Jeff Hustis - Infinera Corp. Thomas J. Fallon - Infinera Corp. Brad D. Feller - Infinera Corp. David F. Welch - Infinera Corp..

George C. Notter - Jefferies LLC Vijay Bhagavath - Deutsche Bank Securities, Inc. Stanley Kovler - Citi Investment Research (U.S.) Dmitry G. Netis - William Blair & Co. LLC Simon M. Leopold - Raymond James & Associates, Inc. Alex Henderson - Needham & Co. LLC Rod B. Hall - JPMorgan Securities LLC Patrick Newton - Stifel, Nicolaus & Co., Inc. Michael E.

Genovese - MKM Partners LLC.

Welcome to the Fourth 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 like to turn the call over to Mr.

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

Thank you, operator. Welcome to Infinera's fourth quarter and 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, as well as Infinera's financial outlook for the first 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 fourth 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'd 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 2016 conference call. Joining me today are Chief Financial Officer, Brad Feller; and President, Dave Welch. Today, I'll review our performance in the fourth quarter, take a look back at 2016 and also share thoughts on our opportunities in 2017 and beyond.

I will then turn the call over to Brad, who will provide a more detailed financial review of Q4 and 2016, plus our outlook for first quarter of 2017. In Q4, we delivered revenue of $181 million, non-GAAP gross margin of 42%, a non-GAAP loss of $0.12 per share.

Revenue came in at the high end of guidance driven by strong performance from our data center business and solid growth in EMEA. In Q4 DCI demand was robust with Cloud Xpress recovering from timing-related softness in Q3 to deliver another strong quarter of revenue.

Even with CX2 on the horizon and a number of competitive solutions in the market, we added six new CX customers in the quarter and enjoyed growth from our existing large ICP customers.

EMEA was also a bright spot in Q4, growing 30% sequentially and 12% year-over-year, driven by solid results from our largest metro customers and some new footprint wins. On the topic of metro, I'm very pleased to report that in Q4 we received an initial metro order from a large North America cable operator.

While the ramp for this customer should be gradual, over time I expect this to develop into a sizeable opportunity. This deal represents a major milestone in the evolution of our metro business, and I commend our team on the win.

Overall, while I see challenges over the next couple of quarters, my expectation is that as we introduce our next generation products and continue to deliver the Infinera experience to our customers, we are well positioned to begin improving our financial results over the course of 2017.

Now, I'd like to take some time to look back at 2016, a difficult year financially, though a year which I believe will prove to be pivotal in increasing our technology differentiation and building out our end-to-end portfolio of solutions.

The issues we faced in 2016 were functions of our historic overexposure to long-haul, significant consolidation in our customer base and technology insertion that lagged market opportunity.

I am confident that the steps we've undertaken to diversify our product portfolio, expand our customer base and ramp-up our technology cadence will enable us to achieve sustainable growth over time.

Continuing to drive our strategy of becoming a multi-product, multi-market company, we announced a number of new technologies and products in 2016, highlighted by the Infinite Capacity Engine, which we refer to as ICE4, and also earning our first deployments of Xceed SDN platform.

Additionally, we announced several products that will come to market this year, including Cloud Xpress 2 and XT-3300 meshponders, both of which are geared towards increasingly disaggregated web-scale architectures; XT-3600 meshponders for service providers, high density metro and long-haul networks; higher capacity DTN-X XTC line cards and switch upgrades; and enhanced XTM metro platform, which delivers 8X increase in density and 16QAM modulation; and finally, a new chassis and modules for FlexILS, the industry's most widely-deployed flex-grid open-line system.

Turning to operations, in 2016, we continued to generate a majority of our revenue from long-haul, despite the downturn we experienced in the second half. The general slowdown in the long-haul markets we serve was exacerbated by significant consolidation amongst our largest customers.

As this dust settles, we still maintain strong market and mind share in long-haul and believe we are well positioned going forward. We also believe that spending in the long-haul market will resume growth and pose a significant opportunity over the next several years. A subsea market is a prime example of the timing challenge we faced in 2016.

Subsea, a business that has traditionally been strong for us, saw a double-digit percentage revenue decline as we missed out on footprint opportunities requiring ICE4.

My conversations with customers at PTC, where we recently unveiled our next-generation of subsea products, gives me confidence that our new offerings will prove compelling and enable us to regain and ultimately grow market share in subsea. As for data center, 2016 was an exceptional year for our Cloud Xpress platform.

We ended the year with 33 invoiced customers, 13 of which were new in 2016, and saw our revenue more than double year-over-year. In addition to our largest ICP customers continuing to grow, we made solid progress winning several new CX customers in a rapidly-growing next tier of ICPs that are building their own DCI infrastructures.

As we look back to when we brought Cloud Xpress to market, our hypothesis that high capacity server-like solutions would be increasingly important has largely played out.

Not only have ICPs placed a high degree of importance on Cloud Xpress in their data centers, we also expect the CX and XT solutions will become more pervasive as service providers adapt web-scale architectures.

Moving now to metro, we made positive strides forward in 2016, completing the Transmode integration, progressing on SDN control across the portfolio, and winning deals with both XTM and XTC solutions. Similar to the early days of Cloud Xpress, we were too optimistic on our timeline for Metro.

This being said, we are now seeing a number of positive signals that are encouraged by the solid momentum with which we ended the year, highlighted by metro revenue in EMEA growing 16% year-over-year in Q4.

On the customer front, in 2016, we won a combined 44 new XTM and XTC metro customers, ranging from smaller deals sold through our expanding global channel program to larger direct sales. I continue to believe that we have the right solutions and team, and we will continue to win new metro opportunities with our installed base of long-haul customers.

Looking now to 2017, consistent with industry analysts, we anticipate the overall market outside of China will grow around 5%, comprised of low-single-digit growth in long-haul, high-single-digit growth in metro and continued significant growth in small form factor DCI.

Geographically, North America persistent growth in cloud traffic should drive spending with ICPs and wholesale enterprise carriers. This is offset by uncertainty, created by the impact of customer consolidation, making the overall uplift for the region in 2017 unclear.

Outside of North America having ended last year with strong momentum, Europe has potential for solid growth in 2017, driven by spending in metro and DCI. As for LATAM and APAC, we see a particularly good market in subsea and have strong expectations for ICE4 products.

Our ability to outgrow the market in 2017 will be largely dependent on our success and timing in delivering our next generation product portfolio, for which there is clear pent-up customer demand. I'm pleased to report in January we shipped our first Cloud Xpress 2 units to major ICPs for lab testing.

My expectation is that CX2 will begin to ship for revenue in the next couple of months with revenue contributions starting in Q2. Additionally, we have hosted major ICPs in Infinera's lab to test the XT-3300 with planned delivery in Q2.

Finally, we have multiple ICE4 subsea field trials with major customers being scheduled for the first half of the year.

In addition to creating market share opportunity, ICE4 will also enable us to improve our cost structure, which was challenged last year by our technology transition and heavy market-based pricing pressure, as evidenced by Dell'Oro estimating that 100-gig ASPs declined 29% in 2016.

In 2017, I expect pricing compression to subside, but remain higher than usual, a dynamic for which we are well situated given the cost structure enabled by ICE4 and our vertically integrated business model. On the technology side, our path forward will be in three distinct paths.

First, we'll increase the cadence of optical engine delivery to every two years. While ICE4 is coming to market now, we already had working 600-gig per wave gen-five PICs in our fab.

We believe the combination of increasing delivery speed and our unique capabilities around optical integration will drive differentiated value for our customers as they seek scalable, yet cost-effective solutions to manage massive growth in bandwidth demand.

Our accelerated cadence will also enhance our ability to maintain and expand presence in key accounts, as customers anticipate future developments and benefits from our new technologies more frequently. A second path forward will be our commitment to lead in the open network philosophy that is becoming instrumental in the Layer T and C architecture.

Open has two fundamental characteristics. First, there is transponder and line system compatibility, basically the ability to operate vendor A's transponder over vendor B's optical line system without penalty.

Infinera was a pioneer in selling our transponders over competitor line systems in the subsea market and now we are driving the same approach into terrestrial networks.

A truly open network enables customers to benefit from having the ability to always choose the best-performing transponder, a dynamic we believe presents a substantial opportunity for Infinera given our technology and cost structure advantage.

As part of open, we've also widely deployed what we believe is the industry's most open line system, which accommodates single waves and super channels over a flex-grid structure that optimizes spectral efficiency as contrasted with the fixed grid line systems typically offered by our competitors.

The flex-grid capability is critically important for customers who desire a future-ready line system as it naturally accommodates higher baud rates and newer modulations like 64QAM and beyond.

While our line system will support competitive transponders, my expectation is that when the choice comes down to which vendor has the most compelling solution, Infinera will fair quite well and I look forward to this battle. A second characteristic of open is the ability to seamlessly integrate with other network management and control systems.

This requires SDN software with an open APIs, which Infinera is delivering through our Xceed Software Suite. As an active member in the Telecom Infra Project and the first Transport SDN vendor to receive the Powered by OpenDaylight certification, I'm confident that our customers will acknowledge Infinera's leadership in open.

Finally, our technology commitment is to deliver industry-leading platforms for both integrated and disaggregated network architectures.

Service providers generally require integrated architectures to accommodate multiple services and users, whereas ICPs increasingly figure disaggregated architectures that can continually take advantage of the latest technologies and optimize cost structure.

While these architectures have distinctive value propositions, our technology differentiation applies to both and comes into play as service providers start to adopt certain web-scale architectural approaches.

This is exemplified by our new XT Series meshponders, more sliceable PICs 5 terabyte scale, and a server-like form factor and are ideal for the mesh networks that service providers manage. Ultimately, integrated or disaggregated, we will deliver building blocks that enable our customers to build the most efficient and scalable networks.

In closing, I am optimistic that we've taken the right steps to position ourselves for significant opportunity. I anticipate that our differentiated technologies and expanding market presence will provide us with significant new customer success in the future.

While there will likely be some challenges over the next few quarters, my expectation is that as we bring our next generation products to market over the course of 2017, our financial performance will steadily improve.

Longer term, every indication suggests that bandwidth demand will continue to grow substantially for the foreseeable future, which is certainly favorable to the industry and for Infinera. Thank you to our customers, shareholders and employees for your ongoing support of Infinera.

Now, I'll turn the call over to Brad for more detailed financial review of the fourth quarter of 2016, plus an outlook for Q1 of 2017..

Thanks, Tom, and good afternoon, everyone. We executed well in Q4, delivering financial results at the high end of our guidance ranges. Q4 revenue was $181 million, down 2% sequentially.

In the quarter, we had mixed results across our verticals with wholesale and enterprise carriers and ICPs collectively up nearly 50%, while telcos and MSOs collectively declined more than 25% sequentially. In the quarter, our top-five customers consisted of two wholesale and enterprise carriers, two Tier 1s, and an ICP.

Two of these customers are greater than 10% of revenue, a wholesale and enterprise carrier and an ICP. With solutions such as CX2 for DCI and XT-3300 for metro and long-haul on the horizon, I believe our wholesale and ICP verticals should continue to be strong for the foreseeable future.

On the other hand, with long-haul spend currently at depressed levels and our metro opportunity still in its early phases, our telco verticals could remain challenged for the next few quarters until the release and adoption of our next generation of products.

Geographically, as Tom mentioned, EMEA was our best-performing region in Q4, accounting for 37% of total revenue and growing 30% sequentially.

This result was driven by broad-based growth across all major verticals, including strong performance from CX, as ICPs start to expand their data center architectures in the region, along with solid results from our traditional metro customers.

Conversely, North American demand was soft in Q4, coming in at 53% of total revenue, and declining 7% sequentially. Offsetting growth from ICPs and wholesalers in Q4 was the aforementioned lighter spend from telcos.

Given our strong customer base in North America and the release of new products throughout 2017, my expectation is that we are well positioned to return the region to growth in the near future.

Regarding LATAM and APAC, both regions experienced sequential declines in Q4, stemming mainly from our current weakness in subsea and certain customer-specific project delays.

Turning now to margins, the positive impacts of year-end deals including instant bandwidth licenses allowed us to deliver gross margins of 41.8% at the high end of our guidance range.

This result was significantly lower than levels we have delivered in recent quarters, driven by a negative mix of revenues, including several investments, to preserve existing business in anticipation of our next generation products, as well as the impact of reduced volumes on our manufacturing infrastructure.

Over the next few quarters, I expect non-GAAP gross margins will remain at similar levels, and then start to improve in the second half of the year as we ramp our new products. Although, it will take some time, I believe our business model still supports our longer-term operating model of 50% gross margin.

Regarding OpEx, non-GAAP operating expenses were $92 million in Q4 at the high end of our guidance range due to ongoing investments in R&D, including the acceleration of certain expenses to get ICE4 products to market.

As we prioritize spending on our next-gen products and make changes to allow us to execute a faster technology cadence, we will continue to maintain tight management of overall spend, in light of the current revenue levels. Putting everything together, in Q4, we had a non-GAAP operating loss of 9.2% and a bottom line net loss of $0.12 per share.

On a GAAP basis, we incurred a net loss of $36 million or $0.25 per share. The difference between our GAAP and non-GAAP results was attributable to approximately $14 million of intangible and other acquisition-related costs, $11 million in stock-based compensation and $2 million in amortization of debt discount.

We also benefited in Q4 from a $9 million gain from the sale of an equity investment. Turning to the balance sheet, total cash and investments increased $4 million in Q4, growing to $360 million. Cash used in operations was $5 million, driven by our operating loss in the quarter.

Further, we began to realize some of the benefits of rebalancing our inventory mix by ramping our ICE4 components and optimizing the inventory levels of our existing products, all without significantly increasing our overall levels.

Other significant drivers of cash in Q4 included a cash inflow of $23 million related to the aforementioned sale of an equity investment, and CapEx of $10 million. Now touching on our results for the full-year fiscal 2016.

Despite a strong start to the year, our revenue for FY 2016 of $871 million was well below our expectations as customer consolidation, customer spending shifts to other markets, and product transitions negatively impacted our revenue.

On a brighter note, I was proud that we achieved 48% non-GAAP gross margin for the year and it cuts 50% in the first two quarters. Unfortunately, achieving these gross margin results could not offset our top-line challenges and requirement to invest in OpEx as non-GAAP operating margin for the year dropped from 13% in FY 2015 to 6% in FY 2016.

I'm confident that as we bring our next generation products to market, diversify our business and increase volume in our fab, we'll begin to ramp margins back towards our long-term margin targets. Finally, in FY 2016, we delivered $38 million of cash from operations.

Now, for our outlook for the first quarter of fiscal 2017, we currently project the revenue in Q1 of $172 million, plus or minus $5 million. As a reminder, the first quarter in our industry is typically challenging, with revenues declining 15% to 20%, historically, as customers take time to finalize their CapEx budgets and convert them into orders.

I expect demand in Q1 will be led by opportunities with wholesale and enterprise carriers and also benefiting from growth in our metro business. Looking beyond Q1, I believe we are well positioned to return to sequential quarterly revenue growth over the course of 2017.

As for gross margin, we currently anticipate non-GAAP gross margin in Q1 to be 40%, plus or minus 100 basis points.

In line with commentary on the last earnings call, we continue to expect margins to remain around this range for the next couple of quarters as we invest to bridge existing customers to our new products, begin to deploy footprint with our next-gen solutions, and absorb fixed costs across a smaller unit base.

Subsequently, my expectation is as we gain traction in the marketplace with our new portfolio of products, margins will begin to steadily climb. In Q1, we currently anticipate non-GAAP operating expenses will be $91 million, plus or minus $2 million.

While we continue to scrutinize our spend levels across the business, we will prioritize required investments around getting next-gen products to market.

Given our expectations about the future business opportunities, we think it is important to have the courage to make the required investments to maximize our opportunity, while remaining mindful of the balance required in the current periods.

It is important to note that after a disappointing FY 2016, incentive plans have been reset in Q1 to reflect expectations for FY 2017, a dynamic that drives higher OpEx throughout the year, including Q1. I anticipate that R&D will likely remain at elevated levels of mid- to high-20s as a percentage of revenue over the course of FY 2017.

Moreover, SG&A expenses should increase during FY 2017, albeit at a slower rate than R&D, largely driven by increased marketing efforts and lab trials, associated with the release of the next-generation of products throughout the year.

Putting this altogether for Q1, the midpoint of our projected guidance translates to a non-GAAP operating loss of 13%. Non-GAAP EPS is expected to be a loss of $0.16 per 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.

In conclusion, given the pent-up customer demand for ICE4, my belief is that as we deliver new products to the market, we'll begin to see gradual improvements in revenue and profitability. We will continue to manage expenses prudently and make the required investments to maximize the significant opportunities ahead.

Longer term, I'm optimistic that our accelerated development roadmap, strong reputation for quality, and unique operating structure will enable us to achieve significant market share expansion and earnings growth over time. With that, I'd like to turn the call over to the operator to begin the Q&A portion of the call..

Thank you, sir. We will now begin the question-and-answer session. And our first question comes from George Notter with Jefferies. Please go ahead..

Hi, guys. Thanks very much. I guess I just wanted to kind of circle back and make sure I'm really clear on the timing of some of these new product deliveries and when you expect them to subsequently generate revenue. Would you mind just kind of going down the roster here, CX2, the meshponder products, the MTC-6 and so on? Thanks..

Yeah. Sure. It's pretty much the same as we've said at Insight Infinera, George. We'll have revenue for the CX2, which is the first product coming out in Q2. As we said there, there was an outside stretch, we'd try to get it in Q1, but I think we should plan on revenue in Q2.

The 3300 will ship in Q2 and we believe we'll see some revenue in Q2, but most of it probably hitting in Q3. The goal, obviously, is to ship. And right now, we're on track for shipping in Q2 for revenue. How it's recognized is probably more dicey.

We said at the Insight Infinera that the DTN-X upgrade and the 3600 are still on track for the second half of this year. We're not giving any more granularity at this point than that. And our upgrade to the TM-Series will be coming out this summer, and we're on track for that.

In regard to the MTC, correct me if I'm wrong, Dave, that's already shipping..

MTC is, yes..

Yeah..

Okay. Great. That's helpful. And then, I guess if I just step back and sort of think about when you guys might start to see the improvement in top line, Brad, I heard your commentary about sequential growth over the course of the year.

Is that driven by new product deliveries or is that driven more by some of the customer situations fixing themselves on the M&A front? What's the bigger picture on top-line growth? Thanks..

Yeah. George, it's primarily the new products, but obviously, Q1 is a seasonally down quarter. So, Q2 tends to be up. I think it will be up more with the release of some of the new products..

We've consistently said that kind of revenue recovery to previous growth will be probably a second half of this year, and I'm staying kind of with that view. I do think that as we get through this Q1, which is always a little bit dicey in our industry, that will help.

But we are also – as you pointed out, George, our customer base is being consolidated at a fairly voracious rate, looking at it. About 40% of our revenue is currently in the process of being merged or acquired. Certainly, different sizes of that, but that's a substantive amount of our revenue.

I don't believe in any situation, except maybe one, we end up in a bad spot. I think we end up in a good spot, probably with stronger customers. But I think that during this process, whether you're preparing to go through the merger or acquisition or have just done it, there's a period of slowdown of spending.

I think you guys have probably seen some of the press releases rightly and commenting on that, and I think we've already been experiencing that. This is not new for us. I don't expect a step function down from here. I think we have started experiencing it in Q3 of last year.

When 40% of your business is being consolidated, there is no chance that that does anything, but slow down decision-making..

Thank you..

Yeah. Thanks, George..

Our next questioner today is Vijay Bhagavath with Deutsche Bank. Please go ahead..

Yeah. Thanks. Yeah. Hi, Tom, Brad..

Hi, Vijay..

Yeah. Hi. So, while you guide one quarter at a time, that's fine, it would be very helpful to hear from you, Tom, and also Brad, any qualitative color you can give.

What are your customers telling you, what are your sales teams telling you, as we head into the back half? Any particular product and market that you think would re-accelerate or pick up momentum heading into the back half? That really helps our modeling view for the full year. Thanks..

I think, as I made in my commentary about clear pent-up demand for ICE4, there is clear pent-up demand for ICE4. We've got customers excited about it. We've got our sales guys excited about it. I think that there's substantive opportunity there. And they're all encouraging us to get that to market as soon as possible.

I think that I see strong opportunity, as I made in my commentary, for subsea. There's a lot of subsea network being built right now that I think ICE4 will do well in. There's tremendous amount still of data center activity, and I think we are well positioned with that.

As we made in the commentary, it's a more competitive environment than it was a couple of years ago. But I think the CX2 will be in a league by itself, so we have to get that to market. And I think our new meshponders are going to be extraordinarily well received.

I also think that our approach to open with a flex-grid capability presents tremendous opportunity, certainly in the second half of the year, but also over a number of years. So, I think that the second half, there's nothing that I believe indicates that it's not going to have a strong and a lot of opportunity.

We talk about some of the metrics that I talked about last quarter, when we look at the number of RFQs, both the quantity across our products and the dollar size, all that's been on a positive trajectory, and a lot of it's reflected in our new products.

So, the data supporting my belief is being validated by what I consider transactional flow of paper.

Dave, you want to make a comment?.

No. We spend a number of – I think our products are well suited for us to go back into taking-a-market-share mode that we're used to for last number of years. I think the bandwidth demand is growing rapidly. It's growing extremely high in some of our markets. But in all markets it's going up.

Our competitive levels are dramatically improving as we bring out the product in the first half of the year. So, I expect to go back into taking-a-market-share mode..

Perfect. Quick follow on would be on product gross margins, what would cause that to uptick? Would it be primarily product mix or any cost efficiencies downstream? Thanks..

Yeah, obviously, the cost structure of the ICE4 products is much better than the current generation. So, that will allow us to have a cost advantage as we go forward. Mix across different products always impacts us.

But the thing that will – two things that will start to drive it back up, Vijay, is the cost structure of the new products and, obviously, having higher volumes going to the fab gives us leverage on that side of things..

Thanks..

Thanks, Vijay..

Next questioner is Stan Kovler with Citi Research. Please go ahead..

Thanks for taking my question. A couple of things I wanted to address, one on the market front.

Can you help us understand your comments about the long-haul and metro and wholesale markets? Is that the same that you talked about back in November, there have been any changes? It sounded like the market sizes were a little bit – market growth was a little bit light? And then beyond that, from a customer standpoint, obviously, the transition with a lot of customers going through mergers, can you help us walk through the phase that we're in with some of these customers? And what is the process that you have to go through to restart at the customer? But not only that, when you go through the merger, if let's say the entity was a Tier 1 or a Tier 2 that you may or may not have business with, how long do those decisions take for you to then either be with – selling to the entire entity versus the existing target customer that you have? Thanks a lot..

Yeah. So, the first question you talked about market growth. The long-haul market slowed down last year after a number of years of probably 8%, 9% growth year-over-year. The long-haul market that was viewed as probably low-single-digit growth, we anticipate that to start to come back this year a little bit.

That was some of the pressure that was put on us last year since we've been vastly a long-haul supplier. I do think that long-haul over a number of years is going to represent a very good growth opportunity.

But as people have finite CapEx, they probably spent disproportionately on long-haul for the last few years and now they're moving that, some cases to IP, some cases to metro, some cases to data center. So long-haul has been under pressure.

I anticipate it will start growing again this year, probably low to single – or mid-single digit, and that should help us, in general. Certainly, as we get ICE4 out, we can bring to market a more cost-effective solution, good margin, but more cost-effective and that should probably help.

In metro, surprisingly enough, metro was supposed to grow a great deal last year outside of China. That was muted, anywhere from low-single digit to flat year-over-year in metro. I do anticipate that metro has to continue to invest.

There are too many applications that are going to require more and more capacity in the metros, all the way through the metro from access through aggregation and actually that positions us well for when we enter the market with our upgraded TM-Series platform.

We anticipate this year metro will start in the mid-single digit, maybe up to 8% – 5% to 8%. Data center continues to absolutely explode, I think anywhere from 60% to 100% expected growth in that market. So, our opportunity needs to be – to maintain as much of the market share as we possibly can.

I think in the last published data set on purpose-built data center, we were at about 90% market share. The probability of us maintaining 90% market share is low. But in a market that's growing 60% to 100% a year, we can have a very, very healthy business. I don't want to give away any market share, but I think it's practical.

Our new CX2, I do believe, is a platform that is in a class by itself. So, I'm optimistic about that. From a customer consolidation perspective, we have some customers that I can't mention by name that are being acquired, a couple in the cable space. I think in all those cases, we're going to end up in an okay spot.

And I think that there is going to be some different business practices. One of the customers historically bought almost all their year spend in the first – almost the first quarter. And the new company is saying we're not going to do that. We're going to have a more linear approach to it.

That puts a little pressure on our Q1, but I'm anticipating that that comes back in the later parts of the year, so that's actually good news to me. I think that in every regard, we are going to be able to, except one, preserve our position in long-haul, and so far we have had receptivity by these new companies to expanding into the metro with them.

And I'm excited about that opportunity. I think when people are being approached to acquire or acquiring somebody, there is very little appetite for introducing new vendors into new spaces, because there is too many uncertainties.

With a lot of those certainties now behind them, they're more interested in looking at architectural approaches for the future. And I think it does give us a door open into new opportunities. The one area that we can comment on, Verizon just completed its acquisition of XO. We have a substantive footprint with XO.

The business with XO has been reasonably good. That dance with Verizon is still to be had with us. I mean, we're certainly engaging with them and I think there will be opportunity, but I'm certainly not forecasting anything at this point until we get further down that pipeline.

The big one, obviously, out there is Level 3 and CenturyLink, both of our largest – two of our largest customers. That acquisition isn't targeted to close until Q3. So, my belief is, for the most part, for at least a little bit of time, things have to be roughly run as our two independent companies. We still see a consistent demand from both of them.

But like I said earlier, when people are going through large-scale integration, typically things slow down. You're not in an invest phase of network because you don't want to ignore what network assets you're picking up. I anticipate we'll get a better picture from that over the next couple of quarters as things get closer to the end.

But I anticipate in the short term, both of them have to run independently. That's a long answer. Sorry about that..

I appreciate the detail, actually. And then, if I just have one quick follow-up on product gross margin, for Brad. Can you parse through the elements of gross margin relative to the prior quarter from a volume perspective and from a mix perspective? So, obviously, inventory is relatively static and revenues still below $200 million.

How much did, specifically, that fab volume impact your gross margin? And does that piece come back in the second half, so gross margin should be in the 45-plus-percent range? Thanks a lot..

Yeah, the loading in the fab and that kind of stuff, the impact is pretty consistent quarter-to-quarter. The bigger impact in Q4 and Q1, quite frankly, is the mix of deals were bringing the revenue.

Including, obviously, as we talked about before, some investment deals to make sure that we are exceptionally well set up for when the gen-four products come out.

So you're thinking about it right, though, that both things, as I mentioned earlier, will contribute to market share – or gross margin expansion over the year, filling up the fab and the cost structure of the new products..

Thank you..

Thanks..

Our next questioner today is Dmitry Netis with William Blair. Please go ahead..

Okay. Thank you very much, guys, and good job executing on the plan. One quick follow-up from the prior question on the gross margin. Are you implying, basically, the next two quarters in that 41.8% rate, 40% in Q1 is what you're guiding to gross margin, so is that your trough quarter basically in Q1? Number one.

Number two, as far as the cash burn goes, I think you saw about $15 million of cash burn in terms of free cash flow in this current quarter. Is that a trough quarter or Q1 will be a trough? Can you comment on that? That would be good..

Yeah. So, I don't like the word trough. But as I mentioned, I think, the margins will stay in the region where they are now. Like I said, it will start to pick up once the new products come out. So, I think that low 40s type of level is what you should expect for the next couple of quarters.

From a cash burn perspective, obviously, still in a very healthy cash position with $360 million in cash. But given the guidance we just talked about, we will burn a decent amount of cash this quarter, probably similar to Q4..

Dmitry, on the margin, it's hard. Never say never on it's the lowest, first of all, because you never know what's going to happen in life. But we kind of think this is where the bottom would be.

Having said that, last year, as I made in my commentary, 100 gig ASPs dropped in the market – was it 27% or 29%?.

29%..

29%, that's fairly unprecedented. And it's not like there's a new technology that's hitting the market that causes that drop. There is a substantive amount of pricing pressure that's occurring.

I do think it starts mitigating, but I think that there is a level of certain competitors who are willing to buy market share whether they can make money at it or not. That can't last forever, but I do anticipate pretty good pricing pressure.

The good news in my mind is when we get ICE4 out, I think we are structurally better prepared for that than anybody else. And I think that we have an opportunity based upon selling ICE4 going back to our margin expansion by the end of the year. But I do want to caveat it.

When the market is in this type of transition with ASPs dropping that dramatically, it's hard to predict..

Okay. Thank you, Tom. I appreciate it. Now, to my real question, if you will, want to talk a little bit on the CX and – CX, CX2, kind of your DCI product set.

First of all, kind of I'm doing the math, and just correct me if my math is off, but you should be – given the comment you said – you made as far as the doubling or more than doubling of that business over the course of the year, you should end up somewhere in the $80 million, $90 million range, which would put you right in the 10% mark.

So, I just want to double check that's correct, and you're forecasting for growth in that business clearly through the 2017 timeframe..

Yes..

And as you speak to that, can you talk to any of the ICPs? I think you had two out of the top four in the prior generation. Has any new ICP come in as a result or are you expecting any new ones as you kind of roll out the CX2? Maybe PTC meetings had helped you secure the visibility of that. So, I'd love to hear your thoughts on that front..

So Dmitry, your math is roughly correct on the fiscal 2016 levels. I'll let Tom comment on the opportunity with the other ICPs for CX2..

Yeah. So, we are still very engaged with a couple of the good solid ICPs that we've talked about before. We've expanded – there is a new tier of ICP – data center guys that are not traditionally considered part of the top five that we've expanded into and they're building substantive data center interconnectivity.

We've done a good job of attaching there. And based upon the CX2, I firmly believe that we'll be able to add a significant new ICP this year based on the CX2. We have to still earn it, but we've been given the nod for they will do the testing.

And that's – the hardest milestone for us historically is getting them to agree that they will do the testing, because they'll only do the testing and sign a contract if they have a business driver and they believe it's a viable solution for them. We have achieved that. So, now, it's down to delivering the CX2..

Great. Can I ask one quick one on EMEA? You rebounded there 30%. You mentioned some traction with CX business there. But I presume there was also telco-related traction there, maybe not.

But can you dissect that market and tell us exactly what went on this quarter, why it was so strong? And was there much of the Transmode product that's sort of rebounding here was this core Infinera business?.

Yes. So, Dmitry, it's a combo of different things. One is we started to see the ICPs who have been doing a lot of their CX builds in North America to start to build out more in Europe. The traditional metro business did really well, and the stable base of telcos there as well was originally strong. So, it was pretty broad based.

I'd say the thing that's probably a little bit better than it's been in the past is just starting to see the ICPs deploy CX in Europe..

Yeah. I would say that the ICP is deploying the CX, but also the TM-Series has done extremely well in the second half of last year, particularly with our traditional customers there. It's been a reinvigorated buying cycle by those guys. And that's really great to see.

In general, as we commented on the call, telco has been weaker for us and I think other people in the industry over the last six months..

Our next questioner today is Simon Leopold with Raymond James. Please go ahead..

Thank you for taking my question.

First, on this ICP market vertical, could you give us a sense of what percent of the fourth quarter sales were coming from that group as you define it and how that compared sequentially and year-over-year as a percent of sales?.

Yeah. So, Simon, in Q4, it was in the range of where it's been historically. We talked about in Q3, just some slower spending from those guys in our Q3. So sequentially, it was up quite a bit, but the level it's at for Q4 is similar to the level it's been historically as a percentage of revenues..

And if my recollection is correct, we can call that kind of 25%ish, is that right?.

It's in that ballpark..

Okay. And then in terms of your full-year 2016, can you give us a little bit of color on 10% customers? Presumably, you'll disclose that detail in the 10-K, but if we could get that now. And this I think is important given our sense that 2015 was – your 10% customers were folks that are consolidating.

And if we're trying to figure out how to model the impact of the consolidation, I'd like to get an understanding of the concentration in 2016, if we could get that detail?.

Sure. So, we talked about the large North American bandwidth wholesaler being consistently throughout the year. They are greater than 10% for the year. There is an ICP that is right on the hairy edge that I think rounds to 10% as well..

And will that be in the 10-K?.

That one won't, because it doesn't officially get to 10%..

Okay. But the other one will. Okay. Thank you very much..

Yeah..

The next questioner today is Alex Henderson with Needham. Please go ahead..

Great. I've got a couple of quick questions, if I could. And I'm assuming you're probably not going to answer this, but I'll give it a shot anyway..

Go ahead..

You hit a peak revenue in 2Q of last year.

Do you think it's possible to get back to those peak level of revenue that you'd hit in that timeframe during the 2018 timeframe, or is this going to be a much slower? And I'm really just – I'm not really looking for that specific number, but using that as a benchmark to determine what the slope looks like in your mind..

Alex, I wake up every day wanting to come to battle believing that we can build a multi-billion-dollar company here. So, every part of me says, sure, we can do that. But I want you to walk away and allow me – why don't you hold off to that question until we start seeing traction with gen two – I mean, our ICE4. And that's going to be dependent upon it.

Do I think that we've demonstrated multiple years of 25%, 24% year-over-year growth? We have. We did that as a single-market company. Now, we're in multiple markets. So, I think the opportunity is tremendous, but I'm just cautious of telling you, gosh, that can happen in 2018. If it happens in 2018, it's going to be based upon the adoption of ICE4..

Similar question, as I'm looking at 2017, is it reasonable to think we can at least get back to quarterly profitability in the back half as sort of at least a standing target?.

Yes..

Good. And then, the third question I had for you is more on the technology side. So, you talked a lot about ICE4, but I didn't hear anything about your ASIC chip and what are you doing on the DSP side of the equation? Obviously, there has been a lot of noise around that front out of both Acacia and then with the AI chip out of Ciena.

I would expect that your DSP development cycle time has got to improve substantially.

Can you talk a little bit about when do you expect to get another one of the – another turn of that out? And does the impact of the acquisition by Inphi impact that at all?.

Yeah. So, I'll try and give you some insight into that. A couple things, to reiterate what Tom mentioned in the conference call. First was we've demonstrated the PIC technology that is consistent with 600-gig per wave demonstration that we are demonstrating that in our lab today.

And if you look back on history, if we're demonstrating our PIC capability, then we're obviously doing that with a plan to bring it into market in not immediate, but not-too-distant future from that. Our DSP technologies that we're going to bring in and productize will be consistent with that 600-gig per wavelength capability.

We have upped the ante in investments for our DSP and ASIC capability as well as our higher capacity PIC technologies. And we expect that to move along, as Tom also stated, at about a two-year rate. And that's moving along. We haven't talked at all about who our partners have been in the past, nor who our partners are in the future.

We continue to evaluate to make sure that we can bring the highest-performing product to market and utilize what technologies that are available to that.

We'll continue to move down a path of vertically integrate where it makes sense and where it creates differentiation and continue to utilize technologies that are available too on the outside, when that makes sense..

Yeah, Alex, One of the things – when I say PIC, I mean our PIC. When I say ICE, it's a combined PIC plus DSP, plus all of the stuff that goes around that. So we're going to make a differentiated commentary on that. We need to talk about PIC as a technology. ICE is an enabling capability that will bring customers useful value in our products..

Our next questioner today is Rod Hall of JPMorgan. Please go ahead..

Yeah. Hi, guys. Thanks for the question. I just wanted to go back to the product availability. You guys are saying it's all on track. I thought that in the Analyst Day, you had said the CX2 would ship for revenue in Q2. And it sounds like, Tom I thought you said ship for revenue in next couple of months, which would put you potentially in Q1.

So, it feels like, to me, you're a little bit ahead, a month or two ahead of your original timeline on that, maybe a little bit more. So....

No, Rod – yeah..

We're roughly – when I say a couple of months, that puts us, two months from now is middle of April. You should think about it in ship and revenue in Q2..

Okay. And then XT, I thought you said right on the heels of the CX2? So, there is no – any chance of XT revenues in Q2? Or you're saying – I know you said Q3, but....

I said there's a chance in Q2, but from a conservative perspective if you're thinking about it, think about Q3. Our goal is clearly Q2 internally..

Okay..

And then, just for clarity on that, revenue comes about, on an XT, it requires a whole network to be certified, not a point-to-point connection certified. So, the time from when it leaves our factory to the time that we can recognize revenue is longer for that product than for the CX2..

Okay. Yeah. I just felt like maybe you were a little bit ahead of what you thought you'd do in the Analyst Day..

I never want my engineers to hear that, Rod. I consider us distinctly behind where I want us to be..

Okay. Okay. The second thing, you mentioned this North American cable operator and orders there..

Yeah..

Can you give us any more color on that? Are those orders for production deployment? Are those orders for testing? I mean, where are you with that? How big is that deal? When does that revenue ramp?.

I can't unfortunately give you a lot more than I've already given you, but it's a TM-Series. It was orders we received in Q4 for production. And I will give you the – we've had follow-on orders in Q1 to extend the original footprint. And as we've learned the hard lesson on metro, that's how it grows.

It's a little bit, followed by a little bit more, followed by a little more as you expand across the footprint. We're excited about the opportunity. It's been a journey. And we stayed at it, and I think we have proven to them that we are providing a differentiated value proposition. It's slow, but it's ramping.

And like I said – like a sales guy said, the first order, it's not a customer. It's a customer when you have the second production order. So, we've had more than our second production order now. But do think small upfront that has the opportunity to scale, I think, substantively over time..

Yeah. And Rod, this type of customer is a – when we talk about a couple of customers being able to pay for the deal by themselves, these are the type of guys we're talking about..

Okay. And then I also – the other thing I wanted to just clarify, I was surprised you had six new CX customers given the CX2 is kind of right out there coming.

Are those guys intending to convert to CX2 or they just don't need the capacity of CX2? Can you just explain how it is you're gaining that many customers on the CX platform prior to CX2?.

Yeah. Sure. Go ahead..

Yeah. I mean, the CX2 is a much higher-capacity box. Lots of customers and applications that prefer a lower capacity box in that scenario. So, we expect to – as we transition for the very high capacity data centers, the dominant, that will transition to CX2. But there's a huge base of opportunity for our current CX products..

Yeah. There's a whole bunch of customers out there, Rod, who have much smaller data centers. We're selling now to enterprises that have small data centers that they want to interconnect to. We are selling into....

Internationally..

...internationally, with very small capabilities. We're selling to a colo as using it for floor interconnect inside of a colo. So, this application, when we talk about data center architectures starting to migrate into other places of the network, that's what we're talking about.

And typically, they will have much, much lower capacity requirements than the top ICPs, where 500-gig is actually a fairly substantive amount of capability. That's great for us, because if you're looking at 100 or 200-gig, we have a great TM solution. If you're looking for 500-gig to 1 terabit, we have the CX. And then the CX2 is for multi-terabits.

So, I think we have a complete suite of products now that can address any one of these applications, whether from ICP or down to an enterprise or bank..

Great. Okay. That's helpful, guys. Thanks, and good job on the results..

Thank you..

Thanks..

The next questioner today is Patrick Newton with Stifel. Please go ahead..

Yeah. Good afternoon, Tom, Dave, and Brad..

Hey, Pat..

I guess, first just a clarification. Tom, you were talking earlier about kind of seasonal – the normal seasonality of second quarter off of a seasonally softer first quarter..

Yeah..

Given you have relatively depressed revenue levels, you have some new product ramps, specifically the CX2 shipping, were you implying that we should see above-seasonal 2Q growth?.

No, I'm not trying to imply that. I'm just saying that Q1 is, typically, in our industry and for us, as we've gone into more markets, a softer quarter. Typically, 2Q starts coming back reasonably well, because Q1 budgets are understood.

I think this year, as I mentioned on the call, we typically had a large cable customer that made most of their orders in the end of Q1. That's not going to likely happen moving forward. It's going to be more distributed through the year.

So, it makes Q1 a little more difficult and it could make Q2 a little more difficult, because they typical ordered in late Q1, we shipped a lot of it in Q2. I think for a year perspective, it doesn't matter. So I think, at this point, Q2 I don't anticipate – I would anticipate it growing, but I wouldn't assume any kind of step function..

Great. Thanks for the clarification.

And then, I guess, for Tom or Brad, given you now plan to release ICE updates every two years and you've expanded your product portfolio well beyond long-haul, should we anticipate increased R&D intensity relative to prior cycles?.

No. Patrick, we talked about before that the levels will be little bit elevated this year in the mid- to high-20s just because of the lower revenue levels. But our model going forward will continue to be 20% of revenue in R&D.

As Dave mentioned, we will likely utilize the mix of internal solutions and solutions available in the market, which will help absorb some of that spend. And I think we do a very good job internally of making sure that we optimize what we spend on, spend in the right ways.

But you shouldn't expect the overall levels to be away from our normal targets..

Great. And then, I guess, Tom or Dave, I think last quarter you talked about pursuing metro opportunities in mobile front-haul and back-haul, I think you referred to them as edge opportunities and seemed pretty excited about that.

I'm curious if you can update us on whether any of those opportunities have turned into wins? And if so, how we should think about revenue ramping?.

Yeah. The back-haul opportunities continue to grow. We're still seeing good success there. The front-haul opportunities are really a technology transition play. We've got a strong offering. We've had some early wins in that. We're involved in a number of RFI to RFP capabilities with some large Tier 1s.

But the transition in that technology and the transition as I think about 5G rollouts, et cetera, it's going to take some time in there. And much like we're seeing with our metro cable guy, when they start making these decisions from the time of the decisions to large revenue ramp can take some time..

I think we've won somewhere in the neighborhood of three to five front-haul opportunities and most of them have been in Asia, which is not surprising since we often see them pushing these architectures first.

The question is going to be can we take that learning, take that attraction and transport it into other geographies, and I think it's too early to call. Do I think it's a substantive potential opportunity? I do.

But a lot of it's going to be depending on if we can take that traction that we're achieving in Asia and replicate that elsewhere, and it's just too early to call..

The next questioner today is Michael Genovese with MKM Properties – sorry, MKM Partners. Please go ahead..

Great. Thanks a lot. I wanted to ask about R&D intensity this year in 2017, because from the Analyst Day, I remember mid-20s and I heard you on this call say mid- to high-20s.

So, first of all, is that new? And secondly, is that more of a statement on more R&D than you would have thought before, or is it a statement on the revenue levels for the year as it's shaping up right now?.

Yeah. So, Mike, it's not a change from what we were expecting. We're just clarifying, it was a mid- to high-20s levels. Obviously, we're going to spend the dollars required to get the new suite of products out. And that's going to take lots of protos and lots of spending in R&D to make sure those things happen.

So, it's nothing different than what we were anticipating before..

Okay. Next question then, you spoke about this goal to win metro – new metro products into existing customers.

What are your thoughts on winning brand-new customers with your new metro products late this year or into next year?.

Well, I certainly think we'll be able to do that. Yeah. There's no question. I mean our sales force is chomping at the bit. And we don't say go target our current customers, we say go sell a bunch of product, and I think there is a lot of opportunity.

Having said that, the easier sale is to somebody who already understands and appreciates the Infinera experience, already has a substantive Infinera footprint; that's a more likely sale.

It's been impeded a little bit by all these acquisitions that have occurred, but we're making progress selling, cross-selling into our networks, both DTN-X, selling them the TM, and also some TM trying to sell them DTN-Xs. So, I think that our goal is to sell pervasively everywhere.

But the easiest sale – quite frankly, none of them are easy – is peoples, they truly do value the Infinera experience and we need to compel them with the TM – upgraded TM. I think the challenge has been, to a degree, like, Tom, we like the TM, we like Infinera a lot, but until we get 16QAM out, we're not going to certify this product.

So, I think the 16QAM opens up doors to customers who have articulated a desire to at least evaluate the TM, but they want to do it on a technology that's fresh versus longer in the tooth..

Okay. And then, last one for me, I took away from this that you did well in the fourth quarter in EMEA, in DCI, and I think in Transmode. And then the first quarter guidance is actually pretty good, all things considered, better than what you said was seasonally normal for the industry.

So, my question is, do you expect a big EMEA contribution in the first quarter that's – and with the same sort of things that drove the fourth quarter, is that in the guidance or are we going to get somehow shift back to North America or a different region?.

Mike, I think EMEA will continue to be strong. I think we've always had a strong customer base there. And now with the broader product set and the ICP starting to move some of their spend to EMEA, I think that will continue to be a strong region. And we've got a very good sales team there and tremendous amount of opportunity..

Thanks for the questions, guys..

Yeah..

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

Thank you for joining us this afternoon and for all of your questions. I look forward to updating you in the near term and next quarter. Have a great day..

The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines..