Infinera Corp (INFN) 2018 Q1 法說會逐字稿

Good day and welcome to the First Quarter Year 2018 Investment Community Conference Call of 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 conference over to Mr. Jeff Hustis of Infinera Investor Relations.

Jeff, you may begin.

Thanks, Chad.

Welcome to Infinera's first quarter of fiscal 2018 conference call.

A copy of today's earnings and CFO Commentary are available in the investor relations section of our website.

Additionally, this call is being recorded and will be available for replay from the website.

Today's call will include projections and estimates that constitute forward-looking statements.

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

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

Please be reminded that all statements are made as of today, and Infinera undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.

Today's conference call includes certain non-GAAP financial measures.

Pursuant to Regulation G, Infinera has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in its first quarter earnings release and CFO Commentary.

Revenue guidance is provided under ASC606 which we adopted on December 31, 2017 on a modified retrospective basis.

I will now turn the call over to our Chief Executive Officer, Tom Fallon.

Good afternoon and thank you for joining us on our first quarter 2018 conference call.

Joining me today are Brad Feller and Dave Welch.

Today, I will review performance in the first quarter and provide commentary on future opportunities.

I'll then turn the call over to Brad who will provide a more detailed financial review and our outlook for the second quarter of 2018.

I was pleased with our financial performance in Q1 as we delivered revenue of $203 million, at the upper end of our guidance range of $195 million to $205 million.

Considerable growth in cable and solid results in ICP, both fueled by ICE4, outweighed typical seasonal weakness from our other verticals and resulted in 4% sequential and 15% year-over-year growth.

In Q1, ICE4 products were a significant contributor to sequential growth in traditionally down quarter for our industry, accounting for nearly 30% of product revenue, up from just 20% in the prior quarter.

In addition to supporting the top line, our bottom line was improved by the increasing contribution of our lower cost per bit ICE4.

As a reminder, our unique approach to driving Moore's Law-like advancements, photonic integration, and our vertically integrated operating model enables us to lower our internal cost structure with each new generation of ICE technology.

This was evidenced by Non-GAAP gross margin improving strongly to 44% in Q1, above our guidance range of 38% to 42%.

In Q1, top line growth and gross margin improvement drove our bottom line, resulting in earnings per share coming in above our guidance range.

Regarding our end markets, DCI, long-haul and metro all grew more than 15% year-over-year in Q1.

DCI and long-haul were fueled by ICE4 traction, and in metro, the new 16QAM XTM II added incremental revenue from several new, mostly European customers.

Subsea, coming off a very strong Q4, had lower revenue both sequentially and year-over-year, largely a function of deal timing.

We are receiving positive feedback from our subsea customers around the capabilities of ICE4 and expect this business to grow in Q2.

We continue to expect to win market share in 2018, mostly driven by our product refresh and specific customer spending cycles.

While our opportunity is not entirely decoupled from broader industry trends, these internal drivers are more material to our outlook in the short term.

Digging deeper into the progress with our portfolio refresh, we added 10 new ICE4 customers in Q1, bringing our total to 27 with most ICE4 revenue to date from cable, ICP and subsea customers.

In metro, having introduced XTM II late in 2017, we had a solid Q1 adding 13 new XTM II customers, bringing our total number of XTM II customers to 25.

With growth in the metro being driven by a heightened demand for robust packet optical solutions, I'm pleased that the XTM II is being well received by the market.

My expectation is that ICE4 and XTM II should continue to increase as a percentage of our overall mix over the course of the year.

In particular, completing our portfolio refresh will improve our positioning with traditional service providers who can now upgrade their existing DTN-X networks with a new 1.2 terabit line card.

We have successful early traction here with 10 customers already having placed orders and we anticipate continued customer growth for the remainder of the year.

Additionally, the 2.4 terabit XT-3600 will be a compelling solution for service providers looking to build new long-haul and metro networks and will complete our portfolio refresh.

The 3600 is slated to begin shipping later in Q2 with first revenue expected in Q3.

2018 remains an important year for winning multiyear opportunities and new customers, something our refreshed portfolio is helping us to achieve.

The last earnings call we noted a significant uptick in customer trials for our new products.

These trials are yielding positive results, having recently been awarded 2 significant multiyear opportunities, one a new long-haul customer in North America and the other a new metro customer in the UK.

As is typical with building new networks, initial revenue should be moderate and ramp more substantially over time.

An important element of our new customer acquisition strategy continues to be Open ICE which unlocks additional market share gain potential for us.

As a reminder, Open ICE breaks down a traditional barrier to winning new accounts by allowing network operators to easily test and ultimately purchase our solutions without having to rebuild their current infrastructure.

Open ICE is also creating opportunities to engage with customers at what historically would have only taken place around full network refresh.

In Q1 we had some solid proof points which included winning a strategic customer in Europe over a key competitor of line system and conducting more than a dozen Open ICE lab and field trials.

As the market gradually embraces the open architectural approach, we feel we are well positioned to win new customers and increase market share over time.

On the technology front, we're delivering optical leadership with ICE4 and demonstrating our commitment to releasing future optical engines in a two-year cadence.

As a proof point, we demonstrated our 600-gig ICE5 technology on the floor of OFC in March and have already started testing 800-gig ICE6 prototypes in the lab.

Coming off a first quarter in which opportunity from the cable vertical enabled unusually high visibility, our current visibility beyond the first half remains typically uncertain.

We have several prospective growth opportunities that we are excited about, but we also observe some potential headwinds.

Regarding opportunities, the previously mentioned new long-haul and metro customers are expected to help drive market share gains and should begin to generate early revenue in the second half.

We are also tracking opportunities for additional customer wins in 2018.

At present, we are modeling the 2018 impacts from new customers conservatively as it takes some time to spend for new customers to ramp.

Initially, having a full portfolio to offer should drive incremental opportunity.

Specifically, several service providers have expressed interest in both the AOFx 1200 for the upgraded line cards to the DTN-X and the XT-3600, a new multiservice platform optimized for service providers.

With the AOFx 1200 already generating revenue, we are focused on delivering the XT-3600 to address emerging customer demand.

Finally, fiber-deep remains a vast multiyear opportunity for us.

We continue to believe we are well positioned with fiber-deep and currently foresee the potential for material revenue contributions from cable operators commencing in 2019.

Regarding potential headwinds, there has been an uptick in activity and speculation around consolidation of European customers.

While consolidation in Europe would not be nearly as impactful as the challenges we faced in 2017, given our position with several European customers including Liberty Global, consolidation in this region would be somewhat impactful on our business.

Next, coming off several strong quarters of ICE4 sales to ICPs, it could be challenging for us to grow our ICP business in the second half.

We continue to expect to begin selling into one new substantial account, but otherwise currently see a limited pipeline of second half growth opportunities.

ICP is an important vertical for us but tends to be somewhat lumpy and have lower visibility, a dynamic our competitors encounter as well.

Finally, amidst our recent wins, we are seeing certain large competitors being uncharacteristically aggressive on price.

While it is unclear whether this might impede our growth or margins in 2018, we are well positioned for this challenge given our refreshed product line, Open ICE, unique capabilities such as instant bandwidth, and our vertical integration driving a fundamentally better margin structure than our peers.

Touching on status with our largest Tier 1 domestic customer, we remain confident in our position and believe spending will eventually pick up, though it continues to be hard to predict the extent of any improvement and which quarter it might occur in.

As this customer works through its process of driving synergies and emerging as a larger, healthier company, we believe we will be an integral part of their long-term plans.

In regard to near term outlook, we are not forecasting any significant change in the current run rate.

In closing, I am pleased with how the first half is progressing, cautiously optimistic that we will grow in the second half.

Longer term, I remain confident in our opportunity, our product refresh is driving multiyear opportunities, laying a foundation for a more diversified, sustainable revenue base.

In particular, I believe Infinera's position as the most vertically integrated systems company in optical will prove to be advantageous.

In addition to enabling us to control our innovation destiny and deliver unique technologies, vertical integration enables a higher margin structure for each new generation of technology.

Thus, as our new products grow as a percentage of revenue, we deliver new optical engines at a faster cadence, should see operating leverage and positive impacts on the top and bottom lines.

In the near term, we remain on track to achieve profitability and positive operating cash flow during the second half of this year.

With that, I'd like to thank our customers, partners and shareholders for their ongoing commitment to Infinera and also thank our employees for their hard work.

I will now turn the call over to Brad to discuss the financials.

Thanks, Tom, and good afternoon, everyone.

On this call I will discuss Q1 highlights, our Q2 outlook and provide some color for the full year.

The detailed recap of our Q1 results is available in the CFO Commentary on our Investor Relations website.

In Q1, revenue was $202.7 million, up 4% sequentially and 15% year-over-year as the continued ramp of our ICE4 products drove strong results even in a seasonally weak Q1.

As Tom mentioned, cable was strong in Q1, up more than 100% year-over-year.

As a frame of reference, our cable business in Q1 of 2017 was significantly impacted by multiple customer mergers.

During the first quarter of 2018, we adopted ASC606, the new revenue standard.

The impact of our transition to the new standard resulted in revenue being approximately $3 million lower in Q1 than it would have been under the old standard.

As our guidance for Q1 was provided based on ASC605, the old revenue standard, we were able to absorb the $3 million impact of the ASC606 adoption and still exceed the midpoint of our guidance.

In the second quarter of fiscal 2018, we expect the revenue momentum we have seen for the past several quarters to continue as both existing and new customers further adopt our new products.

As such, I'm pleased to announce that we currently project revenue of $208 million plus or minus $5 million.

At the midpoint of our range, Q2 revenue would be up 3% sequentially and 18% year-over-year.

Of note, we estimate that the adoption of ASC606 will impact Q2 revenue negatively by approximately $2 million.

In Q2 we anticipate growth will be driven by the further adoption of new products, relative strength in subsea, and higher spending from traditional service providers.

Cable should continue to be a significant contributor to revenue in Q2, as our largest cable customer continues its aggressive build and our European cable customers ramp up spend.

Supporting our cable and service provider verticals, we expect deployments of our new 1.2 terabit DTN-X line cards to ramp in Q2 and throughout 2018, allowing customers to leverage their existing infrastructure to add capacity in a cost-effective manner.

Within ICPs, positions remain relatively steady as we expect CX2 and XT-3300 will continue to drive revenue in Q2, primarily from existing customers.

Our outlook for the second half of 2018 remains largely unchanged with several opportunities and also some uncertainties.

The timing of new customer wins ramping into revenue, the pace of adoption of our new ICE4 products with service providers, and the recovery of business from our largest Tier 1 will determine our level of success in the second half.

We will need to see positive results in these areas to help offset an expected deceleration from cable coming off a robust first half.

Balancing all these factors, we expect revenue in the second half of 2018 will be 2% to 4% higher than the first half.

In summary on revenue, we are pleased with our Q2 outlook and are cautiously optimistic about the second half of the year.

I'm particularly happy with our new customer wins in Q1 which represent multiyear opportunities that will grow and diversify our revenue.

In Q2 and for the rest of the year, we will remain focused on leveraging our refreshed portfolio to win additional new customers and address opportunities with existing ones.

Now turning to margins, non-GAAP gross margin in Q1 was 43.7%, well above our guidance range of 38% to 42% in an early demonstration of the positive impact the mix shift to ICE4 can create.

As a reminder, ICE4 and future generations of new products should carry a significantly better cost structure due to our enhanced levels of integration and leverage on our vertically integrated operating model.

Also benefiting gross margin in Q1 were delays of certain lower margin footprint infrastructure builds as customers finalized their budgets and build plans.

We expect the footprint builds delayed from Q1 will hit in Q2 which will drive lower margins initially but enable higher margin revenue from capacity sales over time.

We believe scale is critical in our industry and thus we intend to continue to be aggressive to win new customers and new deals with existing customers, which given the pricing dynamics we are seeing in the market that Tom alluded to, may put pressure on our margins in the short term.

However, we work hard to balance topline growth and profitability and thus evaluate each deal to ensure good profitability over time.

For Q2, we currently anticipate Non-GAAP gross margin will be 42% plus or minus 200 basis points.

As has always been the case, margins can fluctuate from quarter to quarter depending on a variety of factors including customer and product mix.

Over the course of 2018, we will continue to be aggressive to win new customers and new deals with existing customers.

Given winning new customers tends to require lower margin investments upfront, and also considering current competitive pricing dynamics, today we envision Non-GAAP gross margin of approximately 43% as a reasonable target by the end of 2018.

Turning to OpEx, Non-GAAP operating expenses were $95 million in Q1, in line with the midpoint of our $93 million to $97 million guidance as we invested in lab trials to support customer adoption of our new products.

In Q2, we currently anticipate Non-GAAP operating expenses will be sequentially down at $93 million plus or minus $2 million as we execute on our ongoing cost reduction efforts aimed at enhancing our operating leverage and efficiency.

We will continue to focus our investments on delivering and ramping the reminder of the ICE4 portfolio and driving adoption across the customer base.

Our OpEx plan for the full year 2018 remains intact with G&A costs projected to remain steady and sales and marketing expense levels dependent on our revenue performance.

My expectation is R&D should decrease over the course of the year, particularly once we complete our full product refresh.

Consistent with our restructuring plans, we are on track to achieve a quarterly Non-GAAP OpEx run rate of approximately $90 million by the end of 2018.

Overall in Q1 on a Non-GAAP basis, we had an operating loss of 3.4% and a net loss of $0.05 per share with both metrics coming in better than our guidance ranges due to better than expected revenue and gross margin.

On a GAAP basis, we incurred a net loss of $0.17 per share with stock-based compensation of $11 million being the largest driver of the difference between our GAAP and Non-GAAP results.

For Q2, we currently project a Non-GAAP operating loss of 3%, as we progress towards our second half profitability target.

Below the line, the combination of interest and other expense in Q2 is expected to net out to approximately $500,000, and tax expense should be approximately $1 million.

As a reminder, given our significant NOL balance, our tax expense for the foreseeable future will not be tied directly to profitability, and we anticipate taxes should remain in the range of $1 million per quarter.

Putting everything together for Q2, the midpoint of our projected guidance translates to a non-GAAP loss of $0.05 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 $0.13 per share, primarily related to stock-based compensation expense.

On the balance sheet, given our anticipated operating loss, it is likely cash will decline in Q2.

We continue to actively manage expenses and CapEx, working towards the goal of being profitable and generating cash during the second half of 2018.

Please be aware that our $150 million convertible debt matures in Q2 on June 1,2018.

We are proceeding with our plan to settle this debt with cash at maturity and intend to secure an instrument to provide us flexibility in the short term to accommodate working capital fluctuations.

We do not plan to immediately issue a new long-term debt instrument.

In conclusion, our recovery is steadily playing out as the substantial investments we made in our refreshed portfolio are driving top line growth and bottom line improvements.

As Tom conveyed, we have several promising opportunities on the horizon, though may encounter some headwinds along the way.

While we remain focused on winning key opportunities with existing and new customers, as is typical for us, we do not have sufficient visibility today to pinpoint exactly when they will finalize and to what extent they will benefit the business in 2018.

Overall, the full year is setting up fairly well for us financially.

With our expectation being low teens revenue growth, gross margins solidly in the low 40s and OpEx steadily declining over the course of the year, my expectation continues to be that we will return to Non-GAAP profitability during the second half.

Longer term, I'm optimistic we will continue to execute on our plan of growing market share with our refreshed product portfolio, driving a faster technology cadence and leveraging our technologies and operating structure to grow margins.

With that, I'd like to turn the call over to the Operator to begin the Q&A portion of the call.

(Operator Instructions).

Doug Clark, Goldman Sachs.

My first one is just on the product cycle.

You mentioned that in terms of product revenues, ICE4 is now nearly 30% of total sales.

Do you have any expectation on how high that's going to be by the end of the year?

And how are yields looking on the ICE4 at this point?

Yeah, Doug, so our expectation is that will continue to grow as a percentage.

How much so will depend on how fast service providers adopt the new ICE4 line cards for the DTN-X and the XT-3600.

But you should expect it to continue to grow over the course of the year.

And from a yields perspective, obviously the products we released last year and the products we're releasing now are based on the same optical engine.

So yields are in a fairly good state at this point.

And we've gotten to where we can enhance those yields faster than we have been able to in previous generations.

Okay, then my follow-up is, Tom, you mentioned kind of the pricing dynamic and competitive situation a little bit.

I mean optical systems is just a competitive market always, so I'm wondering if your commentary is signaling something incremental?

And if so, where are you seeing that from?

Is that from competitors coming out with 400 and 600-gig solutions themselves or is it a customer by customer basis?

Yeah, you're right, Doug, this is always a very competitive market.

It's been overserved for a decade or more.

I think what's a little bit different this time and we're putting it out, is we're continuing to see normal type of pricing pressures in general, but we are seeing some of the larger, more traditional optical people I would say being hyper-aggressive on some of the I would call it more important deals that are in the world.

There's a number of deals that are in play right now, both with some of our current customers and also some not customers that we're trying to win.

And we're seeing very, very aggressive pricing from some of the larger guys.

I don't raise it up because it scares us to death, I raise it up because it is a little bit of a new dynamic and I think that there is a little bit of a land grab mentality going on.

I think that with our ICE4 product offering, even at volumes today that are lower than we would anticipate and lower than we've had historically, our margins are certainly among the best if not the best in the industry.

So we have aa structural cost advantage as we continue to ramp ICE4 through the year.

I think ICE4, Brad is correct, it will grow as a percentage of our revenue through the year.

I think in Q2 it will be bigger than it was in Q1, so I'm excited about not only the volume, but the cost structure of a company that comes down.

But it continues to be an overserved industry.

The good news is, there is a ton of bandwidth demand out there, so there lots of opportunities.

But it's a bit of a hyper competitive place right now with more traditionally larger competitors.

Dmitry Netis, William Blair.

Nice quarter by the way, and margins as well.

So as we look into the second half, I want to delve on that a little bit.

Your guidance of being up 2% to 4% over first half implies a pretty nice ramp versus kind of the flat number that you've been sort of projecting at the start of the year.

So I take that as a good news.

Now help me square that with some of the comments you made as far as the limited pipeline in the second half in terms of opportunities that you're pursuing.

If you could just give a little bit of color on what that means and what gives you pause.

I mean it's still directionally better, but yet you're frankly some caution.

Are you just being cautious or is there something else going on?

No, and Dmitry, you said an important word, you said limited pipeline.

And that is not what we're trying to imply.

We have a very, very large pipeline.

As I've said, there is a number of substantive opportunities around the world that we are participating in.

The only difference is, we walked into this year with more than pipeline, we walked in with purchase commits from a couple of customers who were doing very specific builds.

And that's a lot more deterministic than pipeline.

I feel very comfortable with the pipeline, we just haven't won those yet.

Do I believe we'll win our fair share?

I do.

Do I believe ICE4 is being well received?

I do.

A couple of the customers, I said we can't name them yet, that we won, they will start materially impacting in 2019 but they will have opportunity in the second half.

There's a couple of more customers that I feel very comfortable in the next couple of months we will close down.

So please don't interpret that it's a small pipeline.

It's a healthy pipeline with just not as much fidelity as we had at the beginning of the year on specific customer deals.

That's super helpful.

My follow-up would be more on the metro side.

Again, it sounded like metro came in nicely.

You had mentioned mostly European deployments, so I'm trying to square that away as well.

Is it just refresh that you kind of enacted with the legacy transmode box where you refreshed to the new line cards that's driving all the demand?

Or is it something broader than that that you will see as you progress through the year?

Especially kind of the initial goals you set out in cross selling into the North American customers and kind of expanding the share in the metro.

So I was just trying to get a sense if that's moving along the direction that you set out a couple of years ago.

We're off track certainly from what we set out a couple of years ago.

Part of it clearly is we were late on 16QAM in that space and that was important.

I'm excited about the fact that we've now won 25 XTM upgrades to 16QAM.

That's winning some new customers, it's also some customers upgrading.

But most of the revenue that we're getting right now is not yet from the upgrade.

I anticipate that we'll have a big upgrade opportunity over the course of this year, probably in the second half of this year as some of the larger customers evaluate the product and look to upgrade.

We are seeing some cross-win opportunities with the XTM.

It took longer than we certainly thought and it's actually playing an important role in being able to provide end to end growth.

It also is a great well received packet solution for the metro.

I mentioned we won a large European metro.

We just closed that deal and that will start having revenue impact in the second half of this year and it's fairly substantive.

So I do think we are making progress in the metro.

It is certainly behind what we had thought when we bought the company, but it is a well-received product, and as long as we make sure we don't fall back on the technology again, I think we're going to do fine there.

Certainly part of an important play as we talk about high density metro, our access.

I think that technology that they have is partly what we're bringing into the fiber-deep initiative.

Michael Genovese, MKM Partners.

Can you give us more detail on your 10% customers in terms of how much percentage of revenue they each were?

Yeah, so the large cable company was 29%, the Tier 1 was 11%.

My other question is about the ICP market.

We've seen CapEx numbers recently from the large ICPs just off the chart, very, very 100% year-over-year growth, very strong percentage of revenue to CapEx going way up.

But it sounds like you're seeing limited opportunities in that market.

So what's the competitive environment like or what's the pipeline like in the ICP market?

Is there some variability on your outlook?

Could you win new customers or win some customers back, some share back?

Just talk more about ICPs please.

I'll make the first comment and then Dave or Brad, if you want to comment.

We're seeing certainly some opportunity.

In Q1 we had a very strong opportunity with ICP and it's being, ICE4 has been well received, both the CX2 and the XT-3300 platform.

It is a very, very competitive space as you know.

I think that where we have had an incumbency, we're in a better spot than where we are trying to break in.

I think that it is a little bit of a lumpy business and everybody experiences that, but breaking in I think to some of these new ones, we are having more of a challenge with ICE4.

I think a lot of the opportunity will come with ICE5, because if you are a bit late on the technology, and with 16QAM we were a bit late, it's pretty tough to get back in when they have a fairly short cycle.

So I think our ICE4 reception has been good, our customer traction has been good.

I see in the second half more of a challenge of increasing that growth.

Yeah, just to add some color, Mike, two of our big ICP customers as you saw were in the top 5. So they are growing nicely, adopting a lot of the ICE4 solutions.

Obviously we've talked in the past about some of the challenges with one of our historic large ICPs, but we continue to win more and more customers in the ICP space.

They are big household names, but they are not buying in big volumes yet.

But I think over time they will prove to be important customers.

But Tom is right, some of the bigger folks that we would like to grow with, we'll probably have to wait until ICE5.

We do continue to expect to win business with one of those large ICPs, who has not been a customer historically, likely sometime in the second half.

Simon Leopold, Raymond James.

I wanted to see if we could talk a little bit about the cable vertical in terms of what to think of as normalized.

I understand you had a large project this quarter that gave you the good visibility.

My assumption is that that's part of what's continuing to contribute in June.

But I guess we're thinking about the fiber-deep initiatives and overall cable infrastructure spending.

What should we think of as a normalized expectation for that market vertical for you guys?

Simon, you mean in terms of growth rate or size of revenue?

I'll take whatever I can get.

But I'm thinking in terms of percent of revenue overall.

But certainly, any color you can give on the growth rate, your exposure to those kinds of initiatives.

On one hand, I'm imagining you might be a leading indicator and therefore you're going to be up front, this may not be sustainable.

On the other hand, I could paint a picture that's more bullish that says that this is just the beginning of a longer-term spending trend.

Yeah, so I'll answer your question, Simon, then I think Tom or Dave has some color.

So cable historically has been 20%-ish of our revenues.

Obviously in Q1 and anticipating in Q2, it will be quite a bit bigger than that.

The expectation though was and continues to be that the first half will be the majority of the revenues.

We still expect some spend in the second half, but nowhere near the size in the second half that we've had in the first half.

You are right to assume that we are very well positioned in the cable space.

So as the fiber-deep initiatives continue to get more and more attention, that will be a good thing for us in many markets around the world.

Is there some way to think about it longer term beyond this year?

I think there's 2 ways to look.

There's in my mind, how much does cable spend on optical transmission?

And then what is Infinera's share of that?

My view is that cable over the next several years is going to increment their amount of spend on fiber or transport nontrivially.

That's for backbone, it's certainly for the metro access and it's for high density metro.

I think cable is a space that is going to have for our industry a lot of opportunity.

Our job then is to go in and expand our presence.

Clearly we have a couple of very good accounts in North America.

We are continuing to work on new opportunities both with them and some new footprint wins.

And we're also well positioned in Europe with a couple of the cable providers.

All of them are looking at significant capital cycles over the next 5 years as driven by high density metro which carries capacity then through the course.

So I think as an industry, it's going to grow a lot probably as a percentage.

Our job obviously is to go and win some new opportunities.

I think our business can be healthy with them without winning new opportunities, but the opportunity really is where we are working hard to capture some of these new architectures that are being deployed.

That revenue probably won't be really apparent until 2019.

One quick clarification if I might, and hopefully this is very simple.

I'm calculating the services gross margin in March at just over 58% which is a step down from where you've typically trended.

One, did I calculate that correctly?

And two, was there something to explain the significant drop-off if I did?

Simon, as usual, your math is correct.

The 2 things driving the little bit of a tick down there is we mentioned the impact from the adoption of 606.

A portion of that is very high margin services revenue that goes away.

The other piece is a little bit of a worse mix in terms of the deployments we did, so a little bit lower margin deployments in the quarter.

Thanks for taking my questions.

Dave wanted to make one comment on this.

Yeah, just following up on your previous question on the cable space, two things to note.

We're seeing a greater penetration in access plays on some of our product lines and this is coming out with, as Tom mentioned, coming to fruition in some of the opportunities that we've had with the transmit portfolio.

Historically we've always had 3 out of 4 quarters there would always be an MSO or a cable guy in our 10% customer list.

We expect that to continue on, but we expect to be more better positioned for some of their access plays in the coming years.

Jeffrey Kvaal, Nomura Instinet.

I'm hoping to follow-up on the gross margin outlook that you provided.

I think I would love to know how quickly you expect the gross margin structure to get back to that upper 40s or even 50% level that you were at not that long ago, two years.

Your revenue levels aren't that that much below the mid-200s level or won't be by the end of the year that they were two years ago.

So I would have thought that there might have been more progress on the gross margin line than the 43% number, Brad, that you threw out at us.

Thank you.

Yeah, so Jeff, you know, we believe over time that we can still get back in the high 40s and north of 50 again.

It's just going to take more time.

We've talked about scale being very critical for us.

That scale is driven by new customers and new opportunities which come at a lower margin initially.

So if we just wanted to just harvest the business we had, we could be back there very quickly.

We think a better return for our shareholders is actually growing revenue at a very nice clip with margins that are a little bit lower.

So that's been our approach and will be our approach going forward.

But as we continue to scale the revenues, you get more leverage in the fab, as we continue with our faster cadence, you will continue to see that expand.

But we are very mindful of still wanting to grow the revenues at a faster than market clip while maintaining very strong gross margins.

Okay, so the implication there is that as we project your revenue growth into 2019 or even beyond, we should not use that $250 million run rate in order to get you back to a 50% margin, that it's going to require a higher revenue level this time than it did in 2015 or 2016, what number that was?

Yes.

Vijay Bhagavath, Deutsche Bank.

This is Brian on for Vijay.

Thanks for taking the question.

On long-haul optical, are you seeing more demand for capacity replenishment?

Or is it for new network capacity?

And I'll sneak in my follow-up here.

How do you see the APAC business sort of ramping through the rest of the year?

Long-haul, it's quite frankly a mix for us.

I would say in Q1 we had a little bit more fill of network than we've had over the last couple of quarters.

The last half of last year we had a significant number of new footprint wins.

That lowers the margin a little bit, but it assures a growing revenue stream of margin over time.

In Q2 we forecast actually going back to a little bit more footprint wins.

I am actually seeing a good mix of both footprint and capacity add right now which doesn't surprise me, because quite frankly, bandwidth demand is growing pretty pervasively across lots of applications everywhere.

Subsea, long-haul, certainly metro regional.

So I think it's a reasonable balance right now.

I'm more interested quite frankly right now in winning footprint when we can.

That allows us a long-term growth model.

The second part of your question was around APAC.

APAC is a little bit of a mixed model.

Certainly, we participated in APAC.

APAC last year had a very strong year, a lot driven by Subsea.

We are going hard again after some opportunities that we see in India.

We have really not participated much in India over the last few years.

We think that we have some opportunities to go and use our ICE4 technology in that market.

We bring some great capacity or capabilities that they really like.

They like our ease of use, they like our Open ICE.

I think that we need to go hard into the India market.

It's going to be a market that grows for a long time and I think that the India market is actually ripe.

The customer base is interested now in having a diversified supply base.

They've been pretty narrowly focused.

I think it's our opportunity to go in there and try to earn some of that business.

Meta Marshall, Morgan Stanley.

The first question is just on the DTN-X and how are you seeing kind of customers decide whether to upgrade with the DTN-X or maybe look at 3300 or 3600 options?

And then second question, just to kind of triangulate from Doug and Mike's question, is the vast majority of the pricing pressure you're seeing in the DCI market or is it kind of across in maybe some accounts where you might be approaching them with Open ICE?

Thanks.

We're seeing a mix of customers in regard to DTN-X 3600 and 3300 and a lot of customers are actually buying the suite of that package.

The DTN-X upgrade is a wonderful way to take a DTN-X network and basically upgrade it to double the capacity.

They use the same basic infrastructure, same chassis, so it's an in-service type of upgrade they can often do.

And that serves for a network topology of rich switching and grooming and full capabilities.

The 3300 often drops off of the DTN-X network going into a metro region.

It's also a wonderful application for subsea point to point or terrestrial point to point.

And the 3600 is being viewed as a great way to connect a long-haul to a metro or sometimes feed into a subsea network.

So we're actually seeing a number of customers who are looking and deploying all 3 of those boxes depending on the specific application that they're looking at.

Dave, did you want to add anything to that?

Yeah, I just wanted to point out, we've talked about this before, a substantive majority of our customers buy meshed networks.

To fulfill a meshed network, you need to integrate the DTN-X within their portfolio.

There are a number of customers that also buy point to point links or networks.

In that scenario, that's where you see a greater take up or a uniquely take up of a 3300 or a 3600.

But you asked about price pressure across the different platforms.

The more the network is meshed, the more the price has to take into account the added value features that come along with managing of a network and like I say, the majority of our customers buy mesh networks.

The greater price pressure is on the people that are really looking at point to point networks.

And we're certainly using Open ICE to mitigate that.

Historically when a network has been somebody's amp, they got all the transponders.

In the open world, I think it's a wonderful way to opening that to competition.

We're going in hard with Open ICE.

And I think one of 2 outcomes with Open ICE happens.

One, we win a new customer.

Two, all of our competitors have to lower their price of a transponder.

I much prefer alternative one, but I'm not horribly disappointed with alternative two.

Jim Suva, Citi.

Regarding some of the political, international against purchasing from say China versus US and some of those trends which has happened, have you seen any share shifts as a result of the political environment?

No.

In the share shift, the political environment, for quite frankly some time now, there has been an active inability for any carrier in the US to carry government traffic across a Chinese supplier's gear.

So this is not something that really impacts us at all right now.

I think the next big impact obviously is the recent challenge that the government has given in regard to supplying ZTE with product.

That really doesn't impact us a lot either.

ZTE mostly sells to China, they certainly sell around the world, but we haven't considered them much of a direct competitor.

I think that from a macro sense, internet demand, bandwidth demand is going to continue to grow.

And if you look at the macro, there are plenty of suppliers that are going to be able to satisfy that demand.

So I don't think that there is a fundamental disruption or opportunity for us because of those actions.

I think a lot of it is going to play out in a larger political stage around trade, etc., and we're going to see what has to happen with that.

In the meantime, bandwidth continues to grow, really Chinese suppliers haven't been and still can't sell telecom gear in North America, and we can't sell gear in China.

So net net, not much has changed.

Then my follow-up is, you mentioned a desire to go into the India market.

Do we need to build in or consider any additional say sales costs or promotion costs or anything that's unique about going into that market versus your corporate average?

Nothing that would stand out on a big picture perspective.

Obviously there are some investments we are making in terms of setting up a services entity there locally, some of those types of things.

But nothing you should think of as unique to winning new business.

Winning new business comes with some amount of investments, but we believe based on our opportunities, they are not out of the norm type of investments.

And these aren't brand new that we're just starting to go after now.

We've had a sales team there now for a period of time as we prepared to bring Open Ice to market or ICE4 to market, we built a sales capability, so we've been in that selling now for a period of time.

I'm hopeful this year that we actually end up having some opportunities and expect to quite frankly.

Samik Chatterjee, JP Morgan.

I just wanted to start out with the revenue outlook, you're guiding for 10% revenue growth for the year.

That does imply that you're outperforming the market, but wanted to understand which segment do you believe most of that market share gain will come from?

Whether it's metro or the long-haul market?

I mean it sounds from the conversation that it is going to be more from metro segment, but just wanted to understand, if that's the case then what's your outlook for recouping some of the share losses in the long-haul market over the last few years?

Just to clarify your comment, our latest comments today would imply a low-teens growth year-over-year.

Quite frankly, it comes across the board.

There's opportunities in metro as Tom alluded to.

There's opportunities in subsea, our metro opportunities.

There's opportunities in long-haul.

There's opportunities across the board.

Obviously one of the drivers of growth for us in the long-haul side of the business is recovery from some of our customers who went through M&A activity.

So that's not necessarily a net share gain for us.

But as that customer gets through their integration and starts to spend significantly again, they are a big, important customer of ours that will help drive growth there as well.

But quite frankly we're seeing opportunities across the board.

ICP, as Tom mentioned, is very critical for us.

We mentioned the opportunity in the second half with the big new customer, and as we bring out ICE5, I think there's even more opportunities there.

So with a much broader portfolio of products right now, we are seeing a lot of opportunities.

Tom has mentioned Open Ice.

Open Ice has allowed the speed to new opportunities to be significantly faster and it's opening up a lot of eyes and I think that will drive growth over time as well.

Just a quick clarification on the gross margin outlook for 2Q.

I think you're sort of implying a sequential decline or deceleration there in the gross margin which seems to come from the footprint gains at lower margins initially.

But just what are you embedding in terms of the rollout of ICE4 for your 2Q outlook?

Trying to get what the upside and downside there is from the adoption of ICE4.

Sure.

So we expect ICE4 adoption to continue to be strong.

Obviously it has a better cost structure for us, so that is a continued good thing from a margin perspective.

But that will be offset by both new customers and new footprint that we plan to deploy in the second quarter.

Alex Henderson, Needham.

I was hoping you could talk a little bit about whether the FX moves that we've seen over the last 4 or 5 months have started to have any impact in the international market in terms of competitive dynamics?

Seeing some pretty good numbers out of some of the European players.

And then second, all on the same lines, are you seeing any change in behavior out of one of the medium sized companies in the private market that has been under such stress financially in terms of its pricing behavior?

Has that started to moderate at all or are they still behaving aggressively on price?

So Alex, to touch on the first part of our question, there is some impact to FX.

But it all tends to wash itself out when you're in competitive deals.

So it helps us in certain places, it hurts us in other places.

The customer you're alluding to, and you did a nice job of dancing around it, continues to be very aggressive.

They continue to be in many of the deals that we're looking at and continue to be very aggressive.

We like our positioning against them, but they tend to put pressure on the price side of things.

The pricing model, pricing generally, would you describe it -- late last year you said it was extremely aggressive and going into the first quarter you said it had moderated.

It was still aggressive, but not anywhere as bad as it was last year.

Is that still a moderating trend at this point?

I would say, Alex, overall it's fairly moderate, fairly normal.

But what Tom was alluding to is there are cases where we're attacking a customer, a new customer with Open ICE for example, some of our competitors who historically haven't been as aggressive are very aggressive to protect those customers.

And as we have new opportunities with our customers where they may get invited, they're being very aggressive as well.

So I would say overall it's fairly similar to what we talked about the last couple of quarters, but on specific deals we have seen some of those competitors go hyper-aggressive.

David Williams, Drexel Hamilton.

I guess first off, are you -- can you kind of give us an idea maybe where you're seeing the greatest degree of demand from a geographical standpoint?

And maybe how you think that shifts over the course of the year?

Certainly.

Our market presence, so we're still disproportionately North America heavy and we're seeing a lot of demand in North America.

Clearly our cable customers are, even though our Tier 1 has gone down in business, we still see substantive demand.

We see demand actually from our old XO network increasing capacity.

There's relatively healthy demand I would say in North America.

LatAm continues to be under significant pressure for us particularly because of I think a bit of a standoff between Tel-Mex and the government.

And until that gets resolved, I don't think they're going to buy much.

I think there's a huge amount of opportunity there when that resolves itself because there's just no network been built for like a year and a half.

And that's creating a huge amount of pent up I think opportunity for that country.

I think EMEA has been relatively medium, not up and down a lot, probably 4% to 5% growth as a market this year, but I do think we are having some good inroads into new markets, particularly in the metro, that we have not been as successful in historically.

And I do think there's real opportunity there.

APAC will continue to grow at the world level more than anybody else.

And we're certainly not going to participate clearly in the China opportunity, but I do think India is going to be a long-term investment opportunity that will probably lead the world in capacity growth over the next 5 years.

We need to go and win our fair share of that.

I think with ICE4 and our technology cadence now, we have that opportunity and I actually think it's a perfect time.

Because there's been couple of people who have done first market winners and as I talk to these customers, they are maturing into wanting to make sure they have a dual vendor strategy.

I think we're an ideal dual vendor strategy for that market.

So that's kind of my view.

And then in the past you've talked about maybe a third of your product portfolio being rolled out into your TAM.

What percentage I guess would you say is, of your product portfolio, is active and new and how much of your current TAM do you think you are covering with your current products?

If the comment you are referring to is with the CX2 and the XT-3200, those products are targeted primarily at the ICP customers and some of the cable folks.

So that was about a third of it.

As we bring out the 1.2 terabit line cards for the DTN-X, that brings in several of the service provider customers.

And then as we bring in XT-3600, there is more and more opportunities with those customers as well.

So we're probably covering I would call it ballpark 70% to 75% of our current available market today with our current releases.

And that's going to grow much higher as we get the 3600 out.

The bulk of our market opportunity from a revenue perspective is in the DTN-X, the CX and the XT.

And the one thing just to remember about those types of customers, obviously there's more testing involved, it takes longer for them to ramp up.

But we are addressing a much bigger portion of those customers than we have in recent quarters.

Ladies and gentlemen, this concludes our question and answer session.

I would like to turn the conference back over to Tom Fallon for any closing remarks.

Thank you all for joining us today and for your questions.

We look forward to updating you on our continued progress.

Have a great day.

Thank you.

The conference is now concluded.

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