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Calix (NYSE:CALX)
Q3 2019 Earnings Call
Oct 23, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings, and welcome to the Calix third-quarter 2019 earnings conference call. [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.

Tom Dinges -- Director of Investor Relations

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 website.

This conference call will be available for audio replay in the Investor 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 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?

Carl Russo -- Chief Financial Officer

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 entered the fourth quarter with a solid backlog of business, thus, our forecast for a 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 under way 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 Telephone 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 ninefold 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 are 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 ConneXions 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?

Questions & Answers:


Operator

Thank you. [Operator instructions] Our first question comes from the line of Paul Silverstein with Cowen. Please proceed with your question.

Paul Silverstein -- Cowen and Company -- Analyst

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 can give us on that? The new products are growing, I would think that would be positive for incremental margins, not negative. And regionally, the U.S.

was up as a percentage, not down. I think 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 at 16%, but the Tier 2s, which have been a drag on revenue growth over the past year or two. If you could give us any incremental insight on that, that'd be appreciated.

Thanks.

Carl Russo -- Chief Financial Officer

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, etc., can vary the margins. And in these next four quarters, I would say, 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 from 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 average 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 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 have 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, does that answer your questions, Paul?

Paul Silverstein -- Cowen and Company -- Analyst

It does. But a quick follow-up on that. I appreciate you gave us a number of directional data points about growth in the new products from a customer acquisition, as well as from a percentage growth perspective. I recognize it's still very early in the launches to those platforms are actually to access the cloud.

But can you give us a sense for what the revenue base is today?

Carl Russo -- Chief Financial Officer

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, significant -- 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 ConneXions because all three platforms are full-fledged in the market. And on the subscriber edge, we have great expectations for EXOS platform and the GigaSpire systems that run in.

So that's -- beyond that I would not go. Cory, do you have any color you want to add in this?

Cory Sindelar -- Chief Financial Officer

No. I think we're -- you said it right.

Carl Russo -- Chief Financial Officer

OK. Paul, sorry?

Paul Silverstein -- Cowen and Company -- Analyst

Yes. Carl, coming back to the margin question. I trust -- I understand the point about Verizon but as you look over the longer term, and I recognize just pointing where to go, but I trust this can still be a 50-plus and perhaps meaningfully above 50-plus percent margin model with the benefit of greater revenue. Or is that not the case?

Carl Russo -- Chief Financial Officer

That is definitely the case.

Paul Silverstein -- Cowen and Company -- Analyst

OK. I appreciate. I'll pass it on. Thank you.

Carl Russo -- Chief Financial Officer

Thanks, Paul.

Operator

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

Christian Schwab -- Craig-Hallum Capital Group LLC -- Analyst

Great. Congratulations on Verizon being a 10% customer in the quarter. As we look to that customer in 2020, is that part of the enthusiasm for growth from here on out?

Carl Russo -- Chief Financial Officer

It's part of the enthusiasm but it's really not what drives the enthusiasm. What drives 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.

Christian Schwab -- Craig-Hallum Capital Group LLC -- Analyst

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 a 50%-plus gross margin?

Carl Russo -- Chief Financial Officer

Sure. Which is sort of a different way of asking the question that Paul asked. 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 not too distant future where we think that 50-point margin occurs and 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.

Christian Schwab -- Craig-Hallum Capital Group LLC -- Analyst

Great. No other questions. Thank you.

Carl Russo -- Chief Financial Officer

Yup. Thanks, Christian.

Operator

Thank you. [Operator instructions] Our next question comes from the line of Tim Savageaux with Northland Capital Markets.

Tim Savageaux -- Northland Capital Markets -- Analyst

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's been driven internationally, but I wonder if you might comment, sort of, reflect a bit on the difference in terms of what you've seen in terms of your results and outlook? Seems 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 what your point to that is kind of the -- and your more domestic focus is the real delta between some of the unsettled results we've seen and the performance that Calix is putting up here. Could you talk a little bit about that? Thanks.

Carl Russo -- Chief Financial Officer

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 a general industry makeup. But we're also finding that more of them are being aggressive in the way they think about the deploying fiber and wireless, building out a next-generation infrastructure, being open to changing their business model, using analytics, and so those align customers are our key focus. Verizon at one level is somewhat 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 fiber infrastructure, which basically combines the best of wireless and fiber 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 that'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're selling big boxes and, obviously, Calix 1.0 was a box company, you're 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're higher differentiable value but they are lower in any given quarter from a box ship standpoint. So we can do a very significant contract with a very large customer that happens to be software, and then we'd never make the 10% threshold. So you wouldn't see it from that perspective but the revenues are quite diverse.

And obviously, our visibility is going up and our predictability should go up with it. So when you tie all of those together -- I look at companies that are sort of like what Calix 1.0 was like, and I have -- there's 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 the antithesis of where we are going with an all-platform model. It's not our intent, we're just going to be less concentrated because of many, many more customers and because as you move toward software and platforms, any one customer is less able to get to 10%.

So does that paint a picture for you?

Tim Savageaux -- Northland Capital Markets -- Analyst

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 of your platforms sales in terms of the pretty significant both sequential and year-over-year growth you saw in that segment. And then kind of ironically back on the topic of big customers and possibly could be 10%, in terms of your outlook you seem to reference some kind of increasing ramp with a big international customer and probably CityFibre in the U.K.

I wonder if you could talk about how that's progressing as well.

Carl Russo -- Chief Financial Officer

So let's go take the larger ones first. On Verizon, we said that we believe it would get to be a 10% customer, and I think it'll bounce up and down as a 10% customer from quarter to quarter. CenturyLink, obviously, is a very good customer, has a huge Calix embedded base. I expect that they will remain a 10% customer for the most part each and every quarter at some level.

CityFibre is -- they're doing a huge infrastructure build and you build the fiber first and you do the head end, the OLT second, and then ultimately, you do the ONTs. And so that ramp is still well in front of us and they're making progress but as we've said before, they're building brand-new infrastructure and it always takes longer than you think. When you talk about -- use the term Tier 3s, 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 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, at great peril, I don't want anybody getting overly excited, but there's a next generation of CAF that's being currently debated, which is referred to as RDOF, which is the rural digital opportunity fund. The key difference between RDOF and CAF is a clause around allowing price cap carriers to bid for the whole state, which was a feature of CAF, which is now proposed to be removed, which means it would be distributed on a census block by census block basis.

So no longer for the big service provider come in and take the whole state because they committed to it. Now you're going to be down at a census block level, and all of these smaller service providers are going to be quite advantaged in pursuing those funds as well. So we just see lots of capital formation, lots of capital flow into the space. They're able to build brand new models very quickly, and so we see that space growing, and we see our presence in them growing.

Tim Savageaux -- Northland Capital Markets -- Analyst

OK. Thank you very much.

Carl Russo -- Chief Financial Officer

Yup. Thanks, Tim.

Operator

Thank you. [Operator instructions] Our next question comes from the line of Fahad Najam with Cowen and Company. Please proceed with your question.

Fahad Najam -- Cowen and Company -- Analyst

Hi, Carl. Thanks for taking my questions. I wanted to visit your services business, obviously, it's declined 13% year over year. And that would have been prospectively a beneficial headwind to your overall gross margin given that solutions have such low gross margin.

To the extent that these new customers are ramping, should we expect services and revenue to start increasing and thus, the services gross margin will become a headwind again or should we expect that services -- the bulk of the heavy lifting in the services business is behind us?

Carl Russo -- Chief Financial Officer

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 refer to it, which was really the low margin deployment services is behind us, and as you've heard us say, we've been engaged in continually aligning our services business with our platforms and our customer success. So what's happening underneath that number is the offerings mix is shifting toward much higher differential value service offerings, albeit, they're a lower revenue, but as you do more and more, then the revenues will start to grow, but the margins will continue to expand. So we expect modest revenue growth with reasonable gross margin expansion in services.

Fahad Najam -- Cowen and Company -- Analyst

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 type of deployments? I would assume there's a heavy services component with those CAF type deployments.

Carl Russo -- Chief Financial Officer

I -- 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'll be full-blown in platform mode with customer success-oriented service offerings. I don't know what's that going to look like Fahad, literally, I would be throwing a dart.The one thing I will tell you is, we're not going to go backwards on gross margin, because we're not going to take on low, value-added eat-on-the-street deployment services. So just to allay any fears you may have there.

Fahad Najam -- Cowen and Company -- Analyst

That's very helpful. Thank you very much.

Carl Russo -- Chief Financial Officer

Thanks for the question, Fahad.

Operator

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

George Notter -- Jefferies -- Analyst

Hey, thanks a lot, guys. I guess, I wanted to noodle 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 winning 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, AXOS, EXOS, etc.? And then I have a follow-up.

Carl Russo -- Chief Financial Officer

So the answer is that actually I don't know if it's more. It's both. But I would be cautious with the term convert. So as we think about it, we are certainly taking our blue ocean platforms to all of our customers, to the extent that they see the value and they want to update them, obviously, we're happy to help them onboard to the extent that they don't and they want to continue to order our legacy systems.

Obviously, we're happy to do that as well. So we're certainly going to offer them, but we're not going to go necessarily do a forced march if you get my drift or discontinue our systems. We sort of assume that behavior. We'd prefer to let our customers make end-of-sale decisions, not us.

So does that help paint the picture before I answer a question you didn't ask?

George Notter -- Jefferies -- Analyst

Yes. I guess, obviously, you're looking -- you've got a data set, right? You can go back and look at the mix of new customers and existing customers buying the new products. So I guess I'm just wondering what's driving that increasing mix of next-gen products. 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 slowly to the new stuff?

Carl Russo -- Chief Financial Officer

Great question. I'll give you a very simple parameter. The more aggressive the service provider, the more rapidly they're uptaking our platforms, the less aggressive, the more slowly. It's literally that simple.

So if they're aggressive in their markets and they want to take share, they want to raise their ARPUs, they want to lower churn, they want to take a footprint from other competitors, they are unbelievably well aligned, to the extent that they're taking a slower approach, they're less aligned, and we're happy to continue to support them with our existing systems.

George Notter -- Jefferies -- Analyst

Got it. OK. All right. Fair enough.

Thanks.

Carl Russo -- Chief Financial Officer

Yup. Thank you, George.

Operator

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the call back over to Mr. Dinges for any closing remarks.

Tom Dinges -- Director of Investor Relations

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 the 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.

Operator

[Operator signoff]

Duration: 28 minutes

Call participants:

Tom Dinges -- Director of Investor Relations

Carl Russo -- Chief Financial Officer

Paul Silverstein -- Cowen and Company -- Analyst

Cory Sindelar -- Chief Financial Officer

Christian Schwab -- Craig-Hallum Capital Group LLC -- Analyst

Tim Savageaux -- Northland Capital Markets -- Analyst

Fahad Najam -- Cowen and Company -- Analyst

George Notter -- Jefferies -- Analyst

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