Greetings and welcome to the Calix Q2 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] As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to your host Mr. Tom Dinges. Thank you, you may begin.

Thank you, Operator, and good afternoon everyone. Today on the call, we have President and CEO, Carl Russo, as well as 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 trend to differ materially are set forth in today's earnings press release 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 date. 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 available on our website. 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 June 25, 2016, Calix reported revenues of $107.4 million and a non-GAAP loss of $0.04 per share. In just a moment, William will take you through the quarter in greater detail. And Carl will conclude his thoughts on Calix 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 Q2 on May 3. And in that guidance we called for revenue between $104 million and $108 million. Our gross margins are between 46% and 47% and operating expenses in a range of $52 million to $53 million, including approximately $2.4 million of Occam litigation expenses. Thus resulting in a net loss per share of between $0.09 and $0.05 or $0.04 to breakeven if Occam litigation expenses had been excluded. Relative to that guidance, our actual revenue for the quarter was $107.4 million and EPS was a loss of $0.04 per share including litigation expense or a profit of $0.02 per share excluding litigation expense with revenues at the upper end of guidance and the loss per share above the top end of guidance. Gross margin was 47.5% and operating expenses came in at $53million, which includes $2.8 million in litigation related expense. At the gross margin level, the largest drivers were favourable product and customer mix, partially offset by costs associated with the continued ramp of our previously announced turnkey network improvement project. Operating expenses included higher than expected legal expenses, and investments in R&D to support anticipated growth but nevertheless came in line with our guidance. A continuing focus on collections and working capital management resulted in positive operating cash flows of $0.1 million. Our aggregate balance of cash and marketable securities was flat sequentially at $64.2 million from $64.3 million in the prior quarter, primarily due to annual employee share purchase plan activity and better than expected operating cash flow, offset by capital expenditures of $1.6 million. Getting into a bit more of the detail, our $107.4 million in revenue for the quarter showed an increase of $8.3 million or 8.4% from last year’s second quarter level…

Thank you, William. While there is a lot of exciting news to discuss, I would like to begin with our goal. Predictable, profitable growth. Q2 was another strong quarter as we backed up last quarter’s 8% year-over-year growth with another 8% growth quarter. Keep in mind the words predictable, and profitable are modifiers of the most important word, and that is, growth. Our number one focus is to increase our rate of growth and we have been clear throughout that from time to time it may be necessary to push on the OpEx levers to achieve our goals. Our guidance for Q3 is indicative of such. Over the last few years we have made deliberate [ph] investments in research and development to achieve strategic effect. And you can now get a glimpse of what we have been pursuing. Our Compass Cloud continues to allow our customers to target their infrastructure investments for maximum return all the while reducing the operating expense of delivering winning services. When combined with our GigaCenter family of premises [ph] products, Compass Cloud is enabling our customers to deliver an unparallel subscriber experience, thereby decreasing churn and increasing the ability to market new services. Our AXOS platform continues to make strong progress. Last quarter, I reported that it had been deployed in over 20 service providers. I am pleased to report that our growth in AXOS is accelerating and our AXOS platform is now deployed in over 50 service providers. The core attributes of AXOS is fast, always on, and simple, are clearly differentiable and are proving to be critical to our customer’s success. For competitive reasons, I will no longer report on the actual number of deployments going forward, however, as you have read in recent announcements the trend is clear, AXOS is a winner…

Thank you. [Operator Instructions] Our first question comes from Paul Silverstein with Cowen and Company. Please proceed with your question.

Thanks. Two questions if I may. And so, guys apologize, the new focus is on growth but the basic question will be at what point can you -- at this point of time can you anticipate when we should expect gross margins to return to the higher 40s and to return to a forward trajectory on a consistent basis? And then I've got a follow-up.

Okay, Paul. I'll take this and then Carl will talk a little bit more about what's going to happening in the longer term. As we've noted, we are seeing a miles downward pressure on gross margins as a result of these turnkey network improvement projects that we discussed. Obviously there is a typical noise we get in any quarter in terms of product and customer mix, but that if you look under the hood, year-over-year is the major driver. As we look forward we see that on these specific projects we're going to move out of sort of the initially deployments, sort of getting up the learning curve, invested cost phase if you will and that we see there for profitability starting to get enhance as we move to the latter stages of the projects. So, within these specific project themselves we see some improvement in margins, but then looking forward as we continue to execute right through the end of the year, you're going to see that pressure on gross margin. I don't know Carl, if you want to talk a little sort of deeper about the underline trends that are going on here.

Well, so just from a watching the industry for a long time Paul, and thinking about growth rate there's a pretty simple rule. As our growth rate accelerates its actually going to put a downward pressure on gross margin. As the growth rates starts to normalized at some new level than I think you'll start to see gross margin start to drift up. But to William's point if I look out into our future and I think about what we might be able to achieve? There are going to be new things coming into the business next year and the year after that that will have, I can't commit downward effect on margins while margin from the rest of the business are going up. So, I think over the next couple of years you'll see a normalized will start to slowly drift to backup. We're not changing our long term one bit, but we are looking forward right now to in fact driving that growth rate.

Carl, I hate to put words in your mouth. I know it's hard enough to guide for 90 days and you were to guide beyond that, but I think you clearly just said that you're expecting accelerating growth next year which will put downward pressure on margins. Better you tell us not that not only margins be weak but gross can be weak as well.

So, did you say you hated to put words in my mouth?

[Indiscernible]

So, look, the answer is I would change the word expected from -- we are clearly focused on taking what we've invested in for the past few years and we've been messaging you around AXOS, the platform Compass et cetera being forward looking R&D investment. And saying very clearly, we believe that as those platforms start to hit the market they are going to put us position to grow at a more rapid that we have in the past. The 8% year-over-year, quarter of the 8% year-over-year half, I think our early indicators of that, but I wouldn't use expect, I would simple say that our intent is to drive this growth rate. So, if you want to change or expect to drive than maybe I'll let to put those words in my mouth.

All right. One last question, my apologises to others on the call. On AXOS of the 30 new wins and the 50 total wins, how many of those are new customers to Calix and how many of those would be considered to be two ones or twos?

Obviously, I would be very careful about sharing any of those pieces, but let's go down, Tier 1s or Tier 2s, obviously in this quarter you had two announcements, one from each of those relating to AXOS. There is a percentage of new customers and percentage of existing customers. I would say that those percentages mimic roughly what we do every quarter in new customers and existing customers as well. So, it's still early days. What's exciting is something that is as comprehensively revolutionary as AXOS is seeing the uptick that's set of thing.

I appreciate. I'll pass one. Thanks guys.

Thanks, Paul.

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

Hey, thanks a lot guys. I guess I wanted to go back to the gross margin question. So, my memory serves you guys were thinking that the turnkey professional work was going to wind down, I think as the year progresses and it sounds like now that's not the case. I guess I'm just wondering what’s changed there? And then, I also wanted to ask about your year-on-year growth rate, if I look at year-on-year growth X that turnkey professional services work, I'm wondering what that would look like maybe on a quarter-over-quarter basis or maybe year to-date basis, any sense to that would be great? Thanks guys.

Well, I'll take the first part of that question. In terms of the timing of the turnkey professional services project, I think one of the things that happen is that we saw a lack of recognition of some of the underlying costs and revenue associated with those projects relative to anticipation in Q2, but our goal to complete projects on schedule remains and we're confident we will do so. So, inherently you got a little bit compression of margin going into the second half of the year to reflect that bunching of activity into the second half, that's how we classify that part of your question. I don't Carl, if you want to talk about.

Well, let me take a long term basis.

Yes.

If we miss-communicated, my apologise George. The professional services business is growing and will be a continuous part of our business. I think we've make clear that those professional services will be aligned professional services, meaning they will be around our system and services, system and software. But nonetheless we see an increasing desire on the part of our customers to in fact outsource their deployment in turnkey. So, the organization that we're building we expect to be everybody is busy as it is today going forward in 2017, 2018, and beyond. So, that's not going away for sure. We believe we will get better at it as we have in every aspects of the business that we've taken on and that goes back to William's notion of the cost, we think to that nature. So, I expect the margins of how we do that business will go up over time. But we're not getting out of the professional services business. Did I miss-understand your question?

Yes. I think maybe you talk about it in the past in terms of that turnkey were just maturing and I guess now in hind side what you meant was just that -- you know, again the idea that you get better out of the cost kind of moderate. Got it. Okay. And how that on the year-on-year growth rates you know X the turnkey professional services work I'm just curious what those might look like?

Yes. We're not going to give you precise numbers, what I would say in terms of what's going on directionally under the hood is that there is a meaningful overlap between the turnkey projects and what would be sort of business as usual purchases. That's the first point that I would make. So, I don’t think it's appropriate to strip turnkey out. Secondly, we do see though as a result of the turnkey project, some spend by these operators increasing over the prior rate and that is because the operators that we're selling to are experiencing increased competitor pressures and have an increase desire to spend on broadband access. And so, they are bringing forward some of those CapEx plans, so we don't see that that underlying trend starting to modulate.

Got it. I'm sorry, just to unclear on the growth rate. Is it fair to say that your equipment and I guess it’s a little bit tricky, but if you back out the turnkey work I guess I'm just wondering if you'd see growth there? I understand there's overlap between the two businesses as usual versus turnkey, but I guess I though kind of going in here that the turnkey work would give you guys some competitive advantage in the marketplace and kind of help embrasure yourselves even more of the customer said and drive additional equipment revenue, so I just wondering if that's indeed playing out?

So, when we think turnkey George, so I think I understand the parsing issue here. When we think turnkey project we're not thinking professional services. We're thinking the whole project. So the whole project includes professional services, potentially consulting services, equipment and other thing. So, when we look at turnkey project we think about the whole thing. Now, I think the way you're asking the question is more along the lines of the professional services component of that.

Correct.

Am I getting it right?

Yes.

Yes. The professional services component of that is not big. This is not a major revenue driver for the business, but turnkey project as a percentage of the total amount of revenue that we're doing are going to go up. But when we think turnkey project, that means the whole thing together, professional services, the equipment et cetera. Does that help?

Got it. Sure. Thank you very much.

Sorry about that.

Our next question comes from Meta Marshall with Morgan Stanley. Please proceed with our question.

Yes. Couple of questions. First is just if you could address CAF and now that some of the conversion of the USF to CAF is kind of those rules are complete, whether you're seeing spending happening kind of how would you like? And then just a hit on the turnkeys a little bit more, is it something where you think that this will appeal to kind of 10% of your customers or is there like a level of engagement with customers where you think could eventually serve 50% of your customers with these kind of arrangement or how do you think about sizing that opportunity?

Thanks, Meta. So, let's go back to the CAF fee first, so, the CAF from the price CAF carry that's been out as you know for quite a while and distributed inflowing and people are doing network, and I think we've been communicating that now for a couple of two or three quarters that we're seeing that business. If you're question is more around the rate of return folks, as we message last quarter, we will come back this quarter and potentially be able to give you a little more insight. They are still going back around the feedback loop et cetera and so it is not finalized yet. So stay tune on that part of it. So, did I answer your part?

Yes. I guess the first hedge has been to address the idea that coming out of last year you guys said that because of the metrics that were had to be kind of 40% of build out in the first two years that you thought there would be more study kind of demand from those customers having to do those build-out, but I just wanted to get a sense of is that something you're seeing or you starting – are you seeing continuation of lumpy years spend entire around those projects?

So, on the rate of return – on the price CAF carriers you're seeing that begin to flow commensurate with the rates that you're talking about from an ordering standpoint. Okay. On the rate of return carriers we'll still in the process of getting to finalize program, the competitive challenges is just underway, so stay tuned.

Got it. Thank you, guys.

Now, on the turnkey piece to your question, so, the professional services business which is to help our customers, transform their network with new deployments. It's something that we've had for quite of few years in the business, but it is starting to grow more dramatically in recent times driven by two factors. One is CAF, but the other is a different piece that we see with our customers which is they are continuing to figure out how to take OpEx out of their business. And they're no longer staff to take on peak workloads. So, actually they're staffing for troughs [ph] and looking for us to take on those things that represent discontinuous things like a build-out. So if you think that one through, it could be that the turnkey services are available and they're actually taken up by the vast majority of our customers big and small over time. But that's over a many year trend of what you think the service provider business model looks like going forward. Does that make sense?

Got it. Yes. I know that's helpful. I just wanted to get a sense of whether you thought it was opportunity addressable by those customers and it sounds like eventually perhaps…?

We do. We do and that's what we're preparing ourselves for, but again in an aligned fashion I want to keep emphasizing that point. As long as with Calix equipment or Calix software or Calix systems or Calix's platforms were all yours to go help our customers.

Great. Thanks.

Thank you.

[Operator Instructions] Our next question comes from Simon Leopold with Raymond James. Please proceed with our question.

Thank you. Carl, I get here your warning on the Verizon issue where in your prepared remarks, but I'm going to ask question any way. So couple of things on the Verizon opportunity, so getting in the lab is obviously the first step. Few things I wanted to understand is one, you've experience integrating into operational support systems with your CenturyLink work. Just trying to understand if that's a hurdle or part of what needs to be accomplished in addition to validating your product performance in order to be able to move ahead with Verizon if there is some OSS work that needs to occur?

So, the answer is yes, and as you might imagine every customer that we work with big or small have OSS that we have to integrated with. As you might also imagine many of them may have a package that we've already integrated at some other customer win, so make its easy. Verizon has their own systems that you would do that with, so the answer is yes, but we don't see anything untoward actually in our ability to do that.

Okay. And Verizon has talked quite a bit about the launch of service in Boston as relatively new initiative building up bios in that city. I'm presuming that your trial activity would be not be finished in time to align with those particular opportunities, is that a fair assessment?

No comment.

No comment. Okay. At least you answered one of the two on Verizon, so I won't push my luck.

I thought wish you pick them.

Can we go for one for three? I wanted to shift to the CAF II.

Go ahead.

Frontier made an interesting comment on its report last night in saying that the requirements under the programs, the federal programs are for 10 meg, but that was not necessarily always going to be the case. That would minimum that at times they would based on business opportunity build something superior to that in order to sell a faster product. So, I'm trying to understand what you see as the mix and I'm not specifically talking about Frontier, but just using that as an example. What kind of speed do you expect to deliver on the CAF II projects you're involved in today, are they mostly fiber-to-the-node type architectures meeting the may of minimum 10 meg or is there opportunity to richer offering and higher speed, any kind of quantification would be helpful? Thanks.

Well, I don't think I can give you quantification, but I can give you qualification. So, I think Frontier's answer to that that question was actually apt, which is where they see opportunities that they think they'll have a higher demand from subscribers that they build that on top of an essence the funds that they take some CAF. Having said, that, the other piece that you just said which is for the most part, fiber-to-the-node, that is the wildly dominant architecture. But as you also are aware depending upon where you place those nodes, drives what those speeds are. And the other piece is given the different service providers, the maybe selling services over top of their infrastructure that demand even higher speed. So a number of these folks have video services and other offerings that they would do, that might cause them to say you know, we're going to go build our CAF, we can use those moneys and then we'll throw an additional moneys of our own to get to even higher speed. Does that make sense?

It does. But I want to clarify that is that CAF will basically fund that they are minimum and if the operator wants to get to 100 megs, they've got to throw in some value for the incremental effort. Is that the way to understand it?

So the answer is, sure, I mean, CAF is build to fund to the limits that CAF has setup the minimums. And if it cost more than, it's up to the service provider to do so.

And just to wrap up on the rate of return folks. What's your best estimate for when we should get an update and progress?

Apt by the way, I will, in inaptly as I did last quarter say, say come back in 91 days, we'll talk about on the call again and see what we have. I think, we'll have more information next quarter. I don't think you should anticipate more information next quarter meaning the program will have been solidified, but I think we'll have that much more insight.

Great. Thank you for taking my questions.

Thanks, Simon. Appreciate it.

Our next question comes from Greg Mesniaeff with Drexel Hamilton. Please proceed with your question.

Yes. Thanks. You know looking at your SDN product portfolio currently, what would you say is the percentage of your customer based is taking out those products now and where do you see that going in some definable timeframe?

Yes. So, you SDN portfolio I'm not sure we really have an SDN product portfolio, we refer to it as software defined access and the Compass cloud. Are you asking me about the Compass cloud or about AXOS specifically Greg, so I can answer your question correctly.

AXOS specifically.

Well, so as we spoke the growth rate accelerating just in the last quarter. I see every reason for every single customer that we address deploying AXOS over some period of time. That is certainly our intent. Now, if your question is how many of them will be able to fully utilize all of the functionality that's built in AXOS that's a different question.

Okay. It does, if you focus on the later part, when if assuming they would take advantage of the full SDN capability of the platform. When do you see that?

I think that's a general network transformation, discussion and I think there are some customers out there that are further down the path and others. I think there are some out there that are talking like they're further down the path, but not as we want. So I think it's all over the map and I think its early days yet. But I think you're going to start to see deployment decisions made and this is why we focus on deployment as a company and not trials, because we never talk about – frankly we don’t ever talk about deployment much to the extent that we talk about anything we talk about deployment. Obviously in the Verizon case we spoke about a trial because they came out and spoke about the trial, so we thought we need it to make sure that we spoke to it. But deployments are what matters in this environment, because ones they start to operationalize around the framework and they get use to it that's the framework. So, I think you're dealing with years, not decades, but years and certainly not months.

Got you. Just a quick housekeeping question, and giving us the guidance data for the third quarter what was the – does you give OpEx and OpEx range?

Yes. We did. We gave guidance for OpEx of 48.5 to 49.5, that's taking into account the $4.5 million of settlement proceeds that we'll receive from the Occam litigation. If you were to extract those proceeds and look at it on a more normalized basis that equates to $53 million to $54 million.

Got it. Okay, great. Thank you.

[Operator Instructions] There are no further questions at this time. I'd like to turn the call back to the Tom Dinges for closing comments.

Thank you, operator. Calix will be reporting third quarter fiscal year 2016 results on November 1st after market close. In addition, management will be participating in a number of investor meetings and conferences during the third quarter. Information about these future events is 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. Good bye for now.

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