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Calix Inc
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Greetings, and welcome to the Calix Second Quarter 2019 Earnings Conference Call. [Operator Instructions].
It is now my pleasure to introduce your host, Tom Dinges, Director of Investor Relations. Thank you. You may begin.
Thank you, operator, and good morning, everyone. Thank you for joining our Q2 2019 Earnings Conference Call. Today in the call, we have President and CEO, Carl Russo; as well as Chief Financial Officer, Cory Sindelar. As a reminder, yesterday after the close of market, we released our letter to stockholders in an 8-K filing as well as on the Investor Relations section of the Calix website. This conference call will be available for audio replay in the Investor Relations section of the Calix website.
Before we begin, 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 our second quarter 2019 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 call, we will discuss both GAAP and non-GAAP financial measures. Reconciliation of GAAP to non-GAAP measures is included in our letter to stockholders. Unless otherwise stated on this call, we will reference non-GAAP measures.
With that, let me turn the call over to Carl. Carl?
Thank you, Tom. Our second quarter was a good one. Demand was strong, gross margin expansion was good, and OpEx was disciplined. Our effort to harmonize demand and supply with our new manufacturing partners was met with considerable success. While we are not completely finished, we can now say that we will be complete in the third quarter, and there is no meaningful risk remaining. I would like to thank our customers for their patience and our employees for their continued hard work.
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.
As I stated on our last call, we have it right. We have the right platforms and the right services at the right time. Some brief examples from the second quarter were: adding 33 new customers of all sizes and types; continued rapid expansion of the Calix Cloud platform as customers now using Calix Cloud analytics more than tripled year-over-year; generated another strong quarter of bookings and shipments from our EXOS-powered next-generation GigaSpire systems as bookings more than doubled in the quarter sequentially; continued rapid growth of AXOS and AXOS systems as bookings more than doubled year-over-year; and Light Reading recognized the AXOS Intelligent edge -- Access Edge Solution as the most innovative telecoms product at their Annual Leading Lights Awards.
We look forward to a good quarter as we return to profitability and begin generating cash.
With that, let's open the call for questions. Operator?
[Operator Instructions]. Our first question is coming from Paul Silverstein of Cowen and Company.
Carl, can you give us any incremental insight on the two big opportunities, the Verizon and CityFibre, where they're at? I believe Verizon was a 10% accounts receivable quarter -- customer in your first quarter. Where are they at in that ramp? And if you could also shares with us thoughts on CityFibre? And then I've got a follow-up.
Thanks, Paul. So, Verizon is continuing their build-out and CityFibre is continuing theirs. These are both, obviously, big infrastructure build-outs built out over a long period of time. That being said, let me split up the two. I've been on the record in saying that Verizon will be a 10% customer this year. We've got 2 quarters left to go for that promise to be fulfilled, and I can now say that I'm quite certain that they will in fact achieve that in this year. As for CityFibre, actually you may have noted that CityFibre issued a press release just a couple of days ago that they were adding 14 cities to their initial rollout of 12 cities. And that -- basically, that allowed them to now reach 2 million of the 5 million endpoints that they're looking to reach. And so obviously, they're continuing their ramp. Albeit, it is still early days, but they are continuing to build with us, and we expect the ramp of us to just continue throughout this year into next and beyond. It is still early days for the systems side of their build-out. As you know, when you build infrastructure, the biggest part of the infrastructure build to start with is all the engineering and pulling in fiber, but we are actually starting to see orders from them starting last quarter moving into this quarter and accelerating. But again, I would just really say, keep in mind that these are multiyear infrastructure builds, but both are going well. Does that answer your question?
It does. If I remember, in most build-outs in most product markets, it's aced anywhere from 4 to 6 quarters to ramp to peak levels as a general rule of thumb. Would there be any difference -- I recognize these are hard to predict. It's not within your control, but would there be any difference with respect to the Verizon build-out?
Would there be any difference? Well, there has been a difference. I think looking forward less so because as you know, they got off to a slower start than they wanted to in building their fiber. But no, I think those are -- I would just say 4 to 8 quarters is typically the usual ramp you see on these larger projects. But I think you're roughly right. That's correct.
All right. And then one final question for me. With respect to those "legacy customers," the public middle-sized traditional carriers that have been under pressure, if I recall, last quarter, they were down to 20% collectively, and I think that included CenturyLink. This quarter you just referenced that they were less than 1/4. I assume by virtue of the fact that they were dragging revenue this quarter that they're even less than 20%, but I would like to get a better feel for where they are as a collective group in terms of revenue contribution. And it sounds like you're confident there is not that much falling further to go on the downside there?
Yes. So we are, and I want to give you a couple of comparisons, and I'm going to ask Cory to chime in. So Cory, we're going to release the Q, right?
Correct.
And CenturyLink will show as what percent in this quarter?
17%.
Okay. So there is your CenturyLink number in advance of the Q, which is 17% in the quarter. Now let me address the mid-tier and see if I can put this into perspective. If you look at our Q3 guidance, in essence, unlike Q1 and Q2 where we were down from comparable quarter of last year, Q3 actually, we will likely be roughly flat with last year. Like year-over-year, there is significant near-material differences between what was contributed in that revenue from those middle tier last year versus this year. So as you can probably see these numbers are getting in the point where when I said there's really no -- we don't see a risk in 2020, that's the reason we don't see the risk, and so we see that mitigating into Q4. We think we have a good opportunity to not only grow from Q4 -- from Q3 to Q4, but also if you look at that number in Q4, it would represent growth year-over-year from last year. So we're returning to growth, and we're obviously gaining much more confidence because the numbers are just no longer meaningful in that sense. That's a long-winded answer to your question, but hopefully, that gives you the color.
[Operator Instructions]. Our next question is coming from Christian Schwab of Craig-Hallum.
Carl and team, can we -- as we exit 2019 and we have 20% to 25% of sales to legacy customers, legacy products, the Frontiers, Windstream, CenturyLinks of world, and then 75% to 80% growth on our new platforms. That's -- as a starting point, that's correct? Right?
No. No, it is not. No. I want to be very careful about that because there's 2 different ways of looking at things, right? We can look at it from a customer's statement standpoint, which is what we're speaking to when we say less than 25% and 75%. And then separate from that, our product markers. So, our 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. So, you sort of have to do a matrix there.
Okay. Okay. So, I guess, however, you can help investors as we kind of exit 2019 when you believe the ILEC customer base will no longer be responsible for less predictability of the business or a headwind, and we have created this foundation for predictable profitable growth. Can you tell us what -- starting in exiting 2019 and beyond, what investors should expect the top line growth rate of the company over a multi-year time frame to be given the success and growth of the new platforms?
I think there will be a day where we will probably have a much better sense to that. But I hope you would understand -- you as investors would understand that having gone through the accelerated headwinds that we saw coming into 2019 when we thought we had the opportunity to be actually flat or potentially up as a company initially. Now that we're through those headwinds, I mean the bad news is those headwinds have greatly accelerated. The good news is, we're now sitting here saying now we can see it behind us. I would be low to go throw a dart at the growth that we will see in 2020 and beyond until we start to establish a growth rate, Q4, Q1, Q2. So, I think 3 quarters from now, we'll probably be at a better place to do that, but where -- I am in no position to do that today, Christian.
[Operator Instructions]. Our next question is coming from George Notter of Jefferies.
Just some more clarification, I think, around the diversification of the company and maybe this isn't sinking in very well for me. But when you talk about less than 25% of sales coming from this mid-tier ILEC group, just to be clear, does that include or exclude CenturyLink?
Yes. So, there's sort of a mixed ILECs [ph] going on here, and my apologies, you're probably right to be a little confused. The headwind that we're talking about is the mid-tier ILECs. Although previously, we have talked about, obviously, CenturyLink in going through what was going on at Level 3, but we view CenturyLink differently because of their size and structure. So in the less than 25%, we are actually including CenturyLink. Then you take the 17% that Cory spoke about that starts to give you a sense for what Paul was trying to get after and why we feel confident now that the headwinds from the mid-tier are no longer meaningful as far as risking predictability of the business.
Got it. Okay. So, it includes CenturyLink, but certainly it sounds like CenturyLink will continue to be a meaningful proportion of that "mid-tier ILEC number" going forward?
Yes. And if you don't mind, I'll give you a moment on CenturyLink. Item one, I'm increasingly encouraged as CenturyLink is working through their strategy and looking to the future. You know that they're going to be an increasingly fiber-oriented company. And in their thinking about the whole company, we are seeing more and more clarity inside of the company, the decisions that they're making and making more sense for us. And we think we can see where CenturyLink has a relatively smooth amount of spending, and so we don't view that as being something that's going to risk our projections.
Got it. Okay. Great. And then you talked about the 33 customers that you brought in this quarter, and you're having, certainly, a lot of success. Could you – if I go back and look at the history of the company? I mean you guys have always had a large number of customers. And I think historically, you have had success in adding customers. But it seems like you're talking more aggressively about the diversification of the company. And I guess I'm just trying to understand exactly what's different here. Is there a genre of customers that are coming in or a theme that we can talk to that kind of helps explain the customer additions and exactly why that's translating into more material diversification of the company, where in the past that's been a problem?
Yes, the diversification. So let's go back, Paul, because obviously, you are well familiar with the history of the company having been at the IPO. The customer base was diverse from the standpoint of count, but not type. So, when the company was founded, it was really founded to bring broadband access to wireline service providers. And so, what Calix, if you will, 1.0 did was it built a diverse customer base, but they were all ILECs, IOCs, large and small. As we've gone through the platforms and how we view the world, we don't view and have not for a long time now, ILEC any different from cable MSOs or CLECs or WISPs or cooperatives or municipalities or whomever. And so, we view the emerging communication service providers as those people that want to provide in essence, active services to their subscribers. That's uniquely leveraging of our platforms because when we deploy an AXOS system at a small cable MSO, it's the same AXOS system that Verizon is deploying or CityFibre is deploying. When we deploy an EXOS subscriber edge system at a WISP, it's the same EXOS system that we would deploy at a traditional IOC. And so, we now view that diversification as -- we're not trying to consciously diversify the business, we're trying to in fact go reach all of what we believe will be the winning service providers of the future and they happen to come from all different types. So, it naturally ends up diversifying the business. Does that help?
Yes, it does. Is the C here simply that you've got more and more folks out there overbuilding existing incumbent networks? Is that where you're having incremental success?
It's very clearly happening. There's now capital formation behind clean sheet service providers, which really didn't exist 3 years ago. CityFibre could be a more recent big shining example of it, but there are lots of small service providers that are going by -- like a weed serving under-served areas. And so, yes, it is a key part of what's going on from a CSP standpoint. And look, as I said in our notes, we're going to continue to work with all of our customers and even some of the most challenging hands that exist, which is a more copper-based service provider that's carrying a lot of debt, that's a tough hand to play, but we're finding ways to take our platforms and help them succeed as well. But very clearly, you are now able to build a service provider from scratch with a wholly different physical architecture, logical architecture, operating system and business model and get funding.
[Operator Instructions]. Our next question is coming from Tim Savageaux of Northland Capital.
I want to continue to focus on the growth dynamics in various customer segments of the business. And if you look at what you just disclosed with CenturyLink for Q2 and sort of imagine something similar for Q3, that looks to be down something in the order of 25%, 30% year-over-year. My assumption, and this is also my questions to start with, is that the balance of the Tier 2 universe is down more than that, maybe a lot more, just given some of the headlines and asset sales that we see around the Frontiers and Windstreams of the world. So as you look at your Q3 guide, if you kind of carry those assumptions in there, looks like the rest of the business is set to grow double digits and maybe solid double-digits. That math doesn't really work for the first half given the manufacturing issues. But overall, am I looking at that right as I look at your Q3 guidance and year-over-year growth rates in the segments? Or close to right?
So yes. Pretty close to right. I want to be careful on CenturyLink. CenturyLink was $80 million last year as we continue to align with our platforms and where we're heading and work with them. They're not going to be down by the number you said. They might be down by 10% to 12%. I don't want you to get too over center on that. So that's probably a better approximation. But yes, to your point in the general direction, there is a pretty rapidly growing business underneath all of this. We just have to get out from underneath all of this. And the biggest part of the out from underneath all of this is what you cited, which was a space that's been under terrible duress. Maybe you could anticipate a Chapter 11 filing, maybe not. Maybe you could anticipate lots of asset spin-offs and sale, dividend restructuring, et cetera. But in general, you could look out in the future and you can see all those things potentially happening. But man has a lot of them happened in the last few quarters pretty rapidly. And so that's where we've seen the biggest duress. It's happened quickly. It's happened more quickly than we anticipated. But now we're sitting here in a position where it's just not a meaningful effect on our ability to predict the business going forward. So that's my way of seeing that.
Yes. Okay. Directly, sounds like I'm close here. And then what's likely to drive that growth and also be the focus of your customer additions? Is kind of the biggest piece of the business that I think we might have the least kind of visibility on moving part wise? And that's you know municipal carriers, Tier 3s, the very small ILECs, if you will, which look to compromise something on the order of half the business. I wonder if you to describe kind of -- to the extent it's possible, you describe trends across a pretty itemized group. Can you talk about kind of growth expectations in that segment? In particular, what sort of dynamics are driving that? And in terms of overall funding, I mean maybe you're just carrying your own view as to why the tiny guys need to be fairing better than the mid-tier whether that's lack of material competition or what have you? But I'd just be interested in any kind of color you can give us on kind of that Tier 3 dynamic that looks to be outside of your -- the big guys that you've mentioned previously, a key growth driver for the company.
So I will. I won't violate what I said to Christian, which is at high level, that's being able to project the business growth rate going forward. We want to get a couple of quarters of growth behind us, I mean being through these headwinds before we start to say at a high level here's what the right growth expectations are. But I'll take your question and sort of state, well, underlying this, what are some of the drivers? What are you seeing? So there is no question. Look, I can go get employees from our existing customers, legacy customers, new customers. If you put everybody in a room and say, hey, let's go build a new service provider, every single one of them can build a better network, a more efficient way of doing business and ultimately, a much more efficient business model on top of a clean sheet business. No different than any other business. But in the service provider space, you're dealing with such long product life cycles that the weight of legacy versus the benefits of legacy can flip over on you if someone is able to build a clean sheet service provider.
So managing all of those legacy OSSs, I mean, it's almost a Gordian knot that these folks are dealing with. And so I think if you sat down with any customer and said, what if you could, would you like to build your company from scratch? Again, the answer will be yes. Well, there are now people that are doing that and they're getting funding. And so they take the platforms that we built, and if I say, Tim, here's some money, go start a service provider. And you took Calix Cloud Analytics, EXOS as a subscriber or AXOS of the network, used in an open environment to build your OSSs and DSSs. These networks are usually capable of revenue. They have the lowest cost per bit per mile. You can run them with very few people. And so it just becomes a withering competitive framework. Some of them are WISPs, some of them are co-ops, some of them are clean sheets, some are municipalities, although that's, by no means, the biggest space, some of them are electric cooperatives of all things. It runs the gamma. What they have in common is they're typically building an all-fiber and wireless infrastructure. We are winning them with our platforms. So earlier, Christian had asked the question about product markets versus customer statements. I will tell you that virtually all of the 33 new customers that we added, and this is true for the last bunch of quarters now, are won with our new platforms. They're not won with our traditional product set. So they're just building a very, very different-looking communication service provider. Does that help?
It does. And again, well, I guess Q2 is, again, really not that comparable given the manufacturing issues. But let's just talk about Q3. As you guided, in that segment that we're talking about, what sort of growth are you expecting -- not long-term growth rate, just next quarter?
I would merely say that there are segments of the business that are growing at double digits to be sure and I would not go beyond that.
[Operator Instructions]. Our next question is coming from Fahad Najam of Cowen.
Carl, my question is on the diversification comment you made earlier. If I think about it in terms of your business shifting from what you described the Tier 2, Tier 3 ILECs in the U.S. to a Tier 1 in the U.S. and maybe a Tier 1 in the U.K. In terms of fundamental diversification of the business, help us understand, when you say your business is diversifying, I see it essentially being going from a Frontier, Windstream, Verizon and CityFibre, what is fundamentally driving your optimism on the diversification in your business model?
I'm not sure I follow your question. Driving the assets...
In essence, you're going to have two large customers, Verizon and CityFibre from what you at present have CenturyLink and Windstream. So what's the diversification? I mean you're essentially moving from one set of customers to 2 large customers. Is the remainder of the business average contract value with the new logos that you're adding, are those increasing at such a rate that it fundamentally diversifies your business model? Does that clarify the question?
It does. So let me go back to that matrix that I was talking about when Christian was asking about the 75%, 25%. And so what I hear you saying is, numerically, why did the diversification look any different if you're sort of swapping these customers for those and then you're going to end up in a concentrated environment. Is that a fair [indiscernible]?
Yes.
Okay, good. So a different way of thinking about what we're doing is there's 2 evolutions going on. One is the customer statement evolution, and obviously, what we're trying to do is help all of our existing customers. But you have 2 very different product offerings. One is the traditional sort of complex systems box ship company that was Calix 1.0, and Calix 2.0 is an all platform. We have systems along with it, but it's driven really by the platform value, the operating systems and the cloud value. The new customers are coming into that new model. They look different than what a traditional contract would look like. It looks somewhat different to a lot different than a box ship customer and for the -- an older Calix 1.0 type of environment. So it's being diversified not only on a customer statement standpoint, but it's diversifying into a new business model. That's the diversification that changes things, and it's part of what we're learning as we do the business because obviously, a small but growing percentage of the business, for example, shows up not as box ship but it shows up as contracts that are put in place and potentially don't revenue except over the course of 3 years or 5 years. It's just a very, very different structure than a pure box ship model. So that's the 2 dimensions of the diversification, not just one. Does that help?
That does. And if I may ask one more question on, are you beginning to see any kind of related wins at 5G deployment besides Verizon? Is 5G becoming an incremental growth driver for you?
5G is an incremental marketing opportunity. How's that? But you know, look, 5G is, I think, in my opinion, a huge marketing issue, some technology pieces, but mostly, I think not well understood yet in what it actually is and how it works, the spectrums it runs across, et cetera. As you know it's a multi-spectrum standard. Inevitably, 5G I believe becomes the working standard across the industry. But I believe that's going to happen over quite a few years. Irrespective of 5G, I think the thing that we can all understand and agree on is that people carry devices, and these devices are increasingly content-rich and they demand a lot of the communications infrastructure each single device. And the number of devices is growing exponentially.
And the only -- and by the way the number of devices is growing exponentially and they all have a wireless physical layer. They don't have an Ethernet port that you connect to anymore. I'm sure you've noticed that. And so the only way you're going to deal with that content richness and device exponential growth rate is to in fact have less devices on any given antenna. So whether it's 5G, Wi-Fi 6, what you're going to have is enormous proliferation of antennas that has to somehow connect back to the edge of the data center. And when you try and resolve that, both physics and economically, we believe the only way you get there is over a shared fiber infrastructure that you can run wavelengths on. And so with that in mind, NG-PON2 at Verizon is a pathfinder for the rest of the industry whether -- regardless of what antenna you're putting on the end of it. So given your technical background, does that help you see what we're at?
Yes. So asked differently, are you seeing uptick in NG-PON2 besides Verizon? And if that's the case, is that presumably leading into your winning more greater share of your wins because you have an expertise around dealing with NG-PON2?
We certainly see a lot more interest in NG-PON2 for sure across our customer base. But keep in mind that the optics in NG-PON2 are growing, but are still somewhat supply constrained. So our ability to go deploy them at the rate there is interest is still somewhat constrained given the fact that Verizon is a major consumer of the supply today. So there's more matrix than actually is supplied. Sorry, does that make sense?
Our next question is coming from Christian Schwab of Craig-Hallum.
Carl, I just have a quick follow-up. I get this question a lot. I'm wondering if you can walk through, I'm sure there's a wide range of outcomes, but can you talk about the revenue opportunity per customer on the different cloud and software platform systems that you're providing to customers on a go-forward basis and help investors kind of understand the revenue opportunity by application or by customer, if that's easy to do?
It is. I don't know that we've done it publicly, so...
Now we have a chance.
Yes. And so I know and I appreciate you're giving us the stage to do that, but I'm going to respectively demur until I think about what we've shared. So I'll hold that for next quarter. Let me -- I got to go back and look at what we've stated publicly, Christian. So the answer is, we clearly haven't been internally and then obviously, we would be [indiscernible] not to. I don't know that we've shared anything. So I'm sorry for stiff-arm you, but I'm going to have to stiff-arm you at this time.
Thank you. At this time, I'd like to turn the floor back over to Mr. Dinges for closing comments.
Thank you, Operator. Calix management will be participating in a number of investor meetings and conferences during the third quarter of 2019. Information about these future investor events will be posted on the Events and Presentations page of the Investor Relations section of calix.com.
Once again, thank you to 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. Goodbye for now.