Infinera Corp (INFN) 2017 Q2 法說會逐字稿

Welcome to the Second Quarter Year 2017 Investment Community Conference Call for Infinera Corporation. (Operator Instructions) Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn the call over to Mr. Jeff Hustis of Infinera Investor Relations. You may now begin.

Thank you, operator. Welcome to Infinera's Second Quarter of Fiscal Year 2017 Conference Call. A copy of today's earnings is available on the Investor Relations section of our website. Additionally, this call is being recorded and will be available for replay from the website. Today's call will include projections and estimates that constitute forward-looking statements. These may include statements regarding our overall business strategy and results of operations, market conditions, market and growth opportunities, views on our customers and products, expectations regarding the timing of new products and Infinera's financial outlook for the third quarter of fiscal 2017. These statements are subject to risks and uncertainties that could cause Infinera's results to differ materially from management's current expectations. Please refer to Infinera's current press releases and SEC filings, including our most recently filed quarterly report on Form 10-K and subsequent filings for more information on these risks and uncertainties. Please be reminded that all statements are made as of today, and Infinera undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of the call. Today's earnings release and conference call include certain non-GAAP financial measures. Pursuant to Regulation G, Infinera has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in its second quarter earnings release, which has been furnished to the SEC on Form 8-K and is available on our website in the Investor Relations section. I will now turn the call over to our Chief Executive Officer, Tom Fallon.

Good afternoon, and thank you for joining us for our Second Quarter 2017 Conference Call. Joining me today are Chief Financial Officer Brad Feller and President Dave Welch. Today, I will review our second quarter performance, progress on our new products and provide an overview of some future opportunities. Brad will then provide a more detailed financial review for the second quarter and our outlook for the third quarter.

In Q2, we had revenues of $177 million, non-GAAP gross margin of 41% and a non-GAAP loss of $0.15 per share. Revenue was at the lower end of our guidance range due to 1 order coming in later than planned. We received this order in the second week of Q3 and have since fulfilled the shipment to our customer. Other than this transaction, I was pleased with our execution in the quarter, as revenue came in largely as expected across our regions. We came in at the high end of our guidance range for earnings, and most importantly, we began delivering ICE4 products to our customers. Regionally, North America continues to be driven heavily by ICP traffic, with cable spending remaining steady and telco improving but still relatively weak. While EMEA is seeing steady growth in cable, this is being more than offset by challenges from difficult pricing conditions spurred by competition between network operators and persistent low-pricing tactics from certain competitors. Looking ahead, we are addressing new opportunities in EMEA such as the unbundling of dark fiber in the U.K, which should drive future growth in the region.

In APAC, we are seeing opportunities pick up as we start to deliver new subsea solutions to the market. As for LatAm, while bandwidth demand continues to grow, we are dependent on a few large customers, whose spending is currently light due to challenging political conditions or company-specific timing. From a customer verticals standpoint, I'm encouraged by the progress of our cable business, which grew more than 20% sequentially in Q2. We are selling a broad suite of solutions into cable and starting to realize the value proposition of offering an end-to-end portfolio.

As for ICPs in Q2, we maintained our core business amid heavy competitive pressure and got off to a good start with CX2, shipping to 1 large ICP and 2 new ICP customers in the final weeks of the quarter. With CX2 now shipping, the XT-3300 meshponder on its way and the CX1 still a solid solution for many customers, we believe we are well positioned to gain market share with ICP and across the market for data center interconnect applications. Broadly speaking, pricing pressure remained intense, though appears to moderating relative to last year's unprecedented level.

Regarding customer consolidation, we continue to be hindered by the pending combination of CenturyLink and Level 3, as the combined spending of these 2 customers remains much lower than historic levels. Our expectation is that spending between these customers will remain suppressed for the remainder of this year. While consolidation has been incredibly disruptive to our business, my senses is we are starting to turn the corner with the completed mergers that have affected us over the past several quarters and expect the longer-term impact of the consolidation wave to create opportunity for us. We believe there is pent-up demand in our consolidated customers' networks, where during the acquisition process they slowed spend and squeezed as much as possible out of existing infrastructure.

I am pleased we are seeing initial signs of investments resuming and also for opportunities in new markets, as evidenced by recent wins in long-haul and metro with the XT-500 and XTM Series. These same customers are also expressing interest in our XT-3300, XT-3600 as well as our new XTM-2 platform. Such wins and opportunities suggest that we are starting to see growing traction from our R&D investments. Though significant execution will be required to win, as these healthier combined companies resume spend, we expect our new products will encourage Infinera network expansion.

Looking ahead, I am optimistic about our prospects for growing shares and improving financial performance. As we bring new products to market, we are building a pipeline of prospective opportunities. Of note, the CX2 is now generally available and generating revenue in Q2 in line with our expectations. We see several promising opportunities to further expand our market leadership in the DCI market. In addition to CX2, our new ICE4 subsea solution, the XTS-3300, has been installed in a key transatlantic network and is nearing general market availability. Based upon initial deployments, we believe this product currently leads the industry in spectral efficiency, and we are building a strong pipeline of employment opportunities over the coming quarters.

Regarding the XT-3300, we remain on track for general availability in Q3. Our early traction here is solid, as we have a healthy pipeline of prospective opportunities from ICPs and service providers and have already made initial shipments to both a large ICP and a Tier 1 European operator. My expectation is that XT-3300 will generate initial revenue in Q3 and scale over time as the market adopts our unique meshponder solution.

We also recently introduced the XTM-2, an upgrade to our metro portfolio that should be beneficial on 2 fronts. First, our existing installed base, which comprises more than 33,000 XTM chassis, can take advantage of an upgrade to 16QAM modulation with a 3.5 fold improvement in power and an 8x density increase. Second, this density improvement, largely enabled by 16QAM, will improve our metro cost structure as we deploy these line cards. We continue to expect the 400 gig flexponder to ship in Q3. In addition to products expected in Q3, development is progressing on other key solutions, namely the XT and XTS 3600, and the 1.2 terabit line card for the XTC, which we continue to expect will begin shipping in late 2017.

While there remains a significant amount of work to do, I anticipate we will enter 2018 with a strong portfolio of new products, well positioned to build momentum and grow market share. Looking to the future, we see opportunities in the horizon stemming from architectural evolutions that are at the beginning of their planning phase, particularly around fiber densification in the metro for cable operators and 5G for mobile service providers. Additionally, the enormous growth in cloud services is likely to persist, which will increasingly require the most scalable and cost-efficient transport networks. During this period of architectural evolution, our technology approach will allow us to deliver the most reliable, high-capacity, power-optimized solution in form factors that our customers want to deploy, both as integrated solutions and purpose-built platforms. Additionally, with Instant Bandwidth and now Instant Network, our customers can pay for what they need today and instantly access additional capacity to address future network requirements.

In closing, I am optimistic about our prospects, though I'm mindful we are in the early stages of delivering new products and have considerable execution ahead. Given near-term spending can be challenging to predict and our new products must go through normal phases of market adoption, in any quarter there could be bumps in the road. That said, I am confident our technologies and ongoing commitment to deliver solutions that enable our customers to win in their markets is an excellent position to get back to a growing market share and gradually improving our financial performance. We intend to continue to innovate and execute to take advantage of the substantial opportunity ahead of us. With that, thank you to our customers, partners and shareholders for your continued ongoing commitment to Infinera, and thank you to our employees.

Now I'll turn the call over to Brad for a more detailed financial review of the second quarter plus our outlook for the third quarter.

Thanks, Tom. And good afternoon, everyone. As Tom mentioned, Q2 revenue came in at the lower end of our guidance range due to 1 order coming in later than expected. Had it not been for that order, we would have slightly exceeded the midpoint of our revenue guidance. With non-GAAP gross margin and OpEx both coming in favorably relative to guidance, we were able to deliver bottom line results at the high end of our guidance range. Revenue in Q2 was $176.8 million, up 1% sequentially. Our revenue in the quarter was flat to up in all our customer verticals with the exception of wholesale and enterprise, where we saw timing-related pauses from a few customers. We were particularly strong in cable in Q2, driven by solid results from recently consolidated customers, and we also saw telcos grow more than 10% sequentially, albeit off low levels in Q1.

Additionally, we held our core business within our ICP vertical in Q2, with revenue effectively flat sequentially, as customers plan the transition to CX2. Of note, our CX2 revenue in the quarter came in as we expected, in the low to mid-single-digit million range. We had 3 greater than 10% customers in Q2: a wholesale and enterprise carrier, an ICP and a cable operator. Rounding out our top 5 customers were an international Tier 1 and another wholesale and enterprise carrier. As we bring out our new products, I'm optimistic that we will grow revenue sequentially for the remainder of the year, though predicting the magnitude of such growth more than 1 quarter out can be challenging. Geographically, we had a solid quarter in North America, which accounted for 63% of total revenue and grew 12% sequentially, with growth largely driven by strong result from multiple cable operators and an ICP.

International revenue in Q2 was light, stemming from weak results in EMEA and LatAm, partially offset by growth in APAC. Spending in EMEA was weaker in Q2, accounting for 27% of revenue and down 17% sequentially due to lighter spending from our wholesale and enterprise and ICP verticals. While ICP traffic continues to grow in the region, infrastructure build to support such growth can be lumpy, a key factor that led to timing-related weakness from these verticals in Q2. On a positive note, our cable and telco verticals in EMEA both grew sequentially in Q2. And we secured several new opportunities which will benefit us as we move forward, including cross sales with our XTM metro portfolio, multiple subsea wins and also an XT-3300 win with a major European wholesaler. APAC was steady in Q2, accounting for 8% of total revenue, as we made progress expanding our customer base and see future opportunities from new ICE4 subsea offerings. LatAm continued to be challenged in Q2, sequentially down and accounting for only 2% of revenue, as political conditions continue to impede our business with our largest customer in the region.

Now onto margin. Non-GAAP gross margin in Q2 came in above the midpoint of guidance at 40.7%. With competitive pressure still intense and new products just starting to sell, we will continue to be margin challenged until the new products ramp and volumes in our fab increase.

Regarding OpEx, non-GAAP operating expenses were $93.5 million in Q2, at the lower end of our guidance, due to the timing of certain development costs, which have shifted to Q3. OpEx growth in Q2 was driven by R&D, as we focus on completing the development of new products across the portfolio to enable us to return to consistent revenue growth. It is imperative that we continue down the path we've discussed in the recent quarters of investing to ensure our new product platforms get to customers to capture what appears to be a significant market opportunity. We also continue to invest aggressively in demos and lab trials in Q2 to drive market adoption of those new products. Putting everything together, in Q2, we incurred a non-GAAP operating loss of 12.2% and a bottom line net loss of $0.15 per share, at the high end of our guidance but clearly still a weak result that we need to improve upon. We are bringing a compelling suite of new products to market that we believe will improve our financial results, and we will continue to make investments that we expect will maximize our long-term financial opportunities.

On a GAAP basis, we incurred a net loss of $43 million or $0.29 per share. The difference between our GAAP and non-GAAP results was attributable to approximately $12 million in stock-based compensation, $5 million of acquisition-related cost and $3 million in amortization of debt discount.

Turning to the balance sheet. As of the end of Q2, total cash and investments was $333 million, down $25 million from the end of Q1. During the quarter, we took the opportunity to secure one of our core asset, spending $12 million to purchase our module factory in Pennsylvania and also spending an additional $12 million in CapEx to support the business. While our model targets 5% of revenue for CapEx, we will need to maintain slightly higher levels for a period of time to support the business opportunities we believe are much larger than our current revenue run rate. In the quarter, we were able to tightly manage cash from operations, burning $3 million, as positive working capital changes nearly offset our operating loss. Accounts Payable increased as did the inventory, as we grew our ICE4 inventory to ensure we can meet impending new product demand, while maintaining sufficient current product inventory to address near-term demand. We also received $1 million in proceeds from equity issuances in Q2.

Now moving to our outlook for the third quarter of fiscal 2017. We currently project revenue of $190 million, plus or minus $5 million. The midpoint of this range represents sequential growth of 7%. While we are pleased that revenues are growing, this level of revenue is below our expectations from earlier in the year, as the continued impact of customer consolidation and the timing of certain key customer builds are weighing on our outlook for Q3. We continue to see a large number of opportunities with our existing customers and also with new ones. Specifically in Q3, we anticipate building new routes for existing customers that should enable our telco verticals to continue to steadily improve. Additionally, we expect cable results to remain strong in Q3, as we benefit from a key customer spending more consistently over the full year.

Finally, the ramp of CX2 and the early traction with the XT-3300 should drive growth within our cloud end markets. Timing around customer certification and adoptions of new products could result in variability of our expectations, positive or negative.

Now turning to our margin outlook. In Q3, as we begin to ship higher volumes of ICE4 units, our gross margin will be negatively impacted, as we ship the highest-cost units first. These units were manufactured when volumes and yields were well below our current yields and further below our Q4 expectations. To provide some context to this dynamic, early units through the manufacturing process can carry a cost structure which is several times greater than units manufactured once processes have stabilized and volumes have increased. Although this impact is not a new one for us, accurately predicting its magnitude in a given quarter can be challenging with the multiple moving parts. Additionally, in recent quarters, we have discussed commercial arrangements to transition customers to our next-generation products. In Q3, we expect to incur significant incremental costs to fulfill some of these arrangements, as these bridge customers adopt ICE4 solutions.

Finally, as a result of winning several expansion opportunities, we are anticipating a meaningful uptick in footprint deployments in Q3. Our volume of new footprint deployment is increasing by more than 50% quarter-over-quarter, demonstrating the success of our more aggressive approach to new deals over the past several quarters. While these deals carry lower margins up front, they enable higher-margin capacity sales in the future. Given these impacts, we currently anticipate non-GAAP gross margin in Q3 will be 39% plus or minus 200 basis points. Without the impact of the incremental ramp-up in bridge deal costs, the midpoint of our Q3 gross margin outlook would have been slightly higher than our Q2 gross margin result. Although the combination of the above-mentioned items is leading to a challenging margin expectation for Q3, we believe they will drive positive financial outcomes over time and thus is the right thing to do for our longer-term shareholders.

Looking ahead, while we continue to be -- we will continue to be aggressive to win deals and customers. My expectation is the impact of higher early unit costs and bridge deals will significantly lessen in Q4. In 2018, we expect our new products will ship in volumes with a normalized cost structure, allowing us to really start benefiting from the higher levels of integration in our ICE4 products. I continue to believe we will be able to expand margins over time, as ramping the new products through our fab should enable us to realize cost structure benefits and reestablish fixed cost leverage from our vertical integration model.

As for OpEx, we currently anticipate non-GAAP operating expenses will be $96 million plus or minus $2 million. Sequential OpEx growth in Q3 should be led by R&D spending, as we continue the drive to release the new products. We will also incur some incremental marketing expenses related to lab trials and demos to support adoption of the new products. Below the line, the combination of interest and other expense in Q3 is expected to net out to approximately $500,000, and tax expense should be approximately $1 million.

Putting this all together for Q3, the midpoint of our projected guidance translates to a non-GAAP operating loss of 12%, and non-GAAP EPS is expected to be at loss of $0.16 per share plus or minus a couple of pennies.

As for GAAP EPS, we project it to be lower than non-GAAP EPS by about $0.14 per share, primarily related to stock-based compensation expense.

Finally, given our expectation of an operating loss, we expect our cash balance to decline in Q3. Being mindful of this, CapEx spend is expected to decline to high single-digit millions per quarter for the remainder of the year. In closing, we are starting to deliver on a promising pipeline of opportunities, beginning with the CX2 and XT ICE4 platforms. While the timing and magnitude of market acceptance is difficult to predicts, I feel good about our broad suite of new solutions and accelerated innovation cadence, which should enable us to increase market share. Although the impacts of customer consolidation continue to linger, an encouraging sign from customers that have completed integrations is we are starting to see incremental opportunities, which largely have not yet translated to financial results. Additionally, with the consolidation of 2 of our largest customers scheduled to close later this year, we anticipate starting to see incremental growth opportunities from this combined customer in 2018. As we grow the top line, it is imperative that we return to profitability.

On that front, we are investing to deliver a fully refreshed portfolio that we believe is necessary to return to strong top line growth, which given our vertical integration and expected OpEx leverage should improve our bottom line as well. Although a few more quarters of investment are required to complete this refresh, provided our new products perform as expected, I see a clear path towards margin improvement and over time a return to industry-leading profitability levels. Ultimately, I am optimistic that we are well positioned to get back to delivering differentiated financial results. With that, I'd like to turn the call over to the operator to begin the Q&A portion of the call.

(Operator Instructions) Our first question is from Patrick Newton at Stifel.

I guess, first one for, I guess for Tom. On the product side, I'm trying to understand that even with the pushout if we were to pull that back into the quarter, which looks to be at least $4 million, your product revenue was still roughly flat sequentially. So could you help us understand what product lines were down sequentially? And was the total CX family, including the new CX2, up or down sequentially?

Yes, I think the question, Patrick, is we talked about an order that didn't come in that caused us to be at the lower part of our revenue guidance versus kind of at the midpoint. That was not a new product. That was -- we call it business as usual with a long-term customer. They had anticipated getting it to us on time, and they just didn't. So that caused us to miss our revenue plan by a few million dollars, which is disappointing. It had nothing to do with new products. The CX2 started shipping late in the quarter, as we've said. We shipped it to 3 customers, and it was in line with our expectations of what we had said on the call guiding to the quarter. But I'd say that, that met our expectations on the CX1. We had a relatively good quarter on CX1 overall.

Yes, so if I give you the overall, Patrick, the subsea side of the business was actually up in the quarter as was metro a little bit. DCI was roughly flat and traditional DTN-X relatively flat to down a little bit.

Does that answer your question, Patrick?

Yes, I think so. Okay. And then I guess on the metro side, is there anything you can give us on a quantitative basis progress that you're making there? Specifically, you talked about some MSO strength in the quarter. Is that on the metro side? And I guess coupled with that, with the release of the XTM-2 is that going to have any type of material impact in the back half of the year? Or should we think of this more as kind of a slow grind higher given that it has go into labs once it's GA-ed?

Yes, for the metro, I would say our business is still relatively flat. We've won some new customers, which we think could be meaningful over time. I would highlight Europe Cable (sic) [Cable Europe], that is the metro product offering. I would say that XTM-2, which we will start shipping in Q3, I think Q3 and Q4 will vastly be certification periods. We might win some revenue in the business. I would anticipate we would. But from a materiality to revenue perspective, I would say it's a next-year event. I actually have fairly significant expectations for that platform. We have 30,000 installed base chassis, and a couple of our largest customers have been very clear they anticipate upgrading in '18, and they are planning on certifying it later in this year. So I'll -- bluntly, metro continues to be less than our expectations and disappointing. We are working on a number of things and other opportunities that could be substantially material for the company in '18. I'm optimistic about them, but it's too early to say we've got them. I do think the upgrade to 16QAM that it'll have a significant impact to our metro business.

And Patrick, remember that it should not only have a top line impact but also will help with the margin structure of that business as well.

Great. And just one point of clarification. I know you said that, that pushout would put you slightly above the midpoint. Can you just give us the absolute dollar amount? It helps us calculate what you're doing on a sequential basis and just makes the guide a little bit more clear from a fundamental analysis?

Yes, Patrick, we're not going to get into too much more details about that. I mean it was -- it was tough literally a week-to-week push. It doesn't change things materially.

Our next question is from with Vijay Bhagavath, Deutsche Bank.

Tom, like to get your viewpoint on what type of competitive dynamics you and your sales teams are seeing in DCI, data center optical, and then also in these cable opportunities you're pursuing in the metro? That's very helpful. And then is your growth opportunities in the near term mostly U.S centric? And the reason I ask you this is how is Transmode playing out overseas versus your expectations?

Okay. So competition in the DCI space is extraordinary. We certainly have a continued leadership position based upon being a first mover in it. I think the CX1 continues to do very well. And I think the CX2 is going to be a very well-received offering. Unfortunately, as you know, we were a number of weeks late on delivery for our plan; and that has caused, quite frankly, some challenge. We have to go and fight harder now to earn our spots. We shipped to a few ICPs, 2 new and 1 current customer. We have a significant number of opportunities I believe for Q3 and more for Q4, but we've got to go and win those. And the competition, unlike a year ago, is quite frankly, very, very healthy. I do think that our product is easier to use, easier to deploy, has instant bandwidth and instant network capabilities that others do not offer. It's leadership in performance. But it's a fistfight right now in the DCI space. In regard to metro, we are seeing a number of cable opportunities with the TM-Series both in Europe and in North America. We are winning probably more new customers in North America with the TM platform. Europe has a larger installed base because they were selling there longer. But the TM-Series is being, I think, is instrumental in some of these large cable opportunities. When we talk about the densification of fiber in the metro, it's going to be a suite of products across the Infinera portfolio, the 3300 and the TM Series that will offer us -- allow us to offer what we believe is a very compelling solution. So I do think it's a very important part of our portfolio. The installed base continues to grow. The number of customers we have continues to grow. But we have to get the 16QAM out to market. We are at a competitive disadvantage now not offering 16QAM. I think -- I'm unhappy with our performance in metro. But the fact that we've been able to hold the business and win customers without a 16QAM offering to me speaks pretty highly to the fundamental capabilities of the platform and speaks fairly highly to the Infinera end-to-end approach that we're taking, that customers like to do business with us. But we need to get the 16QAM to market.

Yes, perfect. And quickly, Tom, Transmode, how is it playing out versus your expectations?

That's below my expectations quite substantially, quite frankly. Quite frankly, I underestimated the impact of 16QAM in their [deficit]. We didn't help -- quite frankly, help them accelerate. But you know what, tomorrow is the next first day of the rest of our life, and we're going to have 16QAM out this quarter, and I think we can start that hunt. So far, we're receiving a lot of opportunities for it in the customer installed base of 30,000 chassis. A whole lot of those want to upgraded to 16QAM. So I've got reasonable but high expectations on moving forward in comparison to the last year, but make no mistake, it underexecuted -- I have underexecuted on our metro strategy based on the TM.

Our next question is from Jeff Kvaal at Nomura.

I guess the bigger picture question is a lot of your peers who also supply into the cloud space have started to talk about not supplying just the hyperscale community but also the slightly smaller but still pretty cloudy businesses like software-as-a-service. I'm wondering if this is a theme for you or is likely to become one over the course of the next year or so?

Absolutely. We are going to sell not only to the top ICPs, but we're going to second tier ICPs. We're selling to enterprises that have data center applications. We're selling to software-as-a-service companies. If you look across our portfolio of customers like how many customers, we have 40 or so, Brad?

Yes.

A good number of them are not the top 4 ICPs. The biggest volume without question today comes from those biggest ICPs, the biggest volume. It's guys who are carrying massive amount of traffic, which is why we think the CX2 is going to be so compelling to them, offering 1.2 terabits in a single wrap unit. But the CX1 is going to, I believe, be long-lived, as 500 gig continues to be a lot of capacity for smaller-scale data center guys, whether they be enterprises or software-as-a-service guys. So we are making a lot of progress in selling to enterprises and alternatives to the top ICPs. And maybe we should talk about that more. We will next time.

Okay. And then maybe, Brad (inaudible)?

Most of the money right now continues to come from the top 5 ICPs. But I think over the next 3 to 5 years, the portion that comes from other places will continue to grow. And that's why we believe seeding those today, winning those today is very important.

Well, that's what seems to be happening elsewhere in the space, and that's why I asked. Okay. So Brad, sometimes in the past you have been helpful in, obviously, not guiding per se but at least giving us the shape of what we should or maybe shouldn't think about for the following quarters. I'm wondering if you wanted to give us any nudge in one direction or another for the fourth quarter?

Yes. So Jeff, obviously, we don't guide for more than a quarter out. But directionally, obviously, we still expect revenue to grow in the fourth quarter. Obviously, consensus is quite a bit higher than we are today. I don't think that's unachievable, but we'll clearly be challenged from where we are. I mentioned once some of the higher cost units get shipped through some of that pressure will dissipate, and I think we get back to margins starting with a 4. We still have a little bit of OpEx spend to do later in the year. But I think we get into '18 with all the new products out and ramping a -- starting to realize the much better cost structure and starting to get leverage on the OpEx side of things.

The next question is from George Notter at Jefferies.

I just want to make sure -- you guys said a lot in terms of different products and different delivery dates. I just want to make sure that all these different pieces are on track relative to what we were thinking previously at the 3300 and the 3600, the higher capacity line cards, your DTN-X. Can you -- would you mind kind of spinning through those time frames in terms of when they're GA? And I presume in most cases we can assume 1 to 3 quarters in terms of the ramp after that GA and maybe shorter if we're talking about ICPs and longer if we're talking about the traditional service providers. But if you could just spin through that that'd be great.

Yes. So the XTS and the XT-3300 are both coming out this quarter and, candidly, in the next couple of weeks. We have already got both of them deployed in live customer networks, and so far, the results are good. And as I mentioned in the call, on the XTS subsea, we were delighted with the results from the optical performance. We too believe we have the best-performing optical spectral efficiency available today in production. The customer was delighted, and we're delighted. So those will both would be hitting GA in the next couple of weeks. And I would anticipate revenue from both of those platforms this quarter. There will be a certification progress, but I do anticipate it'll vary by customer, that we should have a reasonable volume of those product this quarter. It won't be a step function, but it'll be a reasonable rollout and revenue of both those product this quarter. The XTM-2, the upgrade to 16QAM is anticipated, and I believe we're on track to ship by the end of this quarter. Once again, as I mentioned a minute ago, most of that will be going to customer lab trials in Q3 and Q4. We'll have some small revenue, but I'm really counting on the revenue ramp to hit next year's budgets, as our customers -- our large customers who have a large installed base have put it in their 2018 plan for upgrading of our systems to 16QAM. It's actually -- the timing is actually okay because this will allow them a full quarter or more to certify the product. On the 3600 and on the DTN-X upgrade, the AOFX, we [explained] that it's on track for GA by the end of this year. No more granularity than that. It's still 5 months away. So we are still going through the engineering process. Clearly it uses the same optical engine as we use in the 3300 and the CX. So that level of engineering won't have -- shouldn't create a lot of challenge. Now the 3600 is a brand new platform, and anytime you have a whole brand new OPM integrated platform, there's complexities that you can stumble across. But we anticipate both will go to market by the end of this year. But I would anticipate revenue next year.

Got it, great. Okay. And then...

Does that answer your question, George?

That was great. One last thing I'd love to ask also is there was also some talk about potentially in your PIC chips available on an concomitant basis to other system vendors. Is that still something that you guys are thinking about? And any update there would be great.

I think the -- this is Dave, George. The comment we've made before, which I'll still stick with, is we're a technology company, and we'll make our technologies available to customers in the formats that they want to ultimately buy from it. There's a lot of value in the systems products, but there are some guys as they look to integration that they may want it in a subsystem capability, and we're open to that conversation.

The next question is from Alex Henderson at Needham.

The primary focus I want to narrow down on is the elements of the cost structure on the gross margins that will fall out and sort of what the timing is of some of those. Obviously, you're ramping parts that our new parts. And therefore, you have very low yields initially; and those are, as you said, could be multiples of cost. How long before you get to what you would describe as a normal run rate on those newer parts that then would then allow your gross margins to recover from that?

Yes. So Alex, the main hit will be in Q3. There'll still be some in Q4 but at a much lower level. And by and large, we enter 2018 with a more normalized cost structure. Obviously, over the course of next year, we'll also continue to drive down the cost structure of those parts. But the really high-cost hit for early units should be dissipated by the end of the year.

So in 3Q, what is the kind of the margin magnitude of that cost pressure from that particular item?

Yes, so if you take that and you take the kind of bridge deals, it's about 300 basis points.

Okay. So just to shift to the bridge deals since you're bringing it in here. When do the bridge deals fall out?

Yes. The majority of them is in Q3. There'll still be -- it really depends on when the customer deploys. But my expectation is they're going to deploy the majority of those units for those bridge deals in Q3. Similar, there'll be a bit that lingers into Q4, but I think we'll definitely be done by the end of the year.

So those 2 are kind of similar process quarter-to-quarter in terms of the rate of fallout. So the 300 basis points goes to what, 100 basis points in 4Q and then 0 basis points in 1Q?

That's about right, yes.

Okay. And then within the rest of the mix here, obviously, you've got a bunch of new products launching, and those new products take some time to ramp up. Do you expect the margins to improve as we get out into the first half of next year as the footprint has been built in the back half of this year and then you're populating them? Or how should we be thinking about the footprint build that you're talking about impacting 3Q, 4Q and into '18?

Yes. I mean, it's really about getting the volume on the new products, right? So as we get into the first half of next year and that kind of stuff, it'll be driven by volume. I still think we're going to be building a new footprint early next year because some of the products aren't out until later this year, and that will be a good thing. But in terms of the cost structure, the cost structure will be significantly better than what we're shipping through today, which will drive margin enhancements over the course of next year. But it's really about getting the volumes through the fab.

One comment I'll make, Alex, just to make sure you understand. We are not implying that the ICE4 Gen PICs are coming in costlier than we had planned. The cost targets that we had laid out they're actually on track for, for Q3 and Q4. This is flushing out the earliest inventory when they're -- when you make a few of them, they're very expensive. And like Brad said, most of that flushes out in Q3.

Yes. Totally understand the mechanics of that. Just so I understand, the impact of footprint and volume to the margin mix is what type of gross margin hit? Is 200 to 300 basis points as well?

Yes, I mean the reason I didn't break that out, Alex, is we have that on an ongoing basis in other quarters as well. So it's not necessarily something that I was intending to call out separately, whatever. It's just when you put all those things together and you have a high footprint quarter, those things combined have a significant impact.

This is important to note too. So Brad's calling out an event that's based upon ICE4, and it's based upon a new learning curve. And we also called out these bridge Gen 3 to Gen 4 deals. Those are unusual. Normal course of business is winning footprint opportunities, and we are not implying that margin goes down because of footprint moving forward. That's normal course of business.

Right. So if I'm correct then, what you're saying is your normal course of business would have 300 basis points higher margin than what you're guiding to, which would be around 42%, not in the mid or upper 40s in a recovery in 2018?

Well, so we're talking about through the end of the year, right. Over the course of next year, you're going to get better cost structure as the year goes on as well, which will cause the margins to continue to grow. I wouldn't expect them to being in the high 40s by the end of next year. That said, I still think we can get back to the 50-point levels we've been at historically. It's just going to take a bit of time to do that.

(inaudible) quick comment, Alex, is a relative -- is a relevant comment for Q3 and somewhat Q4.

Right. So just to be clear, you do not expect to get into the 48% or 49% kind of gross margins in the back half of '18. You would still be in a recovery mode on margins at that point?

Yes. I mean, I think we'd still get back up to where they're in line with the top companies in the space. But they're not going to get back up in the high 40s by the end of the year.

The next question is from Rod Hall of JP Morgan.

I guess I just wanted to come back to the DCI commentary and [codecs for S2] and ask whether you guys think you've -- and Tom, you made these comments about having to work harder and so on. Do you feel like you've lost footprint share there to people like Ciena and others that have come in with products? Or is it like that? I mean, is it more of a every box is a new fight for an order type situation? Can you just comment on what you think your market position is now given the delays? And then I have a follow-up.

Yes, a couple comments. Our customers that we have had consistently for a long time have continued to buy a lot from us. There was a window of time one of the ICPs that we -- the large ICP that we talked about for CX2, they had made an alternative decision in the second half of last year, and these orders are an opportunity for us to go back in and re-earn footprint. Most of our customers we have maintained market share with them. As the market continues to grow as other people continue to make choices, over the last 6 months, in particular, there have been alternatives on the market that our competition has taken advantage of the CX2 being later than some of their products. And those customers made an alternative choice. We now have to go in and fight for our share of that market. So I think for the most part that the customers that we've had for the long time, we continue to have them. There has been new customers in the market that have come out and picked some of our competitors because at the time their products, quite frankly, had a better set of specs than ours. I believe today the CX2 has a better set of specs, and we have to go and have a fistfight.

Great, Tom. Appreciate it. And then, I kind of hate to ask this question, but I think it's an appropriate one in the situation. It's 4 quarters now with the guidances of losses down at the bottom of the P&L. Now the cash flow is fine, but the P&L losses continue. And there has been all the issues with R&D and so on. I'm just curious strategically, what you guys think about this business little bit longer term, maybe 4, 5 years out. I mean, does Infinera make sense as a stand-alone business? Does this experience make you think, gosh, maybe this would be better rolled up into a larger networking entity? Just curious what you're thinking at this stage.

So a couple of things. I think in the macro optical transport is becoming more important than it's ever been. As you look to fiber densification in the metro for both 5G and what the cable guys are doing, as you look to the advent of more and more cloud networking, there's more and more as a percentage of optical networking going in to enable new communications infrastructure than has ever been possible. That makes the environment, quite frankly, a healthy demand environment. I think the R&D table stakes are also growing quite dramatically in the space. And I think that's going to continue to put pressure on this industry consolidating. I believe that will in the long term be healthy for the industry. And in the meantime, it's extraordinarily challenging because our R&D requirements continue to go up. And it creates, I think, competitors who must win market share. So pricing is quite frankly remarkably low. Last year was, I think, unprecedented from ASP reduction, and the pressure continues today. I think that we are -- we think about this a lot. We are staying this course today. I believe our ICE4 technology brings substantive value to our customers and to our shareholders over time. And we're 6 months away from, quite frankly, finishing that journey. I think a mistake I made was missing the DCI transition to an optical cadence of every couple of years. That has been an expensive lesson learned. We won't make that mistake again. As we've talked about and you'll see us make more announcements on ICE5 later this year, we will be put into a position where if we claim leadership in a space we won't have a technology lag that causes us to lose that advantage like we did, quite frankly, in ICP. We have to go fight that back, and we should never have to do that again. Your larger scale question of would it be better served as part of a larger entity, I don't know. I believe I need to run and build this company, the employees here need to build this company to be a company that creates value for our customers, expect to make value for our shareholders. We're a public company, so we're always for sale. I think the challenge continues to be in our industry there is not a -- I don't see people wanting to buy optical companies right now. It's a tough space, right? So our goal is to build an entity that sustains itself. You said that our profits certainly have not been acceptable. Completely agree. You said our cash flow has been okay. I disagree. We're consuming cash, that's not okay. And we have to go and fix that next year at the latest. '18 cannot have those results on cash or profit, period.

The next question is from Dmitry Netis at William Blair.

I have a couple questions, pretty quick ones. One is you guys just mentioned some incremental opportunities that you're pursuing and how you -- despite what's going on in the model right now and margins and you obviously trying to get the products out to market, the opportunities are there, is what you're saying, and they're growing -- you referenced like a 50% rate in, was it bookings? I might have missed exactly what it was. But there was a big sequential sort of increase there in opportunities that you mentioned. So just kind of zoom in a little bit on that, and how close maybe we are in you announcing a large metro win on a new product, the type of a win we saw back in the day when the DTN-X rolled out with Telia and CenturyLink, where it was a big project-based win on a new platform that kind of carried the day for you over the next couple years. Are we close to any of those wins in the metro?

I think -- there's a couple of things happening in the metro that are big opportunities, and they're fascinating, and they're becoming more real. One is in Europe, where they have the dark fiber initiative of breaking up BT's monopoly on metro dark fiber. I think that's going to be a substantive market opportunity for somebody. And there's regulatory debate going on right now whether it's going to be October or it's going to be early next year. I don't know when it's going to be. I believe it's going to happen. And I think that there's a substantive amount of opportunity, and we, I think are well positioned to capitalize on that. I think those decisions will be made in the next 2 quarters. Whether we can announce them or not, I don't know. But I think those decisions will be made in the next 2 quarters. I think in the cable space, as they rearchitect around Remote PHY, I think that there's a staggering amount of bandwidth that is being deployed into the metro -- through the [reader] into the metro. Those are -- that's a new architecture that will last in that space for a long time, a decade or more. It's a fundamental altering architecture for that space. Cable, as you know, is one of our stronger areas, and that's the growth that happened last quarter at 20% in that space. I think those decisions will be made over the next 2 to 3 quarters. And quite frankly, between the dark fiber initiative and the Remote PHY initiative, we need to be winners in some of that or we're going to have to inspect our approach to metro. I think we are very well positioned, and I think it's going to be the next 2 or 3 quarters that we understand did we win or not.

And Dmitry, just to clarify the comment on the 50%, that was our level of deployment opportunities or revenue in Q3 versus Q2. So we're seeing a lot of opportunities to build new footprint, which you're familiar with the history of the company. Obviously, as we win that footprint, there's a tremendous amount of capacity to be added to those networks at very high margin. And you alluded to the metro side of the business. There's opportunities in -- across the different market segments or the verticals, whether it's continued growth in the DCI space, as more and more customers continue to build their DCI networks, as the bigger guys continue to build more and more. Obviously, our subsea business, there's a lot of opportunity there given our strength in subsea. And long-haul with some of the new products I think is going to open up new opportunities as well, so.

And that 50% is really a long-haul and regional discussion versus a metro discussion, Dmitry. Brad does raise a good point of one of the areas that we are actually performing fairly well this year is in subsea. And I think with the 33 XTS coming out, I think we have a real opportunity to regain our footing in that space. So we need to make sure we update you guys not only on metro traction but also on subsea traction.

Very good. If I may, one last question, on the DCI. And pardon me playing the devil's advocate here, but as your competitors kind of roll out their next-generation pizza boxes, the specs are coming in, for example, one of your key competitors almost doubled the capacity of what you have in your box despite kind of the 16QAMs and security additions that you are making on software and the ICE4 chipset. So what gives you comfort that you could still win in the market, in the DCI space? Well, win -- let's assume preserve your share or -- clearly, it's not going to stay at that level but at least win new wins -- win new deals with the new product given some of your competitors are doubling capacity in the boxes, which comes in the same footprint. And maybe this is to Dave and Tom, just to sort of give us a little bit of a game plan around the competitive backdrop that may have better throughput or better numbers for gigabit per port there in their platform?

Yes, so this is Dave. I'll try and address it. The DCI guys care about a number of things. They about dollars per gigabit. They care about watts per gigabit. They care a little bit less about RUs -- gigabits per RU because they can't fill the rack anyways with these. It's not like they put 21 or 42 units within a rack. There isn't sufficient power to handle that. So the gigabits per RU, if you talk to the ICPs, they're less on it. The watts per gigabit are very important, and the dollars per gigabit are very important. What's also very important is the ease of operation and the question of whether you need additional gear along. So when the competitor comes out and says, "Hey, I got twice as much capacity as an Infinera," they don't -- aren't including the amplifiers. They aren't including the optical MUXs, et cetera, and all of a sudden those densities aren't 2x. It's a distortion of the actual application space in there. The customers who buy our product are very happy with that. They put it in, they turn it on and the most important thing -- the next most important thing for these guys is the simplicity of operation. They don't have hundreds of people running around the data center. They go and they deploy it; they turn it on, and they expect it to turn itself up immediately. And our software interfaces are highly valued and the ease of operation of that. So with all due respect to my competitors, their distortions of it's the gigabits for the application; and they are missing -- they're forgetting about a number of key boxes necessary to make that application work, which because we use photonic integration are fully integrated into a monolithic (inaudible) for that. Feedback from the customers, very strong. We haven't -- the CX2, they're very excited about, in the midst of either using or certifying for that. Our road map down the road for Gen 5, which is -- will integrate into that ease of software use and that use of MUX-ing as well as Gen 6. And so far, they've been very happy with that.

The next question is from Doug Clark at Goldman Sachs.

My first one is kind of on a customer basis. You had mentioned the impact of consolidation still impacting some of your relationships. And I think you've been pretty clear in the past that CenturyLink has actually been down quite a bit. I'm wondering if you're seeing a trend down in the other customer involved in that deal as well, if that's -- and that's kind of implicit in the third quarter guidance?

Yes, so Doug, if you take the combined customers are relatively flat. So puts and takes on either side, but combined, they're relatively flat quarter-on-quarter. But obviously, still at -- the biggest problem is still at significantly lower levels than they've been in the past.

For the first half of the year, I think it was 35% less business from the consolidated customers than it was a over a year ago. And that's driven, obviously, by the top 2 or 3 of the consolidated customers. In other consolidated customers, as we talk about, we're starting to see some level of resurgence of buying and new opportunities. I've always proposed that once these are done we are -- and that's an okay spot for earning new business. I'm anticipating that will happen with CenturyLink and Level 3 also. The challenge continues to be the best case that closes in this quarter, best case. And until then, I think it's going to be headwinds on more CapEx.

Sure, that makes sense. And then to kind of play the other side of that, I mean, is there any incremental risk or have you factored in the possibility of incremental pauses around the closure of that deal?

Yes. The -- we spent a lot of time with both of them. I literally don't see how they could take their spending below the current levels. It is extraordinarily conservative on their part at this point. And I just don't see how it could go lower at a practical level.

Okay, that's helpful. And then, Brad, one quick question for you. On OpEx, it sounded like you were implying on fourth quarter we could see a modest tick up again sequentially. Once we exit the year, are these levels of OpEx that the company can hold? Or could they continue to grow higher to the extent that sales continue to rise?

Yes, so as you get into '18, Doug, we'll have done the heavy lifting, and so the absolute level of spend will be relatively flat. But as you grow the top line, obviously, it goes down significantly as a percentage of revenue.

Doug, either the OpEx numbers will remain flat because revenue is growing or OpEx numbers will come down.

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

Thank you for joining us for this afternoon with your questions. We look forward to updating you on our continued progress. Have a great day.

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