Harmonic Inc. Q3 FY2022 Earnings Call

Welcome to the Q3 2022 Harmonic Earnings Conference Call. My name is Jonathan, and I will be your operator for today's call. Please note that this conference is being recorded. And now I'd like to turn the call over to David Hanover, Investor Relations. David, you may begin.

Thank you, operator. Hello, everyone, and thank you for joining us today for Harmonic's third quarter 2022 financial results conference call. With me today are Patrick Harshman, President and Chief Executive Officer; and Sanjay Kalra, Chief Financial Officer. Before we begin, I'd like to point out that in addition to the audio portion of the webcast, we've also provided slides for this webcast, which you may view by going to our webcast on our Investor Relations website. Now turning to Slide 2. During this call, we will provide projections and other forward-looking statements regarding future events or future financial performance of the company. Such statements are only current expectations and actual events or results may differ materially. We refer you to documents Harmonic filed 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 metrics, together with corresponding GAAP numbers and a reconciliation of 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 operation, and some of this information is included in the press release. The remainder of the information will be available on a recorded version of this call or on our website. And now I'll turn the call over to our CEO, Patrick Harshman. Patrick?

Well, thanks, David, and welcome, everyone, to our third quarter call. In the third quarter of 2022, Harmonic again delivered excellent business results. Revenue was up 23% year-over-year. New bookings were up 50%. EPS was $0.13 and adjusted EBITDA margin was 13.5%. Both business segments were again solidly profitable and had book-to-bill greater than one. The cable access segment, which we have recently renamed broadband, continues to deliver strong top-line growth with revenue up 60% year-over-year. Video segment revenue transformation continues with SaaS revenue up 64% year-over-year. In mid-September, we updated you on key market trends, our strategy, and our enhanced three-year financial model. Our third quarter results released today further highlight the key points in that presentation and support our confidence in our growth plan. We see robust demand for multi-gigabit broadband and live streaming video. Our associated products and services are winning in the marketplace, and our focused business execution remains resilient despite macroeconomic headwinds. Taking a closer look now at our broadband segment. We delivered strong financial results and further solidified our technology leadership and growth opportunity outlook. Segment revenue was $91.9 million, up 13% sequentially and 60% year-over-year. Segment gross margin rebounded to 45% and adjusted segment EBITDA margin was 18.4%, demonstrating consistently improving leverage as the business scales. New orders were also strong, contributing to near record backlog and deferred revenue. This sustained growth reflects both a robust broadband market and our strong execution. At quarter end, consumer modems served grew to $10.9 million, up 179% year-over-year, still less than 20% of our existing customers' DOCSIS footprint. We added several new customers during the quarter, bringing the number of customers actively deploying our solution to 85, up 25% year-over-year, and we secured an important new DOCSIS DAA win with an international Tier 1. We're also making excellent progress with several Tier 1s who have not yet selected us. Aiding us in winning over these new accounts are two increasingly compelling technology advantages. First, there's a growing industry consensus that the particular variant of DAA we pioneered with Comcast and other early customers that is virtualized CMTS paired with remote PHY nodes is the most architecturally advantageous and market-proven solution and consequently, the best way to go. Obviously, this growing consensus is good news for us, considering the huge technology and deployment expertise lead we have in virtualized CMTS or remote PHY. Our second unique advantage, which is increasingly resonating with prospective customers, is the way our fiber-to-the-home PON solution is seamlessly converged and integrated in both software and hardware with our DAA DOCSIS solution. This competition from fiber-based service providers continues to intensify a multipronged solution that incorporates fiber on-demand capability is becoming a must-have for our customers. Emphasizing this point, another highlight of the quarter was a significant new fiber win with an existing Tier 1 international cable customer, punctuated by an initial multimillion dollar purchase order. Complementing our fiber solution, we've also been investing heavily in new DOCSIS 4.0 capability and believe that here again, we are the industry technology leader, which puts us in an excellent position to benefit as the demand for DOCSIS 4.0 commences in late 2023 and 2024. Putting it all together, our unique combination of DOCSIS 3.1 DAA, DOCSIS 4.0 DAA, and 10G fiber, all managed through common cloud-native core software and analytics is simply the right solution at the right time, provided only by our company. Those of you who had the opportunity to visit the cable industry's premier technology conference in September in Philadelphia saw all of this on display and the tremendous feedback we received from both existing and prospective customers. We left the event feeling even more upbeat about the outlook for our business over the next several years. Referring back to our mid-September Analyst Day, we laid out an aggressive three-year growth plan that calls for over $800 million of revenue and 28% EBITDA margin in 2025. As we head into the final quarter of 2022 and begin looking ahead to 2023, we remain confident in our ability to deliver on this target and excited about the impact we're having on the global broadband market. Turning now to our video segment. Here also, we delivered another quarter of solid financial and strategic execution. Third quarter segment revenue was $63.8 million, down 7.1% year-over-year as expected due to the previously discussed movement of a few larger plant orders into the first half of the year and the corresponding Q2 upside. SaaS revenue growth continues to be outstanding, up 64% year-over-year. As Sanjay will discuss momentarily, segment gross margins were again strong. Segment EBITDA was 6.8%, and we're raising our full-year segment EBITDA guidance, highlighting our continued focus on profitability as we scale our SaaS business. As you will recall from our September Analyst Day, our video business strategy has two key elements: taking a leading position in the growing streaming sales market, particularly for live sports, and maximizing profit from a slowly declining traditional video appliance market. The year-to-date results demonstrate our continued execution of this plan. Specifically, the highlight of the quarter was again streaming SaaS growth, driven principally by larger media accounts expanding their consumer footprints, live sports content rights, and the usage of our service. We secured several important new SaaS customer wins during the quarter, spanning North America, Latin America, and EMEA, expanding our foundation for sustained SaaS growth. As evidenced by recent demand associated with the upcoming Soccer World Cup, we continue to see live sports streaming and the movement of legacy broadcast workflows to the cloud as attractive and growing opportunities and our associated brand and technology leadership strengthen. While SaaS was the highlight, overall demand, including for video appliances, was strong during the quarter with book-to-bill greater than one and a solid sales pipeline extending into 2023. The market seems particularly robust in North and South America, offsetting what we currently see as some possibility of macroeconomic headwind for video in Europe in the coming months, and of course, the loss of our business in Russia. Looking further ahead, we remain confident that our transformation in video to consumption-driven streaming SaaS is working and that we're on track to achieve the targets we laid out for you at our mid-September Analyst Day. As a reminder, this plan calls for greater than 45% compounded annual SaaS growth through 2025, consistent profitability, and a return to mid-teens EBITDA segment margin. The new wins we've recently secured, the high-profile streaming services we're now powering, and our expanding segment gross margins and steady segment profitability demonstrate that we remain on track to achieve these objectives. And with that, let me now turn it over to you, Sanjay, for further discussion of our financial results and our outlook.

Thanks, Patrick, and thank you all for joining us today. Before I discuss our quarterly results and outlook, I'd like to remind everyone that the financial results I'll be referring to are provided on a non-GAAP basis. As David mentioned earlier, our Q3 press release and earnings presentation includes reconciliations of the non-GAAP financial measures to GAAP that are discussed on this call. Both of these are available on our website. For the third quarter of 2022, we delivered another period of strong financial results. Before reviewing our quarterly financials in detail, I'll briefly review the key highlights here on Slide 7. We reported September quarter record revenue of $155.7 million, up 23.3% year-over-year, along with strong gross margins of 50.9%. We also generated adjusted EBITDA of 13.6%, up 187 basis points from the prior year, and EPS of $0.13. Our balance sheet remains sturdy with a cash balance of $105.3 million at September 30. We also reported September quarter record bookings of $171.1 million and continue to maintain near-record backlog and deferred revenue of $490.1 million at the quarter end, positioning us well for the remainder of 2022 and into 2023. Now let's review our third quarter financials in more detail. Turning to Slide 8. As I just mentioned, total company Q3 revenue was $155.7 million, slightly down on a sequential basis and up 23.3% year-over-year. Looking first at our broadband business segment. Revenue for the quarter was $91.9 million, up 13.2% on a sequential basis from Q2 and up 59.6% year-over-year, reflecting both the continued ramp of existing customers and newer customer launches, including modest fiber revenue. In our video segment, we reported Q3 revenue of $63.8 million, down 16.3% sequentially and 7.1% year-over-year. This decline was attributable to a reduction in our appliance business, including a modest impact from unfavorable foreign exchange rates and $3 million of shipments that were moved up earlier into Q2 as we discussed in our last earnings call, offset partially by strong SaaS consumption. Our video revenue included SaaS revenue of $8.9 million, up 63.9% from the prior year, ahead of our expectations. We had two customers representing greater than 10% of total revenue during the quarter. Comcast contributed 38% and Vodafone contributed 11% of total revenue. Total company gross margin for Q3 '22 declined 190 basis points to 50.9% compared to 52.8% in both Q2 '22 and Q3 '21. The year-over-year decline was due to an increased mix of broadband segment revenue as a portion of total company revenue. We achieved broadband gross margin of 45% for Q3 '22 compared to 43% in Q2 '22 and 42% in Q3 '21. Broadband gross margin improved both sequentially and year-over-year due to several factors, including our strategic decision to invest in increasing our inventories, enabling us to use more ocean freight rather than airfreight, which is most cost effective. We also saw modest contributions in margins from improvements in freight rates, improved customer pricing, and favorable products and services mix. Video segment gross margin was 59.3% in Q3 '22, down 390 basis points sequentially and 260 basis points year-over-year. Q3 '22 was modestly impacted by unfavorable foreign exchange rates. Please note that the period I'm referring to were record video gross margin quarters. We've continued to see a strong overall gross margin improvement trend over the past two years as our video gross margins have risen from 54.5% and 58.7% in 2020 and 2021, respectively. Moving down to the income statement on Slide 9. Q3 '22 operating expenses were $61 million, net of modest foreign exchange benefit, as a result of the strong U.S. dollar during the third quarter compared to $61.7 million in Q2 '22 and $54.9 million in Q3 '21. The year-over-year increase was primarily due to increased research and development to support the growth of our broadband business and the ongoing strategic transition of the video segment to SaaS. Adjusted EBITDA for Q3 '22 was 13.6% of revenue at $21.2 million, comprised of $16.9 million from broadband and $4.3 million from video. This compares to an adjusted EBITDA of $24.3 million or 15.4% of revenue in Q2 '22 and demonstrates year-over-year improvement compared to $14.8 million or 11.7% of revenue in Q3 '21. This all translated into Q3 EPS of $0.13 per share compared to $0.16 per share in Q2 '22 and $0.09 per share for Q3 '21. We ended the quarter with a diluted weighted average share count of 113.2 million compared to 109 million in Q2 '22 and 106.4 million in Q2 '21. The sequential increase is primarily due to the increase in convertible debt dilution of 2.9 million shares and the dilutive effect of outstanding RSUs and options by 0.7 million shares, both resulting from an increase in our average stock price during the quarter, increased by the issuance of 0.6 million shares to employees for vested RSUs. The year-over-year increase reflects the dilution of our convertible debt by 2.9 million shares and the dilutive effect of outstanding RSUs and options by 0.7 million shares, both resulting from an increase in our average stock price during the year and 3.7 million shares due to the weighted effect of stock issued to employees and ESCP shares, offset by the impact of the repurchase of approximately 0.6 million shares. Turning now to the order book. We reported new September quarter record bookings of $171.1 million compared to $140.9 million in Q2 '22 and $114.3 million for Q3 '21. The book-to-bill ratio was 1.1 in the quarter compared to 0.9% in both Q2 '22 and Q3 '21. Book-to-bill was more than one for both segments. Turning to Slide 10, we'll now discuss our liquidity position and balance sheet. We ended Q3 with cash of $105.3 million compared to $121.8 million at the end of Q2 '22 and $128.4 million in Q3 last year. The $16.5 million sequential cash decrease is primarily comprised of $8.2 million cash used in operations, primarily in inventories of $16.4 million and prepaid deposits for suppliers of inventories of $7.4 million. These working capital investments for inventories and related deposits are part of our larger strategy to proactively manage the supply chain landscape, enhancing product availability and providing us flexibility to use a higher mix of ocean freight rather than airfreight, resulting in increased gross margin. We also used $1.9 million of cash and purchase of fixed assets, $1.9 million of cash towards taxes for employees withholding on RSUs vesting, and an unfavorable foreign exchange rate impact of $4.3 million. Turning to days sales outstanding at the end of Q3. DSO was 61 days, same as Q2 '22 and comparable to 54 days in Q3 '21. Our days inventory on hand was 116 days at the end of Q3 compared to 100 days at the end of Q2 '22 and 78 days at the end of Q3 '21. The increase reflects continued investment in inventory as we prepare for heavy shipments during the remainder of this year and into next year. Regarding capital allocation, our priorities remain unchanged. Harmonic is committed to strategically deploying capital where we believe it can generate value for our shareholders. Our top priority is to drive future growth. As such, we continue to invest in building inventory, which enables us to better manage the supply chain, fulfilling incoming orders on a timely basis and controlling inventory transportation costs. At the same time, our capital allocation strategy also considers returning capital to shareholders through share repurchases. The timing and amount of any repurchases will depend on a variety of factors, including the price of Harmonic's common stock, market conditions, corporate needs, and regulatory requirements. This balanced capital allocation strategy also takes into consideration anticipated future debt obligations, including our upcoming debt repayment of $37.7 million in December 2022. At the end of Q3, total backlog and deferred revenue was $490.1 million, up approximately 3% sequentially from $477.8 million in Q2 and up 47% year-over-year from $333.3 million at Q3 '21. This large backlog and deferred revenue reflects strong demand from our large broadband customers and growing video SaaS commitments. Note that approximately 80% of our backlog and deferred revenue have customer request dates for shipments of products and providing services within the next 12 months. As mentioned on previous calls, not included in our backlog is additional contractually agreed CableOS business with two of our initial Tier 1 broadband customers. At the end of Q3, this incremental amount was approximately $60 million, down from $96 million last quarter as approximately $36 million went through the purchase or losses and therefore moved into bookings. Free cash flow was negative in Q3 '22, primarily due to the investments in working capital for inventories and related deposits, as I mentioned earlier. Now I'll turn to our revised non-GAAP guidance for 2022, beginning on Slide 11. I will also give brief commentary on key changes from our prior annual guidance we gave in August. For the total company for the full year 2022, we now expect revenue in the range of $612 million to $626 million. The midpoint is a slight increase on our prior guidance. Gross margin is in the range of 50.6% to 51%, up 75 basis points at the midpoint versus prior guidance due to improved gross margins in both segments. Gross profit is to range from $310 million to $319 million, up 2% at the midpoint versus prior guidance. Operating expenses are to range from $242 million to $244 million, down slightly versus our prior guidance at the midpoint, primarily due to favorable foreign exchange rates. Adjusted EBITDA to range from $79 million to $87 million. This represents an 8% increase at the midpoint versus prior guidance. An effective tax rate of 13%, a weighted average diluted share count of approximately 111.2 million, an increase of 1.6 million shares from prior guidance. This is primarily due to increased debt-related dilution given the higher average stock trading price. EPS to range from $0.49 to $0.55 per share. At the midpoint, this is an 8% increase versus prior guidance. Finally, cash at the end of 2022 is expected to come in between $80 million to $90 million. The lower cash balance is primarily reflective of $37.7 million debt repayment maturing in December and additional strategic working capital investments, mainly inventory to support our 2023 revenue growth. Turning to Slide 12. I will review our total company outlook for the fourth quarter of '22. We expect revenue in the range of $151 million to $165 million, down 1% from the midpoint of previous guidance. This guidance reflects a stronger Q3 result. Gross margin in the range of 51.3% to 52.6% at the midpoint, an increase of 180 basis points versus prior guidance. This reflects higher expected broadband and video gross margins. Gross profit in the range of $78 million to $87 million, reflecting an increase of 3% from prior guidance at the midpoint. Operating expenses are to range from $61 million to $66 million, nearly flat at the midpoint of prior guidance. Adjusted EBITDA is to range from $19 million to $27 million, up 7% at the midpoint. A weighted average diluted share count of approximately 113.5 million and EPS to range from $0.12 to $0.18, up 7% at the midpoint of prior guidance. On Slide 13, I will first review guidance for both the full year and fourth quarter of 2022 for our broadband segment. For the full year 2022, based on our progress to date, we expect broadband to achieve revenue between $345 million to $350 million, a 2% increase from the midpoint of prior guidance, implying a full-year revenue growth of 59% at the midpoint. Given our success navigating capacity constraints through the first 10 months of the year, we are modestly expanding the high end of our outlook. Gross margins between 43.2% to 43.6%. This is a 60 basis point improvement from prior guidance due to the reasons mentioned previously, specifically our strategic investments in inventory to reduce freight costs, even as component costs remain high. Gross profit between $149 million to $152 million, up 3% from prior guidance at the midpoint, reflecting both higher expected revenues and margins. Operating expenses between $100 million to $101 million, up 4% versus prior guidance at the midpoint, adjusted EBITDA between $55 million to $58 million, up 4% from the prior guidance at the midpoint, also reflecting higher expected revenue and margins. For our broadband segment in Q4, we expect revenue in the range of $90 million to $95 million; gross margin in the range of 46.4% to 47.4%. Gross profit in the range of $42 million to $45 million, operating expenses in the range of $26 million to $27 million and adjusted EBITDA to range from $17 million to $20 million. Moving to Slide 14. We will review full-year and fourth-quarter 2022 video segment guidance. Currently, we expect revenue in the range of $267 million to $276 million, a 2% decrease from the midpoint of prior guidance. Full-year 2022 SaaS growth is now expected to exceed our annual SaaS growth expectations of 50%. Gross margins in the range of 60.1% to 60.3%, a 130 basis point improvement versus prior guidance at the midpoint due to improved product mix, partially offset by a continued modest foreign exchange headwind. Gross profit in the range of $161 million to $167 million, a slight improvement from prior guidance at the midpoint, primarily due to stronger-than-expected Q3 margins. Operating expenses in the range of $142 million to $143 million, better than prior guidance at the midpoint, primarily due to reduced hiring and improved foreign exchange benefit. Adjusted EBITDA is in the range of $24 million to $29 million, an 18% improvement from prior guidance at the midpoint. For our video segment in Q4, we expect revenue in the range of $61 million to $70 million. The broader range for Q4 reflects increased uncertainty in Europe appliance demand and timing of book deals. Gross margin in the range of 58.6% to 59.6%, reflecting a 330 basis point improvement from prior guidance due to improved product mix. Gross profit in the range of $36 million to $42 million, a slight decrease from prior guidance at the midpoint. Operating expenses in the range of $35 million to $36 million, better than prior guidance at midpoint due to the factors mentioned previously. And adjusted EBITDA to range from $2 million to $7 million, an improvement from prior guidance. In summary, during the third quarter, we continued to execute and drive strong momentum in our broadband segment while advancing our strategic transformation in our video segment, which led us to raise our full-year adjusted EBITDA guidance for both segments. As a result, we ended the third quarter with near-record balances for backlog and deferred revenue. We believe this momentum positions us well for the balance of '22 and into '23, as we continue to execute on our long-term business plan.

All right. Thanks, Sanjay. Look, just before concluding the call, let's review the strategic and execution priorities that have been guiding us this year. For our broadband business, we remain focused on enabling our existing customers to successfully ramp, accelerate deployment, and compete. We're also focused on breaking into the Tier 1 operators that we have not yet secured and vitally important, leveraging our fiber solution to expand our addressed market and create additive revenue growth and value. For the video segment, we're driving rapid expansion of our streaming SaaS brand and customer base. We're further extending our streaming SaaS technology and service differentiation, particularly for live sports, and we're leveraging the traditional broadcast appliance business to profitably enable these transformations. In each of these areas, our year-to-date results have been excellent, and we're well positioned to finish 2022 strong and enter 2023 with great market momentum. We're truly excited about the future of our business, and we greatly appreciate your continued support. With that, I would like to now open up the call for a few questions.

Certainly. And our first question comes from Ryan Koontz from Needham. Please go ahead with your question.

Quick clarification, please. Thanks for the opportunity to ask here. About your Tier 1 fiber trials, I know you announced two last quarter, and this is the third one this quarter. And how are these kind of scheduled out to ship over the coming quarters?

I'll take that, Ryan. First, what we've announced here is not trials, but they are actually purchase order commitments representing planned deployments, so of a couple of different scales, I would say. And yes, what we're announcing today is a third significant win. Last quarter we talked about several customers who have selected us with more of a focus on the domestic market, and we're excited that during the third quarter, we secured our first significant commitment from a Tier 1 international customer.

It's fantastic. And just maybe stepping back in the big picture here as we think about cable operator spending moving away from monolithic legacy systems to next-gen distributed virtualized. Like, where do you feel like we are in that transition or where we may be 25% through the shift to next-gen and at what point do you anticipate we might get to see the market surpass 50? Thank you.

I believe this is an excellent question. There are two ways to address it. One way is to consider what percentage of operators have adopted and started deploying next-generation systems. In rough terms, we estimate that about one-third of the operators, based on subscriber base rather than aggregate numbers, have started this deployment. We presented a chart related to this in our Analyst Day deck last September, which illustrates our perspective on the current market situation. We are at a pivotal moment. Approximately one-third of global cable operators have begun to implement next-generation architecture. As I mentioned earlier, we estimate that they are about 20% into the process. For the remaining two-thirds of cable subscribers in the market, those operators have not yet started their next-generation initiatives. However, our pipeline indicates progress, and the feedback from recent industry events suggests that we are starting to move past this critical juncture. We observe significant activity in the primary market, with many operators getting closer to making decisions and moving forward.

Sure. That's super helpful. Does that answer the question? Yes, you did. And just one more quick clarification. So of the third of operators that have shifted, are they still spending much on legacy or are they largely wound that down and are kind of in a pause in ramp mode now?

Yes, it's hard to generalize. There is still spending on legacy. I mean, what's the best way to think about it? Think about an operator that is maybe operating in two or three cities, even if you are going as fast as they can in next-gen, they may still have an immediate kind of hole to plug in the part of the network being served by legacy equipment. I'm sure you can imagine that. So we think that for sure there is some spending on legacy going on, even under the umbrella of those who have embraced the next-generation stuff, but we think that spend is generally being minimized and on an as-needed basis.

Great. That's super. I'll get back in the queue. Thanks, Patrick.

All right. Thank you.

Thank you. One moment for our next question. And our next question comes from the line of Simon Leopold from Raymond James. Your question please.

Great. Thanks for taking the question. A couple if I may. The first one is, you did host the Analyst Meeting back in September and provided us with some targets for 2025. And I guess, I'm just sort of wondering in 2021, you had given us a target of $830 million for 2024. I guess I just want to put that in perspective; should we still be thinking $830 million as sort of a milestone midpoint to the 2025 targets or should we sort of think about how to extrapolate between 2023 and 2025? Just a little bit of advice on how to consider that.

We don't want this to be construed as guidance. However, we see it as linear growth extending to 2025, meaning we do not anticipate any significant changes in the growth trajectory a year and a half from now. We have experienced strong growth over the past two years, and while we expect that growth rate to moderate slightly as we become larger, we still anticipate a more or less linear growth between now and 2025.

That's very helpful. And then not to get too deep into the technology we can avoid it. But I've been hearing from suggestions that the industry is harmonizing around a Remote PHY architecture and not the MAP by choice. And I guess two parts, one is that true, and two, what are the implications, if any, for Harmonic?

Yes, I would say that there is a growing consensus in the industry regarding the benefits of virtualized CMTS and Remote PHY, although this consensus is not fully established yet. There are discussions happening, but many are recognizing the overall efficacy, technical advantages, and proven volume benefits of these technologies. If the industry indeed converges on Remote PHY, it would be advantageous for Harmonic. It's important to note that we are already well-prepared to support Remote MAC-PHY. However, when it comes to the PHY variant of the architecture, we are significantly ahead of the competition in terms of technology understanding, deployment experience, and expertise. Therefore, if the industry does fully embrace Remote PHY as the preferred architecture, it would further enhance our leadership position in the market.

That's very helpful. That’s the kind of answer I was trying to get, a good understanding. And then, just one last question. You provided a couple of updates on the call regarding some successes in the fiber-to-the-premises architecture. Is there a point at which you would break out the dollar contributions, or how should we consider the implications for modeling the traction of FTTP? Thank you.

Yes. Referring back to the Analyst Day, we set a target for 2025, and we're starting from a small base. This gives you a sense of our direction for the next few years. Currently, data represents relatively small figures. I believe we estimated around $10 million in revenue for that chart, and we expect order input to exceed that this year. It is yet to be determined when we will start to categorize it as it grows within the business. However, we do plan to break it out at some point once it reaches the appropriate scale, and the 2025 targets provide an indication of our anticipated trajectory.

Great. I appreciate it. Thanks for taking the questions.

Thank you.

Thank you. One moment for our next question. And our next question comes from the line of Steven Frankel from Rosenblatt Securities. Your question please.

Good afternoon, Patrick. So just a follow-up on this theme of the industry coalescing behind Remote PHY. To what extent have you seen that either accelerate orders from existing customers or maybe up the urgency among people that were in the pipeline?

No change with existing customers. Existing customers were already engaged and continuing their operations. For those interested, there are several variations of DAA. It's clear that the entire industry is concentrating on DAA, and some customers are still undecided between the different options. However, it seems that more of those on the fence are now favoring Remote PHY. Additionally, part of the current landscape involves increasing urgency due to competition, not just in the US but globally, specifically from fiber and fixed wireless broadband rivals. This has intensified the competitive environment for traditional cable operators. As a result, some of them are concluding that the time to evaluate various technology options has passed, and they need to start planning to implement changes. For operators feeling this urgency, opting for the most widely deployed and mature variant of DAA is certainly beneficial. This presents us with a competitive edge in the market. We believe our position, beyond just the technology, is as a partner that can assist operators in moving quickly. We consider ourselves the leading partner in the industry right now. Even though everything is still evolving, we are excited about the opportunity to help both existing and new customers tackle the challenges posed by fiber and wireless competitors, and we are confident we have the right tools to do so.

Okay. And in the last few quarters, you've kind of characterized your installed base in broadband as kind of going through a shake-down crew for a bit and figuring out DAA and then accelerating deployment. Could you give us some color on kind of how you think those Tier 1s are today? If we had a material movement to more of those customers getting through the shake-down crews and kind of putting their foot on the accelerator in terms of deployment now?

I believe this represents a different perspective on our earlier discussion. We successfully closed a significant new Tier 1 international deal during the quarter, which we are excited about. The progress with other Tier 1s, who have not yet decided on next-generation architecture, is very encouraging. There is a strong urgency for these companies to secure their impressive broadband businesses. They are making an effort to understand the architectural variations, make decisions, and move forward. As I mentioned earlier, we are nearing the point of crossing the chasm; although we haven't completely made it, we are much closer than we were three months ago. We anticipate that 2023 will be a pivotal year with several important decisions being made and hopefully, a number of new large-scale rollouts beginning.

Great. Thank you.

Thank you. One moment for our next question. And our next question comes from the line of Tim Savageaux from Northland Capital Markets. Your question please.

Good afternoon and congratulations on the results, particularly regarding the gross margin, which is where I wanted to focus, especially in broadband. Sanjay, you mentioned a few factors contributing to the strength in Q3, but you are predicting further improvement in Q4 into the high 40s. Could you elaborate on what is driving that? Looking at your results, it appears there has been an increase in router or software revenue within cable access, possibly indicating that some of your new Tier 1 clients are starting to take off. Additionally, you had a strong performance in Europe this quarter. Can you provide some insights on this, both for the quarter and the outlook, particularly concerning broadband gross margin?

Sure, Tim. As I mentioned in my prepared remarks, the key factor behind our gross margin improvement in Q3, which is also why we have increased our Q4 guidance, is our focus on investing in inventories and associated deposits. This strategy is significantly enhancing our gross margin. We are utilizing more ocean freight due to the advantages it offers compared to air freight, which has much higher costs—about eight times greater. Additionally, we've observed slight reductions in freight rates alongside some minor price increases. Overall, taking all these factors into account, we've seen positive results in Q3 and expect to continue this trend in Q4 as we invest further in inventories. Regarding your question about Tier 1s and their ramping process, yes, they are increasing, which also benefits us, and the mix is advantageous. This aligns with our initial guidance from the start of the year, where we anticipated Q1 to be our weakest quarter and projected that we would achieve our highest gross margin in Q4. This expectation has materialized as planned, and we are pleased that our capital deployment strategy is effectively yielding these results.

Great. Thanks very much. And without addressing the elephant in the room here over the last couple of questions, I will ask about your new Tier 1 win that you mentioned at the Analyst Day. And I just want to make sure I have this right. I was looking for a footprint update in terms of your total subscriber footprint that you deferred to this call from the $60 million. So hopefully, you can provide that. Or is that Tier 1, is that relevant? Is it a virtualized CCAP, DOCSIS deal or is it a fiber deal or is it both, I've kind of heard both here during the call, fiber one with an existing Tier 1 customer internationally, is that separate and distinct from what you talked about at the Analyst Day? And can I get that updated footprint number?

I don't have an exact updated footprint number for you, but earlier in Q3, we announced that we secured a new DOCSIS win with an international Tier 1 cable operator. This adds several million homes passed, which represents about a 5% increase to our addressed footprint in cable. Additionally, a previously announced international cable operator has now started to roll out our fiber-to-the-home PON solution alongside DOCSIS, and they have given us a substantial multimillion dollar order for the fiber business.

Got it. Thanks very much.

Does that make sense? Does that clarify?

It makes perfect sense. And you kind of hinted at it a couple of times. But in the past, you've talked about kind of assessing where your group of Tier 1s are with regard to moving to meaningful or full deployment and I think now you have 10 maybe it's about half. Does that remain the case or have you seen some progress there? And that'll be it for me.

We've seen that, Tim. I mean the path we're marching on in terms of the growth, this year we are approximately 60% up year-over-year. I think all that entails the ramp of existing Tier 1s and that's playing out as we planned and anticipated.

In response to Tim's question, yes, we currently have one Tier 1 operator globally, and a few have made progress in terms of fiber to the home, using both our DOCSIS and fiber solutions. Our goal is to penetrate all of them. We believe that, over time, fiber will become an essential tool for every cable operator as they compete. While our ambitions in fiber extend beyond just cable operators, we particularly aim for the Tier 1s that have already adopted our DOCSIS solution to also adopt our fiber solution. We will share updates on our progress in this area and the acquisition of new accounts as well.

Our next question comes from George Notter from Jefferies. Please go ahead with your question.

Hi, this is Kyle on for George. Thanks very much for the question. I was interested that you mentioned investing in inventory makes sense given the revenue growth. But we've also heard that some areas of the supply chain are getting modestly better. Can you tell us how much of this inventory investment is directly related to revenue growth and how much might be still related to protecting yourselves for the supply chain? Or could it be the case that you're reacting to a better supply chain and that might be an offsetting factor? Just a little bit more about the moving pieces of inventory. Thanks.

Sure, Kyle. The first thing I'll say is that the investment we're making in inventories is helping our gross margins in terms of how we transport the inventory to us. Let me be very clear, the cost of inventories still remains high. Once the cost increases from our suppliers, it's very hard to see them decrease. So, those costs get incorporated into the standard cost and remain elevated. What else can we do to bring it down? That’s entirely within our control, and that's where we are allocating our capital. The main benefit comes from freight, which I mentioned. Additionally, we are noticing modest improvements from a combination of factors. Price increases and an improved software and services mix are all contributing to this. Regarding the increase in revenue, this investment in inventories is providing us with an opportunity to meet the strong demand and backlog we have, enabling us to ship products to customers on time.

Okay. Great. Thanks very much.

Thank you. One moment for our next question. And our next question is a follow-up question from Ryan Koontz from Needham and Company. Your question please.

Hi. Thanks for the quick follow-up. You mentioned European macro risk there, and obviously, you had a really great quarter in Q3 here. How should investors think about the risk in Europe borrowing all-out spreading of the war? But just given the energy crisis, what kind of insights can you share with us about the demand picture in Europe next year? Thanks.

Ryan, we don't consider ourselves economists, but so far, we have not observed any major downturn. The competition in the broadband sector is intense, similar to other regions around the world. Our current view is that the broadband segment of our business will likely remain relatively immune to macroeconomic headwinds. However, we may face slightly more challenges in the video segment, as about 30% of our video business is in Europe. This region, encompassing Europe, the Middle East, and Africa, could be more exposed to economic pressures. Historically, however, our video business has shown some resilience even during periods of lower consumer spending. Currently, we experience some uncertainty. As you have noticed, we have provided a broader range for the video segment in the fourth quarter due to this uncertainty. Our current sales pipeline and recent orders in Q3 do not indicate any significant challenges. Nonetheless, we want to emphasize that we recognize some potential risks and will continue to monitor the situation closely while actively pursuing the opportunities in front of us.

Sure. That makes great sense. Thanks, Patrick.

All right. Thank you, Ryan.

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to management for any further remarks.

Okay. Well, thank you very much all for joining us today. We're pleased to report a solid quarter. We're excited about our momentum. We appreciate your interest and support. And we look forward to driving another strong quarter. Thanks very much. Have a good evening.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.