Infinera Corp

NASDAQ:INFN

Earnings Call Analysis

Infinera Posts Strong Q4 Amid Year-End Growth

Infinera's fourth quarter outperformed its outlook with revenue, gross margin, and EPS exceeding expectations, generating over $50 million in free cash flow. The year concluded with its sixth successive revenue growth spike, about 40% gross margins, and a significant 70% boost in year-over-year EPS. In contrast, Q1 appears soft, with a $35 million revenue shift and a 400-basis point gross margin dip expected, yet a recovery to over 40% gross margins is projected from Q2 onwards. A major new contract with a hyperscaler for 800-gig 3-nanometer ZR/ZR+ pluggables could become one of the company's biggest deals, potentially worth hundreds of millions starting in 2025.

Strong Ending to 2023 with an Eye on Future Growth

The company wrapped up the year on a positive note, with the fourth quarter showing strong performance above their outlook range for key financial metrics. They achieved a consistent book-to-bill ratio of approximately 1 and generated over $50 million in free cash flow. The full year 2023 is expected to mark their sixth year of consecutive revenue growth, with projected earnings per share (EPS) growth of at least 70% year-over-year.

Short-term Challenges Balanced by Strategy and Product Confidence

While expecting gross margins to fall by around 400 basis points in Q1 due to high line system shipments and lower volume, the company is confident in its full-year growth and margin expansion for 2024. They have secured strategic contract wins in their Systems and Subsystems segments, forecasting significant revenue from these deals starting in 2025. These achievements are believed to set the stage for sustained financial health and competitive edge in the future.

Initiatives and Qualifications Setting Future Revenue Streams

The company is progressing with several initiatives, such as qualifying their 400-gig ICE-X pluggables with major service providers for applications aimed at reducing power requirements and maximizing U.S.-based semiconductor assets. These actions are vital in securing future revenue and maintaining market leadership in technology solutions for artificial intelligence and machine learning workloads.

Stable Past Performance with Optimistic Projections for 2024

Q3 results revealed revenues of $392 million and a gross margin of 41.9%. Looking forward to the first quarter of 2024, there is an expectation for a slower start, but the company has set a revenue target range of $320 million to $350 million, anticipating a gross margin between 36% to 38%. Additionally, there are hopes for operating expenses of $143 million to $147 million. Despite an anticipated net loss per share of $0.18 to $0.10, the broader picture focuses on a 2% to 3% revenue growth for the full year, margin expansion of about 200 basis points, and at least a 25% growth in EPS for 2024.

Earnings Call Transcript 2023-Q4

[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, executive]

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 our 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 30, 2023, as filed with the SEC on February 29, 2024, and 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 slide -- 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 will allow for plenty of time for Q&A today that we ask that you limit yourself to one question and one follow-up, please.I'll now turn the call over to our Chief Executive Officer, David Heard.

[David Heard, executive]

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 1 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 at our Investor Day, and that EPS is up at least 70% year-over-year.From a portfolio and customer perspective, we continue 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 consortium. Our win rate in the metro remained 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 4 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 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 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 a 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 Subsystem 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 3-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 3-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 demand of hyperscalers, we continue winning managed optical fiber networks or MOFN 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 ICE-X pluggables with a major Tier 1 service provider and a major U.S. cable MSO for applications that include single fiber BiDi 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 product 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 27.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 for the quarter and our Q1 outlook. Nancy?

[Nancy Erba, executive]

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 29. 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 towards completing the work necessary to file our Q3 '23 results and other related SEC filings, our final results for Q3 -- 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 audit completed and file our fiscal year '23 10-K in the next 5 to 7 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% to [Audio Gap] 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 second -- 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 had 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 5 to 7 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 lineup for questions.

[Operator]

Thank you. [Operator Instructions] Your first question comes from the line of Mike Genovese from Rosenblatt Securities.

[Michael Genovese, analyst]

Great. Thank you. Can you start by giving us more color on this major hyperscale win the 3-nanometer ZR+ 800G pluggable, just more color on what that application is, what those products represent? Thank you.

[David Heard, executive]

Sure. Hey, Mr. Ron Johnson, do you want to take that?

[Ron Johnson, executive]

Yes. Thanks, David. Yes, Mike. So we had close a 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 CFP2 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, executive]

Hey, Mike, financially it's -- from a contract standpoint,, it is -- it's kind of the largest contract potential that the company has dealt with in its history. So it really kind of helped 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.

[Michael Genovese, analyst]

Okay. Great. And it sounds like it's a DCI application more than a datacom inside the data center application. Is that correct?

[David Heard, executive]

Correct.

[Michael Genovese, analyst]

Great.

[David Heard, executive]

Then I would just say it's outside the data center, correct.

[Michael Genovese, analyst]

Yes. Okay. And then just my other question is, I guess, just some color on gross margin 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. So we understand how things get a lot better later in the year.

[David Heard, executive]

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, end of year.

[Operator]

Your next question comes from the line of Alex Henderson from Needham & Company.

[Alex Henderson, analyst]

Great. So I was hoping you could help us bridge to 25% EPS growth on 2% to 3% revenue growth and a 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, executive]

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.

[David Heard, executive]

Hey, 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, analyst]

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, executive]

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.

[Operator]

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

[George Notter, analyst]

I guess I wanted to ask about, help me understand sort of the cadence on the top line here, right? So really strong Q4, a 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. So why a strong Q4 and a step down in Q1? And how does that mesh with the sole narrative around working off excess inventory? Thanks.

[David Heard, executive]

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 1/3 of our business. When I take into account these managed fiber optic deals 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 the 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 here we go.

[George Notter, analyst]

Got it. Was the excess inventory issue then in Q4 as well?

[David Heard, executive]

Yes. I mean in terms of raw bookings, we did well in Q3 and Q4 having a book-to-bill of about 1 for those quarters, but it has not been a loose environment in terms of those dollars. It is beginning a 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 just -- they're not as significant of an impact to our business.

[Operator]

Your next question comes from the line of Simon Leopold from Raymond James.

[Simon Leopold, analyst]

Just for 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, executive]

Yes, it's about the 30 -- think of a 1/3 of our product revenues in 2023, and in Q4, it was approaching 40%.

[Simon Leopold, analyst]

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, executive]

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, analyst]

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

[David Heard, executive]

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

[Operator]

Your next question comes from the line of Meta Marshall from Morgan Stanley.

[Karan Juvekar, analyst]

This is Karan on for Meta. I mean, I just wanted to double-click on sort of the $25 million that got pushed out in the 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, executive]

Yes. On the $25 million, no, 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 to the value chain in the industry.

[Karan Juvekar, analyst]

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, executive]

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 will 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, executive]

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 -- 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 or internal consumption--

[Operator]

Your next question comes from the line of Dave Kang from B. Riley.

[Dave Kang, analyst]

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, executive]

Yes. For the year, it was in the mid-50s. And we should continue to see that expand, particularly in '24 as we just talked about with metro coming online.

[Dave Kang, analyst]

Correct. Got it. And then 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?

[David Heard, executive]

Yes. I would say probably very, very similar to '22. So maybe 43, 57, 42, 58 kind of just to be safe. I mean, we typically tend to be 48, 50--

[Ron Johnson, executive]

Was that roughly on the top--

[Nancy Erba, executive]

Roughly--

[David Heard, executive]

We typically tend to be 47%, 48%, but this year, I would say it's more like '22 played out.

[Operator]

Your next question comes from the line of Samik Chatterjee from JPMorgan.

[Samik Chatterjee, analyst]

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 sort of what you're expecting in terms of growth in those two areas? And I have a follow-up.

[David Heard, executive]

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. 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 providers that is -- we have a great application of that software-defined pluggable for fiber limited areas for BiDi, bidirectional, 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 MOFN deals on Asia Pacific, on India, in particular, and on the Middle East.

[Samik Chatterjee, analyst]

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 -- when 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, executive]

Yes. So I think you're right, 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.

[Operator]

Your next question comes from the line of Ruben Roy from Stifel.

[Ruben Roy, analyst]

Thank you. Hey, David. I had a question on the 800-gig. Congrats on the first off. 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, executive]

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 web scalers 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 these potential spend for the web scalers. 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, executive]

Yes, I agree.

[David Heard, executive]

Just to be clear, Ron would have disagreed if he disagreed. He's not just saying that. Excellent.

[Ruben Roy, analyst]

Okay. So either for you or Ron, David, you did mention a little bit about the 400 gig and the cable MSOs, et cetera. But just in terms of how we should think about the ramps of 800 million 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?

[Ron Johnson, executive]

You are.

[David Heard, executive]

So I think 800 is Costco buying, 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 it's 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 said, it's a 3-legged stool, drive lower cost per bit, drive lower power per bit and drive the agility up. And that 400-gig pluggable allows you to move in 25 gig increments, only power, which you need. And that's why we won some green awards, for example, in Europe with that product. So yes, longer life cycles, sorry.

[Operator]

Your next question comes from the line of Christian Schwab from Craig-Hallum Capital.

[Christian Schwab, analyst]

Given the headwinds that we're seeing 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, executive]

That was a trap, well set, well set. 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 said prior is past this inventory digestion period. We're going to continue to put our heads down and 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 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 than EPS. But I'm not setting a number for '25.

[Christian Schwab, analyst]

Yes. 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 on where you think you're positioned in that process?

[David Heard, executive]

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 time frame as well in terms of the impact to the business if we are to be awarded.

[Operator]

Your next question comes from the line of Alex Henderson from Needham & Company.

[Alex Henderson, analyst]

Sneaking in with a second one. Thanks for letting me in. So I was hoping we could go back to this contract that you've got with this hyperscaler, 3 years out $100 million annual run rate, I would think that the initial shipments are in 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, 50, 100?

[David Heard, executive]

No. I have -- what we said in the prepared remarks was the 3-year contract is worth hundreds of millions of dollars. So we believe that we'll start shipping in 2025 with this particular customer. And yes, get more intense than '26, '27 in the beginning of '28, and then we'll be on the new -- with that particular customer, you go from the 800-gig pluggable to potentially a 1.60 pluggable from there. So no, it's -- the number is much larger.

[Alex Henderson, analyst]

So it's larger than 25, 50 to 100--

[David Heard, executive]

Yes, it's hundreds of millions. Yes, it's hundreds of millions over a 3-year period, not like 1 or 2 or -- I don't want to get too specific, but we're -- it's the largest that we've seen.

[Alex Henderson, analyst]

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, executive]

So with a lot of these deals, what I think you will see with a lot of deals in the future as 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, executive]

The only thing I'll add is that it's extremely compelling for them to ramp this quickly because it's a significant improvement in cost per bit and power per bit for their network.

[Alex Henderson, analyst]

So the other question I had for you is you mentioned the managed optical lines that you're growing -- 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, executive]

Ron, do you want to take that?

[Ron Johnson, executive]

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 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 line system component, there's services, there's transponders or pluggables depending on the application. And it looks very similar to any big Tier 1 service provider win.

[Alex Henderson, analyst]

So it's not a high management maintenance contract piece. It's just classic systems.

[Ron Johnson, executive]

[ Classic ] systems with the maintenance contract and the good news is we see the end demand because we're working with the web scaler, so they typically tend to build them bigger because they're looking to interconnect to data centers and terrestrial networks.

[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, executive]

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 what is 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 3, 4 years ago. While the front half of the year 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 confidence and confidence in the back half recovery and our ability to grow revenue, expand share and increase margins and 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.