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

Doug Clark - Goldman Sachs & Co. Patrick Newton - Stifel, Nicolaus & Company, Inc. Jeffrey Thomas Kvaal - Nomura Instinet George C. Notter - Jefferies LLC Meta A. Marshall - Morgan Stanley & Co. LLC Alex Henderson - Needham & Co. LLC Dmitry G. Netis - William Blair & Co. LLC Vijay Bhagavath - Deutsche Bank Securities, Inc. Nicholas Rodney Hall - JPMorgan.

Good day. Welcome to the First Quarter Year 2017 Investment Community Conference Call of Infinera Corporation. All lines will be in 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 call over to Mr.

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

Thanks, Phil. Welcome to Infinera's First Quarter of Fiscal Year 2017 Conference Call. A copy of today's earnings is available on the Investor Relations section of our 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 our overall business strategy and results of operations, market conditions, market and growth opportunities, views on our customers and products, expectations regarding the timing of new products, and Infinera's financial outlook for the second quarter of fiscal 2017.

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 our most recently filed annual report on Form 10-K 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 our website in the Investor Relations section.

I will now turn the call over to our Chief Executive Officer, Tom Fallon..

Good afternoon and thank you for joining us for our first quarter 2017 conference call. Joining me today are Chief Financial Officer, Brad Feller; and President Dave Welch. Today, I'll review our performance in the first quarter, market dynamics and our future opportunities.

I'll then turn the call over to Brad, who will provide a more detailed financial review of the first quarter and our outlook for the second quarter of 2017. In Q1, we generated revenue of $176 million, non-GAAP gross margin of 40%, and a non-GAAP loss of $0.15 per share.

Revenue was the high end of guidance, largely attributable to our return to sequential growth in North America, led by solid results from our wholesale and enterprise carrier vertical. Total revenue in Q1 was slightly down sequentially as long-haul grew, while DCI and metro were each lower.

This decline however was muted in comparison to the 15% reduction our industry typically experiences in Q1. DCI demand continues to be robust due to the continued rapid growth in cloud services. We saw good performance from our Cloud Xpress products and see significant demand building for the Cloud Xpress 2.

I'm also encouraged we are having success with the XT-500, with significant acceleration in bookings and four new XT customers in the quarter.

We anticipate this activity as a precursor to future success with the XT-3300, their XT products help service provider customers adopt some of the benefits of ICP architectures and extend our long-haul footprint into the metro. We're also seeing an uptick in opportunities around open networking, not just from ICPs but from service providers as well.

In Q1, we won open opportunity with a key service provider in Europe that is deploying an Infinera open line system, as open networking becomes a more pervasive deployment alternative, my expectation is there'll be substantially increase our open opportunities as a broader installed base recognizes the value of Infinera's transponder differentiation.

Turning to the overall market. We're still seeing heavy pricing pressure in our end markets, but we expect ASP declines to not be a substantial in 2017 as we saw last year.

Shipping our new ICE4 base products and volume will help us respond to this pressure by improving our cost structure and should also position us to begin growing market share in the second half of 2017. That said, there are some continuing uncertainties facing us.

Recent discussions with customers suggests they are squeezing as much out of current network as possible even as bandwidth demand continues to grow. We are seeing this with our telco customers in particular, whose successful revenues declined materially in Q1.

Additionally, customer consolidation is continuing to impact results as several of our largest customers have slow spending to focus on integration.

Of note, our cable business was down quite a bit year-over-year in Q1, as the new management team and one of our largest customers has decided to spread their spending over the course of the full year instead of spending predominantly in the first half.

While I expect consolidation will post challenges for us through 2017, I see this issue is transitory. My conversations with these customers lead me to believe that as M&A activities dissipate, we are well positioned to grow with them as we emerge in stronger and broader enterprises.

Indications are that we have maintained wallet share in our traditional markets, and are better positioned to earn opportunities in new markets within these customers. At inside Infinera, we announced several new products for our Intelligent Transport Network portfolio.

Our ship dates for these product remains roughly on track, little behind where I would like them, given where the market demand is. Our current expectations are that in Q2, Cloud Xpress 2 for DCI will be generally available. Additionally shipping in Q2 would be the 20-port ROADM card, adding scale to our already available FlexILS open line system.

In Q3, we expect to ship several products including the XT-3300 for long-haul and metro, the XTM Series with a 400-gig module for metro, and our XTS-3300 for the subsea market. I'm pleased we have started to ship limited availability CX2s to an ICP.

These units are currently in our production network carrying live traffic, and feedback to date has been positive. As of today, our expectation is that CX2 will be generally available in the latter half of the quarter.

Given this timing and customer specific dynamics around testing and acceptance, there is more uncertainty (6:41) around how much revenue we will be able to recognize in Q2. That said, over the course of FY 2017 and beyond, I expect CX2 to significantly contribute to Infinera's growth.

Turning to long-haul, while the overall spending environment remains challenging, we are making progress winning new business with our XT-500, with meaningful deployments in Q1 with several large customers including a cable operator, a wholesale and enterprise carrier, and an ICP.

I'm cautiously optimistic that our long-haul business will return to growth in the second half of 2017, as we build on current traction with the XT-500 and address opportunities with our new XT products.

Our expectation for improvement aligns with the most recent Dell'Oro forecast, which projects the DWDM long-haul market outside of China will resume growth in the second half of the year. Regarding DCI, we had a good Q1 with solid spend from our largest CX customers while adding three new customers.

The robust feature set we have developed to address customer needs as the first vendor in the purpose-built DCI market continues to compel customers to choose Infinera.

While viable competition has emerged, I'm pleased that we have maintained market leadership with signally (7:46) estimating our market share in purpose-built DCI was 52% in the second half of 2016. Analysts continued to project this market will grow significantly in the coming years, exceeding $1 billion dollar annually by the end of the decade.

With the impending availability of CX2 and a ramped up technology cadence driving future products to market more quickly, my expectation is we'll continue to grow our DCI business as the worldwide market leader. Now on to metro.

Though Q1 was seasonally weaker, we continue to have success winning opportunities with our XTM Series packet-optical portfolio. The strength of XTM is at the edge where customers appreciate our low power, low latency solutions, and the ability to provide Layer 2 aggregation while fulfilling multiple access applications.

We believe our new 400-gig module, which will yield an 8x density increase and a 3.5 times power reduction per gig, will prove to be very competitive in numerous metro applications. There's also growing interest in the XT-3300 for metro.

While ICPs are generally interested in the XT-3300 for long-haul, service providers are looking at it for both long-haul and metro transport applications, taking advantage of its ease of use, compact form factor, and sliceability.

My view is that the timing of these new products, both for metro edge and metro transport, aligns well with impending inflections around next-gen access architectures, such as remote fi (9:08) at multiple cable operators, and 5G at mobile operators.

We believe these architectural inflections will dramatically increase access bandwidth and drive fiber deeper into the metro, increasing demand across our portfolio. One emerging opportunity I would like to touch on is enterprise; we're seeing early success from our investments in products across the XTM Series and Cloud Xpress.

Of note, we recently deployed a large intercampus network with a healthcare company that is a global leader in robotic-assisted surgeries, which selected the XTM Series based on its low latency. Additionally in Q1, we deployed DCI networks for a large sports apparel company, and also a well-known chip manufacturer.

Our expanding portfolio of purpose-built solutions, complemented with investments in sales, channel, and marketing infrastructure, should drive increasing contributions from areas like enterprise, government, and Tier 3 over time.

On the technology front, (10:00) we announced Instant Network, the next evolution of our highly successful Instant Bandwidth capability, which we believe is the industry's only software-defined capacity offering. Instant Network is a unique capability made possible by our PIC technology and Xceed Software Suite.

Our customers can now create revenue-generating infrastructure by aligning network capacity with services demand, including moving bandwidth from route-to-route as opportunities arise. This is not just a pricing strategy, but a combination of leading hardware and automation software that is delivering a new level of user experience to our customers.

One of our key customers, Telstra, levered its Instant Network to deliver on its Always On service guarantee, which assures network availability to its customers across key subsea cable routes.

Customers appreciate the value Instant Network brings in terms of network optimization and automation, and are excited about their new ability to create service differentiation. I believe we will see more customers embrace Instant Network as a valuable element of their network and go-to-market strategies.

In terms of our optical engines, we continue to make progress on ICE5, (11:09) and remain committed to a cadence of delivering new optical engines every two years.

This strategy should minimize the likelihood of future technology gaps, and is already bringing us increased credibility with customers, as we collaborate around creating and fulfilling long-term network strategies in visions.

In closing, with the stream of new products coming out over the next few quarters and ramped up technology cadence, we're well-positioned to gradually improve our financial results. Pent-up customer demand suggests that our new products are well suited to address evolving architectures that require the most scalable and cost-efficient networks.

I look forward to delivering our new products to the market, continuing to provide the best customer experience in the industry, and ultimately capitalizing on the substantial growth opportunity we have ahead of us. As always, I would like to thank our customers, partners, shareholders, and employees and you for your support of Infinera.

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..

Thanks, Tom, and good afternoon, everyone. We executed well in Q1, delivering financial results at the high end of our guidance ranges.

Q1 revenue was $176 million, down 3% sequentially, given the large cable customer Tom mentioned now spreading its spend across the full year, and the broader challenges we are working through, I'm pleased with our Q1 revenue result.

In the quarter, revenue grew sequentially in all of our customer verticals, with the exception of Tier 1, which continues to be challenged. Our top 5 customers in Q1 consist of two wholesale and enterprise carriers, one ICP, one cable operator, and one international Tier 1.

One customer accounted for greater than 10% of revenue in the quarter, a wholesale and enterprise carrier.

As the year progresses, the combination of pent-up demand for our new solutions across all of our end markets and the possibility that long-haul will return to growth in the second half gives me confidence we can gradually grow revenue sequentially over the course of this year.

Geographically, North America returned to growth in Q1, up 3% sequentially, and accounting for 57% of total revenue. Our progress in North America was attributable to a strong contribution from wholesale and enterprise and solid results from cable, including early growth from the new metro customer we announced last quarter.

Our international results in Q1 were mixed, as EMEA accounted for 33% of total revenue and experienced a sequential decline of 15% in line with typical seasonality in the region. The sequential decline in EMEA was led by telco customers, and partially offset by an increase in wholesale and enterprise.

APAC demonstrated both sequential and year-over-year growth in Q1, accounting for 7% of total revenue. We are making good strides expanding our customer base in this region, with increasing contributions from ICPs and enterprise customers in particular. Finally, in Q1, LATAM was a small contributor, sequentially down and accounting for 3% of revenue.

While I continue to believe our long-term prospects in LATAM are bright, certain customer-specific project delays continue to hinder our business in the region. Now, turning to margins. Non-GAAP gross margin in Q1 was 40.3%, due to ongoing pricing conditions, including investing to preserve existing business ahead of delivery of our new products.

In addition, we continue to be negatively impacted by the reduced volumes within our manufacturing infrastructure. As I have said previously, our gross margins are likely to remain at similar levels, until we see the impacts of new products ramping.

We continue to evaluate deals focusing on the long term, which may continue to put pressure on margins in the short term. Regarding OpEx, non-GAAP operating expenses were $91 million in Q1 in line with guidance.

We continue to balance the spending required to deliver ICE4 products to market and support our faster technology cadence, with ongoing expense management in light of our current revenue levels.

Over the course of FY 2017, we continue to expect R&D expense to be in the mid-to-high 20s as a percentage of revenue, to ensure we deliver the new suite of products to market, and also make the required investments to ensure a robust pipeline of future solutions.

We anticipate SG&A expenses will also increase to support the adoption of the new products, although at a slower rate than R&D. Putting everything together in Q1, we incurred a non-GAAP operating loss of 11.4% and a bottom line net loss of $0.15 per share.

While these bottom line results exceed our expectations going into the quarter, operating the business at a loss is surely not a long-term strategy of ours. Our expectation is that the investments we are making today will maximize our future opportunities and enable us to restore our profitability over time.

On a GAAP basis, we incurred a net loss of $40 million or $0.28 per share. The difference between our GAAP and non-GAAP results was attributable to approximately $11 million in stock-based compensation, $5 million of acquisition-related costs, and $3 million in amortization of debt discount.

Turning to the balance sheet, total cash and investments at the end of Q1 was $359 million, down $1 million from the end of Q4. Cash flow from operations was $3 million, as positive working capital changes offset our operating loss in the quarter.

In Q1, we continued the process of rebalancing our inventory mix, keeping the overall inventory levels steady, as we've ramped the levels of ICE4 inventory and sold existing products. The other significant drivers of cash in Q1 were CapEx of $15 million and proceeds from equity issuances of $10 million.

I'm pleased we're able to keep our cash levels steady in an otherwise challenging quarter. Now, for our outlook for the second quarter of fiscal 2017, we currently project revenue of $180 million, plus or minus $5 million. The midpoint of this range represents sequential growth of 3%.

Our expectation is that sequential growth in Q2 will be driven by our cable and ICP verticals. Tempering growth is the possibility to be (17:19) impacts of pre-closure planning from two of our largest customers merging could cause further softness on our CapEx spend.

Additionally, with CX2 not being generally available until the latter half of the quarter, we are only expecting a low to mid single-digit revenue contribution from CX2 in Q2, as customers must complete their qualifications for us to recognize revenue. Pent-up demand for CX2 remains strong. So it's largely a timing concern at this point.

Regarding margins and expenses, we currently anticipate non-GAAP gross margin in Q2 to be 40% plus or minus 200 basis points.

As we have previously discussed, we won't start to see margin recovery until our new products gain traction in the market, which should enable us to realize cost structure benefits and to re-establish fixed cost leverage from our vertical integration model.

As for OpEx, we currently anticipate non-GAAP operating expenses will be $95 million, plus or minus $2 million. Sequential OpEx growth in Q2 stems predominantly from R&D, as we prioritize delivering new products to market and invest in future technologies that will drive long-term differentiation.

Also, we intent to fund customer trial to support qualification and adoption of new products. Below the line, the combination of interest and other expense in Q2 is expected to net out to approximately $500,000, and tax expense should be approximately $1 million.

Note that despite our current loss position, we still are required to pay tax in jurisdictions where we have cost-plus entities. Hence, under our current tax structure, we will incur a tax expense in most quarters. Putting this all together for Q2, 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 $0.17 per share, plus or minus a couple of pennies. As for GAAP EPS, we projected to be lower than non-GAAP EPS by about $0.14 per share, primarily related to stock-based compensation expense.

In closing, with CX2 nearing general availability, success to date and potential acceleration from our XT portfolio and signals that the long-haul market could resume growth in the second half, we continue to believe that our results will improve over the course of the year.

Note that as we deliver new products to the market, financial improvements will be gradual. For example, on the margin front. Cost structure reductions from new products will be a multi-quarter process, they will not all occur on day one.

Additionally, I anticipate having to continue investing to preserve existing business for the next few quarters in areas where we haven't yet delivered new products. Once we get multiple new products to market however, we should be well positioned to resume revenue growth and margin acceleration.

In the near term, we will continue to manage expenses prudently, while investing to realize our significant future opportunities. Ultimately, I'm confident that our differentiated solutions and operating structure will enable us to grow our top and bottom lines over time.

With that, I'd like to turn the call over to the operator to begin the Q&A portion of the call..

We will now begin the question-and-answer session. Our first question comes from Doug Clark of Goldman Sachs..

Hey..

Hey (20:59). Hey, Doug..

Thanks for taking my question. My first one's on Cloud Xpress.

I'm not sure if I got it in the prepared remarks, is the CX2 slightly later than your original anticipation, or is this timing for kind of later part of second quarter, the expectation going in?.

We were hoping to get it out earlier in the quarter. So, it's slit into the second half. We have started shipping, as I said, to one customer, we consider it – it's pre-GA. We have certain customers who like to take products that we believe are robust, but we haven't finished our testing yet, and it's been running in our network now for two weeks.

And we've gotten good feedback, but we're not done with all of our testing, so that the product will not ship until the second half, which is probably a month later than I'd expected..

Okay.

I mean, can you talk a little bit about what caused those slight delays, and then more broadly outside of this one customer, what type of interest you're seeing from customers in general for it?.

Yeah. The CX2, we have a tendency as a company obviously to push a lot of technology, both our own and market technologies. We incorporated a couple of cutting-edge pieces of technology into the CX2 that accommodate what I think are important features, what we think are important features for our customers.

These new technologies and our own, both had some whole learnings (22:24) that we had to do, meaning we had to go and discover bugs and get them fixed, either by us or some of our technology providers, and that just slowed things down a little bit.

I'm feeling very comfortable that we understand all the issues that are being fixed and (22:39) testing phase.

The disappointing part, Doug, quite frankly, is that the demand, you ask about demand, is a quite frankly extraordinarily large from both our current customers and new customers, and the opportunity either's big or bigger than I had anticipated, the challenge is making sure we get it out to the market, and get into our customer's testing cycle so that we have the opportunity to monetize it as soon as possible.

So I think that the product is in – I consider it in good shape today. (23:10) customer feedback, it's one of our large CX customers. They've been running it for two weeks without problem.

So I'm comfortable that we're progressing, but I want to make sure that we go to mass market where we've dotted all of our i's and crossed all the t's, and that's going to be a few weeks later than we had hoped for, or expected actually..

All right. Got it. Thanks for the detail.

And then my other question is on the two customers that are merging in and perhaps deflating a little bit of second quarter expectations, is it possible that that takes the further step-down later on in the year? Do you think second quarter will be below watermark?.

(23:45) I'll never say never. But the numbers that we're seeing for Q2 have been cut so much. I can't fathom that they could possibly go lower than they are, it's literally, I think, impossible..

Got it. Thanks a lot..

Our next question comes from Patrick Newton from Stifel. Please go ahead..

Yeah. Good afternoon, Tom, Dave, and Brad. I guess, just dovetailing off of the last response, Tom, you have....

Yeah..

...new products kind of slipping slightly, you commented on aggressive pricing. You talked about some merger headwinds, and then you mentioned a challenged environment multiple times in your prepared remarks.

So I'm curious if your second half expectations have been somewhat tempered relative to a quarter ago, when you spoke to an expectation of stronger growth, or should we think about more pent-up demand and an even better second half from where you were sitting a quarter ago?.

My second half view has not gotten more negative than it was the last time we talked. I'm – continue to be optimistic about the second half. A lot of the optimism is based upon the real demand we're seeing for the CX2, the real demand we're seeing for the XT-3300, and I hope people caught the importance of the commentary on winning with XT-500.

That's nice wins for us, but we brought the XT-500 out about a year ago, and it's taking about a year for us to get the architectural buyoff from customers to go with the XT-500, and we're seeing really good success in Q1 with that. I am expecting that that architectural sale has now been accomplished, so that we bring out the XT-3300.

We're able to ramp that up and put it into real applications, versus convince people about the architectural direction. As we've mentioned that we've been behind a little bit in subsea, I'm a (25:41) very high expectations of recovering in that with our XTS-3300. So I'm still optimistic, very optimistic on the second half.

The challenge is, the headwinds that we face that are more specific to us. The integration of these acquisitions, we have been – 40% of our revenue, quite frankly, has gone through an acquisition. We're getting through a lot of those, but the two biggest ones are still ahead of us.

I think that we've paid the fiddler completely for those, like I said in the last comment, I don't think it can go lower from a revenue perspective, but nothing's done until it's done. Once the acquisitions are done, there's always a process of the companies integrating before they start rebuilding.

So that's a headwind that's ours specifically, I do think that the telcom pressure is not ours specifically, and it's real; these guys are really trying to squeeze assets, and it's not just the guys that are being acquired.

I do think that that runs a course, that it has to stop, because bandwidth – everybody agrees, bandwidth in their networks continues to grow. In some of the markets, the pricing pressure continues to be real.

Last year, ASPs in our industry went down – industry saved about 29% per 100-gig port, that's fairly unparalleled except when you do a technology transition. And last year was not a technology transition-led event. I do see distinct pricing pressure still, but I don't think it's as bad as last year.

A part of it is the wholesale space, both in North America and in Europe, are under brutal attack between each other. The cost of capacity of a wave (27:21) in Europe has absolutely cascaded, that brings incremental pressure on CapEx.

The good news is, I believe, particularly with ICE4, we bring a solution that has more CapEx efficiency than anybody else. So I think that's transitory, I think the second half, I'm optimistic about, I'm focused quite frankly right now, on just getting these products out; the demand is real for them..

I appreciate the detailed response, you did just (27:49).

That was probably longer than you wanted, huh, Patrick?.

Couldn't type fast enough.

But you did just touch a little bit on subsea as being an opportunity in the second half, can you elaborate a little bit more there, and perhaps balance commentary on the opportunity in LATAM and can (28:05) APAC against you being in the process of field trials with your ICE4 that's required in certain deployments, and I guess specifically, I'd like to understand when subsea could rebound back to kind of a typical 5% to 10% of total sales?.

Sure. I'll try and add commentary. This is Dave Welch. We're actually seeing pretty good order rate for our subsea business right now, understand that these – the subsea business has the longest time from order to shipment and revenue from that.

We'll be getting out some of our first product out to the field in this quarter, and we expect to see that continued growth. So, as Gen 4 gets out to the field and to our customers' hands, expect that to continue to become a growing competitor.

I feel, from a competitive position, we're actually in a pretty good spot from here going forward with Gen 4, and then with Gen 5 not in the too distant future..

Thank you for taking my questions. Good luck..

Thanks, Patrick..

The next question comes from Jeff Kvaal from Nomura Securities. Please go ahead..

Yes. Thanks very much. I was wondering if you wouldn't mind touching on the competitive landscape in DCI. There have been a few more introductions and certainly, some of the existing products have had a little bit more time to gain some traction.

And then, Brad, I wanted to – just as a clarification, follow-up on your prior – last quarter's comment on breakeven and what it would take to get there, and when that might be. Thank you..

Yeah. So in regard to DCI, we still have a significant portion of the market, but candidly, (29:55) we're under pressure from a couple of people who have introduced viable products and, in the second half of last year, started shipping them in reasonable volume.

Quite frankly, it makes me mad, it's our fault for having our product come out later than we should have, but I do believe with our Gen 4 base product, we have the industry's leading capability. I am – my goal is to make sure we stay above 50% market share in this market, even as it grows to hopefully multiple billions of dollars.

I think with our technology, we have the ability to do that, now clearly, we have a first-mover advantage of ease-of-use in the software features that people want. And I think our customers want us to be in their network.

But, in the ICP space in particular, there is not loyalty like there is in a lot of other markets, they are really loyal to a dollar per bit, and they're loyal to watt per bit, I think with our approach on technology, we can and should lead that market, and with our increased cadence of technology, I'm very comfortable that we're going to, and we just got to get the Gen 4 out, and we'll be in fine shape there.

But we do have a couple of competitors there, any market's going to attract (31:03) the couple of – there's going to be more than one person, and there's – two people are there right now that, quite frankly, are viable competitors..

And Jeff, just to take the second part of your question on the breakeven. I think it's still possible, by the end of the year, obviously with our guide for Q2, it's going to take a decent ramp in the second half, but as Tom mentioned, I think there's a lot of great opportunity as the new products get out to market.

So, it will take some acceleration of revenue, good success for the Gen 4 products, which will drive both the top line and drive some acceleration from a margin perspective. So I'd say, it's a little more challenging than it was when we last talked, but I still think it's possible..

Thank you both very much..

Okay (31:48)..

Okay. Our next question comes from George Notter from Jefferies. Please go ahead..

Hi, guys. Thanks very much. I guess, I wanted to kind of expand the discussion on product availability. I think I understand....

Yeah..

(32:03) on Cloud Xpress 2. But, Tom, the monologue had a lot of content in here, looking at some of these other products, the XT-3300, the XT-3600.

Is the timing on all – the rest of the portfolio the same as you were outlining last quarter and at the Analyst Day or – I just want to be sure that nothing's changed there?.

Well, for the XT-3300, it's roughly on the same time of (32:29) schedule. We said last time that we weren't sure if we'd get any revenue in Q2, probably in Q3, I would say, would (32:37) probably going to be in Q3, and I think we'll all achieve a reasonable amount of revenue from the XT-3300 in Q3.

On the XT-3600 and the DTN-X, we didn't comment today. We have so much that's focused my mind on the CX and the XT, but we're on track for doing those this year, probably in Q4..

In metro as well..

And in metro, the TM upgrade to 16QAM is on track, also in Q3, and it's basically the same schedule we talked about..

Got it. Okay.

And then the TM portfolio, I guess the 16QAM upgrade, I guess I was also wondering if there's anything new to talk to there in terms of peak (33:23) integration, is that still the Gen 5 threshold where you bring that into the portfolio, or do we have that in there earlier?.

Yeah. So, George, I'll try and comment on that. We're actually doing very well from 100-gig wave perspective in the cumulative metro market inclusive of metro data center business. So the vast majority of our 100-gig waves in the metro space are PICs. We will continue to complement that with wavelengths on the XTM and the aggregation markets.

And then as we move towards a – our next generation platform that will create a common operating system across our metro long-haul activities, we'll start bringing in a unified optical engines across our portfolio..

Fair enough. Thank you..

Thanks, Jeff..

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

Great. Thanks.

I wanted to dig in just a little bit more if you could talk about the customer who is utilizing the open line system, and just whether they were using that for kind of new applications or hoping to kind of change a bit of their architecture? And then, second question is just on flexible bandwidth, if kind of rolling out customers on that has had any material impact on gross margins as well, or if it's just kind of price – aggressive (35:05) the margin pressure? Thanks..

Sure. I'll try and address it on the open line system, we've had a number of interactions, we specifically identified eight. One of the customers that have rolled this out that is converted from utilizing our competitor's product to our product, build it off of an open line system as well as build it off of our waves on that line system.

And then frankly, our business is going well. We're happy with – they are happy with the product, we're happy with the growth that they're demonstrating in those networks. And there will be a class of customers that are comfortable with buying their line system independently from their transponders.

And then there's going to be a lot of service provider-centric customers that prefer to have one integrated network. And we're happy with our technologies to address both of those markets. On the flex bandwidth, and I think you're referring to our Instant Bandwidth or Instant Network offerings that we brought out.

I'd say we've been offering Instant Bandwidth since the fall of 2012. And that has been overall an enhancer to our margin offering, and I think that continues to be, as we get into ICE4, I expect a greater percentage of our customers to be a Instant Bandwidth customer. So, I'd say maybe for a brief period of time, they slight added margin pressure.

But overall, I think it will add – it will increase the margin capability of the product line..

Great..

In Q1, we had a reasonable amount of (36:52) for line systems and footprint. In our model, that bears obviously lower margin, that's coming to bear a bit in Q2. The good news about that is when we have low margin because of footprint adds, we have an ability to monetize that and expand margin for a long period of time.

So, for Q2, that's a good reason that margins are under pressure. Getting ICE4 out is part of that solution, and obviously that being a little bit later than we thought is not a good reason that margins are compressed in Q2..

Yeah. So, the biggest thing is really the bridge investments for the new products. So obviously, we're making the right investments so that when Gen 4 gets out, those grow at fairly nice margins, obviously some customers have contractual price compression that hits us in Q1 as well. So it's more of those things than the Instant Bandwidth piece..

Okay. Great. Thanks, guys..

Our next question comes from Alex Henderson from Needham & Company. Please go ahead..

Thanks. I wanted to look a little bit more tightly at the first margin guidance. Seasonally, 1Q is usually the weakest quarter, then you've also got some products coming out in 2Q. I'm little surprised to see, Dave, the idea that you might be 100 to 200 basis points below what you did in 1Q and 2Q, given the plus or minus 2 points on a 40% guide.

What might cause that to slide sequentially like that given the guidance?.

Yeah. So as we mentioned on the prepared remarks, Alex, the impact for Gen 4 that we're planning and the numbers that we guided to is relatively small, and the first units that go out because they don't have optimal yields, they're not going to stop yet, actually can be a drag on margins.

So, that's a small impact, and in fact a negative impact, as we bleed through some of those early units. So, that's the incremental negative.

The overall piece is just really making sure that we're not afraid to make the investments to bridge customers to the new technologies because any amount of delay cause customers to be concerned about other offerings and then start to look at other offerings, and we've been fairly aggressive in making sure that we keep those customers in our portfolio so that they're ready when the products start to get out to market..

Is it reasonable to think that if you were to go to the lower portion of the gross margin that that would also entail possibly going to the higher end of the revenue range that you may be choosing to use that pricing (39:46).

Yeah..

(39:47) pull some revenues in?.

Probably not, I mean, it's just there's a lot of variables right now, Alex, in the couple of larger opportunities that whether they get fulfilled this quarter or not, we'll move it from one part of the range to the other..

All right..

(40:03).

Going back to the R&D line, if I could, just – could you give us a little bit more clarity on the slope of that over the course of the year, is that spiking up here in the June quarter or that – is that going to come back in as we go forward, or flat (40:18) not a little bit, or I mean, is that due to the new product launch timing?.

Yeah. Just getting the new products out of the mix where we have the right investments, it will still grow from a dollars perspective, but relatively small over the course of the year, it will go down though as a percentage of revenues..

Perfect. That's great. I'll seal the floor (40:36). Thanks..

Yeah. Alex, to be clear, I mean, I know you're worried of the 40 points plus or minus 2.

Our intention is to be at 40 points, there's more variability based upon how much of their new product we're going to ship or not, but we try very hard to at least meet our guidance, and I would consider the guidance to be flat, but there's more uncertainty because of the new product launch.

As Brad talked about, there is a large number of opportunities that could certainly move the revenue distinctly. That would be a good opportunity, but I just don't feel like we can commit it, knowing the uncertainty at this point.

So, I continue to be optimistic on where we sit, but considering that the new products are a little bit later than I had hoped, that uncertainty is seen in our guidance..

Great. Thanks..

The next question comes from Dmitry Netis from William Blair. Please go ahead..

Okay. Thank you very much, guys. So, just kind of taking a step back here and looking at the funnel in general, and maybe some of the new products that are coming up here in back half of Q2 and then Q3, specifically CX2, XT-3300.

As you look at the funnel of the opportunities, has the funnel of the opportunities for those products grown from, let's say, three months ago, has it stayed about the same? Just comment generally on what you're seeing, and maybe on the DTN-X, the current product you're shipping, is it still seeing more opportunities coming in your way, on either the new or the old product?.

So I'd say on the CX, the funnel is about the same, it's always been pretty big. We see a lot of opportunity. I wouldn't say it's grown since we saw – talked to you guys last. On the XT-3300, I think the funnel is increasing, and we're seeing new applications.

We talked about a little bit in the access space, the Remote fi (42:39) types of opportunities. We see a substantive amount of potential opportunity in that area, and that includes the XT-3300. But we're also seeing, as the XT-500 sells well, we're seeing more opportunities for the XT-3300 in general.

The DTN-X demand, it's driven a lot by companies that are under acquisition and in the telco space, where there is pressure. The RFQ activity in general for the company is much higher than it's been for a long time. We bottomed out, I think, Q2 of last year on RFQs, and I made a comment on that at the time, when our business fell precipitously.

The RFQ activity has been growing steadily, and in Q1, I believe it was either a record amount of RFQs across our portfolio, or close to a record of RFQs. So I'm seeing in the market, more opportunities than we saw, certainly six months ago, and even three months ago. So the pipeline of activity in general is much better..

Excellent. And my follow-up is, I guess, two-fold. One is, you mentioned the long-haul part of the market grew. I didn't capture whether that was year-over-year or sequentially.

And is that a blip, or do you actually see maybe several quarters of a kind of a long-haul business sort of coming back to life here, despite the consolidation and M&A that we've seen at your customer base? And then on the CX side, is that still (44:11) 10% of revenue, and (44:14) basically filling the void while you're getting CX2 ready to go out in the market, or is CX seeing an air pocket as well? So just, if you could address those two.

Thanks..

(44:27) said the long-haul market was up sequentially, and Q4 was pretty weak quarter for long-haul, quite frankly. I do think that the long-haul business, we do see – start to see recovery.

Some of it's being replaced with XT type of opportunities versus DTN-X, that obviously has a significantly lower selling price, but the magnitude of the opportunities are also bigger volume.

I do think that the – as we said in my prepared statements, we see an opportunity to grow market share in the second half of the year, and I believe that is the case. I do think a number of the customers that have tamped down their spending are going to get to the point in that timeframe where they have to start spending money to grow their network.

It's not like they're not growing their network, but what they're doing is, they're trying to optimize assets in their warehouse, and they're bringing them down to a level that, quite frankly, is going to start bringing them concern. We egged that on a little bit by having very, very fast lead time.

We ship typically in two to three weeks, so there is more and more, I would say, financial scrutiny if Infinera can ship in two to three weeks, why are we having a couple months of inventory in our shelves. They are as intense on asset utilization as I've ever experienced them. So it's real, but it's going to run its course.

So I am more optimistic about our long-haul space than I was over the last couple of quarters. In regard to the cloud business being 10%, personally, I believe it has to be greater than 10% of our business, it has the opportunity to.

If we had the CX2 out fully in volume right now, it would be substantially bigger than 10% of our company, and I think there's a huge opportunity. We made the mistake of delivering ICE4 later than we should. We are not going to make that mistake again. ICE5 is actually on track or ahead of track on all technical performance and schedule.

We need to go and make sure we have a cadence of delivery that never puts us here again. I believe the Gen 4 or the CX2 will put us in a good position of growing market share again, we just got to get the thing out..

Thank you very much..

Yeah..

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

Hi, Vijay..

Yeah, hi. Hi, Tom. Hi, Brad, Dave. Yeah.

My question is on the data center optical opportunities, so will be truly helpful to get your color on what competitive pricing dynamics you're seeing in the DCI market, and where I'm coming from is, who do you run into mostly in terms of the vendor portfolios – the vendors, the suppliers, out there in sales deals? And then, Tom, how do you see the DCI opportunity playing out this year versus last year in terms of growth rate, the number of customers you have now versus prior years, and then also the price declines you're seeing on year-on-year.

Any and all color (47:11) on the DCI market very helpful..

Yeah. Sure. So the DCI market continues to grow robustly. The biggest volumes are being driven by a few guys, but as here (47:21) we talk on the call, we continue to add new customers every quarter, and this is going to be an important part of this long-term move to the cloud, it's not done, it is not just five guys that have this business.

So we're working very hard to address enterprise customers, we're working very hard to get into new markets where they have important PCI applications, and we're achieving a relative success. But the biggest volumes are coming from the top ICP guys. And we continue to be well positioned, where we've historically been.

One of the ICPs, as I mentioned, has already deployed the CX2, and they like it and quite frankly, the mixed blessing of them doing early deployments is they like it. So they're quite frankly putting enormous pressure on us to start shipping to them in a volume. It's a good problem, but it's a problem. So we need to go and execute on that.

There has been a couple of entrants into the market, starting basically Q4 of last year. And we saw a couple of significant – we saw a lots of people deliver products. I consider we had two viable real competitors. And I think that quite frankly, both of their products are good. I do believe that our CX2 is better, the market will decide.

And we just have to make sure it's in labs competing with these guys, and that, quite frankly, the biggest challenge right now is making sure we're not missing lab qualification cycles for buy cycles (48:42). These guys in the ICP space move fairly quickly. So we need to get the product to them and not miss qualification cycles.

Right now, we don't believe we are out of qualification cycles, but if we delay much longer, we run that risk. I think that the long term, we have a huge opportunity, and I said – I tell it to my team internally all the time, we must maintain at least 50% market share in this PCI space. Anything less, we have quite frankly failed..

Yeah. Perfect. And then quickly, Tom, in terms of line rates coming from one data center to another, are they mostly 10 and 40 gig, Tom, or you seem like (49:22) native 100-gig traffic going from one data center to another? Thanks..

That's 100 (49:27) gig..

Perfect. Thanks..

(49:31) I'm too binary....

(49:33).

(49:33) 100 gig..

Yeah..

Okay. Thanks, Tom..

Our next question comes from Rod Hall of JPMorgan. Please go ahead..

Hey, Rod..

Yeah. Hey, guys. Good afternoon. Just wanted to come back to the product development timeline, I guess. It's always been a pretty challenging timeline, and you guys are calling out a slight delay now in CX2.

I just wanted to understand whether how that knocks on and impacts the rest of the timeline, and are you – is this the same group of people like, I think remember that it is, but can you just remind us, is it same group of people that have to get through all these ICE4 product developments, or do you teams running in parallel, so that the CX2 doesn't affect so much what happens with the other products? And then I guess, as an add-on to that, Tom, do you think that your development resources – are you adequately resourced? I mean, is this kind of a one-off because the ICE4 was delayed, or do you feel like you need to add some resource there? Thanks..

Yes. So, we have multiple teams developing these platforms. So, it's not as simple as this one moves a week, so the next three move a week also. Obviously, the CX and XT are very similar platforms. So, well, one impacts the other more. In regard to the XT-3600 and the DTN-X, there are separate hardware teams that are working on that.

The challenge with our ICE product is that the first one we bring to market is where we do the debug of the optical engine for all of them. So, there is not repeat learning around the optical engine. There's certainly new learning that has to occur around the system, because each system has its own requirements.

But the optical engine is quite frankly the heart of our IP, and that's where we can take extra learning on the first one. And one of the challenges moving forward is how do we make sure that we can step and repeat these across multiple platform simultaneously. We will – we're making progress in that arena, but that's a challenge.

So, a long story short, some delay, you shouldn't map it one-for-one, there could be some delays that are corresponding, but you shouldn't map it one-for-one, and I'm comfortable with our overall engineering resourcing, I do think that we have some certain skill sets that we need to continue to add.

But overall, general engineering resourcing, I'm comfortable with..

Great. Okay. Thanks a lot, Tom..

(52:00).

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

Well, thank you guys for joining us today. I appreciate your questions. I look forward to updating you on our continued progress. Have a great day..

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