our expanding customer engagements, again, as we have just discussed.

All of which keep us on track for the start of a meaningful multi-year volume ramp in the second half of the year. We are undeterred by the first quarter and in fact we are encouraged by what’s happening strategically behind it and believe me we are hard at work on the second quarter and the rest of the year.

In that context, we very much appreciate your continued support and we look forward to providing you additional updates on our second quarter or if we see you before that. Thanks very much everyone..

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect. Have a great day everyone..

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