Infinera Corp (INFN) 2019 Q4 法說會逐字稿

Welcome to Infinera's Fourth Quarter and Fiscal 2019 Conference Call.

(Operator Instructions) Today's call is being recorded.

(Operator Instructions)

I would now like to turn the call over to Lauren Sloane, Investor Relations for Infinera.

Lauren, you may begin.

Thank you, operator.

Welcome to Infinera's Fourth Quarter and Fiscal Year 2019 Conference Call.

A copy of today's earnings and investor slides are available on the Investor Relations section of our website.

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

Today's call will include projections and estimates that constitute forward-looking statements, including, but not limited to, statements about our business, plans, including our product road map, sales, our growth, market opportunities, manufacturing operations, products, technology and strategy, statements about the current status of our integration plans and expected synergies and efficiencies, the impact of the coronavirus as well as statements regarding future financial performance in our first quarter and fiscal 2020 outlook.

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

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

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

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

Pursuant to Regulation G, we have provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in our fourth quarter and fiscal year 2019 earnings release and investor slides, each of which is available on the Investor Relations section of our website.

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

Good afternoon, and thank you for joining us today for our fourth quarter and fiscal 2019 earnings conference call.

I'll start with a brief review of our Q4 and year-end performance, share some highlights from this past year and review the opportunity we see as we launch into 2020.

Nancy will then cover our Q4 and fiscal year results in greater detail and provide additional perspective on our financial outlook, with David joining us for Q&A.

2019 was a year of significant accomplishment in creating a new app scale leader in the optical networking market.

Our progress is marked by achievements in 4 key areas.

First, we made significant improvements in our financial performance, ending the year strong with solid Q4 results.

Non-GAAP revenue for the quarter was $386 million, exceeding our guidance range as customer demand remained robust in the quarter.

This represents revenue growth of 15% year-over-year and 18% quarter-over-quarter.

In Q4, non-GAAP gross margins came in at 35%, and non-GAAP operating margin improved to a positive 2.3%, as we achieved our goal of exiting 2019 with non-GAAP operating profitability for the quarter.

For the year, our non-GAAP revenue was $1.32 billion.

With new orders exceeding shipments for both the fourth quarter and the year, we entered 2020 with a healthy backlog.

Second, in Q4, we completed the integration of Coriant and met or exceeded our integration year 1 goals, laying the foundation for improved operational efficiencies as we move forward as an app scale company with a leading end-to-end portfolio.

Third, our portfolio of products and services enabled us to win 10 new Tier 1-scale customers in 2019.

We view these wins as important validation of the value we now bring to the market and believe our portfolio positions us well for continued growth.

Lastly, while cutting costs, we increased our investment in differentiated optical technology, positioning us to lead in the emerging fifth generation 800-gig DSP market and laying the foundation to create an entirely new market category with XR pluggable technology.

With 2019 behind us and the heaviest lifting of integration complete, we believe we are entering 2020 with our business on solid ground.

With this infrastructure in place, we are now sharpening our focus on 3 primary objectives.

First, improving our business model through fully realizing the benefits of the synergy actions executed during 2019 and continued focus on operating efficiency improvement.

Second, crisp insertion of new products into key markets that are transitioning to next-generation technology.

And third, driving revenue growth as we benefit from our expanded customer base and technology position.

Leveraging our new enterprise-wide planning systems and integrated product portfolio and rationalized manufacturing capability, we are well positioned to elevate our operational performance to deliver a leading customer experience and improved financial performance.

Nancy will review our plans to achieve these objectives during her prepared remarks.

In parallel to driving operational improvements in the business, we plan to deliver innovative solutions in 2020 that are well aligned with the major industry trends.

These trends are driven by continued growth in end-user bandwidth needs and the new network architectures required to economically support this demand.

Our product road map is aligned to deliver an array of disruptive solutions for 5G, fiber deep, edge compute and traditional high-capacity optical transmission, creating insertion opportunities today for the largest network transitions our customers are initiating.

Specifically, we are poised to deliver differentiated customer value in 3 main areas and address the most significant trends: the move to ever higher optical capacity that leverages our unique vertical integration to achieve the performance disruption and dollar per bit leadership mandated by the network economics of increasing bandwidth requirements; driving to open and disaggregated network solutions that leverage our heritage in both optical leadership and carrier-class IP solutions and that enable our customers to bring innovation-restricting vendor lock-in that inhibits their ability to build more flexible and efficient networks; and implementation of practical automation that enables our customers to build and easily operate highly scalable and efficient networks in an increasingly disaggregated environment.

As I touch on these topics and the underlying technology transitions that create opportunity for Infinera, I will highlight specific customer successes that have contributed to our business momentum as we enter 2020.

This year will mark an important milestone in high-performance optics with the transition to fifth generation DSP, 800-gig capable technology.

With fifth generation technology creating significant performance and cost advantage for customers, we see a tremendous opportunity for Infinera to grow market share while also expanding our margin through our vertical manufacturing advantage.

Vertical integration historically used to reduce cost is now an enabling capability that we see significantly limiting the number of viable competitors in the high-performance optical market.

High-capacity optical transport is a multibillion-dollar market.

As we consider our opportunity, a few observations drive our view.

First, we do not see commercial optical components being broadly available for 800-gig until late this year or 2021.

By designing and manufacturing our own DSP and optical components, we expect to deliver 95 gigabaud fifth-generation optical systems to the market before commercial components are widely available.

Further, we see commercial DSP manufacturers universally prioritizing 400-gig ZR.

This creates a scarcity in sources of supply for 800-gig technology and opens a tremendous opportunity for those that are vertically integrated and early to market.

Finally, our years of experience with vertical integration will create incremental value at high speeds as key capabilities we developed previously, like Nyquist subcarriers become mandatory to achieving leading optical performance.

We remain on track to deliver 800-gig product during the second half of this year and expect revenues to ramp in 2021.

In addition to ongoing customer demonstrations and trials, we are excited to be showcasing the performance advantages of our ICE6 optical engine at OFC in March.

The evolution to open and disaggregated architectures represents another important insertion opportunity for us.

In the fast-growing compact modular market, we continue to build upon our success with the 600-gig capable Groove platform.

We added over 60 new Groove customers in 2019, and bookings for Groove grew more than 200% year-over-year.

This product is being broadly adopted by cloud and service providers globally and continues to be a key contributor to our strong bookings outlook.

At OFC, we will be introducing expansions to the Groove series, including the addition of our ICE6, 800-gig optical engine.

With the optical engine representing a majority of the cost of purpose-built platforms, we anticipate our unique vertical approach will deliver a cost structure that significantly leads the industry for 800-gig, positioning us for market share wins and simultaneous expansion of margin.

ICE6 in a DCO form factor for easy reuse will then be extended across other platforms in the future.

The transition to disaggregation is now emerging at the IP edge.

Many customers view a disruptive approach as mandatory, given that traditional economics are not viable with the increased bandwidth requirements at the edge.

In 2019, we announced a nationwide deployment at Telefónica Germany with our DRX disaggregated router, and we are now in the process of rolling out this solution in 3 additional Telefónica properties.

Additionally, our cloud pipeline for the DRX and field-proven carrier-class CNOS routing software remained strong and over 20 trials completed in 2019, with committed deployment plans from 2 additional customers.

Further, in combination with the XTM series and Transcend, we have a powerful multi-layer packet edge solution optimized for 5G and DAA applications.

Lastly, the growing importance of automation is creating new opportunities for us as our customers contend with the increased operational cost and network complexity that comes with bandwidth growth and dynamic traffic demands.

Our migration services win with Verizon last year is one example of the value our Transcend automation and virtualization capabilities provide to our customers.

With a full suite of app-based automation applications in our Transcend software portfolio, our practical, easy to implement approach to automation is gaining meaningful traction with customers.

We added 9 Transcend customers in 2019 with deployment applications ranging from network migration and Layer 0 restoration to real-time planning and automated service provisioning.

We intend to build upon these software automation successes as we progress in 2020.

Looking beyond 2020, we continue to be excited on the market potential for XR optics, a unique innovation we introduced at the end of last year, and which is on track to creating an entirely new market category.

XR optics is the industry's first point to multi-point coherent optical subcarrier technology designed to break the inherent limitations of traditional point-to-point optical transmission solutions.

While XR technology can be used to replace ZR and ZR-plus functionality in point-to-point applications, only with XR can customers create true optical networking function at the pluggable level.

Our recent announcements with industry leaders highlight growing interest in this disruptive approach to network transformation, and at OFC, we'll be showcasing our XR optics' progress with a live demonstration of the technology.

Our innovation pipeline is key to achieving our third key objective for 2020, growing revenue with our expanded customer base.

Building on our recent successes and continued traction with Tier 1, ICP and enterprise customers, we see significant opportunity for driving revenue growth through expansion of business with our differentiated end-to-end portfolio and disruptive innovations.

Before concluding my commentary, I would like to address the coronavirus situation.

Like other technology companies with global supply chains, we are closely monitoring developments on a daily basis, are working actively with our suppliers and are developing contingency plans to mitigate potential disruptions.

While we have very limited exposure from a customer perspective, our supply chain does include some risk for material either sourced directly by Infinera or indirectly through some of our supply partners.

The situation in China continues to evolve and due to the unknown duration and magnitude of the coronavirus outbreak, it is too early to fully assess the projected impact on our ability to service our customers, but we do expect some impact in the first half of this year.

Nancy will provide a preliminary view in her guidance.

In summary, we had strong results this quarter and are pleased with the momentum we are seeing in the business following our integration execution in 2019.

With 10 Tier 1-scale wins in 2019, growing bookings, healthy backlog and an innovation pipeline targeting key markets in transition, we see the opportunity to gain market share and grow our top line in 2020.

With a growing scarcity of competitors having the experience and expertise to deliver differentiated, high-capacity optics, we believe the foundation is in place for us to begin making significant progress toward achieving our business model expectations.

I would like to extend my thanks to our customers, partners and shareholders for their continued support and confidence in Infinera.

I especially would like to thank our employees for their continued dedication and commitment to our success.

With that, I will turn the call over to Nancy.

Thanks, Tom, and good afternoon, everyone.

I will begin by covering our Q4 and full year 2019 financial results and then discuss our strategy for additional operational performance improvements, followed by our guidance for Q1 2020 and commentary on the framework we are using to measure our progress this year as we move toward our target business model.

For your reference, we have posted slides with financial details to our Investor Relations website to assist with my commentary.

Q4 non-GAAP revenue increased 18% sequentially to $386 million, exceeding our guidance range of $355 million to $375 million.

Revenue growth was driven by the adoption of our expanded portfolio across an increasingly broader customer base.

We are seeing a healthy mix of customers on our top 10 list, representing Tier 1s, ICPs and cable operators.

This diverse customer mix, coupled with our expanded product portfolio is one of the key outcomes of the acquisition that will continue to benefit the company over time.

We had 1 10% customer in the quarter, a Tier 1 customer that has consistently been above 10%.

We also had a leading cloud provider whose business we won in 2019 that came in just under 10%.

Our geographic mix continued to be skewed more toward North America, driven by strength from our ICP customers with 52% of revenue coming from that region.

Non-GAAP gross margin of 35.2% was at the midpoint of our 34% to 36% guidance and up from 33.1% in the prior quarter, benefiting from our transition to a variable system manufacturing model.

Margin growth was somewhat countered by significant growth in revenue from customers deploying our Groove platform, which currently relies on third-party merchant optics versus our vertically integrated subsystems.

Another factor was the continued growth in the quarter in our line system.

While these initially create margin pressure, the new footprint lays the foundation for higher margin fill growth in the future.

Moving now to operating expenses.

In Q4, non-GAAP OpEx was $127 million at the midpoint of our $125 million to $129 million guidance range.

We continue to focus on improving operational efficiencies as we maintain appropriate investments in key technology platforms, driving our innovation pipeline.

At the same time, we are working to bring our overall operating expense model to one that is prepared to scale with the launch of new products later this year.

In Q4, we recognized $8.8 million in non-GAAP operating profit or 2.3% non-GAAP operating margin and non-GAAP EPS of $0.03.

We are pleased to have achieved both non-GAAP operating profit and EPS in Q4, just 1 year following a significant and complex acquisition.

Non-GAAP revenue for the year ended December 28, 2019, was $1.32 billion, with non-GAAP gross margin of 33.6%.

We reported a non-GAAP operating loss of $82.5 million and non-GAAP EPS of $0.60 loss.

As a reminder, due to the timing of the closing of the Coriant acquisition, we don't believe a full year 2019 to 2018 comparison is meaningful, although it does demonstrate the significant scale we have added.

Turning to the balance sheet.

Total cash and investments finished the quarter at $133 million, up from $120 million exiting Q3.

We ended the quarter with no additional net draw on the ABL.

And during the quarter, we added $50 million to our ABL, bringing the total capacity to $150 million.

We anticipate that we will continue to utilize this low-cost ABL facility for liquidity management, particularly to support revenue growth and operational improvement efforts.

In total, we are very pleased with our Q4 financial results.

Now before moving on to discussing guidance, I will first share some key initiatives we are undertaking in 2020 as we continue to focus on operational improvements.

I view these efforts in 3 categories.

First, supply chain optimization.

We are focused on driving improvements in our planning, logistics and fulfillment processes.

These processes will be enhanced to create a leading customer experience around service levels and delivery while providing a base to improve our cash conversion cycle and operating expenses.

This is an important project as we prepare for the demand growth expected in the second half of 2020 and into 2021.

Second, working capital improvements.

One of the most important outputs of an improved supply chain optimization process is the resulting improvement in inventory turns.

We averaged 2.6 turns in fiscal '19 and exited Q4 with 2.9 turns.

It is imperative to improve this metric as it creates the opportunity to generate significant incremental free cash flow as we grow.

As a point of reference, in Q4 of 2019, if we had 1 additional turn, we would have generated $85 million in cash.

Additionally, we are focused on process and automation improvements to accelerate our order to cash process, improve upon our cash forecasting capabilities and work to decrease both DSO and DPO.

A 5-day improvement in DSO during Q4 of 2019 would have driven $20 million in cash improvement.

Third, vertical integration and margin expansion.

Today, a heavy reliance on third-party commercial components puts pressure on our gross margin.

We are executing a 2-step process to enhance our cost profile.

In the first half of the year, we will work to begin migrating our largest 200-gig customers to our 600-gig technology offering, which leverages tight integration of a commercial DSP with our own internally developed optics design.

As we reduce cost per bit for our customers, we enable the expansion of our own margins as well.

We expect the biggest needle mover will be -- will occur as our 800-gig technology comes to market with our own internally developed DSP and PIC.

And we are able to deliver vertically integrated products more broadly across our portfolio.

Achieving additional operational efficiencies during 2020 should enable us to improve our business metrics through the year, position us to scale successfully with the launch of our ICE6, 800-gig solution and returned to a more heavily weighted, vertically integrated business model in 2021 and beyond.

I'll now discuss our guidance for the first quarter.

Our guidance for Q1 takes into consideration both the typical seasonality that occurs this quarter as well as the potential impact of the coronavirus.

As Tom mentioned, like many other technology companies with global supply chains, we are actively monitoring and assessing the situation.

Given these 2 factors, we currently anticipate Q1 non-GAAP revenue in the range of $315 million to $335 million, which contemplates a projected $15 million impact from the coronavirus.

We expect non-GAAP gross margin to be in the range of 31% to 34% based on lower projected volume, the continued adoption of our 200-gig Groove product by ICPs and potential cost increases resulting from coronavirus-related risk mitigation.

Operating expenses are expected to increase in Q1.

2 key factors are impacting this.

First, R&D increases from NPI investments as we execute on our innovation pipeline, including our XR optics technology, which had strong customer interest.

The XR program is progressing faster than anticipated as evidenced by our recently announced collaborations with II-VI and Lumentum.

The second is due to standard employee-related expense increases at the beginning of the year stemming from typical resets of bonus and payroll taxes.

We currently expect non-GAAP operating expenses for Q1 to be between $128 million and $132 million.

Finally, we expect a non-GAAP operating margin of a negative 8%, plus or minus 200 basis points, and a non-GAAP EPS loss to be in the range of $0.15 to $0.21.

Our working capital efforts discussed earlier are intended to improve our operating cash flow in 2020.

Although we have marked the end of operational integration, we do have certain onetime cash costs that will carry forward in 2020 from actions taken in 2019.

These include onetime cash outflows related to the restructuring of our R&D operations in Munich, repayment of certain advances made as we transition systems manufacturing to our contract manufacturing partner and retention and integration payments.

These onetime cash disbursements total approximately $80 million in 2020 and are more heavily weighted to the first half of the year.

Excluding these onetime payments, we expect to generate cash from operations in 2020.

Even with these onetime cash outflows, we expect to see meaningful improvement in our cash flow from operations year-over-year.

I would now like to take a few minutes to share my thoughts on the company's target business model and how we will enable its achievement in the coming years.

This target model is built upon the foundational items we have discussed today, including alignment with key market trends fueling growth.

Our pipeline of innovation and the fundamental belief in the value of vertical integration that is at the core of our company.

As we have done in the past, we have shared a visual of the next 3 years in our supplemental information posted to our website.

In 2020, we see the market growing in the mid-single digits, approximately 6%, excluding any extraordinary impact or a material worsening of the coronavirus situation.

We expect our revenue to grow this year above market given the positioning of our portfolio in the fastest-growing segments of the market.

As we continue to win new Tier 1s, lay the foundational footprint, which is important, we're positioned to scale further in 2021 and leverage merchant optics in the group platform at 200 gig.

We expect gross margin in the first half of the year to be slightly muted.

As we transition from 200-gig to 600-gig in the back half of the year and drive further operational efficiencies, we expect to start to see the positive impacts on our gross margin in the second half of the year.

For the full year, we currently expect to generate gross margins 200 to 400 basis points greater than in 2019.

Overall, operating expenses will trend down during the year, with improvements in operational efficiencies being somewhat offset by increased R&D spend to fund our new technologies through the year.

We anticipate returning to non-GAAP operating profitability for the second half of the year.

Looking beyond this year, 2021 will be a pivotal year with the ramp of 800-gig and expansion of vertical integration in our product offering.

While we continue driving operational leverage and manage our key innovation investments, we expect to continue to grow ahead of the market and improve gross margins another 200 to 400 basis points, while moving toward our goal of [non-GAAP] profitability for the year.

As we move into 2022 and are positioned to take full advantage of our vertically integrated ICE6, we expect to continue growing faster than the market and achieve our target business model of gross margins in the mid-40% and double-digit operating profit.

In addition, in the same time frame, we expect to have introduced to the market our implementation of XR optics.

2019 represented an important year for Infinera as we undertook an acquisition that positioned us as an app-scale optical leader, grew our global customer base with 10 Tier 1 wins, expanded a product portfolio that is well positioned for the major inflections occurring in the market and increased our investment in differentiated optical products that will begin to hit the market later this year.

With an unwavering focus on driving operational efficiencies, we also returned the company to non-GAAP operating profitability.

In summary, my thanks to the entire Infinera team for helping us close the year strong, while laying a foundation that will serve us well as we work toward building a highly scalable and sustainable business model to maximize shareholder value.

While work remains to be done, my commitment is to drive the operational efficiencies that will be a critical contributor to achieving our long-term targets.

The talent and dedication that I've experienced working with this team since joining in August, combined with the cutting-edge innovation we are bringing to market, gives me great confidence in the path we are on, and I'm incredibly excited about what the future holds for Infinera.

I'd now like to turn the call over to questions.

(Operator Instructions) The first question today comes from Alex Henderson of Needham & Company.

So you guys have been busy over there.

So I think you've had some time now to evaluate your 800-gig DSP.

I was hoping you could give us a little bit more granular clarity on the degree to which it met your expectations, the degree to which it hits your performance targets, whether the implementation gives you advantages on spectral efficiency and other power characteristics versus your nearest competitor?

And to what extent you're happy with the outcome there?

Yes.

Alex, this is Tom.

So we have been busy.

We've got a lot of great things happening both from the integration work completing, winning a bunch of customers, growing the business and creating a really great portfolio of new technologies.

Obviously, one of the keys is our 800-gig.

And you asked about the DSP, I'm going to transition this conversation kind of up level from that.

We are really so comfortable with the DSP, we're really now working on the DCO and implication into the system.

So I think we're through what I would consider, and you never know until you're all done, but the DSP risk is certainly matching our expectations.

We have internal expectations that it will be leading in the market around optical performance.

Obviously, until we publish those and other people publish theirs, that's our own internal speculation.

But we're pretty confident, both with our approach architecturally and the results we're seeing, that we are going to have a really nice 800-gig fifth-generation DSP solution, planning on showing that at OFC.

So hopefully, OFC will occur, and hopefully, we'll be able to show you in our booth.

Great.

If I could follow-up.

One obvious conclusion here is that you've got a lot of technology coming down the pike, but some of it is a ways in the future before it hits the revenues.

But on the other side of the coin, given XR, given DRX, given the 800-gig performance that you're getting, to what extent are you seeing customers, even before those products are launched, buying into your road map and giving you that extra visibility, that extra push and extra heftier demand even before these products are launched?

Yes.

I think a couple of things.

One, we are having some very, very deep and what we call architectural discussions with a lot of the largest carriers in the world around a number of the technologies.

Clearly, the world wants to move to lower dollar per bit and higher performance optics.

I think that the world is viewing us as 1 of 2 people that will do that this year.

And it is allowing us to have significant discussions around both the technology, but also rollout plans, rollout for data center long-haul and subsea.

And that's what I would consider in the near term.

I met -- I commented on the call in regard to the mobile world and new architectures that our customers are saying are mandatory.

And I'm not making this up, a couple of the largest people in the world are saying, we must go to a new approach because the economics of the old approach are life-threatening.

It's a perfect time for us to be taking our leadership disaggregated DRX and CNOS software that is unique in the world from a perspective of having years of field-proven capability, carrier-class quality into the market.

It is an incredibly right time for that to happen in the carrier world.

And I also think -- the cable guys I don't think are as articulate in saying it's desperate, but they also see the necessity of new architectures that break the paradigm that has been held in the industry for a very long time.

In XR, that is not a 2020 revenue.

But as long as I've been in this business, I have never seen customer responsivity as strong to this technology and -- stronger to this technology than anything I've ever seen.

They are fundamentally viewing this as an opportunity that they can actually rearchitect their networks and save somewhere between 50% and 70% of the costs moving forward.

They start with a degree of skepticism, and within a few meetings, meetings that they're insisting from a follow-up perspective on having, they are deeply encouraging us to hurry this up.

That positions us both as a technology leader, but it's opening incredible doors for us to sell our portfolio today.

So I am incredibly -- this is longer than I should have been, I'm incredibly excited about the portfolio richness of IP we have coming to the market over the next couple of years.

And you can't have a follow-up, Alex, because I talked too much.

The next question today comes from Rod Hall of Goldman Sachs.

This is Ashwin on behalf of Rod.

I just wanted to get some clarification on the 800-gig comment you made, Tom.

I was wondering if you'd clarify the shipping and the availability and the revenue comment that you made that the product will be launching in second half in revenue in 2021.

And I believe last quarter, you probably mentioned that you'll make some customer announcement in first half and potentially ship in second half.

Just wondering if you could clarify the time lines there for us versus what you were expecting 90 days ago.

Yes.

So to be clear, our expectations, we will begin shipping for revenue this year.

I think that's what we said last time.

We will be shipping it for revenue this year.

My commentary in the script was meant to encourage not overreaction of a gigantic spike of 800-gig this year.

We anticipate multiple customers this year, but real revenue growth starting next year.

We will go -- the anticipation with OFC, you'll see the product, we will start trialing that in the middle of the year with revenue beginning at the late part of the year and revenue ramp next year.

If I could just follow up.

Actually, on the -- sort of an unrelated, but on coronavirus impact $15 million.

Should we think about that as purely a supply chain stretched lead time, product lead time related impact?

Or are you giving some kind of a...

Yes.

That's -- as Tom said, that's not top line, supply chain limited, which is why we're able to give you that specific number.

The next question today comes from Michael Genovese of MKM Partners.

Just following up on that last question.

The $15 million impact is higher, I think, than -- more than I would have expected.

So can you just talk a little bit more granularity, where are you going to be supply constrained?

What type of products?

Yes.

So while we don't have any -- yes, thanks, Mike.

While we don't have any of our major CMs in China, I think the industry is looking at its secondary supply as well as tertiary supply impacts of some of our partners who have dependencies on China.

So we have some of our ancillary merchant optics that are coming out of that Wuhan area.

They're very discrete to a certain subset of our products.

We're carefully monitoring and have weekly mitigation calls with our supply chain to ensure that as factories are coming up outside the Wuhan area, and as we have dual source, obviously, like I said, not a large portion of our CMs are in China, that we've got our finger on the situation.

But it's $15 million out of that $325 million, and if you kind of add that to the number, that means it's $15 million out of what might have been a $340 million number.

Okay.

Great.

I guess my second question, I want to ask you generally about the verticals, you've got the percentage of verticals slide here.

Tier 1 at 39% is pretty strong.

So besides the 10% customer, what regions are you seeing strength in that -- in the Tier 1 outside of that 1 10% customer?

And then secondly, when you talk about your gross margin guidance for next quarter, and these lower margin products, which vertical is that?

Is that primarily an Internet content provider vertical type of comment?

Or is there -- are you seeing that somewhere else with 200G as well?

So let's take both because they're kind of interrelated, Mike.

Last year, we were proud and announced the winning of 10 Tier 1s, and you've been in the industry long enough to know that as you win these Tier 1s, we're putting out that initial footprint with them, which obviously has a short-term margin impact, but a long-term benefit for the company.

And so we did see some strong Tier 1 wins here in the U.S., but we also saw them internationally in EMEA, in particular.

And you saw that really across the board, across the portfolio, including what Tom mentioned, as some of our wins with our mobile platform, our new mobile platform that's positioned.

When we look at Q1, and we look at the margin impact of Q1 as we make this transition from 200-gig optics to 600-gig optics to ultimately 800-gig optic, the vertical integration goes from complete merchant optic in 200-gig to partial vertical integration in 600-gig, which has a significant margin impact.

And we've talked in prior earnings calls about when we're fully integrated on those compact modular purpose-built platforms, having more of a 25 points of margin impact.

So what we're seeing is, we're happy to win the footprint now.

We can't wait to bring out that -- we're phasing in 600-gig as we speak, and ultimately, 800-gig because that just allows us to fill up that footprint that we're winning with those Tier 1s in both the ICP sector, primarily today as well as we've seeded that Groove platform in with the CSP sector as well.

Does that answer your question, Mike?

Yes.

David, appreciate it.

The next question comes from Samik Chatterjee of JPMorgan.

Just firstly, I wanted to get your thoughts around the exit run rate for the business in terms of revenues.

You've obviously had a strong end or close to the year here.

But I remember when you first announced the acquisition of Coriant, you were roughly at $1.6 billion of pro forma revenue, which moderated later to roughly like $1.3 billion on the delays you were seeing from award wins.

So if you can just give me a sense of where you think the business is exiting now in terms of pro forma revenues?

And have you recovered most of those award wins that might have been pushed out at that time?

Yes.

I'll walk you through the history because unfortunately, I was part of creating the story that we told.

When we acquired the company, we put them together, and we said 2 companies, $1.6 billion combined run rate.

That was a mistake on my part, candidly because we didn't forecast really a lull that occurred, and it did occur.

We saw Q4 and Q1 bookings that were certainly concerning.

We did feel -- as we talk to customers, it was a lull while they evaluated what portfolios we were going to put together, what products we're going to invest in and what products we would not keep.

We talk about Q2 bookings being very strong.

Q3, I talk about book -- Q3 bookings being very strong and Q4 bookings were very strong.

Our -- 1 of our largest challenges right now as we enter into the year is a significant backlog, and as David talked about, constrained ability because of coronavirus.

Our lead times are longer than people like.

So we did take it down to $1.4 billion, quite frankly, as we exited the year with greater than $380 million of revenue, while growing backlog.

We're pretty comfortable with where we're at from a run rate perspective.

We see not only did the lull that occurred go away, but we won, as David pointed out, 10 new customers, and we are having a very healthy demand across a number of portfolios, a number of markets and a number of verticals.

So we enter into the year with record backlog, and we entered the year with a outlook of bookings that's pretty comfortable.

So I think that the misstep of positioning $1.6 billion, we're probably closer to the $1.4 billion run rate rather than the $1.3 billion.

As you impute, Nancy kind of gave you the market growing at 6%.

And our view is looking to grow above that.

If you think about last year's revenue in Q1 being roughly non-GAAP $295 million, our contemplated guidance even with the muted impact of the coronavirus is still up significantly from that.

So work to do, but again, good backlog in front.

Sure.

And if I can just follow-up related to the road map that you laid out in terms of margin targets from here on, one key difference seems to be that when you had laid out the plan earlier, there was a more significant ramp-up in terms of the margin improvement in 2021 versus 2020 with the big volume benefit coming through.

So if you can just kind of walk us through -- this seems to be -- the new plan seems to be more balanced in terms of the 2020 margin improvement in 2021 versus the old year plan.

So what really has changed there?

Yes.

I think 2 things.

For the first half of the year, as I think Nancy intimated, we're winning more of these Tier 1s, laying the footprint.

On top of that, we've got the impact of our 200-gig merchant integration that is impacting us more negatively on the margin side on the front half that is muting a bit of our operational efficiencies that we're driving.

As you get into the back half of the year, we'll see the ramp-up of the 600-gig vertical integration as well as the impacts of taking the operational efficiencies of the IT system that we've implemented and getting the complete synergies across the portfolio as we exit the year.

And I think we're executing pretty crisply to the plan we laid out.

I would say one delta is that we do think -- I do think 600-gig is probably going to be adopted about 2 quarters later than we had anticipated a year ago.

That has been both from a technology perspective, but also customer certification perspective, about a 2-quarter offset.

The next question comes from George Notter of Jefferies.

I guess I have a few questions, maybe more housekeeping type questions.

But do you guys have a backlog number exiting the quarter?

Or should we wait for the 10-K for that?

I think you're going to have to wait for the 10-K for that, but we are very excited about the backlog that we're exiting with.

That should be out in the next week.

Okay.

Super.

And then also, I know, historically, there's been a lot of moving parts in the cash number.

I didn't see a cash flow statement this quarter in the press release.

And so maybe I can just ask you a few questions to kind of understand sort of the sequentials.

You told us that the ABL, you didn't draw down any cash this quarter.

I assume it's still $30 million drawn or is that 0?

And then also, I know you guys have had liquidity out of the Fabrinet relationship.

Was there any draw on that?

And then any factoring in the quarter?

Just trying to understand sort of the puts and takes in cash.

Sure.

Yes, we exited the quarter with the same amount, $30 million drawn on the ABL.

We did not make any -- we did not have any additional, although we do have -- as you know, there are some advances were made, and I alluded to that in my comments that this year, we will be repaying certain payments that were advanced to us as part of the transition to the vertical model with our CM.

So there's some cash that came out through that in Q4 that will be repaid in 2020.

Got it.

Okay.

And then factoring also -- and then just the other question was just what do you think the cash, is there another step-down in cash?

Or did we see the bottom in September?

So on factoring, when we purchased Coriant, there were certain customers where they did have factoring relationships.

Those have remained, but we have not added any additional to that.

Q1, as we mentioned, will have onetime cash outflows, but excluding those for the year, we do expect to be generating cash from operations.

Q1 will likely be down in cash flow with those onetime cash outflows that we're making.

And those were some decisions and execution that we made last year, George.

The next question comes from John Marchetti of Stifel.

I wanted to go back to the 200, 600 and 800-gig transition for a moment.

As we think about that going through the year, how do we think about sort of 600, 800 as we start to go into '21?

And then just given some of your comments, Tom, on the 600-gig being pushed out by a couple quarters as some of those qualifications took a little bit longer than you originally thought.

Being in sort of total control of the 800, do you think you've got a better handle on those types of qualifications as you look to 800?

Or is there a risk that, that 800 slips in a similar fashion, maybe to later in '21 than you originally think?

Well, I think that the 800-gig is more in our control, and some of the slips were based upon feature sets that were not deployed as originally intended in the DSP.

That caused some of the delay.

At this point, we're very comfortable that our DSP feature set is full to the expectation.

Second of all, we'll be able to and we're starting to work with customers, specifically on the 800-gig, so that there is a known transition.

I see 2 types of customers in the market.

Some that are anxious to deploy the 600-gig today because it helps them with dollar per bit today.

And they buy enough gear that $1 per bit reduction is substantive, particularly when some of them have fairly long certification cycles.

And candidly, 800-gig is not in the market today by us or anybody else.

So there's no certification processes that I'm aware of that have started.

So some range of customers are going to certify 600.

They will start deploying that in volume.

We are selling 600-gig today.

We sold some in Q4, we recognized revenue in Q4.

And we'll also recognize increasing revenue on 600-gig in Q1.

The substantive amount that we see is really in the back half as a couple of large people have committed to certifying it, and they want to have that dollar per bit savings today.

We do see another set of customers who are waiting for 800-gig.

They view the 800-gig as the technology they want to move to, and they don't want to go through the effort of certifying 600-gig.

So I believe that there's going to be a mix of those customers.

We do see a reasonable number going to 600-gig today, and then with 800-gig probably next year because the dollars they can save are too substantive.

Got it.

And then maybe just as a follow-up there.

As you do look out into '21, do you expect maybe a situation where 600 is relatively strong in the first half of the year and that gives way to 800 as we go through the year?

Or is there an expectation that 600 can be a real driver of growth throughout the full year with 800 kind of layered on top?

Yes.

I believe, 600 will have a healthy year next year.

I also think 800-gig will ramp very hard next year by whoever has 800-gig in the market.

The performance delta is nontrivial.

The dollar per bit delta is nontrivial.

And I think that both will do well.

When you introduced 200-gig, how long did 100-gig ramp?

For years.

When we introduced 400-gig, how long did 200-gig ramp?

For years.

These transitions as long as bandwidth continues to grow, as bandwidth is continuing to grow, it allows both the current technology to ramp while new technology inserts and ramps very quickly.

The next question comes from Meta Marshall of

(technical difficulty)

Maybe first question for me.

Maybe, Nancy, how to think of real revenue quantum you think about towards achieving the 10% operating margin...

Yes.

I'm sorry.

We were getting nothing but noise here, Meta.

The next question comes from Jim Suva of Citi.

And the detail so far has been greatly appreciated.

I believe in your prepared comments, you had mentioned for 2020 that you'll outgrow the market, which is quite encouraging.

Any commentary just to help us set the stage, so people don't get overly optimistic, especially with coronavirus in the uncertain macro environment?

As I look at consensus and I see consensus is, ballpark, up around 10% year-over-year for sales to about kind of 1.426.

I was just wondering, is that realistic?

Is that kind of, hey, you want to give us a little bit of remember corona or anything like that because definitely 10% is outgrowing the market, but I also wonder about reality and comfort levels around consensus.

If you can give us any type of guidepost.

Sure.

Yes.

We're expecting, right now, the market to be growing at about 6% per year.

And again, that excludes any material coronavirus impact or any change to what we're seeing right now.

So I would expect our growth to be in the mid- to high single digits.

I think that is pretty commensurate with what's out there right now.

But again, what I would say is maybe a little bit different.

As we've looked at Q1 with the coronavirus impact as David mentioned, our guide of $315 million to $335 million incorporates $15 million there.

Q1's seasonally down.

I would expect us to really see kind of a shift relative to growth in the back half of the year, both from a revenue and margin perspective.

The next question comes from Tim Savageaux of Northland Capital Markets.

Congrats on hitting the operating profitability target for Q4, which is something I think you've hung on to through ups and downs here.

And I want to -- first question on the revenue, second question following up on gross margins.

But really in that context of growth expectations for the year, but I really want to frame it a little bit of a different way, which is, so we ex the virus impact, you've got a quarter you just reported and one that you're guiding to, apples-to-apples that are both up 15% year-over-year.

And while we don't have details assuming the backlog is up, I don't know, 30% plus year-over-year, do you expect something to slow down, I guess, throughout the year?

Or maybe give us puts and takes on that 2, 2.5x market growth that you're seeing this quarter and last relative -- and the backlog growth relative to what's pushing that up and maybe what's holding that back?

And where you come out versus the market there?

Yes.

I'll start and then David or Tom can answer.

I mean just as a reminder, certainly, Q1 is seasonally down, we are seeing that typical seasonal pattern, albeit off a high Q4.

I will remind you, we had challenges in Q3.

We've seen those start to clear through in Q4.

So we're very happy with the growth that we're seeing.

And I think it comes from the adoption of the broad product offering, the growth we're seeing in new customers.

So certainly, mid- to high single-digit growth ahead of the market in an environment right now where there is uncertainty in the first half of the year, I think we're pleased with that.

We're certainly going to drive to execute and really improve on our operational efficiencies in this year as well to start see that flowing through to the bottom line more.

Yes.

I think the additional color I would add there is, if you recall from our comments over the last couple of quarters, we've been talking about as we're winning more Tier 1s, we're winning a lot of these customers that are deploying very, very large projects in multi countries.

And those can take a couple of quarters to go from bookings into revenue, which is another reason you've seen the backlog grow.

So as we've looked across the projects that we plan to complete in the fiscal year, we're contemplating the conversion of the bookings into revenue and feel like that's a prudent number.

As Tom started the call, we want to make sure we're providing the right prudent number as we begin the year and staying cautious as we look at the macroeconomic impacts of what we see.

Certainly, we feel good due to the scarcity of the market and where our innovation pipeline is.

I will add one piece of color to this.

Coriant stand-alone company had some very good technology.

But they were vastly viewed as not going to be able to last in the market, and that caused a number of customers to be reticent of growing the opportunities with that portfolio.

Combined with Infinera, I think we now have a end-to-end portfolio that leverages the best of both companies and the carryover of the concern around Coriant is no longer there.

I believe our customer base and new customers that we're winning see the value that we're bringing, and we are disrupting where their investments are occurring, whether it's in optical or IP edge or automation.

So I think that there is a healthy market in general.

Quite frankly, when I look at some of our competitors' announcements, we're not unique right now in growing significant top line performance in the optical space.

It's a healthy optical market.

I think that our opportunity to differentiate with disruptive optics, 800-gig, XR positions us to not only enjoy a rising tide, but also to position ourselves as a true leader in this industry, bringing new network architectures to the market.

I don't know if I lost my follow-up there on the response, but I'll try and squeeze it in and kind of segue over to margins because I assume part of the outsized growth here in the last couple of quarters is the ramp on the cloud side, although even ex that, at least in Q4, you look to have grown kind of around market rates.

And you mentioned that as an impact on margins.

But if we just kind of level-set from low 30s to mid-40s, kind of where you started Q2 last year to where you intend to get, if we look at those, I think, 3 factors that you've mentioned, which is the contract manufacturing transition.

To what extent are there benefits there still in front of you?

The kind of mid-range vertical integration and then full vertical, maybe give us a sense of the potential contributions of each of those 3 in bridging that gap?

Sure.

So I'm going to actually refer you, and I know it's out on the website, but there is the slide that we have in terms of the path to the business model.

We were trying to put a visual in front of you to show you what is happening in each of these next 2 years, where we see the path to getting to that target model.

And at the back half of the year, as we've talked about seeing some of that margin leverage in 2020, that's really when the 200 to 600-gig transition starts to feed into the model.

At the same time, we're going to be putting just kind of a table stakes, right?

We are not done.

Yes, the integration operationally is over, but we are continuing to pound upon our operational efficiencies and what we're going to do internally to drive a company that will scale with the growth we expect to see in the next 2 years.

So the 200 to 400 basis points this year is really a combination of those efforts.

As you move into '21, and as Tom said, these transitions take time, right?

So as we're adding the 800-gig in, and when I say the transitions, I mean, the transition to vertical integration is going to take time, depending upon the customer and where they are and their implementation.

So we see another step function in that year, and then finally, reaching the mid-40s in 2022.

This concludes the question-and-answer session.

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

I would like to thank you for your time today, and I look forward to updating you on our progress, hopefully, at OFC, where we have a lot to show.

Otherwise, we will create a venue where we can give you an update on our 800-gig and XR technologies.

Have a great day.

The conference has now concluded.

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