Harmonic Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended July 3, 2015. Comparisons are to the quarter and six months ended June 27, 2014. Harmonic designs and sells video infrastructure products and services through its Video and Cable Edge segments.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $103.1 million | $109.6 million | $207.1 million | $217.6 million |
| Gross profit / margin | $54.4 million / 52.7% | $49.8 million / 45.5% | $109.4 million / 52.8% | $102.1 million / 46.9% |
| Operating loss | $0.3 million | $8.6 million | $0.3 million | $15.9 million |
| Net loss | $1.0 million | $37.1 million | $3.7 million | $42.5 million |
| Net loss per share | $0.01 | $0.39 | $0.04 | $0.44 |
Cash flow: First-half operating cash flow was $13.6 million, compared with $26.8 million a year earlier. Investing used $4.8 million and financing used $5.7 million. Cash and cash equivalents increased $3.0 million to $76.0 million.
Liquidity and debt: Cash, cash equivalents and short-term investments totaled $105.1 million at July 3, 2015. Current assets were $245.9 million and current liabilities $98.3 million. The company reported no borrowings under its $20 million revolving facility; $19.5 million remained available after letters of credit. It was in compliance with facility covenants, including minimum cash and marketable securities of $35 million and rolling four-quarter EBITDA of $20 million.
Balance sheet and capital allocation: Total assets were $489.2 million, total liabilities $118.0 million and stockholders’ equity $371.2 million. The company repurchased $12.2 million of stock in the first half; $56.5 million remained authorized under its repurchase program.
Material changes and operating drivers
- Revenue declined 6% in Q2 and 5% in the first half. Q2 Video revenue rose 1% to $78.2 million, while Cable Edge revenue fell 23% to $24.9 million. First-half Video revenue decreased 7%; Cable Edge increased 1%.
- Q2 revenue weakness reflected a Cable Edge customer spending pause after recent network-capacity purchases and industry consolidation. Video revenue benefited from higher service revenue, media customers and adoption of newer products, partly offset by lower product demand.
- First-half Video product revenue was affected by customer investment delays ahead of Ultra HD, HEVC and virtualized architectures, weaker EMEA and APAC demand, and the stronger U.S. dollar. Management said adoption of newer video products improved in Q2 but remained at an early stage.
- Gross margin improved year over year, primarily due to lower amortization of acquired intangibles, product mix and operational and supply-chain efficiencies. Lower amortization also contributed materially to the narrower operating loss.
- Segment operating income in Q2 was $4.9 million for Video and $0.4 million for Cable Edge. For the first half it was $4.8 million and $6.5 million, respectively. Consolidated operating results also reflected stock-based compensation and intangible amortization.
- First-half operating cash flow was lower year over year, in part because of a $14.2 million supplier advance payment for future inventory, as well as changes in accrued liabilities and other working-capital items. The advance is expected to offset supplier payables beginning in Q4 2015 through Q1 2016.
Outlook, risks and unusual items
- Outlook: No numerical revenue or earnings guidance is provided in the filing. Management expects customer investment timing to remain uncertain and believes adoption delays for new technologies could continue for several quarters. It expects existing liquidity to cover requirements for at least 12 months.
- Customer and market exposure: The top ten customers represented about 38% of revenue in the first half; Comcast represented about 15%. Customer capital spending, industry consolidation, technology transitions and the strength of the U.S. dollar are key demand risks.
- Contingencies: Avid litigation remained unresolved. Avid appealed the verdict in Harmonic’s favor concerning Media Grid; a separate Spectrum patent matter and related appeal also remained pending. The company could not estimate reasonably possible losses. An adverse outcome could entail damages, royalties or restrictions on product sales.
- Taxes: The IRS notified Harmonic in July 2015 of an audit of its 2012 tax year; an Israeli subsidiary was also under audit for 2012 and 2013. Gross unrecognized tax benefits, including interest and penalties, were approximately $16.2 million. U.S. losses received no tax benefit because of a full valuation allowance on U.S. deferred tax assets.
- Unusual item: Harmonic recorded a $2.5 million first-quarter impairment of its VJU investment after determining the investment was expected to be unrecoverable.
- Restructuring and commitments: The 2015 restructuring plan includes workforce reductions, facility exits and excess-asset disposals, with completion expected by year-end 2015. Non-cancelable supplier purchase commitments were $23.9 million; future operating lease payments totaled $44.7 million.
- Other risks: The company relies on limited-source suppliers and contract manufacturers, has international and foreign-exchange exposure, and faces rapid technology change and intense competition. Management reported disclosure controls were effective at a reasonable assurance level and no material change in internal control over financial reporting.
Key facts investors should verify
- Whether customer spending resumes and newer Video and Cable Edge products gain adoption, especially given the stated potential for delays over the next several quarters.
- Whether revenue concentration, including Comcast’s contribution, changes and how the Cable Edge spending pause develops.
- Whether margin improvement persists when lower acquired-intangible amortization becomes a less significant year-over-year benefit.
- Operating cash conversion and the timing of recovery of the $14.2 million supplier advance.
- Outcomes of the Avid matters and U.S. and Israeli tax audits, including any effects on cash flow or reported results.
- Progress on restructuring, compliance with credit-facility covenants, and the effects of further stock repurchases on liquidity.