Calix, Inc Q2 FY2021 Earnings Call

Greetings, ladies and gentlemen, and welcome to the Calix Second Quarter 2021 Earnings Conference Call. At this time all participants are in a listen-only mode. It is now my pleasure to introduce your host Mr. Tom Dinges, Director of Investor Relations. Thank you, sir. Please go ahead.

Thank you, Donna, and good morning, everyone. Thank you for joining our second quarter 2021 earnings call. Today on the call, we have Chairman and 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 second 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. And with that, let me turn the call over to Carl. Carl?

Thanks, Tom. The second quarter saw the Calix team achieve a number of milestones on our march to an all-platform model. On a wave of continued strong demand, for the first time our all-platform offerings—software and the associated systems and services—were greater than 50% of our bookings. We expect this trend to continue. For the third quarter in a row, we did not have a 10% customer, and we do not expect to have one in the current quarter. This speaks directly to the breadth of our customer base and the predictability of our all-platform model. At the same time, we ended sale on our B6 and C7 products. These two systems were the founding systems of Calix, and this marks another milestone in our continued pursuit of our all-platform future. With these milestones behind us, the Board of Directors has added the Chairman role to my CEO role. I will continue my focus on our long-term strategy, and I’m confident that our executive team, and my friend Michael Weening, our President and Chief Operating Officer, will continue to execute our strategy with excellence while supply remains a challenge and will remain a challenge well into next year. Organic demand for our solutions remains strong. Every day we are excited to help our customers simplify their businesses, excite their subscribers and grow their value. With that, let us open the call for questions. Donna?

Thank you. The floor is now open for questions. Our first question is coming from George Notter of Jefferies. Please go ahead.

Hi guys, thanks very much, and congratulations on the strong results. I guess I wanted to ask about gross margins. If I remember going back three months ago, you mentioned that you had a shipment of low margin product that got pushed from Q1 into Q2. I guess I’m wondering if that had some impact on the gross margin result this quarter. And then also I would imagine your component costs are higher also given the supply constraints around the industry and any sense you can give us for how that might have impacted gross margins also would be great?

Yes, George, you remembered correctly that that shipment was pushed from Q1 into Q2 and it had some impact on our margins. And you’re also correct that the component price increases and higher freight costs contributed to the sequential decline in margin from Q1 to Q2.

Got it. Any chance you guys could quantify that? Is it a point margin, two points, half a point, anything you could steer us to would be great.

Yes. I think Cory in the past has said it’s not any one specific number that he wants to bracket publicly, but it’s more than a point and less than some higher number. It’s a significant amount, George, and that’s I think the best way to frame it.

Got it. Okay. That’s great. And then I guess, I also wanted to ask about CenturyLink, I guess now called Lumen. Your larger customer segment there was down quite a bit year-on-year. Obviously CenturyLink sounds like it’s going through a strategic process around some of their assets, but any perspective on what’s going on there and any chance that account could improve going forward? Let’s say they do make some strategic decisions, maybe get some cash proceeds from those strategic decisions. Could they reinvest in areas of the business that you guys are exposed to?

Yes, George, I think that’s the correct observation. As you know, over the last couple of quarters they’ve been pretty tight on CapEx, as I think they’ve been going through their strategic evaluations. If you notice in the announcement around the Latin American assets they spoke directly to a likely use of proceeds into CapEx and investments. But we think it’s going to continue like this for a while as they continue that focus on where they want to go strategically. So our business continues to move along. If you look across the industry, you’ll see that their CapEx was down across a number of spaces. And I think there is a chance it will improve, but it may improve through Lumen, it may improve through the spun-off assets—whatever they may be—so stay tuned.

Okay, I’ll pass it on. Thanks very much guys.

Thank you. Our next question is coming from Paul Silverstein of Cowen. Please go ahead.

Thanks guys. The 43 new customers in the quarter—that’s a big step up from your historical past. I think the 24 in the preceding quarter and the 20s in the teams before that. Is this the new norm? Was there something specific about this quarter? Then I’ve got a couple of follow ups.

I don’t know if it’s the new norm. I would characterize it as we’ve been investing to get up to our model, and a significant portion of that has been in sales and marketing. I would say stay tuned. But I think you’re going to see increasing aggression on the part of the sales and marketing organization. Michael, do you have any words you want to add to that?

I mean, just to say that we see different sized customers from small to medium-size. Exactly what Carl said—the investments we’re making in the sales and marketing organization are paying off. Along with the platforms being very mature, a customer said to me the other day that we’re the only Wi-Fi 6 platform that’s carrier-class and mature in the marketplace. That’s why they went with us and it’s paying dividends because we were the first in the market. Now that we have all of our new platforms coming into place and our new solutions, we’re very excited about the future, which is leading to new customer acquisition.

All right. Then your mid-sized customers were up again very strong—if I recall correctly there was very strong growth this quarter and strong growth from the previous quarter. Is that indicative of something that’s sustainable, are they back to a growth mode for an appreciable period of time and what’s going on there? Any notes you could offer?

So, I think we’re careful about mid-sized customers, because it’s easy to remember the past and think of mid-sized customers as the Tier-2s. Remember, we defined mid-sized customers as those greater than 250,000 subscribers and less than 2.5 million. So it is indicative of something in the future, but it’s not necessarily that the Tier-2s are weak. That’s our value proposition: as Michael alluded to, in small and medium customers it’s starting to work its way up the stack of customer size.

Got it. One last question if I may. On the non-U.S. side, I know you’ve had your hands full with U.S. demand and so you haven’t—correct me if I’m wrong—been deploying a significant amount of incremental OpEx and resources into non-U.S. The non-U.S. is up strong once again this quarter; any incremental insight on how to read that for the future?

Yes. Same story from my perspective, and I’ll let Michael add some color. We are very much focused on North America, but globally, the drive toward broadband from anywhere is moving through the marketplace.

On the international side, we’re being pragmatic about how we expand. A lot of the growth we’re seeing is actually from existing customers who are making incremental investments in their networks and the markets that they cover and we’re getting the benefit of it, as we have a long history with them. They chose us as a strategic partner. The companies who are with us in international markets understand the value of our platforms, how they simplify their operations and excite their subscribers, and they’re betting on us long-term and that’s why they get more capital and partner with us.

All right, I’ll pass it on. Thanks guys.

Thanks, Paul.

Thank you. Our next question is coming from Chris Howe of Barrington Research. Please go ahead.

All right. Good morning, everyone and congrats on the quarter.

Good morning, Chris. And welcome to the party as it were.

Yes, a party indeed. A few questions here. But leading off, tying together some thoughts with some of the previous questions, the 43 new customers in the quarter and in the shareholder letter you had a brief highlight related to favorable regional mix. The success you had in adding new customers—should we think of that as being tied to how you targeted your potential customer base on a geographic basis?

It’s tied to the same model that we’ve been pursuing, which is a direct model that we’re continuing to invest in. There are more smaller customers than medium customers, and more medium customers than larger customers. So on a numbers basis, you’re going to see most of them in the smaller customers. Michael, do you want to add anything?

Yes, the other part is that given the maturity of our cloud platforms, we’re unique in the market in that we can enter a customer on many different vectors. Fifteen years ago Calix primarily partnered with a customer as an access vendor. We’re now able to transform their call center, their marketing through behavioral analytics insights, help them build a virtual storefront in the home with Wi-Fi 6. That gives us access to competitive accounts that we never had before and we’re entering in different vectors which allows us to win those customers.

That’s great. Thank you for the color. Digging into total operating expenses, you came in better than expected. Can you put this leverage into context for the current quarter and at what point you saw the potential leverage start to realize itself and how perhaps we should think about that on an ongoing basis? I know you’re moving towards the target financial model on a percentage basis that you highlighted in the letter; perhaps you can go into some of the leverage opportunities or what we could potentially see as revenue outgrows your total expense line?

Let me frame my answer in a return on investment manner. We expect to make disciplined investments in OpEx that yield returns, and we are very focused on growth. The leverage is, in our view, a return on investment by driving the growth of the business and opening up new margin expansion opportunities. It is not in bottom-line leverage from having OpEx be below our model. Cory, do you want to add color for Chris on where we’re seeing leverage?

Sure. The underperformance in OpEx this quarter was largely due to not meeting our hiring goals in the quarter. We did add roughly more than 5% to the workforce in the quarter, but fell short of what we expected. Over the near-term, we intend to get to model and so those OpEx investments will continue to increase.

We are planning for success, but we’re not going to lower the bar. For folks coming in to meet a head count goal, we’re going to go get the very best talent we can and we think our culture supports that.

Okay, great. I guess that speaks to one of the recent press releases about the high quality of talent that you’re attracting to Calix—not lowering the bar. My last question is quickly about the lower margin items that got pushed forward from Q1. As we look at the end of Q2, anything there that we should make note of as it relates to Q3?

Sure. We have seen a little bit more of purchase price variances and spot market buys are going to start affecting margins. We factored that into the guidance we provided, but we are moving into the tougher part of our fourth quarter. Remember back in our first quarter call we talked about the push out in lead times leading to gaps in the fourth quarter. As we approach the fourth quarter, it’s becoming increasingly more difficult to meet demand and component costs have increased. We’re going through the most challenging supply part that we’ve faced in the last 18 months in the next couple of quarters.

Okay, great. Thanks for taking my questions.

Thanks, Chris and welcome aboard.

Thank you. Our next question is coming from Michael Genovese of WestPark Capital. Please go ahead.

Great. Thanks very much. So with the upside versus where the street numbers were in 2Q and 3Q, do you have any update to the full year outlook?

Mike, we do—and I’ll let Cory cover that with you. Cory, go ahead.

Yes. Last quarter we were setting up at about 15% per year. With the improved performance in the second quarter and the outlook for Q3, this could grow at 20% or more for the year.

So for the year, what does that make it? I mean, we’re talking about…

About $660 million for the year.

Okay. Does that help, Mike? I hope.

Yes, absolutely. Thanks. Okay, so just could you quickly talk about the legacy products? I mean, you have so many legacy products. They’re all fiber, but what’s really the difference between the legacy stuff that’s phasing out and the all-platform offerings? If you can give us some color, that’d be helpful.

We’re a 21-year-old company. The company was founded on the C7. We acquired a company called Occam, which had the founding product B6. In June we reached end of sale for both of those systems. After those systems came to market in 2007, we built the E-Series product family, which continues to sell and has been phenomenally successful. The initial E-Series was built on an operating system called ESA; those were copper and fiber systems. We also built the GigaCenter family, our first generation of premises systems. All of those are now what we refer to as our traditional or legacy systems. They have broad deployments and many customers still order them robustly. When we brought our platforms to market—AXOS and EXOS, which have become the Intelligent Access EDGE and the Revenue EDGE—along with our clouds, that is our all-platform business going forward. AXOS and EXOS are abstracted operating systems that run on hardware resources underneath. We continued with E-Series for the access side and have brought the GigaSpire family to market for EXOS. We are slowly but surely growing our all-platform systems. Customers with networks built on E-Series or GigaCenter can continue to order those systems, and as they see the opportunity to deploy our platforms, they’ll move to them. Michael, do you want to add some color?

When I joined five years ago, Carl shared that we were on a multi-year journey to build these platforms. The important distinction between the legacy and the new is that our competition largely kept their existing systems and put middleware over top, while we rebuilt platforms from the bottom up using industry standard technologies like NetConf and gNMI and similar elements. That’s why our products are unique: they are built from the ground up to embrace the future and to help service providers understand their customers, leverage data and win.

I just want to point out that I’ll take that compliment.

Okay, thank you. A couple more quick ones: One, any color on gross margin expansion for the overall year—typical 100 to 200 basis points—where do you stand on that right now? And secondly, how are you feeling about Congress and infrastructure-related stimulus for this industry?

Let me add color on gross margin and then Cory can add specifics. We’re working very hard to meet customers’ expanding needs without necessarily raising prices, even though vendors have raised prices. That means paying expedite fees, higher freight, spot silicon purchases—and that’s the color Cory described. Cory, do you want to address the gross margin question directly? And then I’ll talk about Congress.

The strength in gross margin in the first quarter and continued performance in the second quarter gives us confidence that we can achieve margin expansion of 100 to 200 basis points year-over-year. So I think we’re on track to do exactly that.

It’s a fight; no one should take away that it’s an easy environment right now. On Congress, there are lots of puts and takes, and we’re all following these developments. The important point is that, regardless of party affiliation, everyone now recognizes that internet infrastructure matters. These programs often turn out larger than you think and take longer than you think. Calix’s view remains that this is not a pull-forward of boxes; it’s an uplift of our entire model as we help customers build a new business model on top of new infrastructure.

Thanks again. Appreciate it.

Thanks, Mike.

Thank you. Our next question is coming from Ryan Koontz of Needham and Company. Please go ahead.

Good morning. Impressive metric there with software and associated systems bookings north of 50%. Can you give us any color on the trends? What’s driving that and should we think about that as the new normal or a one-time event? Thanks.

So let me be clear: it is our all-platform business—software, the associated systems (both access and premises hardware), and services. That whole business has now made it over 50% of bookings, and once we’ve eclipsed that level in bookings it’s not going backwards. I thought it was meaningful to share that milestone when it happened. We expect it to continue.

That helps, thanks. Specifically on the art of programs, are you seeing any action there? We’ve heard from peers that some engineering work is starting to be funded and folks are looking to get going late this year or early next. Is that in line with what you’re thinking?

You hear a lot of optimism from vendors about timing, and I’ll just say it often takes longer. That being said, we’re clearly seeing people planning and starting to put orders in. It’s still early days. Michael, add color?

Exactly. The growth you’re seeing now is based on us taking market share. While the larger programs you’re describing are a great future opportunity, they take longer and are bigger. We expect those to flow through in subsequent years. The current results are about our organization taking share because customers understand the value of our platforms and want to build new business models to compete with consumer-direct companies that want to own the in-home relationship.

Helpful, thank you. Lastly, any color on the international side? A great quarter there on revenues—any regional color you can offer up?

Just continued execution. Cory?

Yes, it was pretty broad-based international growth, particularly in Europe.

Great. Thanks so much. I’ll pass it on.

Ryan, thanks and welcome.

Thank you. Our next question is coming from Christian Schwab of Craig-Hallum Capital Group. Please go ahead.

Hi, congratulations on another good quarter and guide guys. Most of my questions have been answered. Carl, I have one quick question. When you look at small customers here domestically—less than 250,000 subscribers—what do you hear about penetration rates into that customer base currently and could you identify how many target customers are left out there that are not customers at all of your all-platform offering?

We are well penetrated in North America from 20 years of working there. Having said that, with our all-platform offerings we are very early in the transformation. Michael, maybe you want to add color on business transformation and how early this really is?

Going back 15 years, we primarily competed as an access vendor. Now, with multiple vectors into a customer—marketing, call center, in-home experiences—we can approach customers we previously had little to discuss with. It’s an amazing opportunity. The growth you’re seeing is us taking market share as we enter both new customers and new parts of existing customers’ organizations.

Okay. Let me ask it differently. Given your long history in access, what percentage of your historical access customer base over the last 15–20 years is currently buying your all-platform solution today?

A large minority are buying some portion of it, but it is still a minority.

Okay. I’m trying to frame how big the opportunity can be at a small penetration rate. Given your customer base, there could be hundreds that haven’t adopted your all-platform solutions yet?

Every day I get more excited by the opportunity in front of us. Customers are doing things with us that make it clear we’re earlier in this opportunity than I thought. Our model expands in multiple dimensions—marketing cloud, support cloud, Revenue EDGE—so even with a customer base of over 1,500, we’re barely scratching the surface of expansion opportunities. The expansion potential is significant.

Yes, that’s great color. Thank you guys. Congrats again.

Thanks, Christian.

Thank you. Our next question is coming from Tim Savageaux of Northland Capital Markets. Please go ahead.

Hey, good morning and congratulations.

Good morning, Tim.

Good morning, Carl. I wanted to follow up on some of the market share commentary. You’ve been an established player in the market, especially on the rural side. I was struck by the comments—how would you define your addressable market? If you could estimate your current share of that market opportunity and from whom you’re taking market share, that would be helpful. I’ll follow up after that.

When you look at the overall opportunity—TAM, SAM—you’ve heard me say that on the hardware side we think our customers will capture between $1 and $10 per month per subscriber as we help them grow more successful business models. On who we’re taking share from, be careful about the term because part of this is new spaces that don’t yet exist. The best way to think about it is to list the incumbents and then look in the rear-view mirror to see which businesses grow at what rate and which expand margins. That’s how I would address the question.

Okay. I think I understand that. So you’re saying you’re taking share from internal functions like marketing or IT in some cases, and that expands the TAM. A couple finer points: one, Tier-2s—are you seeing an uptick in activity there and is that market growth versus share gain? And two, international—should we think about growth in Canada, Mexico, Caribbean versus the UK and elsewhere, and what’s driving that?

Tier-2s are part of the mid-sized customer growth segment, but not all of it. We’re having more success with customers that are larger deploying platforms and building new business models. For traditional Tier-2s undergoing restructuring, there will be opportunities over time depending on their strategic alignment. Internationally, our growth is largely from existing customers expanding in their markets. We did add some new international names, but it’s principally the result of continued focus where we’re aligned with international customers.

Yes.

Okay. Thanks.

Our next question is coming from Paul Silverstein of Cowen. Please go ahead.

Sorry, Carl, you’re competing with the conference on that broadband—I’ll let you guys sign off. Thanks.

Thanks Paul.

Okay, Paul.

At this time we’ve reached the end of our question-and-answer session. I’d like to turn it back over to Mr. Dinges for closing comments.

Thank you, Donna. Calix leadership participated in a number of investor conferences in the way during the third quarter of 2021. Information about these events, including dates and times for public webcasts and management interviews will be 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 and for joining us today. This concludes our conference call. Goodbye for now.

Ladies and gentlemen thank you for your participation. You may disconnect your lines and log off the webcast at this time. And have a wonderful day.