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

Good afternoon. Welcome to Needham's 19th Annual Technology and Media Conference. I'm Ryan Koontz. I cover the comm tech sector here at Needham, which includes cloud communications and broadband networking. We're really pleased to have Calix with me today, who delivers a broadband platform and managed services that are enabling their customers to improve life one community at a time. Really happy to have with us today Chairperson, Carl Russo; and Head of IR, Jim Fanucchi. Welcome, guys. How are you?

Great. It's been a good conference.

Excellent. Glad to hear that, a lot of satisfied customers.

I can't speak for that. I enjoyed it.

[Operator Instructions] But we'll start with some planned Q&A with myself and the team. We assume most of you are familiar with the recent results from Calix, we don't need to recount those, you're familiar with what Calix is doing in the market. Let's start with something more interesting. We're really seeing the industry go through all kinds of turmoil, ups and downs. It feels like more turmoil than I've seen in the 30 years I've been in the business in the last 3 years, but -- it's quite a whipsaw. So Carl, I mean, I guess the simple question is if you're an investor, what is the pitch to invest in Calix? What is driving your business today? Talk about your appliance play, your software play, how you monetize that and where are you in evolution to truly becoming a software play on appliances.

Well, I mean, I guess I would back up and say that -- you got a lot of things in there, so we may spend the rest of the time on this one, which is fine. So let's do that. So I would back up actually and encourage investors to look at investing in Calix the same way our customers invest in Calix. And that may come as an odd statement, because our customers don't buy shares in Calix, but actually, when you look at the service provider space and what we do, everything that we do with our customers has very long life cycles, 5, 7, 10, 12, 15 years, and Ryan, you have a history in this space, so you understand what I'm saying. When you're making that kind of a decision...

Yes. [indiscernible]

And it's not a purchasing decision on their part, because they're not only making that decision one time, they're going to be living with it for a long time. And the equipment is not stack. The software is evolving, the features are evolving. And so they're relying upon their choice to not only be there getting installed, make sure it's working, but to keep them on the leading edge of the marketplace for the duration of that product deployment. And so they look at those decisions as investment decisions, and they're making decisions around a whole number of factors. By the way, you could say first and first, let's just start at the balance sheet. Are these guys -- if I talk to Cory, are these guys going to be here? Do they have the staying power? Those are the financial things. Those are actually the easy things to look at. The harder things are actually what you actually highlighted, which are around the platform on cloud and managed services because ultimately, what we're helping our customers deliver is the lowest cost per bit per mile infrastructure with the highest potential for revenue, lowest customer churn, highest Net Promoter Scores. So it's a very, very different investment decision on the part of our customers. And if you understand the way they look at us, then you'll understand the long-term return on investment that ultimately investment in Calix will yield. So let's -- maybe we should start there and go off in whatever direction you want to go off in. But that's why I would say invest in us. It's not a short-term investment. There are certainly trades you can make around the stock price as it relates to the intrinsic value of the company, but I think if you're going to trade in the stock, you sort of have to do the work to understand the long-term value so you understand how to trade around it.

It's not altogether different from the way networks were designed in the past, I'd say it's -- but it is more about software optionality, right? So in the old days, you upgrade the hardware with cards and you bought a platform from a supplier and you were married to that guy for a long time. And obviously, Calix is really changing the marketplace, leading the marketplace, and shifting your innovation into the software domain. And it's the same model is just living from hardware to software to -- so...

Well, let's take that analogy for a moment, because it's a great point. We all used to call our chassis a platform. They're not. They're a chassis. And the reason you know that is every time you change it, it takes you 3 years to change it. Your customers then bring it into their lab. By the way, you build it you make the addition, you add some software, you test it, you broke something, you fix it, you integrate it, you test it again and you go through these cycles. Eventually, you'll release it to your customer. The customer that puts it in their lab, they test it because, guess what, you've given them stuff in the past that probably had a bug in it or two. They do through their integration cycles. Then they decide, yes, it's ready for deployment, then what do they do? They integrated it into their OSS/BSS stack. Five years later, the feature makes it to market. That's not a platform. That's a bunch of complex systems being integrated. What we've actually done is quite literally built a unique OS that's a platform that's separated from the hardware that we actually iterate on every 91 days, and our customers get out of the integration business. So get this. When we release new features or new systems, our customers can turn them up in a matter of hours or a couple of days and be delivering that innovation to their subscribers every 91 days. The rate of innovation that our software platform delivers is otherworldly compared to what they used to do. And so now they actually can get out on the innovation front edge. And rather than them being the last to offer a new thing to their subscribers, they're the first. Changes utterly their stance to their subscribers. So that's just one dimension. We still have systems underneath that we call them applying such as that what they are. We don't have a lot of SKUs, so it's a vastly simplified model. But the platform that's been built is at the OS layer, and then everything above it is literally abstracted from everything below it.

That's pretty analogous to what's happened in the data center, what we see happening in the cloud, really. I mean...

It is -- there is an analog, but there's a key difference. And here's the key difference. When you hear hardware abstraction in the data center, it's not quite as complete or as sophisticated as what AXOS and EXOS do, and here's why. In the data center, everything is meshed and redundant. In the subscriber network, nothing is meshed or redundant. It's in and out. It's a point-to-point PON network. In the data center, when your [indiscernible], your compute or your storage go down, there's no impact on what's going on. And they wait until the next morning, they print out a list of things that failed, and Cory, who's the technician, goes out there with his cart and replaces the stuff. In the subscriber-facing network, if anything goes down, you have 1, 10, 100, 1,000 or more subscribers out. And so AXOS is actually an always-on operating system. And so it's quite a bit different than the way it's instantiated in the data center, because the operating systems and the software in the data center are single binary. What we've built is actually a multi binary OS. I won't bore you with the details, but it's a very, very different beast, and there's only one of them in the world. And it's that which everything else is built on top of.

Right. And that AXOS, it's your core software kernel, so to speak, your platform, [indiscernible], your middleware. You sell it on a license basis and maintenance on top of that, right?

Well, to your point, it's what, as an example, Verizon has built their entire One Fiber intelligent Edge network. It's built on AXOS, and that's how they've gone forward. And it's sole sourced. But as soon as you understand it's that OS that makes the difference, it's not like you're dual-sourcing boxes. You wouldn't have 2 operational models that are different. And they actually literally took advantage of it and put an entirely clean sheet brand-new OSS/BSS on top of it. And here's the other piece that makes it very different. There's no orchestrator because there's no need. So it's a very, very different model that's enabled them to literally collapse their multiple offerings onto a single consolidated network and rip operational expense out of that network. And as you go forward, the percentage of the network offering that is hardware depreciation has continued to go down. The percentage of the network cost that is operating expense has continued to go up. And so where do you want to reduce it? You want to build a unified workflow simple network like AXOS enables you to do. And that's why you see the traction that we have with customers. It's a completely different operating model at the network, and we haven't even started to talk about the cloud and managed services that you can then put on top of it to go at the subscriber offerings.

Well, let's go there. Let's talk about from an investor perspective. I think very clear from a customer perspective why you want that. And so from an investor perspective, you obviously want to buy a successful company's stock, but what -- financially, what does that optionality bring to the investor in terms of your ability to sell into that appliance footprint?

Well, so we're an appliance-based platform cloud and managed services business. And so your question is, well, tell us about the platform cloud and managed services value. It's extraordinary. And the reason it's extraordinary starts with what our customers are doing with it for their subscribers. They end up with an unparalleled subscriber experience, virtually no churn, hugely high NPS scores, very high take rates on the network they've built. Then they have a set of value-added service offerings, which are packaged up for them. They label them themselves. Nobody knows about Calix. The subscriber never sees Calix, and we don't want to be known by subscribers.

White-labeled for your customer?

And they have a set of literal high-value, high-margin offerings that they just lay on top of their network and sell to their subscribers. So they drive very high margins and incremental revenues over the lowest cost per bit per mile model with no churn. It's a beautiful thing. And when you can do that with your customers, they're willing to share it with you. So we're very focused on helping our customers succeed. When you hear the term market share inside of Calix, we're not talking about stuff we do. We're talking about the subscriber share that our customers are taking. What's their market share? That's what we focus on. So there's the value. And ultimately, if you follow that through, we end up with a lot of high-margin recurring revenue that ultimately builds intrinsic value ultimately for our investors.

Yes. Great. And where are you guys in that journey now? Where would you say you are as a company? And I know telecom is a slow-moving beast. I've been in the...

Second or third inning. We're learning a lot, but there's so much opportunity for expansion in just our existing footprint. And then this disruption, you said earlier you haven't seen rates of change like this in your career. You're right. and here's why. The shift from formerly horizontal models, wireline, cable, wireless, with an adjunct Internet offering to a consolidated converged BSP that provides all services to their subscribers is a disruption that's going on now. It's in its second decade, and it's still early days. If you combine that disruption, which is really -- and by the way, you can see it in the market, and here's how you see it. Even though most of the BSPs that are actually building these new models are private, you can see it in the public numbers of the service providers that report them. They're losing Internet subscribers. Well, all you got to do is stop and say, to whom? Well, they're losing them to our customers, but they're private, so you don't see it. But you know they're going somewhere. So you're seeing that from a service provider standpoint. But here's the second piece. From a legacy systems provider standpoint that are in those legacy service providers, the pandemic has done terrible harm to balance sheets. There has been a lot of damage done to balance sheets. And so yes, there's a ton of disruption that we have an opportunity to take our next-generation BSP model to the legacy providers now. And we have a very solid company with a very -- frankly, a pristine balance sheet and balance sheet metrics. Customers know that we're not going anywhere, that we're going to be there for the long haul, that we're innovating on an every 91-day basis, that they can turn these things up. So there's a huge opportunity to go across the chasm and lay a new footprint.

And so with the recent kind of slowdown in adoption, creates a more focused selling effort from you guys to continue to drive software sale?

For sure. For sure. But look, every day, we get up -- job 1. Job 1, without a doubt, is look, we have our Board dashboards. We have our internal KPIs. We focus on the premises deployments, who's coming on to the network and then the platform cloud and managed services deployment is on top of that. So job 1. Job 2 is in this time, you better go land new footprint because it's there to land. Job 3 is working with our customers to make sure they're taking advantage of all funding sources. By the way, private equity, BEAD, other government sources, we can't control that, but we can certainly help them. But make sure it's clear. Job 1, platform cloud and managed services expansion; job 2, landing the footprint; job 3, let's make sure our customers are well positioned for all funding, and that consequently, we might benefit from that as well.

Yes. Excellent. And Cory, how does all this translate to the income statement for you guys? Revenue stalled out a little bit here, but you guys are still making, I think, great progress on the gross margin line. And do you see some leverage there?

Throughout the disruption, what you've seen, including through the pandemic, is on the platform cloud and managed services just continuing to grow. That hasn't stopped. It continues every single day. All our software [ plus ] managed services are priced on a per subscriber basis, and so as long as our customers are adding subscribers, you're adding to that product ship. In the near term, we've got some choppiness associated with our appliances, but even there, that hasn't had an impact on our gross margins. It may change the rate that it grows quarter-to-quarter, but ultimately, it's up and to the right, and guidance for the quarter was to be north of 55% this quarter.

Yes. It's impressive in a business that historically has not been anywhere near that outside of your own business. So in terms of KPIs, Carl, what would you point to for investors to kind of monitor your...

Yes, I mean I was sharing with you our dashboards internally, right? And we don't share the dashboards internally externally. But that's what we look at. To try and help investors understand what's going on without disclosing [ putable ] numbers that competitors might want to understand, there are 2 things that I look at every shareholder letter, which is RPO, so the revenue performance obligations, and our RPOs are software and services. They're not hardware. I have noted with some humor that folks have started reporting RPOs with hardware. No, that's not RPOs. And then the other is...

[ Call ] backlog.

Orthogonal to that are the platform cloud and managed services deployment by customers. And so if you look at those 2, you can sort of get a sense for the progress. Look, directionally, they give you a clear indication. On an absolute number basis, you can't just sit there and go, well, okay, that means their recurring revenue is blank per quarter. But our long-term investors typically build their own models internally, and what they're doing is they're doing a simple algebraic equation. They're guessing at what the margins might be on the appliance side, because you've got a lot of systems companies you can sort of think about, and they're guessing, although we've given a little bit of insight into what the margins look like on the software business. And if you do those 2 margins, you can start to figure out what the revenue mix might be. And that's what everybody is doing. And so that's what I would point everybody to -- and there's not -- we don't have any planned changes in the near term to that. So Cory, I don't -- if you want to add to that, feel free, but that's what I would point people to.

Nothing to add to it?

No, no further add.

All right. And on that customer, so if we look at that customer count, I want to break that up a little bit. How would you characterize that count as far as early adopters, people that are just starting to deploy a little bit of it, and customers that are like all-in buying at all? I mean -- or is it kind of all across the board? I mean you've got 1,000 customers there. How would you spread them across the breadth of adoption, is my question.

Yes. I mean literally spread them across the breadth of adoption, and we're learning -- so the adoption focus starts with not adoption of us, it's actually trying to help them get their subscribers to further down the path. And if you work it from the subscriber and then you work backwards, you're pulling everything else through. So we do have some customers that are end-to-end Calix from the network to the premise, and bottom to top, from the platforms, to the clouds, to managed services. And they're driving higher value for their subscribers and their communities, and they are reaping the benefits of it themselves. But they are still the pathfinders out in front, and it's a smaller percentage, and then you have folks all the way across that spectrum, which, by the way, is the exciting part of the business, because there's just huge opportunities on those journeys to create a lot more value. But by the way, we're also learning things because some of those customers that are back here have tried certain things that haven't worked. So you're swizzling this or you're working on that or there's a different go-to-market or you know what, package this up separately, or help us get to the -- we can go on and on and on. Michael and Cory have made the mistake of allowing me access into the internal system, so I still watch everything. And it's -- I'm just telling you, it's a huge kick to watch the rate of learning and evolution inside the company at the [ phase ] of the subscriber with the customer. It's really cool.

Yes. When you're at the bleeding edge, trying to do things in a whole new way, I'm sure you got to fail a few times and...

Yes. But here's what's cool, right? But here's what's cool compared to our past. In the past, you were doing it to the customer.

Right.

Now you're doing it with the customer, trying to help them yield a better subscriber experience. So you're sort of around on the other side of the table, and when you're a box vendor, you get up every morning having recorded whatever revenue you reported last quarter, you're starting over again, and you're on this relentless, "let me see how I can separate my customer from their cash this quarter." This is very different. You're trying to help them be more successful with their subscribers and their communities, so it's a very collaborative, energizing environment. It's quite different.

Yes. Awesome. Let's shift gears and talk about BEAD. There's been some progress, at least on...

I'm going to turn that over to Cory. Go ahead.

On words in the last few weeks, I've, been happy to see. I don't know [indiscernible] everything, but we can talk about just kind of some of the latest updates here. It looks like some states got some approvals, and we're putting one foot in front of the other, at least, and we don't seem to be completely stalled out.

For sure. Yes. So we go back to the beginning of April that you had one state still approved, Louisiana, and we're now up to 7 states plus the District of Columbia. That cohort represents $6 billion of the $42 billion. So it's on its way. And the importance of that is by the NTIA's form itself, those states have a year to get back to them. So we've got a year. So by May of next year, $6 billion of the $42 billion will have been awarded to folks. So that just gets the ball rolling, which is what we've been saying all along. And [indiscernible] in '25. And obviously, everybody's kind of looking at that pitch on the ramp. And I've been kind of consistent in saying we don't need all 52 states. That's just going to accelerate things and create more of a concern around whether I can get the supply and kind of get ahead on other people and so forth. So the great news is this is all going to be limited by labor, permitting, right? So some of these early states they get out will probably have a more...

The market's not going to grow 100% next year, right? This market's just not going to grow 100% next year. It's just not. Footprint can't grow that fast.