Calix, Inc. (CALX) Earnings Call Transcript & Summary

I hope everybody had a good lunch. Paul Silverstein, senior analyst at Cowen, networking and communications equipment. It is my pleasure to have with us, the illustrious, Carl Russo CEO of Calix. Cory Sindelar, our CFO. I'm going to ask Cory all the questions. He doesn't say much. On that note. So...

So look, I want to start with this. Logically, what is wrong with the following. On top of a very strong growth that you have predating the massive amount of government stimulus that's come broadly. Multiple piece of legislation in the U.S., multiple pieces of legislation broad. That money is going to start rolling. We've already seen the first fund, you reckon that's not meaningful yet from [indiscernible] meaningful yet to move about, but it's going to get meaningful. You're going to have funds from other legislation that's going to kick in at '23 and '24 beyond, plus presumably supply chain is going to ease up, meaning that your ability to ship against demands is going to improve. Why should that translate to acceleration in your already robust revenue? Cory?

Do you want me to answer that first? I'll take a stab at it and I'll let Cory answer it. It may very well. The challenge is simply supply. And the supply chain is going to be a continuing challenge in our view for a number of years to come, just as it has been for the last 3. And we've been pretty clear in messaging that for the last 3. So it's simply a matter of supply and understanding what's going on. And you have to be prepared with the supply chain to literally have said 51 weeks ago that we're ordering for the XYZ company 52 weeks out. And 51 weeks later, you get a phone call got we got pushed out. And so the challenge you have is for the first time in my career, which, as you can tell, is long. We have much better demand visibility than we have supply visibility. So there's everything about your assumptions, which you could all look at and go, yes, but visibility is not there to say, yes.

Just to be clear there's no offset. There's not something moving out there. And to that point, century when it's gone or things going [indiscernible], they were a 30% customer for you back in [ '17 ] were out and say it's probably 4% to 5%, maybe even less. So that huge drag. I'm now seeing that drag last a year or 2, you still put up double-digit revenue. So that drag is gone. Supply chain again, if we assume it uses at some point, plus this rolling kick in of broadband stimulus funds here and abroad. Logically, that should translate to stronger growth.

Still have to supply.

Again, assuming supply chain eases should translate to stronger growth.

Totally agree with you predicate, [indiscernible], you're out assuming that, then yes.

Let me ask you another big picture question. Your "long-term" operating models Cory, I believe you have not discussed, which assumes a static percentage of revenue, percentage of profit for your role at [indiscernible] is into revenue. But which would imply lack of operating leverage, that is clearly not your long-term model that would be an interim model as in this growth phase and as you're investing to support that growth. But long term, I trust not only do we have the benefit of uplift to gross margin as the model continues to shift to software-based as well as cloud-based services, but you're also going to have the benefit of operating leverage if you're going to be on that. I don't want you to answer the question. That question's for Cory.

Well, but the reason there is a no is because if you take hyperbolically, the model to the extreme. And a white box market emerges. And we literally because the operating systems are fully extracted off the hardware, and you literally deselected all of the hardware out of the model then you have a pure platform model, which actually has much higher margins, but much higher outlooks. So part of the kind of metric model that we've built internally so that we don't overspend or underinvest is broken down by the different businesses and what's going on. So part of the reason you're seeing us take the model at the Analyst Day and make a slight adjustment to it is because of the growth rate and the mix. So allow me to further articulate. As you look at the growth rate, if you're investing in sales and marketing on a high-growth company, you're not investing for the revenues of the bookings today, you're investing out here as those people come up to speed. And so you're going to continue to pull that investment up or you will pull that growth rate down. So that's going to cause us to want to shift that up. From an R&D standpoint, if you study high-tech companies that are ramping and have an advantage, they're all going to be between 27 and 30 points of product gross profit to be in a proper investment range. Over that, you're spending. Under that, you're likely stanching off your future growth because you're not staying on top of the disruption money that you're writing. The place where you get some leverage is in G&A. And over time, because of that growth rate and because of the systemic investments that we've been making, that probably comes down a little bit. So here's -- that's the first piece. The second piece is as the software grows as a percentage of mix or look at software models, software models have a much higher sales and marketing as a percentage of revenue. So the operating leverage actually gets driven by OpEx growth, undergrowing margin expansion.

Carl, I appreciate the point. And to that point, I've kept the database for 25 years in every company that's ever shown from the smallest pusher companies to the largest. And there is a scale aspect but at scale, companies don't SG&A at 6%, 7%, 8%, 9% of revenue. It goes down, so in some cases in rest 3%, 4%, but even more modernized companies with less growth, it's sub-5%. I trust you're going to be no different, that's not what's in your model. In your model, it's a long-term model, but that is what 7%, 8%, I think 9%.

8% for the next 4 years.

8% in the next 3 or 4 years to my point. That's not a -- that should be the long-term.

We're not getting in the long-term model. We'll get 2 to 3 years on the model. It's [indiscernible]

We're experiencing [indiscernible]. If you talk about internal model.

No, I sort of like a Saturday Night Live news show going. So let's keep going for a moment. So when you look at the G&A, you're clearly going to get G&A leverage assuming you're not doing reclasses, which by the way, goes on inside of companies. So let's just say you're literally looking at apples and apples. G&A is going to go down. And sales and marketing is going to go up, absolutely going to go up. Because we're going from a legacy hardware company that's winding down to a company that's a platform company that has hardware, but it's diminishing as a percentage of revenue. And so you're going to continue to rotate that sales and marketing expenditure to more and more software, which, by the way, if you look at software companies since you maintain that in the database, you're going to see sales and marketing numbers that are 30%, 40% and 50%. And we're not going to go there. But we are going to go higher. And so my point to you is in the near term, they're likely going to sort of average out and the leverage will come from gross margin expansion as it has, right up until everyone wants everything you went to c*** on the supply chain.

All right. Let's shift to the next topic of the debate. That big software, as you know is a big focus in dollar on this journey from maybe a traditional seller, third-party seller, monetize -- largely monetize [indiscernible] excess hardware to increasingly software solutions, value-added software solutions partner. You spoke about all platforms in both softwares [indiscernible] and also 2 platforms. That's now proven 50% of revenue, right? And I think there was a 3-quarter period where we were from 50% to 75% of revenue.

50% to 70% of booking.

Of booking, excuse me. And so that's a good -- that foreshadows the shift and run new software in Boston.

Well, So let's make sure we understand again. Calix was an integrated hardware member. Calix as a platform vendor that has platforms associated hardware and service offerings. Calix [indiscernible] had no software. So as that is diminishing, you're now putting ourselves in a position where the platforms are driving the strategic purchases by our customers. And that's going to have an increasing amount of software revenue and recurring revenue in it. And so as the crossover occurs, it's merely pointing towards that future model. The reason we give that number is to give folks an understanding of where we are in the transition from literally the 2 separate companies. This one's winding down. This one is winding up. It's going to get to 90% pretty quickly, and then we're going to stop talking about it because obviously, it's no longer meaningful in any way. And the rest of it will just go from bookings and the revenue. And then we're going to have to pick some other metric to share. Don't know what that will be. Today, obviously, we highlight RPOs to give a sense for what's happening in that business. But to your point, the 70-30 points towards the future model, not necessarily software, but it implies higher software content.

It's coming from a different vantage point if you look at breadth and depth of adoption. There's now about a 100 out of your 1800 or so customers, there's a 100 or so to date that have adopted gone forward with the software-based services. And that's obviously grown.

Yes. So the numbers, there's multiple pieces, as you know. In the base model, there's an operating system for the network, there's an operating system for the subscriber and there's the cloud. On top of that are the suites. And then on top of that is the marketplace model. If you simply look at the base model, we are actually in the high hundreds of customers that have adopted one or more. When you then build on top of that the suites, a 100 is not a bad estimate. When you go on top of that to the marketplace model, which we started to launch into with [indiscernible] certify and you've seen the recent announcement of [indiscernible]. That's in the 10s. So what you're seeing is this land and expand model that we're figuring out. What we do know is as customers are further down the path of deploying that whole model, the value it creates is pretty significant as you yourself saw when you're at the Day in Las Vegas. These broadband service providers that are building this new business model are just a whole different type of service provider than the legacy telco or cable or wireless models.

I want to come back to that point, but in terms of the impact of the company, you hit almost reported at [ 53.8% ] pro forma gross margin back in the first quarter. The last year we got cost backed up [indiscernible] supply chain, now so what's going on in this journey transformation or terms the impact and [indiscernible] and that's the piece of privately and publicly on probably about the potential of this 6% to 7-plus percent gross margin, right in the long history book assets going back to Minister Communications [indiscernible]. All the companies lived in the 30s to mid-40s of that.

Yes. The models, as you know, were mid-40s margins, mid-30s OpEx, 10%, 9%, 11%, popping, that was the model. This is -- this has nothing to do with that, literally nothing to do with it. And if you take yourself all the way up to the model, not only does the revenue participation go up per subscriber. But the margin actually goes into an agent model, which is a 100 points of margin. So we -- I don't know where it ends. Cory has informed me that 100 points of margin is the end, you can't go above that. I don't know what that reasoning is, but -- so as the mix shifts, that's going to continue to draw up. What are accelerants to that, the expand. The land is just bringing more people into the model. So the expansion as people get more and more successful when we work with our customers, that has an upward effect on margin. The other thing that in the future might happen as we've talked about is a white box model. So if we get to a place where there are stand-alone capable vendors to provide the hardware, the operating systems we built have literally a hardware extraction layer. They're fully abstracted -- they can go on to anything. I think that happens -- starts to happen over the next couple of years. Obviously, that has a downward effect on revenue in periodic because you're not selling the box anymore. But the margins continue to expand at a more rapid rate.

Again, there was some important not so long ago, the one at [ Brightcom ] which organized hasn't been rolled out [indiscernible].

[indiscernible]

Has closed, I assume still [indiscernible] not happen. But correct me if I'm wrong, [indiscernible] management that size that's going forward. They always plan to embrace their all-platform model, all various clouds, software as a services, the whole [indiscernible].

Correct me if you're wrong. You're correct. The only surprise of that is we are not prone to talking about things that haven't happened and been deployed. They wanted to talk to the market about what they were doing and they don't know if we were okay with them doing that. And the answer was yes. So they announced that. To your point, it is not closed in the sense that they have not closed the spin-off that goes into Apollo and into the new leadership team's hands. But it is the first greater than 2.5 million subscriber, which is where our large category starts service provider to buy the model, the entire model. That's correct.

Carl, I recognize there was some -- in my mind line, the #1 driver in the store is not the massive amount of funds that are coming to the market [indiscernible] the model, but you are also going to have the benefit of this amount of money that's coming in. That said, from a different vantage point, even cable operators. And they're what, about 300 in the United States both beyond the charters of Comcast. And the [indiscernible] is a good example, was hundreds of thousands of subscribers. We're...

They are not thousands [indiscernible].

Thousands [indiscernible].

[indiscernible].

They announced that they're going to go forward with pros [indiscernible]. They're not beat you're seeing costs in [indiscernible] and even in Comcast and [indiscernible] just on [indiscernible] rebuilds generally [indiscernible]. And you're going to play a role in that now.

We do and have been for a number of years. We've been providing that end-state network, if you will, of the fiber network to wireless end points on it to legacy service providers, telco, wireless, cable episodes for years. We actually built a management leader [indiscernible] that allows cable [ MFO ] to build a fiber infrastructure but have it still be treated as if it was an HFC network for [ DOCSIS ]. So we actually built a software translator that allows them to build what we would call a PON, an empty GP network. But to them, operationally, it appears like it's a cable modem, CMTS type of network infrastructure . And so yes, we have -- we obviously have a strong opinion on DOCSIS as an evolution. I have stated publicly that [indiscernible] is nearly tomorrow's copper. Because compared to a fiber and wireless network, it doesn't have the horsepower to compete. And so I think they're all going to end up there at different rates.

But there being fiber with a radio hanging off the fiber.

Yes. So in essence, that radio, by the way, could be the premises router that sits in your house. Don't take what I'm saying as a radio and assume 5G or whatever the case. Whatever that module -- whatever the antenna is modulating at, it's sitting on a piece of fiber, which goes back to the data center at the edge of the network. And we believe that model is going to the broadband service provider model of the future, and it obsoletes all the other models. So how many legacy providers are going to go, that's where we want to go and the ones that want to go there, we think might also want to put a different business model on top of it. Back to your original question, which was the [indiscernible] of investments that are coming in, look, it's $100 million plus over 7 to 10 years in the U.S. We are clearly going to benefit from that. But what's exciting about it is actually not the revenue of the network per se as much as it is -- they -- you now have the ability to have that conversation with an end-state network builder to then say, how about putting a different model on top of it, one where you can delight the subscriber and sell additional services. And that speaks to the whole platform model that we're building. Some will do it, some of them not. Believe me, there are certainly legacy providers that can take the same legacy model and stick it on top of a brand-new fiber network and not understand it.

Let's talk about your previous point you're making. We're seeing take rates, subscriber take rates for fiber [indiscernible] builds that are extremely hot.

Some. There's also some that are extremely low.

But even where some of the results even more cable operators income has not been an issue in terms of those 2 [indiscernible].

Well, it depends on the model. So we have customers that -- I mean -- and you met some of them. But I mean, at the end of the day, we have customers that literally are building into Tier 1 formidable competitors, and just reiterating the market share because the level -- it's not just we get confused by -- because the pipe is the tightest for so long [indiscernible] that we acquaint the type of the service. But there are lots of people that have high-speed pipes that are not happy with their service. When you put the whole model together and start to deliver the level of service to a subscriber and you get these Net Promoter Scores that are 40, 50, 60 and 70, you get churn rates that are literally 0. Somebody dies, that's when they churn. You're talking about just a very different caliber service provider. And when they move into a territory, they just take all the subscribers. And then the second man in, what's the investment case. They have to build the same network to compete for 20% or 30% or 10%, and they just never compete and you end up with these balkanized monopolies. And then the cash flow from the high revenue, no churn, lowest cost per bit per mile network. They overbuild the next guy, and they just keep building out of cash flow. So that's what we're after are the service providers that are aggressive. Because if they're aggressive, the model that we've built will speak to them. If they're not, they won't understand it.

So speak through that model, I often thought that you all are a virtual service provider, where you're enabling third-party service providers to offer better services to run their businesses more efficiently through your two-cloud -- two- or three-clouds [indiscernible] support operations.

Yes. The analogy of one of our investors came up with as he said, you're sort of like Shopify for the service provider. And that's actually not a bad analogy. You're providing the kit for them to literally become a BSP. It's not powered by Calix or it's all their brand and everything else, but you're giving them everything they need to literally go and turn this thing up and go to war. And then the customer success teams that we have will literally work with them side by side to help them meet their objectives. It's just a whole different business.

Just to paint that picture, you have a marketing library, a library of advertisers that are actually quite entertaining. They got to encourage you. You need to check it out. And reaching a number name as on those ads, know where to hear them in the ads. And that gives our customers the ability to pick and choose. So they like advertisements, where they can put their name with their brand on those advertisements.

In actuality, it goes a step further because we've actually built automated tools that are called content builders that literally allow them with very basic folks that are coming up school, can start to build their advertiser by pulling content down and putting their brand on it and going accordingly. So yes, and you continue to do that because look, in the end, the more successful they are, the more successful we are because every one of our platforms monetize is based upon the number of subscribers. So we are very much aligned with their success. And it is felt all the way through the company.

Well, that's a simple obvious concept -- simple concept. But some of that I don't think I've seen implement before a lot of others now speaking in the same language, talking and entering the same picture, but any one time your success is 100% through the success of your customers.

Sure. Quickly, which is a lot more fun being around on their side of the table or in the both of them, pulling on an [indiscernible] and trying to figure it out. By the way, as the platforms are mature, what starts to happen in a legitimate platform business as you start to iterate from an agile standpoint on new ideas that are coming from all different places. Our engineers, our marketers, our partners, our customers. And you literally start to put those into that methodology. And because of the technology we've built in our platforms, we're able to -- we're actually able to really do an agile methodology, which is very different than when you're trying to impose it on a complex box. And so we release everything that we do on a 91-day cadence. And people have struggled with why do we do that? We could release things faster. But in order to be effective, it doesn't matter how fast we can release them. It matters how fast the subscriber can get them. And that means how fast the service provider can deploy them to the subscriber. And getting our customers on a routine cadence of innovation enables them to actually start to culturally affect that level of innovation and surely, but truly, we're seeing our customers true up to actually taking what comes and taking it immediately to the subscribers. And now unlike the laggard, let's just say you were the hot gamer in town. The hot gamer in town never goes to the service provider. They would go out to whatever and get the latest WiFi or this or that, they don't look to the service provider and be the innovator. Actually, on our cadence model, the service providers get the latest and greatest before anybody else gets it. Now all of a sudden not only have they taken care of Cory, he's not a laggard but he's not as fast as you are as a gamer, but you get the games because they're like, "Wow, my service provider has WiFi 6e or WiFi 7." Just like that. Now you've captured the early adopters and everyone else. Now how does anybody compete, not only the service provider that might be competing for the connection. But how does an over-the-top player compete with that. And so now you've created this value proposition with the subscriber where things that are related to the Internet and my service, I buy for my subscriber, I don't buy movies from them. But the things that are logically adjacent, that's the whole ecosystem.

Another basic example is to be secure in this environment [indiscernible] however, if you trusted your service provider, you get the [indiscernible].

But that's the key phrase. And so it's very cumulative because the background names is the aggregate network, Net Promoter Scores for the service provider industry, was about minus 6%, which means you have more detractors, then you have proponents. When you have MPSs of 40, 50, 60, they're telling you they like you. When you start to deploy the suites that we have, ProtectIQ, ExperienceIQ, you're now building a trusting relationship. And when you get to trust, you can start to open up that marketplace and do exactly what you just said. And it becomes a very logical cumulative thing that you'd have to work these VSPs through. They can't go from here to there. You've got to get those levels going. But once they do, it's formidable. And it's really cool because the subscribers are literally trusted consumers of the service providers' offerings.

I have to ask you about supply chain, especially in -- since you just said China lockdowns, the risk of poor congestion over there. I'm [indiscernible] any thoughts on the risk that poses to your ability to fill [indiscernible] and to cost structure.

I think we should bring this pessimistic view from Cory.

There you go. Yes. So on the security, right? 15 months ago, all our silicon providers started saying 52 week lead times. And the concern was 52-week mark, could they really deliver, right? So in the first quarter, we started seeing the silicon providers, component providers meet that 52-week lead time for the most part. Some have delayed, but it's a whole [ bomb ] you have to put together in order to build something. And so we still get surprised. It's not your complex silicon provider. It's more the power control modules and such smaller components that when you can't find them, you're out there sourcing them the best way you can. If you can't source them, you're rebuilding the parts. So what we're finding out is why we have problems, when we have a problem, it's harder to deal with either time or money, going to the spot market and paying the way up for it or you got to redesign the cars so it takes time. And so we're not out of the woods. We're feeling generally better, but we're still being surprised.

China lockdown is still [indiscernible], does it make incrementally more concerned?

For our components, not a whole lot is coming out of that specific region. So it's probably affecting us less than others. But nevertheless, there will probably be downside effects to it. For example, currently, we're seeing a little bit of respite from the air freight rates have come down. They may go back up, right? Because as the lockdown comes up, people are going to try to make up for lost time, starting to expedite material and put it on airplanes. So we might see that go back. But for the most part, the China lockdown hasn't had a material impact on us.

On the other point, certainly obvious that if macro continues to go south, and that uses up demand from other companies or the product markets that would benefit you probably in terms of both access to supply and in terms of using cost pressures.

Likely. Quite obviously, you take up some of those wafers that may have gone another way, has the ability to redirect and we'd be able to get more components to be great. We actually then continue to build inventory and create a little bit more of a buffer for the next shock or surprise that comes down the road.

And it highlights the demand side, interestingly enough, because that whole notion that we just talked about, we have a trusted broadband service provider, providing Broadband as a Service to subscribers that like them. How many of you have heard, broadband is a necessity? How many of you have broadband? How many love your service providers? Look at that. And what happens is the subscribers for our broadband service providers are actually in elastic. They're not going anywhere. But if you're buying broadband from somebody who has a pipe and somebody comes down the road with a slight they're your pipe or a slightly lower cost. Yes, broadband is a necessity, but I'm buying it from them. And so it actually highlights the -- I can be careful of recession for, but we're helping our VSPs be recession proof, which obviously puts us in a position where we think our demand will stay robust. And we could get a [indiscernible]. Look, I don't have to wish any for a global recession, but it would surely be nice to have a little demand to let this supply catch up.

[indiscernible] endpoint, the legislation that's been already enacted, whether the Cares Act, the ARPA, RDOF, infrastructure [indiscernible], those programs, they're [indiscernible] -- they are up, but they're going to be pulled back to the minimum macroeconomic downturn.

They will not. They will continue to create demand. As we said, we think it creates the opportunity for conversations to get on to a new model. The one piece I would caution everyone on the government programs is they always take longer to start. They always take longer to finish than you think. They typically have a bigger economic impact because they bring other dollars like private equity along with them. But the one thing in this case, I think the deployment of these funds will be throttled, not [indiscernible], but throttled by labor availability. You're just not going to see everybody run out and deploy this in the next year or 2 or 3 or 4. It's going to happen overtime.

Will you call this a bad thing because will use the word [indiscernible]...

It is a great thing.

Again, correct me if I'm wrong, but you had -- if all that money was available today, it won't translate to dollar more than revenue, given the constraints you have in the supply side.

Sure. Right. So to your point, you're exactly right. It's actually a very good thing that has been laid out. And look, it's going to be $14 billion a year for 7 years, $10 billion a year for 10 years. It's going to be coming into North America. We have a huge footprint of customers that may or may not benefit from this. We're clearly going to benefit. But as exciting as it is, what we're focused on every day is the business model and the platforms.

Okay. I think we already fell [indiscernible]. I'm going to thank everybody for showing up, [indiscernible] please do let me know. Call...

You're not going to let anybody ask a question?

Does anybody want to ask a question, calls not been answered.

Fine. I'll wait and take all the [indiscernible] the management. Folks, thank you for coming.