Welcome to the Calix First Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. 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, 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'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 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 dates. Also on this conference call, we will discuss both GAAP and non-GAAP financial measures. Reconciliation of GAAP to non-GAAP measures is included in our earnings press release and available on our website. As a reminder, our earnings press release, supplemental financial data, including the recast of the presentation of our historical revenue and cost of revenue for the quarters and full year period for each of 2015 and 2016 and an accompanying earnings release presentation are available in the Investor Relations section of the Calix website. For the quarter ended April 1, 2017, Calix reported revenues of $117.5 million, a GAAP loss of $0.67 per share and a non-GAAP loss of $0.57 per share. In just a moment, William will take you through the quarter in greater detail, and Carl will conclude with remarks on financial guidance, Calix's growth 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 Executive Vice President and CFO, William Atkins. William?

Thank you, Tom. We last provided you with guidance regarding Q1 on February 14. And in that guidance, we called for estimated revenues of between $110 million and $114 million; a non-GAAP gross margin of between 30% and 34%; non-GAAP operating expenses in the range of $61 million to $63 million; and non-GAAP EPS of between a loss of $0.57 and $0.49 on a per-share basis. Relative to that guidance, our actual revenues for the quarter were $117.5 million, above the upper end of our guidance range. Non-GAAP gross margin was 30.1%, at the lower end of our guidance range. Non-GAAP operating expenses came in at $63.1 million, slightly above the upper end of our guidance range. Non-GAAP EPS was a loss of $0.57 per share, at the lower end of the guidance range. At the gross margin level, the largest drivers in the first quarter were costs associated with the quarter-end acceleration in activity for turnkey network improvement projects, including CAF II-related projects, as we completed and closed a large number of sites for an existing project and added new projects as we continue to ramp our services business. These activities resulted in a sharper increase in services revenues, which carry lower margins than our systems product revenues in absolute dollars and as a percentage of revenues. Systems gross margins were negatively impacted by higher warranty and retrofit costs, inventory write-downs for slower-moving product as well as less favorable shifts in product and regional sales mix. Operating expenses were slightly higher than our guidance and increased compared to the year ago quarter, driven primarily by continued investments in R&D headcount as well as our acceleration of cost for prototype builds and the use of outside contractors to support new opportunities with both existing and prospective customer. Getting into a…

Thank you, William. And before I continue, I would like to thank William for his service and helping Calix transform. Thank you, again, William. We finished the first quarter with stronger-than-anticipated revenues and earnings within the guidance range we discussed with you back in mid-February. Our revenue growth accelerated as we completed activity on 1 turnkey network improvement project, and we continue work on others. With that in mind, let me take you through our Q2 guidance. For the second quarter of 2017, we expect revenues to be in the range between $122 million and $126 million, representing growth of 14% to 17% year-over-year. We are guiding non-GAAP gross margin to a range between 40.5% and 43.5% for Q2. While this is down from last year's Q2 level of 47.5%, it represents a 1,000 basis point improvement sequentially. We expect non-GAAP operating expenses to be in the range of $59 million to $61 million, up from $53 million in the year ago quarter. The increase in operating expenses compared to the year ago quarter predominantly reflects incremental hiring and R&D costs to support our strategic investments to pursue broader opportunities in the market. To be clear, this guidance does not include the impact from our restructuring plan. Based on 50 million basic shares, the expectations that I've just finished taking you through result in a guidance range for Q2 of a non-GAAP EPS loss between $0.19 and $0.12 per share. Despite the projected operating loss in Q2, we anticipate positive operating cash flow as working capital velocity should improve relative to Q1. Looking beyond Q2, we see Calix solutions enabling us to continue our double-digit revenue growth. So far, the year is tracking relative to the expectations we discussed a quarter ago, with accelerated services activity in the first half…

[Operator Instructions]. Our first question come from the line of Simon Leopold of Raymond James.

Handful of things I want to check on. One is, I appreciate you sending us -- sending out the slides. I'm looking at the segment details, you're breaking up services now on your fifth slide there. And clearly, the first quarter was a big jump from the past pattern in terms of the services contribution. So I want to make sure I understand, one, what happened in the March quarter? And two, how do we think about this trend going forward? Is it go back to the more normalized level of 2016? Or is this have a longer duration in terms of the services contributions?

So as you heard William note and I think I reiterated, there was one major turnkey program that was closed out. And when that happens, you get sign off on revenues and therefore, the mix was driven in Q1. And if you have more questions, William will certainly be willing to add color.

Yes.

As you look forward, obviously, we have so many things out now. We're not going to forecast them separately. But I will hearken back to the color that we spoke to before, Simon. We expect services to be a larger percentage of revenue in the first half and tailing off somewhat in the second half. And that's the best way I would characterize it. I would not necessarily say it would go back to way, way back historical percentages. And the reason I wouldn't say that is because of the set of service offerings that are now being brought to market and developed by Greg Billings and his team. So we expect services actually to be a significant component of our revenues, albeit probably not as high as it is today.

So that takes me actually to my second question, which was assuming services are still significant in your second quarter, understanding you don't want to forecast all that detail. You have talked about a very significant recovery in the gross margin. So I'm just trying to make sure I understand what's driving that recovery in gross margin if it isn't the change in mix between products and services?

It's not going to be mix. What you should expect to see is both segments that were reporting improved from a margin perspective. And that's as much -- as far as I would go.

Okay. And then, you also mentioned your customer concentration this quarter, appreciate you offering that 55% from 2 customers. Historically, you have not had anything quite that high. So I wondering, if you can give us a little bit more color in terms of was this one customer spiking up or 2 customers being 25-ish percent? Anything you could help us to understand how this compares to your historical trends? And how we should think about a more normalized behavior?

Yes, Simon, it's William here. What I would say is, we did note that we'd closed out one of our major network turnkey improvement projects. And that coincides with that gross and the customer concentration that you highlighted. And so I would just link those two together. And just note that therefore a lot of it is driven by that services activity that we've been discussing.

[Operator Instructions]. Our next question comes from the line of George Notter of Jefferies.

I guess, I wanted to also take you on the gross margin discussion. So looking at your systems gross margin, that was quite a bit lower year-on-year. I think you said 34% change versus, I think, 50% a year ago. How important was the warranty provision and then the inventory write-down in driving that lower gross margin?

The net of it is that you're going to see systems bounce back up. So pretty important.

Yes, we had a number of what I would describe as one-off factors, not totally driven by inventory write-downs or warranty and retrofit or those where we call them out and therefore, they inherently must be drivers. We also had some one-off contractual sort of systems pricing move through the system that moved through our reporting systems. And we don't expect that to be repeated. So I would say there are a number of one-off factors that affected systems margins this quarter.

Got it. Is it fair to say that your systems gross margin would have been up year-on-year or down year-on-year or flat, you ex those one-off items or will it stay there?

I would say, we'll look forward to chatting at the end of Q2. And I think you'll get a better read on things, George. But you are heading -- directionally your question is in the right direction.

I mean, I guess, I ask because the strategy here, I think, has been to develop more and more value in your products [indiscernible] software systems of course. I think the idea here is just to get more margin and more profitability on the systems side is continue to invest. I just want to make sure that that's showing up in your financials? And at this point, I can't see it of course.

Yes, so to your point, that's exactly right. When you think about it from a moving part standpoint, you think about new things that are ramping up that might have a different value, older things that might be ramping down at a different value. Trying to tie those things out without having any excess and obsolete, et cetera, et cetera, et cetera. We're going to go through that transition for a couple of quarters. But inexorably, there's no way we come back by a 1,000 basis points without both sides of that segmentation improving.

Okay. On the services gross margin side, what you think that the right longer-term gross margin would look like in the services business? I mean it seems there's a lot of volatility here certainly, but, I guess, I just wanted to be sure that business makes sense to you guys to be in longer term that you can drive some component of profitability there for the company?

Yes, so it really depends upon how this all evolves. If it evolves to a traditional feet on the street driving the vast majority of this, then services will be by some number of points below corporate average gross margins. If it evolves into a higher software value add then actually you start to -- the services start to track more towards the systems margin and actually go up quite a bit. So it's really a future mix question. And I don't know the answer to it yet. But certainly, we're not intending on staying at the range that we are at for sure.

Our next question comes from the line of Meta Marshall of Morgan Stanley.

Quick question here. If you looked -- I just want to get a sense of over the course of the last year, you certainly focusing a lot on CAF II. And so kind of is the split between copper business versus fiber business just on the products or on the systems side, like has that meaningfully changed year-over-year to become kind of more copper weighted? And then, the second question was, you noted in the script, the revenue was kind of more weighted towards -- or the spend from your customers is more weighted towards services this quarter. And do you expect that the product growth rate would kind of go back to be more towards a high single-digit growth rate kind of going forward?

Yes, let me answer the last one first. It's impossible for us to grow with the rate in front of us without the systems side of the segment growing at a good clip. So hopefully, that answers your second question. On the first, and I think as we discussed before, we don't break things out by a physical layer. We don't tend to think of them that way. And even less so today, as we now have an operating system that's literally any PHY, so it's physically -- it's independent of the physical layer. I'm sitting annulling your question. There may be a certainly greater mix of copper driven by some of the longer reach CAF deployments, but I'd have to go dig and need -- and look at it at a different way than we do.

Okay. Yes, I mean, I'm just trying to get a sense of like there is, obviously, a lot of enthusiasm about fiber builds right now, but it just seems as if like you guys are spending a lot of time -- and your customers are spending a lot of time on kind of CAF II and whether that's distracting from some of their more fiber activity? I guess this is kind of what I'm getting at. Is it CAF II a distraction from fiber activity currently?

So we haven't seen that to be sure. We have seen customers doing more copper. That's why I was thinking about your question, because there's funds coming to them that are going to be deployed on a copper basis, because there're 10 megabits, 25 megabits, et cetera. So there's clearly some more of that there. But by the way from a fiber infrastructure standpoint, they're dragging fiber out to those points.

[Operator Instructions]. Our next question come from the line of Greg Mesniaeff of Drexel Hamilton.

Given the commitments you've obviously made to your major customers recently and the gross margin trends that we have seen, can you give us any sense of any changes in market share that you can report as far as your competitive landscape?

I don't think there has been anything that's noteworthy. Nothing I would call out positive or negative.

Okay. Any color on pricing, macro pricing environment?

Good question, Greg, but no. Neither there actually.

There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to management for closing remarks.

Thank you, Operator. Calix's next quarterly earnings report for our fiscal second quarter ending July 1, 2017 will take place on August 8, 2017 after market close. In addition, management will be participating in investor meetings and conferences during the first quarter. Information about these future 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 concludes today's conference, and thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.