Harmonic Inc. (HLIT) Earnings Call Transcript & Summary

Hi, good afternoon. I'm Samik Chatterjee, the Networking Equipment and Hardware analyst at JPMorgan. The next company within our coverage universe that we are hosting here is Harmonic. As you can see on your screens, we have the pleasure of hosting Sanjay Kalra, the Chief Financial Officer; and Jeremy Rosenberg, who's the Senior Vice President of Business Development of Harmonic. Sanjay, Jeremy, thanks -- thank you to both of you to -- for taking the time to participate in the conference. It's a pleasure to host you both here. Let me hand it over to you because I do want to give you the opportunity to give kind of set the backdrop here with an introduction of the company, just given that there might be more of a mix of new investors as well as investors who know the company well. And then we can dive into some more specific questions. So Sanjay, over to you.

Thanks, Samik. Glad to be here. I'll start. Harmonic has 2 businesses, both under one roof, which are closely related, but very distinct. One we call as cable access, and that's specifically working with cable operators around the globe, enabling them to deliver the next-generation of gigabit broadband services, services which consumers like me and you probably call as cable modem service. We think there's tremendous growth opportunity there. And we've done some very innovative things. And that's really core of one of the business units, perhaps the fastest-growing and fastest-changing part of our business. The other part of the business, which actually is a lion's share of the revenue today, we call as video. And that has to do with everything around creating, originating and delivering, particularly live video and television programming and to consumers around the globe. And here, of course, we do businesses with cable operators also. But as historically, we've done with other pay TV kind of operators, IPTVs, telcos, satellite and direct-to-home broadcast and media companies. And we are seeing increasingly new streaming players here. And that's -- this is a very international business. Approximately 2/3 of our video business traditionally has been outside U.S.

Sanjay, thanks for that. So let me get started with a question, and this is a question that I received quite recently, given some of the interest that came into from investors in trying to understand the company after some of the recent kind of different investor moves that we saw. And investors were really trying to understand how the 2 segments fit together, either -- is there a technology overlap that makes it fit together? Are there customer synergies? So when we talk to a new investor, it's not very obvious to them how our cable equipment business fits in with a video streaming business, particularly given kind of the -- that's where you focus more of your narrative on the video segment. So just help investors piece that together, what is the overlap? What is the synergy getting these 2 segments together?

So Samik, I think probably the greater synergy is for certain accounts, certain cable operator accounts we sell both divisions offerings. And so we have a more extensive engagement with the customer because of that. And so there's some benefit to that. It's relatively modest. And -- but that's probably the most significant synergy between the divisions.

And Jeremy, just to clarify, is there any major technology overlap between these 2 segments? Is there something in terms of R&D synergies that you appear to get or largely, these are 2 independent, indeed?

No. Although they deal with a lot of the same issues and a lot of the same sort of ecosystem considerations, these are very separate R&D teams. And there's a terribly modest amount of sharing between them.

Okay. Fair. So let me start with the video segment. And before I do, I do want to remind the audience, if you do want to send in questions, you have the option of doing that. Just hit the ask a question button on the website and you can send in questions, and I can ask it on your behalf. Now let me start with the video segment here. And I know typically, I do start with the cable side of the business. But let's switch it around this time. Video segment, you raised the full year guidance on expectations of momentum in the video streaming business and new SaaS wins. We have a near-term gauge of the opportunities. How do we expect opportunities will shape up in the longer run? I think you've been a bit more clear about the near-term opportunities here. How should we think about the longer-term opportunities? What can be the upside drivers for the video segment in the long run?

So Samik, we announced in our last call that we will be doing an IR day for both the segments. So there's going to be a video and a cable event in June, and we will announce the date in a few days of that event. Those questions will be answered more crisply there, I would think. So I would leave it for that event. At the same time, I would say that in the longer term, at least directionally, I can provide color. It's going very good. Our exit backlogs and bookings, which we are seeing in the last few quarters, they have been different than the trends we have seen in the past. So it gives us a lot of confidence that our recurring revenues and our streaming revenues are going to increase going forward. And so I think that color I can provide. It's improvement over the past on the coming quarters for videos.

Okay. So let me then dial back a bit and just to then understand the drivers here a bit better. You did see a slowdown during the COVID-impacted period. What -- in the video business in terms of revenue, what led to that slowdown? And now you're starting to see again momentum pick up. So when you start -- when you think about the slowdown and the kind of subsequent acceleration, what have been the drivers towards those 2 individual kind of overall drivers? How do you lay out what drove those 2 different dynamics here?

So Samik, maybe just to paint a simple picture, a number of our customers closed their warehouses for a couple of months, didn't receive shipments and weren't quite sure how they were going forward. And then that was earlier last year. And then everybody got about adapting and started picking back up again. The fundamental drivers for our business are based on consumer demand for video consumption and consumer demand for Internet consumption, which are interrelated and both of those rose last year. So I think what you saw was a real physical pause that our customers were taking to be cautious because of the pandemic.

Got it. So essentially, customers just being more mindful of how much they spend at that point is what you're attributing that?

No, I would say it had less to do with spend than actually physical safety. So just to be clear, in terms of warehouses being closed because they weren't -- we went through a period, as we all remember, where we didn't really understand transmissibility, et cetera, et cetera, et cetera, and how best to deal with this. And so that, that -- that certainly, while that was going on until we readjust it. So I don't really think it was as much a spend issue as just a physical safety issue and the fundamental drivers for our business keeps growing.

So you -- and maybe this is more for Sanjay. Let me see if you can give us any ballpark numbers here. You talked about the video business, and there's 2 different parts of it, the traditional video equipment that you help your customers with and the other one is more of the SaaS opportunity that you are seeing on the streaming side. Can you ballpark that mix for us? How does it look today in terms of how much of the revenue in the video segment is supporting streaming channels versus some of the more traditional video use cases?

So Samik, if you allow me, I would like -- we have not broken those numbers publicly yet. And if we will, we'll start breaking it out at the time of the Investor Day. So I'd like to wait for the time when we share it openly. But overall, I can tell you that the streaming component is increasing. And the broadcast component is also -- is not increasing, but it's not decreasing at the pace that we have seen it in the past. It's much modest than the past.

Okay. I think one of the concerns that have been raised is, clearly, the streaming side is benefiting from strong growth in streaming channels overall. But does that, at some point, reach maturity? Like at the end of the day, there's only that many kind of -- that much consumption that a consumer can have in terms of streaming channels. So do you get to a point where you start to see maturity in the number of streaming channels on their growth overall? And does that -- how correlated to that would Harmonic's growth be in that segment of the business?

So that's a -- that's a great question, Samik, and maybe I can hope to help explain how this is really different. So if we start with that question and just say that we just sent on an OTT basis, what was sent on a broadcast basis. And the material hasn't changed at all. And we're just changing the way in which it's sent, right? Then we're still in the very early days of that transition. I mean I think we all expect that's how it's all going to go. But we're still in the extreme early days of that transition just to send the same material a different way. But the other thing that's going to happen and certainly is happening right now is a customization of that material for each recipient, which is possible because of the way in which it's sent, which was not practical in the prior send. And that probably creates far more growth even than the fact that we're probably not 10% of the way there in terms of the overall physical transition. But then the ability to customize the content because of the delivery system is a whole other level of growth. So I think we're in extreme early days here, Samik, in terms of looking at those. Does it make sense?

Yes. No, that's fair. Sorry, I was on mute here. That's great. So let me move and change gears here a bit and move to the cable segment. You had strong growth in the first quarter. I think what you've highlighted there, though, is margins were a bit weaker or on heavier mix of DAA hardware. Firstly, how are you -- what are you seeing in terms of your customers and their willingness to continue to spend towards cable equipment? Obviously, we saw that momentum in 2020 as well from most cable customers spending to add capacity. How long does this cycle continue? And just then on -- and the second part to that, help us understand the cycle in terms of what they're procuring, how much of the -- how do we shift between hardware and software purchases and what do they prioritize at what points of their investment cycle?

So let me start with the first part, Samik, that we are seeing momentum in the spend from the customers for sure, not only the customers' growth, but the way the customers are spending with us that also has a good momentum. That said, you mentioned about the hardware mix. And you saw the impact on the margins as well. It was actually a mix of supply chain and the increasing mix of DAA. And that was Q1, I think, was more heavier than the outer quarters, which we expect. I think outer quarters should become better based on the guidance we gave. I think in Q1, we ended close to 42%. Q2 our guidance is slightly better at 43% midpoint and full year is 44.5% midpoint. So over the year, we should see improvement in the margins. And the DAA mix also improves in the outer years. And in terms of what's the mix of hardware versus software, and how does that actually play in the outer periods as well, to give a perspective, overall, I think, again, I'll wait for the IR event for cable, where we plan to share a multiyear model, which we should share that mix.

Okay. Got it. So definitely, sounds like a lot to -- there'll be a lot of new information at the Investor Day. So look forward to that. Let's talk about CableOS. You have mentioned adding new customers. I think you recently spoke about a multimillion-dollar purchase order from a Tier 1 operator. So how should we think about the time line in terms of that opportunity fully materializing? Also on a separate basis, how should we think about some of these government infrastructure plans, but maybe that's the more second part of the question. Maybe you address the first one, and then we can dive a bit more into the infrastructure plans.

So Samik, for that particular one, there'll be some revenue in 2021 from it. All the larger customers are somewhat different from each other even in terms of how they roll. But in general, in dealing with a very large customer, you're dealing with a multiyear build out and sometimes multiple POs along the way. As Sanjay has indicated before, I think on the quarterly call, we have contracts that we don't yet have POs for from some of our large customers. We know the POs are coming. It's contracted, but we don't count that in backlog, which is one of the reasons that we give that number to help give a sense of what the total book is that we have. And you can think of some really smaller operators potentially doing a transition within months. But larger operators, multicity, very large, in some cases, they may start in one city, one neighborhood and then build -- and the pace picks and picks and picks and picks up. And we're still in the early days of that. We've -- and we've got a lot more market share to win and a lot more build out to do for the ones that we have won. That's maybe more of an answer than you were looking for in terms of your specific question.

No, that's good. And let me just follow-up on that before we move to some of the infrastructure-related questions. I believe what I've heard you previously quantify on earnings calls is that you support about 3 million modems today with your customers, where the total opportunity is, what, $50 million. And correct me if my numbers are wrong there. But can you talk about these new customer -- this new customer or Tier 1 operator? How -- what does that do to the addressable market of 50 million modems that you've talked about?

That's a great question. You're a fairly smart guy. If I were to give you a direct answer, you might be able to figure out who it is. So I'll let Sanjay...

I don't know the industry that well, so you can give me that number.

I'll let Sanjay decide if he wants to.

Go ahead, Jeremy.

No, I'm stopped. I'm...

Okay. No worries. I'll move on to kind of the infrastructure question here. I think largely, a lot of focus on RDOF, on the Biden Infrastructure Plan amongst investors. Now help me on 2 fronts. One, generally, the perception is that the Tier 2, Tier 3 operators in the rural kind of suburban areas are going to see more of the spending support from the government plans. How is Harmonic's exposure to that segment of customers? Secondly, how should we think about the timing of the benefit? Phase 1, obviously, auctions have already happened. Some of the funds probably will be released later this year, early next year. When does that spend really start coming through to the equipment purchases that Harmonic kind of supports customers with? So a 2-part question there, but hopefully, kind of you can go through them one by one.

So Sanjay, how about I take the first part and you take the second part in terms of when it hits.

Yes.

So Samik, the RDOF, you have a certain amount of RDOF funds in place. And if you go to our website on our more recent press releases is a little -- nice little company called Otelco, taking advantage of our converged platform of PON and DOCSIS, call it, fiber and cable. And we think that's a great tool for some of the operators who are going to play on RDOF. And it's important to understand, when I say converged platform that means common access control shared between PON and DOCSIS, between cable and fiber. So it's a very different kind of solution. It's a very nice tool for those operators for this kind of opportunity. The -- you also mentioned the Biden infrastructure plan, which who knows how that sorts out, cautious optimism, Republicans and Democrats can at least agree that better broadband is better for everybody. And there'll be some kind of funds flowing at least in that part. There may be a fairly significant uplift in terms of broadband in urban because you have a lot of urban customers who cannot afford a lot of broadband. Who knows how that money comes through in terms of subsidies, vouchers, whatever it is, if -- to the extent that, that money comes through that will further push the growth rates of broadband usage in the urban areas, where obviously, we already play very heavily. So that's the first part. Sanjay, if you want to talk about timing?

In terms of timing, so Samik, this is not a very short term, big opportunity for us. We are not baking anything this year for it. It definitely is an opportunity, but more in the outer years, and it will contribute to our overall revenue growth as we march along in the outer years, but not in short term.

Okay. Got it. And as a reminder, again, if anyone in the audience has any questions, please feel free to send them over, and I'll ask it on your behalf. So moving on to more of the competitive landscape. I think, Jeremy, like how should I compare Harmonic's capabilities in the cable segment to companies like Cisco and CommScope that you're competing against? What's the differentiation that Harmonic is bringing, which is allowing Harmonic to gain share? What really should convince investors that Harmonic can gain share from these larger companies?

Well, Cisco is kind of hard to gauge in terms of what their -- their play in this space is close to a rounding error with inside their corporation. And there's no specific breakouts in their quarterlies that give you a clean understanding of where they're going here. So -- and we haven't seen a lot of lean in from them. And so maybe from that, you can read something. Now CommScope was the dominant supplier historically. They, I think, are interested in slowing the transition. As the dominant supplier behind us in technology. That's what we've seen as their response thus far. Is that...

And I mean, maybe just to follow-up on that, just to make sure we understand the differentiation here. In terms of the transition, I'm guessing you're mentioning the transition to more of a virtualized or DAA architecture. Can you just elaborate on that? And where your product portfolio is related to -- like have you seen, particularly, I think, related to CableOS? Have you seen Cisco or CommScope kind of catch-up to -- with any solutions related to where you are?

So the terribly short answer to you is think about it this way. A few years back, we put out a virtualized solution, let's call it, Rev 1.0, years ago. Let's say, we're now at Rev 4.0. We haven't seen Rev 1.0 from them. And this is not a static target. We keep improving our offering. So no, I don't -- we haven't seen anything compelling from them. Now they don't necessarily bring whatever they might be working on compelling to us. So there may be something private that we're -- that's being shown. But publicly, no, nothing.

Samik, I'll just highlight the most recent Dell'Oro report breaks out the market share of the virtualized software where Harmonic has 100% share of the vCMBS. And for DAA, we also have a large share, not 100%, but in DAA hardware, we have more than 45% market share. So I think that data speaks to where we are in this landscape.

Okay. Helpful. I think one of the longer-term concerns that we have surfaced from time to time, and might not be as relevant to Harmonic, but I still wanted to get your thoughts around it, is that as the industry or the customers move increasingly towards virtualized solutions, the overall revenue opportunity for cable equipment companies comes down just because of the lower cost of implementing a solution related to the traditional appliances. Wanted to get your thoughts around that. How much of a -- do you, first of all, agree with that view? And how much of a shrinkage in the overall revenue opportunity would you think that would drive? What's the -- how much of a lower cost is it to implement apples-to-apples network using virtualized solutions, related to the proprietary appliances of the past?

Yes. So it's definitely -- so normally, when you think about solution sets coming into the marketplace, is it better? Is it cheaper? Is it faster? Well, actually, our solution is all 3. It's a significantly higher quality solution. It's a significantly cheaper solution, and it allows a level of flexibility in terms of adapting your network in terms of faster that the others don't do. So it's extremely rare to see that kind of solution. And you're right, our focus is switching people over to this newer solution. It does cost less than the older one. On the other hand, if you look at that at a service group level, and kind of think of service group says, okay, you have the node and you have the license for the node that does this. There's also the need to -- if you've heard densification, right? So the classic DOCSIS architecture is party line, right? So maybe -- now if you're going from 500 Home Pass Service group to a 50 Home Pass service group, you may have a much less expensive solution per service group, but that doesn't necessarily mean your TAM is smaller.

No. Got it. That's a good explanation, Jeremy. Let's move over to the C-band repurposing kind of opportunity that you've talked about. I think you have guided more recently to that opportunity accelerating in the second half. Can you just walk us through what's happening there, what's driving the acceleration? And I think as a second part to that, I think we keep getting questions on whether this is more of a onetime opportunity or something that could kind of be more sustained through the year? So if you can clarify that as well.

So if it's okay, I'm going to take the second part of your question first. Because I think it's really important to understand that there's an overall change in the dynamic of how wholesale video is distributed. So broadcasters to their affiliates, programmers to their affiliates, worldwide, a tremendous amount of that is done by satellite, which is a wireless spectrum. And so what's going on, on a worldwide basis is a conversion over to a terrestrial distribution system for all of that. That's probably a 10-year-plus worldwide phenomenon. A small part of that transition is this taking of C-band, what's called C-band spectrum in the United States and repurposing about 60% of it for 5G use. And that's all under this C-band reclamation. Now that's actually not most of the customers. Even in the United States, it's just a handful -- a couple of handfuls of customers in the United States that are driving all that spend. The FCC is using the license fees coming from this to reimburse. Now if we come back to the first part of your question, the timing on all of that is driven by FCC deadlines for when the satellite carriers have to free up the first chunk of spectrum and then when they have to free up the second chunk of spectrum. And there are time lines for that. And depending upon where a customer is in the lower part of the spectrum or in the mid-part of the spectrum, depends upon when they have to move. So it's completely on the government-agreed time lines that drives this whole schedule. But again, that's actually a small part to what it will be and essentially is beginning a worldwide phenomenon. So we think that our solution set here is not a one-off, Samik. It's -- what we have is a solution that works for satellite and for terrestrial, a hybrid solution that allows programmers, broadcasters to smoothly transition when and if they choose to do so. And we think that, that's a very powerful solution that we brought into the market that we're currently selling into this C-band reclamation for 5G. Does it make sense?

Yes. It makes sense, Jeremy. So a follow-up to that, I know you haven't really quantified how much of revenues you are getting on an annual basis from that, but who are the primary competitors in this area when you start winning business in this? Who are you seeing kind of -- who are you running up against in these opportunities? Are these the traditional Ciscos, CommScopes of the world? And in terms of market share, is this now becoming an opportunity where you're seeing a higher market share than, again, what your traditional kind of cable business is just purely because the technology you are ahead in terms of the offering the technology to -- for your customers to leverage at this point?

Yes. So interesting. So you're exactly right that the current competitors in this C-band 5G are really the legacy suppliers. This particular line of our business was a very small line. We were not among the top 3 in market share in this. We came up with a very new solution. I actually was a customer of Harmonic before I joined Harmonic for that solution set that Harmonic had. And I thought it was a great solution. And what I think we have now is fantastic. And so I think the legacy guys -- so Cisco sold off their legacy part of that. And the operation is now called Synamedia. And CommScope has a little legacy part. And Ericsson sold off their legacy parts. And so they're enjoying a little bubble from this 5G. But I think as we get the market evolution more generally, I think you need this sort of hybrid terrestrial satellite to hunt more generally. So I think we've done very well in this phase. I think we'll do very, very well in the next phase when it's not government money, it's the programmers money, the broadcasters money on a worldwide basis.

A quick couple of questions for Sanjay before I wrap it up here. Sanjay, one, any thoughts on how the next year looks related to the C-band opportunity related to 2021? Secondly, one of the -- I think one of the limiting drivers to the flow-through on earnings related to the top line growth that you're seeing this year has been the higher pace of investments that you talked about? What is that directed to? Which areas are those higher investments directed towards?

So first on the 5G, yes, there is revenue coming in 2022 as well. This was not a onetime thing. It happened in 2020. We are seeing it in 2021. It's continuing from the previous deals, plus the new opportunities that Jeremy mentioned, which are in our current outlook and pipeline. And 2022, also, we are seeing good traction there. So I think it's going to be a continuing stream of our revenue, which is a part of our broadcast revenue as well. So I think it's continuing. Secondly, in terms of the top line impacts, I mean, let me highlight that this year when we gave the guidance, the top end of our guidance was limited more towards the supply chain impact rather than demand. Normally, when we set the ranges of high end and low end, high end is more driven by, okay, how much does the customer need this year, how much can we -- versus how much can we supply. So this year, the dynamic was a little different. We did raise guidance in both the segments. And we -- there is demand. For cable, especially, we had to limit because of the -- what we are seeing in supply chain. But in all the, I would say, in all the segments or both the segments, we are seeing good traction. The backlog and deferred revenue both is high. The pipeline is strong. So we are seeing good activity. In fact, this year, is, I would say, relatively better than last year in terms of performance. If you look at our Q1 results and midpoint of Q2, what we guided and compared to the full year results, which we guided, we are close to 48% in the first half versus full year. Last year, we were less than 40% on cable and close to 30 -- I believe, 42% on video. And this year, we are 48% in both. So it's a relatively significant improvement, and that's because our outlook, our backlog and deferred revenue is very strong.

Sanjay, if I can -- just sorry, quickly clarify. I was more mentioning the OpEx increase of 15% year-on-year that we have in our model. I think you've guided to something very similar, mid-teens OpEx increase on a year-over-year basis. Does that -- pace of investment that we're seeing this year, does that start to moderate in terms of growth rates next year?

Well, outer years as well, next year, specifically, and overall outer years, I would say the growth rate of OpEx shouldn't be as high. I think there is a positive operating leverage, if I say, and that we are spending more this year on revenues, which we generate in outer years on -- like R&D is high because of the expected revenues from various opportunities we are seeing in the outer years for cable. So I think we should see better operating leverage in outer years.

Okay. That's all we have time for Jeremy, Sanjay. Thanks for taking the time to do this session. Thanks for the time today, and also thank you for participating at the conference.

Thanks, Samik.

Thank you. Samik.

Thank you, bye.