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Edited Transcript of CALX earnings conference call or presentation 5-Feb-19 10:00pm GMT

Q4 2018 Calix Inc Earnings Call

PETALUMA Apr 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Calix Inc earnings conference call or presentation Tuesday, February 5, 2019 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

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Presentation

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Operator [1]

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Greetings, and welcome to the Calix Fourth Quarter 2018 Earnings Conference 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. Thank you. You may begin.

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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 Q4 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. This 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 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 call, we will discuss both GAAP and non-GAAP financial measures. Reconciliation of GAAP to non-GAAP measures is included in our letter to stockholders. Unless otherwise stated on this call, we will reference 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. We delivered better-than-expected non-GAAP earnings in the fourth quarter at the upper end of our guidance range and beating consensus by $0.02 per share. This was driven by better-than-expected progress in our transformation to an all-platform company. Our high-margin platforms performed better than we had expected, while our lower-margin legacy business underperformed. This resulted in an overall underperformance on total revenue and yet we beat on earnings. One might ask, how is this possible? The mix between our platform and legacy business was such that our gross margins came in at the very high end of our range, and a special note, the non-GAAP gross margins for our systems was 50%.

Furthermore, our all-platform business has more OpEx leverage, and thus our OpEx came in below our range. Our profitability is more closely tied to how our all-platform business performs and less to our legacy business. In other words, Q4 was a sneak peek into our future, ramping platforms and diminishing legacy revenues, leading to expanding gross margins and disciplined OpEx, together yielding significant income leverage.

While there are many highlights from the quarter, I would like to speak briefly about 3. We continue to expand our addressable market and broaden our base at a torrid pace as we added 190 new customers in 2018. To put this in context, we sell only to communication service providers and there just aren't that many of them. To have this magnitude of new customer additions is extraordinary. And virtually all of these new customers purchased one or more of our AXOS, EXOS or Calix Cloud platforms.

Second, and speaking directly to our Calix Cloud analytics platform, Calix Cloud more than doubled for the full year 2018. And Calix Cloud is now on track to become a significant contributor to the business.

Last, and as we have highlighted previously, our Calix platforms and aligned services are an ideal fit for any forward-looking greenfield builds. CityFibre in the United Kingdom and Verizon here in the United States are examples of state-of-the-art networks being deployed with our platforms. However, I want to make clear that while these types of opportunities are extremely well-aligned with Calix, our all-platform morphed offerings can be deployed for effect by CSPs of all types. For example, on the opposite end of the spectrum from CityFibre might be incumbent local exchange carriers. Transforming an ILEC represents one of the bigger challenges in our industry and yet success can be achieved. For many, Windstream represents one of the most challenging hands to play. And for those following the space, they know that Tony Thomas and his team have reversed the trend and are now adding broadband subscribers. I am proud to say that in the fourth quarter, Windstream chose to deploy Calix Marketing Cloud to help continue the trend. And we are excited to have the opportunity to deploy our success team to help.

In sum, our platforms can help every CSP. We simply must stay focused on looking for a strategic alignment.

Before I open the call for questions, I want to be sure you all have our guidance for the first quarter of 2019: revenue of $100 million to $106 million; gross margin of 45% to 47%; OpEx of $48.5 million to $50.5 million; net loss of $0.07 to $0.02 per share.

With that, I strongly encourage each of you to download our stockholder letter and get all the details on the fourth quarter and a 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 is from Paul Silverstein from Cowen and Company.

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

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Carl, I've never done this before, but I'm actually going to go back in the queue and ask you to come back to me later on.

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

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That's fine, Paul. We'll be happy to be here.

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Operator [4]

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Our next question is from George Notter from Jefferies.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [5]

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I guess, maybe starting off, I was curious about the slowdown you referenced in the letter about larger customers that were slower at the end of the quarter. Can you just talk about what types of customers are we talking about? What sorts of slowdown? What motivated the slowdown? And any size or magnitude you can apply, I'm just curious to learn more about that.

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Carl E. Russo, Calix, Inc. - CEO, President & Director [6]

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Okay. So we spoke to, it's basically 2 customers. I think we said a few. For the most part, it's made up of 2. They would be folks that are ILECs that are dividend paying, carrying debt and are obviously marshaling CapEx. The expectations that were set in October changed from October to December with these 2 customers and they account for the majority of the shortfall. So let me just frame it there and see if you have a follow-on, George.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [7]

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Got it. Okay. And I'm sorry, that was just year-end sort of like balance sheet move. Is that what drove the CapEx or spending slowdown? Or is there any sort of market share shift here? Or I just want to make sure that your position is secure and that the business will improve on a go-forward basis?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [8]

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Well, so let's talk about that because the types of customers that I'm referring to are those that are under pressure in the current market. They have significant copper access infrastructures. They carry debt. They have dividends and there's a lot of being very stringent with CapEx. There were some predictability issues on their part actually in the quarter, which caught us by surprise. But it's not a market share issue per se, it's simply a Q4. To be blunt, a bit of this is, fool me once, shame on me, fool me again, I'm sitting here again going, hmm, interesting. But I think it highlights the very different place we are in as a company with our model. So to your second part of your question, do I think it's going to represent a continuation as we've messaged throughout this segment of customers, sort of in that middle set, are those that are going to be most prone to erosion of CapEx? But to be blunt, there's not a lot of shrinkage left. Does that make sense?

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [9]

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Sure. Okay. Got it. And then, maybe along those lines, I'd be curious, can you give us the 10% customers for the year? I think that you guys typically put some of that information in the 10-K. I'd be curious if you could just give it to us now?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [10]

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So actually the answer is, yes. And you may remember a couple of years back, Paul Silverstein was very pointed about it, "If you're going to put it the K, why don't you just tell me now." So suitably chastised, I will share with you that we had one customer greater than 10% and it was 18%. And if you allow me to amplify on this, I actually want to expand a little bit. First of all, we had one 18% customer. That's significantly less concentration than we've had over the last 2 years. Cory, do you know the numbers for the last 2 years?

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Cory J. Sindelar, Calix, Inc. - CFO & CAO [11]

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Yes. In 2016, 2 customers accounted for 36%, 21% in '15, respectively. And in 2017, 1 customer accounted for 31%.

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Carl E. Russo, Calix, Inc. - CEO, President & Director [12]

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Yes. So the point there is, we're continuing to sort of grow the business up and around of these. If you actually do the math, George, if you look back at CenturyLink, which is our largest customer, and you look at it year-over-year, CenturyLink accounted for $80 million of our $70 million reduction in revenue. And as you might imagine, there were a few other contributors to that around it. So there's a lot of growth in the business happening around that core set. As the business shifts, if you just do a fourth quarter to fourth quarter comparison, I can't give you a better way of understanding what's happening at Calix other than to say, "I think last year, I'm going to pull these numbers, bear with me." I think we did a $137 million or roughly in revenue versus the $115 million in revenue this year, so down $22 million in revenue. And I think we lost $7 million last year and we made $7 million this year. Those are -- I don't need to say anything else about what's happening in the business as we shift to our platform company.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [13]

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Got it. Okay. And then, just along those lines, I am expecting you to say no here, but any chance you could just give us the mix of product or of total sales that comes from legacy systems revenue or conversely comes from new platform product revenue? I mean, if you're trying to kind of highlight the shift in the business, I mean, that would be a great way to do it, certainly.

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Carl E. Russo, Calix, Inc. - CEO, President & Director [14]

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It would be a great way to do it. The other way to do it is, obviously, as we have messaged, which is you're going to see the shift first in gross margin before you see it in revenue. So I won't answer the question in the way you're asking it as in a specific breakout because that's a competitive issue. But I can give you some directional pieces as I did in my quick opening remarks. Calix Cloud, which is one of our platforms now, is set to become a significant contributor to the business. So these things are now becoming significant in the business and will soon become material after that.

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Operator [15]

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(Operator Instructions) The next question is from Christian Schwab from Craig-Hallum.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [16]

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Congratulations on the good execution in the quarter despite the revenue shortfall. I have one quick question. As we have just highlighted, thanks for sharing all that information and diversifying ourselves away in essence from CenturyLink. And as we discussed earlier in prepared comments, broadening the customer list quite successfully, what would you assume we should be thinking if you can for like a top line revenue range for this year? What would be logical from X to Y?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [17]

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Okay, so -- yes, so I'm going to be careful here because Cory is probably going to either kick me under the table or leap across the table and try and choke me to death. But before he does that, let me just tell you what I think. I think you all had us basically growing 6% into 2019. To me, that's the right number. It's just that the 2018 number was less than we thought it was going to be. So I think the growth rate is the right number, roughly. But I think it's off of a lower number in 2018 when we finished it out. Does that answer your question, Christian?

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [18]

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Yes, that certainly does. And then, just a follow-up on the gentleman's question earlier, said in a different way. What would the gross margin of this business look like when legacy revenue is less than half of run rate business?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [19]

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So first of all, I feel compelled to point out that I want George Notter to take note that you just referred to him as a gentleman. So I think that's worthwhile noting. But let me see if I can address your question and give you enough sort of breadcrumbs to get after this. First of all, I don't know, so let me be clear about that. It is very clear, as you all know from doing incremental margin calculation, that the platform business is a wholly different business. However, I want to make sure I draw attention to the legacy business because the legacy box business, which is, frankly, all of the communications industry, if you look at folks that are in this space, they're not a 50 point gross margin systems business, they're in the 30s, sometimes high, sometimes medium, sometimes low. I'm not telling you that our legacy products are in the 30s, but they're obviously lower than corporate average gross margin. The one piece that causes me to not be able to answer your question is, while we are continuing to grow our platforms, and in this year, a lot of our customers that are buying our legacy SKUs are actually going to replace them with our platforms going forward, I suspect we may see some erosion in the margins of our legacy platforms because they're going to be under pricing pressure in that marketplace. So I just don't know yet, Christian, what it will look like. And you and I have actually spoken about the fact that over 2019 as we go through this year, we're going to get a much better read on what that looks like. But inexorably, we're driven to going over 50% as a company and that's where our focus is on in this next year. So I know that's a lots of words around not answering your question, but it's probably the best I can give you.

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Operator [20]

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(Operator Instructions) And our next question is from Paul Silverstein from Cowen and Company.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [21]

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First off, Carl, I'd just like to point out, who says you can't teach an old dog new tricks?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [22]

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Well, listen, suitably chastised, I want to make sure that we continue to deliver upon the 10-K promise. That was 18%.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [23]

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I should chastise you more to get more disclosure.

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

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Please do, Paul.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [25]

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I'm going to ask 1 or 2 questions, if I may. So it sounds like you're doing your job framing it in the sense of you've got margin expansion notwithstanding some revenue disappointment. In the old days, I think almost without fail you and your ADTRAN friends would see margins go up with -- along with revenue or go down along with revenue, and now there seems to be this divorce. So my question to you is, I assume volume still plays a role, but when you think about margin progression over the course of the year and beyond, can you tier the key drivers? And is it too early to talk about where margins can go to? And if you already stated that earlier, I apologize.

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Carl E. Russo, Calix, Inc. - CEO, President & Director [26]

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So if you don't mind, so let me answer your question directly. We are not volume sensitive with any major sense on margin. Volume does not chart the margin. And decreasingly as we pursue our platform business because, obviously, the software content is so high, it's not driven to volume, okay. And to that end, if we are able to not only expand our platforms into fiber-forward greenfield companies that are getting funding, but also be able to take our, frankly, most leading-edge platform, Calix Marketing Cloud, and deploy it with Windstream to help them succeed, we can go anywhere with the platforms provided a customer wants to go drive business success. Having said that, when you look at the margin separation, the margins are -- you did incremental margin calculation. The margins in our go-forward business are well -- are higher than 50% and, obviously, they're going to continue to lift the business accordingly. I want to go back to a piece that you said though and answer a question you didn't ask, but you sort of started going down the path. I will tell you going -- thinking about last fourth quarter and go 2 years ago and 3 years ago, if we were Calix, the broadband access is just some sort of box company without any of our platforms and we were confronted with the quarter that we were just confronted with, we would have been chasing revenue right off a cliff at the end of the quarter, doing ever diminishing pricing deals to try and make revenue, and you'd end up with lower and lower margins on a fixed expense base and you'd actually end up probably falling short of revenue and falling way short on earnings. That should sound familiar to you because it's a picture we've all seen many times in our career. We are in a very, very different place as a company. And what you and I spoke about and then we spoke with all the analysts about, the increasing predictability starts at actually at the bottom line. The business is less and less sensitive at the bottom line, even though we may have times where there's difficulties at the top line. So it's just a very, very different business today, Paul, and I know I'm not answering your direct question because I know you're not expecting me to. Let's just say, it's well higher than 50%.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [27]

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I don't know, who knows, a year or 2 from now you may be going back saying must be giving other ones to the crowd. Let me -- on a serious note, let me ask you, Cory, especially, Cory, hopefully you've got a better handle on the numbers than Carl. Just joking, Carl. From an OpEx perspective, what's the risk of OpEx being higher? What's the opportunity for it to be lower? What will be the key drivers as you go throughout the year?

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Cory J. Sindelar, Calix, Inc. - CFO & CAO [28]

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Yes. So what I think you saw in the fourth quarter is the fact that we're able to take a benefit of the operating leverage in the model. And so Q4 came in lighter than we had originally forecasted. We're going to continue to make forward-looking investments into the business as we progress through the quarter. At the same time, we're going to still look for those opportunities in the old traditional business where they present themselves, the opportunity to take some costs out and we'll scrape those nickels and dimes together. So my expectation is, we kind of move forward through the quarter. We'll do a little bit better than what we've seen in the last, say, several quarters -- 2, 3 quarters. And that will be a combination of us investing in the front end of the business as well as yielding some improvements on the legacy side.

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

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Yes. And so Paul, at the risk of you chastising me into giving you other numbers prior to the 10-K being out, you'll see these numbers shortly. And again, don't hold me to the exact numbers, but at the end of 2017, we were roughly 1,200-and-some-odd employees. At the end of 2018, we were roughly 800. It's just a very different company.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [30]

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Do you all expect headcount to grow from here to remain flat, or do you expect to do some trimming as you go throughout the year?

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

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I expect headcount to be roughly flat, but underneath it, you're going to continue to see puts and takes. It's sort of another -- it's sort of an embodiment of what Cory spoke to. Look, the team has done a continually excellent job of finding expense in nickels and dimes to take out of the legacy business and invest dollars in the platform business. And so you sort of see OpEx, a lot of work going on in OpEx. In Q4, one of the -- look, you and I -- well, I'm old enough, you're old enough too. We didn't do anything extraordinary in Q4. It wasn't like we ran and ran and went, okay, we're going to miss on revenue, let's go cut OpEx. We're just continuing to work the plan. And that's what it resulted in. So I think we have a good shot at staying pretty flat.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [32]

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Just to be clear and I apologize if I'm slow on the uptake here, but relative to what Cory and you just articulated, whatever you say is you have an investment plan ahead of revenue, in front of revenue, but you'll make adjustments on the fly based on volumes, or did I misunderstand?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [33]

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Well, we're going to -- no, we're going to stay pretty deliberate on our investment plan. Obviously, if things ramp faster, we'll invest faster; things ramp slower, we'll invest slower. But we're doing it all inside of the model. Where we think we're making an investment, that would be ahead of revenue that we want to make sure you're aware of. We will call it out. And if you remember, we specifically called out that over Q4 and Q1, we expected services gross margins to go down because we were going to be doing some forward investing on customer success and that would be in COGS for services. By the way, actually in Q4, Greg and his team did a marvelous job and actually outperformed in addition to having made some of those investments. Having said that, we expect services gross margins to go down in Q1 because we're going to make some additional investments and then we'll expect it to go back up again. So in specific cases, we might call it out so that you're not off the reservation, but otherwise now it's inside of just the continued work on the model.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [34]

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All right. Let me ask you one last question, if I may, on competitive landscape. Can you give us an update on what you're seeing?

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Carl E. Russo, Calix, Inc. - CEO, President & Director [35]

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On the platform side of the business, we're out in open field. We've been tacking in this direction for now going on our eighth year of the technologies that we've built. We don't really have competition in the legacy business. The competition framework is roughly the same. We see some opportunities opening up, but I would be very careful about opportunities because of all of the discussions about Huawei, because those are most likely not going to yield service providers that are going to be interested in changing the way they go about building their networks. They're just going to be looking for another vendor. That's distinctly not our play. Not interested in being the third vendor in a box RFP. But there are a couple that probably got started because of that, that have actually morphed into -- they're looking at their network entirely differently and those are opportunities that we have.

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Operator [36]

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(Operator Instructions) As there are no further questions, I'd like to turn the floor back to management for any closing comments.

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Thomas J. Dinges, Calix, Inc. - Director of IR [37]

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Thank you, operator. Please note, before we conclude today's call, starting with the release of our first quarter 2019 results, we are changing the timing of the release of our letter to stockholders as well as our quarterly earnings conference call. We will release our letter to stockholders in the morning before market open at approximately 7:00 a.m. Eastern Time. Following the release of our letter to stockholders, we will host our earnings conference call starting at 8:30 Eastern Time. 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 [38]

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Once again, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.