Calix's Management Presents at UBS Global Technology Conference (Transcript)

| About: Calix, Inc. (CALX)

Calix, Inc. (NYSE:CALX)

UBS Global Technology Conference

November 14, 2012, 10:00 AM ET


Mike Ashby – Chief Financial Officer


Amitabh Passi – UBS

Amitabh Passi

Okay, thank you everybody. We’ll get started with our next presentation. It’s my pleasure to host Calix, and presenting on behalf of Calix is the Chief Financial Officer, Mr. Mike Ashby.

Michael Ashby

Thank you, Amitabh. Thank you UBS for inviting us to the conference. So, I have a presentation here which I’m going to through fairly quickly, because I think most of you probably know Calix reasonably well and then we’ll get to some Q&A at the end of that.

Let’s get through the Safe Harbor very quickly. So, there are secular trends which are driving opportunities and which are forcing service providers to upgrade their networks over time. I think most of you are well familiar with this -- commerce which has gone global, the communications which have become mobile and personal information which has become digitized, and culture which has become virtual. So all of those are pushing our service providers to upgrade their networks. And that is moving towards what we call an all-video world, where today there are a lot of service providers who are upgrading their networks to minimum PUC requirements. That is not sufficient as we move forward into this all-video world.

Calix is the leader in access innovation, we’re the largest telecommunication systems vendor focused solely on access, that’s all we do. Although, all of our development goes into access products, we don’t sell anything on the other side of that. We are the leader in advanced broadband access and we are a partner to over 1000 customers, primarily in North America have just started to expand internationally over the last year, but most of our business to date has been in North America.

We’re focused on access. What is access? In simple terms it’s everything that goes between the cloud and the subscriber. The subscriber being a device, wireless device in most cases, the cell phone, smart phone, tablet, TVs and the access is everything that gets the data from the content in the cloud to the subscriber and back.

In terms of North American access leadership in just access, we are the leader in the multiservice access platform at 63% market share and in total number of ILECs deploying FTTP as you can see we have 446 customers who have deployed fiber to the premises directly. In terms of FTTP OLTs, again 63% market share in total North America.

We recently announced a new agreement with Ericsson, whereby we have acquired a GPON OLT from Ericsson, which we are reselling back to Ericsson through their global sales forces and the part of that agreement, we have also signed a global reseller agreement whereby Ericsson will sell Calix access equipment worldwide. We are the preferred provider of access equipment back through Ericsson’s global sales force as of last week.

It’s an industry in transformation; it is changing considerably from where it used to be. Now you have the data centre, the cloud at the edge - the data centre at the edge of the cloud, which is where the access equipment goes and that access equipment goes all the way through to the subscriber. Our belief is that in the future there is one network, it is all IP, it is over Ethernet and it’s all fiber with Wireless at the end. And that network is the same be it for all types of service providers, be they cable companies, Wireline companies.

What has changed and other people don’t seem to understand is that there is no difference in the end between Wireline and wireless. There is in fact a convergence between the two and that has some wireless becomes moves more to macrocells and microcells and picocells, that data still goes back onto the same access network to get to the cloud and back again.

So opportunities exist for us in not just in Wireline but also in the wireless as we have with mobile backhaul and that mobile backhaul becomes bigger and bigger as there are more small cells pushed out into the network. And what that means it is a connected world and it’s going to remain a connected world, connected directly at all times between the subscriber and content. All times meaning wireless at the end and all the way through the cloud.

It’s also a new broadband business model; for our customers it’s been a big change over the last couple of years, as they have moved from what used to be voice networks which are network facing, where a lot of the money was put into plant and engineering and a very little money at the top end into marketing and customer service. And that’s moved to now a much lower margin and leaner type of business model, where less money is going to the plant and engineering, you have to be much more operational efficient and more money is going into marketing services. That is driven by the subscriber as opposed to the network, so in the past when you had voice you signed up for different features that the service provider was offering you, now it is the subscriber who is driving those features and requesting the broadband connection.

What Calix has done is over the last few years, built up a portfolio of products, these are the products specifically that we sell in North America from our E7-20 which is a 2 terabit backplane Ethernet services access platform and then the smaller versions of the E7-2, C7 Multiservice access platform in which the company was founded, which is still extremely successful, still the largest single selling product in the company. Our B6 ESAN which we acquired from Occam, a series of ONTs that go on the side of the home or inside the home, and then software that manages those.

We have just changed this now in the international basis by adding the BLM 1500, which is a GPON OLT product and the T-series of ONTs so that now we have a complete family allowing our customers to transform the networks wherever they might be, which we believe is a perfect alignment of our products and our service offering with the new business model that these service providers have to put into place.

Our advantages, they are quite simple. We have a very tight product fit. We have the broadest access portfolio there is, but we only do access, so we tend to be the fastest adopters of new technology, roll out new products before anybody else, we have innovation in terms of our technology as it comes out as I mentioned very quickly, and we are architected for extraordinary CapEx efficiency. So, when we sell a chassis we expect it to stand in the network for 15 to 20 years. And as technology changes, you don’t have to change the chassis, we merely have to change the blade that go into that chassis, which incorporates a new technology and you can mix and match that technology as much as you want to. And so with long term capital efficiency and ultra long life for our products and the business model as we already showed, which is aligned with our customers.

From a financial review over the last few years our revenue in 2009 was 232 million. We increased in 2010, and 2011, and 9 months of 2012 to 238, we’re going to be down slightly in 2012 for a number of reasons and I think you’re aware of. But our long term model is to grow the business at 20% in the top line and we believe that we can start doing that again in 2013.

Our gross margin as you can see, we’ve grown from 35% in 2009 up to 44.8 to around 45% in 2012. Longer term model is to get that gross margin up to 50% in the next 2 to 3 years.

Operating expenses have increased as a percent of revenue over the last two or three years, because we had expected - we have invested heavily believing that we would get revenue growth as you know, we expected to grow the revenue in 2012 and weren’t able to. But we do expect that to continue in 2013 revenue growth and we’re going to hold operating expenses flat, which will bring that percentage down and again, over our long term view, we expect the operating expenses as a percent of revenue to be in low 30%, which will allow us to have operating profit in the high teens to the low 20% range within the next three to five years.

Q3 as you are probably aware, we had a fairly good quarter of revenues of 81.3 million, gross margin 44.2; after a disappointing Q2, Q3 was relevantly strong and we have guided up in Q4 and we’re cash flow positive. And we a number of expansion opportunities ahead of us, which I think we’ll talk about when we get to the Q&A part of the presentation.

The one thing which did affect us in Q2 and which was the reason for our short fall, the primary reason for our short fall in 2012 was the USF Reform and the Connect America Fund which caused the regional carriers to delay spending. That spending has continued to be delayed, we’re actually seeing it begin to come back slowly and we think over the next three to four quarters, it will recover, but it was a large drop in the second quarter.

And since the regional carriers represent about 55% to 60% of our revenue that was significant for us, but we have seen and we did say at the time we thought it had bottomed down in Q2 and that seems to be the case. In Q3 we started to see a little bit of an increase, in Q4 we expect to see more of an increase, and over the next 3 to 4 quarters we expect to see that recover completely back to the levels that it was at beforehand.

So, in summary we have the proliferation of IP devices and cloud expansion which is fueling the demand for broadband services that goes on seemingly without end. There is a broad and strategic customer footprint, over a 1000 customers primarily in North America. We are now expanding into international business through our own expansion after Tier II and Tier III accounts as well as the Ericsson reseller agreement which is going primarily after Tier I accounts. So, we think we are well positioned to benefit from the broadband incentive programs that are taking place in the U.S. and in other countries in the world and we believe we are sitting at the nexus of secular growth trends.

And with that I will now finish the presentation and we’ll sit down and will have some Q&A.

Question-And-Answer Session

Amitabh Passi – UBS

Excellent. I’ll kick it off and if anybody has questions please get in and raise your hand.

Michael, why don’t we just start off by as we look at 2013 I think you just said that your hope is, you can be back on the trajectory moving towards 20% growth. Can we just walk through maybe the top three, four or five drivers for 2013 as you look to your business?

Michael Ashby

Yes indeed. There are really three or four things that are driving our growth out there. The first and biggest one is the opportunity to sell into the Qwest territories of CenturyLink, and I think most of you know we had expected to be able to do that in 2012, but the certification process has taken a lot longer than we thought, in fact it has taken a year longer than we had originally thought.

We did receive OSMINE approval in November of 2011, but the internal IT Qwest certification we actually received in this month, November, this month, so exactly one year later, and we certainly didn’t anticipate it would take that long. It took that long because the Qwest IT department were consumed by integrating the CenturyLink and weren't prepared to do product testing. So, we got delay after delay. But that's now finally through, so in December we start being able to sell into the Qwest properties. And that is a significant opportunity for us, which we expect to be able to capitalize on in 2013.

Secondly, another area was the states that Frontier acquired from Verizon 14 states, which were on an operating system that we didn’t support. We again expected Frontier to convert those states to their own operating system in 2011, that conversion actually took place in April 2012. Since then we have been able to sell into those states and are starting to make some significant progress and in fact have orders from all 14 of those states now and slowly that is beginning to increase and that will get the full benefit of that in 2015.

The regional accounts as I mentioned which cut back in Q2 because of uncertainty over the regulatory changes in USF reform that is starting to begin to come back. They are still trying to fight the FCC, they still believe they are going to get changes made. We don’t think there will be anymore changes. The FCC has been quite clear about that and so – and the FCC is due to issue final regulations in December, everyone is betting that they won’t actually make it December, it will be early next year sometime, but once those are out then the service providers have to submit their plans to the FCC. So, by the middle of next year we think that is completely clarified. So, we expect to see the regional accounts slowly return to normal over the next 3 to 4 quarters which is obviously positive for us and which represents growth in 2013 versus 2012.

And then the international expansion which we have been pushing our own into Tier II and Tier III accounts. That has frankly gone slower than we had thought, but it is beginning to pick up steam and we’ve added about 20 customers this year in international and we expect to be able to grow that business next year.

And on top of that the recently announced reseller agreement with Ericsson. Ericsson has an installed base in a lot of international Tier Is and we will now be reselling the product that we bought from Ericsson back through them, but the real advantage of that agreement is to be able to sell our E-Series products through the Ericsson channel over the next - throughout their 10 regions worldwide. And that is where we expect to get the benefit of that relationship.

So, all of those, I think give us the opportunity to grow the business again in 2013 and as we have said we expected a lot of those to happen in 2012, they missed for various reasons, but they are all still there and still real and we should be able to take advantage of it.

Amitabh Passi – UBS

I think, you recently also spoke about $80 million that is being sort of a floor on your revenue run rate. Following the acquisition of the Ericsson assets. Does that now move to $90 million or should we still think about $80 million as the right floor?

Michael Ashby

No, on an ongoing basis that number will move to $90 million.

Amitabh Passi – UBS

Right, okay.

Michael Ashby

So the Ericsson business is approximately $10 million to $15 million a quarter. Obviously, there's some seasonality to that.

Amitabh Passi – UBS

Okay, you didn’t mention AT&T; a lot of buzz and excitement around AT&T in the last couple of weeks following their announcement of spending an incremental $6 billion from their Wireline network. Is that an interesting opportunity for you? Is there a subset of what they've disclosed? Would it be IP DSLAMs, would it be the deep fiber network? Are there pockets you could play in? Just your thoughts around that.

Michael Ashby

It is an opportunity for us, for sure. We have been calling on AT&T for the last nine months or a year. So AT&T know Calix. They know our technology. And, in fact, a couple of months ago, AT&T asked us to respond to an RFP that they issued which went outside of their domain vendor relationship. And then they recently announced, as you know, the $14 billion investment, $8 billion and $6 billion. It all depends on how AT&T decides to upgrade their network and what decisions they want to make. And I suspect that they will not make one decision, but it will be done in various different ways. And so in parts of those, there is certainly an opportunity for us to be able to compete and perhaps break into their market. Again, that's unknown at the moment, but it clearly is out there, and AT&T know us. We know them. So if they make a decision based purely on cost, they will probably just simply buy more Alcatel-Lucent and Tellabs equipment. If they make the decision based on technology, then they will look at Calix.

Amitabh Passi – UBS

And just so that I understand, would the AT&T opportunity be through your reseller agreement with Ericsson, do you think you will pursue that organically on your own?

Michael Ashby

The reseller agreement with Ericsson is an advantage because Ericsson is operationalized throughout AT&T, because one of the problems that Tier I has is when they bring in a new vendor is that they - it’s very expensive to operationalize new products, and what they in fact do is ask you to pay for that upfront, which is not very appetizing. And so, through our Ericsson relationship because those products already operationalized as we start integrating our products through Ericsson, we should be able to fit into AT&T.

Amitabh Passi – UBS

Any questions out there? I guess I will keep going. I wanted to touch on margins. You spoke about your long-term goal of 50% gross margin. Following the acquisition of the Ericsson assets, you have reset to 43%. Can you help me understand what the leverage are to get you to that 50%? And then perhaps related to that, I think for me personally, it was a little surprising to see the gross margin profile on the Ericsson assets. Maybe you could shed some light in terms of why the margins are so low? Is there a structural issue there? Is there room for improving those margins or is that just the nature of the business?

Michael Ashby

No, it’s a good question. So, let’s start with the Ericsson margin. We acquired one product from Ericsson; Ericsson actually wanted to try and sell the whole business, and we weren’t interested in all of their copper products. The only product we acquired was a GPON OLT, and we acquired that product, which was previously being developed and manufactured by them. When you do that, you can’t then just double the price, because otherwise they wouldn’t sell anything. So, we are reselling it back at low margins to them, 25% margins, and that will remain at 25% margin. We do not expect that to change significantly.

The object of our buying that product is really to get a reseller agreement with Ericsson. It is not to try and sell that product in outside of the installed base today. The idea is that we will continue to develop on that product, and we will continue to sell it through the installed base. But the significance of the relationship for us is being able to sell our E-Series products through Ericsson. And if we can successfully do that, our E-Series products even through a reseller have much higher margins, and that’s how we will get our margin profile up through that account. So, the object is not to try and take the 1500 GPON OLT and broaden that, it is in fact to sell our E-Series products through Ericsson and that was what Ericsson were interested in, they were interested in our E-Series products and been able to have those as part of that portfolio.

So, as far as the broader margin question is concerned, our gross margin is primarily driven by mix of products. And the biggest influence for us is mix and our e Series products, which have been developed over the last couple of years, have higher gross margins than any of our other products. So, as those become a greater percentage of the business, so our gross margin increases.

Volume has some part of it too. Volume does help; volume allows us to get better price reductions and better manufacturing costs. So, that has some impact as well. So, the biggest impact is actually mix of products.

Amitabh Passi – UBS

Just on the E-Series, can you give us a sense of how your product mix breaks down today from a shipment perspective between the B, C and E?

Michael Ashby

I can’t give you specific numbers, but what I can say is that the E-Series is the fastest growing segment of the market. Traditionally, the company started with a C-Series product. So, those are still the largest portion of the business, followed by the E-Series and the B-Series, and E-Series has been growing significantly. I think about four or five quarters ago, we had mentioned it was about 10% of product mix and it has been growing from there. And we haven’t given any more specifics than that.

And the E-Series though are the products that we are selling internationally, for instance, we only sell E-Series products, we don’t sell any of the C or B-Series products. And so, slowly we expect to see the E-Series begin to become the largest portion of the business and so to grow at the fastest rate.

Amitabh Passi – UBS

And domestically, is it mainly E or is it both E and C?

Michael Ashby

No, it’s E, C and B, all of those, but the B-series is primarily sold within what was the prior Occam installed base. And C-Series, the largest customer for C-Series is CenturyLink. But CenturyLink also buy our E-Series products. And as companies move more towards fiber, then the E-Series product, which is all Ethernet over IP over fiber, and it is a perfect fit for them.

And what we have seen over the last year or so is that the service providers are beginning to look at fiber more closely and build out fiber more closely, fiber deeper into the network or even fiber to the home, because the competition from the cable is intense. The only way they can beat cable is in fact by pushing fiber further and further into the network, and that moves into what is our expertise in our sweet spot.

Amitabh Passi – UBS

Can we just touch on OpEx quickly? You shared a slide where you showed OpEx as a percent of sales trending up. How should we think about OpEx as we move into 2013, either on an absolute dollar basis or perhaps on a percent of sales basis?

Michael Ashby

OpEx will, in absolute dollar basis, increase as we go into 2013, because we are building in both merit increases and bonus increases for 2013, and we haven’t had those in the last two years. So, there will be a step increase as we go into 2013. But other than that, we are holding operating expenses essentially flat going forward. So, we are - we believe that we have the resources we need in development and in sales to achieve our goals. So, as revenues increase, we will see a much slower increase in operating expenses, therefore an increase in operating income and better leverage as we go forward.

Amitabh Passi – UBS

Okay. Maybe just a question I wanted to clarify. Is your sense that in 2013 you could see double-digit top line growth, like up to 20% or is that just sort of a goal, an operational goal?

Michael Ashby

No, I think we can, I think that’s our goal and I think we believe it to be a realistic goal because of all what we’ve said, we (inaudible) 2012 as I mentioned for a number of reasons, a lot of which were outside of our direct control, and we weren’t able to do that. But those have all become real in 2013. So, we are pretty sure that we will be able to grow the revenue, and we should be able to grow it at close to 20% in 2013.

Amitabh Passi – UBS

And just as a way of clarification, under that scenario would your OpEx then grow less than 20%, so there is leverage in the model?

Michael Ashby

There is leverage in the model, yes, and we are specifically – it’s part of my job as Chief Financial Officer to make sure we keep control of our operating expenses. So, I am not the most popular person in the company, but we are keeping a tight control of our operating expenses and we will do that throughout next year.

Amitabh Passi – UBS

Just a final question for me. Broadband stimulus -- I think the uptake there has been relatively lackluster. I think original expectations were maybe a couple of hundred million. I believe down $60 million to date. How do you see that trending over the next four to six quarters? Should we stay at this $8 million to $9 million?

Michael Ashby

Broadband stimulus has been rather depressing for some time, and not very stimulating for anybody. So, it has in fact, I think as we have explained before, it’s really become a means of funding to some of our customers’ projects. And it will continue over the next probably six to eight quarters until it’s final. It’s not going to increase significantly from quarter-to-quarter, it’ll just continue until it winds down. The good news about the fact that it wasn’t additive is the fact that there isn’t a cliff to like drop off. And once that’s finished and we will just simply go back to funding projects other way.

Amitabh Passi – UBS

Excellent. I think with that we are out of time. We will have a breakout session in the Carnegie room in the conference level. Thanks Mike.

Michael Ashby

Thank you.

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