Newly Adopted Accounting Standard

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. Additionally, it supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40, Other Assets and Deferred Costs-Contracts with Customers. The Company determines revenue recognition through the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, the Company satisfies a performance obligation. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the previous guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The new standard permits adoption by using either (i) a full retrospective approach for all periods presented in the period of adoption or (ii) a modified retrospective approach with the cumulative effect of initially applying the new standard recognized at the date of initial application and providing certain additional disclosures.

On January 1, 2018, the Company adopted Topic 606 and Subtopic 340-40 using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. Accordingly, results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while results for prior periods have not been restated and continues to be reported under the accounting standards in effect for those periods. The Company recognized the cumulative effect of initially applying the standards as an adjustment to the opening balance of accumulated deficit of $1.8 million as of January 1, 2018, with the impact primarily relating to deferring the costs of obtaining contracts (sales commissions) and the upfront recognition of software license revenue. The impact to revenue of applying Topic 606 for the three and six months ended June 30, 2018 was an increase of $2.7 million and $3.9 million, respectively.

Significant changes to the Company’s accounting policies as a result of adopting Topic 606 are discussed below.

Revenue Recognition

Revenue is recognized when a performance obligation is satisfied, which occurs when control of the promised goods or services is transferred to the customer, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company’s hardware products contain both software and non-software components that function together to deliver the products’ essential functionality and therefore constitutes a single performance obligation as the promise to transfer the individual software and non-software components is not separately identifiable and, therefore, not distinct. The Company’s contracts may include multiple performance obligations. For such arrangements, the Company allocates the contract’s transaction price to each performance obligation using the relative stand-alone selling price of each distinct good or service in the contract. The Company generally determines stand-alone selling prices based on the prices charged to customers or its best estimate of stand-alone selling price. The Company’s estimate of stand-alone selling price is established considering multiple factors including, but not limited to, geographies, market conditions, competitive landscape, internal costs, gross margin objectives, characteristics of targeted customers and pricing practices. The determination of estimated stand-alone selling price is made through consultation with and formal approval by management, taking into consideration the go-to-market strategy.

For certain revenue arrangements involving delivery of both systems and professional services, each is considered a distinct performance obligation. Systems revenue is recognized at a point in time when management has determined that control over systems has transferred to the customer, which is generally when legal title has transferred to the customer. For the same revenue arrangements, management believes that control of the associated professional services is transferred to the customer over time. As such, professional services revenue is recognized over the period in which the services are provided using a cost input measure. Prior to adoption of Topic 606, the Company recognized revenue (and corresponding cost of revenue) for systems and associated professional services under the same revenue arrangement as services were delivered and milestones were accepted by the customer and as the systems were installed or delivered to the customer. Accordingly, the Company now recognizes revenue when control of the systems and services has been transferred to the customer, which may be earlier than system installation or customer acceptance, in accordance with the agreed-upon specifications in the contract.

The Company derives revenue from contracts with customers primarily from the following and categorizes its revenue as follows:


•	Systems include revenue from the sale of access and premises systems, software platform licenses and cloud-based software subscriptions.


•	Services include revenue from professional services, customer support, software- and cloud-based maintenance, extended warranty subscriptions, training and managed services.

The following is a summary of revenue disaggregated by geographic region based upon the location of the customers (in thousands):



	Three Months Ended				Six Months Ended
	June 30, 2018		July 1, 2017 ⁽¹⁾		June 30, 2018		July 1, 2017 ⁽¹⁾
United States	$	92,691	$	108,119	$	182,080	$	214,647
Caribbean	1,537		3,767		2,674		4,714
Canada	2,254		3,994		4,540		5,506
Europe	3,744		1,191		4,971		2,769
Other	11,476		9,052		16,840		16,005
Total	$	111,702	$	126,123	$	211,105	$	243,641


(1)	Fiscal 2017 revenue amounts are accounted for under Topic 605.

Concentration of Customer Risk

The Company had one customer that accounted for more than 10% of its total revenue for the three and six months ended June 30, 2018 and two customers that each accounted for more than 10% of its total revenue for the six months ended July 1, 2017. The one customer represented 21% and 17% of the Company’s total revenue for the three and six months ended June 30, 2018, respectively. The two customers together represented 34% and 44% of the Company’s total revenue for the three and six months ended July 1, 2017, respectively. The one customer represented more than 10% of the Company’s accounts receivable as of June 30, 2018 and December 31, 2017.

Deferred Revenue

Deferred revenue results from transactions where the Company billed the customer for products or services and when cash payments are received or due prior to transferring control of the promised goods or services to the customer. The increase in the deferred revenue balance for the three and six months ended June 30, 2018 is primarily driven by cash payments received or due in advance of satisfying our performance obligations, offset by $3.2 million and $8.7 million of revenue recognized that was included in the deferred revenue balance at the beginning of each period, respectively.

Revenue allocated to remaining performance obligations represent contract revenue that has not yet been recognized, which includes deferred revenue and amounts that will be invoiced and recognized as revenue in future periods. This amount was approximately $35.7 million as of the end of the second quarter of 2018 and the Company expects to recognize approximately 48.2% of such revenue over the next 12 months and the remainder thereafter.

Payment terms to customers typically range from net 30 to net 90 days and vary by the type and location of customer and the products or services offered. The period between the transfer of control of the promised good or service to a customer and when payment is due is not significant.

Contract Costs

In connection with the adoption of Topic 606 on January 1, 2018, the Company also adopted the guidance in ASC 340-40, Other Assets and Deferred Costs - Contracts with Customers, with respect to capitalization and amortization of incremental costs of obtaining a contract. The new cost guidance requires the capitalization of all incremental costs incurred to obtain a contract with a customer that it would not have incurred if the contract had not been obtained, provided it expects to recover the costs. As a result of this new guidance, the Company capitalizes certain sales commissions related primarily to extended warranty and Calix Cloud products for which the expected amortization period is greater than one year.

The Company expects that sales commissions as a result of obtaining customer contracts are recoverable, and therefore the Company defers and capitalizes them as contract costs.

Capitalized commissions are amortized as sales and marketing expenses over the period that the related revenue is recognized, which typically range from three to ten years for extended warranty and cloud offerings. The Company classifies the unamortized portion of deferred commissions as current or noncurrent based on the timing of when the Company expects to recognize the expense. The current and noncurrent portions of deferred commissions are included in prepaid expenses and other current assets and other assets, respectively, in the Company’s Condensed Consolidated Balance Sheets.

As of June 30, 2018, the unamortized balance of deferred commissions was $0.8 million. For the three and six ended June 30, 2018, the amount of amortization was less than $0.1 million, and there was no impairment loss in relation to the costs capitalized.

Practical Expedients

The Company expenses sales commissions as sales and marketing expenses when incurred if the expected amortization period is one year or less. This applies generally to all transactions other than extended warranty contracts and Calix Cloud products.

The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which the Company recognizes revenue at the amount to which it has the right to invoice for services performed.

The Company does not adjust the promised amount of consideration for the effects of a significant financing component if the Company expects, at contract inception, that the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less.

Cumulative Effect of Adoption

The cumulative effect of changes made to the Condensed Consolidated January 1, 2018 Balance Sheet was as follows (in thousands):



	Balance at December 31, 2017			Adjustments			Balance at January 1, 2018
Accounts receivable, net	$	80,392		$	491		$	80,883
Prepaid expenses and other current assets	10,759			(245		)	10,514
Other assets	759			698			1,457
Total assets	295,070			944			296,014
Deferred revenue	13,076			(829		)	12,247
Total liabilities	150,107			(829		)	149,278
Accumulated deficit	(667,357		)	1,773			(665,584		)
Total liabilities and stockholders’ equity	295,070			944			296,014

The impact of adopting the new revenue standard on the Company’s consolidated financial statements as of and for the three and six months ended June 30, 2018 were as follows (in thousands):

Condensed Consolidated Balance Sheet



As of June 30, 2018 (Unaudited)	As Reported			Adjustments			Balances Without Adoption of Topic 606
Accounts receivable, net	$	69,535		$	(3,343	)	$	66,192
Prepaid expenses and other current assets	11,059			2,535			13,594
Other assets	1,981			(593		)	1,388
Total assets	282,470			(1,401		)	281,069
Accrued liabilities	47,445			(380		)	47,065
Deferred revenue	17,205			2,304			19,509
Total liabilities	141,310			1,924			143,234
Accumulated deficit	(680,113		)	(3,325		)	(683,438		)
Total liabilities and stockholders’ equity	282,470			(1,401		)	281,069

Condensed Consolidated Statement of Comprehensive Loss



Three Months Ended June 30, 2018 (Unaudited)	As Reported			Adjustments			Balances Without Adoption of Topic 606
Revenue:
Systems	$	102,563		$	(2,513	)	$	100,050
Services	9,139			(214		)	8,925
Total revenue	111,702			(2,727		)	108,975
Cost of revenue:
Systems	54,363			(1,412		)	52,951
Services	6,473			(187		)	6,286
Total cost of revenue	60,836			(1,599		)	59,237
Gross profit	50,866			(1,128		)	49,738
Sales and marketing	20,527			(18		)	20,509
Net loss	(2,793		)	(1,110		)	(3,903		)



Six Months Ended June 30, 2018 (Unaudited)	As Reported			Adjustments			Balances Without Adoption of Topic 606
Revenue:
Systems	$	195,854		$	(3,194	)	$	192,660
Services	15,251			(753		)	14,498
Total revenue	211,105			(3,947		)	207,158
Cost of revenue:
Systems	105,996			(1,897		)	104,099
Services	12,184			(465		)	11,719
Total cost of revenue	118,180			(2,362		)	115,818
Gross profit	92,925			(1,585		)	91,340
Sales and marketing	40,428			(33		)	40,395
Net loss	(14,529		)	(1,552		)	(16,081		)

Recent Accounting Pronouncements Not Yet Adopted

Leases

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires recognition of an asset and liability for lease arrangements longer than twelve months. ASU 2016-02 will be effective for the Company beginning in the first quarter of 2019. Early application is permitted, and the standard can be adopted using either a modified retrospective approach whereby the Company would recognize and measure leases at the beginning of the earliest period presented, or using a prospective approach to initially account for the impact of the adoption with a cumulative-effect adjustment to the January 1, 2019, rather than the January 1, 2017, financial statements. The prospective approach will eliminate the need to restate amounts presented prior to January 1, 2019. The Company is not planning to early adopt, and accordingly, it will adopt the new standard effective January 1, 2019. The Company intends to elect the available practical expedients on adoption. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial statements. The Company expects its assets and liabilities to increase as the new standard requires recognition of right-of-use assets and lease liabilities for operating leases, but does not expect any material impact on its loss from operations or net loss as a result of the adoption of this standard.

Income taxes

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") which provides guidance on accounting for the tax effects of the Tax Cuts and Jobs Act (the “Tax Act”). SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740, Income Taxes, for the year ended December 31, 2017. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete.