Casa Systems Inc (CASA) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Casa Systems Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the call over to Ms. Monica Gould, Investor Relations for Casa Systems. Ma'am, you may begin.

Thank you, operator, and good afternoon, everyone. Casa released results for the third quarter 2018 ended September 30, 2018, this afternoon after the market closed. If you did not receive a copy of our earnings press release, you may obtain it from the Investor Relations section of our website at investors.casa-systems.com.

With me on today's call are Jerry Guo, Chief Executive Officer; and Shaun McCarthy, Interim Chief Financial Officer. This call is being webcast and will be archived on the Investor Relations section of our website.

Before I turn the call over to Jerry, I'd like to note that today's discussion will contain forward-looking statements based on the business environment as we currently see it, and as such, does include certain risks and uncertainties. Please refer to our press release and our SEC filings for more information on the specific risk factors that could cause our actual results to differ materially from the projections described in today's discussion. Any forward-looking statements that we make on this call or in the earnings release are based on information that we believe as of today, and we undertake no obligation to update these statements as a result of new information or future events.

In addition to U.S. GAAP reporting, we report certain financial measures that do not conform to generally accepted accounting principles. During the call, we may use non-GAAP measures if we believe it is useful to investors or we believe it will help investors better understand our performance or business trends.

And with that, I'd like to turn the call over to Jerry.

Good afternoon, everyone, and thanks for joining us today. I am pleased to report that our third quarter revenue was directly in line with the revised fiscal year 2018 guidance we provided in conjunction with the second quarter earnings. This guidance was based on anticipated delays in customer spend as they evaluate significant DAA architecture deployment decisions and continue to digest recent capacity purchases. Consistent with our revised guidance, in the third quarter of 2018, we generated total revenue of $71.5 million. Gross margin for the quarter was 79.6%, a significant increase over the second quarter and relative to a year ago. This was driven by both a higher proportion of initial software purchases for our appliance sales and the shift in our revenue mix toward greater software license sales related to increased capacity demand. Software licensing in the third quarter comprised over 60% of product revenue. Shaun will discuss our financial results in more detail in his prepared remarks later during this call.

I would now like to provide some color on our third quarter performance and then update you on the progress we are making with our new products in cable, mobile and fixed telco. As we noted on our second quarter call, we believe that our core cable business is in a digesting period for the near term as our customers invest increasingly in software and line card-based capacity expansions rather than large-scale appliance purchases. This view is supported by our third quarter results, which were marked by significant software license sales versus chassis modems from earlier in the year and late last year.

Hardware as a percentage of total revenue has in fact shifted from over 80% in 2014 and 2015 to just over 50% in 2016 and 2017 and now stands year-to-date at below 50% as our customer footprint is more firmly established. Software-based capacity expansions, on the other hand, have increased from 3.4% in 2014 to 40% in the first 9 months of 2018. We believe that this pattern of spend in our core cable business will continue for the near term, with our customers increasingly meeting growing bandwidth demand by purchasing software-based capacity for their existing CCAP appliances while finalizing decisions on DAA deployment. On our last call, I referred to this as the annuity portion of our business and noted that our growth going forward will mostly come from new products in cable such as DAA nodes, our Axyom CCAP core and a chassis-based CCAP core, from mobile and from our fixed telco products. This does not mean that we will not see additional hardware sales. In fact, we are seeing appliance sales for new footprint deployments and upgrades of older hardware related to DOCSIS 3.1. And we are seeing sales of our industry-leading high-density line cards. We also expect to continue to take additional incremental share with the new footprint rollouts as we have done for the past 2 quarters with a large Tier 1 cable operator in Europe.

During the quarter, we continued to diversify our revenue base with the addition of 7 new customers for our cable and the fixed telco businesses. Additionally, Europe was up significantly from 14% in Q3 2017 to 28% in 2018, as European customers are now accelerating DOCSIS 3.1 upgrades.

Going forward, we continue to believe that we will see top line growth in 2019 as our customers finalize decisions about the timing of deployment of new technologies in their cable, mobile and fixed broadband networks. Near-term drivers for this are quite favorable in our view. First, we anticipate continued growth in bandwidth demand. Second is the shift in customer spend from CPE to infrastructure. Third, mobile operators are accelerating spend on 5G. All of these trends benefit our business.

On our last call, I outlined the trials we were in with existing and new customers in all 3 of our product areas. As a reminder, during the last quarter, we were engaged in 49 active trials with 40 customers, including 22 in wireless, 7 in fixed telco and 20 in cable for both our CCAP and the Remote PHY products. During the third quarter, we converted 2 trials, one in DAA and one in fixed telco into orders and increased the overall number of trials we are supporting to 56 with the 40 customers. These include 26 in wireless, 7 in fixed telco and 23 in cable for DAA, the integrated CCAP and the virtual CCAP.

In our cable segment, we continued to expand our virtual CCAP trials. Additionally, DAA trials continue to go well, and in fact, we saw our first DAA order conversions in the third quarter and several of our customers are using Casa DAA nodes to carry live traffic as they finalize their plans for full DAA deployment.

We are encouraged by what we are hearing from the large MSOs regarding their plans to move to DAA and virtualization. We are already seeing a few early Remote PHY deployments as certain MSO begin implementing DAA in their networks. We believe that DAA deployments will continue to ramp.

In our wireless business, we noted on our Q2 results call, we are working on final certification and shipment of our $20 million in purchase orders. In the meantime, trials are progressing with our Apex strand microcell, Apex Lifestyle femtos and Axyom 4G 5G packet core. These trials tend to run for longer period as customers become familiar with new solutions and implement operational changes that are required to deploy and to support them. I'm especially pleased to report that these trial engagements are occurring with customers globally. We believe initial traction in our wireless business will be from our Apex family of the indoor and outdoor radio asset network products and the small cell core. We expect revenue from our Axyom 4G, 5G mobile core solution in 2019, and we are already participating in multiple Tier 1 mobile service providers' 4G, 5G core evaluation and the trial processes. We're also seeing significant interest in our strand-mounted microcell, which solves key challenges associated with the backhaul, siting and power. The strand-mounted microcell for both licensed and the CBR spectrum was specifically designed for 3 types of customers: one, mobile network operators to enable them to meet urgent densification needs without the complex deployment issues associated with the pole or tower-mounted cells; two, cable MSOs to deploy their own wireless coverage and to sell its complete small cell site solution, including backhaul, space and power to mobile network operators; and three, converge service providers with both cable and wireless service offerings. As this product is designed to help drive increased traffic over MSO networks, we believe it will also have a beneficial impact on our CCAP core capacity and the DAA sales as well.

In our fixed telco segment, customer reception and engagement for our Axyom virtual BNG and multiservice router has been very strong, and, in fact, we added our first customer for our virtual BNG product during the third quarter. The virtual BNG router is one of 2 current applications associated with this virtualized solution. The other application includes a service provider edge router. The virtual BNG router can be deployed independent of or along with Casa's XGS-PON OLT, including our virtual OLT solution. Service providers have been interested in Casa's NFV disaggregated cloud model and architecture that supports seamless scalability and the use of commodity servers and open switches. The current edge routing market seems to be ready for disruption and Casa is working hard to seize this opportunity.

As I look at what we achieved during the quarter and our outlook for the balance of fiscal year '18 and '19, I remain as optimistic as I have ever been about our business. Given the number of trials we are in, the deployments, new products we're all starting to see, the new customers in strategic markets across the globe and the very positive feedback we are getting from customers about our solutions in mobile and the fixed telco, we believe that we are well positioned for the huge opportunity presented by the transformation in network architecture that service providers are now embarking on.

Before I turn the call over to Shaun, I'd like to comment briefly on a few additional items, namely our buyback program, our CFO search and our guidance for fiscal 2018. First, let me briefly review the results of our buyback program. As you may recall, on August 14, we announced a $75 million repurchase program. We recently completed the program with the repurchase of approximately 5.2 million shares. We are pleased with the results of the program and view it as a good capital allocation strategy given our stock price. Regarding our plans going forward, we are evaluating how best to deploy our cash against all potential investment opportunities. In doing so, of course, we consider the best ways to enhance shareholder value over time.

With respect to our CFO search, our evaluation process is ongoing. We have been working with a retained-search firm and are actively meeting with highly qualified candidates.

Finally, on our guidance for the full year, on our second quarter call, we revised our fiscal 2018 revenue guidance range to $330 million to $350 million. Based on what we're seeing currently, we are pleased to reaffirm this guidance range. Shaun will comment further on this in his remarks.

With that, I'll turn the call over to Shaun for a detailed review of our financial performance and our outlook for 2018.

Thank you, Jerry, and good afternoon, everyone. I will start by reviewing our third quarter financial results and then discuss our full year 2018 outlook. As Jerry mentioned, our third quarter revenue was in line with the revised outlook for fiscal year 2018 we provided on our last call. Key highlights during the quarter included significant gross margin expansion, both sequentially and year-over-year, increased EBITDA from Q2 of this year and continued free cash flow generation.

Total revenue for the third quarter of 2018 was $71.5 million, a 4.1% sequential increase from the second quarter, although as anticipated in our revised guidance, down from $94.3 million in Q3 of 2017. Total product revenue was $60.8 million in the third quarter of 2018, of which $24.1 million or 40% was from hardware and $36.7 million or 60% was from software. This compares to $84.2 million of total product revenue in the third quarter of last year with $36.5 million or 43% from hardware and $47.7 million or 57% from software, continuing the trend of increased software revenue as a percentage of our total product revenue.

Our GAAP gross margin for the third quarter of 2018 rose to 79.6% compared to 73.2% in the third quarter of 2017. The increase in our gross margin was primarily due to sales of hardware products with higher initial software-enabled capacity and a higher mix of software-based capacity expansion shipments. As a reminder, our gross margin can fluctuate from quarter-to-quarter based on the mix of sales of our hardware products with higher initial software-enabled capacity and software-enabled capacity expansions. We continue to expect that as we scale our wireless business, our revenue mix will shift slightly more toward hardware initially, with first phase orders from our Apex family of brand products including our small cell core and purchases of 4G and 5G software cores likely starting in 2019. As a result, we continue to believe that our long-term gross margin will be in the range of low 60s to high 70s.

Turning to expenses. Total GAAP operating expenses in the third quarter of 2018 were $34.3 million or 48% of revenue compared to $28.8 million or 31% of revenue in the third quarter of 2017. The increase in total operating expenses was due to an increase in personnel and related costs to support the growth of our business, the development and sales of our new products and an increase in research and development spending to address our customers' rapid deployment time lines.

Adjusted EBITDA for the third quarter of 2018 was $27.2 million compared to $44.2 million in the third quarter of 2017, primarily due to lower revenue and the increase in operating expenses. During the second and third quarters of 2018, we recorded a tax benefit of $10.2 million and $3.5 million, respectively, related to exercises and sales of equity awards by our employees upon expiration of the IPO lockup and completion of the secondary offering. We currently expect that our effective tax rate for the full year will be approximately negative 3%, but our effective rate may further benefit from the impact of additional equity award transactions in future quarters.

Non-GAAP net income for the third quarter of 2018 was $20.6 million compared to $25.7 million in the third quarter of 2017. Non-GAAP diluted net income per share was $0.22 for the third quarter of 2018 compared to $0.31 for the third quarter of 2017. Free cash flow year-to-date totaled $87.9 million compared with $44.4 million for the same period in 2017. We ended the third quarter with cash and cash equivalents of $308.4 million and total debt of $296 million.

On August 14, 2018, we announced the stock repurchase program, under which the Board of Directors authorized the repurchase of up to 75 million of our common stock. During the 3 months ended September 30, 2018, we repurchased and retired 3.1 million shares for $45.6 million before commission. Following September 30, 2018, we repurchased and retired an additional 2.1 million shares for $29.4 million, thereby completing the purchases under the program.

Before turning to our guidance for the full year, I want to comment on the tariffs that have recently been introduced on components from China and what, if any, impact these are having on our business. Others in our space have noted significant potential impact on their cost from these tariffs. I am pleased to say that these tariffs have not and we expect will not have a significant impact on our business in 2018. We have completed a review of our supply chain and are not expecting a significant impact to our costs for 2019. We have a flexible manufacturing and supply chain and plan to monitor developments in this area to minimize tariffs related-- the tariff-related impact to our cost profile going forward.

I would now like to turn to our guidance for the fiscal year 2018. For the full year of 2018, we continue to expect total revenue to be between $330 million and $350 million. We expect gross margin to be in the high 60s to low 70s. We anticipate that non-GAAP net income will be in the range of $76 million to $83 million and non-GAAP diluted income per share to be in the range of $0.80 to $0.88. Stock-based compensation is expected to be approximately $9.5 million for 2018. Average diluted shares outstanding for the full year are expected to be approximately 92.5 million.

With that, we will be happy to take your questions. Joining Jerry and me for the Q&A session will be Scott Bruckner, Senior Vice President of Strategy and Corporate Development; and Paul Hanna, Vice President of Global marketing.

I will now turn the call back to the operator to open the call for questions. Thank you.

(Operator Instructions) And our first question will come from the line of Meta Marshall with Morgan Stanley.

I wanted to dive into a couple of things. First, just on the full year guidance as far as net income goes. I mean, I understand you're kind of reiterating guidance, but that would imply kind of a steep tick down kind of in gross margins and a steep tick up of OpEx to kind of come in at that range. And so just trying to get a sense if it's just reaffirming guidance or there is something different happening in Q4 that we should be mindful of? And then maybe just a second question, talking about the DAA move and kind of what you're seeing in that market. Obviously, you kind of had your first sale this quarter or kind of first order this quarter. But just pacing for 2019 and has timing expectations changed at all from kind of the pushout you maybe saw last quarter?

Sure. I'll take the margin item. So we've been through our forecasting process. We're now, as we've said, comfortable reaffirming our gross margins in the high 60s to low 70s. Where we end the year, as you know, it's really going to hinge on our product mix for the fourth quarter. And at this point, it's really too early for us to comment on how that's going to shape up. But we'll continue to watch it and it's just dependent on the mix for us. Increased software mix in our revenue mix as well as larger initial software capacity and recent appliance sales particularly in the third quarter is really what was driving those higher margins in Q3.

Okay. Meta, I'm going to take the second question about the DAA. We, as to -- you have seen that we have continuing increase in the number of trials and progress very well with the trials. We do expect the ramp to be in 2019. We're not dismissing the possibility of deploying bigger scale deployment in 2018 either.

Got it. Just to circle back. So I mean on OpEx so, I mean, understanding gross margins and kind of your guidance there. But just on OpEx, there is nothing that we should expect for there to be a spike that would kind of cause earnings to come in within range kind of beyond normal course increases in development? Correct?

Yes. Understood. This is really -- this is our best estimate at this time. We're comfortable with kind of where we are. We're comfortable with the margins at this point and that's really where we are.

And, Meta, we don't expect any significant changes in OpEx for the fourth quarter.

Meta, this is Scott. The last thing I would say, I mean, we've spent a lot of time with you guys talking about what happens in the fourth quarter. And at this point in the quarter, unfortunately, it coincides with our third quarter earnings call. We don't really have a lot of visibility on where year-end spend is going to be. A lot of it is concentrated in the back end of the latter part of the quarter. So right now, it seems prudent from us from what we see today to just reiterate guidance. There is a possibility we could exceed the guidance. But we're very, very comfortable with the numbers that we've put forward for the remainder of the year.

Our next question will come from the line of Simon Leopold with Raymond James.

So I understand the uncertainty, particularly, when it comes to the software and capacity business that can be very late in the quarter. I think what I'd like to double check on are 2 aspects of what you're baking in. One is, just to revisit last quarter, you talked about the wireless business that you'd have the ability to recognize revenue double-digit millions in the fourth quarter. I want to just double check on that particular line item. And then in terms of the capacity expansion wildcard, I understand the uncertainty. I just want to make sure I understand what's implied in even the low end of your guidance. It does look like it has to be up by a decent amount sequentially in the fourth quarter to get to the low end of your revenue guidance for the year. I just want to make sure I'm not missing some other assumption in there.

Simon, as you have seen in the past, our Q4 has always been a bigger quarter than the rest of the year. And we are expecting really 3 products from 3 categories. It's the appliances sale, the software license sale and the wireless sale. And we are not completely certain about the mix of the 3 categories yet, that's why -- we'll take a -- this -- the approach of being prudent at this point.

So just can you confirm the comment you did offer last quarter regarding the wireless revenue recognition?

We are working hard on customer acceptance and delivery at this point. As we stated the last quarter that we have roughly $20 million in orders and are working on the delivery and acceptance.

And just a longer-term trending question. I'd like to get your sense of the virtual CCAP market in terms of how material it is. And I think that the context of my question is that I have the impression there's debate at the operators as to whether or not the transition to a virtual platform makes sense. I just want to get your perspectives on how that market might develop?

Sure. Simon, we expect DAA to ramp up next year. And we do expect 2 different type of deployments. One is the DAA nodes with chassis-based CCAP core. And the second one is the DAA nodes with virtual CCAP core. And we do expect revenue from our virtual CCAP core in 2019. And we believe we have made a significant investment in making that feature-rich, feature parity with traditional chassis-based CCAP core. And the integrated CCAP is not a -- of course, a simple job to just to make that feature-rich and high available. And we believe we are on our way to generate revenue in 2019.

And our next question comes from the line of James Kisner with Loop Capital Markets.

Just a quick clarification. I'm sure that you guys really don't want to give any detail on Q4, which is making it tough for us to understand this guidance. But it sounds that you're saying there's not a big jump in CapEx -- sorry, in OpEx rather in Q4. I just want to confirm that we should not be modeling a very large jump in OpEx in Q4. It seems to be mostly a gross margin hit that we should be modeling to meet this guidance in Q4?

That is correct.

James, just to be clear, I mean I know that it's just the way you phrased it, the gross margin hit. That's where the sensitivity is. That's kind of the way I phrase it. And as Jerry was discussing, that will be a function of the product mix. There are kind of 3 ways as we see -- because it's very important to reiterate this, our customers acquiring capacity. Some of are hardware based, some are software based, and it's at this point difficult to determine what that mix is going to look like. So rather than calling it a gross margin hit, that's where we're sensitizing as well.

Okay. But it seems like you're implying something pretty low here. Like to me, it could be 50% or something, right, I mean, in year in Q4? That -- is that out of the realm of possibility? Is that a crazy number to have?

No, it's possible. We don't think it's a crazy number to have. And I think your math is roughly correct.

Okay. I appreciate that. And in case it's related to the virtual CCAP, the -- it's interesting to guess that you'll have it available next year, I mean Harmonics talked about having a foundational patent being granted for that. I just wanted to, I guess, first understand when you think you might have the GA? It seems like they've got a decent head start in the industry. And separately are you confident that your IP is differentiated and that you're not going to have any issues around IP?

First, we are aware of the patent applications, and we believe we don't have any issues with our intellectual property. As you know that Casa doesn't go out there in the patent running networking software on servers. And that's first thing. And the second thing is that we believe our virtual CCAP has the leading features and leading capabilities, and we believe that we will be a leading vendor in the virtual CCAP core.

And James, this is Paul Hanna. I just want to underscore the point that we've mentioned in the past that we actually launched our virtual CCAP product back in 2016. And obviously, I've been working with a number of customers through trials. And as we approach deployments, as Jerry mentioned, for next year, we're very confident in feature-rich and differentiated capability of our solution.

Our next question comes from the line of Jason Ader with William Blair.

I had a couple of questions. First, on the CCAP hardware side, looks like this year it'll be down north of 20% year-over-year. I know you're not giving guidance for next year, but we've seen kind of a negative 8%, negative 6% over the last couple of years and this year, north of negative 20%. Should we see some kind of reversion to the mean next year? I mean, how do you think we should be thinking about modeling that CCAP hardware business at this juncture?

Well, as we mentioned, this we believe is a transition year. We are -- MSOs are digesting the appliances. The hardware capacity they've purchased next year, we believe, will be a year of ramping up the DAA deployment. And part of the hardware sales will be DAA related, including the chassis-based core as well as the DAA nodes.

This is Scott. I know we talked about this during our nondeal road show. I think it's important to reiterate that these DAA deployments over time are going to have a highly synergistic benefit for our core CCAP product. And that's a function of a couple of things, one is node splitting, which is going to require more ports in the headend. But the second is the fact that several of our large customers have expressed a preference for purchasing new appliances that are preloaded with cards that support Remote PHY nodes for their DAA implementations. So we -- as we've talked about, as this market evolves, we still see strength in our core products, and we see that as providing very stable annuity revenue for us as other areas, DAA, mobile continue on top of that additional growth.

Okay. Understood. And then going back to beating the dead horse on the fourth quarter, Shaun. It's just -- I guess it's hard to kind of understand where you guys are coming from here. You're reiterating this full year revenue which was, just say, at the low end, is $330 million, which would require about $100 million in revenue in Q4. And yet, at $100 million of revenue, the only way to get to the high end of your full year EPS range of $0.80 to $0.88 is to have a 60% gross margin and to have OpEx grow by $6 million sequentially, which is a pretty big jump. So I think we're all just trying to figure this out. It doesn't make a lot of sense. Because to get to 60% gross margin, you'd have to do -- you'd have to have a very low mix of software capacity expansions, which it doesn't sound like is going to be the case. So can you just help us a little bit more in it? And then you're not even telling us that you think you can do the double-digit million in mobility, which is going to be primarily hardware. So if you're not convinced of doing the $10 million or double-digit mobility, how do we reconcile that with this full year EPS guidance?

I mean, first of all, rough cut, your math is correct. Without firm -- these are orders are starting to shape up, we're talking to customers about these deals, but we don't have a clear line of sight to how these deals are going to take shape. They could have higher hardware content. And we've been, I think, prudent in our margin forecast for that relative to OpEx. As we said, we don't see a large amount of growth in our OpEx in the fourth quarter. And we did -- we went through our forecasting process. We've looked at the opportunities that are out there. We've looked at the spendings there. And we feel very comfortable with the top line and our guidance range, regardless of how the wireless plays out.

Okay. Just one quick follow-up there. So the $330 million to $350 million, I mean, to get -- again, to get to the low end of the range, you're going to have to grow by 40% sequentially. It almost feels to me like we could have a situation where you just wanted to keep the revenue guidance as is because you don't want to lower again. But you -- maybe you can outperform on the bottom line just based on where things were and your outperformance in Q3. And is that in the realm of possibility that that's what was going on in your heads as you thought about the full year?

No, Jason, that's not what I was saying. We are basically looking at 3 categories of product mixes. We do not yet know the final mix. We want to be prudent in our margin guidance. We do not want to get ahead of ourselves.

(Operator Instructions) Our next question comes from the line of Tim Savageaux with Northland Capital Markets.

I do want to follow up on the Remote PHY virtualized CCAP discussion because you're -- at least, I think you're kind of toned in terms of deployment timing -- appears to be pulling in a little bit. And I thought I heard you say you might or you could see something in Q4 there. I just wanted to check on that really quick. But the real question is there are industry analysts out there with forecast for that combined category that exceeds $500 million for next year. As you look at the opportunity all in both sides of the plant, if you will, on the head-end side in optical nodes, how material do you see this ramp opportunity for Casa next year? And as an aside to that, would you expect sort of a similar divergence in margins hardware and software, maybe hardware wise comparable to what you've been talking about on the wireless side?

Tim, we -- as I said that we do expect that ramp in 2019. We're not dismissing the possibility of some deployment in -- before the end of the year. And as to 2019 market size, we tend to take a more conservative approach than what's being reported. Paul can make more comment on that.

Yes, Tim. This is Paul Hanna. Obviously, the $700 million in 2019, I think you may have quoted it recently in talks with Harmonic. That's really a data forecast from one of the third-party observers of this space, Kagan in particular. Jeff Heynen's forecast -- his revised forecast as of August and September is closer to $200 million, maybe $250 million for 2019.

Okay. And while we're there, I mean, where do you see yourselves in terms of kind of market share there or at least overall positioning relative to the players who are pursuing that? And would you expect to have a material share of that market even of that size?

Tim, we are -- we cannot really forecast the market share at this point, but we are engaged with all major MSOs.

I'm showing no further questions at this time. I would now like to turn the call back to Mr. Jerry Guo for closing remarks.

Well, thank you to everyone for joining us today. And we look forward to updating you on our progress next quarter and seeing many of you at some of the upcoming investment conferences where we'll be attending.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.