Earnings Call Transcript - CALX 2026-11-03

Operator

Greetings, everyone, and welcome to the CALIX Third 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 Nancy Fazioli, Vice President of Investor Relations. Nancy, please go ahead.

Nancy Fazioli, Head of Investor Relations

Thank you, Sam, and good morning, everyone. Thank you for joining our third quarter 2026 earnings call. Today on the call, we have our president and CEO, Michael Weaning, and Chief Financial Officer, Corey Sindelar. As a reminder, yesterday after the market closed, CALS issued a news release, which was furnished on a Form 8K along with our stockholder letter. It was also posted in the Investor Relations section of the CALS 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, and that 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 third quarter 2026 letter to stockholders and in the annual and quarterly reports filed with the SEC. CAHL assumes no obligation to update any forward-looking statements, which speak only as of their respective dates. Also in this conference call, we will discuss both GAAP and non-GAAP financial measures. Reconciliation of GAAP to non-GAAP measures is included in the third quarter 2026 letter to stockholders. Unless otherwise stated, all financial information referenced in this call will be non-GAAP. With that, Michael, please go ahead.

Michael Weening, CEO

Thanks, Nancy. We have just returned from Calix Connections, where thousands of customers and partners joined us to discuss the path forward and the reality that there is no version of the future where AI is optional, a future we intend to lead for our customers and the markets we serve. With Calix 1 deployed since March, we deliver the trust and security that our customers require to be successful within the new AI reality, allowing us all to move from experimentation to execution safely. In these uncertain times, we believe that predictability is highly valued by our customers and their subscribers, our team members, partners, and investors. For our customers, we provide predictability of cost through our leadership with open-weight models, the platform, and the evolution to specialized models that will land on all devices over time and return on investment as we operate billions of workflows annually, giving us unmatched insight into which agents and workflows will yield the greatest returns for our customers. Predictability for customers extends into predictability for investors, as evidenced by the records that we broke in third quarter and the end-of-year forecast that we'll see revenue at the midpoint hitting 19% year-on-year growth while OpEx leverage begins. At Connections two weeks ago, the new CEO of Allo clearly stated the value of our platform pre-AI. He had come from a multi-vendor broadband provider to Allo, who has partnered exclusively with Calix. The Calix platform at Allo yields 40% lower truck rolls, 60-point higher net promoter score, and is supported by 25 IT people versus 400. That is the power of our platform before AI. With Calix Agent Workforce, which is rolling out at a rapid pace, those results will expand as we automate functions and workflows, yielding new subscribers, revenue growth, reduced churn, and even higher profits for broadband providers, while our platform expands to manage service providers for apartment buildings and multi-dwelling units, and then on to hospitality. Last week, we released the next step in our AI strategy, the Calix Communications Language Model, or CLM, and Calix GEMS, which are designed to bring communication-specific intelligence to the right place across the platform, from the cloud to the network to the subscriber premise. This architecture will enable us to deliver increasingly specialized capabilities for platform customers while enabling large service providers to partner with Kallax by consuming our AI component capabilities into their unique environments. That combination of a differentiated platform, expanding segments with the ongoing expansion of MDU, agentic workflows, AI agents, and the addition of specialized learning models, coupled with a customer success organization that is leveraging AI To enable customers to adopt at scale gives us great confidence in the opportunity ahead and our ability to lead. Our third quarter results demonstrate that customers are responding. This is the payoff from the investments we have made and the partnerships we have built with our customers. We went slow to build the platform correctly. Now we move fast with our customers to compete, win, and expand. Corey, over to you to walk through the details of StrongCorder. Thank you, Michael.

Cory Sindelar, CFO

We delivered record revenue of $302 million, up 3% sequentially and up 14% year-over-year. A key highlight was record software and service revenue of $52 million, up 3% sequentially and 19% year-over-year. As our customers continue to win new subscribers and take market share, Calix One contracts signed in the third quarter more than doubled from the prior quarter, with RPOs reaching a record $396 million, up 2% sequentially and 12% year-over-year. One important note, in connection with our customer supply assurance program introduced early in the third quarter, we began receiving non-cancelable compliance orders, which are added to RPOs. To avoid distortion of this key metric, we elected a practical expedient to eliminate the value of RPOs for contracts with the duration of one year or less, thereby eliminating hardware from RPOs. As part of that elimination, the value of software and service contracts with the duration of one year or less, totaling $6 million was also excluded. These software and service contracts were included in prior periods. Without giving effect to this change, RPOs attributed to software and services would have grown sequentially by 4 percent and year-over-year by 13 percent. Non-GAAP gross margin was 53.5%. Non-GAAP software and service gross margin reached a record 67.2%, increasing 340 basis points sequentially, driven by subscriber growth and continued optimization of our third-generation platform. As our customers continue to focus on subscriber experience and take share, our software and services revenue will continue to increase, expanding our software and service gross margins. Non-GAAP appliance gross margin was 50.7%, which represents a sequential decline of 220 basis points, primarily due to higher memory component costs. We also continued to demonstrate operating discipline and early productivity gains from our human-centric AI investment. Third quarter non-GAAP operating expenses were $124 million, representing 41% of revenue, and down from 42% of revenue last quarter. Our balance sheet remained strong. We ended the quarter with $155 million in cash and investments, after deploying $50 million to repurchase 1.4 million shares. DSO was 38 days, and inventory terms were 2.8, reflecting improved collections and deliberate inventory investments to support customer demand and product availability. After quarter end, we increased our stock repurchase authorization by $100 million, adding to the $44 million that remained at the end of the quarter. Turning to guidance, for the fourth quarter of 2026, we expect revenue to be between $311 and $317 million. This outlook reflects the ongoing broad-based deployment data and order visibility across our customer base. Our fourth quarter non-GAAP gross margin guidance is 52.25% to 54.75%. The range reflects component cost of expectations as well as customer and product makes. As noted last quarter, we chose to include surcharges on new orders. As such, we expect to recover a greater percentage of higher memory costs in the fourth quarter as we work our way to gross profit neutrality. Our fourth quarter non-GAAP operating expense guidance is $129.5 to $131.5 million. The range reflects fourth quarter investments in our annual Connections Customer Innovation Conference and five additional days in the quarter, partially offset by continued productivity gains. Setting aside the fourth quarter bump we see every year due to connections, we expect operating leverage will continue as OPEX as a percentage of revenue continues to drift downward to 40% and below as we continue to deploy human-centric AI internally. Our guidance for non-GAAP EPS is $0.41 to $0.49. At the midpoint of guidance for the fourth quarter, our 2026 non-GAAP EPS is $1.76, which would represent an annual EPS growth of 30%, compared to revenue growth of 19%.

Michael Weening, CEO

Michael, back to you. Thanks, Corey. We have built the industry's leading AI-native platform. Now, we go fast with our customers, amplifying their teams and ours to compete, win, and expand at a rapid pace. Nancy, let's open the call for questions.

Nancy Fazioli, Head of Investor Relations

Thank you, operator. We're ready for questions.

Operator

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star, too, if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Ryan Kuntz with Needham & Co. Please proceed with your question.

Ryan Kuntz, Analyst — Needham and Co

Great, thanks. Good morning. I wanted to ask about RPOs and specifically software bookings there. Are you pleased before you're out there in your recovery from the cloud transition, any trends within the mix of RPOs you'd point out, and what sort of year-over-year booking rate you think you can get to next year on software RPOs?

Michael Weening, CEO

Yeah, I'll talk to the trends, and then Corey can talk about one specific nuance in RPOs. And so, from a, whether we're pleased, yeah, I'm wildly pleased, because what that showed was customers in Q3 actually started to commit to our AI, where we're going from an AI point of view, even though our first, you know, our first workflows just started to roll out in August, which is the, you know, the beginning. But as they start to see what's possible, a huge percentage of them just jumped in, as you saw by the doubling of the contracts, because they agree with where we're going. And frankly, what it validated is that we're going to be the easy button for AI. Everybody in every market needs to figure out what their AI strategy is. And if you're the one who can provide that in a trusted and secure way, but also give them predictability of cost, which, as we know, with tokens and all those things is an issue, we've resolved that. But more importantly, give them a roadmap that shows where they can get predictability of return on investment, which is very hard to acquire. And we can actually give that to them really clearly, saying, here's the stack ranking of the workflows. We're implementing them in this order. And based upon everything and how you run your broadband business, this is the ROI on it. So those were the early adopters. But I believe in the previous call, I had a customer who, you know, and I'll reiterate this, who basically stated, you know, they've never bought into our longer term vision with regards to what we're doing on the smart side of stuff. So they, you know, no matter how much I tried to sell them on smart home and smart business and where we're going, he never bought in. But they signed up in third quarter. And the reason why is for five years. And the reason why is because they know they need artificial intelligence. It was time for them to get on the experience bandwagon. And doing AI and experience at the same time was highly valuable. You know, and then having just come out of Connections, where we had, you know, almost 3,000 people there, the momentum was incredible. If you haven't had the opportunity to watch that event, that's the best event we've ever done. And I could stand up there with confidence in front of all those customers and say, we have nailed it. We absolutely 100%, if you sign up with us for the future with AI, we will give you everything you dreamed. And I can commit to that because, as I said on stage, our chief product officer, who, you know, congrats to him, he just won CPO of the Year here in the Valley, which is a pretty huge accomplishment. And the reason why he won that is because he could stand up in front of our board in the last board meeting and say, we will deliver more innovation on our platform in 2027 than we have in all of 26 and in all of 25 combined. And more importantly, he will do that at flat to down from a budget point of view, showing a massive jump in productivity. So, do I feel good about this? Hell yeah, for sure. Corey, why don't you talk about the numeric and nuance?

Cory Sindelar, CFO

Yeah, Ryan, as I said in my prepared remarks, we wanted to avoid a distortion created by including appliance gross margins or appliance RPOs in that metric and keep it a pure software and services number. And so with that, we elected a practical expedient to eliminate contracts of the ULS. And so you need to add back six million to have a comparable number to prior. And so what would RPOs in the process have been then? 4% quarter-on-quarter and 13% year-on-year, which is pretty good.

Ryan Kuntz, Analyst — Needham and Co

Great. That's great, guys. And Michael, I totally agree with you on the certainty around costs and the ease of adoption. It's very, very compelling. It's exciting.

Michael Weening, CEO

Yeah, Ryan, we're the easy button, right? All you have to do is sign up, and then what happens is These workflows and agents just start popping up, you know, and add connections, I demonstrated in my, when I was on stage, just how trusted and secure this can be, because I gave the example of, there was one of the employees of our customers did something funny. He tried to break one of our agents, and this was, you know, like he would use Microsoft Copilot or something like that. He basically pounded on our agent inside Service Cloud and tried to get it to answer how many calories are in a McDouble, which I didn't know what a McDouble was, because I'm an Egg McMuffin guy, but it's basically a two-patty cheeseburger, and it has 400 calories in it. Lord knows a lot of you have. And, you know, and he took him 51 tries before he could break it. So we also leave them with certainty that from a data privacy and security point of view, that we're going to be able to, you know, protect them because that, you know, you think about the data that they have, that's really important, especially in the, you know, look what happened from a cyber hacking this week where, you know, 6 billion got sold, 6 billion got stolen off of a crypto exchange, right? So, the attacks are increasing from, you know, and pretty much guaranteed that came from Korea. So, these crypto attacks from these nasty nations continue. So, we give them that security. We make them really secure. And then we can demonstrate, hey, by the way, if you implement this, we're going to help you get 30% or 40% productivity.

Ryan Kuntz, Analyst — Needham and Co

That's great, guys. And maybe just a quick follow-up if I could. Could you maybe characterize, you know, where you are in terms of some of your Tier 1 engagements, what kind of conversations you're having there? You know, what kind of the nature of the business opportunities looks like, and maybe give a little closer on some of the larger.

Michael Weening, CEO

Yeah, so we have two large-tier ones in North America that we deal with on a regular basis, as you're well aware of, and those continue to progress at a very rapid rate. We're doing really well. On the international stage, we have started those engagements in the, you know, in 2026. You know these are 18 to 24, 36-month life cycles, and we have many engagements going on internationally. But those are 27, you know, through to 28, where, you know, 28, what happens is you go and win some business in 27, demonstrate it, build footholds, and then you start to really drive revenue through the latter part of the next year and into 28. And so those are going well, and I would say that they're, you know, if you look at some of the press releases that we put out at Connections, there were two specific ones that are relevant to large customers. The first would be our announcement that the Smart Life products are now on Purple. If you're not familiar with what Purple is, Purple is something that a bunch of Tier 1s have come together and built a standard around operating systems on-prem. And so our Smart Life products are now available so that they can actually run those in a Purple container. And, you know, that's just the first step for us. We'll actually take our entire operating system, everything that we've done in EXOS on the prem, and we will make it Purple Certified in the early part of 2027 so that anyone who wants to adopt our operating system can, again, Purple Certified. The second part is what we did with language models, and I cannot overstate how important this is. The release of the Cadillacs communications language model was where we demonstrated that we're not just a data and experience company. We're an AI company. Let's be really clear. We released the language model for the communications sector that is ahead of everybody else. No one else has done what we did, and what it is is we basically implemented specialized training so that language model would understand what a communication service provider needs. Again, if you go to calc.com, you can see that, you know, in my keynote, I actually talked about the release of the language model, and what differentiates that is that we, you know, you can take a large language model, I can have a pink quarry on a pink unicorn flying over a mountain, which was exactly my reference, although he is John DeRocher on stage. But all of that is useless when I'm running a broadband company. What I need is I need to understand how to network and provision. I need to understand how to have great Wi-Fi. What is the experience in an apartment building? All those kind of things. So we stripped away all that superfluous components, got the model down to a significantly smaller state, and then we trained the shit out of it at a very low cost. And in fact, the way that we trained it was really the innovation that we did with AI. And then out of that will come, you know, so that's one of our CLMs. We will have multiples of these open-weight models that we have trained specifically for the communications market, but then the next big step for us is then, that's where I announced the release of Kallax Gems, which is what will happen is that we will then take those and slim them down further into very bespoke and specialized capabilities. So, for example, we will have a CLM that is really great at just doing security, and it will be small enough because we're going to get it down to, you know, a couple hundred million parameters where we can run it for cybersecurity on a premises system, or we can run it for Wi-Fi management on a premises system, or we can get a bigger version of that and run it in the network on an E92. And so the evolution of artificial intelligence is frankly what we're at the forefront on for the communication sector because we are taking these open weight models and transforming them into specialist models that our customers will leverage. Our existing customer base will not need to understand any of that other than to know that we're doing it because it's just going to show up. It's going to show up on an E9.2. It's going to show up on a Gigaspire. It's going to show up all across the new switches that we've just released. That'll just show up on the appliances running as part of the operating system in the cloud, and they're just going to, you know, back to why we're the easy button for AI, because we're so far ahead of what's going on in the AI world that if you didn't see the CNBC interview that we did, look at how that interview is leaning forward, because we are way ahead, and we're going to keep our customers way ahead. And then to your question on the tier ones, that will be consumable by a tier one where I have this massive bespoke custom Gordian knot of an infrastructure. And I will be able to say to Calyx, you know what, I'm running purple on a premises box. And because I'm so slow, I can only have one. So I'm running purple there. But what I'm going to do is I can run Smart Life on it. Oh, and by the way, I can also grab a cyber gem from us that will constantly be updated and will be the best way to protect their customers from a cyber point of view in a small or extra small language model that's specialized for Wi-Fi capabilities or cyber, and they'll be able to consume that from us. And so our differentiation in these large tier ones is that we're going to make, you know, for them, we will make artificial intelligence an easy button. And so that is all the elements, if you didn't parse that out from Connections, because Connections was out of regional customers who, you know, range up to about a half million subscribers, but embedded in there were some very clear messages for Tier 1 that will be the messages we bring to World Mobile Congress and all those, and network acts and those places as we continue to roll those out at an aggressive pace.

Ryan Kuntz, Analyst — Needham and Co

That's really impressive, Michael. Thanks for that rundown. Appreciate it. Thanks for the questions. Yeah, thanks, Ryan.

Nancy Fazioli, Head of Investor Relations

Thanks, operator. Next question.

Operator

Our next question is from George Nauter with Wolf Research. Please proceed with your question.

George Nautor, Analyst — Wolf Research, LLC

Hi, guys. Thanks very much. I was just looking at the appliance growth in year-to-year terms. I think 12.5% is the number I'm looking at. I'm curious what that number looks like in unit terms. Obviously, there are price increases, I think, embedded in that improvement in the appliance I'm just curious what that looks like in units. Thanks.

Cory Sindelar, CFO

Yeah, George, we don't break that out.

Michael Weening, CEO

For the Gigaspires, we're like, so our deployment rates of Gigaspires continue to go up. So, you know, we see an increase in appliance sales, but your point is that customers have been burning down inventory, frankly, because of the fact that, you know, they've been trying to work through that. So, but Gigaspire deployments continue to increase in our customer base, which means that the core demand affiliated with it, George, is still there. So, that's why we look forward into 2027, and we still see very strong demand because Gigaspire growth keeps going up.

George Nautor, Analyst — Wolf Research, LLC

Got it. Okay, super. That's great. And then I'm trying to understand some of the changes you made here in the current RPO metric. It sounds like there was – can you explain what the Customer Supply Assurance Program was all about and why we're including appliance revenue in that number and then, I guess, subsequently backing it out? I'm just curious on the puts and takes of the current RPOs. Thanks.

Michael Weening, CEO

So, I'll explain the program, you explain the financials, okay? Go ahead. Okay, so the program from an insurance point of view is that they give us a non-canceable PO and then we guarantee the price for a period of time. The best for the customer is we're basically giving them some price assurance as, you know, it's been a pretty volatile time from an appliance with memories, right? And what we get is we get assurance on their order And so that's what we put in place. And then, you know, the every single month, George, we taught, you know, unlike in COVID, where we only did one price increase in COVID, this is a very different time. So every month, we change the surcharge on memory, and we keep it up to date. And so therefore, if they don't make that commitment, then they risk as if memory goes up again, the next order, the next order to be, it will be at a higher price. And so that was kind of the incentive for them on why we did that. And it was well received. You know, obviously, no one likes price increases, but simple reality is everything in the world has gone up in price, whether it's gas or memory. So, Corey, why don't you walk through, George, on the archaeometrics and what we did there to make sure it was not polluted.

Cory Sindelar, CFO

Yes. So, George, to ensure that we don't have an RPO number that includes both hardware and software and we're distorting that growth rate on software, we decided to back out contracts of a year or less. All the appliances will be shipped within less than a year. The certainty is for a six-month window. And so, the $6 million applies both to the RPO number that you would add back. You would also add it back to the current RPO number. It goes into both because it's all short-term, one year or less.

George Nautor, Analyst — Wolf Research, LLC

Super. Thanks very much. I appreciate it.

Nancy Fazioli, Head of Investor Relations

Thanks, operator. Next question.

Operator

Our next question is from Chris Squab with Craig Howell Capital Group. Please proceed with your question.

Ben Taxel, Analyst — Christian Schwab

Hey, guys, it's Ben Taxel on for Christian Schwab here. Just a quick question. You know, we took the top line. We're at 19% or above the previous 15 to 20. I guess just any commentary on how we should think about 27? I know you guys probably can't guide 27, but just any commentary on, you know, as it compares to 26 would be very helpful.

Michael Weening, CEO

Yeah, so I would say the biggest thing you should look at is the fact that we've deployed a platform that was in in March. We have all of our R&D organization on full throttle to build out sellable things to drive our sales organization so our customers can be more successful and win more. And as we go through 2027, I stand here telling you that we will deploy more capabilities into the market than we have in the last two years. So the number I gave on stage of connections was 1,400 capabilities versus what we did in 26 and 25, which comes out to about 1,300. So the value there is twofold. First, you know, as evidenced by the momentum that we saw in contract closings in Q3 before, you know, which was really the early jumpers, even before we got the connections and, you know, the release next week is a big release with a whole bunch of workflows and new agents and all these capabilities. So it's kind of like pre-Sci, it's there. And then we went to Connection, showed our customers what's going on. And so I would expect that there is going to be a lot of enthusiasm out of our base for these capabilities. Because again, you know, there is no reality where AI is not the center of everything. And anyone who doesn't have a kick-ass AI strategy is cooked. And so, we're that easy button for a thousand service providers. And as I evidenced, you know, in the previous commentary on where we're going with SLMs, we're going to be the easy button for tier ones, too. And then, you know, with regards to the incremental capabilities, as I continue to mention, we've launched our SmartMDU product. There's another big release in November, and then there's one, you know, for SmartMDU, what, you know, the R&D organization says it's never done, but it gets to a significant level of completeness in February where the SmartMDU consumers are like, that's the product that I needed. And then you're going to see a massive expansion into new markets as we go after MSPs who sell the MDUs. So those are non-fiber-based providers. They're just the ones who build out custom integrations into complex buildings. And the expansion into hospitality. And so, you're going to start seeing us do what we've never done before, which is actually expanding beyond broadband providers into MSPs and hospitality and those areas through the year. So, how do I feel about the year? Corey's not going to guide to that. I'm pretty damn good.

Cory Sindelar, CFO

Ben, let me give you, we'll fall back to our long-term financial target of 15% annual growth. We feel good about that, and that's our baseline as we roll it the next year and look to work to improve upon that number.

Ben Taxel, Analyst — Christian Schwab

Perfect. Thanks. And then, you know, just think about the long-term targets, you know, shared earlier in the year. Gross margins can be flat, you know, consolidated gross margins, got to be flat. I guess it kind of applies to me, like, you know, we're kind of expecting to maybe stabilize here, and then as we go into next year, we could see that, you know, increase from these levels. Is that kind of the right way to think about it?

Michael Weening, CEO

Well, I would personally like to see the blowup of the artificial intelligence market to happen, Because those jackasses are the ones who are driving up all the memory costs across the world. And while losing hundreds of billions of dollars, well, those of us who actually make money suffer at it. So as that actually happens, then what will happen is you'll see the memory market collapse because it's artificially high. If you look at Marvell as making 90 points of margin or 85 points of gross profit, at some point, that's because of what, Micron, making 85% of gross profit. At some point, those guys are going to be punished aggressively for their greed and for what they've done to the broader market. So, and then at that point, we'll get to a more normalized state. You know, and there'll be other countries who also start manufacturing memory as that capacity comes on. You're going to see a massive glut in the memory market. It's going to do what it does every freaking time, which is the prices are going to drop like crazy, and we're going to throw that straight to the bottom line. But when that happens, that's what we all got to wait for. It's great to see Google lose half a billion dollars or half a trillion dollars worth of market cap, so maybe they'll actually get punished with regards to the stupidity on their capital investments, which will be great. And then that all follows to the bottom line for us so that we can actually, you know, have proper margins again.

Cory Sindelar, CFO

And no, I'm not being hyperbolic. Hi, Ben. Let me give you a little bit of perspective. And if you're wondering, Corey's waving me down, but it's true. So, from Michael's commentary, you can take that it's likely to be a very noisy environment. The AI data center bill continues to put pressures on the supply chain, as well as we realign, you know, global supply chains to take into consideration geopolitics. So, both those two things create a very noisy environment for supply chain and cost as we roll into 2027. And we are looking to do our best to manage through this with our program as we partner with our customers to get to a gross profit neutral state by passing along the cost without putting profit on top of it. But I can't tell you, as I sit here, you know, the rate of change as it relates to memory prices. We're expecting it to flatten out relative to what we've seen in 2026, which should make it more manageable. But I would also say that the pressures put on the AI supply chain buildouts are pressuring other parts of the supply chain. Memory just happens So, I think you have it right. I think we look to stabilize appliance margins at these levels and try to build on, you know, where we are now, knowing that it could go up or down as we move into 2027, and we're uncertain about that.

Ben Taxel, Analyst — Christian Schwab

That's extremely, extremely helpful. That's all I got. Thanks, guys. Thanks, Ben.

Nancy Fazioli, Head of Investor Relations

Next question, operator, please.

Operator

Our next question is from Joseph Cardozo with J.P. Morgan. Please proceed with your question.

Joseph Cardozo, Analyst — J.P. Morgan

Hey, good morning, guys, and thanks for the question. Maybe just following up on the margin question, but focusing on the other side of the portfolio here on software and services, obviously saw a nice bump this quarter to the record that you guys kind of articulated previously. Maybe just curious, I think you put out in the past, talked about kind of this, Maybe a 70% type bogey going forward as maybe a little bit of a near-term or medium-term North Star. You know, how are you thinking about trending there? Is that something we can see in the next couple of quarters? And maybe what are the moving pieces there that we should be considering? And then I do have a follow-up.

Cory Sindelar, CFO

Yeah, I think the volatility and the noise associated with the platform transition is now a little behind us. We articulated that we would get back to a new record. We did. And from here, you know, it's all about software revenue growth. We are optimistic about the trajectory of RPOs and where that's headed with all the AI work that we're doing. And so now it's just about adding subs and helping our customers go faster to accelerate the software revenues. And so, yes, 70% is on the horizon. Is it in one quarter, two quarter, three quarters? I can't say for sure. But it's inside that, you know, 2027 envelope. And it's just going to continue to build there. There's not a single day that goes by that software revenue does not go up. Because remember, all of our software stack is all tied to subscriber ads. And as our customers do better, we do better. And with an NPS score of north of 70, 80, 90, our customers are the share gain winners, right? They are taking market share because their whole focus is on subscriber experience. And when they win, we win. So, it's going to continue up. There's just no stopping it.

Joseph Cardozo, Analyst — J.P. Morgan

Got it. And then maybe switching gears just more on working capital dynamics and free cash flow. Obviously, you guys kind of talked about it already in terms of the higher price inventory kind of taking a toll here. But just curious, as we're thinking about how that trend is going forward and maybe what needs to happen, anything, any other levers at your guys' disposal that can kind of help with the trends as we think about our models in the subsequent quarters?

Cory Sindelar, CFO

Yeah, we made a lot of progress this year on, you know, building that supply assurancy with our customers to make sure that as they are taking share, we have appliances that can back them up. You know, I think we've added almost $75 million or more under the balance sheet over the last 12 months, ensuring that we have the inventory necessary to meet those customer demand environment. As I look at it, 27, I don't think we're going to need to be making the same level of commitment as we did in 26. So from a working capital perspective, you would expect to see free cash flow improve year on year inside of that trend. And understand at some point, I don't know what that some point is, the investments we had in inventory will reverse themselves. And then, obviously, the free cash flow generation will accelerate much higher than where we've been. But in this entire environment, we are looking to make sure that we are supply certain as our priority, and it allows us then to focus on footprint expansion. And so that's what we'll continue to do, and knowing that free cash flow generation will accelerate at some point here in the not-too-distant future.

Joseph Cardozo, Analyst — J.P. Morgan

Got it. Thank you, Corey. Appreciate the color.

Nancy Fazioli, Head of Investor Relations

Thanks, Joe. I'll bring your next question.

Operator

Our next question is from Scott Searle with Ross Capital Partners. Please proceed with your question.

Scott Searle, Analyst — ROTH Capital Partners

Hey, good morning. Thanks for taking the questions. I apologize. I got on a minute or two late. I'm not sure if you addressed this. But, Mike, from a high-level macro perspective, certainly some momentum coming out of connections, but are you seeing any slowdown in terms of decision-making or otherwise, you know, given the current macro environment, interest rate environment? It sounds like you're still comfortable with that long-term 15% growth rate, but wondering what you're seeing on the margin. And looking to 27 and 28, if you could comment just on the MDU opportunity in terms of what you think that's going to represent in the mix and how that ramps up in 27 into 28. Lastly, operating leverage, it seems like from an internal standpoint, you're seeing an incredible amount of productivity from your own AI implementation. You've laid out some goals at the analyst day in terms of 2728, I think, from an operating leverage standpoint. I'm wondering how you're feeling about that and if you're feeling better in terms of some of the internal productivity gains that you're seeing. Thanks.

Michael Weening, CEO

Well, that's three questions. All right. So, first, what was the first one? Revenue and – Yeah. So, we did address that. I feel very good about that as we went through the – there's multiple – there's three really elements to that. So, the first one is that we saw the momentum going up to connections because, you know, the early adopters actually seeing that we are the AI easy button. As we presented that connection, again, we had all those folks there. It was an incredible event, and we demonstrated the roadmap for AI based on the insights that we have with regards to workflows, but more importantly, the fact that we can do this at a really rapid rate. So, we have a big release next week where we're releasing more and more workflows and AI. We also talked about the fact that we were releasing or we announced the release of Workflow Studio, which is the ability for a service provider to actually take, you know, think of our workflows, the reference workflow, then they go into Workflow Studio and they have the ability to see the MCP connections they have to other systems. They're able to see agents that are connected to other systems and expand out their workflows and do customizations to improve their business. And that's a critical component. And at the same time, tomorrow or next week, we release our agentic-based Command IQ application, which is a huge step forward from experience. And then also AI Command Center, which is the ability to see everything that's going on from an AI point of view. So I feel very comfortable that as we go through 2027 that our customers who have to face the reality that they need to do something on AI and building it themselves is a fool there and, frankly, it's going to leak to death and, if not, the hacking of their companies because there's so much complexity around AI that we are the ability to give them something that's secure, that they can trust, and that will provide predictable outcomes because we're looking at billions of workflows and building out what are their We're close to improve a business. So on the existing business, I feel very comfortable with our ability to continue to grow. And that growth comes from one thing, them winning more subscribers and growing revenue per sub while reducing term. And the metrics are very clear that we're adding gigas buyers at an increasing rate. And so that's going to continue. The other two segments are I also announced and I'm not going to go reiterate I appreciate that because you did join late, and I talked about the release of Calix's communications learning model, where we're going with Calix Gems, which are specialized learning models that are, you know, large, medium, small, and extra small, and those become yet another thing on top of the work that we're doing where Smart Life just got released to Purple, which is a standard that large customers use, so our ability to actually go and partner with tier ones and help them, you know, press easy buttons. on experience in AI continues to expand at a rapid rate. And then the third part of that, which also addressed your second question on MDU, is that the Smart MDU product, you know, there's a big release in November and then one more in February, which Smart MDU gets to a level of completeness that, frankly, puts us as the dominant provider or dominant capabilities to serve the MDU market for broadband providers, and we are going to see a significant focus through 2027 as we take this massive growth in capacity that we have as the people have moved away from building the platform into the R&D organization, who has completely evolved their processes to drive massive productivity gains in research and development, and that will be focused on managed service providers who support apartment buildings and MDU facilities, And then the expansion into hospitality, which is going to come at a very rapid rate through 2027. And so, and that's all rooted in what I said on stage of connections, which is we will deliver more innovation in 2027 than we have in all of 2026 and all of 2025 combined. Though that number is roughly 1300 and we expect to do 1400. So it's a massive jump in productivity. You know, and my confidence with regards to our productivity on R&D side is evidenced by the fact that our CPO told a very interesting story that I shared on Main Stage 2, which is we had a function for a radius server scope that's 15 man months, and they did it in three. So that answers your last question, which is how am I feeling from a productivity point of view on AI work internally? Well, that shows you what the R&D organization is doing, which is about a 30% to 40% jump in productivity, also evidenced by the fact that we expect the R&D budget in 2027 to be flat. And so, you know, having a flat R&D budget delivering 40% more product functionality is a pretty incredible testament to the power of AI. Across the broader organization, we, you know, look, implementing artificial intelligence inside an organization requires a massive managerial shift. What you, you know, managers to be successful in the past, there's been, there's a number of parameters on what you need to be. To be a good leader, there's a number of things that you need to do. Now, wait, I'm going to, I'm going to say this quote. I'm going to explain what a good leader A good leader is able to have a strategy. They understand how to implement that strategy and execute against it. They're able to attract talent and also manage talent, which means that they remove low performers, they coach people to a higher level of performance, and that attracts people to the team. And the next thing that they have to add to that skill is the ability to analyze workflows. This is one of the biggest skills that new leaders are going to require, which means you need to take a step back and understand, you know, and this is what's old is new again. So this goes back to, look, I'm old. So we go back to the Six Sigma work, right? It's not unlike Six Sigma work where you need to become, as a leader, if you want to be successful, you've got to do the hard grunt work of actually applying a Six Sigma mindset to it, go through what are all your processes, understand what your humans on your team are doing, and then going through piece by piece, pulling all that apart and saying, what will I agentify so I free my team from doing repetitive work that adds no value? And then how is my team going to evolve to achieve outcomes like the R&D organization is going to do? What I didn't tell you was we're going to drop R&D down by half. I told you that R&D is going to be flat and deliver 40%, like a massive jump in productivity. And so that, in the end, is what we are doing from a leverage point of view, which is every single quarter, and in fact, I have my office review just before the board on Monday and Tuesday next week, and every team is getting, in essence, I can't say that, that's crude, an exam of their business from me and my chief of staff. And what they're expected to do is grind through their organization top to bottom, understand how everything works, pull it apart, and agentify it. But this takes time. And so I think what you see in the results in Q3, as you saw, some sparkles of that coming through. You hear the R&D stories, which is pretty bloody clear what the massive value is going to be there. But then, you know, in the other areas of the business, you saw it go from 42 to 41, and you're starting to see the leverage come through. So the way I would describe this is, look, you know, there was an article written about me in Selling Power last, you know, about a month ago. And one of the things they called out is that I'm a grinder. Well, you know what, the good thing is my leadership team is filled with grinders. This is what we do. And so I think that the Calix organization is going to be dramatically more successful than other organizations, primarily because of the fact that I'm surrounded by a leadership team that thinks, you know, who all thinks the same. We know that we have to grind our way through our organizations and understand how all the work gets done and root out inefficiencies, replacing those with AI to allow our teams to do higher value work. So, for example, if I have X amount of people in customer success today, if I double the size of the company, the goal should be I keep that flat and I do that work with agents and humans who are more effective. And so that's the mindset that we're achieving, and I think you're going to see that from us, from myself and Corey. Every single quarter, we're going to be sharing with you, you know, something else that we grinded through and added agents to allow our teams to be more productive. And so, am I feeling encouraged? You know, the good thing is that the distraction of the platform lift that we went through for two and a half years is now behind us. The road forward is really freaking clear. And, you know, my chief product officer, Shane, and I joke about this all the time. And the step that we're currently in is we're no longer trying to figure it out. This is just work. This is just grind this shit out. And that's what we're doing. We're going to grind it out through the end of the quarter and through 2027. And so we're in a unique position because we don't have where other companies are still trying to figure out what the heck they're going to do in this massively changing world. It's really clear. Now we just execute and grind.

Scott Searle, Analyst — ROTH Capital Partners

Perfect. Thanks so much. Nice quarter. Keep grinding. Thanks, Mike.

Nancy Fazioli, Head of Investor Relations

Have a good day. Thanks, Scott.

Operator

Our next question is from Tim Savago with Northland Capital Markets. Please proceed with your question.

Tim Savago, Analyst — Northland Capital Markets

Hey, good morning. And this is kind of good timing. The question was going to be to follow up on the operating leverage comments you guys made during the call. And I guess, you know, Corey, my question to you was going, well, first thing to be, Michael, did you got R&D flat to down? And it looks like you did.

Michael Weening, CEO

I want to comment on that. So let me just comment on that first part is that, you know, what's great is we didn't need to do that. Actually, the leadership team inside the R&D organization, that was always their goal. You know, two and a half years ago, I said this in the, if you haven't taken 10 minutes to watch the CNBC thing that Shane and I did last week, you should. It's, you know, and we'll repost this out the entire interview. And what was interesting, back in November, back in 2023, this is where Shane started to educate us all, and his leadership team started to educate us on the value of open waste, building the platform, and all those things. And then he also started to identify that we could really start to agentify how we build products. And so I would say what's great is that that comment about R&D being flat in 2027 with massive productivity gains is frankly just him doing what they promised to do. They executed against that vision. We made the significant investments over what is now three years of hard frickin' work to get here, and now it's going to pay. So that's kind of how I contextualize it. Sorry, I just wanted to comment on that.

Tim Savago, Analyst — Northland Capital Markets

Oh, great. And I guess carrying that forward, I mean, Cora, the original question was going to be, you know, over what timeframe do you expect to see OPEX drifts below 40% of revenue? You know, it looks like you'll be there for the year in calendar 27 in this context. I just want to kind of bounce that off you in terms of expectations for operating leverage. And, you know, well, let's just start there. I'll follow up.

Cory Sindelar, CFO

Yeah, so we outlined in our investor day back in April that we were looking to grow OPEX at half the rate of revenue growth in 2028. And I think we've taken the goal internally to see where we can do to accelerate that into 2027. So while we're not committing that now, that is still a goal that we have is to accelerate that into 2027.

Michael Weening, CEO

What we have to balance out is going into the new markets. And I don't care what anyone says about AI. It's not replacing sales reps. It's just not. It's going to make sales reps more productive when they're doing less. They're going to do less of what they hate anyways. They all whine about it. I was a sales rep for 15 years. I whined about it, which is internal stuff and analysis and all those things. So they're going to be out there selling. I want to be real clear. Sales is still sales, and anyone who thinks that AI is going to replace sales is probably a marketing or product person who's never sold anything in their life. Those of us who understand the sales organization know that AI will augment their capabilities, but you need sellers. So, the investments that we make in 2027 are actually in sales and marketing because we're entering into new markets. So, for example, take the MSP builder market with what we're doing on MDUs. Our brand is well-known with broadband providers. It's not well-known in that market. So, we've got to go make those investments to build brands. Okay. So we'll balance that out with massive productivity gains and, you know, off-ex leverage, but we've got to go balance out how do we invest in it to grow a grant.

Tim Savago, Analyst — Northland Capital Markets

Got it. And can you hear me?

Cory Sindelar, CFO

Yes, we can.

Tim Savago, Analyst — Northland Capital Markets

Okay, great. And, well, I kind of hesitate to bring this up, but we've talked about memory a little bit. But, you know, my own observation kind of in the early part of the call was that, well, you seem to have gotten a pretty good handle on this, even though it's still a fairly, you know, volatile environment. But, you know, if you look at the compression and appliance margins that we've seen throughout the year, I mean, Corey, can you estimate, you know, I guess what this memory price increase has cost you this year? You know, maybe from an earnings standpoint, is it, you know, 500 BIPs on appliance margins, and that's how we should look at it, and there's a potential to, you know, should we see some more favorable movement, you know, what we could see on the flip side of that?

Cory Sindelar, CFO

Yes, but it's a time statement. I don't know when. Right, so I don't know what 2027 is going to bring. I don't see it relenting in 2027. I still think there's going to be a fair amount of noise. And you're also looking into a cost environment that is spreading beyond memory. So I think 2027 will be as challenging, if not more challenging, than 2026. But again, we're focused on supply, making sure that we have that, and price is secondary to that, Tim. But I can't tell you which way I think 2027 goes. You tell me kind of where memory goes, and I could probably give you a better answer.

Michael Weening, CEO

Hopefully, NVIDIA was a trillion dollars in market cap. That'd be great. A couple of those folks, so that we can actually see some of this. And by the way, it'll be interesting to – even what will be interesting is the elections today, because there's a lot of questions with regards to data centers are an element of the election conversation, right? So do we just see this unmitigated, unstoppable building of data centers, which is consuming memory, Or does something shift? We'll see. Do people actually need to make profit? Right? You know, Lord knows that OpenAI and Anthropics should be bankrupt. We can hope.

Tim Savago, Analyst — Northland Capital Markets

Thanks a lot. Appreciate it.

Nancy Fazioli, Head of Investor Relations

Thanks, Tim.

Operator

We have reached the end of the question and answer session. I would like to turn the floor back over to Nancy Fazioli for closing comments.

Nancy Fazioli, Head of Investor Relations

Thank you, Sam. Calix will participate in a number of investor events during the fourth quarter. Information about these events, including dates and times, and publicly available webcasts will be posted on the events and presentations page of the Investor Relations section of callus.com. Once again, thank you to everyone on this call and webcast for your interest in callus and for joining us. This concludes our conference call. Have a good day.

Operator

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