Infinera Corp (INFN) 2007 Q3 法說會逐字稿

Welcome to the Third Quarter Fiscal 2007 Investment Community Conference Call of Infinera Corporation.

At this time all participants are in a listen-only mode until the question and answer period.

(OPERATOR INSTRUCTIONS)

Today's conference is being recorded.

If you have any objections, you may disconnect at this time.

I would like to turn the meeting over to Mr.

Bob Blair of Infinera Investor Relations.

Thank you.

Good afternoon.

I want to note that the forward-looking statements included in today's call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements address the financial condition, results of operations, business initiatives, views on our market, our products, and our competitors' products, guidance, growth plans, and prospects of the Company in 2007 and beyond and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

Please refer to the Company's current press releases and SEC filings including the recently filed registration statement on Form S-1 and on Forms 10-Q and 8-K for more information on these risks and uncertainties.

Today's press releases, Q3 financial tables, and investor information summary and a guidance reconciliation summary will be available today on the investor section of Infinera's website at www.infinera.com.

The Company 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.

I would like to discuss the non-GAAP financial measures that are included in this afternoon's press release and today's conference call.

In our earnings press release we announced operating results for the third quarter of 2007 that excluded the impact of non-cash stock-based compensation and warrant revaluation expenses.

These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons.

Please see the exhibit to the earnings press release for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, and an explanation of why these non-GAAP financial measures are used and how they are used by management.

On this call we will also give guidance including guidance for the fourth quarter of 2007.

In this guidance we will include non-GAAP invoice shipment results, which exclude the impact of non-cash stock-based compensation expenses from our results.

Again, we have reconciled the non-GAAP invoice shipment revenue results to our GAAP revenue results on the investor section of our website.

We have not reconciled the other forward-looking non-GAAP projections we will discuss today related to gross margin, operating expenses, net results, and earnings per share.

Because we can not readily estimate the impact of customer and product mix on our lower of cost or market adjustments and gross margins, and the impact of our future stock price on our future stock based compensation expenses.

For the remainder of today's call, we will be discussing our third quarter 2007 results and our fourth quarter 2007 guidance, excluding the impact of these items, and we will refer to these results as non-GAAP.

Finally, please note that we recently filed a registration statement on Form S-1 with the SEC.

Because we are in the registration process, we will not be able to answer any questions related to the offering.

I will now turn the call over to Infinera President and Chief Executive Officer, Jagdeep Singh.

Good afternoon, everyone.

It's a pleasure to welcome you to Infinera's conference call for our third quarter financial results.

Joining me is CFO Duston Williams, who will provide a financial report for the quarter and an outlook for Q4 after my remarks.

We're very pleased with our third quarter results as they reflect a growing acceptance of Infinera's disruptive technology.

We're gratified by the continued confidence being demonstrated by our customers and the Infinera team and vision.

We achieved strong year-over-year and sequential revenue growth, as well as our second consecutive quarter of profitability on an invoice shipments basis, along with sequentially stronger gross margins.

Invoice shipments in Q3 totaled $80.4 million, versus $69.0 million in Q2 and versus $42 million in Q3 of 2006.

Gross margins on an invoice shipments basis were 43% in Q3 versus 37% in Q2 and 21% in Q3 of 2006.

Net income on an invoice shipments basis for the quarter was $10.9 million, versus $2.7 million in Q2 and versus a loss of $13.6 million in the year ago quarter.

Our performance is also an indicator of sustained strength in the optical transport market as a whole, as customers continue to report annual expansion rates in network bandwidth of between 70% to more than 100%.

At a recent Stanford University conference, Verizon forecasts that global bandwidth growth will accelerate to almost ten times [per] three to four years with video generating much of this need.

While we can't predict the future, our own interaction with customers in the long haul transport, cable metro, and Internet content provider markets does nothing to dissuade us of this outlook.

This explosion in carrier bandwidth growth creates three fundamental challenges for carriers.

First, to find the most cost effective way to scale their networks to keep up with the raw capacity demands.

Second, to deal with the inherent unpredictability and uncertainty regarding the nature, bandwidth, and traffic matrix of the services they will need to deliver, and third, to scale their network operations to keep up with this capacity expansion.

Infinera's innovative technology addresses each of these carrier challenges.

Our pick eliminates dozens of expensive components, providing what we believe is the most cost effective way to scale the optical network and make it easy to convert optical traffic into digital ones and zeros.

And once the traffic is digital, we can virtualize it, turning it into whatever services our customers need from a pool of fungible bandwidth.

This delivers the flexibility and service providers need to deal with the inherent uncertainty related to their service demands.

What used to be a hardware upgrade with traditional optical equipment becomes a software configuration with our system.

And this translates into a significant operating cost benefit.

We call this bandwidth virtualization.

Our ability to digitally convert customers' network capacity into a vast pool of fungible bandwidth is an approach that's winning in the marketplace against the more traditional incumbent approach, especially with carriers who are at the forefront of innovation around the world.

So far so good, as evidenced by the results we reported today.

In addition to the strength of the absolute numbers in Q3, we're gratified at the substance behind those numbers.

We believe these developments validate our long-term business model and strategy.

Examples include first continued customer growth.

Seven new customers were added in the third quarter, expanding our customer roster to 38 versus 31 in the second quarter.

A year ago we had 17 customers.

Second, customer diversification, we expanded and broadened our business with our growing customer base in the third quarter, reducing our customer concentration.

We had three 10% or greater customers, with the largest accounting for 28% of invoice shipments.

This contrasts with the second quarter when our largest customer accounted for 48% of invoice shipments and with the year ago period, when that customer accounted for 55% of invoice shipments.

Third, market diversification, since our inception we've emphasized the leverage of our technology in providing the same economic advantages to each of our targeted markets.

We've more than doubled our revenue with both the cable MSO space and Internet content providers in the first nine months of 2007 versus the same period in 2006.

It's also worth noting in this context the growing number of Internet content providers who heretofore would not have considered building their own networks, but rather would have turned to bandwidth wholesalers for their capacity needs.

Our recently announced customer wins in cable with Cox Communications and an Internet content provider space with OVH, demonstrated continued diversification of markets, building on our strong base and continued growth in the bandwidth wholesaler market.

It's also important to take note of why we're winning in the marketplace.

We're enabling our customers to deliver services to their customers more quickly, more flexibly, and more cost effectively.

Indeed, new business models and innovative approaches to our customer's customers are being created with Infinera's technology and bandwidth virtualization.

Let me describe some examples.

Interoute is one of Europe's largest pan-European voice and data networks with over 54,000 kilometers of [lift] fiber.

Interoute emphasizes the attributes of simplicity, flexibility, choice, and speed as the major benefits they deliver to their customers.

Their ability to pre-deploy Infinera network capacity for new customers and the fact that we can deliver tributary adapter modules so quickly, has enabled Interoute to market 10Gigs in ten days as the cornerstone of their rapid bandwidth delivery program.

By comparison, conventional tending circuits can take as long as eight weeks to 20 weeks to provision.

At XO Communications they've launched a 3 Guarantee Program to feed optical transport accounts into their new network.

XO promises that they will beat any competitors' price for 2.5Gig and 10Gig long haul service along select network routes, and that they will provide a guaranteed service installation date.

We believe that XO's ability to provide this guarantee reflects their confidence in Infinera to help ensure this speed of delivery.

So there's plenty of innovation and business model changing underway at the vanguard over industry and among our customer base.

As we advance the vision of Infinera's digital optical networks, we're very pleased to be a catalyst for these improvements in our customers' business models.

Duston will now provide a Q3 report and a Q4 outlook.

Duston?

Thank you, Jagdeep.

I'll first provide a brief summary of the Q3 actual results, and then follow that up with an outlook for Q4.

The following analysis of our Q3 results is based on invoice shipments and excludes non-GAAP stock compensation.

Please see the GAAP to non-GAAP invoice shipment reconciliation, which is attached, as an exhibit to today's earnings press release for a reconciliation of these results to our GAAP results.

Q3 by most all accounts was an outstanding quarter for Infinera, one that we are very proud of.

It was an important milestone for us, as we believe it lends further credence to Infinera's long-term operating model and [a] differentiated solutions to customers needs.

On the other hand, the same confluence of positive factors that led to the Q3 upside is not necessarily repeatable in the short-term.

Invoice shipments in Q3 totaled $80.4 million versus $69 million in Q2, versus $42 million in Q3 of 2006.

International sales were 19% of our invoice shipments in Q3, versus 16% in Q2.

We were very pleased with the broadening of the customer base in Q3, which significantly reduced the Company's dependence on its largest customer.

In Q3 we had three 10% or greater customers, with the largest customer accounting for 28% of revenue on an invoice shipment basis.

In the preceding quarter our largest customer accounted for 48% of invoice shipments.

A year ago that customer accounted for 55% of our invoice shipments.

Turning to gross margins, they were 43% in Q3, versus 37% in Q2 and versus 21% in Q3 of 2006.

As we mentioned previously, our gross margins are heavily correlated to customer and product mix and can fluctuate on a quarter-over-quarter basis.

In Q3, the combination of an improved customer mix, better than expected product mix, and some better than forecasted one-time cost related benefits help account for the quarter-over-quarter improvement in gross margins.

Operating expenses for the quarter were $26.8 million, versus $23.8 million in Q2.

The increase in spending over Q2 reflects increased headcount, additional commissions correlated to the higher revenue performance, and incremental variable compensation.

Although R&D spending did increase modestly quarter-over-quarter, it was less than we anticipated, and some R&D project related expenses are expected to roll into Q4.

Operating income for Q3 was $8 million, versus $1.8 million in Q2 reflecting increased revenue and higher gross margins offset to some degree by higher operating expenses.

Other income and expense for Q3 was a favorable $2.9 million, versus $0.9 million in Q2.

The Q3 total included $0.7 million related to asset sales and FX gains.

The favorable quarter-over-quarter performance was mostly related to higher interest income and lower interest expense as the result of our IPO funding, which occurred at the end of Q2.

Net income for the quarter was $10.9 million or $0.12 per diluted share, versus $2.7 million or $0.04 per diluted share in Q2.

Turning to the balance sheet, cash, cash equivalents, restricted cash, and investments ended the quarter at $191.4 million, versus $198.1 million in Q2.

Cash from operations was a negative $2 million.

Year-to-date cash from operations stands at a positive $4.2 million.

DSOs were 47 days, versus 36 days in Q2.

The higher DSOs were predominantly related to a larger percentage of our revenues being accepted in the last month of the quarter.

Inventory turns were 3.2, versus 3.0 in Q2.

Accounts payable days came in at 54 days, versus 51 days in Q2.

Capital expenditures were at $3 million.

And finally, we paid off the last remaining debt amount of $4.5 million.

And the Company now has zero debt.

As we look at Q4, it will be a quarter that is marked with continued new deployments from our existing customer base, as well as a few deployments from newly signed customers.

As is the case with every quarter, our performance will be highly dependent on a number of key factors including customer and product mix, timing of new customer acquisitions, timing of equipment ship and accept dates, accessible deployments into international regions, as well as a level of cost reductions we might realize during the quarter.

With that as background, I'd like to offer the following guidance for Q4 based on invoice shipments, which excludes any non-GAAP stock-based compensation expenses.

Invoice shipments of $83 million to $85 million, gross margins of 39% to 40%, operating expenses of $32 million, net income of $2 million to $3.5 million.

And based on an average estimated, diluted weighted shares outstanding of $92.5 million, which assumes no newly issued shares, this would lead to an EPS of between $0.02 and $0.04.

Operator, would you please now open the call up for questions?

Our first question is from Marcus Kupferschmidt.

Thank you.

Good afternoon, guys.

How are you doing?

I guess my first question is to help to understand the different factors driving your gross margin strength this quarter.

I think you talked about three elements.

Could you repeat those and help quantify how much those helped us?

Sure.

This is Duston.

What we talked about there was customer mix and product mix, as we've talked quite a bit, that depending on how that plays out during the quarter margins are pretty highly dependent there.

And then we did have a one-time cost benefit mostly related to our improved quality quite honestly with continued reductions of annual failure rates that helped it from a one-time perspective.

If you want to look at it and try to quantify the differences there -- if you, we probably were surprised maybe by six percentage points for the quarter from the 37%, maybe, to the 43%.

And maybe 60%, 65% of that or 3.5 to four points maybe is related to product and customer mix.

And two maybe 2.5 points of it probably related to more to the one-time benefits.

Great.

And can you help us understand why it's a one-time benefit that you have better quality?

I mean is it just reversing an accrual?

Yes.

The actual warranty provision was effectively less than what we expected.

And we expect that to -- it's kind of a one-time benefit there as the rates go down.

And we expect that to maintain at that level going forward.

Got it.

And in terms of the next, the fourth quarter outlook, the gross margins.

Can you help us understand what you're looking for in terms of the key factors driving the gross margins and why?

I mean, I guess beside the one-time benefit what else is changing in the fourth quarter versus the third quarter?

Not too much, again, highly dependent again on level of percentage of common equipment and DLMs and TAMs.

You've got customer mix in there, obviously, that plays a key role there.

But new deployments, obviously are tilted a little bit more towards common equipment, lower margins.

But if you take out the one-time benefit from this current quarter there's not a whole lot of change there.

Maybe a little bit of different mix.

But we're thinking somewhere around 39% to 40%.

Okay.

This is my last question and I appreciate the thorough explanations, would be -- help us understand, I mean the gross margins you're generating in the business.

It sounds like certainly it's better than you guided us to.

I don't know if it's better than what you're looking for internally.

But you're still planning the footprint but yet you're seeing better margins.

So what else can you tell us about what's driving this nice expansion that we're seeing?

Again, as we shift to different customers that have different margin profiles, and as those percentages change around, the margins could benefit.

And they have benefited.

And I think we've I guess downplayed a little bit cost reductions.

But I think the team has done an outstanding job with ongoing cost reductions that we really don't talk about that much that continues to occur quarter-after-quarter.

And we continue to realize those benefits also.

Great.

Thanks.

Hasan Imam, your next question.

Please state your affiliation.

Yes, it's Thomas Weisel Partners.

Can you hear me?

Yes.

Thank you.

Strong results.

I had a couple of questions on the gross margin as well.

First of all, in terms of you beat your expected guidance very, very significantly.

And now it sounds like for next quarter you're guiding below this quarter's level again.

I'm just wondering, is there a high degree of uncertainty in terms of the gross margin profile on a quarterly basis?

Or, this quarter was truly an anomaly?

Well, Hasan, again when we look at the margin profile between common equipment DLMs and TAMs, those margins are quite different.

And to pick the exact product mix each quarter and the exact customer mix each quarter is not an exact science, quite honestly.

And we try to do our best.

And we tried to look at what that can be.

But it can change throughout the quarter.

And I say a little change from less TAMs to more common, or more common to TAMs has a pretty significant impact on margins.

We try to take our best guess going into the quarter.

And that's what we see with the 39% to 40% as we see it now.

Got it.

So, looking forward there's no significant trend that you can kind of put your finger on that would mean sustained level of gross margin range?

Well, I mean we said publicly, again from a gross margin perspective our ultimate long-term target model is 50%.

Clearly nothing has changed there.

This quarter has given us more confidence of obtaining that.

I think the only thing looking forward -- I think maybe into '08 we could get a couple of margin points bump from what's out there today.

As I say, the results for the quarter has given us a lot more confidence.

And we'll kind of see how it goes over the next couple of quarters.

Got it.

Great.

One other question, which is your comment that warranty provision, was lower than expected.

So I'm just wondering, does that impact your timing in terms of achieving [these] under SOP 97-2 at all?

No, it does not.

I wish it did but it does not.

Okay.

All right.

And then one other question on the OpEx front, you talked about last quarter as some R&D stuff being deferred so we would be put here a significant ramp this quarter, and it's still below the range you'd given us.

So is that R&D now included in the higher level of OpEx we saw in the third quarter?

Or there's an element of deferred R&D that we're going to see in the subsequent quarters?

Yes, I wouldn't necessarily label it deferred R&D.

It's just again timing of a lot of prototype materials and things like that that get expensed.

But clearly, that is in the Q4 number as we see it.

So when you look at the jump from the $26.8 million or so to the $32 million in Q4, again probably three big elements there.

It's commissions, again, and some variable comp with the higher revenues.

And increased headcount; we continue to add a fair amount of headcount, especially in R&D, and then those prototype materials, which we talked about.

Okay, and then one last question related to customers.

You've announced 360networks and earlier Cox.

Are we going to see those revenues in 2007 in the fourth quarter?

Or, is it more 2008?

You will see that some of that in the fourth quarter.

Okay, great.

Thank you very much.

Congrats.

Thank you.

(OPERATOR INSTRUCTIONS)

Our next question comes from Ehud Gelblum.

Please state your affiliation.

Mr.

Gelblum, your line is open.

Please check your mute button, sir.

We'll check his line.

The next question is from Marcus Kupferschmidt.

Please state your affiliation.

Expected that to take a while to get to me.

I'm with Lehman Brothers.

Guys, could you give us a little more sense about the outlook internationally?

Kind of where you are in terms of winning customers and generating diversification in that area?

And I have a couple of other follow-ons.

Sure.

Jag, you want to take that?

From a not only have we added again the seven customers in the current quarter here, we're also pretty pleased with the spread of those customers.

And we continue to have a pretty balanced growth quite honestly in both EMEA and Asia quite honestly.

Now both of smaller base than North America, but when you look at the where the customers are getting added, they're kind of nicely prorated throughout the three regions.

If I could add a word to that.

If you look at our -- the latest data from the analysts that track market share, in North America we are now the number one player by measure in dollars in market share over the last four quarters.

Worldwide we are number four.

So what that suggests is that we have an opportunity to see some upside internationally over time.

And we expect to continue to stay focused on both domestic and international business over time.

Got it, and kind of going back to the OpEx discussion, given I'm trying to understand more of the long-term model.

The second quarter we said OpEx is split out into the following quarter?

If you have a big uptick, the $32 million in the fourth quarter here, should we assume a bunch of that would be kind of non-recurring or you'd see an OpEx dip going after that because you've kind of had a perfect storm of a lot of delayed stuff hitting all of a sudden in the fourth quarter?

Not necessarily.

Again, we've said the long-term model is 35% of revenue.

But what we expect it to do is to get there in 2009ish or somewhere around there.

Currently this quarter came in at around 33%.

The guidance that we've given is kind of 38% to 39% of revenues.

But I think at this point in the life of the business here we should expect it above that 35% for a while as we continue to fund various initiatives within the Company.

And then gradually come down to the 35%.

Great, and then kind of going into more about the business model.

Where are we in terms of investing in the switching and the metro products that we've been talking a lot about?

And obviously you're not generating business today, and kind of how much of your OpEx do you think is going there?

And how much should we expect let's say a year from now?

Yes, we have on the OpEx; I'll let Jagdeep talk more about the products and stuff.

But on the op ex stuff we haven't obviously broken it out by product and stuff like that, and we probably won't going forward either.

We even [talked] about new platforms versus maintenance existing?

I have not talked about that, no.

Okay, thank you.

Our next question comes from George Notter.

Please state your affiliation.

Hi, Jefferies, just a quick question.

I was wondering if there was anything new in terms of the outsourcing on manufacturing from domestic manufacturing into international manufacturing?

Clearly an option for us, at some point in time.

And it's another good potential source for cost reductions when that's appropriate here.

You should assume that we're doing a fair amount of work looking at that.

Got it.

Any sense for the timing on when we might see that start to occur and flow through the P&L?

If we did that sometime in '08.

Thanks.

Our next question comes from Ehud Gelblum.

Please state your affiliation.

Hi.

It's Ehud at JPMorgan.

Thank you very much for taking my question again.

Sorry about that before.

Two questions if I could, one clearly Level 3 came down substantially as a percent of revenue looking through.

And you may have spoken about this before, I apologize if you did, from 48% to 28%, coincidentally they reported this morning in their own guidance for their own performance going forward has come down as well.

How do you see their percent of your revenue going forward trending in light of what they spent with you this quarter on an invoice basis, and the way they're looking at their own business now, which seems to be slightly more pessimistic?

Did you have perhaps a slightly different perspective on where you expected their revenue contribution to be for you next year?

And, does that change at all now that you see kind of this quarter and what they reported?

And I have a follow-up too, please.

Yes, let me take that and Jagdeep and can interact here.

Level 3, we obviously stay very close to Level 3.

We have and we'll continue to do that.

A very important piece of our business, and we expect it will be going forward also.

But their revenue percentage this quarter quite honestly was not a surprise.

There's really nothing that we saw that really changed there at all.

But I will tell you that looking into Q4 that will probably come down again as a percent of revenue.

And again, we have planned on that for quite some time.

So that is not new news to us at all.

On the other hand, we have stated that it was very important for the Company to diversify its customer base.

And I think you can see the results of us being able to do that.

We'll obviously continue to focus on all segments.

But we've been very fortunate to diversify our customer base.

And as I say we expected Level 3 to come down, and it will probably come down a little bit more as a percent of revenue in Q4; not a surprise and the diversification of the customer base is clearly paying off.

Were there any other customers that were 10% or higher in the quarter that you expect to start popping up as Level 3 comes down?

We had three 10% or greater customers.

And those customers could rotate in and out on a quarterly basis depending on levels of deployment and where they are in their various deployments.

You don't expect any of them to stay necessarily high for a significant period of time?

I don't know.

They could.

It really just depends on their buying patterns.

Okay, thank you.

One last question, do you have a sense as to the fill rate, so to speak, of your chassis that are deployed in the field?

We've got a very good feel for it.

We've got an exact feel for it.

We haven't obviously disclosed that.

It's part of what we call our annuity revenue model.

And we kind of model in what we think those fill rates will be over time and how that plays over time based on what's currently deployed in the field, but we have not disclosed that.

Okay, can you -- put a different way, if each one of you chassis can handle I think four DLMs, do you have any of your chassis out there that you know of that have either all four or three of the four or two of the four filled?

Or, are they basically, they're all ones and twos?

Do you have any that are even close to being filled yet?

The way customers work is that they deploy a chassis and they, as their bandwidth grows, they deploy line cards, both DLMs and TAMs, to fill the chassis.

Once the chassis gets full, it just deploy another chassis.

So there's always sort of available slots in the field.

In fact, if you look at what's out there today.

If you were to take the current installed base of chassis and fill every slot with line card, TAMs and DLMs, the installed base slot revenue value, dollar value, would be actually north of around $700 million today.

Incremental or including what you've done so far?

Incremental, above and beyond what we've shipped so far.

If we were just to stop shipping new equipment and just take the empty slots and populate them with line cards, TAMs and DLMs, at historical ASP that would be north of $700 million worth of value.

That's very helpful.

Thank you.

And that probably comes with a 65% gross margin, too.

I appreciate it.

Thank you.

You're welcome.

Okay, I want to thank all of you for joining us on today's call.

We look forward to keeping you informed of our progress.

Thank you.