Infinera Corp (INFN) 2008 Q1 法說會逐字稿

Good afternoon, and welcome to the First Quarter Fiscal 2008 Investment Community Conference Call of Infinera Corporation.

Your first speaker today is Mr.

Bob Blair, of Infinera Investor Relations.

All lines will be in listen-only until the question and answer portion of the call.

(OPERATOR INSTRUCTIONS)

Today's call is being recorded.

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

Mr.

Blair, you may begin.

Good afternoon, and welcome to Infinera's Q1 2008 Earnings Call.

Today's call will include projections and estimates that 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 and customers, our products and our competitors' products, guidance, timing for the establishment of VSOE, and prospects of the Company in 2008 and beyond, and are subject to risks and uncertainties that could cause actual results to differ materially from any such forward-looking statements.

Please refer to the Company's current press releases and SEC filings, including the Company's annual report on form 10-K, filed on February 19, 2008, for more information on these risks and uncertainties.

Today's press releases, including Q1 2008 financial tables, and investor -- includes an investment 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.

This afternoon's press release and today's conference call also include certain non-GAAP financial measures.

In our earnings press release, we announced operating results for the first quarter of 2008 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 useful, and how they are used by management.

On this call, we will also give guidance, including guidance for the second quarter of 2008.

In this guidance, we will include adjusted GAAP results, which exclude the impact of the roll-off of certain ratable GAAP revenue and costs from the balance sheet, as well as the impact of non-GAAP, non-cash, stock-based compensation expenses from our results.

Again, we have reconciled these adjusted GAAP projections to our GAAP results on the Investor section of our website in the document entitled Q2 Guidance Reconciliation Summary.

We have excluded non-GAAP, non-cash, stock-based compensation expenses because we cannot readily estimate the impact of our future stock price on future stock-based-compensation expenses.

For the remainder of today's call, we will be discussing our first quarter 2008 results and our second quarter 2008 guidance, excluding the impact of these items, and we will refer to these results as adjusted GAAP.

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 first quarter of fiscal 2008.

Joining me is CFO Duston Williams, who will provide a financial report for the quarter, an update on our attainment of VSOE, and an outlook for Q2.

I am pleased to report, in the first quarter, we continued to build on the business success we established last year, delivering record invoiced shipments of $95.5 million, exceeding our guidance for the quarter, and reflecting growth of 43% over the year-ago quarter.

We also achieved a number of other key milestones in the quarter, including profitability on both an invoiced-shipment and GAAP basis, an operating profit of $9.6 million on an invoiced-shipment basis, cash generated from operations of $9.8 million, the shipment of a record number of digital line modules.

BOMs are an important indicator of both our current business win rate and future business potential, as customers eventually populate the BOMs with Tributary Adapter Modules, or TAMs, to bring a variety of new services to their customers.

On the customer front, we have four customers each accounting for 10% or more of our business in the quarter, reflecting our continued success in diversification of our customer base.

These customers included Level 3, Cox Communications, Interoute, and XO Communications.

By contrast, in the year-ago quarter, Level 3, as 57% of our business, was one of two 10% or greater customers.

I am also pleased to announce that we added two new customers this quarter.

Taking into account the merger of two pre-existing customers, we now have 42 customers.

Our leadership in the optical-networking market was recently affirmed with the release of 2007 market share results from Ovum-RHK.

These results indicate that Infinera took first place for the full-year 2007 in the North American multi-reach DWDM market, with a 28% share, and fourth place worldwide, with a 13% share.

Our total invoiced shipments for 2007 were $309 million, up 112% over the 2006 level of $146 million, substantially exceeding total market growth of 24% in 2007.

Our leadership position was also affirmed in the recent report by independent analyst firm, Heavy Reading, which named photonic integration the best hope for network scalability, and cited Infinera as the undisputed leader, with a staggering lead in large-scale photonic integration.

We believe the fundamental reason we're winning in the marketplace and gaining new customers is because we provide a solution that addresses the most pressing problems facing our carrier customers as they seek to compete more effectively in the telecom-services marketplace.

The fundamental issues facing our customers include the decline in revenue per bit for telecom services, the uncertainty over which services their customers will require, the time to provision new services, and the need to differentiate their service offerings to compete.

Our value proposition directly addresses these issues by providing a system that enables cost-effective scaling via photonic integration, extreme flexibility via built-in digital switching, and the ability to rapidly deploy new and differentiated services via the separation of the line and service interface, and that's why we're winning.

Our long-term goal remains to build a world-class growth company by establishing the best optical-transport company in the industry.

Doing so requires that we continue to be able to address real and fundamental business problems that our customers face, and that we do so in a way that is highly differentiated from any other vendor in the industry.

Our continued confidence in our vision and long-term business model is based on a number of different data points.

First, the positive response we're receiving from current and prospective customers relative to the current capabilities and future potential of our platform gives us comfort that we are, indeed, addressing important business problems our customers have.

Secondly, we continue to invest in R&D, and intend to be as compelling in our space over the next few years as we have been over the last few.

Finally, relative to customer acceptance, we have seen traction not just in the current segments in which we lead, but also in important new segments, including with incumbent carriers worldwide.

Regarding R&D, at the OSC Trade Show in February, we made public, for the first time, some important future developments and capabilities of the Infinera platform and our core PIC technology.

First, we outlined a road map for the evolution of the PIC, indicating that we believe it is feasible to achieve a doubling of capacity per chip approximately every three years.

This is significant because total capacity per chip, not bits per wave length, is the fundamental driver of economics.

This is also significant because it marks the first time there has been a road map in the optical industry for capacity per chip.

We also demonstrated a ten channel by 40-gigabit PIC with an aggregate 400 gigabits per second on a single pair of chips, a chip set we intend to commercialize.

Like other vendors in the industry, our solution uses phase-based modulations, specifically DQPSK, to get spectral efficiency.

But unlike those other vendors, which require well over 100 discrete components to implement this functionality, all of the elements for the modulation of all ten channels are integrated onto a single pair of chips.

It, therefore, becomes clear why our approach is so much more effective on the key metrics of cost, space, power, and reliability.

We also demonstrated at OSC how using SOAs on a PIC could allow us to amplify systems and open up the fiber spectrum to the full range of what it can carry beyond the C-band.

While this was purely a demonstration of possible future capabilities, it is significant because we believe that there is no other way to get to this spectrum than with SOAs, and that there is no other cost-effective way to get the SOAs than photonic integration.

Most significantly, we believe that these announcements are important because they illustrate that the Infinera PIC has plenty of head room to advance, a key consideration to accommodate future bandwidth growth and to enable us to continue penetrating the DWDM market on a worldwide basis.

We believe these announcements also help illustrate the staying power of our technological advantage for the foreseeable future.

Of course, the Infinera technology advantage includes not just the PIC, but the entire system, including a wide range of technologies and capabilities.

These capabilities include mixed-signal and analog IT design, digital ASIC design, advanced signal-processing techniques, such as forward error correction and electronic-dispersion compensation, high-speed system design and complex software-control systems.

Therefore, we believe that even if the competitor were able to somehow buy a PIC off the shelf in the future, they would face the huge task and challenge of assembling a team with the many different chip-and-systems skill sets necessary to achieve -- to effectively integrate the PIC capabilities into an optical system.

This is precisely the type of team that we have assembled at Infinera -- a vertically integrated group that has developed a portfolio of over 200 patents and patent applications in the U.S.

and abroad, thereby protecting our competitive advantage.

In summary, we believe Infinera's business is as well-positioned for long-term growth as it has ever been.

We continue to deliver strong financial performance.

Our customers continue to tell us they are extraordinarily satisfied with our products and services, and are using the Infinera platform to differentiate themselves in the increasingly competitive and demanding telecom marketplace.

We continue to win new business and diversify our customer base.

We believe we are poised for growth with the incumbent carriers.

And we continue to reinforce our position as a vanguard leader in the optical industry, through the roll-out and demonstration of PIC-based technology and products that meet the carriers' current and future needs.

Duston will now provide a Q1 report and Q2 outlook.

Duston?

Thank you, Jagdeep.

I'll review our Q1 actual results, provide an update to our VSOE status, and then follow that up with an outlook for Q2.

The following analysis of our Q1 results and results from other quarters and fiscal years is based on invoiced shipments, and excludes non-GAAP stock-based compensation.

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

Q1 was another quarter in which we outperformed our expectations, and another quarter in which the business model demonstrated sustainable strong performance.

Looking at the specifics for the quarter, invoiced shipments in Q1 totaled $95.5 million, versus $93.4 million in Q4.

International sales were 18% of our invoiced shipments in Q1 versus 19% in Q4.

In Q1, we, once again, had four 10% or greater customers on an invoiced-shipment basis.

As expected, Level 3 invoiced shipments increased significantly over Q4, and accounted for 31% of our Q1 invoiced shipments versus 17% in Q4.

Turning to gross margins, they were 45% in Q1 versus 47% in Q4.

A slightly favorable product mix, combined with cost improvements, accounted for the better-than-expected gross margins.

Operating expenses for the quarter were $33.4 million, versus $31.5 million in Q4.

The quarter-over-quarter increase in spending was attributed to higher payroll, prototype, and lab-trial-equipment expenses, which were offset to some degree by lower commission expenses.

Although operating expenses for the quarter did grow by about $2 million, they were lower than we expected.

This delta was related to lower payroll, prototype, and miscellaneous expenses, and we expect much of this variance to roll into Q2 spending.

Operating income for Q1 was $9.6 million, versus $12.2 million in Q4.

Other income and expense for Q1 was a favorable $4.2 million, versus $3.9 million in Q4.

The Q1 total included $0.9 million related to asset sales and FX gains.

Net income for the quarter was $12.6 million, or $0.13 per diluted share, based on 96.7 million shares outstanding versus $15.9 million, or $0.17 per diluted share in Q4.

Quickly turning to the balance sheet.

Cash, cash equivalents, restricted cash, and investments ended the quarter at $316.4 million, versus $305.8 million in Q4.

DSOs were 42 days, versus 39 days in Q4.

Inventory turns were 3.5, versus 3.4 in Q4.

Accounts-payable days came in at 42 days, versus 32 days in Q4.

And capital expenditures were $2.5 million in Q1, versus the $8.5 million in Q4.

I wanted to take a few minutes to provide an additional update on our attainment of VSOE.

During our Q4 of January earnings call, we announced that we had established VSOE for software subscription, a key component of our current service offerings, and we were working to achieve VSOE for EF&I services and training services.

Furthermore, we stated it was our goal to complete the process for these two services by Q4 of 2008.

Today, I am very pleased to announce that effective this current quarter, Q2 of 2008, Infinera has completed the necessary steps to attain VSOE for these additional services.

As a result, starting Q2 of 2008, we will no longer need to ratably recognize product revenue for sales transactions where products are sold with these services.

Product revenue from these transactions will be recognized upon acceptance, and services revenue will be deferred as appropriate, and recognized as services are delivered.

We will continue to recognize a very small percentage, historically less than 3%, of our sales transactions on a ratable basis, related to a number of older customer contracts, which included non-standard service offerings.

As we continue to expand our customer base and the service offerings we provide, we may sell non-VSOE compliant services in connection with the sale of our product.

In the event that we sell products in the future that are associated with such services, the revenue associated with such sales will be recognized ratably over the service period.

This is consistent with any company reporting revenues under SOP 97-2.

Based on these developments, and in an effort to give investors a more complete view of the true economic performance of the Infinera business, the following reporting methodology will be utilized for Q2 through Q4 of 2008.

All of this information will be summarized in the Investor Relations section of the Infinera website shortly after the conclusion of this call.

On a -- our quarterly results and guidance will be based on GAAP results.

The only adjustment will be to subtract out the roll-off of the ratable and product-deferred revenue and cost balances recorded on the balance sheet at the end of Q1 of 2008.

This reflects sales and costs included as invoiced shipments in prior periods.

For transparency and investor clarity, the adjustments to GAAP results for Q2 through Q4 2008, referenced above, are estimated to be as follows.

All of these adjustments will be a reduction to the reported GAAP results.

The revenue adjustments for Q2 '08 will be $72.7 million, Q3 of '08, $37.5 million, Q4 of '08, $14 million.

The cost-of-goods-sold adjustments for Q2 '08, $33.5 million; Q3 '08, $17 million, and Q4 of '08, $4.8 million.

Looking to 2009, a majority of the pre-VSOE ratable product-deferred revenue and cost balances will have been recognized during 2008.

Therefore, beginning Q1 of 2009, we will report results and issue guidance on a GAAP basis, with no further adjustments.

We believe that reporting our results on both a GAAP and invoiced-shipment basis over the last several quarters has given investors a better understanding of the true economic performance of the company.

Now that we have established VSOE for most of the services that we provide, we believe that GAAP, with the adjustments we outlined above, provides a clear understanding of our economic performance.

I also want to point out that the VSOE transition will cause our 2008 GAAP profits to increase significantly due to two factors, the increased up-front recognition of revenue in the current period, and the roll off of the ratable and product-deferred revenue and cost balances already recorded on the balance sheet.

The Company has significant NOLs, approximately $240 million, to cover these accelerated GAAP profits.

However, we will be subject to the minimum AMT tax of approximately 2% of pre-tax GAAP profits.

Combined with various state and foreign taxes, this will result in an estimated 2008 tax provision of approximately 4% of pre-tax GAAP profits.

In Q1, we booked a $1.2 million tax provision.

As we look forward to Q2, Infinera's business continues to perform quite well.

Our business model continues to be validated with solid global customer penetration, sustained profitability, and strong cash-flow generation.

Our existing customers continue to be delighted with the Infinera experience, and from a new customer perspective, we continue to win a large majority of the deals we compete for.

Additionally, as Jagdeep mentioned, we are encouraged with our level of engagement with incumbent carriers worldwide.

Four quarters after becoming a public company, as we look forward, we are pleased with our overall performance and with our current position in the marketplace.

As we have mentioned several times since our IPO, our quarter-over-quarter revenue growth can be influenced by several factors reflecting the nature of our business, including the timing of large customer deployments of Infinera gear, new product releases, the acquisition of new customers, and the mix of products.

In addition, our reportable GAAP results will be impacted to the extent that we provide non-VSOE compliant services as part of the sale of our products to our customers in the future.

We also can, obviously, be affected by overall market conditions.

As a result, our quarter-over-quarter revenue growth may not always occur in a linear manner.

Although the nature of our business lends itself to these occasional short-term ebbs and flows, as I mentioned above, we remain comfortable with our current and long-term positioning in the marketplace.

With that as background, I'd like to offer the following guidance for Q2, based on adjusted GAAP results, which excludes any non-GAAP, stock-based compensation expenses.

Revenue of approximately $88 million to $90 million.

This assumes total GAAP revenues of $160.7 million to $162.7 million, reduced by the $72.7 million I discussed earlier for the amortization of the deferred revenue recorded on the balance sheet at the end of Q1 2008, which reflects sales included as invoiced shipments in prior periods.

Gross margins of 41% to 42%, operating expenses of $36 million to $37 million, net income of $1 million to $2 million, based on estimated average diluted-weighted shares outstanding of approximately 97 million.

This would lead to an EPS of between $0.01 and $0.02.

Before we open the call up for questions, I would like to indicate that we don't see any reason to change our 25% long-term revenue growth rate outlook for 2008 at this time, in either direction.

Operator, if you would, now, open the call up for questions.

(OPERATOR INSTRUCTIONS)

Ehud Gelblum from JPMorgan, you may ask your question.

Hello.

Can you hear me?

We can, Ehud.

Oh, great.

Thanks.

A couple of things I wanted to touch on -- and then get into a little of the guidance, if I could, that Duston just laid out there.

The -- you had mentioned previously, in your last conference call, that you expected no customer to be larger than 20% this year.

Is that still the case?

And as you are now three-months wiser in terms of what Level 3 has been doing with what their plan is for this year, than you were in the last conference call, is there any change to your expectation of how Level 3 -- around that 20% cap or under that 20% cap -- reacts this year?

Yes, Ehud.

This is Duston.

At this point, there is really no conclusive evidence one way or another on that 20%.

We still think that that is a reasonable cap.

As you know, Level 3, like a lot of our customers -- revenues will bounce up and down on any given quarter.

Intuitively -- you saw them bump up to 31% -- intuitively, you'd think they might come down a little bit in Q2.

So there's really no reason that we'd see that change at this time.

Okay.

When you do the math on Level 3 last year versus this year, you get that they -- assuming that Level 3 ends up being 20% at that high end, and your revenue grows 25%, you get about a 27-ish percent decline in Level 3.

Is that still kind of what you're thinking, and matches up what -- with what they had given -- they've obviously poked up again, as you had told us.

But is that still matching up with kind of what you expect and what they are telling you with respect to -- I mean, they're saying publicly down 25%, and it sort of matches with the numbers that you gave, but I just wanted to make sure that's still kind of what you're looking at, and that things haven't necessarily changed with respect to that.

That's our best guess at this point.

Okay.

If I could talk a little bit about the guidance of $88 million to $90 million -- if you were to have looked out in Q2, three months ago, and -- when you gave the Q1 guidance -- would you have expected Q2 to have been down, or is that something that you just sort of learn and find out over the course of the quarter?

Well, as you know, Q1 popped up a little higher than what we thought.

Q2 is in the $88 million to $90 million range.

You always get new information as you go.

We're pretty good once we get -- go into a quarter.

And we've always said that we have got pretty good visibility as we go into the quarter.

And as we get a quarter or two out, that visibility gets less, and it gets solidified once we come up towards the quarter.

So, it's just a little bit of additional knowledge.

And that's what we put into the guidance.

But do you think, as you learned about this -- again, if you can, give some insight as to whether you had expected this three months ago or this something that kind of came out now.

But as you sort of understanding that Q2 would be down vis-a-vis Q1, was your understanding that it had something to do with the macro slow-down impacting your customers, or is it more timing?

Or was it, actually, maybe, perhaps, a change of plans -- whether it's Level 3, Cox or others?

Have any customers changed kind of the pattern of their ordering that led you to this?

Yes.

No.

Good question.

As we said in the call, where -- in the script there -- we're very comfortable and happy with the performance of the business.

We've shown some good, sustained profitability and cash-flow generation, and customer traction on a global basis.

But we've always said, right since the IPO, that the business is one that has ebbs and flows and is not always going to be conducive to perfect linearity.

We've had -- we've been lucky that we've had four quarters in a row with good linear growth, but we've always said, just because of large deployments and the likes, that we could see ups and downs on any given quarter.

And we pretty much think it's just kind of the nature of the business.

Now, your comment about the economy and stuff like that -- to be real truthful there, we don't have any hard evidence that this is any -- related to that or it's not related to that.

So, I don't know.

There could be some of that in there, but I would tend to more lean just to the ebbs and flows of the business.

And you could look back on Q4 of 2006, we had a big quarter, then we had two kind of flat quarters, and then we saw some great acceleration after that.

So, I tend to just look at it -- it's just the nature of the business.

Okay.

So no one, necessarily, changed plans on you, as far as you can tell.

It's just, as the shipments came in or as the orders came in, it laid out that way.

And you were kind of expecting it to happen at some point, but you didn't necessarily know it was going to happen this -- now?

Yes.

That's fair.

Yes.

And we have -- as you know, deals are big.

And the timing of those, depending on when they ship and when they accept and all that stuff, you just -- it's not -- we don't have perfect knowledge of that six months out.

Okay.

One last thing, then I'll hand it over.

Just -- you mentioned tax for the rest of this year.

Taxes in '09 -- are we still looking at the same 4%, or will the NOLs be somewhat used up as you get into'09?

No, I'd still -- I'd bake in the 4%.

With $240 million, and if you look at the consensus out there for profits and things like that, it goes well probably into 2010, maybe beyond that.

Okay, great.

Thank you.

Jason Ader from Thomas Weisel, you may ask your question.

Thank you.

You guys -- made some comments on traction [within] common carriers and kind of the level of engagement being pretty high.

Now, I haven't been on a lot of these calls, but it seems like that's somewhat of a change in language, based on what you guys talked about publicly.

Can you confirm that, and maybe give any kind of color that you are comfortable with on where you are in that engagement -- how far along you are?

Yes, I think that is more than we've said in the past.

And I think -- so that's an accurate assessment.

And I think it's just -- it's pretty much what we said -- which is that we -- we're basically pleased with the level of engagement that we're seeing with incumbent carriers worldwide.

Now, that doesn't mean that there's anything that we are announcing.

It doesn't mean there's anything's eminent or anything like that.

It just means that we're talking to a lot of players and we're pleased where we are with -- relative to those -- that class of player.

Over time, as we've said in the past, we think that will lead to results in that space.

Could you give us some sense of, geographically, where you're engaged?

Is it in several different countries or is it focused on one region?

Well, I think what we've in the past is -- I mean, if you just do the -- you do the numbers -- I mean, there are more incumbent carriers outside the United States than there are in the United States.

So you might expect, just based on numbers, that, probability-wise -- that there's activity worldwide.

But besides that, we haven't really said anything specific about which geographies or where.

And then just a last question on those incumbents.

Jagdeep, what are they -- what has the response been when you get engaged with these guys?

Maybe, anecdotally, could you give us a sense of what the customers really like about the product?

Is it just the same things that some of the other customers like?

Or, is it something a little different based upon their networks?

Absolutely.

That's a great question.

And it turns out that the things that this class of customer is excited about are exactly the same as what every other classic customer get excited about.

It's things like the flexibility of a system, the ability to rapidly turn up new services, the ability to offer differentiated services.

Many of the incumbents, as you know, are competing with sort of more agile players that are able to turn up services more quickly.

The ability to provide next-gen services like Ethernet and so on, more rapidly, is really a key requirement to compete in this space.

And any platform that lets them deliver those kind of differentiated services more rapidly in a cost-effective fashion is going to be looked at.

So I think the good news there is, as we've believed in the past -- that there is nothing fundamentally about the product that doesn't apply to that segment, as any other segment, basically.

And I think where we are today is -- I think we're just -- we're getting more and more confirmation of that as we continue the engagement process with that class of player.

Okay.

And last question -- in the fourth quarter, you had two customers -- I believe they were Internet-content providers -- that were in the 10% group, in addition to Level 3 and Cox.

Could you give us a sense of how those players' spending is looking?

I mean, is it -- was it one big order in Q4, and then they're kind of not spending much for a little while, until they need it again?

Or is it going to be pretty consistent, and it just was, maybe, a touch below 10% this quarter or something like that?

Yes.

Obviously, we don't provide any details there.

But again, like any customer, there will be ups and downs to their purchases.

So one quarter may pop up initially and then come down a little bit.

We did have a new Internet-content-provider customer in the quarter, so we did see a chunk new revenue from that new customer.

But, again, they're going to be like most any customer that -- in any given quarter, they could be up and down.

Okay.

Thank you.

Ajay Diwan from J.

& W.

Seligman, you may ask your question.

Great.

Thank you.

I'm just a little confused here, because you're making this change to the VSOE going forward.

So this $88 million to $90 million then -- does that compare to, basically, the invoiced-shipment number that you just reported?

Or, is that on a different basis?

Yes, Ajay -- Duston -- very comparable.

There's some small stuff in there from some old customers that now will be ratable, that we didn't assume as ratable for that 3%-ish that I was talking about -- but, effectively, very comparable, and in a similar number.

Got it.

And then -- so, then, in Q3 and Q4, you'll be moving to a different set of guidance.

Is that --?

No, it's stays the same -- same as Q2 -- no difference.

Okay.

So then -- just help me, then.

When -- this VSOE change kicks in fully when, then?

What --?

No, we will -- Q1 of '09, we will -- will guide straight-GAAP number, no adjustments.

We'll report a straight-GAAP number, no adjustments.

Got it.

And just one other thing -- the Level 3 then -- do you have an indication from them of what Q2 looks like, like you did that -- since they gave you an indication that Q1 was going to be up, do you have an indication of what their intentions are in Q2, or no?

Yes.

The only -- the only comment I'll make there -- they went up from 17% to 31% quarter-over-quarter, as a percent of the total.

Intuitively -- because they came up so much in Q1, you, intuitively -- it was expected to come down a little bit in Q2.

Okay, great.

Thank you.

Okay.

George Notter from Jefferies, you may ask your question.

Hi.

My question is on the gross-margin line this quarter.

It's the second consecutive quarter of pretty good upside, relative to what you were expecting.

I heard your comments about favorable product mix and cost improvement.

But can you give us any more flavor on where, exactly, those margin benefits came from?

I mean, they were quite substantial relative to -- as a smaller, incremental upside on the top line.

Yes, again, there was a little bit -- well, we shipped more -- a chunk of more DLMs -- as Jagdeep mentioned, a record quarter for DLMs.

TAMs came down a fair amount from last quarter.

But still, we had a reasonable TAM-shipment quarter.

And on the cost side of the equation, it was spread a little bit.

But, again, we saw a little bit of benefit, from a quality perspective, within the warranty costs, again, which continues to speak to the robustness of the product.

And even will all -- we talked a little bit about the record DLM shipments and all that.

But what we didn't mention is that -- interestingly, also, is that we came, I think, within a handful of chassis of having a record chassis-shipping quarter.

So for future -- obviously future revenue potential down the road -- that's also a great sign for us going forward.

Got it.

And then -- so just to put all that into the context of the guidance for gross margins for next quarter -- I mean, you're saying that gross margins are going to come down a fair amount.

I mean, is it -- is that conservatism, then, that you're building in here, into the gross-margin line?

Or, do you expect to have a pretty meaningful falloff in DLMs or TAMs?

Or, what's the thought there?

Yes.

No, it's, again, the same thing we do on the revenue piece of the equation -- when we give the guidance, we take all the knowledge that we have for the quarter and give it our best shot and our best guess for the quarter.

And there's a lot of things that can change -- to your point -- with TAMs and DLMs and commons.

And then you get the whole customer mix -- that you've got different customers with different profiles and things like that.

So I wouldn't view it as conservative.

I'd just view it with the current facts that we know them today.

That's what we think is going to happen.

Got it.

Thanks.

Okay.

(OPERATOR INSTRUCTIONS)

Ehud Gelblum from JPMorgan, you may ask your question.

Thank you very much for the follow up.

Duston the four 10% customers--?

Yes?

Can you give us what they totaled?

One was clearly 31%.

And so, obviously, you're minimum 61% for the four together, but could you give us just (inaudible)?

Yes.

We have not, historically, done that -- probably won't do that.

Yes -- because they're going to bounce up and down.

And in the next quarter, we could have a couple or could have four.

So we -- historically, we have not provided that breakout.

Okay.

And then, just secondly, you did kind of qualitatively give us a sense as to the break down of which -- how they grew, at least -- DLMs, TAMs versus chassis.

You said chassis came within a hair of the all-time.

Can you tell us what quarter that all-time kind of high was?

It's several quarters ago.

I believe it was Q4 of '06.

And I'm speaking off the top of my mind.

And, usually, that's pretty good, so -- we had two big deployments in Q4 of '06.

Okay.

And as you look to next quarter, how do you think the mix changes of DLMs, TAMs, and chassis--?

Yes -- again, from an outlook perspective, we really don't give that detail in advance.

We'll give you a color at -- obviously, at the end of the quarter.

And just -- I just looked at some facts here.

It is -- it was Q4 of '06 that that was the real big pop we had.

Okay.

Thanks.

And this is the last thing -- is the warranty.

You said that warranties got a little bit better.

Does that -- did that allow you to change your reserve for warranties?

And if so, how much did that impact margins?

Yes, it helped margins.

We just look at it -- as you know, we take and look at the annual failure rates every quarter, and see what we've got in the field for units and what we should apply for reserve.

And we just had to take a little less, based on the quality metrics.

So it helped margins a little bit -- not substantial, but it definitely helped.

And now, going forward, you're reserve is -- you're reserving at a lower rate than you had before?

Yes, as long as the -

Okay.

-- slightly lower, as long as the AFRs and things stay at -- stay at a good rate.

Okay.

Anything else change in the reserves?

No.

Okay.

I wouldn't look at this as a reserve change, by the way.

This is just what we booked for the quarter.

Correct.

All right.

Okay?

Thanks so much.

Sure.

Jason Yellin from WRA Investments, you may ask your question.

Yes.

Thanks for taking my call, guys.

Just quickly, if I could -- do you expect your non-Level 3 revenues to be up sequentially in the June quarter?

Well, I guess, if Level 3, potentially, comes down a little bit -- then, yes.

Any other color you can give us on why the non-Level 3 business was down sequentially in the March quarter by as much as it was?

Or, was that as expected?

We expected Level 3 to come up quite a bit in Q1.

Okay.

Thanks.

Okay.

George Notter from Jefferies, you may ask your question.

Hi.

I was just thinking about just -- on the gross-margin guidance going forward -- you guys have talked about off-shoring your manufacturing.

Is that something that you're working on right now?

Was that a factor in the gross margins here in Q1?

Or, is that something that you expect to get the benefit of later on in the year?

George, we've talked about this before.

It's a -- it's an effort that will be done throughout '08.

And any -- yes, little or none, in Q1.

Okay.

And when do you--?

A little bit, but not much.

When do expect the benefit of that to start coming through in gross margins?

And how big might that be?

Yes.

We haven't quantified it.

It's another way for us to reach cost reduction.

There's a lot of different ways -- you can either -- more efficient in our own factories or direct material reductions.

This happens to be, obviously, a -- an advantage from changing locations and geographies.

But we haven't quantified the benefit.

It's a reasonable amount, but I wouldn't look at it as an excessive amount that we're going to get there, into margins.

Got it.

And then, just on general visibility -- I mean, certainly visibility comes in many forms for you -- backlog orders, pipeline analysis through your sales force.

I mean, can you talk about the picture you have on visibility right now?

Is it the same, equal to, or better than the visibility you had coming out of Q4?

Yes.

I'll just take the visibility.

Maybe Jagdeep will chime in on the pipeline, here.

The visibility -- I don't think anything's changed.

We -- it's the same old stuff that we say all the time.

We've got pretty good visibility once we go into the quarter, and I don't think anything has changed from that perspective.

And as you get further and further out, the visibility, obviously, gets to be a little bit less.

And I mean, when you go into the pipeline -- I'll just add that -- and if you look at the quality of the pipeline times the quantity of the pipeline, it's as good as we've ever seen.

Got it -- great.

Thanks very much.

Okay.

With that, I'd like to thank everyone for joining us.

And we look forward to keeping you informed on our business as we move ahead.

Thank you.

This call has concluded.

You may now disconnect.

Thank you.