Calix, Inc. (CALX) Earnings Call Transcript

Good afternoon. Thank you, everyone. I'm Samik Chatterjee. I cover Technology Hardware at JPMorgan. With me for the next fireside chat is Calix. I have Michael Weening, who is the President and CEO. I have Cory Sindelar, who's the CFO of the company. Thank you both for being here. Jim, thank you for being here as well.

I think what -- where we'll start is relatively sort of with a more of introductory question here. Most people in the room can reuse a refresher of what Calix does, how are you positioned to disrupt the legacy broadband service market. And particularly, how you make it a win-win for both the broadband companies as well as the consumer or the subscriber of the service at the end of the day. Can you just start with that, and we'll go into more sort of questions?

Yes, sure. So the paradigm for broadband providers has always been, one, of just providing a pipe, right? What they do is if you look at whether it's a mobile provider or a broadband provider, everything that you do is speed-oriented. So they provide you capacity, they probably provide you connectivity. And really, they've struggled to go beyond that for the most part. And so what we do is a platform, a software and cloud company as we enable them to radically change their business model and embrace the consumer in a very different way. In essence, going beyond that pipe, beyond speed and reaching into the experience, changing both the paradigm inside their home, the services that they provide, which obviously are monetizable for them, but also give these great experiences. For example, our customers on average are -- Net Promoter Score is north of 50. In fact, we press released last week, 1 customer with an NPS of 91 which, if you're familiar with the NPS model, that's like a cult if you're a 91. And whereas the AT&Ts of the world are like a minus 6, minus 5, right? And then on top of that, you have this opportunity in the business side where there's a massive disruption opportunity because the way that business services are delivered is traditionally in an enterprise model, and enterprise doesn't scale down into small business very well. So a managed service model as we're doing there, really creates an amazing new opportunity for broadband providers to serve businesses.

Okay. Great. Let me -- so it seems like the investment community sort of misinterprets what the Calix business model is as well, because they still want to group Calix with legacy sort of broadband equipment or, call it, sort of box companies. You -- I think you've -- if I quote you, you've used the term, it's like comparing apples to jackfruit. How can you offer, like, how do you see Calix being positioned differently? How should investors actually view it in terms of what's the industry group you're more closer to? What's sort of the growth driver for you, rate up to these box companies?

Sure. So I think the best way to understand what Calix does is actually, the compare for us is an appliance in a cyber company. So the concept of you put an appliance in and then there's significant monetization on top of that. And so -- and to explain that, I can go back to -- we're a 23-year-old company, right? This is the third multibillion-dollar company that Carl founded, our founder, and we will organically go to $1 billion this year. And -- but to do that, what we've done is we made a significant investment in the software and cloud platform, and it means a different business model. So the old business model that we had, the best way to understand is how we work with the customer. So if a customer would order like 10,000 WiFi boxes, for example, they would send that into us and they would say, Michael, I need 10,000 and I'm doing -- I'm adding 500 subscribers a week. That's my logic on why I want 10,000. And what we would do, and this was the company that I joined 7 years ago, from Salesforce, we would then ship -- we would say you're doing 500 subscribers a week. That's fantastic. We're going to ship you the 10,000, and that's it. There's no more interaction, and we would expect the customer to go out and achieve those goals. And the extent of our interaction would be, want more? Right? The new business model is, as a platform and software company, they say, "I'd like 10,000, I'm doing 500 a week" and our response is, no, you're not. You're doing 100 a week. And in fact, the reason why we can do that is because we put an appliance in your net, into the home and business, we understand it connects into the cloud, and we can see exactly what you're doing from an incremental monetization but also when it turns up. And so in that scenario, we say, you're doing 100 a week and therefore, we're not going to give you 10,000. We're only going to give you 8 weeks. We're going to send you 800. But more importantly, Samik, let's talk about your goals. You'd actually like to do 500 a week, and so let's talk about how do we get you to those 500 a week. Because in the end, Calix is a data company, and this is what people don't really understand. Real-time behavior analytics that we have at our end -- inside of our cloud, which is about 15 terabytes and going at a rapid rate, every single week, gives us insight into how do you go from 100 to 500. And we had a customer literally ask us that scenario recently where they currently have 12,000 subscribers in a town of 20,000 and they said, our growth is slowing. We would really like to add more subscribers. Our customer success organization went in, did behavioral analytics based upon our marketing cloud, understood their go-to-market, their churn, their upsell opportunities. We also looked at their brand and how they were going to market. They were primarily speed-based, so changed their entire go-to-market strategy, and in 8 weeks, they added 3,000 subscribers. So they basically went from 12,000 out of 20,000 to 15,000 out of 20,000, and that 3,000 was us completely changing the outcome where we help them grow their business. And now, the next stage with that customer is on top of that because we put those appliances into that home. We now have all these managed services on top of it where we're now working with them and saying, now, where are all your upsell opportunities? And as we've said to our investors, the upsell opportunities once that appliance in is an incremental $1 to $10 a month in revenue. That is at above 100% profit margin, so.

Essentially, you're the managed service for the service provider.

Yes, right. And this is something they've always failed at. They've never been able to go beyond speed, right? And we enable that in a huge way.

Okay. Great. So one of the reasons there's a lot of interest from investors in this broadband area in particular, which maybe you can say is again, led by sort of focus on speed and sort of just connectivity overall, is the amount of government funding allocated to it. Now your business model is obviously not contingent on that, but that does provide some opportunity. So maybe outline for us how do you see the insertion opportunities sort of coming up as a result of this government funding?

Yes. There's -- a lot of people are talking about that. And so I would take a step back, and I would say our growth has been funded not by government funding. It's actually been funded by the segment that we're primarily focused on. And what Cory said in January was that if we didn't add a single additional customer, we currently have 988 customers on our platform in one way, shape or form. If we didn't add a single additional customer, we could grow at a healthy rate, and the reason why is because the segment that we're serving is actually a huge target for private equity and family investment funds. KKR is buying up broadband companies. There's a company called Boston Omaha Broadband, who's been buying our broadband companies. So there's been this huge fuel of equity investment coming into it. At the same time, 42% of our customers are not for profits. They're cooperatives, whether they are telco cooperatives or electric cooperatives. And to be really clear, electric cooperatives serve over 40 million households in the United States, and they have a ton of cash flow. We had 1 customer who funded a $300 million network bill off of cash flow. So that kind of underlying financial strength, which is completely separated from the macro things that are currently going on, is really strong. And then as I like to say, that $45 billion that's coming is like taking a big pile of gasoline and pouring it on to an already large bonfire, and it will roll out over the next 10 years. So that's how I would think about it is that it just makes it even stronger, but the financial underpinnings below are very strong regardless of it.

Got it. For the Tier 3, Tier 2 broadband service providers, I think you call them as, in your shareholder letter, as small and medium customers that you work with, how is this enabling them to compete better? How is your service enabling them to compete better against incumbent Tier 1s? And in how many cases are they actually running into Tier 1s in their regional markets? What are you sort of seeing in terms of their customers' success relative to the big Tier 1s?

So they're all up against Tier 1s, and they're eating them alive. So Tier 1 is a big well, and there's -- our customer is actually, with the platforms that we have enabled, enables them to provide a wide breadth of services. As I said, AT&T is -- like an NPS, it's negative. Our customers have, all, an NPS that's 50, 60, 70, as I press released 2 weeks ago, 91. And when you have that type of capability and the 11 managed services that we're offering and all of these incredible appliances that give you a very disruptive business model, it means that when they go head-to-head with an AT&T or something like that, they crush them in their markets. And the reason why is because no one likes to buy from those companies, and as a consumer, you just don't. But if you have a local community-orientated broadband provider who has a really strong brand that's in your community, they're involved in your local school, which we also expand out through our Edge Room capabilities. They're actually working with the local community, for example, around mental health of children and all these different things, you're going to buy from them, and so we think they're significantly advantaged. And then the other thing is if you look at what's happening with the large telcos, it's the same playbook we see all the time is that with the interest rate rises that have happened, right, what do they do? Well, so interest rates went up, so now all of a sudden, I've got 3 or 4 points that I have to cover. So what do they do? They cut CapEx, which AT&T and others have said, and they also cut headcount. Now on top of that, if you look at AT&T's results in Q1, they actually saw a decline in margin. So now we've got a double whammy, but we also have to make up the fact that my margins have declined. So I got to go cut more headcount and cut more CapEx to keep my profitability up, right? Our customers look at that as a massive opportunity. And I literally sat down with a CEO about a month ago, and as we were sitting through it, we went through the 9 towns that he's prioritizing and each of the different competitors are in there, AT&T, Windstream and a few others, targeted out them and said, who are you going to overbuild first and how do we go target them? And then together, we actually went after those markets and said, okay, here's how we go build the business plan. And that's what our customer success organization does. We have the -- some of our competitors, our customer success organization is bigger their entire organization, right? And that's because we can go lean in and build the entire business plan on how to dominate the market, and that's what I brought from Salesforce.

Given all these dynamics, why aren't the Tier 1s more receptive to the product? What do we need to see happen, really, for Tier 1s to then start adopting the Calix product?

So Tier 1s are political animals, right? They're exactly the same all the time. I did -- I sold some of them when I was at Microsoft because I ran the big channel across Europe and those different things, and then it was that one, so I understand their ideas and what they like to do is they like to build. And so it doesn't matter how bad an idea that is, they have big budgets, they have executives who want to build, and so that's what their fundamental premise is. But the simple reality is that as they get attacked by these companies who are -- these disruptions happen small up. And our small customers are clearly disrupting -- I call small. Small is 0 to 250,000 service -- subscribers at $100 a month. That's a $300 million business, right? And I had one of those service providers that actually just got a $520 million investment. I have another one who is actually in the process. It will announce that they just launched a $700 million green bond, right? So when I say small, it's not small. These are beast of companies that will be that next entire second tier, and will take out the Tier 2s that currently exist and who are slow. And so as that happens and as that disruption comes up, what will happen is the Tier 1s will be -- will have to start realizing that they have to be strategically aligned. As evidenced by Verizon, Verizon is our customer. Now why don't we have more Tier 1s? Because Verizon is the only one who actually got it. They're strategically aligned. And the whole narrative on what happened with Verizon 6 years ago, that's when I first came into the company, was we said, look, we built this end-to-end platform that has never been built before, $1.2 billion invested. More importantly, 12 years of hard work to build it. And it's not just a dumb prem system. It's actually the entire thing. It basically runs a broadband company. And what Verizon did was they were going to go and do this, build out their next-generation network the same way they always built it, which was a bunch of dumb boxes. And we said, don't do the dumb boxes. Put the platform in place, tied into the cloud with analytics, instrumentation, telemetry and AI engines, and now, you can run a fully automated network, and they sole sourced the whole thing to us. So how big is Verizon? 100 million subscribers, right? Their entire fiber network will be Calix. And why did they sole source, which they never do? Because of the fact that it's going to generate an 80% reduction in OpEx. And so as they look at what they have to do over the long term over the next 2 decades, when you have a margin gain against an AT&T who's running this disparate network where they built all this garbage together and then they're doing a whole bunch of things in the end, you have a huge gain because your margins are so large, which we've enabled. And then it comes down to what do I want to do on the EDGE? And with our software platforms, they're unparalleled in the marketplace. So we have this flexibility. And will they do it? They will do it over time.

I mean if I sort of think about the strategy then in terms of where you're allocating resources today and most of the investment even as you build these customer success teams to enable your customers is really sort of the focus, let's build and expand with the Tier 3s, they go and sort of take share from the Tier 2s, and we'll wait for the next remaining Tier 1s to come to us. Rather than saying, we push across all 3 segments for now, try to be investing across all 3, is it more of saying, let's just focus on the Tier 3s, everybody else will have to come to us over time?

So I'll take it from a lesson that I learned from Benioff when I first joined Salesforce. I joined Salesforce, it was a $3 billion company, and I run turnarounds, right? So I got hired to go to Tokyo and run a turnaround. And the discussion that we had was, why would I go to Brazil when I can make more money in Minnesota, right? And I think that really is the mindset of our company, focus, right? You can -- when I first joined Calix, we were -- they had this strategy called pins in the map, trying to get to as many folks. No. We're a focused organization who has 16 quarters of beats and raises. And as we released to everybody here last week, we reiterated guidance that everything is strong, and the way we do that is through focus. So to your point, we're not going to go chase -- everyone chases a shiny nickel of the big logo. Who cares, right? Especially if it's crappy margins, why would I go chase a Tier 1 at like 15, 20 points margins? You're going to go where the money is and where the profitability is and where you can have the most value. So we will talk to Tier 1s who understand our strategic aligned to us and understand our value, which is we're the best software and cloud platform that exists in this market, bar none, because we're the only 1 who can actually do it end-to-end. And so as they start to understand that, then we will work with them. And as long as they get strategically aligned, we'll agree to sell to them.

Okay. Now, let's unpack the growth here a bit because I think one of the questions I've got is like how do you -- you've grown on an average of 28% over the last 3 years. How do you unpack that growth between new customers driving it or broadband service providers driving it versus sort of just scaling revenue [ buck per ] customer? That -- sort of maybe unpack that for us a bit, and then we can talk about the forward outlook there.

So if we look at our growth drivers, there's 3 of them. One of them is adding new customers, 2 is adding more subscribers and 3 is expanding our application and platforms. And so if I look at those 3 vectors, the one that drives the most growth is subscriber adds. And so we have nearly 1,000 customers that are on the platform journey with us. And every day, they are just adding additional and incremental subscribers. So that's where our largest growth driver comes from. Two is the application expansion. So once they start on one cloud, they'll adopt the second cloud, they'll adopt the third cloud or they'll start with a one managed service, and they move to a second managed service, and so that's the second. The third driver is really add new customers. And I had said in January that we don't have to add any new customers. We can grow healthily for the next few years just off the existing ones. Now, we're not stopped adding new customers. We're always out there looking for incremental new subscribers and new customers, because they obviously are our future growth. So that's how I would characterize the growth factors for the company.

Okay. Can I just clarify the first one when you say more subscribers, is it the customer going and signing more subscribers on a daily basis? Or how much of that is onboarding more and more subscribers onto your platform where they do a rollout, but it's probably only some portion of their subscriber is -- that gets onboarded to your platform, and the remaining remain on a legacy platform? Then as they go through more of a rollout through the regions that they're in, they bring more subscribers on?

Both. It's all of that.