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Calix Inc (NYSE:CALX)
Q2 2020 Earnings Call
Jul 22, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Calix Second Quarter 2020 Earnings Call. [Operator Instructions] I would now like to turn the call over to your host, Mr. Tom Dinges, Director of Investor Relations for Calix. Thank you. You may begin.

Thomas J. Dinges -- Director of Investor Relations

Thank you, operator, and good morning, everyone. Thank you for joining our second quarter 2020 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 second quarter 2020 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 will reference non-GAAP measures.

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

Carl Russo -- President and Chief Executive Officer

Thank you, Tom. As the COVID-19 pandemic continues, it is clear our mission to connect everyone and everything is more vital than ever. The second quarter reinforced our view that the pandemic has accelerated the secular forces moving through the communications industry, while also creating additional demand, resulting from the expansion of capacity to meet immediate subscriber needs. These two effects combined to drive strong bookings in the second quarter. However, the pandemic has continued to challenge the component supply chain. Fortunately, the Calix supply chain team outperformed in the quarter and enabled us to deliver results well above the high end of our guidance.

For Calix, it appears the future is sooner. As a result, we have undertaken a targeted restructuring of the business. Ironically, the pandemic has allowed us to reimagine our business as it might be three years from now. And thus, we have decided to embrace a full work-from-anywhere culture. This impacts our facilities requirement, and as of the end of the second quarter, we have reduced our overall real estate footprint. Furthermore, as our customers are accelerating their transformation, we are further focusing our product offerings on our All-Platform future. These changes are reflected in the charge we took to our GAAP earnings in the quarter.

There is a growing class of service providers building new business models on top of the unified access infrastructure. These service providers deliver superior subscriber experience and do so at the lowest cost. They are aggressive in growing their subscriber base and they are attracting capital. Our All-Platform offerings speak loudest when the service provider is the aggressor, and we are focused on helping them win.

Even with customer travel virtually eliminated, we still added 18 new customers in the second quarter. This, along with our strong guidance for the third quarter, is confirmation of the opportunity ahead.

With that, let us open the call for questions. Melissa?

Questions and Answers:

Operator

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

George Notter -- Jefferies -- Analyst

Hi, guys. Thanks very much. And I guess a lot of my questions were answered already just through the release from last night and the shareholder letter. But I wanted to ask about gross margins, particularly systems gross margins. And if I look at systems revenue, it was roughly equivalent to what you guys printed a couple of quarters ago in the December quarter. And yet, gross margins for systems were 3 points higher. Certainly, I understand that product mix and customer mix are helping you. But I'm wondering if you can give us some more color around that. Is that Calix Cloud? Is it anything else that might be going on there? And then also, did you guys get impacted by additional supply chain or expedite costs because of the pandemic? Is that in that systems gross margin also? Thanks.

Carl Russo -- President and Chief Executive Officer

George, first of all, I will pass on your compliment to Tom Dinges on the stockholder letter for being comprehensive and answering lots of your questions. So, thanks for that complement. And now, directly to your question on gross margins. As you know, we have said for a long time that as the All-Platform business accelerates, we expect gross margins to expand. But we have also said that we expect gross margins on any particular quarter to be noisy even though the long-term trend is clear. In this quarter, we saw the benefit actually of a little bit of sort of upward noise. So, we had better mix, a number of factors that were just in our favor, but we've also seen -- in my opening comments, I talked about sort of the pull forward of capacity during the pandemic versus what percentage of what we are doing is an uplift of our strategy, so customers actually using this as an opportunity to transform themselves quicker. And the minority of it is that transformation, but it's a good minority. So, those factors combined are just further down the path. So, add in the quarterly noise, and I think you get to where we are.

To your question on expedite fees, actually, yes, they are included in gross margin. And we are still challenged with expedite fees and spot charges on components. Cory, do you want to add some color on that?

Cory J. Sindelar -- Chief Financial Officer

Yeah. I would just say that we're seeing a fair amount of prohibitions in the supply chain. So, we are out there looking for component inventory. Sometimes, we're buying that on the spot market. That's usually higher than our standard cost. And then expedite fees, right? We're continuing to air freight material into the United States in order to meet the customer demand. And we're continuing to see that trend into the third quarter for sure. So, we continue to work the supply chain aggressively in response to component shortages from where we see them.

Carl Russo -- President and Chief Executive Officer

And part of...

George Notter -- Jefferies -- Analyst

Got it. And then...

Carl Russo -- President and Chief Executive Officer

Just real quickly, George, the combination of Cory's comments and mine are also obviously what gives us the guidance for Q3, right?

George Notter -- Jefferies -- Analyst

Got it. Okay. Any sense for how big that supply chain impact was in the quarter? I guess, I'm just trying to look at your systems gross margins and try to normalize for some of that stuff.

Cory J. Sindelar -- Chief Financial Officer

Yeah, George, that's something we haven't broken out. We don't report that separately. We certainly could quantify it. But I'm not going to give you much help on that piece.

George Notter -- Jefferies -- Analyst

Got it. And then, you talked about the work-from-home benefit in the quarter. Could you give us any sense for how much benefit that might have been on the top line? I know it's probably not an easy question to answer, but any color you could give us there would be great. Thanks a lot, guys.

Carl Russo -- President and Chief Executive Officer

When you say on the top line, so what we saw from a revenue standpoint?

George Notter -- Jefferies -- Analyst

Correct.

Carl Russo -- President and Chief Executive Officer

Yeah. I want to break it up into two different things. Again, the pandemic drives a number of behaviors in our customers. And so, there's a significant portion of the beat that relates to that, for sure. And it's broken up into -- the majority of it was pull-forwards on capacity. The minority, we actually saw an acceleration of our All-Platform model. So, I don't know how to quantify it more than just to say, let's just say that it's the majority of the beat.

George Notter -- Jefferies -- Analyst

Great. Okay, thank you.

Carl Russo -- President and Chief Executive Officer

Thanks George.

Operator

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

Paul Silverstein -- Cowen and Company -- Analyst

Thanks. I'll try asking the question, although I suspect I already know the answer. Carl, on Access, EXOS, Cloud and EDGE, beyond what you had in the shareholder letter, can you give us any sense for what the -- I know they're still small and early, albeit ramping aggressively. But can you give us any sense for where they are as a percentage of total revenue collectively?

Carl Russo -- President and Chief Executive Officer

No differently than we've characterized before, Paul. So, you do know the answer. It's -- we've said it's greater than 10% and less than 50%. And that's where we would keep it today.

Paul Silverstein -- Cowen and Company -- Analyst

Okay. It was greater than 10% also last quarter. Presumably, it's that much greater as a percentage, given the numbers that you discussed in the shareholder letter?

Carl Russo -- President and Chief Executive Officer

Correct. It's continuing to grow at an aggressive pace.

Paul Silverstein -- Cowen and Company -- Analyst

Okay. With respect to your larger customers, while they have become the minority of revenue, not much over 20%, it looks like they've also returned to growth. And not only has the risk been moderated, but it looks like they're now also contributing to the larger growth profile. Any thoughts you could share with us in terms of what's going on at CenturyLink, number one, but also with those Tier 2 customers that are still 5%, 6%, 7% of revenue?

Carl Russo -- President and Chief Executive Officer

Yes. Actually, let me broaden your comments because if you look at large, medium and small, all are growing now. And so, it would appear that we are through the dread, many quarters of headwinds, and everybody is now starting to grow at their own rate. CenturyLink, my comments would not change from where they have been in the past, which is, we expect CenturyLink to be roughly flat year-over-year, and their business is moving forward on plan. Everyone else is basically in those sets, sort of chugging along on plan. One quarter might be up a little bit, one quarter might be down. But there's no new news there, Paul.

Paul Silverstein -- Cowen and Company -- Analyst

All right. And finally, is there anything of a one-off nature, either in the quarter or that you would anticipate in this quarter and coming quarters?

Carl Russo -- President and Chief Executive Officer

I can't think of any one-offs from my perspective. Cory, you?

Cory J. Sindelar -- Chief Financial Officer

I think there's a couple in the opex area, Paul. The overperformance in the second quarter has led to a higher level incentive compensation in Q2 comparing to Q1 or what we would expect it to be going forward. And we also -- as you comb through the 10-Q, you'll see that we took a bad debt write-off in the second quarter for one international customer. And so, that was reasonable size enough so that we called it out in the Q. I wouldn't expect that to happen again.

Paul Silverstein -- Cowen and Company -- Analyst

And Cory, on the overcompensation or the better-than-expected compensation, I assume if you had another similarly strong quarter in Q3 and in Q4, we would see the same phenomenon?

Cory J. Sindelar -- Chief Financial Officer

Not [Phonetic] true, but not to the same extent. So, if you were looking at kind of where the targets were set, a Q2 target was lower. So, there's a greater percentage overperformance. Our expectation for Q3 is larger. It will be harder to overperform to the same degree.

Paul Silverstein -- Cowen and Company -- Analyst

All right. Carl, if I may, let me ask you one last question. I know it may [Indecipherable] speculate about the future, but RDOF, there's been a lot of press, a lot of actions in Congress, most recently with the two different bills in the House and the Senate proposing acceleration. Any thoughts you can share? Any incremental insight that you have on the timing?

Carl Russo -- President and Chief Executive Officer

Speculating about the future is fun. So, let's spend a moment on RDOF. As we've discussed, the Rural Digital Opportunity Fund is currently in full flight. There are bids going in. There will be awards being made. But current course and speed on RDOF, the funds won't be distributed until third quarter of next year. There's discussions going on, on Capitol Hill about potentially accelerating this program. If those discussions bear fruit, you may see some of those funds being let earlier next year, maybe even pulled into late this year. However, if that occurs, for us, being a platform and systems provider, we probably wouldn't see an effect until second quarter of next year. So, it might change the revenue impact for us by two quarters, but it still would be very speculative to say that that's going to pass Congress, just as we've talked before about other infrastructure investments that might be coming on top of RDOF, along with various states' investments. So under the general heading of, we believe there will be a lot of infrastructure investment in broadband, I think you and I would agree. The timing of those things and the magnitude is spread out, frankly, all over the next decade.

Paul Silverstein -- Cowen and Company -- Analyst

So, I apologize to you and everybody else on the call for one more question on the -- you brought up an important point, which is, it's not just federal but also states. Can you give us any flavor for the types of the programs and magnitude?

Carl Russo -- President and Chief Executive Officer

There's lots of state programs. That would be a much longer conversation because we'd have to sort of go through them. But they're in the tens of millions and potentially $100 million. So, they're modest compared to RDOF. But these go on in various states quite frequently and actually fly below the radar.

Paul Silverstein -- Cowen and Company -- Analyst

I assume as with US federal, there's been some pickup in those programs to some extent with all the focus on [Indecipherable]?

Carl Russo -- President and Chief Executive Officer

Yeah. As I was saying that I was thinking about, over history, how much pickup there's been, let me defer that and do a little homework. I don't know if there's been a material pickup. They've sort of always been there, but there may have been, Paul. So, I'm going to take a recheck on that one and come back to you.

Paul Silverstein -- Cowen and Company -- Analyst

All right. I'll pass it on. Thank you.

Carl Russo -- President and Chief Executive Officer

Thank you, Paul.

Operator

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

Christian Schwab -- Craig-Hallum Capital Group -- Analysy

Hey, congratulations, guys, on a great quarter and a good outlook. I only have one quick follow-up question regarding CenturyLink. I just want to make sure I heard you correctly that you would expect them to be flat year-over-year, potentially in 2020 versus '19, given the very strong start that they've had in the first half. But are you suggesting that, in aggregate, September and December will be less than the first half of the year, is still your current plan. Is that correct?

Carl Russo -- President and Chief Executive Officer

Well, they've been a 15% customer, I think, in both quarters. And with that, they're running a couple of million dollars ahead of that flat number. So, it's not going to be -- it's going to sort of be the same, Christian. And I think to try and parse it any closer would really be getting down to detail that we don't have a view into.

Christian Schwab -- Craig-Hallum Capital Group -- Analysy

Great. And then, I guess one last question. Can you highlight for us, in particular, what components need to be expedited that are super tight for you today?

Carl Russo -- President and Chief Executive Officer

They run the gamut, from silicon to optics to small components and chiclets [Phonetic]. It's all over the place. I wish it was a narrow set.

Christian Schwab -- Craig-Hallum Capital Group -- Analysy

But it's a broad-based set of stuff is -- I guess, is what you're saying. Is that fair?

Carl Russo -- President and Chief Executive Officer

It is, and it's slowly improving, but so is our demand. And so, we have another quarter of supply chain team burning the candle at both ends.

Christian Schwab -- Craig-Hallum Capital Group -- Analysy

Fabulous. Congrats again. No other questions. Thank you.

Carl Russo -- President and Chief Executive Officer

Christian, thanks for the congratulations. Appreciate it.

Operator

Thank you. Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Please proceed with your question.

Tim Savageaux -- Northland Capital Markets -- Analyst

Good morning, and I'll add my congratulations on some very strong results. I think I have two questions. One on margins, one on the top line. I'll start with the gross margin question. And what I want to focus on is incremental gross margins, which seemed to tell a fairly interesting story if you look at, I guess, on a year-over-year basis. Both your results and your guidance, incremental gross margins look to be in the 70s, I guess, or close or maybe even greater than that. And I wonder what we should take from that with regard to that being an indicator of the kind of status of the Company's software platform transition, and what the eventual business model of Calix 2.0 might look like? And then, I have a follow-up.

Carl Russo -- President and Chief Executive Officer

So first of all, one thing that I take away is that you're good with a calculator. So, that would be my first comment. Secondly, we've spoken in the past about long, long, long term, that this model could resolve itself into 60s. So, I think directionally, that gives you a sense for how we're thinking about it. Keep in mind that our platforms, as you know, are hardware independent as they are fully abstracted operating systems. But while that sets us up to potentially have an all software future, we believe for the foreseeable future, we will always be providing systems for many of our customers because there's really not a stable white box market to provide the hardware independent from the software. So over time, we think we'll continue to see the model more. You are directionally on the right track with your incremental margin calculation. But I would dissuade you from taking that number and starting to drive it into the model in the near term.

Tim Savageaux -- Northland Capital Markets -- Analyst

Right. No problem there. But just in terms of direction, I think a pretty healthy looking metric. Switching to the top line, you had mentioned, I think, 17% growth among smaller carriers. Although you did see some weakness internationally in the quarter, I wonder if you might make a comment on that. And in that context, it looks like US small carrier or rural broadband growth, if we can say that, might have been in the mid-20s, which is pretty significant there. And you've kind of already addressed this to some degree, to the extent that growth rate in the Company's overall growth rate is well above your long-term targets at this point. I imagine there is -- you might point to a pull-in dynamic that would drive that short-term outperformance. But are there any other issues that are driving such above-trend US rural broadband growth, if indeed, I'm getting that calculation right? And if you can talk to what's happening internationally, especially in the context of CityFibre potentially ramping later on? Thanks.

Carl Russo -- President and Chief Executive Officer

Yes. So let's go to international first, which is, as you know, international is a smaller portion of our business, which is quite lumpy and always moves around. So, there's no conclusions to draw there. On your other calculations, I will directly point to the pull-forward being the largest percentage of what we're seeing in overperformance. But there's a minority that is clearly an uplift of the model. And so, one of the things that you sort of have to [Indecipherable] is the pull-forward nature from 2021 and how much of that continues versus not, and that's what we are looking to get our arms around as we go through these next couple of quarters. But what we're focused on is the minority of the outperformance representing an uplift, as in a strategic uplift of our model where customers are genuinely looking at the pandemic as an opportunity to accelerate their transformations.

I think you could understand that we are obviously involved in helping our customers transform their business models. And to the extent that more of them choose to do so sooner because of the pandemic, that's the biggest strategic driver of our business. And ultimately, what would feed the incremental margin calculation that you did in the future. I trust that makes sense.

Tim Savageaux -- Northland Capital Markets -- Analyst

It does. Congrats once again. Thanks very much.

Carl Russo -- President and Chief Executive Officer

Tim, thanks very much, appreciate it.

Operator

[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

Thanks for taking my question. Carl, your comments about your supply chain outperforming, does that suggest that you think that you've gauged [Phonetic] market share against competitors? And can you just elaborate on what do you mean by the supply chain outperforming? What do you think is the issues with the other broader supply chain that you think your supply chain outperformed?

Carl Russo -- President and Chief Executive Officer

Very simple, they outperformed our expectations going into the quarter. When we set the expectations for Q2 last quarter, we did so as a balance of demand and supply. Ordinarily, you're setting it more based upon demand without supply being a particular constraint. And they simply outperformed our expectations going into the quarter. As for market share per se, given the All-Platform focus of the business, we don't see any competitors for that business, so we don't think of it in terms of market share. So, I would simply not answer that question. This is not how we think.

Fahad Najam -- Cowen and Company -- Analyst

Got it. Appreciate it. In your response to Tim's question, you alluded to the fact that you're still trying to grapple with how much of a pull-forward you're experiencing right now. But wouldn't it be fair to say that the current climate is probably the best thing that could ever happen and it's probably the best case scenario? We're all stuck at our home. We're all kind of limited in our mobility, and service providers are a bit mostly caught flat-footed. And so, the gap between demand for bandwidth and their ability to provide that capacity is quite huge right now. But as they add capacity, there seems to be [Indecipherable] indicative of your results there seem to be adding that capacity. So maybe this is like the best case scenario, this is the best demand scenario that you could think of. And then from here on, it just essentially kind of normalizes and goes down and declines as capacity gets added. Wouldn't you say that this is probably the best environment that you can ever have?

Carl Russo -- President and Chief Executive Officer

No, I wouldn't say it's the best environment we could ever have. I have an imagination that could allow me to come up with better scenarios. But this is certainly a very good one. However, this is why we take the time to say the capacity upgrades, and we're trying to parse that, represent more of a pull-forward. It's the model uplift that we're focused on. And so, what's actually very good for us is not the temporary pull-forwards. What's very good for us is that, that work from home is causing a lot of our service providers actually say, wait a minute, we have to figure out how to deliver our services without rolling trucks. We have to figure out a way to satisfy our subscribers in a way that we haven't in the past. And those types of questions cause them to start to look at our All-Platform offerings and accelerate the uptake of those. That's what is the most lasting and telling shift in the business, and that's what we're focused on.

Fahad Najam -- Cowen and Company -- Analyst

Appreciate the answers. I'll pass it on.

Carl Russo -- President and Chief Executive Officer

Thanks Fahad.

Operator

Ladies and gentlemen, this concludes our time allowed for questions. I'll turn the floor back to Mr. Dinges for any final comments.

Thomas J. Dinges -- Director of Investor Relations

Thank you, operator. Calix management will be participating in three virtual investor conferences during the third quarter of 2020. Information about these future events will be posted on the Events and Presentations page of the Investor Relations section of calix.com. Once again, thank you to everyone on this call and on the webcast for your interest in Calix, and thank you for joining us today. This concludes our conference call. Goodbye for now.

Operator

[Operator Closing Remarks]

Duration: 29 minutes

Call participants:

Thomas J. Dinges -- Director of Investor Relations

Carl Russo -- President and Chief Executive Officer

Cory J. Sindelar -- Chief Financial Officer

George Notter -- Jefferies -- Analyst

Paul Silverstein -- Cowen and Company -- Analyst

Christian Schwab -- Craig-Hallum Capital Group -- Analysy

Tim Savageaux -- Northland Capital Markets -- Analyst

Fahad Najam -- Cowen and Company -- Analyst

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