CALIX, INC (CALX) FY 2022 MD&A

ITEM 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts and projections about the industry in which we operate and the beliefs and assumptions of our management. In some cases, forward-looking statements can be identified by the use of words such as “believe,” “could,” “expect,” “may,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “predict,” “will,” “would,” “project,” “potential,” or the negative thereof or other comparable terminology. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and industry and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified in the Risk Factors discussed in Item 1A, in the discussion below, as well as in other sections of this Annual Report on Form 10-K. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. All forward-looking statements and reasons why results may differ included in this report 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 data and insights 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. 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 COVID-19 outbreaks, 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, 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-

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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 and related challenges to persist in the foreseeable future. Similarly, while on-going challenges in supply-chain logistics have improved to an extent, delivery timelines remain elongated. 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 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. generally accepted accounting principles. 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, costs and expenses during the periods presented. We base our 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. We evaluate our estimates, assumptions and judgments on an ongoing basis.

We believe the following critical accounting policies affect our significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Revenue is recognized when a performance obligation is satisfied, which occurs when control of the promised goods or services is transferred to the customer, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Revenue from sales of access and premises systems is recognized when control is transferred to the customer, which is generally when the products are shipped. Revenue from software platform licenses, which provides the customer with a right to use the software as it exists, is generally recognized upfront when product is made available to the customer. Revenue from cloud-based software subscriptions, customer support, maintenance, extended warranty subscriptions and managed services is generally recognized ratably over the contract term. Revenue from professional services and training is recognized as the services are delivered.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Our hardware products contain both software and non-software components that function together to deliver the products’ essential functionality and therefore constitutes a single performance obligation as the promise to transfer the individual software and non-software components is not separately identifiable and, therefore, not distinct. Cloud-based software subscriptions can include multi-year agreements with a fixed annual fee for a minimum committed usage level. To the extent that minimum committed usage level each year varies, we have concluded that each year represents a distinct stand-ready performance obligation and the transaction price allocated to each performance obligation is recognized as revenue ratably over each annual period. Our contracts may include multiple performance obligations. For such arrangements, we allocate the contract’s transaction price to each performance obligation using the relative stand-alone selling price of each distinct good or service in the contract. We generally determine stand-alone selling prices based on the prices charged to customers or our best estimate of stand-alone selling price. Our estimate of stand-alone selling price is established

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considering multiple factors including, but not limited to, geographies, market conditions, competitive landscape, internal costs, gross margin objectives, characteristics of targeted customers and pricing practices. The determination of estimated stand-alone selling price is made through consultation with and formal approval by management, taking into consideration the go-to-market strategy.

Inventory Valuation and Supplier Purchase Commitments

Inventory, which primarily consists of finished goods purchased from CMs or ODMs, is stated at the lower of cost (determined by the first-in, first-out method) and net realizable value. Inbound shipping costs and tariffs are included in the cost of inventory. In addition, from time to time, we procure component inventory primarily as a result of manufacturing discontinuation of critical components by suppliers. We regularly monitor inventory quantities on-hand and record write-downs for excess and obsolete inventory based on our estimate of demand for our products, potential obsolescence of technology, product life cycles and whether pricing trends or forecasts indicate that the carrying value of inventory exceeds our estimated selling price. We also evaluate our supplier purchase commitments, which have increased significantly due to extended lead-times in the current supply-chain environment, and record a liability for excess and obsolete components based on our estimated demand of our products, potential obsolescence of technology and product life cycles. These factors are impacted by market and economic conditions, technology changes and new product introductions and require estimates that may include elements that are uncertain. Actual demand may differ from forecasted demand and may have a material effect on gross profit. If inventory is written down, a new cost basis is established that cannot be increased in future periods. The sale of previously reserved inventory has not had a material impact on our gross margin.

Income Taxes

We evaluate our tax positions and estimate our current tax exposure along with assessing temporary differences that result from different book to tax treatment of items not currently deductible for tax purposes. These differences result in deferred tax assets and liabilities on our Consolidated Balance Sheets, which are estimated based upon the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates that will be in effect when these differences reverse. In general, deferred tax assets represent future tax benefits to be received when certain expenses previously recognized in our Consolidated Statements of Comprehensive Income become deductible expenses under applicable income tax laws or loss or credit carryforwards are utilized. Accordingly, realization of our deferred tax assets is dependent on future taxable income against which these deductions, losses and credits can be utilized.

We must assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe that recovery is not more likely than not, we must establish a valuation allowance. Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. In the third quarter of 2021, we reversed the majority of our valuation allowance and recorded on our balance sheet U.S. federal and certain state deferred tax assets of $162 million. As of December 31, 2022, we determined that positive evidence continues to outweigh negative evidence and concluded that it was more likely than not that our U.S. federal and state (with the exception of California) deferred tax assets are realizable. We currently maintain a valuation allowance of $29.9 million for certain U.S. federal and California deferred tax assets.

Recent Accounting Pronouncements Not Yet Adopted

There have been no additional accounting pronouncements or changes in accounting pronouncements that are significant or potentially significant to us.

Results of Operations for Years Ended December 31, 2022 and 2021

Revenue

The following table sets forth our revenue (dollars in thousands):

Our revenue increased by $188.4 million, or 28%, during 2022 compared to 2021. 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. In particular, we added a new medium-sized customer that began to receive significant shipments during the second half of 2022.

Our revenue is principally derived in the United States. Revenue generated in the United States represented 91% of revenue in 2022 and 83% in 2021. Our primary focus has been and in the near term will continue to be the United States and Canada given our large, direct sales and marketing presence and the amount of government stimulus being invested into underserved and not-

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served areas of these countries. In 2022, we introduced our platform to the United Kingdom. Over time, we expect to move to additional high average-revenue-per-user markets with our platform.

No customer accounted for more than 10% of our revenue for 2022 or 2021. See Note 11 “Revenue from Contracts with Customers” to the Consolidated Financial Statements included in this Annual Report on Form 10-K for more details on concentration of revenue for the years presented.

Gross Profit and Gross Margin

The following table sets forth our gross profit and gross margin (dollars in thousands):

Gross profit increased by $78.8 million to $435.4 million during 2022 from $356.6 million during 2021. Gross margin decreased to 50.2% during 2022 from 52.5% during 2021. The decrease in gross margin of 230 basis points was mainly due to higher component and logistics costs from the COVID-19-pandemic-induced, supply-chain disruption, which more than offset the increase in gross margin due to increased software and subscription contributions. Going forward, we expect that the effects of the global supply-chain disruption will continue to normalize in 2023, and we expect the software and subscription contributions will grow, resulting in potential gross margin expansion.

Operating Expenses

Sales and Marketing Expenses

Sales and marketing expenses consist of personnel costs, employee sales commissions, marketing programs and events, software tools and travel-related expenses. The following table sets forth our sales and marketing expenses (dollars in thousands):

Sales and marketing expenses increased by $48.6 million during 2022 compared to 2021 primarily due to increases in personnel expenses of $33.6 million related to investments in sales headcount and higher sales incentive compensation, travel expenses of $5.7 million, stock-based compensation of $5.3 million and marketing expenses of $1.9 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 attempt to capitalize on Calix’s ability to enable new platform capabilities and managed services for our BSP customers.

Research and Development Expenses

Research and development expenses include personnel costs, outside contractor and consulting services, depreciation on lab equipment, costs of prototypes and overhead allocations. The following table sets forth our research and development expenses (dollars in thousands):

The increase in research and development expenses of $30.2 million during 2022 compared with 2021 was mainly due to increases in personnel expenses of $15.5 million, stock-based compensation of $5.4 million, outside services of $4.5 million and depreciation and amortization of $1.5 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 plan to expand the functionality and capabilities of our platform and deliver new managed services.

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General and Administrative Expenses

General and administrative expenses consist primarily of personnel costs related to our executive, finance, human resources, information technology and legal organizations, outside consulting services, insurance, facilities and fees for professional services. Professional services consist of outside audit, legal, accounting and tax services. The following table sets forth our general and administrative expenses (dollars in thousands):

The increase in general and administrative expenses of $20.5 million in 2022 compared to 2021 was mainly due to increases in personnel expenses of $8.7 million, stock-based compensation of $8.7 million and outside services of $2.5 million. We made continued investments in our information technology infrastructure in 2022.

We expect our general and administrative investments to increase in absolute dollars but decline slightly as a percentage of revenue over time as we expect revenue to grow.

Restructuring Benefit

We initiated a restructuring plan in June 2020 to accelerate our platform future and to align with a work-from-anywhere culture. We incurred restructuring charges of $6.3 million in 2020, consisting of facilities-related charges and severance and other termination related benefits. In 2021, we reversed $0.8 million in facilities-related charges as a result of subleasing the abandoned portion of our San Jose headquarters. See Note 4 “Balance Sheet Details” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

Interest and Other Income (Expense), Net

The following table sets forth our interest and other expense, net (dollars in thousands):

Interest and other income (expense), net increased by $2.7 million in 2022 compared with 2021 mainly due to income from marketable securities.

Income Taxes

The following table sets forth our income taxes (dollars in thousands):

During 2022, our current tax expense was $11.1 million, and our deferred tax expense was $1.9 million. Our effective tax rate was higher than the federal statutory rate of 21% due to state taxes, Base Erosion and Anti-Abuse Tax and the impact of stock-based compensation, partially offset by research and development tax credits and stock option windfall deductions.

During 2021, we recognized an income tax benefit of $162.0 million offset by current income taxes, based on our reassessment of the amount of our U.S. federal and other state deferred tax assets that are more likely than not to be realized, primarily as a result of actual and projected increases in U.S. profitability in the current and future periods.

We continue to maintain a valuation allowance of $29.9 million on certain U.S. federal and California state deferred tax assets that we believe are not more likely than not to be realized in future periods.

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, 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.

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2021 Compared to 2020

For a comparison of our results of operations for the years ended December 31, 2021 and 2020, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on February 22, 2022.

Liquidity and Capital Resources

Historically, we have funded our operations and investing activities primarily through cash flow generated from operations, sales of our common stock and various borrowing arrangements. As of December 31, 2022, we had cash, cash equivalents and marketable securities of $241.7 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. This includes $2.7 million of cash primarily held by our foreign subsidiaries. As of December 31, 2022, our liability for taxes that would be payable because of repatriation of undistributed earnings of our foreign subsidiaries to the United States was not significant and limited to withholding taxes considering our existing net operating loss carryovers.

The following table presents the cash inflows and outflows by activity during 2022 and 2021 (in thousands):

Operating Activities

Our operating activities provided cash of $27.2 million in 2022 and $56.8 million in 2021. The decrease in net cash provided by operating activities during 2022 as compared to 2021 was due primarily to unfavorable charges of $8.3 million in our net operating results after adjustment of non-cash charges and $21.4 million in our net cash outflow resulting from changes in operating assets and liabilities. Non-cash charges consisted of stock-based compensation of $44.8 million, depreciation and amortization of $14.3 million and deferred income taxes of $1.9 million partially offset by net accretion of available-for-sale securities of $1.1 million.

In 2022, cash outflows from changes in operating assets and liabilities primarily consisted of increases in inventory of $60.3 million to improve our responsiveness to our BSPs’ subscriber demand; in prepaid expenses and other assets of $38.4 million mainly due to an inventory deposit to a CM partner; and in accounts receivable of $8.6 million due to increased revenue. These changes were partially offset by increases in accounts payable of $12.1 million due to increased inventory purchases; in accrued liabilities of $12.2 million, mainly related to accrued compensation and accruals for our Calix ConneXions 2022 Customer Success and Innovation conference; and in deferred revenue of $9.1 million due to our platform subscriptions.

Investing Activities

In 2022, cash used in investing activities of $24.1 million consisted of net purchases of marketable securities of $10.0 million and capital expenditures of $14.1 million, primarily related to purchases of test equipment and computer equipment.

Financing Activities

In 2022, net cash provided by financing activities of $25.1 million primarily consisted of proceeds from the issuance of common stock related to our equity plans of $27.5 million. This was partially offset by payments related to a financing arrangement of $2.4 million.

2021 Compared to 2020

For a discussion of our liquidity and capital resources and our cash flow activities for the years ended December 31, 2021 and 2020, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 22, 2022.

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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, in July 2022, our Board of Directors authorized a one-year stock repurchase program for up to $100 million of our common stock. During the year ended December 31, 2022, no repurchases were made under the program.

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 may be adversely affected, and we may need to cease our repurchase program or 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 December 31, 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 December 31, 2022 (in thousands):

(1) Represents outstanding purchase commitments to be delivered by our third-party manufacturers or other vendors. See Note 5 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K 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 2027. See Note 5 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K 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 4 “Balance Sheet Details” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for further discussion regarding our outstanding liability.