Q2 2023 Calix Inc Earnings Call

Greetings everyone and welcome to the Calix second quarter of the 2023 earnings conference call.

At this time, all participants are in listen-only mode.

A question and answer session will follow the brief prepared remarks.

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As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Jim Fanucchi, Vice President of Investor Relations. Sir, please go ahead.

Thank you, Rob, and good morning, everyone. Thank you for joining our second quarter 2023 earnings call. Today on the call, we have President and CEO Michael Weaney and Chief Financial Officer Corey Sindelar. Thank you for joining us today.

As a reminder, yesterday after the market closed, Calix issued a news release which was furnished on a form 8K 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.

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.

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. A reconciliation of GAAP to non-GAAP measures is included in the second quarter 2023 letter to stockholders. Unless otherwise stated, all financial information referenced in this call will be non-GAAP .

With that, it is my pleasure to turn the call over to Michael. Michael, please go ahead. Thank you, Jim. In the second quarter of 2023, the Calix team continued our track record of improvement in our financial performance across the four measurable objectives that we have outlined for investors. First, we have to make sure that we have the best performance in the world. Second, we have to make sure that we have the best performance in the world.

Deliberate revenue growth continued as we achieved our ninth consecutive quarter of growth while delivering record revenue.

Demand remains strong as customers transform their business and communities by leveraging the Calix platform, manage services, and our customer success teams.

Second, gross margin expansion continued with our fourth consecutive quarter of margin growth.

Third, we executed disciplined operating expense management as we invested fulsomely to take advantage of this once-in-a-generation growth opportunity ahead. And fourth, ongoing predictability continued as we met or exceeded the guidance that we laid out for investors in April .

In the second quarter, 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 COWEX 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.

For example, last week we announced that Alu Communications, who has an end-to-end partnership with Calix, secured $650 million in sustainable financing, also known as a green bond, to grow.

During the second quarter, we also hit a milestone with our thousandth customer starting their platform journey with Calix.

including 16 new strategically aligned BSPs who chose our platform for the first time to meet their long-term goals. In addition, 20 new cloud customers signed on to deploy one or more of our clouds and 15 BSPs launched their first managed service or services.

with the support of the CalX 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?

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 CalX 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 is 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 second quarter, Calix was ranked...

number one on the top 50 list for most inspiring places to work in North America.

In addition, we achieved our third Great Place to Work certification, noting the strength of a remote culture as a driver of customer success and corporate growth. Also, our Chief Product Officer, Shane Linares, was named a Top 20 CPO worldwide, and we were awarded the number one Best Place to Work.

the entire Bay Area.

is a great time to be part of the CalXT as we continue to embrace the notion of constant improvement through 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 second quarter. Corey?

Thank you, Michael.

The CalX team executed well across the board and we delivered our ninth consecutive quarter of sequential revenue growth.

with record quarterly revenue coming in at $261 million.

which was at the high end of our guidance range.

We also saw our fourth consecutive quarter of gross margin expansion with gross with non-gap gross margin of 52.8%

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 and managed services.

plus a small product shift from revenue edge to intelligent access edge.

and an easing of the expedite and excess prices paid for components on the secondary market.

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 second quarter, our purchase commitments decreased by $52 million.

from first quarter to $254 million.

This is down 116 million dollars from a high of 370 million dollars in the third quarter of 2022.

This is another advantage of our low-speed count platform model because these components are fungible across multiple product skews.

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 products and supply chain teams now have the time to expand their focus. Our products and supply chain teams now have the time to expand their focus.

on subscriber demand analysis, supplier optimization, process improvement, and cost reductions.

Silicon lead times are still extended, but are improving.

As they improve, we will be able to normalize our inventory and supplier commitments.

Over the next six quarters, we expect to see component at suppliers and on hand to decrease, and our inventory turns to return to the middle of our long-term financial model of 3 to 4 turns.

Based on our second quarter performance, and the expected sequential increase in third quarter revenue and gross margin, we now believe our annual growth for 2023 will be close to 20%.

And our annual mine gap gross margin expansion will be between 200 and 250 basis points and increase from the 100 to 200 basis points we had noted previously.

with our accelerating gross margin expansion.

and discipline, objects, 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.

higher levels of free cash flow and build on our ever strengthening balance sheet. Back to you Michael.

Thank you, Corey. In closing, I remain very excited about the growth opportunity it had for Cali and our strategically aligned customers.

They are leveraging our end-to-end platform, clouds, and growing ecosystem of managed services to deliver offerings across residential, business, education, and the communities they serve, growing market share, and delivering high margins for years to come. Caused by our unmatched financial strength, growing cash value.

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.

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

Thank you. Well now we're conducting a question and answer session.

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Press star 2 if you'd like to withdraw your question from the queue. For participants that are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One will please only pull for questions.

Thank you.

Thank you, and our first question comes from the line of George Nutter with Jeffries. Let's receive your question.

Hi guys, thanks very much. I guess I wanted to start by asking about the gross margin improvement. You know, obviously the supply chain crunch is easing here, that's terrific. But if I go back and I look at, you know, last year, there were points last year where you guys were talking about 300 to 600 basis points of

you know, headwind on gross margins because of the supply chain. And I guess I'm wondering, you know, obviously, you know, 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, you know, how much of a headwind are you still seeing in the gross margin line? And then I have another question also.

Sure, George. Consistent with what we have said in the past, there were three large buckets of cost associated with the pen that they can do supply chain challenges.

And the first bucket of those costs that have been the largest bucket had to do with pricing increases.

George, those pricing increases aren't going to roll back.

the way that those who get online is through future.

products designs where we go out to bid and you try to get the better price for the new design. When they aren't going to roll back prices on the existing design.

And so that's still with us. It was 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. We'll see that trend here for the next couple quarters as that finishes going through the P&L.

And then the third category of costs is all around the logistics and freight costs.

And as I said before, those all normalized back in the first quarter meeting. That had already gone back to pre-pandemic, not only pricing, but transit times.

So, you know, we're making good progress on normalizing, where we're out of supply chain, noting that really still left is the lead times on silicate 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&L. You know.

I'm not going to quantify it for you George, but you can think that all the logistics costs are already normalized back into P&L, so you've already got the benefit of that. The second category is starting to come back through the P&L, and the third you're not going to get.

And I just want to amble up by one point, George, which is on the front end where he talked about new product creation in this regard because of our platform models. We are uniquely advantaged because of the fact that when, if you look at old colleagues, it would generally take us to put out certain excuse anywhere from two to five years.

a huge amount of custom integration and it would like to build every product with basically building an entirely new stack. 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 actually quick turn products.

So while to Corey's point, it's going to take some time, we are uniquely advanced. And you saw this, which I want to call out in the investor letter that we actually now got to below 260 cues, 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.

God, that's helpful. 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 spring time of last year. I know you're lead times at one point were longer than a year. So I'm assuming that part of the Gross Margin benefit here is.

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 PVVs or the access of prices. And so that's kind of where they're all setting the two. 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&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.

As well as I said that in our letter, we get a little bit of benefit from a product shift going on from revenue edge to intelligent access edge.

And that also helped within the corner to give us a little bit better off margin.

Got it. Okay, great. I'll pass it on. Thanks very much, guys. Thanks, George. Our next question is from the line of Ryan Coons with Need of a Company. Please excuse your questions.

Thanks for question. I want to ask about your commentary and the letter on softness and the medium customers. Wonder if you could expand on that? Is this mostly US type customers? And what sort of download revisions on build plan in general? Are you seeing across that segment of customers?

Yeah, Ryan, no problem.

You know, we consider the most valuable aspect of our business model is the continuous predictable sequential growth.

And you know, this year we're gonna grow by some 20% of our last year.

And we have not changed our long-term financial model of 10 to 15%. 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 demand and manage their inventories.

You're going to see anomalies reported in 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 the kind of 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.

And so that's...

You know, that's what we're seeing in terms of the strength of our entire customer base. That's great. Bye, bye.

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. Maybe give some commentary on that shift in revenue.

Yeah, you know, 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 to continue kind of working off of that. But we're also moving into the summer building period.

And so obviously that drives more access to product demand. And so that's what you're seeing. A little bit of working off of inventories as they're getting prepared for their network build this summer. Yeah, and Ryan, 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. 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.

Two proper. Great. Thanks for that. Yep. I'll pass it on.

Super predictable. Thanks for that. Yeah, I'll pass it on. Thanks Ryan.

Our next question is from the line of Christian Schwab with Craig Callum. Please proceed with your question. 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. It's not like the names please continue with the choice call.

Is we go to next?

Yeah, thanks Christian.

As a 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, you know, 100 to 200 basis points of market expansion, and we've been that still applying to 2024 as we sit here today.

Okay, great. And then is, you know, some of the beads, money looks like it's gonna be, you know, awarded and beads. And do you guys anticipate you guys will better fit it all? You know, 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 feeds, but competing that way, but do you anticipate that to be wind at your back or how should we be thinking about that?

Yeah, great question, Christian. I would say, you know, the way we've been answering that question consistently over the last, I would say four to six quarters remains the same, which is, you know, 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 late.

I'd like to share with Alo getting $650 million 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 50 to 75%. That means that when this bead 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. The bonfire is already monstrous. Where our customers are taking care. 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 ten years.

Our next question is from the line of to meet Chatterjee with JP Morgan. Please receive your questions.

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 failure of 20% roughly. And obviously, these are very strong numbers and give rate up to any companies we can compare you to. But still from a high level, if I can sort of ask you, when we look at...

the 20% rate of 28% growth or at 26% growth of prior year. I mean in your mind what is sort of that big, or what is that change really being driven by? Is it the macro, is it some of the revenue edge sort of pulled 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?

Well, so there's two elements to it. But 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, you know, if you think about...

What somebody who is excellent, for example, does with their disposable income, spend a lot of time at the country club, and if their disposable income declines, then what are they gonna do? They're actually gonna hunt her down in their house, and what is centered to, centered to everything that they do, whether it's work, play, education is broadband. So, if there is some kind of macro trend, swinging around, actually we think,

And for the year, and what you're seeing is a shift in our business model.

which is removing to a sequentially growing company. And so what you're going to see is this constant sequential growth, we've already done it nine quarters in a row. And that means that there's gonna be a smoothing out of our revenue and we expect that that's gonna continue through 24 and 25.

instead of where you have the lumpiness that is inherent in this 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. Corey, anything to add on top of that? Yes, I think the decline in revenue growth from say last year at 28% to where we're seeing today at 20%.

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 so they have the right material that they need to finish their builds.

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. Thanks for that. For my follow-up, if I can ask you, you mentioned 15 new customers adopting managed services. What are you seeing from those customers in relation to the type of services they're adopting first?

more curious to hear like how much of that is like a retail like Arlo secure versus like a smart town which seems to us to be a more of wholesale offering 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.

Well, so that's a great question. What we generally see is the initial adoption is, I expand beyond maintenance Wi-Fi, where I'm adding contact ID and experience ID, I'm going to devise malware paths. And then they expand out their smart home strategy. And really, when you think about the RLO and the difference.

components, that's where they actually go to market with a number of them that allow them to, you know, 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.

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 to discount.

Unless you're a CalX partner. In a CalX partner scenario, it becomes all about experience and that becomes something that's really interesting and important for them with smart count. Because you can now take those devices that would be roaming on a mobile network. And if you're living in rural America where 5G coverage is basically non-existent,

If you actually put a fiber-backed smart town with ubiquitous Wi-Fi coverage across the town, that and that MVNO experience now becomes incredible because you're getting great, you know, Wi-Fi calling, you're getting great speed 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...

the revenue component to Corey, it's a long way of saying is that there is this maturity continuum that we see our customers marching down, which starts at one service then goes to two, three, four and forward and Corey if you comment on the revenue implications.

Yes, what I would add is to Michael's comments that it's a portfolio approach. And what we're finding is the more items that we put into that portfolio as to the effect of customers wanting to not more so they start pulling through or more of the items. And so we saw some good traction with our smart.

Biz offering in the quarter. That came out beginning of the year and 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. We're seeing strong traction.

In terms of the value to Calix, as you know we've talked about it representing

you know, all monetizing on subscriber basis.

And that over the long term, we think we could move somewhere between a dollar and $10 per user per month for subscriber per month.

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. When you think about it from a growth, what is a growth? Growth is actually two components.

So these will be significant contributors to what Cory's calling out is that under the 200 base points and our long term model, those will be significant contributors to it. And you saw some of the strength in that. And it wasn't just supply chain as quarter, because of the strength of our managed services that you saw and contribution to margin.

Our next questions are from the line of Michael Genovace with Rosenblatt's securities. Please just hear with your questions. Great. Thanks a lot. First of all, just a very clarification. Can you give us the percentage of current RPOs?

I think it's somewhere around 37%, 37%.

So just on that subject, can you tell us more about what we should...

You know, what is RPOs tell us, right? I mean, the sequential growth of RPOs the last couple quarters has been a little bit weaker and there's been this 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?

Cory, I think you've started by explaining what's in our POs. We've explained it every quarter, right?

Yes, so the Susan, Mike, that's any long-term contract that we have at the customer where they're making a commitment to us.

So what does that mean? 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...

Brand new service that we bring into the marketplace. One of the things we try to do is lower the barrier to sale. And so the easiest way to take a new offering that a customer has no experience with is to offer it on easy basis.

Sell one, we'll take some revenue on it. If not, no problem.

What we find over time is that they get comfortable with these new offerings and what they end up doing is saying, all right, now I better understand how I can sell this, what my attach rate is. I'm willing to make a long-term commitment to you. And so they come back around and we'll sign a three-year agreement. Of course, they're trading this commitment for a better price.

Right, so that's what we see there. So in the meantime, the newer services are not in the RPO number because there's more of a usage file. Software licenses are not a usage file because those are all recognized up front. And then the third thing is really up to true ups.

And to the extent that they have more subscribers than they committed to, we're gonna 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. Okay, just a current from long term. What's driving that? You know, the fact that we're getting more for the current RPOs will have a couple quarters but not much for us in long term.

That's just a matter of timing in when contracts come up for a renewal. When they're gonna 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 billion dollar 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.

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

Okay, that's great. That's a very helpful color. And then just my other question, can you explain a little bit more about the green bonds? And I think you guys have – part of your business is trying to help your customers get funding, whether it's for BEED or other stimulus programs or now for this green funding.

So just give us more background on how that works. And obviously 650 million to Outlook is very meaningful, but it's an overall sort of, as you look at your customer base overall, how significant do you think this kind of funding could be?

Well, so our customers, so 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 Alo 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 five 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 four or five 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, Kalea, all these different capabilities, which all had different boxes, onto a single appliance with our platform on top of it. And so logically, going from four or five boxes down to a single system.

is a massive increase in green. And then you take on top of it that when you think about Wi-Fi 5, you know, you would see all these virus-like pods popping up all over the place on Wi-Fi 5 systems because the Wi-Fi 5 wouldn't actually reach well across the house. We had to put extenders all over the place.

With Wi-Fi 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

you know, three different boxes that I put around my house, well, that's three different consumers of power versus a single Calix system that's optimized with our AI engines and our cloud and allows you to actually run a single system. So inherently that's a, you know, 70% more power efficient from a Wi-Fi point of view.

So all of these components came together and then on top of it, because we are so incredibly efficient in how we stop truck rules 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. You know, the vast majority of customers are now stopping things remotely.

were constantly with hair on fire because everybody's running from customer to customer to support it. So that's another green example on how we did it. And with regards to them pursuing that funding, which was obviously a public market funding, we were absolutely involved. And in fact, Martha Galley, who has been promoted as the CEO of the company, who is a member

is 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, they're funding requests into governments, 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 and great growth So I hope that's a little long answer to it, but it's an important topic and thanks for asking

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. Great. Thanks a lot, Michael.

Thanks for the question, great one. Our next question is from the line of Tim Savage with Northland Capital Markets. Please receive your question. Hey, good morning, and congrats for another strong quarter. Thanks Tim. Mark, you're welcome.

My question, I'm gonna focus back on your gross margins, because I think that's what kind of jumps off the page in this report. I'm gonna focus back on your gross margins, because I think that's what kind of jumps off the page in this report.

In Quarry, you seem to mention three factors, and I'm talking both about the quarter and the outlook where you're looking for, you know, ostensibly, you know, 50 plus basis point increases through the back half of the year. And you seem to kind of break it down into three factors, which is some element of pricing. So that would change.

the software platform shift, and I've heard one that's not coming to my mind right now, and I'm sure you're going to remember.

And I wonder if you can assess, you know, as you look at the quarter and the outlook.

you know, how meaningful each of those factors might be. And again, both for the quarter and as you look in the second half and then I have a follow up from that. Sure, sure Tim. So the third one you talked about was the supply chain.

spa market purchases and the excessive pricing and the next price. So those three factors, you know, I'm not going to break down the quantify it for you, but they are ranked in the letter based on impact size of impact.

excessive pricing and expedites. So those three factors are 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 one is...

continued selling of our software and managed services that's obviously driving, you know, the first and foremost Always present. All right, that growth in the software is just unrelenting. It's just continuing every day. So you're going to see that continue

So that's gonna 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.

you know, PPP charge and 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&L. And I think you're gonna see that for the next couple quarters in addition to the benefit that you saw given in the second quarter.

Got it. And possibly someone related to that, you made a comment in the letter about, at least the strength that you saw in Q1, among your one large carrier customer maintain 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, great question, Tim. …

You know, I don't think it's going to you're going to see material movements in the customer segment pieces That customer that was strong in the first quarter that was strong in second quarter is going to be strong again in the third quarter We know that you

And so you've seen even with that strength, our margin is continuing to improve. It could move around a couple percentage points that's inherently part of the business with the medium and large customers.

you've seen even with that strength our margins are continuing to improve. It could move around a couple percentage points that's inherently you know part of the business with those medium and large customers but it's not going to move around materially.

I'm, you know, Tim, I'm really excited about the margin growth when I go forward for one Ch thri

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 or I'm a net new broadband provider, during that network phase, speed as a technology works well.

And it allows me to get to between 20 and 30 percent market share is the average, usually low 20s. I can get to 20 to 30 percent market share. And so in that phase where I'm building up my network, you know, I'm really focused on getting that share and I'm not necessarily getting it from speed. 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 1.2 billion 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 too fast broadband providers. And if you have too fast broadband providers, you need to look no farther than the mobile market to see the decimation of margin and my market share is being stuck.

between mobile carriers and they can't move it unless they throw everything in the kitchen sink and a 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 a 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 services $2, $5, $2, $10, whatever it is I'm going to drive into that subscriber.

so that I can actually win new customers. And for us, that is the huge opportunity as we go forward on the margin side, where every time they knew to add a new service, our margins go up because those are high-yield services.

And so I'm really excited looking at the second half and especially in 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 two 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. So that's where as we go forward this big margin shift comes and because of the fact that our customers work with us through 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 I want to use, and then how to find what customers actually are 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 you know it was important just to pull up to a higher level to understand that you know the opportunity ahead is massive and we have the unique insights to actually make it happen.

Great, appreciate it. We've got bonfire and freight train there, a couple of pretty good analogies.

Thank you. Have a good one. Our next question comes from the line of Greg Messonnoff with West Park Capital. Please receive your questions. 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? Was it R&D, sales and marketing? And my second part of my question is...

Are you expecting that trend to continue in the second half of this year and how will that impact the outback levels? Thanks. 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 quarters. And so just to recap it, we said that sales and marketing will be between 18 and 20 percent and in the quarter we're at 19.

R&D we say would be at 29% of gross profit and we're a little bit above that. And for G&A we said we'd get 7% of revenue and we're a little below it. But when you put it all together we're right about exactly where we want to be. 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 wanted to share where those investments are being made. I'm going to reiterate this notion that we're investing fulsomely, you know, and I'm going to actually call Carl because he loves that word. But we're at the top levels with regards to investment and the reason why is because there's a massive opportunity ahead.

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 to expand into. And we're super excited on, you know, we're just getting it. As Corey said, we're a $1 billion startup.

Who has that opportunity where you're so excited that you're just getting started when you've moved from 400 million to a billion dollars and that's how we feel with regards to where we're investing across the board So we will get scalability of G&A, right? Which we are as we continue to make significant investments in IT systems and all those capabilities but even then, you know, if I look at our back end with regards to how we built out our IT systems or leveraging Salesforce

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 and all these different component 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, you know,

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 and all these different component 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. Thanks, Greg. Thank you. Our next question is from the line of Scott Searle with Roth. Please receive your questions.

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. Initially or historically, you 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?

couple follow-ups. So one of the ways, the way that we actually build our product is that now that the platform is in place, it's a very collaborative process with our customers. We actually run, I don't know if it's five or six advisory boards at this point. Those advisory boards are one of the 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, support, field service, all these different insights to identify what should we do with our platform. On one side is the simplified side, which is around whether new capabilities through automation and different elements.

If you look at the two 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 two years ago, where Brad Maline 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. 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 Smart Biz is 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 walls for the service provider. Where do the service providers want us to go?

Well, they actually, now that they understand what's possible, 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? Actually, let's take a look eventually.

Those are the types of conversations. So I can't say how many it goes to. It 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 army that's unmatched in this industry because they're right beside the customer teaching them new business models. Let's take smart business.

There's a lot of customers who have an enterprise sales organization, like they sell to enterprise businesses in their markets, but the vast majority of our customers only sell to consumer. So learning how to sell to small business, they're reliant on us to actually bring them best practices and in essence a business model to launch.

And so that's where our big focus is around getting adoption. And so commentary on dollars, Corey? 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 viewed. So, you know, that being said, Scott, it's so early days.

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. We'd rather not get too far ahead of ourselves in that regard. 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. And what they've done is they've adopted or are in the process of adopting all of our technologies. Talk about them. So they launched SmartCount, 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 who we learn from and then we take those learnings with our customer success organization and pass them on to other customers so that they can learn and ramp fast. 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 opportunities. 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 Smart Town, 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 cities. Are you seeing that kind of interest as well? 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 per-size model?

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 maker.

And it just doesn't work. If you go out looking at AD disruption, disruptions start with small customers and go upwards. And so we think that the ability for our service providers to disrupt the entire business market is significant. And so, yes, I see that as a big growth opportunity. On Smart Town, actually, funny, we haven't really been talking to folks about this, but after...

right? Now you can actually wirelessly without putting in a SIM, so you don't have to rely on 5G or 4G or 3G. 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 Smart Town 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? Permits. And if you have a great relationship with the mayor's office, the administration, and all those folks who put up the permits, you're first in line because you're changing that town.

And that is what our customers understand which legacy companies don't. Great question, Scott. Scott, I was wondering if I could slip one more in under the line, across the line here. But you are media-magnostic, and I've had conversations with various wireless ISPs who are adopting you, as long as you've got a Gigaspire solution. I think that is also true within some fiber deployments as well. I'm wondering if that is a big opportunity for growth for you guys to basically get a foot in the door.

well positioned on that front with their access to capital. So broadly speaking,

Are you going to be disproportionately benefiting from Bead versus some other guys because of your customer base and what you can help them achieve from a capital standpoint? Thanks, guys. So the first question with regards to Agnostic, the answer is yes. And then the second question with regards to Bead, it's actually not just access to capital.

Scott, from a traditional form in the way that they have to raise a bond or private equity or those other things. The other part of it is 42% of our customers are not-for-profits and they have significant cash flows. As I referred to in the past, one customer has funded a $300 million network build off of cash flow.

And then on top of that you have other cooperatives that have significant access to capital. So yes, I believe that with regards to deed, they are uniquely positioned, not only from a capital point of view, access in all the different instruments, cash flow and other things, but also the other thing is they actually care. They really care about the communities they're in.

And 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 you want to bet on. I think that that goodwill element and a track record of investing regardless of government funding is what will advantage them when I go forward too. So thanks for the question Scott. Thank you guys. Thank you. We've reached the end of the question and answer session and I'll turn the call over to Jim Fenuche for closing remarks.

Thank you, Rob. CalX leadership will participate in several investor events during the third quarter, both in person and virtually. Information about these events, including dates and times and publicly available webcasts, will be posted on the events and presentations page of the investor relations section of CalX.com. Once again, thank you to everyone on this call and webcast for your interest in CalX for joining us.