Calix, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter ended September 30, 2017; year-to-date results cover nine months. Comparisons are to the quarter and nine months ended September 24, 2016. Amounts below are in U.S. dollars; financial figures are in millions unless otherwise noted.
Business context
Calix supplies broadband access platforms, systems and software to communications service providers. Its portfolio includes AXOS software-defined access and Calix Cloud products. Services include professional services, customer support, maintenance, warranties, training and managed services. Turnkey network improvement and FCC Connect America Fund projects contributed materially to services revenue.
Financial performance
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Revenue | $128.8 | $121.2 | $372.5 | $327.0 |
| Product revenue | $106.4 | $114.0 | $305.4 | $305.9 |
| Services revenue | $22.4 | $7.2 | $67.1 | $21.1 |
| Gross profit | $44.6 | $53.5 | $122.3 | $149.0 |
| Gross margin | 35% | 44% | 33% | 46% |
| Operating income (loss) | $(17.3) | $0.7 | $(68.8) | $(15.9) |
| Net income (loss) | $(17.9) | $0.6 | $(70.2) | $(15.9) |
| Diluted EPS | $(0.35) | $0.01 | $(1.40) | $(0.33) |
Services growth reflected completion of a significant turnkey project during Q1 and progress on previously awarded CAF2 projects. Product revenue declined 7% in Q3, primarily because of lower shipments to a large Tier 2 customer. Services generated negative gross profit of $6.3 million in Q3 and $11.9 million year to date; management attributed margin pressure to the higher services mix and project rework, delays, overruns and third-party costs. Product gross margin was 48% in Q3 and 44% year to date.
- Operating expenses: $61.9 million in Q3, versus $52.8 million; $191.1 million year to date, versus $164.9 million. Year-to-date R&D was $99.4 million, up 31%, mainly reflecting contractors, personnel and product-development investment. The 2016 comparison included a $4.5 million litigation settlement gain.
- Cash flow: Net cash used in operating activities was $28.6 million for nine months, compared with $5.3 million provided in the prior-year period. Investing activities provided $14.4 million, primarily from net security maturities and sales, partly offset by $6.8 million of capital expenditures. Financing activities provided $27.8 million, primarily from net credit-facility proceeds.
- Liquidity and debt: At September 30, cash and cash equivalents were $64.2 million and marketable securities were $6.6 million, totaling $70.8 million. The company had $30.0 million outstanding under its new revolving facility; total stockholders’ equity was $150.4 million. Cash, cash equivalents and securities less facility borrowings were approximately $40.8 million.
- Balance-sheet changes: Versus December 31, 2016, cash and equivalents increased from $50.4 million; marketable securities decreased from $27.7 million; total assets declined from $355.5 million to $319.6 million; and total liabilities rose from $142.5 million to $169.3 million, including the new $30.0 million borrowing.
Material changes, outlook and risks
- In August 2017, Calix replaced its prior credit agreement with a Silicon Valley Bank secured revolving facility of up to $30 million, based on eligible receivables, maturing August 7, 2019. It is secured by substantially all assets, including intellectual property, and carries covenants and a minimum liquidity-ratio requirement. Calix reported compliance at quarter-end.
- A March 2017 restructuring is intended to increase focus on software-defined access and cloud products while reducing costs in the traditional systems business. Charges were $2.3 million year to date; total 2017 pre-tax charges were estimated at up to $4.0 million, including up to $1.7 million expected in Q4.
- Management expected operating expenses to remain relatively consistent in absolute dollars over the next several quarters and decline as a percentage of revenue over time. It also planned to moderate R&D investment as next-generation systems and software platforms come to market, and to pursue greater services-delivery efficiency. No specific revenue or earnings guidance was provided in the supplied filing text.
- Management stated that existing cash, cash equivalents and marketable securities were expected to cover anticipated cash needs for at least 12 months, based on its current operating plan. However, turnkey projects require substantial upfront working capital, and operating cash use, project execution and customer payment timing remain important liquidity risks.
- Calix wrote down $3.3 million of deferred costs after assessing recoverability. Approximately $16.8 million of deferred product revenue related to ongoing turnkey projects remained to be recognized upon customer acceptance or agreed milestones. Customer and project acceptance timing can cause significant revenue and earnings volatility.
- Two customers together accounted for 41% of Q3 revenue and 43% of nine-month revenue. Services represented 17% of Q3 revenue and 18% year to date, versus 6% in each 2016 comparison period. The filing identifies customer concentration, low services margins, project overruns, CSP capital-spending variability, competition, supplier dependence and execution of growth initiatives as material risks.
- Calix planned to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. Management anticipated possible significant timing changes, including accelerated recognition for some obligations currently deferred until customer acceptance, and said the total impact could be material but could not yet be quantified. It also expected to defer and amortize qualifying sales commissions. The company expected lease accounting adoption in 2019 to increase reported assets and liabilities, with no material income-statement impact expected.
- The filing reports no legal proceedings then expected by management to have a material adverse effect and no off-balance-sheet arrangements. Disclosure controls were assessed as effective at the reasonable-assurance level.
Most important facts for investors to verify
- Whether services-project execution improves: monitor services gross margin, deferred-cost recoverability, rework and overruns, and acceptance milestones.
- Whether operating cash use and losses moderate, and whether liquidity remains adequate given the $30 million secured borrowing, borrowing-base limits and facility covenants.
- Whether revenue concentration eases and product demand recovers, especially given the large customers’ share of sales and the Q3 product-revenue decline.
- The final financial-statement effects of adopting the revenue standard, including acceptance-related revenue timing and contract-acquisition cost capitalization.
- Actual restructuring charges and savings compared with the company’s estimate of up to $4.0 million for 2017.