Calix, Inc.
Q2 2013 Earnings Call Transcript

Published: 31 Jul 2013

[Operator:]

Greetings and welcome to the Calix Second Quarter Fiscal Year 2013 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) It is now my pleasure to introduce your host, David H. Allen, Director of Investor Relations and Treasurer for Calix. Thank you, Mr. Allen. You may now 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 our expectations of the similar set up and performance next quarter as in this 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 our expectations, estimates and judgments and current trends in market conditions, and 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 Quarterly Report on Form 10-Q for the period ending March 30, 2013 available at www.sec.gov, in which we discuss these risk factors. All forward-looking statements are made 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 are providing the non-GAAP estimate 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 part of our ongoing activities or meaningful in evaluating our financial performance including stock-based compensation expense, acquisition-related expense if any, and amortization of acquisition related intangible assets. To help you better understand those results, we have included a reconciliation of our GAAP and non-GAAP results in our earnings 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 Relation’s section of the Calix website, which you may want to review in conjunction with our press release and conference call remarks. I’d now like to turn the call over to Calix’s President and CEO, Carl Russo. Carl?

[Carl Russo:]

Thank you, Dave and good afternoon, everyone. Joining me on the call today is Michael Ashby, our Executive Vice President and Chief Financial Officer. The second quarter of 2013 brought continued strong execution of our strategy. We remain focused on delivering the value of our Unified Access portfolio to our customers. This value continues to resonate with our customers as we saw strength across all of our product offerings, geographies and customer tiers. Looking ahead, customer buying behaviors are continuing to normalize. And as such, I’d expect us to demonstrate a similar step up in performance next quarter as we did in this quarter. With that, I would like to turn the call over to Michael.

[Michael Ashby:]

Thank you, Carl and good afternoon, everyone. If you’ve not already done so, I would encourage you to go to Investor Relation’s portion of our website and download the financial slides that we posted concurrent with our press release earlier today. My prepared remarks will provide an overview of our financials and our related business trends. I will close by providing guidance for the third quarter of 2013. As a reminder, the guidance we provided in April for the second quarter called for revenue between $94 million and $98 million, gross margin between 45% and 46%, operating expenses at approximately $40.7 million and the result in EPS between $0.02 and $0.06 per share. Actual revenue for the quarter was $94.4 million within and at the lower end of our guidance. Gross margin was 47.6% significantly ahead of our guidance. Operating expenses came in at $39.9 million, lower than our guidance and as a result EPS was well ahead of our guidance at $0.10 per fully diluted share. We have a strong cash flow and ended the quarter with $69.4 million of cash on hand. Putting it all together, it was another very solid quarter for us. We continue to see strength across all areas of the business. As you may recall revenue in the first quarter of the year was up 15% in the same period in 2012. Revenue for the second quarter was up 20% compared to the same period last year. Each tier that we operated in domestic we did well and our international business also performed very well because we continued to add new customers. The first half of the year is clearly positioned as well to achieve our objectives for the year as a whole. Our international revenue is 13% of total revenues and we do have one 10% customer this quarter. Gross margin at 47.6% is better than we’d expected. Gross margin strength was across the board and primarily reflects the value that we bring to our customers and the differentiation that a Unified Access portfolio brings to the market. Operating expense is $39.9 million, an increase by less than $200,000 from the prior quarter. We have told the investor conference and meetings over the last couple of quarters that our objective for 2013 and 2014 were to return to revenue growth while continuing to improve gross margin percent, control our operating expenses and increase our operating profit. The first two quarters of the year show that we are making good progress and we expect that to continue. Operating expense control has been important while we don’t expect to be able to hold up for any expenses flat each quarter, we do believe that we can continue to improve our efficiency and our leverage. Before I turn my attention to the balance sheet, I would like to remind you that on a non-GAAP basis we exclude certain charges that we do not consider to be part of our ongoing activities or are not meaningful in evaluating our financial performance of the company. These charges, the amortization of intangibles and the amortization of stock-based compensation are both non-cash items. Turning to the balance sheet, we continue to manage our way in capital and ended the quarter with total cash of $69.4 million, an increase of $21.3 million. DSO was 56 days the same as in the previous quarter. Inventory levels decreased this quarter to $37.4 million from $39.2 million at the end of the first quarter, and inventory turns improved to 4.4 up through 3.7 in the previous quarter. Deferred revenue amounted to $71.1 million up, $5.6 million from the prior quarter. Let me now move to our guidance for the third quarter of 2013. We are pleased for the strength we have seen in the business over the last two quarters and expect to continue to build on that momentum. For the third quarter, we are guiding to a revenue range of between $102 million and $106 million. We expect gross margin to come in between 46% and 47%. As we have repeatedly stated, our gross margin can fluctuate from one quarter to the next and we believe of any four-quarter period, we will see a gradual increase towards a long-term target of gross margin in the low 50% range. Q3 operating expenses will fall in the range of $41 million to $42 million. The increase in expected operating expenses is primarily the result of selectively having headcount as we continue to grow the business. The result in EPS will be in the range of $0.11 to $0.15 per share. DSO should remain as around the same level. Inventories will be flat, just slightly up and once again we plan on being cash flow positive for the quarter. At this point, I’d like to turn the call back over to Carl.

[Carl Russo:]

Thank you, Michael. To reinforce our strong guidance for Q3, I would like to take a few minutes to update you on the latest from Calix. Yesterday, we began delivery of our next release of new products designed to make our customers more competitive and more profitable. All are EXA-based offerings that expand our Unified Access portfolio. And I would like to take a moment to highlight just a few. For service providers looking to extend the life of their copper assets by bringing fiber closer to the subscriber and shortening their loop lengths the E3-48C, sealed Ethernet Services Access Node enables internet speeds of 100 megabits per second and greater. This vectoring ready, bonding capable, topology independent platform allows voice, video and internet services to be offered from a single-converged node, capabilities that are unique in the industry. For customers deploying fiber all the way to the premises, the E7-2 is now able to support more than 1,000 gigabit per second enabled subscribers from a single 1RU chassis. The unique modular chassis architecture of the E7-2 allows customers’ unparalleled flexibility at the lowest entry cost and unprecedented scalability as they add new subscribers and new services. Furthermore the node splitting feature of the E7-2 enables the addition of network capacity in the simplest and most cost effective manner ensuring that our customers remain competitive for many years to come. In short, the access innovation contained in the E-series product family is why it continues to be the fastest growing product in Calix history. Further enhancing our customer’s fiber to the premises service offerings is our just released Home Gateway software upgrade which remarkably allows hundreds of thousands of our 700GE ONTs already in the field to instantaneously become fully featured residential services gateways. And this software is available to all of our Calix advantage program members as a simple and free download. When combined with our Compass Consumer Connect offering, our customers can offer to their subscribers an extensive menu of high value in-home managed services thereby raising ARPU and dramatically lowering churn. More revenue, lower operating expenses and CapEx efficiency is what Unified Access brings to our customers and why it continues to resonate with competitive service providers around the globe. At this point, I’d like to turn the call over for questions. Operator?

[Operator:]

Thank you. We’ll now be conducting a question-and-answer session. (Operator instructions) Our first question comes from Amitabh Passi from UBS.

[Amitabh Passi:]

Hi, guys. Thank you. A couple of questions, I was wondering if you can help us understand the dynamics in the quarter, your revenue scheme and at the low end just trying to understand if you can give us some color geographically maybe by customer base what kinds of trends you saw? And then the sequential guide is quite healthy, just any color you can give us in terms of again where the strength is coming from across your customer base, that would be helpful.

[Michael Ashby:]

Yes, Carl, do you want to take that first response?

[Carl Russo:]

Well sure, I can pick the first response from a general statement. Very clearly as we stated in the call, we are seeing good strength across all the segments, so I would not attribute either the guidance or the results to any one segment, Amitabh. Frankly we’re seeing it everywhere. So I’m not sure how to answer your question with any differentiation.

[Michael Ashby:]

Yes, I agree with that, Amitabh. I think we saw strength in Tier 1 and Tier 2, Tier 3 and international business. And as we look forward, we really don’t see that changing. So there doesn’t seem to be any one area that’s really doing them better than the other. They’re all performing fairly strongly.

[Amitabh Passi:]

Okay. And then just a quick follow up on gross margins, Mike, I’m just trying to understand the sustainability of these levels, I wanted to confirm whether the E3-48C whether you actually did recognize revenues in the quarter?

[Michael Ashby:]

No, I don’t believe they’re recognized revenue for the E3-38C in the quarter, in Q2. That’s a Q3 shipment product.

[Carl Russo:]

Yes. Sorry Michael, Real briefly, in my comments, Amitabh, I said we actually began shipping yesterday.

[Amitabh Passi:]

Sorry, it’s my bad.

[Carl Russo:]

That’s okay. Now, it’s a Q3 product. Sorry, Michael, go ahead.

[Michael Ashby:]

It’s all right. And so a general answer to the question on margin, I think we have been pleasantly surprised with the strength of margins and we do see that continuing. I think we have seen strength in the mix of products. Custom mix hasn’t changed very much. That’s been primarily in mix of products. We’ve seen well accepted. As you know those have pretty good margins. And so we are slowly seeing the margin stabilize at that higher rate, and we expect that to continue.

[Amitabh Passi:]

Okay, perfect. I’ll sit back in queue.

[Carl Russo:]

Thanks, Amitabh.

[Operator:]

Thank you. Our next question comes from Simon Leopold from Raymond James.

[Simon Leopold:]

Great, thanks a lot. Just a couple of things I wanted to follow up on, one was the international business. I was wondering if we could get an update on the strategy and the position in that market of where you stand, what you think the trajectory is both considering the Ericsson partnership as well as without it. The other topic I wanted to touch on was vectoring. You mentioned one of the products, the new platform being vectoring ready, which I guess suggest it’s not quite there yet but could be upgraded to vectoring. My impression is you guys have been a little bit quieter in vectoring and some of your competitors have been crowing about the importance of vectoring. Carl, if you could maybe give us some perspective on how you think the technology plays into the marketplace. Thanks.

[Carl Russo:]

So let me go to your first question first, which is international. The way I look at it and I think we’ve been consistent about this, is two-fold; one is we want to make sure that we’re putting, if you will, pins on the map. So what we’re tracking is new customers, new customers, new prospects showing up in the tunnel how are we doing. And as Michael alluded to in his prepared comment, we continue to see very good direction as far as the number of new customers that we’re gaining each quarter and the number of new prospects that are showing up in the tunnel. The second dimension is obviously the expansion of our partnership, and as I think we’ve discussed previously, with the addition of some key folks into the business, we continue to see that partnership getting stronger and stronger, and so we’re very encouraged there as well. On the vectoring side, we’ve spoken to this before but let me make sure that I re-amplify it and clarify, if you will. We think vectoring is a great technology to extend the life of copper assets. But like all technologies that has applications in some places and in not others, or firmly not in others. We’ve been very early to market with vectoring capable platforms. To your point, capability means there’s no hardware changes, there were merely software downloads to go and bring more and more features to them once they’re in the field. We view vectoring as a transient technology to get to even higher speed as our view of this network is that it’s going to continue to explode from a demand standpoint. You don’t have to look much further than yesterday’s news on, for example, the Chromecast HDMI Dongle that Google announced and think about the implications of that and the demands that it will plays on the network. So we are very much supporters of vectoring and believers in it. We are very much, as you know, a standard-based company and we will deploy vectoring as we see where it makes sense for our customers to bring competitive broadband into their networks. Does that answer your question, Simon?

[Simon Leopold:]

It does somewhat. Let me just see if we can kind of zero in. Do you expect vectoring to be a material revenue generator or is it really just kind of incremental to the current base of business?

[Carl Russo:]

Well, I look at vectoring just not the same way technologically, but the same way with new product lifecycles like ADSL and ADSL2 and then ADSL2+ and VDSL. I don’t know that any of them are significant market expanders as much as they are the next technology that gets deployed in that market.

[Simon Leopold:]

Now that’s clear. Thank you very much.

[Carl Russo:]

You bet.

[Operator:]

Thank you. Our next question comes from George Notter from Jefferies.

[George Notter:]

Hi guys. Thanks very much. I guess I wanted to ask about again the gross margin performance has been super impressive obviously not just this quarter but over the last couple of years. And I guess I’m wondering if certainly it sounds like the E-series of the big piece of the story there and you guys are conveying lots of value-added features to customers in getting better pricing. But can you help us understand, is there an aspect of this that’s coming from the ONT strategy? And I know historically you guys have had much better margins on the ONT side than maybe others have in the past. I’m wondering if there’s been any change in the mix and the portfolio? Is there any change in your strategy there in terms of providing those from a Calix perspective or outsourcing them to third parties? Can you give us a sense of any impact from ONT? Thanks.

[Carl Russo:]

So let me tied in to a bigger picture. So the direct answer to your question, George, is no, that is not a significant driver. And in actuality, product mix, per se, is less a driver than it is the acceptance of the unified access approach to building networks. And as customers see the value in that, it frankly helps our margins improve across all aspects of the business. So we obviously continue to drive as a leader in fiber to the premises, our entire premises’ strategy, ONT is another device, et cetera. But there’s no one thing that I would call out I think in the way you’re asking the question like is there something going on underneath that that’s helping the margin in a disproportionate sense. So my answer would be no.

[George Notter:]

Got it. Okay, great. And then also you mentioned I think maybe I misheard some monologue here, but you talked about gross margin and improving going forward a trend towards, I think, the 50% long-term range. Can you restate that comment? Was that over four quarter period or was that a longer timeframe that you’re looking at?

[Michael Ashby:]

Our a long-term target, George, is gross margin in the low 50% range. We’ve always said that as a three to five-year timeframe of which we are starting through that. So at least another couple of years, I think, before we start to get to that level. But we have seen margins increasing each quarter. And in any four quarter period, we do expect to continue to announce and we will eventually be able to get to below 50% range.

[George Notter:]

Got it. Okay. So any four quarter period you’d expect increases? Okay. Great. And then the last question I have is just to come back to the area of discussion, if I look at your international revenue, it looks like it was about flat and dollar term sequentially. Can you just talk about when we might expect to see some kind of inflection point with that relationship and that channel for you guys? Is that something you’d expect to see this year or is that more of 2014 opportunity?

[Carl Russo:]

Well, I’ll give you my impression, and Michael, feel free to add color. I don’t know that we’re going to see an inflection point like an elbow in that sense, George. I think we’re going to just see a continued increase in the deals that are showing up in the tunnel, the mix of products, the different regions. And I view it as being sort of much more organic in that passion than having an elbow. If it does get an elbow in the way that you’re saying it, well then, I think we’re probably doing better than we think at some point in the future. But right now, we’re just planning on continued growth of international with part of being through Ericsson. Michael?

[Michael Ashby:]

Yes. I think the good news for us, George, is that international – last year and year before is in the 7% to 9% range. Now we’re stabilizing up in the 13% to 14% range, which I think is good and it shows the progress that we have made. That progress. Ericsson is one small part of that, but the progress isn’t going after the international Tier 2 and 3 accounts, some strength in both the Caribbean and Canada. And that seems to be stabilizing at a good level. I think that I agree with Carl, Ericsson is not going to just suddenly take off. But having said that, I think we’re not going to see the full impact to that partnership until 2014.

[George Notter:]

Got it. Is there a sense of urgency on your part? I mean it feels like there’s a fair amount of access opportunities out there in the world right now. I think if we listen to Alcatel, they called this morning, I think those guys are talking about 46 deals that they’ve signed in the last three quarters. And I imagine some of those are certainly existing customers where they’re up for new deals. But do you feel like you need to move more quickly through the Ericsson channel and getting that sales and marketing effort round or missing opportunities or do you think this is just sort of a natural progression of the marketplace?

[Carl Russo:]

I hear what you’re saying, George. And by the way, I think the question is exactly right, and you get early morning looking at that. But frankly, I want to make sure that we’re growing our revenues and overtime growing our margins. And that means selling to the value that we’ve built in to the architecture. So it’s very easy to start chasing revenue opportunities that in the end may not be yours anyway. And I’m very sensitive of the fact that we could chase revenue opportunities that actually put significant downward pressure on gross margin because they’re not speaking to the value of what we’re doing. And so for us we’d rather stay focus on just continuously growing the business and growing obviously across all of our customer basis and not chasing deals, per se. But do I have sense of urgency to want to grow the business? You bet.

[George Notter:]

Got it. Thank you.

[Operator:]

Thank you. Our next question comes from Simona Jankowski from Goldman Sachs.

[Simona Jankowski:]

Hi, thanks very much. Just one more follow up on the gross margin side. You talked to the mix aspect of it. Can you also touch on the pricing environment? How would you compare the pricing environment competitively versus this time last year?

[Carl Russo:]

I don’t see any significant change in ASP erosion either to the positive or the negative over that period of time. And I believe I’ve got that right, Michael?

[Michael Ashby:]

Yes, absolutely. I don’t think there’s any change in the environment. And I think before we said it is price competitive. It’s not price crazy, but it’s price competitive and I think it’s the same now as it was a year ago.

[Simona Jankowski:]

So it’s fair to say that none of the margin expansion has been attributable to an easier pricing environment even if we’ve seen some consolidation in the industry?

[Carl Russo:]

Certainly not from my perspective, Simona. Not at all. Nor is it because we are seeing ASP erosion at a more rapid rate. And we’re just doing a super job on cost reduction.

[Simona Jankowski:]

Okay. Got you.

[Carl Russo:]

It feels very much the same year-over-year, to Michael’s point.

[Simona Jankowski:]

Okay. And then –

[Michael Ashby:]

Yes, we – sorry, Simona, I’m just going to say I mean we have concentrated and talked about this before, a lot on improvement of gross margin and then the whole series of things that we do and focus on to make sure that we can increase the gross margin. And those involve controlling cost, reducing cost and improving on negotiating strategy and that’s why it’s a mix of product and mix of customers. And so it’s a whole combination of things that it isn’t any one thing.

[Simona Jankowski:]

Sure.

[Carl Russo:]

Right. But in addition to that, we have to understand that gross margin is sort of a short hand for how your customers value what you’re providing them. And so George had asked the question earlier, we’re very focused on thinking that it’s really architecture that we’re bringing to our customers and making sure that we grow the business as we are doing that.

[Simona Jankowski:]

Sure. And my other question which is going to be more on the demand environment, can you just characterize what you’re seeing in the Tier 2 segment, some of the major customers there have guided CapEx down for the year. But they are facing more pressure now from cable competitors, even Google Fiber coming in with much, much faster speed. Now how do you see that tier responding to that competitive treasure? And do you think that might influence them to change their posture on CapEx either this year or into next year?

[Carl Russo:]

Well, my opening comment would be that the CapEx across the segment has been relatively flat-ish. But I don’t know that I would separate out any one tier. The general competitive environment from a service provider standpoint, to your point, for example, Google, I think sets up pressure across all segments. I don’t think it’s just reserved to the Tier 2, and I know you’re not saying that. So I think that sets a pressure there, how each service provider chooses to respond to it I think still remains to be seen. Michael?

[Michael Ashby:]

Yes, I agree with that. I think it varies customer by customer to how they respond. But there’s a question that the advent of gigabit networks and there’s the coming more talk about and more prevalent is changing the environment.

[Simona Jankowski:]

Right. Thanks very much.

[Operator:]

Thank you. (Operator Instructions). We appear to have no further questions. I’d like to turn the call back over to our speakers for closing comments.

[David Allen:]

Thank you operator. Once again everyone, we’d like to thank you for joining us today. This quarter Calix will be participating in two investment conferences. We hope you can join us at the Jefferies Midwest Corporate Access Day in Chicago on August 28th and then Deutsche Bank DD Access Technology Conference in Las Vegas on September 12. Information about these conferences will be made available on the investor relation section of Calix.com. Thank you for joining us today. We remain focus on executing against the opportunities ahead of us and we look forward to speaking to you at one of these forums. Goodbye for now.

[Operator:]

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