Calix Inc. (CALX) CEO Carl Russo on Q3 2018 Results - Earnings Call Transcript

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About: Calix, Inc. (CALX)
by: SA Transcripts

Calix, Inc. (NYSE:CALX) Q3 2018 Earnings Conference Call November 5, 2018 5:00 PM ET

Executives

Tom Dings - Director, IR

Carl Russo - President and CEO

Analysts

Paul Silverstein - Cowens

George Notter - Jefferies

Christian Schwab - Craig-Hallum

Tim Savageaux - Northland Capital Markets

Operator

Greetings and welcome to the Calix Third Quarter 2018 Earnings 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 your host, Tom Dings.

Tom Dings

Thank you, operator and good afternoon everyone. Thank you for joining our Q3 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 in an 8-K filing as well as on the Investor Relations section of the Calix website. The conference call will be available for audio replay in the Investors Relations section of the Calix website.

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 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, unless otherwise stated on this call we refer the non-GAAP measures.

With that, let me turn the call over to Carl. Carl?

Carl Russo

Thank you, Tom. I will make some brief remarks and then open it up to questions. Our all platform model enables us to deliver gross margin expansion, disciplined OpEx investments, deliberate revenue growth, and increased predictability. I'm very happy to report that all financial metrics were in or better than our guidance ranges.

With non-GAAP net income, $0.03 per share above the high end of our guidance range it was an excellent quarter of execution by the Calix team. While there are many highlights from the quarter I would like to speak about only two. CityFibre joined us working with their customer Vodafone to build a fiber infrastructure in the United Kingdom that will reach up to 5 million homes and businesses. CityFibre is quite interesting as they are a wholesaler building the highest capacity lowest cost per bit - per mile infrastructure for others to provide services on.

CityFibre represents a compelling contrast to Verizon's state-of-the-art retailer model and both are deploying AXOS in their respective unified access infrastructure. CityFibre and Verizon are specific validations of our AXOS platform. Also we continue to expand our addressable market and broaden our base at torrid pace adding 33 new customers which brings us to 99 new customers year-to-date. This is broad-based validation of our revolutionary Calix cloud, CXOS and AXOS platform.

My comments would not be complete without a discussion of tariffs. Like many companies we have built a global supply chain which means we are exposed to the U.S. tariff. However unlike most other companies we expect the impact to last for no more than three quarters. We have already been reengineering our supply chain to take advantage of our platform and we are simply going to accelerate the remaining work.

With the impact of the U.S. tariffs being short term we have decided not to pass on these costs to our customers. Our revolutionary platforms are ramping into the market and we want our sales and marketing team to remain focus on this effort. Furthermore we will not include the U.S. tariffs and tariff related cost in our non-GAAP financials.

With this in mind our non-GAAP guidance for the fourth quarter is revenue of $122 million to $127 million, gross margin of 46% to 48%, OpEx of $51 million to $53 million and net income of $0.08 to $0.14 per share.

With that I strongly encourage each of you to download our stockholder letter and get all the details on the third quarter and the clear view into the future for Calix. Let's open the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Paul Silverstein from Cowens. Please proceed with your question.

Paul Silverstein

Thanks. Carl, just small question and the larger question. The small question, the 33 new customers which brings you to 99 for the year, that's out of how many?

Carl Russo

You mean out of how many customers do we have as a company?

Paul Silverstein

Correct?

Carl Russo

I mean, we have roughly between 1,400 and 1,500 customers give or take.

Paul Silverstein

And were all those 33 new customers for either access, access or cloud?

Carl Russo

Quite literally, virtually all. I think there may have been one or two that weren't. But it is obviously our new platforms that drives all of our new customer acquisition.

Paul Silverstein

Okay. And correct me if I am wrong. You guys aren't yet breaking out revenue for access, access and cloud, is that correct?

Carl Russo

That is correct.

Paul Silverstein

Okay. At some point you plan to do it.

Carl Russo

There's no current plans to do it, you can't predict the future.

Paul Silverstein

Okay. The larger question, beyond what seems like a sizable horizon in city fiber opportunities. Or can you offer some insight regarding what you're seeing with respect to access, access and cloud take up. Any preferably quantitative but I would say qualitative metrics that of data points you could share?

Carl Russo

Not quantitative but I can share with you qualitative that they're all ramping. Yet. So as of course, is newly wrapping because it's now just going into the market, we have a quite a few customers that are on what we refer to as an early adopter program and deploying. But let me see, if I can give you a better sense, especially since we just came off of our connections user group for 2018.

I expect Calix Cloud to ramp up even faster than it's been ramping up. It seems that our customers and prospects are now really starting to understand the power of those platforms to help them shape their business models. I certainly expect AXOS as a network operating system to continue its ramp and to steepen. But remember, these are network decisions that happen over a broad period of time. But it's clearly captured the imagination of sort of the hardcore networking folks.

But AXOS is, I believe, as we help our customers on the subscriber edge, not only manage the complexity of the subscriber edge, but start to monetize. It may in fact be the fastest ramping up of the three. The fourth are the attached services which are Greg and his team have been really doing an excellent job of helping our customers start to transform their businesses. And we're going to see those service offerings ramp as well through 2019.

So qualitatively all moving at or better than my expectations, especially get coming off the energy of connections.

Paul Silverstein

My apologies, to other people on the call, if I could ask one more question. From a margin structure perspective, I recognize hard enough to predict near-term. But as you look down the road, is there any reason why as your legacy platforms decline in excess cloud grow up off also small base. Is there any reason why this wouldn't be or couldn't be a 60 plus percent margin model?

Carl Russo

Well, that's a very long future statement. I made if you start extrapolating incremental revenue and margin and you start to understand what's happening in the business, way, way, way, way long term. I don't know where the ebbs and flow is Paul. It certainly could be in the 60s. But obviously we're focused on the near-term to go above 50 points, and deliver that at $600 million or sooner in revenue. So there's no reason it can't be. But that's such a long range start that I wouldn't throw it.

Paul Silverstein

All right. Out of consideration to others I will pass it on. Thank you.

Carl Russo

Thanks Paul.

Operator

[Operator Instructions] Our next question comes from the line of George Notter from Jefferies. Please proceed with your question.

George Notter

Hey guys, thanks very much. Maybe along the same line, so I guess I'm also interested in the transition away from traditional systems of the products to AXOS and EXOS. But if customers are pushing back on that, let me ask it this way so I assume there is still some revenue run rate of the traditional products here. What inhibits customers from moving more quickly to AXOS and EXOS right now? Is it status quo, incumbency are there switching costs like help me understand kind of the customer decision and why you can't move customers even faster under the new products?

Carl Russo

Well, so great question so let's make sure we're understanding how we approach all of our platforms going forward. We approach them from TAM expansion first, George. So our first goal was to in fact address used cases that would allow us to start to expand our TAM. So if you think back NG-PON2, Verizon, Lap, Intelligent Edge Network and then you sort of work your way back from that into your existing customer base, not because you're trying to delay your customers, just simply you're trying to make sure that you're getting the biggest return on the investment you can make in regards R&D.

So now directly to your question in the case of AXOS to your point it literally comes down to slowly but surely the line cards being available inside of the E7 that run AXOS and so the GPON line card is in the market. There are the new line cards coming out on 10 giga aggregation and there are line cards after that so nothing other than allowing customers to see it understand it and value it.

What we're not going to do is discount the value that exists in AXOS to force or migrate a customer. So customers that are happy on EXA we're perfectly happy to let them stay on EXA. If they see the value of AXOS they can make that decision to step up to AXOS and we'll be happy to help them. But what attenuates that swap rate now is literally just availability of line cards to address more and more used cases. That is occurring obviously this year and will occur in earnest next year.

George Notter

Got it, anyway to sort of measure that availability of line cards I mean if you look at your total line card shipments in the quarter what mix of those might be available on AXOS right now just out of curiosity.

Carl Russo

Yeah there's a way to measure. I think you're asking me will I share that measurement with you, is that right?

George Notter

Correct.

Carl Russo

Yeah, so we're still early days and the focus right now is on the fiber side. So let me see if I can knock the thesis. From a fiber access standpoint substantially all of the fiber access line cards will be available before the - in essence before the end of the year for all our line cards and some of them will be on early adopted programs but they'll all be basically available and volume shipments will continue to ramp in to 2019.

George Notter

Okay, great, that helps. And then I also wanted to just come back and ask about the China tariff situation you mentioned you guys are taking on plans to mitigate the impact but can you tell us exactly what you're doing is it something on the manufacturing side, component sourcing? And then also can you tell us why you decided not to go back to customers and try to pass it on as a surcharge and themes like that below the counter to what we're seeing many other companies doing right now? So wanted to ask about those as well. Thanks.

Carl Russo

So great, so the answer is, it is counter and the reason it's counter is because frankly there are platforms. We've been developing our platforms we started as you know in 2011, we've been running the platforms and networks for now we're going on our fourth year in various forms. And we began four years ago because the platforms are fully abstracted from the hardware to utterly change the way we design and develop and manufacture our hardware.

So Mehdi, who heads our product operations in his team have been slowly but surely realigning our supply chain with our platform model, which means a much greater percentage of our systems are developed in what are called ODM or JDM relationships and less in contract manufacturing.

Our original plan was to continue that re-engineering and complete it over the course of next year. So what happens? Well, the tariffs come up. So we basically will have to accelerate the remainder of our strategic plan. And as such, we believe we can be out from under the tariffs and a couple of quarters, maybe three quarters. Once you understand that now you're looking at decisions based upon the opportunity cost of those decisions. If we were a steady state company, if you will more mature, we would pass on the tariffs, no question about it.

But given the ramp of these new platforms, the opportunity cost statement very simple. Do we want to have our sales and marketing folks explaining tariffs to our customers or do we want them ramping our new platforms and the volume of the new platforms is so high that the correct opportunity cost decision is infect to simply take our energies to the extent that we want to work on the tariffs and focus on accelerating the reengineering of our supply chain and keep our sales and marketing folks focused on doing exactly what you asked, which is exposing our customers, a AXOS, EXOS and Calix Cloud and getting on with it. So I hope that answers your question.

George Notter

Got it. Very good. Thank you very much.

Carl Russo

Thanks, George. Feel better by the way.

Operator

[Operator Instructions] Our next question comes from the line of Christian Schwab from Craig-Hallum. Please proceed with your question.

Christian Schwab

Congratulations on a solid quarter end guys. I only have one quick question. In the near-term, Carl, do you feel better? I would imagine about being able to get to your 50% plus gross margin target, maybe over say, $600 million in yearly revenue?

Carl Russo

So Christian, I'm going to rephrase your question in the way I heard it which is, do you think you can get to it before $600 million?

Christian Schwab

Yes.

Carl Russo

So we're not changing our model. The answer to your question is yes, we do. But until we have a good clear view about and how the mechanics work, we're not going to change that model. And let me just give you a qualifier. If you think back to George's question, it may be that over the course of this coming year what we see it as accelerated ramp on our AXOS and EXOS systems. But by the way, what comes along with that or transitions off of our ESA and first generation Giga family systems.

And when you do those things, there are product lifecycle things that show up in OCOGs, they don't show up in COGS, because you had some components leftover or whatever. So I would want us to be cautious in the next year to make sure that we get a clear line of sight. But your question the answer to your question is yes, you're directionally correct.

Christian Schwab

Great. I guess just one quick follow up, you kind of categorized previously would Verizon could eventually ramp as a full customer? How would you compare the opportunity to the fiber to Verizon?

Carl Russo

It is, so great question. It is substantial. So let's look at CityFibre and their customer Vodafone, because that's what's driving it. CityFibre literally just closed on $3.5 billion in funding to, in fact, drive to the 5 million homes that they're committed to driving to a homes and businesses in the United Kingdom. So they're going to wait Nash from CityFibre was on stage and made the statement on stage - the connection, pardon me. And made the statement that they're going to try and do this within the next 5 years.

So when you start looking at those rollouts and you're talking about a million endpoints. Let's just say that it's probably smaller than what Verizon can be. But look, we said way back when that we wanted to try and make sure that we could add one large customer that would be doing large ramping things over multiple years, every year. There you are.

Christian Schwab

Great. Thanks. No other questions?

Carl Russo

Christian, thank so much.

Operator

[Operator Instructions] Our next question comes from the line of Tim Savageaux from Northland Capital Markets. Please go ahead with your question.

Tim Savageaux

Hi, good afternoon and congrats on the results and guidance. Really follow that CityFibre question was kind of, more of a timing question in terms of when you expect that to ramp. You can see a down ticket in International revenues in the quarter. I'm guessing maybe that's a '19 thing, but do you have any more color in terms of the timing of the ramping of that opportunity?

Carl Russo

Well, so on that particular opportunity you're going to see that ramp as you stated correctly over 2019 and continue on from there because they got a lot of work to do. The CityFibre team is committed to going at this pretty rapidly but I think you're going to see that over 2019.

Tim Savageaux

Great, and maybe and this is - can be sort of a substitute for your typical competitive landscape question, maybe you could talk about the CityFibre competitive situation as a microcosm of that, in terms of kind of how Calix's was able to differentiate when the opportunity relative to what I assume might be the usual suspects or perhaps not any other comment on that the kind of competitive landscape in general or maybe using CityFibre as a proxy for that?

Carl Russo

Well, so great question Tim, and thanks for asking it because quite literally as you might imagine they are well known and we're well targeted but I think the key to understanding the differentiation and I spoke to in my opening comments that it's very interesting to me that CityFibre, a wholesaler looked at AXOS and said that's the right way to go.

The reasoning why that way is as you might imagine a wholesaler is certainly CapEx sensitive but they are far more OpEx sensitive. And what AXOS allows us to do along with the other things that we're doing is get to the lowest OpEx on a cost per bit, per mile, per subscriber sort of basis.

CapEx obviously is also quite efficient because it's a collapse in-go [ph] network infrastructure. But AXOS what drove that decision and that's what they are deploying, not anything else. If you can compare what they're doing with what Verizon is doing, Verizon is actually building sort of the ultimate retailer network. They're providing all services to their subscribers, they're not renting out their network to anyone. And they're building the same network.

So to me it renders very clearly you have these two counterpoint business models arriving at the same network solution, I think it's pretty clear where all of this is going and we're going to stay focused on finding the right minded prospects and continue going down that path.

Tim Savageaux

Is there perhaps more advantage kind of to the software flexibility of the cloud form if you are renting out your network versus retailing or how would you describe those two used cases as would they advantage your product differently?

Carl Russo

That's a very stupid question and the answer is yes, it does because AXOS as you know from a net cost interface native fully yang modeled and the telemetry and intelligence that exists in the network allows CityFibre to actually expose their network to a potential customer and allow them to almost dial up and run it themselves and have multiple customers doing the same thing at the same time. So it does in fact advantage AXOS in quite a unique way.

Tim Savageaux

Got it, and within the quarter what are - and this may have been in the letter somewhere and I may have missed it but can you speak to 10% customers in the quarter and maybe overall levels of concentration if you can?

Carl Russo

Just one 10% customer. And as you can hear from the new customer take-rate the term is expanding, the customer base is expanding and our ability frankly the predictability of the go-forward platform business even on the ramp it's on it's frankly more predictable than dealing with the older legacy access systems business, even though those customers have been around longer the new model is just much more predictable.

Tim Savageaux

That leaves me into my last, I think two part question which is, as you look at to your guidance for Q4 a nice sequential uptick, are there kind of particular drivers there on the Tier 1 U.S. side or any other thing you'd like to call out? And then within that as well looks like systems margin upticked a bit again in the quarter I wonder if you expect that trend to continue or what would do you have any comments on systems versus services margins as they reflect on your overall Q4 margin guidance?

Carl Russo

Okay, so let me go to the first question first. Remarkably, the answer to Q4 things to note is unremarkable. The statistical set that we are building really is less and less dependent on any given remarkable thing, which is very nice for my ability to go to sleep at night. And the second is on the systems margins or calling out anything. So not to give guidance, but to just give you a general view, we expect systems margins to continue to expand.

I want to go back to the caveat that I gave in George's question around transitions. You have to be careful about 2019 and we're going to be very cautious about that. But the general trend should be up. Services in general will go up, although I will note that in this quarter and next, so Q4 and Q1, we are going to make some modest investments. And it actually turns out to be a good thing. And it goes like this. The rate of success on the cloud ramp is such that we are going to invest some modest money in the services organization in the customer success related to deploying our cloud platforms.

I don't want anybody get nervous. It's not like services are going to fall off a cliff, but it's done a sort of go out flattish to slightly down into the first quarter. And then it's going to go right back on its growth ramping in margins, again, throughout '19.

So that's the only shaping I would give you. Please don't take that as specific guidance.

Tim Savageaux

Understood. Thanks very much. I'll pass it on.

Carl Russo

Thanks, Tim.

Operator

[Operator Instructions] Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Tom Dings for closing remarks.

Tom Dings

Thank you, operator. Calix will be participating in several investor conferences during the fourth quarter of 2018, including the Craig-Hallum Capital Group 9th Annual Alpha Select Conference in New York City on November 15 and the Cowen Networking & Cybersecurity Summit in New York City on December 11. Details regarding these events are available on 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. Good bye for now.

Operator

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