Ladies and gentlemen, thank you for standing by, and welcome to the Infinera Corp. First Quarter 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Amitabh Passi, Head of IR, you may begin your conference..

Thank you, operator, and good afternoon. Welcome to Infinera's First Quarter Fiscal 2022 Conference Call. A copy of today’s earnings and investor slides are available on the Investor Relations section of the website. Additionally, this call is being recorded and will be available for replay from our website.

Today’s call will include projections and estimates that constitute forward-looking statements, including but not limited to, statements about our business plans, including our product road map, sales, growth, market opportunities, manufacturing operations, products, technology and strategy, statements regarding the impact of industry-wide supply chain challenges and COVID-19 on our business plans and results of operations, as well as statements regarding future financial performance, including our financial outlook for the second quarter of our fiscal year 2022.

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, including those set forth in our Annual Report on Form 10-K for the year ended on December 25, 2021, as filed with the SEC on February 23, 2022, as well as subsequent reports filed with or furnished to the SEC from time to time.

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’ve provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in our earnings release and investor slides for this quarter, each of which is available on the Investor Relations section of our website.

And finally, as a reminder, we will allow for plenty of time for Q&A today. But we ask that you limit yourself to one question and one follow-up, please. I’ll turn the call over to our Chief Executive Officer, David Heard..

Thanks, Amitabh. Good afternoon, and thanks for joining us today. I will begin with a review of the results for the quarter and provide some color on the broader market context. And then I'll turn the call over to Nancy to cover the details of our financial performance.

We continue to benefit from strong demand and deal momentum in the quarter, both of which were above our expectations, especially following a very strong Q4 2021.

However, our Q1 financial results did not represent our full potential, and we're at the low end of our outlook range due to uncontrollable and previously unforeseen supply chain developments late in the quarter.

Non-GAAP revenue was just below the outlook range, while both non-GAAP gross margin and operating margin were within the low end of the range. From a bookings perspective, we had a big quarter, especially in the US coming from both ICPs and service providers.

Overall bookings grew in the double-digit percentage range on a year-over-year basis, and we ended the quarter with a product book-to-bill meaningfully above one. This was our sixth consecutive quarter with book-to-bill ratio above one.

Not surprisingly, our product backlog set another quarterly record and was up almost above 20% sequentially and over 100% on a year-over-year basis. However, from a revenue perspective, we faced two anticipated headwinds late in the quarter.

First, a $5 million impact due to governmental trade sanctions and our decision to suspend operations in the Russian Federation in early March, the right decision.

Second, a $20 million impact from two new supply chain-related developments including, first, project delays due to customer dependencies, meaning we shipped the hardware, but our customers were delayed in commissioning their network to allow for revenue recognition due to challenges with their site readiness availability of customer resources and customer furnished installation material.

This timing impact was split roughly across product and services revenue. We also experienced a relatively smaller impact from supplier decommits and push outs, partially caused by the COVID shutdowns in China in the last two weeks of the quarter, a time when we typically ship a very high percentage of our quarterly revenue.

These new supply-related impacts occurred against the backdrop of an already difficult semiconductor environment.

The combined effect of the higher logistics, component cost variations, particularly in the broker market and lower volumes impacted gross margin in the quarter by an incremental 150 basis points to 200 basis points versus our earlier expectations.

On the customer front, we continue to secure new large deals with well-known brands at a faster pace than originally expected across long haul, metro and subsea applications, further validating that our 8x4x1 strategy and refreshed portfolio are winning in the market.

In addition to our announced wins in Q1 with customers like Zayo, Windstream, PCCW, amongst others, we had a few other notable brand name wins. First, we secured an ICE6 win with a significant Tier one service provider in Western Europe.

Our momentum and performance leadership in subsea are starting to translate into meaningful terrestrial network wins. Second, we signed a large metro deal for our GX product with a major US service provider, one of the largest deals in our history.

This is a multi-year deployment that we believe will benefit from improved margins as we integrate our own pluggables in the first half of next year. And third, we successfully onboarded a new top ICP with our GX family of products.

We have very strong momentum in the ICP segment and for the first time in several years, an ICP was our number one customer in the quarter. ICE6 revenue grew to the high teens as a percentage of product revenue in the quarter, up from the low-teens last quarter. Bookings have started out strong in Q2.

And we're in the middle of several certifications of major ICPs and Tier one service providers. We remain on track to ramp ICE6 to 20% to 25% of product revenue in 2022. Next, the GX metro product had a record quarter, with bookings up almost 200% year-over-year, driven by a combination of new wins and growth in existing accounts.

We are winning new metro deals at a much faster pace than our prior expectations. While these wins have a near term margin impact as we lay out common infrastructure, the expanded footprint lays the foundation for margin expansion in 2023 when we vertically integrate these platforms with our own products.

And finally, we saw continued growth in open line systems, a good leading indicator of future high-margin transponder sales for long haul and subsea. The subsystems business group achieved several significant milestones for the quarter.

First, our 400 gig XR DSP, which is ZR plus compatible and the industry's first point-to-point and point-to-multipoint DSP was delivered from the fab and is performing well. Initial testing is ahead of schedule. Second, we began early production of our TROSA, the optical front end that represents almost 65% of the bill of materials in pluggable.

As a reminder the DSP and the TROSA are the two critical building blocks in the pluggable and we're off to a good start with both.

We are planning for our first pluggable samples to be available in the beginning of the third quarter and to start ramping revenue in the first half of 2023 and then to drive hundreds of basis points of gross margin improvement in our metro products once we integrate them into our platforms.

And lastly membership in the Open XR forum continues to gain traction. During the quarter we announced the addition of five new service providers to the forum including AT&T and Telefonica and the list of service provider members now collectively represents over 20% of the global telecom CapEx spend.

Furthermore, the first set of equipment manufacturers of routers, switches, servers and wireless RAN, including Juniper, Sumitomo and Arrcus have joined the forum. We have a healthy pipeline of familiar network equipment manufacturers interested in joining.

These proof points validate that we're on track to productize our pluggables, vertically integrate them into our platform and create what is potentially a new billion dollar plus addressable market to point to multipoint pluggables. There is tremendous momentum in our business.

We're winning new customers, growing with existing ones, scaling our ICE6 800 gig in metro solutions and introducing innovative products like our pluggables and software automation suite.

The underlying demand drivers are healthy and as our customers cope with increasing bandwidth needs to accelerate the rollout of 5G, mobile edge compute and deep fiber architectures. These dynamics are playing out, while the industry's number one optical infrastructure vendor Huawei is excluded from many global markets.

Looking ahead to Q2, we anticipate continued healthy demand given our bookings momentum and the expectation of a strong CapEx cycle continuing. At the same time, we believe the acute macroeconomic and supply chain pressures from Q1 will continue into Q2.

In our Q2 outlook, which Nancy will cover in detail shortly, we've incorporated the impact of suspending our operations in Russia as well as the projected temporal impact of further customer delays and product push outs due to constraints on the customers' end. This is a timing impact-only.

Despite these challenges we expect to grow revenue sequentially Q1 to Q2. As we look out further into the year, we now believe 2022 will be a tale of two halves not too dissimilar to 2021, albeit for different reasons.

We expect the lower first half of the year constrained entirely by supply followed by a meaningful uplift in our financial performance in the second half with year-over-year revenue growth in the second half at/or above the high end of our 8% to 12% range and gross margins in the 40% range as we exit the year.

We anticipate the second half of the year will benefit from the continued ramp of our own production of ICE6, conversion of our backlog of revenue, partial benefit from first half push outs of those projects as I mentioned we're timing-only based and some supply chain relief given the actions we've taken over the last six quarters will continue to intensify.

Specific to the supply chain, we believe there are at least two developments that are unlikely to be long lasting and therefore temporary in nature. First, we expect the impact of the COVID-related shutdowns in China to persist through Q2 and we're assuming some relief from these shutdowns in the second half of the year.

Second, we don't believe the elevated pricing levels that we're seeing in the semiconductor broken market are sustainable. And that frankly they're running out of supply, which forces more direct negotiations with suppliers, which is proving healthy for forward forecasting.

Taking these two factors into account we remain focused on the elements we can control. The Infinera team has been working diligently over the last six quarters to eight quarters on the following five areas. First, we continue to qualify additional sources of supply including the redesign of parts for substitution.

Second, we have significantly increased purchase commitments to our contract manufacturers commensurate with the longer lead times and increasing demand. Third, we're investing more heavily in hardware cost reduction programs. Fourth we're significantly increasing production capacity of ICE6 internally given the robust demand we are seeing.

And lastly we're adjusting selected commercial terms with suppliers and customers. These actions have the objective of mitigating some of the supply chain costs and revenue impacts which I highlighted earlier and our enabling us to remain on the path to achieving our target business model.

As I close today, I want to reiterate our confidence in Infinera strategy refreshed portfolio competitive position and customer momentum. We've made tremendous progress and our team continued to work through some unprecedented times and challenges.

I'd like to thank the Infinera team for their continued focus intensity and dedication for servicing our customers, during these dynamic times while taking care of one another. The Infinera culture is intensely focused on doing the right thing. And our thoughts and prayers go out to everyone who has been impacted by the crisis in Ukraine.

Finally I would like to extend my thanks to our customers, partners and shareholders for your continued support. I will now hand the call over to Nancy to cover the financial details of the quarter and our outlook for the second quarter..

Thanks David. Good afternoon everyone. I will begin by covering our Q1 results and then provide our outlook for Q2 '22. My comments reflect our non-GAAP results and outlook. For your reference on our Investor Relations website we have posted slides with financial details including our GAAP to non-GAAP reconciliation to assist with my commentary.

As you heard from David, demand in our fiscal first quarter remains strong coming in much better than our expectations particularly after a very strong Q4 of 2021. We had another quarter with a very strong book-to-bill ratio and set a new quarterly record for both product and services backlog.

However, the industry-wide supply impacts proved more challenging than our expectations resulting in our financial metrics coming in below our plan. Despite these transitory challenges we feel good about our strategy deal momentum new product milestones and NPI ramp and remain committed to delivering our target business model.

Turning to the financial details of the quarter, Q1 revenue of $339 million grew 2% year-over-year with product revenue up over 5% while services revenue was down 8% on a year-over-year basis.

Compared to the first quarter of last year product revenue benefited from higher ICE6 GF metro and line systems revenue but was attenuated by severe supply constraints and the suspension of our operations in Russia.

Services revenue declined year-over-year primarily from a recent dynamic where some customer projects are being shifted out, due to their own site readiness and resource constraints coupled with the impact of our operations in Russia having been suspended. Services bookings however were strong in Q1 and we are entering Q2 with record backlog.

Geographically we derived 50% of our revenue from domestic customers in the latest quarter compared to 48% in the year ago quarter and 42% in Q4 of 2021.

And no customer contributed greater than 10% of our revenue in the quarter.\ Q1 gross margin of 36.2% came in below the midpoint of our outlook range, primarily due to an incremental 150 to 200 basis points of supply chain impact from higher component costs and lower volumes.

And secondarily from a higher contribution of line systems and metro common infrastructure. Partially offsetting these factors was a positive contribution to gross margin from ICE6, which ramped to the high teens as a percentage of product revenue in Q1.

Operating loss for the quarter was $3.5 million, equating to an operating margin of negative 1%, which was below the midpoint of our outlook range. Operating margin in the quarter was impacted by lower revenue and gross margin, partially offset by focused expense control.

Operating expenses in the quarter of $126 million were below our outlook range of $130 million to $134 million as we tightly manage spending while maintaining investments to keep our innovative programs on schedule. The resulting EPS in Q1 was a loss of $0.07 per share. Moving on to the balance sheet and cash flow items.

We ended the quarter with $204 million in cash and restricted cash, up slightly quarter-over-quarter. During the quarter, we generated $16 million of cash from operations and free cash flow was approximately breakeven. We ended the quarter with a 0 balance on our credit facility.

Looking ahead to the second quarter of 2022, we are encouraged by our customer wins, booking momentum and record backlog. At the same time, as David outlined in his comments, we expect the supply challenges to continue in Q2 before seeing some release in certain areas in the second half of the year.

Taking these factors into account, we expect Q2 revenue to be in the range of $350 million, plus or minus $20 million. Representing approximately 3% growth on a year-over-year basis at the midpoint of the range. However, product revenue is expected to grow faster at approximately 8% year-over-year.

Given the increasingly uncertain supply chain environment, we have widened our revenue range for Q2 and have incorporated the following impacts in our quarterly outlook. First, the removal of $5 million in revenue related to our prior expectations due to the suspension of operations in Russia.

And second, approximately $25 million of revenue attenuation from customer delays and project push-ups, including a large global ICE6 deal that is shipping in Q2, but will generate revenue in the second half of the year.

These delays and pushouts will continue to pressure our services revenue, especially professional services tied to new project installations. We are forecasting Q2 gross margin to be in the range of 36.5% plus or minus 150 basis points, up slightly on a quarter-over-quarter basis.

Compared to the year ago quarter, the primary factors influencing our gross margin outlook include a higher mix of ICE6 revenue, which is accretive to the company's gross margin, but is being offset by the impact from a combination of higher supply chain costs as we continue to bear the burden of higher components, materials, logistics and freight costs.

Lower services revenue and margin compared to the second quarter of 2021 and new footprint wins from large household names, which bode well for future quarters. We are planning to recover much of this margin impact as we exit the year.

We are forecasting Q2 operating expenses to be in the range of $132 million to $136 million, as we continue to prioritize investments in both sales and R&D, consistent with the comments we made at the beginning of the year.

Within R&D, our priorities are centered on pluggable metro platforms and software areas critical to driving top line growth and margin expansion. Additionally, Q2 was also the quarter when our annual merit increase picks effect.

We expect Q2 operating margin to be a loss of 2% plus or minus 100 basis points, with operating margins down on a year-over-year basis at the midpoint of the range, primarily due to lower gross margin compared to the year ago quarter.

In Q2, we expect to use cash from some cash from operations as we make select investments in inventory and manage through the impact of the supply-constrained environment. Below the operating income line, we assume $5 million for net interest expense and $7 million for taxes.

Finally, we are anticipating a basic share count of approximately 215 million shares for Q2.

Given the recent external events, including the challenging supply chain environment and the impact to our services revenue in the year from customer project pushouts, based on what we see today, we now expect our full year revenue growth to be at the low end of our 8% to 12% goal and for gross margin to expand by 100 basis points to 150 basis points in 2022 versus our prior 300 basis point to 400 basis points goal.

Our updated outlook for the year also implies a meaningful improvement in our financial performance in the second half of the year, with revenue growth measures for the second half at or above the high end of an 8% to 12% range and gross margin of 40% plus exiting the year.

Our second half financial performance is expected to benefit from product growth, the ramp of ICE6, the deployment of new customer wins secured in the first half, the timing of certain large project deployments completions and our supply chain mitigation efforts.

Despite the slight step back in 2022 from several uncontrollable external developments, we are extremely pleased with our record demand, new customer wins and next-generation technology development. We remain confident and committed to working towards the realization of our target business model.

In closing, I would like to add to David's, thanks to the Infinera team who continue to work tirelessly through a very dynamic environment and to our partners, customers and shareholders for your continued support. Josh, we can now open the line for questions..

[Operator Instructions] The first question comes from the line of Michael Genovese with Rosenblatt Securities. Your line is open..

Okay. Thanks for it. A couple of questions here. First, if I look at the guide for 2Q, it's about $30 million below consensus, and I think you're saying $5 million is Russia. So that leaves us with $25 million for the supply chain.

And what I'm having from a understanding from your language is how much of that is you guys having trouble getting parts versus your customers having from getting other products and delaying network builds?.

Yes. So the delta – It’s a good question, Mike. The question is -- a majority of that is actually project acceptance from our customers' ability to not just get parts but have sites available, have labor available to be able to have site preparation. Good news is, we have good visibility now into that happening.

And a piece of that is a very large ICE6 customer that's deploying in multiple countries. And just based on these delays that we've seen through China and the supply chain, the acceptance for that will now spread that revenue in the back half of the year..

Okay..

It's a majority of the $25 million.

Have a couple of follow-ups on that. So it sounds like you're saying that the stuff you can control in the supply chain or getting parts for yourself. You sound like you wouldn't have missed based on that. You're doing a good job there. And then secondly if you could comment on that but also talk about ICE6 products.

Like how much are other vendors, parts or contract manufacturing services necessary for ICE6-based products? Are you doing a lot of that yourself?.

Yes it's good - another good question. So again just to try to put this into perspective that the - if you think about the miss to the midpoint of guidance for Q1, $5 million of Russia $15 million of project acceptance all based on customer site availability.

However, typically Mike, we have enough wiggle room with the supply chain in what we've been doing over the last eight quarters to be able to hit the high end of that range. So obviously, the late in-quarter supply decommits did not allow us to cover that $20 million impact of Russia in the supply chain.

So I appreciate we've been hanging in there quite well for the last eight quarters and the team is working around the clock but was not able to pull in enough supply to mitigate that 20%. Based on our carryforward of the Russia, in typical markets given our – Mike we're now sitting on $822 million of RPOs. That grew $58 million over the quarter.

I expect that to top $100 million for the first half of the year in terms of growth of the RPOs. So there's plenty of opportunity to go get. But based on the fact that supply chain lead times are no longer 12 weeks, it's hard for us to flip the Russia turn off into another opportunity without having that supply.

And third to your question – yes sorry go ahead..

About the ICE6 how much you – that’s working to yourselves?.

Yes. So look, well we have way more control over ICE6. We always – these supply chain challenges are across. You can have a transistor ferrite, a small device that's coming through your contract manufacturer. And you've seen the reports from the primary contract manufacturers that went through.

They also had some challenges in the supply chain in the quarter. But ICE6 much more in our control not completely. You can always be again impacted by some small device but a lot more in our control. The remainder of what we see and what our customers see are things like power supplies and things that they need in building out their local networks..

Thanks so much.

I can ask a lot more questions but – and I'm probably pass my time but maybe I'll just get one more and then that would be my last one which is you're comparing this next – this year to last year with the back half but we didn't see the kind of I think ramp you're implying in the third quarter of 15% plus sequential revenues in the third quarter.

We didn't have that last year. We had a strong fourth quarter sequentially but not as strong as the third quarter. Talk more about your confidence that not a lot of companies are saying things are going to get better before the end of the year.

So the confidence in the third quarter please talk about that some more?.

Yes. I'd say the confidence in the back half isn't that the supply chain environment gets better. It's that – the projects that we already have out to go to revenue, again remembering those $822 million of RPOs, we'll convert and we have visibility to that.

The second thing is there is a very large degree of that that is on the production of our own ICE6 for Q3 and Q4.

And given our visibility to that supply chain environment and the fact that we in Q2 grew our production capacity by 6% by 30% and are continuing to increase that on a quarterly basis we feel good about the flow through of our own and the service conversion in the back half of the year.

We're kind of holding the supply chain environment the only improvements we expect to see Mike are because we ordered a bunch of parts for a very hefty demand and above even the demand we were seeing last year to be able to cover and we're starting to see that visibility of supply in the back half albeit it wasn't in the first quarter. .

Okay. Thanks Mike. We need to move on Mike. Thanks.

Operator, next question please?.

Your next question comes from the line of Matt Dezort with Needham. Your line is open. .

Hey, Matt..

I think that's Alex.

That's right?.

Yes, Alex. That’s right. Maybe you were putting somebody else in there.

How you doing Alex?.

I'm fine. Thanks. So it's nice to hear Mike on the call here. I just wanted to clarify a couple of the numbers to start with. The Russian number was $5 million in the first quarter. You're saying additional $5 million in the June quarter.

Is it $20 million for the year then?.

Yes. It's $20 million for the year. But given the -- again strong RPO position and lead time we'll be able to convert the back half and cover that with other existing demand. .

Yes. I'm just trying to get the numbers straight. That's all. The second question is it sounds like you're suggesting that there was $15 million in project in 1Q and it's going to be an additional $20 million or so in 2Q.

Is that correct? So there's $35 million in the first half?.

Yes. Sorry it was $20 million in Q1 and it's going to be 25% in Q2. And that's because of the large multi-country project as Nancy mentioned for ICE6. .

Okay.

So that revenue that $45 million in revenue will show up in the back half of the year and that's contributing to the upside to the back half growth rates?.

Yes, some piece of that. And so what we're saying is that that will time shift out in the waterfall of those -- that revenue recognition will happen in the back half of the year. We will see some push ups from the back half of the year but we think the impact of that Nancy will be about... .

About $30 million on the services line. .

Only. .

Yes. We're going to make up on the products that some of the services will take longer to deploy. So think about $30 million impact on the year in terms of services revenue. .

Okay.

So I'm shifting $30 million out of 2022 into 2023 as a result of that?.

Correct. Yes. .

Okay. .

That does not go away. .

Yes. In the back half -- I mean the growth rate in products as you can see good in Q1 at 5% expecting 7% to 8%, eight percentage on Q2. And then it will be higher revenue growth in Q3 and Q4 as we end up with product revenue in the back half of the year at or above the high end of the 8% to 12% range. .

All right. If I'm doing my math correctly the Russian impact is 1.4% and the impact of the $30 million sliding out is another 2.5%.

So that's effectively four percentage points of drift because of those two factors and that's what's bringing the full year down?.

Yes. And we are going to obviously do what we can to offset that in the back half but it's still very early in the year. So I think you have it captured correctly..

Great. And so if the products are shipping now that recognized in the back half of the year, then I would assume that there's a significant improvement in gross margins in the back half, but it sounds like you're talking 40 percentage gross margins in the back half. I think we were already there before this.

So, am I talking about gross margins benefiting in addition to that -- from that shift?.

No, I think we exit the year at or slightly above 40. We've still got the hangover effect on the cost of supply, right? Even though we're able to manage through on the product revenue and product growth, the supply costs are still very real and continuing and we'll offset as many of those as we can in the back half.

And then you'll also have the impact of a lower percentage of services revenue..

I get it. Okay. And then my final question, if I could, just one on the point to multi-point products. Very good news that you're pulling that forward.

Can you quantify the magnitude of the pull forward? Is it like one quarter? Is it -- I mean what's the thought process in terms of the timing of getting that product to market?.

Yes. Well, I think first and most importantly, the DSP that we got back is point-to-point -- endpoint to multipoint. So, it fulfills the ZR Plus portion of our market, which allows us to put that pluggable in our own metro platforms to improve our margin in the first half of the year.

And the fact that, that DSP is back from the fab, ahead of schedule and testing well, just puts us a high degree of confidence -- a higher degree of confidence in our ability to go ahead and hit that margin improvement in the first half of next year and the fact that we're going to have samples out bodes well for all the customers looking to deploy both point-to-point and kind of the industry's first point to multipoint.

It's a big, big, big deal, big confidence boost for us..

Thank you, Alex. Operator, we'll go to next question please..

Your next question comes from the line of Meta Marshall with Morgan Stanley. Your line is open..

Hey Meta..

Hey. A couple of questions for me. I mean, I guess, just in terms of you guys are seeming to indicate that this large project that you guys aren't kind of controlling the timing of is pushed out and that you can basically pull some other orders in or just fill that with kind of the other order activity that you guys are seeing.

I guess just in terms of if the timing -- the timing of this kind of project that's being pushed out, like what kind of gives you confidence of when that timing will take place that some of that is moving into, kind of, 2023 or what gives you confidence in kind of the timing that is there? And do you think that kind of all these other orders can be pulled in? And then the second question that I have is just you mentioned kind of taking some of the negotiations direct and avoiding maybe some of the gray market and that actually being helpful.

I just wanted to see if you could give more detail as far as kind of what you're seeing as far as improvements there? Thanks..

Yes. No, it's both excellent questions. So, look, let me restate for Q1. So, for Q1, from a shipment perspective, we shipped the amount of hardware that we would have expected to cover to the midpoint of our range.

The fact that it didn't revenue recognized due to the kind of customer requirements that was an unexpected dynamic that developed in the last month of the quarter and was not expected given the supply chain impacts. And then typically, we have more supply chain to cover that.

What gives us confidence in this large project that we're talking about that has an impact to Q2 is, we are intimately involved with deploying the product in this one under lots of things that will be under our purview as we implement this.

And we've implemented a first phase of this maybe two years ago Nancy? Two years ago, that had a negative impact to the first quarter of 2020. And this is ICE6 global big revenue and big margin impact that we feel comfortable will spread between Q3 and Q4 based on the contract details that we have.

And we're being I think good and conservative given what we learned in Q1. To your second question, look I think if you listen to some of our suppliers like Fabrinet and others in their commentary they're seeing the same thing where the broker market which has been ridiculous, where we saw 200% markups go to 600%. We've even seen them up to 1000%.

It's beginning to dry up. And some of the suppliers are monitoring that broker market to see when parts go to it trying to punish is probably the wrong word but really control anybody that's dumping and taking profit by moving their parts to the broker market.

And so by in that we're having more direct discussions directly with the manufacturers or the suppliers themselves. And that's giving us more visibility to the capacity they're adding in analog technologies and fabs and in digital technologies and fabs and to when things begin to come online.

And when we can view the commits they're giving to us for our forward needs more confidence when they'll be met. So that transparency is a good thing right now..

Got it. Thanks..

The brokers are a bad thing. Yeah..

Yes. Thank you, Meta. Operator, next question..

Your next question comes from the line of Simon Leopold with Raymond James. Your line is open..

Thanks for taking the question. I guess somebody needs to ask and I will volunteer. You opted not to preannounce the quarter.

And given the degree of the mix and the factors, I just want a little bit of insight into the thought process as to why you opted not to preannounce this quarter? And then, I've got a follow-up regarding one of the projects you were discussing..

Sure. So the outlook range for revenue was $345 million to $375 million. And where we landed was about 2% a little less than 2% below that bottom end of the range. And our gross margin and our operating margin were within the outlook range. We have some challenges with supply. Supply chain is very well known in terms of an industry dynamic.

The impact of Russia in terms of the suspension of activity there also a very well-known and well publicized event globally. So we felt that we didn't need to make a pre-announcement and make that call..

Okay. And regarding the GX Metro deal that you talked about, you characterized it, David, as the largest in your history. I think I know what you're talking about, but I'd like to maybe get a little bit more color to confirm.

Is this something related to an open ROADM type of architecture?.

No..

Maybe give us a little bit more color on the nature of the – either the customers and deployment that makes it special?.

Yes. Nationwide metro footprint on our GX platform starting with merchant integration and will ultimately better in our own vertical integration via our own pluggables. We are also engaged with that other opportunity with the Tier 1 in the metro.

We are winning large initial design wins and initial footprint in the metro as I mentioned at a much faster pace. So we are involved in that other opportunity I think you're alluding to. But this is a nationwide US carrier that we don't define as a Tier 1.

It's a very large footprint of somebody who's laying out fiber to try to get lots of bandwidths out to – two gig out to everybody's home..

Great. That's helpful. I appreciate that insight. Thank you..

Thanks, Simon..

Your next question comes from the line of Rod Hall with Goldman Sachs. Your line is open..

Hey, Rod..

Hi, guys. Thanks for the question. So I wanted to ask you on the product growth. Just to clarify what you were saying, you're expecting product revenue on a full-year basis to more or less catch up in the second half. So no change there. But services revenue will be impacted because of the fact that, it takes longer to recover.

Is that what you're saying?.

Correct. So basically, product catches up, services timing delay of $30 million impacting the quarter. That's how I'd frame it..

Right. Yeah. Okay. That's what we understood. And then the other thing I wanted following up on that the Russian impact and this may come back to kind of an ICE6 question ultimately. But you're dropping $20 million out of the model for Russia. I guess a lot of that's product. You're going to end up kind of flat on the product for the full year.

What fills that in? And is that just better ICE6 performance than you expected, or can you give us a little bit of more color on kind of what's doing better than you anticipated to come back and infill that revenue?.

Well just real quick just – I want to make sure we're not misstating. On the front half of this year as Nancy said, we grew 5% in product in the first quarter. And we expect that to be 7% to 8% as she said in Q2. And in the back half, it's much higher than that, right? So it will – product will be growing across the board.

It will be growing certainly highly driven by ICE6 deployment. But also the thing that's quite surprising is the GX platform as a metro platform is just winning much more than anticipated. Our line system is winning much more than anticipated.

And these are across the board between – certainly in the metro it's CSPs, but we're also seeing even more opportunity with ICPs..

And do you – David, do you guys think that – so you've got this 20% to 25% ICE6 mix target for the full year.

Do you end up above that now given what you know, or do you think – is most of the extra over on the shared - ?.

Hey, Rod, given the unknowns that we saw, I think, in Q1 that we didn't predict the Russian conflict, nor the China shutdown of the pandemic.

So given that, look, I think our – giving the color of outlook that we have, we're just trying to give you assurance that, again, when you're sitting on $822 million RPOs and you know the contracts, you know the design wins you have and you're expecting that to grow again, again commensurate with the first half growing another $100 million in RPOs, that's what gives us confidence.

I don't want to get a little too far ahead of our skis here on the ICE6 rates..

Okay. All right. Well, thanks a lot. I appreciate the color anyway. Thank you..

Thanks, Rod..

Your next question comes from the line of George Notter with Jefferies. Your line is open..

Hi, guys. Thanks very much. I guess I wanted to ask about -- hi, I wanted to ask about vertically integrated products. I think last quarter you told us that 44% or 45% of sales came from vertically integrated products. I'm just curious what that is right now..

Yes. It's about the same right now, George. We have -- as David said, we're seeing the impact of the metro wins that are starting to offset some of that, not changing our objective though to get that into the 16% range next year. But for this quarter, it was about flat last quarter..

Got it. Okay. And then so as I think about the gross margin discussion for the full year, you took the expectation down a bit. It sounds like the issue there is really about component costs. I think you mentioned services mix, but the issue was not the mix of vertically integrated products.

Is that correct?.

That's correct..

And then as you guys work to vertically integrate more of your products, I guess, I'm wondering what the milestones are.

I think you mentioned pluggable for the first half, but are there other details in that sort of transition that you can share with us?.

Yes. So, first and foremost we try to give the ICE6 measure of that growing into the 20% to 25%. No, we're not going to top that off right now, as we mentioned Rod. On the second piece, it's a huge chunk of this. 45% of the bill of materials of a metro deployment for us is the optical engine. And that is the DSP and the TROSAs.

So the fact that we're already producing the TROSAs and we got our DSP back gives me more confidence that as we exit the year, we will feel very good about our margin accretion plan for the pluggable in the metro in 2023, which has always been part of our margin story.

This year was about ICE6 about getting the wins and scaling and next year was about getting additional margin accretion with the pluggable. Those are the biggest pieces of our vertical integration. .

Got it. Okay. .

And the fact that the GX platform -- yes, sorry, the fact that the GX platform is up 200% as that footprint is beginning to -- there's demand for the footprint, which is good..

Okay. Great. And then so you said the pluggable would ship in the first half of the year next year.

Is that early in the first half? Is that midyear?.

Yes. No, no, early, so sorry. Samples come out in Q3 this year, and we'll be going through qualification and qualification in our -- even our own platforms, which is a lot more under our control. So we're ready to go as fast as possible as we enter 2023.

But we wouldn't expect the revenue impact given the capital conversion cycle, if you think about revenue recognition to happen until full half, kind of second quarter, we'll probably see the biggest. So it’s the first step, yes..

Okay. Okay. Thank you very much..

Yes. Thank you..

Your next question comes from the line of Jim Suva with Citigroup. Your line is open..

Thank you. A question for Nancy. Nancy, I see that you upgraded your gross margin guidance, which I think is appropriate and prudent in this stage.

Am I correct that it's folded in the impact of higher ASPs of your components coming in, higher expedited costs, but also these new orders that Dave talked about coming in, that some of those new orders are at pricing that kind of, say, was subdued before this recent environment we're in now.

And so, that also has been fully folded into your gross margin outlook, or how should we think about that?.

Yes. I mean, that would all be rolled into the full year outlook in terms of now being at 100 to 150 basis points up versus the 300 to 400. So I think you've captured the components there..

Okay, great. And then, Dave, I was -- I noticed your optimism about the second half of the year for the recovery of the component availability.

I guess, can you give us any insights about your conviction behind that? Because I think that there may be some of us who may just be a little more uncertain about all of that kind of becoming closer towards delivery..

Hey, Jim, if I'm coming off as super confident about component availability in the second half, let me clarify. I think -- I'm not expecting the component availability to get better, and I'm not expecting for any massive erosion. What we experienced in the first quarter was we had enough at least to ship.

It was tighter than normal, meaning we didn't have enough to cover this, "Hey, we shipped the parts, but our customer couldn't get it." Couldn’t get the parts, nor the people to be able to deploy.

In the back half, we're just assuming that stuff comes through, the other projects we have in deferred and then RPO begin to come through, because we've provisioned for the parts, we see them in our supply chain right now, and we're not seeing right now additional risk. That doesn't mean I'm super fired up about the supply chain environment we're in.

It's been a tough slog. We've been going at this for six to eight quarters now and holding ourselves reasonably well. But I will tell you that there's a bit of this that's under our control, which is the production of ICE6.

So as long as the supply chain holds, we've increased the production output capability of ICE6 and our own capacity, to be able to keep up with a consistent supply chain environment to what it is today.

Is that helpful?.

That was very useful and helpful and clarifies all of it for me. Thank you so much..

Thanks, Jim..

Your next question comes from the line of Fahad Najam with Loop Capital. Your line is open..

Thank you for taking my question. I want to double click more on the component shortages.

Are the component shortages that you're facing -- correct me, if they are like universal products that go across all your product lines, or are they -- are the products more skewed towards your vertically integrated products?.

No, I'd say, actually that a lot of them go to older geometries and things like line systems, other things in the metro. I'd say, it's skewed less towards our vertical integration in newer geometries.

However, there are some parts, power supplies as an example, all kinds of chipsets and ferrites and other things that -- look, just -- it's -- again, they go across the portfolio.

Certainly, much more line system in metro, but there is an impact even when you have your own vertical integration because you're going to have some element you need from an outside supplier.

And what we're doing now is not only managing our direct supply but even if we get it from a supplier in many cases from a CM or from a supply we're going to the second and tertiary source to make sure that that will change us through because some of our decommits were the secondary or tertiary impact to that and that happens primarily when you see things like China happen unexpectedly..

Got it. So, if the parts like the power supplies or power strips or shorter supplies, why wouldn't you optimize your ICE6 maybe prefer your ICE6 shipments over any other portfolio product, because it's better margin.

I'm just trying to understand why aren't you maybe allocating more of your limited supply to ICE6 and rest ICE6 more strongly in the rest of the year?.

Yeah. I mean look, we first optimized to what our customers' demand is and what our requirements and our expectations are from our customer. But then, certainly, we look at the mix. But even ICE6 when put in -- it needs to be put into a line system and things like power supplies, again RACs and other things that again, the industry has been pinched on.

So we do -- we've been doing our best to try to optimize our shipping volumes and hitting customer service but also our shareholder expectations. And for the last eight quarters that's been going pretty good.

This new dynamic of Russia and us shipping the actual goods that we thought would hit revenue but did not on behalf of the customers and ability to get power supplies and other things into their network that was new. So we're making an adjustment. And again that's that $30 million of services that we've kind of pushed out in timing only to the year.

Now we'll continue to stay super, super diligent and we've got an awesome team that's on it but -- and are working with our supply chain partners as well to make sure that we shore up more that's in our control. It tells you how important vertical integration is and the more we can put in our control the better..

Thanks. I have another question on pricing. A number of your peers have now started talking about a second round of price increases. Can you remind us where you are in the -- I guess, you haven't really talked much about price increases that much.

One when should we expect your new price increases to go in effect? And are you also talking about the second round of price increases?.

Yes. It's a good question, and I've been pretty consistent on this that I don't -- this isn't the forum that we talk about our commercial strategies. We have made some adjustments to contractual terms with our supply chain as well as customer network.

But I think we're enjoying winning some new footprint and focused on products that drive the lowest cost per bit. Outside that, we'll work our commercial terms in a more private form..

Your next question comes from the line of Alex Henderson with Needham. Your line is open..

Thanks. A couple of things I wanted to go back to. The first one was there was a comment on the questions about the product being -- or the Russian business being more product. It seems very stable at $5 million a quarter. It sounds like it's more servicer as opposed to product.

Can you talk about what the mix is between service and products within that $20 million?.

Yeah. So I would tell you that out of that $5 billion a quarter….

$1.5 million..

Yeah, $1.5 million is service the rest product..

That's great. Thanks. And then second, you made a comment and Jim Suva talked a little bit about it. But I don't think he -- we addressed the right issue, which is you implied that the pricing was going to come down as volumes of parts have gotten tighter and that seems a contradiction in terms to me….

In economics, yes..

…at least the higher prices. It’s not the other way around. I'm a little confused despite that comment.

Why would you think prices would come down as supply has gotten tighter?.

No. So I think what I'm saying is that the broker market itself when you buy a part from a broker versus directly from a Broadcom, Intel whoever, you're paying more implicitly. And again we've seen crazy pricing there. Just multiples of the product taking a full of $90 part and charging $4,000 for it, but they're running out of parts.

And so that's forcing you to go directly to the direct -- make sure that you're with the direct manufacturer. The direct manufacturer doesn't like that either. And so my point isn't that this quarter that's going to go down or next quarter. But ultimately this will not be something that will be permanent in the market on the broker market….

At these levels?.

…at these levels. We do not believe that that will continue. So didn't mean to state that that goes away this quarter or next quarter. When we say temporal, we mean it's not -- we're not permanently baking those costs of something that's a $90 part paying thousands of dollars for it is permanent. And we're tracking that..

I see. And then you've made a comment about purchase commitments..

Yeah..

One of the comments out of Arista was that they took their purchase commitments up by over 50%. Clearly that's giving them a chip to play with their customers saying, hey we're looking out for you.

Can you quantify the degree that, which you taken the purchase commitments up?.

Sure. Give us a second. Nancy will pick that up. But yeah it's a very good point. So if you think of starting or ending the year at what $764 million of RPO and adding $58 million and I said in the first half we'll add -- my expectation is we'll add $100 million. We have significantly increased our purchase commitments with RCMs and our suppliers.

Nancy will pull that in a second and we'll read it off before Q&A ends..

One last quick question, the comment around service sliding out does that pressure your service gross margins to at or below the recent levels?.

Yeah. Partial pressure, but I think we'll offset because on some of those projects you're using variable labor. So you're using contract labor for pieces of that and that stuff that we're obviously not committing to in the same timeframe. So we can kind of follow the matching principle. .

Okay. Alex on the purchase commitments, we'll get it to you. We typically disclose it in our 10-K and the number I can -- we can give it to you after the call. It was up quite meaningfully from 2020 2021. We'll disclose it..

And it continued to go up in Q1..

Correct, right..

Thank you, sir..

Thanks, Alex..

There are no further questions..

Thanks, Operator..

Sorry. There are no further questions. I'll turn the call back to CEO, David Heard, for closing remarks..

Thank you. So I appreciate everybody's patient questions. We look forward to getting back to you in one-on-ones. We are expanding our customer reach, the demand strength and customer wins ahead -- are ahead of our company expectation.

The execution of our new products with ICE6 momentum, the initial production of our pluggable elements are in line with what we told you on our 8x4x1 strategy and the business model impacts that that brings. The global supply chain impact on our customer rollouts and the cost of expediting parts to fulfill the demand has pushed out due to the timing.

And that's impacted the timing of revenue and margin. As we talked about that has a service impact of $30 million. We know we're not alone, and we fared well in the supply chain up to this point over the last six quarters. We did have some late-breaking impacts between the supply chain in Russia in Q2.

We do have remediation actions in place and we are addressing these developments accordingly. Really do appreciate the partnership with our supply chain partners, with our customers and the continued tenacity of our employees and your patience. Look forward to catching up with you more in one-on-ones and next quarter. Be safe. Be well..

This concludes today's conference call..

Thank you, Operator..

Thank you for joining. You may now disconnect..