Infinera Corp (INFN) 2016 Q4 法說會逐字稿

Welcome to the fourth quarter year 2016 Investment Community Conference Call of Infinera Corporation. All lines will be in listen only mode until the question-and-answer session. (Operator instructions). This call is being recorded. If anyone has any objections you may disconnect at this time. I would like to turn the call over to Mr. Jeff Hustis of Infinera Investor Relations. Jeff, you may begin.

Thank you, operator. Welcome to Infinera fourth quarter and fiscal year 2016 conference call. Copy of today's earnings is available on the investor relaxes situation of Infinera's website.

Additionally the call is being recorded and will be available for replay from the website. Today's call will include projections and estimates that constitute forward-looking statements. These may include statements regards Infinera's overall business strategy, market conditions, market and growth opportunities, Infinera results of operation, views on Infinera's customers and products, as well as Infinera's financial outlook for the first quarter of fiscal 2017. These statements are subject to risks and uncertainties that could cause Infinera's results to differ materially from management's current expectations

Please refer to Infinera's current press releases and SEC filings including Infinera's most recently filed quarterly report on Form 10-Q and subsequent filings. For more information on these risks and uncertainties. Please be reminded that all statements are made as of today and Infinera undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. Today's earnings release and conference call includes certain non-GAAP financial measures. Pursuant to regulation G Infinera has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in its fourth quarter earnings release which has been furnished to the SEC on form 8-K and is available on Infinera's website in the Investor Relations section.

I would now like to turn the call over to Chief Executive Officer Tom Fallon.

Good afternoon and thank you for joining us on our fourth quarter 2016 conference call. Joining me today are Chief Financial Officer Brad Feller and President Dave Welsh. Today I will review our performance in the fourth quarter, take a look back at 2016, and also share thoughts on our opportunities in 2017 and beyond. I will then turn the call over to Brad who will provide a more detailed financial review of Q4 and 2016, plus our outlook for first quarter of 2017. In Q4 we delivered revenue of $181 million, non-GAAP gross margin of 42%, non-GAAP loss of $0.12 per share. Revenue came in at the high end of guidance driven by strong performance from our data center business, and solid growth in EMEA. In Q4 DCI demand was robust with Cloud Xpress recovering from timing related softness in Q3 to deliver another strong quarter of revenue. Even with CX2 on the horizon and a number of competitive solutions in the market we added six new CX customers in the quarter and enjoyed growth from our existing large ICP customers.

EMEA was also a bright spot in Q4, growing 30% sequentially and 12% year-over-year, driven by solid results from our largest metro customers and some new footprint winds. On the topic of metro, I'm very pleased to report that in Q4 we received an initial metro order from a large North America cable operator. While the ramp for this customer should be gradual over time I expect this to develop into a sizeable opportunity. This deal represents a major milestone in the evolution of our metro business, and I commend our team on the win. Overall, while I see challenges over the next couple of quarters, my expectation is that as we introduce our next generation products and continue to deliver the Infinera experience to our customers we are well positioned to begin improving our financial results over the course of 2017.

Now I would like to take some time to look back at 2016. A difficult year financially though a year which will prove to be pivotal in increasing our technology differentiation and building out our end to end portfolio of solutions. The issues we faced in 2016 were functions of our historic over exposure to long-haul, significant consolidation in our customer base and technology insertion that lagged market opportunity. I am confident that the steps we have undertaken to diversify our product portfolio, expand our customer base and ramp up our technology cadence will enable us to achieve sustainable growth over time.

Continuing to drive our strategy of becoming a multi-product, multi-market company we announced a number of new technologies and products in 2016, highlighted by the infinite capacity engine which we referred to as ICE4 and also earning our first deployments of Xceed SDN platform. Additionally we announced several products that will come to market this year, including Cloud Xpress2 and XT 3300 meshponders both of which are geared towards increasingly disaggregated web scale architectures. XT 3600 meshponders for service providers, high density metro and long haul networks. Higher capacity DTN-X, XTC line cards and switch upgrades. Enhanced XTM metro platform which delivers a 8 X increase in density and 16 QAM modulation and finally, a new chassis and module for FlexILS .The industry's most widely deployed flex grid open line system.

Turning to operations, in 2016 we continued to generate a majority of our revenue from long-haul, despite the downturn we experienced in the second half. The general slow down in long-haul markets we serve was exacerbated by significant consolidation among our largest customers. As this dust settles we still maintain strong market and mine share and believe we are well positioned going forward. We also believe that spending in the long-haul market will resume growth and pose a significant opportunity over the next several years.

The subsea market is a prime example of a timing challenge we face in 2016. Subsea a business that has traditionally been strong for us saw double-digit percentage revenue decline as we missed out on footprint opportunities requiring ICE4. My conversations with customers at PTC where we recently unveiled our next generation of subsea products gives me confidence that our new offerings will prove compelling and enable us to regain and ultimately grow market share in subsea. As for data center, 2016 was an exceptional year for our Cloud Xpress platform. We ended the year with 33 invoice customers, 13 of which were new in 2016 and saw our revenue more than double year over year. In addition to our ICP customers continuing to grow we made solid progress winning several new CX customers in a rapidly growing (inaudible) of ICPs that are building their own DCI infrastructes. A look back to when we brought Cloud Xpress to market, our hypothesis that high capacity server like solutions would be increasingly important has largely played out.

Not only have ICPs placed a high degree of importance on Cloud Xpress and their data centers we also expect the CX and XT solutions will become more pervasive as service providers adapt web scale architectures. Moving now to metro we made positive strides forward in 2016. Completing the transmode integration progressing on SDN control across the portfolio, and winning deals with both XTM and XTC solutions. Similar to the early days of Cloud Xpress we were too optimistic on our time line for metro. This being said, we are seeing a number of positive signals that are encouraged by the solid momentum with which we ended the year, highlighted by metro revenue and EMEA growing 16% year-over-year in Q4.

On the customer front, in 2016 we want to combine 44 new XTM and XTC metro customers ranging from smaller deals sold through our expanding global channel program to larger direct sales. I continue to believe that we have the right solutions and team, and we will continue to win new metro opportunities with our install base of long-haul customers. Looking now to 2017, consistent with industry analysts we anticipate the overall market outside of China will grow around 5% comprised of low single digit growth in long-haul, high single digit growth in metro and continued significant growth in small form factor DCI. Geographically the North America persistent growth in cloud traffic should drive spending with ICPs and wholesale enterprise carriers. This is offset by uncertainty created by the impact of customer consolidation making the overall outlook for the region in 2017 unclear. Outside of North America having ended last year with strong momentum Europe has potential for solid growth in 2017 driven by spending in metro and DCI. As for and LatAm and APAC we see a particularly good market in subsea and have strong expectations for ICE4 products.

Our ability to outgrow the market in 2017 will be largely dependent on our success in timing and delivering our next generation product portfolio for which there is clear pent up customer demand. I am pleased to report in January we shipped our first Cloud Xpress2 units to major ICPs for lab testing. My expectation is that CX2 will begin to ship for revenue in the next couple months with revenue contributions starting in Q2. Additionally, we have hosted major ICPs in Infinera's lab to test the XT 3300 with planned delivery in Q2. Finally, we have multiple ICE4 subsea field trials with major customers being scheduled for the first half of the year. In addition to creating market share opportunity ICE4 will also enable us to improve our cost structure which was challenged last year by our technology transition and heavy market based pricing pressure as evidenced by Dell'Oro estimating that a 100 gigabit ASP declined 29% in 2016.

In 2017, I expect pricing compression to subside though remain higher than usual. A dynamic for which we are well situated given the cost structure enabled by ICE4 and our vertically integrated business model. On the technology side, our path forward will be in three distinct paths, first we will increase the cadence of optical engine delivery to every two-years. Coming to market now, we already have working 600 gig per wave genify PICs in our fab. We believe the combination of increasing delivery speed and our unique capabilities and around optical integration will drive differentiated value for our customers as they seek scalable yet cost effective solutions to manage massive growth in bandwidth demand. Our accelerated cadence will also enhance our ability to maintain and expand presence in key accounts as customers anticipate future developments and benefits from our new technologies more frequently.

A second path forward will be our commitment to lead in the open network philosophy that is becoming instrumental in a layer (inaudible) architecture. Open has two fundamental characteristics. First, there is transponder in-line system computability, basically the ability to operate vendor A's transponder over vendor B's optical line system without penalty. Infinera was a pioneer in selling our transponders over competitor line systems in the subsea market and now we are driving the same approach in terrestrial networks. Truly open network enables customers to benefit from having the ability to always choose the best performing transponder a dynamic we believe presents a substantial opportunity for Infinera given our technology and cost structure advantage. As part of open we have also widely deployed what we believe is the industry's most open line system which accommodates single waves and super channels over a flex grid structure that optimizes spectral efficiency as contrasted with the fixed grid line systems typically offered by our competitors.

The flex grid capability is critically important for customers who desire a future ready line system as it naturally accommodates higher baud rates and newer modulations like 64 QAM and beyond. While I insist the most support competitive transponders my expectation is that when the choice comes down to which vendor has the most compelling solution, Infinera will fair quite well and I look forward to this battle. Second characteristic of open is the ability to seamlessly integrate with other network management and control systems. This requires SDN software with an open which Infinera is delivering to our Xceed software suite. As an active member in the telecom infra project and the first transport SDN vendor to receive the powered by OpenDaylight certification I'm confidence that our customers will acknowledge Infinera's leadership in Open.

Finally, our technology commitment is to deliver industry leading platforms for both integrated and disaggregated architectures. Service providers generally require integrated architectures to accommodate multiple services and users where as ICPs increasingly (inaudible) disaggregated architectures that can continually take advantage the latest technologies and optimized cost structure. While these architectures have distinct value propositions our technology differentiation applies to both, and comes in into play as service providers start to adopt certain web scale architectural approaches. This is exemplified by our new XT series meshponders where slice able PICs drive terabit scale in a server like form factor and are ideal for the mesh networks that service providers manage. Ultimately, integrated or disaggregated we will deliver building blocks that enable our customers to build the most efficient and scalable networks.

In closing, I am optimistic we have taken the right steps to position ourselves for significant opportunity. I anticipate that our differentiated technologies and expanding market presence will provide us with significant new customer success in the future. While there will likely be some challenges over the next few quarters my expectation is as we bring our next generation products to market over the course of 2017, our financial performance will steadily improve. Longer term, every indication suggests that bandwidth demand will continue to grow substantially for the foreseeable future which is certainly favorable to the industry and for Infinera. Thank you to our customers, shareholders, employees for your ongoing support of Infinera.

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

Thanks, Tom and good afternoon, everyone. We executed well in Q4, delivering financial results at the high end of our guidance ranges. Q4 revenue was $181 million, down 2% sequentially. In the quarter we had mixed results across our verticals with wholesale and enterprise carriers and ICPs collectively up nearly 50%, while telcos and MSOs collectively declined more than 25% sequentially. In the quarter our top five customers consisted of two wholesale and enterprise carriers, two Tier 1s and an ICP. Two of these customers are greater than 10% of revenue. The wholesale and enterprise carrier and an ICP.

With solutions such as CX2 for DCI and XT 3300 for metro and long-haul on the horizon I believe our wholesale and ICP verticals should continue to be strong for the foreseeable future. On the other hand with long haul spend currently at depressed levels, and our metro opportunity still in its early phases our telco verticals could remain challenged for the next few quarters until the release and adoption of our next generation of products. Geographically as Tom mentioned EMEA was our best performing region in Q4 accounting for 37% total revenue and growing 30% sequentially. This result was driven by broad-based growth across all major verticals, including strong performance from CX, as ICP starts to expand their data center architectures in the region, along with solid results from our traditional metro customers.

Conversely, North American demand was soft in Q4, coming in at 53% of total revenue, and declining 7% sequentially. Offsetting growth from ICPs and wholesalers in Q4 was the aforementioned lighter spend from telcos. Given our strong customer base in North America and the release of new products throughout 2017 my expectation is we are well positioned to return the region to growth in the near future. Regarding LaTam and APAC both regions experience sequential declines in Q4 stemming mainly from our current weakness in subsea and certain customer specific project delays.

Turning now to margins, the positive impacts of year end deals including instant band with licenses allowed us to deliver gross margins of 41.8%, at the high end of our guidance range. This result was significantly lower than levels we delivered in recent quarters, driven by a negative mix of revenues including several investments, to preserve existing business in anticipation of our next generation products, as well as the impact of reduced volumes on our manufacturing infrastructure.

Over the next few quarters I expect non-GAAP gross margins will remain at similar levels, and then start to improve in the second half of the year as we ramp our new products. Although it will take some time I believe our business model still supports our longer term operating model of 50% gross margin. Regarding OpEx, non-GAAP operating expenses were $92 million in Q4 at the high end of our guidance range due to ongoing investments in R&D including the acceleration of certain expenses to get ICE4 products to market. As we prioritize spending on our next general products and make changes to allow us to execute a faster technology cadence we will continue to maintain tight management of overall spend, in light of the current revenue levels.

Putting everything together, in Q4 we had a non-GAAP operating loss of 9.2%, and a bottom line net loss of $0.12 per share. On a GAAP basis we incurred a net loss of $36 million or $0.25 per share the difference between our GAAP and non-GAAP results was attributable to approximately $14 million of intangible related costs, $11 million in stock-based compensation, and $2 million in amortization of debt discount. We also benefited in Q4 from a $9 million gain from the sale of an equity investment. Turning to the balance sheet, total cash and investments increased $4 million in Q4 growing to $360 million. Cash used in operations was $5 million, driven by our operating loss in the quarter.

Further we began to realize some of the benefits of rebalancing our inventory mix by ramping our ICE4 components and optimizing the inventory levels of our existing products all without significantly increasing our overall levels. Other significant drivers of cash in Q4 included a cash inflow of $23 million related to the aforementioned sale of an equity investment, and CapEx of $10 million. Now touching on our results for the full year fiscal 2016, despite a strong start to the year, our revenue for FY16 of $871 million was well below our expectations as customer consolidation customer spending shifts to other markets and product transitions negatively impacted our revenue.

On a brighter note, I was proud that we achieved 48% non-GAAP gross margin for the year, and eclipsed 50% in the first two quarters. Unfortunately, achieving these gross margin results could not offset our top line challenges and requirement to invest in OpEx. As non-GAAP operating margin for the year dropped from 13% in FY15 to 6% in FY16. I'm confident that as we bring our next generation products to market diversify our business and increase volume in our FAB we'll begin to ramp margins back towards our long-term margin targets. Finally in FY16 we delivered $38 million of cash from operations.

Now for our outlook for the first quarter of fiscal 2017, we currently project revenue in Q1 of $172 million, plus or minus $5 million. As a reminder the first quarter in our industry is typically challenging, with revenues declining 15% to 20% historically, as customers take time to finalize their CapEx budgets and convert them into orders. I expect demand in Q1 will be led by opportunities with wholesale and enterprise carriers and also benefiting from growth in our metro business. Looking beyond Q1, I believe we are well positioned to return to sequential quarterly revenue growth, over the course of 2017.

As for gross margin, we currently anticipate non-GAAP gross margin in Q1 to be 40%, plus or minus 100 basis points. In line with commentary on the last earnings call we continue to expect margins to remain around this range for the next couple of quarters, as we invest to bridge existing customers to our new products, begin to deploy footprint with our next gen solutions, and absorb fixed costs across a smaller unit base. Subsequently my expectation is we gain traction in the marketplace, with our new portfolio of products, margins will begin to steadily decline.

In Q1 we currently anticipate non-GAAP operating expenses will be $91 million plus or minus $2 million. While we continue to scrutinize our spend levels across the business we will prioritize required investments around getting next generation products to market. Given our expectations about the future business opportunities we think it is important to have the courage to make the required investments to maximize our opportunity or remind mindful of the balance required in the current periods. It is important to note that after a disappointing FY16 incentive plans have been resent in Q1 to reflect expectations for FY17. A dynamic that drives higher OpEx throughout the year including Q1.

I anticipate that R&D will likely remain at elevated levels of mid to high 20s as a percentage of revenue over the course of FY17. Moreover, SG&A expenses should increase during FY17 albeit at a slower rate than R&D. Largely driven by increased marketing efforts lab trials, associated with the release of the next generation of products throughout the year. Putting this altogether for Q1, the mid-point of our projected guidance translating to a non-GAAP operating loss of 13%. Non-GAAP EPS is expected to be a loss of $0.16 per share, plus or minus a couple of pennies. As for GAAP EPS we project to be lower than non-GAAP EPS by about $0.13 per share, primarily related to stock-based compensation expense.

In conclusion, given the pent up customer demand for ICE4 , my belief is that as we deliver new products to the market, we will begin to see gradual improvements in revenue and profitability. We will continue to manage expenses prudently and make the required investments to maximize the significant opportunities ahead. Longer term I'm optimistic that our accelerated development road map, strong reputation for quality and unique operating structure will enable us to achieve significant market share expansion in earnings growth over time.

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

We will now begin the question-and-answer session. (Operator instructions). In the interest of time please limit yourself to one question and one follow-up. Our first question comes from George not tear with Jefferies. Please go ahead.

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

Sure. It's pretty much the same as we had said in Infinera, we'll have revenue for the CX2, which was the product coming out in Q2. There was an outside stretch we would try to get it in Q1 but I think we should plan on revenue in Q2. 3300 will ship in Q2 and we believe some revenue in Q2 but most of it probably hitting in Q3. The goal obviously is to ship and right now we're on track for shipping in Q2 for revenue and how it's recognized is probably more dicey. We said at the inside Infinera the DTN-X upgrade and 3600 are still on track for the second half of the year we are not giving any more granularity at this point than that. And our upgrade to the TM series will be coming out this summer. And we're on track for that. In regard to the MTC, correct me if I'm wrong Dave that's already shipping.

Okay. Great. That's helpful. And then I guess if I just step back and sort of think about when you guys might start to see the improvement in top line, Brad I heard your commentary about sequential growth over the course of the year. Is that driven by new product deliveries or is that driven more by, some of the customer situations, fixing themselves on the M&A front, what's the bigger picture on top line growth? Thanks.

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

We've consistently said that kind of revenue recovery to previous growth will be probably a second half of this year, and I'm staying kind of with that view. I do think that as we get through this Q1, which is always a little bit dicey in our industry that will help. But we are also as you pointed out, George, our customer base is being consolidated at a fairly ferocious rate about 40% of our revenue is currently in the process of being merged or acquired. Certainly different sizes of that. But that's a substantive amount of our revenue. I don't believe in any situation except maybe one, we end up in a bad spot. I think we end up in a good spot probably with stronger customers, but I think that during this process, whether you're preparing to go through the merger and acquisition or have just done it there is a period of slow down of spending. I think you guys have probably seen some of the press releases in commenting on that, and I think we've already been experiencing that. This is not new for us. I don't expect a step function down from here. I think we started experiencing it in Q3 of last year. When 40% of your business is being consolidated there is no chance that does anything but slow down decision making

Thank you.

Yes. Thanks, George.

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

Thanks. Hi, Tom.

High Vijay.

So you know, while you guide one quarter at a time that's fine. It would be very helpful to hear from you Tom and also Brad any color you give. What are your customers telling you, what are your sales team telling you as we head into the back half, any particular product in market that you think would reaccelerate or pick up momentum heading into the back half that really helps our modeling view for the full year? Thanks.

I think my commentary about clear pent up demand for ICE4 there is clear pent up demand for ICE4. We have got customers excited about it. We got our sales guys excited about it. I think that there's substantive opportunity there. And they're all encouraging us to get that to market as soon as possible. I think that I see strong opportunity as I made in my commentary for subsea there is a lot of subsea network being built right now that I think ICE4 will do well in. There is tremendous amount still of data center activity, and I think we're -- we are well positioned with that, as we made in the commentary, it's a more competitive environment than it was a couple years ago but I think the CX2 will be in a league by itself, so we have to get that to market. I think our new meshponders are going to be extraordinarily well received.

I also think our approach to open with a flex grid capability presents tremendous opportunity, certainly in the second half of the year but also over a number of years. So I think that the second half there is nothing that I believe indicates that it's not going to have a strong and lot of opportunity. We talk about some of the metrics that I talked about last quarter, when we look at the number of RFQs, both the quantity across our products and the dollar size, all that has been on a positive trajectory, and a lot of it is reflected in our new products. So the data supporting my belief is being validated by what I consider transactional flow of paper. Dave, you want to make a comment?

No. we spend a number of -- excuse me. I think our products are well suited for us to go back into taking the market share mode that we're used to from -- for last number of years. I think the bandwidth demand is growing rapidly. It's growing at extremely high in some of our markets, but in all markets it's going up. Our competitive levels are dramatically improving as we bring out the product in the first half of the year, so I expect to go back into taking the a market share mode.

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

Yeah, obviously the cost structure of the ICE4 products is much better than the current generation, so that will allow us to have a cost advantage as we go forward. Mix across different products always impacts us, but the thing that will -- two things that will start to drive it backup, Vijay, is the cost structure of the new products and obviously having higher volumes going through the FAB gives us leverage on that side of things.

Thanks.

Thanks, Vijay.

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

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

Yes, so the first question you talked about market growth. The long-haul market slowed down last year after a number of years of probably 8%-9% growth year-over-year. The long-haul market was viewed as probably low single digit growth. We anticipate that to start to come back this year a little bit. That was some of the pressure that was put on us last year since we've been vastly a long-haul supplier. I do think that long haul over a number of years is going to represent very good growth opportunity, but as people have finite CapEx they probably spent disproportionately on long-haul for the last few years. And now they're moving that-- some cases to IP, some cases to metro. Some cases to data center. So long-haul has been under pressure.

I anticipate it will start growing again this year, probably-- low to--mid digit--single digit, and that should help us in general. Certainly as we get ICE4 out we can bring to market a more cost-effective solution, good margin, but more cost-effective and that should probably help. In metro, surprisingly enough metro was supposed to grow a great deal last rear out outside of China. That was muted anywhere from low single digit to flat year-over-year in metro. I do anticipate that metro has to continue to invest. There are too many applications that are going to require more and more capacity in the metros, all the way through the metro from access through aggregation and actually that positions us well for when we enter the market with the upgraded TM series platform. We anticipate this year metro will start in the mid single digit, maybe up to 8%, 5% to 8%.

Data center continues to absolutely explode. I think anywhere from 62% to 100% expected growth in that market so our opportunity needs to be to maintain as much of the market share as we possibly can. I think in the last published data said purpose built data center we were at about 90% market share. The probability of us maintaining 90% -- market share is low. But you know, in a market that's growing 60% to 100% a year we can have a very, very healthy business, I don't want to give away any market share, but I think it's practical. Our new CX2 I do believe is a platform that is in a class by itself. So I am optimistic about that. From a customer consolidation perspective we have some customers that I can't mention by name that are being acquired.

A couple in the cable space. I think in all those cases, we're going to end up in an okay spot. And I think that there is going to be some different business practices. One of the customers historically bought almost all their year spend in the first -- almost the first quarter. And the new company is saying we're not going to do that. We're going to have a more linear approach to it. That puts awe little pressure on our Q1 but I'm anticipating that comes back in the later parts of the year, so that's actually good news to me. I think that in every regard, we are going to be able to, except one, preserve our position in long-haul, and so far we have had receptivity by these new companies to expanding into the metro with them. And I'm excited about that opportunity.

I think when people are being approached to acquire or acquiring somebody, there is very little appetite for introducing new vendors into new spaces, because there is too many uncertainties. With a lot of those certainties now behind them they're more interested in looking at architectural approaches for the future and I think it does give us a door open into new opportunities. The one area that we can comment on, Verizon just completed it's acquisition of XO. We have a substantive footprint with XO, the business with XO has been reasonably good.

That dance with Verizon is still to be had with us. We're certainly engaging with them and I think there will be opportunity, but I'm certainly not forecasting anything at this point until we get further down that pipeline. The big one obviously out there is level three in Century Link. Both of our -- two of our largest customers. That acquisition isn't targeted to close until Q3, so my belief is for the most part, at least a little bit of time, things have to be roughly run as two independent companies. We still see a consistent demand from both of them. But I -- like I said earlier when people are going through large scale integration, typically things slow down.

You're not in an invest phase of network because you don't want to ignore what network assets you're picking up. I anticipate we'll get a better picture from that over the next couple quarters as things get closer to the end but I anticipate in the short-term both of them have to run independently. That's a long answer. Sorry about that.

I appreciate the detail, actually. And then if I just have one quick follow up on product gross margin for Brad. Can you parse through the elements of gross margin relative to the prior quarter from volume perspective and from a mixed perspective, so obviously inventory is relatively static and revenues still below $200 million, how much did that specifically -- that FAB volume impact your gross margin and does that piece come back in the second half, so gross margin should be in the 45% plus percent range? Thanks a lot.

Yeah, the loading of the FAB and that kind of stuff, the impact is pretty consistent quarter-to-quarter. The bigger impact in Q4 and Q1 quite frankly is the mix of deals where bringing the revenue. Including obviously as we talked about before some investment deals to make sure that we are exceptionally well set up for when the gen 4 products come out. You're thinking about it right though, that both things as I mentioned earlier will contribute to market share -- gross margin expansion over the year, filling up the FAB and the cost structure of the new products.

Thank you.

Thanks.

Our next question is today is from Dmitry Netis with William Blair & Company. Please go ahead.

Thank you very much, guys. And good job executing on the plan. One quick follow up from the prior question on the gross margin. Are you implying basically the next two quarters assume that 41.8% rate, 40% in Q1, is what you're guiding to gross margin, so is that your trough quarter basically Q1? Number two as far as the cash burn goes, I think you saw that $15 million of cash burn in terms of free cash flow in this current quarter. In that a trough quarter or Q1 will be a trough? Can you comment on that? That would be good.

Yeah, so you know, don't like the word trough, but as I mentioned I think the margins will stay in the region where they are now. Like I said it will start to pick up once the new products come out. I think that low 40s, type of level is what you should expect the next couple quarters. From a cash burn perspective, obviously still in a very healthy cash position with $360 million in cash. But given the guidance we just talked about, we will burn a decent amount of cash this quarter. Probably similar to Q4.

And the margin we -- it's hard -- never say never on it is the lowest, first of all, because you never know what's going to happen in life but we kind of think this is where the bottom would be. Having said that last year as I said in my commentary 100 gig ASPs dropped in the market 27% or 29%. That's fairly unprecedented. And it's not like there's a new technology that is hitting the market that causes that drop. There is a substantive amount of pricing pressure that is occurring. I do think it starts mitigating but I think there is a level of certain competitors who are willing to buy market share whether they can make money at it or not. That can't last forever, but I do anticipate pretty good pricing pressure. The good news in my mind is when we get ICE4 out I think we are structurally better prepared for that than anybody else. And I think that we have an opportunity based upon selling ICE4, I'm going back to our margin expansion by the end of the year. but I do want to caveat it. When the market is in this type of transition with ASPs dropping that dramatically, it's hard to predict.

Okay. Thank you, Tom. I appreciate it. To my real question, if you will -- a little bit on the CX and CXE 2, DCI products that you -- first of all kind of -- I'm doing the math and correct me if my math is off, but you should be given the comment you said you made as far as the doubling or more than doubling of that business over the course of the year, you should end up somewhere in the $80 million, $90 million range which would put you right in the 10% mark. I just want to double check that's correct and you'll -- you're forecasting for growth in that business clearly through the 2017 time frame. And as you speak to that, can you talk to any of the ICPs? I think you had two out of the top four in the prior generation. Has any new ICP come in as a result or are you expecting any new ones as you kind of roll out the CX2? Maybe PTC meetings had helped you secure the visibility of that. I would love to hear your thoughts on that front.

So Dmitry your math is roughly correct on the FY16 levels. I'll let Tom comment on the opportunity with the other ICPs for CX2.

Yeah, so we are still very engaged with a couple of the good solid ICPs that we talked about before. We expanded -- there is a new tier of ICP data center guys that are not traditionally considered part of the top five that we have expanded into and they are building substantive data center interconnectivity. We have done a good job of attaching there and based upon the CX2 I firmly believe that we will be able to add a significant new ICP this year based on the CX2. We have to still earn it, but we have been given the nod for they will do the testing, and that's the hardest milestone for us historically is getting them to agree that they will do the testing because they only do the testing and sign a contract if they have a business driver and they believe it's a viable solution for them. We have achieved that, so now it's down to delivering the CX2.

Great. Can I ask one quick one on the EMEA. You rebounded there 30%. You mentioned some traction with CX business there. But I presume there was also telco related traction there--maybe not, can you kind of dissect that market and tell us exactly what went on this quarter, why it was so strong? And was there much of the trance mode product that sort of rebounding here with the (inaudible)

Yes. So Dmitry it is a combo of different things, one is we started to see the ICPs who have been doing a lot of their CX builds in North America to start to build out more in Europe. The traditional metro business did really well, and the stable base of telco is there, as well, was originally strong. It was pretty broad-based. The thing that is probably a little bit better than the past is just starting to see the ICPs deploy CX in Europe.

The ICPs deploying the CX but also the TM series has done extremely well the second half of last year, particularly with our traditional customers there. It has been a reinvigorating buying cycle by those guys and that is really great to see. In general, as we commented on the call telco has been weaker for us and I think other people in the industry over the last six months.

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

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

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

And if my recollection is correct, we can call that kind of 25% ish is that it's?

It's in that ballpark.

Okay. And then in terms of your full year 2016, can you give us a little bit of color on 10% customers that presumably you'll disclose that detail in the 10-K but if we could get that now, and this I think is important, given our sense that 2015 was your 10% customers were folks that are consolidating and if we're trying to figure out how to model the impact of consolidation, I would like to get an understanding of the concentration in 2016, if we could get that detail.

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

And will that be in the 10-K?

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

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

Yes.

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

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

Okay.

You hit a peak revenue in Q2 of last year. Do you think it's possible to get back to those peak level of revenue that you hit in that time frame during the 2018 time frame? Or is this going to be a much slower? And I'm really just -- I'm not really looking for that specific number, but using that as a benchmark to determine what the slope looks like in your mind.

You know, Alex, I wake up every day wanting to come to battle believing we can build a multi-billion dollars company here. So every part of me says sure, we can do that. But I want you to walk away-- why don't you hold off of that question until we start seeing traction with our-- ICE4 and that's going to be dependent upon it. Do I think that we demonstrated multiple years of 25%, 24% year-over-year growth? We have. We did that as a single market company. Now we're in multiple markets. I think the opportunity is tremendous but I'm cautious of telling you gosh that can happen in 2018 when if it happens in 2018 it's going to be based upon the adoption of ICE4.

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

Yes.

And then the third question I had for you is more on the technology side. So you talked a lot about ICE4 but I didn't hear anything about your ASIC chip and what are you doing on the DSP side of the equation. Obviously there has been a lot of noise around that front out of both (inaudible) and with the AI chip out of Sienna. I would expect that your DSP development cycle time has got to improve substantially. Can you talk a little bit about when do you expect to get another one of the -- another turn of that out? And does the impact of the acquisition by (inaudible) impact that at all?

Yes, I'll join and give you some insight into that. The -- a couple things that Tom mentioned in conference call first was we demonstrated the PIC technology that is consistent with 600 gig per wave demonstration that we are demonstrating in our lab today. And, if you look back on history if we're demonstrating our PIC capability then we're obviously doing that with a plan to bring it into market, and not immediate but not-too-distant future. From that our DSP technologies that we're going to bring in and productize I will be -- will be consistent with that 600 gig per wavelength capability. We have upped the ante in investments for DSP and the ASIC capability as well as our higher capacity PIC technologies and we expect that to move along as Tom also stated about a two-year rate. And that's moving along. We haven't talked at all about, who our partners have been in the past, nor who our partners are in the future. We continue to evaluate to make sure that we can bring the highest performing product to market and utilize what technologies that are available to that. I will continue to move down a path of vertically integrate where it makes sense and where it creates differentiation and continue to utilize technologies that are available on the outside, where that -- when that makes sense.

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

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

Hi, guys. Thanks for the question. I just wanted to go back to the product availability. You guys are saying it's all on track. I thought that in the analyst day you said that CX2 would ship for revenue in Q2 and it sounds like Tom I thought you said shipped for revenue in next couple months which would put you potentially in Q1. It feels to me like you're a month or two ahead of your original time line on that.

No. We're -- I say a couple months. Two months is the middle of April. You should think about it in -- shipping revenue in Q2.

Okay. And then XT I thought you said on the heels of this CX2, so there is no -- any chance of XT revenues in Q2? I know you said Q3 but --

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

Okay.

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

I felt like you were a little bit ahead of what you thought you would do in the analyst day.

I never want my engineers to hear that. I consider us distinctively behind where I want us to be.

Okay. The second thing you mentioned this North American cable operator, and orders there. Can you give us any more color on that? Is that a -- are those orders for production deployment or are those orders for testing? Where are you with that? How big is that deal? When does that revenue ramp?

I can't unfortunately give you a lot more than we've already given you, but it's a TM series. It was orders we received in Q4, for production. And I will give you the -- we've had follow on orders in Q1, to extend the original footprint. And as we learned the hard lesson on metro that's how it grows. It's a little bit followed by a little bit more followed by a little more as you expand across the footprint. We're excited about the opportunity. It's been a journey. And we stayed at it, and I think we have proven to them that we are providing a differentiated value proposition. It's slow. But it's ramping. And like I said, a sales guy said the first order it's not a customer. It's a customer when you have the second production order. So we've had more than our second production order now, but do think small upfront. That has the opportunity to scale I think substantively over time.

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

Okay. And then I also -- the other thing I wanted to clarify, I was surprised you had six new CX customers given the CX2 is kind of right you on there coming. Can you -- are those guys intending to convert to CX2 or they don't need the capacity of CX2? Can you explain how you're gaining that many customers on the CX platform prior to CX2?

Sure. Go ahead.

I mean, the CX2 is a much higher capacity box. Lots of customers and applications that prefer a lower capacity box. And it's -- in that scenario. We expect as we transition to a very high capacity data center -- transition to CX2 but there is a huge base of opportunity for current CX products.

There is a whole bunch of customers out there Rod who have small -- much smaller data centers. We're selling now to enterprises that have small data centers that they want to interconnect to. We are selling into -- internationally with very small capability. We're selling to a (inaudible) that using it for floor interconnect inside a (inaudible) so the application we talk about data center architectures starting to migrate into other places of the network, that's what we're talking about. And typically they will have much, much lower capacity requirements than the top ICPs. Where 500 gig is actually a fairly substantive amount of capability. That's great for us because if you're looking at 100 gig or 200 gig we have a great TM solution. If you're looking for 500 gig to a terabit we have the CX, and the CX2 is for multi-terabit. I think we a complete suite of products can address any one of these applications whether from ICP or down to an enterprise or bank.

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

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

Good afternoon, Tom, Dave, and Brad. I guess first just a clarification. Tom you were talking earlier about kind of seasonality-- the normal seasonality of second quarter off of seasonal softer first quarter. Given you have relatively depressed revenue levels, you have some new product ramps, specifically the CX2 shipping. Were you implying that we should see above seasonal Q2 growth?

No, I'm not trying to imply that. I'm saying that Q1 is typic any our industry and for us as we gone to more markets a softer quarter. Typically Q2 starts coming back reasonably well because Q1 budgets are understood. I think this year as I mentioned on the call we typically had a large cable customer that made most of their orders in the end of Q1. That's not going to likely happen moving forward. It's going to be more distributed through the year. So it makes Q1 a little more difficult and could make Q2 a little more difficult because they typically ordered in late Q1 we shipped a lot of it in Q2. I think for a year perspective, it doesn't matter. So I think at this point, Q2 I don't anticipate -- I would anticipate it growing, but I wouldn't assume any kind of step function.

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

No. Patrick we talked about before that the levels will be little bit elevated this year in the mid to high 20s, because of the lower revenue levels. But our model going forward will continue to be 20% of revenue in R&D, as Dave mentioned we will likely utilize a mix of internal solutions and solutions available in the market, which will help absorb some of that spend. And, I think we do a very good job internally of making sure that we optimize what we spend on spending the right ways, but you shouldn't expect the overall levels to be away from our normal targets.

Great. And then I guess Tom or Dave, I think last quarter you talked about pursuing metro opportunities in mobile front haul and back haul I think you referred to them as edge opportunities and seemed pretty excited about that. I'm curious if you can update us on whether any of those opportunities have turned into wins and if so how we should think about revenue ramping.

Yeah, the back haul opportunities continue to still grow. We're still seeing good success there. The front haul opportunities are really a technology transition play. We got a strong offering. We've had some early winds in that. We're involved in a number of RFI to RFP capabilities with some large tier 1s, but the transition in that technology and the transition as I think about 5 G roll outs, et cetera, it's going to take some time. And I am much -- with our metro cable guy when they start making these decisions from the time the decisions to large revenue ramp can take some time.

I think we've won in the neighborhood of three to five front-haul opportunities and most of them have been in Asia which is not surprising since we often see them pushing these architectures first. The question is going to be can we take that learning, take that attraction and transport it into other geographies. And I think it's too early to call. Do I think it's a substantive potential opportunity? I do, but a lot of it is going to be depending if we can take that traction that we're achieving in Asia and replicate that elsewhere and it's just too early to call.

The next questioner today is Michael Genovese with MKM properties -- MKM Partners. Please go ahead.

Thanks a lot. I wanted to ask about R&D intensity this year in 2017. From the Analyst Day I remember mid 20s and I heard you on this call say mid to high 20s. Is that new? And secondly is that more of a statement on more R&D than you would have thought before? Or is it a statement on the revenue levels for the year as it's shaping up right now?

Yeah, so Mike it's not a change from what we were expecting. We're just clarifying it was a mid to high 20s level. Obviously, we're going to spend the dollars required to get the new suite of products out. And that's going to take lots of spending and R&D to make sure those things happen. So it's nothing different than what we were anticipating before.

Okay. Next question then, you spoke about the goal to win metro, new metro products into existing customers. What are your thoughts on winning brand-new customers with your new metro products late this year or into next year?

Well I certainly think we'll be able to do that. There's no question. Our sales force is chomping at the bit, and we don't say go target our current customers, we say go sell a bunch of product and I think there is a lot of opportunity. Having said that the easier sale is to somebody who already understands and appreciates the Infinera experience, already has a substantive Infinera footprint. That is the -- that is a more likely sale. It's been impeded a little bit by all these acquisitions that have occurred but we're making progress selling cross selling into our networks. Both DTX selling and TM trying to sell them DTXs. So I think that our goal is to sell pervasively everywhere, but the easiest sale quite frankly, none of them are easy, is people they truly do value the Infinera experience, and we need to compel them with the TM upgraded TM. I think the challenge has been to a degree like TM we like the TM, we like Infinera a lot, but until we get 16 QAM out we're not going to certify this product. I think the 16 QAM opens up doors to customers who articulated a desire to at least evaluate the TM but they want to do it on a technology that's fresh versus longer in the tooth.

Okay. And last one for me, I took away from this that you did well in the fourth quarter in EMEA and DCI, and I think in transmode. The first quarter guidance is actually pretty good, all things considered. Better than what you said was seasonally normal for the industry so my question is do you expect a big EMEA contribution there the first quarter and with the same sort of things that drove the fourth quarter, is that -- is that in did guidance? Or are we going to get shipped back to North America or different region?

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

Thanks for the questions, guys.

Yes.

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

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

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