Harmonic Inc. — Q3 2010 Form 10-Q
Reporting period: Third quarter ended October 1, 2010; comparisons are with the quarter ended October 2, 2009. Nine-month figures compare the periods ended on those dates. Amounts below are in millions of dollars unless otherwise noted.
Business context
Harmonic designs, manufactures and sells video infrastructure products and services for content production and delivery across broadcast, cable, Internet, mobile, satellite and telecommunications networks. It reports one operating segment. On September 15, 2010, Harmonic acquired Omneon, adding video-server, storage and production-and-playout products.
Financial performance and liquidity
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net revenue | $104.8 | $83.9 | $285.1 | $232.9 |
| Gross profit / margin | $47.5 / 45.4% | $36.1 / 43.0% | $134.0 / 47.0% | $95.0 / 40.8% |
| Operating income (loss) | $1.6 | ($0.6) | $8.1 | ($15.5) |
| Net income (loss) | ($0.4) | $2.6 | $9.4 | ($24.2) |
| Diluted earnings (loss) per share | ($0.00) | $0.03 | $0.10 | ($0.25) |
- Quarterly revenue rose 24.9%; nine-month revenue rose 22.4%. Management attributed growth to customer demand for video-processing and cable products, improved economic conditions, and Omneon revenue.
- Gross margin improved year over year, primarily from higher volumes and product mix; nine-month comparisons also benefited from lower excess-and-obsolete inventory provisions than in 2009.
- Quarterly net loss reflected a $1.7 million tax provision despite pretax income of $1.3 million. The provision included discrete tax items; the reported quarterly effective tax rate was 127.1%.
- Nine-month operating cash flow was $1.2 million, versus cash used of $9.8 million a year earlier. Working-capital changes used $35.3 million, including higher receivables and inventories.
- Cash and cash equivalents were $70.5 million at October 1; short-term investments were $39.6 million, for combined liquidity of $110.1 million, down from $271.1 million at December 31, 2009. Current assets were $324.5 million and current liabilities $112.7 million.
- Investing activities used $105.8 million, including $153.3 million cash paid for Omneon, partly offset by investment maturities and sales. Financing activities provided $22.8 million, including $18.8 million of lessor financing proceeds associated with the new headquarters construction.
- The $10 million bank credit line had no borrowings; Harmonic was compliant with its minimum $35 million unrestricted-liquidity covenant. The line matures March 2, 2011. The filing states that management expected available liquidity to meet requirements for at least 12 months.
Material changes and unusual items
- Omneon’s net purchase price was $251.3 million, comprising $153.3 million cash net of acquired cash, 14.2 million Harmonic shares valued at $95.9 million, and $2.1 million for assumed awards attributable to pre-acquisition service. The acquisition added $147.8 million of goodwill. Omneon contributed $5.6 million revenue and a $0.9 million operating loss from closing through quarter-end.
- Harmonic expensed $5.7 million of Omneon transaction costs in the second and third quarters. Omneon-related assumed awards are expected to generate $15.1 million of compensation expense over a weighted-average 2.5-year service period.
- SG&A increased 34.0% in Q3 to $26.0 million, including $3.4 million of acquisition-related expenses, higher compensation and facilities costs. Research and development increased 19.7% to $19.0 million.
- Goodwill rose to $212.5 million and identified intangible assets, net, to $125.5 million, largely due to Omneon. The filing forecasts $8.5 million of remaining 2010 intangible amortization, including $5.6 million in cost of revenue and $2.9 million in operating expenses.
- Harmonic issued 14.2 million shares for Omneon; shares outstanding were 111.9 million on October 29, 2010, compared with 96.1 million at December 31, 2009.
- The company completed construction of its new San Jose headquarters and relocated in September. It removed the construction asset and financing liability from its books after concluding the transaction qualified for sale-leaseback accounting.
Outlook, risks and contingencies
- Management expected 2010 capital expenditures of $15 million to $17 million, net of landlord reimbursements. No specific revenue or earnings guidance was provided.
- Management expects international revenue to remain significant and customer concentration to continue. Comcast accounted for 26% of Q3 revenue and 17% of net receivables at October 1; the ten largest customers contributed approximately 47% of nine-month revenue.
- Key risks include dependence on cable, satellite and telecom customer capital spending; concentrated customers; volatile order and revenue timing; competition and pricing pressure; supply constraints; international and foreign-exchange exposure; and successful integration of Omneon and Scopus. The filing also identifies economic uncertainty and potential acquisition-related dilution, costs and integration disruption.
- Arris alleged that Harmonic’s Streamliner 3000 infringed four patents and seeks damages and injunctive relief; Harmonic said it could not predict the outcome. An earlier Interkey ex-parte judgment of approximately $1.7 million was set aside; Harmonic recorded no provision and considers the claim without merit.
- Gross unrecognized tax benefits, including interest and penalties, were approximately $48.9 million. The company expected a $2.4 million decrease over the following 12 months due to statute expirations. Tax years 2002–2009 remained open to examination.
- Contractual obligations included $40.0 million of operating lease payments and $24.0 million of inventory purchase commitments; $27.7 million was due within one year. Standby letters of credit totaled $0.6 million.
- Management reported effective disclosure controls. Integration of Omneon and Scopus financial processes and controls was ongoing. Harmonic was evaluating new revenue-recognition guidance effective in 2011; the potential impact was not yet determined.
Important facts for investors to verify
- Whether revenue growth, customer demand and higher gross margins continue after separating acquired Omneon contribution from organic growth.
- Omneon integration progress, realized strategic benefits, acquisition-related expenses and the recoverability of substantial goodwill and intangible assets.
- Cash conversion and working-capital trends, particularly receivables and inventory, alongside liquidity headroom under the $35 million bank covenant.
- Customer concentration, especially Comcast exposure, and the sensitivity of orders to cable, satellite and telecom capital spending.
- Developments in the Arris patent litigation, uncertain tax positions and the eventual effects of the 2011 revenue-accounting changes.