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Edited Transcript of CALX earnings conference call or presentation 5-Nov-18 10:00pm GMT

Q3 2018 Calix Inc Earnings Call

PETALUMA Dec 20, 2018 (Thomson StreetEvents) -- Edited Transcript of Calix Inc earnings conference call or presentation Monday, November 5, 2018 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carl E. Russo

Calix, Inc. - CEO, President & Director

* Cory J. Sindelar

Calix, Inc. - CFO & CAO

* Thomas J. Dinges

Calix, Inc. - Director of IR

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Conference Call Participants

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* Christian David Schwab

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* George Charles Notter

Jefferies LLC, Research Division - MD & Equity Research Analyst

* Paul Jonas Silverstein

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Calix Third Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Tom Dinges.

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Thomas J. Dinges, Calix, Inc. - Director of IR [2]

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Thank you, operator, and good afternoon, everyone. Thank you for joining our Q3 2018 Earnings Conference Call. Today on the call, we have President and CEO, Carl Russo; as well as Chief Financial Officer, Cory Sindelar.

As a reminder, this afternoon, we released our letter to stockholders in an 8-K filing as well as on the Investor Relations section of the Calix website. Conference call will be available for audio replay in the Investor Relations section of the Calix website. Before we continue, we want to remind you that in this call we'll refer to forward-looking statements, which include all statements we make about our future financial and operating performance, growth strategy and market outlook, 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 letter to stockholders and in our annual and quarterly report 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 call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our letter to stockholders. Unless otherwise stated on this call, we will refer to non-GAAP measures.

With that, let me turn the call over to Carl. Carl?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [3]

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Thank you, Tom. I will make some brief remarks and then open it up for questions.

Our all-platform model enables us to deliver gross margin expansion, disciplined OpEx investment, deliberate revenue growth and increased predictability. I'm very happy to report that all financial metrics were in or better than our guidance ranges. With non-GAAP net income $0.02 per share above the high end of our guidance range, it was an excellent quarter of execution by the Calix team.

While there are many highlights from the quarter, I would like to speak about only 2. CityFibre joined us working with their customer Vodafone to build a fiber infrastructure in the United Kingdom that will reach up to $5 million homes and businesses. CityFibre is quite interesting as they are a wholesaler building the highest capacity, lowest cost per bit per mile infrastructure for others to provide services on. CityFibre represents a compelling contrast to Verizon's state-of-the-art retailer model. And both are deploying AXOS in their respective Unified Access infrastructures. CityFibre and Verizon are specific validations of our AXOS platform. Also, we continue to expand our addressable market and broaden our base at a torrid pace, adding 33 new customers, which brings us to 99 new customers year-to-date. This is broad-based validation of our revolutionary Calix Cloud, EXOS and AXOS platforms.

My comments would not be complete without a discussion of tariffs. Like many companies, we have built a global supply chain, which means we are exposed to the U.S. tariffs. However, unlike most other companies, we expect the impact to last for no more than 3 quarters. We have already been reengineering our supply chain to take advantage of our platforms. And we are simply going to accelerate the remaining work. With the impact of the U.S. tariffs being short term, we have decided not to pass on these costs to our customers. Our revolutionary platforms are ramping into the market. And we want our sales and marketing teams to remain focused on this effort. Furthermore, we will not include the U.S. tariffs and tariff-related costs in our non-GAAP financials. With this in mind, our non-GAAP guidance for the fourth quarter is revenue of $122 million to $127 million, gross margin of 46% to 48%, OpEx of $51 million to $53 million and net income of $0.08 to $0.14 per share.

With that, I strongly encourage each of you to download our stockholder letter and get all the details on the third quarter and a clear view into the future for Calix. Let's open the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Paul Silverstein from Cowen.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [2]

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Carl, just a small question and a larger question. Small question, the 33 new customers which brings you to 99 for the year, that's out of how many?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [3]

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You mean out of how many customers do we have as a company?

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [4]

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Correct.

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Carl E. Russo, Calix, Inc. - CEO, President & Director [5]

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Yes, I mean, we have roughly between 1,400 and 1,500 customers give or take.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [6]

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And were all those 33 new customers for either AXOS, EXOS or cloud?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [7]

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Quite literally virtually all. I think there may have been 1 or 2 that weren't, but it is obviously our new platforms that drives all of our new customer acquisitions.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [8]

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Okay and correct me if I'm wrong, but you guys aren't yet breaking out revenue for AXOS, EXOS and cloud, is that correct?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [9]

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That is correct.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [10]

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Okay, and at some point do you plan to do that?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [11]

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There is no current plans to do it. Can't predict the future.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [12]

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Okay, the larger question. Beyond what seems like the sizable Verizon and CityFibre opportunities, can you offer some insight regarding what you're seeing with respect to AXOS, EXOS and cloud takeup? Any preferably quantitative but I would take qualitative metrics or data points that you can share with us?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [13]

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Not quantitative but I can share with you qualitative that they are all ramping. EXOS, of course, is newly ramping because it's now just going into market. We have quite a few customers that are on with what we refer to as early adoptive program and deploying. But let me see if I can give you a better sense, especially since we just came off of our Connexions user group for 2018.

I expect Calix Cloud to ramp up even faster than it's been ramping up. It seems that our customers and prospects are now really starting to understand the power of those platforms to help them shape their business models. I certainly expect AXOS as a network operating system to continue its ramp and to steepen, but remember these are network decisions that happen over a broad period of time. But it has clearly captured the imagination of sort of the hardcore networking folks. But EXOS is, I believe, as we help our customers on the subscriber edge, not only manage the complexity of the subscriber edge but start to monetize it, may, in fact, be the fastest ramping of the 3.

The fourth are the attached services, which Greg and his team has been really doing an excellent job of helping our customers start to transform their businesses. And we're going to see those service offerings ramp as well for 2018. So qualitatively, all moving at or better than my expectations, especially coming off the energy of Connexions.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [14]

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All right. My apologies to other people on the call, but if I could ask one more question? From a larger structure perspective, I recognize it's hard enough to project near term, but as you look down the road, is there any reason why as your legacy platforms decline in AXOS, EXOS, cloud grow albeit off a small base -- is there any reason why this wouldn't be or couldn't be a 60-plus percent margin model?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [15]

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Well, that's a very long future statement. I mean, if you start extrapolating incremental revenue and margin and you start to understand what's happening in the business, way, way, way long-term. I don't know where the asymptote is, Paul. It certainly could be in the 60s, but obviously, we're focused on the near term to go above 50 points and deliver that at $600 million or sooner in revenue. So there's no reason it can't be, but that's such a long-range dart that I wouldn't throw it.

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Operator [16]

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(Operator Instructions) Our next question comes from the line of George Notter from Jefferies.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [17]

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Maybe on the same line. So I guess I'm also interested in the transition away from the traditional systems-level products to AXOS and EXOS. But if customers are pushing back on that, let me ask it this way. So I assume there's still some revenue run rate of the traditional products here. What inhibits customers from moving more quickly to AXOS and EXOS right now? Is it status quo, incumbency or their switching costs? Like help me understand kind of the customer decision and why you can't move customers even faster onto the new products?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [18]

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Well, so a great question. So let's make sure we are understanding how we approached all of our platforms going forward. We approached them from TAM expansion first, George. So our first goal was to in fact address use cases that would allow us to start to expand our TAM. So if you think back, NG-PON2, Verizon Labs Intelligent Edge network and then you sort of work your way back from that into your existing customer base, not because you're trying to delay your customers, just simply you're trying to make sure that you're getting the biggest return on the investment you can make in regards to R&D.

But now directly to your question in the case of AXOS, to your point, it literally comes down to slowly but surely the line cards being available inside of the E7 that run AXOS. And so the GPON line card is in the market. There is a new line card coming out on 10-gig E aggregation and there are line cards after that. So nothing other than allowing customers to see it, understand it and value it.

What we're not going to do is discount the value that exists in AXOS to force or migrate a customer. So customers that are happy on EXA, we're perfectly happy so let them stay on EXA. If they see the value of AXOS, they can make that decision to step up to AXOS and we'll be happy to help them. But what attenuates that swap right now is literally just availability of the line cards to address more and more use cases. That is occurring obviously, this year and will occur in earnest next year.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [19]

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Got it. Any way to sort of measure that availability of line cards? I mean, if you look at your total line card shipments in a quarter, what mix of those might be available on AXOS right now? Just out of curiosity?

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Cory J. Sindelar, Calix, Inc. - CFO & CAO [20]

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Yes, there is a way to measure it. I think you're asking me will I share that measurement with you, is that right?

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [21]

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Correct.

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Cory J. Sindelar, Calix, Inc. - CFO & CAO [22]

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So we're still early days and the focus right now is on the fiber side. So let me see if I can not be facetious with you. From a fiber access standpoint, substantially all of the fiber access line cards will be available before the -- in essence, before the end of the year for all the line cards and some of them will be on early adopter programs, but that will all basically available and volume shipments will continue to ramp into 2019.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [23]

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Okay, great. That helps. And then I also want to just come back and ask about the China tariff situation. You mentioned you guys are taking on plans to mitigate the impact. But can you tell us exactly what you're doing? Is it something on manufacturing side, component sourcing? And then also, can you tell us why you decided not to go back to customers and try to pass it on as a surcharge? It seems like that's a little counter to what we're seeing many other companies doing right now? So I wanted to ask about that as well.

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Carl E. Russo, Calix, Inc. - CEO, President & Director [24]

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So great. So the answer is, it is counter. And the reason it's counter is because frankly, they are our platforms. We've been developing our platforms. We started, as you know, in 2011. We have been running the platforms and networks for now we're going on our fourth year in various forms. And we began 4 years ago because the platforms have totally abstracted from the hardware to utterly change the way we design and develop and manufacture our hardware. So Mehdi, who heads our Product Operations, and his team have been slowly but surely realigning our supply chain with our platform model, which means a much greater percentage of our systems are developed in what are called ODM or JDM relationships and less in contract manufacturing.

Our original plan was to continue that reengineering and complete it over the course of next year. So what happens well, the tariffs come up. So what's left is basically to accelerate the remainder of our strategic plan. And as such, we believe we can be out from under the tariffs in a couple of quarters, maybe 3 quarters. Once you understand that, now you're looking at decisions based upon the opportunity costs of those decisions. If we were a steady-state company -- if you will, more mature -- we would pass on the tariffs, no question about it. But given the ramp of these new platforms, the opportunity cost statement is very simple. Do we want to have our sales and marketing folks explaining tariffs to our customers? Or do we want them ramping our new platforms? And the volume of the new platforms is so high that the correct opportunity cost decision is in fact, to simply take our energies to the extent that we want to work on the tariffs and focus on accelerating the reengineering of our supply chain and keep our sales and marketing folks focused on doing exactly what you asked, which is exposing our customers to AXOS, EXOS and Calix Cloud and getting on with it. So I hope that answers your question.

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Operator [25]

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(Operator Instructions) Our next question comes from the line of Christian Schwab from Craig-Hallum.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [26]

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Congratulations on a solid quarter and guide. I only have one quick question. In the near term, Carl, do you feel better, I would imagine, about being able to get to your 50% plus gross margin target? Maybe over, say, $600 million in yearly revenue?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [27]

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Christian, I'm going to rephrase your question in the way I heard it, which is do you think you can get to it before $600 million?

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [28]

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Yes.

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Carl E. Russo, Calix, Inc. - CEO, President & Director [29]

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So we're not changing our model. The answer to your question is yes, we do. But until we have a good clear view of that and how the mechanics work, we're not going to change that model. And let me just give you a qualifier. If you think back to George's question, it may be that over the course of this coming year, what we see is accelerated ramp on our AXOS and EXOS systems. But by the way, what comes along with that are transitions off of our EXA and first-generation giga family systems. And when you do those things, there are product lifecycle things that show up in OCOGs, they don't show up COGs. Because you have some components leftover or whatever. So I would want us to be cautious in this next year to make sure that we get a clear line of sight. But your question -- the answer to your question is yes, you're directionally correct.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [30]

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Great. I guess and just one quick follow-up. Is -- I know you've kind of categorized previously what Verizon could eventually ramp as a full customer. How would you compare the opportunity at CityFibre to Verizon?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [31]

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It is a great question. It is substantial. So let's look at CityFibre and their customer Vodafone because that's what driving it. CityFibre literally just closed on $3.5 billion in funding to in fact drive to the 5 million homes that they are committed to driving to, homes and businesses in the United Kingdom. So they're going to -- Clayton Nash from CityFibre was onstage and made the statement -- onstage at Connexions, pardon me. And made the statement that they're going to try and do this within the next 5 years. But when you start looking at those rollouts and you're talking about 1 million endpoints, let's just say that it's probably smaller than what Verizon can be. But look, we said way back then that we wanted to try and make sure that we could add one large customer that would be doing large ramping things over multiple years every year. There you are.

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Operator [32]

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

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [33]

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Congrats on the results and guidance. Let me follow that CityFibre question with kind of a -- more of a timing question in terms of when you expect that to ramp. You did see a downtick in international revenues in the quarter. I'm guessing maybe that's a '19 thing, but do you have any more color in terms of the timing of the ramping of that opportunity?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [34]

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Well, so on that particular opportunity, you're going to see that ramp, as you stated correctly, over 2019 and continue on from there because they got a lot of work to do. The CityFibre team is committed to going at this pretty rapidly. But I think you're going to see that over 2019.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [35]

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Great, and you may be -- this is -- can be a sort of a substitute for your typical competitive landscape question. Maybe you could talk about the CityFibre competitive situation as a microcosm of that in terms of, kind of, how Calix was able to differentiate when the opportunity relative to what I assume might be the usual suspects or perhaps, not? Any other comment on the kind of competitive landscape in general? Or maybe using CityFibre as a proxy for that?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [36]

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Well, so great question, Tim, and thanks for asking it because quite literally, as you might imagine, they are well known, and were well targeted. But I think the key to understanding the differentiation and I spoke to it in my opening comments, it's very interesting to me that CityFibre, a wholesaler, looked at AXOS and said that's the right way to go. And the reason they went that way is as you might imagine, a wholesaler is certainly CapEx sensitive. But they are far more OpEx sensitive. And what AXOS allows them to do along with the other things that we're doing is get to the lowest OpEx on a cost per bit per mile per subscriber sort of basis.

CapEx, obviously, is also quite efficient because it's a collapsed single network infrastructure, but AXOS is what drove that decision. And that's what they are deploying, not anything else. If you contrast and compare with what they're doing with what Verizon is doing, Verizon is actually building sort of the ultimate retailer network. They're providing all services to their subscribers. They are not renting out their network to anyone. And they are building the same network. So to me, it renders very clear when you have these 2 counterpoint business models arriving at the same network solution. I think it's pretty clear where all of this is going and we're going to stay focused on finding like-minded prospects and continue going down that path.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [37]

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Is there, perhaps, more advantage kind of to the software flexibility of the platform if you are renting out your network versus retailing or how would you describe those 2 use cases as would they advantage your product differently?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [38]

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That's a very astute question and the answer is yes, it does. Because AXOS, as you know, from a NETCONF interface native, fully YANG modeled and with the telemetry and intelligence that exists in the network allows CityFibre to actually expose their network to a potential customer and allow them to almost dial up and run it themselves, and have multiple customers doing the same thing at the same time. So it does, in fact, advantage AXOS in quite a unique way.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [39]

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Got it and within the quarter and this may have been in the letter somewhere and I may have missed it, but can you speak to 10% customers in the quarter and maybe overall levels of concentration, if you could?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [40]

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Just one 10% customer. And as you can hear from the new customer take rate, the TAM is expanding, the customer base is expanding and our ability, frankly, the predictability of the go-forward platform business even on the ramp it's on is frankly more predictable than dealing with the older legacy access systems business. Even though those customers have been around longer, the new model is just much more predictable.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [41]

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That leads me to my last, I think, two-part question, which is, as you look at your guidance for Q4 and a nice sequential uptick, are there kind of particular drivers there on the Tier 1 U.S. side or any other thing you would like to call out? And then within that as well, it looks like systems' margins upticked a bit again in the quarter. I wonder if you expect that trend to continue or would you have any comments on systems versus services margins as they reflect on your overall Q4 margin guidance?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [42]

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Okay, so let me go to the first question first. Remarkably, the answer to Q4 things to note is unremarkable. The statistical set that we are building really is less and less dependent on any given remarkable thing, which is very nice for my ability to go to sleep at night. The second is on the systems margins or calling out anything. So not to give guidance but to just give you a general view, we expect systems' margins to continue to expand. I want to go back to the caveat that I gave in George's question around transitions. You have to be careful about 2019, and we're going to be very cautious about that. But the general trend should be up.

Services, in general, will go up, although I will note that in this quarter and next, for Q4 and Q1, we going to make some modest investments. And it actually turns out to be a good thing. And it goes like this. The rate of success on the cloud ramp is such that we are going to invest some modest monies in the services organization in the customer success related to deploying our cloud platforms. I don't want anybody to get nervous. It's not like services are going to fall off the cliff. But it's going to, sort of, go out flattish to slightly down into the first quarter and then it's going to go right back on its growth ramp and margins again throughout '19. So that's the only shaping I would give you. Please don't take that as specific guidance.

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Operator [43]

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(Operator Instructions) Ladies and gentlemen, we have reached the end of the question-and-answer session and I would like to turn the call back to Tom Dinges for closing remarks.

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Thomas J. Dinges, Calix, Inc. - Director of IR [44]

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Thank you, operator. Calix will be participating in several investor conferences during the fourth quarter of 2018 including the Craig-Hallum Capital Group Ninth Annual Alpha Select Conference in New York City on November 15 and the Cowen Networking & Cybersecurity Summit in New York City on December 11. Details regarding the events are available on the Investor Relations section of calix.com. Once again, thank you to everyone on this call and on the webcast for your interest in Calix, and thank you for joining us today. This concludes our conference call. Goodbye for now.

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Operator [45]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.