Harmonic Inc. (NASDAQ:HLIT) Q1 2020 Earnings Conference Call April 27, 2020 5:00 PM ET
Michael Smiley – IR
Patrick Harshman – CEO
Sanjay Kalra – CFO
Conference Call Participants
John Marchetti – Stifel
Simon Leopold – Raymond James
Rich Valera – Needham & Company
Steven Frankel – Dougherty
Tim Savageaux – Northland Capital Markets
Samik Chatterjee – JP Morgan
Welcome to the First Quarter 2020 Harmonic Earnings Conference Call. My name is Olivia 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 call over to Michael Smiley, Investor Relations. Michael you may begin.
Thank you, Olivia. Hello, everyone, thank you for joining us today for Harmonic’s first quarter 2020 financial results conference call. With me today are Patrick Harshman, President and Chief Executive Officer; and Sanjay Kalra, our Chief Financial Officer. Before we begin, I’d like to point out that in addition to the audio portion of this webcast, we’ve also provided slides which you can see by going to our webcast or our Investor Relations 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 event 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 in the forward-looking statements section of today’s preliminary results press release.
These documents identify important risk factors which can cause actual results to differ materially from those contained in our projections or forward-looking statements. And please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis. These metrics together with corresponding GAAP numbers and a reconciliation to GAAP are contained in today’s press release, which we’ve posted on our website and filed with the SEC on Form 8-K.
We will also discuss historical, financial, and other statistical information regarding our business and operations, and some of this information is included in the press release. The remainder of the information will be available on a recorded version of this call or on our website.
Now I’ll turn the call over to our CEO, Patrick Harshman. Patrick?
Well, thanks Michael and welcome everyone to our first quarter call. Before delving into our recent business results and outlook, I’d like to briefly address the extraordinary situation we all find ourselves in. Harmonic is a people first business and we’re deeply grateful for the support of our employees and their families have received from essential service providers and local governments around the globe and our sympathies are with those who have been most impacted by the crisis.
We’re proud of the role we play in enabling vital broadband and video streaming services worldwide and appreciative of the continuing strong partnerships with our many customers and suppliers. I’m particularly thankful for the extraordinary efforts being made by our employees to continue to support our customers and drive our business forward.
Several years ago Harmonic embarked on a journey to reinvent our company through new cloud native technology and services. It can be as transformative for our customers as for our own business. While the COVID-19 crisis has presented unexpected challenges. It’s also shining a light on power of our virtualized CableOS and cloud-based video streaming solutions, which have held up extremely well under increased operational pressures, providing our customers unprecedented real-time agility and scalability, as they respond to heavy network utilization and expansion opportunities.
Although we have real near-term challenges to overcome, our key customers are fundamentally healthy and our technology position is both powerful and unique particularly our Cable Access and Video SaaS Solutions. Our objective is to emerge from this crisis stronger and even better positioned.
Turning now to the first quarter results. COVID-19 impacted our global business during the final three weeks of March and our business in Asia-Pacific throughout the entire quarter. Resulting revenue was $78.4 million, down 2.1% year-over-year and non-GAAP EPS was negative $0.10. We nonetheless maintained a solid balance sheet. Our Cable Access segment performed relatively well despite the late quarter disruption with both revenue and key deployment metrics up strongly year-over-year. Our Video segment performance was more heavily impacted as several video appliance shipments and integration projects planned for March were delayed. On the other hand a recurring revenue in Video SaaS and support services performed quite well.
Taking a closer look now at our Cable Access segment, we did have a solid quarter. Revenue was $24 million, up over 85% year-over-year. We’re now commercially deployed with 27 cable operators, up 17% sequentially and CableOS is actively serving over 1.3 million cable modems, up 30% sequentially. These are good results for a quarter that is typically seasonally slow and were both shipments and deployments were somewhat impacted by COVID-19; specifically in March we saw several ongoing CableOS deployments initially paused, restarts and then proceed at a somewhat slower pace following the implementation of appropriate safety precautions.
Looking ahead, the mid and long-term outlook remains positive evidenced by a strong project pipeline, although we do expect continued modest impact and deployment to new design wind velocity in the second quarter. Cable broadband is a healthy end market and we’re fortunate to have several cable industry leaders as foundational CableOS customers. considering only the 27 operators who have already qualified and deployed CableOS, our addressable service footprint opportunity is now over 45 million modem served creating a clear line of sight for significant expansion with already onboard customers.
The fact that we saw only modest disruption a CableOS rollout activities in March is a testament to the commitment of both our and our customers teams and the core software advantages of CableOS which can be remotely configured, operated and supported in a way this industry has never seen before.
Elaborating on this and this is important in terms of competitive differentiation. We see accelerating demand for further broadband network segmentation to address significantly increased upstream traffic from applications such as Zoom. The latest data from the NCTA indicates that U.S. cable upspring peak traffic is up over 35% since early March, nearly doubled the downstream peak growth of 19%.
Unlike downstream gigabit expansion upstream expansion requires different tools and techniques. This is historically much more costly and complex and this is where CableOS really shines. Our new centralized shell and the industry is only two by four remote PHY node when coupled with our scaleable virtualized core are absolute game changers for cable operators planning upstream expansion, including in traditional centralized CMTS architectures. It’s no coincidence that during the first quarter we received our first material purchase order for our new centralized shell product from one of our tier one customers. The significant milestone on the road to expansion across the entire deployment footprints of our customers.
Based on extensive customer conversations, our current expectation is that existing CableOS accounts will continue with modestly slow rollout work through the second quarter reaccelerating the second half of the year, driven in part by even more aggressive upstream bandwidth investment. The near-term outlook is somewhat more variable when it comes to new accounts we’re still working to open but we have seen qualification activities slow at a couple of these accounts as they tactically respond to urgent operational challenges.
We’ve also seen excellent progress continue to be made with several other target new customers, in particular larger prospects who are well equipped to manage tactical challenges while also executing on the strategic broadband initiatives. Again the unique software foundation of CableOS is a game-changer in terms of being able to advance these technology qualifications and trials remotely. We anticipate continuing to bring new customers on board in the second quarter, well likely with a slower initial rollout patient originally planned with deployment, acceleration then happening in the second half of the year.
So summarizing this CableOS update we delivered a strong first quarter. Our strategic growth plan continues to be execute well and while COVID-19 creates near-term headwind and risk, the fundamentals in mid term outlook for Cable Access business are clearly positive with the trend of virtualization likely now accelerated even more favorably for our solutions.
Turning now to our Video segments. Here we saw a greater COVID-19 impact. Segment revenue was $54.4 million, down 19% year-over-year as our video appliances and integration sales fell well below our original expectations. Specifically during March we saw several high confidence deals get delayed. We encountered situations where deals were signed but customers warehouse has been closed so the shipments weren’t possible. We were unable to complete some field deployment projects as that as the customer facilities became closed.
And on the supply chain realm, we contended with server constraints and a significant jump in shipment costs. Our Video segment does business with a broad range of customer types all over the world including traditional broadcasters, traditional pay TV players, media companies and news streaming first customers.
Among these, it was sales of our higher margin broadcast service of broadcasters and media companies as well as business across all customer categories in Asia that were hardest hit.
We do not believe we lost anticipated deals for competitive reasons nor do we believe these deals will permanently disappear. Indeed so far in April, we’ve seen a couple of deals that were delayed subsequently booked. We’re now seeing appliance activity begin to pick back up in parts of Asia. As we look ahead considering all of these facts together with extensive customer and channel partner conversations, our current expectation is that second quarter planned sales activity will continue at a depressed level before rebounding the second half of the year as customer facility lockdown loosen.
Now in contrast to appliances and associated onsite integration activity, the recurring revenue component of our Video business remains solid throughout the quarter. That is our SaaS offerings that run on public and private clouds and our support services. In fact we’re seeing an acceleration of demand for our SaaS for video streaming services.
During the quarter we added nine new streaming SaaS customers of 19% sequentially and 80% year-over-year. Among these new wins where two new tier one players, one a prominent international telecommunications company and the other a prominent domestic broadcast media company.
So remarkably, the international tier one deal was signed in March and the service is already on air, running on Microsoft Azure and streaming to consumers. This rollout speed and efficiency highlights why we’re seeing growing interest in cloud-based SaaS platforms for premium video services and why we now anticipate the current crisis we will further accelerate industry transformation to SaaS models. In turn, accelerating our core video segment strategy.
While SaaS deals come without the upfront revenue and profit of our traditional appliance sales which exacerbates near term revenue headwinds, the long term recurring revenue model we are building is ultimately more profitable, stable and value enhancing.
Harmonic is uniquely positioned to lead the premium video streaming SaaS market and we’re leaning into the opportunity more aggressively than ever. At quarter end, we had over 7,300 cloud based linear channels deployed globally, up 56% sequentially.
I want to share a couple of additional data points that underpin this video SaaS momentum. During the quarter we screened on average over 38 petabytes a month from various cloud platforms which is up over 200% year-over-year; a strong statement of growth and scale. We continue to leverage our unique multi cloud capability and partnerships with Microsoft Azure, Google cloud platform and our deployment expertise on AWS. And we’re leveraging the scale gains and strategic relationships together with increase in customer word-of-mouth as part of a revamped outbound marketing push. I encourage you to check out our recently redesigned website highlighting both video streaming and Cable Access.
In summary, for our video segment. COVID-19 impacted the traditional appliances part of our business in the first quarter and based on extensive customer dialog we expect more of the same in the second quarter followed by a rebound and catch up on pent-up demand.
In parallel, we’re seeing a pickup and streaming SaaS demand and we now see an opportunity to further accelerate execution of our video value creation strategy. We’re determined and confident that we will successfully navigate through the current challenging conditions and come out the other side even stronger business.
With that I’ll turn the call over to you Sanjay for a more detailed discussion of our financial results and outlook.
Thanks Patrick and thank you all for joining our call this afternoon. Before I share with you our quarterly results and outlook, I would like to remind you that the financial results as referring to are provided on a non-GAAP basis. For the first quarter of 2020, we had mixed financial results impacted by the effects of COVID-19, reporting revenue of $78.4 million and $0.10 EPS loss. While we are disappointed by the overall impact of this health pandemic on our financial results, there were some clear bright spots. We improved our recurring SaaS and services revenue by 10.5% year-over-year, maintained reasonable gross margins at 48.9% and have strong backlog in deferred revenueof $207.9 million. Further we maintained a solid balance sheet with a cash at $71.7 million and unused available line of credit of 25 million reflecting a total available cash of $96.7 million, positioning us well for the challenging pandemic environment we are in.
Turning to slide 8, let’s take a closer look at our Q1 revenue and gross margin. Revenue was $78.4 million compared to $122.2 million in Q4, ‘19 and $80.1 million in Q1 ‘19. The revenue decline reflects both typical seasonality and the impact of COVID-19 which I will cover momentarily. Cable Access segment revenue was $24 million compared to $43 million in Q4, ‘19 and $12.9 million in the year ago period reflecting significant progress ramping CableOS over the past year and expected sequential decline after a very strong fourth quarter.
In our Video segment, we reported revenues of $54.4 million compared to $79.2 million in Q4 and $67.2 million in the year ago period. Together with the typical seasonality, our video business was more strongly impacted by COVID-19 as we experience reduced applied demand in March.
Additionally, as anticipated the ongoing transition from video appliance to SaaS resulted in year-over-year top line and backlog impacts. As a reminder we have been successfully and steadily transitioning our Video segments to a more profitable recurring SaaS and services business.
In this regard, Q1 was another quarter of solid strategic execution. We again had two greater than 10% revenue customers during the quarter. Comcast contributed 17% and Vodafone contributed 12% of total revenue. Gross margin was 48.9% in Q1, ‘20 compared to 52.3% in Q4 ‘19 and 54.5% in Q1 ‘19. Cable Access gross margin came in at 43.3% in Q1 compared to 38.3% in Q4 ‘19 and 39.3% in the year ago period reflecting improved software mix.
Video segment gross margin was 51.3% in Q1 compared to 60% in Q4 and 57.5% a year ago period. The decrease in video margins is primarily due to the impact of COVID-19. We experienced both; lower contribution from high margin appliance and integration services and higher operating costs particularly significantly increased freight charges during March.
Our recurring revenue base continues to be a highlight growing through CableOS support services for our expanding CableOS customer support and so cloud-based video SaaS.
During the first quarter, recurring SaaS and services revenue was 39.1% of our total revenue, up from 29.7% in Q4 ‘19 and 34.6% in Q1 ‘19. SaaS and services revenue was $30.7 million in Q1 compared to $36.3 million in Q4 ‘19 and $27.7 million in Q1 ‘19.
The sequential decrease reflecting seasonality in service renewals while the year-over-year growth was driven by both; video SaaS and cable support. SaaS and services gross margins were 51.3% in Q1 ‘20, 63.7% in Q4 ‘19 and 51.3% in Q1 ‘19 with the decline driven principally by the increasing mix of Cable Access support services and associated ramp of CableOS support expenses in anticipation of significant further growth. Our video support services margins were also impacted by incremental costs including freight incurred during March.
We made substantial progress in expanding our videos SaaS customer base in the quarter, which will feed further growth of our recurring revenue base; an important element of strong backlog and deferred revenue position, I will discuss momentarily.
SaaS deployments increased to 57 customers, up from 48 in Q4 ‘19 and up from 25 customers in Q1 ’19, growing 19% quarter-over-quarter and 128% year-over-year. As we look at the rest of our income statement on slide 9, we maintain good expense control during the quarter. Q1 ‘20 operating expenses of $47.9 million compared to $49.2 million in Q4 ‘19 and $47.5 million in Q1 ‘19. The sequential decrees is primarily due to continued expense management coupled with modest travel expense savings. Most of the incremental cost year-over-year are attributable to additional go-to-market expenses for our Cable Access segment to drive future work.
The negative top line and cost impacts from COVID-19 resulted in an operating loss in the quarter. Our Q1 operating loss was $9.5 million comprised of $3.2 million from our Cable Access segment and $6.3 million from our Video segment. This Q1 operating loss of $9.5 million compares to an operating profit of 14.8 million in Q4 ’19 and $3.8 million operating loss in Q1 ‘19. This translated to Q1 EPS of $0.10 loss per share compared to Q4 EPS of $0.12 profit and EPS of $0.05 loss in Q1, 19.
We ended the quarter with a weighted average share count of 95.6 million compared to 97.5 million in Q4 and 88.2 million in Q1 ‘19. The year-over-year increase is due to the issuance of 3.2 million shares to Comcast for exercise of warrants and 3.7 million shares for our employee stock purchase plan and performance-based compensation during the year.
Q1 bookings were $76.3 million compared to $140.1 million in Q4 ‘19 and $81 million in Q1 ‘19 resulting in a book to bill ratio of 0.97 in Q1. Sequentially bookings were lower due to seasonality and the 5.8% year-over-year decline was a result of COVID-19 with the biggest product impact felt on our video appliances and the largest impacts in APAC and EMEA regions.
We will now move to our liquidity position and balance sheet on slide 10. We ended Q1 with a cash of $71.7 million, this compares to $93.1 million at the end of Q4, $69.9 million at the end of Q1 ‘19. This cash decrease of $21.4 million is comprised of $11 million use in operations and as planned $11.2 million use for capital purchases, primarily the purchases of fixed assets. Approximately $10 million of this was related to our new Silicon Valley headquarter which is under construction.
Net of $1.7 million cash generated from financing activities, primarily stock auction exercises and ESPP purchases.
Our current San Jose headquarter lease was set to aspire in April 2020 because of COVID-19 we are still in the process of making phased asset additions and leasehold improvements for the new headquarter facility and consequently we have entered a month-to-month extension of our current lease.
For the new facility as previously disclosed, we’ve signed a 10 year lease and we expect to incur a total CapEx of $20 million of which $3 million was incurred in 2019. $10 million was incurred in Q1 ‘20 with the remaining $7 million expected to be incurred in Q2, 2020. Once we move the new lease facility will reduce our annual cash outflow for rent by $5 million and annual pre-depreciation OpEx by $2 million. So this headquarter location continues to be strongly accretive move for us.
Our days sales outstanding at the end of Q1 was 107 days compared to 65 days in Q4 and 66 days at the end of Q1 ‘19. The significant sequential increase reflects timing difference of accounts receivable from customers. We expect to return to normal DSO levels in the next quarter. Our days inventory on hand was 78 days at the end of Q1 compared to 45 days at the end of Q4 and 72 days at the end of Q1 ‘19.
At the end of Q1, our total backlog and deferred revenue was $207.9 million compared to $210.2 million at the end of Q4 ‘19 and $187.2 million at the end of Q1, ’19, reflecting a modest decline of 1.1% sequentially and a strong 11.1% increase year-over-year.
Historically, approximately 90% of our backlog and deferred revenue gets converted to revenue within a rolling one-year period. Please note that our deferred revenue represents 27% of total backlog and deferred revenue at the end of Q1 compared to 21% at the end of Q4 ‘19 and 28% at the end of Q1 ‘19 indicating that the revenue conversion is happening at the pace expected.
I would also like to remind you that not yet included in this backlog matrix is approximately $199 million of contracted CableOS business associated with 3 tier 1 CableOS contracts which we have previously discussed. If you look at the complete picture including backlog deferred revenue and these CableOS contracts, in aggregate we have future contracted revenues of $406.9 million in hand, a much stronger position than we have had in recent history.
COVID-19 undoubtedly impacted our Q1 results and looking forward, significant uncertainty remains regarding the pandemic and how it will impact our business primarily video appliances and integration revenues.
Now let me turn to over non-GAAP guidance for second quarter on slide 11. While in Q1 we had impact primarily for the month of March but in Q2 we expect the impact of COVID-19 crisis to be felt for the entire quarter resulting in a greater impact than in Q1. Based on this assumption we are providing the following guidance. Revenue in the range of $62 million to $77 million. The video revenue in the range of $42 million to $50 million and Cable Access revenue in the range of $20 million to $27 million.
We are fortunate to have a strong base of recurring revenues and as of today we have visibility into approximately 40% of total revenue heading into the quarter. Gross margins in the range of 47% to 48%. Operating expenses to range from $45 million to $47 million. Operating loss to range from $18 million to $8 million. Adjusted EBITDA to range from $15.5 million loss to $5.5 million loss. EPS to range from a loss of $0.18 to a loss of $0.09. And effective tax rate of 10%. A weighted average share count of 96.8 million.
And finally cash at the end of Q2 is expected to be in the range of $60 million to $70 million. The second quarter outlook activity includes payments of approximately $7 million relating to our new headquarters lease. As Patrick discussed, our mid to long-term drivers remain intact and we believe we are well-positioned in both of our business segments. However, due to the near-term economic uncertainty is arising from the COVID-19 crisis Harmonic is withdrawing its previously issued full year 2020 guidance. We will reassess this position based on the clarity of macroeconomics recovery at the end of the second quarter.
That said since our CableOS activity is concentrated among a relatively small group of customers whose rollout plans we have good insights into, we are able to provide an updated Cable Access revenue outlook for the second half of 2020. Beyond the full Q2 guidance I have just provided, we now expect our cable access revenues in the second half of 2020 to be in the range of $65 million to $85 million.
Finally, in summary, I want to highlight that both our Cable Access and Video segments we are well-positioned with a strong global customer base, strategic relationships with healthy tier ones, historically strong backlog deferred revenue and customer contracts, a healthy cash and working capital position and the growing recurring revenue stream. We are therefore confident in our ability to remain financially healthy and to return to solid growths and profitable operations across our entire business as markets emerge from the current depth of this crisis.
With that thank you all and back to you Patrick.
Okay. Thanks Sanjay. We want to finish by emphasizing the fact that despite the near term challenges as Sanjay just said our core growth drivers remain intact and therefore our strategic priorities for the year are unchanged. For Cable Access business we remain very focused on scaling our tier one customer deployments across the footprints, securing new design wins with additional global operators and launching new solutions that expand our addressed market.
For our Video segments, our objectives continue to be accelerating the growth of our live streaming business especially cloud-based SaaS, expanding our addressed market to include new non-traditional streaming customers also through our SaaS platform and return to consistent profitability. And finally, I want to again recognize the extraordinary efforts of our employees to support our customers and our company during these trying times. But together we’re confident that we will get through this and come out the other side even stronger and better positioned.
Let’s now open the call up for your questions. Thank you.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from John Marchetti with Stifel.
Thanks very much. Patrick, I was wondering if you could just spend a minute and go through some of that weakness in the video, just so we can better understand what’s kind of going on there, particularly on the appliance side. I mean, do you worry about as we look through this that maybe with the focus more on the SaaS business that maybe this lasts a little bit longer as you’re working through this transition? Just curious to get your takeaways or your thoughts kind of how we should think about where that video business really stands right now?
So Video business, John, was purely impacted by COVID-19. We saw the impact primarily in appliances demand as you referred to it. COVID-19 impacts arose primarily due to the reasons Patrick just mentioned, there was — several high confidence deals were delayed. We encountered situations where these were signed, but customers’ warehouses had — were closed, so shipments are not possible. That said, we do not believe these deals are lost for competitive reasons, nor do we believe these deals will permanently disappear. So far in April, we have seen a couple of these deals coming back and subsequently getting booked.
So relative to our guidance, it was purely COVID-19 impact. At the same time, we have seen significant growth in our pipeline for SaaS business. And a lot of traction is there for SaaS business, and we expect those to be converted into orders in months to come, and we expect ramp in SaaS business.
And then maybe, Sanjay, just as a follow-up to that, with that growth expected still to come for SaaS and things like that, how do we think about the margins in that SaaS and software business as we progress through the year, assuming a more normalized sort of contribution to revenue? Just curious, given the big drop this quarter in those gross margins, how we should think about that piece of it as we look out through the remainder of ’20?
So John, SaaS itself, SaaS video margins, we don’t disclose separately. SaaS is still a growing part of our SaaS and Services business. I would say we, as of now, look at SaaS and Services together as our recurring stream of revenue. And SaaS definitely is a good piece of that. But SaaS and Services, the margin which we track is a part of our recurrent revenue. But as we expand and as we scale, particularly SaaS, to which you asked, our gross margins should improve, and we have seen that improvement happening over a period of time.
This quarter, we saw good bookings of SaaS. Actually, our bookings for SaaS in Q1 were higher than the plan, although they are still less than 10%. And hence, we don’t disclose that separately. But we have seen significant ramp in bookings ahead of the plan. And in total, SaaS and Services, which basically is a composition of SaaS together with services from video and services from cable, we have seen a ramp in cable services as well. And that — those margins are increasing. Year-over-year, our margins are higher in terms of dollars, we ended at $30 million, it was less than $30 million in the year-ago period.
Next question is from Simon Leopold from Raymond James.
Thanks for taking the question. So I missed the beginning prepared remarks, so apologies if I’m asking something you clarified. But two things I want to try to get a better understanding on. One is around the disruption to evaluation. So when we think about the CableOS being a new product, being in evaluations in a pipeline, I saw you’ve got 27 awards now, so that’s nicely up. Just trying to understand what gets disrupted or the mechanics of disruption of evaluations, certifications, trials, etc.?
Sanjay — excuse me, Simon, this is Patrick. It was a mixed picture. We did see a couple of evaluations, particularly with smaller customers really slow down really as they operationally scrambled to deal up with kind of the urgent tactics of the moment. If I generalize, we actually saw after a momentary pause, we’ve seen our evaluation qualification processes with larger customers continue well. Our observation is that larger MSOs are capable.
We’re actually impressed with their ability to both attend to tactical operational focus issues as well as keep pushing forward on strategic initiatives.
I guess two additional comments, I think that are important color here, Simon, is number one, all of that is significantly aided by the fact that the core software. I think one of the strong attributes of CableOS is our remote tack that can be always connected like any other software-based service.
And so our ability to support testing, configurations, all of that stuff on the software core, we have complete ability to do that in a remote capacity. And so that’s been quite significant. I think the other thing to mention is that this architecture, one of the attractive things about it is the agility, as we’ve talked about repeatedly. And particularly in the context of now a surge of anticipated work around upstream. I think the importance of that agility, the value of that agility is really coming to even sharper focus, particularly for larger MSOs who have, let me say, sophisticated engineering teams.
And so we think that the competitive differentiation, the rationale for wanting to move to this architecture is even more highlighted in this current situation. And we think that has helped keep, if you will, the pressure on keeping evaluation process, qualification process ongoing.
So that was actually set me up nicely for the follow-up was trying to understand maybe the mechanics of what happens when an operator wants to add upstream capacity. What do they buy from Harmonic? What happens to your business?
Typically, there’s two pieces. There’s additional bandwidth that needs to be provisioned through the core. In our case, it’s a software license running on the same server infrastructure. And then typically, it’s something that happens at the PHY level, either in a centralized architecture right there, in our case, licensing another piece of the shelf, or in fact, adding more upstream capacity — known segmentation deep in the network. And so for us, it’s a combination of additional hardware appliance sales as well as additional licensing.
And the key is that relative to historic or, let’s say, traditional solutions, there’s a lot of rewiring, particularly on the head-end as you kind of break out that new upstream. I think the beauty of our solution is there’s no such rewiring. It is all completely software-driven process on the upstream. And that’s where, I guess, at the risk of getting into too much detail, we think that’s really key to the differentiation of the flexibility, the agility of being able to manage these upstream transitions when you have a truly virtualized core running on off-the-shelf server farm.
That’s helpful, and that’s sort of what I thought. So I appreciate the clarification. One just last one. On the Video business, you’ve got such a mixture of customer types in there. And I presume that one aspect are customers that sell video content and those customers may be dependent on advertising for the business. To what extent is their business health being challenged and therefore, that affects your business in the Video segment? Thank you.
Yes, I think that’s a great question. The answer is, short term, we’ve not seen any such impact. Indeed, particularly with loss of sports, I think the data is clear that the advertising revenue is down. That being said, we don’t have any relationships with a broadcaster sync that they’re kind of down for the count. There is a belief that it’s just a question of when, not if, sports comes back, etc.
And in the meantime, streaming content, including linear streaming content has been through the roof. More generally live video viewing. So all of the customers we’re talking to believe that they may have some bumps themselves in the near-term business. But we don’t see anyone talking about a fundamental change in the way their — the consumer-facing part of the business or the advertising model is.
We do think that more and more customers are starting to think, wait a minute, perhaps a more software and cloud-based scale-up, scale-down solution may make sense. I think that’s going to drive greater mid and long-term demand around cloud-based solutions for, let me call them, more traditional broadcast and media companies, although as we mentioned in the prepared remarks, we’re already seeing some pretty substantial growth of the pipeline there. In no case, though, are we seeing a direct line between ad revenue softness and demand softness.
Frankly, the stuff that was in our pipeline needs to get done, and that’s why we’re quite confident, particularly after follow-up conversations with customers around the globe that they’re going to get back and catch up on pent-up demand. It’s really just a question of how quickly they can — and here, we’re talking about a lot of smaller and medium-sized broadcast and media companies all across the globe, how quickly they can kind of get their operations spun back up to be able to do the work. So again, it seems to be a timing question, not a fundamental shift question in terms of viability of these businesses.
So then just to maybe finish up on that point and to clarify, and then I’ll yield the floor. So if it’s not the health of their business, what was the major factor that softened the Video segment sales this quarter and the guidance for video in the next quarter?
Operational disruption. Remember, well over half of our Video business is outside of the U.S. And Asia is almost exclusively so far a video market for us, for example. Sooner than the U.S., we saw a lot of countries starting to take more severe action of shutting down, and that included sending people to work from home, shutting down labs. So particularly for appliances where you’re shipping into an operational center, you’re doing some on-site integration where the customer’s engineer is doing some on-site integration. We saw all of that slow more pronounced outside of the U.S. than inside of the U.S. in the last weeks of March. So really just operational adjustment to the new model, and not any fundamental strategic or business retrenching.
Next question, Rich Valera from Needham & Company. Now online with a question.
Thank you. Taking your — the midpoint of your cable guidance for 2Q and then the second half, it looks like you’re now at — midpoint is around a low $120 million level versus about $140 million midpoint with your previous guidance. Wondering if you could kind of give a little color on what’s baked into that? Is this mainly around just not having the time to physically deploy hardware, you’re assuming that’s just going to kind of push into next year? Any lost business there, just any color you can add to why that’s sort of been taken down on an annual basis.
Richard, there’s a lot of moving parts, but the simplest answer is it’s a slower roll-out than originally anticipated among new customers we were bringing on this year. The customers that are already rolling out with us, although they’re delayed in the first half, we think they’re largely going to catch up, or they’re going to work hard to catch up. So kind of only minimal impact there is our current view.
In contrast, we think that — I think there’s just no way around it. We think we have lost a little bit of time in the first half of the year with brand new customers. We don’t think, in any way, we’re losing those deals. We just think that the qualification process is going to proceed a little bit more slowly. And the initial ramp is going to proceed a little bit more slowly. We’re quite — we remain quite confident in our ability to pick up those customers we planned on doing so this year. It’s simply a question of the pace of the new customers.
Rich, I will just add that — Rich, I would like to add that the additional guidance we gave or a bigger guidance we gave for second half, it does bring the midpoint for the whole year close to $123 million. But that’s still 29% up year-over-year if we exclude the one-time Comcast pickup.
Got it. And then do you need to win many new customers to make that? You said you have 27 customers today. It sounds like everything you’ve been talking about is really just deployments with those customers. So is it safe to say that your — kind of the midpoint of your guidance doesn’t really need to involve a lot of new customer wins?
I would say it’s modest — modest and more modest contribution from new customers than the original guidance average. And please don’t mistake that by saying we’re stopped trying or we’re not seeing the same opportunity. It’s simply we think we’ve lost a little bit of time. But yes, on a relative basis, the mix now looks much more heavily tilted toward roll-out or expansion of existing wins and relatively less contribution because of time delay — some time delay with newer accounts.
Got it. And just one more, if I could, on the Video business. It’s actually on the SaaS and Service revenue, which I guess is a combination of both now. So that was down $5 million roughly quarter-over-quarter. And I think, Sanjay, you attributed that to volatility in service renewals. Just hoping you could provide a little more color there. Is that business that’s lost? Or is it just a timing issue? And was any of that COVID-related? Thank you.
Well, we believe it’s primarily due to the COVID-related delays we experienced. If we think it’s purely timing. We have seen the April stuff coming in, a part of it, but it’s purely timing related, we think.
I am sorry. Is that professional service? Or are those kind of maintenance renewals?
It’s a little bit of both.
Next question coming from Samik Chatterjee from JP Morgan.
Hey guys, thanks for taking the question. I just wanted to kind of run through as kind of on the cable’s taxes segment. My working assumption here was that cable customers would have to add capacity as they’re looking to manage kind of the higher bandwidth needs or capacity needs from a lot of work from home. And as the kind of view side that you’re seeing some kind of fits and starts on CableOS deployment. Does that generally indicate that some of the spending is now going back to the incumbents because of the disruption? And as you return to more normalcy, that’s when you expect to kind of resume gaining share again? Is that a fair way to characterize it?
No, we don’t believe in this process we’re losing any share, and nor do we believe that we’re going to kind of seed expected share going forward. What we do see is a slightly slower pace, simply because of the social distancing, etc. Our customers were heading in a safe way. As we discussed a moment ago, probably the biggest piece, probably the biggest piece of our CableOS business and ramp this year was associated with more volume roll-outs of existing customers and already won accounts.
And all of those cases, frankly, they were leaning into it really as hard as they could. So a simple — I’ll make it up for sake of example, 20% loss of throughput efficiency doesn’t mean that they’re doing other things with that time. It means they’re simply accommodating the operational realities of the current situation.
And we think that’s particularly going to continue to be prevalent in the second quarter. And our expectation is that loosens or improves in the back half of the year. It’s simply a slower pace of what already was a pretty healthy pace with the existing customers.
And second is also mentioned, but perhaps not clearly enough, layered on top of that is wins with new accounts we’re seeing, in general, those qualifications continue to go well, although, again, we see a little bit of a slowdown in terms of the pace of how quickly that’s happening in the labs. And therefore, we’ve taken, I would say, a somewhat conservative view on how quickly those design wins once qualification is confirmed, how quickly that will translate into field launch and deployment through the rest of the year. So it’s a little bit — a slightly lower pace, but we — relative to what was planned, which, frankly, was already fairly aggressive.
Now we do see a long-term more upstream bandwidth being needed, etc. We think for us that that really underpins the mid to long-term opportunity. And indeed, even with some of our established accounts, we think that can positively impact demand and installation in the — later in the year. But I consider that a little bit more upside at this point and not favoring too prominently into the full-year revenue guidance we’ve given for cable.
Got it. And if I can just follow up, and maybe I missed this, are you still expecting any incremental or higher operating costs because of the supply chain issues that you’re navigating going into calendar 2Q?
Well, we do expect additional freight charges which we experienced in Q1 as well, and we have captured that into our Q2 guidance as well when we came for gross margins. But other than the additional freight charges, we are not expecting any other incremental cost at this point.
Next on line with a question from Steven Frankel from Dougherty. Your line is now open.
Good afternoon. Thank you. Patrick, I wonder if you might spend a couple of minutes talking about the shelf opportunity. Maybe help size that for us of how big is that relative to the overall opportunity for CableOS, and is that included in the 48 million modems that you’re addressing today? Or does that create a new incremental opportunity?
I’ll start with the end. We said 45 million, and it’s included in that. Essentially, the point is, look, even without an additional design win, the people who’ve already selected and started to deploy CableOS in part of their network, collectively, they serve over 45 million modems.
We’re only at 1.3 million modems. So there’s a lot of headroom there. I think one of the questions or concerns has been, well, if I paraphrase back to us has been, hey, that’s great but isn’t CableOS only about DAA, and isn’t DAA only going to be used for a subset of that footprint. And it really remains to be seen exactly how much of our customers’ footprint ultimately will be deep fiber or distributed access and how much will be centralized.
But the point with the shelf is, is that together with our deep fiber solution and now with our shelf, we’ve got the whole thing covered. And so it’s not a question of CableOS being relevant for just a subset of the solution, we think that we’re extremely well positioned for the entirety of the footprint.
And so I think that’s the key takeaway is that with this addition to our offering, we don’t see ourselves occupying a nature a subset, but rather a solution, an integrated solution for the entirety of our customers’ footprints.
Okay, great. And maybe an update on the notion that you might have incremental software products to sell back into the installed base, kind of when would those modules might be ready to start generating revenue? And what’s the timing on the fiber to the home product?
Well, thank you for those questions. You’re definitely paying close attention. I didn’t mention either of those in the script, not because they’re not important but just in the context of everything else going on. So indeed, we — our growth strategy is multi-pronged here. And additional software capability is definitely coming on board from a revenue bearing point of view the second half of this year. And our — we expect by the end of this quarter to be well into field trials with our fiber-to-home product.
All that being said, the guidance that we’ve given, I’d say, is taken a fairly conservative view on the incremental contribution from both of those new areas. Frankly, the idea is not to be overly conservative, but we do have a lot of moving parts here. And we thought it was prudent just to — not get ahead of ourselves in those areas from a modeling or projection point of view. That being said, we continue to be quite bullish about the specific features, software features we have coming in specifically, and in general, the opportunity to continue to come back with additional software-based functionality for additional license capability onto our CableOS platform.
And on top of that to complement what we’re doing on the DOCSIS Cable Access with fiber to the home, particularly — excuse me, targeted at cable operators. So both of those continue to be quite active, very active, not only discussions but now testing and trialing with customers under way, expecting to see some things in the second half, but not yet modeling that in a significant way until we make a couple of more steps.
Great. And I understand the COVID-19 impact on the Video business, but this has been a frustrating business for the last couple of years for bunch of different reasons. Is there anything you can do to try to accelerate the move away from appliances and to SaaS? Any financial incentives or end-of-lifting products, anything to try to kind of force this business to the new world and get out of the hardware business?
Yes. I think it’s a good question. I mentioned in the prepared remarks that we have a revamp to go to market. And indeed, we are challenging ourselves as much as we’re challenging our customers. There’s aspects, frankly, of the broadcast and media landscape that are a little bit — if it isn’t broke, don’t fix it.
And I think as much as us kind of coming with new viewpoints and perspectives, I think that this crisis is definitely changing some of that mindset. So this is forcing on us and our customers I think the opportunity to really rethink how aggressively a transition can happen to cloud infrastructure, both for streaming as well as some core broadcast functions.
So without revealing our entire playbook here, indeed, we’re thinking hard and aggressively along the lines that you’ve suggested. I’d like to see us have a little bit more progress and results to report. But as both I and Sanjay mentioned earlier, the pipeline that has been developed recently is quite impressive.
It’s ahead of our internal plan. And we do think that there is a — it’s not just hyperbole, a real acceleration of activity that’s going to be quite promising for this business over the mid to long term.
And any insight into what’s happening with deal sizes on the SaaS side of that business? Are they still relatively small today? Or are you getting more significant deals as you’ve gotten more presence in the marketplace?
We’re seeing both. I mentioned in the prepared remarks that we had two, what I call Tier 1 wins, one a large international telecom operator, one a large-name broadcast and media player, and both of those are definitely large by historic standards. That being said, among the nine new ones that we brought on board in the quarter, also a number of new, more insurgent TAM expansion kind of accounts. So we’re seeing both. And both are important, expanding the TAM, even with small accounts that will build up a very sizable long tail, we think, is very important. But at the same time, getting large Tier 1 domestically and internationally, the tip to this world is also vitally important. And I’m very encouraged that we’re seeing success on both sides.
Next question is from Tim Savageaux with Northland Capital Markets.
Good afternoon. Thanks for squeezing me in here. I want to follow back up on kind of your major customers’ response to increased network traffic on the cable side. I guess first question either in the March quarter as you look into Q2 here, did you, in fact, see any kind of increases or expedited interest in incremental capacity from your current footprint of CableOS business? That’s one question.
And then secondly, I guess trying to discern to what degree the operators and I think you referenced sort of tactical needs a network in terms of capacity, whether it’s downstream or upstream, whether the nature of your footprint to date can really help them address those issues, given that it’s still relatively small?
Or does it indeed kind of pull-in, especially as you referenced the upstream plans to increase bandwidth? Can that be done in a timely enough fashion to meet these relatively short-term demands for increased traffic? I guess it’s along the lines of whether they turn to more established technologies in a pinch if you will in triage mode or accelerated deployment of new paradigms.
So that’s a bigger question. The first one on whether you did see any increased capacity demand in here in the first half today.
The short answer is yes, Tim. Look, in general, the — I think just to set the context, the cable network sort of absorbed — in general, they’ve absorbed kind of the hit. But what happened is they lost a lot of the headroom and capacity. So it’s not — at least our understanding, it’s not the new capacity needs to be added within the next 48 hours. It’s just they lost their headroom, and now, particularly if you contemplate that work from home and video conferencing behavior may actually become part of the landscape indefinitely going forward, there is a long-term readjustment of what the ceiling needs to be.
And so, we think — from that perspective, we think we’re extremely well positioned. It doesn’t require a kind of an urgent band-aid, or maybe there are some situations that need to band-aided. And given our small market share today, that’s probably not us, but we think that the real interesting opportunities, the fundamental rescaling of the network and particularly, the upstream.
And there we think we’re extremely well positioned. And absolutely, there was heavy conversations about that during the quarter. One of the things that we’re excited about is our first sale, first order of this new shelf product from one of our large Tier 1 customers. And that’s really all about accelerating use of CableOS across the entire footprint and in large part accelerating being able to use CableOS for expanding the upstream.
Okay. Just a follow-up. So, then I guess it sounds like you say outside of the slower pace of new customer evaluations and wins in CableOS that what you’re seeing out of your kind of larger established customers is relatively unchanged outside of whatever kind of short-term logistical delays you might have seen as through the first half here?
Next question is from George Notter from Jeffrey. Your line is open.
Hey, thanks a lot for the question. This is Kyle on for George. So, this one is about the Video business, regarding the business with broadcasters that you mentioned, the higher margin appliance sales to broadcasters. Can you give us a sense for how much of the Video business revenue is tied to that type of activity? Is it like 90% that’s not SaaS, or is it something much smaller than that, I guess I would expect?
And then regarding that activity, can you give us a sense for whether customers are pushing out versus the orders may be lost for you? Is there anything that you can get in terms of your conversations with customers or anything that they’ve said to you, maybe updated timelines that they’ve given to you that would help us understand that?
So Kyle, the first part of the question, broadcast and media represents approximately 40% of our business. And the balance is for service providers. And the mix we saw this quarter, which Patrick mentioned in terms of the broadcast and media views getting delayed, we saw that although we have seen a marginal pick up now after, since Q2 has just kicked off. But that’s the piece which has been shifting a little bit.
And also then Kyle, on the second part of the question, we don’t feel as though — not feel. We don’t believe that we’ve lost any of these deals for competitive reasons, nor have we’ve been told in a single case, have we been told by our customer that the deal is being taken off the table. In every case and we have done an exhaustive scrub as you might imagine, worldwide. It really is a question of timing.
Now, we’re really talking about hundreds of customers in this area around the globe and across a lot of different countries. As I mentioned earlier, over half of this business is outside of the U.S. So, really the question for us and for our customers and channel partners is about timing and about really getting labs and operation centers reopened to reintegrate new product.
And we believe it’s simply a question of when, not if, and that is really across the board, the message that we’ve received and it makes sense to us, because in general, these projects are not — in general they’re driven out of necessity. And we don’t think that the need — the fundamental need has gone away.
Okay. Great. That’s helpful. And is that 90% of the Video business? Is it less than half? Is there anything you can give to us as a general sense for how large that is as a component of video?
So as Sanjay said, we publish for the full company, a broadcast and media business, which is exclusively video, it’s about 40% for the whole company. So just if you kind of do the math backwards, it says broadcast and media is about 60%, 65%, about two-thirds of our video business. And so as an overall category, it’s pretty significant. So you can see that what happened was to a subset of that, it wasn’t across the board. It was to a subset of broadcast and media players, particularly smaller and medium size ones. And where we saw this kind of push out.
And indeed, particularly small and medium-sized companies, we have seen struggle to readapt to work from home and perhaps don’t have the same kind of sophisticated IT systems or whatever. In some cases, we had a couple of small customers who struggle to execute purchase orders from — with clerical people or what have you working from home. So there’s kind of myriad logistical challenges.
And in general, what we see is logistical challenges that have to be overcome. From the point of view of these companies’ internal operations as well as their own countries, regulations on being able to work, etc.
So our belief is that as these logistical challenges become overcome, as the situations become [indiscernible], if you will, one way or another, we believe that these deals will begin to flow again. Our current expectation is that happens in earnest in the second half of the year despite a continuing slowdown in the second quarter.
I’m not showing any further questions at this time. I would like to turn the call back over to Mr. Patrick Harshman for closing remarks.
Okay. Well, thank you very much. We went after time. We appreciate very much all the questions and feedback. The fundamental drivers of the business are healthy. We continue to push forward. We continue to believe in everything we’re doing, and we very much appreciate your support. And we look forward to talking with you all again soon. Thank you. Have a good day.
Thank you. Ladies and gentlemen this concludes today’s conference. Thank you for participation. You may all disconnect. Good day.
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