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spk00: Good afternoon. Welcome to InfoNero's second quarter fiscal 2023 conference call. A copy of today's earnings and investor slides are available on the investor relations section of the website. Additionally, 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 our future business plans, product development, and growth opportunities, including progress against strategic priorities and milestones, trends, competition and customers, capacity growth, excess inventory held by customers beyond normalized levels, expectations regarding industry-wide supply chain dynamics and the macroeconomic environment, market adoption of coherent optical engines, expectations regarding our subsystems business and its impact on our financial results, expectations regarding obtaining government funding, projected year-over-year drivers of demand, revenue, gross margin, operating expenses and operating margin, expectations regarding a future performance, revenue growth, and market expansion, and a financial outlook for the third quarter of 2023. These statements are subject to risks and uncertainties that could cause Infinura'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 31st 2022, as filed with the SEC on February 27, 2023, and in our quarterly report on Form 10-Q for the quarter ended April 1, 2023, as filed with the SEC on May 4, 2023, 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 INFINRR 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, earnings release and investor slides for this order, 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, so we ask that you limit yourselves to one question and one follow-up, please. I'll now turn the call over to our Chief Executive Officer, David Hurd.
spk09: Yeah, thanks, Amitabh. Good afternoon, and thanks for joining us today. I'll begin with the highlights from our Q2 results and then turn the call over to Nancy to cover the financial details of our second quarter and the outlook for Q3. Overall, the second quarter was another solid quarter for us. We beat the midpoint of our outlook range across all key financial metrics, revenue, gross margin, operating margin, and APS. On a year-over-year basis, we grew revenue by 5%, expanded gross margins by 320 basis points, and increased operating margins by 240 basis points while continuing to invest in our strategic programs. In the first half of the year, we increased our top line by 10%. improved gross margins by approximately 300 basis points to 39%, and grew EBITDA by 137% compared to the first half of 2022. Bookings in Q2 improved sequentially with book-to-bill just below 1, which was in line with our expectations. In our subsystems business, we continue to win new strategic deals in the areas we've been prioritizing. For example, first, consistent with our efforts to expand our metro footprint, we want a new deployment with a major U.S. service provider. This is a turnkey award, which will include our GX Metro platform, next-generation line systems, software suite, and professional services. The footprint we establish with this customer will allow for future margin expansion as we integrate our own 400-gig ZR ZR Plus plugables in 2024, which we just made commercially available. Second, our investments in go-to-market and geographic expansion resulted in new deals in India, a market where we believe we have significant growth opportunity. These wins span both subsea and terrestrial deployments in India for domestic service providers and U.S. hyperscalers who are increasing their presence in the region. Finally, we continued our momentum in the hyperscale segment where we landed a new subsea deal with a major hyperscaler. a customer with whom we historically have less share, positioning us well for future expansion in this account. In the subsystems business, we're seeing the first signs of commercial progress. Our 400-gig ZR ZR Plus pluggable is now commercially available, and we're excited about the margin expansion potential as we vertically integrate into the Metro portfolio. We're on schedule to make the first set of software-enabled 100-gig pluggables commercially available in the second half of 24. We will open a significant market opportunity at the edge of the network with broadband access, 5G, and cable networks. And we're on track to deliver the highest performing lowest power 800 gig pluggable that will leverage three nanometer technology and enable our customers to reach greater distances at unmatched economics. In addition to all of our intelligent pluggables have software that enables seamless integration and router switches which allows simplified management, increased agility, and dramatically lowers operating costs for our customers. These achievements have resulted in a solid pipeline and purchase orders from 15 network equipment manufacturers and service providers to date. The purchase orders are broad-based and include our entire suite of pluggables and components from 100 gig to 800 gig. While these initial wins are relatively small in magnitude, they're encouraging and signs of the return we expect to get from our investment going forward. Finally, as a company, we've been a proponent of open architectures and open networks. We're excited to see the addition to three new members to the OpenXR forum in the quarter, including Arista Networks. Total membership in the OpenXR forum is now up to 34 members and represents a significant portion of the overall network spend. Our results in the first half of 2023 continue to build on our momentum over the last five years that validate our strategy as working. From 2018 to 2022, we've grown company revenue at an average of 14% annually, expanded operating margins by over 1,000 basis points, ramped I6 as one of the fastest technologies in our history to ramp, refreshed our entire hardware and software portfolio, and added a significant number of new customers gain share, especially in the metro segment with our refreshed GX portfolio. We're now in a position to expand our market opportunity further with a newly launched subsystems business, a business which we're investing close to $100 million this year. As this business ramps, we expect to benefit from the higher margins in 2024 as we vertically integrate into our metro portfolio. And from the operating leverage, once we ramp up the sale of external pluggables, Furthermore, we've continued to position ourselves to benefit from the Chips and Sciences Act to augment our existing business plan. As a U.S.-based optical semiconductor manufacturer, Infinera is well situated at a time when significant government funding is on the table to reshore and secure critical supply chain, an issue of increasing importance to our customers. While long-term demands will continue to be healthy with data rates growing from network payloads, they're getting amped from artificial intelligence and machine learning. We believe the second half of the year is going to be lighter than our original expectations as our customers are going through a three to four quarter period of inventory digestion that's industry-wide. and are being cautious about spending in a recessionary environment. We believe we're roughly halfway through this projected four-quarter digestion period and are taking this into account in our outlook for the back half of the year. However, for the full year, we expect we'll grow revenue in the low single-digit percentage range and deliver our sixth consecutive year of top-line growth. We'll expand operating profit and EBITDA by double-digit percentages on a year-over-year basis, Like the near-term and temporary industry-wide digestion mentioned earlier, the longer-term secular drivers of our business and target business model remain intact. We're executing to the six strategic milestones we outlined during our March Investor Day, and we're focused on gaining additional market share, expanding margins, ramping the pluggables business, and delivering at least a dollar in earnings per share in the 2025-2026 timeframe. Overall, our investment thesis remains unchanged. We continue to expand EPS. As I close today, I'd like to reiterate the fact that I'm confident in our strategy and our ability to execute through this adjustment period. Over the past few years, we've delivered consistent commercial and financial progress while navigating a pandemic, supply chain disruptions, a war, rising interest rates. As evidence by our progress over the last few years, our systems portfolio is in the best shape it's ever been, and I'm equally excited about the outlook of the new subsystems business. I would like to take this opportunity to thank the Infonera team for their unwavering commitment to our customers and one another and delivering on innovation that matters. In addition, I'd like to thank our partners, customers, and shareholders for their ongoing support. I'm now going to hand the call over to Nancy to cover the financial details of the quarter and the outlook. Nancy?
spk01: Thanks, David. Good afternoon, everyone. I will begin by covering our second quarter results and then provide the outlook for the third quarter. For your reference on our investor relations website, we have posted slides with financial details including our gap to non-gap reconciliation to assist with my commentary. As you heard from David, the second quarter was another strong quarter for us. Revenue was 376 million, up 5% on a year-over-year basis, and just above the midpoint of our outlook range. This performance was primarily driven by strength in the Americas, Asia Pacific, and with ICP customers. Geographically, we derived 58% of our Q2 revenue from domestic customers, a level generally consistent with Q1. There was one customer who accounted for over 10% of our revenue in the quarter, which was an ICP customer. Q2 gross margin of 39.3%. was above the midpoint of our outlook range and increased 320 basis points year over year. Compared to the prior quarter, gross margin in the quarter benefited from higher vertical integration, including I-6, and some relief in supply costs, partially offset by lower services margin as we continue to work through our lower margin professional services backlog. Overall, I'm encouraged by the gross margin trend in the first half of the year, as it supports my confidence in our ability to show continued gross margin improvement in 2024 and beyond as we vertically integrate our Metro portfolio and ramp up our external pluggables revenue. Operating profit in the quarter was $10.7 million, with an operating margin of 2.8%, which was at the higher end of our outlook range. On a year-over-year basis, we expanded our operating margin by 240 basis points. Operating expenses of $137 million in Q2 were below our outlook range of $140 to $144 million as we tightly managed quarterly spending while continuing to make substantial investments in our subsystems business. The resulting diluted EPS was at the high end of our outlook range at breakeven and compared to a loss of $0.05 in the year-ago quarter. Moving on to the balance sheet and cash flow items, we ended the quarter with $167 million in cash and cash equivalents with no amount drawn on the ABL. From a cash flow perspective, we generated $1.4 million in cash flow from operations, while free cash flow was an outflow of $9.4 million. Let me now turn to the outlook for the third quarter of 2023 and our expectations for the rest of the year. As you heard from David, the near-term operating environment has become more challenging than our original expectations, as customers in our industry have slowed the pace of bookings while continuing to work down their inventory. However, even against this backdrop, we achieved our plan in the first half of the year, growing revenue by 10%, expanding operating margin by 350 basis points, and increasing EBITDA by 137% compared to the first half of 2022. We believe we are about halfway through this temporary industry-wide four-quarter customer adjustment period. As a result, we now expect our outlook for the third quarter to be revenue of $376 million plus or minus $15 million, gross margin of 39% plus or minus 150 basis points, operating expenses of $141 million plus or minus $2 million, and operating margin of 1.5% plus or minus 250 basis points. Below the operating income line, we assume $7 million for net interest expense and $4 million for taxes. Finally, we are anticipating a loss of 2 cents plus or minus 4 cents per share, assuming a basic share count of approximately 228 million shares and a fully diluted share count, if profitable, of approximately 260 million shares. We expect to utilize cash from operations in Q3, primarily for working capital, and return to generating cash from operations in Q4. We are continuing to target generating cash from operations for the full year. Despite the near-term considerations, our investment thesis is sound and we are still planning on delivering year-over-year improvement in our financials in 2023. This will include growing revenue in the low single-digit percentage range, driving gross margins to 40%, expanding operating profit in the double-digit percentage range, and delivering at least 25% growth in earnings per share compared to 2022, remaining on the path to delivering a dollar of EPS in 2526. We expect bookings to continue to improve sequentially in Q3, and then again in Q4, and to exit the year with our remaining performance obligations, or RPOs, of approximately $800 million. which should set us up well for 2024 when we believe demand should start to normalize. As I close today, I would like to reiterate that I'm pleased with our second quarter and first half performance, especially considering the industry-wide slowdown that we are experiencing. In the near term, we are tempering our expectations for the back half of the year, but believe our strategic initiatives are on track and we are on pace toward our sixth consecutive year of revenue growth, and fifth consecutive year of operating profit expansion. We expect to improve our earnings per share by at least 25% in 2023, while investing close to $100 million in our subsystems business this year. And we remain on the path to delivering at least a dollar in earnings per share in the 25-26 timeframe. I would like to thank the Infinera team, as well as their continued commitment to innovation and execution excellence. and our partners, customers, and shareholders for your continued cooperation and support. David, we can now open the line for questions.
spk08: Thank you. At this time, I'd like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We'll take our first question from Simon Leopold with Raymond James. Your line's open.
spk07: Great. Thanks for taking the question. I wanted to see if you could maybe unpack what's going on in terms of your verticals. whether they're all behaving similarly in terms of this kind of inventory absorption and slowing, or whether there's an aspect that stands out either because of customer concentration or other reasons. And then I've got a quick follow-up.
spk09: That's a good question, Simon. Good to hear from you. Yeah, so look, I think from an ICP front, they are lumpy orders, and each one of those is behaving differently. I'd say that maybe 50% of the ICPs are burning through a significant portion of inventory and still have nice CapEx forecasts for 2024. And I expect as we exit the year, again, we're, as I mentioned, we used to be with one ICT at a time. We're now doing some form of business with the top seven. So that bodes well for the future. A couple of them are going in still quite strong because of their immediate exposure to machine learning and AI. In the CSP domain, the largest CSPs in the world, I think that's where you see a large portion of that inventory. what we used to call kind of the inner exchange carriers, have been less affected by that. I think the larger conglomerates that offer multi-service access, wireless, others have been burning through inventory. Let's say that's been a bigger challenge for them. So it's spotty in the ICPs, but identified on the applications they're using. And in the CSPs, it's based on... Again, their overall supply chain buying that they did last year, meaning they packed on inventory to cover themselves in supply chain, and they're going to burn that down. Feels like, you know, when we look at the inventory levels that we perceive are out there in the industry. This isn't our inventory. It's total inventory in the industry. They're about, I think, you know, halfway through the inventory burned down.
spk07: So that sets up my follow-up nicely in that. It sounds like you're expecting a couple quarters of this remain, but if I combine the midpoint of your 3Q guidance with the prediction for low single-digit growth in 2023, that would imply at least mid-team sequential growth in your fourth quarter, so somewhat of a nice rebound in the fourth quarter. I want to make sure I'm interpreting that correctly and what you see fueling that implied fourth quarter strength. Thanks.
spk09: Yeah, so backlog, right? So, you know, both our backlog and the order intake that we have in our order forecast that we have with our client base. So I think, you know, again, despite a bit of a softer back half as we see service providers, again, digesting the inventory, you know, we're still continuing to have system design wins out there with carriers. They're just slower to pull the trigger on ultimately getting the orders in and even once they've got the orders in on getting them scheduled. We think that begins to rebound as we exit the year and we get a more normalized 24. Now, despite that, Simon, look, we pull our levers in times like this, you know, you drive efficiency and then both Nancy and my comments, you know, for the fifth year in a row, we'll expand EPS and this year, You can do the math. If you contemplate that we'll grow by at least 25%, that says it's kind of 15 to 20 cents of EPS, which when you go back to our analyst day, you know, that's kind of the view, the upper end of that view was kind of where we said we needed to be. And when we look at the consensus view for next year, that doesn't scare us at all. Nancy also said that we're spending $100 million on a subsystem business. You know, that's over 30 cents if you add it up, and that hasn't yet begun to pay back. The payback will start next year when we start putting the vertical integration in the metro platforms, and then we'll further drive operating leverage as we exit 24 when you start to see true impact from the external pluggable sales in any kind of large-scale fashion. Sorry, long answer, Simon, but did that help you?
spk07: Very much so. Appreciate the details.
spk08: Thanks. Next, we'll go to Madam Marshall with Morgan Stanley. Your line is open.
spk03: Thanks. You know, I just kind of wanted to reconcile some of your commentary that the book to bill was largely as expected with kind of some of the lower order commentary along the way. And I know you had kind of alluded to the fact that you were going to need to see orders improve throughout the year to kind of make expectations. So I guess I'm just trying to see, is this just you didn't see that improvement or the environment kind of further deteriorated?
spk09: Yeah, it's good. Good question. So we certainly did see improvement from Q1 to Q2. We expect to see improvement in Q3 and certainly the whole back half of the year, including Q4, to improve. I think overall the industry had a much softer Q1 than anybody anticipated. And if you look at our competitors and where their book to bills have been, where they've reported, you know, we think we're doing a good job of maximizing our bookings in a pretty sparse first half environment. And we think that will pick up in the back half, but I don't think you'll talk to anybody in the industry that doesn't think the first half was lighter. We all expected, you know, lower bookings, but it, you know, the first half was lighter than anybody had anticipated.
spk03: Got it. And then maybe just as a follow-up, you know, on the new U or on the major U S or risk provider, uh, when Metro win that you noted this quarter, you know, is that a new customer, um, On the 400DR piece of that, you know, is it going to be multi-vendor? Just any kind of commentary on that one.
spk09: Yeah, new customer for us using the whole GX platform, you know, starting out using, call it merchant pluggables. And we are already integrating our pluggables into our platform so that in 2024, we can leverage our own pluggables. And that was part of that deal. So we'll see the margin. That's a great example of how the margin will expand. With our most important customer of our pluggables, our first most important customer is Ron Johnson, who runs our systems business. We're our most important first customer.
spk03: Great. Thank you.
spk08: Next, we'll go to Alex Henderson with Needham. Your line is now open.
spk02: Great. Thanks. I was hoping you could... Give us some clarity on the linearity of orders over the course of the quarter, whether there was any push outs in the period. And as you have given guidance of improving orders in both 3Q and 4Q, do you anticipate exiting the year with a book to bill for the year that is somewhat above 1?
spk01: Hi, Alex. Yeah, the linearity has been challenging for us and I think for the industry as a whole in terms of first half versus second half. And you can see that in terms of some of the working capital usage that we're planning for Q3 as things start to work through there. But for the second half and certainly as we're exiting the year, we believe book-to-bill should be about and potentially a little over one, just as we had said at the beginning of the year. So definitely a second half growth in bookings. and we'll see, you know, how things shake out in Q4, but expecting some good growth there.
spk09: Yeah, just to clarify, Alex, so for the second half, absolutely, we expect the book to bill to be above one. For the year to be seen, you know, I think we'll be close to one for the year, if you were to ask our current prediction. The question on linearity was for the second quarter specifically.
spk02: Was there any change in the linearity during the quarter in terms of, you know, perceptions of when you're going to close deals. The follow-up question I had for you was really on the pluggable side. It was an industry piece out recently talking about 39 vendors of 400 gig ZR. Obviously, not all of them have chips to integrate from themselves, but that's a lot of players, and it does strike me as risky on pricing. considering this is supposed to be an open standard product. So how do you view the market for these pluggables relative to pricing and ability to generate decent profits on them as a standalone business?
spk09: Yeah, we'll have to talk offline, Alex. What we see are the competitors we're bidding against today in active bids and then the awards that we're getting. I think, again, you're right, probably not all of them. There might be rebranding or something, but I certainly don't see 39. I see three or four in any particular bid. And not all of them have their own DSP and their own optics. In fact, we tend to be the only company that has all of the vertical integration and also has the software enablement. And I think as you start to scale these out in networks, especially on the CSP side of things, That's going to prove to be more important, and that same software platform will carry on into our 800-gig product and certainly our 100-gig product. So I'll have to talk to you offline. No way, shape, or form have we seen 39. When we look at the competitive field, it's more like that.
spk02: I have a report that came out specifically saying that there was 39 companies competing in the space.
spk09: Yeah. I'm just telling you what I see competing for a deal.
spk02: Right.
spk09: But what do you think pricing is going to look like? Do you think pricing is going to hold in? Do you think it's going to roll? Any sense of pricing? Yeah, so I think so far, you know, there's pricing depending on the form factor. If it's going into an ICP, it tends to be differently in a DV form factor versus a CFP2 going into a metro network, which tends to be a bit stronger because of the value that's bringing in the overall network. There'll certainly be typical price pressure on an annualized basis, but I think we're well positioned, again, with the vertical integration to hit that down. And they're starting to spend even more time on the whole power and reach because some of the ZR technologies, in terms of them trying to get the reach and punch through rotums, they're looking for a bit more of that performance, and that's what we're going after today. I understand. Thanks. Thanks, Alex.
spk08: 39. Okay, next we'll go to Mike Genovese with Rosenblatt Securities. Your line's open.
spk06: Oh, great. Thanks a lot. David, could you talk about just, you know, in 24, which products in particular, you know, you're excited about? And, you know, for those out there who would say maybe, you know, not having a 1.6 terabit product in 24, know would you know could potentially be a disadvantage um although that seems you know um early to me um to make that anyway how but what would you say to those people um so basically yeah the products that you're excited about and why sort of 25 is a good point to intersect the 1.6 market yeah so good it's a good question you know look overall we've refreshed our entire product line since the corian acquisition right
spk09: So we have a whole new line of hardware, the GX platform, a whole new line of software, a whole new OS, you know, state-of-the-art that takes multi-generational sleds. So it'll take I6, it'll take I7, it'll take I8, and our pluggable line. So I'm pretty excited about, A, having a product in the metro where I don't have to go buy plugs from somebody else and take margins that are destructive. Now, we've been growing the EPS of this company for the last five years while we've been investing in the systems line. And I feel good that we've got a very competitive systems line that's winning with less competitors and Huawei exiting the market. So I just, you know, I know everybody's going to come out and say, well, I got a 1.6 in this timeframe. It's all going to be about closing wave sizes at 400 gig in the metro and then closing them in the long haul at, you know, how many 800 gig lengths and how far can you carry them? and continuing to push the economics. So as we model it, we feel pretty good about that and where we sit against the competition. We're just probably a little surprised right now, especially given where we're trading, that we just continue to drive EPS expansion no matter what the market throws at us. And we're investing. The system's portfolio has never been in as good a shape. And we're putting $100 million to work to make sure the second act in the subsystems piece drives long-term shareholder growth. So more than you asked for, Mike, but hopefully that was helpful.
spk06: Very, very helpful. My second final question, just on AI, how it might impact you in the future, any early thoughts on either higher growth rates for the DCI market or probably maybe more likely your technology and coherent technology moving into the data center. Basically, do you think that a year or two down the line, you'll have an AI story like some of these optical component stocks? Thank you.
spk09: Well, I promise I'm not going to rebrand this as an AI story on this call, given the recent trading environment. That isn't a trick we're going to play. But what I will tell you is, look, our order book You know, as we went through this year and as we look into next year as being impacted by AI and ML, you hit it on the head. You know, there's some ICPs that are going to have to run eight to ten times the payload, and that just means more DCI boxes to be able to do that and the software to be able to manage it. And if they move closer and closer to the metro, you know, other solutions get more payload. So I think that's absolutely going to happen. And, yeah, look, longer term, Yeah, we have obviously had discussions with folks about how you can use our indium phosphide capability in our fab to, you know, have optical do what copper is doing inside the data center against a chipset that's driving AI. But that's long, long term. Nobody wants to hear about that. Now they want to hear that we're going to continue to keep our heads to the ground, put a mouthpiece in, and continue to drive EPS expansion.
spk07: Fantastic. Thank you.
spk08: Okay, next we'll go to Christian Schwab with Craig Halam. Your line's open.
spk10: Great. Thanks for taking my question. David, you've talked even at your analyst day, and I know you hired some people who helped form the legislation on the CHIPS Act, and you keep mentioning that. But, you know, recently Bloomberg just said that there's over 460 people asking for money, right? Germany gave big chunks to Intel, like $11 billion, TSM $5.5 billion. it isn't going to take too much time to run out of the grant money and the CHIPS Act. So I guess I'm just wondering what makes you so confident that you think that, you know, there'll be something left for Infanero.
spk01: So first of all, none of our expectations, and even when we were talking at Analyst Day, assume anything from the CHIPS Act. All we're saying and have said and we still believe is that With our U.S.-based semiconductor manufacturing, optical semiconductor in California and advanced packaging in Pennsylvania, we check a lot of the boxes that we've been told they're looking for, and we're going to pursue as we can. But none of that is incorporated into our outlook or into the dollar VPS or into the cash generation that we've put forward in terms of our long-term business model.
spk10: Great. And then my second question, just as we exit this inventory digestion, you know, kind of halfway through, you know, on the backside of that, you know, is that when you guys would expect to kind of return to the type of growth rates on the top line that you outlined at the analyst day? Is that kind of what we should be thinking?
spk09: Yeah, look, a couple years ago at our analyst day, we said 8% to 12%, and everybody kind of questioned us. We've been growing, and if you take, again, a six-year view or a five-year view, we've been clicking along above that rate. Look, it's too early to talk about 24%, but our long-term view and our long-term business plans have that 8% to 12% growth rate in them. and had a little bit of buffer room for EPS expansion, meaning to continue EPS expansion even if we have little blurbs and blurbals, which we've had. And guess what? We've continued to expand EPS. And in this trading environment, I can't even explain it. Hopefully somebody can to me. But I would tell you that the one thing I do know is if you continue to grow EPS, ultimately it will be valued and take care. Yeah.
spk10: Yep. Perfect. Great. No other questions. Thank you. Okay. Thanks.
spk08: Okay. Next, we'll go to Sameek Chatterjee with JP Morgan. Your line is now open.
spk04: Hi. Thanks for taking my questions. I had a couple, and maybe if I can start with the updated revenue guide for the year. I mean, simplistically, if I look at your full year guide, you're taking your revenue expectations down by about $100 million or so. I'm just wondering, can you sort of quantify that a bit more in terms of how much of that is going to be service provider versus ICP related to your prior expectations or even by geography like how should we think about that being split between America, ZME and APAC as to where you're seeing that sort of reduction coming from just to get a bit more sort of color. No, I'd say
spk09: Yeah, I'd say it's pretty broad-based. I mean, 25% of our revenues are coming from ICP. It's probably in that nature of 25% to 30%, you know, from that sector. The rest is broad-based across service providers. And again, remember, some of these folks have scheduled projects and are just saying, hey, let's delay them out a quarter or two. And honestly, a lot of those customers have moved off and have new management in place and are just trying to kind of make it through the period as they digest inventory. So it's kind of two things going at once. So, you know, we can make pieces of that back from margin and through operational efficiency. And that's why Nancy and myself are confident at the 25% plus EPS expansion this year. And when we look at what you all have contemplated in EPS for next year, Again, remember, we're investing over 30 cents a year in our subsystems business that is, you know, it's an investment at this point. It's not yet paying back and starts to pay back in 24. So that lightens in 24 and lightens in 25. You see that path to a buck. Let's not forget in 2019, we were losing over 60 cents at EPS when we started this journey. Correct, correct.
spk04: And then maybe just for my follow-up, I mean, given the push out of projects being the primary driver of sort of the uncertainty that you're seeing. What drives the confidence for the $400 million plus revenue number in 4Q that you're implying? And also, when you talk about a four-quarter digestion, how much of that is just sort of overall thinking that the comps get easy enough and you start to sort of improve from there, or do you really expect sort of inventory to be completely normalized? How do you get visibility into that sort of specific four-quarter digestion?
spk01: Yeah, so, I mean, the digestion that we're seeing is based on discussion with customers, right? And the growth that we expect in Q4 is, again, based off backlogs that we have today and pipeline and, you know, order opportunity that we're working through now in Q3, right? That's what gives us that confidence in Q4. So we should start to see, you know, inventory start to work through, our own inventory. One comment there is we've already seen, and not something that you guys see quarterly, but you see annually, is the commitments at RCMs in terms of the NCNR on hand and on order, that has already started dropping and has dropped more than the inventory increase you saw on our balance sheet this quarter. We're starting to see those signs. I know they're not all quite as visible to you in terms of the day-to-day, but that's what gives us the confidence in exiting the year in Q4 strong, and then what we see in terms of backlog and pipeline demand normalizing into 24. Good. Thank you. Thanks for taking my questions.
spk10: Thank you.
spk08: Okay. Next, we'll go to George Notter with Jefferies. Your line is now open.
spk05: Hi guys, thanks very much. I guess I wanted to ask about the mix of vertically integrated products for Q2. Do you have a number for I-6 and then a number for overall?
spk01: Yeah, for overall it's about 55% and for I-6 it's in the first half. And so on track to the 35% plus for the year.
spk05: Got it. Okay. And then I think you guys also had like a 55% to 60% target for the full year for overall vertically integrated product. Is that still in the cards or maybe?
spk10: Yes.
spk05: Yes. Okay. And then how do you think about the GX family? You're incorporating pluggables into that product, which is great and certainly very helpful for margins. Certainly there's going to be a testing period, I think, for customers before they can start deploying that commercially. Like, how long do you think that test phase will take? How long before you can be material?
spk09: Yeah, we started doing that, if you recall, in kind of the July-August time period. So early July, as soon as we started the quarter. And what we had mentioned in both the analyst day and in prior calls is we expect that to be kind of complete by the end of the year. And our teams are outselling today. But deployment, we said, would be in 2024. And given we have qualified, I can't even tell you, probably over a dozen different merchant optics in our own platforms, we're pretty aware of what needs to happen there. So, yeah, that'll happen, you know, this year through the end of the year, and we'll be deploying those solutions in 24, and Nancy will see the impact in the almighty income statement and balance sheet.
spk05: Got it. Okay, and then I guess same question for the XTM. I assume that now has pluggable solutions in that as well?
spk09: Yeah, yeah. So we're in parallel going through the XTM and the GX.
spk05: Okay. Thank you very much.
spk09: Most of the volume going forward, you'll see in the GX platform, obviously.
spk05: Okay. Great. Thanks.
spk08: I'm showing no further questions at this time. I'll now turn the call back over to CEO David Hurd for any additional or closing remarks.
spk09: Well, thank you, David. Well, Q2 was another solid quarter for us. Look, we beat the consensus view across the board while making the strategic progress in the six milestones we talked about just a few short months ago in uh in march we're continuing to win new accounts we're growing in new geographies and particularly in the metro where uh you know that is over half the market in optical we're on track as i just mentioned to george to integrate our own 400 gig dd and cfp2 zrzr plus modules we'll start to see those in the margins in 24. we are increasing the vertical integration in the mix as we've said We believe there'll be growth in both embedded engines and pluggables, and that's why we're investing in both. And let's not forget, we're investing $100 million a year in the pluggables that we're not yet seeing the return from, but we expect to start seeing it in something we control in our own products in 2024. Again, the technology and innovation to do what we do is getting harder to do. And doing it in the U.S. is proving to be an advantage, both from a security standpoint and from a supply chain standpoint. So I'm feeling really good about where we're at in terms of the systems portfolio. And I'm really excited about the new subsystems business. Now, that being said, the industry is going through a period of digestion. I've been seeing, you know, we've been seeing this from the competitive field in the industry over the last, you know, over the last couple of quarters and in particular the last 30 days. But our commitment is to continue like we have been over the last five years, to continue to bust out EPS in difficult times like this, because we think it ultimately will be valued. And again, there's less people that are able to do what we can do. So I do appreciate your support, your patience, your good questions. We're going to put our heads down, put our mouthpieces in, and go back to work driving EPS expansion. Thank you, and have a great night, great day. Okay.
spk08: This concludes today's conference call. You may now disconnect. Great day. This concludes today's conference call. You may now disconnect.
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