Jul 31, 2019
Operator
Greetings, and welcome to Casa Systems' Second Quarter 2019 Financial Results Conference Call. [Operator Instructions] Please note this conference is being recorded.
I will now turn the conference over to your host Eleanor Johnson, Investor Relations. Ms.
Johnson, you may begin.
Eleanor Johnson
Thank you, Operator, and good afternoon, everyone. Casa released results for the second quarter of 2019, ended June 30, 2019, 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 Maurizio Nicolelli, 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 SEC filings for more information on these 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 upon 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 that 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.
Jerry Guo
Good afternoon, everyone, and thanks for joining us today. I am pleased to report that our second quarter results were in line with our expectations and represented a significant increase over our results for the first quarter of this year.
Revenue for Q2 was $52.1 million an increase of 47% from Q1. This is consistent with our expectation that the first quarter will likely be our lowest quarter for fiscal year 2019 and that we will see continued improvement throughout the year, driven by capacity-related purchases by our cable customers and revenue recognition from wireless backlog.
During the second quarter, our gross margin also increased significantly, sequentially to 75.4% versus 69% in the first quarter. The higher gross margin was driven by a high portion of software license sales during the quarter across our integrated CCAP hardware and the certain distributed access architecture, or DAA products.
Software licensing in the second quarter accounted for more than 50% of product revenue. While software and the maintenance revenue combined, both high-margin revenues, comprised approximately 2/3 of our total revenue.
Maurizio will discuss these results in greater detail in his remarks later on in this call. But I would like to highlight a few points related to our results for the second quarter and our outlook for the remainder of this fiscal year.
First, while we did see a higher spending in our cable segment during the quarter, our cable revenue came primarily from capacity-related purchases. That includes software licenses and some additional chassis across our full range of integrated CCAP products.
We did recognize some revenue from our new cable products, which included our BDM card and Remote PHY nodes. And we saw increased trial activities in DAA and virtual CCAP.
In fact, our cable trials increased in the quarter by 53%, the vast majority of which was driven by existing and new consumer interest in our DAA, virtual CCAP core and new BDM products. However, revenue from our new cable products was not yet material.
As a result, while we do expect MSOs to increasingly redirect investment into distributed access architecture, we continue to believe that we haven't yet reached an inflection point away from the industry-wide pause in cable spending that we identified on our last call. Our expectation for cable business for the second half of this fiscal year is that revenue will continue to come mostly from software and hardware capacity needs supplemented by a few early shifts to DAA.
Second, I am pleased to report that during the second quarter, we began to recognize some of the revenue in our wireless backlog, and we expect to continue to recognize revenue for this backlog in the third and the fourth quarters. We also saw an increase in our wireless backlog during the second quarter to $31 million, up from approximately $24 million in Q1.
We expect this backlog to continue to grow for the remainder of fiscal year 2019 and we remain optimistic that revenue from wireless will be material for fiscal year 2019. As a reminder, most of the products in our wireless backlog will be from our radio access network portfolio, which are hardware-heavy.
This will likely have an impact on our gross margin for the second half of 2019. Maurizio will provide further details on this.
Additional positive developments for the quarter that I'd like to point out include: new wireless business wins in our radio management software and Packet Core software products; significant increase in trial activity across all products. During the first quarter, we were engaged in 90 active trials with the 67 unique customers, including 37 wireless, eight in fixed telco and 45 in cable for our integrated CCAP and DAA products.
During the second quarter, we increased the number of trials we are supporting to 113 with the 65 unique customers. These include 36 in wireless involved in both our 4G and 5G virtual Packet Cores and our radio products; eight in fixed telco with our BNG and PON products and 69 in cable, most of which are for our DAA nodes and a virtual and a physical CCAP cores; conversion of several trials to orders in our wireless business and in our advanced cable products; an important strategic hire during the quarter with the addition of [indiscernible] to the team as our Chief Customer Officer.
Alf runs out our senior leadership group and will be responsible for our large and growing sales and customer support efforts globally. Closing of our NetComm acquisition on July 1.
NetComm brings a lot to our business, not only in the form of expanding customers and products but also, in engineering capabilities for access devices, including a top-ranked team of RF engineers that will meaningfully augment our radio R&D activities. This is important given the early demand that we have seen for our in-door small sales and outdoor 4G and 5G radio products.
With the acquisition of NetComm, we now offer end-to-end broadband solutions, not only for 4G and 5G wireless, including fixed wireless equipment for the far edge of the network that we believe will represent material use cases for 5G but also, for wireline customers as well by adding the G.fast capabilities that can be paired with our PON and virtual BNG products. While operators are facing challenges of rolling out a full fiber network, in particular when connecting multiple dwelling units, or MDUs, the reverse power of G.fast distribution point unit or DPU, enables fiber-like broadband speed over existing copper lines.
The reaction to this acquisition from our respective customer bases has been very positive. We have already identified and are pursuing cross-selling opportunities with several wireless and wireline customers for our end-to-end solutions and are actively working on integrating the two businesses.
Regarding our outlook for the second half, we're updating our revenue guidance to a range of $320 million to $350 million, including our expectation for revenue from the recently acquired NetComm business, which Maurizio will discuss in his remarks. While we have tempered our expectations for spend from our cable customers for the remainder of 2019, we do expect to see them continue to purchase software and hardware-based capacity as we saw in Q2, as well as engage in some DAA rollouts.
And we are focused on recognizing revenue from and the building our wireless backlog. With that, I will ask Maurizio to comment on our financial results.
Maurizio Nicolelli
Thank you, Jerry and good afternoon, everyone. I will start by reviewing our second quarter 2019 financial results and then discuss our outlook for fiscal 2019, which now will include two full quarters of NetComm results.
Our second quarter performance was in line with our expectations and we have started to see a modest uptick in spending, heading into the second half of the year. Total revenue in the second quarter of 2019 was $52.1 million, which compares to $68.7 million in the second quarter of 2018 and $35.5 million in the first quarter of 2019.
Total product revenue was $42.2 million in the second quarter of 2019, of which $20.6 million or 49% was from hardware and $21.6 million or 51% was from software. This compares to $58.5 million of total product revenue in the second quarter of last year, with $33.9 million or 58% from hardware and $24.6 million or 42% from software.
Hardware sales during the second quarter accounted for 39% of total revenue, down from 49% in the prior year quarter. Our wireless backlog had increased to $31.1 million, up 30% from Q1.
As we enter the second half of the year, we continue to see significant interest in our wireless portfolio of products. We believe that this will contribute to our anticipated quarter-to-quarter revenue growth for the remainder of the calendar year.
Our GAAP gross margin for the second quarter of 2019 was 75.4%, up from 71.9% in the second quarter of 2018. This increase in our gross margin was primarily driven by a higher portion of software revenue during the quarter.
Turning to expenses. Total GAAP operating expenses in the second quarter of 2019 were $35.6 million, up 8% from $32.9 million in the second quarter of 2018.
The growth in total operating expenses was due to increased hiring in our research and development group and $582,000 related to the nonrecurring, professional fee costs associated with the NetComm acquisition. Headcount at June 30, 2019 totaled 812, up 35 net new employees since March 31, 2019.
The majority of the new hires were related to mobile research and development. Our adjusted EBITDA in the second quarter of 2019 was $9.5 million compared to $19.8 million in the second quarter of 2019, primarily due to the higher income from operations in the prior year period.
We recorded a tax benefit of $558,000 in our provision for income taxes during the second quarter. As in previous quarters, this was related to exercises in sales of equity awards by our employees and minor adjustments to our effective tax rate.
Non-GAAP net income for the second quarter of 2019 was $6.1 million compared to $22.2 million in the second quarter of 2018. Non-GAAP diluted net income per share was $0.07 for the second quarter of 2019 compared to $0.24 for the second quarter of 2018.
Free cash flow for the quarter was a negative $19.2 million compared to a positive $29.3 million for the same period in 2018. Negative free cash flow during the quarter was driven by higher inventory balances associated with new products, the timing of supplier payments and reduction of deferred revenue from certain products that were delivered and paid in previous quarters.
We ended the second quarter with cash and cash equivalents of $244.2 million, which includes $130 million of restricted cash, primarily for the NetComm acquisition, and total debt of $294.4 million. While we did not repurchase any shares under our share repurchase program during the second quarter, we currently have approximately $75 million of share repurchase authorization available.
We continue to review our capital allocation policy between M&A opportunities, share repurchase and debt repayments. I would now like to turn to our guidance for fiscal 2019.
Our guidance now reflects the combined results of NetComm, which closed on July 1 for the second half of 2019. As we have stated in the past, although the timing of deployments may vary from quarter-to-quarter, we believe we remain well positioned to grow our market share and deliver long-term growth.
For the full year of 2019, we expect total revenue to be between $320 million and $350 million. Of this amount, we expect revenue from the acquired NetComm business to be approximately $70 million to $80 million.
We expect our full year gross margin to be in the range of 50% and 60%. Our full year Casa standalone gross margin, which excludes NetComm, is expected to be between 60% and 70%.
We continue to expect that we will recognize meaningful wireless revenue in the second half of the year, primarily from RAN hardware purchases, which will put pressure on our gross margins. The NetComm gross margin for the July through December 2019 period is expected to range between 25% and 30% as revenue is driven primarily from hardware sales.
As part of our Phase II integration, our goal is to increase NetComm’s gross margin by leveraging Casa’s supplier relationships. Adjusted EBITDA is expected to range between $40 million and $50 million, down from our previous expectation of $50 million to $60 million due to a slight reduction in annual revenue and gross margin expectations.
We anticipate non-GAAP diluted income per share to be in the range of $0.20 and $0.30 and GAAP diluted income per share to be in the range of zero and $0.10. Stock-based compensation is expected to be approximately $11 million in 2019.
As Jerry mentioned, integration with NetComm is progressing well. We continue to expect to recognize annualized cost savings of $7 million to $8 million within the next 12 months and non-GAAP diluted income per share accretion of approximately $0.02 in 2019 and between $0.07 and $0.08 in 2020 from initial deal synergies.
Overall, we continue to remain confident in our opportunities in this transitional period. We are starting to see an uptick in spending from our largest cable customers, and interest in our wireless products is building each quarter.
Additionally, NetComm provides new avenues for further penetration into our customer base through cross-selling opportunities into our consolidated customers. Joining us now for Q&A will be Scott Bruckner, Senior Vice President of Corporate Development & Strategy.
With that I will now turn the call back to the operator to start the Q&A session. Thank you.
Operator
[Operator Instructions] Our first question is from Meta Marshall, Morgan Stanley. Please proceed with your question.
Erik Lapinski
Hi, everyone. This is Erik on for Meta.
Thanks for taking our question. It sounds like DAA evaluations are generally trending along, as you mentioned some revenue you may start to recognize as the year progresses.
Can you maybe walk us through just how those evaluations are going? And if you’re seeing any challenges?
Jerry Guo
Well, we have been doing the DAA evaluation with multiple – quite a number of MSOs. And as we have stated in the past, DAA deployments is a lot more challenging than the traditional CCAP or CMTS upgrade, which is limited to indoor equipment only.
And DAA tends to have both the indoor component and outdoor component. And operators are also forced to do video – broadcast video, narrowcast video and set-top box control in the DAA upgrade cycle.
So it is more time-consuming and takes a longer period of time. But we believe that we have solutions for both North American market as well as international markets.
So take care of both data sides as well as the video side.
Erik Lapinski
Thanks. That’s helpful.
And then maybe just maybe one more quick on the NetComm business. What type of visibility do you have as you’re kind of putting together your forecast?
Is it a bit better there? And just any kind of differences from the rest of the business?
Maurizio Nicolelli
So NetComm’s business is fairly concentrated in revenue around a small number of clients. They have – NetComm’s business is – there’s much more visibility within the three to six-month period.
So it makes it – it’s better for us to – it’s easier for us, I should say, to project their revenue just because there’s more clarity within the next three to six months, because a lot of their orders are already pretty much preordered with some very good visibility. So a little bit of variability in there but much better visibility than our existing Casa business.
Erik Lapinski
Got it. Thank you.
Operator
Our next question is from Simon Leopold, Raymond James. Please proceed with your question.
Simon Leopold
Great. Thank you very much for taking the question.
So just wanted to check in. On the NetComm business, I appreciate you breaking out the contribution, the 70% to 80%.
Just wondering if you’re familiar with any kind of seasonal patterns to expect from that particular business that we should try to take into account?
Maurizio Nicolelli
So the third and fourth quarter are fairly consistent in terms of total revenue in the business. There’s not much variability between those two quarters.
Thus, I would – but you could use that guidance and really split it between the two different quarters.
Simon Leopold
And just historically, what should we think in terms of – as we’re thinking about kind of seasonality for our 2020 models?
Maurizio Nicolelli
I think best is to use the historical information for NetComm to base your models going forward.
Simon Leopold
Okay. And then you did talk about the cable outlook being tempered.
Just want to make sure I’m thinking about it correctly. It seems obvious but just to verify, last quarter, you had core Casa revenue for the year $250 million to $300 million.
You basically are suggesting the lower half of that range now, $250 million to $270 million, if we adjust for the NetComm. Is that the right way to think about it?
Maurizio Nicolelli
That’s a 100% correct. You got it.
Simon Leopold
Perfect. And then just lastly, if you could give us an update on where you stand on virtual?
I understand that you’ve got sort of dual-pronged strategy that either leverages the chassis or standalone, and you’ve had some lab activity. If we could get an update on your virtual CCAP?
Thank you.
Jerry Guo
Yes. I mentioned that in the script and also in the past, we have been conducting DAA trials with a lot of our MSOs globally.
And we have basically provided DAA nodes or Remote PHY nodes. We have provided physical CCAP core and virtual CCAP core, sometimes both for the same customers.
So we basically are providing whatever is needed for the customer to provide their traditional services, including the DOCSIS data as well as the video.
Simon Leopold
So do you have deployed commercially pure virtual additions of CCAP? Or are they leveraging the current chassis architecture?
Maurizio Nicolelli
We – currently, we’re not really splitting between the two scenarios. And some of them will prefer a physical, some of them prefer a virtual.
We basically are doing a complete solution for them.
Simon Leopold
Great. Thank you for taking for taking the questions.
Operator
[Operator Instructions] Our next question is from John Marchetti, Stifel. Please proceed with your question.
John Marchetti
Thanks very much. I just wanted to touch base real quick on the guidance for NetComm for the second half of the year.
I’m curious if that includes any sort of cross-selling opportunities or anything baked into that or we should think of – at least, for the remainder of the 2019 that being solely the book of business that NetComm wireless came in with?
Maurizio Nicolelli
So we’ve been very conservative with our guidance. The $70 million to $80 million guidance for revenue does not include cross-selling opportunities.
That is the Phase II integration work that we’re working on right now. So there’s a big opportunity for us to be able to sell our Casa products into the NetComm customers and vice versa selling NetComm products into the Casa customer base.
So the answer to your question is, no. That is incremental for the future and we’re working hard towards that.
Scott Bruckner
John, it’s Scott. Just to give you a little more color because the – when we announced the transaction, I think we mentioned on the last call, it was just for Mobile World Congress in Barcelona.
And what we saw was significant interest for both customer bases about the end-to-end products. So with customers, we are engaging on end-to-end solutions with specific interests in 5G fixed wireless access, 5G cores into the NetComm customer base and then a combination of our virtual BNG routers with NetComm’s DPU solutions.
John Marchetti
Got it. That’s very helpful.
And then in terms of the expanded backlog that you saw in the wireless business, I’m assuming, it grew even faster than the $24 million to $31 million, just given your comments that you recognized some revenue in 2Q, as we go through the second half of this year, can you just give us a sense of how that book of business sort of continues to build? What you’re hearing from the customers who are in?
And again, maybe if there’s any color that you can share along what might be a long the fixed wireless access lines versus maybe some of the 5G core work?
Jerry Guo
You are right about the backlog growth. We recognized some revenue and we – and at the same time, we grew the backlog.
We have – we are getting really excited – a lot of excitement about our – both our video products as well as our core products. We expect the wireless backlog to continue to grow throughout the year and through next year as well.
We believe that’s going to be a long-term growth driver for us, and we have seen the excitement even in the short term.
John Marchetti
Great. Thank you very much.
Operator
Our next question comes from Tim Savageaux, Northland Capital. Please proceed with your question.
Tim Savageaux
Good afternoon. A couple of questions, one on cable and one on wireless.
You mentioned you’re seeing an uptick in spending among your large cable customers, and that’s pretty much in line with what they were kind of implying in their capital spending guidance for the second half. I guess my question is how broad-based is that among your major customers?
And as an aside, did you have any 10% customers in the quarter?
Scott Bruckner
So we do have 10% customers in the quarter. Just as a reminder, in the first quarter, we had two customers that were at 10% or greater.
I think we’ve done pretty good in diversification. This is not including, again, pro forma for NetComm.
So they’re now four that are at 10% or greater.
Tim Savageaux
That is in the second quarter or pro forma with NetComm?
Scott Bruckner
That is in the second quarter.
Tim Savageaux
Okay. Great.
And so I guess the implicit answer to that is your uptick in cable was pretty broad- based, and I’ll move on to the wireless side.
Scott Bruckner
So Tim, sorry, I neglected to answer that. It actually was.
We saw it across the board. And it was consistent with our expectation that we’ve been expressing for, not even just the last quarter but the quarter before that when we began to see a compression in spend in core infrastructure technology, we knew that at some point, given the growth in bandwidth demand, that there would be a need to spend on capacity, and that’s exactly what we started to see in the second quarter.
And in fact, that’s our expectation for the remainder of the year with respect to the bulk of what we think we’ll see from cable. We haven’t yet, as we mentioned, seen an inflection point in investments in DAA although the number of trials in DAA during the quarter, and to the earlier question, that does include both integrated to physical cores and virtual cores has increased significantly.
We take that as a very good sign. But the spend on capacity was pretty much across the board, and it was on software, it was on chassis, and it was on line cards.
Tim Savageaux
Great. And when we move on to wireless and kind of asking about the backlog again, but also about the trial pipeline with the specific focus on kind of Tier 1 carriers in the U.S.
and I’m happy to hear global comments as well. But as you look at that backlog, can you talk about – any color on how many traction with the range of Tier 1s in the U.S.
you might have? Specifically whether the closing of the Sprint team mobile merger might be a positive catalyst for you.
And maybe describe that backlog in trial pipeline if it’s appropriate to, as you mentioned some traction on the radio access side? Or whether you are also working on wins that might be considered sort of more strategic network-wide on the core side?
Jerry Guo
The backlog growth did come from multiple Tier 1 carriers and including multiple Tier 1 carriers in the U.S. And in terms of the core as a strategic component, we believe that’s going to be a in 2020.
Tim Savageaux
Got it. Thanks very much.
One last one. Was there a 10% customer on the wireless side or was it all cable?
Jerry Guo
That was our cable.
Scott Bruckner
That was our cable. Yes.
Tim Savageaux
Thanks.
Operator
Our next question comes from Jason Ader, William Blair. Please proceed with your question.
Jason Ader
Thanks. Jerry, can you give us an update on Full Duplex or Remote PHYs?
And whether that is something that you believe your customers are going to want and maybe they’re waiting for Full Duplex to be available before they broadly deploy.
Jerry Guo
Well, we believe that the industry is actually – the industry has different opinions about different solutions, going forward. And we, as a supplier, making our second-gen DAA nodes for Duplex capable.
We don’t believe it’s going to be a one- size-fits-all. And we believe there will be customers who want DAA and there will – for Duplex, there will be actually MSOs, who prefer maybe extended spectrum and other technologies as well.
Jason Ader
Okay. And then would you care to give a prediction on when you think an inflection point might occur for DAA deployments?
Jerry Guo
We believe that it’s going to start to grow toward late this year and throughout next year. And – but the timing is very hard to forecast given how much delay that industry has experienced.
Jason Ader
Okay. So…
Maurizio Nicolelli
Jason, one more thing I would add to that is, as Jerry noted, the evaluation of the technology or of moving to distributors has become more complicated because as we’ve talked about there’s number of flavors. There are kind of five or six variations to begin to think about distributed.
So that complicates it. We did take some of the announcements that you’ve heard in the quarter from others about some interesting orders in virtual is actually a very encouraging sign.
We always think it’s a good sign when one of the leaders makes a big move in a new technology direction because that gives validation to the technology that hopefully, will spur others to move forward. Having said that, we still believe that it’s very early days in the shift from integrated to distributed architectures.
And so a conclusion about who’s captured DAA or even any conclusion about when the inflection point happens, to our mind, is still quite premature.
Jason Ader
Okay. And then my last question is just on NetComm.
Could you provide us an estimate of what the growth for the business will be this year, kind of pro forma versus last year for the whole business, so 2019 versus 2018 just for NetComm? And then just on the gross margin, is that sort of the range that we should expect going forward for NetComm?
Or is – there’s other developments that could change the trajectory of gross margin for the NetComm business?
Maurizio Nicolelli
Sure. This is Maurizio.
So the guidance of $70 million to $80 million is actually a nice uptick from their July through December quarter of the previous year. So if you look at it in terms of the second half of 2018 versus the second half of 2019, there’s been a nice double-digit uptick in terms of growth.
In terms of the gross margin, right now, it is hovering between 25% and 30%. Given our ability to leverage our supplier network, it is our goal to increase that margin going forward over the next 12 months and that’s really integrating their supply chain group with our supply chain group to really get some efficiencies there going forward.
Jason Ader
Thank you.
Operator
We’ve reached the end of the question-and-answer session and I would now turn the call back over to Jerry Guo for closing remarks.
Jerry Guo
Well, thank you to everyone for joining us today. We look forward to updating you on our progress next quarter.
And in the meantime, welcoming you to visit us at CTE in New Orleans and Mobile World Congress Americas in Los Angeles.
Operator
This concludes today’s conference. You may now disconnect your lines at this time.
Thank you for your participation.