Harmonic Inc.
Q4 2020 Earnings Call Transcript

Published: 1 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Q4 2020 Harmonic Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please note that this conference is being recorded. I would now like to hand the conference over to your speaker for today, David Hanover, Investor Relations. Sir, you may begin.

[David Hanover:]

Thank you, Towanda. Hello, everyone, and thank you for joining us today for Harmonic's Fourth Quarter 2020 Financial Results Conference Call. With me today are Patrick Harshman, President and Chief Executive Officer; and Sanjay Kalra, Chief Financial Officer.

[Patrick Harshman:]

Thanks, David, and welcome, everyone, to our fourth quarter call. Harmonic delivered a strong fourth quarter with record new bookings, sequential quarterly and year-over-year revenue growth and earnings and cash generation that exceeded expectations. Both our Cable Access and Video segments contributed meaningfully to these results. For Cable Access, financial success is being driven by scaling existing customers and by continued new customer wins. For Video business, demand for both innovative new broadcast and streaming solutions resulted in our strongest revenue quarter in two years. Big picture. Looking back on 2020, Harmonic responded incredibly well to unexpected challenges and opportunities, demonstrating the transformative value of our newer solutions, the depth of our customer relationships and the extraordinary capabilities of our global team. Despite continuing pandemic challenges, our businesses exiting the year with strong market momentum, record backlog and deferred revenue, and a solid plan for growth and value creation.

[Sanjay Kalra:]

Thanks, Patrick, and thank you all for joining us today. Before I discuss our quarterly results and outlook, I'd like to remind everyone that the financial results I'll be referring to are provided on a non-GAAP basis.

[Patrick Harshman:]

Okay. Thank you, Sanjay. We want to conclude by summarizing our strategic priorities for the year. For Cable Access business, our objectives are accelerated expansion of existing Tier 1 deployments, entering new global operators, particularly additional Tier 1s, and expanding our addressed market through CableOS's new fiber-to-the-home capabilities. For our Video segment, our objectives are accelerating the growth of our streaming and SaaS customer base, capitalizing on the coming transformation of traditional media and broadcast infrastructure globally and delivering both top and bottom line growth. Putting it all together, we aim to create value to deliver industry-leading solutions and to enable superior subscriber experiences worldwide. And finally, I want to recognize and thank everyone who hung with us through a crazy year, our exceptional employees, our customers and our stockholders. Your support has been essential. Let's now open up the call for questions.

[Operator:]

Thank you. Our first question comes from the line of Simon Leopold with Raymond James. Your line is open.

[Simon Leopold:]

A couple of things I wanted to ask about. The first one is just getting a better understanding of what's driving the increased operating expenses in the 2021 forecast. I guess when I look back at 2018, 2019, you held spending pretty stable below $200 million for the year, and then we understand why 2020 would have been down. So what kind of assumptions are you making in terms of the sort of recovery of travel expenses and a normalization as opposed to investment in new initiatives, expanding the sales force, things like that. Just if you could help us bridge the OpEx forecast? And then I've got a follow-up.

[Sanjay Kalra:]

Sure, Simon. This is Sanjay. Sorry, I was on mute. As I mentioned in my prepared remarks, we are planning to increase our sales and marketing expenses as well as we are working on expanding our customer base. And together with that, we are increasing our R&D expense, primarily for Cable Access segment, and both of these initiatives are a significant factor of why the OpEx is increasing. And at the same time, we are seeing some benefit of saving in travel as well, as you mentioned. Our travel expenses are lower in -- we experienced lower in '20 compared to last year, but that's kind of a benefit. But overall, I think it's mainly driven by increase of our sales and marketing expenses and R&D.

[Simon Leopold:]

And then one of the topics, I haven't really heard you guys talk much about is the RDOF government funding program. I imagine that, that could present some incremental opportunities. Just if you could maybe elaborate on how you would think about that as an opportunity for incremental revenue for Harmonic?

[Patrick Harshman:]

Hi, Simon, Patrick here, I'll take that. We do see it as an incremental opportunity. In fact, what we talk a lot about Tier 1s with CableOs. As you've seen from various press releases, et cetera, we've had a fair amount of success with the other end of the market, the smaller cable operators, the so-called Tier 2 and Tier 3. You may recall that we signed a pretty significant agreement with the National Cable Television Cooperative, the NCTC, a year or so ago to actually cooperate and bringing CableOS to that part of the market. And indeed, that's where a lot of the RDOF stuff is going to happen. And so both our existing relationships around our existing CableOS platform as well as are now coming for way into fiber-to-the-home, we think will be advantageous. That being said, we're not prepared to wrap a number around that. It's still an emerging opportunity. So, I'd say watch this space, and we'll continue to communicate with you as it takes more shape. But it's definitely something that is on our radar screen and does present an opportunity.

[Simon Leopold:]

And maybe just to level set folks, even if you were to win opportunity, I presume that wouldn't really contribute until 2022. Is that a reasonable assumption?

[Patrick Harshman:]

We don't have a significant RDOF of revenue built into the guidance that we've just provided. I wouldn't preclude the opportunity of upside there. But yes, by and large, our thinking is that, that is -- I think wins can be happening this year, but our assumption is most of the revenue would start to flow the following year.

[Operator:]

Thank you. Our next question comes from the line of Rich Valera with Needham & Company. Your line is open.

[Rich Valera:]

Question on the video business. Looks like you had really strong rev rec from your sort of wave one win for re-banding. It looks like you're expecting that to be down in the first quarter. Wondering how you're thinking about that for the balance of the year? I'm assuming you expect that to be up in 2Q? And do you expect any of that engagement to flow into the second half as well? And then kind of as a follow-up to that, how are you doing on pursuing kind of Wave 2 opportunities for re-banding? And do you think there's the chance you could land something on the Wave 2 side in the first half of the year or this year, how you -- just how you're thinking about Wave 2 and how that pipeline looks?

[Patrick Harshman:]

Okay. Rich, I'll take a swing at it and Sanjay, please –feel free to fill in any blanks. The first piece of business that we've won, we do expect additional revenue to be recognized in both Q1 and Q2. We expect the totality of what was originally run last year to be recognized by the end of the second quarter. There is a significant and, in fact, growing pipeline of additional opportunities that we are actively pursuing. Our objective is to be awarded additional projects during this year. It remains possible, if not likely that we'll see additional revenue this year. Certainly, we are targeting additional revenue in 2022. So this is an opportunity that specifically focused on 5G continues to look attractive to us. That being said, if I can expand slightly, Rich, we're seeing some pretty interesting, I'd say, knock-on effects from this whole thing. The combination of the success of the auction and the innovation we're bringing around solutions to not only compress things in satellite, but actually to bring some of that content onto fiber terrestrial IP networks. That's intriguing for operators that maybe even don't have a media pressure because of the whole bandwidth reclamation thing. So this whole industry dynamic is getting a lot of attention and is indeed serving as a catalyst for a number of media companies to really rethink their media -- their distribution strategies. It's opening the door to a lot of conversations and into a wave of activity around traditional broadcast infrastructure that frankly has been kind of slow-moving over the last couple of years. So we're increasingly seeing this as less of a stand-alone distinct opportunity that's kind of one or two or three or four bullets, but more a catalyst for the overall industry to really rethink some fundamental architecture paradigms and opportunities going forward. It's tied intimately to the whole idea of moving to the cloud as well. So I think that somewhat long-winded answer, but there -- but I also -- I wanted to highlight that it's an evolving space, and it's is causing us to be incrementally more encouraged about spending around broadcast infrastructure in general.

[Rich Valera:]

Got it. So one final follow-up, if I could. And maybe this is diluted a bit by your statement there, and I appreciate the color on how that sort of -- that opportunity is sort of diversifying. But can you talk about what sort of baked into your initial Video guidance for '21 with respect to additional re-banding wins? You should have had wins baked in already? Or just wondering how we should think about that back half?

[Sanjay Kalra:]

Rich, we can't really specify what percentage we are baking in the guidance for any particular kind of an opportunity. That said, I just want to highlight that if you look at our total backlog and deferred revenue, it's a record this year. And it's comprising of not only Cable but it's Video, Cable, like all categories of revenue in all various streams, it's up year-over-year and quarter-over-quarter. And as I also mentioned, 80% to 90% does convert in one year. So we are feeling pretty good about the year how this whole deferred revenue is going to shape up and convert to revenue. And I think, yes, the question mainly was for SES, which we discussed. It tapers off later for H1. But I think we have a strong backlog which should get us to the year what we guided for.

[Operator:]

Our next question comes from the line of Samik Chatterjee with JP Morgan. Your line is open.

[Samik Chatterjee:]

Patrick, Sanjay, I just want to start off with a broader question about the strength in 2021. You, obviously, have strong backlog as well as contracted revenue. You're guiding to strong revenue growth. But I think Sanjay, in your prepared remarks, you just mentioned you feel like visibility into the full year is less than usual. I just wanted to see what's driving that comment? What's driving kind of the impression that either is it like customers are not willing to spend? Or are you more hesitant about their piece of spending? Just wanted to check on that.

[Sanjay Kalra:]

Yes. Samik, I would say that there is still limited visibility regarding the macroeconomic outlook for later part of this year. And it kind of also depends on what's the -- and what's the relevant impact of that on customers deployment plans and could there be shifts. So I think that was the main point of highlighting that the visibility for full year is less than normal. But otherwise, I think our backlog and deferred revenue stands and supports all what we want to accomplish next year.

[Samik Chatterjee:]

Okay. Okay, got it. And just a quick follow-up, Sanjay, I think this is also for you. When I look at gross margins, you're guiding to 54.5% at the high end for 2021. I know 2019 is probably not the best compared just given the software revenue you had, but 2018, you had done 54% gross margin at a lower revenue base. And I'm just wondering why isn't there more upside on the gross margin at the high end of the guide? Why isn't there more kind of leverage on that, just given the higher revenue guide versus 2018?

[Sanjay Kalra:]

So let me highlight one thing. Definitely, our gross margins are improving in both, but there is also a segment mix shift happening. Starting from '18, if you come to 2021, along the years, we have marched the path that our Cable revenue as a percentage of total revenue is increasing and both segments have different margin profiles. So from that perspective, we are getting to a margin of 54.5% overall combined for the Company. If you look at '18, it was primarily driven by Video, which is higher margin in Cable. So I think the segment mix should also be considered for the year-over-year gross margins.

[Samik Chatterjee:]

Okay. Good. Sanjay, just quickly, are there any supply chain constraints that are limiting factors on gross margin at all in 2021, anything on that aspect?

[Sanjay Kalra:]

No. They are not. We have planned appropriately for that. So we don't expect any supply chain issues to impact our performance execution for next year.

[Operator:]

Thank you. Our next question comes from the line of Steven Frankel for Colliers. Your line is open.

[Steven Frankel:]

Patrick, I would like to get a feel for where are we in the traditional Video business in this transition to SaaS. So have we seen the bottom in the perpetual business and maybe some -- just some commentary on how you see that mix playing out in '21?

[Patrick Harshman:]

Well, I think it's a good question. Its many ways is the right question, Steve. And the truth is, we don't have perfect visibility. I mean, just to take a step back, I think you know, but for the broader audience here. We've been -- on one hand, we've seen, as I mentioned a moment ago, kind of a stagnation of investment in traditional broadcast infrastructure really as many companies have tried to figure out where to go, and we've seen growth of around streaming, and in particular, the SaaS component of streaming, which makes sense, which parallels what's happening. That being said, we come off of a very strong position in traditional broadcast infrastructure. And so we were disproportionately hit, I'd say, by stagnant spending on broadcast infrastructure. In many ways, although it has come a lot of challenges, the positive aspect of the pandemic is it's been a real wake-up call for a lot of media companies, even around their traditional infrastructure about the value of getting to cloud, about the urgency of evolving some of that infrastructure to get off a satellite, to become more personalized, get ready for targeted advertising, et cetera. So, we see a real growing tailwind behind a broadcast infrastructure, flattening, let's say, the decline curve on that substantially. And while at the same time, we see growing momentum behind what we're doing in streaming and particularly the SaaS component of streaming. So putting it all together, we feel comfortable coming out this year with the growth forecast that we have put forward. But keep in mind, a lot of what we're talking about is simply about timing. I think if you take a step back, there are billions of dollars of advertising and subscription revenue, riding on this infrastructure. It's not going anywhere. It's going to be around, and Harmonic has an amazing position as really a foundational supplier enabler of that infrastructure. So admittedly, we've had a little bit of a difficulty kind of calling the timing. But the need for a rejuvenated investment cycle in its infrastructure has always been apparent to us, and we're seeing encouraging signs that we're really on the cusp of that, and we try to capture that as best we can in the guidance we've given you for this year.

[Steven Frankel:]

Great. And then flipping over to the Cable Access business, very impressive back half operating margins. Should we think of those as kind of the new normal? Or were there particular things that happened in the back half that kind of makes the back half margin above what you would consider the run rate in that business?

[Sanjay Kalra:]

So Steve, definitely, Q4, there was a decent mix of hardware and software, giving us very good margins to start with. But at the same time, the strong margins were also accompanied with good cost controls and combining to produce a very good operating result for the segment. Long term, we do expect gross margins to improve further. But I think the expenses said differently were light this quarter. And we're doing a more aggressive spending next year, as I mentioned, for research and development, for Cable, at the same time, increasing the go-to-market for sales expenses. So definitely, we expect the gross margins to continue improving. But operating margin, I just want to be cautious that expenses are light this time, but we are going on a little bit more spend.

[Steven Frankel:]

And that increase in spend, is that mostly fixed or there's a material variable component there as well?

[Sanjay Kalra:]

Well, I think there are two pieces. There is a piece for research and development, which I would classify as fixed. But at the same time, for sales expenses it's mainly variable.

[Steven Frankel:]

Okay. That's helpful. And then on the fiber-to-the-home stuff. Was there material revenue recognized in the quarter for that new product? Or is that something we'll start to see in Q1?

[Sanjay Kalra:]

I think there's more coming for next year.

[Patrick Harshman:]

You mean this year, I think.

[Sanjay Kalra:]

Yes.

[Patrick Harshman:]

So no, Steve, there was not material revenue. We're very pleased. Last quarter, we talked about our first win. We saw that project being deployed. We have several other, let's say, advanced trials that are going quite well. So, we're excited about the progress there, but indeed we have yet to recognize material revenue.

[Steven Frankel:]

Okay. And then last question. You keep redefining what CableOS is broadening its mission. Is there anything new on the competitive front with your competitors getting to market with something that maybe looks like what CableOS was or what it might be at the moment and not where it's going next year or next quarter?

[Patrick Harshman:]

We're not aware of any meaningful change in the competitive front. I mean, I think, as you know now for a couple of quarters, our competitors have largely changed their tune and everybody is talking about virtualization as well. That being said, we continue to perceive that we are well ahead. To the point you just made, though, it would be the wrong mental picture. I think we're kind of in a stationary position, waiting for people to catch up. I mean, really tying into your question about expenses, we continue to have the pedal firmly on the ground in terms of really pushing forward. And so, I would say redefining what it is, but we're expanding what it is. And having a core cloud-native foundation enables tremendous flexibility and optionality as we go forward. Our fiber-to-the-home solution that you just asked about a moment ago, for example, it's not a completely separate product. It's a variation of the same networking core software. Particularly when it comes to the cloud-native capabilities and the real-time NON telemetry that some of our customers are talking publicly about. We're not aware of anyone who's playing the same game, frankly. And our intention is to continue to invest and depress our advantage and stay well out ahead.

[Operator:]

Thank you. Our next question comes from the line of George Notter with Jefferies. Your line is open.

[George Notter:]

I wanted to go back to a comment earlier. I think, Sanjay, you were talking about reduced visibility, and I heard your comments certainly about the macro being part of that. But I mean, to be fair, we're beyond the presidential election, vaccines ready distributed. I think the environment is probably more certain feeling than it was, say, three or six months ago. Obviously, you guys have a lot of orders in the order book here for this year. I'm still confused by the comment about lower visibility. Is there something that you're formulaic about your business that's driving that reduction in visibility or am I missing something? Thanks.

[Patrick Harshman:]

Yes. I think there is some confusion, George. Let me try this time. I think the comment was relative to any other ordinary year. The comment wasn't relative to three months ago or six months ago. We're saying at any other non-pandemic year sitting here. It's always a little bit of a look in the crystal ball to say what's going to happen in the second half of the calendar year. And our comment was simply as we look at 2021, we think that, that picture is a little bit hazier than it would be in another year, 2018, let us say or non-pandemic year. That's all. So certainly, the visibility relative to what it was six months ago has improved. And I think there are a number of reasons to be modestly encouraged about the overall situation. And I think that encouragement is manifest in the guidance that we've provided.

[George Notter:]

Got it. Okay. That's great clarification. And then I also wanted to ask about another comment. You mentioned earlier, I think you said that 5% of 50 million cable modems in your CableOS customer base are being run on CableOS. And I know that situation persisted for a while, but can you just talk about the catalysts or the levers that can get you into a higher mix of that network going forward?

[Patrick Harshman:]

Yes. I think it's a key question, and it's one of the reasons why we call out scaling within our existing customers is this kind of growth job number one. Frankly, it's not something that we can do on our own. This is -- as you know, this is -- in many cases, reengineering networks, et cetera. It's profound work, and there is a certain pace in which our customers can move. Now we think they climbed a tremendous learning curve over the last 12 to 18 months, and we're seeing the pace of deployment increase. I think our strong order book speaks to that. At the same time, we're all learning things. And one of the things I mentioned in my prepared remarks is enhancements we're making to the systems to further improve the operationalization of the overall solution. So our customer is gaining more experience, more confidence, more training of their own staffs, subtle improvements and enhancements to the technology. All of that is contributing to a continuously increasing deployment pace. And I think that, that dynamic will continue. And I think our customers' public statements support this, but I think we will see a continually increasing pace of deployments of CableOS within our largest customers' footprints as we go forward.

[Operator:]

Thank you. Our next question comes from the line of Tim Long with Barclays. Your line is open.

[Tim Long:]

Two if I could. First, can you talk a little bit about the new Tier 1 win, maybe anything that was different about that? And how we should think about timing? And maybe kind of what that means as you get another one as far as converting some of the pipeline that's out there? And then second, could you talk about SaaS business and kind of customer count, and what we need to see happen to see that revenue line start accelerating?

[Patrick Harshman:]

Okay. Thanks, Tim, for both questions. On the new Tier One, top five North America cable customer, frankly, every one of them is different of the big guys. This was a -- you may recall, we've been talking about it for a couple of quarters. We've been working on it for some time, and it's just great to have a multimillion-dollar order in to have that shipped. And I'd say it's more than just a foot in the door. It's a great start, and it's one that we're going to continue to push behind. As with all of our engagements, I mean, it's somewhat success-based. So, we're very focused now on making this first wave of deployment successful and we think doing that will open the door to further deployment. I guess the other thing I'd say more broadly about Tier 1 is that, the experience of all of our large customers is at scale, is getting just to be better known throughout the industry. So I think there's a virtuous circle here, greater deployment scale, greater word of mouth, CTO chatter, better and better results, better and better operating metrics coming back from the customers who have deployed us. All of that is -- it's not lost on the leading CTOs in the industry. So, we think that there is a virtuous circle of confidence and recommendation that's happening. And it creates a tailwind, which is not to say that every Tier 1 isn't going to have their own rigorous evaluation and approval process. I mean, let's face it. Broadband right now is the goose that's laying the golden egg. So everyone is going to be extremely cautious about introducing the new technology. However, the virtues, the advantages of the -- of our new technology are more apparent and more clear than ever before. So our confidence is greater than it's ever been about our ability to continue to pick up such wins. Now on the Video front, the SaaS business, we did see an acceleration particularly in the second half of the year. I think that part of this is just natural there, again, we're also building a brand beyond our traditional, let's say, broadcast heritage. At the same time, we also saw the pandemic really being a catalyst for more focused, more realization for the advantages of having a SaaS service in a public cloud and particularly cloud-based service at a time when many operators were struggling to properly care and feed for their on-premises deployments. As I mentioned in the prepared remarks, we picked up 17 new customers including a couple of very significant, what I call, blue-chip kind of household name wins. That's pretty exciting. And look, we're just going to kind of continue to push forward there. I think we've got good momentum. There's an inherent lag, as you know, between picking up a SaaS win and recognizing and reporting the revenue. Bookings and SaaS as part of the record bookings -- excuse me, backlog and deferred revenue that we have right now. But having that revenue flow through, it's recognized ratably with usage over time. In some cases, these are multiyear contracts in place of all at once capital purchase order. So there is an inherent headwind there. But frankly, we think that maybe blocked. One of the criticisms of our business has been a little bit the up and down of it and having strong backlog and deferred revenue, a growing portion of that being associated with SaaS and then having that play out in a way that gives more stability and reliability to our revenue. We think it's a positive dynamic over time. And it's one that we're encouraged by the momentum we're seeing, and then we're going to continue to lean into.

[Operator:]

I'm showing no further questions in the queue. I'll now turn the call back over to management for closing remarks.

[Patrick Harshman:]

All right. Well, thanks, everybody, again, for joining us here today. And more generally, for supporting us through what certainly was a rollercoaster of the year. We're excited about the momentum that we have, the opportunities in front of us, and we look forward to reporting back to you soon. Thanks very much. Have a good day.

[Sanjay Kalra:]

Thank you.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.