Calix's Management Presents at Credit Suisse Annual Technology Conference (Transcript)

Nov.28.12 | About: Calix, Inc. (CALX)

Calix, Inc. (NYSE:CALX)

Credit Suisse Annual Technology Conference

November 28, 2012 4:00 PM ET


Michael Ashby - Chief Financial Officer


Paul Silverstein - Credit Suisse

Paul Silverstein

Everybody had a good lunch. My name is Paul Silverstein, Senior Analyst, Communications Equipment, Credit Suisse. It’s my pleasure to have with us Michael Ashby, who is CFO of Calix. And Michael is going to do a presentation and then we’re going to follow with some questions from myself, as well as from you all. Thank you, Michael.

Michael Ashby

Good afternoon, everybody. I’m going to take you through a pretty quick high level presentation of Calix for those of you who are not quite so familiar with the company. I will skip the Safe Harbor statement that hasn’t changed very much recently.

I’ll move straight into some of the trends that are driving opportunities for the industry as a whole. One, obviously, is the fact that commerce is going global, as I’m sure you’re all well aware. Communications are moving to mobile and personal, obviously cellphone, tablets, et cetera, iPads that are growing exponentially. Information, which is becoming more and more digital, all new information is obviously digital, but lot of old information is becoming digitized. And finally, the culture, which is becoming virtual.

So all of these things together are driving an opportunity in our industry and moving toward what we call an all video world. So slowly everything is moving towards video, you know, you can’t go to a website today where you don’t need video and video requires a cross bandwidth which is an opportunity for us, and for our industry.

Calix is the leader in access innovation. We are the world’s largest telecommunication systems vendor focused solely on access and that is the significant advantage to us. We believe it’s the fact that we concentrate on access, we are specialist on access and we are the largest telecommunication systems vendor focused solely on access.

We’re also the leader in advanced broadband access and I’ll show you some statistics in a few minutes on that. And we are a trusted partner to over a 1000 customers, primarily in North America, very few internationally. We are starting to go internationally, but mainly North America including 18 of the 20 largest ILECs and one of the three Tier 1 accounts.

As I mentioned, we are focused on access. What is access? Access is everything between the cloud and the subscriber. The cloud housing the content and the subscriber being the user with their wireless devices and the access is the network that gets information between the cloud and the subscriber and vice versa.

In terms of access leadership, in MSAP, which is multiservice access platform, Calix is the largest provider or seller of multiservice access platforms in North America; also have the largest number of customers deploying fiber-to-the-premises in North America. We are also in terms of fiber-to-the-premises OLTs the largest provider in North America at 63% share. This is in OLTs, not ONTs.

We recently announced a global arrangement with Ericsson. There are several parts of that agreement and we can perhaps talk about that a little later, but it is an important agreement for us allowing us to be a preferred provider of access equipment to Ericsson through their global sales force outside of -- including North America, but it’s primarily on international as far as the as reseller arrangement is concerned. And we also acquired from them one product line of GPON OLT which we are reselling back to Ericsson to their installed base internationally.

It’s an industry in transformation and it’s an industry that is changing considerably. We believe that the future is quite clear. It is one network. It is all IP. It is over Ethernet. And it’s all fiber with the wireless at the end. And it’s quite simple to see where it’s going. The question is how quickly is it getting there.

We are beginning to see that change somewhat over the last three quarters. We are beginning to see service providers looking more and more at moving towards the one network via Ethernet over fiber and that’s driven partially by the competition that’s coming from cable companies who are advertising 100 megabits per second to the home, and you can’t match that very easily with copper technology. So that is pushing service providers to look more and more at integrating fiber, moving fiber into their network and we are beginning to see that change over the last few quarters.

There is also a convergence of wireless and wireline. There are many people say well you sell primarily to wireline service providers. In fact, we also sell to some of the cable companies for business services. But we also - our products do a lot of mobile backhaul, because wireless is a part of, guess I may have skipped over it too quickly, wireless is a part of the whole integrated network of the future.

So as we move towards small cells or picocells, or femtocells or microcells, whatever they might be called, that traffic all ends up going back on to an access network which we are part of building. So the growth of wireless is as important to us as the growth of wireline itself.

And what that leads to is a connected world. It is a connection between the cloud and the subscriber. So everything that is housed in the cloud, the content has to get its way to and from the subscriber, that has led to a new broadband business model for our customer.

So traditionally the networks used to be primarily based on plant and engineering running separate networks, operations and administrations was a heavy costs, with marketing at the top, so when you had a phone in the past, the service provider would sell you features on that phone, such as caller ID or voice mail, et cetera, and you bought those features depending on what the service provider was pushing them. It was called a network facing network at that time.

It’s changed. It’s moving toward what we call a lower margin and a leaner system which is completely the other way around and which is actually driven by the subscriber. So today it’s not the service provider who is selling you features, it is actually a subscriber who is demanding more bandwidth and demanding more information, and more broadband access, and that’s what’s driving the business model. So our customers have to be much more nimble. They have to have less in plant and engineering. And they have to spend more on how to make money out of that network.

Our products are there to enable that transformation and the real question is, how quickly are people moving their transformation in the networks. We have a series of products which allow them to do that from our E7-20, which is an Ethernet services access platform with 2-terabit backplane that has a capacity, which is far greater than needed today, but which in a few years time, I’m sure won’t be.

And then a series of E7-2 products that are nodal product or remote products, remote pivotal products that tie back to the E7-20.

C7 MSAP product which is the original product of Calix, which is the most successful MSAP sold in North America today, complemented by the B6 ESAN product, which we acquired from Occam about 18 months ago, almost two years ago. And then a series of ONTs, all of that pooled together with software does the management and does the data mining and data information flow from the networks.

That has recently changed with the acquisition from Ericsson of BLM 1500 GPON platform and some T-Series ONT so now we have a full portfolio of products, the 1500 series is installed in a lot of Tier 1 accounts, internationally, and with the T-Series ONTs and those complement effectively our E-Series and our C-Series products.

So we believe that we have a perfect alignment from a product point of view with the new business model of less investment in plant and engineering upfront, and much more looking at the total cost of ownership over a period of time as our customers move towards building fiber networks.

Our advantages are fairly simple. We are focused on access. We think there is a tight product fit. All of our development goes into access. We are not putting money into anything ancillary; we are putting money into where we believe the biggest bottlenecks are which is in the last mile in the access network.

We are architected for extraordinary CapEx efficiency. So when we sell a chassis, it tend to stay in the network for 15 to 20 years, and we then come out with new technologies that can upgraded by replacing the blade, you don’t have to change the chassis, but you can move to the newer technologies and you can mix and match the technologies as your network changes. And we have a business alignment which is perfectly aligned with our customers for long-life network and for operational efficiency.

Quick review of financials, for those of you who are not so familiar, in 2009, our revenue 232 then we grew to 287 up to 344. For the nine months of 2012, about 238. Our revenues are going to be down slightly in 2012 for a number of reasons that we can talk about later.

But our longer-term model is to get to 20% compound annual growth rate and our longer-term model is to get our gross margins which are currently in the mid 40s up to the 50% range and be able to then as we grow, our operating expenses will reduce as a percent of revenue to the low 30% range allowing us to be able to have operating income in the high teens to 20% range. That’s our longer term model in the next two to three years. We think we would be able to achieve that.

In Q3 itself, after a disappointing Q2, we had a fairly strong Q3, revenues of $81 million. Gross margin held at the mid 40s, 44.2%, and an EPS of $0.04 a share. We’re cash flow positive and we have a series of expansion opportunities ahead of us that we believe we are going to be able to take advantage of in 2013.

Those include penetrating the former Verizon properties of Frontier that we’ve already started to do quite successfully. Those include finally getting certification for our products at the Qwest side of CenturyLink. That certification actually comes through this month. We will be able to start capitalizing on that beginning December.

Tier 1 accounts, starting to be targeted. We’ve been calling on AT&T and Verizon for the last few months and are beginning to get known there and those are longer-term opportunities but nevertheless potential opportunities for us. And on international, where we’ve been growing our business through the Tier IIs and through Tier IIIs somewhat slowly to begin with, but that’s beginning to take off. And then the Ericsson arrangement which we think will offer us opportunity going down the road.

And finally, though it isn’t on here is the -- we had a precipitous drop in our revenue from regional accounts in Tier II -- in second quarter of this year, due to the USF reform and we’re slowly starting to see that come back and expect that to recover over the next few quarters.

Customer spending remained weak in Q3, macroeconomic concerns and then the USF reform that I just mentioned with regards to the Connect America Fund that upset our regional accounts and has been a cause of concern for them. A number of them are trying to fight the FCC, they’ve got changes made. As I said, it is beginning to come back a little bit in Q3. We see that slowly recovering over the next few quarters and the FCC are due to issue final regulations actually by the end of this year.

Although (inaudible) it’ll probably only next year some time and then by the middle of next year we believe that those regional accounts would to start recover from the levels that they were at previously. So a lot of good things happening for us in the future. We’re pretty optimistic about 2013.

And in summary, we have a large product portfolio of IP devices. We are hinged to the cloud expansion and the subscriber expansion. We have a broad and strategic customer footprint, over 1,000 customers in North America growing internationally, just starting to grow internationally.

Historically we’ve only addressed over 15% of the market so there is another 85% available to us out there which we are trying to get into through our international expansion and through our Ericsson relationship. And we are well positioned to benefit from broadband incentive programs such as the Connect America Fund and other incentive programs that are taking place throughout the world.

But we believe we are sitting at the nexus of secular growth trends and looking towards a successful outcome as we start to grow the business again in 2013. With that, I will sit down and hand over to Paul for some questions

Question-and-Answer Session

Paul Silverstein - Credit Suisse

As always, I’ve got plenty of questions. But why don’t we see if anybody from the audience has anything they want to ask?

Unidentified Analyst

What kind of revenue run rate do you believe you need to be at to, not to get to the 20% operating margin but to see the acceleration in your operating margins?

Michael Ashby

Well, there are a couple of things there. One, we think we can grow the revenue at approximately, at least a target of 20% growth rate, at the same we’re improving gross margins, but in order to get the right operating leverage we need to improve gross margins. Gross margin improvement is not so much volume related, it’s actually more mix related, mix of product related.

As we sell more of our E-Series product which are our newer products those have better margins. They become a great percentage of revenues and our margin increases. So over the next couple of years, we think we can get the margins up from the mid 40s up to around 50% and in doing that while we hold operating expenses relatively flat, we’ll be able to get the leverage on operating income.

So if you want to put a revenue number on it, I think we need to be at about $120 million in terms of revenue for operating expenses to be down in the low 30%.

Paul Silverstein - Credit Suisse

While we’re waiting for the next question, I want to ask you about competition, Michael. What is this competition that copper and fiber broadband access market both in U.S. and abroad, specifically, –am I being overly generous in my assessment that your architecture is far better positioned for fiber opportunities than Adtran. And are you seeing Huawei and the Chinese at all in the U.S. notwithstanding the recent highly publicized congressional report. And finally have you seen any benefit from ALU’s ongoing balance sheet issues?

Michael Ashby

Well, the competitive environment has changed a lot in the last year or so and as you mentioned, thanks to Congress, at least Chinese competitors are not strong competitors in North America and won’t be for the next couple of years. They are effectively excluded from any large deals and they don’t go after small deals. And so they’re really not effective.

Alcatel-Lucent, the question mark over Alcatel-Lucent has certainly meant that we’re not seeing people not buying from Alcatel-Lucent but we’re seeing people interested in talking to other vendors to make sure that they have other options so that is certainly opening up doors as well.

And then we have seen a lot of smaller competitors go out of business as well as the larger ones, Motorola Mobility is no longer in the business and Ericsson have now sold their business to us, so they are no longer in business. So the competitive environment has really changed dramatically.

In terms of Adtran and ourselves, we are the two major competitors in North America, I think the way that we look at it – the way I specifically look at it is to say that we are a -- Calix is a fiber company that supports copper. Adtran is a copper company, supports fiber. Also when it comes to basic copper infrastructure, Adtran is very competitive. They are cost competitive.

When it comes to technology and fiber then I think Calix has the edge in general.

Paul Silverstein - Credit Suisse

Michael, if I can push you on that, if we look at metrics, I’m sure as CFO you track that stuff, I suspect religiously, not just in terms of revenues but if you look at your win rate, or any other metrics you care to share vis-à-vis Adtran and others with respect specifically to fiber based opportunities, what does that look like?

Michael Ashby

Well, I can’t give you a specific number except to say that we win a vast majority of fiber deals. Where we don’t win is if it’s a straight cost comparison on a copper deal, ADSL or -- particularly ADSL. But when it comes to technology choices and fiber choices, then the vast majority of those we win.

Other places we compete internationally, for instance against Huawei, and we’ve actually had some success against Huawei. Where we don’t win is where Huawei come in and build a soccer stadium (inaudible) and we can’t compete with that. But in places where it’s straight competition, we are able to compete effectively because of our technology and in some cases actually gain a premium over our competitors because of that.

Paul Silverstein - Credit Suisse

I don’t want to hog up the time but (inaudible) if anyone else has anything. All right. Let’s talk about the obligatory (inaudible), I know you went over these in your presentation but if you could give us an update on CenturyLink, the progress there, on Frontier and I want to then ask you about Ericsson but why don’t we start with CenturyLink and Frontier which I know comes up every other week?

Michael Ashby

CenturyLink is our largest single customer and we have not been able to sell into the Qwest properties as you’re aware because that the OSMINE certification. We actually got OSMINE certification on our first set of products in November 2011, now one year later we are finally getting internal IT Qwest certification. It’s taken one year to get that, which was a year longer than we had expected.

The reasons for that was the IT department in Qwest were consumed by integration with CenturyLink; weren’t doing any product certification, we weren’t been able to get on the calendar until later in the year.

But the first set of products are now going through this month and we have more products that will go through in April of next year and then November of next year. And we start to compete - we’ve been actually selling into Qwest for the last year.

We have a number of projects that we’re working on with them and we will start to be able to deliver in December. So, next month and so effectively 2013 and we expect to be able to compete effective within all aspects, all areas of CenturyLink.

In Frontier and Verizon states, it’s a similar situation where they have exclusivity, Adtran had exclusivity because we didn’t support the Bell Atlantic operating system and Frontier converted in April of 2012 all of their states on to the Frontier operating systems. So, we’ve been able to compete since then. And in both Qwest and Frontier there’s the similar situation, where they had been buying a lot of equipment from Adtran, which was primarily copper-based ADSL equipment to meet minimum PUC requirements.

What they are looking at now is upgrading those network on a project-by-project basis, state-by-state or region-by-region and moving more towards fiber networks and that’s where we start to compete and have a better advantage.

Paul Silverstein - Credit Suisse

Okay. Let me bring it back to the Ericsson agreement. Again, I know you just went over it, but you’ve spoken about an incremental $10 million to $15 million per quarter at 25% gross margin from the Ericsson OLT platform.

But clearly, at least from my view the more attractive portion of the deal is the opportunity to sell E-Series and other platforms via Ericsson into accounts that prove much more challenging for you to sell in to direct. Can you provide some color on that opportunity on Ericsson’s broadband access footprint and how long and what needs to happen to have Ericsson resell your E-series and other platforms.

Michael Ashby

Yeah, indeed. Ericsson can actually resell the E-series platforms immediately, but the E-series platform as of yet doesn’t interface with the Ericsson operating system. We have some work to do to interface with their operating systems, which will take two or three quarters to complete.

But the reason behind the Ericsson deal, the main reason behind the Ericsson deal from our point of view was the global reseller agreement. We bought the GPON OLT and we are reselling that to them, we are going to be reselling that primarily to their installed base, their current installed base.

And we will not be taking that out to new customers specifically unless requested. Now the objective is for us to sell the E-series product through the Ericsson sales channel. To do that, we’re in the process of hiring channel managers and the process then of training the Ericsson sales regions all our products, finishing off the interfaces to the EntriView operating system and [service] [ph] on operating system that Ericsson has. And once those are done then we can sell those products through the Ericsson global sales force.

And Ericsson is organized by 10 separate sales region, which are -they are all separate P&L, so they sell a system, usually with systems integration in professional services and with that system, which is generally speaking a mobile system, they require access equipment. And now we look to them just like an Ericsson products unit for access equipment, so their access equipment will come from us.

We have a preferred provider arrangement that’s not exclusive. If a customer says no I want to buy Huawei’s access equipment, for instance, or Adtran, they can do that but Ericsson have to take us in first.

And so it opens a lot of doors for us and they are installed in a large number of Tier 1 primarily in developing countries, not developed countries, developing in Europe, Eastern Europe and developing countries in Asia, some in the Middle East Africa and South America and so they are in all places where we would have trouble, or take a long time to get into their on own.

That opens a door for us, gives us a great opportunity and the reason for the agreement is not specifically to have that product line. It is more specifically to be able to have the reseller agreement with Ericsson globally.

Paul Silverstein - Credit Suisse

Michael, I recognize that it’s not exclusively makes you the preferred partner for Ericsson. But does it supersede the relationship that Ericsson -- that reseller agreement that Ericsson had with Adtran?

Michael Ashby

No. It doesn’t. And Ericsson’s agreement with Adtran is for AT&T and because Ericsson is one of the two domain vendors for access equipment for AT&T and so Adtran have to sell through Ericsson to AT&T.

And Ericsson didn’t want this agreement to be exclusive partially because they have an arrangement already for AT&T with Adtran, and we didn’t wanted it to be exclusive either, because Ericsson may not be the partner that we want to use for every deal. And so it specifically [organized] [ph] to be preferred provider, they have to take us in which means that whenever they go into an account where they have to take us in first.

And in the case of AT&T they can still sell Adtran, but they also have to present Calix and so it does open up some window of opportunity for us, although that was not (inaudible) the primary purpose of the deal.

Paul Silverstein - Credit Suisse

Okay. Michael, I’ve got to ask you, I know there’s very little (inaudible) customer opportunities. But given AT&T’s recent Project Velocity IP announcement and the related CapEx, I’m hoping you’ll shed some light on what you think is the opportunity at AT&T and how you’re positioned to address it. My own view is that there’s much less here than meets the eye than the superficial number suggests in terms of that IP DSLAM, but who cares what I think, if you could shed any light on it that’d be great.

Michael Ashby

Well, I actually do care what you think…

Paul Silverstein - Credit Suisse

I’m flattered.

Michael Ashby

…of what exactly AT&T means by that, but AT&T had traditionally have made low cost decisions and if they just simply decide to upgrade their current network, there are low cost routes they can take and in which case they will have to do the same thing in two years time again. If AT&T decide that they need to look at longer term solutions and look at new technologies, then it’s quite likely they will talk to someone like Calix.

I think in our view, they are not going to make any one particular decision. They’re actually going to do little bit of different things. And then, so does it open an opportunity for us? Potentially. It is something that we are counting on in 2013? No. But certainly it could become interesting particularly if AT&T decide as other service providers are doing, that they need to push the fiber deeper and deeper into the network.

The problem with them, with VDSL2 even with vectoring and bonding as it still gets you to only generally speaking 35 megabits, perhaps 75 if you are lucky and that is not enough to compete against some of the new cable offering that are coming out. So AT&T have a problem that they have to decide.

Paul Silverstein - Credit Suisse

That cited 35 megabit, that’s over what distance?

Michael Ashby

It varies depending on the length of copper but it’s over a fairly short…

Paul Silverstein - Credit Suisse

Fairly short because it grades over distance.

Michael Ashby


Paul Silverstein - Credit Suisse

I mean, you’re getting 35 if you’re within a certain reach, beyond that it starts to degrade significantly.

Michael Ashby


Paul Silverstein - Credit Suisse

Okay. We’re technically out of time in the interest of keeping the day on schedule. If there’s one question in the audience we could take that, but I don’t want to (inaudible) up. All right. With that thank you Michael.

Michael Ashby

Yeah. Thank you very much.

Paul Silverstein - Credit Suisse

Thanks everybody.

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