Harmonic announced revenue for the third quarter of 2018 of $100.6 million, an increase of 9% compared to the year-earlier Q3 2017 and a slight increase of 1.5% versus the revenue result in the preceding quarter, Q2 2018.
Management had issued guidance for Q3 2018 revenue of between $93 million and $103 million.
The third quarter builds on momentum from the first half. Year-to-date revenue through the first nine months is up 12.6% compared to the first nine months of 2017. Also notable in the revenue disclosures, sales to Comcast represented 16% of total revenue in the quarter or $16 million. In September 2016 Harmonic had entered into a Warrant agreement with Comcast “to further incentivize them to purchase our products.” It appears to be working.
GAAP gross margins were 49.8% for the quarter, a 130 basis point decrease versus the 51.1% recorded in Q3 2017 and a 220 basis point decrease when compared to the 52.0% gross margins in Q2 2018. The sequential decrease in gross margins is attributable to a larger hardware component in Harmonic’s CableOS business segment.
Operating loss for the quarter was $3.6 million compared to operating losses of $14.2 million in Q3 2017 and operating income of $0.6 million during the preceding quarter.
For the quarter, Harmonic recorded a GAAP net loss of $7.7 million or ($0.09) per diluted share. This compares favorably to a net loss of $15.5 million or ($0.19) per share in the year-earlier quarter, though an increase versus the net loss of $2.9 million or ($0.03) per share in Q2 2018.
As observed in the write-up of Harmonic’s Q2 2018 results, the continued improvement in profitability was accomplished through revenue and gross margin performance, but also a series of restructuring initiatives. In each of the past three years, Harmonic has instituted a restructuring plan. Restructuring charges have totaled $18.0 million, $6.5 million, and $3.5 million in 2016, 2017, and year-to-date 2018. The below review of operating expenses will highlight an almost $8 million decrease in SG&A between this quarter and the year-earlier Q3 2017.
Harmonic reports across two business segments: (i) Cable Access, which includes CableOS, Harmonic’s next-generation software-based Converged Cable Access Platform (CCAP) solution; (ii) and the Video Segment, consisting of Harmonic’s compression, storage, and related streaming solutions. The Q3 results highlight the differences in operating profiles of these – increasingly distinct – operations.
Cable Access recorded year-over-year growth of 153% in the quarter, whereas the Video Segment declined by 8.9%. There is some importance context on the accounting treatment of the year-over-year period, which adds to the discussion. “Beginning in the fourth quarter of 2017, we adopted a more precise attribution methodology as activities relating to selling and supporting our CableOS solutions have become increasingly distinct from those of our video solutions” stated Sanjay Kalra Harmonic’s CFO on the earnings call. A simple comparison between the quoted segment revenues for Q3 2018 and Q3 2017 would show growth of 275% by Cable Access and a decline of 12.8% for Video Segment. Before Sanjay (a special thanks) clarified this point to me, I was preparing to point out that Harmoinic was underselling the growth of its Cable Access business. The correct growth figures of 153% for Cable Access, and by extension a decline of 8.9% for the Video Segment, were included in Sanjay’s prepared comments.
The diverging selling and support activities coupled with the contrasting growth profiles beg a corporate question that I will refrain explicitly raising here. I will, however, note all analyst questions on the call were devoted to CableOS.
Part of the explanation for lower growth rates from the Video Segment is the transition to a subscription business model. On last year’s third quarter call, Sanjay indicated the transition of a traditional $1 million CapEx purchase to an equivalent SaaS order would reduce revenue by $600,000 in the initial annual period. During the current quarter Sanjay stated Q2 2018 SaaS bookings (for the Video Segment) were $6 million. Whereas on a CapEx basis much of this figure may have been recognized during the current quarter, (using above Math and assuming even quarterly recognition) likely closer to $600,000 was recognized as revenue during the quarter.
The transition to a SaaS business model is still quite early. Harmonic’s management indicated current SaaS customers number “nearly 20.”
There were several other notable developments disclosed by management on the Company’s Video Segment. These developments are illustrated in the below slide.
I have reached out to Harmonic’s investor relations to get a clarification on what is considered an OTT channel. The statement on 35,000 linear OTT channels would benefit from some background. While the Video Segment has generated non-GAAP operating income for the past five quarters, I think it is important to point out the non-GAAP figures don’t bear the burden of restructuring expenses or the considerable stock-based compensation Harmonic issues each quarter ($5.4 million in the quarter). Harmonic’s diluted share count has increased to 87.8 million from 81.4 million in Q3 2017, primarily due to stock-based compensation.
Notwithstanding the above, I do believe management is in the right to highlight the improved operating profile of the division, and as important, the consistency of the performance. When SaaS business models are discussed, most of the attention is on the recurring revenue component and less is on the broader benefits to a technology supplier. According to Harmonic’s disclosure Annual Recurring Revenue (“ARR”) for the SaaS business is now $9.3 million, which is less than 3% of 2017 annual sales for the Video Segment. The transition, however, is still having a meaningful, positive impact on performance. “Underpinning this more consistent financial performance [for the Video Segment] is the transformation of our historically broadcast-centric appliance business to a more profitable and predictable over-the-top streaming software and SaaS business” stated Patrick Harshman, Harmonic’s CEO on the Q3 earnings call.
Additional Financial Information from Harmonic’s Q3 2018 Results
On a geographic basis:
- Revenue from the Americas region contributed $54.1 million for the quarter, an increase of 11.2% versus the prior year and a sequential increase of 2.3% against the preceding quarter. Americas accounted for 53.8% of Harmonic’s revenue for Q3 2018, a slight increase versus the 52.9% from Q3 2017, and the 53.4% contribution recorded in Q2 2018
- Revenue from the EMEA region was $26.3 million for Q3 2018, a decrease of 4.4% versus Q3 2017, and a decrease of 16.9% against the preceding quarter. The EMEA region was responsible for 26.2% of Harmonic’s revenue in the quarter, a decrease versus the 29.9% contribution from Q3 2017, and the 31.9% contribution in Q2 2018.
- APAC revenue was $20.1 million during the quarter, a 27.5% gain over against Q3 2017, and a substantial 38.5% increase against Q2 2018. APAC represented 20.1% of Harmonic’s revenue for the quarter, a notable increase versus the 17.2% contribution in Q3 2017 and 14.7% in Q2 2018.
On a product type basis:
- Product revenue was $62.8 million in the quarter, a 8.0% increase over last year and a 3.6% increase over the preceding quarter. Products contributed 62.4% of the quarter’s revenue, compared to 63.2% in Q3 2017 and 38.9% in the preceding quarter.
- Services and support revenue amounted to $37.8 million in Q3 2018, an increase of 11.7% against Q2 2017, and a decline of 1.91% versus Q2 2018. Service and support revenue was 37.6% of revenue for Q3 2018, which compares to 36.8% in Q3 2017 and 38.9% in Q2 2018.
On a segment basis:
- Video segment revenue for the quarter was $73.3 million, a decrease of 8.9% compared to Q3 2017, and a decrease of 4% versus Q2 2018. Revenue results were in-line with guidance for the quarter ($70 – $76 million). As a percent of total sales, video products represented 72.9% of revenue in Q3 2018. This compares to 87.5% in year-earlier period Q3 2017 and 79.9% in the preceding quarter Q2 2018.
- Cable Access revenue was $28.0 million during the quarter, an increase of 153% versus Q3 2017, and an increase of 38.7% compared to the preceding quarter. Revenue exceeded the high-end of quarterly guidance ($27 million). Cable Edge represented 27.9% of revenue in Q3 2018, versus the 12.0% contribution in Q2 2017, and 20.4% of revenue recorded in Q2 2018.
On a market basis:
- Broadcast and Media sales were $33.8 million during the quarter, a year-over-year decline of 18.6%, and a sequential decline of 24.7%. Broadcast and Media was responsible for 33.7% of revenue for the third quarter of 2018, a meaningful percentage decline from the 45.2% in Q3 2017 and 45.4% in Q2 2018.
- Service Provider sales were $66.7 million in the third quarter, a 32.4% year-over-year increase, and an increase of 23.3% versus Q2 2018. Service Provider represented 66.3% of revenue in the quarter, a rise from 54.8% contribution in Q3 2017, and an increase from the 54.6% contribution during Q2 2018.
- Research and development (“R&D”) expense was $22.2 million for the quarter, an increase of 4.5% compared to Q3 2017, and an increase of 3.3% against Q2 2018. Expressed as a percentage of total revenue, R&D expense represented 22.1% of sales in the quarter. R&D spend was 23.1% in Q3 2017 and 21.7% in Q2 2018.
- SG&A expense was $29.7 million for the quarter, a decrease of 19.9% versus Q3 2017, and an increase of 6.2% compared to Q2 2018. As a percentage of total sales, SG&A was 29.5% of revenue in the quarter. This compares to 40.3% in Q3 2017 and 28.2% in Q2 2018.
The Company’s cash position ended the third quarter of 2018 at $61.6 million, up from $54 million at the end of Q2 2018.
Bookings for the quarter were $79.5 million, a year-over-year decrease of 17.2% and a 26.3% decline compared to the previous quarter. Management attributed the decline to typical Q3 seasonality where more business is billed in the third quarter than booked. This helps explains the sequential decrease, but not the year-over-year decline since presumably a seasonal decline occurs in all years. Given the growth of the Cable Access business, the low bookings number would suggest a disproportion booking decline for the Video Segment compared to last year. Management did confirm in the question and answer session of the earnings call that the Video Segment was more responsible for the booking decline. This was partially explained by a strong Q3 in 2017 for the Video Segment, reflecting a revenue catch-up after a slow first half in 2017.
As part of the discussion of bookings, management was quick to point out the total backlog and deferred revenue was up 3% year-over-year to $207.6 million, though down 10% sequentially.
For Q4 2018 management is anticipating total revenue in the range of $104.7M – $117.7M and GAAP gross margins of 48% – 48.5%. Operating income is expected between a loss of ($3.2) million and income of $4.2 million.
Video revenue is expected to contribute between $80 million and $83 million in the upcoming quarter with Cable Access anticipated to record revenue of $24.7 million to $34.7 million.
Full year guidance for GAAP revenue is $394.5 million to $407.5 million for 2018 with the Video Segment expected to contribute full year revenue between $304 million to $307. The mid-point of the guidance for the Video Segment will represent a year-over-year decline of 4.4%
Press Release: Harmonic Q3 2018 Earnings Announcement
Press Release: Harmonic Q3 2018 Earnings Presentation
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