Harmonic Sees Growth in Broadcast Business

NEW YORK: Harmonic see a growth opportunity among broadcasters, the company’s chief executive told Wall Street this week. Networks and stations increasingly focused on creating content and diversifying delivery are of particular interest.

“We believe that with more over-the-top delivery, the companies that own, create and originate content, own the rights to content, are in an increasingly strong position,” Patrick Harshman, president and CEO of Harmonic. “They’re going to be not only delivering that content to aggregators, but to consumers themselves. A space where Harmonic has not participated very much historically.”

Harshman spoke to analysts Wednesday at the Jefferies 2012 Global Technology, Media & Telecom Conference in New York.

“We do business with just about anyone who is anyone in satellite direct-to-home; IPTV operators and large cable operators,” Harshman said. “But we have been putting increasing focus on growing the base of our business with large media companies around the world—Turner and the BBC, etc.”

In the trailing 12 months, Harshman said cable accounted for 46 percent of Harmonic’s business, with satellite and telco comprising 22 percent; and broadcast and media, 23 percent. Harmonic’s broadcast and media business grew 17 percent on a pro forma basis in 2011.

“Actually, it was the main engine of our growth last year,” Harshman said, later noting, “We think we haven’t fully leveraged it.”

Harshman’s pitch at the Jefferies Conference came during a particular tough period on Walls Street for Harmonic. The company’s share price has taken a pounding since late April when it announced first-quarter results. Revenues, though down, met expectations, while margins fell. Shares fell from more than $4.80 on April 24 to as low as $4.26 since then. Harmonic (NASDAQ: HLIT) was trading in early afternoon today at around $4.40.

Net revenues for the first quarter were $127.7 million compared to $132.8 million for 1Q11, due in part to a slowdown in Europe. More than half of Harmonic’s business is outside the United States, with 25 percent generated in Europe.

“We’ve definitely seen a slowdown in demand from Europe. Last year was a record year for our European business, all the way through our fourth quarter, which was a record quarter for our European business. We saw a sharp slowdown in demand for the first quarter,” Harshman said.

“We’re not exactly sure how long that is going to last. Our competitors are largely the same, worldwide. We don’t believe we lost any market share in Europe, but it’s a situation we take seriously and it’s concerning. It definitely had an impact on us in the first quarter. It impacted our guidance in the second quarter [$130 million to $140 million]. ...Having Europe be approximately 25 percent of our business, says that we’re going benefit when Europe expands, and suffer when there is a contraction.”

However, he said, “Our view is that being strong in Europe and strong overseas is in the long-term interest of the business.”

The margin drop—42 percent GAAP gross margin for 1Q12 compared to 47 percent for 1Q11—had to do with Harmonic’s edge QAM business. It’s HectoQAM product provides more capacity than clients initially deploy, Harshman said. Revenues are derived from licensing on active capacity.

“In almost in every case where we’ve shipped it, it offers capacity beyond what clients need today,” Harshman said. “We sold a lot of razors out there and only about half of the blades.

“Gross margins was disproportionately low in the first quarter, but the amount of footprint we’re in out there has never been larger. We have more unlicensed hardware out there than ever before. we see tremendous opportunity,” he said. “We will recap those gross margins. We will sell 100 percent of the licenses on that unlicensed hardware.”

Harshman said he expects to see the QAM revenue between six months and two years out. He based the projection on a previous, smaller deployment with a prior-generation product.

Edge QAM and access comprised 27 percent of Harmonic’s business in last 12 months. Video processing—transcoding and encoding—was 41 percent. Production and playout, fueled by Harmonic’s acquisition of Omneon, comprised 18 percent of revenues and services, 13 percent.

Harmonic revenues rose nearly 30 percent last year over 2010, in large part due to the Omneon acquisition, which Harmonic completed in late 2010. Still, Harshman said, Harmonic continues to work on “pulling the sales force together and getting it to execute the way we really want in terms of leveraging our entire product line.”

Omneon’s business was 70 percent international, another key growth target for Harmonic, Harshman said. He noted that pay TV has lower international penetration compared to the United States. Global penetration of digital TV is also less than 50 percent. The company expects “a lot of investment” from Latin America, Southeast Asia, India and Eastern Europe, he said.

One area that’s growing but small is new media.

“One of the questions we get most often from investors is, ‘what’s happening around new media?’” he said. “New media is still a relatively modest part of our business, and if you talk to any of our end customers, they’ll tell you new media is a modest part of their business.”

He said they are starting to see more “scaled” deployments, as with Harmonic’s deal with ZON in Portugal and Switzerland’s telecom provider, Swisscom

“Over-the-top is still a growing, but modest part of the business, that Harmonic believes will be a growth driver over time,” he said. “This is particularly true as we look at the evolution of this market. It was not too long ago that mobile video meant delivery to a very small screen, and quality didn’t matter that much. Now, mobile and over-the-top video is going to the newest iPads, with very high-resolution HD screens, or to widescreen, 50-inch Samsung televisions that are connected to an Xbox or through a Blu-Ray device that’s talking directly to the Internet. So over-the-top Internet no longer means second quality in terms of video quality. The ability to delivery good video quality... with a minimum amount of bits, bandwidth, is extremely valuable, and something where Harmonic is uniquely positioned in the market place.”

The third linchpin in Harmonic’s growth pitch—in addition to the broadcast and international markets—is its own product line.

“This is a very dynamic technology space. We see big moves from MPEG-2 to MPEG-4, and from traditional video transport to IP networks,” he said. “ We’re very focused on extending our leadership position in video technology.”

He said the company had 450 engineers developing video products, and that it was investing around $100 million a year in research and development—twice the 2008 investment.

“Although we’re not able to disclose the customer name, in first quarter, we did our did largest ever transcoding deal, a software deal, for someone who is running transcoding in a cloud... on a base of servers that are not provided by Harmonic. We provided the software to run on their data center, and to crunch their video for their on-demand delivery,” he said.

Harmonic finished 2011 with $550 million in revenues, having generated just over $40 million in cash. As of Q112, Harmonic had $168.5 million in cash, no debt, “and modest capital requirements for the business,” Harshman said.

Accounts receivable on an 80-day basis was $111.8 million. Inventory totaled $65.6 million. Capex in 1Q12 was $3.7 million, with an expectation of $15 million to $20 million for full-year 2012. Harmonic recently instituted a buy-back program, committing $25 million for the 18-month duration of the program.
~ Deborah D. McAdams