Business context and reporting period
Harmonic Inc. filed this unaudited Form 10-Q for the quarter and six months ended July 2, 2010. It designs, manufactures and sells video-processing and edge-and-access products and related services for cable, satellite, telecom and broadcast customers. The company reports one operating segment. Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Revenue | $95.5 | $81.3 | $180.4 | $149.0 |
| Gross profit | $45.7 | $33.5 | $86.5 | $58.9 |
| Gross margin | 47.8% | 41.3% | 48.0% | 39.5% |
| Operating income (loss) | $4.1 | $(4.2) | $6.6 | $(15.0) |
| Net income (loss) | $4.4 | $(7.9) | $9.8 | $(26.8) |
| Diluted EPS | $0.05 | $(0.08) | $0.10 | $(0.28) |
- Revenue increased 17.5% in Q2 and 21.0% for the first half year over year. Q2 video-processing revenue rose 30.6%; edge-and-access revenue rose 6.4%. International revenue grew 33.2% in Q2 and represented 48% of revenue; Comcast contributed 16% of Q2 revenue.
- Gross margin improved with higher volumes, better margins in video processing and cable edge, and lower year-ago Scopus-related inventory charges. Q2 margin improvement was partly offset by $2.2 million of inventory provisions and higher warranty, freight and royalty costs.
- Operating expenses were $41.6 million in Q2, up from $37.7 million. SG&A included $2.4 million of Omneon transaction expenses. Six-month R&D and SG&A were $33.9 million and $44.9 million, respectively.
- Six-month operating cash flow was $5.5 million, versus cash use of $13.1 million a year earlier. Net income and non-cash charges were partly offset by a $20.3 million net working-capital cash use, including higher receivables and inventories.
- Cash, cash equivalents and short-term investments totaled $277.9 million at July 2, 2010, compared with $271.1 million at year-end 2009. Cash and equivalents alone were $187.9 million; short-term investments were $90.0 million.
- Total assets were $595.2 million; total liabilities were $168.5 million and stockholders’ equity was $426.7 million. The balance sheet included a $24.3 million long-term financing liability related to headquarters construction. No bank-line borrowings were outstanding; the company had a $10 million facility maturing March 2, 2011 and was compliant with its $35 million liquidity covenant.
Material changes, outlook and risks
- Management attributed revenue growth to customer demand for HDTV, video-on-demand, M-CMTS, switched digital video and video-transmission solutions, as well as improved economic conditions. It expects international revenue to remain significant and customer concentration to continue. Results may fluctuate because orders and revenue are often concentrated late in the quarter and expenses are relatively fixed in the short term.
- Harmonic agreed to acquire Omneon for approximately $190 million in cash, subject to adjustments, plus 17.1 million Harmonic shares; stated estimated total purchase value was approximately $274 million, net of expected acquired cash. The transaction was subject to approvals and closing conditions and was expected in the second half of 2010. Management expected existing liquidity to cover requirements for at least 12 months, including after the transaction, but noted additional funding might be needed if assumptions proved wrong. The acquisition would reduce cash and dilute existing holders.
- Management forecast 2010 capital expenditures of $16–18 million, net of landlord reimbursements. It expected remaining-2010 amortization of approximately $3.9 million in cost of revenue and $1.1 million in operating expenses, excluding any Omneon-related amortization.
- Tax benefits materially affected reported earnings: six-month income-tax benefit was $2.9 million, principally reflecting discrete benefits from expired statutes of limitation and release of part of a California deferred-tax valuation allowance. Unrecognized tax benefits were approximately $46.3 million at July 2; tax years 2002–2009 remained open to examination.
- Key risks include dependence on capital spending by a concentrated customer base, competition and pricing pressure, international and foreign-exchange exposure, component and supplier constraints, execution and integration risks from acquisitions, and potential volatility in demand and quarterly results. The company also disclosed Arris patent litigation seeking injunctive relief and damages, with outcome not predictable.
- In Israel, Interkey obtained an approximately $1.7 million ex-parte judgment after the reporting date. Harmonic sought to set it aside, said it believed it was likely to prevail, and recorded no provision. Management cautioned that adverse litigation outcomes could materially affect results, financial position or cash flows.
Important facts for investors to verify
- Whether the Omneon acquisition closed, its final cash and share consideration, financing impact, dilution and integration costs.
- Whether revenue growth and margin improvement continued, particularly given customer concentration, timing of large orders and inventory provisions.
- Working-capital trends and cash generation, including inventory and receivables, alongside headquarters construction and capital spending.
- Developments in the Interkey and Arris matters, including potential costs, damages, royalties or sales restrictions.
- Changes in unrecognized tax benefits, California deferred-tax asset assumptions, and compliance with the bank-facility liquidity covenant.