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No. of Recommendations: 4
Q3 2007 Earnings
Harmonic posted their earnings last night October 23.
Last traded at $11.57 up from $9.97 when I last posted at the beginning of September. In after hours HLIT are down 4% to $11.10 so it is possible investors didn’t get the earnings or guidance they wanted.

Earnings Release: <snips>
- Strong Growth in Sales and Earnings; Increased Revenue from Satellite Customers Worldwide; New Products Driving New Video Delivery Solutions
- Net sales of $82.3 million, up 31% from $62.9 million in the third quarter of 2006.
- sequential revenue growth in both domestic and international markets, with international sales representing 46% of revenue in the third quarter.
- Gross margins increased sequentially as a result of a larger proportion of revenue from higher margin video processing solutions and software and services, partially offset by a charge of approximately $1.8 million to write down excess inventory of older products.
- GAAP net income was $9.4 million or $0.12 per diluted share, up from $4.0 million, or $0.05 per diluted share. GAAP net income for the third quarter of 2007 included a net benefit from a reduction in excess facilities reserves of approximately $1.4 million, resulting primarily from an extension of a sub-lease. Excluding the lease benefit and non-cash accounting charges for stock-based compensation expense, the amortization of intangibles, and a one-time charge for acquired in-process technology from the recent acquisition of Rhozet Corporation, the non-GAAP net income for the third quarter of 2007 was $11.9 million, or $0.15 per diluted share, up from $7.5 million, or $0.10 per diluted share, for the same period of 2006.
- cash, cash equivalents and short-term investments of $99.0 million, up from $82.2 million as of June 29, 2007. During the third quarter of 2007, the Company reduced its inventories by $6.2 million compared to the previous quarter.

Business Outlook
The Company anticipates that the combined net sales for the fourth quarter of 2007 and the first quarter of 2008 will be in a range of $155 to $165 million and gross margins will be 41% to 43% on a GAAP basis. Non-GAAP gross margins for the same period, excluding stock-based compensation expense and the amortization of intangibles, are anticipated to be in a range of 45% to 47%.

My last quick and dirty estimate was:
Still Long and holding, though the October $10 covered call trading position I entered back at the end of April is now likely to swell my cash coffers and leave me with less HLIT. Despite the recent rise I now need to take a deeper look to see if I should be reinvesting those profits in HLIT. Very rough dirty quick look, past 6 months eps of .18 plus high estimates for next 6 months of .29, gives $0.47 eps. With such outstanding growth investors may pay up to a P/E of 40, meaning the best possible return in 6 months is almost 90%. Using consensus eps for next six months and same other figures $.41*40=$16.4/9.97-1 = a 65% return. All these estimates are best case, conservative figures would obviously be much lower.

With one more quarter in the bag how is that estimate stacking up?
They have improved gross margins and are growing at around 30%.
Current ttm eps is $0.43 with current estimates predicting no change on that for eoy.
Their guidance implies a lower top line growth rate for the next six months, that needs to be looked at.
Analysts are predicting $0.59eps for 2008. with range of .54-.68
Quick P/E look
2008est	Low	Mean	Good	High  
P/E 0.54 0.59 0.64 0.68
25 13.50 14.75 16.00 17.00
30 16.20 17.70 19.20 20.40
35 18.90 20.65 22.40 23.80
40 21.60 23.60 25.60 27.20

Return Current 11.57
17% 27% 38% 47%
40% 53% 66% 76%
63% 78% 94% 106%
87% 104% 121% 135%

So quick and dirty it looks like a 20-80% return seems possible and a 50% return seems probable over he next 18 months. Of course a conservative analysis would yield considerably lower returns. For example, due to a recession telecommunications companies fearful of a 2002 like meltdown may hunker down and not buy any new products sending HLIT back into the red. As HLIT’s products are exactly what the market wants at the moment I see that as unlikely, but possible.

The VOD market that HLIT is selling into is only now starting to take off and has many years of expansion ahead of it. Harmonic as the recognised leader due to their large R&D investment over the years looks like it will now bear fruit.
On current earnings they appear slight under to fairly valued with plenty of upside potential.

They also announced today they are offering 13M-15M shares for sale
I have not seen any details of the deal yet. They were very mum about it on the call, deflecting all questions.
As they have $100M is cash why are they selling shares? Big acquisition or expansion planned? As they have a contract manufacturing model I’d guess a major strategic acquisition. Harmonic have been a consolidator in the VOD field. Last year they bought Entone a private developer of video networking software. This year they bought Rhozet a transcoding company, i.e. their software converts video across different formats.

With around 80M shares outstanding these shares represent around 16-19% dilution (depending on the oversubscription).

$9.3M in operating cash flows for the nine months of 2007. $17M cash flow from ops for the quarter. $6M of that appears to be from reduction in inventories, i.e. they sold more than they made.

Conference Call – I listened to this in the background, they seemed happy and positive.

Insider Transactions: nothing of note

Short interest has doubled over the last year and as at September was 6.7M shares

Q3 10-Q has not been filed
Q2 filing

Background Information
Harmonic Inc. designs, manufactures and sells systems and software that enable network operators to provide a range of interactive and advanced digital services that include digital video, video-on-demand (VOD), high definition television (HDTV), high-speed Internet access and telephony.

Although the current price is not a booyah table thumping buy it appears fair. As I have a position, albeit diminished due to the my covered call position being called (sheesh sometimes you just have to settle for 25% 5 month returns) I am happy to wait for the possibility of lower prices. They have set the bar low for the next two quarters so there is a risk I might not get to add more. However, there is also a question mark around the upcoming offering.
I see this as a better investment over the next 1-3 years than NFLX and believe HLIT has more upside and less downside potential over that time frame.
As I’ve commented before Harmonic are an Emmy awarded company with Royce as their largest mutual fund holder.

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