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Edited Transcript of HLIT earnings conference call or presentation 28-Oct-19 9:00pm GMT

Q3 2019 Harmonic Inc Earnings Call

SAN JOSE Nov 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Harmonic Inc earnings conference call or presentation Monday, October 28, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Patrick J. Harshman

Harmonic Inc. - President, CEO & Director

* Sanjay Kalra

Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer

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Conference Call Participants

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* John Warren Marchetti

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

* Kyle P. McNealy

Jefferies LLC, Research Division - Equity Analyst

* Richard Frank Valera

Needham & Company, LLC, Research Division - Senior Analyst

* Steven Bruce Frankel

Dougherty & Company LLC, Research Division - Senior VP & Director of Research

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* W. Chiu

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Nicole Noutsios

NMN Advisors - Principal

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Presentation

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Operator [1]

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Welcome to the Q3 2019 Harmonic Earnings Conference Call. My name is Chris, and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded.

I would like to turn the call over to Nicole Noutsios, Investor Relations. Nicole, you may begin.

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Nicole Noutsios, NMN Advisors - Principal [2]

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Thank you, Chris. Hello, everyone, and thank you for joining us today for Harmonic's Third Quarter 2019 Earnings Conference Call. With me today are Patrick Harshman, our CEO; and Sanjay Kalra, our CFO.

Before I begin, I'd like to point out that in addition to the audio portion of the webcast, we've also provided slides to this webcast, which you can see by going on our webcast on our IR website.

During this call, we will provide projections and other forward-looking statements regarding future events or future financial performance of the company. Such statements are only current expectations, and actual events or results may differ materially. We refer you to documents Harmonic files with the SEC, including our most recent 10-Q and 10-K reports and the forward-looking statements section of today's preliminary results press release. These documents identify important risk factors which can cause actual results to differ materially from those contained in our projections or forward-looking statements.

And please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis. These items, together with corresponding GAAP numbers and a reconciliation of GAAP, are contained in today's press release which we posted on our website and filed with SEC on Form 8-K.

We will also discuss historical, financial and other statistical information regarding our business and operations, and some of this information is included in the press release but the remainder of the information will be available on the recorded version of this call or on our website.

And now I'd like to turn the call over to our CEO, Patrick Harshman. Patrick?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [3]

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Well, thanks, Nicole, and welcome, everyone, to our third quarter call.

Harmonic delivered a strong quarter, both financially and strategically. The financial headlines: a revenue of $115.7 million, up 14% (sic) [15%] year-over-year; record gross margin of 67%; and record non-GAAP EPS of $0.25.

Our virtualized CableOS solution was the primary driver of this growth, demonstrating the operating leverage achievable as we scale our software-based solutions. And scale is where we're headed. As we saw during the quarter, a clear tipping point of industry consensus that virtualization is the future of Cable Access worldwide and that Harmonic's CableOS is the industry-leading platform driving this transformation.

On the Video side of our business, we're similarly seeing positive momentum from our transformation to live over-the-top as we launched powerful new streaming capabilities and as new cloud-based customer deployments accelerated.

We also refinanced approximately 2/3 of our convertible debt during the quarter, taking advantage of favorable terms and confirming our confidence in paying down the remaining 1/3 of the original debt principal in cash by the end of 2020.

Taking a closer look at our Cable Access segment. Let's start with the financial headlines. Revenue in the quarter was $55.7 million, of which $42.9 million was gross profit as virtualized CableOS software dominated the revenue mix. We also anticipate a solid fourth quarter and correspondingly raised our full year segment revenue and corporate operating profit guidance.

With our Comcast relationship serving as a strong foundation, we're making good progress expanding our customer base. At the end of the third quarter, CableOS had been commercially deployed by 19 cable operators globally, and the associated number of served modems had grown to over 935,000, up 20% from the end of the second quarter. It's important to understand that these early deployments are generally still in the first phase of adoption. We see it will grow in 2020 and beyond as deployment footprints expand and network traffic scales.

Not yet included in these numbers are the international Tier 1 distributed access architecture deployments that we've discussed previously. With both customers, progress is good and our confidence is high. With one of these customers, we expect deployment and revenue to begin to ramp in the fourth quarter. With the other, deployment in revenue is expected to begin in the first half of next year.

As we've learned both in the U.S. and overseas, working with large operators to fundamentally transform their access architectures is a complex process requiring painstaking work. And as evidenced in the third quarter, once the transformation begins rolling, such design win engagements can be very rewarding.

While launching and scaling early customers and securing new design wins has been our primary focus, we've also continued to aggressively extend our technology leadership position. During the quarter, we announced new CableOS cloud native capabilities that unlocks significant new real-time analytics, operations automation and quality of service benefits far beyond traditional solutions.

Additionally, leveraging our cloud native containerized architecture, we've announced a groundbreaking converged fiber-to-the-home and data-over-cable service capability where unified CableOS core software and a converged IP-over-fiber delivery network serve both remote 5 for cable and remote OLT for fiber-to-the-home edge devices. And we think this is a big deal as it multiplies the benefits of our virtualized access network core and expands our addressable market.

The majority of our cable customers who operate hybrid broadband access networks for both data-over-cable is complemented by fiber to the premises for new housing developments, large residential buildings and business services. Having a unified core access platform will be a further game-changer in terms of operational efficiency and service flexibility, and really, customer response to this announcement has been very positive.

Those of you who attended the recent Cable-Tec Expo in New Orleans, the cable industry's signature annual event, will confirm that virtualized cable access has moved to center stage of the industry's vision for the future and that Harmonic is recognized as the technology company leading this transformation. This recognition is being amplified by strong public validation from our early customers.

I want to share with you some of the powerful operational data our CableOS customers presented publicly at this event: 70% power savings, 20-to-1 physical space reduction, a drop in mean time to detect network issues from 30 minutes to 15 seconds, and an improvement in targeted software upgrade precision from 20,000 to 70 home -- households passed. This all translates to very significant improvement to quality of service, an equally significant operational savings relative to conventional CMTS and HSC network technology. This is an extremely powerful message the broader industry is now starting to understand and embrace.

Correspondingly, the Dell'Oro Group forecast a 50% compounded growth rate toward a $1.2 billion virtualized Cable Access market by 2023. With this market growth chart as a backdrop, let me be clear. This is a market category that Harmonic largely invented and that we're now uniquely positioned to lead. And with the fiber-to-the-home opportunity mentioned previously and other converged access services on the horizon and not yet factored into such market size estimates, our opportunity is only going to get larger.

Considering this Dell'Oro forecast, I want to make a couple of additional important points. First, it's essential to understand that this market is comprised of 2 distinct product categories: virtualized core CMTS software, which we expect to deliver approximately 90% gross margin; and Remote PHY hardware, which we estimate will settle out at around 40% gross margin. Although we're targeting and leading the market in both categories, it's important to understand that the associated revenue dollars are not equally valuable.

For example, when we say we've signed $175 million software license agreement, you should understand that such a deal represents approximately the same gross profit, this $400 million Remote PHY sales.

And second here, I want to take this opportunity to remind you of several key attributes of the previously announced software license deal with Comcast. The deal is a $175 million 4-year software license, which, according to this data from Dell'Oro represents about 15% of the virtualized software market over the next 4 years, with the required Remote PHY products being incremental business opportunity that we're actively pursuing.

So to be clear, $175 million is the minimum cash we'll see through this deal. Additional sales of associated Remote PHY equipment or any other technology or services to Comcast will be incremental to our top and bottom lines.

And finally, this unique software license covers Comcast's direct service footprint. CableOS adoption by any other cable operator in North America or elsewhere, whether sold directly by Harmonic or through any other channel, will also be incremental to our business. And of course, our focus is on winning as much of this additional cable operator business as we can in 2020 and beyond.

We've got a great start with Comcast and a couple of other Tier 1 operators, and we see momentum building every day. CableOS and the visionaries on our team have really created a tremendous new market opportunity, one that we are determined to take full advantage of.

Okay. Turning now to our Video segment. Here also, execution of our strategic transformation is showing real progress. As a reminder, our Video business transformation is about moving from our historically broadcast-centric appliance business to a more efficient, future-proof and profitable over-the-top streaming business, where we provide our technology as either software running on cut servers or a Software-as-a-Service running on public, private or hybrid cloud.

As has been the trend over the past several quarters, Q3 was again characterized by expansion of over-the-top streaming engagements, with both traditional and new customers and the corresponding decline in traditional broadcast hardware sales.

Specifically, Video segment revenue was $60 million, and associated gross margin was 57.7%. A strong margin result reflects our continued software transition. A couple of video deals originally expected to be closed in September were instead closed in October, and consequently, the Q3 top line was softer than anticipated, and our fourth quarter guidance has been correspondingly increased.

Our fourth quarter video deal pipeline is quite strong, our total second half Video segment outlook is unchanged, and our full year segment profit plan remains on track.

The positive strategic news of the quarter is that we see our live over-the-top streaming platform continuing to be adopted by more customers, both existing and new customers, domestically and internationally.

Breaking into new nontraditional streaming accounts is core to our Video segment growth strategy. During the quarter, we added 8 new live streaming SaaS customers, bringing our total to 36, which is up 29% sequentially and 140% year-over-year, our strongest quarter yet of new SaaS customer additions.

The other important strategic development of the quarter was the introduction of a very innovative new CDN optimization solution that is an extension of our live streaming platform. Reliably scaling live streaming video, particularly live sports broadcast with mass appeal, to millions of simultaneous viewers without compromising quality or introducing latency is a key unsolved challenge for the streaming industry. Harmonic is uniquely qualified to take this problem on, and during the quarter, we both announced our entry into the space and achieved very positive results with an initial scale deployment for a large mobile operator.

Moving into this live streaming delivery optimization area significantly increases the size of our addressable market and further differentiates our live streaming platform.

Highlighting the expansion of our traditionally addressed market, let's review some of our recent publicly announced over-the-top streaming wins. Telkomsel is the incumbent mobile operator in Indonesia with over 200 million mobile subscribers and a strategy of delivering live streaming sports at scale over their mobile network. Vidgo is a new virtual MVPD here in the U.S., with a creative business model that includes Harmonic-enabled targeted advertising. With IndyCar, Harmonic is enabling a compelling live from-a-top pit streaming experience that depends critically on real-time quality of user experience. Sky Italia is a very innovative operator, taking advantage of our latest AI-enabled video compression to minimize bandwidth consumption and maximize video quality for their new over-the-top streaming service. And Shop LC is a great example of a fundamentally new kind of live video application that relies critically on our industry-leading low latency streaming solution.

Big picture, the second wave of over-the-top, which is live streaming at scale, is now beginning to play out, and Harmonic is uniquely positioned to take advantage of this opportunity. While we must contend with the decline of a traditional broadcast business in the near term, our expanded streaming solution portfolio, now addressing both origination and scalable CDN delivery, together with an expanding customer base, position us for profitable growth.

In both our Cable Access and Video business segments, we've invested for the future, transforming our businesses with powerful cloud native technologies and services that are now helping to redefine where the market is headed. The success we're beginning to see in the marketplace and the financial success we delivered this quarter cause us to continue to be confident in our ability to drive sustained profitable growth and value creation through this year, into 2020 and beyond.

With that, I'll now turn the call over to you, Sanjay, for further discussion of our financial results and outlook.

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Sanjay Kalra, Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer [4]

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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 I'll be referring to are provided on a non-GAAP basis.

For the third quarter of 2019, we delivered solid results. Revenue was a record $115.7 million, and gross margin was a record 67%, resulting in a $0.25 EPS. We improved our balance sheet with a material improvement in working capital, reporting cash of $66.7 million, and we refinanced our convertible debt with significantly improved terms, positioning the company for reduced interest expense and reduced potential dilution.

Turning to Slide 11. Q3 revenue was $115.7 million compared to $84.9 million in Q2 '19 and $101.4 million in Q3 '18, resulting in a 36% quarter-over-quarter growth and a 14% year-over-year growth. This growth was driven by our Cable Access segment.

Cable Access revenue was $55.7 million compared to $13.3 million in Q2 and $28.1 million in the year ago period. Of note, in Q3, we recorded 37.5 million of the 175 million CableOS software license agreement which we closed with Comcast in July.

In our Video segment, we reported revenue of $60 million compared to $71.6 million in Q2 and $73.3 million in the year ago period. As a reminder, Q3 is typically a weak quarter seasonally due to summer vacations. And specifically related to the third quarter, a few anticipated deals were booked in early Q4 instead of Q3. This resulted in lower Q3 Video revenue and commensurately higher Video guidance for Q4 which we will cover shortly.

In Q3, Comcast was our only greater-than-10% customer, contributing 44% of total revenue.

Gross margin was 67% in Q3 compared to 53.6% in Q2 and 52.1% in Q3 '18. Cable Access gross margin was 77.1% in Q3 compared to 30.8% in Q2 and 38.7% in Q3 '18, a result of CableOS software revenue recognized during the quarter. Video segment gross margin remained strong at 57.7% in Q3 compared to 57.9% in Q2 and 57.2% in Q3 '18.

Our recurring revenue base has continued to grow through expanded support services for our traditional appliance-based solutions and through cloud-based SaaS offerings. During the third quarter, recurring SaaS and services revenue represented 28.2% of our total revenue compared to 35.9% in Q2 '19 and 28.3% in Q3 '18. SaaS and service revenue was $32.6 million in Q3 compared to $30.4 million in Q2 and $28.7 million in Q3 '18. This increasing recurring revenue category continues to have higher gross margins than our appliance and integration category and is a key component of our long-term margin expansion strategy.

Total SaaS and services gross margins were 60.6% in Q3 '19, 62.6% in Q2 '19 and 60.9% in Q3 '18. We also made good progress expanding our video SaaS customer base, delivering growth of 29% quarter-over-quarter and 140% year-over-year. In Q3 '19, our SaaS customer count was 36 compared to 28 in Q2 '19 and 15 in Q3 '18. Delivering expanded services for our growing SaaS customer base is a key element of our video growth strategy.

As we look at our income statement on Slide 12, we maintained strong expense control during the quarter. Q3 operating expenses were $47.7 million compared to $48.3 million and $47.2 million in Q2 '19 and Q3 '18, respectively.

We reported record profitability in the quarter. Our Q3 operating income was $29.9 million, which comprised of $31.6 million of our operating income from Cable Access segment, and an operating loss of $1.7 million from our Video segment. Our Q3 operating income of $29.9 million compares to an operating loss of $2.8 million in Q2 and $5.7 million operating income in Q3 '18.

We ended with a diluted share count of 97.6 million compared to 88.9 million in Q2 and 87.8 million in Q3 '18. The increase in share count reflects a dilutive effect of 3.5 million convertible note shares, 2.3 million shares of Comcast warrants and 1.9 million shares of employee-related RSUs and options.

Please note, this calculation considers our average trading stock price of approximately 6.9 per share for the quarter and uses the treasury method of convertible note and warrant calculations.

During Q3, we refinanced approximately 65% of our convertible notes due in 2020 with favorable terms for the company. The new notes carry a coupon rate of 2% with a conversion price of 8.66 compared to the original notes which carry a 4% coupon and a conversion price of 5.75. We plan to pay down approximately 35% of the original principal amount of notes in cash in December 2020.

Using an if-converted method, as a result of this refinancing, we have immediately reduced the potential dilution by 5% and annual interest expense by 19%. Once the remaining 35% of the original notes are paid off in cash, our refinancing will effectively reduce the potential dilution by 40% and annual interest expense by 55%.

We reported strong Q3 EPS of $0.25 compared to Q2 loss of $0.04 and a profit of $0.04 in Q3 '18.

Q3 bookings were strong at $126.5 million compared to $92.6 million in Q2 and $79.5 million in Q3 '18, resulting in a book-to-bill ratio of 1.1 in Q3, 1.1 in Q2 and 0.8 in Q3 '18.

Please note that our year-to-date book-to-bill ratio is 1.1.

We will now move to our strengthened liquidity position and balance sheet on Slide 13. We ended Q3 with cash of $66.7 million. This compares to $58.1 million at the end of Q2 and $61.7 million at the end of Q3 '18. This cash increase of $8.6 million reflects $6 million cash generated from operations and $5 million generated from financing activities, primarily stock option exercises and ESPP purchases, net of cash used in capital investment activities of $2 million, primarily due to the purchase of fixed assets.

Please note that the net cash impact as a result of our convertible debt refinancing was less than $1 million.

Our days sales outstanding at the end of Q3 was 78 days compared to 75 days in Q2 and 70 days at the end of Q3 '18. Our days inventory on hand were 68 days at the end of Q3 compared to 63 days at the end of Q2 and 43 days at the end of Q3 '18. The increase in inventory days is primarily due to increasing nodes inventory for our CableOS segment.

At the end of Q3, backlog and deferred revenue was $192.5 million. This compares to $194.7 million in Q2 and $207.6 million in Q3 '18.

Please note that not yet included in this backlog metric is over $200 million of contracted CableOS demand associated with 3 Tier 1 CableOS customer contracts, which we have previously discussed, including our agreement with Comcast which we have begun to recognize into backlog and revenue.

Regarding the Comcast software license agreement, let me provide a reminder of what we explained last quarter about the GAAP and non-GAAP accounting treatment. For the $175 million Comcast CableOS software license agreement, the total license revenue to be recorded will be net of warrant vesting charge of approximately $20 million, resulting in a net GAAP and non-GAAP revenue of approximately $155 million over a period of 4 years.

Now let's turn to Slide 14 for our non-GAAP Q4 '19 guidance. For Q4 '19, we expect revenue in the range of $108 million to $118 million, with Video revenue in the range of $78 million to $83 million, and Cable Access revenue in the range of $30 million to $35 million. This reflects an increase of $8 million to the Q4 Video revenue range communicated in July.

Gross margin in the range of 51% to 52.5%. Operating expenses to range from $48 million to $50 million. Operating income to range from $5 million to $14 million. This reflects an increase of $4 million to the previously communicated Q4 guidance primarily due to increased Video revenue expectations.

EPS to range from a profit of $0.03 to a profit of $0.11; an effective tax rate of 12%; a weighted average share count of 95.8 million. This share count reflects a decrease from Q3 of approximately 2.4 million shares primarily due to decreased dilution as a result of our convertible note refinancing. And finally, cash at the end of Q4 is expected to range from $90 million to $100 million.

Moving to Slide 15. We provide the corresponding updated full year non-GAAP 2019 guidance. Specifically, for the full year, we now expect revenue in the range of $389 million to $399 million, with Video revenue in the range of $277 million to $282 million, and Cable Access revenue in the range of $112 million to $117 million. This top line guidance is higher than our initial full year expectations of our Cable Access segment. And for our Video segment, we have raised the low end that we had initially provided by $5 million.

Gross margin in the range of 57% to 57.5%, an improvement from our prior guidance of 56% to 57.5%. Operating expenses to range from $191.5 million to $193.5 million, improved from our prior guidance of $192 million to $196 million. Operating income to range from $28.5 million to $37.5 million, significantly improved from our prior guidance of operating income of $15 million to $35 million. EPS to range from a profit of $0.20 to a profit of $0.29, materially improved from our prior guidance of a profit of $0.07 to a profit $0.26.

An effective tax rate of 12%, a weighted average share count of approximately 93.8 million shares, year-end cash to range from $90 million to $100 million.

Regarding 2020 expectations, we have recently kicked off the planning process, and we will be able to share more detailed guidance at our next earnings call. At this time, we expect to be profitable in both segments in 2020 and continue our progress towards becoming the market share leader for both Cable Access and live video streaming.

In summary, the strategy of the company is working effectively in both segments, and we remain very focused on continued execution.

With that, thank you, and back to you, Patrick.

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [5]

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Okay. Thanks, Sanjay.

Speaking of execution, we want to wrap it up by highlighting our strategic priorities for the remainder of the year and as we head into 2020.

For our Cable Access business, we're focused on successfully executing on our existing Tier 1 customer engagements, securing new design wins with additional global cable operators and leveraging our market-leading position to scale the business.

For our Video segment, our objectives are to continue to expand our base of over-the-top streaming customers to drive new growth through our expanded live streaming and network delivery solutions, and to deliver segment profitability as we're on track to do this year.

We're confident in our business, and we're looking forward to a strong fourth quarter. And we want to thank you all for your continuing support.

So with that, let's now open up the call for some questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) John Marchetti from Stifel.

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John Warren Marchetti, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [2]

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I just wanted to touch real quickly on the Cable Access business here. Obviously, a very strong quarter here driven by a lot of the software. And I know you're not giving guidance for '20. But as we start to look out at some of these additional deals coming on and the mix shift changing a little bit, just thinking about gross margin here, Sanjay, how do we sort of account for a lot of the variability in there between the 2 different pieces?

This is -- this was obviously primarily a big software quarter, but just thinking about how the remainder of that Comcast deal flows through as well as some of those other deals that you've mentioned coming on, how we should think about maybe that mix either being more aligned? Or do we see a series of hardware shipments first and then expect a follow-through of software? Just trying to think about that as we're looking out over this intermediate term here.

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Sanjay Kalra, Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer [3]

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Yes, John, thanks for the question. So yes, Q3 definitely is a very strong quarter, reflective of a very strong mix of software, as you see, above 70% margin. Q4, our guidance entails a little bit less than 70% because it's more of a hardware mix, is a little higher than what we saw in Q3. But at the same time, we do need a little bit more experience to understand how the proportion of software sales and hardware sales growth will evolve over time to get to a very precise measurement.

However, overall, if you look at the chart, which was earlier displayed today on the call, the mix of hardware and software over a longer period of time should result in a margin of 60%-plus. We will see variability as we have already experienced like Q3 is more than 70%, as I said. In the past year also, we've seen 50%. So it needs to settle down, but believe overall, 60%-plus is reasonable.

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John Warren Marchetti, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [4]

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And then if I could just follow up there for a second, Sanjay. When I go back to the announcement or when you talked about the announcement last quarter and then you mentioned the 2 international deals, those deals, if I remember correctly anyway, were much more sort of blended. That 50 was not -- or the numbers that you quoted for those deals were not software-specific. Just curious if that's still the case.

And when you talk about the $200 million or so that's not yet included in backlog, if that's primarily software, if that's a mix of software and hardware. Just trying to get a sense for maybe the magnitude of this because you showed that Dell'Oro chart that you spoke to, Eric, (sic) [Patrick] in the presentation, just trying to get a sense for as we're looking out into '20 and 21, just how big of an opportunity it really is for CableOS here.

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [5]

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John, maybe I'll -- this is Patrick. I'll step in. So in terms of those 3 deals, 2 internationals that we've spoken about and Comcast, Comcast, of course, is 100% software. So we do think the hardware there is an additional opportunity, but that's not part of "the deal."

In contrast, the 2 international deals that we spoke to about are, indeed, as your question suggests, were blended deals, where the contracts covered both the virtualized software as well as the Remote PHY element. So indeed, those 2 deals we see as blended margin deals, a combination of lower-margin hardware and high-margin software, whereas the Comcast one, in terms of what's contracted, is exclusively software.

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John Warren Marchetti, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [6]

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And then just one last quick one, and I'll jump back into the queue. But when you talk about the size of these deals and obviously being multi-year and all that, is the sense that these are -- when all is said and done that these represent 50% of the network you'll build, when all is said done? Is it a full build? I'm trying, I guess, to get a sense for if there's follow-on opportunities, even with these existing contracts that you've announced or if those really do essentially cover the entire footprint, if you will, that they're looking to change over to DAA.

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [7]

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The short answer is, is that there's follow-on expansion opportunities in all 3 contracts that we've talked about publicly. And in particular, with the international ones, only covering a portion of the potential opportunity or footprint.

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Operator [8]

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Rich Valera from Needham & Company is online with a question.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [9]

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Another question on the Cable business. Just wondering what drove the upside relative to your prior guidance for the year. I noticed you're not expecting something like any rev rec from the second international. So just curious if you could give any color on what drove the higher expectations for this year for cable.

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Sanjay Kalra, Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer [10]

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Yes, Rich, so when we presented the initial expectation, there was a $34 million kind of software expectation, but that was at midpoint of our range of plus/minus 10%, and we came a little bit higher towards our high end of $37.5 million. That was the primary reason for a marginal increase there.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [11]

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Got it. And then in the Video business, nice to see some stability, at least in the annual guidance there. I was hoping to get a little color on sort of what's going on under the covers.

Patrick, you'd talked about having some sort of teasing pains as you shifted the sales force from your traditional kind of hardware process to SaaS and said you were kind of having to educate them on that. I wonder if you could give us an update sort of on where they are in that process.

And then this new product you're talking about, the CDN capability for live streaming at capacity, is that having any near-term impact on the numbers? Or is that more of a 2020 contributor, do you think?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [12]

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I'll start with the last question first. We think it's more of a 2020 contributor. I mentioned that we have a very successful kind of advanced field trial that's ongoing. I think we'll probably see a little bit of revenue associated with that the back end of this year, but the opportunity really starts to grow for us in 2020.

So on the first part of your question, look, the whole company is in a little bit of a learning mode, and frankly, I think if you look at the industry at large. I'll go to some of the earnings calls of some of our customers over the past several days, we're all in a big transition from a traditional broadcast-based services to streaming platforms.

In our case, indeed, there's not only new technology, but as you said, some amount of business is -- it's fairly modest. We're still in the 5-plus percent of total bookings being SaaS, but that's a learning curve for our organization and our sales force, in particular. And as I highlighted a couple of moments ago, we're also building, I think, very exciting relationships with new customers. But also for the company and the sales force, in particular, getting out and discovering new up-and-coming streaming businesses that are not our historic customers is part of the challenge, but, of course, part of the opportunity here.

So I'd say work in progress, Rich. Definitely have made improvement over the course of the year, but our plan is to really lean in more to these growth opportunities in 2020. And to do that, our whole company, including our sales force, needs to continue to evolve in much of the way, as I said, that we see the rest of the industry having to pivot.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [13]

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And one more, if I could. It looks like based on your percentage of revenue from Comcast that you did indeed have some hardware sales to them this quarter. I'm wondering if you could characterize kind of how that piece of the opportunity is going. I mean you've, I think, been on record saying that you expected to share the node part of the Comcast deployment with other vendors. Can you give any color on how you feel like that's going for you in terms of maintaining or keeping a share that you feel is kind of what you want?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [14]

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Yes. I appreciate the question because it is important for us. It's not as high margin, but nonetheless, we think that can be a very profitable business. And in fact, we've worked extremely hard and invested quite a bit. And as we highlighted on our last call, we've actually been fortunate enough to file and have some approvals of some patents granted in that space. So we feel very strongly about our competitive position there, and indeed, we like what we're seeing so far in the deployments.

I won't be specific about Comcast or any other customer, but let me say, in what's deployed so far, we believe that we have the lion's share of the DAA nodes that have been deployed worldwide. And we think that the performance as well as the operational advantages of our products are really distinguishing themselves in the marketplace. So we're excited about our ability to lead not only in the software piece of these new architectures, but also in the hardware Remote PHY piece.

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Operator [15]

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Simon Leopold from Raymond James is online with a question.

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W. Chiu, Raymond James & Associates, Inc., Research Division - Senior Research Associate [16]

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This is Victor Chiu in for Simon. You touched on this during the prepared remarks a little, but could you help clarify how the margins and profitability differ if another cable operator adopts virtualized [cable access] through some other channel, as you suggested, versus making directly with Harmonic? And how might that type of strategy play out, I guess, practically speaking?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [17]

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We have a history of doing a lot of our international business through sales channels, Victor. And historically, the sales channel provides some value add -- value-added reseller. And so we may give up a sliver of merchant, but at the same time, the end price may be higher. And if we think about CableOS going through an alternative channel or being offered by -- as a service by an alternative channel, we see it largely the same.

So we're pretty bullish on both our direct sales opportunities with CableOS as well as a variety of strategic partnerships that can bring that technology to market. All of it, frankly, is additive to the top as well as the bottom line. And if we can use those kind of channels to accelerate market share, so much the better, is our view.

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W. Chiu, Raymond James & Associates, Inc., Research Division - Senior Research Associate [18]

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Okay. That's helpful. And at the cable trade show last month, we got the impression that cable operators have fragmented to a certain degree in terms of the specific strategies that they're pursuing regarding network upgrades. Comcast is really the only major operator right now that's pivoting hard towards virtual, and some of the others are making a more gradual transition. So can you just help us understand your perspective on this dynamic and how that impacts Harmonic?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [19]

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Well, I -- candidly, we have a somewhat different view. As we've mentioned here, we're working with at least 1 other top 5 operator who we believe has pivoted hard to virtual. So by no means do we think Comcast is alone. And in fact, data shared by them as well as other operators, we think, at that event was quite eye-opening for the broader community. So we see a -- another bump in terms of momentum coming out of that show. That's for sure.

Now look, not every operator is ready to go upgrade their plant next year. So I think part of the dialogue that we heard at the cable show was what does the architecture look like 4 years from now, and there's this whole DOCSIS 4.0 discussion that we're right in the middle of. But the silicon for those kind of technologies, those kind of -- that's still several years away. And when those technologies are there, in fact, with a software-based platform, we think we're going to be there before the rest of the market.

But in the meantime, our view is that if an operator is feeling competitive pressure or has any other reason to be upgrading their network, a virtualized solution is increasingly clearly a winning strategy.

Does it mean every customer's going to pivot that way? No. But we think that the momentum is clearly swinging in the direction of virtualization.

And I guess the last thing I would say candidly, Victor, is, as you know, we're no strangers to kind of the naysayers and the positioning on the reasons why this market transition won't happen. And I think if you step back and look at the progress that's been made and the pivot made by the market over the last 6 to 12 months, it's pretty astounding. And our view is we're going to continue to see that kind of a pivot in broader market perception and adoption over the coming 12 months.

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W. Chiu, Raymond James & Associates, Inc., Research Division - Senior Research Associate [20]

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Okay. That's helpful. And just really quickly, some of the discussions we've had raised questions about Cisco's commitment to the cable TV sector. So do you have any opinions or thoughts on that?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [21]

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No. We have a couple of good competitors, and they're doing their thing. We're doing our thing. Our customers continue to tell us they see us as substantially ahead. And our head is down -- and heads are down, and we're doing all we can to bring our solution to market. We take nothing for granted, and we believe that we compete with some good companies that are capable of doing good things if they so choose.

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Operator [22]

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Steven Frankel from Dougherty is on line with a question.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [23]

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Maybe if you could start by giving me some color on what the pipeline looks like in CableOS now that Comcast has made its commitment. You've had a couple of other Tier 1 companies make commitments. What's next? What should it look like? And what's the tenor of those discussions and maybe how they've changed since the Comcast announcement?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [24]

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I think starting with the last piece of the question, how it's changing, that is real-time. We've been talking about the advantages and I think having good resonance with some customers. But the fact that now you've got multiple credible customers themselves talking about real, tangible financial benefits having deployed the solution, this is changing the conversation in the market, and that's kind of real-time. So I think that the dialogue and the credibility and the understanding is changing real-time in the market in a positive way from our perspective.

That being said, we're -- you kind of -- you got to take it operator by operator. We're investing and expanding our go-to-market capability. We're now involved in one way or another with more large and small operators than ever before. That being said, I'd be honest and tell you, we still have work to do to fully cover the market. But domestically as well as internationally, the number of conversations going on is significant. The number of lab and field trials is also significant. So we've kind of got all the full gamut of engagements underway.

And look, our objective in 2020 is to push as much of that over the finish line as we can. And so our discussion, Sanjay earlier alluded to 2020 planning, it's just as much about our go-to-market activity here as it is the financial bottoms-up. We think we've got the industry-leading solution. We think we've got some wind at our back. We just need to get out there and have the conversations, find the customers who are motivated to invest and get on with it. And that's increasingly happening across the cable landscape domestically and internationally.

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Sanjay Kalra, Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer [25]

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And Steve, I would just add that while this question is for pipeline, but I want to remind that we have over $200 million of demand associated with our 3 Tier 1 customers of CableOS, which is not yet included in our reported backlog and deferred revenue number. So that helps see the full picture of growing business expectations we have.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [26]

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Yes, that's really helpful. And on this international DAA customer that you thought maybe you would get a little bit in Q3, it sounds like now it's Q4. Could you maybe give us some insight as to why their timetable has stretched out a bit? Because you got that order a while ago. And what needs to change to get that to revenue?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [27]

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If I roll the clock back, we were kind of there with Comcast 3 or 6 months ago. So from some perspective, at a higher level, I think we're just figuring out, Tier 1s -- big Tier 1s are complicated beasts. And they have processes, organizations, et cetera. There is nothing fundamental standing in the way. So we are extremely confident in the rollout. I think we're becoming a little bit more experienced with the challenges and the on-the-ground realities of just getting it across the finish line.

So taking a little bit longer. We thought no particular singular issue stands out, Steve. It's just the kind of painstaking work with punchless kind of items across complex organizations.

So I think as we think about our business going forward, on one hand, we're more confident than ever. We can land these Tier 1s, we've got the credibility and we're going to win them. The time frame for deployment, it's a little bit challenging.

So the question -- I think we're going to get better and better, execution-wise. I think we're already seeing that in this case, and we're doing our best to accelerate. But particularly this first wave of them, it's going a little bit slower, but nothing fundamental. And we -- that's why I said it before, and I'll say it again, we're confident in what we're seeing, and we're confident in these engagements.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [28]

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Okay. And then just quickly switching gears to the Video business. Do you feel like you have a line of sight on the bottom in that segment with this transition to SaaS and new OTT product and the other things that you'd talked about? Or do you think you're still kind of figure out where this business bottoms and starts to grow again?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [29]

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We think of it as having 2 distinct components. We try to not to hide the fact that we've got a broadcast component that is declining. That being said, we don't think, at least for the foreseeable future, it's declining to 0. Broadcast, particularly internationally, is and will continue to be a very important means of getting live video to large numbers of subscribers. So modest continuing decline there, but perhaps not as acute. Now that kind of the -- a lot of the pain in the U.S. has been kind of worked through.

On the other hand, the streaming thing is going to continue to grow. And again, going back to the recent earnings calls of several prominent video service providers, I think on one hand, they acknowledge their challenges with the existing level. But on the other hand, I think you heard from them a commitment to continuing to invest in video, particularly in streaming, to stay relevant and keep that as a relevant part of their combined offering.

So it's a balancing act for us. It's hard exactly to say when there's a crossover point, but we're gaining momentum on the streaming side. And with -- particularly with some of our new technology developments, we think the addressable market on the streaming side is getting larger. And as we look out over a multiyear period of time, in fact, we see net-net a -- an expanding addressable market, combining the 2. And that's very positive.

And yes, it's challenging to forecast exactly in the short term, but there's no doubt in our mind that this is ultimately a very interesting, strategically important and profitable business for us and for our customers. And so we're continuing to innovate, and we see good growth opportunities that we'll continue to pursue.

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Operator [30]

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Tim Savageaux from Northland Capital Markets is on line with a question.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [31]

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Congrats on the results. A couple of questions here I think I want to know -- I want to know how I want to approach. The first is with regard to gross margin guidance for Q4. And given the magnitude of the rebound that you are forecasting for the Video side and also the increasing mix you've noted around recurring revenues, software, SaaS, is it fair to assume that you would expect Video gross margins to increase in Q4? Or are there maybe some other mix factors involved with big deals there that might change that expectation?

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Sanjay Kalra, Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer [32]

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So Dave, in terms of the gross margins for Q4, we've -- in this year, we've had 57.5% approximately in every quarter. And based on how we are seeing the mix of the software deals as well as our SaaS deals and hardware deals, overall, we are ending up 57.5%. And that's a reasonable margin to presume for Q4. We believe it's going to be very similar. Our guidance entails range of 55% to 57%, and that's what we've seen, and I think that's going to continue.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [33]

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Okay. So in the same ballpark. Well, and even in -- at a flat level, it does imply Cable Access gross margins coming back down to levels you had seen previously. And assuming that the Comcast software contribution goes back out of the run rate that you've described in the past, that, I think, implies a pretty material step-up on the hardware side in Q4.

I guess if you look at the -- just to eliminate the Comcast software revenue recognition from Q3, you've got the overall revenue going from close to $19 million to the low mid-30s, I wonder if you might be able to describe it in any more detail kind of what's going on there from a -- if I'm right to think that's very hardware-centric in Q4, and maybe balance that against your comments about -- and I know you don't want to mention Comcast specifically, Patrick, but you seem to be discussing the hardware element as a potential future opportunity, although it does appear that, that's happening now.

So I guess the overall question is, do you expect material Comcast hardware shipments in Q4? Or do you expect -- assuming that, that hardware uptick is what I'm seeing there? Or do you expect that to be more broad-based?

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Sanjay Kalra, Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer [34]

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So Tim, I'll start. In terms of Q4 Cable segment margins, our expectation is approximately 40%, and that's what we baked in the guidance. And you're absolutely right, the mix in Q4 is more hardware-centric versus software-centric as we saw in Q3.

And the other Tier 1, as we briefly discussed earlier, is going to start contributing revenue from Q4. And as we experienced in the Comcast deal, hardware follows and then later on software follows. So there is more of a hardware mix in Q4, and hence, you see 40% which has dropped from Q3. But that reflects a full year gross margin of 55% to 57% for the entire Cable segment.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [35]

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Okay. A lot of moving parts there, but I'm sure I'll figure it out.

Let me move. There was a competitive question before that I'd like to expand on and not include -- well, actually, to include both of your largest competitors, to the extent that -- I don't know if it's too much to say Cisco's exiting the business, but it may not be, and I think it's fair to assume integration challenges on the part of CommScope and Arris as well.

Can you comment in any more detail on whether you think either or both of those events or situations could result in material share gain opportunities for Harmonic, not tomorrow, maybe, but over time?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [36]

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Tim, I think our biggest opportunity is really just to leverage the technology that we have and the lead that we have. As I mentioned a couple of moments ago, we -- and I personally continue to receive a feedback from a healthy cross-section of customers who are exposed to what's going on in the market that we have a substantial lead. And this isn't just on kind of our product, but the operationalization of the product and really leveraging the cloud-native attributes, et cetera.

So I hear your question, but the way we're thinking about it is, look, is to continue to invest, to continue to innovate and to leverage our leadership position to drive success. And frankly, it would -- what we don't want to do is lean back for a second assuming that our competitors may be taking the foot off the gas. We don't know. We really don't know what's going on in either of those shops. Both shops have a history of executing over time, and we have a lot of respect for them.

But really, we think we're in a position -- we've put ourselves in the driver's seat. You've seen the growth that we think that -- we think that outside analysts think is associated with this new virtualization and Remote PHY opportunity. We think we're well ahead. It's just incumbent on us to take advantage of the opportunity. And whether or not competitor decisions somehow clear the way even more or not, I don't know. But the main thing here is that we've created a lead, and we think it's incumbent on us, and we're determined to take full advantage of it.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [37]

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Got it. And last question for me would be on the bookings for the quarter, and again, assuming that the Comcast software element is a bit of a wash. Actually, it would seem like your book-to-bill outside of that's even a little bit higher. And again, given your guidance for Video bouncing back to that degree, I would assume at first blush, you had -- you saw some strong bookings there. But you also did mention a couple of big deals moving out into October.

So with that in mind, I wonder if you could characterize the strength in bookings in the quarter kind of ex that Comcast software revenue recognition looking at Cable or Video or if it was biased in any particular fashion.

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Sanjay Kalra, Harmonic Inc. - Senior VP, CFO & Principal Accounting Officer [38]

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Yes. I think the bookings for Q3 were strong, $126.5 million. Again, Q4 also, I mean we are expecting strong bookings in Q4. Q4 generally is -- historically has been a very strong quarter seasonally, and hence, our Video expectation has increased for Q4. At the same time, for Cable, we are, in terms of the plan, we originally anticipated. In terms of guidance, you see is the same what we discussed earlier. But Q4 for Video, we have increased.

Our booking expectation is strong, and we believe that our expectation, as we have continued the book-to-bill ratio of 1.1 year-to-date, we expect that to continue exiting this year as well.

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Operator [39]

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And George Notter from Jefferies is online with a question.

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Kyle P. McNealy, Jefferies LLC, Research Division - Equity Analyst [40]

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This is Kyle on for George. Good job on the results. Wondering if there's anything you can add. And this question may have been asked in a different way earlier, but I'll ask it here in a different way. With regard to how many of your initial CableOS customers are deploying significant portions of their footprint as opposed to test markets and smaller areas. I know you have a mix of all, but is there something you can add in terms of how many of your initial customers have big parts of their footprint moving in the direction of being deployed?

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [41]

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Well, look, we reported 935,000, so that's actually a pretty modest number compared to the footprints of some of the customers we're working with. So clearly, what has been deployed to date is a small fraction.

We believe, based on what we're told as well as the success that's being achieved out there, we believe that the solution is not going to be used as a niche solution by any of our customers, but in fact is going to be deployed broadly.

Now all of that, I guess, remains to be seen. But we are working towards broad deployments with all of our key customers. And particularly, as some of the operational and financial advantage data starts to flow in, we think that more than ever, there's compelling reasons to be deploying our technology as broadly as possible.

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Operator [42]

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Thank you, ladies and gentlemen, and that concludes today's conference. Thank you for participating. You may now disconnect.

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Patrick J. Harshman, Harmonic Inc. - President, CEO & Director [43]

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All right. Well, thank you, everybody.

Goodbye, and we look forward to talking with you next time.