Harmonic Inc. — Q3 2015 Form 10-Q
Reporting period: Third quarter and nine months ended October 2, 2015; comparisons are to the periods ended September 26, 2014. Amounts below are in millions of U.S. dollars unless stated otherwise.
Business context
Harmonic designs and sells video infrastructure products and services. Its two reportable segments are Video and Cable Edge. Results depend heavily on customer capital spending by cable, satellite, telecommunications, broadcast and media companies.
Financial results and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $83.3 | $108.1 | $290.4 | $325.7 |
| Gross profit | $46.2 | $53.4 | $155.6 | $155.6 |
| Gross margin | 55.5% | 49.4% | 53.6% | 47.8% |
| Operating income (loss) | $(6.3) | $(3.5) | $(6.6) | $(19.4) |
| Net income (loss) | $(4.8) | $1.1 | $(8.5) | $(41.4) |
| Diluted EPS | $(0.05) | $0.01 | $(0.10) | $(0.44) |
| Operating cash flow | Not presented separately | Not presented separately | $8.6 | $27.5 |
Q3 revenue fell 23% year over year; nine-month revenue fell 11%. Product revenue declined, partly offset by higher services revenue. Gross margin improved year over year, primarily from lower amortization of acquired intangibles, operational efficiencies, product mix and customer rebate accrual reversals. Despite lower operating expenses, the Q3 operating loss widened as revenue weakened.
Segment revenue in Q3 was $71.9 million for Video, down 12%, and $11.4 million for Cable Edge, down 57%. Video segment operating income was $3.6 million versus $6.6 million; Cable Edge recorded a $4.0 million operating loss versus income of $0.1 million. For the nine months, segment operating margins were approximately 4% for each segment.
At October 2, cash and cash equivalents were $61.6 million and short-term investments were $26.0 million, totaling $87.6 million, compared with $104.9 million at December 31, 2014. Current assets were $226.6 million and current liabilities $89.3 million. Total liabilities were $107.0 million. The filing reports no credit-facility borrowings; $19.5 million remained available after letters of credit. The $20 million revolving facility was scheduled to mature December 22, 2015. Harmonic reported compliance with its covenants, including minimum cash and marketable securities of $35 million and rolling four-quarter EBITDA of $20 million.
Nine-month operating cash flow declined to $8.6 million from $27.5 million. The company attributed the 2015 result to its net loss, working-capital changes and a $14.2 million advance payment to a supplier for inventory, among other items. Investing activities used $5.7 million and financing activities used $14.0 million, including $20.0 million of share repurchases. Cash and cash equivalents declined $11.5 million during the period. No funded debt balance is reported.
Material changes and unusual items
- Revenue weakness affected both segments and all reported regions. The largest Q3 segment decline was Cable Edge, reflecting customer consolidation, project delays and spending caution ahead of next-generation CCAP technologies. Video revenue was affected by softer demand, customer technology transitions and deferred projects.
- Management said customers were delaying purchases ahead of Ultra HD, HEVC, virtualized video architectures and CCAP. These delays had begun in 2014 and could continue for several quarters. DOCSIS 3.1 CCAP product deployment was scheduled to begin in mid-2016.
- The nine-month 2015 net loss included a $2.5 million impairment of the VJU investment. Nine-month 2014 results included a $21.8 million tax provision, largely affected by a substantial valuation allowance; this makes the year-over-year net-loss improvement less indicative of operating performance.
- Harmonic recorded $0.7 million of restructuring charges in the first nine months of 2015 and expected to complete its 2015 restructuring actions by year-end. The plan included workforce reductions and facility and asset actions.
- The company repurchased $20.0 million of shares during the first nine months. $48.6 million remained authorized under the repurchase program at October 2, 2015.
- After quarter-end, CFO Carolyn V. Aver resigned effective November 2, 2015, and Harold Covert was appointed CFO. Worldwide Sales head George Stromeyer resigned October 30, 2015.
Outlook, risks and contingencies
Management stated that existing liquidity was expected to cover operations and contemplated cash requirements for at least the next 12 months, while noting that results and operating cash flow could fluctuate. The filing provides no specific revenue, earnings or margin guidance. Management highlighted uncertainty in the timing of customer investment and continuing customer consolidation.
Key risks include dependence on customer capital spending and a concentrated customer base; competitive and technology-transition risks; foreign-exchange exposure; reliance on limited suppliers and contract manufacturers; and the possibility that new products or standards are adopted later or faster than anticipated. The company had approximately $21.2 million of non-cancelable supplier purchase commitments. Two Avid patent disputes remained unresolved; Harmonic said potential losses could not be reasonably estimated and an adverse outcome could materially affect results, cash flow or product sales. Tax audits and a $1.6 million Santa Clara County property-tax assessment appeal were also disclosed.
Harmonic reported that disclosure controls were effective at a reasonable assurance level and that no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Whether the scheduled December 22, 2015 credit-facility maturity was extended, renewed or repaid, and whether covenant compliance continued.
- Whether customer project deferrals eased and whether Video and Cable Edge demand and segment profitability improved, particularly given the severe Q3 Cable Edge decline.
- Whether DOCSIS 3.1 CCAP deployment and adoption of VOS, Ultra HD and HEVC products proceeded as planned.
- How much of the gross-margin improvement is sustainable after lower acquired-intangible amortization and the customer rebate accrual reversal.
- Developments in the Avid appeals, tax examinations and property-tax assessment appeal, along with any resulting financial exposure.
- The effects of CFO and senior sales leadership transitions, restructuring completion and continued share repurchases on execution and liquidity.