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Calix Inc
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Greetings, and welcome to the Calix Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the brief introductory remarks. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Mr. Tom Dinges. Thank you. You may begin.
Thank you, Operator, and good morning, everyone. Thank you for joining our third quarter 2019 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, 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 Web site. This conference call will be available for audio replay in the Investor Relations section of the Calix Web site.
Before we continue, 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 third 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 conference 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. We delivered solid results in the third quarter, achieving flat year-over-year revenue, which marks a significant turn in our business. To be clear, we intend to grow our revenues from here. Our results in the third quarter were strong, with revenue and earnings above Street expectations, and we generated cash. Demand was strong throughout the quarter, and we enter the fourth quarter with a solid backlog of business, thus our forecast for our return to growth. Our transformation to an all-platform company providing cloud, software, systems and services to facilities-based CSPs of all types has been underway for a few years. We are pleased and energized to have it now begin to show through on the top line.
As for the secular disruption rolling through our industry, we believe we have it right. We have the right platforms and the right services at the right time. Three examples of the business outcomes we helped our customers achieve in the third quarter were, Farmers Telecom Cooperative achieved a 66% reduction in tech support costs with Calix Support Cloud, and is reallocating those resources to elevate their subscribers' experience with our EXOS-powered GigaSpire. 3 Rivers Communications engaged our professional services team leveraging automation tools, best practices, and quality systems that resulted in a 50% improvement in their resource efficiency. And Northwest Communications Cooperative used Calix Marketing Cloud to achieve a nine-fold increase in their most recent marketing campaign.
Helping our customers achieve their business outcomes when they deploy our platforms is core and central to our mission. We're excited that this focus now has us entering the fourth quarter with a strong pipeline of demand on top of a solid backlog. And next week, we are hosting our 2019 Connections Event, which promises to be the best yet. We are positioned to ride the wave of secular disruption moving through the communications service provider marketplace, and as the all-platform leader, we intend to grow from here on out.
With that, let's open the call for questions. Operator?
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Paul Silverstein with Cowen. Please proceed with your question.
Thanks, Carl. Two questions, if I may. One, to your commentary in the investor letter about the margins being impacted by customer and products, any incremental insight you could give us on that. The new products are growing, I would think that'd be positive group incremental margins, not negative, and originally the U.S. was up as a percentage not down and that would also be positive. What's going on there? And then with respect to revenues, from a customer perspective, can you give us any incremental insight on the "Legacy" group of customers CenturyLink, which obviously you all disclosed as 16%, but the Tier 2s which had been a drag in revenue growth over the past year or two, can you give us any incremental insight on that, that'd be appreciated. Thanks.
Thanks, Paul, and good morning. Let me address those in order. So, from a margin standpoint, as we've said throughout, we think of it in terms of red ocean and blue ocean, our legacy systems versus our blue ocean platforms, and you're right, product mix as we accelerate on blue ocean would tend to move the margins up. The challenge that we have really are two. One is that in any given quarter product mix, red to blue, what they are, et cetera, can vary the margins. And in these next four quarters I would say of continuing to transition the business while we expect revenues to continue to grow from here, there's still going to be some noise in the margin line for red and blue.
The second factor actually is we have a very large customer that, as you might imagine, has pricing that might be better than corporate average pricing, and therefore margins lower than corporate gross margins. In Verizon, that now was more than a 10% customer in the quarter, and frankly I'm pretty happy with the margin line being where it is and having that in the mix. So that's the way I would look at the margins.
On your second question, we spoke about the legacy group and we included, if you remember, CenturyLink in that and said it's less than 25% of our business. And I think on the last call we said it was roughly between 25% and 20%, with last quarter's CenturyLink being 17% of that. We include CenturyLink because they were one of those legacy customers from the start of our business, albeit today they're sort of a very different customer, but if we project that forward, I would tell you that in Q3 they were roughly in the same zone of 20% to 25%, by the way and they've been running in the 20% to 25% range all three quarters of this year. So, hopefully that helps you, before I ask Cory if he has color to add, did that answer your questions, Paul?
It does. But quick follow-up on that, I appreciate you all gave us -- you gave us a number of directional data points about growth in unit [ph] products from a customer acquisition as well as from a percentage growth perspective. I recognize it's still very early in the launches of those platforms access -- access and cloud, but can you give us a sense for what the revenue base is today?
So the answer is no, because we consider it unfortunately too competitive a data point. The best thing I can do is use some language and just basically say it's -- what is it significantly -- it's obviously material at this point and has been for quite some time, and it's growing quite rapidly. To add a little color that you didn't ask for but maybe just to help, we are very excited going into connections because all three platforms are full-fledged in the market. And as a subscriber Edge we have great expectations for our EXOS platform and the GigaSpire systems that run it, so that's -- I would -- beyond that I would not go. Cory, do you have any color you want to add to any of these?
No, I think we're -- you said it right.
Okay, Paul, sorry.
Yes, but Carl, going back to the margin question, I trust -- I understand the point about Verizon, but as you work over the longer term, and I recognize there's quite a way to go, but I trust this can still be a 50-plus and perhaps meaningfully above 50%-plus margin model with the benefit of greater revenue, or is that not the case?
That is definitely the case.
Okay, I appreciate it. I'll pass it on. Thank you.
Thanks, Paul.
Thank you. Our next question comes from the line of Christian Schwab with Craig-Hallum. Please proceed with your question.
Great. Congratulations on Verizon being the 10% customer in the quarter. As we look at that customer in 2020, is that part of the enthusiasm for growth from here on out?
It's part of the enthusiasm, but it's really not what drives the enthusiasm. What drives the enthusiasm in the company is the continued expansion of our addressable market and served market manifested in two ways, the new platforms and their growth; albeit we're not giving you numbers on what those are, for Paul's earlier question, but the numbers that we are giving you is our new customer rate, and that expansion is really, in my opinion, what's building the value of the business, because not only is it unlike anything else we see in the marketplace, but it's a very predictable, highly differentiated set of customers that are on attack. That being said, yes, we're very excited by Verizon, but what drives our excitement by far is the sea change that we see in the marketplace.
Great. And then just to follow-up on the gross margin question, and your comment that you're very happy with the gross margin guidance for the December quarter given the mix of business and would expect that to continue. Can you give us a scenario of what type of mix or revenue would be needed for you to get to 50%-plus gross margin?
Sure, which is sort of a different way of asking the question that Paul asked, I'm not -- I guess the way I would answer it, Christian, is the following. As we continue to accelerate our new platforms there's going to come a time in the not too distant future where we think that 50-point margin occurs and that that's in our rearview mirror, and we continue to grow from there. Obviously, our new platforms are a material part of the business and growing rapidly. I would reserve the right to come back to you on that in a couple of quarters and give you a more direct answer.
Great. No other questions. Thank you.
Yes, thanks, Christian.
Thank you. [Operator Instructions] Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Please proceed with your question.
Hi, good morning, and congrats on the results. I guess my first question is kind of higher level, which is there's been a fair bit of volatility, I guess, among your peers across the kind of broadband access space spanning both fiber and copper solutions. I guess most of that has been driven internationally, but I wonder if you might comment or sort of reflect a bit on kind of the difference in terms of what you've seen in terms of your results and outlook, themes like, in addition to Verizon, the kind of U.S. Tier 3 market has been sort of important to that growth. Seems like it was up 15%-20%, I wonder if you expect that to continue, and would you point to that as kind in your more domestic focus as the real delta between some of the unsettled results we've seen in the performance that Calix is putting up here, to talk a little bit about that. Thanks.
Tim, sure, and thanks for the question. I'm going to relate it back to Christian's question about enthusiasm around Verizon, and then see if I can paint a picture. So, I'm going to come at it from a customer statement standpoint and reiterate that we're looking for strategically aligned customers of all sizes. That being said, there are more customers that are small than large, just by just a general industry makeup, but we're also finding that more of them are being aggressive in the way they think about deploying fiber and wireless, building out a next generation infrastructure, being open to changing their business model using analytics. And so, those line of customers are our key focus.
Verizon at one level is somewhat is unusual. Verizon is obviously very large. But for us, they represent a very technological leading edge of where we are actually heading with obviously the Intelligent Edge one fibre infrastructure which basically combines the best of wireless and fibre in a next generation infrastructure. So, that's clearly what we are focused on. The second piece of that is from a product market standpoint, our platforms obviously are changing a number of things about the business. One of the things it's changing is actually in the future we are less likely to have 10% customers than in the past, and the reason for that is when you are selling big boxes -- and obviously Calix 1.0 is a box company, you are forever chasing large customer deals to fill in the next quarter.
As we do more software, more platforms, more services, our revenues are actually stretched out over time. They are higher differentiable value, but they are lower in any given quarter from a box shift standpoint. So we can do a very significant contract with a very large customer that happens to be software and it would never make the 10% threshold. So, you wouldn't see it from that perspective, the revenues are quite diverse. And obviously, our visibility is going up and our predictably should go up with it. So, when you tie all those together, I look at companies that are sort of like what Calix 1.0 like and I have somewhat -- there is some level of empathy there because it's a witheringly difficult business to predict. And you always end up in a high concentration environment, and some of the companies you mentioned are highly concentrated. It's is the antithesis of where we are going with an all-platform model. Our -- now it's not our intent. We are just going to be less concentrated because of many many more customers and because of as you move towards software and platforms, any one customer is less able to get to 10%. So, did that paint a picture for you?
Sorry. It does, but I would like you to comment further on the Tier 3 U.S. market in particular and what sort of -- whether I guess that's market growth or share increasing penetration, your kind of platform sales in terms of the pretty significant sequential and year-over-year growth you saw in that segment? And then kind of ironically back on the topic of big customers possibly could be 10%. In terms of your outlook, you seem to reference some kind of increasing ramp with the big international customer probably CityFibre in U.K. I wonder if you could talk about how that's progressing as well.
Let's go take the larger ones first. On Verizon, we said that we believe that it will get to be a 10% customer. And I think it will bounce up and down as a 10% customer from quarter to quarter. CenturyLink obviously is a very good customer, has a Calix embedded base. I expect that they will remain a 10% customer for the most part each and every quarter at some level. CityFibre as you know, they are doing huge infrastructure build, and you build the fiber first and do the head end, the OLT second, and then ultimately you do the ONT. And so that ramp is still well in front of us and they are making progress. But as we said before, they are building brand new infrastructure. And it always takes longer than you think. When you talk about -- use the term Tier 3, we do not use the term Tier 3s anymore. We use the term small customers. And the reason we do that is deliberate. Tier 3 is sort of a legacy telco statement. Small actually opens it up to all the different customer segments that we see not just telcos or IOCs, or cooperatives, but municipalities, cable MSOs, electric cooperatives, WISPs. We can go on and on. And in that space, we see tremendous growth, lots of capital formation to go address unmet needs, and we believe we are growing share as well as the market is growing in and of itself.
If you look forward and I don't -- look, agree parallel, I don't want anybody getting overly excited, but there is a next generation of CAF that's being currently debated which is referred as RDOF, which is the Rural Digital Opportunity Fund. The key difference between RDOF and CAF, there is a clause around allowing price CAF carriers to bid for the whole state which is a feature of CAF, which is now proposed to be removed which means would be distributed on a census block by census block basis. No longer could a big service provider come in and take the whole the state because they committed to it. Now you are going to be down in a census block level. And all of these smaller service providers are going to be quite advantaged in pursuing those funds as well. And we just see lots of capital formation, lots of capital flow into the space. They are able to build brand new models very quickly. And so, we see that space growing and we see our presence in that growing.
Okay, thanks very much.
Does that answer your question?
Yes.
Thanks, Tim.
Thank you. [Operator Instructions] Our next question comes from the line of Fahad Najam with Cowen and Company. Please proceed with your question.
Hi, Carl. Thanks for taking my question. I wanted to visit your services business. Obviously, it's declined 13% year-on-year, and that would have been prospectively beneficial headwind to your overall growth given that services have such long gross margin. To the extent that these new customers are ramping, should we expect services revenue to start increasing that the services gross margin will be a headwind again? Or, should we expect that services -- the bulk of the heavy lifting in the services business is behind us?
Actually, it's a combination of both. So, what we expect to see from here gently is services actually to start to grow at a modest rate because the heavy lifting as you referred to which was really the low margin deployment services is behind. And as you heard us say, we have been engaged in continually aligning our services business with our platforms and customer success. So what's happening underneath that number is the offerings mix is shifting towards much higher differentiable value and service offerings albeit they are lower revenue. But as you do more and more, the revenue will start to grow. But, the margins will continue to expand. So, we expect modest revenue growth with reasonable gross margin expansion in services.
That's helpful. So, going back to your commentary about the next generation of CAF funding coming in, typically can you walk us through how the services mix is in those types of deployments? I would assume there is a heavy services component with those CAF II type deployment -- CAF type deployment.
So to be perfectly honest, I don't know what it's going to look like as we go forward because when RDOF happens, we will be full blown in platform mode. With customer success oriented service offering, I don't know what that's going to look like, Fahad. Literally I would be throwing a dart.
Got it. Appreciate the answers.
The one thing I will tell you is we are not going to go backwards on gross margin because we are not going to go take on low value-added eat-on-the-street deployment services. Just to lay any fears you may have there.
That's very helpful. Thank you very much.
Thanks for the question, Fahad.
Thank you. Our next question comes from the line of George Notter with Jefferies. Please proceed with your questions.
Hey, thanks a lot guys. I guess I wanted to needle on the product transition some more. You guys talked about red transitioning to blue so to speak. And as you think about the transition, is it more about wining and ramping new customers or relatively new customers, or is it really more about converting existing customers of older systems to the next-gen products, XOS, EXOS et cetera? And then, I have a follow-up.
So the answer is that actually I don't know that was more, it's both, but I would be cautious with the term convert. So as we think about it, we are certainly thinking our Blue Ocean platforms to all of our customers. To the extent that they see the value and they want uptake them, obviously we are happy to help them on board. To the extent that they don't and they want to continue to order our legacy systems, obviously we are happy to do that as well. So, we are certainly going to offer them, but we are not going to go necessarily do a forced march if you get my drift, or discontinue our systems, we sort of issued that behavior. We would prefer to let our customers make end of sales decision, not us. So, does that help paint the picture before I answer the question you didn't ask?
Yes. I guess obviously you are looking -- you've got a dataset, right? You can go back and look at the mix of new customers and existing customers buying the new products. So, again I guess I was wondering what's driving that increasing mix of next-gen product. And then, I guess the second piece of this is I was also trying to understand what the friction points are with existing customers who are not moving off of the legacy products? What is it about those customers or their situations that cause them to move more slowly to the new stuff?
Great question. I will give you very simple parameter. The more aggressive the service provider, the more rapidly they are uptaking our platforms; the less aggressive, the more slowly. It's literally that simple. So, if they are aggressive in their markets and they want to take share, they want to raise the ARPUs, they want to lower churn, they want to take the footprint from other competitors, they are unbelievably well aligned. To the extent that they are taking a slow approach, they are less aligned, and we are happy to continue to support them with our existing systems.
Got it. Okay, right. Fair enough. Thanks.
Yes, thank you, George.
Thank you. We have reached the end of our question-and-answer session. I would like to turn the call back over to Mr. Dinges for any closing remarks.
Thank you, Operator. Calix management will be participating in a number of investor meetings and conferences during the fourth quarter of 2019. Information about these future 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.
Goodbye.