HARMONIC INC MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-Q)
The terms "Harmonic," "Company," "we," "us," "its," and "our," as used in this Quarterly Report on Form 10-Q (this "Form 10-Q"), refer to
Harmonic Inc.and its subsidiaries and its predecessors as a combined entity, except where the context requires otherwise. Some of the statements contained in this Form 10-Q are forward-looking statements that involve risk and uncertainties. The statements contained in this Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. In some cases, you can identify forward-looking statements by terminology such as, "may," "will," "should," "expects," "plans," "anticipates," "believes," "intends," "estimates," "predicts," "potential," or "continue" or the negative of these terms or other comparable terminology. These forward-looking statements include, but are not limited to, statements regarding:
•changing trends and demands in the markets we serve, particularly emerging markets;
•macroeconomic conditions, including inflation, rising interest rates, ongoing global supply chain disruptions, volatile capital markets and foreign currency fluctuations, particularly in certain geographies, and in financial markets; •the impact of geopolitical events, including the
Russia- Ukraineconflict and rising tensions between Chinaand Taiwan, on our business and the markets in which we operate;
•new and future products and services;
•the expenses of our customers;
•our strategic direction, future business plans and growth strategy;
•industry and customer consolidation;
•the expected demand for and benefits of our products and services;
•concentration of revenue sources;
•expectations regarding our CableOS solutions and SaaS solutions;
•the impact of the COVID-19 pandemic, and related business and government responses to the pandemic, on our operations and people, on business activity in the markets in which we operate and on global economies and regional, and on our results of operations;
•any future acquisitions and disposals;
•anticipated results of potential or actual litigation;
•our competitive environment;
•the impact of our restructuring plans;
•the impact of government regulations, particularly in terms of tariffs and economic sanctions;
•expected income and expenditure, including the sources of such income and expenditure;
•the expected impacts of changes in accounting rules;
•expectations regarding the usability of our inventory and the risk that inventory will exceed expected demand;
•expectations and estimates relating to goodwill and intangible assets and their associated book value; and
•Use of cash, cash requirements and ability to raise capital, including redemption of our convertible bonds or repurchase of our common stock.
These statements are subject to known and unknown risks, uncertainties and other factors, any of which may cause our actual results to differ materially from those implied by the forward-looking statements. Important factors that may cause actual results to differ from expectations include those discussed in "Risk Factors" in Item 1A of Part II of this Form 10-
Q. Allforward-looking statements included in this Quarterly Report on Form 10-Q are based on information available to us on the date thereof, and we assume no obligation to update any such forward-looking statements. 19 -------------------------------------------------------------------------------- Table of Contents OVERVIEW We are a leading global provider of (i) versatile and high performance video delivery software, products, system solutions and services that enable our customers to efficiently create, prepare, store, playout and deliver a full range of high-quality broadcast and streaming video services to consumer devices, including televisions, personal computers, laptops, tablets and smart phones and (ii) cable access solutions that enable cable operators to more efficiently and effectively deploy high-speed internet, for data, voice and video services to consumers' homes. We classify our total revenue in two categories, "Appliance and integration" and "SaaS and service." The "Appliance and integration" revenue category includes hardware, licenses and professional services and is reflective of non-recurring revenue, while the "SaaS and service" category includes usage fees for our SaaS platform and support service revenue from our appliance-based customers and reflects our recurring revenue stream. We conduct business in three geographic regions - the Americas, EMEA and APAC - and operate in two segments, Video and Broadband. During the third quarter of fiscal 2022, our Cable Access segment was renamed the Broadband segment to reflect a broader strategic view of the category. There has been no change to the composition of the segment; therefore, no prior periods were restated. Our Video business sells video processing, production and playout solutions, and services worldwide to cable operators and satellite and telecommunications ("telco") Pay-TV service providers, which we refer to collectively as "service providers," as well as to broadcast and media companies, including streaming media companies. Our Video business infrastructure solutions are delivered either through shipment of our products, software licenses or as SaaS subscriptions. Our Broadband business sells cable access solutions and related services, including our CableOS software-based cable access solution, primarily to cable operators globally. Historically, our revenue has been dependent upon spending in the cable, satellite, telco, broadcast and media industries, including streaming media. Our customers' spending patterns are dependent on a variety of factors, including but not limited to: economic conditions in the United Statesand international markets, including the impacts of the COVID-19 pandemic and the Russia- Ukraineconflict, such as inflation, rising interest rates, ongoing supply chain disruptions, volatility in capital markets and foreign currency fluctuations; access to financing; annual budget cycles of each of the industries we serve; impact of industry consolidations; and customers suspending or reducing spending in anticipation of new products or new standards, new industry trends and/or technology shifts. If our product portfolio and product development plans do not position us well to capture an increased portion of the spending in the markets in which we compete, our revenue may decline. As we attempt to further diversify our customer base in these markets, we may need to continue to build alliances with other equipment manufacturers, cloud service providers, content providers, resellers and system integrators, managed services providers and software developers; adapt our products for new applications; take orders at prices resulting in lower margins; and build internal expertise to handle the particular operational, payment, financing and/or contractual demands of our customers, which could result in higher operating costs for us. The worldwide spread of COVID-19 has impacted our business, operations and financial performance. In our Broadband segment, COVID-19 led to delays in certain deployments and new engagements with some cable operators, which generally occurred in the first half of fiscal 2020 when widespread public health responses were initially implemented, including travel bans and restrictions, social distancing requirements, and shelter-in-place orders. Similarly, in our Video segment, sales of video appliances and services fell during the first several months of the pandemic as transactions or shipments were delayed and we were unable to complete certain field deployment projects as customer facilities closed in the first half of 2020. Since the second half of fiscal 2020, we experienced a rebound and increases in sales activities, transactions and deployments in both business segments, in part due to the loosening of certain COVID-19 restrictions, and customer adaptation to such restrictions. We expect that the effects of the COVID-19 pandemic, will continue to have an impact on our results of operations. More recently, the United Stateshas experienced high levels of inflation, which may result in decreased demand for our products and services, increases in our operating costs including our labor costs, constrained credit and liquidity, reduced customer spending and volatility in financial markets. The Federal Reservehas raised, and may again raise, interest rates in response to concerns over inflation risk. There continues to be uncertainty in the changing market and economic conditions, including the possibility of additional measures that could be taken by the Federal Reserveand other government agencies, related to the COVID-19 pandemic, macroeconomic conditions, geopolitical disruptions pandemic and concerns over inflation risk. 20 -------------------------------------------------------------------------------- Table of Contents The extent to which our operations will be impacted by the COVID-19 pandemic, the Russia- Ukraineconflict and economic uncertainty will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including ongoing supply chain disruptions and the pricing and availability of certain materials and components, increased costs relating to securing timely and sufficient supply of key product components, new waves of infection in the countries and regions of the world in which we operate or conduct business, the impact of global vaccination efforts, and actions and policies of governments and businesses in response to future phases of the pandemic. As such, given the uncertainty around the duration and severity of the impact on market conditions and the business environment, we cannot reasonably estimate the full impacts of COVID-19 or the Russia- Ukraineconflict on our future results of operations. Refer to "Risk Factors" in Item 1A of Part II of this Quarterly Report on Form 10-Q for additional information. We believe a material and growing portion of the opportunities for our Video business are linked to the industry and our customers (i) continuing to adopt streaming technologies to capture, process and deliver video content to consumers and, increasingly, utilizing public cloud solutions like our VOS SaaS platform to do so; (ii) transforming existing broadcast infrastructure workflows into more flexible, efficient and cost-effective operations running in public clouds; and (iii) for those customers maintaining on-premise video delivery infrastructure, continuing to upgrade and replace aging equipment with next-generation software-based appliances that significantly reduce operational complexity. Our Video business strategy is focused on continuing to develop and deliver products, solutions and services to enable and support these trends. Our Broadband strategy is focused on continuing to develop and deliver software-based cable access technologies, which we refer to as our CableOS solutions, to our cable operator customers. We believe our CableOS software-based cable access solutions are superior to hardware-based systems and deliver unprecedented scalability, agility and cost savings for our customers. Our CableOS solutions, which can be deployed based on a centralized, DAA or hybrid architecture, enable our customers to migrate to multi-gigabit broadband capacity and the fast deployment of DOCSIS 3.1 and/or FTTH data, video and voice services. We believe our CableOS solutions resolve space and power constraints in cable operator facilities, eliminate dependence on hardware upgrade cycles and significantly reduce total cost of ownership, and are helping us become a major player in the cable access market. In the meantime, we believe our Broadband segment will continue to gain momentum in the marketplace as our customers adopt and deploy our virtualized DOCSIS 3.1 CMTS and FTTH solutions and distributed access architectures. We continue to make progress in the development of our CableOS solutions and in the growth of our CableOS business, with expanded commercial deployments, field trials, and customer engagements.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
Our unaudited condensed consolidated financial statements and the related notes included elsewhere in this report are prepared in accordance with
U.S.GAAP. The preparation of these unaudited condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Our critical accounting policies, judgments and estimates are disclosed in our 2021 Annual Report on Form 10-K, as filed with the SEC. There have been no significant changes to these policies during the nine months ended September 30, 2022. ACCOUNTING PRONOUNCEMENTS For a summary of recent accounting pronouncements applicable to our condensed consolidated financial statements, refer to Note 2 to the Condensed Consolidated Financial Statements in Item 1, which is incorporated herein by reference. RESULTS OF OPERATIONS Net RevenueThree Months Ended Nine Months Ended (in thousands, except September 30, September 30, percentages) 2022 October 1, 2021 Change 2022 October 1, 2021 Change Appliance and integration $ 116,441 $ 91,853 $ 24,58827 % $ 351,293 $ 250,427 $ 100,86640 % as % of total net revenue 75 % 73 % 76 % 71 % SaaS and service 39,297 34,468 4,829 14 % 109,330 100,918 8,412 8 % as % of total net revenue 25 % 27 % 24 % 29 % Total net revenue $ 155,738 $ 126,321 $ 29,41723 % $ 460,623 $ 351,345 $ 109,27831 % 21
-------------------------------------------------------------------------------- Table of Contents Appliance and integration net revenue increased in the three and nine months ended
September 30, 2022, compared to the corresponding periods in 2021, primarily due to an increase in our Broadband segment net revenue as a result of increased penetration of existing Broadband customers and new Broadband customer deployments.
SaaS and Services net revenue increased in the three and nine months ended
Gross Profit Three Months Ended Nine Months Ended (in thousands, except September 30, September 30, percentages) 2022 October 1, 2021 Change 2022 October 1, 2021 Change Gross profit
$ 78,604 $ 66,154 $ 12,45019 % $ 230,187 $ 181,804 $ 48,38327 % as % of total net 50 % 52 % (2) % 50 % 52 % (2) % revenue ("gross margin") Our gross margins are dependent upon, among other factors, the proportion of software sales, product mix, supply chain impacts, customer mix, product introduction costs, price reductions granted to customers and achievement of cost reductions.
Our gross margin decreased in the three and nine months ended
Research and development costs
Three Months Ended Nine Months Ended (in thousands, except September 30, September 30, percentages) 2022 October 1, 2021 Change 2022 October 1, 2021 Change Research and development
$ 30,466 $ 26,552 $ 3,91415 % $ 89,219 $ 74,863 $ 14,35619 % as % of total net revenue 20 % 21 % 19 % 21 % Our research and development expenses consist primarily of employee salaries and related expenses, contractors and outside consultants, supplies and materials, equipment depreciation and facilities costs, all of which are associated with the design and development of new products and enhancements of existing products. The research and development expenses are net of French research and development credits. Research and development expenses increased in the three and nine months ended September 30, 2022, compared to the corresponding periods in 2021, primarily due to higher employee compensation costs as a result of headcount increases and annual compensation adjustments.
Selling, general and administrative expenses
Three Months Ended Nine Months Ended September 30, September 30, (in thousands, except percentages) 2022 October 1, 2021 Change 2022 October 1, 2021
Selling, general and administrative
$ 36,379 $ 34,231 $ 2,1486 % $ 109,790 $ 102,728 $ 7,0627 % as % of total net revenue 23 % 27 % 24 % 29 % Selling, general and administrative expenses increased in the three and nine months ended September 30, 2022, compared to the corresponding periods in 2021, primarily due to higher employee compensation costs as a result of headcount increases and annual compensation adjustments.
Amortization of intangible assets
Three Months Ended Nine Months Ended (in thousands, except September September 30, October 1, percentages) 30, 2022 October 1, 2021 Change 2022 2021 Change
Amortization of intangibles $ - $ - $ - n/a $ -
$ 507 $ (507)(100) %
Intangible asset amortization expense decreased in the nine months ended
22 -------------------------------------------------------------------------------- Table of Contents Restructuring and Related Charges We have implemented several restructuring plans in the past few years. The goal of these plans is to bring operational expenses to appropriate levels relative to our net revenues, while simultaneously implementing extensive company-wide expense control programs. We account for our restructuring plans under the authoritative guidance for exit or disposal activities. The restructuring and related charges are included in "Cost of revenue" and "Operating expenses-restructuring and related charges" in the Condensed Consolidated Statement of Operations. Three Months Ended Nine Months Ended September 30, October 1, (in thousands, except percentages) 2022 October 1, 2021 Change September 30, 2022 2021 Change Cost of revenue $ (9) $ -
$ (9)n/a $ 91 $ 346 $ (255)(74) % Operating expenses Restructuring and related charges 335 - 335 n/a 2,136 43 2,093 4,867 % Total restructuring and related charges $ 326$ - $ 326n/a $ 2,227 $ 389 $ 1,838472 % Restructuring and related charges increased in the three and nine months ended September 30, 2022, compared to the corresponding periods in 2021, primarily due to higher severance and employee benefit costs recorded in conjunction with restructuring activities in fiscal 2022, including the impact of ceasing operations in Russia. Interest Expense, Net Three Months Ended Nine Months Ended (in thousands, except September 30, October 1, September 30, October 1, percentages) 2022 2021 Change 2022 2021 Change
Interest expense, net
Interest expense, net decreased in the three and nine months ended
September 30, 2022, compared to the corresponding periods in 2021, primarily due to the adoption of ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity's Own Equity, on January 1, 2022, which eliminated debt discounts on the 2022 Notes and 2024 Notes resulting in an elimination of debt discount amortization expense. Refer to Note 2 of the Notes to our Condensed Consolidated Financial Statements for details of the ASU adoption. Other Income (Expense), Net Three Months Ended Nine Months Ended (in thousands, except October 1, October 1, percentages) September 30, 2022 2021 Change September 30, 2022 2021 Change Other income (expense), net $ (118) $ (213) $ 95(45) % $ 4,218 $ 659 $ 3,559540 % Other income (expense), net is primarily comprised of foreign exchange gains and losses on cash, accounts receivable and intercompany balances denominated in currencies other than the functional currency of the reporting entity. Change in other income (expense), net in the three months ended September 30, 2022, compared to the corresponding period in 2021, was primarily due to foreign currency exchange losses resulting from the fluctuation of the Euro against the U.S.dollar. Change in other income (expense), net in the nine months ended September 30, 2022, compared to the corresponding period in 2021, was primarily due to a gain of $4.2 millionrecorded on the sale of our investment in Encoding.com in May 2022. Refer to Note 3 of the Notes to our Condensed Consolidated Financial Statements for details on the sale of investments in Encoding.com. 23 --------------------------------------------------------------------------------
Table of Contents Income Taxes Three Months Ended Nine Months Ended (in thousands, except October 1, September 30, October 1, percentages) September 30, 2022 2021 Change 2022 2021 Change Provision for income taxes
$ 1,282 $ 942 $ 34036 % $ 7,098 $ 3,006 $ 4,092136 % The provision for income taxes increased during the three and nine months ended September 30, 2022, compared to the corresponding periods in 2021. The increase was largely driven by the mandatory capitalization and amortization of research and development expenses in the United Statesstarting January 1, 2022, as required by the Tax Cuts and Jobs Act, which results in additional income tax expense in the United States. In addition, there was an increase in foreign income in 2022 which resulted in additional foreign income tax. Segment Financial Results Three Months Ended Nine Months Ended (in thousands, except September 30, September 30, percentages) 2022 October 1, 2021 Change 2022 October 1, 2021 Change Video Revenue $ 63,824 $ 68,729 $ (4,905)(7) % $ 205,881 $ 202,415 $ 3,4662 % as % of total revenue 41 % 54 % (13) % 45 % 58 % (13) % Gross profit 37,859 42,534 (4,675) (11) % 124,679 118,879 5,800 5 % Gross margin % 59 % 62 % (3) % 61 % 59 % 2.0 % Operating income 2,907 7,904 (4,997) (63) % 17,317 13,235 4,082 (31) % Operating margin % 5 % 12 % (7) % 8 % 7 % 1 % Broadband Revenue $ 91,914 $ 57,592 $ 34,32260 % $ 254,742 $ 148,930 $ 105,81271 % as % of total revenue 59 % 46 % 13 % 55 % 42 % 13 % Gross profit 41,343 24,165 17,178 71 % 107,290 65,111 42,179 65 % Gross margin % 45 % 42 % 3 % 42.1 % 44 % (1.9) % Operating income 15,303 3,903 11,400 292 % 33,573 10,191 23,382 229 % Operating margin % 17 % 7 % 10 % 13 % 7 % 6 % Total Revenue $ 155,738 $ 126,321 $ 29,41723 % $ 460,623 $ 351,345 $ 109,27831 % Video Our Video segment net revenue decreased during the current three-month period, primarily due to a reduction in sales of Appliance products. Net revenue increased during the current nine-month period, primarily due to growth in SaaS and Appliance products, partially offset by the timing of a few broadcast projects and the impact of ceasing sales activities in Russia. Video segment operating margin decreased during the current three-month period, primarily due to near-record video segment margins generated in the comparative period, due to favorable software mix. Operating margin increased during the current nine-month period mainly due to higher revenue and margin expansion in SaaS and Appliance.
Our Broadband segment’s net revenues increased in the current three- and nine-month periods, primarily due to increased penetration of our existing broadband customers and deployments of new broadband customers. Our Broadband segment’s operating margin increased in the current three- and nine-month periods, primarily due to revenue growth and margin expansion.
24 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources We expect to continue to manage our cash from operations effectively, together with deploying cash in working capital for growth. The cash we generate from our operations enables us to fund ongoing operations, our research and development projects for new products and technologies, working capital and other business activities. We continually evaluate our cash needs and may decide it is best to raise additional capital or seek alternative financing sources to fund our operations, the growth of our business, to take advantage of unanticipated strategic opportunities, or to strengthen our financial position, including through drawdowns on existing or new debt facilities or new financing (debt and equity) funds. In the future, we may enter into other arrangements for potential investments in, or acquisitions of, complementary businesses, services or technologies, which could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. Conversely, we may also from time to time determine that it is in our best interests to voluntarily repay certain indebtedness early. We believe that our current sources of funds will provide us with adequate liquidity during the 12-month period following
September 30, 2022, as well as in the long-term.
Material cash needs
Our principal uses of cash will include repayments of debt and related interest, purchases of inventory, payroll, restructuring expenses, and other operating expenses related to the development and marketing of our products, purchases of property and equipment and other contractual obligations for the foreseeable future. As of
September 30, 2022, we had outstanding $167.7 millionin aggregate principal amount of indebtedness, consisting of our 2022 Notes, 2024 Notes, and other debts, of which $42.1 millionis scheduled to become due in the 12-month period following September 30, 2022. As of September 30, 2022, our total minimum lease payments are $37.8 million, of which $1.7 millionis due before December 31, 2022. On February 3, 2022, the Board of Directors authorized us to repurchase, from time to time, up to $100 millionof our outstanding shares of common stock through February 2025, at such time and such prices as management may decide. The program does not obligate us to repurchase any specific number of shares and may be discontinued at any time.
Liquidity sources and conditions
Our sources of funding for our significant cash requirements are primarily from our sales of our products and services and, where applicable, proceeds from credit facilities and debt and equity issuances.
September 30, 2022, our principal sources of liquidity consisted of cash and cash equivalents of $105.3 million, accounts receivable, net, of $105.6 million, and our $25.0 millionrevolving credit facility with JPMorgan Chase Bank, N.A. The Credit Agreement was renewed in October 2022. Refer to Note 13 of the Notes to our Condensed Consolidated Financial Statements for details on the renewal of the Credit Agreement. Our cash and cash equivalents of $105.3 millionas of September 30, 2022consisted of bank deposits held throughout the world, of which $69.6 millionwas held outside of the United States. At present, such foreign funds are considered to be indefinitely reinvested in foreign countries to the extent of indefinitely reinvested foreign earnings. In the event funds from foreign operations are needed to fund cash needs in the United Statesand if U.S.taxes have not already been previously accrued, we may be required to accrue and pay additional U.S.and foreign withholding taxes in order to repatriate these funds.
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