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Yesterday, Calix reported its earnings. They grew some to $111M in revenue and were profitable on a non-GAAP basis (I will put GAAP and a few other things in a post after earning season so this can be understood). The way I would say it is that 2014 was a modest increase over 2013. And yet, the stock is getting pounded this morning. Right now it is down about 15% while the basic market is about flat. So let us examine why that is.
I see that there are 3 issues that are causing the challenges here and they are all somewhat related. The first one is that Q1 guidance was down significantly from Q4. In Q1, Calix expects to bring in $91M in revenue (actually they gave a range, but $91M is the midpoint). They quoted seasonanilty is the issue and it certainly could be. In this case, seasonality for Calix comes from two places: Budgets and Winter. Remember to make revenue, you need not just to sell something but ship it. Many telephone companies don’t finalize their construction plans until sometime in Q1 and that means that orders may or may not show up during Q1. Secondarily, new systems for Calix are mostly outdoors. During Winter months, construction for a good part of the country is halted. So, this also slows revenues. Calix customers will generally wait to order until they are sure they can put the product in the ground. There are parts of their business (upgrades, Central Office Units, spares) that are not impacted. For a company like Calix, seasonality is a way of life.
The second issue is International. You may recall that Calix bought part of Ericsson. The part that Calix bought was a business similar to Calix’s existing business but had sold more overseas. Calix announced that it had a growth strategy by pursuing markets outside of North America. Well, here the results are rather unambiguous. There has been no growth. This means this initiative has failed and that Calix investors should not expect significant growth in markets outside of North America. This happens. One of the big issues outside the US is that Chinese companies like Huawei and ZTE are much more important competitors. It is hard to win against large embedded vendors like that, so challenges with a growth plan outside the US should not be unexpected.
The third issue is Operating Expenses (OPEX). Callers noted an ongoing increase in OPEX and wondered if that was a long term problem. One of the more misunderstood parts of business is that costs rise for a company even if it is not hiring. Insurance, Power, and Salaries are just some of the costs that drift upward over time. Even a small growth in Headcount can lead to significant Operating Expense growth. The thing is that Cost (like OPEX) is a dollar for dollar contribution to losses or profits. Revenue Growth gets modified through Cost Of Goods Sold (COGS). So for Calix to make $1 in profit it needs to sell about $2 in product. Alternately, it can cut $1 of Cost.
Bundle all this together and the question arises “How is Calix going to grow?” You can not expend the amount of OPEX (particularly in R&D) that Calix is without analysts expecting growth – significant growth. Analysts are not asking where are you getting the next $10M in annual revenue, but where are you getting the next $100M. Add on to this the changes that the FCC has been mulling in Net Neutrality and their redefinition of Broadband (see my Net Neutrality Friday series). Many Calix customers depend on US Government Grants and Loans to build out their networks. Calix has plenty of products that meet the new definitions of Broadband, but how will this impact customer spending. All of this leads back to “How is Calix going to grow?” I certainly have lots of ideas around that and would provide them if they wanted to pay me to do so. But for now, we will leave it as an exercise for the most casual of observers.
So, as an investor what does all this mean. Calix is a good sized company stuck in a rut. If you invest in them now, it means that you believe that they will find a way out of it. If you decide not to, it means that you think they are what they are. One last closing note you should know before investing. On the call Huntsville, Alabama was mentioned. That was a reference to Adtran – Calix’s primary competitor. Before buying or selling Calix, study Adtran. They are in hand to hand combat in many accounts, the outcome of which adds or subtracts earnings.
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