Infinera Corp (INFN) 2009 Q1 法說會逐字稿

Welcome to the first quarter fiscal 2009 investment community conference call of Infinera Corporation.

(Operator Instructions).

Today's conference is being recorded.

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

I would now like to turn today's conference over to Mr.

Bob Blair of Infinera Investor Relations.

You may begin, sir.

Thank you, and good afternoon, and welcome to Infinera's Q1, 2009 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 conditions, results of operations, and our products and competitor's products, and prospects of the Company in Q2, 2009 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 Company's annual report on Form 10-K, filed February 17, 2009, for more information on these risks and uncertainties.

Today's press releases, including Q1, 2009 results and associated financial tables, and an investor information 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 2009, which exclude the impact of non-cash stock based compensation.

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 for an explanation of why these non-GAAP financial measures are useful and how they are used by management.

On this call, we'll also give guidance, including guidance for the second and third quarters of 2009.

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

For the remainder of today's call, we will be excluding the impact of these items as we discuss our first quarter 2009 results, and our second and third quarter 2009 guidance, and will refer to these results.

I will now turn the call over to Infinera President and CEO, Jagdeep Singh.

Good afternoon, and thank you for joining us.

With me is Chief Financial Officer, Duston Williams, who will provide a report on our Q1 results and our outlook.

Turning to our first quarter results, we posted revenue of $66.6 million, within the guidance range we provided, and we recorded an operating loss of $16.5 million on lower than forecast gross margins of 31%.

As we advised on our January call, Q1 revenue and gross margins were impacted by the timing of some large new customer deployments and unfavorable mix of lower gross margin common equipment associated with our recent high level of new customer wins.

The Q1 gross margin performance was influenced by additional factors that Duston will cover in his remarks.

I'd lake to take a moment to discuss our top line performance.

The strength of our business top line can be analyzed in terms of two different components, revenue from existing customers and new customer wins.

The first obviously indicates how much current customers are spending on our equipment in any given period, and the second relates to new network build activity, which will drive future revenue.

As indicated in our Q1 results, current customers clearly bought less equipment in Q1, reflecting the macro economic conditions prevalent in the quarter.

However, offsetting this effect was the fact that new customer build activity continues at a robust pace with several important new customers selecting Infinera as their platform for their next generation WDM networks.

While no revenue from these wins was recognized in the quarter, these new wins include two new Tier 1 European PDTs that we believe represent important new accounts, both in terms of future revenue potential and in terms of their competitive significance, given we beat out several of our top competitors to win.

In addition to these new Tier 1s, we had another important European customer win in the quarter.

Two of these three wins represent a dollar figure in the double digit millions on initial deployment, and we expect this revenue to be realized later this year.

Of course, those who follow this industry know new customer wins are associated with lower gross margins because of the common equipment required for a new customer deployment.

This factor resulted in margin pressure during the quarter.

We believe the continued strength in new customer build activity is a key reason to be encouraged about the prospects for recovery from the slowdown reflected in our Q1 results.

A related reason to be optimistic about the long term health of our business is our progress with Tier 1 carriers.

A year ago, we said that we were pleased with our traction with Tier 1 carriers and that we saw no reason why the benefits of the Infinera PIC based solution would not be as good a fit for this class of carrier as we've seen with other customers.

We've delivered on that promise with a string of Tier 1 successes that began with Deutsche Telekom less than a year ago, and was followed up last quarter with our win at OTE, the $10 billion Greek telecommunications carrier.

Today, we're happy to report the two new additional wins at the European based Tier 1 customers that I referred to earlier, bringing our total customer Tier 1 customer count to six, including three of the world's top five carriers.

The fact that these Tier 1 customers are choosing to go with us over their established suppliers, provides strong evidence of the compelling nature of the Infinera value proposition, and this gives us the confidence that we will be able to add to our TIer 1 count over time.

A third encouraging development that I want to note is our recent success in winning deals that include some re-networks.

A more demanding DWDM application from a performance standpoint, and typically one that comprises larger size deals.

Our ability to compete for these opportunities is based on the ultra-long-haul system that we added to our portfolio last year.

Yet another important development is the success we've seen in advancing our technology.

Throughout the economic downturn, we have remained committed to extending our technology leadership position through enhanced functionality of future generations of Infinera based networks.

You will recall that a year ago, we announced the industry's first PIC based road map, indicating our belief it is possible to double capacity per chip every three years, and we promise to have our next generation PIC in the hands of our developers in 2009.

Last month, we demonstrated our 40 gig solution at the OFC trade show, an important step toward achieving that goal.

We showed working Photonic Integrated Circuits delivering 400 gigabits per second of optical capacity in a single pair of chips using complex modulation formats.

The key here is that unlike our competitor's discreet 40 gig solutions, the Infinera 40 gig solution is integrated, which allows us to offer carriers substantially superior economics, scaling, and efficiencies.

For example, this platform will enable our next generation optics to deliver up to 80% power savings over competitor's 40 gigabit optics, and it integrates more than 300 optical functions into a single package.

This is a tangible result of the investment we continue to make to extend our competitive advantage of providing the market's only large scale PIC based solution.

And finally, we feel good about our relationships with, and the diversity of, our current customer base.

Although in Q1 we saw lower spending by certain customers, we continue to see customers building out their networks, as we discussed earlier, and we believe there is no inventory buildup at customer sites.

What this means is that once activity does pick up, we are in a good position to immediately benefit from the upturn.

We also continue to make very good progress with existing bills.

With DT, for example, we continue to further penetrate other parts of the network and have already shipped gear for their north American routes.

So, even as we manage through the current macro economic environment, we are encouraged that we continue with new customer footprint worldwide.

This provides further evidence that our Photonic Integrated based solution remains the only effective path with which customers can scale their networks to address their bandwidth growth needs.

We also believe that our unique, vertically integrated business model continues to put us in a very strong position to protect our competitive lead and to respond more quickly than our competitors to a potential uptick in customer demand.

Moving forward, we remain focused on our strategic growth initiatives which are, first, to continue to invest in and dominate the core space that has brought us to where we are, long-haul WDM, where we currently lead the market in North America with a 24% share, and have a 10% share worldwide.

Second, we remain focused on expanding into the metro market which we think will roughly double the size of the market that we currently address.

Third, we remain focused on leveraging our successes in North America and Europe to win market share in other parts of the world, including the Asia Pacific region.

We've expanded our investment in the region as evidenced by the recently announced opening of our Beijing Development Center in China, as well as the naming of Satoshi Fujita as President for our operations in Japan.

Fujita San will play a key role for Infinera in Japan with his relationships and experience that includes 30 years at NTT, as well as his role as President of Alcatel-Lucent Japan.

Finally, we remain focused on winning additional Tier 1 carriers, an area mentioned earlier, we're seeing great success in and we continue to focus on.

So in conclusion, we remain confident in the long-term growth opportunities for Infinera in optical transport and believe that our technology advantage will allow us to continue to gain share in the transport market, especially as several other players in the space retreat.

It's important to keep in mind that the increased footprint we're winning today, while it may have some near term negative impacts on margin, has great potential to translate into continued market share growth and revenue and margin expansion for Infinera in the future.

Our goal remains to build a strong, sustainable business for the long run and we believe when the economy turns, we'll be well positioned to achieve better top and bottom line performance.

I will now turn the call over to Duston, who will cover our Q1 performance and outlook.

Thank you, Jagdeep.

I'll review our Q1 actual results and follow that up with our outlook for Q2.

The following analysis of our Q1 results as based on non-GAAP, and results from other quarters are based on adjusted GAAP and invoice shipments.

All references exclude non-cash stock based compensation.

Looking at the specifics for the quarter, GAAP revenues in Q1 totalled $66.6 million, basically at the mid point of our guidance of $65 million to $70 million, versus $86.2 million in Q4.

In Q1, Level Three was our only 10% customer, representing 30% of our GAAP revenues, versus 18% in Q4 of 2008, and 31% in Q1 of 2008.

Gross margins in Q1, which were below our expectations, were 31% versus 36% in Q4.

The lower gross margins were in part caused by higher than expected lower cost of market inventory adjustments.

Additionally in Q1, one of our customers utilized a greater than anticipated portion of a significant fixed dollar product discount.

Previously, we had expected this discount would be used by the customer throughout 2009, but it now appears that this discount will be fully utilized by the customer in the first half of 2009, spread across Q1 and Q2.

During the quarter, we also discovered a supplier quality issue, which was detected by our in-house test processes.

Although it did not result in any defective parts being deployed in any customer networks, this issue did impact margins during the quarter.

Summarizing the effect of these factors, the additional LCM adjustments had approximate 3% margin impact, the supplier quality issue had a 3% margin impact, and the higher than expected utilization of the customer discount in Q1 accounted for another 3% impact.

Operating expenses for the quarter were $37.5 million versus our guidance of $41 million, and versus $40 million in Q4.

The $3.5 million favorable variance to forecast was a direct result of conscious cost management including delaying some head count additions and pushing significant project expenses into Q2.

The operating loss for Q1 was $16.6 million versus an operating loss of $9.3 million in Q4.

Other income expense for Q1 was an unfavorable $.9 million versus and unfavorable $.4 million in Q4.

Net loss for the quarter was $17.6 million, or loss of $0.19 per basic share, or $0.18 per diluted share, versus a loss of $9 million in Q4.

Quickly turning to the balance sheet, cash, cash equivalents, restricted cash and investments ended the quarter at $306.5 million versus $312.6 million in Q4.

We used $2.9 million of cash from operations in Q1, versus a negative $5.4 million.

DSOs were 61 days versus 74 days.

Inventory turns were 2.8 versus 3.8.

Accounts payable days came in at 44 days versus 45 days.

Capital expenditures were $6 million in Q1 versus $7.8 million.

Our Q2 performance will be influenced by factors similar to those that occurred in Q1.

A few large, new customer deployments and some deployments of new footprint with existing customers, resulting in up front LCM adjustments and very low initial gross margins upon revenue recognition, as well as the greater utilization of one time customer discount and the lower than historical average TAM volumes.

On our January call, we said that we anticipated three significant new European customer wins for which all the revenue would be recognized outside of Q1.

We also indicated that these new additions would have a greater portion of lower margin common equipment associated with them, which would significantly impact margins both prior to shipment through lower cost of market inventory adjustments and upon customer invoicing.

We expect the initial revenue recognition will occur in Q2 for one of the three new customers, with revenue upwards of $10 million, but with very low gross margins.

We anticipate revenue recognition for another one of the three new customers in Q3 that's slightly more than $10 million, however, the negative LCM impact will occur in Q2.

The third new customer, which is the smallest initial deployment, is anticipated to be invoiced in Q3 with revenue recognition occurring at some future period based on various revenue recognition complexities.

Two of these new customers are European DTTs.

In addition to these new customers, we also expect some initial revenue in Q2 from two existing customers for significant, new US deployments.

One of these deployments is for an internet content provider and is a continuation of the new nationwide buildout, and the other is in the initial phase of a new nationwide overbuild.

As you might expect, the initial deployment for both of these customers will be heavy on common equipment and will initially have significant downward pressure in gross margins in Q2.

While we had previously assumed the one time customer discounts would be spread evenly throughout 2009, it now looks like they will be fully utilized in the first half of 2009.

In total for Q2, we expect that these discounts will negatively impact gross margins by approximately 7%.

In the long run, the cumulative effect of all these new deployments and new customers is, of course, very positive and should position us well for additional product sales, including higher gross margin tributary adapter modules.

With these near-term hits to our gross margin performance, it is important to keep this key long-term consequence in mind.

Regarding TAM volumes in the near term, we continue to experience lower than historical average volumes in Q1, and from what we see now, we anticipate this trend will continue into Q2.

Because of the importance of TAMs to our overall business models, we thought it would be appropriate to provide some additional details on our historical TAM shipments.

For the period of Q4 2006 through Q3 2007, we shipped an average 1300 TAMs per quarter, for this four quarter period.

During this period, we averaged 29 customers and gross margins of 35%.

For the period of Q4 2007 through Q3 2008, we shipped more than 2,000 TAMs in each quarter and averaged 2100 per quarter.

During this period, we averaged 44 customers and gross margins of 45%.

We now have an excess of 58 customers, and we have experienced TAM shipments in Q4 2008 and Q1 of 2009 that were a good deal less than 2,000, and also anticipate TAM shipments in Q2 2009 of at least 25% below the Q4 2007 through Q3 2008 average of 2100 TAMs.

The only explanation we have for this dropoff in TAM shipments, even in the face of significant customer growth, is to correlate it to the general economic conditions that have prevailed in this time frame.

It is not surprising that the Infinera business model suffers significantly in any given quarter that has this confluence of factors, very low gross margins and LCM adjustments related to large new deployments combined with accelerated one time special discounts, below average TAM shipments, and lower overall revenue levels.

Although we remain very pleased with the overall acceptance of the Infinera product solution as evidenced by our TIer 1 traction in new customer wins in general, our Q2 guidance is reflective of this confluence of factors, and of our continued investments for future to ensure that we build a strong and viable business for the long term.

Based on the factors above, the following guidance for Q2 is based on GAAP results and excludes any non-cash, stock based compensation expenses.

Revenue of approximately $70 million, gross margins of 25% to 30%, operating expenses of $40 million, and an operating and net loss of approximately $19 million to $23 million, which based on an average diluted weighted shares outstanding of $98 million, this would lead to an EPS loss of $0.19 to $0.23.

Looking ahead to Q3, we believe there is reason to expect that both revenues and gross margins will increase from Q2 levels.

This is based on the fact that we believe revenue recognition from a portion of these larger deployments with new and existing customers will occur in Q3, along with our expectations that this time, the current customer base spending remain stable, no additional new large deployments occur, and that TAM shipments will not decline from the levels we are currently seeing.

With that, operator, if you could please open the call up for questions.

Thank you.

(Operator Instructions).

Ehud Gelblum, your line is open, sir.

Can you hear me?

We can.

Great, thank you.

Duston, for a quick moment, I thought you were about to give us Q3 guidance there.

No, no.

We thought it was appropriate to share with you at least a generic feel for what we potentially see happening in Q3.

All right.

I'll try and get a little bit more than just generic in a second.

But, just to clarify a couple things you and Jagdeep said earlier.

When you talked about having three of the world's top five carriers as customers, DT is clearly one of them.

Does Level Three count as one of your top five?

We haven't said any specifics about who they are.

All we said on the call is they are three of the top five.

So if you look at who the top five carriers are worldwide, I think that will give you a sense for the kind of carrier we're talking about.

But how do you judge?

Do you consider Level Three a top five?

How do you measure that, revenue, traffic?

If you look at it by revenue, for example, that would clearly, the top carriers in the world are all going to be Tier 1 incumbent players right now.

Okay.

In that case, Level Three would not be one, and it's a carrier you're talking about.

We're not talking about an internet service provider that would be in that category?

That's right, and just to be more specific, Level Three is not one of the world's top five carriers, and internet content guides aren't really carriers.

This is really top carriers in the world.

Okay.

I wouldn't have thought they he were either.

I just wanted to make sure.

Okay.

The LCM that cost you 300 basis points of gross margin this quarter, what happened with that?

Was that a surprise to you versus your guidance before, that 300 basis points of gross margin hit, or was that something that was in the guidance normally?

It sounded like is that extra lower cost inventory that was more than you expected that to be.

Why was that?

Was there more discounting than anticipated?

Were the costs of the goods higher than expected?

Why was that adjustment more than you thought, to the tune of 300 basis points of gross margin?

Yes.

Ehud it's obviously not a perfect science here when we go and try to do all this stuff, and you know, the LCM has various factors that play in there, and they start with the amount of POs that we have on suppliers, not even in our inventories but just PO commitments on suppliers.

The amount of inventory levels we have in house.

The customer mix of that product that anticipates to ship, in this case in Q2.

So there's a lot of different factors, and there's just no way that we can nail that specifically, and those factors change.

We had a little bit more inventory.

In that case, for these additional new builds that were in shipments that we're planning had built up a little bit of inventory.

Some customer mix has changed within there.

It's hard to predict exactly how many dollars of POs you're going to have on suppliers at any point in time in the quarter.

So, it's a bunch of three or four different factors that added up to about 3%.

Okay.

That to your question is clearly over and above what we had anticipated.

The other 300 basis points came from the discount that was taken.

I'm assuming this was one customer that was given a discount to apply to all of his purchases for the entire year, or was this specific types of purchases and they did more of that specific type of purchase than you expected?

It was one customer, and it was product discount that we had struck a while ago related to common equipment, which we had anticipated based on what we thought purchasing patterns of the customer might be, would be pretty much evenly spread throughout 2009.

What we've seen now in Q1 and what we anticipate to happen in Q2, we believe that that customer will exhaust all those discounts in the first two quarters based on their increased demand effectively for those products.

So the discount was on common equipment.

So that should be read as that customer's building out the initial coverage of the network faster than you expected?

They're buying more of that common equipment that we offered the discounts on faster than we expected.

Okay.

So that's more coverage.

They couldn't have applied it to TAMs or anything else, to DLMs, just to common equipment?

Correct.

Finally, and then I'll give up my side of things.

You said the discounts impact Q2 gross margin by 700 basis points?

Yes.

Is that a continuation of this one discount?

It is.

It's the exact same discount.

It's just what's happened now is that the amounts that we expected to happen in 3 and 4 are basically pulled in.

So as we see the forecast now anyway, they all get flushed.

To this one customer?

Correct.

Were the three new customers you had, the two Europeans and other, did they get discounts as well?

Every customer's structured differently.

So every contract is different.

Finally, how do you know or what prevents this customer, who got the discounts and used them early, from asking for more discounts later?

Is it that they no longer will be making core equipment purchases?

The second they go to DLMs and TAMs, there are no discounts at all, or is there a possibility their discounts could keep going?

We don't see that, no.

Okay.

I appreciate it, thank you.

Sanjiv Wadhwani, your line is open Please state your company.

Stifel Nicolas.

Just a quick question on spending patterns from your customers.

I know obviously, it's difficult to gauge, but just Jan, Feb, March, how things progressed, and maybe first 15 days of April, if activity levels have gone up, they're still pretty low, just sort of generically, if you could talk about that?

I don't think that I can give you a level of fidelity you are looking for by week for example, or even by month.

I think really the key point that I referenced in my talk was that while clearly current customer purchasing of our equipment was down in Q1, based on what the numbers were for top line, new network build activity continues at a fairly robust level.

In other words, the big deals that were in our pipeline, for example, in Q4, for that matter Q1, have not been canceled and have not even been pushed out, and that's a key point he signed for us for the fact that that there is still activity which is important.

The other key point, of course, is that we're winning a lot of that activity, right, as evidenced by the fact that we now have six Tier 1s as customers.

As I mentioned earlier, three of the top five carriers as measured by revenue.

So the activity exists and we continue to win many of those buildouts.

Got it.

And when you compare the two recent European Tier 1 PTT wins to DT, would you classify the opportunities as bigger, similar or sort of less than DT?

Well, I think in my talk, I actually said that two of those three are actually going to be double digit million initial builds, so they're fairly sizable builds.

I don't think we ever quantified DT, but independent of that, it's clear that these are significant networks.

Got it.

All right.

Appreciate it.

Thanks so much.

Sure.

George Notter, please state your affiliation or company.

Hi.

Jefferies.

I guess I was just trying to step back a little bit, looking at the margin issue.

Can you talk a little bit about what the competitive dynamics are right now?

If we go back and look at your business and business model, a year ago, I understand obviously, you had a bigger mix of TAMs, but back then, a lot less of the revenue stream was coming from incumbent telcos, and now you've got more of it coming from incumbent telcos.

You've got new wins in the pipeline.

You're seeing margins really come in.

I guess I'm trying to understand the dynamic there.

What's different about the business and the new customer opportunities now, versus a year or two years ago, when you had much better margins?

Yes.

This is Duston.

I think as you mentioned, one of the factors that exposes us a little bit is the downturn in TAMs, and where normally we could have a reasonable level of TAMs to offset some new customer wins and some bigger customer wins, right now, we don't have that TAM volume.

Now, if you look back again in my comments there, we had roughly 2,000 TAMs a quarter with 35 customers or so, it sure would think we could get back to those levels with 58 customers, but we'll have to see.

But, you know, I think we've seen a little bit on these larger deals, a little bit more pressure on the common equipment from a pricing perspective, but a lot of that, a good chunk of that, will get behind us here in Q1 and Q2.

And, we've still got a lot of revenue coming from other sources, whether it's internet content or the MSOs, or different revenue sources.

Clearly, at this point in our business model, we're not going to have a large majority of our revenue from Tier 1 or PTTs.

Got it.

Okay.

Is there any discounting going on on DLMs or TAMs, at all?

On the TAMs, due to our vertical integration, we're already we believe, very competitive from that perspective, so, we've seen, as I say, some additional common pressure, but the TAMs, we think were pretty well set there from a competitive perspective.

Okay.

So fair to say that you're not discounting TAMs more aggressively than you have in the past or there's nothing new, pricing wise, going on there?

Correct.

Great, thanks.

Thank you, George.

Hasan Imam, state your company, please.

Yes, hi.

It's Thomas Weisel Partners.

I just had a couple of questions.

First of all, on the OpEx front, could you maybe comment on how you're thinking about that, given gross margin compression and reduced revenue run rates?

Are you planning to pull in spending a bit, or is the view that it's really a temporary down tick and we're going to have a recovery shortly, so strategy is to spend your way through?

Then, I have a follow up.

Yes, we've been pretty consistent as far as a strategy goes with the spending.

I think the only difference in our view is that we've gotten a little bit tighter on the SG&A side of the equation where we've pretty much, although we're selectively hiring some resources here and there, we pretty much closed down most of that hiring.

On the flip side, on the R&D piece, we continue to fund that at a reasonable pace.

Now, we've got recharges and things that flop quarter to quarter, but we're still clearly hiring for key positions within the R&D rank.

As you know, Hasan, these projects sometimes go two plus years out.

So for to us take focus off those now, we don't believe that's a prudent thing, and we feel pretty good about the new customer activity and the existing customers, some of the new activity we're seeing there.

So we're looking at it really close, but we continue to hire key resources in R&D, and we'll continue to do that.

Great.

Thank you.

Then, on the gross margin front, I have more of a longer term question which is, one of the most exciting parts of the Infinera story has been this huge cost advantage you are going to have in terms of cogs, versus the traditional optical equipment.

At one point, shouldn't we assume that that should start showing up in gross margins, given that you'd have one-tenth of the cost of your competitors, whereas price discounts are not going to be as significant?

When is that point, do you think?

Obviously a good question.

I think the key point to note there is that margins are obviously higher on the TAMs than they are on the common equipment, and all of the value we create relative to the PIC and the Integration really applies to those line cards, DLMs and TAMS, as opposed to the common equipment, the sheet metal and basic amplifiers and so on.

There's not much that the PIC does for those things.

There are no PICs for those parts of the product line.

So given than disparity in margins, the overall blended margin is going to be a function of the mix of the new common equipment sales and TAM sales.

There's nothing pointing out.

In Q4 and Q1, we saw a drop off in TAM shipments, and at the same time, we also saw a number of big wins which meant more common equipment.

So, because we continue to win new customer footprint at a rate that we believe is higher than any of our competitors, there's obviously that downward pressure from the common equipment sales, but your point.

in general, is valid, which is as we start filling out those empty slots, you clearly would expect the margin to go up.

We can't tell you when or the timing for when that happens, but if you look at the numbers, the history doesn't point it out.

Clearly, the four quarter period that Duston referred to had obviously, a lot higher margins than what we're seeing today.

It also happens to have a much higher level of TAM shipments than we're seeing today.

Clearly, TAM shipments and gross margins are highly correlated, as we all know.

Unless we believe there's some systemic reason why new customer footprint wins are not going to turn into new TAMs, then over time, we would expect those TAMs to ship and margins to go up.

One last point to make.

Keep in mind that the customer, even though there's a lot of pressure on us in terms of margins, the customer doesn't get anything out of the common equipment.

They really only get value when they plug a TAM in and light up a circuit.

light up a wavelength.

So obviously, customers are going to deploy TAMs, but the mix would be a function of new wins versus lighting up of current TAMs.

Great.

I have just one last question.

Thanks for that answer.

In terms of your comment, Jagdeep, that incumbent customer deployments have weakened but at the same time new builds are progressing to plan, isn't there kind of a disconnect here?

With operators facing the same macro picture, why aren't we seeing slowdown in the green fields or push up in the green fields, as well?

What do you think is the real disconnect there between the two groups?

You know, one possible difference is the guys that are doing new buildouts are doing the buildouts for a reason.

The reason is they're flat out at capacity.

So, they might need to deploy new capacity just to be able to grow revenue at all, and maybe the guys that have existing gear are trying to be more efficient about what they use.

Again, we don't have any unique insights into what our customers are thinking from an inside perspective obviously, but we're kind of reporting what we see.

The facts are that the TAM shipments in Q1 were lower than what they've been historically.

The facts are that new network buildout activity continues.

That's just the facts we're reporting.

Thank you.

Thank you.

Simona Jankowski, state your affiliation, please?

Thank you, with Goldman Sachs.

Thank you for providing that incremental detail on the historical TAM shipments.

That's certainly very helpful.

One thing I just wanted to clarify on that is when we compare the situation now to the one you're highlighting back in late 2006 and through the third quarter of 2007, when you were shipping about 1300 TAMs on average, if I got that number right, right now, you said you are shipping about 25% less than a year ago so that would put you right now at about 1500.

That's still higher than what you guys were shipping back then.

Revenues are about the same level, but yet margins are actually lower.

So can you just clarify, what's kind of the main driver of that discrepancy of why, despite the higher TAMs, margins are still lower?

Then, kind of related to that, back in that period, while TAMs were low, you were in a period of hyper growth with revenue growth of over 100% each quarter year-on-year.

Right now, we're in a negative growth trajectory, so we're seeing if we're kind of getting hit on one side, we'd get some benefit on the other.

Let me answer a couple things, and let Jagdeep chime in, too.

You've got to look at it, and obviously we didn't provide detail on the mix of common equipment and all that stuff, but I mean the issue that we're facing now is why aren't margins higher even though revenues are lower, and you've got 1500 TAMs or whatever you say there.

We've still got facing a lot of these LCM adjustments with these new builds, which would put a lot of pressure on the gross margins, and if you look at the percentage of common equipment between probably now and historically, I think if you went back and looked at that as a percentage of the total revenue is probably a greater mix of common equipment also.

And also, those back in the 1300, as I say, TAM arranged per quarter, we had roughly 35 customers driving those.

Today, we've got upwards of almost 60 customers, and we certainly expect those levels to get back to the 2,000 level sometime in the future.

Is the LCM phenomena something you were not experiencing back then?

Not to that extent.

Okay.

And then, one of the other follow-ups I had, you mentioned that you're expecting a couple of your European carriers to have double digit million of sales this year.

Was that primarily in common equipment or does that include a reasonably large proportion of TAMs within that double digit million?

It will be dominated by common equipment, but obviously, it will include DLMs and TAMs.

Thank you very much.

(Operator Instructions).

Jeff Schreiner, your line is open.

State your affiliation, please.

Yes, CapStone Investments.

Good afternoon, gentlemen.

I was wondering if we could talk a little bit about a historical time line from what we've seen in terms previously, of signed contracts of the customer to much larger scale deployments?

When looking at the historical, how is that comparison with what we're seeing here in early 2009?

Jeff, I'm not sure.

Could you repeat that, please?

Yes.

What I'm trying to understand is it seems that some of the pushouts Jagdeep has referenced in terms of some of the large customers, I'm wondering if we're seeing a change in terms of not only the time of when I signed the contract with Infinera, I deploy the common equipment and I start uploading TAMs and get to maybe a more normalized equipment, if that has changed dramatically from what the historical patterns used to be?

I understand the question.

I don't know that we're seeing any dramatic change in the time lines of new rollouts.

I mean, typically, we win a deal, we get awarded.

They first tell us, verbally, we won the deal and then we negotiate the contract, and then, we ship gear again the contracts, against POs.

That gear gets installed and accepted.

Over time, they start adding more TAMs as they add more bandwidth.

I think the time line on which all that occurs has been largely consistent.

It obviously varies by customer size and network bandwidth growth and so on.

But in general, we don't know there's been a dramatic change in the timeline for how new customer deployments occur.

What visibility would you say you have currently?

We heard you almost ready, as one caller stated, to possibly make some statements about Q3.

Could you give us some idea of where visibility is today and maybe where it was just even two months ago?

Yes.

It hasn't changed dramatically from what we always say.

As we go into our current quarter, we've got reasonable visibility.

The only difference, I guess, with Q3 in this case is that as we see it today, there's a few chunks of revenue, if you will, that will get invoiced in Q3 from some of these larger deployments.

So from a visibility perspective, we have insight into that, obviously in advance of which we normally would. So, I think that's probably the only change from a visibility perspective.

As I say in the current quarter, I think, nothing's changed from all of our recent quarters that we've got, reasonable visibility, not perfect, but reasonable visibility into the current quarter.

Okay.

One final question, gentlemen.

Thank you for your time.

Just kind of following off that, Duston.

I mean, if you have some reasonable visibility, then does management now think that first quarter 2009 could quite possibly be likely low for the operating model in fiscal year 2009?

Do things start to move higher from here, as you move to the transition from comment to TAM, and the Company should start to see incremental benefits from that?

Yes.

I mean, the only thing we additionally commented on was the Q3 comment that all of the things being equal with a few of these larger guys getting invoiced, that we could see revenues going up in Q3, but we haven't really quantified it beyond that, whether it's the low or how the rest of the year looks, or anything like that.

Okay.

Thank you, gentlemen.

Ajay Diwan, state your affiliation, please.

It's J & W Seligman.

I just had a few questions.

In the past, you talked about the cable MSOs as a group, as a meaningful customer base.

Can you just give an update on what you're seeing from those guys in terms of deployments?

Yes.

This is Jagdeep.

They continue to be customers.

I think one of the key points is that we have a fairly diversified customer base from a market segment standpoint as bandwidth wholesalers, MSOs, internet content guys, and the Tier 1s.

I guess the nice thing about having that diversity is that they don't all move in exact lock step.

So at any given quarter, your top customer list moves around in terms of the different segments, and so, there's ebbs and flows in each of those segments relative to their own industry developments.

But overall, those guys remain customers.

We continue to work with them as we do with the other segments, and are generally pleased with their activity.

Got it.

But in general, they've kind of seen the same macro effects that you're generally refer to, so their purchases may be kind of lower than what they are on a normalized basis?

They actually increased a little bit in Q4 from the Q3 levels, actually.

And in Q1?

Haven't commented on that.

Okay.

Got it.

Then of course, we also refer to new activity, new buildout activity that we're seeing in the customer base.

That spans all the different segments.

That includes the MSOs as well.

Got it.

You said that you have a new application on the submarine side.

I was wondering, given the distances tend to be so long.

and my general understanding of one of your key value propositions is these low cost optical to electrical conversions.

You would think you don't need to do that in a submarine.

Why are you winning in that environment?

Can you tell me?

Yes.

It's a good question.

If you recall last summer, we announced our ultra-long-haul system that did on the order of 2,000 kilometers of reach between electrical sites, and the reason we did that is because it was an emerging market for longer reach WDM platforms driven by a number of different applications, and submarines happened to be one of them.

Because of that system and the capabilities we had at that time, our system does compete quite effectively in that environment.

Effectively enough to win against the incumbent competitors.

Submarine is a great example where you obviously don't have the ability to access the signal in the middle of the ocean, so you have to drive thousands of kilometers between digital sites, and the key is to have a system that has the optical reach to be able to cover that, and our system has that as of last summer.

So, it's a much more complete offering overall.

The other thing I'd point out is that that whole segment is actually seeing a reasonable level of activity.

It seems to go in cycles and I guess the last big cycle was on the order of a decade or so.

A lot of those systems are running low on capacity and so there seems to be a high level of activity across multiple customers in that space.

One final point if I could just add a little bit different note.

She asked a question, and this is relevant.

The other thing we've been doing is increasing the capacity of the system, so our first generation system,t four years ago, had 40 channels worth of 10 gig capacity.

on the order of 500 kilometers of reach.

So what that meant was every 500 kilometers, you were buying more DLMs, and every 40 channels, buying new line system with more capacity.

We then added longer reach and doubled the capacity to 80.

Last summer, we added even longer reach, ultra-long-haul, and doubled the capacity to 160.

So the side effect of that, to answer Simona's question from earlier, is that the benefit is you lower the customer's first in cost because there's not as many DLM sites that you need.

You also have lower up front DLM requirements, which is one of the factors that would lower the first in margins of these deals.

Then the offsetting effect is you have a longer stretch of time in which you're just adding TAMs with no other common equipment required on that link.

So you go for 150 wavelengths worth of TAMs, so the longer term margin for those routes actually gets better.

Got it.

So is it fair to infer one of these Tier 1 wins you're talking about is a submarine application?

And the second thing is, given that the margins are so low, are these kind of field deployments lab trials or actual RFP wins?

Can I classify where they are because it feels like the initial sale, you're kind of giving away the product.

I don't know how else to put it, but if you can maybe clarify, are these actual RFPs that you responded to and won, or are they trials, or what kind of wins are they?

Yes, in many cases, most cases, the Tier 1s were, in fact, RFPs, so I think it's a safe assumption, most of Tier 1 wins that we're talking about came as a result of winning an RFP.

Definitely no lab trials.

I don't know any labs that would buy double digit millions types of gear.

So, these are real deployments, real networks.

We haven't commented on anything more about where the submarine networks are, which carrier these belong to.

So we've said that there's three of the top five Tier 1s.

We have six Tier 1s worldwide now.

We said we're winning submarine networks, but we haven't said any more than that.

To your point about the margins, about giving away commons.

In effect, that to some extent, is the business model of this industry.

The common equipment has always been low margin equipment, and the vendors made their money effectively, on the line cards.

The only question is how attractive are your line card, transponder or tributary optics margins?

And if they're really attractive, then there's a really good business model over time as they fill.

If they're not, that's a problem.

We obviously believe our TAM margins are better than people that are building discreet based optics.

That's good for us.

But in the end, where the margin's going to be at any point in time is going to be the function of the mix between the TAM fill rate of a given network and new customer footprint that we won.

Got it.

Thanks a lot.

Thank you.

Todd Brady.

State your affiliation, please.

Wells Fargo.

I think you already answered my question.

I wanted a clarification.

You said Level Three was 30% of your revenues.

Can you quantify or actually break out the top five customers and what percent they represented of revenues?

And I think you answered my question, but are any of your customers running into financing issues in building out their previously planned networks because of the capital markets?

Thanks.

Sure.

Yes.

Historically, we've only broken out the 10% or greater customers.

So we've never given a layer below the 10%, and well, we obviously won't start now on that.

On the financing part of the equation, I don't know if anybody, I think the question was has anybody delayed their rollout because of financing?

I don't know of anybody that has delayed any significant rollouts or buildouts because of financing issues.

You know, we had one customer last quarter we provided a bad debt reserve for in Russia.

That was what kind of a one off thing.

Occasionally, customers ask us for some help here and there, and whatever.

There's been nothing, no significant changes or delays because of financing that's been obvious to us anyway.

Okay.

Thanks.

Okay.

Thank you.

George Notter, state your affiliation, please.

Hi.

It's George Notter at Jefferies.

Just as a follow-up, I guess I was trying to figure out what your head count was here at Q1 end?

962, I believe, George.

Okay, so you were still hiring additional people here?

Correct.

And that leads into a question about operating expenses.

So where do you think operating expenses go in absolute terms over the longer term or intermediate term?

Obviously, you're investing aggressively here in a multitude of projects, Metro WDM, the 40 gig PIC development.

Does it stand to reason that once those projects start to roll off, your operating expenses would roll off with them, or do you think you can kind of continue to spend at these rates or even higher going forward?

What's the longer term picture?

Yes.

It's hard to tell whether things would significantly roll off.

I mean, the big chunks of things, NREs, the more one time project related, and there are obviously several million here and there that can come and go easily.

You know, we will continue, I think, potentially to add modestly to R&D expenses.

SG&A might vary a little bit with commissions on revenues and things like that, but I wouldn't expect any substantial upward change in expenses, or on the downside, I wouldn't expect, at this point anyway, any substantial downward change.

If I can just add a more qualitative point addition, as well.

George, the obvious sort of the challenge is how do you balance the need to have a competitive product line, say a couple years out, with the need to have an OpEx line that's consistent with the top line, and there's never any easy answer to that.

It's all judgment calls related to what functionality you believe is going to be required to be competitive in the couple year time frame, balanced against what the outlook is with top line growth.

So, you know in the end, if we didn't see a fundamental top line that was capable of sustaining, we obviously would have to take action in that scenario.

But if we do believe that there's a real business, there's a real top line here to be had, then in order to earn that top line, we need to have functionality that's competitive.

That's kind of generic answer to the question.

Obviously, it is a judgment call we keep making on a regular basis.

So in fact, on that note, let's go ahead and close the call.

I want to thank you all for joining us today.

I think we clearly continue to see evidence that our value proposition is resonating with customers based on our recent wins, and combined with the continued advancement of our PIC based technology, we believe that we are well positioned to resume top line growth and improve our bottom line performance as the macro economic environment improves.

We look forward to reporting on our progress in our next earnings call.

Thank you.

This concludes today's conference.

You may disconnect at this time.