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, 2022. 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 a broadband delivery platform (cloud, software and systems) and managed services that enable service providers of all types and sizes to innovate and transform their businesses. For our customers to successfully transform their businesses into the innovative BSPs of the future, they require actionable data for critical business functions such as network operations, customer support and marketing. However, this data is often trapped in disparate systems or departmental silos. Our Calix platform, which includes Calix Cloud, Revenue EDGE and Intelligent Access EDGE, gathers, analyzes and applies machine learning to deliver real-time insights seamlessly to each key business function. Our customers utilize these insights and data to simplify network operations, marketing and customer support and deliver experiences that excite their subscribers. This enables BSPs to grow their brand through increased subscriber acquisition, loyalty and revenue and to reduce their operating costs, creating value for their businesses and the communities they serve. We market our Calix platform and managed services to communication service providers globally through our direct sales force as well as select resellers. Our customers range from smaller, regional service providers to some of the world’s largest service providers. Customers are defined into small (less than 250,000 subscribers), medium (250,000 to 2.5 million subscribers) or large (greater than 2.5 million subscribers). We have enabled approximately 1,900 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 develop, market and sell our platform and managed services to strategically aligned customers of all types such as WISPs, 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 the Calix platform and managed services. 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 component and labor shortages and increasing lead times as well as disruptions as a result of pandemics or natural disasters, 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 have in the past spent 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 networks 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 have impacted our cost of revenue for the three and nine months ended September 30, 2023, or 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, investments to support expansion of cloud and customer support offerings as well as our customer success organization, changes in product warranty, incurrence of retrofit costs, amortization of intangibles, support fees for silicon-related development work for our products, changes in trade policies, allowances for obligations to our suppliers and inventory 18 Table of Contents write-downs. In addition, we periodically elect to ship by air versus by ocean in order to meet delivery commitments to our customers, which is more costly. 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 our revenue declines. 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 or accrual for supplier commitments) and have in the past been and may be negatively impacted by 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; investments in marketing programs; 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. 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. 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, inventory valuation and supplier purchase commitments and income taxes, 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, 2022. For the nine months ended September 30, 2023, 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 nine months ended September 30, 2023 as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the year ended December 31, 2022 that are significant or expected to be significant to us. Results of Operations Comparison of the Three and Nine Months Ended September 30, 2023 and October 1, 2022 Revenue The following table sets forth our revenue (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent Revenue $ 263,835 $ 236,334 $ 27,501 12 % $ 774,859 $ 623,324 $ 151,535 24 % Our revenue increased by $27.5 million and $151.5 million for the three and nine months ended September 30, 2023, respectively, as compared to the corresponding periods in 2022. The increase in revenue was primarily due to higher revenue from our growing base of small and medium BSP customers and the continuation of BSPs seeking to provide their subscribers a better experience by adopting our platform and managed services. During the second half of 2022, we added a new medium- 19 Table of Contents sized customer that began to receive significant shipments during the second half of 2022 and the nine months ended September 30, 2023. For the three and nine months ended September 30, 2023, United States revenue was $235.1 million and $695.5 million, or 89% and 90% of our revenue, compared to $215.9 million and $565.4 million, or 91% of our revenue for the same periods in 2022. International revenue was $28.7 million and $79.4 million, or 11% and 10% of our revenue, for the three and nine months ended September 30, 2023, as compared to $20.5 million and $57.9 million, or 9% of our revenue, for the same periods in 2022. No customer accounted for more than 10% of the Company’s revenue for the three and nine months ended September 30, 2023 and October 1, 2022. Gross Profit and Gross Margin The following table sets forth our gross profit and gross margin (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent Gross profit $ 140,549 $ 118,572 $ 21,977 19 % $ 405,070 $ 310,544 $ 94,526 30 % Gross margin 53.3 % 50.2 % 52.3 % 49.8 % Gross profit increased to $140.5 million and $405.1 million for the three and nine months ended September 30, 2023, from $118.6 million and $310.5 million during the corresponding periods in 2022. The increase in gross margin of 310 and 250 basis points for the three and nine months ended September 30, 2023, respectively, compared to the corresponding periods in 2022, was mainly due to increased contributions from our platform and managed services, a shift in product mix and the sell through of a lower amount of excessively priced components acquired in the secondary market during the supply-chain disruption partially offset by excess and obsolete inventory charges. Operating Expenses Sales and Marketing Expenses The following table sets forth our sales and marketing expenses (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent Sales and marketing expenses $ 52,356 $ 46,134 $ 6,222 13 % $ 158,817 $ 123,363 $ 35,454 29 % Percent of revenue 20 % 20 % 20 % 20 % Sales and marketing expenses for the three months ended September 30, 2023 increased by $6.2 million compared with the corresponding period in 2022 primarily due to increases in personnel expenses of $5.8 million mainly related to sales headcount and higher sales incentive compensation and in stock-based compensation of $1.3 million, partially offset by lower marketing expenses of $1.4 million. Sales and marketing expenses for the nine months ended September 30, 2023 increased by $35.5 million compared with the corresponding period in 2022 primarily due to increases in personnel expenses of $25.8 million mainly related to sales headcount and higher sales incentive compensation, stock-based compensation of $5.4 million and travel expenses of $2.2 million. We expect our investments in sales and marketing will increase in absolute dollars, but be relatively consistent as a percentage of revenue, as we extend our market reach and grow our business in support of our key strategic initiatives. 20 Table of Contents Research and Development Expenses The following table sets forth our research and development expenses (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent Research and development expenses $ 46,963 $ 33,196 $ 13,767 41 % $ 135,477 $ 93,443 $ 42,034 45 % Percent of revenue 18 % 14 % 17 % 15 % Percentage of gross profit 33 % 28 % 33 % 30 % Research and development expenses for the three months ended September 30, 2023 increased by $13.8 million as compared with the corresponding period in 2022 mainly due to increases in personnel expenses of $10.7 million, stock-based compensation of $1.4 million, prototypes and test equipment expenses of $0.9 million, and depreciation and amortization of $0.9 million. Research and development expenses for the nine months ended September 30, 2023 increased by $42.0 million as compared with the corresponding period in 2022 mainly due to increases in personnel expenses of $27.9 million, stock-based compensation of $4.6 million, prototypes and test equipment expenses of $3.2 million, depreciation and amortization of $2.4 million and outside services of $1.9 million. We expect our investments in research and development to increase in absolute dollars, but remain relatively consistent as a percentage of gross profit, as we seek to expand the functionality and capabilities of our platforms. General and Administrative Expenses The following table sets forth our general and administrative expenses (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent General and administrative expenses $ 25,301 $ 19,237 $ 6,064 32 % $ 73,100 $ 54,179 $ 18,921 35 % Percent of revenue 10 % 8 % 9 % 9 % General and administrative expenses for the three months ended September 30, 2023 increased by $6.1 million as compared with the corresponding period in 2022 mainly due to increases in personnel expenses of $3.2 million and stock-based compensation of $2.3 million. We plan to continue to invest in our information technology infrastructure and headcount due to the growth of our business. General and administrative expenses for the nine months ended September 30, 2023 increased by $18.9 million as compared with the corresponding period in 2022 mainly due to increases in personnel expenses of $9.0 million, stock-based compensation of $8.2 million and outside services of $1.1 million. We expect our general and administrative investments to increase in absolute dollars but decline slightly as a percentage of revenue over time in relation to increased revenue. 21 Table of Contents Interest and Other Expense, net The following table sets forth our interest and other expense, net (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent Interest and other expense, net $ 2,214 $ 461 $ 1,753 380 % $ 6,105 $ 396 $ 5,709 1,442 % Percent of revenue 1 % — % 1 % — % Interest and other expense, net increased by $1.8 million and $5.7 million as compared with the corresponding periods in 2022 mainly due to a higher rate of interest earned on our cash, cash equivalents and marketable securities as well as a larger cash and investments balance year over year. Income Taxes The following table sets forth our income taxes (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent September 30, 2023 October 1, 2022 Variance in Dollars Variance in Percent Income taxes $ 1,190 $ 7,023 $ (5,833) (83) % $ 7,857 $ 10,872 $ (3,015) (28) % Effective tax rate 6.6 % 34.3 % 17.9 % 27.2 % For the three and nine months ended September 30, 2023, our income tax expense was $1.2 million and $7.9 million for an effective tax rate of 6.6% and 17.9%, respectively, which differed from the statutory rate of 21% primarily due to state taxes, the effect of non-deductible stock-based compensation for executive officers offset by the favorable impact of U.S. federal research tax credits, excess tax benefits from stock-based compensation and the U.S. tax impact of foreign operations. The effective tax rates for the three and nine months ended September 30, 2023 are lower than the similar periods in 2022 primarily as a result of additional U.S. federal research tax credits and the U.S. tax impact of foreign operations. For the three and nine months ended September 30, 2023, we recognized a tax benefit of $3.6 million related to the finalization of our 2022 tax returns. Our income taxes may be subject to fluctuation during the year and in future years as new information is obtained. This may affect the assumptions used to estimate the annual effective tax rate, including factors such as actual results differing from our estimates of pre-tax earnings in the various jurisdictions in which we operate, which could impact the recognition of our deferred tax assets, further benefits from stock option exercises, investments in our foreign operations, 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. Liquidity and Capital Resources Historically, we have funded our operations and investing activities primarily through sales of our common stock, cash flow generated from operations and various borrowing arrangements. For the past few years, we have generated cash flow from our operations as our business has grown. As of September 30, 2023, we had cash, cash equivalents and marketable securities of $250.1 million, which consisted of deposits held at banks and major financial institutions and highly liquid marketable securities such as U.S. government agency securities and commercial paper. Operating Activities Net cash provided by operating activities was $41.3 million for the nine months ended September 30, 2023 and consisted of net income of $35.9 million and non-cash charges of $63.4 million offset by cash flow decreases of $58.0 million reflected in the net change in assets and liabilities. Non-cash charges primarily consisted of stock-based compensation of $50.1 million and depreciation and amortization of $12.2 million. Cash flow decreases resulting from the net change in assets and liabilities primarily consisted of an increase in prepaid expenses and other assets of $48.5 million mainly due to advanced payments to supply chain partners, an increase in prepaid taxes and reclassification of contract assets from deferred revenue; a decrease in accounts payable of $19.8 million related to the timing of vendor payments; and a decrease in accrued liabilities of $3.8 million due to the payout of incentive compensation and payments related to our Calix ConneXions 2022 Customer Success and Innovation conference. These changes were partially offset by a decrease in accounts receivable of $13.1 million, mainly due to increased linearity of shipments in the third quarter of 2023 resulting in higher collections in the quarter. 22 Table of Contents Net cash provided by operating activities was $21.1 million for the nine months ended October 1, 2022 and consisted of net income of $29.1 million and non-cash charges of $47.0 million offset by cash flow decreases of $55.0 million reflected in the net change in assets and liabilities. Non-cash charges primarily consisted of stock-based compensation of $31.5 million, depreciation and amortization of $10.8 million and deferred income taxes of $5.2 million. Cash flow decreases resulting from the net change in assets and liabilities primarily consisted of an increase in inventory of $52.2 million to improve our responsiveness to customer demand, an increase in prepaid expenses and other assets of $32.9 million mainly due to advanced payments to supply chain partners and an increase in accounts receivable of $15.3 million in line with our revenue growth. These changes were partially offset by an increase in accounts payable of $36.2 million due to increased inventory purchases and an increase in deferred revenue of $9.1 million due to Calix Cloud and Revenue Edge subscriptions. Investing Activity For the nine months ended September 30, 2023, cash used in investing activities of $38.5 million consisted of net purchases of marketable securities of $52.4 million and capital expenditures of $13.9 million, consisting primarily of purchases of test and computer equipment and software. For the nine months ended October 1, 2022, cash used in investing activities of $17.2 million consisted of net purchases of marketable securities of $8.0 million and capital expenditures of $9.3 million, consisting primarily of purchases of test and computer equipment. Financing Activities Net cash used in financing activities of $23.3 million for the nine months ended September 30, 2023 primarily consisted of purchases of our common stock of $42.4 million and payments related to a financing arrangement of $7.6 million. This was partially offset by proceeds from the issuance of common stock related to our equity plans of $26.7 million. Net cash provided by financing activities of $20.5 million for the nine months ended October 1, 2022 primarily consisted of proceeds from the issuance of common stock related to our equity plans of $21.5 million partially offset by payments related to a financing arrangement of $1.0 million. Working Capital and Capital Expenditure Needs Our material cash commitments include non-cancelable firm purchase commitments, 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. Furthermore, our Board of Directors has authorized a common stock repurchase program for up to $100 million of which $57.6 million remained available as of September 30, 2023. Our stock repurchase program does not require us to purchase a specific number of shares and may be modified, suspended or terminated at any time. 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 generate sufficient cash flows or obtain other sources of liquidity, we will be forced to terminate our stock repurchase program, 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. Contractual Obligations and Commitments Our principal commitments as of September 30, 2023 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 September 30, 2023 (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) $ 275,666 $ 178,537 $ 82,816 $ 9,882 $ 4,431 Operating lease obligations (2) 13,508 4,592 6,847 1,735 334 Revenue share obligation (3) 4,217 4,217 — — — $ 293,391 $ 187,346 $ 89,663 $ 11,617 $ 4,765 (1) Represents outstanding purchase commitments to be delivered by our third-party manufacturers or other vendors. See Note 6, “ Commitments and Contingencies ” of the Notes to Condensed Consolidated Financial Statements included in Part I, 23 Table of Contents Item 1 of this Quarterly Report on Form 10-Q for further discussion regarding our outstanding purchase commitments related to our third-party manufacturers. (2) Future minimum operating lease obligations in the table above primarily include payments for our office locations, which expire at various dates through 2029. See Note 6 “ 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. 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.