Calix Inc

NYSE:CALX

Earnings Call Transcript 2018-Q1

[Operator]

Greetings and welcome to the Calix First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Tom Dings. Thank you, you may begin.

[Tom Dings, Director of IR]

Thank you, operator, and good afternoon, everyone. Thank you for joining our Q1, 2018 Earnings Conference Call. Today on the call, we have President and CEO, Carl Russo; as well as Chief Financial Officer, Cory Sindelar. As a reminder, this afternoon, we released our letter to stockholders and an 8K Filing, as well as on the Investor Relation Section at the Calix website. The Letter to stockholders is in lieu of any prepared remarks. In this call, we consist a question and answer only. The conference call will be available for audio replay in the Investor Relations section of the Calix website.

Before we turn the call over to the operator to start the question and answer session, we want to remind you that in this call we refer to forward looking statements, which include all statements we make about our 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 today's Letter to stockholders and in our 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 on this conference call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our Letter to Stockholders. With that operator, please open the call for questions.

[Operator]

Thank you. At this time, we'll be conducting a question-and-answer-session. [Operator Instructions] Our first question is from Meta Marshall from Morgan Stanley. Please go ahead.

[Meta Marshall, Morgan Stanley]

Great, thanks guys. Just maybe a couple to start with. On this shortfall, the kind of where you expected, I'm just having read the letter, is that shortfall more on just the difficulty in predicting kind of services on a quarter-to-quarter basis post CAF2, and post CAF2 slowdown or implementation slowdown or was it more on the product side where you were surprised? And then second understanding that, you might have full visibility into convey your largest customer, but just where you're seeing them fallout for the rest of the year as they finish their kind of post M&A review would be helpful.

[Carl Russo, President and CEO]

Thanks Meta and good afternoon. So, let me address the revenue part first. The way I re-characterize it is actually less to do with products, interestingly enough, it actually is more to do with sort of thinking through more of our legacy revenue mix versus where we're heading from a new customer standpoint. As you noticed in the stockholder letter, actually new customers and new products are actually doing very well.

And the challenges on the revenue side are really back to the same theme that we've had for a number of quarters now, you and I as an example, around getting our arms around predicting some of the projecting revenues from some of our legacy wire-line customers as they go through some of the transitions, that they're going through.

So the lightness on the revenue was really driven by that, offset by actually what we're seeing on new customers and new platforms, which by the way you can see show up in the gross margin line. Does that all fit for you and make sense?

[Meta Marshall, Morgan Stanley]

Yeah. That makes sense.

[Carl Russo, President and CEO]

Okay. And then to your direct question about CenturyLink, there is really no change in your message they are continuing new work through their strategies and their processes, we're starting to understand how the internal purchasing processes and capital governance process works. For the strategic standpoint, I remain very bullish on their strategic opportunities to succeed and very bullish on our ability to help them succeed so there is really no change there other than as you might imagine it's taking them time to work through the process and perhaps a little bit longer than we thought.

[Meta Marshall, Morgan Stanley]

Okay. And then you know, in your letter you noted that kind of your smaller customers or smaller new customers there is success across AXOS and Calix Cloud, but like on the tier 3 traditional customers can you just maybe point through couple of products like, is it the WiFi product is there, where are you seeing the most kind of uptick with the tier 3 customers?

[Carl Russo, President and CEO]

We are seeing uptick across all of -- in essence our three legged product stool, as if we thinking about it from a network standpoint, from the premises side and then from the Calix Cloud side. If your question is from a revenue standpoint, well the revenue in cloud is going to be smaller than in the network around the premises side. But actually all three are doing very, very well.

[Meta Marshall, Morgan Stanley]

And I guess since kind of the premise side of the newest side, just trying to get a sense of is that, was that a material part of growth or is still just uptick kind of in new customers and just traditional network products [multiple speakers].

[Carl Russo, President and CEO]

Okay. So let me see if I can give you a little bit more there. So remember EXOS is coming to the market now. EXOS is on the subscriber edge, but it's our third generation, our second generation was the Giga family. And the Giga family has been growing like a weed for quite some time and continues to. So we are very bullish on the opportunity on the subscriber edge for opportunities for growth. So that's clearly an area that's being growing and will continue to grow.

Having said that Calix Cloud Analytics are growing at a great grip as our AXOS licenses, they are just different revenue dollars and they are different margin dollar and you sort of have to think through all that, but all three are showing growth.

As far as customers, because you sort of segmented me into sort of the traditional ILACs [ph], the small ILACs. We tend to think of smaller customers as all of the species of customers whether they are ILACs or CLAX [ph] or municipalities or small cable MSOs or electric utilities or hospitality providers, that whole segment is the growth opportunity for us, both in revenue as well as customer count. And what's really very good for us is the diversification. So we continue to diversify our revenue base at a pretty steep clip.

[Meta Marshall, Morgan Stanley]

I will pass it on. Thanks.

[Carl Russo, President and CEO]

Thanks Meta.

[Operator]

[Operator Instructions] Our next question is from David Williams from Drexel Hamilton. Please go ahead.

[David Williams, Drexel Hamilton]

Hey, guys. Good evening and thanks for taking my questions. I guess first I want to see if you maybe wanted to talk a little bit about Verizon ramp and if you are seeing any movement there, everything has changed maybe since last quarter. Just any update I guess on Verizon.

[Carl Russo, President and CEO]

We continue to progress with Verizon and continue to ship to Verizon. And I mean that's all I think we would be willing to say at this point in time other than we continue to be very excited about where they are heading as a company and our alignment with it.

[David Williams, Drexel Hamilton]

And you had said before that you thought they could be at [ph] 10% customer. Is that still maybe how you -- you think it could still be that size I guess going forward, are you still comfortable with that?

[Carl Russo, President and CEO]

In any given quarter in this year we think that's possible and long-term certainly that yes, we are, David.

[David Williams, Drexel Hamilton]

Thanks. And then thinking about obviously the budgets have been the low constrain or maybe not constrained but just held up, do you think that maybe we are creating some pent-up demand that comes back into the back half of the year and does that maybe come in slowly or does it come in all at once? Kind of what are you thinking I guess, how are you preparing for -- how does the rest of the year unfolds this April 's budgets to get release and you get maybe a flood of orders?

[Carl Russo, President and CEO]

So I think there is a specific set of customers that you are referring to there that would be more publically traded traditional wireline folks, is that correct?

[David Williams, Drexel Hamilton]

Yes, sir.

[Carl Russo, President and CEO]

So I do not know David. There is lots of messaging on the Street on CapEx that would indicate that that would be the case, i.e. that people are holding to their CapEx projection even though they are off to a slow start, but I think we would be wise to recognize that when that typically happens, it's sort of systemically hard for a customers to catch up later in the year, there is just too much to do.

So I think it will be less than wise for any of us to sit and think that that's the case, albeit, we expect spending to pick up, I do not know if it catches up to previous year. So does that help you?

[David Williams, Drexel Hamilton]

It does, and I appreciate that. And then I guess maybe one last question. What exposure or what opportunities did you previously had with level III and I guess combined CapEx budget between CenturyLink and Level 3, is there a potential making opportunity to pick up some increased dollars there with CenturyLink with the acquisition?

[Carl Russo, President and CEO]

So, yeah, and I think it -- the direct answer to your question is none, as an we did not have exposure to level 3, given their history and what markets they were serving and where we were coming from historically. To then think about their combined strategy and what it might be, as we think through the new CenturyLink, and what their strategies are going forward, and what we think they might be, we see significant opportunities for strategic alignment around higher speed services, that are likely more fiber-based, and we're very encouraged by the early signs that we see there. So, yes, we do see an opportunity for strategic growth. But again, I'd just maybe caution you that, they're still working through those things.

[David Williams, Drexel Hamilton]

Okay. And then one last on the, if I may, on the guidance…

[Carl Russo, President and CEO]

Please go ahead David, take your time.

[David Williams, Drexel Hamilton]

Sorry, I'd just stay on the guidance, comments on your guidance is it tended on some of that budget being release and how much of that is maybe just the visibility that you have in front of you today, I guess what are the risk to that revenue guidance you provided? It seems to be a little better than I would have thought, just kind of giving the shortfall this quarter.

[Carl Russo, President and CEO]

So, I'm going to, I'll tell you what, let me let Cory answer that question first. And well, maybe I'll give you a little bit of color on this and how do you think this through. I think our guidance is the sum total of the messages I just laid out which is we're seeing very good uptick and amongst diversified customers, we're seeing our new products and platforms continue to have very favorable reviews in the marketplace. So, that's we're just seeing on the gross margin.

On the revenue side, we're being somewhat attenuated because of trying to understand what's going on at these customers. And so together I mean, it sort of speaks to where we're going as a company, you're going to see gross profit continue to grow and you're going to see us continue to keep hands on OpEx in a very disciplined fashion. But, in the next 90 days, we're still little bit cautious on revenue growth on some of the segment. So, Cory any color to add?

[Cory Sindelar, Chief Financial Officer]

I'd just say that part of the increase from Q1 and Q2, it's pretty difficult to where you see a seasonal uptick with purchasing cycles and probably making up a little bit of it from the shortfall in Q1.

[David Williams, Drexel Hamilton]

Thanks for the color guys. I certainly appreciate it, and best of luck to you on the quarter.

[Carl Russo, President and CEO]

Thanks David.

[Operator]

[Operator Instructions] Our next question comes from Christian Schwab from Craig-Hallum. Please go ahead.

[Christian Schwab, Craig-Hallum]

Thanks for taking my question. So, it is far as CAF2 at your key customer in 2017. It was a rough expectation of the dollar amount that was just all CAF2 for that customer and then can you also let us understand, what percentage of that might have been service versus product?

[Carl Russo, President and CEO]

So, we never broke out CAF2, other than to say that we were focused on making sure we could deliver it. For a break out of service versus product Cory do you have -- I mean, I'd be very careful about doing this.

Let me see if I can comment it differently. Obviously, if you look at our services mix in Q1, our services mix as a percentage of revenue was down quite a bit from previous year, while at the same time, the gross margin on the services were up. So, I think you can probably start to extrapolate from their question as what's happening on the services side, from a deployment standpoint and CAF, we're continuing to deploy against the CAF2 program. But I'd say in a very controlled fashion is the way I would cover it.

[Christian Schwab, Craig-Hallum]

Right. So, in line with what you've been saying to the last few quarters, said another way. Now, that maybe poorly structured CAF2 service agreement that other people kind of put together that, kind of, held us back that is done in the profitability of that will improve as kind of we've talked about overtime, as other things layered in, is that still your fundamental view point on a go forward basis?

[Carl Russo, President and CEO]

Well, it is, except for you to make sure, I correct you giving me a pass, because one of those other people that did it was me. So, I'm the one that stepped in it in the first place but if you go and look at in the stockholder letter, I think it's on Page 3, and you look at the services gross margin and the product gross margins, it is exactly what we've been saying for the last few quarters, what happened is that you'll see this snap back and we'll get the profitability in services.

And then as we grow from there, we expect the gross margins in services to continue to grow as services themselves shrink as a percentage of revenue, and what's driving that margin expansion are two things, the better execution against the deployment services CAF and other things. But also as our platforms grow, we've attached services going along with them that as we've discussed are at much higher margins. So, yes, to your point, exactly consistent.

[Christian Schwab, Craig-Hallum]

Perfect. And then, with those migrations that really successes that you're seeing as far as your new product platforms, as far as reviews and customer uptake and Verizon beginning to ramp, I know we talk about $600 million been a long-term target, we've talked about that for a little while. How longer we really anticipating that that takes, is that kind of a multi-year thing or do you want to bracket it at this point?

[Carl Russo, President and CEO]

I don't want to bracket it, but let's be -- I do want to make sure I spend the moment on the revenue growth and what we're seeing early in this year, because it's causing us to be cautious from a revenue perspective. But the flip side is, here's what I can tell you about that model. I think you can now look at that chart on Page 3, and the chart on Page 4, around operating expenses and realize how we get to the gross margin and OpEx model. And to your point, really now the question is what's the revenue growth rate overtime and all I can tell you is, there're things that are in our control, and there're things that are out of our control.

There're certainly a set of customers that right now are challenging to predict revenue on. But we're very busily growing our new customer base and our new platform uptake. So, those are the sort of the levers, as far as bracketing it. It's not in the way our future, it's clearly with inside of what we're planning to go execute against. But I wouldn't want to put a date on it.

[Christian Schwab, Craig-Hallum]

That's great. I don't have any other questions. But I will say, thank you for putting out the letter with all the information, instead of reading it to us, because we can all read for the best use of everybody's time. So, thank you for doing that.

[Carl Russo, President and CEO]

You're welcome. And I'll take it both in that spirit and also that you were probably tired of hearing us throughout a long speech. I know we were, so we appreciate it. And thank you very much Christian.

[Operator]

[Operator Instructions] Our next question is from George Notter from Jefferies. Please go ahead.

[Unidentified Analyst]

Hi, this is Kyle on for George. Thanks a lot for taking the question. One of the two, circle back with services business and specifically the nice gross margin result progress and services gross margin by the way this quarter. I noticed that it was a lower to revenue result for your services business. And just want to know how careful we should be in terms of projecting that trajectory going forward? What was there higher mix of engineering type professional services in the quarter? How indicative is the trajectory in this current quarter or going forward to the rest of the year?

[Cory Sindelar, Chief Financial Officer]

Yeah. So the make-up is largely still deployment services as a relative waiting amongst the different types of services. What you're seeing is the better execution as Carl told you about, in terms of the margin improvement. We expect that that will continue as we progress through the year, as a total amount of services, as a percentage of total revenue. We see that coming down significantly and the trend continuing to be about where it is for the balance of the year.

[Unidentified Analyst]

Okay, thanks. And then, just looking at seasonality through the end of the year, should we look for this kind of be shape the way through this year where it kind of ramps into the end of the year? Is there any -- are there any like CAF2 type project timeline that we should think about in terms of the lumpiness of the services business through the year? How should we think about the topline services business?

[Cory Sindelar, Chief Financial Officer]

Yeah. So, I think you're going to see a typical seasonality curve, like you have seen in prior years and the other thing I'll point out, particularly with our adoption of 606, our services contracts are now complete. So, it's going to be a little bit more linear progression in terms of revenue as opposed to completed contract and it being as lumpy as it would might've been in the past.

[Unidentified Analyst]

Okay, great. And one last for me, nice to see you saw some diversification benefit from the smaller customers, picking up some of the [ph] slack and the weakness in tier 1. That being said, is there anything else you can add in terms of when business trends may pick backup at the larger merger related impact to customer and what your visibility looks like there, if any? Thanks.

[Carl Russo, President and CEO]

Yeah. I spoke to it a little bit before call but happy to go through it. We as a company, when we're first found and grew up with an initial set of wire line customers and they're very good customers for us and we want to do our best to help them succeed. But it is a challenging hand to work with right now for some of them. And so, we're just very cautious on projecting revenues.

So, that being said, the new platforms and our ability to reach new prospects, and expand our customer base and expand our applications inside of those customers, is continuing to grow actually unabated. So, it sets a very robust gross profit base underneath the business that's growing. And we will just be cautious on forecasting those customers, I think, that's the only prudent thing to do.

As far as the turning up, you heard a question earlier from David, I believe asked the question around, there is a lot of folks that are saying they're going to hold to their CapEx numbers, and so they're off to a slow start, does that mean they'll catch up. I don't think they're being dishonest or disingenuous, I just think if we're better served by being cautious about the fact that if you get too far behind, it's just very hard to catch up. So, we're going to be very muted on how we forecast those customers and we're going to focus on making sure that we're driving our gross profit growth and that we're being disciplined about our OpEx.

[Unidentified Analyst]

Okay, great, fair enough, thanks a lot.

[Carl Russo, President and CEO]

Thank you very much Kyle. Tell our George prays for us.

[Unidentified Analyst]

I will.

[Operator]

[Operator Instructions] And if no further questions, I'd like to turn the floor back over to Mr. Dings for any closing comments.

[Tom Dings, Director of IR]

Thank you operator. Once again, thank you everyone on this call and on the webcast for your interest in Calix and thank you for joining us today. This concludes our conference call. Good bye for now.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.