Greetings and welcome to the Calix Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only-mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Tom Dinges, Director of Investor Relations. Thank you, Mr. Dinges. You may begin.

Thank you, Tim, and good afternoon everyone. Today on the call, we have President and CEO, Carl Russo; as well as the Executive Vice President and Chief Financial Officer, William Atkins. This conference call will last approximately 60 minutes and will be available for audio replay in the Investor Relations section of the Calix website. Before we begin, I want to remind you that in this call, we refer to forward-looking statements, 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 today’s earnings press release and in our Quarterly and Annual 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 earnings press release. Unless otherwise noted, all numbers referenced in today’s conference call are non-GAAP. As a reminder, our earnings press release, supplemental financial data, and an accompanying earnings release presentation are available in the Investor Relations section of the Calix website. For the quarter ended September 24, 2016, Calix reported revenues of $121 million, and a non-GAAP profit of $0.12 per share. In just a moment, William will take you through the quarter in greater detail, and Carl will conclude with his thoughts on Calix’s strategy and market outlook. This will be followed by questions from analysts. With that, I would now like to turn the call over to Calix’s Executive Vice President and Chief Financial Officer, William Atkins. William?

Thank you, Tom. We last provided you with guidance regarding Q3 on August 2 and in that guidance we called for revenue of between $115 million and $119 million, a gross margin of between 45.5% and 46.5%. Operating expenses in the range of $48.5 million to $49.5 million and net income per share of between $0.08 and $0.12, including approximately $4.5 million of Occam litigation settlement gain recorded as a reduction to operating expenses or a loss of minus $0.01 to income of positive $0.03 per share if Occam litigation expense in settlement gain had been excluded. Relative to that guidance, our actual revenues for the quarter were $121.2 million and non-GAAP EPS was $0.12 per share including Occam litigation expense in settlement gain, or a profit of $0.03 per share excluding the Occam litigation settlement gain, with revenues above the upper end of guidance and non-GAAP EPS at the upper end of our guidance range. Gross margin was 45% and operating expenses came in at $48.3 million, which includes that $4.5 million in Occam litigation settlement gain or $0.09 per share recorded as a reduction to operating expense. At the gross margin level, the largest drivers were costs associated with the continued ramp of turnkey network improvement projects and increased activities with CAF II projects as well as product and regional sales mix. Operating expense included continued investments in R&D to support growth initiatives. Our aggregate balance of cash and marketable securities was down sequentially at $61.3 million from $64.2 million in the prior quarter, primarily due to operating cash usage including cash outlays related to turnkey network improvement projects and capital expenditures of $2.2 million. Getting into a bit more detail, our $121.2 million in revenues for the quarter marks a new quarterly record, representing an increase of…

Thank you, William. I’ll begin this quarter as I did last quarter by reiterating our goal, predictable, profitable growth. Q3 was another solid quarter of progress for Calix with revenues increasing 8% compared to the year-ago period. Growth this quarter was broad-based, and as I said last quarter, growth remains our number one focus. Our guidance for Q4 reflects our continued focus on growth as we expect another quarter of solid growth driven by increased systems and service upgrade investments by our customers. The latter reflects the desire of our customers amid tightening internal resources. So relying more heavily on partners like Calix to provide a broader array of aligned professional services as we’ve noted for over a year now, our professional services team has ramped to meet customer needs and we are seeing improvements on the productivity front. However, this shift will pressure our margins in the near-term. Looking to 2017 and beyond, the rate of change in our industry is increasing and our opportunity to bring disruptive economics to the access infrastructure is enormous. Our view has always been driven by the pursuit of one converged network, built on a software defined access foundation and elevated by a cloud service offering. It is now clear that customer readiness for this change is here and our opportunity is directly ahead. To capture this opportunity and drive our growth, we’ve noted that from time to time, we’ll have to push on the OpEx levers to achieve our goals and in Q4 we’ll continue doing just that. To be clear, these investments are generating solid returns. Here’s just a few examples. In late September, we launched the AXOS E3-2 Intelligent Access Node, while the E3-2 incorporates Layer 3 functionality and is ideally suited for the needs of the cable MSO market.…

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Simon Leopold of Raymond James. Please proceed with your question.

Great. Thank you for taking my question. A couple of things I wanted to see if we could get a little bit more insight on, and I know, this first one is probably a bit of a challenging question, but you did enter the trial, the lab trials with Verizon, that you talked about I think last quarter with a press release at least, just want to see if you can give us any indication on how that’s going? What the timeline might be for getting additional updates on the status? And if there is any insight you can give us in terms of the – the impact this has on your operating expenses I know Tier 1 trials can be expensive to support?

Simon, thanks for the question. So it’s a good challenging question, let me directly answer your question by saying, there is no news that we will – we’ll report at this time other than the following. We had not made it clear what the system was that was going to Verizon. With our announcement prior to the User Group of the E92 intelligent access system, I think it’s now clear what that system would be, and so the E92 bring-in all of the functions that are required along with NG-PON2 is in fact the system that’s being used, beyond that, there is no news to report at this time.

Any indication of a timeline you can give us or the impact on your OpEx in the – even in the near-term?

So, thanks for reminding me I apologize, on the OpEx piece I mean, pretty clearly William messaged to the OpEx forecast and I mentioned that there is some pushing on the OpEx levers to go achieve what we want to achieve. I think it would be wise to assume that some percentage of that investment is related to trials and things of that nature like this, beyond that I wouldn’t go.

Okay. And then the other bucket of opportunity is the – the CAF II funds from the rate of return carriers, could you help us, give us an update of where that opportunity stands?

So, all of that is now rotating into time horizons for 2017. And it’s clear now from obviously coming from the user group where many of those carriers might have participated that those things are moving forward. I think as I’d mentioned before, it’s my view that this is likely – this particular portion is likely to start to look more incremental than substituted. And I think that will be the case from what I have seen over the last two weeks.

Great. That’s very encouraging. Thanks for taking my questions.

Simon, appreciate it.

[Operator Instructions] Our next question comes from the line of Greg Mesniaeff of Drexel Hamilton. Please proceed with your question.

Yes, thank you. I have a question on gross margins on the guidance that you gave. Is it fair to assume that some of the guidance you gave on the gross margins for the fourth quarter factors in some attempts to lower cost of goods sold on products to perhaps offset any lower, or rather any higher costs associated with the shift towards service and support that you’re referring to?

So, Greg, as you might imagine, we have a pretty consistent cost reduction effort that goes on related to COGS. I think as William alluded to and I think I reiterated, the rotation towards a greater percentage of revenue albeit still small, on service deployments has a downward pressure, irrespective of the efforts that we put in on COGS.

Okay. But is it fair to assume that there is an ongoing effort to reduce product COGS to at least, may be partially offset or offset the higher COGS associated with the service revenues?

Well, the – it would be hard to do something unusual. So, I guess what I’m trying to make sure I’m being clear is we continually go after reducing COGS and there is no discontinuous effort that will go on because of that. William do you want to add?

Just want to weigh in Greg and I understand why you’re phrasing the question. What I would say is that – is not through shall we say a tactical response to the increased amount of service revenues going through our P&L causing us to focus on reducing costs for our systems rather it is an ongoing effort. You recall that we had an Investor Day roughly six months ago where we took people through our long-term model, a model we’re still committed to at 50% plus gross margins and that assumes that a lot of building blocks, that Carl specifically referred to, in terms of AXOS and moving to, this sort of single architecture will definitely drive operating and cost efficiencies through our system. So, we continue to do that anyway. It’s not and I know you’re phrasing that way, but I want to be sure that you and other people on this call understand...

No. That’s very helpful. That’s very helpful.

...not reactive.

Okay. That’s – and then just as a quick follow up, can you tell us who the two greater than 10% customers are?

That we do not do. No, we don’t disclose that.

Okay. Fair enough. Thank you.

Thanks, Greg.

Our next question comes from the line of George Notter of Jefferies. Please proceed with your question.

Hi, guys. Thanks a lot. I guess I wanted to just step back and kind of better understand the longer-term outlook on gross margin. I think you said, 50% is that a longer-term goal, but I guess I want to understand how the trajectory looks in driving back towards that kind of a number. Obviously from the commentary, we’re looking at your some lower gross margin assumptions. It sounds like the first few quarters of the year, next year at least, and kind of help me understand why the mix would swing back such that you guys can get to a 50% gross margin number?

Sure. I’ll tackle next few quarters aspect of your question, and then I’ll pass the baton on to Carl for the longer-term outlook. In terms of I think as we’ve highlighted and in fact we’ve given you a small window into what early 2017 might look like. We’re specifically calling for services as an increasing portion of our margins over that period of time – of our revenues over that period of time. And therefore, given the fact that services are traditionally a lower-margin business than the systems business, you’re going to see some downward pressure on gross margins as we execute on those projects. But that doesn’t again take away from what we’re doing in the underlying systems business, and for the business overall. Carl, do you want to address that?

I mean in the longer-term, if you looked at the business from a, basically a products and a services standpoint, our products business platforms, Calix Cloud, AXOS, and the systems business together is going to continue to go up in margins over time as the differentiable value of this goes up over time, Calix Cloud, AXOS and the leverage that we get from it. On the services side, we’re building a services business, and as such you can think about what long-term professional services businesses look like. And as we get towards that model from a professional services standpoint, then our long-term model is I think well within reach. But obviously, we’re going after building that professional services business, and we lag the long-term model for professional services.

Got it. Okay. I guess I asked the question because – I guess, my inclination here is to think that the services mix stays elevated for some time, your customers are trying to move more and more of that unionized labor of the payrolls and ask you to do more of the installation work. I would imagine that that doesn’t necessarily flip back in terms of their – your desires. And so, I would imagine the mix on services will be elevated for some time. I guess, is what you’re trying to tell me that there is a significant gross margin improvement in services ahead of us, or is it just the product side grows so fast ultimately that you can overcome that increased services mix, I guess, I’m just trying to understand sort of the logic here?

Well, I think so – let me address it in a couple of different ways, and then I’ll ask William to share his thoughts as well. So, first and foremost, professional services as we’ve discussed, we think of it in an aligned fashion. So, we’re not interested in going out and doing generalized professional services turf stuff on other peoples, systems, software et cetera. That’s just not anything we can lend any value add to. So everything that we do is related to Calix, products platforms, service offerings, systems et cetera. With that in mind, we believe there’s lots of opportunities all over the professional services spectrum, to help our customers transform their networks, their business models et cetera. So long-term, we believe an aligned services organization is a very good thing strategically for us to help our customers win. That being said, we are entering this business and we do believe over time obviously, we’re going to get more and more efficient at it and yes, the margins are going to go up. But I also would say that I believe our products – our product margins will go up over time as well, but it’s not one needs to go up wildly just to take care of the other. William, please feel free.

Yeah. I mean, I’d just like, just echo Carl, looking out beyond the next few quarters. You’re going to see as we hit our stride with professional services, essentially a slackening of the negative impact on the overall margin posed by introducing what is inherently a lower margin line of business, right. So, inherently that lower margin becomes a little bit less lower, if you know what I mean. So, there is that and then on the product side, I think, we’re making great strides in terms of enhancing margins on the product side as well. So, those two move together to pull our overall corporate margins up, again once you look out beyond the next few quarters.

Got it. And the one last question I had, I guess, extends off the prior question. So, you mentioned, CAF II, there were some news flow in the last two weeks. Obviously, I think, that’s the ruling around the rate of return carrier, but can you just kind of walk us through exactly what – what came out and how specifically it impacts your business, thanks?

I’m not sure, I would go any deeper than the following that in essence, the rules are now set. Everybody knows what they’re going to go do and we expect funds to be deployed across 2017.

Got it. Okay. Great. Thank you.

Right. Is there something else that you’re looking for? I mean, today is specifically is the day that everybody is making their elections on which way they’re heading. So, this program is rolling.

I guess, I was just wondering, what happened in the last two weeks, you referenced that in a prior question?

Oh! I’m sorry. So in the last two weeks, I’ve been – so we had our User Group, and there were hundreds of customers there, and so there is nothing like being amongst hundreds of customers, you will have these conversations, and not only listen to the fact but the mood if that makes sense.

Got it. Okay. Fair enough. I get it. Thank you so much.

No. I’m sorry, George. I missed your question. Thanks, George.

[Operator Instructions] Our next question comes from the line of Paul Silverstein of Cowen & Company. Please proceed with your question. Paul, your line is open. Please, proceed with your question. Please double check to see if your line is on mute. Paul, please respond as you’re not asking the question at this time. Our next question comes from the line of Simon Leopold of Raymond James, which is a follow-up question.

Great. Just a quick follow-up. Given that it’s the end of the fiscal year, I was hoping you could give us the 10% customers for 2016 the detail identities et cetera?

No, actually William, we neared on that ones, Simon, we’ll give just the...

I think it was on the quarter, I’m looking for the full year, which you, I expect will disclose in your 10-K filing? I think, you promised to do that?

I won’t do that, Simon, but what I will do is I can give you a sort of sneak preview what’s going to be coming up in our 10-Q in terms of customer concentration if that is helpful?

Sure.

Okay.

Sure.

I mean for the three months, we’re looking at 37% for the current quarter versus 27% same quarter last year, for nine-month year-to-date we’re looking at 34% relative to 26% year-to-date last year. So, I hope that helps you in your modeling.

It does. Thank you. Thanks a lot for the follow up.

Yup thanks, Simon.

[Operator Instructions] At this time, we have no further questions over the audio portion of the conference. I will now like to turn the conference back over to Tom Dinges for closing remarks.

Thank you, Tim. Our next quarterly earnings report for the year ended December 31, 2016 will take place on February 14, 2017 after market close. In addition, management will be participating a number of investor meetings and conferences during the fourth quarter. Information about these future investor events will be posted on the events and presentations page of the investor relations section of calix.com. Once again, thank you for your interest in Calix and thank you for joining us today. Goodbye for now.

This conclude today’s conference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful rest of your day.