Greetings everyone, and welcome to the Calix Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the brief prepared remarks.[Operator Instructions]. As a reminder, this conference call 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 fourth quarter 2023 earnings call. Today on the call we have President and CEO, Michael Weening; and Chief Financial Officer, Cory Sindelar. As a reminder, yesterday after the market closed, Calix issued a news release which was furnished on our Form 8-K along with our stockholder letter, and both were 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, that we will refer to forward-looking statements, including all statements the company will make about its future financial and operating performance, growth strategy, and market outlook and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause actual results and trends to differ materially are set forth in the fourth quarter 2023 letter to stockholders and in the annual and quarterly reports filed with the SEC. Calix assumes no obligation to update any forward-looking statements, which speak only as of their respective dates. Also in this conference call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of the GAAP to non-GAAP measures is included in the fourth 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. Ordinarily, I would speak about the results we outlined in the investor letter, where the team delivered a strong Q4 with record revenue and margin, completing our fourth year of deliberate revenue growth, gross margin expansion, disciplined operating expense investments and ongoing predictability. However, these are not ordinary times. 2024 represents both a challenge and a unique opportunity for Calix with one constant, our unique platform, cloud and managed services continue to lead the way with robust growth as they enable our strategically aligned broadband service provider customers to simplify their operations and go-to-market strategy, innovate for residential, business, government and communities and growth for their investors, members and the communities they serve. This strategy is enabling their success as they take market share from legacy network operators at a faster and faster pace. Since our last investor call, we have seen a significant broadening in the number of customers interested in competing for BEAD funds. Today, nearly all our customers are either assembling a BEAD strategy or actively pursuing funds. The clear reality is that the BEAD funds are simply too large at $42 billion and to close for any strategic minded BSP to ignore. While they do this, they slow their new builds as BEAD money could be used instead of consuming their own capital, and thus, we'll slow our appliance shipments until decisions are made and funds are awarded. At that point, the winners will move ahead and those who decided to skip the BEAD program or did not receive BEAD funding, we'll begin investing to ensure that the winner does not impinge on their market. This represents a delay but also represents a unique opportunity for Calix in 2024. Before I discuss this unique opportunity, I'd like to turn it over to Cory to review our disciplined execution in the fourth quarter. Cory?

Thank you, Michael. We closed 2023 with another quarter of strong execution, resulting in record revenue of $264.7 million. Continued robust growth in our platform, cloud and managed services drove record non-GAAP gross margin of 54.1%. Our supply chain has settled into a new normal where price increases from the past are difficult to undo. We will rely on future design wins and product releases to drive down costs over time, much like prior to the pandemic. Consequently, we consider the pandemic-induced supply chain challenges to be behind us. From a balance sheet perspective, we continue to see improvement in component lead times during the fourth quarter and continue to work down our purchase commitments as they decreased by $51 million from the third quarter to $176 million, back to a pre-pandemic level. Over time, we expect to see an improvement in inventory turns and a reduction in supplier deposits. These reductions in working capital requirements, combined with continued profitability will result in consistent quarterly double-digit operating and free cash flow. I do want to offer some commentary on the inventory and component liability charges we took in the fourth quarter as they impacted our GAAP results. Over the past few years, we have provided progress checks on our transformation from a box ship company to an appliance-based platform, cloud and managed services company. Last year, we communicated that our legacy business represented less than 10% of our fourth quarter 2022 bookings and that the transformation was largely complete. Over the past year, we benefited from the legacy customers moving to our platforms at a faster rate than we initially anticipated. In the fourth quarter of 2023, we reached a point where we could see the end of the shipments for this legacy product set. While this transformation over the…

Thank you, Cory. The unique Calix platform, cloud and managed services are enabling our BSP customers to win in their markets against the legacy network operators. The insights, data and operational capabilities that they provide, combined with our direct sales, service and success relationships give us unparalleled visibility into more than 1,000 BSP customers planning and execution. This visibility makes it clear that their new network builds are going to slow in '24. However, at the same time, new subscriber additions will continue unabated on our customers' existing network infrastructure as they take market share from legacy network operators. Therefore, we are confident that in 2024, our platform, cloud and managed services will continue their robust growth, while our appliance shipments will slow. For four reasons, we believe this is a unique opportunity prior to the arrival of $42 billion in BEAD funds for new builds in 2025 and beyond. First, we are excited that the vast majority of our BSP customers are contemplating or already applying for BEAD funding as we believe they are best placed to win as they have spent decades servicing rural [ph] and travel community. Second, we believe our BSP customers will provide the best experience to those formerly under or unserviced subscribers going well beyond the fiber connection. Our platform-enabled BSPs will supercharge residential for home office workers in use cases like the farm, education, small and medium business, which are the economic lifeblood of rural America and for local governments. Third, we believe our BSP customers have demonstrated for decades that they will make the most effective use of taxpayer dollars. They care about the communities they serve, and we'll do the right thing, investing taxpayer dollars for the greatest long-term effect to improve the community. And fourth, we believe this presents Calix…

Thank you, Michael. Rob, let's open the call for Q&A now.

Thank you. We'll now be conducting the question-and-answer session. [Operator Instructions] Thank you. And our first question today comes from the line of George Notter with Jefferies. Please proceed with your question.

Hi, guys. Thanks very much. I guess I was - I appreciate the press release or rather the shareholder letter and all the detail on all the different stimulus programs that your customers are chasing right now. I guess the question that I have is, as I look at all these programs, RDOF, ARPA, the ARPA capital projects piece, ReConnect, Tribal, there's numerous state programs. It seems to me that a lot of those funding dollars are flowing now. And so I guess what I'm trying to get my head around is why are you seeing such a big wait for effect around BEAD yet there are stimulus dollars that are available to operators today, so hoping to better understand that. And then also, I think in the letter and then on the call, you mentioned a few significant customers that are kind of holding things up. Is this a few customers? Is it broad based? Like what's the picture you're seeing? Thanks.

Thanks, George. I'll address the first one. So with regard to the funding that is flowing, yes, there are component of it. But the pause as we started to see in Q3 is definitely you saw game [ph] momentum in Q4 was around the fact that this dollar value coming from BEAD is so significant that they need to assemble a strategy on how they're going to use it or if they're going to go after. And so while there are - there is money flowing for sure, this program is so large that every - from our perspective, almost every single customer has said, I need to have a strategy to either pursue it actively and they're doing it right now or consider it, and therefore, it's a setup for the future.

Got it. And then do you think that - sorry, go ahead, guys.

I was going to answer that second part of the question, do you want to follow up to what Michael said...

Sure, sure. Yes. Please go ahead. I'll follow up afterwards.

Sure. So regarding the few significant customers, it is exactly that. It's a few significant customers. And when we say significant, that doesn't mean they're large, medium or small. It just means that they represented a significant amount of revenue in 2023. And as they moved into 2024, they froze their purchasing in the near term here, while they reevaluate what they want to do for 2024.

Got it. So it sounds like this is a few customers out of nearly 1,000 customers that you're actively seeing this wait for effect from. Is that correct? And is it that you're anticipating the other bulk of your customers to also go into this wait for effect? Or is it that you're not yet seeing that?

Well, let's distinguish this between the two factors we're talking about. There's the slowdown related to government stimulus while they work through that decision-making process. That is broad-based. The hold up for capital expenditure replanning is narrow. That's a few customers only, and I don't anticipate it to expand beyond that.

Got it. Okay. And then the other question I had is, just to be clear, this is affecting the OLT business. Specifically, you're not seeing this impact on the CPE side of the hardware business, correct?

Well, as we said, our platform, cloud and managed services will continue their robust growth. And so you saw that in Q4.

Yes, George. So when we're talking about the government stimulus, it is affecting network builds, new network builds. So it's not affecting the existing footprint. On the few significant customers, it's both - it's both sides of it. They froze their CapEx.

Got you. Okay. Okay. Super. I'll pass it on. I appreciate the help. Thanks, guys.

Thank you. Our next question is from the line of Ryan Koontz with Needham & Company. Please proceed with your question

Thanks. George, hit the key ones there. In terms of your small - I want to double-click though on the small customer revenue there. It does seem to be slowing. And obviously, that's not a contributor to your few customers tightening. Any commentary on the small customer sentiment going into '24 relative to your guide for Q1?

Well, I think this goes back to, again, the BEAD funding, right? So if we look at what their decision-making is through 2024, we saw that the Enhanced A-CAM offering in the third quarter actually got many of our customers thinking more seriously about BEAD as an early decision factor. Then our customers who typically don't enter their budgeting process until after Thanksgiving. So they took a moment to start contemplating that as they look at '24. And then now that it's right in front of them, that is part of their decision-making process through 2024. So they are either actively applying for BEAD right now or they're working out their strategy to say, how am I going to apply for it? So those come into the pause in their decision-making for sure. They are, in fact, you talk about our small customers, they are rural America.

Got it. That's helpful. And Cory, you talked about on the prepared remarks your opportunity for further cost reduction on the hardware front. Can you kind of tell us in general what your thoughts are there? Is this mainly about sourcing, redesigned to modern components, kind of optics. And can you kind of give us any clues there as to where your opportunities lie for cost reductions on hardware?

Yes, Ryan. What we are basically saying is that we have come through the global supply chain challenges. And the only thing that really remaining are those price increases that were passed along. You don't get those back. Our vendors don't voluntarily lower their prices for you. So the only way and the only place you have leverage is really when you're going out to bid on new design wins. And so this is something that we would look to do much like we did pre-pandemic. It's when the new product is released, we've come out with a new design win on our new platform. We aren't going to necessarily redesign products in lieu of that, right? So we will wait and come out with the next-generation products. We do that 5, 6, 7 hardware devices a year, and that's how we will go about clawing back those price increases.

Got it. Okay. Thanks, Cory. That's helpful. I'll pass it on.

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

Hi, good morning. Thanks for the question. This is Joe Cardoso on for Samik. So first question from me is, it sounds like cloud and managed services growth is expected to continue in the face of these pauses and delays. But can you just talk to the impact of the growth rate there from the slowdown in appliances and whether we should expect a slower growth rate in that part of the business? I guess I'm just trying to better understand the correlation between appliances and cloud and managed services and whether you expect a slower growth rate there on the temporary pauses or delays? And then I have a quick follow-up. Thanks.

Yes. The managed - the platform, cloud and managed services is growing constantly. It's just at a steady rate, just continuing to grow. We saw that all through the pandemic, through supply chain slowdown and it continues even today. So if you're looking at a relative mix of revenue, the slowdown is on the appliance side. So it's a lower appliance revenue, you're going to end up having a greater percentage of software in your mix. And that's why we believe we will be at the higher end of the target financial model with that 100 to 200 basis points for 2024. So there you go.

Okay. I guess just my next question is you obviously highlighted the slowdown investments from existing customers from the government subsidies on the horizon. However, just curious if you could talk to the trends you're seeing from new customers and clarify whether those same factors are impacting your ability to onboard new customers to Calix? Or is that less of a hurdle on the new customer front? Thank you. Those are the questions.

Actually, that was the point of my opening remarks and what you saw through the letter, which is we recognize 2024 or see it as a unique opportunity for us, in fact, to expand footprint. So our platform, cloud and managed services continue to differentiate us in the minds of evolving service providers who are looking at 2024 and then the tsunami of money that's coming in 2025 and beyond. As a decision point, they're no longer just taking out a purchase order to continue the existing network and what they were currently doing for a strategy. They're actually looking broadly at their strategy and saying, what do we have to do to actually compete and win? Do we remain a legacy network operator which is right with challenges? And I am in all my conversations with CEOs and GMs, this is one of the big things as we talk to prospects who are not on the Calix platform, they're talking about the fact that building a fiber network does not transition into actually success. And in fact, it's a commoditization that's coming in broadband, and they're really, really worried about it. In fact, I was - I had a prospect that I was talking to before Christmas, and he was emphatic, he said, the thing that keeps me up at night is the commoditization of my business, which opens it up as this for the expansion of footprint. This is the opportunity where we can - with that customer exactly the conversation then led to well with what we've built in this platform in the managed services in the cloud, we help you transition into a broadband service provider who has a diversified business of residential, small business, medium business, government, education, all these different component parts, so you can differentiate in the marketplace and win, which means build the fiber and then fill it with customers and then drive all the upsell and cross-sell. So as we look into 2024, when I said there's a unique opportunity ahead, that's explicitly what I'm talking about. This positive decision-making is not cut a PO [ph] and keep doing the same thing. It is actually look at my business model, and there's only one company in this entire industry who actually has a new model that will allow them to succeed for the long term. That's why 2024 is a massive opportunity for us to expand our footprint and win in the market.

Got it. Thanks, Michael. Appreciate all the color, guys. Thank you.

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

Hey. Good morning, guys. I just have - my question is about when you began to see this. You guys have always been the most cautious and negative about the timing and acceleration of government programs and the fact that usually, they'll end up being bigger than anticipated, but they'll take much longer to get started. All of that seemed to be extremely - not all of that with $42 billion now that much to think about that could be a tremendous risk. And so between that and the significant customers kind of - is this something that truly started to trickle out after Thanksgiving and is accelerated into this conference call. I'm just kind of surprised you guys didn't call this issue before this conference call.

Before this conference call, okay? We had an incredible Q4. And so from a visibility point of view, you're right, we've always stated that we have great visibility on what we're doing with customers. And the reason why we can provide you a clear explanation today is because of that visibility. And so the conversation that as I stated, after Thanksgiving, they go into their budgeting cycles and almost every customer started in Q3, but in Q4 and explicitly after the Thanksgiving the enter budgeting cycles, almost every customer that I spoke to, general managers and CEOs, we're focused on what is my plan for BEAD? It is such a large amount of money, and it is right in front of them, that even customers who have never pursued a dollar of broadband money ever in their history are now considering in their 2024, 2025 strategy because they can't ignore it. It's right here and it's so big. And so that in the end is the last component of this where it has become very clear.

Great. No other questions. Thank you.

Thank you. Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Please proceed with your question.

Hi, good morning. Question on the, I guess, trying to get a little more color on the opportunity, the share gain opportunity you're discussing here for calendar '24, I mean, should we be thinking more kind of in the medium and larger carrier area given the - the extent of your market share among smaller carriers? And is there a way for you to quantify maybe in terms of annual revenue or total TAM value kind of what you consider to be the size of that opportunity, what's up for grabs, if you will. And I assume that none of these share gains - potential share gains are factored into your '24 outlook? Thanks.

First of all, none of those are factored into our 2024 outlook. And we call it footprint expansion, where we're - they may be with an existing legacy box company, and they're contemplating as they continue their expansion, can they apply new business models to that incremental footprint. So it's not in 2024, and it's really around size of the customer, there's a wide range of them. It's all across the continuum, where we're having the conversation around how do you change your business model to address the disruption that's happening in the market and not see yourself commoditized. And the best example is we have - that example I referred to with this CEO that I was speaking to, who is quite thoughtful of, he said, they've never done business with us. And he was contemplating and the conversation started about pawn [ph] and different things like that, box shippers [ph] And my statement to him was actually, let's talk about your business, what keeps you up at night? And he said I'm worried about being commoditized, which then led to which we call out in Q4, the growth driver in our business, which is our platform, cloud and managed services and how we can help him and his organization differentiate in the market. So that represents the opportunity in 2024. No, it's not factored into what we're doing from a numbers point in this year.

I guess maybe to follow up a little bit more. I mean, let's say you were - I don't know what you would consider to be reasonably successful in this endeavor. But let's say you are in '24, what could that add to the revenue run rate at Calix in '25 and going forward?

Well, as Cory identified, in Q1, we consider this a low point and that we will have a return sequential growth quarter-on-quarter, which that will contribute to it. So Tim, I don't think we're prepared to quantify what we think the footprint gains might be.

Yes. I was getting that sense. Thanks.

Thank you. Next question is from the line of Scott Searle with ROTH MKM. Please proceed with your question.

Hey, good morning. Maybe to dive in on the timing, Mike. It sounds like from a BEAD funding standpoint, some of at least the initial awards are starting to slip out a little bit. I'm wondering if you can take us through the process and the time frame that you start to expect to see awards, I know there's a challenge process. So when do we start to see some of those initial awards? And then it sounds like the market then bifurcate from your customer base. Customers who get awards when the timing and the impact of that revenue stream would be, I think the early expectation was in the beginning of 2025. I'm wondering if those deployments are slipping. And then for the customers who don't get BEAD funding to keep their pedal - foot on the gas to deploy ahead of incoming competition. When does that start to reaccelerate?

There's a lot of questions in there. So first of all, with regards to BEAD funding. So to your point, you basically netted it out that we see the funding flowing in early '25, right? So you're going to see the second half going through the process and then 2025, you're going to see it flowing. So in the second half of this year, what happens to the other group that you talked about, which is if I am - well, I'm in my decision-making phase right now. I'm deciding, first of all, July, and this is the first bifurcation, do I apply for the funding that's out there? Or do I not right? So if I go into the applying for funding, the same people who do my planning and all the work that I do for new builds are going to be tied up in the BEAD submission process. And so they're all going to be focused on that. And the group that decides, you know what, I'm not going to go for BEAD funding. I've now made that decision. I'm going to - then their planning folks will go into [ph] and we'll start doing the overbuilding before BEAD money shows up, which will be competitive. So now back to the other group. So I've applied my BEAD e funding second half, I get my awards, there's challenge processes, and then in 2025, that starts to flow.

Got you. And Mike, just to clarify though, when you say funding flowing, you're not talking about awards, you're actually talking about deployments that are impacting sales at that point in time. Is that correct?

We think that once the awards are made, they will start sourcing their equipment in anticipation of getting those networks being built. So we would expect to see some initial orders late in the year. Now remember that BEAD process is very complex. Not only do you have a challenge phase right now where you cite [ph] with the service levels, with the maps. And that's going to take way into the summer before they even get into the proposals where they're actually submitting bids [ph] on the network. And like we commented in there, and this is the state's last opportunity to really make sure that all these unserved areas are being taken care of by the BEAD money. So it's in the state's interest to make sure that these, quote [ph] orphan locations are being picked up by these service providers that are building. So there is a back and forth process where they're going to try to get those orphan ones picked up by somebody. And then finally, each state is going to submit their awards simultaneously for all of the participants. So there's no partial awards going on, right? So it's kind of, each state will be all or nothing, right? Here it is, here's the date. And so that process is likely to take all the way into late '24 or early '23, depending on what states you're in. So it's going to start coming out state by state, and that's when we'll start seeing it. But the bulk of the awards will likely be made very end of the year, early '25. And that nuance is really important because as you heard Cory say, the states are focused on stopping cherry picking, right? Which bluntly, when I talk to customers, that's one of the things that irritate them the most, is actually that those of you who will cherry pick areas that they want and will not go after the unserved or the underserved areas. And this process will focus on that. And that's also why we believe our customers are best placed to win because they actually care. They look at this as an exciting opportunity to expand their footprint past where they serve and get to those places. So that makes them the best choice at a local level.

Okay. Very helpful. And just to, I guess, extrapolate that into '25, right? Your long-term target for growth has been 10% to 15%. I know it's early, but is the expectation in '25, we return to those levels? And then just real quickly on the managed services and RPO growth, it continued to be pretty healthy on that front. I think going back to connections, SmartBiz was one of the centerpieces that was gaining a lot of momentum with your customers. I wonder if you could just clarify where you're seeing the strength in terms of the RPO growth in managed services? Thanks.

So in terms of 2025 revenue growth rate, yes, Scott, we think we'll return to that 10% to 15%. We'll move back into the double digits. With regards to the strong growth in Q4 of our platform, cloud and managed services, SmartBiz is one of those components. But I would point to one of the biggest reasons why we think that we have this unique opportunity in 2024 is because our existing customers are continuing to deploy at a rapid rate, which Cory, with clarity as stated, is going to have an impact on our continued margin expansion, right. And these new prospects who have never spoke to us is surprising to me in the last 3 months since we last spoke, how many product companies I have spoken to, who have never done business with us and are now saying back to my point, that commoditization risk is finally starting to sync in, and they're keeping them up at night. And it's very clear that there's only one company who has spent 13 years and $1.2 billion building out a platform that allows them to differentiate in their market and win and they're talking to us. So you're going to see that continued strength in platform, cloud and managed services.

Thank you

Thank you. At this time, we've reached the end of our question-and-answer session. And I like to turn the floor back to Jim Fanucchi for closing remarks.

Thank you, Rob. Calix's leadership will participate in several investor events during this first quarter and the information about these events, including the date and time and publicly available webcast will be posted on the Events and Presentations page of the Investor Relations section of our website at calix.com. Once again, I would like to thank you to - I would like to thank everyone on this call and webcast for your interest in Calix and for joining us today. This concludes our conference call. Have a great day.

Thank you to everyone who joined us today. You may now disconnect your lines at this time, and thank you for your participation.