I figured I’d publish my post-quarter Calix update here. As someone noted to me, I probably won’t be getting a Christmas card from them. 🙂 But if the emperor is prancing around in new clothes made of nothing more than delusion, I’m not obliged to play along with the charade.
See below for the post-call note I sent to Calix’s CEO and Chairman of the Board. See link below for a PDF of my more detailed article on Seeking Alpha.
In an alternate universe, there’s a Calix with appropriately lowered expectations, a detailed investor deck, and intact credibility. It is currently rallying from $6 to $7.50 on the quarter’s results. People who bought ahead of the quarter are starting to relax and settle in for the ride. New investors are reading a clear, detailed shareholder letter that focuses on 2020 prospects. Doing their own math and thinking about buying in. The deep value folks who’ve supported CALX, feeling good about a job well done, are maybe marking up the price where they’ll start selling off to the growth crowd.
All is well in that alternate universe.
In our reality, we are wallowing in the swells. Engine off. A windmilling rudder. Cash is low. Praying a storm doesn’t hit before we get headway again. The easy excuse is “What can we do if Frontier and Windstream shifted plans on us?” The answer is You can do plenty right now.
- Significantly improve the depth and detail of your disclosures. What does Calix 2.0 look like? I have no idea. Maybe you’ve hinted at it in conference 1-on-1’s. That sort of selective disclosure isn’t going to work for a $400m cap left-for-dead stock. Put it on paper and get it out there.
- Fix your forecasting and guidance process. Quarter after quarter we see a reliable skew towards insupportable optimism. Put on some corrective lenses that aren’t quite so rose colored. Forecasting is tough, but most companies get it more right than Calix does. OR at least get it wrong in both directions.
- Change your tone. I wasn’t at the Cowen conference and I have no idea what was said, but [Cowen Analyst] didn’t hang himself with that table-pounding note [ahead of the quarter that drove CALX up to $7.50] unless someone handed him a whole lot of rope. One more person with singed fingers.
- Promote or hire someone with intact investor credibility to add weight to a more sober message. A credible message still needs a credible messenger.
The above won’t get Windstream and Frontier back to buying, but it would eliminate a massive uncertainty discount. The weight of that uncertainty depresses the valuation. It also depresses trading volumes. The quarter-by-quarter stream of self-inflicted whipsaws only drives people away.
If you shit in your own backyard long enough, people stop coming over. Other people start writing up the truth for all to see. Its not a lot of fun for anyone. So do something to change the situation.
Key messages From The Seeking Alpha Article (link to PDF below or link to website here.)
My best guess is CALX will drift with the market until we get to the 3Q19 report – probably in mid-October. A decisive turn in the numbers may not come until 2020.
Today’s market reaction just takes CALX back to mid-June 2019 levels. With the stock holding above $6 today, the pre-quarter run up and subsequent drop could be seen as just a blip in an improving trend. But there is damage done.
Calix has singed the fingers of yet another crop of recent buyers who might have been convinced to become long-term holders of the company. Questions left un-answered by management on the 2Q19 call (see below) will also make it that much harder to find new buyers. Investors tend to be wary about crediting improvements in advance after a stock has burned them so frequently and recently. In the meantime, that leaves Calix and its current owners at the mercy of market tides.
I continue to hold the stock. I’ve done enough digging to see through to those improving fundamentals. Per the below, there is still 50%-100% upside on 2020 numbers with more potential in 2021. The question is how long it will take until numbers turn up decisively enough and/or disclosures improve significantly enough for the market to price that in.
At some future date, the numbers will win out. The market will duly price them in. A more forthcoming approach to disclosure would bring that date forward by several quarters. It is mystifying and frustrating that Calix management (and its Board) doesn’t seem to grasp that truth.
Calix produced a 7 page investor letter on July 23. They held a 36 minute call on July 24. Yet they failed to answer some very simple questions that would seem central to analyzing and understanding the stock. I present them below. Their call transcript is here.
Questions Left Un-Answered on the Call.
Calix 1.0 to 2.0 Transition/Trajectory: Calix management it pitching a “Calix 1.0 to Calix 2.0” transition to a higher gross margin, more software-based, more profitable business model. But they have given no detail. What is a reasonable range of margin expectations for Calix 2.0 at maturity? How long to get there? How big are Calix 2.0 products and service as a percent of total revenues today? When will it become a majority of Calix’s revenues? The only comment given on the call was a highly un-specific “our [new] platforms are growing very rapidly, but still off of, let’s say, minority numbers. Our traditional and supporting products or our legacy products are still the large majority of the business.”
Composition of the Customer Base That is Actually Growing? Calix did (finally) disclose that CenturyLink, Windstream, and Frontier are down from over ¾ of revenues to “less than ¼.” CenturyLink was 17% of 2Q19 revenues, leaving bankrupt WindStream and struggling Frontier at around 7% combined. So we know who is shrinking. But we know very little about who is growing. Calix gives no detail on the composition of the other 76%+ of its revenues. We know that Verizon and CityFibre are relatively big and growing fast, but we don’t know how big or how fast. We are wholly in the dark on the rest of their customer base. This is particularly frustrating as one of Calix’s great strengths should be its relatively wide customer base among rural telcos, cable companies, electric cooperatives, and new over builders. That diversity could be perceived as a strength if we had some numbers to back it up. The only detail given on the call was “Headwinds from our publicly traded ILEC customers will continue through the third quarter and into the fourth quarter. We are confident that these headwinds will no longer be a meaningful factor in the business entering 2020. It is worth noting that not many years ago, this narrow category of customers represented more than 3/4 of our business. Today, that same set of customers delivers less than 1/4 of our business. The flip side of this story is the robust nature of the future Calix business model. We continue to add new customers at a rate greater than 100 per year. That is remarkable. And as the headwinds from our legacy business subside, this new business will continue to shine.”
Outlook for Verizon and CityFibre? Engagement With Other Potential Marquee Customers? Calix management did provide a significantly more detailed update on marquee customers Verizon and CityFibre (see quote below). It is not clear if they will continue to deliver that much-needed context. Moreover, they continue to provide no insight into engagement with other large potential customers. It is never advisable to count chickens before they are hatched. But it would help to have some rough color on how many eggs are left in the nest that might hatch.
Cash Flow Outlook? As a rule of thumb, telcos like to see about one quarter’s worth of cash (or more) on their supplier’s books as a cushion in the event of a downturn. For Calix, this would amount to about $100-$150m. Net cash at present is about $10m. Calix does seem likely to turn cash positive in 3Q19. It appears to have the continuing support of its lender Silicon Valley Bank (the source of the $25m revolving debt shown on the balance sheet). Calix also has roughly $15-$20m of excess inventory that should convert to cash as its contract manufacturer recovers from its 1H19 production problems. But it doesn’t appear that Calix will be comfortably liquid until well into 2021. Will they be able to finance growth in the meantime? When will shareholders see a cash return on their invested capital?
Internal Management Changes to Address Persistent Forecasting Errors and Operational Failures. In the past three years, Calix has experienced two major operational failures – poorly negotiated, negative margin services contracts that dragged down results for all of 2017 and the more recent disruptive manufacturing shift out of China in 2018-2019. Calix has also persistently failed to set and communicate realistic forecasts and guidance to investors – as evidenced by the jagged path of the stock price. It would seem to behoove the company to 1). Make structural management changes to improve execution going forward. 2). Discuss and disclose those changes so investors might have more confidence in that future execution. As it stands, it is not clear if Calix management even sees a need for structural improvement.