Calix, Inc (CALX) Q3 2022 Earnings Call Transcript

Greetings and welcome to the Calix Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the brief prepared remarks. As a reminder, this conference is being recorded. It’s now my pleasure to introduce your host Jim Fanucchi, Investor Relations with Calix. Sir, please go ahead.

Thank you, operator and good morning everyone. Thank you for joining our third quarter 2022 earnings call. Today on the call we have Calix’s Chairman, Carl Russo; President and CEO, Michael Weening; and Chief Financial Officer, Cory Sindelar. As a reminder, yesterday after the market closed Calix issued a news release and filed an 8-K with the SEC, noting that our stockholder letter had been posted in the Investor Relations section of the Calix website. This conference call will be available for webcast replay in the Investor Relations section of the Calix website. Before I turn the call over to Carl and Michael for their opening remarks, I want to remind everyone on this call, we will refer to forward-looking statements, including all statements the company will make about its 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 the third quarter 2022 letter to stockholders and in annual, 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 in this conference call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in the third quarter 2022 letter to stockholders. Unless otherwise stated, all numbers referenced in this call will be non-GAAP measures. With that, it is my pleasure to turn the call over to Carl. Carl?

Thank you, Jim. Robust demand continued in our third quarter, which resulted in a 37% year-over-year increase in revenue and a 65% year-over-year increase in RPOs. This growth continues to be driven by broadband service providers that are providing broadband-as-a-service rather than just a dumb pipe. We expect this trend to continue, and many of our aggressive DSP customers are using the economic slowdown as an opportunity to gain share by delivering an exceptional subscriber experience to those who have never received one. On the supply front, the Calix team again outperformed and we benefited from a pull forward of inventory, which provided us with the resources to meet more demand and enter the fourth quarter in a better position to meet our customers’ subscriber growth. Higher revenue in the third quarter combined with the revenue guide for the fourth quarter puts us on a pathway to deliver our third consecutive year of 25% growth. The disruption that we have spoken of for years continues to pick up speed. Our medium-sized customers are growing as a percentage of our business. And while we do not normally forecast bookings mix, I expect we will see more than 90% of our bookings in the fourth quarter come from our all-platform, cloud, software, associated systems, and services. These two observations combined with our consistent performance indicate that our transformation is nearly complete, and thus it is appropriate that I step up to the Board and have Michael lead our evolution going forward. Michael, it's all yours.

Thank you, Carl, for the opportunity to follow you and lead Calix into the next phase of our evolution. Last week at ConneXions, our annual customer success and innovation conference, we shared that Calix is entering the third phase of our corporate journey, which we define as the ecosystem and partnering phase. In this phase, we are building on 12 years and more than $1 billion of investment in our platforms to help our service providers transform their business. At ConneXions, we demonstrated that the maturity of our platforms allows our customers to innovate at a speed that has never been seen before in the broadband industry. In closing, the enormous opportunity we are capitalizing on grows every day. The Calix team is committed to executing with excellence, to help our customers simplify their business, excite their subscribers and grow their value to shareholders, members, and their community. With that, let me hand it back to Carl.

Thank you, Michael. This is the last time you will hear me say operator, let's open the call for questions.

Thank you. At this we’ll be conducting a question-and-answer session. Our first question comes from the line of Paul Silverstein with Cowen. Please proceed with your question.

Thanks, guys. Michael, congrats, you have a lot to fill. I think you all made clear in your remarks, but I got to ask, because it came up last night after you reported from some clients. The shift to software, I heard you say that you're 90% or you expect 90% of bookings to come from all platforms. But the RPO number sequentially and the deferred revenue number sequentially for some out there wasn't consistent and overly concerning, but didn't appear consistent with the overall growth. Any thoughts you could share in terms of software cloud progression as a portion of revenue and that speaks to future revenue growth? And just to be clear, the pull forward you referenced was inventory, not taking demand in the future periods?

So let me start with the end. The pull forward was inventory; ordinarily that word is a scary word, but in our supply challenge times, being able to pull forward inventory was a good thing. And you saw that in the outperformance on revenue. By the way, that also actually partially answers the first question you had, which was we had significant revenue growth on the hardware side, because of the pull forward. But I think I'll let Michael speak to the nature of the platform business in general and outlook. Michael, can you share your experience?

Yes, it can be lumpy, because we were up 65% year-on-year and we continue to close contracts. So that growth will be at variable levels. And I’d like to call that just last quarter, we had 18% growth; we saw it in one of our greatest growth quarters.

Yes. And coming out of ConneXions, it's very clear that our customers understand the opportunity ahead. And as we help them move into new markets and change how they address their subscriber opportunity through incremental clouds, services, and everything that we're doing with the suites. There is no doubt that there is a significant growth opportunity ahead with those customers.

Alright. One last question if I may. I trust you continue to have good visibility into next year based on the current strength you’re seeing, and that this strength is not significantly influenced by the upcoming distribution of funds from various broadband legislation in the U.S. and abroad. I assume that's still minimal, not even substantial. So that's my question.

You're absolutely correct, Paul. That's a trickle that will take a decade to roll out.

And your visibility into next year, Michael?

Continue to be strong. As Cory will discuss as we provide guidance, we expect to see consistent growth at an incremental level every year.

You're talking about demand.

I would like to discuss margins as well, but I want to avoid upsetting my colleagues who are waiting on me.

Now it's just our demand capability as we believe quite strong. And I would echo, having attended ConneXions and invested just a few minutes on stage. The excitement is just off the charts.

Alright. And Carl, with respect to margins, I'll apologize for the question. It sounds like this is the start of meaningful margin recovery and back to that very fine training you’d established some up until you got gobsmacked along with everybody else by the increase in freight logistics teams, et cetera?

As we said, so the answer is, we think this is the beginning of recovery. I'm excited to see it just starting to turn up in our guidance would indicate for Q4 it might get a little more of a turn up. The way I think about that, which is back to the 100 basis points to 200 basis points in 2023 makes me feel that much better about us achieving that. Keep in mind that we've always said that if the headwind is slow, the mix of the business will start to take over again and margins will start to expand. And I think that's where I would characterize it. Without going too long on a discourse in the supply chain, there's still lots of issues out there, even though we're seeing some improvements.

No. Carl, you did just say 200 basis points to 300 basis points, not 100 basis points to 200 basis points?

No, 100 basis points to 200 basis points.

Alright. I'll pass the line. Thanks guys.

200 basis points to 300 basis points, I was mistaken. If you heard 200 basis points to 300 basis points, you were mistaken.

Thank you, Carl.

I figured this thing off last conference call you and I have to get it going in. Thanks, Paul.

Thank you. Our next question comes from the line of George Notter with Jefferies. Please proceed with your question.

Hi, thank you everyone. Michael, congratulations on your promotion; we look forward to collaborating with you. I wanted to inquire about Brightspeed. I noticed that your medium-sized customers have roughly doubled sequentially, which stands out considering the historically consistent revenue run rate from that segment. I'm curious if this growth is related to Brightspeed. Do you have any insights on that?

Well, so the answer is Brightspeed is coming into the mix, but it's not the driver of that. It's more medium-sized customers, but to be clear, Brightspeed is now accepting deliveries as they position themselves to take over, which they did at the beginning of October. So it started coming into the mix in the third quarter, but it's not the primary driver. It is simply we are seeing more medium-sized customers start to step into what we're doing. And as we've discussed, as you know, George, for many years, when the small second segment was growing, seemingly at 90%, which didn't quite make sense. We said that as the disruption continues, you'll start to see larger customers take it off. That's what that's all about. It's not any one customer.

Got it. Okay, great. That's helpful. And then last quarter, if I go back to the earnings call, you guys talked about a $100 million buyback. I guess, I assume that you might have engaged some of that buyback program during Q3. I didn't see it looking on the cash flow statement. Any thoughts on the buyback program at this point?

Yes, George. Like we talked about last quarter, when we decided to go work with the Board and put that buyback in place, the company stock was at a much different level. We are looking at our cash requirements. We look at it on every quarter at the Board level as a strategic level. We're getting to a point where we had no immediate needs for cash. And all of a sudden, you're sitting there looking at a $30 share price going, we don't know where this ends. But at some point, our stock becomes a better alternative use for cash than our existing needs of just having it ready for the business. And so we went ahead and through that capital allocation process, decided we had to put a program in place. By the time you got put in place, obviously the shares have recovered to a point where we're going to leave the cash on the balance sheet and we'll continue to revisit this every six months or so. And so that's kind of where we're at. So yes, the shares recovered; we didn't have an opportunity to step in and repurchase shares.

Got it. Okay, and then just last one is, it's a quick one. At this point, what is the sort of impact you're getting through the gross margin line associated with higher input costs? I think at one point you guys told us 400 basis points to 700 basis points. I'm just curious what that is now? Thanks a lot guys.

Yes. So I wouldn't change that rate, George. It's still kind of a net number. And as we stated in the stockholder letter, the improvement in margin this quarter was largely more of a reflection of product mix. We finally solved some of those golden screw problems on our access product line and we were able to shift more of that inside the quarter, and that product mix then obviously helped us with the overall margins. So, to focus on the future, George, let me ask Cory a question. Are you finished with expedites? Are you still working on them?

During this quarter, we faced another component issue, prompting us to expedite some products via air freight, which can be quite costly. We are still managing this situation. However, we are expediting less now, as indicated by our inventory balance, which has increased nicely during the quarter. We're still within our initial target range for a turns ratio of three to four, currently at 3.1. This level of inventory should allow us to minimize further expediting and ideally avoid any more air shipments.

Thank you, Cory.

Our next question comes from the line of Michael Genovese with Rosenblatt Securities. Please proceed with your question.

Great. Thanks very much. Congratulations on a good quarter, guys. Now obviously, hardware is in an extremely strong cycle and seems like it's going to stay in a strong cycle. My question is, for your sales cadence and your sales cycles, is there a phenomenon where new customers tend to order hardware first and then there's a software pull-through later? Is that a good way to think about it? Or could you just talk about that a little bit, please?

That's a great way to think about it. In fact, as we've talked about over the last few years, the way we're going in the marketplace is that once they put, for example, a gateway into the home, whether it's a home or small business, that's where the service provider then has a unique opportunity, which has never happened before, which is going way beyond connectivity, where they start to sell services, managed services. So that starts out with Tech IQ and Experience IQ, and if you watched ConneXions you will see that we continue to expand that portfolio opportunity for broadband service providers. We announced our service offerings, and what you've seen in our growth is a direct reflection of that opportunity. So absolutely, that's the right way to think about it.

And so just to even dig down on that deeper, I mean, if we look at a new customer like Brightspeed, which I understand isn't the main reason for the 6% growth of medium as a category, but if we're just taking them as an example, would you expect that in the beginning the mix is more towards hardware and that later the mix is more towards software? Is that fair?

Absolutely, yes. No, that's great. That's absolutely right.

Okay, I want to ask a little bit more about the gross margin in the supply chain and these are really small points. So maybe this question is like too cute or something. But, you know, Cory said there was a supply chain issue in the quarter, but you still did 50 basis points, I think 50 basis points, 60 basis points above consensus. And then the guide for the next quarter is better than the guide you gave last time, but it's the midpoint is down very slightly sequentially. So just can you talk about really the fourth quarter versus the third quarter supply chain? Is it the same? Is it an improvement? Are you guiding that there could be more surprises? And if there aren't, maybe it'd be at the higher end of the range, what are you thinking there?

I think your question is a bit too clever, but we will address it. To provide some context, if the headwinds start to ease, the business mix will likely begin to positively impact the results. While it's important to be cautious about any single quarter, I will now pass it over to Cory for further insights.

Yes. So Mike, I mean, I think you're kind of too finely tuned. There is still enough variability inside the quarter that you're going to be able to see various things that, for example, I entered into or agreed to $5 million worth of PPVs to solve a problem that we have. Right? So those PPVs or price variances are still coming through. And I'd characterize the whole supply chain this way: In the last 91 days, things have improved in certain areas. But those areas that were problematic remain problematic, and we're still chasing them. So there are still, call it, a dozen or so parts that make it very difficult for us to get everything that we want. And so when we're buying them, we're paying up for them. And in certain areas, it’s getting better, right? So lead times remain extended, albeit I've heard for the first time, one vendor reduced their lead time from 52 to 26 weeks, so there's some evidence of it getting better. On the logistics side of the house, rates have come down, and they're continuing to come down. There's still not pre-pandemic levels, the port congestion seems to have cleared up in Long Beach, but rail and trucking seems to still be kind of a mess. So it's getting better, not where it needs to be. And so then you're still looking at the fact that we're having to build more products. But I would say the increase in inventory that you're seeing is really a reflection of all of the work that we did in the last six quarters. I think we’re finally getting some of those purchase commitments that we made six quarters ago and they're actually starting to show up. So it's a combination of that, a lot of the long order fund leaders that we bought, solving some of the golden screw problems, and, you know, a little bit of improvement on the shipping logistics.

Thank you, Cory.

Our next question comes from the line of Michael Genovese with Rosenblatt Securities. Please proceed with your question.

Great. Thanks very much. Congratulations on a good quarter, guys. Now obviously, hardware is in an extremely strong cycle and seems like it's going to stay in a strong cycle. My question is, for your sales cadence and your sales cycles, is there a phenomenon where new customers tend to order hardware first and there's a software pull through later? Is that a good way to think about it? Or could you just talk about that a little bit, please?

That's a great way to think about it. In fact, as we've talked about over the last few years, the way we're going in the marketplace is that once they put, for example, it gets a gateway into the home, whether it's a home or small business, that's where the service provider then has a unique opportunity, which has never happened before: going way beyond connectivity, where they start to sell services, managed services. So that starts out with Tech IQ and Experience IQ, and if you watch ConneXions you will see that we continue to expand that portfolio opportunity for broadband service providers. We announced our service offerings, and what you've seen in our growth is a direct reflection of that opportunity. So absolutely, that's the right way to think about it.