Harmonic Inc. (NASDAQ:HLIT) Q4 2022 Earnings Call Transcript

Harmonic Inc. (NASDAQ:HLIT) Q4 2022 Earnings Call Transcript January 30, 2023

Operator: Welcome to the Q4 and Full Year 2022 Harmonic Earnings Conference Call. My name is Latif and I will be your operator for today’s call. Please note that this conference is being recorded. I will now turn the call over to David Hanover, Investor Relations. David, you may begin.

David Hanover: Thank you, operator. Hello, everyone and thank you for joining us today for Harmonic’s fourth quarter and full year 2022 financial results conference call. With me today are Patrick Harshman, President and Chief Executive Officer; and Sanjay Kalra, Chief Financial Officer. Before we begin, I’d like to point out that in addition to the audio portion of the webcast, we have also provided slides for this webcast, which you may view by going to our webcast on our Investor Relations website. Now going to Slide 2. During this call, we will provide projections and other forward-looking statements regarding future events or future financial performance of the company. Such statements are only current expectations and actual events or results may differ materially.

We refer you to documents Harmonic filed with the SEC, including our most recent 10-Q and 10-K reports and the forward-looking statements section of today’s preliminary results press release. These documents identify important risk factors, which can cause actual results to differ materially from those contained in our projections or our forward-looking statements. And please note that unless otherwise indicated, the financial metrics we provide you on this call are determined on a non-GAAP basis. These metrics, together with corresponding GAAP numbers and a reconciliation to GAAP, are contained in today’s press release, which we have posted on our website and filed with the SEC on Form 8-K. We will also discuss historical financial and other statistical information regarding our business and operation and some of this information is included in the press release.

The remainder of the information will be available on a recorded version of this call or on our website. And now, I will turn the call over to our CEO, Patrick Harshman. Patrick?

Patrick Harshman: Well, thanks, David and welcome everyone to our fourth quarter call. In the fourth quarter, Harmonic closed out 2022 with another period of excellent results. Revenue was a record $164 million, EPS was $0.17 and adjusted EBITDA margin was over 16% as both business segments were again solidly profitable. Our broadband segment grew revenue 38% year-over-year and contributed EBITDA margin of 21%. Video segment transformation continues with fourth quarter SaaS revenue of 51% year-over-year and segment EBITDA margin over 9%. This impressive fourth quarter and full year results demonstrates the tremendous market success and execution momentum we are carrying into 2023. We are entering the year with strong demand, unique technology and competitive differentiation and continuing confidence in our ability to deliver on the multiyear growth plan we outlined in our September 2022 Analyst Day.

Now taking a closer look first at our broadband segment, we again delivered excellent financial results that reflect both a healthy broadband market and expanding breadth and depth of our technology leadership position. Segment revenue was $96 million, up 4% sequentially and 38% year-over-year. Segment gross margin was over 47% and adjusted segment EBITDA margin was 21%, demonstrating consistently improving operating leverage. Sensing the worst of the supply chain disruption risks are behind us, some customers slowed orders as a step towards normalizing advanced purchase lead times. Nonetheless, we again exited the quarter with near-record backlog and deferred revenue. Our sustained broadband growth is a result of both the robust end market and strong go-to-market and project execution.

The quarter end modem served grew to $15.2 million, up 218% year-over-year. And we again added several new customers during the quarter, bringing the number deploying our solution to 91, up 25% year-over-year. Among these new wins is our first Asia-Pacific Tier 1 operator an account we expect to begin to scale in 2023. Looking ahead, we are confident about both our 2023 and multiyear growth prospects. Our global pipeline of new account relationships is excellent, aided by growing industry recognition of our technology and deployment execution leadership. Two areas of rapidly expanding leadership to highlight are DOCSIS 4.0 and Fiber-on-Demand. In the DOCSIS 4.0 area, we have made great strides with both variants of the standard, ESD and FDX and we are actively supporting on customers in advanced demonstrations and trials of these technologies.

In the fiber area, our converged PON plus DOCSIS solution is unique and gaining increasing recognition from both existing and prospective customers as a powerful competitive advantage. Although we only recorded modest fiber revenue in 2022, we are entering 2023 with several new design wins, good order backlog and a trajectory that is in line with our 2025 fiber growth target. Regarding 2023, more generally, the full year growth outlook that Sanjay will share momentarily is supported by our year end backlog, deferred revenue and the existing plans of our current customers with only very modest contribution assumed from new accounts. To be clear, we are confident about winning new accounts in 2023, both large and small. And for now, we are conservatively assuming these new wins will drive significant revenue and growth starting in 2024 and beyond, supporting our multiyear growth targets.

As a reminder, in our mid-September Analyst Day, we laid out an aggressive 3-year growth plan that calls for over $820 million of revenue and 28% EBITDA margin in 2025 as we closed a very successful 2022 and head into 2023. We are pleased with our continued financial execution. We are excited about our increasingly strong technology and leadership position in the market and we are confident in our ability to continue to execute our overall strategic plan. Turning now to our video segment. Here also, we delivered an excellent quarter. Fourth quarter segment revenue was $68.3 million, up 7% sequentially, although down 21% year-over-year when compared to an extraordinarily strong fourth quarter in 2021. SaaS transformation execution continues to be the highlight, with record quarterly revenue of $10.5 million, up 51% year-over-year.

As a result, quarterly gross margin was 59.9%, also up year-over-year and adjusted segment EBITDA margin was over 9%. Full year segment gross profit and adjusted EBITDA margin finished ahead of the guidance we provided at the beginning of the year despite the loss of business in Russia and Ukraine, an encouraging result. As you will recall from our September Analyst Day, our video business strategy has two pillars: taking a leading position in the growing streaming SaaS market, particularly for live sports and maximizing profit from the traditional video appliance market with a financial focus on gross profit and EBITDA. Our full year 2022 results are fully in line with our longer-range projections and support our continued confidence in the execution of this plan.

Our streaming SaaS growth was again driven principally by larger media accounts expanding their consumer footprints and live sports content rights and correspondingly expanding consumption of our servers. The World Cup was a notable international success in the fourth quarter and SaaS usage exceeded our expectations and feedback on the quality of service we delivered was excellent. During the quarter, we also again secured several new SaaS contracts, including for Blue Chip North America Sports Services that will launch later this year. We continue to see live sports streaming and the movement of legacy broadcast workflows to the cloud is attractive and growing opportunities. And with our recent successes, our brand and technology leadership in high-quality streaming is strengthened.

While SaaS transformation continues to be the headline, our video client sales pipeline remains solid, including in Europe, where we are pleased to say we are not seeing an impact from macroeconomic headwinds. Putting it altogether, we remain confident that our transformation in video to consumption-driven streaming SaaS is working and we are on track to achieve the targets we laid out for you in our September Analyst Day. As a reminder, this plan calls for greater than 45% compounded annual SaaS growth through 2025, consistent profitability and return to mid-teens EBITDA segment margin. Our full year 2022 video segment results, the high-profile streaming services we are now powering and the new wins we have recently secured and our full year 2023 guidance, all demonstrate we remain on track to achieve these objectives.

And with that, Sanjay let me turn it over to you for further discussion of our results and our outlook.

Sanjay Kalra: Thanks, Patrick and thank you all for joining us today. Before I discuss our quarterly and annual results as well as our outlook, I’d like to remind everyone that the financial results I’ll be referring to are provided on a non-GAAP basis. As David mentioned earlier, our Q4 press release and earnings presentation includes reconciliations of the non-GAAP financial measures to GAAP that are discussed on this call. Both of these are available on our website. We finished the year delivering another quarter of strong financial results and our strong balance sheet at year-end positions us well for continued growth in 2023. Before reviewing our quarterly financials in more detail, I’ll briefly review the Q4 and full year 2022 key highlights here on Slide 7.

For the fourth quarter, we reported record revenue of $164.3 million, with strong gross margins of 52.7%. We also generated strong adjusted EBITDA of 16.2% and EPS of $0.17. Our balance sheet remains solid, ending 2022 with a cash balance of $89.6 million while reducing convertible debt by $37.7 million. For the full year 2022, our total revenue was a record $625 million, up 23% as broadband revenue increased over 60% and video SaaS revenue increased 63% year-over-year. Adjusted EBITDA of $86.5 million, increased over 50% year-over-year. Diluted EPS increased 62% to $0.55. We exited the year with near record backlog and deferred revenue of $457.1 million. Now, let’s review our fourth quarter financials in detail. Turning to Slide 8, again, total Q4 revenue was $164.3 million, up 5.5% on both a sequential basis and year-over-year basis.

Looking first at our broadband business segment, Q4 revenue was $96 million, up 4.5% sequentially and 37.7% year-over-year, reflecting continued current customer ramp up and newer customer launches, including modest fiber revenue generated during the quarter. In our video segment, we reported Q4 revenue of $68.3 million, up 7% sequentially and down 20.7% year-over-year, with the comp being a very strong Q4 2021. Our video revenue included SaaS revenue of $10.5 million, up 51.3% from prior year, once again ahead of our expectations. We had one customer representing greater than 10% of total revenue during the quarter. Total Comcast Corporation contributed 48% of total revenue. Total company gross margin was 52.7% for Q4 €˜22, up 180 basis points sequentially and 220 basis points year-over-year, reflecting increased gross margins in both of our business segments.

Broadband gross margin was 47.6% for Q4, up 260 basis points sequentially and 730 basis points year-over-year. This improvement was due to several factors, including a favorable products and services mix, which included high margin non-recurring services, our strategic inventory investments in 2022, modest improvement in freight rates and improved pricing. Video segment gross margin was 59.9% in Q4 €˜22, up 60 basis points sequentially and 110 basis points year-over-year. We have seen a strong overall gross margin improvement over the past 2 years as Q4 video gross margins have risen 370 basis points from 2020 and 110 basis points from 2021 respectively primarily due to SaaS continuing to scale. Moving down to the income statement on Slide 9, Q4 operating expenses were $63 million, up 3.2% sequentially and 8.5% year-over-year.

The increases were primarily due to increased research and development to support the growth of our broadband business and the ongoing strategic transition of video segment to SaaS. Adjusted EBITDA for Q4 €˜22 was $26.6 million or 16.2% of revenue, up 88 basis points versus Q4 €˜21, comprised of $20.2 million from broadband, representing 21% of segment revenue and $6.4 million from video, representing 9.3% of segment revenue. This all translated into Q4 EPS of $0.17 per share compared to $0.13 per share in Q3 €˜22 and $0.16 per share for Q4 €˜21. We ended the quarter with calculated diluted weighted average share count of 117.3 million compared to 113.2 million in Q3 €˜22 and 110.5 million in Q4 €˜21. The sequential increase is primarily due to the issuance of shares for settlement of the premium for convertible debt conversions upon maturity in December and an increase in outstanding convertible debt dilution and the dilutive effect of outstanding RSUs and options resulting from the increase in our average stock price during the quarter.

Turning now to the order book, we reported new December bookings of $130.2 million. The book-to-bill ratio was 0.8% for the fourth quarter, which was in line with our expectations. For Q3 €˜22 and Q4 €˜21, our book-to-bill ratios were 1.1% and 1.7%, respectively, which is higher than what we have seen historically. That’s because in the past few quarters, some customers ordering patterns were affected by the challenging supply chain landscape. As supply chain conditions improved, we expected this ratio to normalize and approach the historical benchmark. Consistent with that, our book-to-bill ratio for the full year was 1.04%. Turning to the balance sheet on Slide 10, we ended Q4 with cash of $89.6 million compared to $105.3 million at the end of Q3 €˜22 and $133.4 million in Q4 last year.

The net $15.7 million sequential decrease was primarily due to a cash payment of $37.7 million for the principal of maturing convertible debt. You may recall, we mentioned December €˜22 debt maturities on our last earnings call. We generated $19.4 million cash from operations, net of investing $19.5 million in inventory. Increased inventory has, by design, enabled us to meet strong demand for our products and to proactively manage our supply chain, enhance product availability and provide us with flexibility to use a higher mix of ocean freight rather than air freight, resulting in improved gross margins. As noted earlier, these investments helped drive the gross margin expansion we reported for the quarter. We also used $1.9 million of cash in purchase of fixed assets and saw a favorable foreign exchange rate impact of $4.9 million.

Turning to days sales outstanding at the end of Q4, DSO was 59 comparable to previous quarter and previous year period. Days inventory on hand was 140 days at the end of Q4, up 20% compared to the end of Q3 €˜22 and up over 50% compared to end of Q4 €˜21. The increase reflects our continued proactive investment in inventory as we prepare for strong shipments growth during 2023. Regarding capital allocation, our top priority is driving our future growth. As such, we will continue to strategically invest in building inventory to meet the strong demand we are seeing. This strategy has proven highly successful to-date as demonstrated by our revenue and gross margin results for Q4. Having said that, should the supply chain situation improve considerably, we have the optionality to manage our working capital differently and generate additional cash by keeping lower inventory levels.

Along those lines, our capital allocation strategy also considers returning capital to shareholders through share repurchases. The timing and amount of any repurchases will depend on variety of factors, including the price of Harmonic’s common stock, market conditions, corporate needs and regulatory requirements. This balanced capital allocation strategy also takes into account anticipated future debt obligations as well as our current debt repayment of $37.7 million in December 2022. At the end of Q4, total backlog and deferred revenue was $457.1 million. This large backlog and deferred revenue reflects strong demand from our large broadband customers and growing video SaaS commitments. Note that approximately 80% of our backlog and deferred revenue has customer request days for shipments of products and providing services within the next 12 months.

As mentioned on previous calls, not included in our backlog is additional contractually agreed CableOS business with two of our initial Tier 1 broadband customers. At the end of Q4 €˜22, this incremental amount was approximately $47 million, down from $60 million last quarter as approximately $13 million went through purchase order process and therefore, moved into bookings. So in summary, operating cash flow was strong in Q4 €˜22, consistent with our capital allocation strategy I discussed earlier. Our free cash was invested in inventory to meet demand and support growth as well as for debt repayment. I’ll now review our non-GAAP guidance for 2023, beginning on Slide 11. For the full year 2023 based on our progress to date, we expect broadband to achieve revenue between $445 million to $465 million, a 30% increase at the midpoint, based on the strong demand trends we continue to see.

This guidance includes revenue from existing Tier 1 customers and does not include significant revenue from potential Tier 1 customer wins in our pipeline: gross margins between 45% to 46%, a 190 basis point improvement over 2022 based on assumed hardware and software mix, that is typical of what we have seen over the past 18 months, operating expenses between $120 million to $123 million, adjusted EBITDA between $86 million to $97 million. For full year €˜23, video segment results we expect revenue in the range of $250 million to $270 million, gross margins range of 58.5% to 60.5%, operating expenses $140 million to $144 million, adjusted EBITDA, $12 million to $25 million. For total company for the full year €˜23, we expect revenue in the range of $695 million to $735 million; gross margins in the range of 49.8% to 51.3%, operating expenses in the range of $260 million to $267 million, adjusted EBITDA in the range of $98 million to $122 million.

An effective tax rate of 20%, up from 13% last year as we have exhausted our NOLs in the past year. A weighted average diluted share count of approximately 118.3 million. Please note that the convertible debt-related dilution included in our share count uses the average stock price for the last 90 days, which was approximately $14. As a reminder, the share count figure utilized in our dilution calculation will change depending on the stock price movement. For those modeling this, consider as an example that currently, an increase in our stock price by $1 would increase dilution by only approximately 400,000 shares. Inversely, a decrease in our stock price by $1 would decrease dilution by approximately 900,000 shares, EPS range from $0.56 to $0.72 per share, subject to the just mentioned dilution calculation.

Cash at the end of €˜23 is expected to come between $90 million to $100 million. Now on Slide 12, I’ll review the non-GAAP guidance for the first quarter of 2023. For Broadband segment in Q1, we expect revenue in the range of $97 million to $102 million; gross margins, 45% to 46%; operating expenses, $29 million to $30 million, adjusted EBITDA of $16 million to $18 million. For our video segment in Q1, we expect revenue in the range of $55 million to $60 million, gross margins, 58% to 59%; operating expenses, $35 million to $36 million; adjusted EBITDA in the range from a loss of $2 million to a profit of $1 million. For total company for first quarter of €˜23, we expect revenue in the range of $152 million to $162 million, gross margins, 49.7% to 50.8%; operating expense is $64 million to $66 million; adjusted EBITDA, $14 million to $19 million; effective tax rate of 20%; a weighted average diluted share count of approximately $117.9 million; and EPS to range from $0.07 to $0.10; cash to range from $75 million to $85 million.

In summary, during the fourth quarter, we continued to execute and drive strong growth in our broadband segment while advancing the strategic transformation of our video segment. We ended the fourth quarter with a strong backlog and deferred revenue position. We believe this and the strong demand we continue to see from both our new and existing customers positions us well for 2023 as we continue to execute on our long-term business plan. Thank you, everyone, for your attention today. And now I’ll turn it back to Patrick for final remarks before we open up the call for questions.

Patrick Harshman: Well, thanks, Sanjay. So in summary, we delivered a record of 2022, ahead of our initial targets through continued focused execution of our strategic plan, our technology, our customer relationships and our people are all extraordinary and working extraordinarily well together, pointing to compelling value creation, opportunities we’re determined to take full advantage of. We’re excited and confident about 2023 and the longer-range future of our business, and we appreciate your continued support. With that, let’s now open up the call for questions.

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Q&A Session

Operator: Our first question comes from the line of Simon Leopold of Raymond James. Your line is open, Simon.

Simon Leopold: Great. Thanks for taking the question. I’ve got two, one on each segment. I want to start out asking about the 2023 outlook for the video segment, which is a little bit lower than the 2022 sales. And as I recall, the outlook you gave us for 2025 reflected some modest growth. And so I would like to get an understanding of whether or not that long-term 2025 outlook has changed or what factors are leading to the 2023 decline versus 2022, specifically to the video segment? And then I’ve got a follow-up on broadband.

Patrick Harshman: Okay. Well, thank you, Simon. I’ll take the first one. The outlook for 2025 has absolutely not changed at all. We’re seeing somewhat faster transition to SaaS. And in particular, some of the new wins will not materialize as revenue until later this year. I mentioned in the prepared remarks, we had a couple of very significant new sports wins. If it was traditional appliance business, we would have recognized that revenue kind of immediately upon booking and shipping of appliances. But as with the way SaaS works. We will only start recognizing that revenue as the services themselves or launch the natural consumption happens. So in short, the plan is fully on target. In fact, if anything, we see sands moving a little bit ahead of plan.

You’ll note that the gross margin actually evolution is a little bit ahead of plan. And the slight movement in revenue would actually review favorable as it reflects quicker success around movement to SaaS than we anticipated even 6 months ago.

Simon Leopold: Great. Thank you for that. And then I guess, I’m struggling with how to ask about the Broadband segment. But I’m trying to understand what’s built into your assumptions in terms of incremental contributions from Tier 1 cable operators and how you envision your customer concentration evolving? I guess I’m sort of struggling with maybe the timing and the extent of what’s baked into the numbers versus what you have yet to secure hopefully, you can maybe understand that and drill into that a little bit for us?

Patrick Harshman: Yes. Well, it’s a little tricky for us as well, as you might imagine and so in fact kind of led to our decision at the risk of being too conservative to just kind of cut it black and white. The guidance we’ve given you excludes new Tier 1s that we’re quite optimistic about bringing on board. The issue is until we bring them on board and until we have visibility to the timing and the impact of the initial orders, it’s premature for us to put it in the guidance. I think the good news is, therefore, that we’ve given you guidance that is based almost exclusively on the activity around our existing customer base and put that together with our high confidence and being able to bring on new Tier 1 customers, we feel that really underlines our confidence in our 2024 and 2025 targets.

Now look, if we get in a position where we can confirm additional Tier 1s, and we further confirm that they’ll have a meaningful incremental impact for us in 2023. We will update our 2023 guidance accordingly. But frankly, stepping back and looking at the big picture, that’s not nearly as consequential as from our perspective is, number one, winning those accounts; and number two, having them firmly in the pipeline. Indeed, as you kind of allude to, further diversifying the customer base in 2024 and 2025.

Simon Leopold: Thank you very much for taking the questions.

Patrick Harshman: Thank you.

Operator: Thank you. Our next question comes from the line of Steve Frankel of Rosenblatt. Your question please, Steve.