Sonoma County: News and Notes

This week we will be reviewing the results from Calix for the 2nd Quarter of 2015. They announced these results yesterday after the market closed. The company recorded $99M in Earnings in Q2 with very high Gross Margins of over 51% and Operating Expenses of $47.5M. Each category was better than the guidance provided in the Q1 earnings call but the Gross Margin was particularly strong. We will focus on this number a bit later. But in general, the quarter was about flat accounting for inflation. The company made a GAAP loss but a non-GAAP profit. I have explained the difference in the past. In this case, I would read the non-GAAP numbers as they represent the actual operating conditions at Calix.

First, why is this change in Gross Margin so important? The reason is that the company has claimed that its R&D spend has allowed it to make products that were either of lower cost or of higher value compared to its competitors. Investors can look at this as money in the bank. Generally speaking Gross Margins tend to remain flat in a business, unless the market conditions change. This expansion speaks well for the company and its prospects of growing profitably in the future.

Next a down note, last year Calix was touting potential expansion into International markets. This quarter saw a markedly smaller amount of International Revenue at $7.5M. There has been a downward trend over time, so bad news on this front is not huge news. It is also a small piece of the overall business. However, this means one of the growth initiatives has failed and continued to show that it has failed. I find it interesting that the company tried to spin this on the call. They called the results "Lumpy". This implies that business comes in good sized chunks. However, you can't look at a long term downward trend and call it a mixed bag (which is the point of calling it lumpy). I will come back to this at the end of this note.

So, really the question is where will growth come from. The most likely source would be the purchase of parts of Verizon's network by Frontier. Verizon is not a Calix customer but Frontier is. However, this may be a problem going forward. Much of the business in the bigger properties that Frontier bought are part of FiOS. This is particularly true in Florida, Texas and California. Unlike the last go round, this batch of lines has lots of installed FiOS. This means that Alcatal-Lucent (ALU) is now a significant vendor to Frontier in Access. Frontier won't be able to just replace the ALU gear. ALU is a tough competitor in Access and I think that might monkey up Frontier for Calix. ALU has a wide portfolio of products throughout the network and a larger deal might get cut by ALU to win more business. This will be something to watch next year.

Also, there was a report this week in Light Reading that Huawei is starting to gain some traction in the smaller carriers in the US. This would be a long term negative for Calix. Huawei would be one of the main International competitors. We have seen how well Calix did Internationally. If Huawei can get even traction as a stalking horse (somebody who bids low but does not win to drive down prices), this could be bad news for the Gross Margin at Calix in the long term. We have no evidence of this, but keep an eye on Calix's Gross Margin next year.

Finally, let's come back to the lumpiness or failure on the call and the company's characterization of it. What people want out of management is honesty. I get that a Quarterly Conference Call is a Sales call for Calix stock. But Management damages its credibility when it continues to predict growth on what is a failed initiative. Implying that the International business is about to turn around removes that confidence. Given the nice Gross Margin this quarter, maybe it is time to say that Calix's International Business is what it is.

Have a great week!

Jim Sackman Focal Point Business Coaching Business Coaching, Executive Training, Sales Training, Marketing

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