Jeff Hustis - Head-Investor Relations Thomas J. Fallon - Chief Executive Officer & Director Brad D. Feller - Chief Financial Officer David F. Welch - Co-Founder, President & Director.

George C. Notter - Jefferies LLC Alex Henderson - Needham & Co. LLC Vijay K. Bhagavath - Deutsche Bank Securities, Inc. Simon M. Leopold - Raymond James & Associates, Inc. Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc. Douglas Clark - Goldman Sachs & Co. Stanley Kovler - Citigroup Global Markets, Inc. (Broker) Rod B.

Hall - JPMorgan Securities LLC Jess Lubert - Wells Fargo Securities LLC Tim Savageaux - Northland Capital Markets Dmitry G. Netis - William Blair & Co. LLC Meta A. Marshall - Morgan Stanley & Co. LLC.

Hello and welcome to the First Quarter Year 2016 Investment Community Conference Call of Infinera Corporation. All lines will be in a listen-only mode until the question-and-answer session. Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn the conference over to Mr.

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

Thank you, operator. Welcome to Infinera's first quarter of fiscal year 2016 conference call. A copy of today's earnings is available on the Investor 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, integration of Transmode as well as Infinera's financial outlook for the second quarter of fiscal 2016.

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 first quarter 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 first quarter 2016 conference call. Joining me today are Chief Financial Officer Brad Feller, and President Dave Welch.

Today I'll go over financial highlights for Q1 and provide an update on our business and (02:27) the market and how our recently announced technology advancements will help us continue to win market share.

I will then turn the call over Brad, who'll provide a more detailed review of our first quarter results and our outlook for the second quarter of 2016. We executed well in Q1 with revenues of $245 million, non-GAAP gross margins of 50%, and non-GAAP earnings of $0.19 per diluted share.

We continue to outgrow our market while generating industry-leading margins. While we are not yet able to generate 50% margins consistently, our Q1 result is a powerful demonstration of the value we deliver to our customers and the unique leverage we derive from our vertically integrated operating model.

We saw strength in the cable vertical and Q1 with multiple customers investing in long-haul and embarking on trials in metro. The ICP and wholesale enterprise verticals were also strong in the quarter as bandwidth growth and network architecture evolutions drive these customers to make significant investments in DCI, long-haul and metro.

These customers continue to make substantial investments to support the rapid network architectural shift to the cloud, a trend that bodes well for Infinera over time.

Overall, we believe the demand environment for bandwidth remains positive across our customer verticals and geographies, as workloads continue to rapidly shift to the cloud and trends such as 4K video, 5G mobile and the Internet of Things emerge – all driving increased bandwidth consumption.

We are seeing most customers continuing to build footprint and add capacity, although some are exhibiting more choppiness in their spending than we had anticipated. We view this as a near-term dynamic and are not concerned about the medium- to long-term opportunity these customers represent or the opportunity of the overall market.

Focusing on long-haul, we have seen some public statements suggesting that the long-haul market is saturated. We believe this is the wrong term, as saturation implies that the market has stagnated, which in our view is absolutely not the case. Let me be clear on what is happening.

In order to handle unrelenting traffic growth, long-haul networks have largely made the transition from 10 gigabit and 40 gigabit to 100 gigabit. However, bandwidth consumption is not slowing down, which means that capacity adds to existing networks and new network builds will be at 100 gigabit.

Instead of a concern, we view this transition as a tremendous ongoing revenue opportunity for Infinera.

Our systems provide the easiest, most cost-effective way for customers to add capacity by simply plugging in our 500 gigabit super-channel line card and taking advantage of our system, which is capable of delivering 12 terabits of capacity per chassis, a staggering amount that requires no new chassis or line system amplifier upgrades to bring online.

We believe the vast capacity capabilities of our deployed infrastructure and alignment with the fastest growing customers position us well to continue to outgrow the long-haul market this year and to grow our business substantially through the end of the decade. Turning to data center, Q1 was an outstanding quarter for Cloud Xpress.

We added 5 new invoice customers bringing our total to 25 and posted our best revenue quarter to-date.

CX with its high-capacity low-power and ease-of-use design is proving to be broadly applicable across our customer base to more ICPs, to data center operators like Equinix, to carriers like Windstream, and to enterprise customers which increasingly come to us via channel partners.

We expect the largest ICPs in the world will remain the most substantial players in DCI and we believe that we are well-positioned to earn significant market share from these customers. Today two of our top IC customers have adopted Cloud Xpress pervasively in their data center architectures.

Demonstrating their satisfaction with our solution and increasing adoption across their infrastructures, these ICPs continue to ramp volumes in Q1. We are having success expanding our data center presence with existing customers and also with the new prospects.

News that received a lot of attention at OFC with Microsoft's announcement that it would utilize PAM-4 models to address certain DCI applications. We were not surprised by this announcement and have consistently acknowledged that there will be certain DCI opportunities that will be driven by customer-specific requirements.

We agree with industry analyst ACG's recent assessment that a pluggable base approach like PAM-4 is more complementary to coherent-based solutions like Cloud Xpress than competitive.

Pluggables in general are likely to be attractive in shorter-reach fiber-rich environments for customers who can manage the higher operational complexity required versus a plug-and-play coherent solution like CX.

There are a broad set of different applications across the DCI market segment and we are unwavering in our belief that Infinera's long-term opportunity to be the DCI market leader remains firmly intact.

Our vertical integration of PICs, DSPs and software gives Infinera a structural technology advantage enabling us to deliver a high-capacity, low-power, and easy-to-use solution, an unparalleled combination of attributes that we know, based on our year-plus of interactions with CX customers the market values.

I believe we will continue to distance ourselves from the competition in the DCI market as we incorporate new technologies such as those offered by our recently announced Infinite Capacity Engine.

Now for metro, we continue to address opportunities in several large accounts and we're happy to report that we just closed a TM-Series deal with a very substantial customer, Telia Carrier recently rebranded from TeliaSonera International Carrier. This specific win has supported a 100 gig metro expansion in select U.S.

markets including a deployment in bay area as part of a new West Coast Low-Latency Route. This deal highlights the traction we're gaining with our customers for metro solutions as compelling extensions of traditional Infinera DTN-X long-haul enabled networks.

Additionally, reflecting a continuation of Transmode's previous success in metro, we won a number of smaller deals in the quarter and it continued to build our pipeline of prospective metro opportunities. I continue to be optimistic in regard to the Transmode acquisition.

The integration both from a process and product perspective is on track, and our Swedish team brings rich packet, metro, and access skills to the company.

One area in particular that I would like to highlight today, we are very excited about the capabilities that Transmode has brought in mobile fronthaul, a new architecture that is gaining traction from the impending rise of 5G mobile networks and drive the CRM architectures.

(08:33) estimates the global fronthaul market will grow from a couple hundred million dollars today to more than $1 billion by the end of the decade as mobile operators deploy a large number of radio heads and bring fiber to the tower to manage the massive bandwidth demands at the edge of their networks.

Although mobile fronthaul opportunity has resulted in competitors racing to announce product, Infinera is already winning real deployments with three fronthaul customers to date and multiple trials in progress with Tier 1 carriers.

Consistent with the rest of our portfolio, we believe our solutions' combination of low latency, minimal power and commercial availability will appeal to customers, as they seek optimal ways to respond to growing network traffic demands.

Closing on metro, while we have been clear that it will take some time to generate the synergies that we are expecting, our early customer wins and ongoing market opportunities give me confidence that we're on the right track. I continue to anticipate significant cross-selling success in the second half of the year.

On the technology front, at OFC we made one of the most significant announcements in Infinera's history, introducing the Infinite Capacity Engine, a multi-terabit optical subsystem powered by photonics from our new Gen-4 PIC technology and advanced electronics from our next-generation FlexCoherent DSP.

With up to 2.4 terabits of super channel capacity and reach up to 12,000 kilometers, our new technology is a step function in optical engine capacity that we believe will satisfy the market's bandwidth demands not only at attractive price points for our customers but also at attractive margins for Infinera.

Furthermore, the Infinite Capacity Engine will enable more agile and efficient intelligent transport network architectures. Our mission has always been to deliver an infinite pool of intelligent bandwidth.

The Infinite Capacity Engine is a significant step toward fulfilling this mission, as it enables network operators to pre-deploy up to 2.4 terabits of capacity in a single module and activate it on-demand in any direction with any color and any modulation.

This not only delivers more efficient architectures with up to a 50% lower cost of ownership than conventional approaches. It provides for the first time in the industry a truly flexible optical layer ready for SDN control. It's a game changer. Now, I know it's a complex concept.

We hope you will take the time to understand its full implications on network architectures. On the topic of SDN, I'd like to take a moment to address Infinera's approach. Over the next few years, we expect that our customers will increasingly be required to deliver customized on-demand services at the optical layer of their networks.

While the industry is doing significant work around the software aspects of SDN, it is important to understand that SDN solutions are only as good as the flexibility of the underlying hardware infrastructure. Truly flexible and scalable optical infrastructure requires a massive pool of pre-deployed intelligent optical bandwidth supporting it.

We're delivering that today with the PIC and taking it to the next level with the Infinite Capacity Engine.

As we did in supporting Telstra's delivery of the world's first commercial transport SDN deployment, we will offer open solutions that will work across network architectures and allow customers to use their controller of choice, whether proprietary, open source, or potentially from Infinera in the future.

Our objective in SDN is not to be a software company but instead to continue to deliver differentiated intelligent networks based upon dramatic and necessary hardware and software innovation that enables our customers to fully realize the benefits of SDN. In closing, I remain very optimistic about the state of our business.

Our customer base is healthy and broadening. Success in the short term will largely be dependent on the timing of our customers making investments in network upgrades particularly in metro and data center. While there is some uncertainty on this timing, we consider our customers making these investments a when rather than an if decision.

In the medium and longer terms, the trends are undeniably favorable. As a frame of reference, our introduction of Gen-3 PIC technology in the early part of the decade propelled us to a long-haul market leadership and was instrumental in building a large percentage of our current installed base.

We consider the new Infinite Capacity Engine based on Gen 4 PIC technology to be an even more significant technology leap and this time we have a strong installed base already in place that is hungry to leverage our technology advancements in their network with straightforward line card installations.

By continuing our commitment to innovation leadership and delivering the Infinera experience with each and every transaction, I am confident we will execute on the significant opportunities we have ahead of us. As always, thank you to our customers and partners for their ongoing commitment to Infinera and thank you to our employees around the world.

Now, I'll turn the call over to Brad for a more detailed financial review of the first quarter plus our outlook for the second quarter..

the cable operator, a wholesale and enterprise carrier, and an ICP. Following seasonal trends of investing in the first half of the year, we had a terrific quarter in cable with multiple operators investing in the networks to keep up with end customer demands.

The ICPs along with the wholesale and enterprise carriers, who carry a large volume of the ICP-driven traffic, also continue to be a source of strength for us.

Whether driven by use of the server traffic as people consume more and more media in their daily lives or whether by growth from server-to-server traffic as cloud architectures drive bandwidth multiplication, we do not expect bandwidth demand to subside anytime soon. As a result, we expect these verticals to continue to be strong into the future.

During Q1, we saw excellent revenue growth from Cloud Xpress, which helped offset seasonal softness in long-haul and metro. Although I think we're making good inroads in expanding our business, we are not yet seeing meaningful revenue from cross-selling opportunities or the new products we announced late in 2015.

From a geographic perspective, our largest customers drove strong growth in North America accounting for 71% of total revenue in Q1. Internationally, EMEA revenue was steady at 25% of total revenue, due to both success adding capacity to certain long-haul customer networks and steady contributions from our metro portfolio.

APAC and LatAm revenues were weak in Q1 at 3% and 1%, respectively, due to the timing of deployments in these regions. Service revenue in Q1 was $29 million, down 14% sequentially but up 11% year-over-year. Service revenue tends to be seasonally soft in Q1 as customers often take time to finalize their CapEx budgets, submit orders, and build networks.

As we continue our expansion in metro, we see the opportunity to further grow our services business. Moving now to gross margin and operating expenses, non-GAAP gross margin for the first quarter came in above our guidance range at 50.2%.

This exceptional result is a clear demonstration of our ability to deliver best-in-class gross margins in line with our intermediate-term target.

Our ability to deliver strong gross margins is attributable to a multitude of factors, including differentiated cost structures enabled by our vertically integrated business model, differentiated pricing strategies such as instant bandwidth, which benefit both our customers and us along with the ability to maintain a balanced portfolio of deals with overall strong profitability over time.

Additionally, we believe that our move towards offering purpose built products versus a one-size-fits-all approach will also have a positive effect on gross margins as we move forward.

Finally, we anticipate margin benefits from the Infinite Capacity Engine as we simultaneously increase the functionality of the PIC while driving down the cost per bit. While 50% gross margin in Q1 was a fantastic result, Q1 tends to be a stronger margin quarter as a result of the mix of revenues.

While it will take some time for us to get to a point where we can generate margins at this level on a consistent basis, we are confident that the combination of our operating model and the underlying strength of our business will enable us to consistently achieve 50% gross margins in the not-too-distant future.

Service gross margin also contributed to overall gross margin strength in Q1, increasing to 64% from 60% in Q4. Services margins in Q1 tend to be stronger due to lower levels of deployment services. Non-GAAP operating expenses of $93 million in Q1 were in line with the midpoint of our guidance.

In the quarter, we made incremental investments to support timely delivery of future product portfolio enhancements, including the Infinite Capacity Engine, and to expand our presence across emerging geographies and verticals.

To address our growing TAM, we plan to continue to target R&D expenses at 20% of revenue for the year, spend strategically in sales and marketing, and make calculated investments in G&A to bolster our infrastructure as we expand the solutions we offer in the verticals we serve.

Putting it all together for Q1 on a non-GAAP basis, operating margin came in above our guidance range at 12.3%, net income was $28 million, and EPS was at the high end of our guidance range at $0.19 per diluted share.

In Q1, the shares used to compute non-GAAP EPS were 147 million, down from 149 million in the prior quarter, primarily due to a lower stock price in Q1. Our strong profitability in Q1 exhibits our commitment to balancing investing for growth with maintaining strong profitability.

On a GAAP basis in Q1, we had net income of $12 million or $0.08 per diluted share. The difference between our GAAP and non-GAAP results was attributable to approximately $8 million in stock-based compensation, $6 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 generate cash in the business despite significant cash outflows in the quarter including the year-end bonus. Our total cash, cash equivalents, and investments as of the end of first quarter were $361 million, an increase of $4 million over the previous quarter.

In Q1, we generated cash from operations of $10 million, spent CapEx of $11 million, and realized $5 million in net proceeds from employee stock activities.

Now, for our outlook for the second quarter of fiscal 2016, as Tom alluded to, among certain customers we are seeing signs of spending lumpiness, driven by uncertainty around the timing of their investments.

While it is difficult to predict how long these dynamics could affect our results over the short term, the strong bandwidth demand environment, the customer experience we provide, and our differentiated technology gives us confidence in our medium- and long-term outlook.

For Q2, we currently project revenue to be $255 million, plus or minus $5 million. The midpoint of this range represents year-over-year growth of 23%. While we are disappointed with this outlook, we have had a very strong run of quarters, exceeding not only Wall Street's but our own expectations in what can be a lumpy underlying demand environment.

We remain very confident in our ability to maintain strong growth levels and to do so in an ever more profitable way over time.

As we have stated in recent quarters, while we expect to continue to outgrow the long-haul market, our ability to continue to significantly outgrow the overall market will depend on the success of the new products we released late last year and synergies associated with selling Transmode's products into the historic Infinera customer base.

The level of trial and eval activity, along with some early customer wins, suggest that we are on the right track with these new products, though it inevitably takes time to translate these positive signals into significant revenues.

Net-net, while we are experiencing a convergence of local and macro issues that we do not see as indicative of any longer-term trends, it is challenging to predict the timing of customer spending in our industry and to determine whether this is a one quarter dynamic or one that might persist further into 2016.

We currently project non-GAAP gross margin in Q2 to be 48% plus or minus 100 basis points as we expect new deployments across our product portfolio which we believe are important to our longer-term success to slightly offset the continued underlying strength of customers adding capacity to their long-haul networks and cost benefits from our vertically integrated model.

We currently anticipate non-GAAP operating expenses to be $95 million plus or minus $2 million as we balance the need to invest in key areas that will allow us to maximize our market share opportunity with ongoing profitability. 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 $500,000, and tax expense should be approximately $1.5 million. We currently project the diluted share count to be approximately 148 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 $0.13 per share primarily related to stock-based compensation expense and amortization of intangibles. In summary, I continue to be excited about the significant opportunities we have ahead of us and our ability to continue to deliver strong financial results over time.

My sense is that the release of our next-generation technology will be well-timed to meet impending customer opportunities across our portfolio and our unique business model will continue to enable us to deliver strong financial results.

We are making the right investments to ensure that we are well-positioned to respond to the macro trends that are driving explosive demand for bandwidth. In the not-too-distant future, I'm confident that we will be able to achieve our intermediate goals of 50% gross margin and 15% operating margin, even as we continue to outgrow the market.

We will share more with you about how and when we intend to deliver these financial results at our next Insight Infinera Analyst Day, which will take place in the third quarter. Stay tuned for more details.

In the meantime, we intend to continue to deliver strong financial results as we build the foundation for our next phases of growth and profitability. With that, I'm going to turn the call back over to Tom for some closing remarks..

In light of our Q2 guidance, I'd like to share some final perspectives. We're coming off a remarkable succession of quarters where our results and guidance exceeded the investment community's expectations. While we are disappointed in our Q2 outlook, we are also cognizant that our industry can be lumpy from quarter to quarter.

This being said, I encourage you not to allow the short-term fluctuations to blur your perspective of Infinera's tremendous long-term opportunity. We believe bandwidth demand will continue to remain incredibly strong driven by megatrends that will last for several years.

In addition to the ongoing migration of workloads to the cloud, we also see video as a key bandwidth driver as Facebook delivers video autoplay and Twitter announced their intent to stream NFL games. These types of services demonstrate the increasing importance of delivering high-quality video content towards ICPs.

ICPs are also seeing a bandwidth multiplication effect as their architectures increasingly distribute applications and replicate data, driving server-to-server traffic to grow even faster than server-to-user traffic.

Finally, we see network evolutions like the rise of gigabit cities, the Internet of things, and 5G mobile, all having multiplier effects on bandwidth demand as well.

We see these developments as guidepost of the broader industry's health as customers will increasingly value Intelligent Transport Networks as the optimal way to respond to this massive demand growth.

Our next-generation technologies are ideally suited and well-timed to address the emerging network requirements and will play an integral role in enabling us to continue to deliver highly scalable cost-efficient networks and the best customer experience in the industry. I am exceedingly optimistic about Infinera's opportunity.

By continuing to execute, we expect to gain market share across the end-to-end optical transport market and to deliver outstanding bottom-line results while doing so. Now, I'd like to turn the call over to the operator to begin the Q&A portion of the call..

Thank you. Your first question comes from the line of George Notter with Jefferies. Please go ahead..

Hey, thanks a lot, guys. I guess I wanted to sort of dig in on this discussion of lumpiness that you're seeing in the business right now.

Can you tell us anymore in terms of what exactly you're looking at? How many customers are we talking about here? Is this a reflection of any kind of product development issues or overhang ahead of the pending availability of the 2.4-terabit capability? Sorry for all the questions here. But....

That's okay, George. You want some understanding. I got it..

Yeah. I mean, is this related to certain products, long-haul, metro, Cloud Xpress? Is it related to certain customer types? I mean, any more you can kind of give us would be great..

So I'll walk you through probably more detail than I usually give because it is an interesting time. The overall environment, as I said on the call, I still see a huge amount of bandwidth demand. So I don't think that there's anything fundamental in the industry that's causing a problem.

I also think when I look at the business environment, it's neither great nor bad. It's kind of an okay environment. We see customers deploying. We don't see any kind of freeze on things. But there have been a couple of areas that are stronger and some weaker than others.

So on a strong perspective, Q1 bookings, for instance, in the long-haul market was the best bookings quarter we've had in a couple of years. For the CX product, we had record revenue and bookings in Q1. Both of those spaces did very well. In the metro market, I would call this – we've had a mixed kind of quarter.

We picked up new customers as you've seen. We announced today a really significant cross-selling opportunity. We've announced two of the three wireless front-haul architectural wins that we announced. We picked up several new smaller customers.

But we have one significant metro customer who has historically been part of the Transmode customer base and who hasn't bought for about two quarters. And there's nothing, I don't believe, that's structural there around the relationship. We believe that there is a big opportunity for us in the next quarter or so.

There's an opportunity that's been driven to them by one of their customers, and I think they get back on track soon. Having said that, it's a big enough customer that it's really tough to backfill that in the short term. North America was pretty strong in general. I continue to see it being strong. Europe was reasonable.

LatAm and APAC were a little bit softer than usual and a little bit softer than we had anticipated, though I don't think it's anything more than timing. So that's kind of where the overall business looks. I think overall, like I said, a pretty healthy.

One of the things that rattles around in my concern list is we've seen over the last couple of weeks Ericsson had a pretty concerning, I guess, result. Juniper's pre-announced. Both Microsoft and I guess Google kind of missed expectations.

And I have a little bit of pensiveness around me until I see more results of what's happening in the broader market. As I talk to the suppliers who sell us optical components, they're kind of calling it an okay environment too, except for China which is extraordinarily strong.

So I think China continues to drive a huge amount of component demand, and they're seeing the rest of the world just be okay, which is kind of where I see the world as being okay. We talk to industry analysts. They're still forecasting the overall (29:44) market to grow somewhere in the 7% to 9% range for the year. That's reasonable growth.

That's kind of been what it's been for the last few years. And if you look at our Q2 guide, it's kind of up – certainly below our expectations, below street expectations, but it's up quarter-on-quarter 4%. If the industry is growing 7% to 8%, that's not a terrible result. We're still gaining market share.

It's terrible from the perspective of what I think we can do and will do, but it's not a terrible result. So that's a fairly long answer, George, and that's about all the detail I can give you. I don't know if that helps or not..

Got it. So, that's super helpful. One quick follow-up.

So if I were to parse the delta relative to, I guess, pre-expectations for June, is it fair to say that most of the difference comes from this particular customer on the Transmode side or is that just one smaller component?.

I'd say most, but not all. There are other things that are less dramatic as a percentage basis, but that's, I would say on a percentage basis, the most significant one..

Okay. Thank you..

The next question comes from the line of Alex Henderson with Needham. Please go ahead..

Thanks.

I think that was very helpful discussion, but could you parse a little bit between the product and the installation services side of it? This variance in the quarter for us was on service, and so are we going to see a continuation of that? In other words, a fairly slow service and a little bit more skew to product in the quarter as you fill line cards and the like?.

Yeah. So, Alex, Q1 is normally a softer quarter for us for services because the deployment services tend to be smaller in Q1 because it just takes time for customers to finalize their budgets, purchase it, get it installed. So a lot of that revenue carries over and doesn't get recognized in Q1. So that's just more of a Q1 dynamic.

Obviously, if we talked about two other dynamics within services, one, as the installed base grows, the services revenues grow. But we are in a phase that it's more capacity adds versus new networks. So those two things will counteract each other a bit..

So the guidance for the June quarter is more biased to product than normal and the seasonal swing in service is probably less – is more dampened than normal?.

Yeah, I mean it's obviously services 10% to 15% of our revenues. So it's more of our product issue than it is a services issue that we're seeing from the revenue side of things..

Okay. Thank you..

Thanks..

Our next question comes from Vijay Bhagavath with Deutsche Bank. Please go ahead..

Yeah. Hey, thanks. Hey, Tom, hi, Brad..

Hi, Vijay..

Hi. So it's a solid execution in Q1. It's been a rough start of the year for many of your peers. So congratulations on the better-than-fair Q1. A question for you and a follow-up if I may. The question is on Transmode starting to hit the U.S. market, your U.S. customers. Help us understand the Transmode dynamics in the U.S.

Do you have a design win pipeline already in place with some of the major cable companies, et cetera? And would the third quarter be earliest in terms of getting revenues from these U.S. customers for Transmode? Thanks..

So we certainly have a pipeline of opportunities that we're developing with North America customers. The Telia announcement we made today is actually for their North America network. Telia's been a long-term Infinera partner. I believe we have 100% of their international North America backbone and now we're going to move into their metro.

And it's interesting because, obviously, Telia is headquartered in Stockholm, which is where Transmode is headquartered. But they were unable to craft a deal until we acquired them. And because of our great relationship with Telia we've now become an end-to-end supplier in the North American network.

It's one of our – it's not our first cross-sell opportunity, but it's one of our more important ones because it demonstrates we're dealing with a Tier 1 international carrier, that they value this end-to-end performance, they value the Infinera relationship, and they have confidence in us delivering that Infinera experience to them.

We continue to do a reasonable amount of growth in North America, and I believe in the metro for the Transmode product, most of the growth will come out of North America. We are investing heavily and as you know we have a significant portion of our customers and our revenue come from North America historically.

And I view a number of these as being potential TM-Series extensions of DTN-X networks. We're in different phases of trial, some with cable, some with wholesaler, some with – I can't remember if there's other markets we're those other markets enterprise through channels.

So there's a number of deals that we're working on with our current customers to see if they will pick them.

I think that, as I said, these take a long time because you have to not only find the right opportunity; you have to convince them that you are a compelling value proposition, and you've got to convince them to displace somebody that's already there. So it doesn't happen overnight.

I still believe we'll have a better sign or a better understanding of the opportunity in the second half of this year and that's where I think these cross-selling opportunities will start kicking in. But I do believe North America represents our best avenue for growth for that product offering..

Then a quick follow-up, Tom, is just a bigger picture question, that a landmark moment for the company would be starting to sell into the major U.S. telcos such as Verizon, AT&T. You think your entry point into Verizon or in AT&T would be the metro product or would it be like the data center optical product? Thanks..

Well, we – no, we constantly are working to sell to those guys. I think there's a number of potential opportunities. There's wireless fronthaul opportunities with our Transmode product. I mentioned that we've run three, and we're actually in trials or labs with another half a dozen or so.

I'm not going to mention which ones they are, but they're significant carriers. I think that cable represents – I mean, sorry, CX represents opportunities potentially for the carriers, AT&T and Verizon. And quite frankly, there's interest in our solution around SDN. So we're going to continue to work very hard to earn their business.

Having said all that, I just want to remind people my view. We're building a great business with or without the AT&Ts and Verizons.

I think we can continue to grow this business faster than the market because the people who are investing the most in network are the Internet content guys, the cable guys, and the wholesale and enterprise carriers and that's our – we are best positioned. I want the business. I want to earn the business. It will help us grow. We don't need it to grow..

Okay. Thanks, Tom. Very helpful..

Thanks, Vijay..

The next question comes from Simon Leopold with Raymond James. Please go ahead..

Great. Thank you for taking my question. So, I wanted to first see if I could clarify the sort of sources of weakness in terms of your commentary. It sounds like you're pointing to sort of two aspects. One is lumpiness in long-haul, but somewhat softer metro. And I want to get a better understanding of that softness in metro.

How much of that is sort of Transmode-related and how much of that is traction on the new XTC platform? And then in terms of kind of the longer-term trend, your exposure to ISPs' web-scale. I believe in the past you've talked about that as being 20%, 25% of revenue. I want to make sure I've got that number right.

And if you could talk to how you expect that trend evolves over the course of the next, let's say, one to two years, thank you..

Yeah. So, two questions. I'm going to take the first part on is it the TM-Series from Transmode of the XTC-2 family that we introduced. And they're two different things. So the TM, I think the softness that I talked about specifically with that one significant customer is a TM issue.

And the challenge is that as we're trying to win these and are winning cross-sell opportunities, it's too big of a hole to fill in the very, very short term. So, I think the TM Series product with that one customer is most of that issue. The XTC-2 is actually being well received into the market. We've won some opportunities.

We're being trialed in other places. But it's a relatively long sales cycle, and I anticipate that it'll take a few quarters to start generating meaningful revenue. So I can't backfill – we can't backfill that hole with XTC-2 right away.

Whether the XTC-2 is going to see a weakness in the market, which is might you'd (39:08) be asking, it's too early to tell because it's too early in the adoption cycle. I'm still very confident in our overall metro portfolio.

I do believe we'd fill that gap with the customer coming back, and I do believe the XTC-2 will be well received into the market. But it'll take another couple of quarters for it to generate any meaningful revenue.

Brad, can you answer the question on web-scale?.

Yes. So, Simon, we've said historically that each of our individual verticals are 20% to 25%. The growth in both Internet content providers and the enterprise and wholesale carriers has grown faster than the overall market. And obviously, the wholesale and enterprise carriers carry a lot of that traffic for the ICPs.

So those two verticals combined is more like half of our revenues today..

And how is that changing over the next one to two years?.

Yeah. I mean I think those guys are going to continue to grow at a very fast clip. We see the ICPs defining the next-generation architectures, they're building very aggressively with cloud, that kind of stuff. So my expectation is they will continue to be a very healthy chunk of the overall revenues..

Yeah, I think it's going to be very healthy. Whether they're going to be growing as a percentage or not, uncertain, because I anticipate we're going to go and be more successful going into metro markets, enterprise markets, those types of things. So I think that they will be an important part. They're going to continue to grow a lot.

Whether their percentage grows or not, I actually hope not because I think that we need to grow the rest of our business even more..

Great. Thank you for taking my questions..

You're welcome, Simon..

The next question comes from Sanjiv Wadhwani with Stifel. Please go ahead..

Hey, thanks. Couple of questions. Tom, on the large customer on the Transmode side, what gives you the confidence that it is going to come back? It looks like you're saying it's probably going to come back in the next quarter or two quarters, I guess.

Is there a new build over there or something else going on that gives you that visibility? And then one quick question for Brad. In terms of the gross margin strength in Q1, you talked about a mix being sort of different in Q1 that impacted gross margins positively. Can you just give a little more detail on that? Thanks..

Yes. So, why do I have confidence in it coming back? It's been a long-term customer that had a very good relationship previously with Transmode and with us.

We've talked to them about their business and why it has slowed down, and there's a specific opportunity that they've won or are close to winning that when that happens their intention is to reinstigate significant purchases with us. Until it's done, it's not done, but I have every belief that what they're telling me is true.

I have no reason not to believe it. And then timing becomes a question. Is it a Q2 or a Q3? We're obviously not counting on it being in Q2..

So, Sanjiv, to touch on your gross margin question, it's a combo of things. One, obviously, the deployment services being less, as those are less than corporate average margin, that pushes up the services margin and the overall margins. Also, Q1 being more capacity adds, those capacity adds tend to deliver much higher margin profile for us.

And we've said that our margins ongoing will be steady in that 47%, 48% range, but that it could move a point or two either way, based on the mix of the business..

Got it. That's helpful. Thanks..

Okay..

Next question is from Doug Clark with Goldman Sachs. Please go ahead..

Hi. Thanks for taking my question. It was interesting that you didn't call out cloud or Internet content providers for the second quarter guidance. I'm wondering on your expectations for the second quarter, if indeed you expect that to grow off of a record first quarter.

And then similarly and related, are you seeing any change in the competitive dynamic? A few of the large competitors are now a little bit more pronounced in the market, so I'm wondering if that's factoring into purchasing decisions as well..

Well, I'll take part of it, and then I'll let Brad and Dave answer part. I don't think in our guidance we've ever called out any kind of guidance in the future except here's our revenue, here's our margin, here is our earnings. So we don't do anything around any specific market when we're giving our guidance. So please don't read this as unusual.

I believe we're going to have – in regard to ICP market, we sell a lot of different product into that market. We sell DTN-Xs; we sell CXs. I assume you're talking about the CX, and I anticipate another strong quarter on CX. Whether it will be a record quarter, I don't know.

But it's going to be a strong quarter on the back of a record quarter, and it's going to be from a couple of new customers that we've just won and haven't been announced yet, and it will be mostly driven by the same people who have driven this growth over the last couple of quarters.

So I'm still very positive on the cloud market and our position in that cloud market from a growth of customers and pervasiveness within the customers we've won.

Dave, you want to comment at all on new competition we're seeing in that market?.

Sure. This is Dave Welch. There are products that are slowly coming online. To address this, for the most part we aren't seeing that as having any major impact on our market share for that.

They are comfortable with our deployment processes, our capacities, our densities of our current CX products and they've shown tremendous excitement about our future-generation CX products..

All right. Thanks for that. And then my follow-up question was on the Infinite Capacity Engine. I know you talked about a timeframe of later this year in terms of product introduction.

Can you give us a little bit more specificity in terms of what the timeline for seeing product in market could be?.

No, we're going to go and announce – we're going to have Infinera – Insight Infinera in Q3, and we're just going to have to make people wait..

Got it. Thanks..

The next question is from Stanley Kovler with Citi Research. Please go ahead..

Thanks. I just wanted to ask if we can get some clarification on any FX impact around Transmode as well.

And if I think about Transmode sequentially and then into Q2, can you help us understand the operating level of revenue that Transmode is on versus when you bought the company? I was thinking like it's somewhere between $150 million, maybe, and $180 million in revenue that they were on track for – approximately heading into 2016 and how that compares to where you see them now.

And I know that you haven't explicitly given your guidance but just curious on that.

And then separately, on the product cycles outside of the European customer, can you help us understand how the products from September are tracking versus your prior product cycles with DTN-X and how it compares at this stage of the game along that adoption curve? I have a follow-up. Thank you..

Okay. Stan, I'll try to address each of the components you brought up. First, on FX, like any company, the devaluation of the euro over the last year for customers that we have things denominated in euros obviously hurts us.

But it's something that we factor into our guidance, that we put hedging in place where we can, and like anyone, like I said, it impacts us but it's not a huge driver in the overall results. But it is a headwind for us. In terms of your question on the Transmode side of things, we're not, as we said before, going to break out that business separately.

But I just want to clarify one thing. You said $150 million to $180 million run rate. They were more on a $120 million to $130 million run rate if you looked at last year. And we continue to be happy with what that business is doing.

Obviously, as we continue to get cross-sell opportunities, we'll be able to expand that business, and longer-term put our vertically integrated technology into those products.

In terms of your question on the product cycles, as Tom mentioned, we've seen good traction on some of the new products, whether it's the Transmode gear, whether it's XTC-2, whether it's XT. Inevitably, though, those things, from a, they're interested, they've given us a design win, to actually significant revenues, it takes time.

I wouldn't say it's any different than past cycles per se. I would say it's fairly normal..

Yeah. It's certainly different than when we originally launched the DTN-X because the DTN-X was a step function of capacity improvement replacing basically the DTN, and a vast majority of our customers who had DTN migrated very quickly to DTN-X.

So it was a market that we already had a very dominant position in and it was our next generation in that same market. These new platforms are taking us into new markets where we're having to typically replace an incumbent that's not us.

So it's going to be slower than certainly the DTN-X ramp, but as Brad said, we're comfortable with the trajectory that we're on. And I think by later this year we should have some – we'll meaningfully know if it's going to impact revenue in a positive way..

Thanks. And just to follow up, outside of the European issue, how are we thinking about the seasonality of CapEx for this year? I mean, obviously, it seems like first half of the year is turning up to be a lot weaker than prior years; in terms of seasonal patterns, more back-end loaded.

Are you thinking about giving more of a full-year outlook? And besides that, how are the carrier decisions around NFV and SDN and these changing architectures factoring into the push-out of their decisions on new products? Thank you..

So I'm going to take part of this first. You've said a couple of times that the European customer we mentioned – you're drawing a conclusion that we mentioned a European customer. We said, a customer, and I would encourage you not to geographically assume. In regard to CapEx spending, like I said, I'm seeing an okay environment in general.

I'm not seeing anybody saying we're scared to spend, or our corporate's coming down and saying there'll be no expansions. I'm not seeing people throw caution to the wind and a build-it-and-they-will-come model either.

I'm seeing pretty rational behavior in spend, and what I continue to believe is that what's going to continue to drive the expenditure is just raw bandwidth requirements. There is nobody telling me – I mean nobody – that they're not seeing a continued growth in bandwidth.

And as long as there's a continued growth in bandwidth I feel very comfortable we're going to continue to grow the business. And that will trump FX issues, it will trump a problem here or a problem there with a customer. And I am as bullish as I've ever been on the bandwidth environment in the medium- and long-term.

It is very fundamental, the things that are happening. In regard to NFV and SDN, I think we see more and more requests for SDN and NFV, particularly for us SDN, to be presented to them our solutions.

And I think we do a fairly good job of articulating a very cogent strategy and the value proposition of both our SDN solution, but more importantly the underlying hardware of our intelligent optical network. And I think we – this summer you'll see us make some more announcements, and in August you'll hear a whole review of it.

And I think, actually, SDN positions us very well to sell more optical gear. I think I've said this before, and I mean it. Our architecture was built to be SDN-ready. It's not because we saw SDN but we saw what an intelligent optical network can do.

And I do believe that the more pervasive SDN becomes the more applicable Infinera's architecture is within that. Unlike the router guys or the switch guys, our stuff's not going to be subject to NFV. People aren't going to virtualize what we do. A photon going from A to B takes what we do, and no software's going to replace that.

All of these things to me are exciting because it makes the optical layer more strategic. Having a giant pool, an infinite pool of intelligent bandwidth is what enables SDN and NFV to come to life. If you have constrained optical capacity, you can't have a responsive, adaptive network.

We have the most unconstrained optical capacity, scale of capacity, because of our PIC design. It pumps me up..

Thank you. The next question comes from Rod Hall with JPMorgan. Please go ahead..

Hi, guys. Thanks for giving me a question. I've got two, I guess, for you. I wanted to go back to the gross margins because you guys disclosed products and services gross margin at the GAAP level. And both of them moved up pretty healthily in the quarter, and so I just – yeah, I know, Brad, you made that comment about mix affecting the margins.

But on an isolated view, are the products and services gross margin you guys are showing us here in Q1, how sustainable are those? And why should – if you're going to tell me they're not sustainable, why should we believe they do back off again? And then I've got a follow-up..

Yeah. The services side I think are sustainable because obviously, the more the follow-on maintenance services grows and the install base grows, that is obviously very high margin profile. Now, from quarter to quarter it can move around a bit based on how much deployment revenue we have, but over time, I think they will sustain at this level.

The product side, as I said before, can move around a point or two from quarter to quarter. And obviously, we wouldn't be talking about an intermediate term of 50 points of gross margin if I didn't think we could do it on a consistent basis. We're just not there yet.

We will have quarter where we would hit it, but it's going to take us a little bit more time to sustainably be there quarter-after-quarter. And it's really just largely mix-driven. And it could be reserves in the quarter; it could be warranty cost. There's a lot of things that are involved with margin. They move things around point or two in a quarter..

Okay. And then – yes, thanks for that. And then my follow-up was, Tom, in your opening comments, you talked about this misperception of long-haul. And I think a lot of people see long-haul as either on or off, it's 100 gigabit or it isn't, and of course there were a lot of (54:15) long-haul and the penetration of (54:17) i it's what matters.

And I just wonder if you could talk a little bit about – do you know what the penetration rate of 100 gigabit at a (54:26) is in the long-haul networks? You have any idea? I mean, if you could give us any color on that?.

Yeah. This is Dave Welch. I think I'm going to break your question into two questions there. The pertinent questions are what fraction of new bandwidth going in the ground is 100 gigabit versus 10 gigabit. And the answer is the majority of long-haul traffic bandwidth going underground right now is 100 gigabit.

That is – the second important question is how much is that traffic and continue to grow. And the growth vehicles that drive this are substantial and are multiyear in there. You've got more and more services. Tom mentioned video services, cloud video services, and then you've got 5G migration on top of that.

So you've got an underlying pressure where you've got access to the individual via the move into 5G that is going to drive substantial access bandwidths up. And then you have – that hits a data center multiplier on top of that that is going to drive a lot of that traffic out over to long-haul. The old networks had kind of a rough 80%/20% rule.

The voice network had an 80%/20% rule where 80% was local and 20% was long-haul. Now that the long-haul has allowed large content of data-center-to-data-center interconnect traffic that no longer holds. And much more of the total bandwidth traffic will be in the long-haul sector as opposed to isolated in a metro access sector..

But Dave, do you have any idea how many wavelengths out there are 100 gigabit-stage versus other speeds? I mean I would think it's a pretty low number but I'm just curious if you ever seen any quantification of that..

Total bandwidth deployed in 100 gigabit is greater than total bandwidth at 10 gigabit right now..

Yeah, that's 80% of the 100 gigabit. It's not the number of waves, but it's 80% of the capacity, I think, is at 100 gigabit today..

Okay. All right. Thanks, guys..

Thanks..

The next question comes from Jess Lubert with Wells Fargo Securities. Please go ahead..

Hey, guys. I also have two questions.

First, for Tom, I was hoping to understand given some of the choppiness you're seeing to what extent there's been any change in your market growth expectations for the year across the different verticals, and to what extent you do expect the business to strengthen or return to normal seasonality as you look out towards the second half of the year? And then for Brad, I was hoping you could help us understand how you're thinking about the need to invest moving forward and to what extent you might continue to invest ahead of sales if the business remains sluggish beyond the June quarter?.

Yeah. So, what we've been clear on is our expectation has been that we will grow faster than the market. That's not very useful because we are really in the long-haul market now, the metro market, and the cloud market.

And my anticipation is that we need to grow faster than the market certainly in long-haul and faster than the market certainly in metro. The long-haul market is supposed to grow 7% to 8% for this year and we will certainly stay to our commitment that we're going to go faster than that.

The challenge is we've probably grown three times the market rate the last few years. I had no anticipation of growing three times or even double the market rate this year in long-haul because if you look at our market share in long-haul, certainly in North America, we're going to have a hard time growing much faster than the market.

We have just too large of a market share. So we have to continue to expand outside the market. So you should assume in the long-haul we anticipate beating the 7% to 8%. In the metro market, it's forecast to grow roughly the 8% to 9% range.

We're obviously a relatively new entrants in that with the opportunity to cross-sell a lot of TM-Series platform, which I believe we can go do; and then the introduction of the XTC-2 family. So we should be able to go certainly faster than the metro in that space.

The one caveat being it's a lot of new products for us to introduce and that takes a bit of an adoption cycle. In the cloud market – the CX market, that growth is all over the map of what industry analysts expect. And I think we're going to continue to grow rapidly there, but I don't have a good sense for what – really how fast the market will grow.

And we're going to be challenged there. If you look at the what is called the pure play, dedicated, purpose built cloud box, we had 100% of the market last year because we basically created the market with the CX. So we're not going to maintain a 100% market share.

There will be competitors who have introduced some products – some of them look pretty good – that will win some market share. I do believe that we can grow certainly more than double-digit growth in that market this year without question. The question really becomes, to me, how fast will that market grow.

And it's really hard to get an understanding of that. We get better, probably, data from our customers than we get from industry analysts. So I'm anticipating that will continue to grow at a good clip..

So just to address your question on OpEx and investment. We've talked about for a while that 2016 is going to be a year where we need to invest. We are going away from just being a long-haul company that's attacking $5 billion market and now addressing markets that are expected to be $12 billion to $15 billion over the next several years.

It's critical that we get out the next-generation technologies. So as I mentioned, we'll stick to the 20% of revenue in R&D to make sure we get the next-generation technologies out. We continue to invest in the sales side of things to make sure we got the right resources to attract the broader markets.

That being said, we will look at certain spend to make sure that we're spending on the most important things and put some restrictions. But let me be clear, we will continue to invest..

We will continue to invest but, I'll be also clear, we're not going to invest with the expectation of making that increased revenue. We're kind of a pay-as-you-grow kind of company. We'll continue to invest in R&D because I firmly believe in the opportunity ahead of us across the next several years.

I believe we have a lot of opportunity to grow our revenue with our current investment in sales. We're going to hire selectively. But I think we will look carefully about expanding G&A and those types of things..

Is it feasible to think that operating margins in the second half to be flat relative to the first half?.

It depends. We're not going to go that far out..

Thanks, guys..

Okay. Thanks..

The next question comes from Tim Savageaux with Northland Capital Markets. Please go ahead..

Hello, Tim.

How are you?.

I'm doing all right. Thanks. Good afternoon. Clarification on the previous discussion about, I guess, the Transmode customer issue with regard to its impact, whether that's commentary about Q1 just reported or Q2 anticipated. And I guess my confusion tends to be some degree from, you had a very, very sharp drop-off in Latin America.

And so, I guess, is that – and yet we're still able to put up some pretty good numbers for the quarter. So is there a relationship there? And is that – I guess is that looking backward or looking forward commentary with regard to Transmode customer issue? And then I've got a quick follow-up..

Yeah. It's not a LatAm issue at all from a metro perspective. LatAm – Brad can comment on LatAm in general. We're seeing lot of opportunity in LatAm. I would say it's more seasonality in LatAm than anything else.

In regard to the TM customer, whether it's a backward looking or forward-looking, the answer is yes, it's backward-looking for Q1 and it's forward-looking to Q2, so both..

So Tim, it's one of those things where they've slowed down spend. We still think it's a healthy customer and will be a good customer over time. They've just significantly slowed down their spend. We don't think it's a competitive issue. It's just a timing thing.

LatAm, Q1 is always going to be a lighter for us both in LatAm and APAC, just because it's a decent amount of it is subsea, which, as I commented on before, to be able to turn on those networks in Q1 tends to be more difficult. And it's a little bit just timing of customer spend. I expect LatAm and APAC to recover for the most part going forward..

Okay. And then just sort of follow up quickly on that, so – and assuming, as I would, that it's a relatively small amount of Transmode's revenues coming in the door for U.S.-based – I know you're trying to grow there. But assuming that's relatively small, you mentioned a pretty strong U.S. number.

I think if you make some assumptions, you're talking about 30% type year-over-year growth, and overall kind of mid-teens organic growth for Infinera. As you look at either one of those metrics, U.S.

or organic revenue, would you expect those are – it might – are those growth rates for Q1, I think, in the ballpark? And would you expect, I guess, to continue double-digit revenue growth for Infinera on inorganic basis, as would seem to be implied here based on how you can see your trends (01:04:03) on major customer commentary?.

Yes. So, we'll probably not going to get as exact as you would like us to get, Tim, but the growth year-over-year obviously is – Q1 last year we didn't have any Transmode. Transmode's existing business has been steady sans that big customer that Tom talked about, and not a lot of cross-sell synergies yet.

So it's mid-teens growth for the Transmode business; it's mid-teens organic. And going forward, we'll see what the mix turns out with as we go forward..

Okay. Thanks guys..

Thank you..

Next question comes from Dmitry Netis with William Blair. Please go ahead..

Thank you for squeezing me in, guys. I've got a couple of questions here, very quickly. On the Transmode, sorry to beat a dead horse here. but would I been incorrect also assuming this was historically the largest customer of Transmode that you saw weakness with? I mean can't we....

We're not going to go there (01:05:28).

It was among the biggest. We can't go any more specific than that..

Yes..

And you made a specific comment that – I was just trying to see, was this not a European customer? Is it clear that it's not a European customer or (01:05:45).

No, I once pointed out – somebody drew a conclusion that it was European. I didn't say it was European, and I wanted to make sure that other people didn't have me implying then that it was European. I'm just making a comment it was a large customer. So I'm going to leave it at that, Dmitri..

All right. Fine. Let's move on to a different topic then. The PAM-4 side, Tom, just to kind of get your perspective – I know you spent sometime in the script, and we appreciate that view.

But to what extent or what percentage, I guess, of the DCI market do you think this technology can carve out? Have you given that some thought, that short reach PAM-4sof direct-detect technology? And then can you play in that market potentially? I know you – can you do a line cost (01:06:31) maybe or something to that effect? You have a very good partner in Arista that you signed.

I mean, how should we think about that?.

Well, I'm going to break it into a couple of parts, and then I'm going to Dave who's certainly more technologically savvy than I am to answer. I look at the PAM-4 opportunity in the short term as being an interesting architectural and marketing statement that has, I think, zero viable market share this year.

So I think that it impacts our market this year zero percent. And I like what Andrew Schmitt has recently – he's the new – Cignal AI Consulting Group he started. And he's pretty astute engineer. And he estimates that the PAM-4 market will be about a $50 million to $100 million market by 2019.

So by 2019 most people say that the cloud interconnect market will be a few billion-dollar market and this represents $100 million opportunity in that market. And he says PAM-4 is a short-termed tactical opportunity that will be marginalized as cost and power density of coherent improves. And I would agree with that.

If you look at the history of capabilities that are semiconductor-driven, power and size improve over time. And I believe coherent will continue to be demonstrated the right solution. PAM-4 is not a solution today. It's a potential solution for later and the short-term opportunities may be a couple of years.

So I think one of the things I like to say is I think it's a flash in the PAM is what I really believe about this technology.

Dave, why don't you add some technology to that discussion?.

Sure. I think this portion of the market that is successful via PAM-4, as Tom indicated, is something of shorter reach, and that I would tend to characterize that something as certainly on-campus type of architecture.

And for an application, that is stuff going outside of the building to minimize the amount of traffic that will be able to be accessed by the PAM-4. So I don't see it displaying a – it will play a complementary architectural role to high-capacity coherent pipes.

And further, coherent is going to continue to march down the path for very high-capacity lower-cost and lower power structures going forward..

And you guys don't have any intention of playing in that market potentially? As you said, it's potentially maybe just 5% of the total market by 2019..

So we don't have any intention in playing and whatever called the pluggable market of which PAM-4 is a participant in..

Okay. Great. And then....can I ask one more? Or.....

Yeah..

Make it quick..

Make it quick..

Very quickly on the 2.4 terabit, and I think this question may have been asked by actually the first person on the call.

But as you introduce the PIC, what was the response of your customers? And would you – or have you seen any posturing? I guess I'm looking at the downside of this, potentially, how customers come back to you saying, we'll wait for that product as opposed to buying the existing 500 gigabit product? Can you talk to that a little bit?.

No, we're seeing customers continue to buy the bandwidth that they need. They're always looking to bring online as our customer and their applications required; there's no change in that. Remember most of our customers benefit from programs like 10 gigabit in 10 days or 100 gigabit in 10 days.

And so the overhang is – minimal overhang of that at this point. They're excited about the operational simplicity that's added by going to deploying 2.4 terabits at a shot, very excited about how it integrates into our flexible optical infrastructure. So that – all things are going well in that front..

There's really not a worry in this architecture because our customers can take these new cards with the new PIC and slide them right into a DTN-X chassis. So this is not like they have to say, oh my God, do I have to buy a new chassis? You don't. Your investment-protected for this new technology..

The next question is from Meta Marshall with Morgan Stanley. Please go ahead..

Hi, thanks for taking my call. Just a quick question on whether you think that kind of getting the PIC into the TM-Series or into some of the Transmode series is critical to kind of expanding that base or kind of the cross-selling opportunity in your core customers..

I would say the cross-selling opportunities is really driven by customers that have an Infinera product now, that they like our operating system and they want to be able to roll that out to more and more applications. And for the most part, I'd say almost probably 75% or 80% of our DTN-X customers have an interest in doing that.

That's driven by operational simplicity. It's driven by being able to turn services up on Infinera gear from end-to-end and the benefits that come from that. On top of that, the TM-Series becomes that much more stronger as we integrate our PIC technology on to their platform.

It gives us a greater density advantages, it give us some interoperability advantages, it gives us some cost structure and power advantages as well. And they look at that, absolutely you see the upside..

Okay. Great. And then just a quick follow-up on with some of your cable customers, I think some of them will change focus to DOCSIS spending later on in the year.

And is that something that you will think will change spend on your products and there's kind of accelerating spend now or is it just unrelated kind of the pattern of spending on your products?.

I think two things. Cable invariably spends most their money in the first half of the year, and we're seeing good spend from cable. So we won't have a good picture for next year's cycle until certainly later this year.

But I think as long as bandwidth continues to be a driver, and I don't see anything in the cable space that says bandwidth's not going to continue to be a driver, I'm comfortable that that market is going to continue to be good.

And I actually think we have an opportunity to grow overall in the cable space, leveraging the relationships the Transmode is bringing to the table..

Great. Thank you..

Thanks, Meta. (01:13:53).

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

Thank you. The conference is now concluded. Thank you for attending. You may now disconnect..