CALX

Greetings everyone, welcome to the Calix second quarter 2026 earnings conference call. At this time, all participants are in a listen only mode. A question and answer session will follow the brief prepared remarks.

If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Nancy Fazioli, Vice President and Investor Relations. Nancy, please go ahead.

Thank you, Darryl, good morning everyone. Thank you for joining our second quarter 2026 earnings call. Today on the call, we have President and Chief Executive Officer, Michael Weening, and Chief Financial Officer, Cory Sindelar.

As a reminder, today after the market closed, Calix issued a news release which was furnished on a Form 8-K along with our stockholder letter, was also posted in the investor relations section of the Calix website. Today's conference call will be available for webcast replay in the investor relations section of our website.

Before I turn the call over to Michael for his opening remarks, I want to remind everyone that on this call we will refer to forward-looking statements, including all statements the company will make about its future financial and operating performance, growth strategy, and market outlook, 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 the second quarter 2026 letter to stockholders and in the annual and quarterly reports filed with the SEC. Calix assumes no obligation to update any forward-looking statements which speak only as to their respective dates.

Also in this conference call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in the second quarter 2026 letter to stockholders that was posted yesterday. Unless otherwise stated, all financial information referenced in this call will be non-GAAP. With that, Michael, please go ahead.

Thank you, Nancy. Much like the dot com revolution before it, the AI revolution is changing how society functions and will transform business models in every industry. The key difference between the dot com era and the AI era is the rate of change. The AI rate of change is unprecedented, those who move fast will lead the industries they serve.

The second quarter was the beginning of Calix, the AI leader, as we began realizing the value of our 15-year investment through the first full quarter of our AI native Calix One platform being live. Calix One has access to data, insights, and the ability to autonomously or through team member augmentation, improve operations, marketing, support, and subscriber experiences for our service provider customers regardless of size.

These expanding Calix One capabilities enable our customers to address the threat of broadband commoditization through differentiated experiences, resulting in winning new subscribers, growing revenue, higher retention across consumer, business, MDU, and the municipal segments they serve, while improving operating costs with a predictable implementation of AI capabilities.

Customer interest in Calix One exploded in Q2, driving record RPOs, record software and services revenue. While the strength of the platform was evidenced by the significant jump in software and service margin as we had all customers live. We also tripled the number of customers that signed up for Calix Agent Workforce Cloud.

More important is the makeup of those customers. They were not only the innovators who partner with Calix early in the product life cycle and are committed to the value that can be realized in their business model by being first to market.

The customers who signed up in Q2 span the entire adoption life cycle from early adopter, which is expected, to late majority, which signals a significant Calix Agent Workforce Cloud-enabled shift across our base. The shift is that every business leader knows they must have an AI strategy or they will be at risk.

The late majority adoption proves that Calix One is a secure, trusted, and predictable approach for every customer to adopt AI. It is secure and trusted as we have invested 15 years into the platform and domain knowledge to meet our customers' needs. Since November 2023, we have evolved the platform to be AI native while ensuring that our processes, culture, security, and governance expanded to meet the needs of the AI era for our customers.

It is predictable as our AI native platform architecture allows us to use any AI model, and it is our belief that hardened open source models meet our workflow, use case, and industry needs. That means Calix has solved for the largest issue that is raging across all industries. How to use AI predictably as one cannot calculate an ROI on a cost that can quickly run out of control.

In our architecture, we have issued tokens through hardened open source AI models and the acquisition of pure compute. Calix One customers are adopting a platform that delivers AI capabilities that can be trusted, are secure, and are offered at a predictable cost, which will yield an ROI that will grow every month with their subscription as we acquire new subscribers, grow revenue, reduce churn, and lower operating costs through the power of Calix Agent Workforce Cloud.

At Investor Day, I shared a slide that showed Our annual feature rate peaked at 181 in 2018. Our second-generation platform feature rate peaked at 918 in 2024. With the third generation of our platform launched, our customers can expect that our past innovation velocity will be quickly surpassed with Calix Agent Workforce Cloud. Which brings me to the Calix team.

This team continues to win awards as one of the best cultures in any industry. Having outlined a subset of awards in the investor letter, including Fortune recognizing Calix in the 100 Best Companies to Work For list. The strength of this type of culture has never been more important. While AI is a powerful technology, it requires teams to get the most of it.

Our customer success organization will help our customers leverage Agent Workforce Cloud to transform, and inside Calix, our leaders are taking a human-centric approach to AI to ensure that Calix transforms internally by understanding how we work so that we can agentify those portions of our business that will benefit from it.

We are using AI to gain operating leverage across Calix. In summary, we are committed to transforming our customers and ourselves through the power of AI. With that, I'll turn it to Cory to cover the details of an amazing quarter. Cory?

Thank you, Michael. We saw continued strong and broad-based demand in the second quarter, delivering record revenue of $293 million, a 5% sequential increase, and 21% year-over-year growth exceeding our guidance range. Importantly, this quarter, we experienced a return to strong software growth.

Software and service revenue grew to a record $50 million, up 7% sequentially and 16% year-over-year. As customers began to realize value from agentic workflows on Calix One. Last quarter, with the completion of our platform migration, we said our focus would pivot to agentifying our BSP customers and RPOs would accelerate-

Sorry, Cory, can I please pause you? Darryl, Operator, I understand from some of the people on the call that the call has been dropping. Could you please come on and let us know if we should restart the call?

I am here, and I have heard everything thus far.

Okay. Apparently, those who are participating via webcast, there were portions of the call that dropped, and I'm wondering if we should start the call once again.

I can confirm as well the webcast has been stable, and I've been spot-checking, and I have heard as well through the webcast.

Okay. You can confirm that the webcast is acceptable and there are no issues for the listeners?

As far as I can tell, there are no issues.

Okay. Apologies, Cory. You can go ahead with where you were continuing.

This quarter, we experienced a return to strong software growth. Software and service revenue grew to a record $50 million, up 7% sequentially and 16% year-over-year. As customers began to realize value from agentic workflows on Calix One.

Last quarter, with the completion of our platform migration, we said our focus would pivot to agentifying our BSP customers and RPOs would accelerate in the second half of 2026. Our customers moved faster than anticipated as we saw record RPOs of $386 million, up 3% sequentially and 11% year-over-year.

Current RPOs were $162 million, up 3% sequentially and 21% year-over-year. Based on the strong momentum exiting the second quarter, we continue to expect RPO growth to accelerate in the second half of the year as we deliver additional agentic workflows and demonstrate the value of Calix One.

As we discussed last quarter, we would be running on a single cloud infrastructure this quarter. As such, having garnered the corresponding cost reduction and when combined with the agentic platform-driven demand, we yielded an 810 basis point sequential improvement in non-GAAP software and service gross margin.

To give you a sense of the continued leverage in the model, I will break with precedents and say that we expect software and service gross margin to set a new record in the third quarter. As the AI leader in the broadband space, we are also focused on being the leader in human-centric AI deployment inside our own company. We demonstrated meaningful operating leverage in the second quarter of 2026.

Non-GAAP operating expenses were approximately $122 million or 42% of revenue, down from 45% in the prior quarter, reflecting both leverage in our growth model and early productivity gains from our human-centric AI investments, as well as lower incentive compensation and timing of certain expenses. Turning to appliances.

Appliance revenue was a record $243 million, a 4% increase sequentially and a 23% increase year-over-year. Non-GAAP appliance gross margin was 52.9%, representing a decrease of 460 basis points sequentially and 170 basis points year-over-year due to higher memory costs, which was partially offset by memory surcharges.

As a result of the above, non-GAAP net income was $31 million, or $0.47 per diluted share, above our guidance range. We generated free cash flow of approximately $12 million. Our balance sheet remains strong.

We ended the quarter with cash and investments totaling $194 million after deploying $69 million to repurchase 1.6 million shares. DSO was 42 days and inventory turns were 2.7, reflecting deliberate investments in inventory to secure supply and meet continued strong demand. Turning to guidance. For the third quarter of 2026, we expect revenue between $301 million and $307 million, up 4% at the midpoint over the prior quarter.

This reflects continued strong broad-based demand, even as customers are more tightly managing their own inventory in response to higher memory costs. For 2026, we expect annual revenue to grow at the higher end of the 15%-20% growth range provided last quarter. Our third quarter non-GAAP gross margin guidance is 52% at the midpoint, reflecting higher memory cost impact.

As we navigate this industry-wide exogenous event, we remain focused on supply to ensure our customers can continue to meet strong subscriber demand while we maintain a footprint-aggressive stance. As you are well aware, there are many inflationary cost pressures across all industries. In our space, memory cost represents the most extreme of these pressures. As we partner with our customers on surcharges, they value certainty.

Certainty of costs, and most importantly, certainty of supply. Our surcharge program is structured to deliver exactly that, with the goal to recover the incremental memory costs without adding profit. This means over the long run, memory surcharges will be gross profit neutral while remaining a headwind to gross margin. Given the implementation of our memory surcharge program, we expect appliance gross margin will bottom in the third quarter of 2026.

The third quarter non-GAAP operating expense guidance is $124.5 million at the midpoint, a sequential increase driven primarily by the timing of expense and higher incentive compensation, partly offset by continued productivity gains from our human-centric AI investments. Michael, back to you. Thanks, Cory. In the last year, there's been much debate about AI, agents, and the effect it will have on customers and the markets they serve.

We believe that Calix is uniquely positioned to take advantage of the AI market opportunity in the broadband market based on our 15-year investment in the Calix platform and our work since November 2023 to evolve the platform and our processes for the opportunity ahead.

Our customers all know they need AI, and we are best placed to deliver subscriber growth, revenue growth, churn reduction, and cost improvements with Agent Workforce Cloud in a trusted, secure, and predictable way.

Predictability of AI costs is the biggest issue gaining AI adoption, and our architecture has solved that problem for our customers. Trusted, secure, and predictable costs are now possible for all customers, regardless of size, and we began to see the results of Calix One and Agent Workforce Cloud in Q2. Tripling Calix One contracts while delivering record RPOs and record software and service revenue is just the start.

This is the beginning of Calix, the AI leader. Now that the platform is live and running, we are excited for the opportunity for our customers to grow in the markets they serve and for our Calix team members as they leverage AI to transform how we do business and deliver operating leverage for our shareholders. Nancy, let's open the call for questions.

Carol, you can open the call for questions. Thank you.

Thank you. We'll now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two to remove yourself from the queue.

For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for your questions. Our first question has come from the line of Joseph Cardoso with J.P. Morgan. Please proceed with your questions.

Hey, good morning. Thanks for the questions here. For my first, if I may, I just wanted to touch on your expectations for gross margins to bottom here in the third quarter. Totally appreciate it's a difficult operating environment. I guess, what's just driving the confidence here relative to calling the floor?

Is it largely related to cycling past the grandfathered backlog relative to the surcharges, or are there other levers you're seeing relative to inventory, product redesign, et cetera, that's kind of driving your confidence here in terms of calling the floor in 3Q? Then I have a follow-up. Thank you.

Yeah, Joseph, it is exactly as you outlined. It is the fact that we have grandfathered a certain portion of the backlog. As we go through the next few quarters, that backlog as a percentage of the total will shrink. New orders are being, the surcharges are being assessed at kind of our current cost structure.

We're also adjusting those now on a monthly basis as opposed to a quarterly basis. Over time, we expect that gap to getting to gross profit neutral to improve. I should say that our goal for the whole surcharge program is to get to gross profit neutral. As we partnered with our customers this quarter to address these higher memory costs, it became clear that they value certainty and certainty of cost and more importantly, certainty of supply.

We had to modify our program to address this. Consequently, we did not raise prices on backlog for a second time. Meanwhile, new orders, we will adjust to reflect our actual costs and adjust it monthly instead of quarterly. As more revenue comes in from those new orders, the closer we come to being gross profit neutral. That's why I believe in Q3, we will bottom in the appliance gross margin.

Nope, got it. Makes sense, Cory. Thank you. Maybe as my follow-up, you raised the full year guide to the higher end of the range, which, if I take literally at the high end, implies a pretty solid sequential ramp here into the upcoming fourth quarter. First, am I thinking about that correctly relative to how you're framing the exit rate for the year?

If so, could you help us think through the drivers, given all the moving pieces? Obviously, you guys have gone into detail around the new platform momentum. I believe BEAD should start kind of flowing through here into the fourth quarter in terms of a tailwind, and I'd assume some benefit from the surcharging pricings there.

Maybe just help us think through, if I'm thinking about that framing, as well as maybe what are the drivers here in terms of the acceleration into the fourth quarter, or, well, I guess third and fourth quarter, but maybe what's implied in the guidance. Thank you.

Yes, yes, and yes, I think is what's the answer to that. If we take a look at what we're seeing from our customers, the demand environment remains strong. Understanding that we can see all their activity through our clouds, even though we're seeing these higher surcharges and them changing their ordering patterns, the underlying demand environment remains very strong. That has not changed at all in this environment.

If you think about it, the quickest return on investment is adding a new subscriber to an existing network. It doesn't really matter what those higher memory costs are when it comes to connecting a new subscriber to their network. They're going to move. They're going to go ahead and buy that premises equipment and move forward. Number one is the underlying demand environment is strong. Two, you saw a return to our software growth.

Exiting the second quarter, the momentum is very high. We reiterate the fact that we expect our software to continue to re-accelerate into the back half of the year. You are correct that we expect to have some BEAD revenue pick up in the third and fourth quarters as we exit the year. No real change in terms of that demand environment.

Certainly, the BEAD environment is extending a little bit in a lot of areas, as it relates to the impact to revenue for us in the second half, no changes in that environment. We are looking at a back half that is strong across the board. Let me contextualize with a couple customer interactions.

I've been on the road quite a bit over the last quarter talking to customers. To Cory's point about adding a subscriber, it's a really salient point because we have been saying this at all times, is that as organizations move through their build cycles and, for example,

they come to end of building fiber, then their entire organization pivots away from being a really efficient construction company to how do I become a really great sales and marketing organization that can win subscribers.

The first thing I would say is that I continue to hear that theme in a lot of places. In fact, I had one CEO conference and a panel I was on who basically said he could see the end of really the big builds in fiber for his company, and everything that he's thinking about is how do I add subscribers.

For Calix, that adding of subscribers means that we install a new subscriber, we provide new services, and we have an incredible strong revenue opportunity. Our customer success organization and the AI tools we are putting in place are really great at helping on the marketing side. The other side of it, though, as I said in my opening statement, which cannot be understated, is that we have cracked the code on how to make AI predictable.

This means that customers all know I need AI. In fact, we as Calix, as we look at the change of how we get leverage out of our operating model and how we transform our teams, we know we need AI. The biggest challenge that we have, frankly, is how do we do it in a predictable way.

This predictability cannot be understated, where we believe that Calix will become the easy button because not only do we offer a predictable cost model

We had 25, 30 CEOs in our office a couple weeks ago, we provided a very predictable roadmap over the coming quarters where we show workflow by workflow, here's how we're going to agendify their business and where we see the payoff ROI and output.

Frankly, those CEOs all left feeling incredibly enthusiastic about the opportunity to transform their teams and how AI will very clearly, with a strong ROI, change their business. That's just going to snowball as other companies see this implemented within their peer group, then they adopt quickly too, because it's inevitable. You have to adopt it. It's just about what's the fastest path with the most predictability, and that's what we've cracked the code on.

Thank you, Michael.

Thank you.

Very appreciate that color.

Thanks.

Thank you.

Thank you. Our next question has come from the line of Scott Searle with Roth Capital Partners. Please proceed with your questions.

Hey, good morning. Thanks for taking the questions. Hey, Cory, maybe to just dive in quickly, the impact on the memory charges, in the third quarter. I'm wondering if you could quantify both the sales and EPS impact. It looks like just from a cursory glance that EPS would have bracketed or maybe even been higher if you had fully implemented memory surcharges across the board in the third quarter.

And then looking to the prior guidance from the Analyst Day for 2027, 2028, I wonder if you could give some early thoughts in terms of, how are you progressing in terms of the comfort on the revenue outlook and particularly on the OpEx front? Much lower in the second quarter. It sounds like you're going to be able to continue to leverage internal AI capabilities and efficiencies to carry that forward into the future.

Does the model start to change or accelerate a little bit of when we should start to see operating leverage?

Let's talk about that. We'll go ahead and talk about that first. I think the revenue outlook is firming up. I think there are plenty of demand drivers as we look into 2027, 2028. Software is re-accelerating. The power of the agentic workflows is resonating with customers, we see that will continue to drive our software and our software gross margins higher. We've got the tailwind of BEAD will happen at some point in 2027.

In the meantime, customers are continuing to add subscribers. We're seeing no letup in terms of the demand environment. To reiterate our 15% growth targets for 2027, 2028, they're on track. In terms of the OpEx leverage, we are a leader in terms of the broadband space. We're obviously going to continue to be an AI leader in the human-centric deployment of AI inside of Calix.

You're starting to see some evidence of that work in the quarter. We expect more of that to come as we're committed to that as a strategy. I would say it's too early for us to accelerate that OpEx improvement, understand it's a keen focus inside the company to accelerate that.

I'm not changing guidance at this point, which is we will drive OpEx at a lower rate than revenue growth next year, leading to operating leverage, we'll see what we can do to get to half or better, growing at half the rate of revenue or better. Leave that as a goal, not a commitment.

Cory, just the memory impact sales, and EPS in the third quarter. That'd be helpful if you could provide some context. Mike, if I could just quickly, the competitive landscape, there was a lot of talk throughout the second quarter about the Starlink impact, et cetera.

I wonder if you could just update your thoughts in terms of, I'll call it the terrestrial competitive landscape, then throw in the satellite impact of how that's impacting your customers and what they're doing. Thanks.

On the EPS side, Scott, essentially it was a flip, right? We overperformed on EPS in the second quarter, the impact on not changing surcharges on the backlog had an impact into the quarter, the third quarter. We picked up a nickel in the second quarter. We lost a nickel in the third quarter. For the year, we think we're EPS neutral.

That was part of what we thought about in terms of partnering with our customers and trying to get through this event of higher memory costs. On the competitive landscape, especially like fiber competitor versus fiber competitor, that changes market to market, town by town. Competition exists, and it really just depends on how many people are building in that market and what their offerings are.

Our position remains the same, is that if you're in a market and you deploy the full Calix solution, you're going to be uniquely advantaged because of the fact that, again, this comes from a number of CEOs who have proven this theorem over and over again. If you just are in market as a consumer broadband provider, you're at risk.

If you are the broadband provider who takes the approach that we've built with our customers to being the dominant provider and the dominant brand in a town or in a location, you'll destroy your competition because you're selling consumer, you're winning the businesses-

You're in the MDUs, that entire footprint comes together to provide you roaming capabilities through SmartTown that allows you to be the dominant brand with regards to talking to the PTA and the local school board around how do you provide Wi-Fi roaming for all students who are underprivileged and who just want to have access to broadband to do homework. How do you provide roaming as an augmentation technology for police, fire, ambulance?

They currently have their public safety radios, but they could be in areas where there's worse coverage, or they're using an iPhone that you've given them. Now whenever they actually hit your roaming network and where there's Wi-Fi coverage, police, fire, ambulance can actually have faster speed and do better downloads on their iPhones and on the P25 radios.

All these things come together to you building a great partnership with the mayor, with the head of Parks and Rec, with all these different groups, the fire chief, the police chief, that allows you to become the dominant brand in your town. That brand dominance makes you local and helps you win subscribers.

With regards to Starlink, as we've always been saying forever, the satellite providers, whether it's Starlink or Amazon, have a place. If you're in a super rural area where it's going to cost $500,000 to run a fiber, then Starlink is a great option. If you're out on the boat, Starlink is a great option.

Where it won't be an option is or where our customers know that if they lost the Starlink and they're in the town and they've got a fiber connection, then they need to really look inside their business and decide what's gone wrong.

Because no logical customer is going to pick a Starlink over a fiber. The capacity differences are astronomical. Fiber is going to destroy them from an experience point of view. If the service provider does the smart thing, and the smart thing, for example, is they have to offer outdoor Wi-Fi.

If you have an attach rate that's 40% on outdoor Wi-Fi, that customer is going to be wildly sticky because you've now put Wi-Fi by the pool, you got Wi-Fi by the backyard, by the garage, all those different places, and there's going to be no impetus, even if Starlink uses their significant capital availability to run this at a significant loss as we expect Amazon to do.

That cheap offer will be beaten over by the fact that I have a great experience. I have incredible speeds. I have Wi-Fi everywhere I need it. I have virus protection that protects me every day and hacking protection. Therefore, plus, when I go to the local parks, as my phone picks up and it wanders around town, why would I ever go anywhere else? Satellite has a place. It's that 5%-10% of the market.

Beyond that, it really comes down to customer execution, and they should crush them.

Thanks, Scott.

Thank you. Our next question comes from the line of Christian Schwab with Craig-Hallum. Please proceed with your questions.

Hey, great. Thank you. I just want to be clear on the no surcharges on backlog. It appears to me that customer certainty on pricing and the decision not to surcharge backlog was made sometime during Q2, as gross margins now are implied a little bit different than the Analyst Day on the 23rd. In addition, we also bought a substantial amount of stock at higher prices than where we're going to open up this morning. Is that fair, or was that the plan all along?

No, Christian, it was not the plan all along. Our plan all along was to do cost recovery. That was the plan we outlined at the start of it was to get to gross profit neutral. As we partnered with our customers, it was important for them to have certainty around price. We've made a couple changes. Backlog was adjusted in the second quarter, where we implemented the surcharge from the second quarter.

To say there's no surcharges on backlog is not an accurate statement. There are. What we said is we're not going to adjust it again as we move forward. We gave them that certainty because customers were upset about changing price after the fact. That was an acknowledgment of that in our partnering with them.

The second side of that is that we've gone to adjusting surcharge pricing on a monthly basis versus quarterly basis. Increase the frequency at which we have a chance to adjust the new orders coming in. That's what we've done. It had an impact to Q3 gross margins, but ultimately our goal has not changed, which was to maintain a gross profit neutral stance. Over time, we will narrow that gap.

Yeah. Okay. That's clear. Thank you for that. On a go-forward basis, kind of reiterating the fact of 15% annual growth through 2027 and 2028 plus. If memory prices continue to increase and we have surcharges, that 15% is an organic number, correct?

Yeah. I mean, all our growth is organic. Are you saying it's inclusive of surcharges?

Right. As we get to this time next year, if memory prices continue to increase, the top-line growth rate of the company should be to some degree greater than 15% is my question.

We'll see about that, right? At the end of the day, let's break that up between access and prem. On the premises side, I see no impact to the higher memory costs. As we talked about, as they bring on new subscribers, particularly in an existing built network, it's their greatest return on invested capital. They're going to do that regardless of whether there's incremental memory costs.

On the access side, it's really driven by CapEx budgets. As you know, we are only just a small part of the overall rising cost environment, right? There are rising costs on fiber, labor, construction, fuel, et cetera. Our customers, as they look at their CapEx portion of the business, will reevaluate how much they actually spend. There can be actually demand destruction with higher costs as it relates to the CapEx.

Fortunately for Calix is that the large majority of our revenue does come from the premises side, and access is a small part of the overall business. To say that all the surcharges is additive to our revenue growth rate would probably not be an accurate statement. Hopefully that helps.

That makes it very clear. Thank you for that. No other questions. Thanks, guys.

Thanks, Christian. Next caller.

Thank you. Our next question has come from the line of George Nader with Wolfe Research. Please proceed with your questions.

Hi, guys. Thanks very much. I just had some questions about the Agent Workforce Cloud progress here. I know you guys made a decision to bundle that with the other cloud offerings and not really charge customers on an à la carte basis for that. I think the view was that you would monetize via increased subscriber penetration over time.

I'm just curious, where are we now? You've got some early feedback, I presume. Do you feel like that's still the right decision to drive for increased subscriber penetration? Do you think that model is going to work well? What's the perspective, again, a few months into the Agent rollout? Thanks.

Yeah, great question, George. If anything, we think that's 100% right. If anything, actually, we're even more confident in that approach because what our customers want is we basically did was we took everything was à la carte. You would go and buy everything, like you'd buy one, two, or three of the clouds. You'd add on one of our smart components.

You'd bundle it all together, and you do it all bespoke, which meant that customers had a lot of complexity. On one side of it, our customers, when we actually had an all-in, they would say, "Well, I want to buy it à la carte." Then when you make it à la carte, they say it's too complex. By going down this approach, there's a couple reasons why this is right.

The first one is that you can't actually deploy AI effectively unless you're across the entire enterprise. If you look at the three functions in a business, operations, marketing, and then everything that you're doing around service, call center and field support, every time you interact with a customer,

it requires all three of those elements to come together in a workflow to deliver an outcome. At the first level, we believe that this has to happen because you have to have everything. That wasn't really a choice, so we went forward with that, and that's what we did. That's the first part of it.

The second part of it is now that we've been in market for a full quarter, our customers really know that they have to do AI, and this provides them with a very clear approach to actually transform their business. Because what happens is, whether or not, like if I want to change my marketing team, I may or may not be ready to change it at this moment in time.

I now know that I have the Agentic workflows that allow me to improve marketing when I am ready, and I'm ready to couple implementing AI in marketing with a change of my team. This also makes it so that our customers can go at the pace that they require. The third part of it is our greatest growth driver is when customers add subscribers.

Making a few incremental pennies on top of a subscriber is not really the growth area. As we said, we're $1 to $10 per subscriber. They add a new subscriber, we go from zero to great cash flow, as you saw with that our margins are going back to where they were before, and we're going to achieve incredible software and cloud margins.

That means that that's going to be at a very, very profitable rate. Which brings me to the last point is it's very predictable for our customers. Frankly, it's now that we've had a full quarter, it's very predictable for us.

We can deploy AI in a highly predictable way. Our intent is not to just win a little bit here and there, but as you saw by the tripling of the cloud contracts, our intent is to roll up the market.

We have become, and this will be proven with every press release that starts flowing out like crazy, which are customer success stories, that we are the easy button for AI and for our path to winning more subscribers, increasing revenue per subscriber, and reducing churn, which is how they grow.

Got it. Just as a quick follow-on to that, do you have metrics or any perspective now on customers that are actually using the agentic feature? What's the feedback look like there? Thanks a lot.

It's good. We just started rolling out the workflows. We're starting to see the productivity numbers. It's a good question. We're now in the process with our success organization of going through and doing clear measured ROI with customers. Everyone sees the value of it, but have I measured the ROI? We know it's there. It's just about actually getting the physical measurements done, which takes time because, hey, I know what it costs me today.

What does that workflow and that process cost me 90 days from now, is what we're focused on measuring. What you're going to see through the quarter, through Q3, and as we ramp up for Connections in Q4, you're going to start seeing a lot of workflows as we get that data, which allows us to share with customers.

That's what our press releases are focused on, is that a customer who sees a return on investment of that agentic workflow, whether it's 10% or 70%, we'll start seeing those shared out in press releases at a rapid rate through the end of the summer and into the early fall.

Thank you.

Thanks, George. Next caller.

Thank you. Thank you. Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Please proceed with your question.

Hey, good morning. You mentioned a return to record gross margins on the software side, which I think prior were maybe 66%, so call it 67-plus. I guess my question to start with, and I have a follow-up, is where can that gross margin go?

I think we have discussed the potential for that to have a seven in front of it at some point in the future. I'd be interested in your expectations for the trajectory of software and services margins a little bit farther out and whether there's a ceiling that we should be thinking of or how to think about that. Thanks.

Thanks, Tim. We clearly see a pathway to have a seven on the front of it, we'll continue that mark. Ultimately, where it asymptotes to is a little bit of uncertainty because it depends on some of our approach related to large customers. We could actually end up in a situation where we are driving a lot more software revenue at incredibly high gross margins, and especially with private clouds.

If we're doing a private instance on a large customer, the margin in that environment is 100 points. It's hard to say how fast that'll accelerate or where it asymptotes out to. 70 is in sight, and we'll just see ultimately where it asymptotes out to. There's a lot of headroom still left to go on expanding that software and services gross margin. 70 is just a way station onto where it ultimately ends up.

Great. Over on the appliance side, I guess was my next question, which was, it seems like you're looking for that to bottom and maybe tick up a bit in Q4.

Again, the broader question, and I don't know that you're ready to guide here, is it reasonable to expect appliance gross margins to make their way back, I don't know, to the low to mid-50s by the end of 2027, I guess? What sort of slope should we be looking at there?

Well, Tim, I would love to tell you what that looks like. If you could tell me what memory costs are going to do, then I could probably help you triangulate on that. If you believe the hyperscalers and their capital deployment, I think that next year will be harder than this year. That's only if you believe those CapEx numbers.

As soon as you break on those CapEx numbers, it changes the entire pricing dynamic. It's hard to say. All I know is we've put together a program which over time will get us to a gross profit neutral stance. Regardless of what those surcharges are, we're going to continue to march to that path. We'll just see what ultimately happens next year as it relates to memory costs. That's the best we can do at this point. Thanks, Tim.

Great. Thanks.

Thanks, Tim.

Thank you.

Next question.

Our next question has come from the line of Michael Genovese with Rosenblatt Securities. Please proceed with your questions.

Great, thanks. I guess given where we are with Calix One's rollout, and that's just started, and you've got visibility to that driving an acceleration. I guess if we just tie that into RPO, my question would be, is there a way to say how many quarters in a row you think RPO could accelerate from here, given the visibility that you do have to the Calix One acceleration going out to more and more customers?

Should we just think about RPO going up through the end of the calendar year? I know RPO is usually tougher seasonally in the first half of the year. Is there reasons to think it would also be accelerating in early 2027 as well?

Yeah, it's going to accelerate for sure, because if you think about the year that we've had, right? Q1 was a hamper to sales because of the fact that we were in the process of converting 1,200 customers from the previous platform to the new platform, and it was highly disruptive. While we had exactly zero subscribers go down, we had some challenges with regards to some of our workflows, frankly, on customer implementations.

As one would expect, that's a disruption to sales because the sales teams then are working with customers and helping them get through that. We crossed that at the end of March, which then meant Q2, while there was some cleanup that had to be done, and the product team was turning off the old system, the majority of the effort got to, okay, where's the value?

We got customers back on track, and then we started to have the conversation around, okay, well, what's this going to deliver? Customers are asking the same thing, "What's in it for me? Why do we do this?" You saw the impact.

The impact was a tripling of contracts. I made a really important point in my comments and in the letter, and that is with regards to what were the types of customers who bought Agent Workforce Cloud contracts. Very different. In the past, we would normally go into this cycle.

Q2 would have been, you have the innovators and the early adopters who are jumping all over it. Why? Because they believe in Calix. They know the business value that we offer. They're trying to change and improve how they run their business. They're trying to get ahead of this, right?

While the middle majority, late majority, and the laggards all sit on the sidelines and say, "I'll tell you what, when you come with ROIs," like the great question George asked, "Show me the ROIs, but I want to see 30 of them before I actually buy, because I'm a suspenders and belt decision-maker."

That was the traditional cycle, which bluntly, I've been living with as a leader inside Calix since the day I started, across 10 years in May. That's been probably the biggest gating element in our business. This cycle was radically different. We actually had a customer who I have personally been trying to close for almost a decade on SmartHome. A decade.

I have called on that leader more times than I can count, trying to convince him to transform his business and actually deploy our virus protection and malware and all the capabilities of what we're doing with SmartHome. I'm a really good sales leader, and we could not get him over the line. That customer, who would then be called a late majority in our traditional, if you take what we learned in Marketing 101 in university, he would be in the late majority.

He signed up for Calix Cloud and, in fact, asked us to extend the contract beyond our normal three-year term. Why? Because he knows that artificial intelligence is a non-negotiable. This is not a nice-to-have. This is not, I provide my customers fiber, and I would like to differentiate my value proposition by adding virus protection or malware.

This is everybody on the planet needs to deploy AI in their business, or they're screwed. They are going to get crushed by the competitor that does it. It is that level of pressure, and every CEO is under that same pressure. I need to sit in front of my board, and it doesn't matter if my board is sophisticated or unsophisticated, they all know that when I come to the next board meeting, the only question I need to be asking is:

Where's your AI plan, and how faster is it going to drive results? We did this in a predictable way. We have become the easy button if they want to deploy AI effectively because we have a 15-year track record of demonstrating that we can be trusted by our customers, that we do it in a secure manner.

By the way, the scariest thing about AI is how dangerous it can be from a trust and security point of view. Last, we do it predictably. This predictability, I cannot understate how important this is. It is going to be a huge inhibitor on deployment for companies who cannot provide their solutions in a predictable way.

I can tell you inside Calix, it is stopping a bunch of our AI projects because without the predictability with regards to what is AI going to cost, and with the craziness of tokens, it's very hard to, when a team comes and says, "I'd like to do this $100,000 project to implement AI to change this element of my business.

Oh, by the way, it's $100,000 to do the workflow and people transformation, but I estimate that the token cost is going to be this, but it could be 30 times as much. I really don't know." Which means, am I losing money, or am I actually getting a return on investment? That in a specific example, we currently use Copilot with all of our employees. We have a co-work proposal in front of us, then over my dead body am I going to approve that when it's all token-based.

Frankly, we looked at our pilot project and the costs are through the roof, and the ROI is nowhere to be seen other than, "Hey, my employee actually did a bunch of stuff better." If I can't see what the headcount gains are or the productivity gains, it's just like Because employees are throwing everything and the kitchen sink into the AI engine hoping that their job will get easier.

Our predictability in the form of cost, but also we sat down with our 1,200 customers. We know there are billions of workflows they're running, and we know what can be agentified easily and what cannot, which leads to a quick ROI, means that our customer velocity is going to go through the roof. Especially as, again, back to what George said, great question, which is, where's the ROI?

Well, I've got a customer success army that I talk to every single day, and they know that their number one mandate is find out what the current KPI is, implement the workflow, and get the change in KPI so that we know we can basically say, "You implement this workflow, here's your ROI."

The power that we are going to bring into the broadband market is unmatched because we have access to their customer's data in a trusted way. We have access to all of their billions and billions of workflows, and we are the best placed to actually turn those into AI workflows at a rapid rate. That's why we spent two and a half years building it out so that we can now. We went slow.

Believe me, it was painful to actually go slow because everybody's going AI, AI, and our product officer was under constant pressure from me saying, "Get that shit out. Get it out." Right. He refused to because he knew that if we did this in an unpredictable way, then the AIs would start hallucinating and would do a horrible job.

Everything that we're doing is trusted, secure, and more importantly, predictable, not only from a business outcome point of view, which is the delivery of the ROI. They know that if they turn that workflow on, they're going to get this output and this improvement. Also from a cost point of view, which was the architecture that Shane and his team brilliantly implemented, which allows us to use hard and open source and eliminate tokens. All these things come together.

A long way of saying, "Heck yeah, let's go make money for our customers and then in turn for ourselves and our investors.

Great. Awesome. Thanks for all that. Last question, just to follow up quickly. It just does seem like the third quarter guide sequentially is a little bit below historical, and so I just guess I'm asking, specifically on BEAD, was there any kind of change from the second half of the year into the first half of next year? Or any other reason that's kind of holding back specifically the third quarter guide from being a little bit higher?

No. I look at the third quarter guide and it's in line with what we outlined in terms of expectations for the year. Probably moving to the higher end of our guidance range that we provided last quarter. I think on the underlying, everything is tracking according to our plan.

Great. All right. Perfect. Thank you so much.

Thanks, Mike. Operator, we'll take that last question.

Thank you so much. Our last questions will come from the line of Ryan Koontz with Needham & Company. Please proceed with your questions.

Hey, thanks. Maybe just start with some housekeeping. I know you're not reporting on customer tiers here, but could you give us any color that you saw across your different segments there and maybe the source of your 12% customer concentration in the quarter, and update on any new Tier 1 engagements that may be looking at your private cloud options? Thanks.

Yeah, Ryan. We're not going to provide kind of any color on customer breakdown on mix. The 12% customer in the quarter, we're not at liberty to disclose who that is. The expectation is, yes, they were a 10% customer in the quarter, but they likely will not be a 10% customer for the year. Kind of understand that it was a blip in the quarter, and you wouldn't expect to see that happen again.

Then on customer engagement, I kind of gave a lot of color in my last answer with regards to what the engagements are like. That goes across the board. That's all sizes of the customers. The contracts that we closed in the quarter were actually, the majority of them were smaller customers, which is pretty normal. You see that, but we're broadly engaged in sales cycles across all customer sizes.

The great thing now is that we're back to selling because we're done a two-and-a-half-year implementation and we can actually demo it and show it. With larger customers, they have longer deal cycles. The average on a larger customer, you have 12 to 24 months on a deal cycle. We're now deep into it, and more importantly, we're not talking about PowerPoints. We're actually showing things. Great momentum.

Makes sense. Maybe on your RPOs, you talked about expecting acceleration there. We did see a divergence in 2Q between current picking up and that long-term not growing as much. Can you maybe expand on that in terms of long-term RPO expectations going forward? Do you think that'll normalize going forward as you get some renewals?

Yeah, Ryan, it's always a function of the tail on those RPOs and subject to customers coming back up for renewal. My expectation is that with the Calix One contracts, we'll see an early renewal cycle. You will probably see that total RPO growth will continue. The current RPO is that one eliminates the effect of the shrinking renewal, the tail coming in.

Strengthening the current RPO is really what you want to focus in on. That being said, with the power of the Calix One platform, I would expect customers of all sizes to renew their contracts early to move on to the platform. I think you're going to see total RPOs grow.

Makes sense. Great. Maybe lastly on, you talked about token costs and your use of open source, and you've migrated to GCP. Maybe expand on that a little bit in terms of how you compare competitively with other options with your open-source approach.

What other options in what regard?

Well, just if you would implement this on an off-the-shelf frontier model or something like this, what type of cost savings are you seeing relative to-

Daryl, let's talk about that. Right. Okay, I get what you're saying. When a company goes and uses our platform to decide to build it in a bespoke manner, right? That's the first thing is that the challenge that they have is that they also are now entering into software life cycles, they need to consider that.

With regards to us using a frontier model or using our hardened open source, the difference is that we don't really see the gains of it. If you compare the gap between what is a frontier model and what is an open-source model, it's a very small gap, especially if you look at the workflows that we're doing. We're not asking this system to go and code a new back-office system or do incredibly crazy things.

We're asking it to take what is a well-defined workflow, well-defined context that exists in our knowledge layer, apply that workflow with agents to execute against clearly defined boundaries, and drive great outcomes.

Our use cases, our workflows, and the models that we're going after, actually, they lend themselves perfectly to this approach. I don't need to paint you flying on a unicorn over a mountain and make it look 3D authentic, right? This is not the use case. Yeah, it's highly applicable.

Thanks so much.

Thanks, Ryan. Thank you, Daryl.

Thank you, Ryan.

We can close the call.

Thank you so much, everyone. This does now conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.