Harmonic Inc. (HLIT) Earnings Call Transcript & Summary

Good afternoon. I'm Samik Chatterjee. I cover some of the IT hardware and networking equipment names at JPMorgan. The afternoon session, we're kicking that off today with Harmonic, and we have the privilege of hosting Patrick Harshman, the CEO of Harmonic for a fireside chat. What we intend to do is kind of do a Q&A. And for the audience, there is the option to send in questions via the Q&A feature. So let me just encourage you to send in your questions through that feature, and I'll ask those questions on your behalf.

Patrick, thank you for attending the conference. I just wanted to more start with maybe if you can give investors an overview of what Harmonic is all about? A bit of background about what you do and kind of you've seen some recent successes, kind of just give them a background of those recent successes for Harmonic as well?

Sure. Well, thank you very much for having me. It's a pleasure to be here with you. So Harmonic has 2 businesses under 1 roof that are closely related, but distinct, one we call Cable Access, and that's specifically working with cable operators, enabling them to deliver in the next-generation of gigabit broadband services, services that you as consumers probably know is your cable modem service. We think there's tremendous growth opportunity there, and we've done some very innovative things. And that's really the core of one of the business units, perhaps the fastest-growing and fastest-changing part of our business. The other part of the business, which actually is the lion's share of the revenue today, we call Video. And this has to do with everything around creating, originating and delivering particularly live-video television programming to consumers around the world. And here, of course, we do business with cable operators, but also historically, other pay-TV kinds of operators, IPTV, telcos, satellite direct-to-home, broadcast media companies and increasingly, new streaming players. And that is a very international business. Approximately 2/3 of our video revenue is outside of the U.S.

Got it. Patrick, that's great. So let me just start with kind of the more hot button topics for investors nowadays. What are you seeing in terms of the COVID-19 disruption in relation to how is that changing some of the spending plans or CapEx plans for your customers? How are you thinking about kind of a return to normal level of demand on that front?

Yes. Well, look, our crystal ball is still a little bit fuzzy about what's coming. But I can certainly share what we've seen so far. I think the good news is, is the spaces we're in, we think, are relatively healthy in the context of this. I mean, high speed data, the way we're communicating today is at least I'm communicating over my cable broadband from home. And of course, streaming video entertainment nuance is also performing extremely well. So if I think back to the 2008 kind of recession, in fact, our business performed relatively well in that time, while people pulled back, consumers pulled back on a lot of spending. In general, the things that we're enabling, broadband access infrastructure, video programming for in-home consumption, the kind of things that we've seen hold up well in recession context and so far, also holding up in terms of service demand in the context of this COVID situation. I mean that being said, there's no way around it. As this COVID thing unfolded, there was certainly a disruption. We saw most of the quarter in our business in Asia Pacific, I mentioned earlier that our video business, in particular, is quite international. And they're just work-from-home changes in customers' operations, even as we see them getting back to and figuring out their operational plan going forward, the initial, let's say, response entailed some disruption on both the cable in the Video side of the house. That being said, particularly on the Cable side, where we see a lot of pressure to roll out additional broadband infrastructure, we're cautiously optimistic that we're going to see a fairly good rebound in terms of activity, even as this pandemic drags on.

Got it. You mentioned the rebound that you're kind of expecting from the cable customers. Now in general, when we kind of look at CapEx from these cable customers over the last few years, that's been on a steady decline, is probably the best way to describe that. What's changing on that front? Why the confidence that you would have a rebound, particularly given the CapEx trends that we've seen more recently from these customers?

Well, I think it's important to understand that historically, the biggest part of Cable CapEx went into consumer devices, set-top boxes are historically expensive to develop and to deploy. Same things with cable modems. And what you see, in particular with cable operators, as they pivot to more connected and cloud-based technologies, you see much less capital intensity going into that consumer premises equipment. So yes, the headline expense has been coming down, driven primarily by a reduction in consumer equipment. But in fact, you've seen growing investment in what they call scalable infrastructure. This is the back-end capability, the network, the cloud infrastructure that allows services to be delivered to increasingly thin or maybe even nonexistent consumer devices. And it's that part of the cable arena that we play in. And so from both a backward-looking and a forward-looking perspective, we think scalable infrastructure, provisioning more and more high-speed data is an area of a lot of strategic focus and growing spending from the cable operators.

You mentioned the architecture rollouts by the cable customers, particularly on the scalable architecture front. If we focus on DAA, virtual CCAP, kind of the next-generation technology for with cable customers, if I dial back to 2018, 2019, following the DOCSIS 3.1 upgrades, there appeared to have been a slowdown in terms of kind of customer information to push forward with DAA or virtual CCAP. What are you seeing changing on that front? Is anything changing in the landscape that makes customers more willing to now roll these new technologies out quickly? What -- and you've had some wins as well. So I'm sure you're having those conversations with a lot of more customers now?

Yes. I think it's a great question. And indeed, it's a very dynamic environment. So the opportunity is twofold. One, for those operators and really in the North America that have already upgraded to DOCSIS 3.1, we see several of them starting to look to what's coming next. In this country, you have coming intense competition from things like 5G or from fiber-to-the-home. And I think is being demonstrated in this pandemic. Even with those upgrades, we see capacity -- we see traffic really coming up right up against the rails of capacity. So there's quite a bit of interest out there in what comes next and how to take that next step to 1 gig, ultimately, the 10-gig kind of service. And we think that cable operators, in general, are not content to kind of rest on the laurels, but, in fact, want to really press their advantage and be well positioned for the even next-generation of services, whether that be commercial services, like this video conference, new high resolution, low latency gaming or just growing broadband traffic overall. The other thing, though, that I want to note is that outside of the U.S., actually, the adoption to 3.1 is actually, in general, slower. And so there's a lot of opportunity even for that next upgrade to 3.1 outside of the U.S. in places like Latin America, Asia, and parts of Europe. So our strategy is twofold with the advanced North America operators work with them on what that next-generation of service looks like. It's really going to compete very effectively with fiber-to-the-home with 5G it's going to enable these new services. And outside of the U.S. and with smaller operators even in the U.S. to work on helping them get to 3.1 for the first time. In both cases, we think we are bringing innovations that really make a difference operationally and commercially.

So we've hosted some of your competitors in our conference already and kind of one of the themes that came out is kind of understanding next-generation technology and the adoption of that by the cable customers. But right now, just given the disruption, what are you seeing in terms of just kind of priorities changing and some of these projects getting pushed out, I think some of the competitors that are kind of incumbents are mentioning seeing some of that, which might be favoring the incumbents at this point. So how -- what are you seeing on the ground? How much of a push out in some of these strategic projects? Does that change materially in terms of timing of when these rollouts happen?

Yes. So let me break it apart into customers that have already qualified and begun deploying our CableOS solution and those that haven't. In the former case, we did definitely see a speed bump coming in March and early April, as I mentioned earlier, people -- customers adapted to what social distancing meant as you roll out this technology, perhaps getting a little bit more automated in terms of doing software things remotely. But other than that speed bump, let me call it, it's been back to the races. And our view for our customers where -- who have begun deploying CableOS already continues to be quite positive for the remainder of the year. I think where the story is a little bit more nuanced is with new design wins that we had in process. And there, on one hand, we've seen some who have -- are leaning in and after that speed bump are back to it. In fact, they're more motivated than ever to get on with things like DAA and virtualization because they see what this pandemic is making clear to all of us is that we're going to see permanent changes in behavior and consumption of broadband services. It's also true, however, that we've had a couple of other customers where the qualification process is still somewhat slowed down in mire. And perhaps they don't have quite the same wherewithal to drive new qualifications while they kind of tend to more urgent operational issues. Maybe the last thing I would say is we've never thought that we would, all in one fell swoop see 100% of the market flip to us. So the fact that there's ongoing investment, software licenses or whatever onto our competitors' platforms, it's not a surprise that, that's happening now. And even without this pandemic, we would have assumed that there'd be some kind of incremental care and feeding for that infrastructure, while our customers and our prospective customers are planning for the kind of the next phase rollout with the new technology. So don't we see -- we've never seen the investments as mutual exclusive. I think our opportunity and our view is, is that over time, however, we think that there is going to be a steady transition of investment to away from old architectures into new ones. And here, we think we're extremely well positioned competitively. And really, as we look at this pandemic, we think that this is doing more to feed the conviction of the CTOs in the industry that they need to make this move rather than change any sentiment or conviction about this move. It's clear more than ever that the moving to virtualization, agile infrastructure makes a whole lot of sense.

So I wanted to just follow-up on that exact thing where you mentioned a couple of times that the current pandemic kind of feeds into the need to move to virtualization or DAA architecture, can you just remind investors in terms of when you mentioned scalability of the architecture? What are the magnitude of cost savings? Or what are the key drivers of what -- why it makes more and more sense for customers even despite kind of the disruption they're seeing longer-term plan to move to these architectures versus the traditional kind of integrated CCAPs that they've been using?

Yes. Well, look, I think here investors know this story, I think, from other adjacent fields. I think the broader industry move to cloud technology is not just because it's cool, but in fact, because it delivers meaningful on capital and operational savings. And to that extent, cable is no different than any other category. You take advantage of commercial off-the-shelf compute, which -- imagine that versus tens, hundreds of different kinds of boxes with different management systems. So from a capital management perspective, whether it's a private or a public cloud environment, it's a game-changer. And then from an operational perspective, the embracing microservices opens up the door to much greater efficiency in terms of telemetry, managing, setting up, wrapping down services, flexibly scaling infrastructure to in the case of cable, for example, delivering more bandwidth to 1 part of the network really on a dime. So it's about agility, it's about speed and it's about operational savings. Just as a data point, at a cable -- major cable event that was held in the fall, Comcast presented some of their early results publicly that they were seeing from rolling out. And they talked about literally 1/20th of the power -- excuse me, of the space consumption with using this new technology, using their data center technology with their software running, 1/7 of the power consumption as well as a whole host of additional telemetry example advantages, which were translating into better customer satisfaction. So it's not just us saying that what we've seen is our lead customers talking very publicly about a number of operational benefits that really translate directly to the bottom line.

Got it. Moving to the Comcast agreement. Can you -- it's a multiyear agreement that you've signed. Can you outline kind of what the base case is or what the ongoing rate is in terms of recognition reignition from them? And what are the drivers that can create upside in revenues with them? Is there any opportunity to kind of upsize that over time?

Sure. Sure. So the Cable solution we've been talking about, it really has 2 components or 2 elements. There's a centralized all software piece that runs on the data center infrastructure we've talked about. And for lack of a better term, there's kind of conversion devices, which are at the edge of the network that take IP traffic and convert it to radio frequency that ultimately needs to be delivered over coax to your home or to a small or medium-sized business. The agreement we do with Comcast is for the software piece, and we did a 4-year unlimited license agreement. It's a unique deal. We've not done or we're not doing anything like that with any other customer. It was $175 million unlimited license for 4 years that they can use across their own footprint, their own service footprint. So from that perspective, it will be recognized in the revenue over time, but that part of the deal is done. And that's kind of great news in terms of really having that kind of in the guaranteed pipeline, and it's a very high-margin business. So what are the upsides? Or what else is coming with Comcast? Well, a couple of things. Number one, those conversion devices those are estimated to be roughly half of the addressable broad market. And we don't expect Comcast to be any different from them. So of course, we've got ongoing sales of what we call nodes and our more recently announced shelf products that we are -- that we'll be selling to Comcast as they deploy this technology. But at the same time, we're also continuing to work on new software innovations, additional capabilities that aren't part of the original license agreement. And that's one of the beauties of the software model. You you're not constrained by the installed hardware. And to the extent new functionality -- it can be envisioned and developed, it can be layered on seamlessly. For example, and it's not with Comcast, but another one of our Tier 1 customers is field trialing right now new software functionality that dramatically reduces latency for gaming applications. And here, CableLabs had a very interesting study where people who are gamers will pay additional money to be able to really have a better low latency experience. This is optional. This is not part of the DOCSIS spec but can come as this pretty compelling additional software technology that can be seamlessly layered on top. So we're looking at those kind of things as an additional layer on our capability. And the last thing I'd say is we talked publicly about -- I think the previous quarter, we announced that we are moving into using the same software core technology for fiber-to-the-home, and we'll be releasing this year a Remote OLT, pretty familiar with the technology on the optical line terminal. So for cable operators to use the same software core speaking to both a remote DOCSIS for traditional cable applications, as well as this new remote conversion device for fiber-to-the-home. And that's another application area that is outside of the context of the agreement with Comcast. Now I am not suggesting they're going to buy -- purchase any of that, but we are continuing to develop and innovate, we think, compelling technologies that will give us, we think, expanding opportunity with Comcast and others.

Patrick, let me clarify one part of that kind of a response that you had related to Comcast, you're supplying them -- you're kind of providing them the software. The nodes you mentioned is kind of where the upside is, and you would ideally expect them to kind of the nodes to be kind of 50% of the broad market -- broadband market as the industry is. But does Comcast is the -- does Comcast necessarily need to buy from Harmonic for interoperability or can they use any other nodes?

No. I mean, that's -- by definition, it's a completely open system. So there's others in the market. CommScope is in the market with the node product. Cisco is as well. We think we've developed a very compelling node and very compelling shelf product from both a cost and a functionality perspective. But to be clear, and to answer your question, that's a distinct competitive playing ground. And while we certainly envisioned and developed the whole system together, by definition, it's open. And so Comcast is not obligated to buy nodes from us or from anyone else. They've got flexibility. And our software, I think, has part of the advantage. Our core software is interoperable with any products that will -- any DOCSIS compliant product that will be developed out there.

Well based on some of your new wins, including Comcast, I think CableOS is kind of right now considered to be the leading solution in the space when it comes to virtual solutions. Where do you think the competitive landscape is? Like we understand your competitors have nodes or hardware products that they've rolled out, but when it comes to the virtual solution, where do you think the competitive landscape is? How much time does it take competition to catch up to what you have already in terms of capabilities on CableOS? Just help us think through that.

We signed our initial agreement with Comcast as our lead customer as part of a development process 3.5 years ago. So we've been at it, and we've been making a substantial investment as our balance sheet and our earnings will indicate ahead of this project. So it's nontrivial. And we've been spending the better part of the last 18 months doing what I would call system-level development in innovation beyond the core. But the way the whole thing works together, incredibly complex and investors who have been following us for some time will remember that this time a year ago, some broader system issues with the switches and what have you. So at this point, the intellectual property is not just what we've developed ourselves with our core code. But it's more broadly the ecosystem know-how and expertise working end-to-end. So the long way of saying is we feel as though we've been continuing to press our lead. We think that the experience we've gained has -- will continue to really differentiate us in the market. Listen, we don't know what we don't know about our competitors position, but we are consistently told by customers large and small, that we are at least 18 months ahead of the nearest competitor. And it's not to say we're not paranoid and continuing to work really hard. But we have not come up against virtualized core with any of the Tier 1 or really the Tier 2 accounts that we've been engaged with.

Got it. Maybe let's kind of discuss and before we kind of move out of the Cable Access cable segment, this Comcast is the kind of anchor customer or the big customer there. Just give us an update of the new customer wins beyond Comcast. I mean, particularly, I think you've announced Vodafone as a 10% revenue customer, but any additional color on what that relationship looks like? What that revenue opportunity looks like? And kind of what to track in terms of milestones of new customer additions or logo additions for you?

Yes. So look, we've been -- okay, well, the cable operators are notoriously gun-shy about publicity, and that's a little bit frustrating. But beyond Comcast, we've announced by name only 1 other CableOS customer, and that's Com Hem in Sweden, who's the largest cable operator in Scandinavia, which is, again, a very competitive broadband first kind of region of the world. It's not surprising. They were also an early adopter here. So besides that, we've announced 3 other unfortunately unnamed Tier 1s. And by here, we mean top handful in each geography of operator. So yes, Vodafone in Europe has shown up as a 10% customer in the last 2 quarters. Unfortunately, we've not been cleared by them to discuss the exact nature of that business. But separately, we did announce earlier last year a large frame agreement greater than $50 million with a leading operator. In fact, Vodafone is now the #1 cable operator in Europe. We also announced in the fourth quarter coming out of the fourth quarter 2 additional what we consider Tier 1 wins, one in the Americas, another one in Europe, which had not yet contributed any revenue so by definition, not Vodafone in the fourth quarter. And we're beginning to scale both of those through the first part of this year, and we expect them to be significant revenue contributors as we get deeper into the year. And that's really it for the -- so 5, what we would consider Tier 1s that are beginning to span the globe. And maybe going back to the beginning of our conversation, we have another number of, what I would consider advanced trials. But not yet quite commitments and deployment plans with several other Tier 1s in both North America and internationally. And beyond that, we're increasingly doing work both directly and through channel partners with a growing number of smaller cable operators, as we discussed earlier, particularly those who have not yet rolled out this DOCSIS 3.1 standard.

Let me move to the Video business. And kind of in place first kind of hit on the longer-term trend that you've seen there of steady revenue declines? And kind of if you can take investors through what's been the primary driver of that? I understand your services business or kind of the one that's addressing the OTT segment has been growing. But overall when you put that together why are you seeing a kind of steady decline in that business in the kind of more longer term, even pre-COVID kind of disruptions?

Yes. So similar -- from a technology perspective first, not unlike cable. Several years ago, we realized that our historic appliance business was probably not the best model for our customers and for us. And so we embarked on really converting all of our intellectual property over to not just software but containerized software that could run in cloud environments. The strategy there was, although we realized it would be a headwind from a revenue perspective. But let's move to a higher-margin software license business and with the subside of that, actually, let's go one step further, recognizing the one of the things that our customers really value about this Harmonic in this business was our service and support. Let's take that software and run it on the public cloud as a SaaS, creating an even stickier and hopefully higher value way of delivering our technology for our customers. So that's the journey that we've been on. And as you point out, that certainly predates COVID. And associated with that, you've seen -- you've seen the top line coming down, but you've seen the gross margin steadily increasing. In fact, in the fourth quarter of last year, we hit a record 60% gross margin which, if you roll back the clock several years ago, this was a high 40% margin business. So you really see this strategy playing out of a move gradually away from appliances and to more software license sales. And a subset of that is we have a growing SaaS business. And here, we have seen an impact from COVID, a real acceleration of SaaS engagements. We now send our most recent call through or what we would consider Tier 1 wins, 1 with a large name a media and broadcast company in the U.S., another with a large named international a telecom operator overseas. And in addition to the appliance transition, a move to SaaS also as -- and investors will undoubtedly know also entails a revenue headwind. Instead of a onetime revenue recognition, let's say, a $3 million deal, we'll sign a 3-year deal, a SaaS deal for $3 million, and -- but we'll only be recognizing over time. So as a consequence, this business, yes, the revenues are down, the gross margins are up. And the backlog in deferred revenue, I think, an all-time high for this business. So we're really changing the business model. It definitely is a little bit sausage making as we deal with the headwinds in the short term. But we think mid to long term, it gets us to a pretty exciting place, a higher-margin stickier recurring revenue model. And that's our objective here with the Video business, and we're kind of committed to powering through the beating ourselves off of the appliance, the lower margin appliance revenue.

Got it. Before I carry on, let me just remind investors, if you do have any questions, you can use the Q&A feature to send them in. Patrick, just continuing on that line, you mentioned the acceleration you're seeing in the SaaS business as result of COVID. We did in the last quarter, quarterly earnings report, see kind of an acceleration in the video appliance sales moderation as well. When you look across and you mentioned most of that business is international, which is kind of where the impact is greater. How are you looking at how much of that is temporary? Just kind of a pause, just kind of waiting for things to get back to normal and how much of that is a real evaluation from the customers about that expansion plans or their own business plans?

Look, we have yet to talk to a customer who is really pulling back from the market. That being said, they're kind of preparing the weather -- weather the storm, advertising revenue and sports content is down. And that certainly is having a toll on some customers. On the other hand, we've seen streaming volume up. And in many ways, this is an ideal time to rethink the business model and the model of operation. And I think that's what's a little bit behind. So there's 2 things that are behind the slowdown in appliances. I think one is yes, a pause in spending, trying to get through this COVID transition. And maybe also managing the CapEx and the context of a couple of challenging quarters coming up ahead. On the other hand, no one thinks the sports industry is going away. We're already in conversations, for example, about taking advantage of the additional time to do new things in anticipation of the Olympics. And as I mentioned, it's also affording some customers the opportunity to say, "Hey, you know that cloud thing, you've been talking about, maybe now is the time to really stop and think about that." So yes, I think that discussion and thought process does create somewhat of a headwind short-term on the business. But to the extent it feeds into our pipeline of SaaS and cloud opportunities, we view that as positive. And for those that aren't, we think that they're just holding their breath a little bit. And we we're consciously optimistic. We'll see a good bounce back in the second half of the year. But unlike Cable, we did -- we don't feel the visibility is good enough to exact call it. And hence, we pulled back from guidance from Q3 and Q4. We're hoping by the time we announced this quarter, Q2, we'll have better visibility into the remainder of the year.

Okay. Patrick, as we get close to wrapping up here, maybe the best way to kind of wrap up is if I ask you to kind of quantify when you put the business model together on the Cable side as well as the Video side, and as you start to cycle past some of the headwinds on the Video as you move to a SaaS, what are your expectations in terms of what the longer-term growth outlook for the company looks like? And also the margin improvement profile if you're moving to more software-based kind of products?

Well, look, on the Cable side of the business, we kind of came from almost nothing to about $100 million last year. And as we've said, we think that there's no reason this is nearly -- this is -- north of $1.2 billion, $1.5 billion spend. As the market leader in virtualization and DAA, which is where it's going, our objective is to be #1 in that market. So I'm not ready to call it $1 billion business, but several hundred million So we see a great opportunity for continued growth on the Cable side, only accentuated by work from home trends, which are growing. On the Video side of the business, it's a little bit more about converting what has been historically, a fairly healthy a $300-plus million business. Our objective is to convert that business to a higher margin, stickier recurring revenue and software license business. And so it's really about getting to an even greater profitability and consistent profitability and recurring revenue there. And that's a transformation that we think we're well on our way to executing. So it's slightly different playbooks for the 2 different parts of the business, all based on cloud technology. But both are well on their way. And frankly, both, we think that the current pandemic is creating additional mid to long-term tailwinds for.

Great. I'll wrap it up there, but thanks a lot for attending and participating at our forum.

So thank you very much. I appreciate the conversation and the support and the interest very much. We look forward to talking with you, and everyone else again soon.

Thank you.

All right, thank you.