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, 2021. 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 broadband service providers, or BSPs, of all types and sizes to innovate and transform their businesses. Our BSP 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 BSPs to grow their brand through increased subscriber acquisition, loyalty and revenue and to reduce their operating costs, thereby increasing the value of their businesses and contributions to their communities. We market our cloud and software platforms, systems and services to BSPs globally through our direct sales force as well as select resellers. Our customers range from smaller, regional BSPs to some of the world’s largest BSPs. We have enabled approximately 1,700 BSP 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 component and labor shortages and increasing lead times as well as 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 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 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 have impacted our cost of revenue for the three months ended April 2, 2022, 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 as well as our customer success organization, changes in product warranty and incurrence of retrofit costs, amortization of intangibles, asset write-offs, support fees for silicon-related development work for our products, allowances for obligations to our suppliers and inventory write-downs. Given the ongoing supply chain disruptions related to component shortages, longer lead times as a result of increased global demand for certain components and disruptions related to the COVID-19 pandemic, we have experienced and are continuing to experience product supply delays and related challenges, and we expect these delays 18 Table of Contents and related challenges to persist in the foreseeable future. Similarly, challenges in supply chain logistics have persisted due to greater global demand for transport services as well as labor shortages and resulted in increases in our global freight charges. In addition, we periodically elect to ship by air in order to meet delivery commitments to our customers, and air freight rates remain elevated relative to pre-pandemic 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 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 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. 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 is highly uncertain and difficult to predict, particularly as variants of the coronavirus continue to spread around the world. In March 2020, we instituted office closures, travel restrictions and a work-from-anywhere policy for substantially all our employees due to shelter-in-place mandates. In July 2021, we reopened our U.S. offices to fully-vaccinated employees, who choose to work in the office, and we lifted certain travel restrictions. The COVID-19 pandemic has had a prolonged impact on our supply chain operations due to restrictions, reduced capacity and limited availability from suppliers on whom we rely for sourcing components and materials and from third-party partners on whom we rely 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 and managing global logistics and transport services for our products due to shortages and delays. 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, 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, 2021. For the three months ended April 2, 2022, 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 2, 2022 as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the year ended December 31, 2021 that are significant or potentially significant to us. 19 Table of Contents Results of Operations Comparison of the Three Months Ended April 2, 2022 and April 3, 2021 Revenue The following table sets forth our revenue (dollars in thousands): Three Months Ended April 2, 2022 April 3, 2021 Variance in Dollars Variance in Percent Revenue: Systems $ 174,426 $ 153,302 $ 21,124 14 % Services 10,522 8,772 1,750 20 % $ 184,948 $ 162,074 $ 22,874 14 % Percent of total revenue: Systems 94 % 95 % Services 6 % 5 % 100 % 100 % Our revenue increased by $22.9 million for the three months ended April 2, 2022, as compared to the corresponding period in 2021 mostly due to higher systems revenue of $21.1 million, as compared to the corresponding period in 2021. Services revenue increased by $1.8 million compared to the corresponding period in 2021. The increase in systems revenue was primarily due to higher revenue from our growing base of small, regional customers as BSPs continue to adopt our All Platform offerings and seek to provide a better Wi-Fi experience for their customers. The increase in services revenue was due to the continued ramp in our service offerings aligned with cloud and software products for our customers. For the three months ended April 2, 2022, revenue generated in the United States was $165.6 million, or 90% of our total revenue, compared to $139.3 million, or 86% of our total revenue, for the same period in 2021. International revenue was $19.3 million, or 10% of our total revenue, for the three months ended April 2, 2022, as compared to $22.7 million, or 14% of our total revenue, for the same period in 2021. No customer accounted for more than 10% of the Company’s total revenue for the three months ended April 2, 2022 and April 3, 2021. Gross Profit and Gross Margin The following table sets forth our gross profit and gross margin (dollars in thousands): Three Months Ended April 2, 2022 April 3, 2021 Variance in Dollars Variance in Percent Gross profit: Systems $ 88,513 $ 83,639 $ 4,874 6 % Services 3,279 2,603 676 26 % $ 91,792 $ 86,242 $ 5,550 6 % Gross margin: Systems 50.7 % 54.6 % Services 31.2 % 29.7 % Overall 49.6 % 53.2 % Gross profit increased to $91.8 million for the three months ended April 2, 2022, from $86.2 million during the corresponding period in 2021 due to higher revenue for both systems and services. The decrease in systems gross margin of 390 basis points for the three months ended April 2, 2022 compared to the corresponding period in 2021 was mainly due to higher component and logistics costs. Services gross margin increased by 150 basis points for the three months ended April 2, 2022 compared to the corresponding period in 2021 as our service revenue reflects a greater contribution from higher gross margin services aligned with our platform offerings, which more than offset the investments in our customer success organization. 20 Table of Contents Operating Expenses Sales and Marketing Expenses The following table sets forth our sales and marketing expenses (dollars in thousands): Three Months Ended April 2, 2022 April 3, 2021 Variance in Dollars Variance in Percent Sales and marketing expenses $ 36,091 $ 28,051 $ 8,040 29 % Percent of total revenue 20 % 17 % Sales and marketing expenses for the three months ended April 2, 2022 increased by $8.0 million compared with the corresponding period in 2021 primarily due to increases in personnel expenses of $5.9 million, mainly related to investments in sales headcount and higher sales incentive compensation, travel expenses of $1.1 million and stock-based compensation of $1.0 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. Research and Development Expenses The following table sets forth our research and development expenses (dollars in thousands): Three Months Ended April 2, 2022 April 3, 2021 Variance in Dollars Variance in Percent Research and development expenses $ 29,817 $ 24,364 $ 5,453 22 % Percent of total revenue 16 % 15 % Percentage of systems gross profit 34 % 29 % Research and development expenses for the three months ended April 2, 2022 increased by $5.5 million as compared with the corresponding period in 2021 mainly due to increases in personnel expenses of $2.5 million and stock-based compensation of $2.2 million and outside services of $0.6 million. We expect our investments in research and development to increase in absolute dollars, but remain relatively consistent as a percentage of systems gross profit, as we 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 April 2, 2022 April 3, 2021 Variance in Dollars Variance in Percent General and administrative expenses $ 16,031 $ 13,025 $ 3,006 23 % Percent of total revenue 9 % 8 % General and administrative expenses for the three months ended April 2, 2022 increased by $3.0 million as compared with the corresponding period in 2021 mainly due to increases in stock-based compensation of $1.8 million, personnel expenses of $0.6 million and outside services of $0.5 million. We expect our general and administrative investments to increase in absolute dollars but decline slightly as a percentage of revenue over time as revenue continues to grow. 21 Table of Contents Income Taxes The following table sets forth our income taxes (dollars in thousands): Three Months Ended April 2, 2022 April 3, 2021 Variance in Dollars Variance in Percent Income taxes $ 1,701 $ 150 $ 1,551 1,034 % Effective tax rate 17.3 % 0.7 % For the first quarter of 2021, we maintained a full valuation allowance against our deferred tax assets, resulting an income tax provision primarily due to state and foreign taxes payable. For the first quarter of 2022, after having released the valuation allowance during the third quarter of 2021, our income tax expense was $1.7 million for an effective tax rate of 17.3%, which differs from the statutory rate of 21% primarily due to U.S. federal research tax credits and excess tax benefits from stock-based compensation partially offset by state taxes, the inclusion of income from certain foreign operations and the effect of non-deductible stock-based compensation for executive officers. Our income taxes may be subject to fluctuation during the year and in future years as new information is obtained, which 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 We have funded our operations and investing activities primarily through sales of our common stock, cash flow generated from operations and various borrowing arrangements. As of April 2, 2022, we had cash, cash equivalents and marketable securities of $213.1 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 $7.4 million for the three months ended April 2, 2022 and consisted of net income of $8.1 million partially offset by non-cash charges of $14.7 million and cash flow decreases of $15.4 million reflected in the net change in assets and liabilities. Non-cash charges primarily consisted of stock-based compensation of $10.5 million and depreciation and amortization of $3.9 million. Cash flow decreases resulting from the net change in assets and liabilities primarily consisted of an increase in inventory of $16.1 million to support revenue growth and to mitigate supply chain shortages and disruptions and an increase in accounts receivable of $2.7 million in line with our revenue growth. In addition, there was an increase in prepaid expenses and other assets of $6.7 million mainly due to advanced payments to supply chain partners and a decrease in total accrued liabilities of $2.0 million. These changes were partially offset by an increase in accounts payable of $8.2 million due to increased inventory purchases and an increase in deferred revenue of $4.0 million due to Calix Cloud subscriptions and support contracts. During the three months ended April 3, 2021, net cash provided by operating activities was $9.9 million 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. Investing Activity For the three months ended April 2, 2022, cash used in investing activities of $20.1 million consisted of net purchases of marketable securities of $16.9 million and capital expenditures of $3.2 million, consisting primarily of purchases of test equipment and computer equipment. 22 Table of Contents 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. Financing Activities Net cash provided by financing activities of $5.9 million for the three months ended April 2, 2022 and $8.6 million for the three months ended April 3, 2021 primarily consisted of proceeds from the issuance of common stock related to our equity plans. 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. 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. 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 borrowing, 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. Contractual Obligations and Commitments Our principal commitments as of April 2, 2022 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 2, 2022 (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) $ 317,604 $ 245,071 $ 52,519 $ 12,865 $ 7,149 Operating lease obligations (2) 17,267 4,593 9,161 3,513 — Revenue share obligation (3) 13,997 5,164 8,833 — — $ 348,868 $ 254,828 $ 70,513 $ 16,378 $ 7,149 (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, 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 2026. 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. The schedule reflects our expected revenue-share and true-up 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. 23 Table of Contents