|Shares Out. (in M):||51||P/E||0||0|
|Market Cap (in $M):||302||P/FCF||0||0|
|Net Debt (in $M):||-41||EBIT||0||0|
I believe Calix, Inc (CALX) represents a compelling long opportunity at current levels. The story here is relatively straight-forward. The stock is currently trading near historic low valuation levels in terms of EV/S due to extremely depressed bottom line results YTD in 2017 caused by several factors that should reverse moving forward, and more recently by a negative pre-announcement from their primary competitor. While the stock does not currently appear cheap on bottom line metrics (they’re generating losses), I believe they will return to profitability in 2H18 and their significant earnings power (relative to the current valuation) will become apparent over the next 12-18 months. Trading at just 0.5x EV/Sales, the valuation is compelling for a company that has grown its top line at a respectable 9% CAGR over the past 5 years (since 2012), was consistently profitable on a full year basis from 2010-2015, and has a target operating model of double digit operating margins. As they return to profitability and show progress towards their target operating model, I would expect the valuation to move closer to its nearest comp (ADTN) at about 1.2x Sales, representing a more than doubling in the stock from here.
What do they do?
CALX is a supplier of hardware/software to Communications Service Providers (CSPs). They are focused on the access (or last mile) piece of the telecom network. Their offerings enable CSPs to provision a wide range of service offerings to end customers through packet-based technologies over diverse types of physical networks (DSL, DOCSIS, GPON, etc). Basically CALX products allow their CSP customers to increase offerings to their end customers while reducing investment in physical networks and with lower operating costs. Their customer base is primarily telcos (as opposed to cable) in North America and they’ve historically served Tier 2/3 operators. While they have about 1300 customers, they do have some customer concentration, with CTL being their largest at 21% of sales in 2016 (and likely somewhat more than that YTD in 2017).
As one can see, the recent poor operating results are not at all consistent with their historical profitability levels.
Before getting into a discussion of CALX’s recent results and my forecasts, I’ll briefly discuss what is likely the company’s biggest top line growth driver moving forward, namely VZ’s NG-PON2 rollout. By way of background, both ADTN and a CALX/Ericsson partnership were selected in mid-2016 for initial lab trials. ADTN specifically press-released their participation in mid-2016, while CALX did not. However, ADTN has referred to being one of two vendors in the trial, and CALX on their Q217 earnings call talked about beginning field trials for NG-PON2 with a ‘large North American Tier 1’. This can only refer to VZ. CALX on the same call stated “this customer can and we believe will become a greater than 10% customer. There's no question in our minds about that.”
It is believed that VZ will end up using both ADTN and CALX/Ericsson in their NG-PON2 rollout. This article discusses VZ’s goal of using multiple vendors and interoperability amongst vendors:
…while this blog indicates a belief that CALX/Ericsson will be the “primary beneficiary” of VZ’s NG-PON2 (albeit they speculate at poor margins):
The timing of the ramp is certainly still an open question. ADTN stated recently that they don’t see a ramp from VZ before 2H18, though VZ (speaking at CALX’s annual user conference in October ‘17) said the following:
"If everything goes correctly... by the end of the year it should be in a state that's a deployable state from Verizon's perspective," said Verizon Director of Technology Vincent O'Byrne, speaking at the 2017 Calix Connexions Innovation and User Conference here. "[We will then] start deploying probably in the first quarter of next year."
In summary, I assume that CALX is involved here and that VZ likely becomes very material to revenues over time. As discussed more below, I assume some upward inflection in growth in 2H18 due to VZ.
While CALX’s recent top line growth has been strong at 14% YTD in 2017 (relative to its 5-year CAGR of 9% since 2012), this has been entirely driven by significant growth in its recently negative GM services business, which has been the primary factor driving bottom line losses recently. Focusing specifically on the services business, a couple factors have been responsible for significantly dragging down GMs here, namely their taking on (or perhaps being forced by large customers to take on) significant structurally low margin ‘development services’ business, poorly priced contracts (with poorly defined project scopes) signed in 2016 that largely have been recognized in 2017, and poor internal management/cost controls. 2017 YTD service GMs are -17% and were -27% in Q317. There are a number of reasons to believe this drag reverses moving forward:
The other significant factor driving losses recently has been a big ramp in R&D spending, as they’ve invested significantly in 1) their software-defined networking (SDN) platform called AXOS which they believe will be accretive to product GMs over time, and 2) investment in projects for new customers (I believe significantly related to VZ). Non-GAAP R&D expense increased nearly $10M from $21.7M in Q116 to $32.5M in Q117 (a 50% Y/Y increase), but has trended down slightly since then and has been guided to continue to trend down in $ terms moving forward as the incremental spend for investment in the AXOS platform is largely finished at this point.
Finally, I’d note that product revenues will likely grow sub-1% in 2017, substantially lower than in prior years. This also likely has been a drag on sentiment recently. I think this re-accelerates in 2018. While the company did not historically break out product revenue versus service revenue, the disclosures in 2017 included 2016 splits and indicate that product revenues were well over 90% of their business through Q316 (but had fallen to 83% of revenues in Q317 due to the 200%+ growth in services revenues). I think the 5 year revenue CAGR of 9% is generally representative of their product revenue growth rate over that period, given how immaterial services revenue had been before 2017. I believe the biggest reason for this slowdown in 2017 is a tough Y/Y comp (when revenues grew 13% in 2016), while management also attributes it somewhat to a shift in spending by their customers towards services. I find the latter explanation a bit questionable to be honest. Nevertheless, I believe that product revenue growth should move back towards the historical trend for a couple reasons:
In the model above, the key assumptions I’ve made for 2018 are:
Under these assumptions, their operating margins approach 5% in Q418 (and annualized EPS approaches $0.50), putting them well on their way towards their target 10%+ operating model ($1+ in EPS) with continued revenue growth.
In addition to the factors discussed above that have dinged profitability (and the stock) that I believe will reverse moving forward, most recently competitor ADTN pre-announced a big miss on revenues in Q417. On 12/28/17 after the close, they announced that revenue would come in at $125M versus prior guidance of ~$160M, a miss of over 20%. (on a side note, a nice gift to their institutional shareholders on the last trading day of the year!)
They blamed merger-integration related spending delays at a ‘domestic tier 1 customer’. This customer is CTL, who acquired LVLT during the quarter. In addition the being CALX’s largest customer, I believe CTL is also ADTN’s largest customer at 24% of 2016 revenues. ADTN’s stock has predictably sold off (~11%) since the announcement. CALX’s stock has also been hit – it’s currently down over 6% since ADTN’s pre-announcement (after selling off as much as 12%). This is despite CALX announcing their earnings date this past week without themselves pre-announcing. My discussions with the sell-side in the immediate aftermath of ADTN’s pre-announcement led me to believe that it was one particular program at CTL where ADTN was the sole supplier that was the culprit. That said, given the magnitude of the miss, I believe ADTN must have seen weakness elsewhere beyond CTL given the magnitude of the miss (unless CTL essentially went to zero for them, which seems unlikely). We’ll know more about ADTN when they report this coming Wednesday, Jan 17. But the fact that CALX did not pre-announce only strengthened my view that this was ADTN-specific. While I can’t rule out that some CTL-related weakness could show up for CALX, the stock has already been marked down, which I believe is likely presenting an opportunity here.
Given that CALX has recently been unprofitable and I expect it to stay so for a few more quarters, the most tangible valuation metric we currently have to look at is EV/Sales. CALX currently trades at ~0.5x Sales, which is very low relative to:
|Entry||01/16/2018 06:39 AM|
You say the company was consistently profitable from 2010-2015, but when I pull up the financials and/or look at the 10-K it looks like it has been losing money on the operating line every single year in that time period. What am I missing?
|Subject||Re: Consistently profitable?|
|Entry||01/16/2018 09:12 AM|
I realized after posting I should have made this more explicit. The financials are labeled as 'pro forma', but I didn't explain. Pro formas back out stock-based comp, amortization of intangibles, and most recently some small restructuring charges in 2017. The vast majority of the delta you're seeing though is SBC & amortization of intangibles.
|Subject||Re: Re: Consistently profitable?|
|Entry||01/16/2018 09:38 AM|
Perhaps this helps as well. I've labeled it is here as non-GAAP net income (rather than 'pro forma'); it has the adjustments from GAAP that I just described. For 2010-2016, here is non-GAAP net income versus FCF (CFFO-CapEx):
|Subject||Couldn't agree more|
|Entry||01/16/2018 12:01 PM|
I wrote up CALX just under two years ago and while it has been a frustrating holding, I think they are on the cusp of a breakout. While the top line has come in largely as I expected, since I wrote up the stock the R&D expenses continued growing and we had the services margin debacle of 2017. I believe Calix has completed a large product development cycle- relasing Axos, Calix Service Cloud, Marketing Cloud and the new mesh WiFi product along with all its normal access updates and a ton of custom work for Verizon- and they have been clear that they expect R&D to decline on an absolute basis going forward.
I actually don't agree that the top line will come in below consensus for a host of reasons- first and foremost likely adding in Verizon where I believe they are ahead of Adtran and maybe already shipping to a limited extent, some other new customers, a generally healthy wireline access investment environment (their customers are large net winners of tax reform and of the end of net neutrality), the fruits of all of this product development, etc. Offsetting this is possible merger-related weakness at CTL and financial trouble at WIN.
CTL merits its own discussion. My understanding is that it is largely LVLT's management that is taking over CTL. CTL has been losing broadband subscribers because they have under-invested in their network in urban/suburban areas and cable is eating their lunch. LVLT management has historically been more forward-looking and fiber-oriented. I think the end result is that CTL will invest more in fiber to the home, which historically has been supplied more by CALX than ADTN. From talking to a couple of sell-side analysts, I believe that it was CTL's vectoring program that lead to weakness at ADTN, which was 100% supplied by them. Vectoring is an upgrade at the DSLAM that enables DSL to go to 100Mb+, a decent upgrade in speeds but still well short of what cable can deliver. I think CTL's broadband subscriber adds over the last year demonstrate that the vectoring program was not working as expected, which lead to its suspension and possible cancellation. A suspension of vectoring would explain why ADTN preannounced negatively but CALX didn't (if indeed we aren't due for a nasty surprise in CALX's Q4 results). If the new CTL management decides to do fiber in more places I would expect ADTN to win some share, but doing this will take a while to ramp up and could lead to a hole in ADTN's 2018 results given vectoring was a large part of their CTL biz. It does seem like the environment is healthy and ADTN is adding some new customers (including Verizon) so they could do OK over the next couple of years.
Anyway, I think it's possible that by 2019 we are looking at a $650M top line biz doing $65M in EBIT and $1.20 in non-taxed non-GAAP EPS. Other small caps with double digit growth toplines are trading at 20x+ earnings, so I don't think a triple to $19 or so is out of the question if everything breaks right. This would be only 1.5x sales or so.
|Subject||Re: Couldn't agree more|
|Entry||01/16/2018 01:31 PM|
Thanks for all the additional color. I agree that I could be too conservative on top line. I model product revenue growth at 9% in 2018 after ~0% in 2017, so I definitely bake in some optimism, but should the VZ ramp (biggest swing factor IMO) be sooner/larger than expected this year, that will end up being too low. Like I mentioned, I believe I'm only below the street (and only slightly at $536M vs $543M) due to my conservatism on service revenues, modeling them down 20% Y/Y.
|Subject||ADTN earnings call|
|Entry||01/17/2018 11:35 AM|
ADTN's earnings call this morning was generally supportive of my prior understanding of the situations at both CTL and VZ as it pertains to CALX.
With regards to CTL, they said the weakness was specific to one program (vectoring) where they have the 'vast majority' of that business (all but said they're the sole-source which I think they are). While they said other areas beyond vectoring are under review at CTL, they indicated that all the weakness they're seeing with CTL in Q4/Q1 is around this one program. While we obviously can't rule out merger-related weakness that spills over and impacts CALX, everything ADTN said today supports the idea that this issue is ADTN-specific.
As far as VZ's NG-PON2 rollout, they reiterated what they said previously: they expect to see shipments begin in 2H18. This is essentially how I'm thinking about it for CALX at this point as well.
|Entry||01/30/2018 01:08 PM|
CALX announced this morning that Verizon NG-PON2 deployments using CALX's AXOS platform will begin in Q118. Confirmation of CALX participating here and the earlier (than I was assuming) timing are significant positives. Given this announcement, I think it's quite likely that my 2018 product revenues could be too low, particularly in the first half of the year...I will await the CALX earnings call on Feb 13 for more color on how big this could be for them this year.
CALX - Calix and Verizon Achieve Major Industry Milestone with the First Large-scale Deployments of AXOS and NG-PON2, Tu 01.30.18
PETALUMA, Calif., Jan. 30, 2018 (GLOBE NEWSWIRE) -- Calix, Inc. (NYSE:CALX), today announced that Verizon has selected the AXOS E9-2 Intelligent Edge System to begin large-scale NG-PON2 deployments in the first quarter of 2018. These deployments will include the AXOS RPm (Routing Protocol module for Layer 3) and the AXOS SMm (Subscriber Management module for disaggregated Broadband Network Gateway). By leveraging an always-on, converged services platform, Verizon will deploy a single access network for residential, business, and mobile services. This industry-first use of NG-PON2 technology will help Verizon realize a radical reduction in network operating complexity and costs while enabling the Company to deploy new services with unprecedented speed.
"Several years ago, we determined that we were going to need a better network to meet our growing customers' demands for bandwidth and higher throughput. We saw that the single wavelength systems (e.g., 10G EPON and XGS-PON) were only possible interim solutions and that we needed a longer term solution. NG-PON2 is a platform that will meet the customers' envisioned needs for the next decade or more given its many evolution paths as well as bringing many operational benefits to simplify the network. It represents a paradigm shift in the design of access networks," said Vincent O'Byrne, director of technology planning at Verizon. "NG-PON2, allows us to converge our many service networks into a single unified intelligent network, and simplify our operating model by integrating the OLT and subscriber management system."
"We also need to drastically shorten the time it takes to deploy new services," added Lee Hicks, vice-president of technology at Verizon. "The best way to achieve these goals is through leveraging breakthrough technologies like NG-PON2 and the automation of manual functions across the network. Innovative partners like Calix are enabling us to leap frog the competition and consolidate multiple network elements into one platform and automate many of our most critical network functions. We are excited to now begin this transformation, starting in Tampa, Florida and expanding into other markets."
With the inclusion of the industry's first compliant NG-PON2 optics, the AXOS E9-2 Intelligent Edge System now delivers on the promise of software defined, converged networks. By consolidating the subscriber management, aggregation, and optical line terminal (OLT) functions into a single point in the network that is closer to the subscriber, Verizon will realize significant operations expense reductions with fewer network elements while dramatically improving their ability to automate the network.
"Calix has pursued the vision of a unified access network for a decade, and through the AXOS software platform the vision is now a reality," said Carl Russo, president and CEO of Calix. "AXOS allows a service provider to deliver all services on a single, elastic, converged access network that is always on. AXOS provides the flexibility to move intelligence deep into the access network, close to the subscriber where it makes architectural and financial sense. Quite simply, no other offering in the industry can match this value proposition. Over the last decade, we have made a significant investment in software development and built the world's only Software Defined Access network, while Verizon has pioneered fiber everywhere. Culturally, our teams are a perfect match, and we are very excited to partner with Verizon as AXOS-enabled NG-PON2 enters production and reshapes how service providers architect their networks forever."