CALIX, INC 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities and Exchange Act of 1934, as amended, or the Exchange Act. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections of earnings, revenue or other financial items, any statement of or concerning the following: the plans and objectives of management for future operations, proposed new products or licensing, product development, anticipated customer demand or capital expenditures, anticipated growth and trends in our business and industry, future economic and/or market conditions or performance and assumptions underlying any of the above. In some cases, forward-looking statements can be identified by the use of terminology such as “could,” “may,” “will,” “would,” “expects,” “believes,” “intends,” “plans,” “anticipates,” “estimates,” “projects,” “predicts,” “potential,” or “continue” or the negative thereof or other comparable terminology. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including those identified in the Risk Factors discussed in Part II, Item 1A, of this report on Form 10-Q, as well as in other sections of this report and in our Annual Report on Form 10-K for the year ended December 31, 2020. All forward-looking statements and reasons why results may differ included in this Quarterly Report on Form 10-Q are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ. Overview We are the leading global provider of cloud and software platforms, systems and services that focus on the access network, the portion of the network that governs available bandwidth and determines the range and quality of services that can be offered to subscribers. These cloud and software platforms enable communications service providers, or CSPs, of all types and sizes to innovate and transform their businesses. Our CSP customers are empowered to utilize real-time data and insights from Calix platforms to simplify their businesses and deliver experiences that excite their subscribers. These insights enable CSPs to grow their businesses through increased subscriber acquisition, loyalty and revenue, thereby increasing the value of their businesses and contributions to their communities. We market our cloud and software platforms, systems and services to CSPs globally through our direct sales force as well as select resellers. Our customers range from smaller, regional CSPs to some of the world’s largest CSPs. We have enabled approximately 1,600 CSP customers purchasing directly and through partners to deploy passive optical, Active Ethernet and point-to-point Ethernet fiber access networks. Our revenue and potential revenue growth will depend on our ability to sell and license our cloud and software platforms, systems and services to strategically aligned customers of all types such as wireless internet service providers, fiber overbuilders, cable MSOs, municipalities and electric cooperatives in the United States and internationally. Our growth is also highly dependent on the speed and willingness of customers to adopt these platforms. Revenue fluctuations result from many factors, including, but not limited to: increases or decreases in customer orders for our products and services, market, financial or other factors that may delay or materially impact customer purchasing decisions, non-availability of products due to supply chain challenges, including disruptions as a result of the COVID-19 pandemic, contractual terms with customers that result in delayed revenue recognition and varying budget cycles and seasonal buying patterns of our customers. More specifically, our customers tend to spend less in the first quarter as they are finalizing their annual budgets, and in certain regions, customers are challenged by winter weather conditions that inhibit fiber deployment in outside infrastructure. Our revenue is also dependent upon our customers’ timing of purchases, capital expenditure plans and decisions to upgrade their network or adopt new technologies, including adoption of our software and cloud platform solutions, as well as our ability to grow our customer base. Cost of revenue is strongly correlated to revenue and tends to fluctuate due to all of the above factors that may cause revenue fluctuations. Factors that impacted our cost of revenue for the three months ended April 3, 2021, and that we expect will impact cost of revenue in future periods, also include: changes in the mix of products delivered, customer location and regional mix, changes in the cost of our inventory, including higher costs due to materials shortages including components, supply constraints or unfavorable changes in trade policies, investments to support expansion of cloud and customer support offerings, changes in product warranty and incurrence of retrofit costs, tariffs and associated costs to mitigate the impact of tariffs, amortization of intangibles, asset write-offs, support fees for silicon-related development work for our products and inventory write-downs. In particular, given the recent supply chain disruptions due to the COVID-19 pandemic, we have seen increases in our global freight charges as we have elected to ship by air in order to meet delivery commitments to our customers as well as air freight 17 Table of Contents rates have increased from prior year levels. Cost of revenue also includes fixed expenses related to our internal operations, which could increase our cost of revenue as a percentage of revenue if there are declines in revenue. Our gross profit and gross margin fluctuate based on timing of factors such as changes in customer mix and changes in the mix of products demanded and sold (and any related write-downs of existing inventory) and have in the past been negatively impacted by increases in mix of revenue towards deployment services, increases in mix of revenue from channel sales rather than direct sales or other unfavorable customer or product mix, shipment volumes and any related volume discounts, changes in our product and services costs, pricing decreases or discounts, new product introductions or upgrades to existing products, customer rebates and incentive programs due to competitive pressure or materials shortages, supply constraints, investments to support expansion of cloud and customer support offerings, tariffs or unfavorable changes in trade policies. Our operating expenses fluctuate based on the following factors among others: changes in headcount and personnel costs, which comprise a significant portion of our operating expenses; variable compensation due to fluctuations in shipment volumes or level of achievement against performance targets; timing of research and development expenses, including investments in innovative solutions and new customer segments, prototype builds and outsourced development resources; asset write-offs; investments in our business and information technology infrastructure; and fluctuations in stock-based compensation expenses due to timing of equity grants or other factors affecting vesting. While we more recently had net income of $33.5 million in 2020 and $20.6 million for the first three months of 2021, we have incurred significant losses since our inception, and as of April 3, 2021, we had an accumulated deficit of $648.5 million. Further, as a result of factors contributing to the fluctuations described above among other factors, many of which are outside our control, our quarterly operating results fluctuate from period to period. Comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. COVID-19 Pandemic We are subject to risks and uncertainties as a result of the COVID-19 pandemic. The extent of the impact of the COVID-19 pandemic on our business remains highly uncertain and difficult to predict as coronavirus continues to spread around the world including through new variants. Although the availability of vaccines has increased, there are no assurances as to when the pandemic will be contained. Since March 2020, we have instituted office closures, travel restrictions and a mandatory work-from-home policy for substantially all of our employees. The spread of COVID-19 has had a prolonged impact on our supply chain operations due to restrictions, reduced capacity and limited availability from suppliers whom we rely on for sourcing components and materials and from third-party partners whom we rely on for manufacturing, warehousing and logistics services. Although demand for our products has been strong in the short-term as subscribers seek more bandwidth and better Wi-Fi, customers’ purchasing decisions over the long-term may be impacted by the pandemic and its impact on the economy, which could in turn impact our revenue and results of operations. Furthermore, our supply chain continues to face constraints primarily due to challenges in sourcing components and materials for our products. The prolonged impact of COVID-19 could exacerbate these constraints or cause further supply chain disruptions. Critical Accounting Policies and Estimates Our financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. To the extent there are material differences between these estimates and actual results, our financial statements may be affected. Our management evaluates its estimates, assumptions and judgments on an ongoing basis. Our critical accounting policies and estimates, which are revenue recognition and inventory valuation, are described under “Critical Accounting Policies and Estimates” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2020. For the three months ended April 3, 2021, there have been no significant changes in our critical accounting policies and estimates. Recent Accounting Pronouncements There have been no additional accounting pronouncements or changes in accounting pronouncements during the three months ended April 3, 2021 as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the year ended December 31, 2020 that are significant or potentially significant to us. 18 Table of Contents Results of Operations Comparison of the Three Months Ended April 3, 2021 and March 28, 2020 Revenue The following table sets forth our revenue (dollars in thousands): Three Months Ended April 3, 2021 March 28, 2020 Variance in Dollars Variance in Percent Revenue: Systems $ 153,302 $ 94,509 $ 58,793 62 % Services 8,772 7,173 1,599 22 % $ 162,074 $ 101,682 $ 60,392 59 % Percent of total revenue: Systems 95 % 93 % Services 5 % 7 % 100 % 100 % Our revenue increased by $60.4 million for the three months ended April 3, 2021 as compared to the corresponding period in 2020 due to higher systems revenue of $58.8 million. Services revenue increased by $1.6 million compared to the corresponding period in 2020. The increase in systems revenue was primarily due to higher revenue from our small, regional customers and, to a lesser extent, our large-sized customers, as service providers accelerated some deployments to respond to demand for network capacity and relieve network capacity constraints as well as provide a better Wi-Fi experience. The increase in services revenue was due to the continued ramp in our service offerings aligned with cloud and software products offset by lower professional services related to CAF deployments. For the three months ended April 3, 2021, revenue generated in the United States was $134.7 million, or 83% of our total revenue compared to $88.1 million, or 87% of our total revenue for the same period in 2020. International revenue was $27.4 million, or 17% of our total revenue, for the three months ended April 3, 2021, as compared to $13.6 million, or 13% of our total revenue, for the same period in 2020. No company accounted for more than 10% of our total revenue for the three months ended April 3, 2021. For the three months ended March 28, 2020, only Lumen Technologies, Inc. (formerly CenturyLink, Inc.), or Lumen, accounted for more than 10% of our total revenue, representing 15% of our total revenue. Cost of Revenue, Gross Profit and Gross Margin The following table sets forth our cost of revenue (dollars in thousands): Three Months Ended April 3, 2021 March 28, 2020 Variance in Dollars Variance in Percent Cost of revenue: Systems $ 69,663 $ 50,708 $ 18,955 37 % Services 6,169 5,350 819 15 % $ 75,832 $ 56,058 $ 19,774 35 % Our cost of revenue increased by $19.8 million for the three months ended April 3, 2021 as compared with the corresponding period in 2020. The $19.0 million increase in our systems cost of revenue was less than the percentage increase in revenue compared with the corresponding period in 2020 and was due to the increasing spread between fixed costs in relation to revenue growth and continued growth in our All Platform offerings along with favorable customer and product mix. This was partially offset by increased freight costs due to higher prices for transportation as well as a mix towards more air shipments to meet delivery commitments. The increase in services cost of revenue for the three months ended April 3, 2021 compared with the corresponding period in 2020 was mainly due to increased personnel costs as we made further investments in our customer success organization. 19 Table of Contents The following table sets forth our gross profit and gross margin (dollars in thousands): Three Months Ended April 3, 2021 March 28, 2020 Variance in Dollars Variance in Percent Gross profit: Systems $ 83,639 $ 43,801 $ 39,838 91 % Services 2,603 1,823 780 43 % $ 86,242 $ 45,624 $ 40,618 89 % Gross margin: Systems 54.6 % 46.3 % Services 29.7 % 25.4 % Overall 53.2 % 44.9 % Gross profit increased to $86.2 million for the three months ended April 3, 2021 from $45.6 million during the corresponding period in 2020 due to higher systems gross margin. The increase in systems gross margin for the three months ended April 3, 2021 compared the corresponding period in 2020 was mainly due to continued growth in our All Platform offerings along with favorable product and customer mix. Services gross margin increased for the three months ended April 3, 2021 compared to the corresponding period in 2020 as our service revenue mix shifted away from low gross margin deployment services to higher gross margin software maintenance and services aligned with our platform offerings. Operating Expenses Sales and Marketing Expenses The following table sets forth our sales and marketing expenses (dollars in thousands): Three Months Ended April 3, 2021 March 28, 2020 Variance in Dollars Variance in Percent Sales and marketing expenses $ 28,051 $ 20,624 $ 7,427 36 % Percent of total revenue 17 % 20 % Sales and marketing expenses for the three months ended April 3, 2021 increased by $7.4 million compared with the corresponding period in 2020 primarily due to increases in personnel expenses of $6.8 million, mainly related to investments in sales headcount and higher sales incentive compensation expense, marketing expenses of $0.5 million, stock-based compensation of $0.5 million and outside services expenses of $0.5 million. These increases were partially offset by a decrease in travel expenses of $1.3 million. We expect to slightly increase our investments in sales and marketing as a percentage of revenue in order to extend our market reach and grow our business in support of our key strategic initiatives. Research and Development Expenses The following table sets forth our research and development expenses (dollars in thousands): Three Months Ended April 3, 2021 March 28, 2020 Variance in Dollars Variance in Percent Research and development expenses $ 24,364 $ 20,671 $ 3,693 18 % Percent of total revenue 15 % 20 % Percentage of systems gross profit 29 % 47 % Research and development expenses for the three months ended April 3, 2021 increased by $3.7 million as compared with the corresponding period in 2020 mainly due to increases in personnel expenses of $2.0 million, outside services of $1.7 million, stock-based compensation of $0.6 million and depreciation and amortization of $0.4 million. These increases were partially offset by lower facilities expenses of $0.8 million. We expect to slightly increase our investments in research and development as a percentage of systems gross profit to expand the functionality and capabilities of our platforms. 20 Table of Contents General and Administrative Expenses The following table sets forth our general and administrative expenses (dollars in thousands): Three Months Ended April 3, 2021 March 28, 2020 Variance in Dollars Variance in Percent General and administrative expenses $ 13,025 $ 10,669 $ 2,356 22 % Percent of total revenue 8 % 10 % General and administrative expenses for the three months ended April 3, 2021 increased by $2.4 million as compared with the corresponding period in 2020 mainly due to increases in unallocated-facilities expenses of $1.2 million, stock-based compensation of $1.0 million and personnel expenses of $0.7 million. Beginning in the third quarter of 2020, we changed our facility allocation to align with our work-from-home initiative, and consequently, most of facilities expenses are retained in general and administrative expenses. These increases were partially offset by decreases in professional services fees of $0.3 million. We expect to slightly increase our investments in general and administrative expenses as a percentage of revenue to enhance and automate our internal information systems, databases and processes. Provision for Income Taxes The following table sets forth our provision for income taxes (dollars in thousands): Three Months Ended April 3, 2021 March 28, 2020 Variance in Dollars Variance in Percent Provision for income taxes $ 150 $ 329 $ (179) (54) % Effective tax rate 0.7 % (5.0) % The effective tax rate for the three months ended April 3, 2021 was determined using an estimated annual effective tax rate adjusted for discrete items, if any, that occurred during the respective periods. While we have recently reported profitability, we have not yet been able to establish a sustained level of profitability in the U.S. or other sufficient significant positive evidence to conclude that our U.S. deferred tax assets are more likely than not to be realized. Therefore, we continue to maintain a valuation allowance against most of our U.S. deferred tax assets. At some point, if we establish a sustained level of profitability and project continued profitability, we may reverse a significant portion of our valuation allowance recorded against U.S. deferred tax assets, resulting in a non-recurring, non-cash income tax benefit. Our effective tax rate may be subject to fluctuation during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of forecasted pre-tax earnings in the various jurisdictions in which we operate, valuation allowances against deferred tax assets, the recognition or de-recognition of tax benefits related to uncertain tax positions and changes in or the interpretation of tax laws in jurisdictions where we conduct business. 21 Table of Contents Liquidity and Capital Resources We have funded our operations and investing activities primarily through sales of our common stock, including an underwritten public offering in August 2020, cash flow generated from operations and a financing arrangement for consulting services. As of April 3, 2021, we had cash, cash equivalents and marketable securities of $150.0 million, which consisted of deposits held at banks and major financial institutions and highly liquid marketable securities such as U.S. government securities and commercial paper. Operating Activities Net cash provided by operating activities was $9.9 million for the three months ended April 3, 2021 and consisted of net income of $20.6 million and non-cash charges of $9.2 million, consisting of stock-based compensation of $5.2 million and depreciation and amortization of $4.1 million. This was partially offset by cash flow decreases of $20.0 million reflected in the net change in assets and liabilities. Cash flow decreases resulting from the net change in assets and liabilities primarily consisted of an increase in inventory of $19.9 million to support revenue growth and to mitigate supply chain shortages and disruptions and a decrease in total accrued liabilities of $15.2 million, mainly related to incentive compensation payouts, rebate redemptions and a reduction of customer advance payments. In addition, there was an increase in accounts receivable of $5.0 million, due to product shipment timing, and an increase in prepaid expenses and other assets of $1.3 million mainly due to prepaid software licenses. These changes were partially offset by an increase in accounts payable of $16.2 million due to increased inventory purchases and an increase in deferred revenue of $5.4 million due to support contracts, extended warranties and Calix Cloud subscriptions. During the three months ended March 28, 2020, net cash provided by operating activities was $1.2 million and consisted of $6.5 million of non-cash charges and $1.7 million of cash flow increases reflected in the net change in assets and liabilities, partially offset by a net loss of $6.9 million. Cash flow increases resulting from the net change in assets and liabilities primarily consisted of an increase in accounts payable of $9.5 million, primarily due to timing of payments to our contract manufacturers, or CMs, a decrease in inventory of $9.6 million due to lower deliveries due to the supply disruption during of the quarter, an increase in deferred revenue of $2.1 million mainly due to increased Calix Cloud subscriptions and an increase in accrued liabilities of $1.4 million due to an increase in inventory held by suppliers. This was partially offset by an increase in accounts receivable of $20.6 million, mainly due to timing of shipments and delays in processing invoices due to the ERP migration. Non-cash charges primarily consisted of stock-based compensation of $3.0 million and depreciation and amortization of $3.5 million. Investing Activity For the three months ended April 3, 2021, cash used in investing activities of $13.5 million consisted of net purchases of marketable securities of $11.2 million and capital expenditures of $2.3 million, consisting primarily of purchases of test equipment and computer equipment. Net cash used in investing activities of $1.7 million for the three months ended March 28, 2020 consisted of capital expenditures primarily for purchases of test equipment, computer equipment and software. Financing Activities Net cash provided by financing activities of $8.6 million for the three months ended April 3, 2021 consisted of proceeds from the issuance of common stock related to our employee equity plans. Net cash provided by financing activities of $0.1 million for the three months ended March 28, 2020 mainly consisted of proceeds from the issuance of common stock related to our employee equity plans of $1.1 million offset by payments related to financing arrangements of $0.8 million and payments to originate our loan and security agreement with Bank of America, or BofA Loan Agreement, of $0.2 million. Working Capital and Capital Expenditure Needs Our material cash commitments include non-cancelable firm purchase commitments, contractual obligations under our BofA Loan Agreement, normal recurring trade payables, compensation-related and expense accruals, operating leases and revenue-share obligations. We believe that our outsourced approach to manufacturing provides us significant flexibility in both managing inventory levels and financing our inventory. In the event that our revenue plan does not meet our expectations, we may be required to curtail or eliminate expenditures to mitigate the impact on our working capital. The BofA Loan Agreement provides for a revolving facility up to a principal amount of up to $35.0 million, including a $10.0 million sublimit for letters of credit. The BofA Loan Agreement matures, and all outstanding amounts become due and payable, in January 2023. The BofA Loan Agreement is secured by substantially all of our assets, including our intellectual property. 22 Table of Contents Loans under the credit facility bear interest at a rate per annum equal to either LIBOR (customarily defined) plus an applicable margin between 1.5% to 2.0% or Prime Rate (customarily defined) plus an applicable margin between 0.5% to 1.0% (3.75% as of April 3, 2021), in each case largely based on a fixed charge coverage ratio measured at the end of each fiscal quarter. As of April 3, 2021, we had no outstanding borrowings and had full availability of $35.0 million. In March 2018, we entered into an agreement with a vendor to develop software products pursuant to which we would become obligated, if the vendor delivered software that meets our technical requirements for commercial sale, to make minimum revenue-share payments of $15.8 million over the subsequent three years. The payments are based on a revenue-share rate applied to revenue from developed product sales subject to a minimum and a maximum aggregate amount over the three-year sales period. We had our first sale in August 2019. Revenue-share payments are paid quarterly in arrears, and we began making payments in the fourth quarter of 2020. In December 2020, we amended the agreement to increase the revenue-share rate, limit the revenue-share payments to $15.8 million and extend the revenue-share period until March 2024. We believe, based on our current operating plan and expected operating cash flows, that our existing cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for at least the next twelve months. If we are unable to execute on our current operating plan or continue to generate operating income and positive cash flows, our liquidity, results of operations and financial condition will be adversely affected, and we may need to seek other sources of liquidity, including the sale of additional equity or incremental borrowings, to support our working capital needs. In addition, we may choose to seek other sources of liquidity even if we believe we have generated sufficient cash flows to support our operational needs. There is no assurance that any other sources of liquidity may be available to us on acceptable terms or at all. If we are unable to generate sufficient cash flows or obtain other sources of liquidity, we will be forced to limit our development activities, reduce our investment in growth initiatives and institute cost-cutting measures, all of which may adversely impact our business and potential growth. 23 Table of Contents Contractual Obligations and Commitments Our principal commitments as of April 3, 2021 consisted of our contractual obligations under non-cancelable outstanding purchase obligations, operating lease obligations for office space and a revenue share obligation. The following table summarizes our contractual obligations as of April 3, 2021 (in thousands): Payments Due by Period Total Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years Non-cancelable purchase commitments (1) $ 134,858 $ 116,770 $ 15,249 $ 2,839 $ — Operating lease obligations (2) 17,612 3,885 7,744 5,983 — Revenue share obligation (3) 15,314 2,555 12,759 — — $ 167,784 $ 123,210 $ 35,752 $ 8,822 $ — (1) Represents outstanding purchase commitments to be delivered by our third-party manufacturers or other vendors. See Note 7, “ Commitments and Contingencies ” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion regarding our outstanding purchase commitments. (2) Future minimum operating lease obligations in the table above include primarily payments for our office locations, which expire at various dates through 2026. See Note 7 “ Commitments and Contingencies ” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion regarding our operating leases. (3) Represents remaining payments related to a revenue-share obligation, including imputed interest associated with developed software product and related enhancements, by an engineering service provider. The schedule reflects our expected revenue-share payments based on our revenue projections for the developed products over a sales period through March 2024. If the minimum revenue-share payments are not achieved by the end of that period, a true-up payment will be due. See Note 5 “Balance Sheet Details” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion regarding our outstanding liability. Off-Balance Sheet Arrangements As of April 3, 2021 and December 31, 2020, we did not have any off-balance sheet arrangements. 24 Table of Contents