Harmonic Inc. (NASDAQ:HLIT)
Q4 2016 Earnings Conference Call
February 28, 2017 05:00 pm ET
Blair King - Director, IR
Patrick Harshman - President, CEO
Hal Covert - SVP, CFO
George Notter - Jefferies
Steven Frankel - Dougherty & Company
Tim Savageaux - Northland Capital
Matthew Galinko - Sidoti
Victor Chu - Raymond James
Welcome to the Q4 and Full Year 2016 Harmonic Earnings Conference Call. My name is Candace and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and please note that this conference is being recorded.
I will now turn the call over to Blair King, Harmonic’s Director of Investor Relations. Blair King, you may begin.
Thank you, Candace. Hello, everyone and thank you for joining us today for Harmonic’s fourth quarter and full year 2016 earnings conference call. Again, my name is Blair King and with me here at our headquarters in San Jose, California are Patrick Harshman, our CEO; and Hal Covert, our CFO.
Before we begin, I’d like to just point out that in addition to the audio portion of this call, we will have provided slides for the webcast, which you can also see by going to the Investor Relations Page on harmonicinc.com and clicking on the link to our preliminary fourth quarter and full year 2016 results.
Now turning to our Slide 2, during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements are only current expectations and actual events or results may differ materially. We refer you to documents that Harmonic files with the SEC, including our most recent 10-Q and 10-K reports and the forward-looking statement section of today’s preliminary results press release. These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.
Please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis. These items, together with corresponding GAAP numbers and a reconciliation to GAAP, are contained in today’s press release, which we have posted on our website and filed with the SEC on Form 8-K. We will also discuss historical, financial and other statistical information regarding our business and operations. Some of this information is included in the press release, and the remainder of the information will be available in a recorded version of this call on our website.
So with that, I’ll now turn the call over to our CEO, Patrick Harshman. Patrick?
Thanks, Blair, and thank you everyone for joining the call today. So let’s turn to our Slide 3. Our fourth quarter revenue was $114 million up 12% sequentially and 31% year-over-year, our strongest revenue quarter in three years. Underlying this top line result is a story of two business segments, different points of transformation. Further along is our video business which delivered revenue growth of 14% from last quarter and 45% year-over-year. Well our still pre-CableOS, Cable Edge performance was expected with revenue down 10% sequentially and 37% from a year ago, and combined bookings were $117 million up 20% from the third quarter and 16% from a year ago, driven principally by our video business.
As a result of greater than one book-to-bill for the fourth out of last five quarters backlog and deferred revenue remains at a near record level of $188 million, up 4% sequentially and nearly 60% from the fourth quarter of 2015 underscoring the continued shift of our video business towards software services and recurring revenue. Gross margin was 56% up over 3.5 percentage point sequentially further highlighting this ongoing software and services transitioned of our video business.
I’m putting it all together EPS was $0.08 highlighting the earnings power of our video business as we approach full integration of Thomson Video Networks, albeit offset by the continuing short-term loss of our Cable Edge segment as we invest heavily on our CableOS launch. So with that summary, let’s take a closer look at our video business and turn to Slide 5.
The first key message here, is we’re driving profitable growth on the video side of the house, delivering sequential top and bottom line improvements in 2016 and finishing in a real high note with record fourth quarter performance. Video segment revenue grew to $105 million, gross margin exceeded 57% and segment operating margin expanded nearly 700 basis points to 13.5%, demonstrating the viability of double-digit operating margin target we’ve established for this business.
The second key message is that our video business transitions to software over the top and cloud continue to gain momentum. And thanks to no small part, to the addition of Thomson Video Networks sales of our software-based video clients has grew over 200% year-over-year and during the quarter eclipsed for the first time sales of legacy hardware based appliances and one of the key drivers of this software plans growth is increasing demand for new higher quality live over the top services. In fact enabled by our innovations over the past year, one [ph] of the top video codex and compression efficiency, over the top license sales were also up over 200% year-over-year as over the top format accounted for over half of the total profiles we delivered to the market in 2016.
And well most of this over the top business was down as traditional perpetual license CapEx. The fourth quarter saw us continue to expand our new cloud based Software as a Service model including signing on an additional tier 1 account. And recall that we announced our first tier 1 cloud customer on our previous conference call. So important context for the video revenue bookings and deferred revenue numbers where reporting is modestly growing recurring revenue stream. And carrying this momentum forward, the third key message is that our video business outlook for 2017 remains positive. While we anticipate and exaggerate sequential first quarter decline due to both the strength of the fourth quarter and the fact that several new first quarter deals will be recurring revenue rather than traditional CapEx.
The fundamentals of our video business are healthy, our innovation and service engines are strong, our full year book-to-bill is record 1.1. our backlog and deferred revenue stands at all-time high, as the business transitions to be more software and service-centric and we’re building new recurring revenue streams, leveraging the industries most advanced cloud based video processing capability, all of which means we’re executing on our long-term strategy to drive sustainable video business earnings growth.
Okay with that, let now turn to our Cable Edge business on Slide 5. Well I’m pleased to share significant fourth quarter progress on our CableOS growth agenda. Our first year, we achieved our first GA product release of CableOS meaning we now have a high performance software based CMTS available for sale in the marketplace. Second, we made our first revenue shipments of this product and saw the product deployed into live commercial environment delivering DOCSIS broadband service to paying European cable subscribers. And third we further expanded our tier 1 customer engagements during the quarter expanding both centralized software and distributed CMTS architectures while deepening our software feature set and operational knowhow. We’re demonstrating strong industry leadership here and our innovations and progress continue to garner serious tier 1 customer engagement.
Now at the same time global demand for Legacy EdgeQAM technology continues to decline and consequently our Cable Edge segment experienced its lowest revenue quarter on record. The flipside of the CableOS coin as our cable customers look ahead to all IP video services. The combination of weak legacy product demand and heavy new product investment will continue to weigh on our combined financial results until CableOS revenue starts to ramp, later this year.
And on this point, I want to assure you that our confidence and the ultimate success of CableOS continues to grow and our corresponding outlook for 2017 and beyond remains unchanged. A multichannel news article published just today citing new market research in which over 60% of cable operators say they’ll be deploying virtualized CCAP and or distributed DOCSIS [ph] architectures by the end of 2018, certainly bolsters our view that conditions are right for us to entering this market.
With that in mind, through the first half of this year we’re focused on successfully executing and scaling our early commercial deployments and driving successful volume field trials of both centralized and distributed virtualized software DOCSIS architectures. With high visibility field activity and credibility expanding over the next several months, our plan is to then begin ramp CableOS design wins and shipments in the back half of the year, setting the stage not only for return to profitability of our Cable Edge segment, but also a leading market position in 2018 and beyond.
So in summary here, we believe we’re uniquely well positioned to be a leading player in the new $2 billion plus CCAP market. We’re executing this plan and remain committed to successfully turning our CableOS innovations into a powerful new growth engine for our business.
And with that Hal, let me turn the call over to you.
Thank you Patrick. We want to thank everyone for joining our call today. During my discussion I’ll cover three topics. First our financial results for Q4, 2016 and the full year of 2016. Next our financial goals for Q1, 2017 and then our financial performance aspirations for 2017. Before discussing our Q4 financial results, we would like to start with some opening comments. For our Q4, 2016 we achieved financial results for both revenue and EPS ahead of our financial guidance, this was primarily due to completing certain video projects that represented approximately $4 million of revenue and $0.03 of associated EPS that we recorded in Q4 that were initially planned for Q1, 2017. This event combined with Q1 typically being our weakest quarter from a seasonality standpoint will be reflected in our financial guidance for Q1, 2017.
Although our financial guidance for Q1 will be below Wall Street expectations, we think that it is reasonable to consider Q4, 2016 actual financial results in conjunction with our Q1, 2017 financial goals. When this approach is taken it provides a more realistic picture while business momentum, with our current momentum we remain committed to our 2017 financial aspirations that we provided during our Q3 earnings conference call in November of 2016.
During Q4, 2016 we essentially completed the integration of TVN. We are now operating with fully integrated functional area such as R&D, sales and G&A just as important our IT systems are integrated with one Harmonic interface for our customers. From a financial standpoint, we exceeded our goal to obtain $20 million of synergies from the Harmonic plus TVN combination on annualized basis starting in 2017 and we’re well positioned for the combination to be accretive from a non-GAAP operating profit standpoint plus interest expense related to our convertible notes within one-year of closing the acquisition.
Now turning to our financial results. Please note that our financial results and guidance discussed during the call based on non-GAAP measurements. The table reconciling GAAP and non-GAAP measurements is included in our earnings call presentation and in our earnings press release issued earlier today. Bookings for Q4, 2016 were $116.9 million compared to $97.3 million in Q3, 2016 and $101 million in Q4, 2015. For 2016, bookings were $441.1 million which consisted of $384.5 million for video and $56.6 million for Cable Edge compared to $372.2 million in 2015 off which video represented $290.8 million and Cable Edge $84.1 million.
The increase in year-over-year video bookings of 33% represented both organic and inorganic growth. The decline in Cable Edge bookings of 31% was accounted for by the drop in bookings for legacy products as we continue the transition to our new CableOS products and services currently underway. Bookings and shipments for these new offerings are planned to ramp in the second half of 2017. Non-GAAP revenue for Q4, 2016 was $113.8 million versus $101.7 million in Q3, 2016 and $86.6 million in Q4, 2015. The sequential increase reflects the continuing improvement in our video business and certain video projects highlighted earlier.
In addition to the sequential improvements, the year-over-year increase includes the benefit of the TVN acquisition that was closed on February 29, 2016. Non-GAAP video segment revenue for Q4, 2016 was $104.8 million versus $91.7 million in Q3, 2016 and $72.4 million in the same quarter last year. Non-GAAP Cable Edge segment revenue for Q4, 2016 was $9 million versus $10 million in Q3, 2016 and $14.2 million in the same quarter last year. In Q4, 2016 we did not have any 10% customers.
For 2016, we recorded non-GAAP revenue of $408.4 million compared to $377 million in 2015. In 2016, non-GAAP video revenue was $353.5 million compared to $291.8 million in 2015 or an increase of $61.7 million or 21%. This increase was mostly accounted for by the TVN acquisition. Non-GAAP Cable Edge revenue for 2016 was $54.9 million compared to $85.2 million in 2015 or decline of $30.3 million or 36%. This decline reflects the decrease in bookings discussed earlier.
Non-GAAP gross margin was $63.8 million for Q4 2016; $53.4 million for Q3 2016 and $47.6 million for Q4 2015. Non-GAAP gross margin as a percent of revenue for Q4, 2016 was 56.1% versus 52.5% in Q3, 2016 and 55% in Q4, 2015. The sequential and year-over-year increase in gross margin was a result of higher percentage of video revenue overall with favorable software content.
In 2016, non-GAAP gross margin was $217.8 million compared to $205.4 million for 2015 or an increase of $12.4 million. This increase consisted of higher video non-GAAP gross margin with a meaningful offset accounted for by Cable Edge. Non-GAAP video gross margin for 2016 was $196.2 million compared to $167.6 million in 2015 or an increase of $28.6 million. This increase was mostly due to the TVN acquisition. Non-GAAP Cable Edge gross margin for 2016 was $21.6 million compared to $37.8 million in 2015 or decline of $16.2 million. This decline was mostly due to the decrease in Cable Edge bookings and subsequently revenue previously discussed.
Non-GAAP operating expenses for Q4, 2016 were $54.2 million compared to $52.9 million in Q3, 2016 and $46.7 million in the same quarter last year. The sequential increase was primarily related to higher commission expense. The year-over-year increase was related to the TVN acquisition. For 2016, our non-GAAP operating expenses were $215.4 million compared to $193.5 million in 2015. The TVN acquisition was a reason for the increase. Our non-GAAP operating profit for Q4, 2016 was $9.6 million compared to $0.4 million in Q3, 2016 and $1 million in Q4, 2015. The sequential and year-over-year increase was primarily related to higher video revenue overall with favorable software mix.
For 2016, our non-GAAP operating profit was $2.4 million compared to a profit of $11.9 million for 2015. This decline was due to lower Cable Edge revenue in gross margin. Non-GAAP EPS for Q4, 2016 was $0.08 versus a loss of $0.01 in Q3, 2016 and $0.01 EPS in Q4, 2015. This improvement was related to our video business. For 2016, our non-GAAP EPS was a loss of $0.04 compared to EPS of $0.10 in 2015. The decrease in EPS was primarily due to the decline in revenue and gross margin for our Cable Edge operating segment which accounted for our non-GAAP EPS loss of approximately $0.13 in 2016. We had 80.1 million shares of non-GAAP common stock outstanding as of the end of Q4, 2016 versus 78.1 million as of the end of Q3, 2016 and 85.6 million as of the end of Q4, 2015.
Now turning to our balance sheet. We ended Q4, 2016 with $62.6 million in cash and short-term investments compared to $52.7 million at the end of Q3, 2016 and $152.8 million as of the end of Q4, 2015. The $152.8 million included net proceeds of approximately $75 million for the issuance of our convertible notes in December, 2015. We issued $128 million of convertible notes and purchased $50 million of our common stock concurrently as well as paying $3 million in related fees.
In 2016, we used approximately $83 million for the acquisition of TVN and incurred approximately $21 million of cash outflow related to TVN restructuring and integration expense. To summarize, we ended 2015 with $153 million in cash and short-term investments. From this amount deductive $83 million that we paid for TVN and $21 million of restructuring and integration expense incurred in 2016. This calculation nets to $49 million of cash. As of December 31, 2016 we had $62.6 million in cash and short-term investments. Therefore, if you subtract $49 million from $62.6 million, we generated approximately $13.6 million non-GAAP cash flow from operations in 2016.
Our day sales outstanding at the end of Q4, 2016 were 70 days versus 89 days at the end of Q3, 2016 and 73 days at the end of Q4, 2015. Our days inventory on hand were 68 days at the end of Q4, 2016 compared to 65 days at the end of Q3, 2016 and 90 at the end of Q4, 2015. At the end of Q4, 2015 we had $188.4 million of backlog in deferred revenue compared to $181.1 million as of the end of Q3, 2016 and $120.1 million as of the end of Q4, 2015. Our backlog and deferred revenue reflects the changing nature of our business as we transition to project oriented software products and services and lower level of booking shipped [ph] business. Approximately 75% of our backlog is projected to be converted to revenue within the rolling one-year period.
Staffing at the end of Q4, 2016 was 1,376 compared to 1,412 at the end of Q3, 2016 and 989 the same time last year. The year-over-year increase was related to the TVN acquisition. We expect staffing to decline as of the end of Q1, 2017.
Now turning to our financial goals for Q1, 2017 as suggested in my opening remarks we think that it is reasonable to consider Q4, 2016 actual financial results in conjunction with our Q1, 2017 financial goals. The following are Q1, 2017 financial goals. Non-GAAP revenue $87 million to $95 million which includes video revenue of $80 million to $86 million and Cable Edge revenue of $7 million to $9 million. Non-GAAP gross margin as a percent of revenue 53% to 54% which includes video gross margin percent of 54% to 55% and Cable Edge gross margin percent of 38% to 40%. Non-GAAP operating expenses $52 million to $53 million.
In addition I would like to highlight two points regarding non-GAAP operating expenses. First our peak non-GAAP quarterly operating expenses in 2016 occurred in Q2, with approximately $58 million of expense. Second, we believe that our operating expenses in 2016 will be relatively flat on a quarter-over-quarter basis if you take the midpoint of our Q1, 2017 non-GAAP operating expense range into consideration. Non-GAAP operating loss of $2 million to $6 million. Non-GAAP EPS loss of $0.04 to $0.08. Non-GAAP common shares of stock outstanding approximately 81 million shares. Cash and short-term investments at quarter end $60 million to $65 million which includes payments of approximately $4 million for TVN integration charges incurred in 2016. Non-GAAP effective tax rate 15%.
Now I would like to highlight our key financial performance aspirations for 2017. These are the same aspirations that we communicated during our Q3, 2016 earnings conference call. First our target is increased non-GAAP video revenue on a year-over-year basis, this statement is based on normalizing our 2016 non-GAAP video revenue. Our non-GAAP video revenue for 2016 would have been approximately $15 million with a full year of TVN non-GAAP revenue. Therefore, our normalized 2016 non-GAAP video revenue was $353 million as reported plus $15 million or $368 million, that is a base in which we plan to grow in 2017 and pursuit double-digit non-GAAP operating profit for our video operating segment.
Next our goal is to achieve an annualized run rate for non-GAAP Cable Edge revenue of approximately $100 million in the second half of 2017 propelled by shipments of our new CableOS products and services. With this revenue run rate, we plan to pursue our goal of achieving double-digit non-GAAP operating profit for our Cable Edge operating segment as we exit 2017.
Based on this goal, we believe that our Cable Edge operating segment will not be a non-GAAP drag on overall EPS in 2017, as it was in 2016. We will report on our progress and related action plans as we pursue our financial aspirations during each of our earnings conference calls in 2017.
I will now turn the call back over to Patrick.
Okay, thanks Hal. Turning to our last slide, Slide 10. We want to close by emphasizing the transformative progress we made in 2016 and how it sets us up well for an exciting and pivotal 2017. Specifically we have one overarching objective and that is to build on the momentum created by our video and CableOS software innovations to significantly improve the long-term profitability and cash flow of the business.
In video, objective number one is to increase value by driving continued revenue growth in margin expansion catalyzed by the ongoing conversion of the market to software based over the top platforms. And objective number two, will grow market share and strengthen our financial model by further advancing our leadership position in cloud, Software as a Service offerings and 4K.
With the successful integration of Thomson Video Networks largely behind us, we’re creating improved operating leverage in the business is evidenced by our fourth quarter segment results. We’re now focused on bringing it all together over the course of this year to deliver objective number three double-digit operating margin in the business. On a standalone basis, our video segment is strategic market leading and profitable business with compelling upside.
And on the Cable Edge side of the house, we entered the year with the industry’s first fully software-based CMTS on the launch pad. With much product development, heavy lifting behind us objective number one is successfully scaling early commercial deployments and several advanced high volume field trials and here I can tell you, the year is off to a good start.
At the same time, there is growing industry buzz around what we’re doing and objective number two, we have the pedal to the metal to ensure new design wins with additional tier 1 operators. And Hal just outlined objective number three continues to be to exit the year with both $100 million annualized run rate and a competitive market position that will enable a compelling growth business well into the future.
While the first quarter is looking a little softer, following a strong fourth quarter. We want to emphasize that our broader targets for 2017 remain unchanged. We’re moving full speed ahead, leading the charge and software-based video processing and cable broadband delivery. And we continue to see tangible new momentum in results as we share with you here today.
Our entire organization is excited, confident and we’re laser focused on the continued execution of our strategic video and Cable Edge growth initiatives and on driving a sustainable new phase of profitable growth and shareholder value creation.
So with that, let’s now open up the call to your questions.
[Operator Instructions] and our first question comes from George Notter of Jefferies. Your line is now open.
I guess I wanted to start up by asking some questions on the CableOS side. I know from prior conversations with you guys that either a still lot future developments that was going on in the CableOS platform and you had a minimally viable product I think was the term that you used and you were going to continue to kind of build out the future, I guess I was curious where exactly are you in that development and when do you get to threshold where you feel like it’s more broadly available and applicable to your customer set. Thanks.
So George, thanks for the question. We feel that we’ve passed that threshold. You’re current in remembering that whatever it was three or four months ago, we were closer to I would call the minimal arrival product phase, we made tremendous progress over that time and that what has enabled us to have our first GA launch of the product and in fact, being production with a major cable operator in Europe today. So I would call ourselves future complete with just the hesitation [indiscernible] that particularly in the world of virtualized CMTS and software and somewhat new and there is a lot of evolving ideas about the broader ecosystem. So we have a product that works well and we think delivers on the features you would expect and off the shelf CMTS today, that being said there is some additional feature development ongoing that’s really almost towards 2.0 functionality in the context of a virtualized system.
So really what we have over the next four months between now and mid-year George it’s less about feature development and it really is more about sure that we’re operationalized [ph], that we’re ruggedized, that we demonstrated the solution really at significant scale and volume and that’s the work that we’re embarked on now.
Got it, okay and then if I heard you correctly, you were talking about the Cable Edge segment is exiting this year at $100 million revenue run rate, if I remember correctly from last quarter that was also the same commentary and so is that correct and then also the legacy platforms here are rolling off, I guess that puts more weight on your CableOS platform in terms of how you think about the revenue contribution and I guess I’m wondering, what’s changed that makes you more positive on the CableOS revenue contribution, if the math is right here. Thanks.
Yes, to your first point George I think, you’re correct on saying that this is same picture that we had during our last earnings call. We think we can exit this year 2017 again on the back half of the year with $25 million annualized run rate, based on the information that Patrick provided about the progress and the rollout that we’re pursuing right now, we think that’s a pretty solid number. Your second point about the legacy product drop off in Q4 again there was $9 million and we think in Q1 we’re going to be roughly in the same range about $9 million, although the mix of that’s going to start changing CableOS starting to pick up. Again with the first shipments in Q4, we think we’re building on that the real momentum will start into Q2 and beyond.
So we think, we’re in a good shape from a revenue standpoint and as we indicated in our last earnings call. we believe that the CableOS parts are going to have a higher software content, so we feel good about the margins again the real impact being in the second half of the year, but that positions us then to exit the year with the double-digit operating profit for our Cable Edge business as we roll into 2018.
Got it, okay. That’s helpful and then on the $25 million quarterly run rate, is that. Do you think you can achieve that run rate just with the customer that you’re shipping at or shipping to commercially right now obviously in addition to the legacy products? Or does that require turning on additional cable operators for GA and for revenue prior to yearend?
It’s not a high number of customers but it is more than one customer and we’re currently shipping to more than one customer and we expect that will continue. Again we’re not looking for dramatic uptick, we’re looking for few solid tier 1 deals to happen for us in the back half of the year and then we think, we have the opportunity to build on that and getting more tier 1 customers as well as the fast followers that we think will happen once the tier 1 guys really start pursuing with the new products.
Got it. Okay fair enough. Thank you very much.
Thank you. And our next question comes from Steven Frankel, Dougherty. Your line is now open.
Maybe we could start with, just how many CableOS trials are going on today and what is the pipeline look like for other companies and may trial over the next couple of quarters?
It’s not an exact number that we want to disclose but let’s call it several and there’s multiple like here in the Americas and there is multiple in Europe right now. As Hal just highlighted our focus is on quality, I would say over quantity. We think that there are certain large influencers in the marketplace and our strategy is really around doing a great job and proving our metal with the influencers and then capitalizing on that with, what you might call. I think what Hal just referred to as fast followers in the market.
Okay and switching gears a little bit. What was the organic growth in the video business in quarter in a year?
Again, we’ve seen as Patrick highlighted a continuing strength in our business and if you take our core video business the organic piece of it, we actually had year-over-year growth and it’s a pickup in over the top activity as well as just our continuing shift from the hardware orientation, the ACIS based approach that we have before to software and off to shelf hardware, so just general health across all of our geographies.
Okay and when do you think 4K becomes meaningful driver to this business?
It sounds like the internal question. It’s certainly creeping in and becoming more and more present. Our server platforms we’re supporting 4K and we’re seeing growing demand for that and indeed there is growing activity around the 4K delivery. In fact, there was a news item just today about a 4K system being delivered by SCS. I think Frontier is the latest customer they’ve signed up and as you know from previous press releases, we’re part of that ecosystem.
So we don’t expect it to be a huge hockey stick driver, at least our guidance doesn’t contemplate that in the video business. But we think it’s starting to pick up and it’s certainly something we got our eye on in terms of upside. From a volume perspective, we wouldn’t expect to see that before the second half.
And video margins obviously step down in Q1 because of the revenue that got pushed. Is there anything other volume you need to get that business to double-digit operating margins and keep it there.
I think in Q1 as I mentioned, we have those projects that we actually closed in Q4, that we initially planned for Q1, also had a pretty good software content to them and that resulted in the step down for Q1, but if you look over the balance of the year, we believe that our software aspect of the whole mix will continue to be strong, so we think we’re at a run rate now to generate a double-digit operating profit and we just need to concentrate on the top line, we have a good control over the product mix and good control over the OpEx related to our video business, so it’s really its ramping the top line, in line with our financial aspirations for 2017.
And then one last one, maybe just a brief update on where you think you’re competitively in CCAP with - I saw the same article you referenced that everybody is interested in virtual CCAP, who else is positioned to deliver that technology today and where do you think, you fit in competitive stack today?
We’ve got couple very good companies through the established players and I think that they’ve, as I’ve read it in the public press that they’re acknowledging that, that the market is going to pivot that way, they’re talking about a transition over several years and leveraging their existing platforms to facilitate transition. So just as you would expect in incumbent to say, so I think relative to that we’re the - a little bit the upstart, we’re not evolving from anything, we’re out in the market with a completely software based, more than that, a completely virtualized CMTS stat [ph].
We think we’re pretty far ahead technologically and we’re starting to prove that out, as I said earlier in volume in the field. So it will be interesting, I think to some extent it’s not that different in the virtualization trends you’ve seen parts of the telecom market from that broader perspective to some regarded little surprising it comes related to cable, but we are here now and I’d say in sharp contrast to when we’ve announced this product back in October. I think now the rest of the industry is acknowledging, it’s not a question of if, but when which is good news from our perspective and we’re running hard as the insurgents with the, what we think is real leapfrog position, but time will tell and we think it won’t be that much time. We’re very focused as I said on proving this out, greater scale over the next several months.
Great, thank you.
Thank you. And your next question comes from the Tim Savageaux of Northland. Your line is now open.
Couple of questions and congrats on the strong Q4. Given that you’ve kind of reiterated the pro forma growth target for video, in 2017 I was interested by some of anecdotal commentary around strength in the cloud business licenses for over the top and I wonder if you can comment on the dynamics that we might expect in terms of revenue growth and gross margin as we look at video for 2017 and I guess, more specifically is it reasonable to expect maybe I guess revenue growth from the lower end and margin growth on the higher end, I guess given some of these dynamics around cloud and more software based sales and maybe along those lines you can characterize kind of the size of that software business if you will or cloud business or whatever metric that might be appropriate to maybe give us the sense of those dynamics.
Yes, so let me start then Patrick can chime in after that, we’ve been going through two transitions in our video business. The first one is going from the ASIC base to hardware environment that we were in the past to software and off-the-shelf servers, we think as Patrick indicated early on, we’re well into it and we absorb the impact of that and that’s embedded in our numbers now. The other transition which we, is just starting now and it’s going to take I think longer than the hardware transition is cloud based approach.
Our business is picking up there, as that becomes a more important part of our business just from a number standpoint, we’re going to give you metrics to start measuring that. We think the combination of those two will help us basically grow the top line in 2017 as well as get our gross margin overall back in the 57% range that we had prior to 2016, when we absorbed TVN so, we’re making good progress there, Patrick talked about the initial deals that we’ve had, it’s not a big number relative to our overall number but it’s going to be an important part of our numbers and it’s got the recurring revenue aspect to it, so some real important characteristics and again we’ll put out more metrics as we close more deals along that track. So Patrick I don’t know if you want to add, anything additional on that.
No, I think that’s right. Maybe I just remind also in the earlier comments to reiterate. In fact we see a modest effect even in the first quarter. Well the software thing is outlook on the first quarter is primarily as you outlined Hal associated with traditional seasonality as well as order timing in the first quarter, a third effect is the fact that we do expect to see several million dollars of cloud business close this quarter, but other would have been CapEx that we would have recognized this quarter and instead this will be revenue that will recognize rateably over time. So as Hal said, the good news is it’s not the whole business flipping 50% or greater percent, so it’s not a body blow or dramatic transition, but it is something that we think it’s going to build overtime and of course as that layers in quarter-over-quarter, we think we’ll start to see some positive benefit from the deferred revenue flowing through, by the time we get to the end of the year and that’s certainly one of the reasons why we remain confident in the, our full year outlook for the video business, despite what maybe optically it looks like a somewhat softer first quarter.
And again just add kind of a final point on that, I think as we indicated certainly if we run through our numbers for 2017, we’re going to have top line growth based on our plan and again we believe that we can get our gross margin back in line, so that says these two transitions that are underway are really helping us both from the top line and a gross margin standpoint.
Understood and thanks. If I could follow-up with one more question. And it’s I think interesting and impressive actually that you found [ph] 10% customers in the quarter, but I would like to get some color on maybe where you saw some of the strength from a bookings perspective. It looks like at least service provider revenues were up pretty strong, although you did have some positive comments with regard to streaming and over the top as well. So I wonder if we can infer that’s your more traditional linear Pay TV continuing to move into streaming type applications or perhaps if you could provide any additional color across the various categories, cable, satellite, telco if you well or geographies from a customer perspective.
Well frankly the strength in the video business was pretty broad based and that is both geographically, we had a good America’s quarter, but we also had a particularly good Europe, Middle East and Africa this past quarter, but it was also up pretty broad based from a customer type perspective as you’ve just hypothesised indeed we had a good quarter with our service provider customers and that is telco, cable as well as satellite and particular with the terrestrial guys, a good amount of that was associated with new streaming platforms, which is exciting for us to see.
That being said, particularly in the US we had a good quarter also with the broadcast and media crowd, but there again we see kind of convergence of technology, a fair amount of that business was also streaming over the top related. So fairly broad based and really that’s been part of theory of what we’ve been striving for with the video business.
Okay, thank you.
Thank you. And our next question comes from Matthew Galinko of Sidoti. Your line is now open.
Congrats on the strong exit 2016, I was hoping you could provide maybe a little bit more color on the structure of those recurring deals that you talked about 2016, are they multi-year commitments, are they single year, are there minimum contract values, how should we think about how those deals are being put together and are they representative of how you’re intending to go forward with more of those sorts of deals?
Yes let me start and then again Patrick can chime in. the deals have different flavors, in general they’re multi-year deals but for the most part they’re usage based. So the amount of revenue could vary again depending on the usage on quarter-over-quarter basis and I think the general structure that we’re going to have going forward is try to lock in, minimum periods for the deal from a timing standpoint as well as minimum commitments, but again fundamentally they’re multi-year usage based deals.
Yes, that’s it.
Great and I think you touched on this but if maybe could you just, maybe just go back over your comments on more of your video sort of the profiles your video revenue this quarter relating to off top formats as oppose to traditional linear sort of expect, a similar mix in 2017 and going forward or just how you think about that?
Yes so the comment was, is that we saw strong growth 200% year-over-year in terms of the number over the top related licenses that we sold into the market and indeed, I also commented that the over the top formats or profiles actually for the first time exceeded those of the let’s say the traditional broadcast type. The world is moving towards over the top and that’s both the new players as well as the traditional providers. I think that’s all pretty clear, so we think that this trend will continue.
What’s exciting from our perspective is that, in many ways the over the top services are joining the big leagues. I mean you may have noticed also I think published earlier today. Reed Hastings comments from Mobile World Congress talking about the importance of video quality and regardless of the size of the screen that the over the top content is being viewed on, in the way we look at it, these over the top services are going to still serve everything from ultra high definition television set to a tablet, to a smaller mobile screen.
Regardless the consumer expectation is going to be of excellent video quality and it’s going to put tremendous pressure on the network bandwidth and so we think our leading codec technology puts us in a great position for this that convergence of particularly live TV delivery over these over the top networks.
Great and maybe just one final question and relating to those, which could deal are you finding them fairly competitive to get to percentage line, from start to finish if you give us some idea of how long it’s taking to go?
I think it’s a question would be better served answer for your six months or now, just when we got greater statistics. A little bit like CableOS, we’re not going after every account, we can’t hear. We’re really targeting influential players, where we see the right business model to flip from CapEx to cloud and so therefore and frankly, as Hal alluded to just a moment ago. Each of the situations we’ve been successful and so far had a little bit of a different flavour. That being said, I think that the convergence of our let’s say excellent traditional video technology now packaged up in a cloud ready format, it’s unique in the market place and we’re definitely finding competitive differentiation through this combination.
Great. Thank you.
Thank you. And our next question comes from Victor Chu of Raymond James. Your line is now open.
I just wanted to delve a little into your [indiscernible] business I think you guys touched on it earlier a little bit, but are there specific factors there driving your visibility and optimism towards the $100 million annual run rate for the second half of the year because I guess the guidance seems to imply some pretty extra ordinary sequential growth I guess in the latter half of the year. So I guess what things are driving you to be confident in keeping that guidance.
Let me start and I’ll pass it to Patrick. We went through a fairly extensive planning process for 2017 and based on that planning process which is heavily integrated to interaction with our customers, we believe that based on trials that are going on right now and feedback that we’re getting from them and they’re anxious to move forward because this saves them lot of money and enhances their position with tier customers that the ramp that we talked about will occur in the back half of 2017 again primarily based on our R&D progress as well as customer feedback. Patrick, I don’t know if you want to.
No, I think that’s exactly it. We’re certainly not making any projections in a vacuum [ph]. We’re closely engaged with several customers as I said actually spanning both the Americas and Europe and based on the progress we’re making, the feedback we’re getting, we built the business plan that we have a high amount of confidence in.
Okay and I guess I wanted to ask quick about the pull-ins was the pull-ins revenue in the fourth quarter related by any chance related to the warrant agreements that you entered into with some of your customers. I guess, okay I’m sorry.
I’m sorry, I didn’t want to cut you off Victor, go ahead and finish you.
Well and if it is, is it possible that you could see a recurring pattern towards the end of the year again, if this is a pattern that we should kind of expect to be seasonal perhaps going forward.
First of all I wouldn’t characterize them as pull-ins we didn’t intentionally pulled them in we completed a project and based on completing that project, that put us in a position where we fundamentally had to recognize revenue and record it. And we’re likely to have that situation continue on a quarter-over-quarter basis because again as we’ve indicated our business is going more to project going more to project oriented activities and it’s hard to tie down the exact date that a project closes on. So if it flips from one [indiscernible] to another, may end up in another quarter and these projects had nothing to do with our CableOS activity, in fact they were in our video segment not in our Cable Edge segment.
And so therefore there was no connection to the warrant agreement that you.
Yes, no connection at all.
Okay, so it wasn’t really. Okay great. Thank you.
Thank you. And I’m showing no further questions at this time. I’d like to turn the conference back over to Mr. Harshman for closing remarks.
Okay, we’re good. We’ll just wrap up by reiterating that we’re pleased by the growth and profitability in our video business and the underlying competitive momentum that we’re generating there, particularly around our software based initiatives and for us as you’ve heard this afternoon 2017 is all about continuing to drive this forward. So in the other hand in the Cable Edge side of things while the short-term financial outlook remains challenging, the real story here is all about executing this CableOS volume, field trials and early commercial deployments to the first half of the year and of course then we’re really looking forward to the back half of the year and to start the meaningful multi-year volume ramp of this new business.
We appreciate very much your support, your feedback and we look forward to keeping you all updated and speaking with you again soon. Thanks very much everyone.
Thank you ladies and gentlemen.
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