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

All right. Welcome to Needham's Virtual Tech Week Conference. I'm Ryan Koontz. I cover the broadband networking and cloud communications sectors here at Needham. Really happy to be joined by Calix today that I'm sure most of you know. I've got the pleasure of hosting Carl Russo, not founder but Chairperson and former CEO, who most of you have known for a long time; and Cory Sindelar, CFO; and Jim Fanucchi in IR. Welcome, gentlemen.

Welcome. And I'll accept founding shareholder but not founder.

Fair. That's right. Good point.

So let's just kick this off. Before we get into kind of bigger industry questions, let's dive in to something that came up in the earnings call that you brought up that I think caught a lot of folks by surprise, which is this debate around ACAM versus BEAD. And can you walk us through kind of the short version of what that is and how it's affecting your visibility into '24?

I appreciate your plea for the short version, but I'll do my best because I'm going to ask Cory -- apparently, you haven't met me. I'm going to ask Cory to at least give you a sense for maybe the mind of a CFO at a BSP and how they're dealing with it or thinking about it, but I'll give you the entry. First of all, by the way, it surprised us because for many years, the federal government has been saying OpEx subsidies, the likes of Universal Services Fund, which is where ACAM came from, are going to be residual. And they have been slowly going down. And they said, "We're going to take our funds and put them into CapEx like RDOF or CAF or BEAD and enable you to build the network, but then you have to operate it." And so actually, it surprised us because at the end of July, early August, they came out and said, "Hey, surprise, we're going to give you an opportunity to extend ACAM to 2038, and we're going to raise the subsidy from $200 to $300 plus per subscriber line. But if you go for it, you can't go for BEAD. If you go for BEAD, you can't go for this. And make your choice and make it by the end of September." Some of our customers got extensions, but in essence, that's what happened. Now let me be clear about...

You're saying it was December cutoff on this?

September.

September cutoff, yes.

Yes. 60 days, which, by the way, since you've been in this industry a long time, know none of our infrastructure-based service providers make decisions in 60 days on anything. They don't even make decisions on 60 days as to what Cheetos show up in the vending machine in the cafeteria. So when you go down that path, what's going on there? Well, first of all, which customers? So the key to understanding which customers is this is a USF fund, which means it's a telco-oriented fund. So it's affecting roughly 1/3 of our customers that have -- in their legacy telco, they may have become BSPs. So that's the first piece. The second piece is, obviously, now they're faced with an OpEx versus a CapEx decision and then petitioning the NTIA if they go with ACAM and trying to get them to not put BEAD in. So there's a lot of complexities to it. Suffice it to say, they don't make decisions quickly, and it affected their decision making, threw a whole bunch of desktop in the air in front of 1/3 of our customers by count. That's what caused us to go, "Wait a minute, we have some visibility haze here. We need to make sure we run the business conservatively." And so Michael, Cory and the team made the decision to, "You know what, we're going to run OpEx at 1%, the low end of the range, and we'll see what happens." And that was what the guidance was. Now to understand how it affects the way the service provider thinks, you got to think like a CFO. And to think like a CFO, I happen to have one here. Cory, over to you.

Yes. So Ryan, they were headed down the path of looking at what government programs they were going to try to get some additional funding from. That would be BEADs, some of the state-repurposed ARPA funds. There's all kinds of different programs. And then when ACAM came along, they're basically trading upfront cash for a 15-year annuity. And that then has impacts on, what are they going to do? Are they going to go to get a loan from a bank to do it? They're going to have to fund it from free cash flow and therefore maybe take longer on how they're going to approach those new buildouts. And so that's what they don't have planned out. So they had a very short window to make a decision. They made the decision. But like several of them said to me at ConneXions, they just hadn't figured out what that all means. The knock-on decisions of this decision hasn't been determined yet and that they're in the planning. So when we're sitting there trying to say, "Hey, how much equipment are you going to deploy in '24?" And they say, "Don't know yet." That's exactly the answer you get, don't know. So our visibility becomes more opaque and so hence, our backlog of our decisions. So let's plan to the low end of our visibility and understand that it really didn't change the near quarters, right? '23 guidance didn't change for the year.

Those are the tough points to get through, too. I mean hats off to that.

And then Q1, we think we still can grow sequentially. So what we're talking about is Q2, 3 and 4, and like I would say to anyone, it's easier for us to bring revenue up because there's demand that needs to be met versus us to take OpEx down, right? So let's plan here and be in a situation where we're not getting over our ski tips with our investments in OpEx and see what happens.

Assuming these guys are following through on this ACAM annuity, there's different time pressure for that then on the actual build?

Well, sure because it's stretched out over 2038. And to Cory's point, it's a per month OpEx subsidy versus a lump-sum CapEx. So it remains to be seen how our customers will go about timing those buildouts now that they are going to ACAM. We don't know.

Do they have a mechanism for finding build sites to mark them off from BEAD subsidies, so they're not getting double subsidized on any of these...

Well, so the answer is, for sure, they're going to go back to the NTIA to say that the -- well, remember, there's a broadband map. So the portion of the broadband map that's underserved in their territories, they're absolutely going to go back and say, "You can keep your BEAD money. You don't need to give it to anybody. We got it. We got it covered." So yes, there is that mechanism.

Got it. And Cory, kind of -- and the follow-through on that with regards to finance, you said you're limiting your OpEx expansion, setting the growth bar low. Puts and takes on gross margin at this point, just no change in your general view there kind of...

No changes from what we said 3 weeks ago. And what we said 3 weeks ago was we're going to finish this year at somewhere around 240 basis points, so above our 100 to 200 basis points in terms of margin expansion and that we can grow 100 to 200 basis points next year on top of this higher base. And because there may be less hardware revenue running through it, we might be at the higher end of that 100 to 200 basis points.

Wow. That's great. Carl, so meanwhile, we've just kind of seen some pretty big train wrecks happen all around this year, missed earnings, guide-downs, kind of a collapse in the market really from the ADTRANs and Clearfields and CommScopes. They're just kind of staring into an empty abyss, it almost looks like. How -- you've executed and haven't had a miss in years. And what -- how is Calix able to do that relative to their not-so-peerish companies?

Sheer brilliance of the chairperson. All right, maybe that's not the cause. So look, all kidding aside, look, I'd like to tell you, this is the finest team of executives and people I've worked with in my career. It is actually. But if we were in the communications box space, there's no doubt we would have not achieved what we've achieved. What enables us to be different is many, many years ago, we looked at the world and said, there's a disruption coming, and we started building the things necessary to do that. And so when you go from a land of horizontal network providers, cable MSOs, telcos, wireless, enterprise networks, et cetera -- and it becomes clear in 2006 that all that's going to go away because you're going to have device-enabled subscribers connecting to content and applications in the cloud over a single unified subscriber-facing network. Now you have 2 networks. You have a subscriber-facing network, and you have the data center network. Well, if you think about what I just said, there's only 2 companies that have managed through these last 4 years in this fashion, us in the subscriber-facing network and Arista in the data center network. And it's because of that disruption. And as much as you can look at the data center network and say, "Well, they're just routers," actually no. It's a different set of functions that you're trying to put into the data center. By the way, if you look at the subscriber-facing number and say, "Well, it's just PON," actually, no, you're taking subscriber-facing functions and putting them together. And that is what Verizon saw in their own way back in 2016 when we started talking to them about their One Fiber network. They realized, "Hey, we could build a collapsed unified network. We were the only ones that had built what was necessary to do it." And that's why, to this day, they're a great customer, we're a great vendor to them. And it remains a sole-sourced network because the only way you could do it is with AXOS. So look, the disruption was what we saw way back when. What has been remarkable, it's sort of like when Hemingway was asked, how did you go bankrupt? His answer was, "Well, slowly at first and then all of a sudden." And so when you see these disruptions, they're hard to see, and then all of a sudden, they get tippy. And what's been very interesting is not only the roll-off on the P&L side of the equation and the missed set of expectations. But there are balance sheet [indiscernible] going to remember that just a couple of years ago, were unassailable that are now in question. It's gnarly. And so look, if we were Calix 1.0 providing boxes to legacy service providers, we'd be in the same place, maybe marginally better or marginally worse. We're not. It's an entirely different business model selling to the disruptors. We're not the disruptor. It's the BSPs that are the disruptor. And so that's what's enabling this performance. And run a clean shop, a really stout leadership team because you don't -- you could still screw that story up. You could still have crappy DSOs or uncollectible receivables or whatever, and you see a pretty pristine balance sheet all the way down to the P&L to the balance sheet. So that's my long-winded answer to your very short question. What's your next question?

Well, can you expand on just a little bit with your platform approach and software and recurring and -- you're literally years ahead of anybody else in this space.

Well, I don't know that we're years ahead. There's no one doing what we're doing. So until somebody gets in the starting blocks, I don't know what that time is. Look, let's be clear, nothing that we built is not something that somebody else couldn't build. I will tell you, it will vary from hard to really hard, but some of what we've built is quite unique and very difficult. But having said that, the first thing you have to realize is why we built it in the first place in order to want to copy it. And so it speaks directly to the business model that is the BSP. Doesn't really speak at all to the legacy service providers. And so that whole platform and managed services approach and enabling them to have NPSs of 60, 70, 80, zero churn, selling new value-added features to their subscribers and building loyalty, it's just a whole different model, period. So I mean that's the best way I can address it.

That's great. Let's talk about just kind of general CapEx. It feels like it's under pressure out there in general. Can you parse that a little bit across the different types of customers that you talked to in groups and what their current kind of climate is like? Or...

It follows the disruption. The BSPs that are advanced, the most advanced BSPs in our customer set are raising equity, layering debt on top of it, taking share and building out their models. And they're blissfully unaware of anything else going on. If you come all the way through to legacy service providers, well, now you're dealing with, instead of a 3-year payback on network builds, which is what many of our customers are doing, you're back to the old legacy homes passed 17% take rate, 10-year payback. Oh, by the way, I also have debt from acquisitions I did. I have loan maturities. It's just brutal. But that's not our customer set. It was our customer set 10 years ago. It is not today. And so you've seen that in our mix. We don't have 10% customers. And even as we continue to build up in the medium-size and large customers, it's just a very controlled environment.

Yes. So you kind of see the disparity across all of your customer sets more or less in terms of some folks that are still legacy mindset and some folks, there's...

I mean we still have legacy customers that came from Calix 1.0 that are very, very small portions of revenue today. Now if they were large portions of revenue, they would have -- holy crow. I mean look, you don't want to call folks out by name, but there are clearly legacy service providers that built themselves up through acquisitions that have spun off pieces of themselves now and they're trying to figure out what their models are that have just stopped CapEx. If you are a big vendor to them, good luck. And by the way, if you're a big vendor to them, they probably overordered and you shipped a lot of boxes into their warehouses and they're turning off CapEx. So you've got this walk through the desert for God only knows how long to try and sort that out. Not the world we're in.