Calix, Inc Q1 FY2021 Earnings Call

Greetings, and welcome to the Calix First Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Operator instructions: Please note, this conference is being recorded. It is now my pleasure to introduce Tom Dinges, Director of Investor Relations. Thank you. You may begin.

Thank you, Operator, and good morning, everyone. Thank you for joining our first quarter 2021 earnings call. Today on the call, we have CEO Carl Russo; Chief Financial Officer Cory Sindelar; and President and Chief Operating Officer Michael Weening. As a reminder, yesterday, after the close of market, we released our letter to stockholders in an 8-K filing, as well as on the Investor Relations section of the Calix website. This conference call will be available for audio replay in the Investor Relations section of the Calix website. Before I turn the call over to Carl for his brief opening remarks, I want to remind you that in this call, we refer to forward-looking statements, which include all statements we make about our future financial and operating performance, growth strategy, and market outlook, and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause actual results and trends to differ materially are set forth in our first quarter 2021 letter to stockholders, and in our annual and quarterly reports filed with the SEC. Calix assumes no obligation to update any forward-looking statements, which speak only as of their respective dates. Also, on this conference call, we will discuss both GAAP and non-GAAP financial measures. Reconciliation of GAAP to non-GAAP measures is included in our letter to stockholders. Unless otherwise stated on this call, we will reference non-GAAP measures. With that, let me turn the call over to Carl. Carl?

Thanks, Tom. One year ago, we saw our business begin to accelerate, and we questioned how much of the growth was due to the work-from-home shift driven by the pandemic, and how much from investments in our new platform offerings. As the year progressed, we became more comfortable that the majority was due to an uplift in our all-platform offerings. While there is much work to be done, we can now see a path to ending the pandemic. And with the pandemic swelling across most of the regions we serve, our bookings remain strong and were robust this quarter. It is clear Calix platforms have been the substantial driver of our growth for the last four quarters. In a quarter where we again had no 10% customers, we grew revenue by 60% year-over-year, we saw strength across the business, and our visibility continues to improve, while supply limitations remain our largest challenge. We again outperformed in the quarter, enabling us to exceed our guidance and build inventory to support the success of our customers. However, with silicon lead times stretched out to 50 weeks from 30 weeks in some cases, we expect supply to be a challenge throughout the remainder of this year and well into next year. As we continue to invest in growing our team, we also remain focused on keeping our culture tight. This keeps us well positioned to continue to capitalize on the opportunity ahead. We have the financial strength and the process maturity to execute on our mission to help our customers simplify their businesses, excite their subscribers, and grow their value. With that, let us open the call for questions. Daryl?

Thank you. We will now be conducting a question-and-answer session. Operator instructions. Thank you. Our first question comes from the line of George Notter with Jefferies. Please proceed with your question.

Hi, guys. Thanks very much, and congratulations on the great results and guidance. I guess I would like to start by seeing if you guys have any new commentary or updated commentary on the component lead time situation and supply chain dynamics. I'd love to double-click on what's changed over the last three months in your mind.

So, George, as I said in my prepared comments, this remains the biggest downside risk to our business. It is a struggle every day, and we expect it to be a challenge in the second half. As you remember, back some four months ago, lead times went from 30 to 52 weeks, which sort of created a divot out in the second half. But what I'd actually like to do is ask Michael to add some color on the work that goes on, and what he's seeing from his perch as President and Chief Operating Officer. And then furthermore, ask Cory to come on afterwards and add some color as well. Michael?

Thanks, Carl. As he mentioned, we outperformed in Q1. And as we look at future quarters, the focus that we used to have, which was just on the big chips that would pop up and be an area where our supply team would focus on, is now shifting beyond that to all components, because we're seeing some problems in the market that are a bit of a surprise: it could be a $0.10 chip or a $1,000 chip. As we go forward and we look at the supply chain, that's where all the data and analytics and focus on process will pay dividends. We expect that we'll have to focus on that, and that it's no longer just a one-off multiple-quarter scenario. It's an industry-wide challenge that we've invested in to be successful over the long-term. I will say that one of the hires we're really happy about in Q1 is we added Jerry Cederlund, who has run multi-billion-dollar supply chains. He comes from CommScope and ARRIS. And along with the other folks who have joined the team in Q1 and Q4 last year from Dell and other large companies, we've really bulked out our supply chain teams, so we're able to meet the challenges we had, and we see it as something that will happen every quarter over the long term, and we're ready to face it.

Thanks, Michael. George, last quarter we mentioned that some significant silicon pushed out from 32 weeks to 50 weeks. Just to highlight, even though we performed better here in the near term and took up our second quarter guidance, it still creates a kind of a divot or a hole back in the back half of this year, because ultimately we just kind of skipped right over the fourth quarter. We continue to work that problem. So, we still think the second half will be a harder supply chain challenge than the first half. And we also think we see this broadening, as Michael said, to a greater set of components. So we're seeing new challenges every day. We have to get up and continue to work the problem.

Got it. And then just to follow up on that, can you talk about supply chain impacts on the Q1 results? And is there anything you can say in terms of how much revenue you weren't able to ship in the quarter, or also impacts on gross margins in the quarter?

Carl, are you on mute? I don't know. We can't hear Carl.

Carl, are you self-muted? Okay. Everyone, please stand by while we get Carl back on the line. Operator, Carl is dialing back in. Okay. He's now back online.

Okay. Can you hear me now? Not sure what happened there. My apology. I apologize. So, George, when you look at the work that went on, our focus is on the success of our customers, and in actuality with all the work that we do in the quarter, we do a very good job of staying with our customers' demand. So there really weren't any pushes or pulls in the quarter. What you've seen in Q2 with the guidance is a result of the work that the team has been doing throughout Q1 and into Q2. We feel like we can supply more demand. So, to your point, what the supply has made it difficult to do is to forecast out. I mean, we have strong demand, but our expectation setting is actually bound by the supply chain and the challenges that we have. And so, in the quarter, it's a good question; there really wasn't any significant pushes or pulls. And we hope to do the same obviously in Q2. On the margin side, it also makes things more difficult to predict as well, and in this quarter it sort of caught us a little bit. So, Cory, maybe you want to cover that one, please?

Yes, sure. Inside the quarter, we clearly over-performed on the gross margin line, and there were really two drivers for that. The first was product mix. We had some lower-margin systems that did not ship in the quarter due to some component shortages for them, and more significantly, didn't reach their port of destination by the end of the quarter due to logistics delays. None of these products will ship or be received in the second quarter. The result in Q1 is that we shipped higher-margin system products than we were originally anticipating inside of Q1. The second and probably larger impact on the first quarter margins had to do with carrier freight. With the partnership that we've established with our customers throughout the pandemic, and as well as the outperformance by our supply chain team, we were able to shift more of our inbound shipments away from costly air freight toward ocean-based transit, resulting in lower than projected freight costs. We expect that we'll continue to be able to move away from air freight in the second quarter, but I would also point out that we have higher transportation rates from all shipping options, and that they remain elevated and will continue to have an impact on gross margin. With the broadening of chips with longer lead times, what we're seeing is that we're going to have to move to the spot market or pay premiums. So, we still have to struggle with PPVs to meet our supply objectives and satisfy our customers. So, George, Q2 guidance reflects our best estimate at this time of all these items on our gross margin.

Great. Thank you very much.

Thanks, George.

Thank you. Our next question comes from the line of Paul Silverstein with Cowen. Please proceed with your question.

Not to give you all a hard time in such a good quarter, but I am confused by a number of the responses to the previous question. No doubt that's my shortcoming, not yours, but with that said, let me ask: you're saying gross margin and revenue growth were not at all impacted, or would not have been better, let alone much better, but for the supply constraints. But I could swear I just heard Cory say that you could not ship some products. They happen to be lower gross margin, which helped your margins, but I assume you didn't ship higher-margin, more full-function products in place of a little bit lower-margin products. And I assume your customers didn't pay you more for those higher-margin products. So if that was the case, I understand the benefits on gross margin, but I think commonly wouldn't that have adversely impacted your revenues? Would you say your revenue would have been that much better but for your inability to ship those lower-margin products for which you didn't have components?

Yes. Let me see if I can simplify it, Paul. And I understand the conflation because of the way the sentence was juxtaposed. So, there's two big things for the morning. The key that Cory said that I would direct your attention back to was one of the things that actually got in the way was the freight challenges, where we actually shipped items to a customer. The customer, in essence, is happy with them, but they did not reach their destination in time to be recorded as revenue. We did everything we could do. The customer is happy, but it got stuck in freight across the placard. That was one of the mixed issues that Cory is referring to. And I will tell you that particular mix issue was a lower-margin product. So let me just intersect those two and see if that helps you get through the confusion.

So, if it had got there on time, your revenue would have been higher or your margin would have been lower?

Correct.

Okay. Let me move on.

And welcome to the Suez Canal.

So if I try to reconcile your ability to ship against demand, but the challenges presented by the 50-week lead times and the broadening — some more than just your high incentives — you're just doing a better job managing inventory, and that's the comments about your buildup of inventory stocks? And I also want to ask you, Carl, you last quarter had observed the silver lining from the supply constraints. Was that an already significant portion in a growing number of customers who are giving you long-term insight into their plans, which is not typically the case, which in turn I assume translates to much improved visibility over at least a quarter or two, if not three. Has that continued in terms of increasing number of customers providing you that visibility and giving you more confidence? And also the question about the inventory buildup relative to the extended lead times.

So if you actually track the breadcrumbs in your question you sort of answered part of your question in your question. Let me see if I can tie that out for you. As we've discussed, as we are increasingly success-based, as the stickiness of our software platforms increases and delivers those outcomes for our customers, 20 years of building relationships with these customers, we're getting a better and better view into their businesses. Envision us working with them. It may or may not be orders. In most cases, it's not. It's more planning, but we now have a better understanding of what we're trying to run after with supply. Then comes the second challenge, which is now trying to figure out how to fulfill that supply. So it's counterintuitive. In an old-world box ship business, you wouldn't build inventories; you'd just be shipping everything you brought in. But what we're able to do because of the visibility is, as we are in essence chasing components in the supply chain to help our OEM players, et cetera, we're actually building inventories while we're also laying out the demand for the future and raising predictability. All those things combined, component supply is still going to be our number-one issue from a predictability standpoint. Let me stop there and see if that answers your question. I may ask Michael and Cory to chime in, but I just want to see if that explains it for you.

Yes, it's good enough for now. I'll revisit offline.

Thanks, Paul.

Our next question comes from the line of Michael Genovese with WestPark Capital. Please proceed with your question.

Great. Thanks very much. Good to be on the conference call. So Q1 there was out-performance you guys did, and you're saying the supply chain was about as expected. So clearly to me, that means you sold more licenses and sold more services to customers that already have hardware in place. So what I'm wondering is, do we have a metric? It sounds like 'land and expand' are about hardware. To me that's the least interesting part about the story. So what should we be following to track land and expand?

Welcome to the call, Mike. The best way we can describe it is it is a land-and-expand story. The way you can see it is that as the mix shifts, you'll see gross margins expand. For competitive reasons we don't break it out today. There may be a point in the future where we do, but there's nothing else I can point you to. Cory, any comments you'd like to add?

Yes. I think the only comment I'd add is we also provide breadcrumbs every quarter on some of the bullet points in terms of where you're seeing some of the growth rates around customers that we've added. So that gives you an indication of the landing part of that land-and-expand equation and some of the metrics around our platforms.

Okay. Great. So on this margin, have you guys ever thought about an upper bound you want to put on this? I mean 100 to 200 basis points into the year, well into the future until we get to 70%? Or do you not want to talk about an upper bound?

We've been asked if the business can be 60% or above and we've answered yes. We've also been asked is there an upper bound, and the problem is we don't know. We've modeled things extensively, but the different revenue streams in the business are so different and the margins can get quite high that it's very sensitive to future mix, and we simply don't have enough run time on the bottom line yet.

Last quarter you might recall we said it would be challenging to get to the 100 to 200 basis-point improvement target. But in line with our first-quarter over-performance on gross margin and the guidance we provided for the second quarter, we are getting more comfortable that we will achieve our target financial model for gross margin increase this year.

Okay. Thanks so much for answering the questions and congrats on how exciting the story is.

Mike, welcome aboard. We appreciate it.

Our next question comes from the line of Ryan Koontz with Rosenblatt Securities. Please proceed with your question.

All right. Question on the guide and typical seasonality. Obviously there's more software content and less hardware dependence on weather and fiber installation, but customers still deal with weather and installation. Is there a new seasonality in your business with the higher software content? And are you seeing a faster release of budgets this year, or is it purely a mix change and change in customer behavior as it relates to software applications rather than outside plant and more CPE? Can you share some qualitative thoughts on seasonality?

Ryan, as you come on board at Needham, you'll hear us talk about land and expand and working with our customers to succeed. We have said in the past that we expect our business to slowly but surely lose the traditional telecom seasonality. Last year was unusual because of the pandemic and went exactly opposite to that. We think this year is going to be much more representative of the future of this business, which is decreasingly connected to budget flushes or the seasonality of fiber, because we are so focused on our customers' business outcomes. Michael, if you wouldn't mind relating a little to help Ryan get a sense for how powerful that is?

Sure. The evolution we've seen in the Calix business model is that we moved from our heritage as a fiber equipment company to investing significantly over the last 11 years in software and cloud platforms. Once you become a business partner, and the customer success organization is working closely with our customers to identify how they use the insights and the data in their network to understand their subscribers and convert that into reductions in churn, growth in ARPU, and acquisition of new customers, the model changes. We focus on three things. First, we give them the simplest operating models in the marketplace. On the fiber side our platforms sit on top of it, collapsing the CO and allowing them to run with significant OpEx savings while driving an effective go-to-market for the premises. This converts into things like reductions in truck rolls. Second, we help them excite their subscribers and compete against consumer-direct companies. Our customer success organization works closely with them to understand subscribers, put great go-to-market motions in place, and grow revenue with each subscriber. Third, those two pieces come together to drive growth in value of their business, whether to their community, members, or investors. We're seeing this expand our TAM; 20 years ago we were relevant in a section of their business; we're now relevant across their business. Examples include GVTC in Texas, which invested over $300 million in fiber and rolled out our Revenue EDGE marketing cloud, support cloud to run their call center, and our GigaSpire Wi-Fi 6, generating incremental services and revenue. They've achieved an NPS of plus 44 and a 25% increase in loyalty. Bascom saw a 95% adoption of the EDGE suite. We ran over 20 million FCC broadband performance-compliant tests this quarter for our customers, which is unheard of. STRATA Networks ran a marketing campaign and saw over 60% increase in adoption of their mobile app. Norvado had a 99% uptake on their premium Wi-Fi upsell. These examples show we are no longer just providing hardware; we're helping customers build a successful business, and that's why they're selecting us more than ever.

Ryan, the enthusiasm you hear in Michael's voice is the enthusiasm that courses through every Calix employee, because our mission is helping our customers succeed. It's a very different energy through the company and it's quite exciting.

That's helpful. Really inspiring. Thanks so much.

Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Please proceed with your question.

Good morning. First question is on the gross margin guidance. You're looking at margins coming down maybe in the neighborhood of 200 basis points on a similar revenue level. To what extent is that mix with lower-margin systems creeping into Q2 versus any impact from pricing on chips or other input cost increases? Can you assess the relative impact of both of those or any other items on gross margin?

Cory, why don't you take that one?

Sure. Tim, the significant portion of Q2 guidance being down relative to Q1 is the push-out of those lower gross-margin systems. There is a bit more PPV when you're out buying components and building inventory, so PPV is up a little bit compared to the first quarter. But the largest component of our margin guidance relative to Q1 is the lower-margin product mix where we differ from Q1 to Q2.

Got it. Thanks. And with regard to the outlook for the second half of the year, you're obviously taking a fairly conservative stance and doing much better. But in terms of the second half, what kind of expectations do you have for OpEx? You're guiding to a pretty significant uptick in Q2. Is there a particular focus on that spend, and do you expect that to continue to creep up through the second half despite a moderation in revenues?

Let me address the conservative nature. We're trying to grapple with significant variability in the supply chain. As that variability narrows, you'll see us narrow the range we're thinking through. The range in Q2 reflects more confidence in the supply we have laid in for Q2. In retrospect, guidance may appear conservative, but it's prudent given the variability we've been chasing in the supply chain. As we plan OpEx, we have the model we laid out at Analyst Day, and if you do the math, we're not investing fully into that model yet. We intend to scale up into that model because the opportunity is in front of us and it is large. There's a lot of discussion around broadband funding plans in North America, and every new network is an opportunity for us to help the customer deploy a new business model. So we are going to fight hard to invest fully; look at our Analyst Day model and revenue expectations to see where we're driving.

Great. One more: international was a strong point in the quarter. Any color on what's driving that growth and your expectations going forward? Is it a mix factor driving margins as well?

International typically affects margins as it can be somewhat lower margin. The major issue in international has been refocusing international to align customers and be profitable, which Michael did. That business is benefiting from increased demand. Michael, do you want to speak about international and North America sequencing, and Cory can add color as well? Michael?

The international markets for us are focused on aligned customers. If a customer understands we help build their business and will grow with them, they're a fit. If they're just looking to buy a simple box and basic Wi-Fi or fiber hardware, we're not that partner. We're a company that builds simple networks with low OpEx, excites subscribers, and helps them grow. That's our focus whether the customer is international or in North America.

You might also see in our 10-Q we did a breakdown of revenue by geography. Year-over-year we saw good growth across all geographies. In particular, in Q1 the Middle East was up. It bounces around quarter to quarter, so you'll see lumpy results, but we're seeing good progress.

Thanks, Cory.

Our next question comes from the line of Paul Silverstein with Cowen. Please proceed with your question.

Carl, I apologize if I misunderstood, but in response to the question about calendar-year growth outlook, I thought I heard you say you're looking at 15%, but then I heard you say you're moving at 5% to 10%. Did I mishear what you said?

You may have misheard or I misspoke. Given our Q1 performance and our Q2 guidance, and leaving expectations as they are for Q3 and Q4, with the supply challenges we have, if you just look at that it basically takes us to roughly 15% year-over-year growth for this year. We don't change the Analyst Day model yet; we'll stand pat on the 5% to 10% long-term model, but current trajectory implies around 15% for this year if the underlying assumptions hold.

Okay. And then with respect to gross margin progress, you guys now are saying that you think you will deliver the 100 to 200 basis-point improvement in margin that last quarter you said would be challenging. Is that correct?

That's correct. Cory said that.

Okay. I'll take the rest offline. Thanks so much.

Thanks, Paul.

Our next question comes from the line of Ryan Koontz with Needham & Company. Please proceed with your question.

Ryan, could you check if you're self-muted?

I was. Thank you. With regard to the model and thinking about OpEx and the lifting of the pandemic also convoluting things, how should we think about where OpEx is depressed today because of less travel and other expenses, and what amount of OpEx impact from the pandemic might snap back looking out a few quarters?

I'm going to ask Michael to speak to the travel piece, but I want to dissuade you from overthinking this. I would call your attention back to the model we laid out at Analyst Day because that guides our investments going forward. Parsing the travel piece, Michael?

As Carl mentioned, we're in growth mode with regards to travel. The pandemic has brought permanent changes. The way we do business isn't going back to the way it was before. Many employees prefer some level of remote work, and productivity gains have been realized by work-from-anywhere approaches, which we've supported for years. This also enables customers to engage differently. In the past, our sales engagements were very face-to-face, but customers are now comfortable with video and virtual meetings. Virtual engagement allows us to bring a larger virtual team into customer interactions — customer success, data analysts, data scientists, call center experts — which in the past would have been difficult to coordinate in person. So travel will change; in the long term it may be 40% to 60% of the travel we used to do. Customers are embracing virtual events and 'circles of success' where multiple customers come together to share best practices and learn from each other, which is very effective.

Got it. Real clear. Thanks.

Thanks, Michael.

Our next question comes from the line of Michael Genovese with WestPark Capital. Please proceed with your question.

Everybody else is doing it, so I thought I'd come back too. Small customers have been strong for a while. When I look at the numbers for the quarter, it looks like sequentially there was a nice change, better than seasonal change certainly for medium customers. Two questions: what's going on with medium customers, and when are large customers going to get strong again, in your view?

Let me frame this. We're riding a wave of disruption. Anytime you're creating a new market, small customers are the first to move — they have less inertia. Medium customers are being restructured and recapitalized right now, so they represent an exciting opportunity to start to move into the success mode. Large customers will take longer; it could be years. We expect growth to continue bottom-up from smallest to largest.

Okay. That's fair. Last question: on taxes should we model in any meaningful taxes going forward?

That's a good question. We're evaluating that every quarter as profitability increases. Not for this year, but looking to next year you should probably put in an effective tax rate in the mid-20s, and I would guide you to somewhere between 25% and 27%.

Thank you.

Thanks, Mike.

There are no further questions at this time. I would like to turn the call back over to Tom Dinges for any closing remarks.

Thank you, Operator. Calix leadership will participate in a number of investor conferences and meetings during the second quarter of 2021, including our annual meeting of stockholders on May 13th. Information about these events, including dates and times for public webcasts of management interviews, is posted on the Events and Presentations page of the Investor Relations section of calix.com. Once again, thank you to everyone on this call and on the webcast for your interest in Calix. Thank you for joining us today. This concludes our conference call. Goodbye for now.

Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a great day.