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Calix, Inc. (NYSE:CALX)

Acquisition of Ericsson’s Fiber Access Assets and Implementation of Global Reseller Agreement

November 5, 2012 4:30 PM ET

Executives

David Allen – Director, IR and Treasurer

Carl Russo – President and CEO

Michael Ashby – EVP and CFO

Analysts

George Notter – Jefferies and Company

Ehud Gelblum – Morgan Stanley

Mark Mckechnie – Evercore

Jim Hillier – UBS

Operator

Greetings and welcome to Calix’s acquisition of Ericsson’s fiber access assets and implementation of global reseller agreement conference call. At this time all participants are in a listen-only mode. A brief 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 introduce your host David Allen, Director of Investor Relations and Treasurer for Calix. Thank you. Mr. Allen, you may begin.

David Allen

Thank you, operator and good afternoon everyone. Before we begin the call I wanted to remind you that this call contains forward-looking statements regarding future events including but not limited to our acquisition of the fiber access assets from Ericsson and the global reseller agreement between the two companies, our development of new products that will continue help our customers transform their networks, the ongoing expansion of the total addressable markets, the future business and financial performance of the company, and our expectations of revenue, gross margin, earnings per share, stock-based compensation and amortization of intangibles. These forward-looking statements are based on our expectations, estimates and judgments in current trends and market conditions and involve risks and uncertainties that may cause actual results to differ materially from those contained in these forward-looking statements.

I would encourage you to review the company’s various SEC reports including our annual report on Form 10-K for the fiscal year ended December 31, 2011 and our quarterly reports on Form 10-Q for the quarters ended March 31, 2012, June 30, 2012 and September 29, 2012 available at www.sec.gov in which we discuss these risk factors.

All forward-looking statements are made as of the date of this conference call and is except as required by law, we do not intend to update this information. Also on this conference call we will be discussing our non-GAAP expectations. We will be providing the non-GAAP estimates to enable interested parties to evaluate our performance in the same manner in which we evaluate our own operation. These non-GAAP measures exclude certain charges and benefits which we do not consider to be part of our ongoing activities are meaningful in evaluating our financial performance including stock-based compensation expense, amortization of acquisition related intangible assets and other acquisition related expenses.

To help you better understand those expectations, we have included reconciliations of our past GAAP and non-GAAP results on our Investor Relations website on the page labeled Historical Financials.

All numbers that are discussed in today’s conference call are non-GAAP unless otherwise noticed.

This conference call will be made available for audio replay in the Investor Relations section of the Calix website at www.calix.com.

I would now like to turn the call over to Calix President and CEO Carl Russo. Carl?

Carl Russo

Thank you, Dave. Good afternoon everyone. Joining me on the call today is Michael Ashby, our Executive Vice President and Chief financial Officer.

Before I turn the call over to Michael, I would like to give you a brief summary of the transaction. I’m proud to announce that on Friday, November 2, Calix finalized the purchase of Ericsson’s fiber access assets. We also entered into a global reseller agreement with Ericsson. The EDA1500 GPON solution, EntriView Element Management System and associated ONTs are now part of the Calix unified access portfolio.

We believe this enhanced broadband access portfolio to be the most comprehensive and advanced available on the market capable of serving all tiers of customers worldwide. We believe the combination of Calix direct sales channels, our existing channel partners worldwide and now Ericsson gives Calix a formidable global selling machine.

With that, I would like to turn the call over to Michael.

Michael Ashby

Thank you, Carl and good afternoon everyone. I’m going to give you some high-level information on the transaction and some guidance for the fourth quarter of this year. We have acquired certain assets from Ericsson and those include capital assets, inventory, 50 employees in San Jose, California, transition support and a global reseller agreement. The consideration for this transaction was $12 million in cash.

The transaction will be accounted for as a business combination. The valuation of the different elements is proceeding and we expect it to be completed before the end of the year. The transaction closed on November 2 and so we will see two months of revenues and costs and expenses during the fourth quarter. I expect the revenue in this quarter to be minimal because the agreement does not include the transfer of any backlog or deferred revenue. As a result, we are only expecting revenue of around $4 million from the former Ericsson business between now and the end of the year. Gross margin on that revenue will be at around 25%.

We are pleased to welcome the former employees of Ericsson who are joining the Calix team and based in a building on Ericsson’s Silicon Valley campus which we are subleasing. The total additional operating expense will amount to around $2 million for the remaining two months of the quarter. The net impact on the fourth quarter will be a reduction in EPS of $0.03 per share meaning that we now anticipate our EPS for Q4 to be $0.02 per share, gross margins to be 43%, and revenue to be approximately $91 million.

In addition, we expect to have some one-time acquisition related expenses in this quarter and probably some in the first quarter of next year and as we have done in previous acquisitions, we will exclude those from our non-GAAP earnings and show them in the reconciliation between GAAP and non-GAAP.

Going forward Ericsson becomes a sales channel, so what we will now call the BLM1500 GPON access terminal, t-series family of ONTs and the EntriView Element Management system as well as our e-series products, p-series family of ONTs and compass suite of software applications. As with our other sales channels, we will not be breaking out either the revenue, margin or expenses related to this channel separately. We will continue to give guidance each quarter for the next quarter and that guidance will include revenue, cost, and expenses from the Ericsson sales channel.

Let me announce the signing of the definitive agreement on August 22, we stated that we expected this transaction to be accretive to non-GAAP earnings per share. With the exception of this abbreviated first quarter after the close, we expect the transaction will be accretive through 2013.

With that, I will turn the call back over to Carl.

Carl Russo

Thank you, Michael. We are excited to have completed this transaction and be in a position to bring our industry-leading portfolio of systems to customers worldwide. We are equally excited to be partnering with Ericsson, the global leader in wireless as we continue to pursue our vision of unified access.

At this point, I would like to turn the call over for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from George Notter with Jefferies and Company. Please go ahead.

George Notter – Jefferies and Company

Hi, there, thanks very much guys. I guess I wanted to ask about the Ericsson reseller arrangement. I guess I will lay out the questions here. First, can you tell us what’s involved there? Are you going to have to integrate your e-series products under the EntriView Element Management System and can you just confirm that that then effectively allowed the e-series now to be designed into Ericsson’s customer’s OSS systems? Is that a fair assumption?

Carl Russo

George, obviously there is a number of things that we will take on like any acquisition, there are integration efforts that we will choose to do on and some that we will choose not to do. In this case, pretty clearly the EntriView System, which is their element management system, has been installed in many customers. And so to smooth the uptake of the e-series products worldwide, that is a likely integration target that we will do.

George Notter – Jefferies and Company

Got it. And then how long would that take?

Carl Russo

It will take some months to quarters, if not years, but depending upon the different systems and what we are doing, it’s going to take some effort for sure.

George Notter – Jefferies and Company

Got it, okay. I presume that that obviously is a big leveraged point here in terms of the opportunity you have with this reseller arrangement.

Carl Russo

Well, we believe it will be but that remains to be seen, I think the customers are the one that make the decision. But certainly that’s the key thrust of what we are doing, yes.

George Notter – Jefferies and Company

And then if I look at the Ericsson sales force, I guess I want to understand better where you guys sit in the hierarchy of all the different product lines at Ericsson, the salespeople sell, how are those guys incentivized to sell Calix products vis-a-vis the other products that they have in their toolkit?

Carl Russo

Well, specifically I won’t go down into the specifics but you should think of it as no different than any other product that they would be selling. So neither more incented or less incented.

George Notter – Jefferies and Company

I guess I presume if I am an Ericsson sales person, there is a lot (fewer) revenue dollars associated with access infrastructure, I would think vis-à-vis wireless infrastructure. I just want to understand again where you guy sit in the hierarchy because the hierarchy isn’t just about the percentage, comp rates that those guys are comped at, but it’s also about the size of opportunity.

Carl Russo

Well, so it depends on the opportunity, it depends on what the individual service provider is bidding out or trying to sell, number one. Number two, it also depends on how easy or hard we make it to sell the products either on their own or along with other wireless bids for example. So as you well know, compensation is part of it but frankly training and ease of selling is a bigger part of it.

George Notter – Jefferies and Company

Got it, okay. And then how long does it take to get the Ericsson sales force up and running in terms of training them on I guess potentially the e-series products and what Calix brings to the relationship. How does that process work for you guys?

Carl Russo

It takes time. I mean obviously it takes roadshows, material efforts inside the region but keep in mind that there has already been work in the field on opportunities together and yielding a let’s just say a small tunnel of opportunities and potentially some bookings. So it’s already going, but it will take time George to bring all these pieces to bear, so you should look for this building over the next few quarters.

George Notter – Jefferies and Company

Got it. Last question I have is just on gross margin. I think you said 25% gross margin for the stub two months on this quarter. Is that the right kind of gross margin we should use thinking about Ericsson’s GPON product going forward or is that number artificially low here just in this last couple of stub months for some reason?

Carl Russo

No, it’s not artificially low for these stub months. It’s a reasonable number for the BLM1500 and it is born of two things. Number one, obviously the BLM1500 is now going to be manufactured by us but distributed by the Ericsson sales team, so there is some margin stacking in there, George, that’s number one. Number two, the BLM1500 was very much mix driven by their approach to tier 1s. So it’s really a GPON OLT that was driven into the tier 1 space which as you know is amongst the most pricing challenged of the access sub spaces.

So for those reasons, I think you would be safe using that number.

George Notter – Jefferies and Company

Got it, okay. Thanks very much.

Operator

Thank you. Our next question comes from Ehud Gelblum with Morgan Stanley. Please go ahead.

Ehud Gelblum – Morgan Stanley

Hello, Carl. Hey, Mike. Couple of questions. Did I hear you right, Mike, that you said there are 50 people coming over to – Carl said that. I had that originally when you bought it, you were closer to 60, 61. So have you trimmed a few, do not take everyone over, are there – do you plan on trimming some more and do we have those numbers right that you take more or less, fewer than you originally had in the business when you first had the original conference call?

Carl Russo

Yes, the original sizing was – again, all details weren’t done at that time, Ehud. I will let Michael make comment on this as well. In the end when – all mutual parties get together, 50 came down to be the right number. Michael, any?

Michael Ashby

Yes, we had the original agreement just allowed us to interview I think up to over 60 people, which we did and out of the 60, we chose the skillsets that were right for us which ended as being around 50 people.

Ehud Gelblum – Morgan Stanley

Okay. When you sell for the Ericsson sales force, is there – what type of profit did they take from this – what is the gross margin? Is that 25% going through the sales force, but as you bring, maybe going around this – the Ericsson sales force and possibly moving to other go to market strategies, you can lift that gross margin? Is there some delta between going to the Ericsson sales force that they maintain versus going around them on the gross margin?

Carl Russo

I mean clearly when you are going through a channel, there is always a channel margin, otherwise the channel partner isn’t going to be in the deal, right, and I don’t think that’s your question. I think your question is the mix continues to grow with both the existing EDA, now the BLM1500, as you add e-series to it, what happens, and we obviously anticipate that those margins will go up.

As for specific on what the markup or the uplift is, I mean it’s all over the place from a variability standpoint and I wouldn’t make comment anyway. Michael, any color from you?

Michael Ashby

No, just to reinforce, I think the reselling of the BLM product back to Ericsson is at a relatively low margin but the objective of this deal is to start selling the e-series and p-series products. And as those become a greater percentage over time, then those are obviously at a higher margin and we will be able to sustain higher margins.

Ehud Gelblum – Morgan Stanley

But as you do – since that’s obviously been part of the deal is taking your standard Calix products and moving them through the Ericsson channel, do you anticipate the gross margin in those products changing as you go through that channel or do you think the characteristics of the channel are very similar to your current channel?

Michael Ashby

No, I think very similar to our current channel. We are already selling tier 2 and tier 3 through resellers and international and this is not going to be any different.

Carl Russo

Right. One comment. As you know, when you are pushing in the markets and gaining share, right, likely your margins are going to be lower than as your footprint grows, right. So market share and margins track each other.

Ehud Gelblum – Morgan Stanley

So if we keep these separate and we – like you said, we are supposed to keep this low-single digit revenue number for the new product, the old Entrisphere product. If that ends up being still 25% gross margin, should we be modeling the proper Calix e-series, p-series, etc. at a lower gross margin than you have today as we go to next year because of pushing through the channel and getting into new areas or should that, I mean it’s been on a nice trajectory the last couple of quarters, should we continue the trajectory it’s been on?

Carl Russo

I think my comment would be – no, I don’t think you are going to see a material effect so I wouldn’t model it differently, but Michael, you are in charge of modeling here.

Michael Ashby

Yes, I think you got it right and you will see – we expect to be able to maintain good margins on the e-series and p-series products, even going to Ericsson or other reseller channels.

Ehud Gelblum – Morgan Stanley

Okay. Finally, do you think your – by going through the channel, do you think your applications will change and maybe more wireless focused and then could that open up new areas obviously, mobile backhaul is an area that that you are in somewhat but certainly nowhere near the majority of your revenues. Do you think that will change over time that you can become – that mobile backhaul can become a much more prevalent and much more – a larger piece of your business in terms of change in the drivers?

Carl Russo

Well, the short answer is absolutely yes; the longer answer is, obviously, one of the things that’s strategically a big driver in bringing these two companies together is our view of wireless and wireline interdependence as you go forward as opposed to substitutability, and that’s driven by just the (broad) content bandwidth, richness of the devices that are hung off of wireless antennas. And so, you simply have to go from a large cell to ever smaller and smaller antenna radios to make this whole thing work. So when you get smaller cells, femtocells, whatever you would like to call them, the need for a robust terrestrial infrastructure underneath them goes up. And so, we ought to be able to, as we work together at Ericsson, deliver, frankly, ever more robust and better thought through tighter product market fit products for that space.

So yes, yes and yes, but obviously there is work to do as we go forward. But the future of 4G LTE and then next generation LTE is pretty exciting.

Ehud Gelblum – Morgan Stanley

Right. Finally, should we take this $2 million a month sort of run rate for the new product and assume that maintains most till next year, so roughly around $6 million a quarter?

Michael Ashby

No, it’s actually $2 million for two months, Ehud. So it’s more like $3 million a quarter.

Ehud Gelblum – Morgan Stanley

Okay, I am dry. Ever done –

Michael Ashby

About the OpEx, $2 million for November, December, so it’s more like $3 million.

Ehud Gelblum – Morgan Stanley

$2 million in the OpEx. I am sorry, I wrote down revenue $4 million and OpEx $2 million. Did I get that backwards?

Michael Ashby

No, that’s right. So which are you asking?

Ehud Gelblum – Morgan Stanley

The revenue number.

Michael Ashby

No, that’s not necessarily correct, I think. We expect this transaction to be accretive in 2013 and so if you do the sort of the math backwards, then we would expect revenue to be between $10 million and $15 million a quarter going through 2013.

Ehud Gelblum – Morgan Stanley

A quarter?

Michael Ashby

A quarter.

Ehud Gelblum – Morgan Stanley

Revenue from the EDA1500, $10 million to $15 million a quarter?

Michael Ashby

Yes.

Ehud Gelblum – Morgan Stanley

Is it constant or is it going to – some seasonality to it?

Michael Ashby

Well, no, there is going to be some seasonality obviously and then we obviously – our plan is to add to that selling the e-series and p-series products, but that will be later on in a few quarters’ time.

Ehud Gelblum – Morgan Stanley

Okay, I appreciate it.

Carl Russo

Thanks Ehud.

Operator

Thank you. Our next question comes from Mark Mckechnie with Evercore. Please go ahead.

Mark Mckechnie – Evercore

Actually most of my questions have been asked and answered but maybe Michael, if you could tell us what kind of the geographic split for the new products you are getting from Ericsson? And when you said that $10 million to $15 million a quarter, that’s all the EDA1500, just to be clear that doesn’t include the cross selling?

Michael Ashby

No, it’s not just the EDA1500, it’s EDA1500 plus the ONT – the associated ONTs that go with it. So it’s the combined reseller of the Ericsson products that we have acquired.

Carl Russo

Not including cross selling the e-series into it, Mark.

Michael Ashby

As far as the geography is concerned, it is essentially all outside of North America. So it’s in different geographies but it is outside of North America, it’s international.

Mark Mckechnie – Evercore

Okay, great. And then just to be clear too that net gross margin, I think I don’t know if it’s George or who was asking the question about the 25% level, but you think you will stay at that level, you think you can add the $10 million to $15 million a quarter revenue level?

Michael Ashby

Yes. As far as reselling back the Ericsson equipment, I think it’s going to be approximately 25% gross margin on that equipment.

Mark Mckechnie – Evercore

And is there a timing of when you cut that over to your production because it sounded like you are going to cut that over I would guess from Ericsson to your own production or is that being done by a contract manufacturer, right, isn’t?

Michael Ashby

That cuts over immediately, Mark, because Ericsson happened to use the same outsource manufacturer that we use which is Flextronics. And so, that is almost immediately transitioned and becomes – just moves over to Calix.

Carl Russo

Arguably our easiest manufacturing integration of any of the acquisitions we have done.

Mark Mckechnie – Evercore

But it obviously benefits the same contract manufacturer, that’s why you are not going to see a really material change in your cost structure, right?

Michael Ashby

That is correct, yes.

Mark Mckechnie – Evercore

Great, thank you.

Operator

(Operator Instructions) Thank you. Our next question comes from Amitabh Passi with UBS. Please go ahead.

Jim Hillier – UBS

Hi guys. It’s actually Jim Hillier for Amitabh. I guess I just have a couple of clarification questions. In terms of the OpEx assumptions, for next year, should we be assuming I guess around $12 million or so in operating expenses post deal?

Michael Ashby

If you are talking about the full year, yes, that’s correct, around $3 million a quarter.

Jim Hillier – UBS

Okay, great. Also, in terms of the integration charges, are these going to be more of a one-time in 4Q or would you expect those to continue maybe in the first quarter and I guess would you expect those to be material at all?

Michael Ashby

I don’t know the answer to that in total and certainly there will be something in Q4 and probably Q1 as well and those relate to some specific integration costs that we have – they are all one-time costs, but they will spill over into Q1. As to the amount, we are in the process of taking a look at that, we already know what that’s going to be. But we will exclude that from our non-GAAP results and show it as the merger-related expenses.

Jim Hillier – UBS

Fair enough, thanks very much.

Operator

(Operator Instructions) There are no further questions at this time. I would like to turn the floor back over to David Allen for closing comments.

David Allen

Thank you, operator and again thank you for joining us today. We hope you can join us at one of our upcoming investment conferences which we are participating in this quarter including the Goldman Sachs Smallcap Technology One-on-One Summit in San Francisco on Wednesday, the UBS Global Technology Conference in New York on November 14 and the Credit Suisse Technology Conference in Scottsdale, Arizona on November 28. Information about these events has been posted on the Investor Relations section of our website. Again, thank you for joining us today. We remain focused on executing against the opportunities ahead of us and we look forward to speaking to you at one of these forums. Good bye for now.

Operator

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

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