HARMONIC INC. (HLIT) FY 2023 MD&A

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements and the related notes. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and those listed under Item 1A, Risks Factors. For discussion of comparison of our results of operations and cash flows for the fiscal years ended December 31, 2022 and 2021, refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on February 28,2023.

Business Overview

We are a leading global provider of (i) broadband solutions that enable broadband operators to more efficiently and effectively deploy high-speed internet, for data, voice and video services for their customers and (ii) versatile and high performance video delivery software, products, system solutions and services that enable our customers to efficiently create, prepare, store, playout and deliver a full range of high-quality broadcast and streaming video services to consumer devices, including televisions, personal computers, laptops, tablets and smart phones.

We classify our total revenue in two categories, “Appliance and integration” and “SaaS and service.” The “Appliance and integration” revenue category includes hardware, licenses and professional services and is reflective of non-recurring revenue, while the “SaaS and service” category includes usage fees for our SaaS platform and support service revenue from our appliance-based customers and reflects our recurring revenue stream.

We conduct business in three geographic regions—the Americas, EMEA and APAC—and operate in two segments, Broadband and Video. Our Broadband business sells broadband access solutions and related services, including our cOS (formerly CableOS) software-based broadband access solutions, to broadband operators globally. Our Video business sells video processing, production and playout solutions, and services worldwide to cable operators and satellite and telco Pay-TV service providers, which we refer to collectively as “service providers,” as well as to broadcast and media companies, including streaming media companies. Our Video business infrastructure solutions are delivered either through shipment of our products, software licenses or as SaaS subscriptions.

Historically, our revenue has been dependent upon spending in the cable, satellite, telco, broadcast and media industries, including streaming media. Our customers’ spending patterns are dependent on a variety of factors, including but not limited to: economic conditions in the United States and international markets, and impact of factors such as the Hamas-Israel and Russia-Ukraine conflicts, inflation, rising interest rates, potential supply chain disruptions, volatility in capital markets and foreign currency fluctuations; volatility and uncertainty in the banking and financial services sector; access to financing; annual budget cycles of each of the industries we serve; impact of industry consolidations; customers suspending or reducing spending in anticipation of new products or new standards; and new industry trends and/or technology shifts. If our product portfolio and product development plans do not position us well to capture an increased portion of the spending in the markets in which we compete, our revenue may decline. As we attempt to further diversify our customer base in these markets, we may need to continue to build alliances with other equipment manufacturers and suppliers, cloud service providers, content providers, resellers and system integrators, managed services providers and software developers; adapt our products for new applications; take orders at prices resulting in lower margins; and build internal expertise to handle the particular operational, payment, financing and/or contractual demands of our customers, which could result in higher operating costs for us.

More recently, the United States has experienced high levels of inflation, which may result in decreased demand for our products and services, increases in our operating costs including our labor costs, constrained credit and liquidity, reduced customer spending and volatility in financial markets. The Federal Reserve has raised, and may continue to raise, interest rates in response to concerns over inflation risk. There continues to be uncertainty in the changing market and economic conditions, including the possibility of additional measures that could be taken by the Federal Reserve and other government agencies, related to macroeconomic conditions, adverse business conditions and liquidity concerns, or bank failures or instability in the financial services sector, geopolitical disruptions and concerns over inflation risk.

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Our Broadband strategy is focused on continuing to develop and deliver software-based broadband access technologies and related DAA nodes and other hardware devices, which we refer to as our cOS solutions, to our broadband operator customers. We believe our cOS software-based broadband access solutions are superior to hardware-based systems and deliver unprecedented scalability, agility and cost savings for our customers. Our cOS solutions, which can be deployed based on a centralized, DAA or hybrid architecture, enable our customers to migrate to multi-gigabit broadband capacity and the fast deployment of DOCSIS and/or FTTH data, video and voice services. We believe our cOS solutions resolve space and power constraints in broadband operator facilities, eliminate dependence on hardware upgrade cycles and significantly reduce total cost of ownership, and are helping us become a major player in the broadband access market. In the meantime, we believe our Broadband segment will continue to gain momentum in the marketplace as our customers adopt and deploy our virtualized DOCSIS, CMTS and FTTH solutions and distributed access architectures. We continue to make progress in the development of our cOS solutions and related DAA nodes and hardware devices, in the growth of our Broadband business, with expanded commercial deployments, field trials, and customer engagements.

We believe a material and growing portion of the opportunities for our Video business are linked to the industry and our customers (i) continuing to adopt streaming technologies to capture, process and deliver video content to consumers and, increasingly, utilizing public cloud solutions like our VOS SaaS platform to do so; (ii) transforming existing broadcast infrastructure workflows into more flexible, efficient and cost-effective operations running in public clouds; and (iii) for those customers maintaining on-premise video delivery infrastructure, continuing to upgrade and replace aging equipment with next-generation software-based appliances that significantly reduce operational complexity. Our Video business strategy is focused on continuing to develop and deliver products, solutions and services to enable and support these trends. Currently, we are seeing a slow-down in capital spending by some of our Video business customers, which is causing delays for some of our appliance-based projects and creating near-term headwinds for our Video appliance business.

Video Business Strategic Review

As previously disclosed in our Q3 2023 earnings press release and Form 10-Q filed on November 3, 2023, we initiated a formal strategic review process for our Video business to better position the Company for long-term shareholder value creation. As noted in our prior disclosures, we received indications of interest in our Video business from a number of parties. To date, that interest has not yet translated into a definitive agreement with any party. We are continuing the strategic review process, and no specific timetable has been established for the completion of the review. We do not intend to disclose further details with respect to the review process unless and until our board of directors approves a specific transaction or otherwise concludes its review.

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CRITICAL ACCOUNTING ESTIMATES

Our unaudited condensed consolidated financial statements and the related notes included elsewhere in this report are prepared in accordance with U.S. GAAP. The preparation of these unaudited condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

We believe that the following accounting estimates involve a greater degree of judgement or complexity than our other accounting estimates. Accordingly, the critical accounting estimates that we believe have the most significant impact on Harmonic’s unaudited condensed consolidated financial statements are set forth below:

•Valuation of inventories; and

•Accounting for income taxes

Valuation of Inventories

We state inventories at the lower-of-cost (determined on a first-in, first-out basis) or net realizable value, including allowances for excess and obsolete inventory. These reserves are based on management’s assumptions about and analysis of relevant factors including current levels of orders and backlog, forecasted demand, market conditions, and expected product lifecycles. Situations that could cause changes in the level of these inventory reserves include a decline in business and economic conditions, a decline in consumer confidence caused by changes in market conditions, a sudden and significant decline in demand for our products, inventory obsolescence because of rapidly changing technology and consumer requirements, or failure to estimate end customer demand properly. If actual market conditions deteriorate from those anticipated by management, additional allowances for excess and obsolete inventory could be required and may be material to our results of operations.

The gross amount of inventory reserves charged to the cost of revenues totaled $7.4 million, $6.0 million, in 2023 and 2022, respectively.

Accounting for Income Taxes

In preparing our consolidated financial statements, we estimate our income taxes for each of the jurisdictions in which we operate. We estimate actual current tax expense together with assessing temporary differences resulting from different treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets.

Management’s judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We record a valuation allowance to reflect uncertainties about whether we will be able to utilize our deferred tax assets before they expire. In evaluating the need for a full or partial valuation allowance, all positive and negative evidence must be considered, including our forecast of taxable income over the applicable carryforward periods, its current financial performance, its market environment, and other factors. Based on the available objective evidence, at December 31, 2023, we determined it appropriate to release the valuation allowance against U.S. federal and certain other states net deferred tax assets of $67.7 million and recorded a one-time income tax benefit. We believe it is not more likely than not the California net deferred tax assets of $32.3 million will be realizable. Accordingly, a full valuation allowance of $32.3 million is maintained against the California net deferred tax assets. To the extent that we determine the deferred tax assets are realizable on a more likely than not basis and an adjustment is needed, an adjustment will be recorded in the fiscal period the determination is made.

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Results of Operations

Net Revenue

The following table presents the breakdown of net revenue by category and geographical region:

Appliance and integration net revenue decreased by $37.9 million in 2023, as compared to 2022, primarily due to a decrease of $68.2 million in our Video segment revenue, partially offset by an increase of $30.3 million in our Broadband segment revenue. The decrease in our Video segment revenue was mainly due to a one-time deployment of our appliance products for a customer in 2022 amounting to a $41.6 million and a decrease of $26.6 million attributable to lower sales across all regions in 2023. The increase in our Broadband segment revenue was mainly contributed by higher volume from our existing customers including initial shipments on a new project with a large Tier 1 customer in 2023.

SaaS and service net revenue increased by $20.9 million in 2023, as compared to 2022, primarily due to an increase of $10.4 million in revenue from increased usage by our existing customers, a $5.8 million increase in revenue from the acquisition of new customers, and a $4.7 million increase in revenue from higher demand for support services from our existing customers.

Americas net revenue decreased by $5.2 million in 2023, as compared to 2022, primarily due to a one-time deployment of our Video appliance products for a customer in 2022 amounting to a $41.6 million, and a $2.6 million reduction in sales within our Video segment in 2023. These decreases were partially offset by an increase in our Broadband segment revenue of $39.0 million resulting from higher volume from our existing customers including initial shipments on a new project with a large Tier 1 customer in 2023.

EMEA net revenue decreased by $5.4 million in 2023, as compared to 2022. This decline was primarily attributed to reduced sales, with decreases in our Video and Broadband segments of $3.4 million and $2.0 million, respectively. The reduction in sales in both segments was a consequence of lower demand for our products.

APAC net revenue decreased by $6.5 million in 2023, as compared to 2022, primarily due to a reduction in sales of $8.2 million in Video segment due to lower demand, partially offset by a $1.7 million increase in revenue from higher demand in our Broadband segment.

Gross Profit

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Our gross margins are dependent upon, among other factors, the proportion of software sales, product mix, supply chain impacts, customer mix, product introduction costs, price reductions granted to customers and achievement of cost reductions.

Our gross margin increased by 90 basis points (bps) in 2023, as compared to 2022, primarily driven by margin expansion in both our Broadband and Video segments, largely attributed to an increase of 53 bps from lower shipping costs and an increase of 37 bps due to favorable product mix.

Research and Development Expenses

Our research and development expenses consist primarily of employee salaries and related expenses, contractors and outside consultants, supplies and materials, equipment depreciation and facilities costs, all of which are associated with the design and development of new products and enhancements of existing products. The research and development expenses are net of French Research and Development (“French R&D”) credits.

Research and development expenses increased in 2023, as compared to 2022, primarily due to higher employee compensation costs as a result of headcount increases to support the growth of our Broadband business.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased in 2023, as compared to 2022, primarily due to higher employee compensation costs of $11.4 million as a result of headcount increases and annual compensation adjustments to support the growth of our Broadband business and non-recurring advisory fees of $5.2 million incurred for the strategic review of the Video business.

Restructuring and Related Charges

We have implemented several restructuring plans in the past few years. The goal of these plans is to bring operational expenses to appropriate levels relative to our net revenues, while simultaneously implementing extensive company-wide expense control programs. We account for our restructuring plans under the authoritative guidance for exit or disposal activities. The restructuring and related charges are included in “Cost of revenue” and “Operating expenses-restructuring and related charges” in the Consolidated Statements of Operations.

Restructuring and related charges decreased in 2023, as compared to 2022, primarily due to higher severance and employee benefit costs recorded in conjunction with restructuring activities in fiscal 2022.

Refer to Note 10, “Restructuring and Related Charges,” of the Notes to our Consolidated Financial Statements for additional information.

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Interest Expense, Net

Interest expense, net decreased in 2023, as compared to 2022, primarily due to the repayment of the 4.375% Convertible Senior Notes due 2022 upon their maturity.

Other Income (Expense), Net

The change in other income (expense), net in 2023, as compared to 2022, was primarily due to a gain of $4.2 million recognized on the sale of our investment in Encoding.com in May 2022. Refer to Note 3, “Investment in Equity Securities,” of the Notes to our Consolidated Financial Statements for details on the sale of investment in Encoding.com.

Income Taxes

The change in provision for (benefit from) income taxes for 2023, as compared to 2022, was primarily due to the release of the valuation allowance against U.S. Federal and certain state deferred tax assets due to improved historical earnings and projected earnings.

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Segment Financial Results

(1) Segment operating income and segment operating margins are Non-GAAP financial measures. Refer to Note 16, “Segment information, Geographic Information and Customer Concentration,” of the Notes to our Consolidated Financial Statements for a reconciliation of the Company’s consolidated segment operating income to consolidated income before income taxes.

Video

Our Video segment net revenue decreased by $54.8 million in 2023, as compared to 2022. This decrease was primarily driven by a reduction in appliance and integration revenue of $68.2 million, partially offset by an increase of $13.4 million in our SaaS and services revenue. The decrease in appliance and integration revenue was primarily due to a one-time deployment of our appliance products for a customer in 2022, amounting to $41.6 million, and a $26.6 million decline in sales across all regions in 2023, primarily due a decline in demand as a result of macroeconomic conditions impacting our customers’ capital budgets in 2023. The increase in our SaaS and services revenue was primarily driven by $10.4 million increase in usage from our existing customers and $5.8 million increase in revenue from the acquisition of new SaaS customers, partially offset by a $2.8 million decrease in revenue attributable to lower support services revenue from existing customers. Video segment operating margin decreased in 2023, compared to 2022, primarily due to the decrease in revenue.

Broadband

Our Broadband segment net revenue increased by $37.7 million in 2023, as compared to 2022, primarily due to a $30.3 million increase in revenue from higher product sales and a $7.4 million increase in support services revenue from our existing customers. Our Broadband segment operating margin increased in 2023, compared to 2022, primarily due to lower shipping costs in 2023.

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Liquidity and Capital Resources

We expect to continue to manage our cash from operations effectively, together with deploying cash in working capital for growth. The cash we generate from our operations enables us to fund ongoing operations, our research and development projects for new products and technologies, and other business activities. We continually evaluate our cash needs and may decide it is best to raise additional capital or seek alternative financing sources to fund our operations and the growth of our business, to take advantage of unanticipated strategic opportunities, or to strengthen our financial position, including through drawdowns on existing or new debt facilities or new financing (debt and equity) funds. In the future, we may enter into other arrangements for potential investments in, or acquisitions of, complementary businesses, services or technologies, which could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. Conversely, we may also from time to time determine that it is in our best interests to voluntarily repay certain indebtedness early. We believe that our current sources of funds will provide us with adequate liquidity during the 12-month period following December 31, 2023, as well as in the long-term.

Material Cash Requirements

Our principal uses of cash will include repayments of debt and related interest, purchases of inventory, stock repurchases, payments for payroll, restructuring expenses, and other operating expenses related to the development and marketing of our products, purchases of property and equipment, facility leases, and other contractual obligations for the foreseeable future.

As of December 31, 2023, we had outstanding $130.9 million in aggregate principal amount of indebtedness, consisting of our 2024 Notes and other debts, of which $120.4 million is scheduled to become due in the 12-month period following December 31, 2023. As of December 31, 2023, our total minimum lease payments are $30.7 million, of which $7.1 million is due in the 12-month period following December 31, 2023. For details regarding our indebtedness and lease obligations, refer to Note 11, “Convertible Notes and Other Debts”, and Note 4, “Leases”, respectively, of the Notes to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.

On February 3, 2022, the Board of Directors authorized us to repurchase, from time to time, up to $100 million of our outstanding shares of common stock through February 2025, at such time and such prices as management may decide. The program does not obligate us to repurchase any specific number of shares and may be discontinued at any time. As of December 31, 2023, approximately $94.9 million of the share repurchase authorization remained available.

Sources and Conditions of Liquidity

Our sources to fund our material cash requirements are predominantly from sales of our products and services and, when applicable, proceeds from debt facilities and debt and equity offerings.

As of December 31, 2023, our principal sources of liquidity consisted of cash and cash equivalents of $84.3 million, net accounts receivable of $141.5 million, $30.0 million from our receivables purchase arrangement, $160.0 million from our new credit agreement, and financing from French government agencies.

Our cash and cash equivalents of $84.3 million as of December 31, 2023 consisted of bank deposits held throughout the world, of which $57.3 million was held outside of the United States. At present, such foreign funds are considered to be indefinitely reinvested in foreign countries to the extent of indefinitely reinvested foreign earnings. In the event funds from foreign operations are needed to fund cash needs in the United States and if U.S. taxes have not already been previously accrued, we may be required to accrue and pay additional U.S. and foreign withholding taxes in order to repatriate these funds.

On September 29, 2023, we entered into a Master Receivables Purchase Agreement with JPMorgan Chase Bank N.A, as purchaser. The agreement allows us, from time to time, to sell certain eligible billed receivables in an aggregate outstanding amount of up to $30 million. As of December 31, 2023, there were no receivables sold under this agreement.

On December 21, 2023, we entered into a Credit Agreement (the “Credit Agreement”), by and among the Company, certain of our subsidiaries from time to time party thereto, the lenders from time to time party thereto, and Citibank, N.A., as administrative agent for the lenders. The Credit Agreement provides for a secured revolving loan facility in an aggregate principal amount of up to $120.0 million (the “Revolving Facility”), with a $10.0 million sublimit for the issuance of letters of credit, and a secured delayed draw term loan facility in an aggregate principal amount of up to $40.0 million (the “Term Facility”). As of December 31, 2023, there were no borrowings outstanding and approximately $0.2 million of letters of credit outstanding under the Credit Agreement. The Credit Agreement refinances and replaces our prior credit agreement, dated as of December 19, 2019, as amended, with JPMorgan Chase Bank, N.A., as lender. For details regarding our Credit Agreement, refer to Note 11, “Convertible Notes and Other Debts”, of the Notes to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.

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Summary of Cash Flows

Operating Activities

Net cash provided by operating activities increased by $1.6 million in 2023, as compared to 2022, primarily due to a decrease of cash used in our working capital, partially offset by lower income before income taxes.

We expect that cash provided by or used in operating activities may fluctuate in future periods as a result of a number of factors, including but not limited to, instability and uncertainty in the financial services sector; the impact of the Russia-Ukraine and Hamas-Israel conflicts on macroeconomic conditions, which may affect demand for our offerings; fluctuations in our operating results; shipment linearity; accounts receivable collections performance; inventory and supply chain management; and the timing and amount of compensation and other payments.

Investing Activities

Net cash used in investing activities increased by $7.2 million in 2023, as compared to 2022, primarily due to proceeds from the sale of our investment in Encoding.com in 2022.

Financing Activities

Net cash used in financing activities decreased by $38.1 million in 2023, as compared to 2022, primarily due to the repayment of the $37.7 million principal of the 2022 Notes in 2022, and stock repurchase transactions in 2022. The decreases were partially offset by higher payment of tax withholding obligations related to the net share settlement of restricted stock units and payments of debt issuance costs associated with the Credit Agreement.

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New Accounting Pronouncements

Refer to Note 2 to the accompanying Consolidated Financial Statements for a full description of recent accounting pronouncements, including the dates of adoption and estimated effects, if any, on results of operations and financial condition.

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