Infinera Corp (INFN) 2009 Q3 法說會逐字稿

Welcome to the Third Quarter Fiscal 2009 Investment Community Conference Call for the Infinera Corporation.

(Operator Instructions.) I would now like to turn the call over to Mr.

Bob Blair of Infinera Investor Relations.

Sir, you may begin.

Good afternoon and welcome to Infinera's Q3 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 and customers, our products and our competitors' products, and prospects of the Company in Q4 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 on February 17, 2009, for more information on these risks and uncertainties.

Today's press releases, including Q3 2009 results and associated financial tables and investment 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 third quarter of 2009, which exclude the impact of non-cash stock-based compensation expenses and restructuring and other costs associated with the closure of our Maryland fab.

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

Please see the exhibit to the earnings 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 fourth quarter of 2009.

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

We have also excluded the impact of restructuring and other costs associated with the closure of our Maryland fab from this guidance.

For the remainder of today's call we will be excluding the impact of these items as we discuss our third quarter 2009 results and our fourth quarter 2009 guidance and 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 today are COO, Tom Fallon, and CFO, Duston Williams.

We are pleased with the results we achieved in our third quarter.

During the last year, in the context of the economic downturn, it has been our strategy to focus on winning new footprint, advancing our industry leading technology, improving our margins, and maintaining our operational excellence.

In our third quarter we made solid progress on all of these fronts.

We grew our revenues and gross margin sequentially to 83 million and 38%, exceeding our guidance, and our operating loss came in at 5.8 million, better than our guidance of a loss of 12 to 13 million.

Earlier in the year, we indicated that we believed Q1 may have been the bottom of the macroeconomic erosion for us and we believed that with two sequential quarters of growth in our business and our Q4 outlook this expectation has played out.

We continue to expand our footprint with the addition of four new customers, including two tier one customers, which we have previously discussed, Telefonica and TeliaSonera.

We achieved greater customer diversity as three customers accounted for 10% or more of our revenue, none of which were level three, which as you know, has historically been our largest customer.

Level three remained in our top five customers and was just shy of 10% of revenue.

For the fourth quarter in a row, international revenue grew to 37% of our business in Q3, reflecting our continued success beyond our traditional stronghold in North America.

It is important to note though that this metric will likely fluctuate from quarter to quarter due to periodic large spending by customers in either regional category.

Our success with internet content providers continued this quarter with a new eight-figure win with another major player in this space.

We expanded our total addressable market with further penetration into the submarine and metro edge markets with new products.

Consistent with our 8-K announcement during the quarter and our focus on providing the best solutions for customers, even if it's not the first to market, we are on target to deliver our 10x40 gig PIC to our developers by the end of this year as we prepare to bring another disruptive technology to market.

And we've significantly strengthened our technology resources with the addition of an experienced engineering team at our new development center in Ottawa.

This team has deep expertise in signal processing and complex modulation schemes, important building blocks for the next generation of optical transport and they were the core architects of Nortel's 40-gig implementation.

The key to successful technology development is the quality of the team and we believe that we now have the industry's best signal processing team working alongside the industry's leading PIC experts on our future implementations.

The signal processing for our 10x40 gig PICs has been developed by our Sunnyvale team, so the Ottawa group will be focused on generations beyond this.

Our ability to grow our revenue and expand our customer base in the current environment is significant for several reasons.

First, it validates that there continues to be significant WDM investment by our customers, and second, it shows that Infinera is winning its fair share of the spending, both in terms of new customer wins and with existing customers who are choosing to remain with Infinera as their WDM vendor of choice.

It means customers are choosing our value proposition over that of our competitors, including some of the biggest vendors from around the world.

Our customer roster is now 66, compared with 49 one year ago.

With the addition of Telefonica and TeliaSonera this quarter, we now have six tier one customers around the globe, of which three, NTT, Deutsche Telecom, and Telefonica, are among the top five service providers in the world.

It is also important to note that we achieved our third quarter revenue level with greater customer diversification than ever before.

As mentioned earlier, three customers accounted for 10% or more revenue this quarter and our largest customer for the quarter was an existing but unannounced cable MSO customer.

One of our newest tier one service providers, Telefonica, was another one of our top five customers.

And even though level three was less than 10% of revenues this quarter, we were still able to grow revenues nicely and exceed our guidance.

So we believe that our efforts to diversify the customer base across regions and vertical markets and to decrease our reliance on any single account are succeeding and will continue to be a significant positive for our business.

Another key factor in our business is our ability to successfully compete in the submarine networking market.

The submarine market has enjoyed strong growth in recent years as increasing transcontinental traffic has risen sharply.

According to data from independent analyst, Ovum, the submarine networking market is nearly $1 billion this year, growing at 20% per year.

This market tends to be fairly cyclical in nature and appears to be in an expansion phase today.

As a result, we are seeing significant activity there in terms of both the number and size of deals.

We believe that Infinera's solution is especially well suited for the submarine market because it enables operators to increase capacity in their networks while taking advantage of the operational benefits of Infinera's digital architecture which are not achievable with traditional WDM systems.

We have already seen a healthy win rate in these deals, including business with Telefonica and Global Crossing.

In addition to the immediate opportunities that we're seeing in the submarine market, we are also encouraged about the longer term prospects of our recently announced ATN metro edge product.

The new ATN product provides customers with a seamless end to end managed WDM solution, extending the bandwidth management functionality of our existing metro offering deeper into the networks.

With the introduction of this product, we now address all of the major categories within the $8 billion WDM space, including submarine, ultra long haul, long haul, regional, metro core, and metro access.

Customers have asked us for the solution and we already have six customer commitments, including the recently announced DeltaCom purchase.

Finally, I wanted to take a moment to reiterate our 40-gig strategy.

It's important to emphasize that our goal is to be the best in the market with a 40-gig base product that solves the operational and cost challenges of our customers.

We believe that our unique PIC based products will provide us with an even more significant competitive advantage in the 40-gig market than they currently do in the 10-gig market, because of the cost and complexity associated with 40-gig technologies.

We also believe that we are in the very early stages of the 40-gig market and expect that our integrated cost effective 40-gig product when introduced will enable us to capture a meaningful portion of this market and accelerate the adoption of 40-gig by the mainstream market.

Our mission remains to be the world's best provider of optical transport networks and consistent with our approach to the 40-gig market our core strategy is always going to be one of differentiation.

We believe that we are uniquely positioned to be able to provide the best product to solve our customers' business challenges.

We believe that our financial results as well as our new customer wins, customer diversification, existing customer activity, and continued progress with our industry leading technologies validate our strategy as a sound one.

I will now turn the call over to Duston, who will cover our third quarter financial results and fourth quarter guidance.

Thanks, Jagdeep.

I'll review our Q3 actual results, and then follow that up with our outlook for Q4.

The following analysis of our Q3 results is based on non-GAAP.

All references exclude non-cash stock-based compensation and restructuring costs associated with the previously announced closure of our Maryland fab.

Looking at the specifics for the quarter, GAAP revenues in Q3 were 83.4 million, compared to our guidance of 80 to 82 million, and versus 68.9 million in Q2.

We had three 10% customers in Q3, including a top five cable company, XO, and Telefonica.

Level three was slightly less than 10% of our GAAP revenues versus the 20% in Q2.

Gross margins in Q3, excluding a negative 3% or 2.7 million impact related to the restructuring costs associated with our previously announced fab consolidation efforts, were 38% versus 31% in Q2.

This compared to our guidance of 35 to 36%.

Although the gross margins exceeded our previous expectations, they were impacted to some degree by lower margins on large new customer deployments, as well as TAM shipments being below historical norms.

We invoiced about 100 more TAMs in Q3 versus Q2.

Operating expenses for the quarter, excluding restructuring costs of .6 million, were 37.7 million versus our guidance of 41 million, and versus 40.2 million in Q2.

Good expense controls, combined with lower than expected headcount additions and NRE charges, which were pushed out to future quarters, accounted for a majority of the spending reductions.

The overall headcount for the quarter was 970 versus 973 in Q2.

Headcount additions in R&D during the quarter were more than offset by reductions associated with our fab consolidation efforts.

The operating loss for Q3 was 5.8 million versus our guidance, which called for an operating loss of 12 to 13 million versus 18.6 million in Q2.

Other income expense for Q3 was a favorable 1.2 million versus a favorable .5 million in Q2.

Income taxes for the quarter reflect a favorable 1.6 million due to an adjustment related to a tax refund from last year--last fiscal year.

Net loss for the quarter was 3.1 million or a loss of $0.03 per share, versus a loss of 18.2 million in Q2.

Turning to the balance sheet, the cash, cash equivalents, restricted cash, and investments, ended the quarter at 280.5 million versus 287.1 million in Q2.

We used 8.3 million of cash from operations in Q3 versus a use of 18.8 million in Q2.

DSOs were 61 days versus 72 days; inventory turns were three versus 2.6; accounts payable days came in at 44 days versus 51 days; and capital expenditures were 2.8 million in Q3 versus a similar amount in Q2.

Our Q4 base operating outlook shows higher revenue as our new and existing customer wins should continue to aid revenue growth as we close out our fiscal year end.

At this point, gross margins appear to be up slightly from Q3 as we complete most of our recently announced large new deployments.

We also expect Q4 TAM billings to approximate the levels of Q3.

However, as we know, TAM bookings can be somewhat volatile and several hundred more TAMs in any given quarter can have a positive impact on our gross margins.

Operating expenses will increase in Q4 due to additional R&D headcount, as well as increased NRE charges.

In addition to this base operating outlook for Q4, we will also conclude our restructuring costs related to the fab consolidation efforts.

The following guidance for Q4 is based on non-GAAP results and excludes any non-cash stock-based compensation expenses and the Maryland fab related restructuring costs.

Revenue of approximately 86 to 88 million, gross margins of 38 to 40%, operating expenses of approximately 42 to 43 million, operating and net loss of approximately 8 to 9 million, and based on an estimated average diluted weighted shares outstanding of 99 million, this would lead to an EPS loss of $0.08 to $0.09.

In addition to the above outlook, as I discussed on our last earnings call, we expect to book approximately 2 million of restructuring charges in Q4 that are associated with the fab restructuring.

Approximately 50% of this charge will be included in cost of goods sold, with the remaining 50% included in R&D expenses.

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

(Operator Instructions.) Our first question is from Michael Genovese with Soleil Securities.

Go ahead, your line is open.

Great, thanks.

It's Mike Genovese with Soleil.

Thanks.

Guys, congratulations on a good third quarter.

Just first a point of clarification, the OpEx for the fourth quarter of 42 to 43 million, that--is that right--that excludes stock comp expense.

Is that right?

That's correct.

Okay, great.

Now, on the new products, can you help us with any kind of breakout on the undersea and the metro products?

Is there any difference in gross margin profile on those products relative to each other and relative to the DTN?

Every deal is different, of course, and every customer is different.

I wouldn't say there's significant differences in gross margin.

There's some differences, of course, but I would not say they're big differences.

Okay.

With the ATN, do you think that that's a product--is that a product you would expect to win new customers for that don't--that aren't deploying the DTN, or do you think that that will primarily be customers that--long haul customers that want to extend the operating system to the metro?

Yes, that's a good question, Mike.

So the--obviously, as we do with every platform that we have, there is a roadmap for the ATN, like there is for the DTN and the submarine products, and so on, that involve multiple leases over time.

The functionality we prioritize for the initial release is in fact the functionality that our current DTN customers value significantly.

So, for example, what the ATN--one of the key things the ATN lets our customers do is extend the bandwidth management functionality to the edge, so they can, for example, take in four 2.5-gig streams, combine them into a single 10-gig stream on the ATN, deliver that to the DTN in a way the DTN can then split up and groom in different directions.

You can't do that today with a third party metro block.

So that's a unique a value that the ATN offers to a DTN network that can't be gotten anywhere else.

Having said that, clearly, over time, if we have a platform, the intention would be to make it a fully competitive block that competes not only in customers of the DTN today, but in new accounts as well.

If I could just get one more in, on--thanks for that answer, Jagdeep.

On the share, you say you're win--you think the optical market sounds like it's recovering pretty nicely, so you're winning your fair share.

But do you think that you're gaining share or would you look at other vendors - Sienna, Alcatel, others - and think that they are growing at about the same rate as you are in optical, or are--is there anything notable in the competitive environment?

Any specific vendors you could call out as either gainers or losers at this point?

Well, we won't know the Q3 statistics until the analysts publish their reports, which won't be for a few weeks from now probably.

But I think what's clear is that we certainly continue to win a significant fraction of the deals that we actually compete on.

So clearly, not everybody in the universe of optical products could be winning that many deals, because that would add up to more deals than there are in the pipeline.

So we're clearly growing more rapidly than many of the players.

What we don't have [idea] on yet is whether we're growing more rapidly than everybody or not.

Thanks a lot.

You're welcome, Mike.

Our next question is from Simona Jankowski with Goldman Sachs.

Go ahead, your line is open.

Hi.

Thank you very much.

I did notice that this was the first quarter for you guys of sequential growth in the United States after four quarters of declines and this is despite the level three headwind.

So I just wanted to get a little more color of what you think drove the strength in the U.S.

It's--again, it's just the buying patterns.

There wasn't any new win there.

However, we did have some new deployments with existing customers.

Some of that, obviously, in the U.S., that helps that.

So, again, any given quarter you're going to see strengths in various regions.

Yes.

If I could add, I mean, I think we distinguished that we had customers and new wins or new deployments within current customers.

And we certainly had new deployments, new wins, that we won in our current customer base, whether they were building out new layers of their optical transport network, [did RPs], and chose Infinera for those networks.

And that's obviously one of the key drivers for the growth that we've seen this year.

Yes.

And Simona, the top two customers, as you say, they were both U.S.

deployments, so significant revenue driven from those two customers.

Okay.

And then, you did say that you added four new customers and I believe at least one or two of those were new ATN customers, which would imply that for the DTN you maybe only added two or three customers.

I just wanted to see if that's accurate, and if so, is that a bit low on the DTN side.

Yes.

No, that's not accurate.

That's a good question though.

So we added four customers, but the way the math worked on the ATN piece, we have six today.

The four that we had at the end of the quarter all were existing customers.

So that didn't sway the count there.

The two additional customers that make up the six total ATN customers are new customers outside of DTN purchases.

So you're saying those two additional ones came in this calendar quarter.

Correct, in Q4.

Got it.

Okay.

And then, another question on the ATN, which is my understanding is that it's not a PIC based product.

And so, assuming that's the case, where do you see the biggest differentiator?

Is it really mostly having to do with the interface with your DTN and the bandwidth management extension that it enables, or do you think there's going to be other elements that are differentiating?

And related to that, what do you think is going to be the gross margin impact of that product?

Well, so, the--if the product weren't differentiated, we wouldn't have done it.

We would've just bought a third party product or done a partnership.

The bandwidth management functionality is pretty critical.

You--the fact that customers can now, as I mentioned earlier, take in say four 2.5-gig streams, combine them together in a single 10-gig stream, and then have that be groomed, i.e., switched and muxed or demuxed, through the DTN network that they already have, is a really significant advantage that they cannot drive any other way.

That enables them to have end to end bandwidth management and end to end transparency, so they can pick up traffic in their metro edge nodes and deliver it all the way through the network without the need for excess CapEx on back to back transponders or back to back bandwidth management systems and so on.

So that's a pretty significant advantage we believe and that's what's--that's one of the key drivers behind the wins that we're seeing in that product line.

No, I mean, clearly, it's a pretty significant differentiator for existing customers who already use the DTN.

But I guess the question was just more as a standalone metro platform, given that it doesn't have the massive differentiator that the PIC gives you guys in the DTN, how important is that bandwidth management interoperability as a standalone metro product?

Well, two quick comments on that front.

One is the--keep in mind that the PIC that we sell exists on exactly one of our [FFU], as we call them, or (inaudible) units, one line card contains the PIC.

Everything else that we sell really is designed to complement the PIC and make it more compelling in the networks.

And this is another example of that kind of functionality.

For example, we sell amplifiers today that don't have PICs in them, but are needed in order to build a long haul optical network.

Metro edge falls in the same category.

That isn't to say that we're never going to have a PIC in the metro.

It's just to say that the particular application that the ATN is targeted towards is in fact extending the bandwidth management capabilities of the DTN towards the edge.

The second quick point I would make is that if you look--if you talk to customer that buy the DTN platform today, clearly, the PIC is one of the key differentiators of the platform.

But the other key differentiator is in fact the bandwidth management capability.

No other WDM system has built in integrated bandwidth management or switching capability.

So if you look at every other competitor in the WDM space, in order to switch traffic you need external bandwidth management or you need a switch of some type, like the (inaudible), for example.

The DTN has that functionality built into it, so it's a pretty significant part of the overall value proposition and that certainly with the ATN is designed to extend all the way to the edge.

Okay.

Thank you very much.

You're welcome, Simona.

And your next question is from Brent Bracelin with Pacific Crest Securities.

Go ahead, your line is open.

Thank you.

I had a follow-up question on the new product side.

What was the revenue contribution from metro and submarine in the quarter?

What--was it meaningful?

What percentage of sales?

And how should we think about that as a driver going forward?

Yes, Brian.

We haven't historically broken out individual pieces of the business like that.

At some point in time perhaps we'll look at the ATN piece.

But historically, we have not done that.

Okay, fair enough.

Given the spike in revenue sequentially here, 21% sequential, I would've thought the TAM shipments--these billings would have been a little higher.

What's been the interaction so far with service providers relative to their bandwidth needs?

How should we think about kind of capacity right now in the backbone?

Well, I think that TAM shipments certainly have gone up.

And as Duston indicated in his comments, we shipped more TAMs in the third quarter than we did in the quarter prior.

So that's obviously the right direction.

We just think that TAMs are not where historical indications would suggest that they ought to be if you look at it relative to TAMs for a customer, for example.

So there's still obviously--we expect room for more TAM shipments over time.

But having said that, there clearly was an increased uptake of TAMs in the quarter compared to the previous quarter and that we think is directly driven by increased bandwidth demands on the part of our customers.

Fair enough.

And then, my last question for you, Duston, on the fab consolidation.

When that's actually finally behind you, would you expect a snap back to kind of the 40%-plus gross margins?

Kind of give us a little update on that relative to the gross margin profile and timing of the fab consolidation.

Yes.

We--last call, what we talked about there was in Q2 of 2010 via those efforts we'd expect 2%'ish gross margin improvement.

We didn't correlate that to a specific margin number.

But we did say that we'd expect at least a 2% improvement and those efforts have been going just fine and probably maybe a bit ahead of schedule.

Okay, fair enough.

Thank you.

Thank you.

Our next question is from George Notter with Jefferies.

Go ahead, your line is open.

Hi.

Thanks very much.

I wanted to ask about the gross margin improvement sequentially.

I--obviously you had a lot of help from higher revenues, increased levels of TAM shipments.

I know also there were some product discounts that you had expected to flow through in the June quarter I think fell in the September quarter.

I guess I'm trying to understand when I look at the seven point improvement in gross margin sequentially, I'd love to sort of parse that out in terms of puts and takes and how much came from volume, how much came from TAMs, and give us a sense for what drove that.

Thanks.

Yes.

So--George, Duston.

We're not going to get into the exact specific there, but again, you're right.

We had several large deployments in Q3.

We've had--or in Q2.

We've got less of an impact in Q3, including the Q3 results, so that helped margin.

Then we guided up--we had guided to 35 to 36 because we knew we were going to see some improvements there.

But Q3 still has some of that impact in it, quite honestly.

TAMs, we mentioned about an extra 100 TAMS, so that helps by--all things being equal, by about a percentage point there.

And in Q3, we also had probably a little help with some customer mix that has also helped margins into Q3.

As we look into Q4, we still have some of those one time deployments, but we do expect maybe a little bit of margin improvement.

That's why we guided to 38 to 40% margins.

Got it.

Okay.

And then, anything new just on the competitive environment in terms of pricing?

I mean, obviously, you're getting some benefit on margins just through growth in the top line, TAM mix, and so on.

But has anything changed competitively in terms of the pricing environment?

I would say things seem pretty consistent where they have been.

Obviously, the com equipment always tends to be under more pressure than the transponders do.

And I don't think there's been any kind of dramatic change in the competitive pricing environment that we're aware of.

Got it.

Okay, thanks very much.

Thank you.

Our next question is from Sanjiv Wadhwani with Stifel Nicolaus.

Go ahead, your line is open.

Hi.

This is actually [Chris Kustaluwan] for Sanjiv.

And just a follow-up on the competitive question environment.

Can you guys share any thoughts on the Nortel auction process and how that might be affecting the environment in general?

So the question is regarding M&A, and obviously we have a longstanding policy of not commenting on M&A activity.

Is that the question or--?

--No, it's more--is there any impact I guess from a competitive standpoint or--.

--Okay--.

--Or as this process is kind of evolving?

Right.

Obviously, as you know, Sienna has been announced as the stalking horse bidder for that asset.

To be quite honest, we don't really see a big difference in terms of the competitive environment or competitive dynamic, regardless of where that asset resides, whether it resides with Nortel like it used to or whether it resides with Sienna, for example.

The underlying fundamentals of the asset don't change.

The issue with the 40-gig approach has been and remains the cost structure of all the complex modulation schemes and so on.

And there is really nothing that Sienna or anybody else for that matter could bring to fundamentally change that.

Now, obviously, the PIC does bring something to change that.

But nobody in the industry has a PIC.

So our view is that relative to where that asset ends up, it doesn't fundamentally change the competitive dynamic that we're seeing in the marketplace.

Okay, that's helpful.

And let me just follow-up on the two additional customers that you mentioned that came on, specifically I believe toward the ATN product.

Did they actually--did they join specifically because you have the ATN product or was this--may have been kind of a DTN/ATN combination or can you shed some light on exactly how those two customers were acquired?

Well, I can say that for one of those customers in fact the ATN was the driver behind the whole deal and ended up being a very significant part of the win.

We'll be talking more about that customer over time, obviously, as we announce it formally.

But we're certainly pleased by the fact that the ATN is able to not only couple with the DTN in many networks, but literally be the driver for new wins in other situations like the one that I just reported to you.

So we haven't announced the customer, so I can't say any more about that.

But I think over time we will plan to provide more information about ATN customers.

Okay.

Thank you very much.

You're welcome.

Our next question is from Alex Henderson with Miller Tabak.

Go ahead, your line is open.

Thanks.

Hey, guys.

First off, can you talk a little bit about the four new customers in the quarter, who you displaced and who you were up against in those competitions?

I think we can say that, for example--two of the four were Telefonica and TeliaSonera.

And we don't--we obviously are not at liberty to talk about our customers' proprietary networks.

Customers don't always publicize their vendor decisions.

But I can say that the displaced vendors were the usual suspects.

There's a handful of players that are global telecom communications equipment vendors and you can assume that those vendors were the incumbents.

So the large, multinational optical telecom equipment players were the incumbents to those accounts.

Okay, second question.

This is more of a bookkeeping question.

As I understood your guidance, you said the $8 to $9 million loss at the operating line and at the net income line, which would imply that you have got some material movement within those two line items between there, the interest/other and the tax line.

I assume the tax line normalizes back to about $100,000 a quarter the way it was.

Does that imply some reversion in the other gains line back to more of a breakeven type number or how do I think about that?

No.

You should think about it as interest income hovering around 500,000 - it was a little less than that this quarter - offset by some level of tax provision, 200,000 maybe, and some other miscellaneous things that we always have running around in there to kind of net back to zero.

And can you give us any sense what you think your headcount will do for the fourth quarter?

It will go up to some degree, but on a net basis, probably not up all that much as we continue to finish up some of the fab consolidation efforts.

And what headcount you will see, vastly dominated by R&D.

And can we go back just to the operating lines?

If I'm reading the income statement correctly, that's a pretty good increase sequentially from the third quarter to the fourth quarter in operating expenses.

Can you give just a little more granularity on what exactly is driving that?

Yes.

Again, what we expected--with some large development efforts that we're doing, we again thought that there would be some significant NRE charges, several million, in the quarter.

And those aren't easy to predict.

And right now, we're pretty sure anyway, that those have moved to Q4 and that's why we've actually bumped the outlook up from the 37.7 to the 42 to 43 level range.

So--.

--So a couple of million dollars in the R&D line from the NREs.

At least.

And I assume that the G&A, which was surprisingly low in the quarter, snaps back as well?

It probably snaps back a little bit.

We had in the prior quarter some consulting things that we were working on and things like that that were a one-time pop that came back out.

So there'll be some other things floating around in there.

So it will come up probably not exactly where it was, but it will come up in the quarter.

Okay, one last question and then I'll cede the floor.

Can you talk a little bit about the grooming functionality in your products?

You're talking about four streams of grooming capability in the 10-gig product.

But I would think as you get to a 40-gig product that you would need to significantly increase the number of streams that you're able to groom at, and particularly as we get towards the edge of the network.

Again, you referenced four streams of grooming at the edge, which seems awfully coarse for edge applications.

Can you talk a little bit about how we should reconcile those?

Yes, that was just an example.

I mean, obviously, we can--that system is designed to take in gig [eze] and so on, in addition to OC-48s.

So clearly, that was only an example.

But you're absolutely right.

The edge is going to have a finer granularity of grooming as a requirement.

The point I was making simply was that you don't get any grooming at all if you use a third party box there.

The ATN is what allows you to get that--to get the grooming capability.

And obviously, over time as we continue to add functionality we just need to add more and more capabilities on the [block] line including more interface types and more [line rate] types and so on.

Yes, but the grooming on the PIC is still four streams, correct?

The grooming on the PIC is--well, the grooming on the DTN is at the 2.5-gig level.

That's correct.

It's not a PIC dependency.

It's the switch fabric on the DTN itself.

So when you go to 40-gig, it would still be 2.5 and therefore you'd have more streams of grooming?

Well, we haven't announced the details of the grooming on the 40-gig product.

We've announced the 40-gig PIC and we've talked about the timelines and when we think will be to market.

But we haven't talked about the system around that.

You can assume the system that goes around the PIC will also be obviously a next generation system, so it will have more functionality than the DTN has today.

Thank you.

You're welcome.

Our next question is from Mark Sue with RBC.

Go ahead, your line is open.

Hi.

This is Jay Longabardion for Mark Sue.

I was just hoping that you could reiterate the timeline as to when you'll be bringing that 40-gig to market and also potentially comment on the pricing pressure you're seeing on the 10-gig.

Yes.

On the 40-gig, we can really--what we said at the--during the quarter in our 8-K.

Basically, the--what we said is that we're on track to provide the 40-gig PIC to our internal developers this year as we promised over a year ago.

And secondly, we also indicated that for our previous generation system, for the 10-gig system, it took roughly between a year and two years to get a PIC based system to the market after we got PICs to developers.

So using that math, you can kind of extrapolate and say, okay, if the lead time between PIC and system were the same as it was in the 10-gig case, that gives you an idea of when you think we might have systems in the marketplace for 40-gig.

Okay, thank you.

You're welcome.

And once again, just on the pricing pressure on the 10-gig.

Are you experiencing--can you comment on the--.

--Again, I think we haven't seen any dramatic change in the pricing environment.

We obviously--individual deals tend to be more or less price competitive depending on the customer dynamic.

And the only consistent theme is that the com equipment tends to be under more price pressure typically than the transponders do, and that of course is built into our whole business model where we just expect lower margins on the first in commons and much higher margins on the TAMs and the transponder equivalent.

So--but overall, I wouldn't say there's been any meaningful change or any dramatic change in the pricing environment that we're aware of.

Okay, thank you.

You're welcome.

And our next--(Operator Instructions.) And our next question is from Blair King with Avondale Partners.

Go ahead, your line is open.

Yes.

Hi.

Thanks.

Just a couple of questions.

The first one would be just if you could with the--there was a--if I recall correctly anyhow, a 150 basis point or so discount that was expected to flow through in the third quarter.

And I'm just curious if that actually did happen.

And then, a follow-up to that.

Are you talking about one time related discounts?

Yes.

I think there was a discount, if I recall correctly, given to a customer in the first quarter that was to flow through the second and third quarter, some of which was taken last quarter, and then there was a balance coming into this quarter.

Is that correct?

That might have been when we were talking about Q1 and Q2 impacts.

I mean, at any point in time we've got various discounts flowing through the P&L.

And previously what we were talking about is that things got flushed through in Q1 and Q2 quicker than we thought.

Right.

But I don't--I can't remember referencing anything specifically for Q3.

We do have the one--the large deployments, which are lower margin com equipment that we've referenced several times, that continue to impact the margins to some degree.

Okay.

So then, maybe just the follow-up there, Duston, would be if you look at the gross margin guide, it looks like at the mid point anyway it's up about 2.5% [unrelatively] flat TAM shipments.

Is there any way you can kind of tell us or give us some color as to what's going on there and what we might be able to extrapolate out of that into 2010?

Yes, sure.

As these deployments kind of flush through the P&L, the larger ones, we would expect margins to increase along with the TAM shipments.

We still are not at the levels that we were back in 2007 and the beginning of 2008.

So clearly, we would expect at some point those TAM shipments to resume in 2010, which has pretty good leverage on the margin.

Okay.

All right.

So then, one other--a couple of other quick ones.

And if--on the top line.

I think last quarter there was some conversation around inventory acceptance and revenue flowing into the third quarter that just didn't happen in the second quarter.

Can you give us an idea of what portion of that inventory accounted for the third quarter revenue?

We don't give that level of detail, but you're right.

At any given quarter we have stuff that we've shipped waiting for customer acceptance.

Just like this--end of this--end of Q3, we had a reasonable amount of inventory that we've shipped that's awaiting customer acceptance.

So we have that every quarter.

Some quarters are bigger, some are smaller.

But anything that was at the end of Q2 has been flushed in Q3.

Anything here at the end of Q3 will be flushed in Q4.

Okay.

And then, just lastly, on the geographic distribution, you may have mentioned this.

But did you give a breakdown on sales between the U.S., Asia, and Europe?

We didn't provide that level of detail.

Europe was a fairly big piece.

Asia, specifically, was not a big percentage this quarter.

Okay.

Yes.

Appreciate it.

Thanks.

Okay.

And our next question is from Michael Genovese with Soleil.

Go ahead, your line is open.

Great, thanks.

Thought I'd get back on.

Just a couple follow-ups here.

When I talk to carriers, especially about metro regional applications, but increasingly I think in the long haul, it's a small market today of packet optical transport.

But it seems more important and more what carriers want going forward in terms of optical gear having layer two connection oriented switching and aggregation capabilities.

And as they kind of--I consider you guys to be sort of a pure play DWDM company.

Do you have a roadmap to address packet optical and layer on some of these technologies, such as VLAN switching, T-MPLS, and MPLS-TP, things like that?

Is that something you're looking at?

And do you agree with me that the market might be headed in that direction?

Mike, this is Jagdeep.

Yes, we've--so quickly, yes, we completely agree to that.

That's very much a direction that the market is likely to head down.

And we've said for a while that the whole premise behind our product is by lowering the cost of the OEO conversion we can--with the PICs, we can take the signal from the optical photonic domain into the electrical domain.

And once you're in the electrical domain, you can see the bits, you can start applying all of the processing power that is available in silicon.

And that includes not only things like low level techniques like silicon processing, coding, modulation, equalization, to improve the quality of the signal transmission, but it absolutely includes things like bandwidth management, whether it's done at the TDM level like we have today, so you can switch at the sonnet and OTN levels, but also includes packet functionality.

The key point that we've made in the past is that if packet optical becomes a reality in the optical transport network, then we believe no company is better positioned that Infinera because we have a low cost means of going from the optical domain into the actual domain, which is mandatory before you can even process packets at all.

So, yes, we very much think that's a real possibility for the future of the network and we think that that would be actually a good direction for the industry going (inaudible) of Infinera's strengths.

Okay, great.

And I want to ask you about the statement you made about another internet content provider and the eight-figure opportunity.

A couple of things I want to parse there.

First of all, when you say another, I guess, if you could just remind me, you have announced--have you actually announced the names of any internet content providers?

Because I guess if you have another would mean a different one than the ones you've been talking about.

And then, secondly, when you say opportunity, how certain of an opportunity is that, that that will actually lead to that kind of magnitude of actual purchase orders from the customer.

Yes.

So on that latter part, just to clarify, when we said opportunity we actually meant win.

So that's a done deal.

It's not a hope.

It's a win that we already have.

And to your first question, yes, we have not announced sort of other major plans in that category.

But we have said that we have some of the top names in the internet content space as customers today.

And the key point I was making on that comment was that we have now won another, i.e., in addition to the ones we have, another major name in the internet content space.

And we want to just quantify that by saying it's a bigger deal to make clear that it's a significant customer and a significant win.

But we're obviously not at liberty to disclose the name of the customer at this point.

Over time, if the customer is comfortable and we're comfortable we might do that.

But at this point, we're simply saying that it's another major win meaning it's a new internet content provider that was not a customer before and now is, and it's a sizeable win.

Finally, very quick, Jagdeep, can you just remind us when the CEO changeover happens?

December 31 will be my last day on the job, and Tom Fallon will take over on January 1.

Thanks.

And actually, that's a good note to end the call on.

I just want to thank you all for joining us today.

We remain focused on being the best provider of optical transport networks.

And our new win momentum and financial results continue to provide evidence that our disruptive solutions are resonating with customers and prospects as the industry's best, most cost effective solution.

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

Thank you.