Good day and welcome to the Infinera fiscal first quarter 2019 financial results conference call. All lines will be in a listen-only mode until the question-and-answer session. [Operator Instructions]. Today's call is being recorded. If anyone has any objections, you may disconnect at this time.

I would now like to turn the call over to Ted Moreau, Investor Relations for Infinera. Ted, you may begin..

Thank you Sean. Welcome to Infinera's fiscal first quarter 2019 conference call. A copy of today's earnings and CFO commentary are available in 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, including but not limited to, statements about our business, plans, products and strategy, statements about the acquisition of Coriant, integration plans and synergies, as well as statements regarding our first quarter outlook.

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

Actual results may differ materially as a result of various risk factors, as included in our most recently filed 10-Q as well as the earnings release and CFO commentary furnished with our 8-K filed today.

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 conference call includes 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 the first quarter 2019 earnings release and CFO commentary. I will now turn the call over to Mr. Tom Fallon.

Tom?.

Good afternoon and thank you for joining us on our first quarter 2019 conference call. Joining me today are CFO, Brad Feller and COO, David Heard. I will start with our Q1 financial performance and by highlighting the unique opportunity for the new Infinera.

Then I will turn the call over to Brad to provide a detailed review of our Q1 results and an outlook for Q2 and the remainder of the year. Significant progress in Q1 was overshadowed by revenue that was below our guidance.

While our backlog in the quarter continued to grow, we are unable to achieve our revenue guidance range as one significant network deployment in Asia did not progress as expected. This one transaction represents the full delta between our internal expectations for the quarter and our achieved result of $296 million in non-GAAP revenue.

Non-GAAP gross margin of 35% beat our 31% guide as we began to see the benefit of new pricing policies, continued to realize positive impacts from our ongoing synergy execution and enjoy the favorable product mix.

Operating expenses of $139 million were above the midpoint of our range due to some specific one-time cost incurred in the first quarter, mostly in G&A. This resulted in a non-GAAP loss of $0.23 per share, which was better than our $0.29 to $0.25 loss range.

We are encouraged about our expanding opportunity pipeline and the strategic engagements we are continuing to develop with both existing and new customers. In Q1 bookings, we saw strength in international markets, particularly in the U.K. and with the European Tier 1 and in subsea.

Our subsea bookings grew significantly on both a sequential and year-over-year basis. Infinera's optical performance created through our ICE4 DSP continues to lead the market in spectral efficiency, the key driver of overall subsea network value.

In North America, our carrier and cable business experienced reduced new purchases in the quarter versus the prior year. Further, ICPs were weaker, we believe as a result of software CapEx spending in general.

Despite the Q1 revenue results, we are encouraged that most of our significant market segments are showing strength as we enter Q2 driving a very strong expectation for bookings that I will discuss in my outlook.

The quarter was highlighted by significant progress on a number of fronts, particularly in regard to developing new product opportunities, investing in technology leadership and executing on our integration plans. At OFC, we demonstrated our 600 gig Groove solution, which delivers industry-leading optical performance.

By combining a leading merchant DSP and our own unique optical design, our solution delivers differentiated optical performance, leading power metrics and a cost structure advantage. In Q1, we invoiced 30 new Groove customers. Groove revenue in Q1 grew over 40% sequentially and more than 4X year-over-year.

Riding on this momentum, we see significant trial demand for the 600 gig Groove solution from both existing and new potential customers, ranging from the largest ICPs to traditional carriers.

This product currently has limited availability and we expect revenue to scale in the back half of the year as customers certify and integrate this product into their operations. Also at OFC, we announced our vertically integrated 800 gig ICE6 solution, with impressive demonstrations of our 800 gig PIC.

Our industry-leading internally developed ICE6 DSP will include our innovative and field-proven advantage of subcarriers and SD-FEC gain sharing, while adding probabilistic shaping, furthering our lead in high capacity optical performance that drives lower network transmission costs for our customers.

We remain on track to commercially ship 800 gig platforms into the market in the second half of 2020. We view our optical leadership position as unique in the industry as the only optical system supplier of 600 gig today, with 800 gig slated for 2020. We currently expect one other 800 gig solution to be in the market in the 2020 timeframe.

And we believe our vertical ownership of the optical supply chain will prove strategically important to creating time to volume advantage.

We are confident that our optical performance differentiation and unique position as the only supplier with a solution portfolio encompassing both 600 gig and 800 gig offerings places us in a position to earn market share with customers who relentlessly drive cost per bit through optical technology early adoption.

Expanding from our traditional network market into the IP edge, we believe we have a unique asset with our new DRX disaggregated router and XTM solution, which we announced at Mobile World Congress [ph] in Barcelona.

We believe that 2019 remains a positioning year for 5G wireless backhaul and DAA networks and the DRX places Infinera as a network challenger, bringing a disaggregator in open architecture to the edge router market.

Today, we have multiple commitments for deployments of our DRX solution with further eight trials from several Tier 1 customers scheduled for this year. On the integration front, we have accomplished a great deal in seven months and remain on track to complete the functional integration this calendar year.

Specifically, we have implemented measures that are expected to yield $100 million of synergies for 2019 and have further plans in place for combined OpEx and COGS savings to significantly exceed our aggregated commitment for this year.

We have completed two of our three major system implementation projects with the entire company benefiting from salesforce.com integration and agile deployment, a system used to unify our supply strategy and deliver cost optimization. We have specific manufacturing consolidation projects that are expected to be completed by the year-end.

We remain on-track to close our Berlin center in Q3 and have contracted with Fabrinet to transition production to one of their low cost manufacturing centers. We are also reducing the number of our external manufacturing and logistics centers by roughly 50%, significantly reducing our fixed cost exposure and ongoing operating cost.

And finally, we remain committed to achieving both non-GAAP profitability and positive cash from operations in Q4 of this year.

While integration always brings challenge and risks, to-date I am pleased with the substantial progress and remain confident in our ability to achieve our committed goals and establish a strong foundation for the new Infinera.

We expect to see these results to scale on a step function basis in the second half as cost savings flow through the P&L and the transition to a variable cost base supply chain takes effect. This will be reflected in expanded margins and lowered OpEx in the second half. We see a very strong outlook for Q2 bookings.

With our new product offerings, recent design wins and progress with customer trials, we expect our ICP based bookings to significantly expand with opportunities in both subsea and traditional data center interconnect. In fact, our Groove platform was just certified at a leading global ICP and we expect the first deployments to begin in Q2.

This certification is based on our currently shipping 200 gig module, with upgrades to 600 gig planned for either later this year or early 2020. We see this as a significant opportunity, one of several we expect based on this platform.

On the cable front, we continue to see some challenge as part of our customer base works through an inventory position that will take time to digest, following more aggressive spending last year.

Overall, we expect strong sequential bookings growth in Q2 with each segment experiencing sequential double digit growth and highlighted by ICP, which we expect to double quarter-on-quarter.

We are very encouraged by our current bookings outlook and pipeline, which we view as an affirmation of our strategy and the positive positioning of the new Infinera with customers that we had highlighted during our Q4 earnings call.

Having brought together two comparably sized companies, we are now addressing much larger Tier 1 and subsea consortium opportunities. Given the scale and complexity of certain deployments, we are finding that time to revenue for these larger engagements can take longer than what we had experienced in the past.

While bookings in Q2 are expected to be very strong, the timing of the revenue associated with these opportunities will be spread across Q2, Q3 and into Q4.

Based on our new end-to-end portfolio, some of these opportunities are large solution deployments, where revenue will only be realized upon successful turn-up of networks that span multiple countries and continents. Several other bookings currently include requested shipments in the first part of Q3.

Collectively, while these factors lead to a Q2 revenue expectation that's below our plan, we see our overall strategy remaining intact. Because of the timing of network deployments that we now see for the first half of 2019, we are lowering our 2019 revenue expectation from $1.4 billion to $1.3 billion.

While bookings for the year are expected to come down by some degree, the revenue decrease is more significant due to the timing issue.

We expect to carry a substantial backlog and bookings momentum into the second half of the year and this momentum is expected to position us to close the year with our original commitment of non-GAAP profitability and cash from operations in Q4 of 2019 intact.

The combination of a strong pipeline, near term bookings outlook, trials momentum and technology plans that we have in place, gives me confidence and resolve that we will exit the year as one profitable integrated company, ready to benefit from the next wave of optical spending, driven by general capacity expansion, data center interconnect growth, 5G and fiber deep applications.

In summary, two quarters ago we bought Coriant to increase scale and deliver an end-to-end optical networking capability to the most significant customers in the world. We remain confident this was the right decision for the company and its shareholders.

In seven months, we have converted our portfolio, created positive traction with significant Tier 1s and ICPs around the world, cut our expenses and fixed cost infrastructure and increased our synergy commitment for year one, while bringing leading technologies and innovative solutions to the market.

Looking back, we are realizing many of the benefits we planned for when we chose this path. What we did not plan for was a longer deal to revenue conversion cycle over the first three quarters, which we are now seeing in our disappointing first half revenue.

In that period, we did grow backlog in each of the first two quarters as a combined company and expect significant sequential backlog growth in Q2 as our booking outlook vastly exceeds our revenue plan in this period. Based on our revised expectations of the year, we are currently expecting second half revenue to grow 15% to 20% over the first half.

With our commitment on fixed cost elimination that will benefit us in Q3 and expense reductions that are in place and growing, we see margin expansion of several 100 basis points over the first half average and operating expenses coming down to $125 million per quarter.

We expect this combination of growth, margin expansion and expense reduction to return us to profitability in Q4. I look forward to reporting on our progress in achieving these objectives in the coming quarters. Brad will now walk you through the specifics of Q1 and our outlook..

Thanks Tom and good afternoon everyone. Today I will discuss Q1 highlights for the new Infinera, provide our outlook for Q2 and share some updated color on our outlook for 2019. The detailed recap of our Q1 results is available on the CFO commentary on our Investor Relations website.

In Q1, non-GAAP revenue was $296 million, compared with our $310 million midpoint of guidance. Compared with Q4, revenue declined 12% sequentially, which is approximately in line with typical seasonality in our industry.

Our Q1 revenue was below our expectations, driven entirely by one large network deployment in Asia which did not progress as expected during the quarter. But we still expect a significant opportunity to materialize this year. We can't yet determine the timing and thus have not included it in our outlook for the second quarter.

During Q1, we continued to win new deals with existing customers and also added new customers while building backlog. We saw relative strength from North America and APAC and we have one customer, a North American Tier 1, represent 11% of total revenue in the quarter.

With regards to gross margins, non-GAAP gross margin in Q1 2019 was 35.3%, well above the guidance range of 29% to 33% and the 31.9% we reported in Q4. During our Q4 2018 earnings conference call, we outlined several margin enhancing activities we are undertaking to drive margin improvement and we are executing on those activities.

We have taken significant actions to remove fixed cost infrastructure from our manufacturing and services organizations. In the second half of the year, we expect to begin to realize the full margin benefits resulting from the transition of our Berlin manufacturing facility to Fabrinet.

Further, our supply chain organization continues to make progress in driving down product costs through price negotiations and strategic alignments with key vendors, which will flow through the income statement as we turn inventory in the second half of the year.

Finally, we have aligned our global pricing approval processes, allowing us to tightly control discounts provided and ensure proper return on investment. We are already seeing the benefits of these approaches in our deal margins, driving significant improvement in the profitability of the Coriant products.

In addition to the benefits from the above activities, which we expect to continue to realize, we received some one-time benefits in the quarter related to favorable resolutions of the certain manufacturing and quality reserves. Turning to OpEx.

Non-GAAP operating expenses were $139.4 million in Q1 2019, which was above our $138 million guidance midpoint as we had higher outside professional services spend to support annual audit activities along with incremental rent expense in connection with the adoption of the new leasing standard.

I would like to remind you however, that our Q1 2019 OpEx of $139.4 million remains below pre-acquisition levels even after absorbing a $9 million step-up in expenses related to the reset of compensation related benefits and taxes to start the New Year.

We continue to make strong progress on integration synergies, which we believe will allow us to exit the year with operating expenses of approximately $125 million per quarter.

The combination of the above factors in the first quarter resulted in a non-GAAP operating loss of 11.9%, which was a 160 basis points better than the 13.5% loss we had estimated as part of our Q1 guidance. We had a non-GAAP net loss of $0.23 per share as compared to the midpoint of our guidance which was a non-GAAP net loss of $0.27 per share.

We believe as we grow our revenue and execute on our synergy plans, we have the opportunity to drive our financial results back to significantly better levels over time. Turning to the balance sheet. At the end of the quarter, we had $211 million in cash, down from $269 million at the end of 2018.

Our cash burn in the quarter was higher than our expectations, as we had some large customer receivables expected at the end of the quarter which did not materialize and we built buffer inventory to reduce risk related to revenue plan execution and manufacturing transitions.

Since the end of the quarter, our cash collections have begun to recover and we expect to bleed off the additional buffer inventory later in the year. Turning to our outlook for the second quarter of 2019.

We expect robust bookings during Q2, up significantly on a sequential basis, as we begin to receive customer orders on some of the deals we have won in previous quarters and continue to drive new wins.

That said, a significant portion of the expected bookings increase in Q2 relates to large network deployments, which will take multiple quarters to install, certify and receive the acceptance required to recognize the associated revenue.

While we are excited about our continued deal wins, many of these represent very large network deployments which are very complex and thus determining the exact timing of revenue recognition can be challenging.

This phenomenon, along with demand softness in our cable vertical, is driving us to guide non-GAAP revenue for the second quarter of 2019 of $300 million, plus or minus $10 million. In the second quarter of 2019, we expect to deploy an unusually large volume of new footprint with customers.

Many of these networks are being deployed with ICE4 based products, which have very limited capacity activated on day one which pressures margins. That said, as these networks add capacity in the future, the field generates much higher gross margins.

This is a positive dynamic for the business as it tends to be a strong sign of both future revenue growth and margin expansion. In addition, although we continue to take actions to lower our fixed cost infrastructure, we have not fully completed these reduction efforts and in certain cases have temporarily engaged additional transition resources.

Accordingly, we will be required to absorb incremental fixed cost in Q2 on the lower revenue base. As a result, we currently expect non-GAAP gross margin for Q2 2019 to be 30%, plus or minus 200 basis points.

As I stated earlier, we expect a step function increase in these margin levels in the back half of the year, as our fixed cost basis is transformed to a variable model and supplier cost reductions flow through the income statement. Turning to operating expenses. We continue to make significant progress in lowering our operating cost basis.

Recall that in Q4, we implemented certain headcount reductions to drive efficiencies in our business. These actions will continue to lower our operating expense and real estate footprint throughout the year, keeping us well ahead of our targeted integration synergy plans outlined in the middle of 2018.

As we look specifically at Q2, we anticipate non-GAAP operating expenses of $135 million, plus or minus $3 million. Further, we remain on track to consolidate our multiple ERP systems to one system during Q3, which will allow us to run the business much more efficiently and allows us to further reduce the spend levels.

Below the line for the second quarter, we currently expect $2 million to $3 million of net interest expense and tax expense of $2 million to $3 million. Putting it all together, we currently project a Q2 non-GAAP operating loss of 15% and a bottom line non-GAAP net loss of $0.28 per share, plus or minus a couple of pennies.

As a result of the lower revenue and gross margin outlook for Q2 and knowing that we will be required to pre-build inventory to meet the expected stronger second half, we anticipate our Q2 cash burn at fairly consistent levels to those experienced in Q1.

That said, we expect to significantly reduce the cash burn in Q3 and anticipate generating cash in Q4. We estimate our low point of cash during the year to be in the $150 million to $160 million range, likely in Q3.

We will continue to evaluate cash financing alternatives to allow us working capital flexibility, as we drive synergies and transform the business over the course of the year. Looking at the full year 2019.

With the timing challenges referenced above and customer demand softness in certain verticals, we have reduced our revenue expectations for the year to $1.3 billion. As we continue to execute on our detailed synergy plan, we expect to improve gross margin and operating expenses over the course of the year.

As we have been driving hard on the synergies, we remain confident in our ability to drive non-GAAP profitability and generate cash in Q4 of this year. Finally, I would like to provide some perspective around my resignation.

Over the last few years, I have had multiple health scares driven by stress, have young children at home and want to make sure I am around to watch them grow up. As such, I have determined it's time to invest in my health and I have made the very difficult decision to leave Infinera at the end of Q3 of this year.

I want to emphasize that I still very much believe in the tremendous opportunity that the new Infinera has as a company with a much more robust portfolio of solutions, with access to the largest customers in the world. I plan to continue to be a shareholder and cheerleader for the company.

I want to thank Tom for the opportunities he has provided for me to grow as a CFO. Infinera is a family and I will truly miss many of my colleagues and wish each of them the success they deserve. Thank you for your support along the way. With that, I would like to turn the call over to the operator for the Q&A portion of the call..

[Operator Instructions]. Our first question comes from Simon Leopold with Raymond James. Please go ahead..

Thanks. First of all, Brad, just want to thank you for the time you spent working with us. Wish you best of luck in your next endeavors..

Thank you..

Shifting over to the question. So we saw an announcement you made recently regarding a project with Verizon. I imagine that that's coming through the historic Coriant, Tellabs position. I wanted to see if you could give us an idea of the kind of opportunities similar to that you see in the business.

I imagine that there are others like that and just trying to get an idea of how to size that in terms of the model and the opportunities that I assume you know what I am referring to?.

I do know what you are referring to. It's an exciting opportunity for us for a couple reasons. One, it's using our Transcend Software Suite that we did pick up from Coriant.

If you think about these large networks from classically Tier 1s, they have a huge number of old networks, old circuits, old architectures and all of them want to migrate into the new world. And with the Transcend software, they are able to map all of their network, all of their services. It's the first phase of a several phased program.

The first phase is mapping what they have and Transcend does a magnificent job as an SDN manager and an orchestrator of being able to let them map their capability. The second phase will be to actually start moving that circuit into new capabilities. And the third phase will obviously be hopefully our Transcend software managing those new networks.

The excitement, to me, is a couple fold. One, they picked Transcend and have found it so far to be an excellent choice. We are about a quarter into this project with them. They held back the press release until they achieve success. They are achieving success and we will probably continue to grow this opportunity for quite a while.

We also have a professional services opportunity to actually help them with this migration which we are working hard to migrate. You are exactly right. This is not unique to Verizon. It's basically everybody who wants to transition an old TDM network into a new world architecture.

And we think we are being well positioned for that and I think it goes back to our comment, why Coriant? Well, because of their relationship, they had a seat at the table and this opportunity came up and the trust that they had with that team, the capability of Transcend allowed us to have an advantage in earning that business..

Great. And then as a follow-up, I wanted to see if you could maybe unpack or build a bridge to the upside for gross margins you reported in the first quarter versus your original expectations. Was it a matter of just walking away from bad deals, hence it's the lower revenue? Or if there are other aspects to that? Thank you..

Yes. It's a combination of things, Simon. It's partially the mix of what we sold. Obviously in Q1, it's tough to get new network deployed. So it tends to be a better mix and that was better than we expected. Our supply chain team continues to drive nice cost reductions and we continue to be very diligent with everything we are doing.

We did have some one-time benefits on the warranty side of things that benefited us as well. So a variety of different things. The good news is the majority of those continue and get better as we go throughout the year. What you see in Q2 is just a pause just because of the very large amount of new deals that we will deploy in Q2..

Yes. I think both a pause. And this is David Heard, I apologize. It is also a transformation step that we are taking as a company to move from a fixed cost structure to a variable cost structure. I think for those of you who follow Fabrinet, they announced that they were taking over our Berlin facility.

And so we have already seen, so this quarter, we are in heavy lifting mode of transferring that over to Fabrinet and we expect to be able to get the benefit of that in the back half of the year. That is a substantial reduction in overall fixed cost.

In addition, as we said, when we did the acquisition, we thought that there was upside to the standard margins associated with the Coriant products and we have seen that already. Even though, it takes time to take the material cost reductions and flow them through inventory, that will compound in the back half of the year.

And so while we will have a bit of a step back in new footprint which is good and we will have a step back because we will have some duplicate costs in Q2, we are feeling confident about both the integration efforts and the business model impacts for the back half of the year..

Great. Thanks for taking the question..

Thanks Simon..

Our next question comes from Rod Hall with Goldman Sachs. Please go ahead..

Yes. Hi guys. Thanks for taking the question. I wanted to start off this Berlin facility and the Fabrinet takeover. David and I guess, Brad, you too had referred to that impacting cost later in the year.

Is there any way you could quantify that for us so we could understand what the impact there would be? And I guess it's embedded in the synergies, but maybe just clarify that as well?.

Yes. So it's a few hundred basis points per quarter impact. So it is significant for us..

Okay. Great. The other thing I guess I just wanted to circle back around to and I know this is a broad topic, but just to get your take on the whole 600 gig versus 800 gig cycle situation.

I know, Tom, I talked to you about this and your thinking was that there will be a substantial 600 gig cycle and 800 gigs probably not something that will materialize until later.

I am just trying to get a feeling for how big the 600 gig cycle might be? And when you think it peaks? And how 800 gig affects it? Just any more color as time has progressed here on that..

Well, I still believe that 600 gig is going to be a big opportunity. Why? Because it reduces cost, it just reduced network cost. Right now, a lot of our competitors has a very good 400 gig solution. They have had a really great run with being kind of unique in that space. 600 gig is going to absolutely have lower cost than 400 gig.

And if you look at one of the transitions that's happening in the market to disaggregated and open, one of the opportunities once you have a disaggregated open network, you just drop in the next transponder. And I think that the acceleration of transponders in the market is going to be real.

The pent-up opportunities we see for 600 gig and the Groove are significant and that's one of the reasons we won this ICP, is we are going to have an 600 gig solution. Do I think 800 gig, is it going to steal opportunity for 800 gig? Probably not. 800 gig is going to do the same thing 600 gig does.

Lower the cost of transmission to the largest carriers of capacity in the industry, particularly in areas like subsea and ICP. I think that people are moving to 600 gig today because it's available today. Nominally available today, certainly in volume in the second half of this year.

While 800 gig is coming, with new technology there's always delays of risk and gap. Once you have an open disaggregated network, great, take 600 gig today, take 800 gig when it's available. But don't lose the opportunity to build and run the lowest cost networks. So I see a significant opportunity in 600 gig. I see a significant opportunity in 800 gig.

We are the only people that have both 600 gig today and 800 gig tomorrow. And I think next year, we are in a nice position of being kind of in a duopoly with 800 gig..

I think that's the big delta, Remember, we sell 100 gig, 200 gig today and we are used to managing these cycles. In the ICP cycles, I think people are getting carried away that 600 gig tends to operate or any potential technology tends to have a two to three year cycle and they don't completely stop when they adopt a new cycle.

So as Tom said, I think you can see 600 gig end of this year or 2020, 2021 and we will continue that maturity curve as you get into 2022. And I think you will start to see scale operations of 800 gig in 2021 and go similar.

In the service provider world, those technologies tend not to have a three-year cycle, just because of the adoption paying to get it out in a mesh network. Those tend to have more like five-year cycles..

Okay. And one other thing, in North American revenues, there are only up about $4 million year-over-year and I am assuming maybe there is some dissynergy there.

Just curious what kind of the underlying revenue trajectory looks like there and whether the low increase year-over-year is just due to a little bit of short-term dissynergy or any other color you could give us on that?.

No, it's a good question. I think that there is no dissynergy there.

What we are seeing, as we said, was just some softness that you have seen from some of our competition in North American cable spend in the first half of the year and as Tom mentioned in his prepared comments and Brad reiterated, some softness in the ICP portion of the spend that was picking up because of our design wins and inbound orders in the ICP space..

In general, North America and Americas were pretty solid in Q1, offset by one cable and the ICP space being weak. We were seeing, outside of that, relatively good growth..

Okay and then just ending with my thanks to you too, Brad. Thanks for all the support and help over the years. I really appreciate it. Best of luck..

Thanks Rod..

Our next question comes from Samik Chatterjee with JPMorgan. Please go ahead..

Hi. Thanks for taking the question. I just wanted to start off on the revenue guide for the back half of the year. I think you are kind of implying $700 million in terms of the back half, which is a modest kind of improvement over the first half or a step function kind of over the first half in that sense.

Now how much of this is, you talked about booking accelerating in Q2, how much of this you are kind of looking at in terms of building an expectation for bookings that would accelerate in Q2? And how much of this is based on kind of bookings that you already had in Q4 and Q1? And I am trying to get visibility, what's the risk in terms of that back half? How much is booked and how much is kind of based on expectation of the bookings accelerating in Q2..

Yes. So the biggest driver is the bookings increase we expect in Q2. We commented that it is a significant increase over both what we had in Q1 and what we have had historically. So that will help the second half. We also have new products that are ramping. So Tom mentioned the 600 gig Groove.

We think there is great opportunity in the second half there as well, as well as new wins that we expect to continue to have in the second half..

Yes. If you remember, we grew backlog significantly in Q4. We grew backlog again, not significantly, but grew backlog again in Q1 and we anticipate an exceptionally strong Q2 of bookings which will grow backlog again. We have plans in place on these rollouts that will be in Q3 and Q4.

Some of them are subsea where that you don't get revenue until you actually hand over the network. Those are all scheduled for later this year. And I mentioned this ICP win, we see significant uptick in opportunity in the second half based on this very specific deal.

Now there's not enough backlog obviously to cover the second half, but we feel pretty comfortable that the opportunities we see support this up to 20% growth in second half revenue..

Okay. And if I could quickly clarify, you are talking about a lot of new wins here, that's driving the confidence in the back half.

How are you thinking about kind of the gross margins exiting the year? Are they still kind of how you are thinking about this three months or six months earlier and kind of does the pace of new wins, we have seen a bunch of announcements from you in terms of new businesses that you are pursuing, does that impact your thinking about gross margins exiting the year?.

No. We still expect gross margins actually in the year to be in the mid-30s. As we get the fixed cost infrastructure out, that will be a great thing. It will allow us to absorb some of the new deals..

Okay. Thanks..

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

Great. Thanks. I had just a couple of questions.

On the new footprint deployments that you are talking about and just the timing that it will take to kind of get signed off, just a sense of what type of products are those? Is it the X 3600 or X 3300, just products that are new and might take a little bit longer to get tested within networks? And then second question for me.

Second question, on the Asia customer that pushed out, is it just a push out? Is it a revision of the order? Just any context there. Thanks..

Yes. So the first question you had Meta was, it's fairly broad. 3600 is obviously a very complex product that we use in subsea and some very robust applications. That's part of it, but there is also some very big deployments with some of the historic Coriant products as well, where we are doing large terrestrial and subsea builds as well.

So there's things that fall in all of the different the camps. On the large deal in Southeast Asia, can't get into too much detail, but we remain confident that the deal will happen and will give revenue. It's just hard to say at this point. The customers' plans have not gone exactly how they would expect..

Yes.

I would probably add that with the addition of the Coriant customer base which pretty much gets us to two times the customer base and a much wider portfolio, a lot of these are solutions sales and in many cases with Tier 1s and much larger carriers that tend to move at a bit of a slower pace in terms of the rollout of these networks and thus the prediction of bookings to revenue..

Got it. Thanks guys..

Thanks..

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

Thanks. Clearly there is a gap here between reported revenues and the orders that you are taking in. Some of that having to do with revenue recognition. Some of that having to do with a variety of other factors.

But I was hoping you could talk to what portion of the original $1.4 billion in revenues you think you will have in terms of actual orders during 2019? Is this simply a timing issue of revenue recognition being different from your historical patterns and therefore, you are basically on a track to win the business you thought, you are just not recognizing it..

It's a slight combination of both. And I have said in my call, in my prepared remarks. Bookings are probably a little bit light from our original plan. The revenue is significantly down based upon timing.

And I think part of the bookings down means as you roll out these networks and they are delayed, the follow-on fill, the follow-on opportunities don't happen as fast. If you look at the first half as I look at the first half of our bookings, combining Q1 and Q2 and take an average, we are actually not far off of the original plan.

We are a little down. And we see the second half pipeline looking exceptionally good. We have not experienced, what I would consider losses. Part of it quite frankly, is the change in what we are seeing in cable. So I had a very specific outlook that I shared with you that we got from customers last time. It's a different outlook today.

So part of that reduction is based upon the new outlook in that one customer base..

As we look at the book-to-bill ratio in the March quarter and for that matter, in the June quarter based on the commentary of being significantly up, is that 1.15, 1.2 type book-to-bill number? Or what are we talking about here?.

Yes. So Q1 is roughly in line. Q2 is obviously much higher than a one-to-one..

Okay. And then as you are looking out at the scale and the magnitude of what you are deploying in 2019, do you think you can get back to the original 1.8 as we move out to 2020.

I know that's a little bit out there, but clearly there's a lot of momentum here and there's also a lot of pent-up businesses that's embedded in some of these large deploys that will get turned on a year later in terms of new wavelengths.

Can you talk a little bit about, are you going to be able to get back to that original expectation at some point? Or is that a bridge too far?.

Well, for certainly today Alex, it's a bridge too far. I mean today, let's be honest, I am taking down our revenue guide for this year which isn't so great and it embarrasses us, embarrasses me. I think we have an opportunity to start building the business. I know we do. We are winning customers. We have a huge pipeline of pent-up demand.

I am not going to go out into a 2020 time-frame at this point. We will take it under advisement to look at that. There's lots of reasons to think to be optimistic. I think our 600 gig is going to do well, I am sure our 800 gig is going to do well in the market, the DRX, it's a new market for us.

But if you think about opening up new markets for us to go after, with a disaggregated router, the market really wants a disaggregated router to break the lock that current competitors have on it Coming from our Tellabs side, we have a huge heritage in software to support all the feature richness at the metro edge.

It's certainly too early to declare any victory. But we have got several deployments that are committed for this year and eight Tier 1 trials planned for this year. That's a 2020 play. So there's lots of reasons to be optimistic, but we are certainly not going to go and talk about that today..

One more question and then I will cede the floor. The pulse product obviously is getting a lot of attention. The timing of that sounds like it's a little bit later to scaling up the revenues than we had initially thought.

Can you talk a bit about the amount of trials you are doing? And what the timeline for that ramp around the pulse DCI product will look like?.

Groove..

Are you talking about the Groove, Alex?.

Yes. Groove, I misspoke..

Yes. Okay. Because the pulse, I would say that has to be somebody else's and I haven't seen it. I have not seen it in the market..

That is not baked into the pipeline or the revenue for it..

Okay. I am sorry..

The Groove, no, that's okay, a couple of points of fact, right. I said we had 30 new customers in Q1. That's a really big number of new customers. Now not all of them were large. But that's a substantive number of new customers. The Groove, I think, is an exceptionally well designed product for both today's technology, but also adopts next technology.

So that entire installed base can basically upgrade to 600 gig. Our 600 gig is also creating a lot of excitement. And what's interesting is we talked to a number of customers. They are particularly interested in the fact that we have a roadmap of 600 gig today and going to 800 gig. They are very familiar.

We have reviewed what ICE6 does at a very technical level. They are very interested. They are interested in both. They are not going to wait. Now I am not going to go into the exact number of trials. We have a big pipeline of trials. We have actually received our first orders. I am excited about the Groove in general.

I am particularly excited about the opportunity for 600 gig and then scaling it to 800 gig..

Thanks..

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

Hi guys. Thanks very much. I just want to echo my comments on Brad. Hi, we are going to miss you, Brad. Good luck and best wishes. The question, I guess I was just curious around the customer feedback on the DCI portfolio. I hear the commentary certainly with Groove and it sounds like you have got good traction there.

But I am thinking about the heritage products on the DCI side. You have got a CX 2 platform that I think was running somewhere around $100 million a year. Obviously, there's a Transmode portfolio there as well. I think it was running over $100 million a year, not quite DCI certainly.

But can you just talk about kind of how you are managing the transition from those products to the Groove and other products? And then, how the customer feedback looks? And how are you kind of keeping customers in the fold as they migrate? Thanks..

Yes. Thanks. Good questions. This is David. So certainly the Transmode product is actually being more tied, as Tom mentioned, with the DRX product in 5G and DAA deployments.

Actually that whole product line, we are seeing a very large pipeline, a very strong bookings, actually strongest over the last couple of years that we have seen, because of the whole shift towards 5G and DAA.

And as Tom mentioned, the trump card of having the DRX in 330,000 locations of mobile ex-haul from our past history, from Coriant, is very helpful. On the DCI front, it's much easier to manage product transitions as I mentioned, when they are three-year cycles, three to four year cycles, where they kind of pull them out like they do servers.

And so what we have really been able to do with our existing customer base is ensure there isn't a very large cost to continue to support our existing CX line. And the move to something like a Groove as we show our roadmaps for being the only player that has 600 gig, 800 gig and the track record.

Every time you would go to one of these new technology shifts from 400 to 600, from 600 to 800, we kind of show a chart that you tend to have the field that's able to do that technology. And so the customer reception has been quite positive, because of also the expertise of software and usability that's been brought to us by Coriant.

We are able to kind of melt both worlds. So again, the transition, much easier on a three-year cycle..

If you remember, the CX is a fixed configuration platform. It is 100 gig or 200 gig. So it was always intended to be a few year platform. When we acquired Coriant, we ended up killing our next generation. Well, it was one of the decisions we made to kill the next generation CX 3. however you want to call it and replace it with the Groove.

So this is a natural transition that customers have been expecting. We still sell the CX vastly into current customers, but we still pick up a couple customers along the way. But the Groove is really the replacement product for the CX and our customers accept that.

The Groove, quite frankly, with its slated architecture actually allows architectural technology migrations much better than the CX does..

Okay. And then one follow-up if I could, just on the balance sheet. I was curious about your cash restructuring costs. Just trying to figure out how much is kind of left here until the restructuring effort is done? Thanks..

Yes. So George, there is still some to go. Obviously, Q4 and Q1 had some pretty significant things. Obviously there will be further actions to go. The Berlin facility transition we have gotten support for. So it won't be a net cash outflow for us. But you will see some over the course of the year.

So you should expect to see cash burn in Q2 and then less in Q3 and turning positive in Q4..

Yes. Think about big items, George. Moving Berlin is a significant item. So that pays back very quickly. And then we have an ERP conversion happening in Q3. So as you know, ERP conversions take time and money and that will allow us to, for the most part as I said, functionally close the acquisition.

I said by the end of the year, we are certainly targeting earlier than that..

Thank you..

Thanks George..

To ensure that everyone has a chance to ask a question, we please remind you to please limit yourself to one question and one follow-up. Our next question comes from Jeff Kvaal with Nomura Instinet. Please go ahead..

Yes. Thanks for taking the question. I had maybe a bigger picture question on 800. I am wondering, Tom, how you are feeling about the timelines there? I know some of your rivals are talking about timelines. They are a little earlier than the ones that you have laid out.

And if you could talk us through how that's going to work from your point of view and what that means for the cadence over the next ICE6 et cetera, et cetera.

And then my follow-up is, I just wanted some clarification if you are your cost savings ahead of your prior synergy targets in terms of like you will get to a larger number? Or you are just getting to where you thought you would faster than you had expected? Thank you..

Yes. Certainly on the 800 gig this is what I would say. I am not going to talk about where a competitor might be. But what we see is that there will be two of us in the market in 2020 and that's a fairly unique position for us and we are excited about having the opportunity to have our technology in the market with only two competitors.

Our industry continues to be over-served in general. Great. Let's go and make it less served on the technology side. Second point is, we feel very comfortable with our schedule on 800 gig. As we said at OFC, we plan on having first silicon back we said September, October. It's probably going to be October. But that's still good, well on track.

That will allow us to start doing demos of the technology with customers in the first part of next year. And we plan on ramping the volume in the second half of the year. And I think one of the things that I am excited about is that we own our optical chain of supply.

The 800 gig optical supply chain today is fairly nascent and young and there's a lot of people bringing technologies to market to support 800 gig probably in the 2020 timeframe.

By us owning our own vertical integration, there is an opportunity for us, probably not that have time to first market advantage, but time to have volume advantage, first to volume. So that's where we really see the opportunity is. And when you are winning, going after these ICPs, it's a step function of demand. It's zero to a bunch very quickly.

So I think that that is going to play, my belief is that will play well to our strategic value, not only around cost but optical performance and the ability to control the destiny of the supply chain and not be dependent upon suppliers who have to make investments for a young market. So I think that's why we are excited about it.

And then as we said, we showed our 800 gig PIC at OFC. So working optics today..

And Jeff, to address the second part of your question. To clarify, we are significantly above our previous expectations on synergies. That's what's allowed us to absorb some of the softness in revenues related to the timing and still achieve financial results for the year in the same ballpark and still get to profitability by the fourth quarter..

Yes. I would say ahead and above. Ahead by the results of the gross margins this quarter and what we see happening. But again, we have some transitory things happening in Q2 that position us very well to be completely ahead for the full year..

Thank you..

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

Yes.

Hi Tom, Brad, how is it going?.

Hi..

Hi Vijay..

Yes. So a question for you, Tom. Hi Brad also, very good working with you. Best of luck with everything. So Tom my question is around any operational excellence milestones and initiatives you have put in place? I mean, these results are no fun to read.

So any kind of definitive milestones you have in place, both in the bottomline and also on topline anything around portfolio attrition, any changes in go-to-market so that you can focus on where your products had the most differentiation and competitive advantage? And then a follow-on for you, Brad..

Yes. I am going to have David to answer this. He is driving the integration and he runs product management engineering. So he can probably give you the crispest answer and I will add anything that I feel important..

Yes. I would say, well, the results of the shift here are not fun to read at the macro level. I think what we are saying is, in the first quarter, we achieved the better end of EPS by driving cost out, by increasing the standard margin on the Coriant products and driving the integration faster and harder than originally forecasted to you guys.

I think going forward, yes, we have actually done a nice job of bringing together the full portfolio, as we just managed about, as we just discussed about the ICP migration, we are seeding new products out to the market that are out there.

We continue see standard margins increase as we see the flow through of the material price reductions that our supply chain has been able to get on materials. And on the back half, we have moved 50% of our entire supply chain that we have reduced and made variable with an excellent partnership with Fabrinet.

So I think those are good milestones that drive gross margin improvement and bottomline operating income and we have recommitted that on less of that topline from revenue associated with the booking shift that we would still be, we are still committed to profitability and cash flow in Q4..

Those are the operational metrics. Vijay, I am going to add three other things to it which are around new products, because quite frankly we bought this. We think we can operationalize it, make a profitable company and then we want to grow the business.

So to me, operational milestone number one, ramp 600 gig in the second half of the year and win market share. Operational issue number two, deliver 800 gig in our new converged platform that combines the best of Coriant and the best of Infinera in the middle of next year.

Operational new product and number three, use the DRX to attack this inflection of a disaggregated IP edge. It's a next year opportunity. But I think that this year is the insertion. Those are the three things that I am really working on..

Perfect. A quick follow-on for Brad. Obviously you laid out some cost synergies, potential revenue synergies when you announced the Coriant deal.

How do you like benchmark or what's your report card, Brad, on the synergies?.

Yes. So Vijay, we are, as we commented, significantly above the synergy targets that we have laid out before. We weren't expecting revenue synergies that we baked into the plans. But since we are higher on the synergies that we are driving, it's allowed us to offset some of the short term softness in the revenues..

Thank you..

That gave us a very good report card..

Our next question comes from Michael Genovese with MKM Partners. Please go ahead..

Great. Thanks very much. Brad, I looked at the CFO report in the ICP revenue, right? It was last quarter $29 million, going to $20 million this quarter. So your exposure to the market there seems fairly limited.

Is that spread across many customers? And I am just wondering what's the takeaway on the ICP market should be, because your forward-looking comments on DCI, I think are really good, but we are talking about CapEx weakness in the quarter.

Sort of could you discuss how many accounts that was? If you know what weakness versus share loss? And I think you sound more positive going forward than in the quarter. So just want to make sure that we feel good about DCI for the year..

Yes. So Mike, the bit of softness that you see is, it's a few different customers. Obviously, we are in a bit of a transition in that market. So that's caused the softness in Q1. I think it's also just overall muted spending in the ICP space. That said, the interest in the Groove portfolio going forward is very strong.

We mentioned that we just won a very large ICP. They have very significant plans and I think they are one of several very large customers that we have an opportunity to ramp that product with. So that's why currently, we are in a bit of a transition and we have been for a while even before the deal and going forward we feel much better..

Yes. I think CapEx in that industry was light in general in Q1, but we are seeing a significant number of opportunities in two areas with ICP. One is obviously data center interconnect, I think the Groove allow us to compete healthily. We won, as Brad said, one. And we have a number of field trials in Q2 and Q3 with the 600 gig.

They are looking for a next generation alternative. And I think this is not maybe understood, there is a massive amount of subsea build happening with ICP. We won our first cable, as I talked about in Q4.

Per customer, we had the best spectral efficiency on this transatlantic link with our ICE4 and that is material for these guys from $1 per bit and well, how much can you fill a fiber. We also are right now quoting a number of subsea deals supporting the ICP space. I can't say we are going to win them all. I can't say we will win any.

But we are in the game with these and based upon our performance, I feel comfortable that we will have opportunities. So I think ICP is going to continue to spend. I do think there is going to be more in subsea than historic for us..

Okay. Great. Awesome. I just have my follow-up here, this could be a long answer, so feel free to make it short, given the time. But I just wanted to ask you about ZR, because I have been getting incoming questions on 400 ZR from some investors that are pretty off base in terms of understanding what it is and who the suppliers of it will be.

So first of all, will your ICE6 have the ZR? Will that be a part of it? And can you just talk about sort of the economics and the opportunity of ZR for you?.

Well, we will not have a ZR solution. We are not going to build a ZR solution. We have talked about building follow-on solutions. The ZR, I think, our view is that it will come out probably from a volume perspective maybe next year and it certainly has some overlap in portions of our market.

So I don't want to mislead people and say that there is not going to be somewhat of an overlap, particularly for the less than 100 kilometer type of range.

Having said that, we believe that on a dollar per bit level, that's still going to drive a lot of the decisions and we need to go and create solutions that will compete with that, certainly with 600 gig and 800 gig.

But one of the things I think people don't necessarily understand is that there's a number of particular ICPs that have told us they are not interested in ZR, specifically because what they are looking for is an optical solution that simplifies their ability from a component perspective and network perspective that can go up to reaches of a couple of thousand kilometers.

So they can use a platform that goes in data center and Metro that is the same optical technology. So I would not look at the market as 100 kilometers and less as the market. You got to piece that apart and say which customers are going to say, I am going to break my solutions in to two markets, one for metro and one for data center interconnect.

And I am actually fairly encouraged by the number that are saying, they one optical solution across. I think the ZR Plus is a more interesting technology and that's going to be couple of years from now and that's when you will probably see us do something around technology that has more optical reach..

Yes.

Just to you a number, just how we look to plan for short reach applications over a four-year period, we think that may scale to a $900 million-ish number, of which, it will be a commodity with three to four main suppliers and where we are investing in markets like ICE6, where there's going to be two players and where there is significant differentiation that is in a commodity, in fact where performance is king.

And we have built investments in place to be certainly interoperable on the metro edge with things like ZR, but we are also putting things in place to be able to have a next advance as you start to see dynamic policy at the edge of the network. But certainly we are announcing those technologies..

Just to clarify, you are saying, the ZR market is $900 million.

Do you have a compare like what the overall market and non-ZR market in that forecast would be? Do you have a sense of that?.

We do. The entire optical market that we look at in that kind of 2023 time period is about a $14 billion market. And when you take just the short reach portion of DCI, of guys like Ovum and others and what their numbers say, it's roughly that $800 million to $900 million number. Some will be shorter, some will be higher.

Be careful, because some people talk about ZR which is short reach, as Tom said, which is a spec and we will be interoperable with a number of players, three to four or more, in a commodity market. ZR Plus is actually not a standard interoperable..

And that $900 million, does not parse apart the market if that says I won an optical solution that spans greater distances. So it's uncertain at this point..

Correct..

Thanks very much..

Our next question comes from Tim Savageaux with Northland Capital Markets. Please go ahead. This will conclude our question-and-answer session. I would now turn the conference back over to CEO, Tom Fallon, for any closing remarks..

I would like to thank our customers, partners and employees for their commitment and the shareholders for their patience. During this exciting transition, I look forward to fulfilling this opportunity with you. Have a great day..

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