That's it. There is time for lunch. All right, perfect. Welcome, everybody. Just to level set for Morgan Stanley disclosures, please see morganstanley.com slash research disclosures. I'm Meta Marshall. I cover networking here at Morgan Stanley. We're delighted to have Calix here with us today. Carl Russo, Chairman, and Cory Sindelar, CFO, which I might have mispronounced, but.
Nope, you did just right.
Perfect. Well, thanks so much for being here today. Appreciate it, as always. Maybe, Carl, just to start with, Calix can enable customers to offer best-in-class connectivity offerings, kind of breaking out of that dumb pipe offering. That's a very compelling value proposition. So what is the biggest hurdle that you run into with customers?
I think I should stop with a compliment when you said it's very compelling, and the disruption that you hear us speak about is actually not us. It's the service providers that are moving from a pipe for a price model to recognizing that the subscriber really matters, and it's their experience that matters, not the speed of the pipe. And so, to your point, it is very compelling to the subscriber, which allows the service provider to win. Here's the challenge. Cable companies, wireline companies, wireless companies for 60 years have grown up not really worrying about subscriber experience. Just we'll provide the service. We're sort of a monopoly, and we'll worry about operating the network. When you become an experience provider, you're actually literally inverting the company. Rather than thinking network out, you're thinking subscriber in.
The biggest impediment is the culture and the processes of the service provider. The leader of that company saying, we've got to become an experience provider, and literally turning their whole culture upside down. That is the biggest impediment. It's long term what this disruption is all about. I think that answers your question from the impediment. If you want to know what we're doing about it, that's a different discussion.
We'll get into that. I guess we've seen a lot of M&A recently around the space. Has that changed, kind of whether it's management changes or mindset changes to kind of flipping that equation?
A lot of the M&A has been driven by private equity, actually. And if you remember when a number of the wireline providers sort of went upside down, some of them went through Chapter 11. Private equity came in and said, hey, if we build fiber, we're going to get a lot of subscribers because of speed. And what's happened over time is those models have built fiber but haven't gotten to particularly high take rates. So not a lot of subscribers for the fiber that they built, 20%, things of that nature. And so actually, those very same owners have now become very sensitive to, wait a minute, interest rates are going up. Let's slow down on builds. And let's see if we can put subscribers onto that network that we've built.
When you get to a higher take rate, lower churn, higher revenue per user, per subscriber, the valuation of the business is quite different. And one of the things that has become noticed by those investors is there have recently been acquisitions done, one of which was done of Lumos, which was a Calix broadband experience provider. And the price for fiber connected subscriber that they received was three times what the normal trade has been of service provider acquisitions. That got a lot of attention.
OK. So you're kind of seeing that wheel start of kind of more recognition of customer experience. Maybe kind of circling back for those who might not be as familiar with the company, can you just outline some of your offerings around customer experience and why they are so differentiated in the market? And maybe which ones out of that portfolio are seeing the most traction?
So the answer is yes. And the way we've approached it actually is by packaging it vertically. And we've learned in the go-to-market that if you just have a set of products that you offer, it's hard for the service provider to actually take those to the subscriber and help them. So we actually started packaging it vertically into SmartHome or SmartBiz or SmartTown. You'll see that if you go to our website. And you'll see it in a lot of our customers' websites because we don't brand what we do to the subscriber. We make it ready for the service provider to brand. And so by verticalizing it that way, it's easier for them to go to market. And so clearly, the SmartHome, which is to residential subscribers, is the biggest driver of the model to date.
But if you want to start to look at, for example, what's now happening as more and more service providers are starting to say, wait a minute, there's a different subscriber model out there as opposed to a pipe model. SmartBiz is a very interesting package. And the reason it is is it addresses small and medium businesses. If you remember in the enterprise space, selling your products to small and medium businesses has always been like the bane of your existence. How do you staff it? How do you reach it profitably, et cetera? And what we've built is a vertical offering. So it has an appliance, the Wi-Fi router. It has the operating system, the AXOS. It has our cloud. And then it has the managed services that are appropriate for a small business owner.
And the service provider can take that entire package and go take it directly to their small and medium businesses. So recently, one of those legacy been through bankruptcy re-emerged companies, Windstream, announced that they are starting to deploy SmartBiz to their 18 states. Irrespective of any of our other offerings, that's what they're going to market with. So actually, it wasn't so much the components. It was figuring out, oh, this actually enables, by packaging it this way, the service providers to go faster.
You've had some very large customers over time. You've also had a fair amount of small customers. Just where do you see kind of the market evolving in terms of your customer base and just also kind of customer base that's providing services to customers in general?
To subscribers?
To subscribers.
OK. Yeah. Well, that's our preference because otherwise we get confused in time. You're talking about the customer's customer or the customer?
Right.
The customers and the subscribers. So let's look at the evolution. Speed was good enough for a long period of time. It is no different. Sorry about this. It's my age. I have a 186. Then I have a computer with a 286. And I know mine is better than yours because I have a bigger number. Eventually, and the reason that is, is because the processor is the constraint for the experience. When the processor gets to the point where it's not constraining the experience, you'd better be selling something else. Otherwise, you're just in a race to the bottom. Broadband is now reaching that point because you now have fiber. And you have Wi-Fi that has the capacity if you manage the antennas and build them properly, where speed is not the differentiator.
So when you look at what's going on, the market is going through a disruption that's natural. You're moving from pipe and price being a proxy for the experience to pipe and price as disconnected from the experience. And the providers that are starting to figure that out are the ones that are winning. So where does it start? With the smaller service providers. Why? They don't have the mass. They don't have the ability to develop the products themselves. If they don't do something that's differentiated because they're smaller, they get run over. So that's where it starts. Today, we have more than 1,000 service providers deploying our platforms in one form or another. Clearly, those 1,000 are mostly small. What's happening now is you're starting to see the medium and the large customers engage in conversations with us.
And that disruption was clearly starting to happen six quarters ago. And Michael and the leadership team, you go to the front. That's when the CEO and the leadership team have to be out with customers having those conversations, which is why you have the pleasure of speaking with me today instead of Michael. So we are in this disruption sort of moved like a sigmoid. And so we're now at this elbow. So you can see it happening.
OK. I mean, there's been a lot of government funding over the years, various alphabet soup type of.
Still is.
Right. We've now seen kind of new BEAD, I think, has been in focus over the past couple of years. There's just a lot of confusion right now. But just how do you see the program playing out? And just what extent does it influence your business, if at all?
Let's talk about BEAD specifically. Then let me frame it back into the larger context, at least for us. BEAD is a roughly $50 billion, $45 billion program that was put together in the Biden administration. It has moved very slowly because of various restrictive covenants that are in it. New administration comes in. Lots of questions about will it even survive. If you're asking me to throw a dart, I believe it survives. Some of it may be clawed back. There's going to be a delay. There's a new NTIA administrator coming in. She has yet to be approved. I believe she's been nominated. I think you'll see a pause. Then I think you'll actually see it speed up. Why will it speed up? Because they're going to take all the restrictive covenants out of it.
OK, union labor, environmental, it's all going to go out the window. And so you're going to see the deployments happen faster. Now let's frame it up to Calix because capital coming into the space is actually number four on the list of things that we look at. And it's under the heading of capital that's coming into the space. BEAD is one of those. Other government programs you mentioned that are ongoing are more of those. But believe it or not, as large as BEAD is, it's not the largest component. Private equity is. If you go look at private equity, you're going to see far more dollars on the sidelines looking for places to invest than BEAD would be. So in actuality, it's important. But it doesn't drive our business. Now the last piece, our business is geared to subscribers.
There's some 90 million endpoints in the U.S. alone that today are fed by fiber. Getting those subscribers onto the model is a much bigger addressable market than adding four or five million new subscribers to the network. So yes, you get the network, et cetera. But that's a small opportunity for us compared to making sure that we get this right first. So as I say, it's number four on our list. Important. But it's not going to drive the model.
So what are one, two, and three?
Now you're asking for secrets. I also didn't read the Morgan Stanley disclosures. So I'm not sure I can answer. All kidding aside, if you were sitting in our board meeting, we have a strategic dashboard, and the number one thing that we look at are the rate of deployments of GigaSpire by week. The GigaSpire is the subscriber premises system, small business, medium business, residential, doesn't matter. It's a Wi-Fi router. It's branded by the customer. We build it. That deployment rate really points to the future value in front of us. Because when that's deployed, then you can put additional services on top of it because it's at the subscriber end. That rate has continued to go up and to the right, not just the total number, but the actual weekly deployment rate continues to grow.
Obviously, if you understand our model, that's the first thing you would focus on. The second slide that we focus on is platform, cloud, and managed services deployments on top of those GigaSpire. So you're obviously looking for that rate to continue to grow. So it's sort of a land and expand or deploy and expand model. The third thing that we look at is landing new appliances, so new network into accounts that haven't bought from us before. It could be customers like Windstream who used to be one of our largest customers in Calix 1.0. When we backed away, we really lost them as a customer. And now they're coming back. So you're looking at those new footprint adds. And then number four is additional network builds. So there I've given you a secret.
All right. Perfect. Maybe turning to you, Cory, for a second. You noted that Q2 2024 marked a bottom. And you've since kind of guided to sequential growth. What gives you confidence in sustaining that trajectory in 2025? And as you mentioned, kind of returning to double-digit growth by the end of 2025. And just.
Yeah. So, all of the vectors that we were talking about all through 2024 have started to reverse themselves or have gone away. So, if we take a look at whether it be large capital carrier spending, whether it be normalization of order flow, or the pause that PE-backed entities took, all of them had an impact in 2024. By the time we got to Q2 of 2024, we started already to see those factors start reversing themselves. So, back at that time, we said that we would see sequential revenue growth of 1%-5% at that time, starting at the lower end and getting to the middle of that range by the end of 2025. And every day since July, our visibility has continued to improve. You start seeing things in the marketplace like large capital carriers saying they're going to invest a lot more money in 2025.
Supply chain and order normalization has had another six months to kind of work itself out. And a lot of those PE-backed entities are going again. Right? So they've had that work through, now moved to pivot to focus on, let's turn on more subscribers instead of doing more network builds, trying to get that cash flow going. And they've all kind of started working themselves out. So all those factors kind of undoing have helped. And then one last point. In 2024, during this pause when things slowed down, it gave us the opportunity to talk to a lot of more companies that were looking and reevaluating their business models. Now, we didn't cut our OpEx. We invested straight on through. And that gave us a lot of opportunities to talk to a lot of customers.
You can see some of the customer additions that we had in 2024 are largely takeaways. Those will all start layering in over 2025 as we move forward. We feel very comfortable with that kind of sequential revenue growth. BEAD is not meaningful.
OK. All right. Perfect. Maybe sticking with you for a second, given the recent shift towards subscriber systems and increased medium and large customers, just how should we think about the gross margin trajectory kind of throughout the year kind of relative to kind of targets for 100-2 00 basis points of annual improvement?
Sure. As we said, our platform, cloud, and managed services all monetize on a per-subscriber basis. And so pre-pandemic, post-pandemic, that has only gone up and to the right. Every single day, our customers are adding subscribers to the network. And so the software mix continues to go up. Not only is the software mix going up, inside of that software mix, you're actually seeing margins improve. So as we add more managed services, that's very high gross margins. That's adding to it. And our clouds are still maturing. So you'd expect those margins to improve. So you've got that end of the spectrum continuing to improve. On the appliance side, we're going to see appliance revenue come back more meaningful in 2025. So that'll shift that mix a bit. And then even inside of that appliance mix, we talked about all these customers looking to add more subscribers.
So we'll have more premises systems. So there's a little bit of a headwind there as those premises systems get added in relative to the access network. But at no point do we think that that headwind on the premises systems actually makes our overall corporate margin go negative.
OK. OK. Interesting. And then just how should we think about just the mix of platform, cloud, managed services revenue and just how this impacts kind of the financial model?
You want to take it first?
Go ahead.
You take it first. I'll add color. All right. I'll take it first.
OK.
Go for it. Look, in the end, the platform, cloud, and managed services are growing at an elbow rate. If you look at our quarterly stockholder letter, there's a clear inflection in the recurring revenue of the RPOs. And so that acceleration is what makes us say we're now at the elbow of the disruption. And that's being driven by our existing customers expanding more subscribers on their network and also adding new customers that you heard Cory talking about earlier. So I think that rate will continue to outgrow the appliances, even though we're clearly starting to get much more visibility on the appliances. So I don't think it stops. The shift inside of the appliances will continue towards premises. But eventually, that shift slows down because there's only so far it can shift.
So when you put those two together, I think you've heard Cory say that gross margins are going to expand at the lower end of the range for a period of time and then probably start to go back up. And at the top line, the sequential growth rate is probably going to continue to go up, still inside the range of 1%-5% per quarter. But that's a big range.
Right. Yeah. Maybe can you just elaborate on kind of what you're seeing in the competitive environment and not just kind of new wins but chances for competitive displacements?
So when you think about the broadband experience provider versus the legacy service provider, let's go back to the legacy service provider in Calix 1.0 and the C7, which we went public on, as you may remember.
We're both very young.
We were. So yeah, the legacy service providers have a box system, a box. We were part of that as Calix 1.0. We had a set of competitors. They're still doing that. If you look at the broadband experience provider and providing that level of platform, cloud, managed services, a narrow set of appliances that meet their needs, a direct engagement model helping them, a customer success team, there's no one doing that. So in this model, there really isn't anyone doing what we're doing. If you look backwards and say, well, but wait a minute, there's still legacy. Yes. But if we're taking footprint, it's not because we're going back and trying to compete with a legacy provider that wants to continue selling pipe. They'd either, and this is where the whole leadership team going to the front matters.
Michael, as CEO, can sit with the CEO of a customer and can decide for himself whether or not they really want to make this jump or they're just looking for a second vendor. And if it's just a second vendor, then it doesn't help us. And it doesn't really help them. So in this mode, there's really no one doing what we're doing. In that mode, there's still a set of legacy vendors that are competing.
OK. Maybe, Cory, back to you for a second. RPOs was growing 10% sequentially in Q4. Just kind of what's kind of driving that momentum? And then just, or maybe just how to think about that conversion timeline to kind of revenue?
I'll go back to what I said before. Our platform, cloud, and managed services all monetize on a per-subscriber basis. And so what's causing an acceleration of our RPO? Number one, it's more subscribers being added. Right? So the rate at which they continue to come on board is at an ever-increasing rate. At the same time, we're starting to see the proliferation of the managed services. So that's adding to a second dimension of it. And then third, we are adding new customers. But we're also getting maturity on the model. So if I take a brand new customer today, they've got zero subscribers on our platform. So an initial contract will look very small. Right? And if I just do a simple linear extrapolation, maybe it's 1,000 subscribers going to two in year two and three in year three, that's your revenue stream.
But when they come back for the renewal, continuing the same extrapolation, it's 4,000, 5,000, 6,000. That looks like a contract that's about 2.5x the initial contract because of what they're adding. And that's what's happening. Our customers that have been on the platform the longest are coming back, have shown the greatest strength in adding subscribers, the greatest improvement in the marketplace. And the renewals are all that much larger as a result of the success that they're having adopting our platforms.
OK, so you've also had seven consecutive quarters of double-digit free cash flow. Not sure if that's growth or percentage. But what are your expectations for working capital efficiency and just kind of cash flow generation throughout the year?
Yeah. So we've said publicly that we'll continue to generate double-digit free cash flow on a quarterly basis this year.
To interject, double-digit millions.
Millions.
To answer your question about percentage.
Double-digit, yes.
Millions. OK. So $10 + million per quarter. And you've seen that for the last seven. We'll continue that trend. This year, we expect the top line to re-accelerate a bit. So that'll start some capital will be going back into our working capital. But we'll see that grow nicely as we get into the back half of the year, especially as the revenue comes back, the margin continues to expand. And we're holding OpEx flat. Means there's a lot more leverage going to show up in the second half of this year. So that'll generate more free cash flow.
OK. Verizon, obviously, has been kind of a marquee name for you guys. They have continued to invest kind of consistently over the last six years. Just how do you guys think about kind of this relationship, and what do you think kind of investors kind of miss sometimes about it? Sounds like a big name, but maybe not as lumpy as people might think of with a big name.
Look, I don't know that investors miss. I think at times, to understand the dynamic of what we do, there are subtleties there that sort of point to the power of the model. So to your point, look, Verizon's been a great customer. We love them. I think they love us. It is in the network. So the part that they have purchased from us is our network operating system and our E-Series of systems that go into their network. Believe it or not, that is a sole-sourced network. It was not deliberately set out to be sole-sourced. But they had a view, and Verizon's always been an engineering-led company where they'll look out over the horizon. They wanted to get to a single unified workflow for their entire converged network. And this is back in 2017. And the way to build that is with an architecture like AXOS.
And so it was literally a natural fit. What's hard to understand about it is in times past, you would have thought of that as being, oh, that's going to be a 10% customer. With the E-Series system and the software, there's a recurring nature to it, et cetera. It never really gets to be a giant 10% customer unless they literally get lumpy in their shipment requests, even though their deployments may be going about that pie wedging. And we do the network side. We do not do the premises side in their network. We interoperate. So what might investors want to understand? That the power of the AXOS operating system leads to a sole-sourced network that delivers the lowest cost per bit per mile network infrastructure that we are aware of in the world. It is the highest speed, highest scaled network.
It's a 4 x 10 gig network that has the lowest cost per bit per mile operational expense of any network.
OK. You mentioned SmartBiz up front. Just can you kind of elaborate on, again, just who that ideal customer is and just kind of what some of the traction you're seeing with that business?
Yeah. So the subscriber might be, in another life, Mimi's Flower Shop. And an ALLO might come to you and say, hey, we've got a SmartBiz offering. Well, what is that? Well, it's an offering that allows your customers to come in. They can connect to your Wi-Fi. You can start to keep records on who's coming in. And you start to get a whole level of customer intelligence as Mimi's Flower Shop. And I don't know if you have one of those going or not yet. But if you do, let me know. I might be an investor. And you now, all of a sudden, are able to provide this very simple Wi-Fi with an app.
You can do it yourself as opposed to having to have an enterprise IT consultant come in and set it up for you and then do all the work for you. Literally, the service provider can come in, turn it up. It's labeled with ALLO's internet. By the way, when the splash page comes up, it could very well for the customer, for when they connect, it's Mimi's Flower Shop. You know who your service provider is. And you have something that literally you can run off an app on your phone. So it is just that simple. And it's very, very easy for the service provider to deliver it to you. You cannot do this today in any manner, shape, or form.
OK. So you've talked about a lot of on the list of the four priorities, there's just a lot of opportunity. But how are you weighing international as kind of a part of that? And just what are the steps or investments you need to make to kind of further go after that?
It's a great question, so international comes at the opportunity cost of the U.S. We have an enormous untapped market in the U.S., even as mature as we are. We're still here in this disruption, and so everything gets graded against that, so our international investments are deliberate, looking for beachheads that are aligned, and the team does a very good job in that, but there's not some frontal assault on that market in the way we might be doing in North America. We've got 1,000 customers here. There's all the reasons we should continue to make sure that we execute against North America. That's what we're doing, so we are most definitely investing in international, but in a very deliberate fashion. It is not yet time to go turn that thing on the way we would have it in North America.
OK. And then, Cory, I mean, just how are you thinking about or, and Carl, just how are you guys thinking about kind of capital allocation, just given the amount of investment opportunities that there are for you guys?
You've heard by our comments that we're an organic grower. Right? We spent a lot of time simplifying our model, getting down to 200 SKUs, a fully abstracted operating system. The last thing we want to do is go buy another big hardware company and try to bolt that on. That's not going to happen. But that doesn't mean we won't go look at small software technology tuck-ins, something along those lines. And so from a capital perspective, we like cash. But we're not going to be a bank. And so we have a very deliberate model that we go through every quarter with the board to look at our cash needs. And we look at our cash kind of in three buckets. We've got our operational cash, our growth capital. That would come at a very high opportunity cost to use it.
We then need to have a sufficient amount of cash to deal with strategic opportunities as they arise. And we want that strategic flexibility to have it. And then we kind of have rainy day cash where we would have each one of those have a lesser and lesser opportunity cost. So we look at what cash we're going to generate, how much cash we have, potential needs. And we come up with a matrix. And we'll put that into a plan that we put out there. And so we'll be unemotional buyers of our stock. And ultimately, as more cash piles up on the balance sheet, the less sensitive we are to price. And we let it go.
Yeah. OK. Maybe, Carl, just like last question for you. You've laid out a lot of exciting vectors of opportunity over the next couple of years. What are the one or two metrics do you think that investors should be looking at to kind of judge the success of that?
Well, I mean, look, there's the obvious financial metrics of top line growth and gross margin expansion, et cetera, which speak to what's going on in the model. And obviously, you would start there. But in the shareholder letter that we do publish, if I were to pick the two most critical, one is the RPO growth because that's the best proxy that we release today on what's happening in that business. And the second is there's a histogram that talks about the number of customers that are deploying the platform, the number of customers separately that are deploying clouds, and the number of customers that are deploying managed services. That histogram gives a reasonable insight into where we are in the whole maturity process. And so the platform sort of comes first, the cloud second, the managed services third.
And so you had asked me a question earlier about the broadband experience provider and their evolution. The more evolved they are, the more they're deploying managed services. But they started down here. And if you go look at that chart, what you'll see is big high numbers for the platform, almost as high numbers for the cloud. And the managed services are down here. But they're starting to do this as more and more customers do that. And every year, we have our customer get-together, which is 3,000 customers in Las Vegas ConneXions. And it is, well, it's a love fest. But more importantly, more customers get on stage than Calix folks. And they talk about what they're doing. And the reason I share that with you is, look, we can talk about what we're doing until we're blue in the face.
But when a customer gets up on stage and says, here's what I did in our community. And it had this effect. All the other customers sitting there going, I could do that. And it just sort of brings that wave of disruption just that much further. And that's when we see these vectors expand. And there is a noticeable step up every time customers get up in front of other customers.
Perfect. All right. Cory, Carl, thanks so much for being with us today.
It's been great seeing you.
Thank you very much.
Thank you.
I thought it was a significant discussion in sum.