Basis of Presentation and Significant Accounting Policies (Policies)

6 Months Ended

Jun. 29, 2018

The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP 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 financial statements and the reported amounts of revenue and expenses during the reporting period. The Company’s reported financial positions or results of operations may be materially different under changed conditions or when using different estimates and assumptions, particularly with respect to significant accounting policies. If estimates or assumptions differ from actual results, subsequent periods are adjusted to reflect more current information.

Significant Accounting Policies

The Company’s significant accounting policies are described in Note 2 to its audited Consolidated Financial Statements included in the 2017 Form 10-K. There have been no significant changes to these policies during the six months ended June 29, 2018 other than those disclosed in Note 2, “Recently Adopted Accounting Pronouncements”.

Recent Accounting Pronouncements

RECENT ACCOUNTING PRONOUNCEMENTS

Recently Adopted Accounting Pronouncements

ASC Topic 606, “Revenue from Contracts with Customers”

On January 1, 2018, the Company adopted ASC 606, Revenue from Contracts with Customers (“Topic 606”), using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for the reporting period beginning January 1, 2018 are presented under Topic 606, while prior period amounts are not restated and continue to be reported in accordance with our historic accounting under ASC 605, Revenue Recognition (“Topic 605”).

Under Topic 606, the Company began to recognize a contract asset for satisfied performance obligations that do not provide the Company with an unconditional right to consideration, which was restricted under the previous standard. In addition, the Company changed its revenue recognition for professional services from a completed contract method to a percentage of completion method.

The cumulative effect of initially applying Topic 606 to the Company’s condensed consolidated balance sheet on January 1, 2018 was as follows (in thousands):



CONDENSED CONSOLIDATED BALANCE SHEETS	Balance as of December 31, 2017			Cumulative Impact from Adopting Topic 606			Balance as of January 1, 2018
ASSETS
Accounts receivable, net	$	69,844		$	1,781		$	71,625
Prepaid expenses and other current assets	18,931			3,578			22,509
Other long-term assets	42,913			773			43,686

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deferred revenue	$	52,429		$	(4,826	)	$	47,603
Other non-current liabilities	22,626			(473		)	22,153
Accumulated deficit	(2,057,812		)	11,431			(2,046,381		)

The impact from adopting Topic 606 on the Company’s condensed consolidated financial statements was as follows (in thousands):



	Three months ended June 29, 2018									Six months ended June 29, 2018
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS	As Reported			Previous Accounting Guidance			Impact from Adopting Topic 606			As Reported			Previous Accounting Guidance			Impact from Adopting Topic 606
Total net revenue	$	99,160		$	98,714		$	446		$	189,287		$	188,037		$	1,250
Total cost of revenue	47,557			47,316			241			90,501			90,141			360
Total gross profit	51,603			51,398			205			98,786			97,896			890
Operating expenses:
Selling, general and administrative	27,988			28,570			(582		)	59,151			59,541			(390		)
Income (loss) from operations	642			(145		)	787			(8,685		)	(9,965		)	1,280
Loss before income taxes	(2,022		)	(2,809		)	787			(14,638		)	(15,918		)	1,280
Net loss	(2,913		)	(3,700		)	787			(16,607		)	(17,887		)	1,280



	As of June 29, 2018
CONDENSED CONSOLIDATED BALANCE SHEETS	As Reported		Previous Accounting Guidance		Impact from Adopting Topic 606
ASSETS
Accounts receivable, net	82,635		78,065		$	4,570
Prepaid expenses and other current assets	19,377		15,918		3,459
Other long-term assets	42,863		42,360		503
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deferred revenue	56,278		60,032		(3,754		)
Other non-current liabilities	19,169		19,594		(425		)
Accumulated deficit	(2,062,988	)	(2,075,699	)	12,711

Revenue Recognition

The Company’s principal sources of revenue are from the sale of hardware, software, hardware and software maintenance contracts, and end-to-end solutions, encompassing design, manufacture, test, integration and installation of products. The Company also derives recurring revenue from subscriptions, which are comprised of subscription fees from customers utilizing the Company’s cloud-based media processing solutions.

Revenue from contracts with customers is recognized using the following five steps:

a) Identify the contract(s) with a customer;

b) Identify the performance obligations in the contract;

c) Determine the transaction price;

d) Allocate the transaction price to the performance obligations in the contract; and

e) Recognize revenue when (or as) the Company satisfies a performance obligation.

A contract contains a promise (or promises) to transfer goods or services to a customer. A performance obligation is a promise (or a group of promises) that is distinct. The transaction price is the amount of consideration a Company expects to be entitled from a customer in exchange for providing the goods or services.

The unit of account for revenue recognition is a performance obligation (a good or service). A contract may contain one or more performance obligations. Performance obligations are accounted for separately if they are distinct. A good or service is distinct if the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and the good or service is distinct in the context of the contract. Otherwise performance obligations will be combined with other promised goods or services until the Company identifies a bundle of goods or services that is distinct.

The transaction price is allocated to all the separate performance obligations in an arrangement. It reflects the amount of consideration to which the Company expects to be entitled in exchange for transferring goods or services, which may include an estimate of variable consideration to the extent that it is probable of not being subject to significant reversals in the future based on the Company’s experience with similar arrangements. The transaction price also reflects the impact of the time value of money if there is a significant financing component present in an arrangement. The transaction price excludes amounts collected on behalf of third parties, such as sales taxes.

Revenue is recognized when the Company satisfies each performance obligation by transferring control of the promised goods or services to the customer. Goods or services can transfer at a point in time or over time depending on the nature of the arrangement.

Deferred revenue represents the Company’s obligation to transfer goods or services to a customer for which the Company has received consideration (or an amount of consideration is due) from the customer. Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. During the three and six months ended June 29, 2018, the Company recognized $24.1 million and $44.0 million of revenue, respectively, that were included in Deferred revenue at the beginning of each respective period.

Contract assets exist when the Company has satisfied a performance obligation but does not have an unconditional right to consideration (e.g., because the entity first must satisfy another performance obligation in the contract before it is entitled to invoice the customer). Contract assets are reported as a component of “Prepaid expenses and other current assets” on the Condensed Consolidated Balance Sheets. See Note 6, “Balance Sheet Components’ for additional information.

Shipping and handling costs are accounted for as a fulfillment cost and are recorded in cost of revenue in the Company’s Condensed Consolidated Statements of Operations.

Hardware and Software. Revenue from the sale of hardware and software products is recognized when the control is transferred. For most of the Company’s product sales (including sales to distributors and system integrators), the control is transferred at the time the product is shipped or delivery has occurred because the customer has significant risks and rewards of ownership of the asset and the Company has a present right to payment at that time. The Company’s agreements with the distributors and system integrators have terms which are generally consistent with the standard terms and conditions for the sale of the Company’s equipment to end users, and do not provide for product rotation or pricing allowances, as are typically found in agreements with stocking distributors. We offer trade-in rights which are specifically identified and accrued for at the end of the period through contra-revenue.

Arrangements with Multiple Performance Obligations. The Company has revenue arrangements that include multiple performance obligations. The Company allocates transaction price to all separate performance obligations based on their relative standalone selling prices (“SSP”). The Company’s best evidence for SSP is the price the Company charges for that good or service when the Company sells it separately in similar circumstances to similar customers. If goods or services are not always sold separately, the Company uses the best estimate of SSP in the allocation of transaction price. The objective of determining the best estimate of SSP is to estimate the price at which the Company would transact a sale if the product or service were sold on a standalone basis. The Company’s process for determining best estimate of SSP involves management’s judgment, and considers multiple factors including, but not limited to, major product groupings, geographies, gross margin objectives and pricing practices. Pricing practices taken into consideration include contractually stated prices, discounts offered and applicable price lists. These factors may vary over time, depending upon the unique facts and circumstances related to each deliverable. If the facts and circumstances underlying the factors considered change or should future facts and circumstances lead the Company to consider additional factors, the Company’s best estimate of SSP may also change.

Solution Sales. Solution sales for the design, manufacture, test, integration and installation of products, including equipment acquired from third parties to be integrated with Harmonic’s products, that are customized to meet the customer’s specifications are accounted for based on the percentage-of-completion basis, using the input method. Some of our arrangements may include acceptance provisions that require testing of the solution against specific performance criteria. The Company performs a detailed evaluation to determine whether the arrangement involves performance criteria based on our standard performance criteria. The Company has a long-standing history of entering into contractual arrangements to deliver the solution sales based on standard performance criteria. For this type of arrangement, we consider the customer acceptance clause not substantive and recognize product revenue when the customer takes possession on the product and recognize service on a percentage-of-completion basis. However, if the solution results in significant production, modification or customization, we consider the arrangement as a single performance obligation and recognize the revenue at a point in time, depending on the complexity of the solution and nature of acceptance.

Professional services. Revenue from professional services is recognized over time, on the percentage-of-completion basis using the input method.

Input method. The use of the input method requires the Company to make reasonably dependable estimates. We use the input method based on labor hours, where revenue is calculated based on the percentage of total hours incurred in relation to total estimated hours at completion of the contract. The input method is reasonable because the hours best reflect the Company’s efforts toward satisfying the performance obligation over time. As circumstances change over time, the Company updates its measure of progress to reflect any changes in the outcome of the performance obligation. Such changes to an entity’s measure of progress are accounted for as a change in accounting estimates.

Support and maintenance. Support and maintenance services are satisfied ratably over time as the customer simultaneously receives and consumes the benefits of the services. As a result, support and maintenance revenue is recognized on a straight line basis over the period of the contract.

Contract costs. The incremental costs of obtaining a contract are capitalized if the costs are expected to be recovered. Costs that are recognized as assets are amortized straight-line over the period as the related goods or services transfer to the customer. Costs incurred to fulfill a contract are capitalized if they are not covered by other relevant guidance, relate directly to a contract, will be used to satisfy future performance obligations, and are expected to be recovered.

The Company recorded a net decrease to the opening balance of accumulated deficit of $1.4 million as of January 1, 2018 for capitalizing contract costs due to the cumulative impact of adopting Topic 606 for sales commissions related to customer contracts with an amortization period in excess of one year. Anticipated contract renewals, amendments, and follow-on contracts with the same customer are considered when determining the period of amortization.

The net capitalized contract costs as of June 29, 2018 were $1.8 million, of which $1.3 million and $0.5 million were reported as components of “Prepaid expenses and other current assets” and “Other long-term assets” on the Condensed Consolidated Balance Sheets, respectively. The amortization of the capitalized contract costs during the three and six months ended June 29, 2018 was $0.3 million and $0.5 million, respectively.

Significant Judgments. The Company has revenue arrangements that include promises to transfer multiple products and services to a customer. The Company may exercise significant judgment when determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together.

The Company allocates the transaction price to all separate performance obligations based on the SSP of each obligation. The Company’s best evidence for SSP is the price the Company charges for that good or service when the Company sells it separately in similar circumstances to similar customers. If goods or services are not always sold separately, the Company uses the best estimate of SSP in the allocation of the transaction price. The objective of determining the best estimate of SSP is to estimate the price at which the Company would transact a sale if the product or service were sold on a standalone basis. The Company’s process for determining the best estimate of SSP involves management’s judgment, and considers multiple factors including, but not limited to, major product groupings, geographies, gross margin objectives and pricing practices. Pricing practices taken into consideration include contractually stated prices, discounts and applicable price lists. These factors may vary over time, depending upon the unique facts and circumstances related to each deliverable. If the facts and circumstances underlying the factors considered change or should future facts and circumstances lead the Company to consider additional factors, the Company’s best estimate of SSP may also change.

Practical Expedients and Exemptions. Under Topic 606, incremental costs of obtaining a contract such as sales commissions are capitalized if they are expected to be recovered, and amortized on a straight-line basis. Expensing these costs as incurred is not permitted unless they qualify for a practical expedient. Other than capitalized costs of obtaining subscription contracts which are amortized regardless of the life of expected amortization period, the Company elected the practical expedient to expense the costs to obtain all other contracts as incurred, when the life of the expected amortization period is one year or less by using a portfolio approach.

The Company elected the practical expedient under Topic 606 to not disclose the transaction price allocated to remaining performance obligations, since the majority of the Company’s arrangements have original expected durations of one year or less, or the invoicing corresponds to the value of the Company’s performance completed to date.

The Company elected the practical expedient that allows the Company to not assess a contract for a significant financing component if the period between the customer’s payment and the transfer of the goods or services is one year or less.

See Note 14, “Segment Information” for further disaggregated revenue information.

Other Recently Adopted Accounting Pronouncements

In January 2016, the Financial Accounting Standards Board (“FASB) issued Accounting Standards Updated (“ASU”) No. 2016-01, Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities, which requires equity investments to be measured at fair value with changes in fair value recognized in net income and simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. The Company adopted this new standard in the first quarter of fiscal 2018, and the adoption did not have a material impact on its condensed consolidated financial statements. See Note 3, “Investments in Equity Securities” for additional information.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires entities to present the aggregate changes in cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. As a result, the statement of cash flows will be required to present restricted cash and restricted cash equivalents as a part of the beginning and ending balances of cash and cash equivalents. The Company adopted this new standard in the first quarter of fiscal 2018 on a retrospective basis. The Company’s total restricted cash balance was $0.3 million and $1.7 million as of June 29, 2018 and December 31, 2017, respectively. The Company’s total restricted cash balance was $1.9 million and $1.8 million as of June 30, 2017 and December 31, 2016, respectively. These restricted cash balances are presented as a part of the ending and beginning balances of cash, cash equivalents and restricted cash on the Company’s Condensed Consolidated Statements of Cash Flows for the corresponding periods. See Note 6, “Balance Sheet Components” for additional information.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The objective of ASU 2017-01 is to clarify the definition of a business in order to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. The Company adopted this new standard in the first quarter of fiscal 2018, and the adoption had no impact on its condensed consolidated financial statements.

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), to amend the existing accounting standard for lease accounting. Under this guidance, lessees and lessors should apply a “right-of-use” model in accounting for all leases (including subleases) and eliminate the concept of operating leases and off-balance sheet leases. The new leases standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. The new ASU will be effective for the Company beginning in the first quarter of fiscal 2019 and early adoption is permitted. The Company will be required to recognize the right-of-use assets and liabilities of operating leases upon adoption of the new guidance. The Company continues to evaluate the effect of adopting this guidance on its consolidated financial statements and related disclosures.

In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which amends ASC Topic 842 to provide another transition method, allowing a cumulative effect adjustment to the opening balance of retained earnings during the period of adoption.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets and certain other instruments. For trade receivables and other instruments, the Company will be required to use a new forward-looking “expected loss” model. Additionally, credit losses on available-for-sale debt securities should be recorded through an allowance for credit losses limited to the amount by which fair value is below amortized cost. The new ASU will be effective for the Company beginning in the first quarter of fiscal 2020 and early adoption is permitted. The adoption of the new ASU is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The new ASU removes Step 2 of the goodwill impairment test and requires the assessment of fair value of individual assets and liabilities of a reporting unit to measure goodwill impairments. Goodwill impairment will then be the amount by which a reporting unit's carrying value exceeds its fair value. The new ASU will be effective for the Company beginning in the first quarter of fiscal 2020 on a prospective basis, and early adoption is permitted. The Company is currently evaluating the impact of adopting the new ASU on its consolidated financial statements.

In June 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The new ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of cost. The new ASU will be effective for the Company beginning in the first quarter of fiscal 2019 and early adoption is permitted. The adoption of the new ASU is not expected to have a material impact on the Company’s consolidated financial statements.

Revenue Recognition, Policy

Revenue Recognition

Revenue from contracts with customers is recognized using the following five steps:

a) Identify the contract(s) with a customer;

b) Identify the performance obligations in the contract;

c) Determine the transaction price;

d) Allocate the transaction price to the performance obligations in the contract; and

e) Recognize revenue when (or as) the Company satisfies a performance obligation.

Shipping and handling costs are accounted for as a fulfillment cost and are recorded in cost of revenue in the Company’s Condensed Consolidated Statements of Operations.

Revenue Recognition, Multiple-deliverable Arrangements

Professional services. Revenue from professional services is recognized over time, on the percentage-of-completion basis using the input method.

Derivatives and Hedging Activities

The Company uses forward contracts to manage exposures to foreign currency exchange rates. The Company’s primary objective in holding derivative instruments is to reduce the volatility of earnings and cash flows associated with fluctuations in foreign currency exchange rates and the Company does not use derivative instruments for trading purposes. The use of derivative instruments exposes the Company to credit risk to the extent that the counterparties may be unable to meet their contractual obligations. As such, the potential risk of loss with any one counterparty is closely monitored by the Company.

Derivatives Not Designated as Hedging Instruments (Balance Sheet Hedges)

The Company’s balance sheet hedges consist of foreign currency forward contracts that generally mature within three months, are carried at fair value, and are used to minimize the short-term impact of foreign currency exchange rate fluctuation on cash and certain trade and inter-company receivables and payables. Changes in the fair value of these foreign currency forward contracts are recognized in “Other income (expense), net” in the Condensed Consolidated Statement of Operations and are largely offset by the changes in the fair value of the assets or liabilities being hedged.

Offsetting of Derivative Assets and Liabilities

The Company recognizes all derivative instruments on a gross basis in the Condensed Consolidated Balance Sheets. However, the arrangements with its counterparties allows for net settlement, which are designed to reduce credit risk by permitting net settlement with the same counterparty.

Fair Value of Financial Instruments

The Company uses the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The fair value of the Company’s convertible notes is influenced by interest rates, the Company’s stock price and stock market volatility.

The authoritative accounting guidance establishes a framework for measuring fair value and requires disclosure about the fair value measurements of assets and liabilities. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. This guidance requires the Company to classify and disclose assets and liabilities measured at fair value on a recurring basis, as well as fair value measurements of assets and liabilities measured on a nonrecurring basis in periods subsequent to initial measurement, in a three-tier fair value hierarchy as described below.

Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The guidance describes three levels of inputs that may be used to measure fair value:


•	Level 1 — Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.

•

Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The forward exchange contracts are classified as Level 2 because they are valued using quoted market prices and other observable data for similar instruments in an active market.


•	Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Goodwill and Intangible Assets, Goodwill

Goodwill represents the difference between the purchase price and the estimated fair value of the identifiable assets acquired and liabilities assumed. Goodwill is allocated among and evaluated for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment. The Company has two reporting units, Video and Cable Access.

The Company tests for goodwill impairment at the reporting unit level on an annual basis in the fiscal fourth quarter, or more frequently, if events or changes in circumstances indicate that the asset is more likely than not impaired. The Company performed its annual goodwill impairment review at the reporting unit level as of October 31, 2017, with no goodwill impairment indicated. There were no events or circumstances which triggered additional impairment reviews for the periods presented.

Restructuring and Related Charges

The fair value of this liability is based on a net present value model using a credit-adjusted risk-free rate. The liability will be paid out over the remainder of the leased properties’ term, which continues through August 2020.

Share-based Compensation Expense

The Company estimates the fair value of employee stock options and stock purchase rights under the ESPP using a Black-Scholes option valuation model. The value of the stock purchase rights under the ESPP consists of: (1) the 15% discount on the purchase of the stock; (2) 85% of the fair value of the call option; and (3) 15% of the fair value of the put option. The call option and put option were valued using the Black-Scholes option pricing model.

The expected term of the employee stock options represents the weighted-average period that the stock options are expected to remain outstanding. The computation of the expected term was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The expected term of the stock purchase rights under the ESPP represents the period of time from the beginning of the offering period to the purchase date. The Company uses its historical volatility for a period equivalent to the expected term of the options to estimate the expected volatility. The risk-free interest rate assumption is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term. The Company has not paid and does not plan to pay any cash dividends in the foreseeable future.

Segment Information

Operating segments are defined as components of an enterprise that engage in business activities for which separate financial information is available and evaluated by the Company’s Chief Operating Decision Maker (the “CODM”), which for Harmonic is its Chief Executive Officer, in deciding how to allocate resources and assess performance. Based on our internal reporting structure, the Company consists of two operating segments: Video and Cable Access. The operating segments were determined based on the nature of the products offered. The Video segment sells video processing and production and playout solutions and services worldwide to broadcast and media companies, streaming new media companies, cable operators, and satellite and telecommunications (telco) Pay-TV service providers. The Cable Access segment sells cable access solutions and related services to cable operators globally.

Warranties and Indemnification

The Company accrues for estimated warranty costs at the time of product shipment. Management periodically reviews the estimated fair value of its warranty liability and records adjustments based on the terms of warranties provided to customers, historical and anticipated warranty claims experience, and estimates of the timing and cost of warranty claims.

Harmonic is obligated to indemnify its officers and the members of its Board of Directors (the “Board”) pursuant to its bylaws and contractual indemnity agreements. Harmonic also indemnifies some of its suppliers and most of its customers for specified intellectual property matters pursuant to certain contractual arrangements, subject to certain limitations. The scope of these indemnities varies, but, in some instances, includes indemnification for damages and expenses (including reasonable attorneys’ fees).