Calix, Inc (CALX) Q1 2022 Earnings Call Transcript

Greetings, and welcome to the Calix First Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded. Today on the call, we have Calix’s Chairman and CEO, Carl Russo; Chief Financial Officer, Cory Sindelar; and President and Chief Operating Officer, Michael Weening. This conference call will be available for audio replay. During this call Calix will refer to forward-looking statements, which include all statements the company will make about its future financial and operating performance, growth strategy and market outlook. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause actual results to differ are set forth in the first quarter 2022 letter to stockholders. Calix assumes no obligation to update any forward-looking statements. Also on this conference call, Calix will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in the first quarter 2022 letter to stockholders. Unless otherwise stated, all numbers referenced on this call will be non-GAAP measures. With that, let me turn it over to Calix’s Chairman and CEO, Carl Russo. Carl?

Thank you, Laura. Robust demand for our all platform offerings continued in the first quarter as the Calix team executed with excellence. This combination delivered a breakthrough in our business model, a 5% sequential increase in revenue from the fourth quarter of 2021. We have put the seasonality associated with traditional systems businesses in our rearview mirror, and we are confident we will deliver sequential quarterly revenue growth from now on. This is the last significant piece of our evolution to delivering increased predictability resulting from our continued shift to our all platform model. This shift continues to build as over 70% of our bookings in the quarter came from our software platforms and associated systems and services. This is up from 50%, just three quarters ago. Our platforms enable BSPs to offer broadband as an exceptional service rather than just a dumb pipe. This makes our BSPs essential to their subscribers and thus very resistant to macroeconomic factors. Furthermore, it ensures demand for Calix platforms will remain robust. However, supply remains the key challenge and will continue to be for the foreseeable future. That said, we are making progress in our 14% year-over-year revenue in the first quarter has given us enough confidence to raise our 2022 full-year guidance from 5% to 10% growth to 10% to 15% growth. This is in line with the long-term guidance we gave at our Investor Day at the end of February. In essence, we are now pulling forward our entire guidance model into 2022, except for gross margin, which we believe will remain around 50% in 2022 and then grow from there. We have made modest and targeted pricing adjustments, which will roll into the revenue line over time. While these will not change our gross margin guidance for 2022, they do reinforce our confidence in returning to our 100 basis points to 200 basis points of gross margin improvement in 2023 and beyond. In closing, the enormous secular opportunity we are capitalizing on is growing every day. The Calix team is committed to executing with excellence to help our customers simplify their businesses, excite their subscribers, and grow their value. With that, let’s open the call for questions.

Good morning. Thanks. Not something I normally ask about, but Cory, what’s the tax rate issue? And is this just going to impact this year, or is that going to be the new norm going forward, this 26 to 28 that you referenced in the letter as opposed to the low-20s you had previously referenced?

Good morning, Paul. This issue relates to a set of new rules created with the Tax Cuts and Jobs Act of 2017 which includes a set of rules called BEAT, Base Erosion and Anti-Abuse Tax. This tax was intended to prevent U.S. companies from avoiding domestic tax liability by shifting profits out of the U.S. Because of our growth rate, we now fall under these rules. Most large companies pay enough U.S. Federal income tax that BEAT is not triggered. However, given that we’re using our NOLs, we have a BEAT tax obligation. This BEAT tax is based on our planned annual foreign expense reimbursement and does not fluctuate with our profitability. The expectation is we will be in a BEAT-paying situation until our NOLs run out. So, I would advise that the 26% to 28% rate will be with us for one or two years, potentially three years.

So through and including at least 2024, maybe 2025?

Not 2025. So 2022, 2023, and 2024, potentially 2024.

And you'll go back to the rate that everybody else is paying when you consume the NOLs?

Correct.

All right. That’s actually all I have. Thank you.

Our next question comes from the line of Michael Genovese with Rosenberg Securities. You may proceed with your question.

Thanks a lot. My first question, can you just give us the remaining performance obligation number and then also, I think of that number as primarily reflecting the three-year contracts for the cloud sales, but I think there’s probably some other stuff in there. So could you just help us think, how much of it is cloud and how much of it is other stuff?

Sure, sure. Mike, the number for Q1 you will see it posted on our 10-Q filed at the end of the day today. It’s $138 million for the quarter. It is the majority cloud, also included in cloud you have the adding suites, and there are support contracts and extended warranty in there. There is no hardware included in those numbers. Those are all non-cancelable contracts.

Right. And then if my understanding is that the operating systems licenses are one year, so they’re not in the RPOs, is that right?

That is correct. The operating software is recognized as they sign the contract and is not included; it’s been delivered once the contract is signed. So you don’t find that in the RPO.

Yes. And I just want to confirm my numbers here. It looks like it’s about up about 82% year-over-year. That’s – that is okay. Great. And then Cory, can you also, Cory and or Carl talk about the decision? I mean, it looks to me like you’re a little bit above the OpEx target model, just for Q2. I know you’re going to be at the model for the full year, but can you talk about the decision to hire that many people right now, and what’s behind that?

What’s behind it is, what’s in front of us, which is an enormous opportunity that we intend to fully take advantage of. As we get better and better at growing the team, we have the ability as we grow revenue to invest fully in our model. Very clearly, you should take that as a very strong indicator of what I said at the start of my comment, which is we had robust bookings, and we see the opportunity in front of us to be unrelenting. We intend to take advantage of it and not leave any of this opportunity lying fallow in the field.

Great. And Carl, last question for you, I guess. In the financial community, there’s a debate about what exactly is going on in the macro and what’s going to happen with the consumer, and your customer subscribers are households, and set under the definition of consumer. So, there’s basically a debate about how resilient broadband will be. I’d love to get your view on that.

Great question, Mike. One of the things that everybody I think has concluded is that broadband is becoming a necessity. I think you hear that all the time, and there’s an assumption with that that therefore dollars will be spent by subscribers and consumers and businesses on broadband. That is true. What we are focused on, however, is helping our customers deploy broadband as a service with all sorts of things that excite their subscribers. Why is that important? Because broadband sold as a dumb pipe is a commodity. If a competitor comes along with a lower price or a higher speed, you’re going to lose that subscriber. We are helping our customers build a model that results in very high net promoter scores, very low churn rates. Our customers are building a recession-proof offering. If our customers are recession-proof, then actually we are recession-proof. I think it actually frees up in the broad sense, shipping and silicon and might actually benefit us more than we expect. Sorry to say with a recession, but I actually think we could end up being better off in a recession. Michael, can you share an example of a customer success story or two about this?

Sure. On the networking side, we had a significant customer success story with Blue Ridge Cable, who has over 250,000 subscribers, a cable company that in the past has remained on to access. They’ve decided to rebuild their entire existing cable network with fiber as they see the significant opportunity ahead in the transition of the consumer to broadband. They’re not a dumb pipe; they are a full service provider. They are looking to us to do things like going beyond the fiber provided today by expanding offerings like ProtectIQ, which is our malware and security deployments. We had companies like Canadian Fiber who are now stopping over a 100 threats a month per home. They’re also looking to us to expand their offerings around very sticky services like our recent announcement with Arlo, wherein we enable small broadband service providers to build out home security solutions. This means customers will be entrenched with services from their trusted provider. The last success I’ll add is that there’s significant broadband funding going into this market, as you’re aware. With Calix Support Cloud, the largest deployed support cloud in North America, we’ve built full custom testing into it to meet government obligations and ensure customer compliance. We’re now exceeding 20 million tests a month. No one in the marketplace is even close to what we’re doing.

Thanks, Michael. Good stuff.

Our next question comes from the line of George Notter with Jeffries. You may proceed with your questions.

Hi guys. Thanks very much. Maybe just continuing on the Calix Cloud discussion. Can you guys give us a sense of how you’re doing in terms of subscriber or customer adoption on Operations Cloud, and then maybe some of the revenue suites, ProtectIQ, ExperienceIQ? What are you seeing there in terms of adoption rate?

So early days on Operations Cloud, but the way I would gauge it is where interest goes, bookings will soon follow, and it is ramping quickly, but obviously off of a zero pace. I would tell you, we are robustly certain that Operations Cloud will be every bit the winner that Support Cloud has been as it grows rapidly through our customers. You’re seeing that in the 82% year-over-year growth in RPOs.

Well, I’ll state that if you look through our press releases from Q1, we press released a 90% growth in the suites. Specifically around ProtectIQ, we’ve seen companies like Centranet achieve a 94% adoption rate. So we’re seeing massive ramp-up on the suite side as service providers are educated by our customer success team on how to be successful and change the lives of their subscribers. Cooperatives and not-for-profit companies, which make up a large percentage of our customer base, are embracing this because they see it as their obligation to improve their members’ lives. Security is a key requirement given current conditions. Operations Cloud is our fastest ramping cloud ever, and it solidifies in the marketplace that Calix platforms are unique. No one is tying the subscriber platform to the access network as we do. This allows service providers to automate entire operational processes in ways never done before, enabling even small service providers to be as efficient as larger ones.

Got it. Thank you.

Our next question comes from the line of Christian Schwab with Craig-Hallum. You may proceed with your question.

Hey, congratulations on a good quarter and improved revenue outlook. I guess my only question is regarding gross margins. It sounds like, just to make sure I heard it correctly, you guys are raising prices modestly on certain products or platform offerings to help offset the significant component logistic costs that impacted us this quarter. However, that improvement won’t be seen until 2023. And that’s when we kind of return to a 100 basis points to 200 basis points of gross margin improvement for a couple of years. Did I hear that correctly?

Yes, I want, well sort of, let me make sure I’m being clear. The first thing is we’re bringing our model forward except for gross margin. At the same time, I also made the comment that we have made targeted specific pricing adjustments across different products. These are prices going forward on new quotes in business. Recognize that lead times and other factors mean these will roll through bookings and then into revenue. It’s just going to take time. They are not the reason we believe we will return to 100 basis points to 200 basis points of margin growth in 2023. Our own work and platform acceleration will continue to drive our gross margin model.

Yes, that’s perfect. And then just remind us, what do you think is the peak gross margin potential for Calix over time?

I don’t know, because as we continue to layer into the model, we will provide more value for our BSPs’ subscribers, those products typically have higher margins. We know we will go above 60%. We don’t know where it will go from there. It depends on how the market shapes, as there could be stable white box solutions. We just know we want to get back to our 100 basis points, 200 basis points and keep going, as we aim for averages above 60%.

Great. No other questions. Thanks guys.

Thanks, Christian.

Our next question comes from the line of Chris Howe with Barrington Research. You may proceed with your question.

Good morning, Carl. Good morning, Cory. Just leading off here on the topic of bookings, you mentioned 70% of total bookings. As we think more about this number, you obviously have many different points of adoption within the customer, whether it’s your Support Cloud or other avenues. Can you go into a little bit greater detail about the organic acceleration of adoption as this matures further down the line, as well as the work that’s being done by your Salesforce?

So are you asking if the 70% as a percentage continues to grow? The continuous drumbeat of land and expand is accelerating. Separate from that, our legacy systems stopped developing. For example, our legacy systems do GPON, but XGS-PON wasn’t developed into them. Customers wanting to move to 10G PON provides a reason to switch to our platforms. The same is true with Wi-Fi 6 versus Wi-Fi 5. On top of that, there’s constant growth in our platforms.

Sure, to add, two elements from a hardware perspective will start customers thinking about switching. But those open conversations allow us to dive into how we transform their business by leveraging unique platforms for subscribers and the network. This allows us to change the conversation around operational efficiency and go-to-market strategies, creating a new relationship with subscribers. With continuous updates and innovations, we integrate this into go-to-market strategies, enabling upselling.

Thanks, Michael. That’s certainly very helpful. Just one quick follow up. I know it’s a small percentage, but international revenue is about 10% of revenue. You mentioned the European customer. How should we look at the international opportunity versus the domestic opportunity?

No, it’s consistent with what we’ve said, which is we continue to own our international efforts, but our first priority is North America and taking advantage of the huge opportunity in front of us.

Okay. All right. Thanks Carl.

Thank you.

Our next question comes from the line of Tim Savageau with Northland Capital. You may proceed with your question.

All right, good morning. Sorry about that. And congratulations on the results and outlook. I wanted to follow up on gross margins given a couple of factors, including the increase in the all platform bookings and price increases. Can you share an estimate of the impact of supply issues? Given those dynamics, where would gross margins be for the quarter, for the year?

That's hard to quantify. If this never happened, we’d be a lot higher. Looking forward, the supply will continue to be a challenge. There are a few things improving and others getting worse. It’s hard to put a stake in the ground on this side. The platform is compelling, and we are comfortable with 100 basis points to 200 basis points next year. This year will be a fight to keep that 50 in front of it.

Okay. Thanks very much.

Thanks, Tim.

Our next question comes from the line of Fahad Najam with Loop Capital. You may proceed with your question.

Good morning. So I’ll follow-up on Tim’s question. Can you give me a breakdown of your gross margin headwinds? Component cost versus freight? Can you give us a sense how these factors compare?

It varies by the day, but I’d say 50/50 is a good proxy.

Yes. I would weigh material cost more so than freight costs at this point because of performance price variance that we have to pay to source missing components.

Got it, appreciate it. And then I noticed a healthy increase in employee stock comp expense. What are the inflationary pressures you’re seeing in hiring new talent, and how should we think about your OpEx rate going forward? Any color there?

Well, our OpEx model stated at the Investor Day includes 17% to 19% for sales and marketing, 30% for product gross profit in R&D, and 8% for G&A. We will invest in our model as much as we can, believing it yields the best return. On inflationary points, Cory?

If you look at our OpEx investments, it’s largely personnel-driven as we make those investments across the organization. We’ve been able to hire at a robust rate and plan to continue investing to address our opportunities, so expect us to align with our OpEx model for the foreseeable future.

In the current hiring environment, people are job-hopping for better offers. To maintain a consistent team for our customers’ success, we focus on our culture. Michael, can you share color on that?

From a culture perspective, we listen to our employees, ensuring a culture that is adaptive. Our philosophy around culture is that it should grow and change as we bring in new people. This approach has yielded us accolades, being ranked among the top mid-cap companies and receiving awards for best outlook, best engineering team, best global culture, and best places to work. New hires are highly proactive in researching our culture before joining, and we want them to make informed career decisions.

Yes. One last question on software recognition. If the end consumer adds a new service to the existing offering, is that constructed as a new contract for revenue recognition?

Sure, let me break that up between operating licenses, software licenses, and our SaaS clouds. A customer may buy our OSS on a license basis for a certain number of subscribers. We will recognize that license revenue up front. There’s a portion of maintenance that is ongoing. As they bring on more subscribers, they’ll buy more licenses, recognizing some additional license software at that point in time. The clouds are recognized over time, and as more subscribers come onto the platform, we perform true-ups that reflect increasing growth rates and are recognized ratably over the committed service period.

Thanks, Cory. Great. Thank you. Appreciate the answers.

Thanks, Fahad.

Our next question comes from the line of Ryan Koontz with Needham. You may proceed with your question.

Thanks for the question. Would you comment, Carl, on your strength and your mid-size customer base and the opportunity there? We’re clearly seeing a broad shift from copper over to fiber in this segment it seems.

It’s not necessarily copper and fiber driving it, although that’s part of it. As you look at our shareholder letter and the small, medium, and large mix, you see small customers growing and becoming medium customers. Last quarter we saw small customers growing to over 250,000 subscribers. We are also seeing additional medium customers joining us. There’s a disruption happening, and larger customers are starting to see the opportunity.

Yes, it does. Thanks.

Okay. Other questions, Ryan?

Covered them all.

Thanks. Laura, I don't know if there's any other questions in the queue.

Our next question comes from Paul Silverstein with Cowen. You may proceed with your question.

Thanks. What is the breadth of adoption of either one or multiple software suites? I recognize we’re talking about less than a handful in total of how many customers are present and what's the take rate for new customers that have migrated to adopting one or more suites? Can you give us any sense in terms of the breadth of adoption at present and how it's progressing?

There are hundreds of customers now deploying one or more cloud platforms. Two or more clouds is over 100 customers, but you shouldn't assume anything more than that.

How about the software enabled by Access, whether it's ProtectIQ or one of the other couple offers?

Again, ramping and broadly deployed, but think in terms of hundreds, not thousands.

And on the discussion of the ongoing lockdowns in China, any thoughts you’d care to share?

The lockdowns present a huge challenge. More transmissible variants make stringent quarantines hard to maintain. Minor interruptions are likely, but I don’t expect it to turn into a major situation like we faced two years ago.

Is there a point in the next several weeks to two months where this could become meaningful?

If it becomes meaningful, you won't see it immediately. It'll create a gap in lead time. We’ll address it if it happens, but right now there's no effect to report.

Two last quick questions. In terms of resiliency of your customer spending or current buildouts, how do you see that holding up during an economic downturn?

On the network side, build-out is not elastic based on macroeconomic factors. Our offering allows DSPs to differentiate and shift from commodity to Broadband-as-a-Service, which is compelling in tough economic times.

Since there's nothing on quantification, what is employee turnover? Has it changed?

Our turnover is very low and well below industry comparables.

Current RPO that you'll see at the end of the day is $138 million, which compares to $75 million in the year ago period, 125 last quarter.

Thanks, Paul.

We have reached the end of this question-and-answer session. I would like to turn this call back over to Mr. Sindelar for closing remarks.

Thank you, Laura. Calix leadership will participate in a number of investor meetings during the second quarter of 2022. Information about these events, including dates and times for public webcasts of management presentations will be posted on the Events and Presentations page of the Investor Relations section of calix.com. Once again, thank you to everyone on the call and on the webcast for your interest in Calix and for joining us today. This concludes our conference call. Goodbye for now.

You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.