Good day, and welcome to Infinera’s Fiscal Second Quarter 2019 Financial Results Conference Call. All lines will be in a listen-only mode until the question-and-answer session. Today's call is being recorded. If anyone has any objections, you may disconnect at this time.

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

Thank you, operator. Welcome to Infinera's second quarter of 2019 conference call. A copy of today's earnings and CFO commentary are 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, including but not limited to, statements about our business, plans, sales opportunities, manufacturing operations, products, technology and strategy, statements about the current status of our integration plans and synergies, as well as statements regarding our third 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, we have provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in our second quarter of 2019 earnings release and CFO commentary. I will now turn the call over to our Chief Executive Officer, Tom Fallon..

Good afternoon, and thank you for joining us on our second quarter 2019 conference call. Joining me today, our CFO, Brad Feller; and COO, David Heard. After quickly reviewing our Q2 financial performance, I will summarize how we see the market evolving and describe the opportunity created by our innovation roadmap.

I'll then turn the call over to Brad, who will provide a more detailed review of our Q2 results and an outlook for Q3 and the remainder of the year. Over the past several months, we've made tremendous progress toward building the new Infinera, and at scale optical networking innovator as envisioned when we acquired Coriant in the fall of 2018.

As we approached the one-year anniversary of this acquisition, we are witnessing strong progress around the foundational pillars that support the thesis of our strategy.

First, with significant order and pipeline improvements and the largest consumers of optical technology, we are enhancing our scale, a mandatory ingredient to be a leader in this industry.

Second, as we near the end of our integration period, solid execution continues to support our expectations of returning to non-GAAP profitability and cash flow in the course of fourth quarter just over one-year from our closure of the acquisition. We are on track to substantially finish our integration work in the fourth quarter of this year.

And finally, our investment in differentiating innovation, which has remained robust through this integration period, has positioned us well for the next generation of optical spending. Before elaborating further on these key pillars, I want to mention several recent notable events and provide an integration update.

Last week, we announced that we hired Nancy Erba as our new CFO. Nancy brings significant experience in running large-scale operations in industry that demand execution efficiency and it's a great addition to the team. Welcome aboard Nancy.

We've closed on $100 million asset-backed loan facility with Wells Fargo to provide an additional cost effective source of liquidity as we execute on our business plan. We believe this gives us the appropriate working capital flexibility needed to scale the Tier 1 relationships we've been developing in the market.

We have slowly transitioned manufacturing from our Berlin facility and are successfully ramping production with Fabrinet in their variable low-cost manufacturing center. These steps drive out significant fixed costs from our business. We will have a positive impact on gross margins as we exit the year.

On the IT front, we have now completed the third and final systems implementation project on time and in a new scope. Infinera is now unified with one version of SAP, one version of salesforce, and one instance of agile. These unified systems will allow us to continue to bring down expenses and more efficiently run a significantly scaled business.

With these steps and many others, we have now implemented cost reduction activities that will deliver in excess of $100 million in non-GAAP OpEx savings and an excess of $160 million in combined non-GAAP OpEx and COGS savings in 2019.

And importantly, on the innovation front, we taped out our ICE6 DSP, a critical deliverable required for us to lead in the next-generation optical performance. While there's more work to be done, our integration progress remains fully on track as we continue to exceed the milestones outlined when we closed the transaction.

These significant accomplishments laid a foundation for achieving fourth quarter non-GAAP profitability and capitalizing on future market opportunities. Moving onto our Q2 financial results.

We are towards the upper end of our guidance range with non-GAAP revenue of $307 million, non-GAAP gross margins of approximately 31% and non-GAAP operating expenses at $132 million. Revenue benefited from healthy demand from our top customer, so successful initial ramp of our new ICP customer and solid demand from other global Tier 1 relationships.

As we had anticipated during Q1 earnings call three months ago, a highlight for the quarter was the strength of our bookings, which grew greater than 15% quarter-on-quarter. We saw particular strengths from Tier 1s globally, significant growth in Subsea bookings and strong bookings from our new ICP customer.

In fact two of our top five bookings in the quarter came from customers that were new to the Company. The strength more than offset continued weakness from our North American cable customer and it's created a significantly expanded pipeline for the second half of the year.

In part due to our success and adding new customers, a significant portion of Q2 shipments were footprint expansion opportunities. We've pushed our non-GAAP margin down to 31% from 35% in Q1, in line with our expectations entering the quarter. This footprint was about equally split between new customers and new opportunities with current customers.

We view this footprint expansion as a great investment. One, that creates the opportunity to earn higher margin transponder fill over time, a dynamic we've experienced periodically through our history.

Following our third consecutive quarter of backlog growth, bookings, momentum, and positive order trends, we are increasingly confident in our near and longer-term visibility. All the prudent and our guidance, we see healthy market demand and we believe we're well positioned to capitalize on a number of industry and macro trends.

These include the continued shift to the cloud and migration to open and disaggregated network architectures and the selection of trusted suppliers that have a robust technology roadmap for continued differentiation. One important architectural trend is to continue momentum to disaggregated network model in a growing number of customer networks.

This is reflected in a significant growth of this segment, which is predicted to be a multibillion dollar market over the next few years. Our Groove platform is meaningfully contributing to this trend as bookings grew 75% quarter-on-quarter and 80% year-over-year.

This platform not only opened up opportunity at the previously mentioned ICP, but it was also the cornerstone of the new Tier 1 in Asia that began shipping in Q2. The promise of disaggregation is also moving beyond the optical domain with significant customer interest at the IP edge.

Not only will this bring customers or reduction in CapEx, the real advantage is allowing them to deploy services faster by breaking the chokehold, the proprietary enclosed devices have had in this market.

Our DRX built with our field-proven hardware and software carrier-class IP stacks has now successfully completed lab trials to the leading Tier 1 customer and it's related from first office application in the second half of this year.

While this market is still developing, the opportunity we see in 5G and DAA networks for this solution is validated by a significant pipeline of trials with some of the largest Tier 1s and cable operators around the world. In both of these use cases, we believe our timing is ideal for bringing this revolutionary architecture to the market.

It is also clear that some larger customers are becoming uncomfortable with their over-reliance on certain suppliers, opening up opportunities for the new Infinera. One of the reasons of network security, continuity of supply, global politics, and customer pressure or general overexposure.

These customers are evaluating alternatives to their current solution. While generally we don't believe telcos will decommission working networks, we do see a growing interest by them to expand their networks with other vendor alternatives.

During Q2 for example, we’re awarded our first Huawei replacement deal with a Tier 1 in Asia and we anticipate more of these opportunities arising over the course of time. And finally, ICE technology differentiation becoming significantly more important in vendor selection.

Our customers participate in highly competitive markets and their own competitiveness is closely tied to the underlying technology and enables delivery of their services.

As we are invited to new opportunities, we see a shift in the customer buying criteria from primarily evaluating what is available today to evaluating what we reliably will be able to deliver over the next couple of technology generations.

In this regard, we are uniquely positioned in the market with both ICE4 and our 600 gig solutions providing costs and performance leadership today. Our ICE6 on schedule for delivering 800 Gig in 2020 and ICE7 on the drawing board. Today, we remain one of only two suppliers that have committed 800 gig over the next year.

As the optical supply chain continues to consolidate, our position in the market as a differentiated optical technology provider continues to be enhanced by our successful integration of Coriant. On that note, our integration plan has never been just about capturing cost efficiencies.

As I noted earlier, we've maintained our R&D leadership but optical performance and now with the most significant integration risk behind us. We can focus even more our resources on technology development and productization.

As we communicated during our July 17 Technology Roadmap webcasts, our focus is in three distinct categories; optical leadership, optical and IP disaggregated platforms, and automation that delivers network solutions. In optical leadership, we have recently introduced our 600 gig solution with our Groove platform.

In the first half of the year, we successfully completed 14 customer trials and had 18 additional trials scheduled for the second half. Today, five customers have verbally awarded those wins with one of them extending as a PL. This customer is also a new Groove win for us and our Technology Roadmap was a critical decision criteria.

A significant number of other Groove wins have been based on our roadmap of offering both 600 gig and 800 gig technology. Even if initial deployments are with lower speed solutions. Based on these wins we expect initial 600 gig revenue in the second half of 2019 with a significant volume increase in the first part of 2020.

At the heart of our portfolio is our vertical integration strategy of developing and manufacturing optical engines.

As wavelength speeds continue to advance, we believe that vertical integration becomes a mandatory ingredient and the ability to fundamentally deliver the technology and to control the cost structure that makes it economically attractive.

We view recent industry consolidation as a continuing endorsement of the vertically integrated strategy installed at our inception nearly 20 years ago.

We have recently achieved an important vertical integration milestone with a tape out of our ICE6 DSP, putting us on track for first silicon this fall and 800 gig product delivery in the second half of 2020.

As communicated during our recent roadmap webcast ICE6 will deliver better spectral efficiency and lower cost per bit, not only at 800 gig, but through a range of transmission rates from 200 gig – 800 gig opening up a tremendous market opportunity.

Our customers will be able to use the same technology for application spanning from short reach data center interconnect to transoceanic links, improving their operating costs and simplifying their network architectures. Our remains only one of two vendors with published 800 gig solutions come into the market in the near-term.

We are the only one promising 1.6 terabytes of capacity in a single device. This level of integration in the DSP in corresponding optics is the core of Infinera differentiation. Well, our heritage has been focused on high capacity optical integration. We continue to expand our toolbox of optical intellectual property.

At ECOC in September, we intend to lay out our plans for using this IP to bring a new architecture to the aggregation market with a unique pluggable strategy. In summary, the combination of significant order momentum, pipeline improvement and customer wins has driven improved confidence and momentum in our business.

We expect to grow our backlog in Q3 and are reiterating our 2019 revenue target of 1.3 billion and the expectation of turning cash flow positive in Q4. The benefits of the Coriant acquisition on materializing and the finalization of integration is now with insights from the new Infinera.

We have enhanced customer engagements with lager customer driving opportunities. We are demonstrating success and driving scale. We are close to completing our integration work you'll be in a company position to create profitability and positive cash flow.

And most importantly, we have continued to invest for the future, bringing innovation to the market that should create customer and shareholder value. I want to thank our employees for their hard work and creating the positive momentum in our business.

I'd also like to thank our customers who share our vision and are creating the optical networks of tomorrow. Now I'd like to hand the call over to Brad for a more thorough review of the financials..

Thanks Tom, and good afternoon, everyone. Today, I will discuss our Q2 highlights and provide our outlook for Q3 in the remainder of fiscal 2019. The detailed recap of our Q2 results is available in the CFO commentary on our Investor Relations website.

Q2 non-GAAP revenue of $307 million represents a 4% sequential increase coming in towards the upper end of our $290 million to $310 million guidance range. Revenue improved during the quarter due to strength within the ICP vertical as well as with global Tier 1s.

Our ICP vertical exceeded expectations driven by a new ICP customer deploying our Groove DCI platform. This new ICP relationship which came as a benefit of the Coriant acquisition contributed to the sizable footprint expansion we experienced during the quarter.

Our Tier 1 strength was fairly broad but was particularly good with our largest North American customer and our largest APEC customer. During Q2, we won both several new customers and new opportunities with existing customers and each contributed to strong backlog growth.

We saw solid demand from a number of customers in North America, including from our largest customer, which represented 13% of total revenue in the quarter as they continued building new routes with us. In addition, our revenue within LATAM doubled in the quarter as we saw some recovery in spend across this region.

As additional color on Tom's commentary about our expanded Tier 1 relationships, eight of our top 10 customers in the quarter would be considered Tier 1 scale customers. We believe that these relationships along with the new ones we are now creating as a combined company, provides a solid foundation for future growth opportunities.

As we commented on during our last earnings call, we saw a robust pipeline of opportunities in Q2 that we expected would drive growth in the second half. The good news is that we were able to convert those opportunities into a strong bookings quarter in Q2, contributing to significant backlog growth entering Q3.

Also of note, following the Coriant acquisition, we have a more diversified customer base. Our top 10 customers represented 43% of revenue in the second quarter of 2019 is compared to 67% in the year-ago quarter. This more diverse customer base as allows us to offset continued soft spending within our cable vertical.

Non-GAAP gross margin of 30.7% was slightly above the midpoint of our 28% to 32% guidance range. As we expected going into the quarter, we experienced significant footprint expansion with both existing and new customers.

As we've stated throughout Infinera's history, this initial footprint often requires an upfront investment that carries lower gross margins.

However, given the size and scale of many of these customers, these investments typically generate a very strong return, once customers expand capacity within these networks, resulting in a significant margin expansion opportunity in the future. Moving now to operating expenses.

We continue to make solid progress with our OpEx synergies as Q2 non-GAAP OpEx came in at $132 million, compared with our $135 million guidance midpoint and well below the pro forma levels of the combined companies from a year-ago.

While we take actions to reduce our overall OpEx spend, we are focusing our R&D dollars in areas where we can differentiate and where we see the best opportunity for the Company. Our ability to differentiate with our solutions has always been a key principle of Infinera.

Taking it all together, we had a non-GAAP operating loss of 12% and a non-GAAP net loss of $0.24 per share. Both metrics better than our guidance range, although both significantly below our longer-term expectations.

As we continue to take the key actions necessary to transform the Company and benefit from increased scale, we expect financial results will continue to improve. Turning to the balance sheet. Total cash and investments finished the quarter at $140 million.

The ending cash balance was slightly below our expectations, as we made a decision to invest in working capital to support second half revenue growth and accelerated some integration spending. These impacts were only partially offset by operational outperformance in the quarter.

These investments in working capital represent the building of a strong asset base, which we expect to benefit our cash position as we work it off over the second half of this year. In order to provide us the flexibility to absorb working capital fluctuations such as those described above.

As we continue to transform the Company and pursue large new customer opportunities. Last week, we closed a $100 million credit facility with Wells Fargo. We believe this facility satisfies our near-term capital needs.

Although, we do have the ability to upsize this facility by $50 million in the future, if certain conditions are met and the need arises. Turning to the third quarter. We have some important integration milestones, which we are closely managing.

First off, we are tracking ahead of our financial synergies and are on track to complete the integration by the end of the year with future synergies to come with vertical integration. Second, we have now transitioned our Berlin manufacturing operations to Fabrinet in Thailand.

This program is six months in the making and we have a high degree of confidence in Fabrinet's ability to ramp up our product in line with the plan. We will continue to closely manage this transition and expect a smooth ramp. Third, in early August, we went live with the new combined ERP system.

As of today, there have been no major issues and we expect a smooth transition though complete validation has not yet been accomplished. This is an important step in finalizing the integration, driving synergies and having full financial and operational visibility across the organization. Now to our guidance for the third quarter of fiscal 2019.

As mentioned earlier, our Q2 bookings increased materially in the quarter, representing the third consecutive quarter of backlog growth. As we continued to see a strong pipeline, we expect another solid quarter of bookings and Q3, which would allow us the opportunity to once again build further backlog.

For Q3 we currently anticipate non-GAAP revenue of $330 million plus or minus $10 million. This is representative 7.5% sequential quarterly increase in revenue. Looking at the second half, we expect to continued solid pipeline of opportunities and strong backlog will allow us to reach our $1.3 billion revenue targets for the year.

On gross margin we anticipate Q3 to be another quarter of strong footprint deployment with both new and existing customers. While we have been pleased with the opportunities we are winning.

Many of these networks take advantage of our unique ability to pre-deploy bandwidth, allowing our customers to react quickly to their customers demand with our instant bandwidth capability. In these cases, the initial deployments have a very small percentage of bandwidth activated.

As a result of these upfront investments the anticipated gross margin expansion is projected to shift out by a quarter. On the positive side, we have now officially completed the transition of our Berlin manufacturing to Fabrinet, which significantly improves our cost profile and reduces fixed costs.

We expect this transition to have a positive impact on margins as 2019 progresses and we begin to sell the lower cost inventory. Rolling up the various components we currently anticipate Q3 non-GAAP gross margin of 32% plus or minus 200 basis points.

Based on the further benefits from the Berlin manufacturing transition in Q4 and as our product mix begins to level out in the period. We continue to expect non-GAAP gross margin in the mid-30s range for the fourth quarter of this year.

Keep in mind that our non-GAAP gross margin in the first quarter of fiscal 2019 was 35.3% and was representative of a more normalized product mix. Since then, we have taken multiple actions to lower our cost structure, providing us confidence in our ability to achieve these gross margin levels as we exit the year.

With regards to operating expenses, we have made tremendous progress with driving down our operating expense levels. As mentioned, we have now completed the migration onto one global ERP system, allowing us to further drive efficiencies in the business. As we still need to stabilize on the new system.

We expect only a minor benefit to operating expenses and Q3, leading us to anticipate non-GAAP operating expenses of $130 million plus or minus $3 million for the quarter. As we progress into Q4, we expect to be able to drive further expense reductions allowing us to finish the year in the mid-120 million range for non-GAAP operating expenses.

Putting it all together, we expect to Q3 non-GAAP operating loss of approximately 7% and a bottom line non-GAAP loss of $0.17 per share plus or minus a couple of cents.

In relation to cash levels in the third quarter of fiscal 2019 as we articulated on our last call, we expect a significantly smaller cash reduction driven by improved operating results and working capital benefits as we utilize the inventory built to support the factory transition.

As we move into the fourth quarter, we continue to believe that our improved financial results viewed by our strong backlog position and diligence on working capital will lead us to both non-GAAP profitability and cash generation. This thing, my last earnings call here - this will be my last earnings call here.

However, I want to reiterate that I continue to be very optimistic about the future of Infinera. I'm appreciative of the great experience and the committed people I've had the opportunity to work with on this journey and I believe the Infinera is well positioned to complete the transformation that began with this acquisition.

I'm excited to hand the CFO reigns to Nancy as I believe she's the right person to take the company forward and she brings a strong financial and strategic background along with the hunger and dedication to drive change in the business. Thank you for your support over the years.

With that, I'll turn the call over the operator for the Q&A portion of the call..

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Rod Hall of Goldman Sachs. Please go ahead..

Thanks. This is Balaji on behalf of Rod. Congrats on the stabilization and the quarter and Brad, all best wishes for your next move as well. I think my question really is on – focus on the recent announcement on Acacia's acquisition by Cisco.

Maybe if you want to comment on the state of the merchant solutions and if you think that there's other suppliers available for future needs and if you want to comment on your own potential to be a merchant supplier? Thank you..

Yes. So a good question. And we're certainly seeing a lot of interest there. A couple of things. One, I personally believe this is good for us and it's good for the industry. I know Raj, I know Bill very well. I am a 100% consonant.

They're going to continue to provide us the technology that we need in the platforms today and they're going to make available technology if we choose to in the future. We've been clear, we will make our own DSPs in optical technology and we will also buy where it makes commercial sense to do that.

And I fully believe that that technology will be available to us. Two, I do think it makes our own strategy around vertical integration, quite frankly, more valuable.

There are fewer choices every day on the market and I think that this DSP technology and soon to be the optical technology, the value of being able to control that value chain are going to become more appreciated. And I think it underscores some of the basic value and the opportunity of Infinera.

In regard to will we make our technology potentially available in the merchant? Two quick points. We have been approached in regard to our ICE6 by some people who I think maybe in conjunction with this Acacia, Cisco announcement are now interested in diversifying and working with other suppliers.

I also see that the point that it's resonating with the market, that we are one of two choices in 800-gig and lots of people need 800-gig besides the two people that are making it. So people are approaching us to discuss opportunities in DCO.

I don't know if anything will materialize, but clearly it's something directionally that we are going to spend time with. I was very clear on my script that at ECOC, we will discuss where we're heading with our pluggable strategy. You should pay attention to see how we're planning on commercializing parts of optics and DSP..

That makes sense. If I could ask just one more question. It was good to see the increased spend with your Tier 1 customer in Mexico, do you see the LATAM revenue levels in the quarter as sustainable going forward? Or, I recognize it's pretty small, so it can be lumpy, but just want to get your comment on that..

Yes. I think as a combined company, we have a pretty diverse customer base in LATAM, and I think, there's lots of opportunity there. So I see – continue to see going forward the opportunity that continue to grow those revenues.

The large customer that I referenced, historically has been a quite a large customer and to see them start to come back with spend would be another nice phenomenon..

We're also winning new customers in LATAM. There's substantial investment happening there and I think we're well positioned..

Great. Thank you..

Thanks..

Our next question comes from Jeff Kvaal of Nomura Instinet. Please go ahead..

Yes. Thanks very much. I guess could we begin by talking about what looks beyond the integration a little bit? It sounds like you're making great progress on putting everything together ahead of schedule.

What kind of improvements can we think about for the margin structure once we get beyond the fourth quarter? And is it possible for us to be talking about a low or even mid-40s number at some point in the future?.

Yes. That's a great question. So obviously as we continue to take out the fixed cost and exit the year, that is a great accomplishment for the future cost structure and we're going to continue to work down operating leverage.

As we put out and we've had a very successful quarter as Tom mentioned with the Groove platform, which is a compact modular platform. Going forward, substantial year-over-year growth, 80%. That is a sled-based architecture. Modular platforms will continue to be sled-based as we start to put our own vertically integrated optical technologies.

Those products themselves increasing their gross margins by 20 points to 25 points over what we're seeing today.

So where you're seeing a bit of muted margin footprint that's out there today, it's great for us because we're winning new Tier 1, as Tom said, that are looking for somebody that provides the existing technology today that's unique in their ability to provide 600-gig, which we get a bit of better margin structure and as we get to 800-gig, we will have the industry leading cost structure..

So I agree with everything said. Nancy is just getting on-board. She'll take over as CFO officially the first part or end of August. We will plan on having an Analyst Day, we will update officially kind of our outlook of the business model before the end of the year. We need to give her a chance to get a smarter than a topic..

Okay. Thank you all, and Brad, thank you for all your help over the years..

Thank you, Jeff..

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

Thank you very much. I was hoping we could talk a little bit about the 800 gig chipsets. You've obviously now announced your finished taping down the ICE6.

Does that increase your expected probability of getting them back without any issues? I had been estimating around an 85% probability that when it came back it would be running well? Can you talk about some of the reasons why your success should be better than the problems that both NEL and Nokia appear to run into on their 600 gig deep – DSPs?.

Yes. I can't speak to the specific challenges. They might've had, but I can only tell you this. We are on schedule to our original schedule with our ASIC. It is a non-trivial accomplishment to tape out. Our history of taping out and having per silicon is we've never had to complete the respin in ASIC. So I have high confidence.

We have never put as much resource or diligence or tools on validating the design as we have this time. We made sure to work with world-class partners in every aspect of the technology going into this. We saw that we need to minimize any unnecessary risk wherever we could.

So we spent the appropriate money, making sure that we were as bulletproof as possible. So I have high confidence. Second of all, a lot of the technology that's in ICE6 is actually not the first time we're bringing that technology to market. We've been doing subcarriers for a long time. We had been doing probabilistic shaping.

We have been doing SD-FEC gain sharing. The values that enhance the performance of optical, we are taking them to next-generation. This isn't first-generation for us and I think that that will be an advantage moving forward. But Alex, having said that, until it comes back in October and it works, it doesn't work. So I'm going to keep my fingers crossed.

I have high expectations..

Have you guys hurt or talk to anybody that is familiar with the – whether Sienna is taped down yet or whether – where their 800 gig chip as we haven't been able to find anybody who suggests that they've already seen this product in the field in any form or fashion.

I'm a little concerned that that they're suggesting that it's available so soon when I can't find evidence of it.

You already evidence of that being in the field?.

No. We're not – we're extremely focused on our own execution there. And I'd add to Tom's comments, it's not only on the DSP, but last year at ECOC with our PIC, our ICE6, which is our sixth-generation that doing this and it gets harder to marry that photonic integration with the DSP every generation.

We've demonstrated over a terabit per wave capacity yet over 100 gigabytes at 64 qualms. So we've actually provided to the industry almost a year-ago. Our operating results in open transparency, the PIC is ready, ready to go, the DSP is taped out. That's what we're focused on getting the market.

So everybody else is very focused on the rates between us and Sienna. All I know is this is our sixth time at that and the market of two is much better than a market of seven or eight, so..

Great. Thanks..

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

Hi. Thanks a lot guys. Brad, best of luck. I guess I do have some, I guess balance sheets driven questions here.

Can you help us just understand kind of where we are in the restructuring effort, just in terms of the costs? I think if I go back to the announcement of the Coriant deal or maybe soon thereafter, you guys talked about a $75 million to $80 million total cost on cash restructuring.

How much of that is behind you at this point? How much of it is still in front of us?.

Yes. So George, we still have another quarter in Q3 of higher levels of spend around integration. As we get into Q4, it drops down pretty significantly. And then as David mentioned, expect to ramp the initial or ramp down and complete the initial integration.

So basically you've got one more quarter left of heightened spend and then it drops off pretty significantly in the fourth quarter..

The integration costs George, roughly what we had said. So in that same ballpark, and as Brad said, they ramp up dramatically in Q4. Q3 is about the same as Q2 was from an integration cost perspective..

Got it, okay. Fair enough. And then if I just look at the cash quarter-on-quarter $140 million this quarter, it feels like there's quite a few moving parts in that number. I'm hoping you can kind of walk me through some of those. So for example, there was I think an issue with a customer outage that that may have affected cash.

I think there was a legal settlement you referenced in the CFO commentary. I don't prior quarters there's been some factoring. But can you walk us through those moving parts and kind of give me a sense for how much cash was burned, I guess organically in a sense Q-on-Q? Thanks..

Yes. So George, overall the majority of the burn is the cash from operations. That as we said, will continue to drop off, will get lower in Q3 and then flip the positive and Q4. The increase in Q2 was really a strategic decision we made to pay ahead some prepaid through some of our contract manufacturers.

Build some inventory to make sure we can meet the demand for the second half. So working capital hard us to the tune of about $20 million, we also increased the integration costs, so that we can accelerate it and get the benefits and the P&L faster. Those are the biggest moving parts..

Okay. Thank you very much..

Yes. I would just add that the delta versus expectations was the decision we made to increase working capital associated with the integration and with the stronger second half bookings and trends, transformation work that we're doing as we moved to Berlin facility to give our customers smooth delivery of those higher bookings.

One of the things that might not be well understood that certain optical components are quite frankly on allocation and it's a challenge to make sure you have sufficient supply. So as you have a ramping environment, it's pretty important for us to make sure we have the supply covered..

And our next question today comes from Christian Schwab of Craig-Hallum Capital Group. Please go ahead..

Great. Thanks for taking my question.

Brad, good luck on whatever is next in your journey? Well my question has to do with Tom, you were kind of first a few quarters ago to kind of mention traveling across in particular Europe at the time that there was tremendous interest in people seeking alternatives to Huawei, which would lead to future business, but and all telecom narratives usually move a little bit slow.

Now that you've kind of seen your first Huawei Replacement Asia, can you give us an update on kind of a multi-year outlook and possibly give us any idea of the magnitude of the opportunity you may have?.

Well, have you pointed out the telcos move at a fairly methodical path cadence. I believe that the trend is sent and there's going to be increasing decisions made to minimize the risks. There's a number of factors that I said in my script.

Some of it's political, some of it's continuity supply, some of it's national security, some of it quite frankly comes from customer pressure. There's a number of customers some of the ICPs who will not allow their traffic to be carried across Chinese gear.

So if that becomes more of a mainstay, there are fewer, fewer telephone companies or telepany companies people carry internet traffic. They're going to be to using the Chinese gear. I think all of these things play and all of them are actually causing people to second guess the presence of that level of investment they have in their network.

And I think that we've won the first one. I think that we will win more over time, but it's going to be, I think relatively slow. I do see, quite frankly, Huawei countering pretty hard in regard to making billion dollar investments in a number of countries to balance this out.

So this is in no way stay perform done, but I do believe that the direction forward is more pressure will be applied to people who are delivering the gear from China and it's an opportunity for us..

Great. And then my last question has to do with you guys being approached by customers for your ICE6 technology.

Can you quantify should any of those customers actually lead to design wins or use of your product? Is there any way for you to give us an idea of the revenue opportunity that could be there over time?.

Yes. So it's probably early innings for us to be talking about that.

We certainly have the capability as Tom mentioned that the Cisco acquisition as Acacia, kind of shows the valuation that we have for our DSP and vertical integration given we build similar DCOs for our product line that our substantial portion of the shipping volume of what Acacia shifts.

But it's a little early for us to talk about and as we said, as Nancy gets on Board and we look at our long-term model with the second phase of vertical integration and this is a potential we'll be able to reveal a bit more..

Great. No other questions. Thank you..

Thanks Chris..

Thanks..

Our next question comes from Tim Savageaux of Northland Capital Markets. Please go ahead..

Hi, good afternoon. Couple of questions. First one would be on the cable fronts and you did see what looks to be a pretty steep sequential decline in Q2.

However, if you kind of look at what the operators are saying and doing with regard to their second half capital budgets as well as some equipment suppliers with similar exposure to some of your major customers, that does seem to be turning a bit in the second half. I wonder if you have any visibility.

Two, I guess, cable as a vertical bottoming in Q2 and whether you see any raise of lights in terms of resumption in spending in the second half. And I have a follow-up..

In regard to cable bottoming, I'm going to rely quite frankly on what the industry talks about as we look at CapEx numbers, et cetera. I think that could be happening. We know that we have a range of cable customers. Some of them are investing more and some of them are investing less.

The one I think you're probably referring to is the one that came down for us significantly. Candidly, we are not putting anything really in Q3 in a very, very metered amount in the rest of the year. And we're going to wait for a recovery. It's very dangerous to take broad general things and apply them to a specific scenario.

Everybody will have a different scenario of how much inventory do they have in their warehouses, et cetera. So I would encourage caution on taking an industry dynamic and applying it to any specific customer scenario..

Very good. As you just stated, you are not really building any of that into Q3 or the second half..

Correct. We are taking a conservative approach and we are hoping to be pleasantly surprised. .

And one question if I could on – back on the Huawei replacement situation, I wonder if you can kind of describe the specifics of that not in terms of the customer of course, but in terms of the sales cycle, whether that was right in the wake of the ban is just something where the overall political pressure that’s been mounting over the last year or kind of describe how long that took to go from initial inquiry to close?.

Yes. It's a PTT in Asia, so it's a significant potential customer. It is a customer that the Coriant side of the house that actually been working on for a couple of years. So this is not like all of a sudden this new pressure came out and they'd been an RFQ. This is a relationship that's been being worked for a long time.

I think that the opportunity to have an alternative to Huawei presented as an opportunity to expand as an initial new vendor. And what I get excited about is, these PTTs never picked somebody for one deal, right. We have our first deal with them. It's a nontrivial deal, but it's not going to change the company's landscape.

But the opportunity to become a significant supplier over time is real. And I think that this is a meaningful direction and it's a meaningful opportunity. But I don't want you to think that this new political pressure caused them to send out an RFQ and we responded. It's been a relationship in development for a couple of years..

Yes. Just to add a little bit that jumps onto the Huawei piece. As we look at these Tier 1’s and as Brad mentioned, we lay out that footprint expansion with Tier 1. I think part of the strategic logic of the Coriant acquisition was our expansion globally and to diversify the network.

And as Brad mentioned, moving from 67% top 10 to 43% further diversifies us. But these PTTs and Tier 1’s do take time. We have been pleasantly surprised that we've closed seven Tier 1’s and new PTT opportunities since the beginning of this year in 2019. So it doesn't happen quickly.

So we are not pounding our chest here, but it does give us ample opportunity to be able to scale those opportunities for both revenue as well as very important gross margin growth..

Okay. Thanks very much, and all the best of Brad..

Thanks..

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

Thanks guys. Two questions.

First, on 600 G, just where were we in the quarter? Was at mostly orders and kind of what level of orders or where there any revenues at all for 600 G, and what do you expect the second half to look like for some of that technology?.

Yes. There were orders, one physical order, five commits. I still believe 600-gig is going to be a very significant technology adopted into the market. And it's going to be differentiated around how many did you sell versus how many are making a decision on your platform based on your technology roadmap. 200-gig today, 600-gig today, 800-gig tomorrow.

We have a number of Groove wins now that are rolling out 200 gig today with an expected upgrade path. I have to go to 600 gig at the beginning of next year. That's why they picked the Groove. So I actually believe that we will absolutely get revenue this year, but the revenue ramp will be next year.

But the decisions are being made based upon the roadmap of 600 gig and 800 gig availability. 600 gig in a simple. It offers lower dollar per bit than alternatives on the market today. And that's what customers want. But they had a long certification cycle.

They're going to go do it when they're network planning cycle is appropriate and we see – I see most of the people we're talking to planning from the first half of next year for big installs..

The nice piece of that group platform and the compact modular space, which we're number two now in the market with the aspiration to be number one is again, the Groove is in a real Groove here in terms of its ability to offer the 200 gigs, 600 gig and then that platform architecture moving forward to 800 gig at the lowest cost per bit.

So it's been a real vehicle to get insertion opportunities into the Tier 1 into these ICPs that when they scale, they go fast and hard..

Okay, great. And a second question, I guess Brad – I guess you're shifting out the GMs, by a quarter of when they're going to go back up to mid-30s. I guess, what's the chance of them shifting out again and it seems like they could shift that again for either good or bad reasons, right.

It could be that we get so many new orders that they're going to stay down here for yet another quarter.

But how confident are you in these fourth quarter mid-30s would seem important to get to breakeven or above? What's your level of confidence, I won't shift that again?.

Yes. So Mike, you are right that the reason they declined in Q2 was a very good reason. That's a great opportunity for us and for our shareholders.

If you look at the different components to the increase in margin over the second half of the year, and especially in the Q4, one is a mix shift, which – you shouldn't read it as though we don't expect to be still growing footprint in the fourth quarter. But what generally happens is there's more a year-end money, which tends to be licenses.

There's less new networks that are built in the fourth quarter. We will have the benefits, the full benefits of Berlin. The full benefits of all the fixed costs we're taking out. And the reason I gave the metric around Q1 is, Q1 before we did all these cost reductions, we hit those same mid-30s gross margin.

So things happen in the market, but I'm confident that we have a great opportunity to go meet those numbers..

Great. Brad, where you go, we're going to miss you..

Thanks..

And our next question today comes from Meta Marshall of Morgan Stanley. Please go ahead..

Great. Thanks, guys. I wonder if you could just kind of describe the relationship that took place with the new ICP. You've mentioned it was a new growth group customer, but that that relationship may have come through Coriant.

So just kind of background on that new customer win and then just what you're seeing as far as kind of timelines of maybe past Cloud Xpress customers and how long it's taking them in the testing process as they look at Groove? That's all for me. Thanks..

Yes. So a couple of things, one, the Groove was brought to us with Coriant. I was interesting is that that when we announced the acquisition, we actually took the Groove product out of their lab and said, we're going to wait until we feel comfortable with this acquisition before we go and recertify it.

After we got the acquisition accomplished, they put it back into their lab and we tested it and certified it. So it's been actually – really great validation that they are comfortable with both the technology and the combined entity that the Groove is a platform that we are going to continue to invest in.

We made the decision probably at the beginning of Q2 and we started shipping in Q2 in fairly significant volumes and we see a very, very nice pipeline of opportunities from this platform. Right now, doing data center interconnect, but they're also now talking to us about other opportunities and other platforms.

So I'm excited about that overall platform. And I think that they will probably one of the customers that upgrade to 600 gig in the first half of next year. The second question, how long will it take for CX customers to migrate? You're presuming that all the CX customers are going to migrate. Some of them will. Some of them won't.

We still offer the CX 2. We still offer the XT-3300 and we offer the Groove today, and each is quite frankly preferred by some customers. Clearly the growth of the company is moving to the Groove..

Our next question today comes from Simon Leopold of Raymond James. Please go ahead..

Great. Thank you for taking the question. A couple of things I wanted to check on. You did indicate that you expect to generate cash from operations in the fourth quarter, which would of course imply that you expect to burn cash in the third quarter. If we just sort of think about that the midpoint of your guidance.

Could you give us some sense of how much cash you anticipated burning, whether there's any kind of one-time items in there or something we should be conscious of?.

Yes. It's an expectation for Q3 Simon is $20 million to $30 million overall cash reduction in the quarter..

Great. That's very helpful. And you had I guess a GAAP, non-GAAP difference in revenue. It sounds like you had a credit you provided to a customer from something last year. I don't quite understand that.

Could you explain what happened there?.

Yes. So we had a discussion with the customer this quarter. They had to compensate some of their end customers. We agreed to reimburse them for those warranty costs that will be given to them in the form of credits over time..

Great. Appreciate that. And Brad, I just want to thank you for your help and wish you best of luck. Thanks a lot..

Thanks..

Our next question today comes from John Marchetti of Stifel. Please go ahead..

Thanks very much. Last quarter time you talked about an Asian customer who delayed some of those orders that that you kind of took it out of the book because you weren't sure how that looked.

I was just curious where that stands now, if that was behind some of the APAC strengths in this current quarter and if it's in there for the second half of the year? And then secondarily last quarter there seemed to be a lot of excitement or enthusiasm around the Subsea market didn't hear much of that, during your comments today, we're just curious if you could characterize what you're seeing in that market as we look out in the second half of the year..

Yes. So two things in regard to the Asia customer that we pulled out of Q1 and then did not put in Q2. We are also not contemplating in our Q3 guidance or Q4 guidance. We still think it's an opportunity my bet, is it does come in but there are some issues around it that make us too uncomfortable to commit to it at this point.

So I'm going to wait and watch and work to continue to have the opportunity. If they do build the network eight hours, I'm sure. But it's become a big enough question mark that I'm not going to contemplate it in outlook, but my view is there's a reasonable likelihood that it would occur sometime this year.

In regard to Subsea I kind my air on really not talking about it. Brad talked about it a bit in his grip and we had a very strong bookings quarter in Q2 in particularly with ICE4. ICE4 continues to lead the industry in spectral efficiency quite frankly with a lot of Subsea decisions are made around.

We got our consortium PO in Q2, which was a substitute wind both from a technology. It's a wind from a deployment across a number of routes that'll happen over the next three quarters.

It's what are the challenges wining scale is aside as is between the time we get the PO and ship it and then recognize revenue and that's part of the gap that between revenue recognition that causes a little bit of a challenge for us.

But that and why we have to make an investment in inventory because that inventory is ours until they allow us to invoice it and they don't allow us to invoice it until they had an up and running invested.

But it's a huge win because the consortium has a number of Tier 1s that we want to do business with and we had them all here a few weeks ago and we're going to use that as an opportunity to go on a calling card. We continue to win Subsea and ICP and we continue to see the ICP space. I'd be a hotbed for a Subsea activity.

So overall, I'm still a very excited about Subsea and I'll tell you when I talk about people looking at technology generations and the people who look at Subsea are the ones who probably poke at technology generations hardest. Because what they're looking for is constantly improving dollar per bit, lot per bit and the reach that a bit can go.

And they are really pushing it hard. And that's where I think our ICE6 positions us very well. Selling what we have today, but also selling the promise of our capabilities as we go deep dive into what our performance of ICE6 is with them..

Thank you, Tom..

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

Hi. Thanks for taking the question. I just wanted to start off with the ICP revenues. If I’m right, you saw a sequential improvement in the revenues from Q1 to Q2, I think $20 million to $29 million, roughly.

Can you help us with how much of that was attributable to the new ICP that you started to ship to, and also how you're thinking about kind of the ramp in revenues with ICPs for the remainder of the year, particularly, are you continuing to expect a ramp with the new customer that you're now shipping to?.

Yes. Samik, the majority of the growth in the quarter was that new customer, and that was their initial ramp. We expect them to continue to ramp as the year goes on. They would actually have liked to us have shipped more in the quarter. So we actually built some backlog with that customer.

So expect them to continue to grow, not only through the course of the year, but as Tom mentioned, I think the opportunity with that customer are significant. One, as we transitioned the 600-gig as we have subsea opportunities, it's a very big opportunity for us..

You'll also see the ICP grow from a revenue perspective in Q3 and not just from that customer..

Got it. Also if I can just ask you on the strength you are seeing with the North American Tier 1’s and if you can kind of go into a bit more detail there.

What's driving the strength? I know you mentioned 5G, and you also mentioned subsea where to kind of what you're seeing on the metro side as well in terms of investments where we expect most of the 5G investments to come in?.

Yes. We should delineate between, again the three quarters of building out backlog and that continuing for the remainder of the year is different than the strength we're talking about in these new Tier 1 wins. In many cases when these Tier 1s deployed, they're deploying new design wins.

So some of them are getting new design wins on the open-compact modular platform that we're talking about, the Groove going forward based on our optical leadership.

And some of these both North American Tier 1’s and we talked about global PTTs that are considered Tier 1s are also completing or beginning their architectures for 5G and DAA Access Architectures. And that's where we're starting to see those initial design wins.

What you first get with the Tier 1 is a design win is a trial period, in some cases paid for, in some cases unpaid and then they begin roll-outs.

I would like to reinforce that in the – getting back to growing bookings and backlog that happens as they scale those opportunities, which is a multi-quarter, multi-year for 5G and DAA and a very large opportunity.

So again, design wins on the edge of the network with our distributed router platform as well as our fronthaul, backhaul platform and in the compact modular business with the Groove..

Brad talked about North Americas Tier 1 strength that came from our classic product building a long haul product and winning new routes. So one of the things that we've been really delighted with is the amount of new routes we are winning with two of our North America Tier 1s in the classic long haul space.

And that makes me also believe that they are not building these routes to not fill them over time. And I do believe that even though we're paying a little bit of a margin pressure on this in the near-term, the fact that we are winning substantive new routes with these two Tier 1’s that have been long-term partners is a good sign..

Got it. Thank you..

And our next question comes from Jim Suva of Citi. Please go ahead..

Thank you very much. And thus far your questions and the details to those have been very good and appreciated. But I heard one thing that maybe my hearing is off and I'm getting too old or maybe I heard it wrong and maybe you can [indiscernible].

Brad, on your prepared comments, you mentioned that there was like a gross margin push outs, and if so can you help us better understand why or maybe I just completely heard that wrong and you give us some details around that. Again, I apologize if I heard it wrong. Thank you..

Yes. So Jim, when we looked at the second half of the year earlier, we expected a bit more of a ramp of the gross margin in Q3 and then a further ramp into Q4.

So although we are increasing the margin from Q2 to Q3 and still believe the opportunity in Q4 is strong, the amount of new footprint we're building in Q3 is going to push that growth of the Q3 increase in margin into the fourth quarter. That's what I was commenting too..

Thank you. This concludes our question-and-answer session. I'd like to turn the conference back over to Infinera management for any final remarks..

I'd like to thank all of you for your time today and I look forward to updating you on our continued progress. Before signing off, I would like to thank Brad for his partnership and his friendship. He has been truly committed to Infinera and I wish him the very best. Have a great day..

Thank you, sir. Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day..