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CALX > SEC Filings for CALX > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for CALIX, INC

Form 10-Q for CALIX, INC


2-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

This report includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities and Exchange Act of 1934, as amended. All statements other than statements of historical facts are "forward-looking statements" for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statement of the plans and objectives of management for future operations, any statements concerning proposed new products or licensing, any statements regarding product development, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential," or "continue" or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the Risk Factors set forth under Part II, Item 1A below, and for the reasons described elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.

Overview
We are a leading provider in North America of broadband communications access systems and software for fiber- and copper-based network architectures that enable communications service providers ("CSPs") to connect to their residential and business subscribers. We enable CSPs to provide a wide range of revenue-generating services, from basic voice and data to advanced broadband services, over legacy and next-generation access networks. We focus solely on CSP access networks, the portion of the network that governs available bandwidth and determines the range and quality of services that can be offered to subscribers. We develop and sell carrier-class hardware and software products, which is referred to as the Unified Access portfolio that are designed to enhance and transform CSP access networks to meet the changing demands of subscribers rapidly and cost-effectively.
We market our access systems and software to CSPs globally through our direct sales force as well as a limited number of resellers. As of September 29, 2012, we have shipped over fifteen million ports of our Unified Access portfolio to more than 1,000 customers worldwide, whose networks serve over 50 million subscriber lines in total. Our customers include 18 of the 20 largest U.S. Incumbent Local Exchange Carriers, or ILECs. In addition, we have over 400 commercial video customers and have enabled over 750 customers to deploy gigabit passive optical network, or GPON, Active Ethernet and point-to-point Ethernet fiber access networks.
Our revenue decreased to $81.3 million and $238.8 million for the three and nine months ended September 29, 2012, respectively, from $83.7 million and $253.1 million for the three and nine months ended September 24, 2011, respectively. Revenue growth will depend on our ability to continue to sell our access systems and software to existing customers and to attract new customers, including in particular, those customers in the large CSP and international markets. During the second and the third quarters of fiscal 2012, we experienced softness in our business due to lower demand across multiple customer markets. We believe this was due to a slowdown in capital expenditures by service providers increasingly concerned about macro-economic conditions and uncertainties associated with the implementation of regulatory reforms. We expect these issues to continue and these issues may negatively impact our results for the remainder of 2012. Additionally, we expect that our planned acquisition of Ericsson's fiber access assets will have a positive impact to revenue beyond 2012. Since our inception we have incurred significant losses, and as of September 29, 2012, we had an accumulated deficit of $485.9 million. Our net loss was $7.1 million and $21.8 million for the three and nine months ended September 29, 2012, respectively. Our net loss was $6.9 million and $47.3 million for the three and nine months ended September 24, 2011, respectively.
Revenue fluctuations result from many factors, including but not limited to:
increases or decreases in customer orders for


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our products and services, large customer purchase agreements with special revenue considerations, varying budget cycles for our customers and seasonal buying patterns of our customers. More specifically, our customers tend to spend less in the first fiscal quarter as they are finalizing their annual budgets. Customers then typically decide to purchase our products during our second fiscal quarter. In our third fiscal quarter, customers are in the process of deploying such products and as a result there is typically less spending. In addition, difficulties related to deploying products during the winter also tend to limit spending in the third quarter. Finally, in our fourth fiscal quarter, customer purchases typically increase as customers are attempting to spend the rest of their budget for the year. As of September 29, 2012, our deferred revenue of $46.0 million primarily included certain contracts with customers who receive government supported loans and grants from the U.S. Department of Agriculture's Rural Utility Service ("RUS") that include installation services, services, special customer arrangements and ratably recognized services. The timing of deferred recognition may cause significant fluctuations in our revenue and operating results from period to period.
Cost of revenue is strongly correlated to revenue and will tend to fluctuate from all of the aforementioned factors that could impact revenue. Other factors that impact cost of revenue include changes in the mix of products delivered to our customers and changes in the cost of our inventory. Cost of revenue includes fixed expenses related to our internal operations which could impact our cost of revenue as a percentage of revenue, if there are large sequential fluctuations to revenue.
Our gross profit and gross margin have been, and will likely be, impacted by several factors, including new product introduction or upgrades to existing products, changes in customer mix, changes in the mix of products demanded and sold, shipment volumes, changes in our product costs, changes in pricing and the extent of customer rebates and incentive programs. We believe our gross margin could increase due to favorable changes in these factors, for example, increases in sales of our advanced E-Series Ethernet service access platforms, upgrades to our C7 platform, new introductions of our P-Series optical network terminals and reductions in the impact of rebate or similar programs. We believe our gross margin could decrease due to unfavorable changes in factors such as increased product costs, pricing decreases due to competitive pressure and an unfavorable customer or product mix. Changes in these factors could have a material impact on our future average selling prices and unit costs. Also, the timing of deferred revenue recognition and related deferred costs can have a material impact on our gross profit and gross margin results. The timing of recognition and the relative size of these arrangements could cause large fluctuations in our gross profit from period to period.
Our operating expenses have fluctuated based on the following factors: timing of variable compensation expenses due to fluctuations in order volumes, timing of salary increases which have historically occurred in the second quarter, timing of bonus accrual due to changes in the Company's performance, timing of research and development expenses including prototype builds and intermittent outsourced development projects and increases in stock-based compensation expenses resulting from modifications to outstanding stock options. Our operating expenses for fiscal 2011 include merger-related expenses and amortization of intangible assets from our acquisition of Occam as discussed in more detail below. As a result of the acquisition we have also incurred increased compensation costs across all operating expense categories due to additional headcount and increased facility related costs. We anticipate that our operating expenses will increase as a result of our planned acquisition of Ericsson's fiber access assets as discussed in more detail below.
As a result of the fluctuations described above and a number of other factors, many of which are outside our control, our quarterly operating results fluctuate from period to period. Comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance.
Planned Acquisition of Ericsson's Fiber Access Assets On August 20, 2012, Calix and Ericsson Inc. ("Ericsson") entered into an Asset Purchase Agreement under which Calix will make a one-time cash payment to acquire Ericsson's fiber access assets ("EFAA"), including the Ericsson EDA 1500 GPON solution and its complementary ONT portfolio. In connection with this planned acquisition, Calix will offer employment to up to 61 U.S.-based employees of Ericsson, and will transition ongoing support of the acquired products from Ericsson to Calix.
On August 22, 2012, Calix and Ericsson also signed a global reseller agreement, under which Calix will become Ericsson's preferred global partner for broadband access applications. We expect this agreement to provide Calix with an extensive new global reseller channel, while our acquisition of Ericsson's fiber access portfolio delivers powerful new complements to our industry-leading Unified Access portfolio. This agreement will also provide Ericsson's existing fiber access customers with world-class support and maintenance, and an expanded portfolio of access systems and software from a leading company totally focused on access.
The transaction is expected to close in the fourth quarter of 2012 and will be accounted for using the acquisition method of accounting in accordance with the accounting standard for business combinations. We will consolidate EFAA's financial results in the condensed consolidated financial statement from the date of acquisition. We expect the acquisition to have a


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positive impact on our international business over time. Acquisition of Occam Networks
On February 22, 2011, we completed our acquisition of Occam Networks, Inc. ("Occam"), a provider of innovative broadband access products designed to enable telecommunications service providers to offer bundled voice, video and high speed internet, or Triple Play, services over both fiber optic and copper networks in a stock and cash transaction valued at approximately $213.1 million which consisted of $94.5 million of cash consideration and a value of $118.6 million of common stock issued and equity awards assumed.
As a result of this acquisition, we recorded $50.6 million in goodwill and $97.7 million in other intangible assets. We are amortizing the definite-lived intangible assets over their useful lives. Under the acquisition method of accounting rules, we revalued the Occam assets and liabilities acquired at the time of the acquisition, based on their fair value.

Critical Accounting Policies and Estimates Our financial statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. To the extent there are material differences between these estimates and actual results, our financial statements will be affected. Our management evaluates its estimates, assumptions and judgments on an ongoing basis.
Our critical accounting policies and estimates are described under "Critical Accounting Policies and Estimates" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2011. During the nine months ended September 29, 2012, there have been no significant changes in our critical accounting policies and estimates.
Impairment of Goodwill and Intangible Assets Goodwill is not amortized but instead is subject to an annual impairment test or more frequently if events or changes in circumstances indicate that it may be impaired. We evaluate goodwill on an annual basis as of the end of the second quarter of each year. Management has determined that we operate as a single reporting unit and, therefore, evaluates goodwill impairment at the enterprise level. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate an asset's carrying value may not be recoverable. To evaluate for impairment, the Company utilizes a two-step process. The first step requires the Company to compare its fair value to its carrying value including goodwill. The Company determines its fair value using both an income approach and a market approach. Under the income approach, the Company determines fair value based on estimated future cash flows, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of the Company and the rate of return an outside investor would expect to earn. Under the market-based approach, the Company utilizes information regarding the Company as well as publicly available industry information to determine earnings multiples that are used to value the Company. If the carrying value of the Company exceeds its fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of goodwill with the carrying value of goodwill. An impairment charge is recognized for the excess of the carrying value of goodwill over its implied fair value.
In accordance with our annual goodwill impairment test and in consideration of the recent significant decline in our stock price, we evaluated the potential impairment of goodwill as of June 30, 2012 in July 2012. The goodwill impairment testing process involved the use of significant assumptions, estimates and judgments, and is subject to inherent uncertainties and subjectivity in determination of the fair value of our sole reporting unit. In performing the first step of the goodwill impairment test, we determined the fair value of our reporting unit by combining two valuation methods, a discounted cash flow analysis (DCF) and market multiples of comparable publicly traded companies. Under the DCF method, we prepared annual projections of future cash flows over a period of five years (the "discrete projection period") and applied a terminal value assumption to the final year within the discrete projection period to estimate the total value of the cash flows beyond the final year. These projected cash flow estimates were then discounted using a discount rate that reflected market-based estimates based on comparable publicly traded companies, and included an additional risk premium specific to Calix. Under the market multiples method, fair value was determined by applying multiples of Revenue and EBITDA (earnings before interest, taxes, depreciation and amortization). In addition, we analyzed the fair value of our reporting unit and our total market capitalization for reasonableness, taking into account certain factors, including control premium, which were based on values observed in market transactions. Based on our analyses, we determined that the fair value of our reporting unit exceeded the carrying value


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by approximately 15%, and therefore the second step of the goodwill test did not need to be performed. However, significant changes in these estimates and assumptions could create future impairment losses to goodwill.
At the end of the third quarter of 2012, we reviewed events and changes to our business subsequent to the impairment test performed in July 2012 and concluded that there were no indicators of impairment to the carrying value of goodwill during the three months ended September 29, 2012. As of September 29, 2012, there was no impairment to the carrying value of goodwill. Recent Accounting Pronouncements
In the nine months ended September 29, 2012, there were no new accounting standard updates that would materially impact the Company's financial statements.

Results of Operations
Comparison of the Three and Nine Months Ended September 29, 2012 and
September 24, 2011
Revenue
The following table sets forth our revenue:
                             Three Months Ended                                              Nine Months Ended
                                               Variance    Variance                                           Variance     Variance
         September 29,      September 24,         in          in        September 29,      September 24,         in           in
              2012               2011          Dollars      Percent          2012               2011           Dollars      Percent
                                                     (in thousands, except percentages)


Revenue $ 81,301 $ 83,655 $ (2,354 ) (3 )% $ 238,794 $ 253,084 $ (14,290 ) (6 )%

Our revenue is principally derived in the United States. During the three and nine months ended September 29, 2012 and September 24, 2011, revenue generated in the United States represented approximately 94% and 93%, respectively. Revenue decreased during the three and nine months ended September 29, 2012 compared with the corresponding periods of fiscal 2011, primarily due to a decrease in shipment volume resulting from the softness in demand across multiple customer markets which the company believes is due to a slowdown in capital expenditures by service providers increasingly concerned about macro-economic conditions and uncertainties associated with the implementation of regulatory reforms. We expect these issues to continue and these issues may negatively impact our results for the remainder of 2012. Cost of Revenue and Gross Profit
The following table sets forth our costs of revenue:

                                            Three Months Ended                                               Nine Months Ended
                                                            Variance      Variance                                            Variance     Variance
                        September 29,     September 24,        in            in         September 29,      September 24,         in           in
                            2012              2011           Dollars       Percent           2012               2011           Dollars      Percent
                                                                    (in thousands, except percentages)
Cost of revenue:
Products and services  $      45,707     $      49,002     $  (3,295 )       (7 )%     $      132,797     $      143,209     $ (10,412 )       (7 )%
Merger-related
expenses                           -                 -             -          -  %                  -             19,966       (19,966 )     (100 )%
Amortization of
intangible assets              2,088             2,806          (718 )      (26 )%              5,451              7,510        (2,059 )      (27 )%
Total cost of revenue  $      47,795     $      51,808     $  (4,013 )       (8 )%     $      138,248     $      170,685     $ (32,437 )      (19 )%
Gross profit           $      33,506     $      31,847     $   1,659          5  %     $      100,546     $       82,399     $  18,147         22  %
Gross margin                      41 %              38 %                                           42 %               33 %

Cost of revenues decreased during the three and nine months ended September 29, 2012 compared with the corresponding periods of fiscal 2011, primarily due to the fact that we did not incur any further merger-related expenses subsequent to 2011, a decrease in cost of products and service revenues resulting from decreased revenues and decreased write-down charges for excess and obsolete inventory as a result of improved inventory management, and a decrease in amortization of intangible assets.
The decreases in amortization of intangible assets during the three and nine months ended September 29, 2012 are due to the completion of the amortization of certain intangibles that we acquired from Occam, offset in part by an increase in the


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amortization of core developed technologies that began amortizing during the second quarter of 2012 as discussed below. At the end of the first quarter of 2012, upon the completion of the research and development efforts associated with the in-process technology, we determined that this technology had a useful life of 5 years and therefore reclassified it as core developed technology. We began amortizing this intangible asset to cost of revenue during the second quarter of 2012.
Gross margin increased during the three and nine months ended September 29, 2012 compared with the corresponding periods of fiscal 2011, primarily due to the absence of merger-related expenses, lower excess and obsolete inventory write-down charges, and lower intangible assets amortization expenses. Excluding merger-related expenses, gross margin increased slightly from 38% and 40% for the three and nine months ended September 29, 2011, respectively, to 41% and 42% for the three and nine months ended September 29, 2012, respectively, primarily due to a combination of product mix and cost reductions. Operating Expenses
Research and Development Expenses
The following table sets forth our research and development expenses:

                                               Three Months Ended                                               Nine Months Ended
                                                               Variance      Variance                                           Variance      Variance
                          September 29,     September 24,         in            in         September 29,     September 24,         in            in
                              2012              2011           Dollars        Percent          2012              2011           Dollars        Percent
                                                                       (in thousands, except percentages)
Research and development $      16,165     $      16,717     $     (552 )       (3 )%     $      49,604     $      50,340     $     (736 )       (1 )%
Percent of total revenue            20 %              20 %                                           21 %              20 %

Research and development expenses decreased during the three months ended September 29, 2012 compared with the corresponding period in fiscal 2011, primarily due to a decrease in prototype and consulting expenses resulting from the timing of new product development activities, offset in part by an increase in compensation expenses due to increased headcount.
Research and development expenses decreased during the nine months ended September 29, 2012 compared with the corresponding period in fiscal 2011, primarily due to a decrease in prototype expenses resulting from the timing of new product development activities, and a decrease in stock-based compensation expense. These decreases were offset in part by an increase in compensation expenses due to increased headcount resulting from the acquisition of Occam on February 22, 2011 and the expansion of our China development center, and an increase in consulting expenses in connection with our pursuit of OSMINE certification.
Research and development expenses as a percentage of revenue for the three and nine months ended September 29, 2012 compared to the corresponding periods in fiscal 2011 remained relatively flat.
We are continuing our strategic investments in our Unified Access portfolio. We intend to continue to dedicate significant resources to research and development and to develop new product capabilities to support the performance, scalability and management of our Unified Access portfolio. Sales and Marketing Expenses
The following table sets forth our sales and marketing expenses:

                                              Three Months Ended                                               Nine Months Ended
                                                               Variance      Variance                                          Variance      Variance
                          September 29,     September 24,         in            in        September 29,     September 24,         in            in
                              2012              2011           Dollars       Percent          2012              2011           Dollars       Percent
                                                                      (in thousands, except percentages)
Sales and marketing      $      15,093     $      12,593     $    2,500         20 %     $      44,880     $      38,831     $    6,049         16 %
Percent of total revenue            19 %              15 %                                          19 %              15 %

Sales and marketing expenses increased during the three months ended September 29, 2012 compared with the corresponding period in fiscal 2011, primarily due to an increase in compensation and related costs driven by an increase in headcount resulting from the hiring of additional employees to pursue our international expansion.
Sales and marketing expenses increased during the nine months ended September 29, 2012 compared with the corresponding period in fiscal 2011, primarily due to an increase in compensation and related costs, an increase in travel-related


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costs, which were driven by an increase in headcount resulting from our acquisition of Occam on February 22, 2011 and to pursue our international expansion.
The increases in sales and marketing expenses as a percentage of revenue for the three and nine months ended September 29, 2012 compared to the corresponding periods in fiscal 2011 were primarily due to the increase in expenses in the respective periods.
We will continue our investments in sales and marketing in order to extend our market reach and grow our business in support of our key strategic initiatives. General and Administrative Expenses
The following table sets forth our general and administrative expenses: . . .

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