Calix Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 20, 2023

There are 12 speakers on the call.

Operator

Greetings, everyone, and welcome to the Calix Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow with a brief prepared remarks. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jim Fanucchi, Vice President of Investor Relations.

Operator

Sir, please go ahead.

Speaker 1

Thank you, Rob, and good morning, everyone. Thank you for joining our Q2 2023 earnings call. Today on the call, we have President and CEO, Michael Weeney and Chief Financial Officer, Corey Sindelar. As a reminder, yesterday after the market closed, Calix issued a news release, which was furnished on a Form 8 ks along with our stockholder letter, which was also posted in the Investor Relations section of the Calix website. Today's conference call will be available for webcast replay in the Investor Relations section of our website.

Speaker 1

Before I turn the call over to Michael for his 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 Q2 2023 letter to stockholders and in the 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 in this call, we will discuss both GAAP and non GAAP financial measures.

Speaker 2

A

Speaker 1

reconciliation of GAAP to non GAAP measures is included in the Q2

Speaker 2

With that, it is my pleasure to turn

Speaker 1

the call over to Michael. Michael, please go ahead.

Speaker 2

Thank you, Jim. In the Q2 of 2023, The Calix team continued our track record of improvement in our financial performance across the 4 measurable objectives that we have outlined for investors. First, deliberate revenue growth continued as we achieved our 9th consecutive quarter of growth, while delivering record revenue. Demand remains strong as customers transform their business and communities by leveraging the Calix platform, managed services and our customer success teams. 2nd, gross margin expansion continued with our 4th Consecutive quarter of margin growth.

Speaker 2

3rd, we executed disciplined operating expense management As we invested fulsomely to take advantage of this once in a generation growth opportunity ahead. And 4, Ongoing predictability continued as we met or exceeded the guidance that we laid out for investors in April. In the Q2, I continued to invest a significant amount of time meeting with customers, prospects, Partners and team members, the feedback remains positive as we continue adding broadband service providers of all sizes that are strategically aligned with Calix. As we noted in our investor letter, these Calix partnered BSPs Continue to attract significant private and public investment to grow. They are not seeing the impact of tightening credit markets Unlike the debt laden legacy providers who are pulling back.

Speaker 2

For example, last week we announced that Allo Communications With an end to end partnership with Calix, secured $650,000,000 in sustainable financing, also known as a green bond to grow. During the Q2, we also hit a milestone with our 1,000 customer Starting their platform journey with Calix, including 16 new strategically aligned BSPs Huichu chose our platform for the first time to meet their long term goals. In addition, 20 new cloud customers signed on to deploy 1 or more of our clouds And 15 BSPs launched their 1st managed service or services with the support of the Calix team. Last, But certainly not least, our culture continued to embrace the better, better, never best mindset. At all times, our team is constantly asking how can we improve.

Speaker 2

During our advisory board sessions, our customers and our product, Sales, marketing and customer success teams collaborate on how to supercharge BSP success. Internally, we encourage Calix team members to challenge the norm and continue our journey of non stop improvement. This approach has built our purpose driven culture, which contributes to the success of our customers, Partners and team members and as a key driver of why people want to join Calix, we continue to be recognized as one of the best places to work in any industry. In the Q2, Calix was ranked number 1 on the top fifty list for most inspiring places to work in North America. In addition, we achieved our 3rd Great Place to Work certification Noting the strength of our remote culture as a driver of customer success and corporate growth, also Our Chief Product Officer, Shane Lennyak was named the Top 20 CPO Worldwide and we were awarded number 1 best place award in the entire Bay Area.

Speaker 2

It is a great time to be part of the Calix team as we continue to embrace the notion of constant improvement To our better, better, never best mindset. Before I close, I'll turn it over to Corey to expand on the team's stellar performance in the Q2. Corey? Thank you, Michael. The Calix team executed well across the board and we delivered our 9th consecutive quarter of sequential revenue growth With record quarterly revenue coming in at $261,000,000 which was at the high end of our guidance range, We also saw our 4th consecutive quarter of gross margin expansion with non GAAP gross margin of 52.8 percent At the high end of our guidance range and an increase of 100 basis points from last quarter, this improvement in gross margin was Due to the continued expansion of our platform in managed services, plus a small product shift from revenue edge to intelligent access edge And the easing of the expedite and excess prices paid for components on the secondary market.

Speaker 2

As we have said consistently, our platform model provides us unique insights, starting with subscriber demand, which gets translated all the way back to component purchase commitments with our suppliers. During the Q2, our purchase Commitments decreased by $52,000,000 from 1st quarter to $254,000,000 This is down $116,000,000 from a high of $370,000,000 in the Q3 of 2022. This is another advantage of our low SKU count platform model because these components are fungible across multiple product SKUs. Our component inventory on hand and at suppliers combined with our finished goods provides us with the basis to say That we have ended our pandemic induced supply chain crisis. Our product and supply chain teams now have the time to expand their focus On subscriber demand analysis, supplier optimization, process improvements and cost reductions, Silicon lead times are still extended, but are improving.

Speaker 2

As they improve, we will be able to normalize our inventory and supplier commitments. Over the next 6 quarters, we expect to see component at suppliers and on hand to decrease and our turns Inventory turns to return to the middle of our long term financial model of 3 to 4 turns. Based on our 2nd quarter performance and the expected sequential increase in 3rd quarter revenue and gross margin, We now believe our annual growth for 2023 will be close to 20% and our annual non GAAP gross margin expansion will be between 202.50 basis points, an increase from the 100 basis points to 200 basis points we had noted previously. With our accelerating gross margin expansion and disciplined OpEx investments, you will see further operating income leverage. When you combine the increased operating leverage with our improved supplier commitments and inventory levels, We will be able to generate significantly higher levels of free cash flow and build on our ever strengthening balance sheet.

Speaker 2

Back to you, Michael. Thank you, Corey. In closing, I remain very excited about the growth opportunity ahead For Calix and our strategically aligned customers, they are leveraging our end to end platform, clouds And growing ecosystem of managed services deliver offerings across residential, business, education and the communities they serve, Growing market share and delivering high margins for years to come. Backed by our unmatched financial strength, Growing cash balance and a pristine balance sheet, we will continue to invest in our business to enable our customers to win at a faster And faster pace. Jim, let's open the call for questions.

Speaker 2

Operator, at this time, please open the call for questions.

Operator

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

Speaker 3

Hi, guys. Thanks very much. I guess I wanted to start by asking about the gross margin improvement. Obviously, the supply chain crunch is easing here. That's terrific.

Speaker 3

But if I go back and I look at Last year, there were points last year where you guys were talking about 300 to 600 basis points of headwind on gross margins Because of the supply chain and I guess I'm wondering, obviously, there's been a big build on inventory. You're still Consuming that high priced inventory, but I guess what I'm wondering now is could you give us an update on that number? How much of a headwind are you still seeing in the gross And then I have another question also.

Speaker 2

Sure, George. Consistent with what we have said in the past, There were 3 large buckets of cost associated with the pandemic induced supply chain challenges. And the 1st bucket of those costs and the largest bucket had to do with price increases. George, those price increases aren't going to roll back. The way that those will get on line is through future products, designs where we go out to bid and you Trying to get the better price for the new design win.

Speaker 2

They aren't going to roll back prices on the existing design. And so that's still with us. It is likely to stay with us for some time to come. So second category is around those expedite costs going out into the spot market and you're starting to see those things roll off. You'll see that trend here for the next couple of quarters as that finishes going through the P and L.

Speaker 2

And then the 3rd category of cost is all around the logistics and freight costs. And as I said before, those all normalized back in Q1, meaning that had already gone back to pre pandemic, not only pricing, but transit times. So we're making good progress on normalizing We're at supply chain. The only thing that really still left is the lead times on silicon and they're improving each quarter. So for me to kind of tell you how much of that translates into still an overhead on our P and L.

Speaker 2

I don't mind, I'm not going to probably quantify it for you, George, but you can think that all the logistics costs are already normalized back P and L, so you probably got the benefit of that. The second category is starting to come back to the P and L and the third you're not going to get. I just want to amplify one My point George, which is on the front end where he talked about new product creation. In this regard, because of our platform model, We are uniquely advantaged because of the fact that when if you look at old Calix, it would generally take us to put out Certain SKUs anywhere from 2 to 5 years. A huge amount of custom integration and it was like build every product with basically building an entirely new stack.

Speaker 2

When you have a platform that's abstracted from all of the underlying appliances that support it, what you gain is this opportunity where we can So while to Corey's point, it's going to take some time, you're uniquely advanced and you saw this, which I want to call out in the investor level Letter that we actually now got to below 260 SKUs, which is frankly unheard of in the industry and Surprised me that the team was able to get there so quick from I believe it was 292 last quarter. But that just shows that this ongoing improvement that Teams is driving to will yield significant advantages in the future. And when you have fungibility across the components, It is wickedly competitive.

Operator

Got it. That's helpful.

Speaker 3

And then the follow on here was just on the price increase. If I remember correctly, you guys took a price increase back in the springtime of last year. I know your lead times at one point were Longer than a year. So I'm assuming that part of the gross margin benefit here is fully biting down into product sales that were repriced higher. Is that part of the narrative here?

Speaker 3

And then is that fully in the model at this point? Or is there more to go?

Speaker 2

So George, that's kind of where it gets convoluted because there was another price increase on the silicon components put through in January of this year. And that's eating into some of the favorability that we're getting on the PPBs or the excessive prices. And so that's kind of where they're offsetting the 2. That's kind of why when we said at the very beginning of the year, we thought that the supply chain would have A neutral effect to our P and L and that the margin expansion was purely related to software expansion. But now we're seeing the point where the excess price components are rolling off and it's giving us a little bit of a bump.

Speaker 2

As well as I said in our letter, we get a little bit of benefit from a product shift going on from revenue edge to Intelligent Excess Edge. So that also helped within the quarter to give us a little bit better margin.

Speaker 3

Got it. Okay, great. I'll pass it on. Thanks very much guys.

Speaker 2

Thanks, Troy.

Operator

Our next question is from the line of Ryan Coons with Needham and Company. Please proceed with your question.

Speaker 4

Thanks for the question. I want to ask about your commentary in the letter on softness in the medium customers. Wonder if you could expand on that. Is this mostly U. S.

Speaker 4

Type customers? And what sort of downward revisions on Build plan in general are you seeing across that segment of customers? Thanks.

Speaker 2

Yes, Ryan. No problem. We consider the most valuable aspect of our business model is the continuous predictable sequential growth. And this year, we're going to grow by some 20% over last year. And we have not changed our long term financial model of 10% to 15%.

Speaker 2

And as I stated in the prepared remarks, we have unparalleled visibility From the subscriber demand all the way back through the component suppliers, This has enabled us to continue our sequential growth throughout the pandemic. And as we continue to work with our customers to help them grow their subscriber You're going to see anomalies from quarter to quarter. For example, in this quarter, You see the continued strength of our small customers because they have relatively balanced inventories, While seeing a slight decline in shipments to the medium and large customers. And again, this is a result of the unparalleled visibility into the subscriber demand that we have. But the most important point is that the subscriber demand continues to grow every day.

Speaker 5

And That's

Speaker 2

what we're seeing in terms of the strength of our entire customer base. That's great.

Speaker 4

Quick follow-up, if I could, on the shift from revenue edge to intelligent access edge. Is this more supply chain driven or kind of traditional build cycle seasonality? I assume you've been expecting this. Can you maybe give us some commentary on that shift in revenue?

Speaker 2

Yes. As we start working with our as we continue to work with our customers around their inventory balancing, Where they got ahead of themselves a little bit on the revenue edge side. So that's just continued kind of working off of that. But we are also moving into the summer buildings period. And so obviously that drives more access product demand.

Speaker 2

And so that's what you're seeing, a little bit of working off of inventories As we're getting prepared for their network builds this summer. Yes. And Brian, just like last quarter when everyone was going, what was going on between large and these kind of things? What we stated in last quarter and we will restate again this quarter and we will state again in Q3 and Q4 Is that everything that we do from a shipment point of view is planned. And the reason why is because we're unique in this industry in that We actually work really closely with their customers not only around what their network builds are, but also how fast they build those networks And then we stand beside them and help them drive subscriber demand.

Speaker 2

So as we go into Q3 and Q4 in the second half, everything that we're going to be doing is very planned And there are no surprises. It's actually us deciding as a corporation and as a leadership team, what we should ship to whom Based upon a partnership with those customers, whether they're small customers, medium or large. Super helpful. Thanks for that. Yes, I'll pass it on.

Speaker 2

Thanks, Ryan.

Operator

Our next question is from the line of Christian Schwab with Craig Hallum. Please proceed with your question.

Speaker 6

Great, thanks. I just want to follow-up on George's question since we did pull in some of the gross margin improvement into this calendar year from our original expectations Based on the things already described, as we look to next calendar year, Corey, what should we be thinking about earnings gross margin improvement year over year?

Speaker 2

Yes. Thanks, Christian. As it relates to next year, we haven't given any kind of guidance for 2024. So I would fall back to our long term financial model where we've targeted 100 to 200 basis Point of market expansion and we see that still applying to 2024 as we

Speaker 5

sit here today. Okay, great. And then is some of the

Speaker 6

beads money looks like it's going to be Awarded and being spent, do you guys anticipate you guys will benefit at all in More than likely in calendar 2024 from some of this government stimulus, how should we be thinking about that as it impacts Calix? I know that We're not out there selling speeds and speeds, but and competing that way. But do you anticipate that to be When did you back or how should we be thinking about that?

Speaker 2

Yes, great question, Krishan. I would say the way we've been answering that question consistently over the last, I would say 4 to 6 quarters remains the same, which is there is already a big bonfire going on, which is our customers are winning in the market. They are Taking market share from legacy service providers and growing at a rapid rate. For example, at Lake Sherry to Allo getting $650,000,000 through a green bond, which is enabled because of the fact that we have a unique platform that is greener than anything else out there by, I don't know 50% to 75%. That means that when the seed money comes out, they'll also be well positioned to win A significant amount of it and as it rolls out over the next 10 years, think of it like gas on a bonfire.

Speaker 2

The bonfire is already monstrous where our customers are taking share. And of course, this will make them move faster and start building out into areas Where the economics didn't make sense, but government stimulus will help them. So for sure, there's a long term benefit and it's going to go over the next 10 years. Corey, any comments? Yes.

Speaker 2

So Christian, our current view is that we ought to start seeing some of that late 'twenty four and as we move into 'twenty five.

Speaker 6

Okay, great. Kind of what we're hearing from others. Thanks, guys.

Speaker 2

Thanks, Christian.

Operator

Our next question is from the line of Samik Chatterjee with JPMorgan. Please proceed with your questions.

Speaker 7

Hi. Thank you for taking my question. I have a couple and Maybe for the first one, if I can start with the growth forecast for the full year of 20% roughly. And obviously, these are very strong numbers and could you rate up to your any companies we can compare you to. But still from a high level, if I can Ask you when we look at the 20% relative to a 28% growth or a 26% growth the prior year, I mean, in your mind, what is sort of that big or what is that change really being driven by?

Speaker 7

Is it the macro? Is it some of the revenue edge sort of Pull forward that you talked about, like when you think about the big buckets here in terms of that growth stepping down from a 28% to a 20%, How are you sort of thinking about what's driving that?

Speaker 2

Well, so there's 2 elements to it. The first, I'm going to take the macro discussion head on. We do not see any macro concerns in any way shape or form. And I've stated this over and over again, if actually a macro issue did pop up, for example, like a recession, This would be advantageous to our customers and I can go into depth on why. And it's simply because of the fact that if you think about What somebody who is affluent, for example, does with their disposable income, spend a lot of time at the Country Club and if Their disposable income declines and what are they going to do, they're actually going to hunker down in their house and what is centered to everything that they do whether it's work, Play education is broadband.

Speaker 2

So if there is some kind of macro trend swinging around, actually we think it's advantageous, but we don't see that. As I said, I was on the road all of Q2, all of Q1 and our customers don't have this Concern, with regards to what's going on, on the growth side, we've as Corey stated in his remarks, We see us getting closer to 20% for the year. And what you're seeing is a shift in our business model, Which is we're moving to a sequentially growing company. And so what you're going to see is this constant sequential growth, we've already done it 9 quarters in a row And that means that there's going to be a smoothing out of our revenue and we expect that that's going to continue through 2024 and 2025 Where instead of where you have the lumpiness that is inherent in the business this year, that lumpiness goes away in 2024. And so we're kind of just eliminating the old business model is what I would say.

Speaker 2

Corey, anything to add on top of that? Yes, Samek. I mean, I think the decline in revenue growth from, say, last year at 28% to where we're seeing today at 20%

Speaker 6

Has a lot to

Speaker 2

do with this, the supply chain induced inventory challenges. When you get lead times going to 52 weeks, your customers are going to buy inventory to ensure they can complete their builds. And as the lead time start coming back in, they just don't need to carry as much inventory. So we're going through this period of time where Our customers are adjusting their inventories and we're working with them to rebalance them. Do they have the right materials that they need to finish their builds?

Speaker 2

So we're continuing to work through it, but the great news is they're continuing to grow. Every day they continue to grow. They aren't slowing down their bills. They're going as fast as they can in an environment where there's constrained labor and permitting issues and so forth, but they are growing every day. Therefore, we will continue to grow every day and that's why we're very confident in the sequential revenue growth that we talk about.

Speaker 7

Okay. Thanks for that. For my follow-up, if I can ask you, you mentioned 15 new customers adopting managed services. What are sort of what are you seeing from those customers in relation to the type of services they are sort of adopting first? More curious to hear like How much of that is like retail, like Arlo Secure versus like a SmartTown, which seems to us to be a more of wholesale offering?

Speaker 7

And how do those sort of really play out in your revenue model as well in terms of how you monetize that with the BSP customer?

Speaker 2

Well, so that's a great question. What we generally see is the initial adoption is I expand beyond managed WiFi where I'm adding Text IQ and Experience IQ and going to the virus And then they expand out their smart home strategy. And really when you think about the Arlo and the different components, that's where They actually go to market with a number of them that allow them to finish out the smart home. And then what they start thinking about is, okay, now they've got the smart home now, how do I add smart business, smart town, all the different components? And a good example would be We're hearing a lot of customers actually talking about I want to become an MVNO.

Speaker 2

And an MVNO is a fascinating situation in this market because the simple reality Is that in most cases becoming an MVNO as a broadband provider is only a discounting strategy. That's it. Why do you actually bundle your cell phone with a broadband package? It's because of the fact that you want a discount, unless You're a Calix partner. In a Calix partner scenario, it becomes all about experience and that becomes something It's really interesting and important for them with SmartTown because you can now take that those devices that would be roaming on a mobile network.

Speaker 2

And if you're living in rural America where 5 gs coverage is basically non existent, if you actually put a fiber back smart town with You pick it as WiFi coverage across the town. That MVNOs experience now becomes incredible because You're getting great Wi Fi calling, you're getting great speeds to your device regardless of where you are in the town. And so I guess it's a long way of saying and I'll leave the revenue component to Cory. The long way of saying is that There is this maturity continuum that we see our customers marching down, which starts at 1 service then goes to 2, 3, 4 And forward and, Kory, do you comment on the revenue implications? Yes.

Speaker 2

What I would add to Michael's comments is that It's a portfolio approach. And what we're finding is the more items that we put into that portfolio has the effect of Customers wanting to adopt more because they start pulling through more of the items. And so we saw some good traction with our Smartbiz offering in the quarter, that came out beginning of the year, so we're seeing strong traction there. And then as well, likewise, very strong traction with Bart. So those are newer offerings in the marketplace.

Speaker 2

We're seeing strong attraction. In terms of the value to Calix, as you know, we've talked about it representing A all monetizing on subscriber basis and over the long term, we think we could move Somewhere between $1.10 per user per month, per subscriber per month. And so these new offerings, albeit Maybe larger amounts are going to be applied to an attach rate that will just simply help us move that average from $1 closer to the $10 mark. Yes, when you think about it from a growth, what is the growth? Growth is actually 2 components, revenue and market.

Speaker 2

So these will be significant contributors to what Corey is calling out is that 100 to 200 basis points in our long term model. Those will be significant contributors to it and you saw some of the strength in that. It wasn't just supply chain this quarter because of the strength Our managed services that you saw contribution to margin.

Speaker 7

Okay, great. Thank you. Thanks for the responses. Thank

Speaker 2

you, sir.

Operator

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

Speaker 8

Great. Thanks a lot. First of all, just as a clarification, can you give us the percentage of current RPOs?

Speaker 2

I think it's somewhere around 37%.

Speaker 8

Yes. And then so just on that subject, Can you tell us more about what we should what does RPOs tell us, right? I mean the sequential growth of RPOs the last Couple of quarters has been a little bit weaker and there's been this mix shift towards current away from long term. And Since we don't exactly know what's in RPOs, can you just help us understand what's going on there?

Speaker 2

Corey, I think you'd start by explaining what's in RPOs. We've Every quarter, right? Yes. So Mike, that's it's any long term contract that we have with the customer where they're making a commitment to us.

Speaker 7

So what does that mean?

Speaker 2

Well, that means it's the clouds. It means some of the managed services where they enter into a minimum commitment. It's our support contracts, maintenance contracts, those kinds of things, anything that has a commitment to it. What's not in there, hardware is not in there. Anything on a usage model, so you take something like a brand new service that we bring into the marketplace.

Speaker 2

One of the things we try to do is Lower the barrier to sale. So the easiest way to take a new offering that a customer has no experience with is to offer it on a usage basis. Zalvo will take some revenue on it. If not, no problem. What we find over time is that they get comfortable with these new offerings What they end up doing is saying, all right, now I better understand how I can sell this, what my attach rate is.

Speaker 2

I'm willing to make a long term commitment to you. And so they come back around and we'll sign a 3 year agreement. Of course, they're trading this commitment for a better price, okay. So that's what we see there. So in the meantime, the newer services are not in the RPO number because they're more of a usage model.

Speaker 2

Software licenses are not in the usage model because those are all recognized upfront. And then the third thing is really up to true ups. So on these engagements, we are billing on a monthly basis. And to the extent that they have more subscribers than they We're going to recognize that in the period and that's not in the RPO number. So that's a summary of what's in and not in our RPO number.

Speaker 8

Okay. Just the current from long term?

Speaker 2

Yes.

Speaker 8

What's driving that? The fact that we're getting more sort of current RPOs in the last couple of quarters, but not as much growth in long term?

Speaker 2

That's just a matter of timing of when contracts come up for renewal. I mean, they're going to continue to work their way over and the renewals will go back and replenish the duration on it. So I think that's just a timing statement of when contracts are, where they're at. But at the end of the day, understand we're a $1,000,000,000 startup And inherent in that is that we are still learning. And if you look at our trends, you'll see that we grow stronger in some corners, lower in the others, And it's just inherently lumpy.

Speaker 2

What I can tell you is that we expect our RPO to grow every quarter for the foreseeable future.

Speaker 8

Okay, that's great. That's very helpful color. And then just my other question, could you explain a little bit more about the green bonds? And I think you guys have a part of your business is trying to help your customers get funding, whether it's for bead or other stimulus Programs or now for these green funding. So just give us more background on how that works.

Speaker 8

And Obviously, dollars 650,000,000 to Alu is very meaningful, but as an overall sort of as you look at your customer base overall, How significant do you think this kind of funding could be?

Speaker 2

Well, so our customers in the case of a green bond, what we assisted them with is that if you actually look at the platform model and how we help a company like Allo build a business It's through a radically different architecture. And so if you and in the end, the same architecture is the one that Verizon has deployed Where they would have been very transparent for 5 years that it drives an 80% reduction in operating costs every month. And that comes from the fact that if you go and build a traditional network, you're buying 4 or 5 different boxes to build a network and operate it Versus Calix, who has collapsed or consolidated all of those functions and the functions being Subscriber facing, provider edge capabilities, the BNG, access aggregation, CALEA, all these different capabilities, which all had different boxes On to a single appliance with our platform on top of it and so logically going from 4 or 5 boxes down to a single system It's a massive increase in green. And then you take on top of it that when you think about Wi Fi You would see all these virus like pods popping up all over the place on Wi Fi 5 systems because the WiFi 5 wouldn't actually reach well across the house.

Speaker 2

So you had to put extenders all over the place, right? With WiFi 6 and the architecture that we built where we optimize power and all the different capabilities, less than 7% of the homes that we support actually require a second system. And so you think about that, I can go and buy Something from Amazon, for example, that has 3 different boxes that I put around my house. Well, that's 3 different consumers of power Versus a single Calix system that's optimized with our AI engines in our cloud and allows you to actually run a single system. So inherently that's a 70% more power efficient from a Wi Fi point of view.

Speaker 2

So all of these components came together and then on top of it because we are so incredibly efficient in how we stop Truck rolls to support customers through the policy management and all the insights and analytics that we give a service provider, Which is unheralded in the industry, it's never been done before at this level. The vast majority of customers are now are stopping things remotely Where just a few years ago, they were constantly rolling a truck. And in fact, we just have a we're in the process of standing up a customer right now And their biggest negative on their margins every single day is the fact that they didn't have those analytics and insights to actually drive down truck rolls. So they were constantly with hair on fire because everybody is running from customer to customer to support it. So that's another green example On how we did it.

Speaker 2

And with regards to them pursuing that funding, which was obviously a public market funding, We were absolutely involved. And in fact, Martha Galli, who has been promoted as the EVP of all the ESG work that we're doing, She is actually leading this effort with our customers to support them on as they go after these type of financial vehicles Or as they put in their funding request into governments and all the things to really highlight how this transformative business model Completely changes how they do business from an operating cost, from an environmental impact point of view And then also that leads to higher margins and great growth. So I hope that is a little bit of a long answer to it, but it's an important topic and thanks for asking.

Speaker 8

Great. Thanks a lot, Michael.

Speaker 2

Thanks for the question. Great one.

Operator

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

Speaker 9

Hey, good morning and congrats had another strong quarter.

Speaker 2

Thanks, Jim.

Speaker 9

You're welcome. My question, I'm going to focus back on gross margins because I think that's what kind of jumps off the page in this And Corey, you seem to mention 3 factors, and I'm talking both about the quarter and the outlook where you're looking for extensively 50 plus basis point increases to the back half of the year. You seem to kind of break it down into 3 factors, which is some element of pricing, the software platform shift, And the third one is not coming to my mind right now, but I'm sure you're going to remember. And I wonder if you can assess, As you look at the quarter and the outlook, how meaningful each of those factors might be? And again, both for the quarter and as you look into the second half, and then I have a follow-up from that.

Speaker 2

Sure, Jim. So the third one you're talking about was the supply chain, spot market purchases, the excessive pricing and expedites. So those three factors, again, I'm not going to break down and quantify it for you, but they are ranked in the letter based on impact, size of impact. So number 1 is continued selling of our software and managed services. That's obviously driving the 1st and foremost and it's always present, Right.

Speaker 2

That growth in the software is just unrelenting. It's just continuing every day. So you're going to see that continue, Both in the Q2, Q1 and then obviously into the Q3, we still think the Access business is going to be strong. 3rd quarter primarily is because they're finishing up their network builds. So just like you saw a year ago with a very, very strong access print For Q3 a year ago, I suspect we're going to see that again here in the Q3.

Speaker 2

So that's going to help with our margins. And likewise, the third one is the easing of our purchase price commitments. As you know, there's a delayed effect from it. We haven't had a material PPV charge entered into a new one in 90 days. So consequently, it's just a matter of time for the commitment that we entered into previously to work their way through the P and L.

Speaker 2

I think you're going to see that for the next couple of quarters in addition to the benefit that you saw here in the second quarter.

Speaker 9

Got it. And possibly somewhat related to that, I think you made a comment in the letter about At least the strength that you saw in Q1 among your one large carrier customer maintained in Q2. As we look into the second half and you mentioned kind of a summer builds among the smaller BSPs, From a customer mix standpoint, small through large carrier, are you anticipating Any major changes there either in Q3 or Q4? And would that have any impact on the direction of gross margins? Great,

Speaker 2

great question, Tim. I don't think it's going to you're going to see material movements in the Segment pieces, that customer that was strong in the Q1, that was strong in the second quarter is going to be strong again in the Q3, we know that. And so you've seen even with that strength, our margins are continuing to improve. It could move around a couple of percentage points that's inherently part of the business with those medium and large customers, But it's not going to move around materially. Tim, I'm really excited about the margin growth on a Forward for one simple reason.

Speaker 2

And that's because we're actually getting to this pivot point in the broadband industry, Which, think of it like a big freight train coming. And that freight train is commoditization. So the first stage of a broadband That we're in, in the broadband industry is that whether I'm overbuilding a DSL network or I'm a cable company overbuilding myself Armand, we're a net new broadband provider. During that network phase, fee as a technology Works well and it allows me to get to between 20% 30% market share is the average, usually low 20s, but I can get to 20% to 30% market share. And so in that phase where I'm building up my network, I'm really focused on getting that share and I'm not necessarily getting it from speed.

Speaker 2

I'm actually also getting a significant component of that initial market share from dissatisfaction with the existing incumbent. But the second phase of broadband, which is what we've invested $1,200,000,000 and growing into and 12 years of hard work to prepare for Is that, that speed will become a commodity and not a differentiator, Especially because most markets will have 2 fast broadband providers. And if you have 2 fast broadband providers, you need to look no farther than the mobile market To see the decimation of margin and this my market share is being stuck between mobile carriers and they can't move it Unless they throw everything in the kitchen sink and toaster and everything else into it to try and convince them to come over, there's no differentiation, Which is what we've built our company for to actually address this in this next stage, which is broadband providers on top of Highly efficient network need to differentiate with their subscribers, whether they're business subscribers, education or consumers And build out a go to market where they have a really high NPS. So they've got great customer loyalty and that loyalty drives Incremental service is $2 $5 $2 $10 whatever it is I'm going to drive into that subscriber and so that I can actually win new customers.

Speaker 2

And for us, that is the huge opportunity as we go forward on the margin side, where every time they knew add a new service, Our margins go up because those are high yield services. And so I'm really excited looking into second half and especially into 2024 because We reached this maturity point where they get their 20% to 30% market share and they're now turning to Calix and saying, okay, now how do I get to 50? How do I get to 60? And in fact, one service provider I was just talking to 2 days ago, the CEO said, I got to 51. Now I want to figure out how do I get to 62% market share, which in a legacy model is bluntly unheard of unless you're a monopoly.

Speaker 2

So that's where as we go forward, this big margin shift comes. And because of the fact that our customers work with us To our customer success army, sitting beside them, building out and understanding the micro segments with regards to how do I market, What are the social channels they want to use and then how to find what customers actually have a propensity to buy And we're right beside them doing that every single day. We are the masters of our own fate because of the fact that we will help them drive revenue and we will help them drive margin. They will succeed and then in turn we will succeed. So while we're talking about some of those component parts of it, I think it was important just to pull up to a higher level To understand that the opportunity ahead is massive and we have the unique insights to actually make it happen.

Speaker 9

Great. Appreciate it. We've got Bonfire and Freight Train there, a couple of pretty good analogies

Operator

Our next question comes from the line of Greg Messonov with Westpark Capital. Please proceed with your questions.

Speaker 10

Yes. Thank you for taking my question. You referenced headcount increases during the last two quarters. I guess that's been driving OpEx growth To pretty much the top end of your guidance ranges for the last two quarters. In what area was the headcount increase concentrated?

Speaker 10

Was R and D, sales and marketing. And my second part of my question is, are you expecting that trend to continue The second half of this year and how will that impact OpEx levels? Thanks.

Speaker 2

So, Craig, let me kind of comment on kind of where we're at with the financial model and then I'll let Michael talk to you about where we're making those investments. We're right on our model. And that's the good news is we've been on our model now for a couple of quarters. And so just to recap it, We said that sales and marketing will be between 18% 20% and in the quarter we are at 19%. R and D, we stated to be at 29% of product Gross profit and we are a little bit above that.

Speaker 2

And for G and A, we said we'd be at 7 And we are a little below it. But when you put it all together, we're right about exactly where we want to be. And we've said Repeatedly, we're going to continue to invest fulsomely to our model and that will continue in the second half of this year. And so as it relates to where are we making those investments, Michael, why don't you share where those investments are being made? I'm going to reiterate this notion that we're investing fulsomely An homage to actually core to Carl because he loves that word, but we're at the top level with regards to investment and the reason why is because there's a massive opportunity Right.

Speaker 2

We don't see a slowdown. We see our customers growing at a faster rate. They need our help. There are all kinds of new market opportunities for us Expanding to and we're super excited on we're just getting as Corey said, we're a $1,000,000,000 startup Who has that opportunity where you're so excited that you're just getting started when you've moved from $400,000,000 to $1,000,000,000 And that's how we feel With regards to where we're investing across the board. So we will get scalability of G and A, right, which we are, As we continue to make significant investments in IT systems and all those capabilities, but even then, if I look at our back end with regards to We built out our IT systems, we're leveraging Salesforce and Oracle Financials and all those different components, I would put it best of breed, Right, and able to leverage that.

Speaker 2

But then in sales and marketing and everything that we're doing on the product side, you're going to continue to see us To move at the top pace, one of the great things is that with all the awards that our culture is winning with all the ways that Our customers who are incredibly inspiring and in fact that's one of the biggest things we use to attract talent is we actually talk about the purpose of our customers as they Change communities and they drive education and they help underprivileged children, all these different components parts, we really help them do that and That's allowing us to actually meet the model which we struggled with for a long time. So you're going to see us investing fulsomely. Thank you for that.

Speaker 8

Thanks, Greg.

Operator

Thank you. Our next question is from the line of Scott Searle with ROTH. Please proceed with your questions.

Speaker 11

Hey, good morning. Nice quarter. Thanks for taking my questions. Hey, guys. I wanted to go back to the managed services side of the equation.

Speaker 11

Initially or historically, right, you had talked about a Curated offering or suite of around 10 services. You're moving beyond that, but I was wondering if you could give us an update about what's going on in the pipeline? What sort of opportunities are you starting to explore? And if we look out 18 months Is there a number of services that you would expect to be offering at that point in time? And maybe coupling in with that, I know you talked about that $1 going to $10 When do you expect to see some of the initial more aggressive customers starting to get to the upper end of that range and beyond it?

Speaker 11

And then I had a couple of follow ups.

Speaker 2

So one of the ways that so the way that we actually build our product is that now that Platforms in place. It's a very collaborative process with our customers. We actually run, I don't know if it's 5 or 6 advisory boards at this point. Those advisory boards are one is leadership advisory where myself and a number of executives work with CEOs, COOs and General Managers around what are the business opportunities for them. And then we have advisory boards around operations, marketing, For field service, all these different insights to identify what should we do with our platform.

Speaker 2

On one side is the simplified side, which is around Whether new capabilities through automation and different elements that we should do, operations cloud being a good example and end to end provisioning to drive Up margins in the broadband service provider and then the excite side, which is what are those new managed services. And what are we going to do on the go forward? Well, if you look at the 2 managed services that are launched most recently, which is SmartTown and Smartbiz, Those actually came from customers. SmartTown came from a customer and you can watch connections last year or 2 years ago, Brad Meline and I were on stage and he talked about how he called me to identify that opportunity and we're really proud of the fact that that's rolling out in gangbusters. And then small business actually came from about 10 or 15 customers who were pushing on us really hard saying Enterprise technology that's delivered to the large customers does not scale down.

Speaker 2

And so where do we go next year? That actually comes down to our collaborations with customers. So for example, you can see how in the initial stage of Smartbiz It's actually just about a small business, a baker, a small A travel agency, whatever, the corner store, right, where they get wireless backup from us, they get all these different component parts And it's fully managed, so it's really high margin with no truck rolls for the service provider. Where do the service provider want us to go? Well, they actually know that they understand what's possible.

Speaker 2

They see things like, for example, eliminating SD WANs. SD WAN is purchased by, it's very expensive and most customers 90% of the time, they don't need all the functions. They only need one thing, which is a VPN. So is that where we're going to go? Potentially, those are the types of conversations.

Speaker 2

So I can't say how many it goes to. Actually really comes down to what makes most logical sense for our customers and can they sell it. Because here's the other part, We cannot just create a whole bunch of different solutions and not have them sell it like crazy. And so this is the big focus for us And that's why we have a customer success RME that's unmatched in this industry. We are right beside the customer, Teaching them new business models.

Speaker 2

Let's take Smart Business. There's a lot of customers who have an enterprise sales organization like they sell the enterprise businesses in their markets, But the vast majority of our customers only sell to consumer. So learning how to sell the small business, They're reliant on us to actually bring them best practices and in essence a business model for launch. And so that's where our big focus is I'm getting adoption. And so commentary on the dollars, Corey?

Speaker 2

Well, I'm proud of you not going too deep about futures. That's very good. Thank you. Although you were giving me the strangle you view. So That being said, Scott, it's so early days.

Speaker 2

And just what we've launched will take us a while to get going, right? So We're excited about what we have in market right now. But we just know that now that we've created the platform, there will be more to come. Rather not get too far ahead of ourselves in that regard. Yes.

Speaker 2

And on the topic of who are the early adopters, The early adopters are generally the ones who are in those advisory boards because they're driving us. Hey, do this, do this, right? And they want to be in. And one of the press releases that we just put out was Tom Bigby Fiber and it's in the investor letter also, right. We put them in there.

Speaker 2

And what they've done is they've adopted or in the process of adoption, adopting all of our technologies top to bottom. So they launched SmartTown, they're launching Smartbiz, they're right there with everything, which is great because those types of all in customers Who are in competitive markets and taking a significant amount of share and differentiating quickly, those are the ones that we learned from and then we take those learnings with our customer organization and pass them on to other customers so that they can learn and ramp fast.

Speaker 11

Great. That was very helpful. But Mike, if I could follow-up on Smart Biz and Smart Town specifically, those seem like they're pretty large potentially unique Are they going to be some of the larger revenue generators once they reach a little bit more of maturity? And then specifically, I think on SmartTown, You were referring earlier to what you're able to do in driving MVNO opportunities. But when I start to think about it, it seems like it's a gateway into smart city, Other IoT and sensor, are you seeing that kind of interest as well?

Speaker 11

And then how does the model work around that? Do you end up kind of charging Per operator, per community or is that more of a 1st place model?

Speaker 2

So Actually really good, very insightful. And so great question, Scott. So on the Smart Business, absolutely it's going to drive a lot of revenue. As we stated, We're shocked by how big a gap in the market there is on the smart business because everybody's trying to take enterprise class technologies and scale it down to the baker It just doesn't work. If you go out looking at any disruption, disruptions start with small customers and go upwards.

Speaker 2

And so we think that the ability for our service Right. To disrupt the entire business market is significant. And so yes, I see that as a big growth opportunity. On SmartTown, Actually funny, we haven't really been talking to folks about this, but absolutely the innovators are looking at this as the way The concept that's why it's called SmartTown. I can now sit down with the Mayor and I can say, hey, we have a ubiquitous WiFi mesh Across the town, now we can start connecting your parking meters and this is the biggest problem that towns have when they want to become smart is connectivity, Right.

Speaker 2

Now you can actually wirelessly without putting in a SIM, so you don't have to rely on 5 gs or 4 gs or 3 gs. I can now connect water meters. I can connect Parking meters, I can connect the lights, the traffic lights, I can add lamps and all these other things. So SmartTown represents a significant way not only for them to generate revenue, which in turn becomes revenue for us, But it's a great way for them to build a relationship with the town. And if you want to expand your network and build it into new areas, What do you need?

Speaker 2

Permits. And if you have a great relationship with the Mayor's office, the administration and all those folks who put out the permits, You're first in line because you're changing that account. And that's what our customers understand, which legacy companies don't. Great, Mike.

Speaker 8

This is Scott.

Speaker 11

But I was wondering if I could slip one more in under the line cross the line here. But on You're medium agnostic and I've had conversations with various wireless ISPs who are adopting you, right, as long as you've got a Gigaspire solution. I think that's also true within some fiber deployments as well. I'm wondering if that's a big opportunity for growth for you guys to is basically getting a foot in the door with additional carriers. And if I could quickly follow-up on BEAT as well, I know it's further on the horizon, so I apologize for asking, but it seems like it's going to be a highly politicized environment And there are some new rules that are starting to creep up in terms of matching funds and capitalization of the potential operators, which is Actually kind of detrimental to the whole point of what the I think is supposed to do, but it seems like some of your customers are well positioned on that front with their So broadly speaking, are you going to be disproportionately benefiting from the versus some other Guys, because of your customer base and what you can help them achieve from a capital standpoint?

Speaker 11

Thanks, guys.

Speaker 2

So the first question with regards to agnostic, The answer is yes. And then the second question with regards to Bede, it's actually not just access to capital, Scott, from a traditional form in the way that they have to rate a bond or private equity or those other things, other part of it is 42% of our customers are not for profit and they have significant cash flows as I referred to in the past. One customer who funded a $300,000,000 network build off of cash flow. And then on top of that, you have other cooperatives who have significant access to capital. So yes, I believe that with regards to BEAT, they are uniquely positioned not only from a capital point of view, access And all the different instruments, cash and cash flow and other things, but also the other thing is they actually care.

Speaker 2

They really care about the communities they're in. Therefore, when they sit in front of a local legislator and say, do you want the big soulless legacy company who has been underfunding this town forever? Do you really believe them that they're now going to do it or actually we've been investing regardless of these and we're just looking to expand the massive Positive impact we're having on the community already. Who do you want to bet on? I think that goodwill element and a track Record of investing regardless of government funding is what will advantage them on a go forward too.

Speaker 2

So, thanks for the question, Scott.

Speaker 11

Thank you, guys.

Operator

Thank you. We've reached the end of the question and answer session. And I'll turn the call over to Jim Fanucchi for closing remarks.

Speaker 1

Thank you, Rob. Calix leadership will participate in several investor events During the Q3, both in person and virtually, information about these events, including dates and times and publicly available webcast 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 webcast for your interest in Calix and for joining us

Operator

You may now disconnect your lines at this time. And thank you for your participation.

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Earnings Conference Call
Calix Q2 2023
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