Jeff Hustis - Head-Investor Relations Tom Fallon - CEO Brad Feller - CFO Dave Welch - President.

Michael Genovese - MKM Partners George Notter - Jefferies Vijay Bhagavath - Deutsche Bank Alex Henderson - Needham Sanjiv Wadhwani - Stifel, Nicolaus Meta Marshall - Morgan Stanley Simon Leopold - Raymond James Dmitry Netis - William Blair Douglas Clark - Goldman Sachs Stanley Kovler - Citi Research Tim Savageaux - Northland Capital.

Welcome to the Fourth Quarter Year 2015 Investment Community Conference Call of Infinera Corporation. All lines will be in listen-only mode until the question-and-answer session. [Operator Instructions] Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn the call over to Mr.

Jeff Hustis of Infinera Investor Relations. Jeff, you may now begin..

Thank you, operator. Welcome to Infinera's fourth quarter of fiscal year 2015 conference call. A copy of today's earnings is available on the Investors Relations section of Infinera's website. Additionally, this call is being recorded, and will be available for replay from the website.

Today's call will include projections and estimates that constitute forward-looking statements.

These may include statements regarding Infinera's overall business strategy, market conditions, market and growth opportunities, Infinera's results of operations, views on Infinera's customers and its products, as well as Infinera's financial outlook for the first quarter of fiscal 2016 and integration of Transmode.

These statements are subject to risks and uncertainties that could cause Infinera's results to differ materially from management's current expectations.

Please refer to Infinera's current press releases and SEC filings, including Infinera's most recently filed quarterly report on Form 10-Q and subsequent filings for more information on these risks and uncertainties.

Please be reminded that all statements are made as of today, and Infinera undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. Today's earnings release and conference call include certain non-GAAP financial measures.

Pursuant to Regulation G Infinera has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in its fourth quarter and full year earnings release, which has been furnished to the SEC on Form 8-K and is available on Infinera's website in the Investor Relations section.

I would now like to turn the call over to Chief Executive Officer, Tom Fallon..

Good afternoon, and thank you for joining us on our fourth quarter 2015 conference call. With me are Chief Financial Officer, Brad Feller, and President Dave Welch. Today, I will review our Q4 performance, take a look back at our achievements for the full 2015 year and also share thoughts on how we are positioned to win in the market.

I will then turn the call over to Brad, who will provide a more detailed review of our fourth quarter and full year financial results and our outlook for the first quarter of 2016. Q4 was another strong quarter for Infinera with revenue of $261 million and non-GAAP gross margin of 48%.

Our strong revenue results and gross margin outperformance drove non-GAAP earnings to $0.21 per diluted share in the quarter.

I was pleased that the broad strength we saw across our customer base in the quarter as customers from multiple verticals invested in solutions across Infinera’s end to end portfolio, in particular ICP results were strong, growing nicely both sequentially and year over year as our data center interconnect or DCI business continues to ramp.

We saw opportunities open up in Metro during Q4 with strong growth in a number of TM-Series RFPs relative to Transmode typical levels. Even more interestingly, we had a solid uptick in Q4 of end to end RFPs that include both the TM and DTN-X platforms.

As a reminder, these would have been opportunities that neither company would have been able to compete for prior to the acquisition.

Our Q4 results and overall exceptional financial performance in 2015 directly reflect the value Infinera delivers to its diverse customer base via purpose built products, best in class technology and superior customer service.

Continuing to exceed our customers’ expectations with innovation and operational excellence remains our guidepost to sustaining a profitable growth trajectory in the long term. Now I’d like to take some time to reflect on our accomplishments in 2015 and how they position Infinera for long term success.

We exit 2015 on a $1 billion run rate, fully armed to address customers’ unyielding bandwidth requirements with an end to end portfolio of capabilities. Financially, our 33% year-over-year growth marks a third consecutive year of growing at more and double the rate of the overall market.

Even without Transmode, the core Infinera business grew in the mid 20% fueled by continued strength in long haul and the early success of Cloud Xpress. Strong revenue growth did not come at the expense of profitability as we improved our best in class non-GAAP gross and operating margins in FY15, to 48% and 13% respectively.

Leverage from our vertical integration, the value proposition our Intelligent Transport Network and our commitment to prudent expense management enabled us to post a nearly 500 basis point increase in operating margin in FY15.

I am particularly that we were cash flow positive during every quarter in 2015, generating a $133 million in cash flow from operations during the year. Turning now to operations.

We continued the transformation to a multi-market company in 2015 by adding data center and Metro to our core long-haul business enabling Infinera to address a $15 billion TAM. Long haul remained the primary growth driver as exhibited by IHS ranking Infinera number one in North America long-haul market share for 2015 through Q3.

Having booked considerable 100G long haul footprint, today we stand well positioned to fulfil our customers’ capacity expansion requirements and benefit from continued long haul capacity growth. Also, contributing to our long haul success in 2015, revenue from our subsea business grew meaningfully year over year.

As for data center in 2015 we’re off [ph] to a very successful first year for our Cloud Xpress platform ending the year with 20 invoice customers, including a number of large ICPs. The customers we added in Q4 have the potential to grow sizably.

Plus, we continue to see positive bandwidth growth proof points from early Cloud Xpress customers, several of which placed follow-on orders during the second half of the year.

The strategic importance that our customers have placed on Cloud Xpress and their data center architectures has spurred product announcements from several competitors, validating our expectation that our groundbreaking approach to DCI would prove to be an attractive market opportunity.

More than a year after our first sale, we believe that Cloud Xpress remains one of the only purpose built DCI products commercially available. Having a four-year time to market lead in the customer deployments has enabled us to better understand the market, customer requirements and to further optimize and add differentiated features to the product.

Thus we believe we’re in a great position to extend our headstart on the competition by continuing to innovate and by providing the best solutions to our data center customers. In addition to DCI, we aggressively moved to the metro market in the second half of 2015, acquiring Transmode and announcing XTC-2.

With early resoundingly positive reviews from our customers and employees, I couldn’t be happier with the integration of Transmode and progress to date. While it’s too early to validate our assumptions on synergies, we are engaged in the right RFPs, are having the right discussions and are starting to see the early traction that I expected.

Our expanding end to end portfolio, including TM Series and new purpose built products like the XTC-2 and XT-500 places Infinera in a strong position to take market share by addressing the changing requirements of our growing and diverse customer base.

Across our customer verticals, we continue to see sustained bandwidth growth and significant network architecture evolutions occurring.

Specifically, the massive shift of workloads to the cloud and virtualization of switching and routing platforms increasingly compels our customers to demand the most scalable optics available, something our vertical integration of PICs and DSPs and software enables Infinera to provide better than anyone.

We continued to enjoy broad success in 2015 across customer verticals, highlighted by our offering solutions that address the traffic growth and architectural shifts driven by internet content providers.

Our ICP strength is evidenced by both Ovum and Dell'Oro ranking Infinera number one in worldwide market share for the combined ICP and carrier neutral data center operators in Q3 of 2015.

Additionally, in 2015 revenue from enterprise and wholesale carriers which carry a significant volume of the traffic created by ICPs remarkably doubled year over year. From a geographic perspective we had a solid year, maintaining our strength in North America while growing in Europe.

I am especially encouraged by the momentum we have built in LATAM and APAC. We saw pronounced growth in 2015 stemming from our growing channels program and expanding portfolio that better suits customer size and reach requirements.

Looking now to 2016, consistent with industry analysts we anticipate the overall market to grow 6% to 7% in long haul DWDM, 9% to 10% in Metro DWDM and double digits in DCI. Growth estimates for the DCI market vary considerably between industry analysts but all [ph] project the market will grow substantially in 2016.

While overall long haul growth is slowing, our aggressive deployment in a 100G long haul footprint over the past few years places Infinera in an excellent position to continue to outgrow the long haul market. As the 100G traffic growth remains strong, we expect customers to continue to turn to Infinera to fulfil their growing capacity requirements.

Never sitting still, we also expect to benefit in long haul from continued technology innovations and new purpose built platforms like XT-500.

Across the broader market we believe we have good opportunity to gain market share in 2016 based on driving the growth trajectory of Cloud Xpress, achieving traction from new products, adding long haul capacity to 100G footprint and revenue synergies from our new Metro portfolio.

Of utmost importance in 2016, we will be completing the Transmode integration which will require heavy lifting and financial investment. Full integration gives us an end to end portfolio with best in class unified management and access to a $15 billion TAM.

While it will take time to translate early positive indications into financial results we’re expecting, I believe we are on track for the Transmode acquisition to be accretive in 2016 and instrumental to our long term success.

Additionally, we intend to make important investments in 2016 to expand our direct and sales presence with governments, tier 3s and LATAM and APAC. In 2016 we expect to continue to extend our core technology lead and further enhance our product portfolio through the introduction of our next generation Terabit PIC technology.

While skeptics have recently suggested that competitors that use photonic technology are beginning to close the gap on Infinera, we disagree and intend to demonstrate that the technology differentiation we offer to our customers is actually expanding.

Infinera’s terabit photonic integrated circuits will enable our customers to achieve space, power and network efficiency advantages that lower their operating costs while delivering superior reliability and performance.

Vertically integrated, we are ideally positioned to deliver our next generation roadmap and do so profitably by owning our own cost structure. We will continue to opportunistically make big bets to create disruptive solutions and have the courage to make decisive actions that capitalize on market opportunities and bolster our differentiation.

In short, we will play to win. Acquiring Transmode, a small highly profitable company with a track record of winning at large customers is a prime example of this velocity and action [ph]. We believe that bringing a winner like Transmode under the Infinera umbrella will be a key catalyst to drive Infinera to the next level.

Longer term we see service providers adopting SDN and network function virtualization to run as many network functions in the cloud as possible. We see this ultimately transforming service provider networks into a key two-layer architecture, layer C, the cloud services layer and layer T, the intelligent transport layer.

This transformation increases the importance of scalable optics and intelligent transport while reducing the need for hardware based routers. We are seeing the pressure caused by this transformation on router vendors and the resulting scramble to acquire WDM optical assets whether differentiated or not.

This is a proof point that those who can deliver scalable optics with the right amount of packet and software control are very well positioned at Layer T. You cannot create photons in software and Infinera’s innovation in this domain leads the industry.

I believe Infinera is ideally situated with our unique intellectual property to deliver the most scalable, flexible and programmable intelligent transport network solution in the industry and to play a significant role in accelerating this new [ph] transformation.

In closing, Infinera’s journey to achieving a $1 billion run rate has been a challenging one but unbelievably gratifying one as well. I am very proud of our employees for this outstanding accomplishment.

We have earned our reputation and position in the market from being a technology leader as next generation networks increasingly rely on optical transport and from unwavering dedication to providing our customers with the Infinera experience. As we embark on the next phase of our journey, we have never been better positioned to succeed.

Thank you to our customers and partners for their ongoing commitment to Infinera. Thank you also to our employees around the world for making 2015 a resounding success. Now I will turn the call over to Brad for a more detailed financial review of the fourth quarter and the full year, plus our outlook for the first quarter. .

Thanks, Tom, and good afternoon everyone. As Tom mentioned, we had another terrific quarter in Q4, continuing to grow our revenue and doing so in a profitable way. Revenue growth in the quarter was attributable to strong results across our end to end portfolio.

As long haul remained strong, DCI continued its ramp and the Metro business acquired from Transmode contributed to our fourth quarter [ph]. Q4 revenue was $261 million, a 40% increase over the fourth quarter of last year, up 12% sequentially and at the high end of our guidance range.

I was pleased by our results across all our customer verticals in Q4. Growth stemming from the trend of increasing ICP-driven traffic that Tom referred to was a key driver in the quarter as the ICPs and wholesale and enterprise carriers both posted strong revenue results.

In the fourth quarter, our top 5 customers were comprised of two wholesale and enterprise carriers, two Tier 1s and an ICP. We had one greater than 10% customer in the quarter, a wholesale and enterprise carrier.

From a geographic perspective, North America was strong in Q4 at 60% of total revenue as many of our largest customers are based in the region. Internationally, both the Transmode and Core Infinera portions of the business performed well in EMEA resulting in the region posting a sequential uptick in Q4 to 23% of total revenue.

LATAM again posted strong results in Q4 accounting for 10% of total revenue due to continued traction both of large carriers based in the region and international carriers expanding their global footprints. APAC was steady in Q4 representing 5% of the total revenue.

Services revenue for the quarter was $34 million, up 9% sequentially and 21% year over year. We continue to grow our services revenue as customers consistently see value, turning to Infinera for deployment services and our broad base of support offerings. We believe our intelligent [ph] and metro market will further expand our services opportunity.

Moving now to gross margin and operating expenses. Non-GAAP gross margin for the fourth quarter came in above our guidance range at 48.3%.

Consistent deal discipline, the continued benefits of our vertically integrated business model and the capacity adds to long haul networks through both line card adds and Instant Bandwidth licenses, drove our strong margin performance in the quarter.

Our Instant Bandwidth program provides a win-win situation for us and our customers as it enables the pre-deployment of capacity into customers’ networks allowing them to quickly react to business needs and providing us with the high margin software-like revenue stream as they license at additional capacity.

Additionally, the Metro portion of our business delivered strong gross margin performance in the quarter. Services gross margin was also a meaningful contributor to gross margin outperformance, coming in at 60% in the quarter, slightly up sequentially and up more than 300 basis points year over year.

We are performing well on our objective of further enhancing the value we provide to our expanding customer base and driving higher efficiency on footprint deployments. As we saw revenue and margin trending above plan for the quarter, we took the opportunity to accelerate spend in certain key areas.

Incremental spend in Q4 was focused primarily on R&D and integration related activities, resulting in non-GAAP operating expenses coming in above our guidance range at $93 million.

We increased our R&D spend as we continue to target 20% of revenue which will allow us to further enhance our product portfolio and ensure we deliver on our next generation PIC and XT technologies.

In relation to integration spend, we spent meaningfully on lab and trial geared to support the prospects of our Metro business as we are seeing increasing interest in these solutions and don’t want to miss out on the opportunity ahead.

On the sales side, we continued to make investments in Q4 to address new markets and verticals and also triggered commission accelerators stemming from revenue outperformance for the year.

We believe that by pairing the delivery of strong financial results with the courage to make significant investments to address our rapidly expanding TAM, we will achieve the right balance for our shareholders. We achieved a non-GAAP operating margin of 12.7% in Q4.

Even as we expand our addressable market and make significant operational investments, we continue to achieve best in class profitability. Interest and other expenses netted to a gain of $200,000 and tax expense for the quarter was $1.8 million.

The Q4 uptick in tax expense was primarily attributable to having a full quarter of revenues from the Transmode business taxed at a full Swedish rate.

In Q4, the shares used to compute non-GAAP EPS were 149 million, up from 145 million in the prior quarter, primarily due to the full quarter’s impact of shares issued in connection with the Transmode acquisition.

In summary, non-GAAP net income for the fourth quarter was $32 million or $0.21per diluted share, down from $0.22 per diluted share in the prior quarter and in line with our guidance. On a GAAP basis in Q4, we had net income of $13 million or $0.08 per diluted share.

The difference between our GAAP and non-GAAP results was attributable to approximate $9 million in stock based compensation, $8 million of intangible amortization and other acquisition-related costs, and $2 million in amortization of debt discount. Now turning to the balance sheet.

We continue to demonstrate our ability to generate significant cash from our business with cash from operations of $26 million in Q4. In the quarter, we invested $15 million in CapEx to support the growing business and we generated $2 million in net proceeds from employee stock activities.

As of the end of Q4, our total cash, cash equivalents and investments were $356 million, up from $344 million at the end of the previous quarter. Now summarizing our results for the full year fiscal 2015.

Any way you look at it, 2015 was an extraordinary year for Infinera, a testament of value we deliver to our customers and our employees’ exceptional execution. In FY15 we increased revenue 33%, expanded our non-GAAP gross margin by nearly 400 basis points and more than doubled our non-GAAP operating income.

In addition, we generated $133 million of cash from operations and $91 million of free cash flow, representing a free cash flow margin of greater than 10%. On a GAAP basis, we posted income of $51 million in FY15, a significant improvement over $14 million in the prior year. Now moving to our outlook for the first quarter of fiscal 2016.

As a reminder, the first quarter in our industry can be challenging as customers take time to finalize their CapEx budgets, convert them into orders and build networks. Based on the last three years of data from Dell'Oro and IHS, in the first quarter the overall DWDM market has declined on average approximately 14% sequentially.

We currently project revenue for the first quarter of fiscal 2016 to be $245 million, plus or minus $5 million. While the midpoint of this range represents a sequential decline of 6%, year-over-year growth of 31% continues to significantly outpace the industry.

We currently project non-GAAP gross margin to be 48.5%, plus or minus 100 basis points, as we continue to deliver value to our customers and execute on our financial operating model.

We currently anticipate non-GAAP operating expenses to be $93 million, plus or minus $2 million, flat sequentially as we continue to target R&D expenses at 20% of revenue for the year, make strategic investments in sales personnel and continue to spend on acquisition integration.

In addition, Q1 spending is impacted each year by higher payroll taxes due to the calendar reset, focal [ph] RSU vesting and the bonus payout. Throughout 2016, it is critical for us to invest in key areas that will allow us to maximize on market share opportunity in longer term as the end to end market continues to expand.

The midpoint of our projected guidance translates to a non-GAAP operating margin of 11%, plus or minus 100 basis points. The combination of interest and other expenses is expected to net out to approximately zero and tax expense should be approximately 1.5 million.

We currently project the diluted share count to be approximately 147 million shares and project non-GAAP EPS to be $0.17 per diluted share, plus or minus a couple of pennies. As for GAAP EPS, we project it to be lower than non-GAAP EPS by about $0.12 per share, primarily related to amortization of intangibles and stock based compensation expense.

Looking ahead, I am often asked how we will balance Infinera’s revenue growth potential with further enhancing profitability. The answer continues to be that our operating model enables us to [ph] not to be inversely related.

Long haul is poised to continue posting strong results to both the top and bottom lines as the 100G market evolves to higher margin capacity sales. In addition, as we bring to market additional purpose built products based on our new technologies, I believe it will not only allow us to increase our market share but also our profitability.

We will continue to make investments in vertical integration to enable Infinera to deliver best in class technologies, control our supply chain and also maximize our profits.

We will also prioritize investments in technology and operational infrastructure to enable Infinera to capitalize on future market share opportunities and continue our operational excellence.

In closing, I am pleased that our financial results continue to be strong on both the top and bottom lines, even as we bring new products to market, integrate Transmode and make longer term investments in the business. We are executing well and are in a great position to win in the market.

As bandwidth demand growth remains strong and we continue to provide a differentiated experience, we remain in an excellent position to continue delivering best in class growth and profitability to shareholders and the Infinera experience to our customers. With that, I’d like to turn the call over to the operator to begin the Q&A portion of the call.

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[Operator Instructions] And our first question will come from Michael Genovese of MKM Partners..

Thanks for the question.

On the outlook for 1Q, on the down 6% sequentially, can you give us any color on the different product lines in terms of the TM Series versus the organic products, if one would be significantly different than the other in that sequential movement?.

Mike, it’s an overall thing, it’s not one product or another, it’s just the dynamic in the industry that it takes customers time to get their budgets finalized and get POs [ph] to us. We feel like the underlying demand is good, it’s just getting those orders in, that kind of stuff but it’s not unique to any one product..

And can you kind of go into some detail about couple of balance sheet items.

I mean deferred revenue is way up and inventory is also a significant increase, it looks like finished goods oriented, I mean does that suggest visibility or problem, what is it?.

Yes. So our deferred revenue in the fourth quarter, Mike, is always higher because we have our maintenance renewals in the fourth quarter, so that’s really the thing that’s driving that, and as our installed base obviously gets bigger, that becomes a bigger number.

If you look at the inventory side of things, obviously we are releasing quite a few new products, as we go into this year. So it’s really just making sure that we have the right amount of supply to capture the opportunity in front of us..

Mike, this is Tom. I’d really encourage you not to imply that inventory is because of lack of visibility. Over the last year what we’ve said pretty consistently is we’re going to try to bring back our lead times into being shorter, they’ve creeped out over the year and we’ve made a very very methodological attack on lead times.

To do that, you do need particularly as your product line grows, some more inventory to do that.

We’ve got now our lead times in a very very good position, particularly as we are working hard on the internet content provider space, whereas sometimes the planning is less – you get less forecasts than you would like and we are committed to solving those problems, unlike some of these competitors, we don’t have one or two quarters’ worth of backlog.

We try to respond very quickly to orders as they come in, we believe it’s a compelling advantage for our customers and we believe it’s a compelling advantage for us, particularly in this space..

And if I could just follow up on my first question on the Transmode side of the world. I heard a lot in the beginning comments about RFPs. I didn’t hear as much detail as I would have liked to hear, I think just because you didn’t give it about actual cross-selling successes to date.

Is there anything there that you can point to even if just in general terms?.

RFPs include both new customers, both of us and also cross selling proposals and what you should really focus on quite frankly is, are we seeing more opportunities? We are seeing a lot more opportunities for Transmode gear than Transmode did independently, that’s good.

A lot of that is because it’s going into potential Infinera customers and one of the things I am going to caution everybody about is it’s easy to think, oh, Infinera already has these customers, gosh, selling them something new would be really easy. It might be easy but it’s going to take time.

You have to quote it, you’ve got to explain it, they have to test it, they have to have an application.

I don’t think we’re going to see, as I said I think in the commentary, I have every belief the synergies we thought we were going to happen, or are on track to happen, but it’s probably a second half of this year before you really see the pull-through of these synergies. .

And the next question comes from George Notter of Jefferies..

I guess just maybe to start by sort of the economic environment that we are in, I mean going through the earnings season, lots of commentary from a variety of IT infrastructure companies about softening in emerging markets and customers slowing at quarter end.

I mean, are you seeing any of that from your customer base, what’s the perspective there?.

Yes, again my perspective, George and I think I am not an economist, I don’t understand a lot of the things that some of these people are talking about describing behaviours. I am sure they are real and they are creating concerns. But what I see are a couple of dynamics.

I see a permanent move to the cloud architectures, that’s not slowing down, and that’s going to be good for our industry and our company. And I see a non-slowdown in the requirements that our customers see on bandwidth.

And regardless of what’s happening in China, regardless of who is going to be the President, regardless of what the dollar does, strengthening or weakening, if there is demand for bandwidth, we’re going to go do well.

And I was just in PTC, a conference that happens every year in our industry, and I met a dozen customers or so, and usually you meet with them and there is a smettering of issues, your price is too high, I want this feature.

That was one consistent theme from every single customer at this time and it’s never happened before, whether it’s from Europe customer, American customer, APAC customer, they see demand and that’s what they were interested in talking about, how can we help them win deals because the demand environment for bandwidth is exceptionally good.

That is to me trumps everything else that’s happening on the world stage, and I think that we are excited about that which is why we are trying to make sure we have short lead times.

And one dynamic we are seeing this quarter, which is a little different, lot of our customers build based upon plans, they methodically build out capacity, and we are seeing some set of customers starting to do buy or win, meaning, if they win a deal they are buying from us.

They are doing less structured internet buildouts but they are aggressively going after bandwidth demand opportunities and they are coming to us with quick lead times. Does that give us a little bit less visibility? It does, but it’s a great advantage for us because we use time as a weapon.

And I think it’s a great thing that our customers are seeing demand and whether they are building structurally or building opportunistically, as long as they’re going to Infinera, I don’t care. .

And one follow up I had, I guess I was curious about Cloud Xpress in Q4, I guess, if you go back you guys at one point said 30 million to 60 million was kind of range for Cloud Xpress and then I think you were kind of pointing to lower end of that range.

I mean, I’d love to get an update on kind of where Cloud Xpress look out [ph] for the year and what kind of momentum you are seeing in terms of traction with revenue?.

Yes, it played out in the range that we had said, as we said it got off to a slower start than we thought because of certifications which I still believe are architecturally important and put us in a great position, and I will give a little comment on Q1.

The momentum that was building near the end of the year has actually accelerated in Q1 for the Cloud Xpress product.

It’s actually in Q1 so far exceeding our expectations, and that’s what we thought would happen, it’s architectural win, it’s a proof point in the industry and even though a number of competitors have announced competing products, we are really not seeing them impact the market yet. We feel like we’ve got a real winner with the CX family. .

Yes, George, to Tom’s comments, we obviously continue to add more and more customers and the types of customer that can be very meaningful over time, so I think that’s another good proof point. And then the adoption for the 100G product that we released in Q3 was nice in Q4 as well. .

And the next question will come from Vijay Bhagavath of Deutsche Bank..

Tom, I have a bigger picture strategy question for you and then a follow up for Brad. A question for you, Tom, is what is the sustainable modes around Infinera’s business? I get this question asked a lot from clients especially in recent marketing meetings.

And where they are coming from and where I am coming from is you have Cisco, Juniper, maybe some of the web 2.0 customers of yours looking to enter the 100 G data center optical market, the stage could get quite crowded honestly heading into next year, so the question really is how do you maintain your competitive advantage, your differentiation, your mode and also your pricing power in a crowded market heading into next year?.

I am assuming a comment from Dave who is much more astute in technology than I am – I answer, first of all, it’s important that you talk to people about this crowded market, there is a huge difference of people announcing products for sale, and actually selling products that solve problems.

Over a half a dozen people have announced our products for sale and we’re fundamentally seeing almost nobody actually delivering those products. They know it’s sexy, they know it’s important, but there is a technology barrier to getting in there, that’s non-trivial. How we sustain our advantages, I will let Dave comment. .

First, our business is the management of the services we’re able to win and the optics are critical to maintain it and differentiated optics are critical in maintaining that and Tom alluded in his commentary that it is critically important if you want to plan on playing in this space that you maintain a position of differentiated optics for that.

The PIC is a horse we are riding on that and that continues to show and continues to dominate the supply of wavelength out there.

We are running at around 30% of total 100G wavelengths deployed in the long haul, when we were at the 10G market we supplied 48% of all 10Gs deployed in the long haul for many years, and that’s because that optical technology is what differentiates it.

The ability to add services be it the layer 1, layer 2 or even layer 3 as the optics are what can ultimately differentiate your ability to manage those services across that and we have a unique distinct advantage. .

It’s important – I agree with everything Dave said, it’s important that the optics that create this differentiation, it’s vertically owned IP from both an intellectual property perspective and the manufacturing perspective and we believe that is mandatory and we do not see people going after that to disrupt our leadership there, and in fact, as I said, we announced our next generation Terabit technology this year.

Our gap is widening on our capabilities versus the industry’s capabilities. .

The industry is also in the midst of voting, that’s really the thing that they need to – are comfortable breaking on, are the higher layer services, and the ability to manage our layer 2 or layer 3 functionality from a greater diversity of players as it leads a tremendous opening for a company like ourselves to go in and add those capabilities to our transport boxes.

What you don’t see is the ability to virtualize differentiated optics. .

Just a quick follow on for Brad, the case that Brad argues, there could be gross margin distraction, as you sell more diverse set of products, Metro, DCI, long haul and on and on, so help us understand from your lens how would you manage gross margins as your product portfolio and SKU –.

Vijay, obviously our guidance continues to show margin continuing to expand, so I know there is people that don’t necessarily want to – don’t think that that’s going to happen, but we do have a differentiated approach to the market. We are very selective in the deals that we take.

We have the leverage of the vertical integration and there is multiple dynamics to our business that will continue to allow us to expand margin. We said over time we can get to 50% gross margin. I still believe that is the case and I am confident we will get there over time..

And next we have a question from Alex Henderson of Needham & Company..

First, can you just give us a quick update on your tax rate expectations now that the R&D tax credit has been passed and made permanent? What does that do to your tax rate?.

Alex, in ’16 it shouldn’t change our tax rate, we will still be in a full evaluation launch position for ’16. Out in ’17 as we’ve talked about, we will – our taxes will go up as we continue to be more and more profitable, but we are working on that. I can’t give really any specifics at this time..

Well, would it lower a little bit or would it change?.

Yes, I mean it may lower a bit..

Second question, there is a lot of concern about the 6% growth rate guidance that you [ph] gave but it sounds like a lot of that 6% had more to do with revenue recognition timing associated with some large contract deployments that have happens a criteria [ph] on them.

There is an assumption that you would also see that but on the other hand, you intend to be putting a line extensions to existing customers but you’ve already got the DTN-X certified in their network.

So do you think that deferred revenue acceptance would slow down the timing of Metro for recognition – would be less than – please?.

I’ve got no commentary on Seina [ph] business, you need to ask them on their questions. I can tell you what I think. I think that the long haul market is going to grow, 6% to 8% a year and we’re going to grow our market share. I think Metro is going to grow, we’re going to grow our market share.

DCI is going to grow, we’re going to grow our market share. And I don’t think rev break is going to materially alter how we – on our ability to build this business over the next couple of years. That just doesn’t bother me. We have three weeks or four weeks worth of backlog, they got half a year, it’s a different model.

I don’t understand theirs, they probably don’t understand ours. But you need to not to club us together. .

And next we have a question from Sanjiv Wadhwani of Stifel..

A couple of questions from my end. Brad, first one for you, if you look at the operating margin guidance for Q1, I think it was around 11, 11.5% or somewhere around there. But I guess with your OpEx ramping, how should we think about operating margins for the full year, you’ve expanded that really nicely 2013 into 2014, and into 2015.

So should we still look at operating margins expanding this year versus last year?.

I mean we are not going to provide guidance for the full year, Sanjiv. The reason it’s down in Q1 is obviously the revenue being a little bit lighter and us investing based on the full year and the future and not just our Q1.

So I think we will still deliver strong operating margins, the reality is I think if we are able to even maintain what we’ve done is a good result. The reality is after you’ve had multiple years of increasing it, several hundred basis points a year, it’s really tough to maintain. .

And one of the things that you guys need to be careful of, we have consistently said our R&D is going to run 20% of revenue because we’ve grown so quickly that [ph] achieving that and your industry continues to model us at less than 20%, and it always perplexes me. We’re going to run R&D at 20%. .

I think investors just want to listen, that’s the bottom line.

Second question is, just on the Metro side, Tom, you talked about Transmode, just curious to see what the initial feedback on your core organic Metro product, what kind of transaction are you seeing and should we be expecting sort of a second half ramp and pick up over there?.

As you indicate, DTN-Xs, Infinera’s product line has had a good position within Metro and that continues to be the case, and actually what we find very encouraging is that our customers that use our IQ NOS operating system continuing to want to be – to take advantage of the ease of use and the completeness of that operating system.

So we’re going to see continued Metro growth of both the XEC based products as well as we grow the TM underneath of our network management and DNA [ph] capabilities, we will be able to grow that even further with having the added value of our IQ NOS software. .

Just to add to that, Sanjiv, given what Tom mentioned earlier about timing to get things into network and the test cycles that kind of stuff, it is going to be more of a second half type of impact..

One last question, Brad, for you, on seasonality. It looks like last year or year before you kind of booked seasonality, you are looking at some seasonality in Q1 better than industry but still some seasonality.

Any change in sort of the seasonal patterns Q2 through Q4 that we should be aware of?.

I don’t think so..

I just think the bigger we get the more we’re going to be part of any kind of industry seasonality. We have been fortunate to have escaped the last couple of years, kind of holding flat but when the industry spends roughly 14% less quarter on quarter we’re just large enough now, that we’re going to be part of that..

And the next question comes from Rod Hall of JPMorgan..

This is AK [ph] on behalf of Rod. Thanks for taking my question.

I was wondering if you could comment on 100G Metro build out plan by telecom carriers, what are your expectations for that?.

We continue to see growth in the deployment of 100G in the Metro, it’s pretty much as we had talked about throughout the ’15, as ’16 is a timeframe which we think that will start accelerating.

The majority of services out there in the Metro right now are still 10G but they are making decisions based on your capability of supplying of 100G to the market and we are seeing a pickup in interest and a pickup in deployment but it’s going to be later in ’16 before you see that starting to accelerate. .

Next question comes from James Faucette of Morgan Stanley. .

Hi this is Meta Marshall for James. A couple of questions.

First, there was kind of a jump in CapEx and as we understand this kind of investment for Transmode, but is there a level of cash cost we should be expecting or period of elevated CapEx? And then second, I know you mentioned the competitors like Arista entering the DCI market and not having the pull, sort of capabilities, given you guys had a partnership with them, just how that partnership has evolved?.

I will address the CapEx and then let Tom or Dave address Arista. We target our CapEx at 5% on an annual basis, that’s for the entire business, that’s not just getting Transmode up to speed whatever, that’s across our vertical integration and that kind of stuff.

So we were little bit higher in the fourth quarter but still in line with our 5% for the year, so that’s how you should model going forward..

In regard to competitors, we’re going to always see new sets of competitors whether it’s Cisco or Arista incorporating optics into their platform or Juniper buying BTI, and I think that’s a normal part of any healthy industry where there is a big opportunity. And my belief with Arista particularly they are good partners of ours.

So we joint sell together, sometimes we win with them, sometimes we don’t, sometimes they are going to create opportunities to have an integrated platform, that will be potentially advantageous for very short reach kind of optics, but my take is we have a huge toolbox of vertical IP around optics and we’re just going to be better than anybody else who integrates optics into their platform.

So that’s what we are going to go do and quite frankly if they or anybody else can do better optics than us, we’ve got to better challenge than Arista competing with BTI. I think there is a fascination right now with optical and I think it’s really a strong statement for our position in the market.

Arista is putting optics into their platforms, I believe, not because they want to be in the optical business but they want to have more customer controls, the same reason that Cisco does. I look at Juniper buying BTI for the same reason.

I think that they are all trying to have customer control of networks and architectures but if you don’t do it from an intellectual property base that allows ongoing sustainable competitive advantage I think you are going to have a really hard time being successful there. It’s what we do, day and night, it’s all we do.

So I don’t worry about that as being competition, I will work with any of them who are interested in solving customer problems with us, otherwise we will just go ahead and beat them in the market either way..

The next question comes from Simon Leopold of Raymond James..

I wanted to talk a little bit more about what’s going on in the metro space. First starting with a clarification in that, in your prepared remarks you mentioned the core revenue growth which leads me to calculate the Transmode contribution through the fourth quarter at something around 27 million.

Wanted to see if I am doing my math correctly if that’s what you intended.

And then more broadly, I’d like to get a better understanding of what you expect metro to be as a contribution to the full year, so maybe as a percentage of total sales or something like that, given that it’s hard to apply growth rates because of the acquisition and new products, you’re obviously easily growing faster than the market on a year over year comparison.

So maybe we could term in terms of percent of revenue you consider coming from metro in 2016?.

So Simon, we didn’t break out the specific on the Transmode piece. We did say that there is a full year’s impact of those revenues – the partial quarter in Q3. The thing to remember those are, our metro business is broader than just the TM series that we bought from Transmode.

So it is a bit bigger than you noted in your response but metro grew, DCI grew, and long haul grew as well. As a percentage of total sales I mean you can look at Transmode being the biggest piece, you can look at what they have done historically.

Obviously as that business ramps up, that will become a larger percentage but we expect the overall business to grow as well. So it will probably be to the second half of the year before we can break out a specific what you should expect for the metro business. .

The next question is from Dmitry Netis of William Blair..

I have a quick sort of housekeeping item and then more a general question. On the housekeeping side, as I look in the press release, I think you guys had two 10% plus customers at least, if I am reading it correctly. And I think Brad you said there was one on the call. So I am just trying to reconcile that..

Yes, two for the year, one for Q4. .

And then Tom, so you on the Web scale cautiousness you expressed in the third quarter, can you talk about whether that’s dissipated now, that eye had done away, you certainly noted that ICP being strong and up sequentially and also year over year.

It will be great if you can qualify how much they were up sequentially at least year over year or whichever you like to tackle, but that question on the web scale kind of commentary last quarter and then the ICP growth which if I remember is 20%, 25% of your revenues, correct?.

I don’t know if we’ve broken out. I don’t remember what my cautionary comment on ICP was, Web scale guys was last quarter. If I was cautionary at all it’s to try to maybe move some of the expectations that I think people, analysts get run away with the expectations.

As I recall last quarter, analysts were worried about spending from the ICPs going down and I said I didn’t see that, and I still don’t see that, and I continue to – and recently on a number of the large guys had come out and said they are increasing their CapEx.

And I think sometimes too much focus is on the number or word CapEx which covers a huge number of things, and people need to continue to focus more and more on bandwidth, is bandwidth growing or not, and I continue to see large web-scale guys putting in very very large infrastructure and buying a lot of bandwidth and I think an area that’s often missed by analysts is how much wholesale and enterprise carriers are carrying internet content by content, it’s staggering and I said on the call that our business with that market doubled last year.

That is carrying a lot of internet content guys traffic. So we see great presence in the enterprise and wholesale carrier market. We have great presence and a growing presence both for long haul and cloud interconnect with the data center guys and the ICPs, and so I remain optimistic on our position there and on the demand in that market.

There have been a number of people who have come out and said that we’re going to go and enter that market competitively, that’s clearly something we need to watch. To my surprise very few people are delivering products there now. So that’s been a positive surprise.

I anticipated a quarter ago, there was going to be maybe four or five platforms that would actually be in the market to date, I don’t see them yet. So that’s good news and we see, as I said on the call, or the earlier question, our CX business actually this quarter is growing faster than it’s grown.

So I am not cautious really on that market any more but I don’t remember being cautious on it in Q3..

Is there any way you can qualify the enterprise wholesale piece of the business [indiscernible]?.

So as we said Dmitry, we have multiple different businesses that we operate in multiple verticals, that are similar size. Obviously as we mentioned in the prepared remarks, ICPs and bandwidth wholesalers are growing faster and grew faster in ’15. So you can – I let you do your math from there..

The next question comes from Doug Clark of Goldman Sachs..

I want to follow up on one previously about kind of the competitive mode landscape. Just wondering as you move into the metro market where perhaps one terabit PICs aren’t as necessary or in high demand as the long haul portion of the network.

On what aspect do you think you can differentiate in these new markets that you’re moving into, particularly in kind of the service provider or metro?.

I’d go back to our phone call back in -- what was that – August, September around Transmode.

Transmode was a market share – one of the market share leaders in Europe with their platform and they are there because they are offering both not only a complete set of services from the agent through the metro core capability but because they are able to give the lowest power, lowest size offering to meet that market space, and they were very successful of that.

We expect to continue to take advantage of that, we’re seeing successes from that approach, philosophy and technologies in the front haul market, we’re seeing successes of that in the cable market, we’re seeing successes in Europe and in North America, and as we bring that to the strength of Infinera customer space, we expect that to continue to grow.

What’s important is to be able to create an end to end service from your access points all the way out through your high capacity cores.

There is -- as we said it before, there is absolutely a place for a PIC inside the TM platform, we plan on pursuing that in order to drive space power density advantages as well as to take advantage of our instant bandwidth capabilities that we offer, and expand it into the metro and complement that with the low power consuming well designed low latency solutions of the access technologies that Transmode has.

.

Doug, I’d be careful thinking that our only PIC we’re doing to do is the one terabit PIC. As we talked about over the last year we are coming up now with multiple favors of PIC including PICs that can be sliceable in its smaller granularity which will we think play very nicely into the metro market. .

I also think – we do think about technologies for the long term and it’s important for us to deliver technologies that have a direct meaning over the next year or two, but it’s also important that we continue to develop technologies that have applications for driving improvement in network capabilities over the many years.

And I won’t be surprised if my kids have terabits to their homes, so we shouldn’t assume that that’s not going to be an application technology for metro..

A point of interest and point out the government target is to get to a megabit per student in every school. You had that up quickly and you realize the type of bandwidth that it needs to get out there and the government incentives to be able to achieve that especially for low income areas which aren’t on the network right away.

The bandwidth is going into the – I think the number I head earlier today from a customer is about, there is still a small fraction of the number of people on the internet today compared to the number of houses that are passed, and as these incentives to be able to drive the megabits to each of the school student and the respective families associated with that, is going to drive the bandwidth in the metro markets up substantially.

.

And then my follow up was more on the first quarter guidance, you talked about the impact of timing of budget releases and the finalization of that, and a month and half into the quarter half way through, are those budgets actually being released, are you seeing spending come unlocked, or is it still the anticipation of that to come?.

Yes, we are starting to see that unlocked, Doug, but there’s still – we get a budget done and basically you have to create those POs, that you get those POs to us, we have to deliver the gear as to get installed.

So that’s where there is still a little bit of uncertainty in what happens in the quarter in Q1 because it is – tend to cause issues going later in the quarter. .

I want to add a little clarity. Budgets are being released et cetera but we wouldn’t have guided to 245 if we couldn’t touch in the field 245, so I don’t want you to read that there is – we take the guide very very seriously. So we’re not depending upon budgets being released that we aren’t aware of yet. .

And the next question is from Stanley Kovler of Citi Research..

I have a clarification question just on the international organic growth.

From the math there, it looks like when we back out Transmode you had something like 17% year over year growth, international markets, and if you can just help us understand some of the drivers there with your web customers, building out a lot of the data centers in Europe, how much are you seeing of that versus true European based customers, growing there? And the follow up is just to update us on your plans to give some more formal model to think about on margin, something you alluded to in the prior call?.

So Stan, it’s a combination of things that’s driving the international growth obviously.

You mentioned the Transmode side, but we do have a very good base of customers throughout Europe who are building, we also see the ICPs whether it’s the phenomenon that Tom talked about where the enterprise and wholesale carriers are building for the ICPs in Europe or the ICPs building themselves in Europe, there has been relative strength around each of those different areas and if you go broader internationally we’ve talked for several quarters now about the LATAM market being one that we are getting traction not only with the bigger carriers down there but seeing bigger global customers wanting to build more footprint in that region.

If you go to your second question around the formal model, we’ve talked about being mid this year we will come out with that model.

I think that still is on track to be the case, as we finalize what we see with different products, they get more and more familiar with the Transmode side of the business but we feel very good about the 50, 15 we talked about over time. .

If I can just – a follow up, what was the traction with some of the new products you came with in early Q4 XTC series and things like that? And if you can help us differentiate between the visibility you are seeing between your US based customers and what you are seeing in the international market as well, how that’s impacting the guidance?.

So the products that we talked about and our launch we’re coming out in Q4 centered around our offering of XTC2, small size chassis or 100G PIC based line card, that’s within that, we’re seeing orders come in for that, we’re happy with that.

I think the interest of that product line on the basis of our overall operating system or IQ NOS, IQ network operating system, is going to be a winner, we’re very happy with the progress so far..

We’re also seeing good interest with the XT-500, it’s a new approach to long haul.

We have some software release that we have found is going to be an interesting addition to it that some customers are now waiting for, and we’re seeing some traction with the XT-500 but I think that once we come out with these new features in the middle of the year we’re going to create a new application that I am extraordinarily pumped up about, the CX 100 as we talked about earlier, selling like cupcakes.

So overall we see a good pipeline of new products, we see a lot of early activity with them and usually it takes six to nine months before it really has a meaningful revenue kind of impact. .

The next question comes from Tim Savageaux of Northland Capital..

And that’s kind of where my question is focused, which is obviously there is not just them, several of your peers even Nokia this morning talking about the pronounced seasonal weakness or just general double digit down sequential guide, and I’d say what’s notable about your performance is you’re much better than that.

I would imagine given the CX commentary that you are going to see sequential growth through seasonality from Cloud Xpress, and I wondered if you might be able to comment on when you see that getting to a 10% of revenue type level, I would imagine mid-16. .

I am not going to comment on that. Our whole business is growing very rapidly.

The CX product line obviously is growing faster than our overall business but I want to make sure you understand we’re going to grow in long haul, we’re going to grow in metro, we’re going to grow in data center interconnect, and do I forecast that business being 10% of our company at some point, certainly I do.

But I think it’s more important than anyone product offering is, are we winning market share in a market that is growing and we are doing that in all areas. And I think one of the things that I am never going to want to have happened, I don’t want my guys selling CX products to be competing with my guys selling Transmode products.

Large companies have those problems. They think that they got to not only beat the outside guy but the inside guy.

I just want to solve customers’ problems in the most economic way possible, I don’t care if they buy TM or a CX or DTN-X or XT, the beautiful thing we have right now is an entire portfolio of technologies to solve customer problems in a way that is economically excellent for us because we are building purpose built platforms and I think it’s just really important for the industry to look at, are we growing market share in a growing market? If we can continue to do that, it doesn’t get better than that, unless you are vertically integrated and can scale that to profit which we can.

So I am really excited about where we are at. And I am less excited about which product that we’re going to sell..

If I can follow up back on the last call there was some comment around pockets of weakness, really I don’t think you were specifically referring to cloud at all, but maybe I was taken to speak to maybe the cable guys or – CenturyLink is doing a bit better but any way no commentary about pockets of weakness this time but more normal seasonality, I mean do you have – you kind referenced that it was sort of a broad cautionary comment but to the extent you were referring to anything specific last time, what are you seeing now I guess?.

I think last time we didn’t comment on really pockets of weakness, what we commented on was a couple of customers pushed out orders that they had wanted in Q4 and they pushed them out to Q1.

And I made the commentary because it was unusual, they weren’t gigantic of course but they weren’t small orders either, and they were customers who have a presence in the world that matters, and to me it was a question, was this in the first sign of something more systemic, and at this point in time, I believe it was not something that was more systemic.

But if you do see the industry a little bit, it is changing. We’ve seen a couple – certainly people whether it’s LinkedIn or Twitter or people having challenging business right now and I think that does cause people to tactically to try to optimize their spend rates.

I don’t think it fundamentally alters their strategy, I don’t think it fundamentally alters the infrastructure that they are putting in place that they deal with higher transmission requirements. But it does – necessarily try to optimize around when I am deploying that capital and I think that we’ve seen some of that.

I think we’re going to continue seeing some of that as some of the changing landscape, there is good news about lot of these, I think for people who are serving bandwidth.

I hate to see the companies that had difficulties but candidly in Silicon Valley, I am anticipating it’s going to be a little bit easier to hire people for a while, because there is going to be more caution than some of these companies that have to prove their valuation.

We are a company that is growing, we are structurally growing profitability, we continue to add to hire and I am hoping that this allows us the ability to continue to attract many people. End of Q&A.

This concludes our question and answer session. I would like to turn the conference back over to Tom Fallon for any closing remarks..

Thanks everyone for joining us this afternoon for your questions. We look forward to updating you on our continued progress. Have a great day..

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect..