Calix reported flat revenue of $114.5 million for its third quarter, spurred by an increase in sales to Verizon and smaller providers. While CEO Carl Russo pointed to these results as indications the vendor's transition to a software and services company are well underway, the analyst community is more cautiously optimistic.
Continued sales of its legacy hardware and low-margin services dragged on profits even as the vendor's revised "Calix 2.0" focus on open software-based platforms and services gathered momentum, wrote CEO Carl Russo in a letter to stakeholders. This switch in gears -- marked in part by relocating Calix's headquarters from Petaluma, Calif., to San Jose just over a year ago -- generated some quarters of negative revenue reports, he said. But he said the strategy is now starting to pay off.
"We're excited that this focus now has us entering the fourth quarter with a strong pipeline of demand on top of a solid backlog," he said. "We are positioned to ride the wave of secular disruption moving through the communications service provider marketplace … and we intend to grow from here on out."
Sharing the numbers
In Calix's most recent quarter, systems revenue was up 1% from 12 months prior, based on a 14% increase in shipments in systems of Calix Cloud, EXOS and AXOS platforms, but partially offset by pressure on the vendor's legacy systems revenue, Russo wrote.
Services revenue declined 13% versus September 2018 numbers. Calix continues to accelerate next-generation -- a.k.a. more margin-rich, consultative -- services surrounding its platforms, but this revenue was "more than offset" by the margin on lower professional services associated with its legacy technologies, Russo wrote. That story will change as customers buy more of the new platform-related Calix services and the legacy service offerings dwindle away, he said during the earnings call.
"What we expect to see from here is services actually to start to grow at a modest rate because the heavy lifting -- which was really the low margin deployment services -- is behind. We have been engaged in continually aligning our services business with our platforms and customer success," said Russo. "What's happening underneath that number is the offerings mix is shifting towards much higher [differentiating] value and service offerings, albeit they are lower revenue. But as you do more and more, the revenue will start to grow. [And] margins will continue to expand."
That's due in part to Calix's work with a growing base of smaller providers. These operators -- a mix of municipalities, utilities, ISPs and WISPs -- typically have fewer internal resources for marketing and sales, and also seek automated solutions: The types of platforms Calix has developed in its new iteration.
As a result, Calix predicts "modest" revenue growth and "reasonable" gross margin expansion in services in the short term, Russo said.
Who's buying, who's shying away
Unlike some competitors that found growth opportunities via international providers, most Calix customers remain on this side of the Atlantic, with domestic customers accounting for 88% of revenue in Q3. It does, however, have several strong international clients, like UK altnet CityFibre. However, since CityFibre is early on in its infrastructure-construction phase, Calix's current role is limited, Russo said, until it gets beyond deploying fiber.
In Q3, CenturyLink represented 16% of Calix's business (down a nudge from the 17% it accounted for in Q2 2019) and Verizon accounted for one-tenth, Russo said. CenturyLink has slowed its purchases since the Level 3 acquisition, impacting many access vendors (and beyond). The combination of Calix's work with the operator and other cabelcos beset by financial pressures concerned at least one analyst who tracks this industry.
"We're intrigued by additional evidence of Calix' ongoing product transformation, a diversifying customer base, and the potential for improving profitability," Jeffries Group Equity Analyst George Notter, who was on the Calix earnings call this week, wrote in a report. "Nonetheless, the still-significant exposures at CenturyLink, Windstream and Frontier keep us on the sidelines with respect to the stock."
As software platforms and services begin accounting for more of Calix revenue versus legacy systems, the size of the customer will shift; more and smaller operators in various hues will begin representing a larger percentage of sales, Russo said. Subscription-based revenue stretches over time, with many customers purchasing add-on services, applications or features, he noted. The vendor must hope its "Calix 1.0" customers soon migrate from those earlier systems, liberating the vendor to focus exclusively on its future, not its past.
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