Harmonic Inc. (HLIT) Earnings Call Transcript & Summary

So getting a little -- ops harmonic overload, which is great. So maybe Patrick, let's start out with -- in September, you guys kind of gave some updates for longer-term opportunities and growth metrics for the 2 businesses.

So maybe if we could start off there. We'll talk a little high level and then get into the businesses.

Okay. Well, good to see you, and thanks to you and your team for hosting me today. I think as people know, we operate 2 related but distinct divisions, our Video and our Broadband division. And indeed, in September, we published updated 3-year targets for both sides of the business. And in short, we see the -- both the technology and the business transformations we launched a couple of years ago continuing to drive pretty exciting results. On the Broadband side, we see a lot of open highway ahead of us. and we anticipate growing what was basically no business a couple of years ago to over $800 million of revenue and nearly 30% EBIT operating income in 2025. Tim, and on the video side, the top line growth is more modest, but there the story is really a transformation to more SaaS, a higher margin. business model and associated with that operating EBITDA margin expansion to, I think, about 15%, 14% or 15%. And hopefully, we've shown good indication this past year that we're well on track to deliver those things.

Right. Great. Excellent. One of the common themes around the space has been supply chain. You guys have done very well. So maybe talk a little bit about how you guys have navigated so well and how price increases and other mitigating factors are kind of helping protect the model for you guys?

Well, it has been tough. And as generous to say, we've done well. I think we've been somewhat less impacted than others, and we've got a great team. We've been hugely focused on it. And from the beginning, we made a strategic decision to pay, to be blunt about it. So we're on a market share gain mission, and we didn't want to lose any of that momentum even at the expense of gross margins. So we worked hard on creatively sourcing components that were in short demand. In many cases, we paid extra for those components, we where necessary, did hardware design changes at significant additional cost. And where necessary, we air freighted things from our manufacturing assembly location in Malaysia to other parts of the world. So you saw our margins take an impact. But the good news -- and that's the bad news. But the good news is our competitive momentum, our revenue growth momentum continues strong. And I think, well, we're not out of it yet, we're coming out of it in a relatively strong position.

Right. Okay. Good, good. Maybe we'll get into the businesses a little bit, so we'll talk on the Broadband side. Could you talk a little bit about kind of the health of the CapEx environment for the cable MSOs to your large customers and how you see that trending? Obviously, there's a lot of competition that they're facing from the wireline or fixed wireless or other operators. So maybe just talk kind of broadly about the health of the end market.

Well, I mean, we think it's a great market to be in, very healthy. As you said, the competitive environment for our customers is very active to severe worldwide, not just in the U.S. but worldwide, fiber-to-the-home is coming. 5G wireless, fixed wireless products are coming. So I would say the competition for the broadband subscriber and enablement of next-generation broadband services is it's healthier or more active than I think we've ever seen. And of course, all of that is somewhat accelerated by the pandemic. I think the other thing to notice, particularly about the cable space that we address is historically, a lot of CapEx went into set-top boxes and cable and CPE equipment. And with the way service is evolving, those activities are much less capital intensive. So even without increasing CapEx, we see our customers slashing a lot of spend to the network or what they would call scalable infrastructure. So that's quite healthy as well.

Great. Great. Maybe let's follow it up with kind of DAA and virtualization and next-generation architectures. Talk a little bit about Harmonic's positioning there. Obviously, you got Comcast, you got a big win there. Maybe just touch on how you're differentiated and how you're winning in the market there.

Well, sure. I think before we come to us, it comes back to the competition that exists. And really, I think as we as our customers look forward to the next 5 to 10 years, the playing field is no longer 10 or 100 megabit service. It's gigabit services, it's ultimately 10 gigabit kind of services. So the challenge the industry was up against was how do you scalably, cost effectively roll out a platform that can deliver 10 gigabit services. And frankly, what got the cable industry here is not what's going to get to the 10 gig. And that's where a move to virtualization, both from a CapEx point of view, but also from a manageability, a real estate point of view, really came to the fore. Indeed, we did a lot of pioneering work with the support of Comcast, but also several other cable operators who really had a vision and had a need for, I'll call it, a next-generation architecture and technology that could scale to ultimately to 10 gig and beyond. And that's really the catalyst for the opportunity and what we've been working with these customers on beginning to deploy.

Okay. Maybe if you could touch on your large customer and your deployment kind of what inning are you in? How do you see the rollout of the DAA architecture with them?

Yes. So -- well, let me slightly generalize it to the customers we've won. At the end of the third quarter, we have won and deploying a little over 80 customers worldwide. And those customers have themselves somewhat north of 60 million cable modems in their combined footprint. And of that footprint, they've used our technology to deploy at the end of the third quarter, just under 11 million. So with our existing customers, we're about 11 out of 60 to 65, so 15%, 17% done with the footprint of just those who have deployed us to date. And that footprint is somewhat less than 1/3 of the overall market. So put differently, if you look at the overall market, we're about 5% penetrated. So I think either way you slice it, it's relatively early innings, both with those who are deploying us and certainly with the market at large. And that's consistent with where I think the industry is in terms of amending a real competitive response to fiber and getting to these multi gigabit or 10 gigabit services that I've mentioned.

Right. Okay. Maybe on to the architectural side is matters, maybe we won't geek out too much here, but Remote PHY, Remote PHY-MAC, cable show, there was kind of some different views out there. So could you kind of just break down how that -- the change may be provides incremental opportunities for Harmonic.

Sure. Under the top level umbrella everything we've been talking about and that you've mentioned that's DAA, there are, let's say, 2 different variants that have been discussed by the industry. You can think of it for those who are maybe as old as you and I can remember, VHS and Betamax kind of things. So the same objective but slightly different ways of getting there. The solution that we've been deploying to date is one of those variants called Remote PHY. But there has been a, let's call it, a competing or alternative version of this DAA architecture called Remote MAC-PHY. And without getting into and we can, what exactly that means. I would say that the existence of the 2 options has somewhat slowed parts of the industry, which to adopt, which is better, et cetera, et cetera, a lot of analysis about that. And as your question alludes to, what we have seen over the past just 3 or 4 months is -- it's not a 100% change. But I would say a growing consensus in the industry. You know what, let's go with the MAC -- sorry, without this MAC-PHY, let's just go with the PHY architecture that Harmonic and Comcast and Vodafone and earlier customers have been deploying. It's proven. It has a lot of advantages. It's being deployed successfully at scale. And again, there's still some customers who are on the fence, but we see growing consensus to go that way, which I think it's encouraging to us. To be clear, we have -- we support both ways, and we were prepared -- are prepared to support both alternatives. But to the extent that the industry really coalesces around one version and particularly the version that we have so much experience deploying in volume, almost 11 million subscribers. We think that's a positive thing for the industry in terms of just clarity in unanimity and also for us in terms of the expertise that we've built up on deploying a volume.

Okay. Great. Yes, I think one of the things investors tend to like about this end market for you? Is there some bigger incumbents like a Cisco that's kind of not really too involved? So talk a little bit about the competitive landscape? And separately, are you envisioning a lot of the larger carriers ultimately kind of splitting -- having multi sources? And is that just going to be maybe at the node level? Or how do you see opportunities even if you don't win the first deal at an MSO?

Right. Well, look, the historic players in the space before we entered or Arris, now CommScope, Cisco and Casa. All 3 are companies that have been obviously extraordinarily successful and have great people and technology. That being said, we think we cut all of them in the industry by surprise by rolling out a virtualized platform. And we think we are not a little bit ahead, but way ahead, Tim, in terms of this technology. To the best of our knowledge, there is no scale competing solution, a virtualized core. That being said, the hardware endpoints, there is competition. I think the latest Dell'Oro market research says that Harmonic has 100% of the virtualized CMTS market and about 70% share of the hardware end points. Indeed, we don't guarantee those kind of -- those are kind of [ dizzying ] share numbers. We don't project that over time. And in fact, going back to the beginning of the conversation, the 3-year targets we've established assume -- don't assume that kind of share. But it's a heck of a place to be starting from. And we're investing strongly, and I think we've got a great opportunity to leverage that leadership position to continue to lead.

Right. All right. Okay. Maybe touch on your fiber-to-the-home and fiber initiatives. So obviously, as these cable architectures develop, there's going to be times where they want more of a fiber strategy. So talk about how you're developing product and going to fit into that piece? And how do you see that growing your TAM?

Yes. It's a super important initiative for us. And frankly, from both a defensive as well as an offensive perspective. as we got going with our cable solution, we really understood that the architecture we're deploying really brings 10 gigabit out into the neighborhood. And creates a 10-gigabit point of presence, if you will, deep in a residential or kind of mixed residential small business neighborhood. And we and our customers simultaneously began to realize this infrastructure 80% of it can be reused for a fiber-to-the-home or fiber-to-the-business offering. And that offers a lot of intriguing possibilities, a higher tier of service, a competitive response to someone coming in with a fiber offering, for example. And so since coming up with that realization, we've been hard at work on a, I think, a very compelling fiber-to-the-home solution that leverages that existing cable infrastructure commercially and technologically and it's gaining a lot of attraction. We said at the end of the second quarter, we booked over $20 million of product in the second quarter. We announced a, without naming them, an important Tier 1 international win in the third quarter associated with that was a -- new million dollar -- multimillion dollar order. So modest revenue this year, but we see it as a pretty significant and strategically important adder to the business as we go forward in 2023 and beyond.

Okay. Excellent. Let's move over to Video a little bit. Obviously, a different dynamic here, a little bit more of a transition going on. So maybe if you could just talk a little bit about kind of legacy business and kind of newer SaaS streaming models to kind of the transition we're going through here.

Sure. At some level, it's easy to understand because I think we all see it as consumers. There's a legacy pay-TV service. Maybe some of us still have that. But then there's all the new streaming services. And for sure, all of us are participating as consumers in that. And so it won't be surprising to know that the level of investment in the legacy Broadcast and pay-TV infrastructure has been -- is flat to declining. Even though that's where most of the eyeballs or most of the advertising dollars are still going. And where there's a really a lot of excitement and investment and new business opportunity, is around streaming and for our technology, particularly streaming of live content, which is a very different, more difficult, fundamentally different kind of opportunity than streaming on-demand movies. And so if you understand that from a consumer perspective, you kind of understand what's going on with our business. We have really market-leading technology, particularly for high-quality live content. We see flat to modestly declining revenue associated with the legacy platforms, but we see strongly growing business sector, the streaming platforms. And we've kind of added an additional wrinkle to this transition. In that our streaming technology, we've developed is pure cloud-native software that can be run on the public cloud. So a little different than our historic video appliances. We're offering a variant of our streaming technology as a SaaS. And this SaaS activity has been growing over 60% a year for the last 2 years. And going back to the multiyear model that we projected, we see approximately half of the revenue in 2025, moving to a recurring SaaS kind of business. And to be honest, our video business historically has been somewhat secular up and down, modest gross margin profile. So we see the opportunity to move to a recurring revenue, higher-margin SaaS business, at least in part, is a significant enhancement as we transform this video business from where we've been historically in broadcast to streaming.

Okay. Great. Focusing on the streaming side, kind of a different -- you've got different buckets of competitors there from some of the big guys that do it themselves or some players like you and even the Amazon the AWS is in the world. So maybe talk about your differentiation product quality, what you guys do that some of the others can't. And where is the sweet spot for Harmonic?

Yes. It is a very fragmented space. As you said, there's a couple of players, Netflix, Disney through its BAMTech acquisition. For example, that they have the scale and the inclination to do it themselves. But the vast majority of the media market, we think, has no interest in that kind of heavy -- it's a heavy lift this kind of engineering, again, particularly for a lot of content. And where our differentiation is on super high quality, super low latency live content. I think we've all experienced that anyone who's tried to look at a major sports event online, you see something that's 30 seconds or whatever behind. You see breakups and you know that this is a tiny fraction of the total viewing audience trying to watch it online. If 100% of the Super Bowl was to move to the Internet tomorrow, it kind of infamously the Internet would break, and that's true. So there's a lot of very difficult problems associated with cashing, compression, quality in a little latency way, and these are really the sweet spot of -- what we've done historically in broadcast that we're now bringing to streaming, and this is a source of differentiation. So just to maybe put a finer point on it, several of the accounts that we've won on the sports streaming side, they have in-house solutions for their video on demand store. If you'd be able to go watch Spider-Man 3 or whatever it is, or the old reruns of The Office. They've turned to Harmonic for their live streaming platform. And that's really the opportunity that we see going forward.

And I think you could put some metrics around latency and what are the real differences from a spec standpoint with your solutions compared to some of the others that are out there.

So latency is a big one. Our customers and our objective, which we're just about there, is latency that's no different than the broadcast television platform. We wanted [indiscernible] the World Cup, and we're delivering this in many locations as we speak. The World Cup that you're watching through a traditional broadcast platform is delivered exactly in sync with the streaming experience. I mentioned cloud a moment ago. Another thing that we've done that we've really put a lot of emphasis on is having a true multi-cloud experience. A recent Tier 1 media win that we closed, part of what put us over the top. We're showing a demo that simultaneously had our stack running on AWS, Azure and Google Cloud, each feeding redundant CDNs. I think it was EdgeCast and Akamai. It's very powerful, again, particularly if we're competing against an in-house cloud solution. And multi-cloud capability, real time or near real time with exceptional video quality is turning out to be a winning formula for media companies.

Okay. Wrapping up soon, but maybe if you can just touch high level. You got these 2 businesses. There's some overlap, but not really. So maybe talk about synergies, talk about structure, how you think of the structure of the company maybe over time, the businesses have separated more than they were several years ago.

It's a fair question and a fair statement. I mean we got our start in cable and service provider land. And over time, the Video business has migrated and particularly with streaming to be more about the content owners themselves. That being said, we're still participating with Video with traditional service providers. And it remains to be seen to what extent that there's cost ownership between different media companies -- and so I think as I go to talk to CTOs, particularly in our large service provider customers, there is interest in both sides of the business, and there is a certain amount of overlap. And frankly, the fact that we're leading in terms of the cloud-native adaptation of these technology stacks is somewhat reinforcing. That being said, I'll be honest to the point of your question, I'd say it's modest synergy. So nothing is broken today or needing to be addressed, and there is no kind of strategic initiative around doing something different. That being said, I -- look, I think it's incumbent on any management team to always be looking at what could we do better? What could we do differently? And so in that's the case for us, our management team and our board. And look, both businesses have fantastic technology and fantastic opportunities. If those opportunities and the associated value creation trajectories are better served for some other constellation, it's an opportunity that we'll jump on. I mean we're not wed to any particular configuration of the business. And I think with both businesses seeing a lot of success we think we will have interesting strategic opportunities going forward.

Okay. Great. Great. I think we're up against time here. But thank you very much for the time. You guys have had a great year. Stocks done well. So that's a good endorsement.

We've been fortunate. Our customers have been good to us. The market has been good to us, and we've worked hard, and we appreciate your support, Tim.

Awesome. Thank you.

All right. Thanks a lot.

Thank you so much.