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Calix Inc. (NYSE:CALX)

Q2 2014 Earnings Conference Call

July 29, 2014 04:30 PM ET

Executives

David Allen - Director, IR

Carl Russo - President and CEO

William Atkins - EVP and CFO

Analysts

Tim Quillin - Stephens

Christian Schwab - Craig-Hallum Capital

George Notter - Jefferies

Simona Jankowski - Goldman Sachs

Simon Leopold - Raymond James

Paul Silverstein - Cowen and Company

Amitabh Passi - UBS Investment Research

Sanjiv Wadhwani - Stifel, Nicolaus & Company

Operator

Greetings, and welcome to the Calix Second Quarter 2014 Financial Results Conference Call. At this time, all participants are in a listen-only-mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, David Allen, Director of Investor Relations and Treasurer for Calix. Thank you, Mr Allen, you may begin.

David Allen

Thank you, operator, and good afternoon everyone. Before we begin the call, I would like to remind you that this conference call contains forward-looking statements regarding future events, including, but not limited to the size of our funnel of our sales opportunities, the long-term growth prospects for Calix, our expectations for the next quarter, our development of new products that will continue to help our customers transform their networks, the future business and financial performance of the company and our expectations of revenue, gross margins, earnings per share, stock-based compensation and amortization of intangibles. These forward-looking statements are based on estimates, judgments, current trends and market conditions that involve risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements.

I would encourage you to review the Company’s various SEC reports, including our Annual Report on Form 10-K for the period ending December 31, 2013 available and our Form 10-Q for the period ending March 29, 2014 available at www.sec.gov, in which we discuss these risk factors. All forward-looking statements are made as of the date of this conference call and except as required by law, we do not intend to update this information.

Also on this conference call, we will be discussing GAAP and non-GAAP results. We will be providing the non-GAAP estimates to enable interested parties to evaluate our performance in the same manner in which we evaluate our own operations. These non-GAAP measures exclude certain charges and benefits, which we do not consider to be a part of our ongoing activities or meaningful in evaluating our financial performance, including stock-based compensation expense, acquisition-related expenses if any, and the amortization of acquisition-related intangible assets. To help you better understand these results, we have included a reconciliation of our GAAP to non-GAAP results in our press release. All numbers that are discussed in today’s conference call are non-GAAP unless otherwise noted. This conference call will be available for audio replay in the Investor Relations section of the Calix website at www.calix.com. In addition, our earnings press release, along with supplemental financial data has been posted in the Investor Relations section of the Calix website, which you may want to review in conjunction with our press release in conference call remarks.

I would now like to turn the call over to Calix President and CEO, Carl Russo. Carl?

Carl Russo

Thank you, Dave and good afternoon everyone. Joining me on today’s call is William Atkins, our Executive Vice President and Chief Financial Officer. The Calix team performed well this quarter. Revenue exceeded our expectations and the quality of our earnings was excellent. This crisp execution all occurred on a backdrop of increasing activity in our customer base and with positive signs coming across all areas of our business.

I will come back with some thoughts on what’s ahead. However I would like to turn the call over to William to review Q2 in detail and share our guidance for Q3. William?

William Atkins

Thank you, Carl. We last provided you with non-GAAP guidance regarding Q2 on April 29 and in the guidance we called for revenues between $94 million and $97 million, a gross margin of between 45% and 45.5%, and operating expenses in a range of $42.3 million to $42.9 million, thus resulting in an EPS of between $0.00 and $0.02 per share. Actual revenue for the quarter was $98 million and EPS was $0.10 per share, both better than our guidance. Gross margin was 47.7% and operating expenses came in at $41.6 million, both metrics also ahead of our guidance.

As we indicated on April 29th, we expected Q2 be a cash generating quarter, and it was; with Calix ending the quarter with total cash and marketable securities of $79.3 million, up from Q1’s $75.5 million. Revenue for the quarter was $98 million, an increase of $3.6 million from last year’s second quarter level of $94.4 million, and it was also up sequentially from this year’s Q1 $85.8 million figure. International revenue was $12.6 million in Q2, up from $12.1 million in Q2 2013 and also up from $10.6 million in Q1. We had one 10% customer again this quarter.

At 47.7%, gross margin was higher than had been expected and reflected customer and product mix, a lower contribution of deferred and recognized revenues and some timing differences in anticipated revenues. The gross margin in Q2 was up from Q2 2013’s 47.6% level and also up from Q1’s 45.9% level.

Q2 operating expenses of $41.6 million were slightly lower than anticipated, but were up from the prior quarter by $0.9 million. Timing shifts and engaging outside consultants and implementing real estate and other plant, property and equipment improvements and in hiring contributed to this favorable performance relative to guidance. OpEx was up $1.7 million from the same quarter a year ago, primarily due to increases in personnel expenses, largely consisting annual compensation adjustments, and also due in part to additions in year-over-year headcount, which increased slightly from Q1.

Turning now to the balance sheet, we ended the quarter with total cash and marketable securities of $79.3 million, an increase of $3.8 million in the quarter. We expect the remainder of the year to be cash flow positive. Receivables DSOs were 38 days, compared to 43 days in the previous quarter. In anticipation of another strong quarter, inventory levels increased slightly to $45.9 million from $45.1 million in Q1. Inventory turns increased to 3.9 times in Q2 from 3.4 times in Q1 while decreasing from Q2 2013's 4.4 times. Deferred revenues was $45 million, down from $47.5 million in the prior quarter, reflecting the completion of a number of broadband services or BBS projects that were recognized as revenues during the second quarter.

As I noted earlier in my discussion of our gross margins, the level of closeout of deferred revenue in Q2 was lower than we anticipated going into the second quarter but was more than offset by demand from other customers. We expect the completion of these projects by the end of the calendar year and further substantial balance of our BBS related deferred revenues to be recognized in our P&L by year-end.

In terms of guidance of the third quarter of 2014, we expect revenues to increase over Q2. We also expect to continue to be profitable and cash flow positive for the remainder of 2014. Our guidance for Q3 is as follows. Revenue for the third quarter is expected to be in a range of between $102 million and $106 million. Gross margin is expected to be down this quarter, primarily due to two factors; one, product and customer mix considerations; and two, the recognition of additional BBS revenues, some of which will have carried over from timing delays in the second quarter. As we discussed in the April earnings call, these BBS revenues have lower margins because of their higher level of contracted professional services. In part, due to the possibility of some bunking of deferred revenue recognition in the third quarter, we are widening our guidance for our anticipated gross margin and we are therefore guiding to a 44.5% to 46.0% range for Q3.

As was the case this past quarter, we expect operating expenses to increase at a rate slower than revenues in Q3. OpEx is expected to be in the range of $42.5 million to $43.5 million with, a sequential increase primarily due to consulting and personal expenses and expenses related to the facilities improvement as I mentioned earlier. The expectations that I have have finished taking you through resulted in a guidance range for Q3 earnings per share of $0.05 to $0.10.

At this point, let me hand the call back over to Carl.

Carl Russo

Thank you, William. The second quarter brought more examples of the acceleration and demand for broadband services, particularly fiber-based services. And looking forward that demand continues unabated. The secular opportunity is making high performance broadband services available to all subscribers, regardless of their location and Calix is focused solely on enabling this evolution in access infrastructure. We are seeing this play out and are expanding dialogue with different types of service providers including traditional telcos, cable operators, municipalities, electrical operators, wireless companies and new market entrants across the globe. The Calix Unified Access Architecture speaks directly to these converging business models and our focused software, systems and service offering are gaining interest and footprint on all fronts. In closing, I'm encouraged that we are matching this increasing opportunity with a continuously improving execution of the Calix team.

And with that I would like to turn the call over for questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question is coming from the line of Tim Quillin with Stephens. Please proceed with your question.

Tim Quillin - Stephens

I know you understand kind of a limited visibility in your business but 4Q was obviously a swing factor last year into the downside. In previous years has gone up. Do you have any feedback at all from your service provider customers of what 4Q might be like in terms of a budget flush or lack thereof?

Carl Russo

Stated simply, we are seeing business as usual right now, which I would say is more reminiscent of the times passed. So certainly no negative indicators. William, you may want to comment on what you are seeing as you look out?

William Atkins

I think we’ve indicated that we’re looking at single digit top line growth for calendar year end and that’s something we’re still very confident about Tim.

Tim Quillin - Stephens

Okay. And then how is the pipeline building for 2015? So I tracked your Web site. There is 32 deployments of database services. We hear a lot about gigabit right now. It sounds like within your customer base there is a little bit of REIT mania right now that might free up additional capital that could be spent on broadband equipment. But how do you think about building up a growth story as you get past this year?

Carl Russo

So it’s not a problem per se. I think you’ve hit on all the trends. Pretty clearly we are seeing increasing conversations across every segment as I indicated in my earlier comments around the world. So it is a generalized trend of trying to meet that demand for providing subscribers broadband services regardless of their location and the implications that that has across, not only the networks but the business models. And so to your point you’re seeing REITs -- we've commented earlier our customer is self-funding and making investments as opposed to relying on the federal government. We have been seeing positive signs and those trends continue as I mentioned unabated. So for us it looks the same throughout,no doubt. No downward slowing, but also I wouldn’t say that there is going to be some geometric acceleration. It’s just slowly but surely building this momentum. So very encouraging.

Tim Quillin - Stephens

And do you have and I think one - this is my last question, thank you. But I think at one point you had a targeted business model in terms of the margins. Is there --do you still have a target operating margin which I think was kind of high teens, low 20s at one point and at what revenue level might you hope or expect to get to something that looks like that? Thank you.

Carl Russo

So let me give you a generalized statement and then I'm going to ask William to give you some color. We have long stated that we believe that we'd slowly but surely built to a greater than 50 point gross margin. I think you remember that, Tim. And we don’t see anything that gets in the way of that. Obviously as we go into markets where we don’t have share, you’re going to typically see margins that are lower than our corporate average. We’ve talked about those drivers, new products coming in. But the net of it is we believe we have the opportunity to get over 50 points of gross margin. And I don’t think there is any change there.

From a growth standpoint on the operating margin I’ll ask William to make a comment. I want to make sure that I'm being clear that we are going to make disciplined investments in both the sales marketing front of the business as well as in product development areas where we see the opportunity to get returns. I'm not trying to sit on anything that’s wildly disproportionate and our OpEx is in fact under growing our revenue growth. But I just want to make sure that you understand that if we see an opportunity, we’re going to go for it.

Now with that, I’ll let William do the other side of it.

William Atkins

Thanks Carl. Basically Tim, to Carl’s point, we are seeing operating expenses growing more slowly than our revenues and that’s a trend that we'd like to see to continue. We are still focused on achieving those better than 50% gross margin levels and 30% operating expense levels. So that’s something that we’re still targeting. But we aren’t putting a specific figure on it. So, with that I think that we’re confident about that kind of margin growth going forward.

Operator

Thank you. Our next question comes from the line of Christian Schwab with Craig-Hallum Capital. Please proceed with your question.

Christian Schwab - Craig-Hallum Capital

International revenue, did I miss that? Did you give that?

William Atkins

International revenue is around 13% of Q2 for this quarter and we disclose it -- let me just get the specific number while Carl can talk little bit more about the international opportunity.

Carl Russo

I’ve giving the opportunity to advance for time here Christian but I'm glad William is turning it over in a second.

William Atkins

It was $12.6 million.

Carl Russo

And let me just fill in the mapping. I am very encouraged by what we’re seeing in international because what we’re now seeing is the organic new accounts, pins on the map growth that we’ve been focused on for quite some time and we are opening new accounts at a very good rate and it’s building a nice robust foundation to bookings growth in the future and that’s exactly what we’re seeing going forward. So while the revenues are obviously a trailing indicator from bookings and they are growing, we expect that growth to start to accelerate.

Christian Schwab - Craig-Hallum Capital

Great. And then just roughly, as you see accelerated demand for the fiber based services, can you give us roughly kind of an idea of the mix of cable today and where that could possibly be exiting ’15 or ’16?

Carl Russo

I won’t give you a breakdown by segment. Obviously we don’t do that. We have announced a few items in the quarter that we thought would be interesting and material for both our customers and our investors with the announcement of Open Link cable, which allows our customers to deploy fundamentally a GPON fiber to the prem infrastructure inside of a cable operating model. We are clearly seeing increasing dialogues across all the different types of service providers. But beyond that I wouldn’t go.

Christian Schwab - Craig-Hallum Capital

Great quarter.

Operator

Thank you. Our next question comes from the line of George Notter with Jefferies. Please proceed with your question.

George Notter - Jefferies

Thanks very much. I wanted to ask more on the international business $12.6 million. But can you -- that number I guess is flat year on year and up a chunk sequentially. But can you tell us more about what’s going on with the Ericsson reseller arrangement? Do you have proof points now where you’re selling E-Series into heritage Ericsson EDA 1500 customers inside that network management umbrella; and when do you expect to see more of a ramp on that arrangement?

Carl Russo

George, thanks and again I think you’re on a cell phone. We’re having a hard time hearing you. But I think you’re asking for proof points on Ericsson. And so especially to the E-Series and selling that product, we are definitely seeing proof points across the board. And again as I mentioned earlier, it’s about pins on the map, also existing infrastructure and just the general numbers of customers that we’re interacting is growing at a good clip. Inside of that yes, the E-Series is in fact seeing deployed in those environments. And as far as something material and something that -- you might see press releases on -- you will see if there is something interesting in the future. But the direct answer to your question is yes, we are.

George Notter - Jefferies

Got it, okay. And then I also wanted to ask about linearity in the quarter and the DSO calculation came down. So I presumed that there was less of a business shift in the last month. Is that fair to say?

Carl Russo

Less of a what, sorry in the last month?

George Notter - Jefferies

Just backend loading…

William Atkins

There is a bit of backend loading that happens but that’s a trend that happens in pretty much every quarter. So we’re just basically seeing a greater customer take up and so now -- and there's also a little bit of deferred revenue that effects that calculation but even if you took the deferred revenue movements out of the quarter, it would still be very solid DSO number.

Operator

Thank you. Our next question comes from the line of Simona Jankowski with Goldman Sachs. Please proceed with your question.

Simona Jankowski - Goldman Sachs

I wanted to ask you a follow up question on the gross margin guidance. I think -- I understand the BBS impact. But outside of that can you just expand a little bit on the product and customer mix factors that you’re referencing? And if we were just to look at it on a like for like basis, so excluding the impact of BBS, what would margins be doing in that scenario?

William Atkins

We don’t discuss specific margins relating to specific customers for specific products Simona. But what we have said in the past is that when you have follow on business once you’ve established footprint that does tend to be at a higher margin level. And so that tends to be what happens when we talk about customer and product mix.

Carl Russo

And let me just add Simona, just a little bit of color because I think this may help you with what you’re trying to get at. The underlying trends of the business are supportive of us expanding our margins to over 50 points over time.

Simona Jankowski - Goldman Sachs

Got you. So Carl, so you’re not seeing any more intense pricing. It’s just more the ebbs and flows of in which quarter you happen to have more new customer acquisitions versus in which quarter you may have more of a fill kind of business. Is that right?

Carl Russo

There are little pieces of that but I want to go back to your first question, which was from a competitive standpoint. We are seeing no significant changes in the competitive stance around the globe. You’ll see little things over here and little things over there but statistically speaking, it’s consistent with what we have seen. And to your point, certainly parts of it are mix, part of it are new customers, specific things you may be doing; but again I want to echo what I said earlier, which is the underlying trends of the business are in fact supportive of us trending over 50 points of gross margin over time.

Simona Jankowski - Goldman Sachs

And during the quarter Cisco announced that they’re entering the access market as well with a GPON product. Can you just comment if you've seen them yet or do you have any view of that product and what you think of them getting into the business maybe perhaps more in the intermediate to longer term?

Carl Russo

We’ve excited to see more people acknowledge what we’re seeing the access space, number one. Number two, it really goes on the heading of I said earlier in that we aren’t seeing any significant changes in the competition from an access perspective. But obviously over time anybody stepping into the space, we’re going to see eventually. And if you look at over 10 years, we have seen are seeing competitors come and go. We take none lightly or frivolously. They are all viable competitors in this space. But strategically we remain focused on unified access infrastructure globally.

Operator

Thank you. Our next question comes from the line of Simon Leopold with Raymond James. Please proceed with your question.

Simon Leopold - Raymond James

I wanted to get two quick clarifications and then a trending question. On the clarification, I think you said the gross margin forecast for 3Q was 44.5% to 46.0%. Did I get that correct?

William Atkins

That’s correct Simon. We’re widening our guidance by half a percentage point in each direction effectively.

Simon Leopold - Raymond James

Okay. And then in terms of the revenue guidance, on prior calls you’ve talked about expectations of delivering year-over-year growth in each of the quarters, and the low end of this guidance the, $102 million would actually be down a little bit year-over-year. So it sounds like you’re backing off of that prior comment. Am I reading this correctly?

Carl Russo

I'll give you my perspective, because I’m the one that said, I think we can deliver quarter-over-quarter -- year-over-year growth in each of the remaining three quarters. The midpoint of William’s guidance is $104 million which in fact represents incredibly modest growth over I think $103.7 million which is what we did last year this quarter. So backing off I think is probably a misread. I think there has to be a range that William is comfortable with, and that’s what he has done. William I don’t mean to speak for you that’s certainly I just did.

William Atkins

Yes. You just did. I think the complicating factor here is the deferred revenue that we touched on in our answers to some of the questions and in our prepared remarks. And what we're seeing there, just to expand on that a little bit is; these are part of revenue which in the sense are the lowest priority for a customer to close out. They’ve already received the underlined equipment. They've already made the vast majority of their payments and it’s the sense, it’s just a question of closing out paperwork together with working with some outside third party consultants. And so their priority is lowest for basically closing out this revenue base. But what we're seeing here, we are seeing some pressure coming from the relevant government funding agencies in the other side to have this paper work closed out, which is why we remain confident that the deferred revenue component that comprises of the BBS deferred revenues is going to come down by the end of the calendar year to a small level. But nevertheless there could be some timing shifts between Q3 and Q4, which was why we’re being very, very explicit about what’s going on with those revenues.

Simon Leopold - Raymond James

Okay, then I wanted to see if we could put gigabit in a little bit more context, in that you've talked about numbers of projects, and they are nice number, several dozen gigabit projects. I'd like to get a sense of context of how many customers you have overall, so that we can sort of place the 32 in context of that and then a sense of how much revenue, what percentage of revenue was coming from these projects now and what you expect it will be, let’s say in 2015?

Carl Russo

So let me answer the first question first. We're on record saying we have over a 1000 customers by the way and we said it’s larger than that. We've actually been on record saying we have over a 1000 customers that are doing fiber to the prem. So that puts that into perspective. The reason we’re citing these is they are early indicators of what is clearly the conversation in marketplace Simon, and so with that you can anticipate that from revenue standpoint it’s a very small percentage.

Having said that, it’s arguably and strategically the most important conversation that’s going on out there. When you compare it with the rich broadband services that are being put over top up, be it gigabit offerings. So we believe today it represents the best future prognosticator that exist in the marketplace.

Simon Leopold - Raymond James

And that’s pretty much what I suspected. So my question was sort of go in, was trying to get a good sense of, and I was assuming it was small this year. When does it get to be material? When do you maybe hit 10% of revenue threshold from gigabit projects?

Carl Russo

So what you are asking here, Carl is the elbow of the market, right? And here is that, let me answer your question, I don’t know. Here is what I can tell you. The pre-elbow ramp is slowly but surely tilting up. So we're going to get to an elbow or it’s just going to tilt up and we won’t even know we're at an elbow until we're past it. Does that make sense?

Simon Leopold - Raymond James

It does. I appreciate the frankness.

Carl Russo

I mean I wish I could give -- listen, trust me, William would love me to be able to give an accurate forecast of that number. I cannot. But I will tell you, there isn’t a customer visit I that make, where this conversation isn’t front and center, not a single one.

Operator

Our next question comes from the line of Paul Silverstein with Cowen and Company. Please proceed with your question.

Paul Silverstein - Cowen and Company

Just a couple, including clarification from May. One, going back to the question about Cisco that Simona asked, I trust followed from your comments that they are not having any impact on pricing, put aside market share issues that you clearly responded to but they're not in fact catching pricing at this point either.

Carl Russo

Who is they?

Paul Silverstein - Cowen and Company

Cisco.

Carl Russo

Oh, no. We're not doing anything that -- we're seeing no change in the comparative situation out there.

Paul Silverstein - Cowen and Company

If I heard you correctly earlier, you said there's no meaningful change in pricing either or am I making that up?

Carl Russo

No. there is no meaningful change in the competitive landscape. So what does that mean? It means that pretty much each quarter and seasonally adjusted we see ASP erosions of certain amounts and things of that nature. The trend is the same as it’s really been for quite a while. So there is always going to be some level of pricing erosion. We don’t see anything discontinue it, is what we've seen in the past. So is that clear?

Paul Silverstein - Cowen and Company

Yes, I recognize that you're in an industry, in every product market in which pricings come down. The simple question is, is the rate changing and I heard you say no?

Carl Russo

No. That’s correct.

Paul Silverstein - Cowen and Company

Secondly, at the risk of beating the dead horse, since the questions come up many times, but I'll ask you again, just to make sure I understand, a little slow in the uptake, with respect to the ability, which has been a constant issue over the many years in business and in this marketplace, how would you contrast share us looking through your visibility today to 90 or 180 days ago? And what -- given the pickup in activity, if I remember correctly, two quarters ago, three quarters ago, you cited a meaningful improvement or meaningful increase in the nature of the conversations you’re having and now today we hear about a continuance of this conversation, the furtherance. What could go wrong that would -- what could change for the worst in terms of the rug being pulled out? How likely is that? Help us understand how quickly things could change or not change?

Carl Russo

So there's a couple of ways I want to come at this question, asked this question because you’re right and obviously the concerns you addressed are the same concerns we have ourselves. So we’re constantly testing and retesting our assumptions and William joining has helped actually refine those processes even further. That being said, let me give you a few indicators. We are seeing our customers expand the horizons on which they’re making investment decisions. And that would be a positive sign. We are seeing our customers evaluating fiber much deeper or fiber as a premise and in order to do so you have to think about your return on investment from a very different economic model with different returns, but you have to have a more strategic scope when you make that investment decision. We’re seeing more of that.

And so unlike last year where we were sort of seeing the competitions but everybody was trying to sort of figure out in that last quarter what’s going on with this effect, the Google effect, if you remember those conversations; I don’t even see a hint of that today. If I then align that with what I feel are better and better processes internally to take what was already a robust sales funnel but now really work on the details, I don’t see any big rocks going wrong. There could be smaller rocks. I am encouraged by our internal execution. So I don’t mean to be looking through rose colored glasses. I'm not seeing any negative language.

And the last piece is you’re also seeing increased investment from our customers in their own businesses. Tim earlier mentioned REIT's I think. There's all sorts of investment constructs that are being used to marshal dollars to make those investments. And let me ask William to add some color to this.

William Atkins

I think Paul, and I’ve said this to you as well as some of the other people that are on the call. In addition to getting really granular on the sale funnel as Carl has highlighted, one of my major goals is obviously to improve the predictability of our numbers going forward. And so coming out of that process is a strong desire to start the beginning of each quarter with a much more solid understanding and much more reliable book of revenues if you will that might have previously been the case. So I'm still working my way towards that but that is basically our end goal and that’s what we’re working towards. I hope that helps you.

Paul Silverstein - Cowen and Company

It does. Let me apologize to you all and the others on the call but if I could ask one more along these lines. And Carl I think you identified in your remarks some meaningful increase in your customers. I don’t know if that was a general comment or in connection with international, but either way -- I don’t think you’ve done historically, but can you share with us quantification of how much revenue came from your customers and how many new customers we’re talking about in terms of speaking to this visibility from another perspective?

Carl Russo

So we’ve never shared it from a percentage standpoint Paul, as I think you would understand and respect. But you also have a long history in this industry and you understand in complex networking businesses that new customers and new network wins lead to add-on business, because when you go in and build a network, you’re constantly adding to it. And so we’re routinely seeing over 20 new customers every quarter and obviously a significant percentage of them are coming out of the international market. And that’s a really healthy rate.

And when we look further out into the funnel and look at new opportunities, guess what, those customers that were new customers that we closed a quarter or two quarters ago are popping back up in the funnel with new business. So it’s just that healthy organic growth that you really want to see that has taken us a while frankly and longer than I thought a number of years ago to get going in international, but its going.

Operator

Thank you. Our next question comes from the line of Amitabh Passi. Please proceed with your question.

Amitabh Passi - UBS Investment Research

William my first question was for you. You exited the quarter with a deferred revenue balance of $45 million. I think historically warranties and stuff have been around $21 million. Do you expect the deferred revenue balance to come down by the difference, $25 million $26 million over the next couple of quarters? Is that how we should be thinking about it?

William Atkins

Broadly that would be the correct trend, but just to get into the numbers a little bit more, we finished Q1 with deferred revenues of 47.5 and we dropped -- as I think I referred to in my remarks, we dropped total deferred revenues down by 2.5. And as I recall indicating to everybody on the call, if you remove the extended warranty component from the deferred revenues that we disclosed in our 10-Q, you will see that basically all of that movement was in the non-extended warranty component, which is a very good proxy for BBS revenues. So you can see that the rate of erosion of those revenues slowed from Q1 to Q2 and that’s what led to our remarks about deferred revenue timing differences.

Looking forward we see that rate picking up and by the end of the year we’re going to have some deferred revenues that relate to broadband stimulus on the balance sheet at the end of the calendar year but nothing like the levels that we've had in the past. It will be relatively small amount, and mostly, the erosion of most of those revenues taking place over the next couple of quarters.

Amitabh Passi - UBS Investment Research

I guess the motivation for the question was, if I normalize for the deferred revenue moments and again I’m making an assumption here, if you presume $7 million or $8 million comes through in 3Q, it seems like ex-deferred revenue in the base business is roughly flat sequentially, despite the positive commentary of the growing pipeline. So I was just trying to understand if there is some other dynamic that may have helped Q2 that you’re not seeing repeat in 3Q in the base business?

Carl Russo

Short answer is no, we’re not. As features that Q2 demonstrated with the timing shift of the deferred revenues into Q3, we still delivered a good quarter and we see going forward strong underlying revenue growth, absent the BBS revenues that are still strong.

Amitabh Passi - UBS Investment Research

And then one final question. So we think about the early part of 2015 as the BBS headwinds are behind and I understand and I appreciate that gross margins can be volatile. Should we still expect directionally margins to maybe trend back to 46% or 47% in the first half of 2015?

William Atkins

We’re not guiding people to specific margin levels for specific quarters or halves in 2015, but overall we’re seeing gross margin ultimately trending to over 50% and so as you say, there are going to be some chops and lumps and bumps along the way, but that’s what we see it happening. But no, we're not going to guide to specific margins for quarters or halves in 2015.

Operator

(Operator Instructions). Our next question comes from the line of Sanjiv Wadhwani. Please proceed with your question.

Sanjiv Wadhwani - Stifel, Nicolaus & Company

Two questions, Carl. I was wondering if you could talk about CAF and any thoughts on spending outlook from tier 2s and tier 3s? I don’t think we sort of went through that during the call. And then second question related to that is, one of the competitors is sort of talking about how CAF is resulting in more services oriented revenues as they do things like installation for some of those customers. I’m wondering if you’re getting those same types of requests from some of your tier2-tier3 customers.

Carl Russo

So I may have to ask you to clarify but let me go back on the first bit. As we've discussed many times, CAF isn’t in essence funding source. It’s going to be driven towards more unreserved environments. Typically that’s going to be more rural than urban, which basically comes straight over top of what has been a traditional strong point for Calix and those service providers. So we view it as a positive.

Having said that, I don’t want to say it's like BBS, but often times what you'll see service providers do is they will look to bundle the projects and the installation in the form of a project when they go and deploy it. So there are certainly times when we see bundled services and systems together in the form of a project, and in which case, you will see from a gross margin standpoint, those particular situations will likely have lower gross margins than typical mix. And we’ll make decisions on a deal by deal basis as to what's strategic to us and what we want to compete on. If you're asking about doing services, separate from that?

Sanjiv Wadhwani - Stifel, Nicolaus & Company

No. That was kind of a bundled situation where it's sort of broadens a project but as a system and services piece bundled together. So, no, you answered my question on that. I appreciate it. Thank you.

Carl Russo

Yes, and we will go compete for those, as we see strategic alignment with where we're heading.

Operator

(Operator Instructions) There are no further questions at this time. I'd like to turn the floor back was to Mr. Allen for closing comments.

David Allen

Thank you Operator. Calix will be participating in the Jefferies Semiconductor Hardware and Communications Infrastructure Summit in Chicago on August 27. Information about future investor events will be posted on the Events page in the Investor Relations section of calix.com. We remain focused on executing against the opportunities ahead of us and we look forward to meeting with you at one of these future events. Once again, thank you for joining us today and good-bye for now.

Operator

This conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Calix's (CALX) CEO Carl Russo on Q2 2014 Results - Earnings Call Transcript

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