Infinera Corporation (NASDAQ:INFN) Q4 2023 Earnings Call Transcript

Infinera Corporation (NASDAQ:INFN) Q4 2023 Earnings Call Transcript March 6, 2024

Infinera Corporation misses on earnings expectations. Reported EPS is $0.02 EPS, expectations were $0.1. Infinera Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon. My name is Krista and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Infinera Corporation Fourth Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Amitabh Passi, Head of Investor Relations. You may begin your conference.

Amitabh Passi: Thank you, Krista. Good afternoon, everyone. Welcome to Infinera’s fourth quarter of fiscal 2023 conference call. A copy of the press release issued by Infinera today is available on the Investor Relations section of the website. This call is being recorded and will be available for replay from our website. Today’s call will include projections and estimates that constitute forward-looking statements, including, but not limited to statements related to the matters referenced in the press release and current report on Form 8-K that the company issued today and our financial outlook for the first quarter of 2024. These statements are subject to risks and uncertainties that could cause Infinera’s results to differ materially from management’s current expectations.

Actual results may differ materially as a result of various risk factors, including those set forth in an annual report on Form 10-K for the year ended on December 31, 2022, as filed with the SEC on February 27, 2023, and amended on February 29, 2024, and in our quarterly report on Form 10-Q for the quarter ended September 30th, 2023, as filed with the SEC on February 29th, 2024, as well as subsequent reports filed with or furnished to the SEC from time-to-time. Please be reminded that all statements are made as of today and Infinera undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. Today’s conference call includes references to non-GAAP financial measures, except for revenue, balance sheet items, and cash flow from operations, which are each discussed on a GAAP basis.

Pursuant to Reg-G, we’ve provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in our earnings release and investor slides. Sorry, there are no investor slides this quarter, each of which is available on the investor relations section of our website. And finally, as a reminder, we’ll allow for plenty of time for Q&A today but we ask that you limit yourself to one question and one follow-up, please. I’ll now turn the call over to Chief Executive Officer, David Heard.

David Heard: Thanks, Amitabh. Good afternoon and thanks for joining us today. I’ll begin with the highlights for our preliminary fourth-quarter results and then turn the call over to Nancy to cover the preliminary financial details of our fourth-quarter performance and outlook for the first quarter. Overall, the fourth quarter was a strong quarter for us, in which the midpoint of our preliminary revenue, gross margin, and EPS ranges are all expected to come in above our outlook ranges. We delivered a book-to-bill of approximately one for the second quarter in a row, and we generated over $50 million in free cash flow. Furthermore, during the quarter, our GX Systems portfolio performed strongly, landing new Tier 1 design wins with global service providers and ICPs. It now represents almost 50% of our expected annual product revenue, and in Subsystems, we shipped our first 400 gig ICE-X coherent pluggables vertically integrated into our own GX Metro platform.

Combined, the third and fourth quarters of 2023 marked a strong finish to the calendar year. While capital markets and macroeconomic conditions were challenging throughout 2023, we kept our heads down and believe we’ve delivered on our commitments to you. For the full-year 2023, we expect to deliver our sixth consecutive year of revenue growth, expand gross margins to approximately 40%, expanded operating margins, and increased operating profit in the double-digit percentage range, and delivered EPS in the 20% to 25% range. Also consistent with what we committed to you in our investor day, and that EPS is up at least 70% year-over- year. From a portfolio and customer perspective, we continued to build on the momentum of the last few years as we landed new customers during the year and successfully expanded into new market segments and geographies.

Let me touch on a few of the 2023 highlights. First, we won new strategic deals with major service providers, including notable wins in the U.S., Europe, India, Australia, and several multinational subsea consortiums. Our win rate in the Metro remains strong with revenue in this segment growing to almost 50% of product revenue in 2023, an important part of our investment thesis and forward opportunity with the Huawei situation. Second, we had another banner year with U.S. hyperscalers and delivered our fourth consecutive year of 30-plus revenue growth in this segment. We’ve increased our market share with hyperscalers by approximately 1,000 basis points over the last four years, and our total exposure to them, including the indirect business that they drive through carrier service providers and subsea consortia, is approaching approximately 50% of our revenue.

Third, we exceeded $10 million in bookings for our Subsystem products and recognized our initial revenue in the year. This was an important milestone for the company and consistent with the goals we communicated at our March Investor Day. To date, we’ve received purchase orders from 26 customers that span our entire Subsystems portfolio. Additionally, membership in the XR Forum continued to expand in 2023, and the new list of members included Lumentum and Arista. And fourth, we announced the commercial availability of our 400 gig XR pluggables and also shipped our first Metro systems with our own vertically integrated pluggables in Q4. The use of pluggables in our Metro systems will be a key driver of margin expansion getting into the back half of 2024.

Our consistent performance over the past few years highlights that our strategy is working and that our portfolio is in the best shape it’s ever been, as evidenced by our win rates. Our key growth and profitability financial metrics are trending up and to the right, and we feel great about the underlying long-term secular drivers in the business. However, in the near term, as we look at the first half of 2024, we’re planning for a slow start to the year consistent with what our peers in the industry are seeing and communicating. In Q1 In particular, we’re experiencing a temporary low point in revenue and margin driven by two factors. First, from a revenue standpoint, approximately $35 million of revenue has shifted out of the quarter, with roughly $10 million being recognized earlier in Q4 and $25 million of shippable backlog shifting from Q1 into future quarters.

And second, from a margin standpoint, we expect gross margin to be approximately 400 basis points lower in Q1 due to a 300 basis point impact from the timing impact of higher line system shipments in Q1 associated with many of our global Tier 1 customer wins. This is ultimately a good news story in the back half of the year and for the longer term. And a 100 basis point impact from the combined effects of lower volume in Q1. The good news here is our commercial wins and strategic deployments give me confidence that we remain on path to deliver a full year of revenue growth and expanded margins in 2024 with gross margins expected to return to 40% plus starting in Q2. The even better news is both the pace and scale of our design wins across the portfolio are accelerating in this quarter, Q1.

This is especially true for hyperscalers, who we believe will continue to drive healthy levels of spending across the industry in the years ahead. Already in the first 60 days of 2024, we’ve achieved major hyperscale influence strategic wins with our Systems and Subsystems solutions, including the following developments. First, you’ve seen from our press release this morning, we’ve announced a new line system that puts our portfolio under the GX family. We’ve already landed wins with five service providers and hyperscalers that are expected to lead to significant revenue and margins with follow-on transponder sales, and we have a strong pipeline of additional customers. Second, we have won our first contract with a major hyperscaler for 800 gig three-nanometer ZR/ZR+ pluggables.

This win has the potential to be among the largest contracts for the company, scaling to hundreds of millions of dollars over a three-year period beginning in 2025. This is the first of multiple contracts in this key market segment that we expect to land in 2024. These pluggable wins will drive additional volume through our U.S.-based semiconductor manufacturing assets and be incrementally accretive to the financial model. Third, influenced by traffic demands of hyperscalers, we continue winning Managed Optical Fiber Networks or Mofin deals in India, the Middle East, and Asia, with at least three wins quarter to date in Q1 with three different hyperscalers. These private network builds are driven by hyperscalers and their preference for suppliers along with service providers across the globe.

Fourth, in addition to shipping our first Metro systems with our own 400 gig pluggables, we’re also qualifying our 400 gig ICEX pluggables with a major Tier 1 service provider and a major U.S. cable MSO for applications that include single fiber Bi-Di, and business-to-business PON Overlay. And fifth, we’ve invested in producing the first test chips for inside the data center applications driven by AI that will drive down power and leverage our U.S.-based semiconductor assets. While these days are early and architectures are still evolving, we believe our unique vertical integration and indium phosphide capabilities are competitive differentiators inside the data center. We look forward to talking to you on the progress as this further develops.

Based on the stack-up of those strategic wins, my confidence in our strategy, portfolio, and execution is as high as it’s ever been. Despite the short-term inventory digestion customers are going through and the timing of the mix impacts of laying down new routes, in the long term, demand for bandwidth continues to grow as hyperscalers accelerate the rollout of artificial intelligence, machine learning workloads, and service providers drive fiber deeper into networks. We believe we’re uniquely positioned to gain with these customer segments. We look forward to diving deeper into our product and technology strategy at this year’s Optical Fiber Communications Industry Show in San Diego, California on March 27th, and as I close today, I’d like to thank the Infinera team for another solid quarter of execution and results and their continued commitment to our customers and one another.

I’d also like to thank our partners, customers, and shareholders for their continued support. I couldn’t feel better about our strategic position and I believe we remain well-positioned to deliver our seventh consecutive year of revenue growth, expand margins by approximately 200 basis points, and deliver EPS growth of at least 25% in 2024. I’ll now turn the call over to Nancy to cover the preliminary financial results of the quarter and our Q1 outlook. Nancy?

Nancy Erba: Thanks, David. Good afternoon, everyone. I will begin by addressing our third-quarter filings and then cover our preliminary followed by our outlook for the first quarter of 2024. For your reference, we have included a GAAP to non-GAAP reconciliation of our preliminary financials and outlook in our press release to assist with my commentary. As a reminder, any financial commentary provided today for Q4 ’23 or the full fiscal 2023 period are based on our preliminary non-GAAP results. As most of you are aware, we filed our Q3 ’23 Form 10-Q on February 29th. This represented a tremendous effort by the Infinera team and our auditors over the past few months given the intensive and time-consuming nature of the matters under review.

I want to emphasize that despite the delayed review process, there were no adjustments to prior period financials. Our results for Q3 were revenue of $392 million, gross margin of 41.9%, operating income of $30.3 million, and diluted EPS of $0.08, all of which exceeded the midpoint of our original outlook range. Since our efforts over the past few months have been directed toward completing the work necessary to file our Q3 ’23 results and other related SEC filings, our final results for Q4 ’23 and fiscal year ’23 have been delayed. As a result, we are sharing preliminary unaudited ranges today. We currently expect to have our year-end audits completed and file our fiscal year ’23 10-K in the next five to seven weeks or about mid-April, and plan to be back on our normal cadence in Q1.

Turning to our performance in the fourth quarter, I am pleased with the strong finish we had to the year. The midpoint of our preliminary range of $435 million to $452 million is expected to be at or above our outlook range. This quarterly performance was primarily driven by strength in the Americas and with ICPs or hyperscalers. Geographically, we derived over 65% of our Q4 revenue from domestic customers, a level higher than normal given the strength at U.S. hyperscalers and service provider customers. We had one ICP customer that accounted for over 10% of our revenue in the quarter. Turning to gross margin, we expect the midpoint of our Q4 preliminary gross margin range of 39% to 41% to be above that in our outlook range and up on a year-over-year basis.

Compared to the prior year, gross margin in the quarter benefited from higher vertical integration, continued relief in supply costs, and ongoing cost improvements. Overall, I am encouraged by the trend in 2023, with gross margin expected to approach 40% for the year and be up approximately 300 basis points for the year. Preliminary operating margin of 5.7% to 8.3% is expected to be within our outlook range, while operating expenses of $145 million to $147 million are expected to be slightly above our outlook range. Our Q4 operating expenses included approximately $3 million of incremental spend as a result of the extended financial review I referred to earlier. We expect this level of incremental spend to continue through Q1 and partially into Q2.

In Q4 we also executed on a tax structuring initiative that allowed us to true up a $7 million tax benefit for current year and prior years. The resulting preliminary diluted EPS is expected to be $0.07 to $0.13 with the midpoint representing above our outlook range. Moving on to the balance sheet and cash flow items, we ended the quarter with approximately $174 million in cash and cash equivalents. We generated over $50 million of free cash flow in the quarter, and we benefited from higher net income, the partial work down of our inventory, and an improvement in shipment linearity. Let me now turn to the outlook for the first quarter of 2024. As David mentioned, like the rest of the industry, we are expecting a slow start to the year as our customers continue to work down their excess inventory and manage CapEx prudently in the short term.

Therefore, specific to Q1, we expect revenue to be in the range of $320 million to $350 million, including the impact of approximately $35 million of revenue that shifted out in the quarter. Gross margin to be in the range of 36% to 38%. This lower margin includes a 400 basis point margin impact, primarily from higher line system shipments with fill expected in the following quarters and from lower volumes in Q1. Operating expenses to be in the range of $143 million to $147 million, including approximately $3 million of incremental expenses related to support our fiscal ’23 audit and an operating margin loss of 8.5%. Below the operating loss line we assume approximately $8 million for net interest expense and approximately $4 million for taxes.

Finally, we are anticipating a net loss per share of $0.18 to $0.10 assuming a basic share count of approximately 232 million shares. As you heard from us this afternoon, overall, we feel great about our strategy and the strength of our portfolio, as evidenced by the pace and scale of recent design wins across both our Systems and Subsystems portfolios. In the first 60 days of the quarter, I am encouraged by our win rate deployment of line systems, setting us up for future margin expansion. I’m encouraged by the growth of our sales funnel and the margins on our bookings, which I believe puts us on a path to drive revenue growth of 2% to 3% for the full year and deliver on our seventh consecutive year of revenue growth. Expand gross margin by approximately 200 basis points for the year and earnings per share expansion with EPS growth of at least 25% in 2024.

As I close today, I would like to reiterate that I’m pleased with our ’23 performance for the full year. We hit several important milestones in the year with gross margin approaching 40%, bookings exceeding $10 million for our Subsystems products, vertical integration in the mid-50th percentile for the company, and we proactively strengthened our balance sheet. Looking ahead, we remain laser-focused on continuing to accelerate revenue growth, drive earnings per share expansion, and generate cash flow in the quarters and years ahead. We plan to file our fiscal year 10-K in the next five to seven weeks, as I said earlier, and we are back on track to file our Q1 10-Q on our normal cadence. In closing, I would like to take the time to thank the Infinera team, especially my finance team, for their continued commitment to innovation and execution, as well as to our partners, customers, and shareholders for your continued patience, cooperation, and support.

Krista, I’d now like to open the line up for questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Mike Genovese from Rosenblatt Securities. Please go ahead.

Mike Genovese: Great, thank you. Can you start by giving us more color on this major hyperscale win? The three-nanometer ZR+ 800 gig pluggable, just more color on what that application is, what that product is? Thank you.

David Heard: Sure. Hi, Mr. Ron Johnson, do you want to take that?

Ron Johnson: Yes, thanks, David. Yes, Mike. So we had a closer contract with a major hyperscaler basically to deliver product early ’25 with revenue expectation in ’25. And the application is an 800 gig PCS pluggable that would go into multiple different form factors, QSFP, OSFP, CFP-2, and provide capability to optimize their power per bit, their performance, and their cost per bit. And this will be interoperable in multiple parts of their network, effectively addressing all of their terrestrial applications. So in short, point-to-point Metro peering applications, even in long haul applications. It’s an opportunity to drive lower power, lower cost for all of their terrestrial network.

David Heard: Hi Mike, financially from a contract standpoint, it’s kind of the largest contract potential that the company has dealt with in its history. So, it really kind of helps launch the Subsystem business that we talked about going forward with the kind of volumes that really spin the fab nicely for cost reduction that will help across the portfolio.

Mike Genovese: Okay, great. And now it sounds like it’s a DCI application more than a datacom inside the data center application. Is that correct?

David Heard: Correct.

Mike Genovese: Okay. Great. Then on the…

David Heard: I would just say it’s outside the data center, correct.

Mike Genovese: Yes. Okay. And then just my other question is, I guess just some color on gross margins as we move through the year. It sounds like you’re calling for 200 basis points of gross margin improvement this year if that’s correct. But we’re starting with a bad quarter in 1Q for some specific reasons. We understand how things get a lot better later in the year.

David Heard: Yes, look, the amount of line systems that we’re laying out in the first quarter and the cost of that is significant. It’s just a heavy, heavy mix which bodes well for the second half being heavy. So while we start out, we look at our inbound bookings and their standard margin rates and we look at the forecast for the remainder of the year and the fill on those line systems as well as additional line systems we still intend to deploy. And it gives us comfort around that 200 basis point – roughly 200 basis point improvement year-over-year just like we committed to last year and delivered last year.

Mike Genovese: All right. Sounds good. Thanks a lot.

David Heard: Thanks, Mike.

Operator: Your next question comes from the line of Alex Henderson from Needham & Company. Please go ahead.

Alex Henderson: Great. So I was hoping you could help us bridge to 25% EPS growth on 2% to 3% revenue growth. And nice but still modest 200 basis point margin expansion. Is it a function of something below the line? Is it a function of very tight OpEx costs or declining OpEx costs? How do we bridge to that?

Nancy Erba: Yes, I think it’s a combination of all of those, right? It’s the growth rate on the top line, the expanding 200 basis points of margin, right? So, knowing we’re approaching 40%, think approaching 42% for the full year, and then we will be certainly keeping our operating expenses in control. You’ll see probably two areas, think of it in the $15 million increase for the year in total, some of which we talked about in terms of expenses on the audit, and some catch-up we have to do in the first half, but also the work that we’re doing in R&D in particular, and really investing in that growth. And as David mentioned, some of the chip development that we’re doing inside the data center, will – you’ll see a small step up there. But net-net, it gets us into that 25% growth in EPS.

Amitabh Passi: Hi Alex, if I could just remind you, in ’23, right, if you look at the contemplated ranges, we’ll go 2% to 3%, and EPS will be up over 70%. So the leverage is there in the model.

Alex Henderson: Just to be clear, what is the drag that you’re assuming relative to the accounting issues in the numbers in both the fourth quarter and in ’24?

Nancy Erba: Sure. It’s about $3 million in Q4. It’s about the same $3 million, roughly in Q1. And then it should temper from that in Q2 and get back to normal.

Alex Henderson: I see. Thank you so much.

Nancy Erba: Sure.

Amitabh Passi: Thanks, Alex.

David Heard: Thanks, Alex.

Operator: Your next question comes from the line of George Notter from Jefferies. Please go ahead.

David Heard: Hi, George.

George Notter: Hi, guys. How’s everyone doing? Thanks very much for the question. I guess I wanted to ask about – help me understand sort of the cadence on the top line here, right? So, really strong Q4. Big step down in Q1. I would imagine there’s a bit of seasonality here, but I think the narrative is really around excess inventory. And I guess, as I think about it, the excess inventory issue has been around for a few quarters now. You guys have been talking about it for a few quarters.

David Heard: Sure.

George Notter: So why a strong Q4 and a step down in Q1? And how does that mesh with this sole narrative around working off excess inventory? Thanks.

David Heard: Yes, no, it’s a good – very good question. Remember that when I talk our exposure as well, I think most people think of the service provider exposure in our business and think the likes of Verizon, AT&T, BT, Vodafone. If I just took those four as an example, that’s probably, Amitabh, less than 5% of our revenue in 2023. And when I look at our exposure from the webscalers, or ICPs, as we call them, both direct, I think in Q4 it was probably approaching 40%. For the year, it’s probably a third of our business. When I take into account these managed fiber optic fields that they’re influencing, it’s close to 50%. So, when we looked into Q1, we had some amount of shippable backlog between a few customers that moved from Q1 just scheduling-wise out into Q2 and Q3.

And we were able to accomplish about $10 million worth of projects in Q4. So, that does explain part of the step-down. We’ve been winning these long-term strategic deals in quarter, but the book-ship business has been a bit slower as some of our customers as everybody is aware of are continuing to burn down inventory, which we think is about the end of the story as we get out of the first half. And they’re also being a bit cautious on setting their budgets. And Q1 is always in our industry and for our company is always our toughest quarter. And there we go.

George Notter: Got it. Was excess inventory an issue then in Q4 as well?

David Heard: Yes, I mean, in terms of raw bookings, we did well in Q3 and Q4 having a book-to-bill of about one for those quarters. But it has not been a loose environment in terms of those dollars. It is beginning segment-by-segment to be able to wear off. And that’s why I kind of like our exposure on the ICP front. And I hate to say it, I want more positive business with customers that I mentioned that are major Tier 1 service providers, but they’re just – they’re not as significant of an impact to our business.

George Notter: Got you. Okay. Thank you very much.

David Heard: More upside. Thanks, George.

Operator: Your next question comes from the line of Simon Leopold from Raymond James. Please go ahead.

Simon Leopold: Thank you for taking the question. Just first David, if you could clarify, I think you made the point that direct plus indirect sales to hyperscale or ICPs was close to 50%. But what was the value of the direct sales to hyperscalers again?

David Heard: Yes, about 30 – about think of a third of our product revenues in 2023. And in Q4, it was approaching 40%.

Simon Leopold: So, I guess one of the things I’m trying to sort of square here is the full-year growth outlook of 2% to 3%, I would assume we’d expect follow-through from that hyperscale group. So they’re growing much better than that 2% to 3%, which means something else is declining. You have not guided by vertical in the past, but maybe if you could help us unpack sort of the relative vertical movements to sort of square that.

David Heard: Yes. Look, I think the hyperscalers, if you look at the average CapEx are expected to grow in the double digits still in 2024. Again, we’re winning the line systems – the new line systems with both hyperscalers and with CSPs. They will be laying those out based on wins that we just had over the last 60 days. They probably – they don’t probably, they lay those out in the back half of the year and begin to fill. So you’re right, some of the – we expect continued strength in hyperscale. The wholesalers are continuing to do well. Subsea is continuing to do well. I think you’re going to see a lot of these Tier 1 wins that we have, just not have the scale until we get into 2025.

Simon Leopold: Great. And you also mentioned very significant share gains over a period of number of years with this group of customers. Who have you been displacing? Thank you.

David Heard: Yes, that’s a good question. I’m sure it depends on the situation, and you probably know better than I do. I am not going to – I won’t comment into our particular competitor’s business.

Simon Leopold: Appreciate it. Thanks, guys.

David Heard: All right. Thanks, Simon.

Operator: Your next question comes from the line of Meta Marshall from Morgan Stanley. Please go ahead.

David Heard: Hi, Meta.

Kron Geoff: Thank you. Hi, this is Kron on for Meta.

David Heard: Hi, sorry for that.

Kron Geoff: Hi. Yes, I mean, I just wanted to double-click on sort of the $25 million that got pushed out into future quarters. Any maybe further detail on why that was pushed out? Or was it just simply timing of contracts? And then the point you made on sort of Q4 still being impacted by inventory digestion, I guess. Just where do you feel we are in terms of service provider, inventory digestion, and sort of what you’re expecting across the year with that?

David Heard: Yes, on the $25 million, I mean, that’s from backlog. So it’s just scheduling in terms of timing of people putting projects in, whether it’s into a data center or whether it’s out into a network. And that happens from time to time. Unfortunately, it happened in Q1 as people were laying out resources and our expectations to where our customers were. The second part of the question is, look, I think we have been saying consistently that we thought this year the front half would be softer than the back half because from our – not from analyst reports, from our direct contact with both CSPs, wholesalers, ICPs, cable operators, we do think as we get into the back half and look, based on some of the infrastructure wins we’re getting now, we believe that the spend and the inventory situation frees up in the back half. And that’s been consistent industry commentary, I believe if you talk through the value chain in the industry.

Kron Geoff: No, that makes a lot of sense. And then maybe moving on to sort of operating margins. Q1 coming down a little bit, but I guess just how you’re thinking about operating margins throughout the year and maybe just in the back half of the year, just how much of a benefit you think the pluggables opportunity can be to margins? Thank you.

Nancy Erba: Yes. On the operating margin, right, you should see consistent improvement kind of quarter to quarter to quarter through the year. As you see the revenue and the gross margin step up, as I mentioned, you’ll see some tapering off in terms of the unique spend we’re doing right now within G&A. In terms of gross margin relative to Subsystems, it’s going to be – it’ll be modest, right? There’s not going to be a big step up that you’ll see in ’24, but really as David mentioned, with some of the wins that we see, it’s a ’25 benefit to us as we start to see that revenue really step up and the opportunities that we’re seeing are giving us more and more confidence, in particular in terms of the funnel that we see. And then, as I mentioned in my statement earlier, the margin on those bookings and the improvement that we’re seeing there as well.

David Heard: Yes, I would say just real quick, let’s differentiate between two things there. So the external sales of pluggables like to the web scaler that Ron went through, very exciting. We don’t expect that to positively impact margin because that’s a ’25 impact for us. The biggest impact is what we talked about before to the 200 basis points of margin improvement is really, remember that huge increase in Metro that we’re getting this year. We’ll now be able to integrate our own plugs into that. And so that will be a margin benefit leading to that 200 basis point improvement for internal consumption.

Kron Geoff: Okay. That’s perfect. Thank you.

Operator: Your next question comes from the line of Dave Kang from B. Riley. Please go ahead.

Dave Kang: Yes, thank you. First question is regarding your vertical integration. Just wondering if you can provide what that was and how we should think about it first quarter and beyond.

Nancy Erba: Yes, for the year it was in the mid-50s, so – and we should continue to see that expand, particularly in ’24, as we just talked about with Metro coming online.

David Heard: Correct.

Dave Kang: Got it. And then on your outlook for the year, how should we think about first half versus second half? Should we be thinking about like – something like maybe 40-60 or even more back-end loaded?

Amitabh Passi: Yes, I would say probably. They’re very similar to ’22. So maybe 43-57, 42-58 kind of just to be safe. I mean, we typically tend to be 48-52.

David Heard: Was that roughly, Amitabh?

Amitabh Passi: We typically tend to be 47%, 48%. But this year I would say it’s more like ’22 played out.

Dave Kang: Got it. Thanks.

Amitabh Passi: Thanks. Thanks, Dave.

Operator: Your next question comes from the line of Samik Chatterjee from JPMorgan. Please go ahead.

Samik Chatterjee: Hi, thanks for taking my questions. Maybe if I can start with the first one to sort of ask you to talk a bit more about your outlook on a more geographic basis. I know you mentioned India and the wins there. You mentioned Huawei as sort of one of the drivers of the growth outlook that you have. I understand most of the ICP probably sort of will be reported eventually in the North America business, but when you think about EMEA and India as a region, how should we think about what you’re expecting in terms of growth in those two areas? And I have a follow-up.

David Heard: No, it’s good. It’s good. So obviously, again, very highly indexed on the ICP strength. Actually, Alex Henderson brought this up, I think four quarters ago about when you do the subsea, are you getting the terrestrial benefit? We’re just beginning to see that. So I would tell you India and Asia —

Amitabh Passi: Hi Samik, I think we’re getting some static from your end, Samik.

Samik Chatterjee: Okay, let me go unmute.

David Heard: Okay.

Amitabh Passi: That’s better. Thank you.

David Heard: Perfect. Thanks. Again I think India and Asia, we’re seeing nice wins again already in the first 60 days with three different content providers doing those landed deals. So, we do expect the Asia Pacific region, we’ve had some new leadership there, some new staffing there, doing a great job. The funnel is full. In the Middle East, we see big opportunities and are winning big opportunities both in subsea and terrestrial in the Middle East. So that’s been a nice growth area for us. I think you won’t see it in the numbers in 2024, but you will see it in the wins in Europe with Tier 1 service providers we are winning in Europe. I expect to see that really scale in terms of the numbers in 2025. And again, as I said in the prepared remarks, on the 400 gig pluggable front, we have North America cable provider, that is we have a great application of that software-defined pluggable for fiber limited areas for bi-di, bi-directional as well as PON Overlay that allows them to use the same fiber.

So I expect again, design wins there and then for cable in 2025 to become a nice growth area for us. Because it’s been way too small for us historically. All of those are consistent with what we said in our March Analyst Day in terms of concentrating on these Mofin deals on Asia Pacific, on India in particular, and on the Middle East.

Samik Chatterjee: Got it. And sorry if you’re still getting static. I apologize for that. But just maybe a quick follow-up for Nancy. You’re starting the first quarter at a lower gross margin than we envisioned. Obviously, you’re keeping the full-year guide. That implies you’re exiting at a higher run rate than we thought. So maybe any color on where do you want – where do you envision exiting for the year in terms of gross margins? And what does that sort of tell us in terms of vertical integration relative to where you probably sort of imagined exiting the year? Thank you.

Nancy Erba: Yes. So I think you’re right. It will scale up as we go through the year, and we’ll have to exit the year close to mid-40s, in order to hit the 200 basis point growth. And that is, as we mentioned, very much tied to Metro VI, as well as the growth of our VI in general. So, we should expect to be in the 60s, in 2024, in order to hit that 200 basis point improvement.

Samik Chatterjee: Right. Thank you. Thanks for taking my questions.

Operator: Your next question comes from the line of Ruben Roy from Stifel. Please go ahead.

David Heard: Hi, Ruben.

Ruben Roy: Thank you. Hi, David. I had a question on the 800 gig, congrats on the first of, I’m sure, many wins there. How are you thinking about that from sort of the perspective of the rest of the business? Meaning, is that incremental, or do you expect any impact to the systems business? Any color there for 2025?

David Heard: The good news is the penetration of that, in terms of the dollar value. One, the growth rates we see are pretty tremendous. Again, driven by AI and ML with the webscalers that we’re currently in front of for 800 gig, and we don’t expect this to be the last. This is the first and very, very large. Second is we weren’t in a lot of this potential spend for the webscalers. So, this is kind of net new for us, for the business. So it really doesn’t cannibalize anything we’ve had. Did I get that right, Ron?

Ron Johnson: Yes, I agree.

Ruben Roy: Great. Okay. Thank you. I appreciate the detail. Just to be clear, Ron would have disagreed if he disagreed. He’s not just saying that, yes.

Ruben Roy: Excellent. Okay. So, either for you or Ron, David, you did mention a little bit about the 400 gig and the cable services, MSOs, et cetera. But just in terms of how we should think about the ramps of 800 versus 400, it seems like 800 could be sort of faster ramps, bigger ramps versus longer tail, longer cycle for 400 gig. Am I thinking about that right?

David Heard: You are. So, I think 800, it’s Costco buying in huge swaths, huge chunks, defined product, defined application, because it’s ZR, ZR+. The 400 gig one will consume it and continue to increase our consumption year-over-year in the Metro, for our own product. And then for these applications, again, I mentioned we’re certifying with the North American cable, but we’re also certifying with another global Tier 1 for an application. Look, because its software defined, it ties into their network operations. They just take a little bit longer, but I think you’ll see a very long life cycle for that given the differentiation and the fact that as Ron says, it’s a three-legged stool, drive lower cost per bit, drive lower power per bit, and drive the agility up. And that 400 gig plug allows you to move in 25 gig increments, only power which you need. And that’s why we’ve won some green awards, for example, in Europe with that product. So, yes, longer life cycle. Sorry.

Ruben Roy: Got it. Understood. Thank you, David.

David Heard: Thanks Ruben.

Operator: Your next question comes from the line of Christian Schwab from Craig-Hallum Capital. Please go ahead.

Christian Schwab: Great. Thanks for taking my question. Given the headwinds that we’re seeing, you know, structurally in the industry this year, but the big design wins in hyperscale that we talked about and further to come, I know it’s only March of ’24, but the strength that you were talking about in ’25, you should be able to grow the top line double-digit plus in calendar ’25, right?

David Heard: Well, that was a trap. Well said. Well said. Well, look, certainly these are very, very large opportunities. You’re right. It’s March of 2024. I’d be silly to give 2025 guidance. But I think what we’ve said prior, is past this inventory digestion period, we’re going to continue to put our heads down, get design wins, continue to drive margin improvement and EPS expansion. And if you remember our Analyst Day, we talked about, we think steady state in the business. Once you get through these externalities that – or 8% to 12% was the kind of growth rate we said. This gives us great comfort, both in that and as well as in our business model, from a financial perspective in terms of margin and EPS. But I’m not getting a number for ’25.

Christian Schwab: No, understood. Thank you for that. And then my last question is, we’ve all been kind of waiting for CHIPS Act money to be released. Do you have an update of where you think you’re positioned, in that process?

David Heard: Here’s what I’d tell you. Again, I think we’ve been very diligent over the last couple of years, and are very well positioned, but we’re not allowed by actual rules of the CHIPS Act, to give a status on where we’re at there. What I’m confident is we’re an excellent fit for the CHIPS Act, and that as they go to push awards out, that should be something we see in the ’25 timeframe as well in terms, of the impact to the business, if we are to be awarded.

Christian Schwab: Great. Thanks for answering my questions.

David Heard: Thank you.

Operator: Your next question comes from the line of Alex Henderson from Needham and Company. Please go ahead.

Alex Henderson: Oh, sneaking in with a second one?

David Heard: There you go.

Alex Henderson: Thanks for letting me in. So, I was hoping we could go back to this contract that you’ve got with this hyperscaler, three years out, $100 million annual run rate. I would think that the initial shipments are, the first year that would be fairly low. And then, it would ramp probably double to say, $50 million and then hit that $100 million. Is that kind of the cadence of that ramp, $25 million, $50 million, $100 million?

David Heard: No – what we said in the prepared remarks was the three-year contract is worth hundreds of millions of dollars. So, we believe it will start shipping in 2025 with this particular customer and, yes, get more intense in 2026, 2027, and the beginning of 2028. And then we’ll be on the new – with that particular customer, you go from the 800 gig pluggable to potentially a 1.6 T pluggable from there. So, no, it’s – the number is much larger.

Alex Henderson: So it’s larger than $25 million, $50 million to $100 million?

David Heard: Yes, it’s hundreds of millions. Yes, it’s hundreds of millions over a three-year period, not like one or two or – you know, I don’t want to get too specific, but we’re – it’s the largest that we’ve seen.

Alex Henderson: And just to be clear, that’s all pluggables. Is there additional equipment sales associated with that, or is it more, narrow than that?

David Heard: So, with a lot of these deals, what I think you will see with a lot of deals in the future is you will see us get a pluggable win for the pluggable, and then we will have to compete independently for the platform that that goes in, the GX platform, and line system that that goes in. So in many cases, we have the opportunity to not only win the pluggable, but also win the platform that that goes in. So there has – that doesn’t even count that dollar impact. Ron, anything to add there?

Ron Johnson: I don’t think I would add, is that it’s extremely compelling, right for them to ramp this quickly, because it’s a significant, improvement in cost for per given power for their network.

Alex Henderson: So the other question I had for you is you mentioned the managed optical, lines that you’re going – you’re winning in some service providers, particularly India. Can you talk a little bit about the mechanics and the economics, of that type of transaction, where you’re actually, in line with that business?

David Heard: Ron, do you want to take that?

Ron Johnson: Yes. So you’re referring to managed optical fiber networks, and these are effectively opportunities, where we work with the end customer who’s a hyperscaler and a service provider, who’s providing the actual service. And then we agree on a bespoke network for them, right, to consume and to use all on their own, for their own specific application in that particular country. And from an economic perspective it’s very much like any other service provider win where there’s a line system component, there’s services, there’s transponders, or pluggables to print on the application, and it looks very similar to any big Tier 1 service provider win.

Alex Henderson: So it’s not a high management, you know, maintenance contract piece. It’s just classic systems.

David Heard: Classic systems with the maintenance contract, and the good news is, we see the end demand, because we’re working with the webscaler. So they typically tend to build them bigger, because they’re looking to interconnect to data centers and terrestrial networks.

Alex Henderson: Great. Got it. Thanks.

David Heard: Thanks, Alex.

Operator: And that concludes our question-and-answer period. I will now turn it back to Chief Executive Officer, David Heard for closing remarks.

David Heard: Hi, thank you. 2023 was another great year for us. We delivered on our commitments that we made during our Analyst Day, and I would say, it was a pretty rough landscape. Through Q4 of 2023, we have met or exceeded our outlook in 15 out of the last 16 quarters. Our portfolio is in the best shape it’s been. We’re winning new customers globally with less than 25% of our products from legacy systems. I mean, it’s a dramatic shift from where we were three, four years ago. Well, the front half of the year, is starting off a bit sluggish, which we called out, last year as this inventory burns out. We are winning some major design wins in both systems, and subsystems that build our – competence and confidence in the back half recovery.

And our ability to grow revenue, expand share, and increase margins in EPS. So, we appreciate the support of our customers, employees, and shareholders. We’re now going to get back to work, and continue executing a very sound investment strategy and focus on continued EPS expansion. Thank you all, and have a nice afternoon or evening.

Operator: This concludes today’s conference call. Thank you for your participation, and you may now disconnect.