Infinera Corp (INFN) 2010 Q3 法說會逐字稿

Good afternoon.

Welcome to the third-quarter fiscal 2010 investment community conference call of Infinera Corporation.

All lines will be on a listen-only mode until the question-and-answer session.

(Operator Instructions).

Today's call is being recorded.

If anyone has any objections, you may disconnect at this time.

I would now like to turn the call over to Mr.

Bob Blair of Infinera Investor Relations.

Sir, you may begin.

Good afternoon.

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 addressed the financial condition, results of operations, business initiatives, views on our markets and customers, our products, and our competitors products, and prospects of the Company including Q4 2010 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 March 1, 2010 for more information on these risks and uncertainties.

Today's press release is including Q3 2010 results and associated financial tables.

An investment information summary will be available today on the investor section of Infinera's website.

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 includes certain non-GAAP financial measures.

In our earnings press release, we announce operating results for the third quarter of 2010 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 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 will also give guidance including guidance for the fourth quarter of 2010.

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 our future stock-based compensation expenses.

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

Thanks, Bob.

Good afternoon and thanks for joining us.

With me is our CFO Ita Brennan.

Our financial results for the third quarter of fiscal 2010 were outstanding, representing the strongest validation yet of our long-term business model.

We posted records in revenue, corporate gross margin and shipments of our tributary adapter modules.

In addition, the combination of stronger revenue, higher profit margins and ongoing operating expense control resulted in significant income leverage with an operating income contribution $18.5 million for the quarter.

This compares to operating income of $3 million for Q2.

At the beginning of the year, we stated we would focus on profitability and I believe these numbers speak clearly to the results of that effort.

Specifically, our gross margin achievement of 51% in Q3 is a powerful proof point of the long-term business model and representative of where we believe we can take the business consistently over the long term.

While our financial results for the third quarter were exceptional, our bookings during the quarter were below our expectations.

We believe this is related to a number of factors -- a return to more typical, shorter lead times in North America, the completion of some customers' recent capacity additions, renewed economic uncertainty affecting some of our customers buying behavior and the inherent lumpiness of the DWDM industry.

Overall, this gives us less visibility than we have had in recent quarters.

We continue to have strong market share both domestically and internationally which we believe is the ultimate litmus test of customers' continued confidence in our product roadmap.

However, we think it's reasonable to expect our growth trajectory will moderate from time to time to accommodate periods of network absorption and our fourth quarter appears to be one of those periods.

It is important to note that we are seeing strength in the overall pipeline of deals in our major geographies as demand for capacity continues its inevitable growth.

We are competing for these significant pieces of business but the outcomes and timing are hard to predict at this time.

Our market share of success demonstrates customers' continued confidence in our unique and differentiated PIC-based networks and our expanded product roadmap that provides end-to-end solutions.

We believe that carriers continue to invest in our networks because we consistently deliver on our proven value proposition of superior economics, quality, reliability and network utilization.

More than six years after our introduction of the industry's first PIC-based digital optical network, not one of our numerous DWDM competitors has accomplished the feat of bringing to market a network based on the intelligence of a digital optical architecture.

We think that optics and bandwidth management are the core of the optical network and that optical integration is critical to achieving the all-important scaling and lowest total cost of ownership for our customers' transport networks.

This approach is what makes Infinera foundationally different than other DWDM players.

Our value proposition has lead us to an expansion of the number of our DWDM market share position on a revenue bases in North America to 39% versus 20% a year ago and our worldwide share to 15% up from 10% a year ago based on data from Dell'Oro for the first half of this calendar year.

We are confident based on our Q3 performance that we will continue to have strong market share.

Considering that we do not yet participate in most North America Tier 1 opportunities, this is a remarkable accomplishment and validation of our unique value proposition in the marketplace.

We believe our share numbers demonstrate continued strength in 10G network deployments and the confidence our customers have in their systems compatibility with our 40G cheek and 100G solutions that we have committed to ship in mid-2011 and in 2012 respectively.

Our customer base grew with the addition of two new invoice customers in the third quarter and we believe we are on track to reach at least 80 customers by the end of the year.

Earlier today you may have seen that we announced that Midcontinent Communications, one of the nation's largest independent cable providers, has deployed an Infinera network in the Dakotas and Minnesota.

We continue to enjoy strong support from our cable customers who find our PIC-based solutions provide the simplicity and scalability to meet the rapidly growing Internet and IP video demand they see.

Adding new customers remains an important objective.

At the same time, expanding business with our now sizable roster of existing customers through the sale of new solutions and expansion into untapped territories is of equal importance.

On that note, I'm very pleased to report today that Infinera gear has recently been certified by Qwest Communications for use in their regulated business and we have been deployed in select Qwest local markets.

This is in addition to our existing national deployments request.

I'm also pleased to report that we added six new customers for our ATN Metro product in Q3, bringing the total number of ATN customers to 15.

Nearly 20% of our customers now deploy the ATN, an encouraging sign that network operators find value in the simplicity and efficiency of an integrated VPN plus ATN network solution.

Longer term, we continue to have significant untapped growth opportunities to expand the Infinera footprint both in underpenetrated geographies such as Europe, South America and Japan and newer product areas such as subsea and metro edge.

Our investments will continue to be targeted at expanding our presence in these markets and in strengthening our competitive and differentiated technology leadership position in our core DWDM market.

On that front, our ongoing product development investments have yielded some important investments advances during the quarter.

In September, we were pleased to demonstrate our 100G coherent PIC technology over a 1300 km route from Denver to Dallas with our long-time customer, XO Communications.

You may recall that in July.

we told you that we had successfully [taped out] our coherent 5 x 100G receiver PIC.

The XO demonstration was significant because it was the first demonstration to include this newly fabricated receiver PIC plus our existing 5 x 100G transmitter PIC.

Another key aspect of this trial was that it was accomplished over an existing Infinera line system, the same line system that we had been selling to our customers, thereby demonstrating that the investment our customers make with us today is preserved when they move to future transmission speeds.

Finally, the demonstration highlighted another key advantage of our product, namely our system's ability to successfully run 100G and 10G waves simultaneously over the same infrastructure.

The response from the customer base of this trial was extremely positive with several customers requesting similar trials.

Also in September, in partnership with our European customer, Colt, we completed a successful trial of 100 Gb ethernet services which ran over Colt's existing London to Frankfurt Infinera network.

This is the latest of several such trials we have conducted and it demonstrate not only that Infinera is leading a leader in this technology, but also that 100 Gb ethernet services can be delivered over today's Infinera products.

Earlier this month, we also announced the launch of our digital OTN solution made possible by new releases of hardware and software on both our DTN and ATN platforms.

Network operators are excited about OTN because it improves their network efficiency and manageability.

We believe Infinera's new offerings represent the most complete OTN implementation in the industry, combining OTN service interfaces, switching and transmission while operating seamlessly across both metro and long haul.

The new digital OTN products are in customers' hands today and will become generally available by the end of the month.

We remain bullish about the long-term growth potential of our served markets and about our ability to grow faster over time in the overall market.

The ever expanding scaling requirements and the needs of our carrier customers to support the growth of high-bandwidth services we believe will result in strong industry demand over the next several years.

This coupled with our unique technology advantage, expanding and deepening customer relationships and a broadening of our solutions offerings builds the foundation for us to consistently achieve our long-term business model.

In closing, I want to thank the Infinera team and our supply partners in helping us to achieve a Q3 performance to be proud of.

I also want to acknowledge our customers who are the primary reason for our success.

On a separate note, I want to acknowledge and thank Jagdeep Singh, one of our founders, for his tremendous contributions to the Company.

As indicated in an 8-K filing today, Jagdeep has stepped down from our Board of Directors to devote his time and energies to the pursuit of his next ventures.

He started the Company along with Dave Welch and Drew Perkins almost 10 years ago, built a world-class team, took Infinera public, lead us through the economic downturn and successfully transitioned the Company to this management team.

Ita will now provide you a report on our Q3 financial performance and our outlook for the December quarter.

Thanks, Tom.

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

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

All references exclude non-cash stock-based compensation and any restructuring costs.

Total GAAP revenues in Q3 were at record levels for the third consecutive quarter and $130.1 million compared to our guidance of 125 to $128 million and revenues of $111.4 million in Q2.

We had two 10% or greater customers in Q3 including Level 3 at 19% of revenue and Global Crossing.

Although we had expected an increase in revenues from Level 3 in the quarter, their contribution was significantly higher than we had expected and included a large number of higher margin TAMs.

This upside was somewhat tempered by lower than expected bookings in the month of September.

International revenues amounted to $35.7 million or 27% of total revenues for the quarter.

EMEA accounted for $20.3 million or 16% of this amount with the balance coming from the other Americas and Apac.

Our services revenue for the quarter increased to $13.5 million versus $11.7 million in Q2.

Services margins improved slightly to 54.2% compared to 53.1% last quarter but remained below historical levels due to a higher mix of installation and deployment services.

Overall gross margins in Q3 were 51% versus 44% in Q2.

This compares to our guidance of 45 to 47%.

As mentioned above, we experienced strong demand for TAMs from Level 3 in the quarter, the total TAM shipments in excess of 3000 units.

This increase in TAM mix had a favorable impact of approximately 3.5% on overall gross margins for the quarter.

In addition, we [required] a lower than expected common equipment sales and this combined with favorable impacts from increased volume and cost improvements contributed to the remainder of the gross margin improvement experienced in the quarter.

We had added two new customers in the quarter for a total customer roster of 77 and expect to add at least three new customers in Q4.

One of the new customers added in Q3 was a new ATN-only customer.

In addition, we completed five new ATN deployments with existing customers, bringing our total ATN customer count to 15.

We continued our focus on expenses.

Operating expenses for the quarter were $48.1 million versus our guidance of $49 million to $50 million and versus $46.3 million in Q2.

The better-than-expected performance was partly attributable to the timing of certain non-recurring engineering expenses or NRE and prototype charges and from lower than expected SG&A expenses.

We expect 1 million of the NRE charges to roll into the fourth quarter.

Overall headcount for the quarter was 1040 versus 1028 in Q2.

Most of the headcount additions occurred in R&D with a few targeted additions in sales and marketing.

Operating income for Q3 was $18.5 million.

Other income and expense for Q3 was a favorable $0.5 million.

Net income for the quarter was $18.7 million resulting in earnings per diluted share of $0.18 versus our guidance which calls for earnings of $0.07 to $0.10 per share and versus earnings of $3 million in Q2.

Now turning to the balance sheet.

Cash, cash equivalents and restricted cash and investments ended the quarter at $288.1 million versus $279.6 million in Q2.

We generated $10 million of cash from operations in Q3 versus $11.2 million in Q2.

DSOs were at 45 days, same as in Q2.

Inventory turns were 2.9 versus 3 in Q2.

This mainly reflects the ongoing impact of holding increased levels of inventory to protect against constraints in the supply chain.

We expect to begin reducing inventory levels in the fourth quarter.

Accounts payable days were 52 days, up from 42 in Q2.

Capital expenditures were $5.9 million in Q3 versus $5 million in Q2.

Now turning to our Q4 outlook.

We are entering Q4 with less visibility than in recent quarters.

Backlog levels exiting Q3 were similar to where we were at the beginning of the year with bookings in September having slowed versus recent run rates.

We've included the impact of the three new customer wins in our revenue guidance.

However, this growth is offset by the fact that many of our existing customers have already completed significant network buildouts earlier this year and are not likely to drive incremental revenue in the December quarter.

While our sales pipeline of new deals remains strong, the outcome and timing for closure of these deals is not clear and would most likely not impact the fourth quarter.

In addition, we expect Level 3's contribution to both revenue and to margin from their TAM shipments to be lower than we experienced in Q3.

Although Q4 is normally a quarter where we might expect to benefit from some end of quarter budget flush, these amounts are typically unforecasted and any potential impact has therefore not been included in our Q4 guidance.

The combination of all these factors calls for revenue guidance just below our record Q3 10 performance which represents continued growth off of our Q2 and prior quarter numbers.

At this point, our gross margin outlook assumes TAM shipment of approximately 2400 units, in line with our previous discussion on the Q2 earnings call.

Common equipment sales will increase from Q3 levels with the completion of our new customer deployments.

Our previous guidance and operating expenses indicated that all things being equal, we would exit 2010 at an operating expense run rate in the mid-40 million range per quarter.

A number of items have occurred since we provided that guidance that impact the Q4 run rate as follows.

Our sales commissions run rate has increased by approximately $2 million per quarter due to revenue outperformance on a year-to-date basis.

In addition, we will continue to add targeted sales headcount in support of future revenue expansion.

Our R&D run rate will be approximately $28 million reflecting the inclusion of $0.5 million to $1 million of OSMINE certification expenses needed to support future deployments at Qwest and $1 million of unspent NRE expenses rolling from Q3.

The following guidance for Q4 is based on non-GAAP results and excludes any non-cash stock-based compensation expenses.

Revenues of approximately 115 to 120, gross margins of approximately 45 to 47%, operating expenses of approximately $50 million to $51 million, operating and net income of approximately $2 million to $5 million.

Based on estimated average weighted diluted shares outstanding of 108 million, this would lead to EPS of approximately $0.02 to $0.05 per share.

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

Thank you.

(Operator Instructions) Kevin Dennean, Citigroup.

Great, thanks very much.

Obviously, congratulations on a great quarter.

You've talked a little bit about your visibility being weaker during the month of September.

I'm wondering, can you give us a sense -- and maybe, Tom, this question is best for you.

Can you give us a sense, Tom, for where you think we are in the optical cycle?

I mean, your longer-term enthusiasm clearly comes through in your comments.

But you know, these numbers are pretty I think disconcerting in terms of the sequential downtick and I think will call into question a lot of doubt about the sustainability of the cycle into 2011.

So if you could just give us some thoughts there?

Kevin, I will.

I think it's a little bit in my mind a mixed perspective.

I do believe that [when I talk to] customers, the consistent message of increasing Internet demand, increasing need for more services, increasing need for bandwidth continues to be very consistent and I think that that is part of what I would hope and believe is a longer-term build cycle for Internet capacity.

And those cycles typically last two to five years.

I mix that with what some of the customers talk about is a little bit of uncertainty particularly around -- in Europe about the stability of the euro or the pound in North America around just making sure the demand they're seeing continues at a robust pace.

And I think that it's important for me and us here to remind ourselves that quarter to quarter dynamics are very difficult to manage in this business.

But if you look at year over year, I'm much more comfortable believing that the cycle of 4G, video everywhere, handheld devices that are driving business applications, videos that are being downloaded to cell phones, YouTube in high def, all of these things are going to continue to fundamentally alter the landscape toward more bandwidth.

I don't see anybody talking about that dynamic changing and I don't see anybody talking about they believe their networks are prepared to deal with this increased demand requirement.

Balance that with I think short term making sure that they don't spend money ahead of when they comfortably feel they can deploy that demand and start earning revenue from it, they write, I am optimistic upon the horizon.

I think we have to make sure we don't make long-term decisions based upon short-term lumpiness and lumpiness I think is often used to describe negative quarters.

I think sometimes it could also be used to describe positive quarters and I think that's what our Q3 looked like.

Ita pointed out in her section, I think if you look at our Q2 to Q4 results, I'd be pretty happy with -- reasonably if you linearize that versus seeing the lumpiness.

With the industry growing ballpark some people say 8% or so this year, 8 to 10% maybe next year, our goal is to continue to grow faster than the market and I think there's no reason I don't believe we can do that.

I think there is every reason we can do that.

Then just a follow-up.

You talk about kind of upside lumpiness.

So if I recall correctly, your September guidance called for 12 to 15% revenue growth.

Looks to me like you did about 17%.

Level 3 clearly outperformed your expectations on TAMs.

Which to me implies that something kind of underperformed.

Can you talk about -- you talked about Level 3, you talked about Europe.

But can you talk a little bit more about what you're seeing in the customer base both in terms of geographies and customer type?

Because it seems to me that there had to be some negative surprises in the quarter too.

I will start, and then Ita -- I'll ask Ita to finish up.

Clearly we had a very, very strong Q3.

July started off quite well.

August is typically a not great month, a lot of vacations booked internally and externally.

But it didn't not meet our expectations.

It was as we had typically seen and the difference this year was we did not see September come back as we have historically seen it in the quarters and it did not happen to our expectations.

Particularly Europe was below our expectation.

In Apac, it's a very, very small portion of our business today.

So it really -- I can't say it underperformed or performed better than not.

It's just a small portion.

In North America we had a good business from a lot of people who we see repeat business from, but they had done substantial buildouts in Q1 and Q2.

We didn't have as you saw any top 10% customers from content providers or cable this time.

They all bought from us but none of them were buying these massive network rollouts that they did in the first half of the year.

And I think there is an absorption period as people spend money, as they build networks.

As they start then consuming that network with bandwidth, there's going to be some cycle time in between when they go to the next build.

And I do believe we are seeing a degree of that.

So that's where I would comment on.

Ita, anything you want to add to that?

Yes, I mean the only other thing I would add is our visibility has probably decreased somewhat as well just because the supply chain issues that we saw earlier in the year have been resolved and we're not seeing customers needing to give us visibility to growth and kind of normal repeat business.

So the first couple of weeks of October have been healthy, reasonable bookings but we don't see beyond that.

So we'll have to see how that plays out here over the quarter.

Great.

Thanks.

Alex Henderson, Miller Tabak.

I was wondering if you could give us some thoughts on the competitive environment and particularly if there's been any change in pricing or any change in competitive activity that would alter the balance of your business.

This is Tom.

This is always a competitive business.

It always will be.

There are too many people that participate in this industry.

We certainly haven't seen what I would consider to be anything that is brand new that's really changing how we think about things.

In North America, we are not seeing as we've always been concerned about Huawei, we're not seeing them being a significant dynamic right now.

Though I think that will probably change.

I will say to (inaudible) their integration seems to be going okay.

They are not changing I don't think and becoming more competitive, but it's also not reaping a lot of opportunities for us to take advantage of missed execution.

And I think that Alcatel continues to execute too.

So I think there's a lot of people that are executing.

I still think that the biggest advantage anybody has typically in this industry is the incumbency.

I think we're very, very well regarded by our customer base.

That's why we continue to not lose customers and take advantage of opportunities to grow.

So I don't see a fundamental change in the competitive environment today.

So no real change in pricing as a result of competition?

There's always pricing pressure, there's an expectoration in the industry that pricing goes down every year.

We understand that and we want to make sure our customers remain competitive and we're trying not to give them lots of reasons to go look for alternatives.

But I don't think there's been any step function in pricing that really would alter the dynamics.

There's also quite a bit of buzz around 100 Gb coming sooner than initially thought, that some of the service provider seem to be pulling that forward and some of the Tier 1's in particular may be slowing down some spending on the 10 Gb in anticipation of that.

Can you talk to whether you are seeing a pull forward of the timeline from people wanting to deploy 100?

I certainly think 100 Gb is going to have pressure to ramp it up, but it's still a brand-new technology.

It's just being introduced in the market today in very small quantities.

I do think that it will start being rolled out more significantly, but in still fairly small units in 2011.

And I think in 2012 and 2013, there's going to be significant absorption of 100 Gb.

We continue to believe that it will replace 40 Gb as rapidly as the market will allow it to because 40 gig is not going to cost in except where you have true fiber exhaust.

I think there's more and more belief of that too.

I don't -- I think that the Tier 1 perspective of replacing 100 gig for 10 gig, we don't sell really a lot to the Tier 1's, so I can't really comment knowledgeably on that.

Within our customer base, we continued to tell them where we are with our 100 gig platform and they are -- continued to be anxious for us to make sure we hit those dates, though I'm not aware of any customers who have laid out that that would cause us to lose opportunity potentially with them.

There is some increased pressure on 40 gig for certain spaces in the market, in particular submarine.

As you know, we're bringing 40 gig to market, we said mid next year.

There's pressure on that date and I do think that 40 gig in submarine is going to be very important next year.

And then the continued pushout of the R&D expense that you were anticipating around protos and the like, is that a reflection of any slippage in timing of developing the product or how should we think about the reasoning for that?

I wouldn't think that at all.

In fact, that million dollars was probably spent in the first two weeks of October.

So it was really just the team weren't ready to accept some prototypes as final, but they were actually completed early in October.

Just as a comment too, I'm very happy with our continued progress on our 100G technology and platform.

It's making great progress.

All right, thank you.

George Notter, Jefferies & Co.

I'm hoping you can take me back in time and give us some sense for what's happened with leadtimes here.

I mean, you mentioned that changing leadtimes is the source of the change in visibility in your business.

I guess I'm a little bit confused because I know for example on the TAM side, you have (inaudible) TAM program where you tend to shift TAM modules in 10 days or less.

I haven't really kept track of where we are in terms of the DRN or ATN leadtimes.

I heard have heard ATN leadtimes are stretched.

But I mean, the sense is this is part of the larger story here.

Can you walk us through what happened to leadtimes and where they are now?

Thanks.

George, thanks.

Let me try to provide a little clarity.

Probably a more accurate depiction of this is our weaker than expected September bookings has led to less backlog and therefore shorter leadtimes and therefore we don't have as much visibility.

Leadtimes started out -- we have typically said as a Company, we want to be able to sell and ship DTNs in approximately four weeks, ATNs approximately two weeks, Just-in-TAMs about 10 days.

Our customers are used to that.

We believe time is a weapon.

At the beginning, end part of Q2 and early Q3, I would say our DTN leadtimes were probably seven to eight weeks, so almost double what they had historically run and what our customers are used to.

Our Just-in-TAM continued to be at 10 days, though we were not hitting our service levels with a high enough frequency.

Usually we're about 100% on time to that and we were probably 90% on time to that during the end of Q2 and Q3 as we were really pressed to respond to unforecasted demand.

And ATN leadtimes were also extended mostly because the XFP mix that had very, very long leadtimes.

We've now brought those leadtimes back down partly because obviously we're building inventory to respond to it, but also because of the lighter than expected bookings in September where our DTNs are probably like Ita said, our backlog is similar to what it was at the end of last year, so our leadtimes I would say are now at a typical level.

Does that answer your question?

Yes, that was very helpful.

Thanks very much.

Ehud Gelblum, Morgan Stanley.

Thanks, appreciate it.

A couple questions.

Ita, you mentioned that the TAM upside added 350 bips of gross margin.

Is that versus what?

I guess, is that versus what a normal mix would have been or versus what you were going to do because you actually guided TAMs up?

We know that your 600 extra TAMs were 2400 to 3000.

So I'm just trying to figure out, is that the move from 2400 to 3000 or the move from wherever you thought it was which was maybe 2700 to 3000?

That's the move from 2400 to the -- in excess of 3000 that we actually saw in the quarter.

Okay, where did you expect them to be?

Because you did say they were going to be up.

Well, we guided to 2400.

That was kind of our feel for where it would be when we gave guidance at the beginning of the quarter and we're benchmarking against that, comparing the 3000 (inaudible) to get to the 3.5% gross margin impact.

Okay, so the guidance of 45 to 47 which you beat by -- let's just say you beat by 500 basis points, 600 extra TAMs and the -- was the extra 3.5 basis points.

Yes.

And then should we assume that the lack of chassis was the difference between call it a 46% gross margin and that 47.5%?

Yes, I mean, if you say the commons and stuff probably accounted for another maybe 1.5 points or so and the rest is just volume and flow-through on fixed costs and stuff because they had a higher volume in the quarter.

Okay, so as we look at next quarter, how do we look at the puts and takes?

If revenue ends up being at the lower end of your range, 115 or a little below, should we be looking at gross margin on the lower end as well?

If it ends up being 120 or above, should we look at being in a 47% plus range without the visibility (multiple speakers)

It's all going to depend on the mix, right?

I think right now, what we're assuming is a 2400 TAM mix gets you to that kind of 45 to 47% with a reasonable common mix based on the new deployments that we talked about on the call.

That kind of gets you to the 45 to 47.

I'm not really kind of willing to peg it to anywhere kind of at the ends of those ranges for now.

So if I compare it to Q2, I think you did 2400 TAMs then as well with only $111 million in revenue and a gross margin that was basically right there.

Your gross margin was 44% and a little below it.

So what all I'm trying to just understand is it seems to get from the 111 you did in Q2 to someplace in your new guidance range of 117, 118, 119, let's say.

The difference if you have the same number of TAMs has to be more common equipment, yet you have a higher gross margin.

So that's versus the Q2 number.

I am just trying to correlate why Q2 was lower than this and why we couldn't -- I mean, could we possibly end up as a -- back to the 44% in Q2 or below if the difference in revenue is extra common equipment.

I think [you could pick] trying to get from the 44% from last quarter, we did see some costs pick up etc.

in the quarter as well kind of in that -- in the gap, if you like, of getting us to the 51%.

So there was certainly a point or so of cost improvements etc.

that we realized in the quarter that will carry on to next quarter.

And the rest of it is really all about assumptions around the TAMs and the common mix which right now we're saying -- I'm pegging at 2400 TAMs and our normal common mix.

That will put us somewhere in that range.

But it's not an exact science.

There's a lot of moving pieces.

So that's kind of where we would peg it right now.

Okay, so if we go back to -- again, I don't mean to beat a dead horse, but I'm trying to get a handle on what I need to do in my gross margins when I assume [certain things in] revenue.

But if we have a repeat of Q2 which was $111 million revenue and the same 2400 TAMs that you're thinking of, do you think your gross margin would be higher than the 44% you did in Q2 because of other things that have (multiple speakers)

(multiple speakers) around the gross margins if that were the case.

That's actually very helpful.

If I could dig a little bit further into Qwest, what is the timing of -- clearly you need to get through OSMINE but should we be looking at this as being a mid-next-year revenue event or is it only 2012?

What I said was that it's been certified for their local regions which is the OSMINE controlled area and that deployments began last quarter and that we have ongoing OSMINE expenses now based upon being certified in a regulated portion of the business and I'm afraid that's really all I'm authorized to talk about in regard to that specific customer.

I'm sorry, I must have missed that earlier.

Is there an impact from this on gross margins as well from getting into Qwest, being that it's not exactly a new customer?

You did have prior business there but not in this part of the business because that came from OnFiber originally.

This is sort of a new win.

You've got a good memory.

I try.

They have been a partner of ours now since they acquired OnFiber and we've extended the OnFiber relationship [in there out of region] and we have a fairly consistent level of business.

This was a new wind within that relationship.

Ita, can you comment on the margin impact?

Yes, I mean, we obviously had some deployments with them in Q3.

We're not really kind of in a position to talk further about kind of what we will do with them in the future, when we will see that flow.

That's actually specifically kind of limited, what they would like us to talk about on the call.

Okay, the last thing I just wanted to ask about was I saw deferred revenues came down this quarter fairly substantially.

Can you comment on that?

Did it have -- was that Level 3 stuff that was sitting there and came off?

Did it have something to do with ratable?

Just trying to understand.

Yes, I mean, the majority of it is related to just normal kind of -- we bill a lot of our services in the fourth quarter annually for annual billing.

So you will see kind of deferred services from services and stuff grow again at the end of Q4 and then it bleeds off, kind of will step down.

So Q3 is the lowest that that gets.

But we did also have I would say maybe $3 million to $4 million of deferred revenue that we recognized which is kind of a once-off.

We had a future deliverable that we completed in Q3 that we recognized in the quarter.

So that's sort of akin to saying that your net bookings were -- and your order backlog is down as that deferred revenue came off.

Yes, I mean, that contributed to the revenue number in Q3.

That's what you mean, right?

I'll stop there, I appreciate the time.

Thanks.

Michael Genovese, Soleil Securities.

From your experience in September and what you saw with the customers, at this point, would you say it's limited -- what you saw, would it be limited to just your comments just to Infinera and your customer base or is there -- do you have any reason to believe that there's something bigger going on in the industry or your competitor -- is there any reason that you would believe that your competitors would have seen some of the same trends and lower visibility coming out of September into October?

It's a good question and we try to think through that.

We thought that customers who have said they're worried about in Europe the pound and the euro, I have a hard time believing that's just an Infinera dynamic.

I don't know that for a fact.

We've seen other competitors of ours talk about potential weakness in Tier 1's.

We don't see a lot of that activity, so we try to correlate that to what we're seeing.

I don't think that we represent or what we sell represents any kind of differential from an opportunity or a risk perspective than the industry in general and the only one caveat I will say is that with -- we have 77 customers, so if a large number of them as in our case deployed very large networks in the early part of the year, we're going to be more prone to those specific customers digesting that capacity than other people.

So they might have the same type of challenge with their customer base, but most of them -- the larger competitors certainly had a much larger installed base, so it will have less influence on any specific quarter would be my speculation.

Right, now some of these customers in the MSO segment and wholesale segment have been customers of yours for years.

I believe you probably have seen cycles like this before, these absorption cycles.

Do you have any kind of way to think about how long absorption can take, how many quarters of process of absorption of a customer who put a lot of chassis in the field in the first quarter for example, when would you expect some of these customers to come back and become significant chassis customers again?

I think it's based on two things.

One is customer demand.

So in the early part of the year when customer demand was -- I think I talked about this last time, our customers were seeing demand significantly greater than they had planned and they were expediting orders from us that were unplanned on our side.

So the whole industry was surprised a little bit by the robust level of very short-term demand.

So I think capital frees up when they're running the risk of being threatened by losing business.

I think the other time it frees up is when you get new budget cycles, typically at the beginning of the year.

So if one of the reasons we say our visibility is less is we can't sense that whether there is this unprecedented demand has been unforecasted by the industry, it appears that that unforecasted period is a little bit behind us.

So I would be surprised if the lull lasted more than six months.

As long as the Internet demand continues to grow at about 50% per year, there's no reason to believe that any type of lull would be more than one quarter or two sans some macroeconomic challenge.

Great and I think you addressed this question a little bit earlier but just if I could just get to it more directly.

Do you expect that when -- did you expect that there could be a negative impact that when some of this customer demand for new network buildout comes back that your customers will want -- that some of your customers will want a native 40G solution which could then impact your business six to nine months from now to a certain extent?

Or do you think that your roadmap of 10G going to 100G is going to keep you with the same market share in the customer base that you currently have?

We are very clear to our customers that we are coming out with a 40G solution middle of next year.

They're very aware of that.

They are -- we work with them very intimately on both our 40G and 100G roadmaps.

They understand where we have promised the products to them.

Will it satisfy 100% of the customers?

I can't say that without question but we believe what we know about their network rollouts today, we are on track to satisfy what they're looking for.

I still believe that most demand will go to 100G versus 40G except where there's real constraints on fiber capacity.

And I think we are once again well positioned for our 100G solution with our customer base.

As we look at quotes and wins and losses, the amount of losses we have today, it still comes down to the vast -- the two largest issues are incumbency and price.

Those two statistics are the ones that have driven the win-loss ratio for the last two years and it's not changing.

It's much less of a technology or feature than it is incumbency and price.

Simona Jankowski, Goldman Sachs.

Tom, I just wanted to follow up on that last comment you made about the two biggest reasons you would lose would be incumbency and price.

For the incidents in which you lose on price, how are those trending as far as a percent of the overall?

Are you seeing that become more or less frequent?

And I guess the reason I ask is because 10G is now pretty mature, so it seems like some of the pricing pressure seems to have become a little bit more intense recently.

So I was curious if perhaps you're seeing that happen more often.

We tend to -- again, our win-loss hasn't changed a lot over a period of time and we continue to win the majority of the opportunities that we are participating with.

When we lose, price and incumbency are somewhat interchanged.

[We just take] what the account team will qualify it primarily under one reason or the other.

Incumbency is probably the biggest obstacle and pricing climbs can be a reasonable excuse to allow and incumbent to stay in there.

I don't see the intense 40G pricing that people have implied could happen.

We look at this both for 40G, both medium performance and high performance 40G and we still see 40G at approximately four times the cost or price of a 10G.

Now we do think that's going to come down to a degree next year, maybe at 20% or so.

But that will still be roughly three plus to four times the cost of a 10G because 10G pricing is also coming down to a degree.

Maybe just to ask it another way, it seems like when you guys first came out about five years ago, your price differential was just extraordinary, about maybe 50% or so depending on the data you look.

It seems like that's now narrowed, not that your technology is no longer disruptive, it clearly still is, but it just seems the commodity part of the market has been kind of -- has been really hammered.

So do you track that and do you feel like your price advantage is now a little bit diminished or do you still feel like the percent discount you're able to offer is still the same as it used to be?

I think on a raw cost per port basis, the economics, the value proposition has diminished to a degree.

And I think our next opportunity to really create a new inflection point will be with our 100G platform where I think we will have distinct advantages with integration over the very, very expensive discrete path for 100G.

I do think, however, our customers have grown to appreciate that it's not just the cost of a port, but it's the utilization through bandwidth management utilization, the effective use of a network.

As 40G and 100G pipes are being rolled out, people are understanding the challenge of filling those pipes effectively and the value proposition we bring is not only value through integration, but also then the digital optical architecture which allows you to fill those pipes.

So we still believe our customers experienced dramatic operating cost advantages that even if the price per port becomes closer to parity, our customers have a distinct advantage and that's why we continue to I think not lose our customers.

And then another question as a follow-up on your comment that you didn't have any 10% customers among the Internet content providers, I just wanted to understand a little bit of the nature of the pause you're seeing there.

Because for example when I looked at Google's CapEx last Thursday, it was certainly a huge number that seemed to only accelerate.

So if I just take that as a proxy, should I interpret that as meaning that they've basically gotten enough of your kind of products in inventory and so they're simply digesting that in the next couple of quarters?

Or is it more that they have moved on to other parts of their CapEx needs away from the optical side to maybe other elements of their data centers in their network?

I think just to look at it, a couple of pieces, from a numbers perspective we did have -- filled three of the cable guys in the top five customers.

Although they didn't make the 10% limit, THERE were still significant contributions from them.

When we look both at the cable guys and the Internet content guys and the amount of money that they have spent kind of year to date, we do see them kind of falling off in Q4 but I think that's just because they have deployed a significant amount of network equipment that they now have the ability to go and fill and utilize that equipment and that we should see that for the next period of time and then they'll come back and redeploy some more chassis and commons going forward.

So I think it's more the natural cycle of how the networks get deployed.

Okay and then just the last question for me.

When I think about what percent of your customer base or your installed base may need a 40G solution from you given they're facing potentially a bandwidth exhaust situation, obviously you've highlighted the submarine customer segment as one such group of customers.

Are there any others that would fall into that category?

And maybe more broadly, is there a way you can sort of bracket for us what percent of your customers might face that situation?

In other words, I'm just trying to get a sense for whether into next year you might see something like 5 or 10 or 50% of your installed base needing to buy 40G from you or is it --?

Just kind of what order of magnitude would that [rate path] be for your customers?

I think the vast majority of our customers as they plan particularly terrestrial builds are looking for the 100G platform.

Where we do see interim pressure is around the submarine side.

I can't recall how many submarine customers we have today.

It's half a dozen or so.

And I think that somewhere between half and all of them might want 40G.

Not all of them will.

Maybe half of them to two-thirds will want potentially a 40G solution.

But I see most of the pressure coming from submarine.

Submarine will also tend to lean over a little bit to the terrestrial side.

So some portion of our terrestrial customers will look for potentially a 40G but I think the vast majority of our customer base is looking for delivery of our 100G platform in 2012.

Okay, thank you so much, Tom, appreciate it.

And, Ita, thank you as well.

Brent Bracelin, Pacific Crest Securities.

I wanted to follow up on the visibility question.

You talked about kind of visibility and digestion period around Internet and cable.

is that the primary area you're seeing less visibility?

Or are you also seeing less visibility with the two largest customers, Level 3 and Global Crossing?

Just trying to understand the scope of the downtick and visibility specific to Q4.

I think as we look through our customer base, we see kind of cable and Internet content guys definitely have had a very strong run from a deployment perspective and they are definitely falling off from a networks -- new network deployment perspective in Q4.

I think if you look at specifically Level 3 like we said, we've guided on the basis that they will not have the same demand as we saw in Q3.

Difficult to tell what will happen there.

We're taking a normalized kind of view of their numbers for Q4 and then we'll just see what happens.

We don't have a lot of visibility to how that will play out.

I think on other customers, again as you go through the list, we will see growth purchases from customers as they fill out the existing networks that are deployed.

The pipeline is strong still.

The timing of that is difficult to tell.

It's the difference between winning two opportunities and have them turn up in Q4 versus them turning up in Q1.

It makes a huge difference to the numbers.

So it's just our -- it's difficult to assess kind of the timing of how that will play out.

Fair enough.

And then as we think fast forwarding here and the assumption that potentially this digestion period could extend six months and on top of typical seasonality in March where [surf fighter] spending, CapEx spending is down sequentially, why couldn't we see an environment here where your revenue could decline sequentially for the next two quarters?

Is that the current thinking or at this point because of limited visibility, you just don't have much insights into what that Q1 seasonality could look like?

Yes, we don't have a lot of visibility to Q1.

We're obviously not guiding Q1 right now.

You know, if you look historically at the spend pattern, that hasn't necessarily been the case for us.

I think particularly if you look in the cable and Internet content guide, we tend to see them come back at the beginning of the year with new budgets.

Whether that happens this year or not, we're obviously not in a position to say yet.

But that has kind of if you look back historically been the pattern.

That is important because I think the Tier 1's in particular have a lull in Q1 spending while they digest and get new budgets that are cascaded through their organizations.

We have been fortunate so far as Ita said that we've not really seen the lag time between when these new budgets in the second tier industries are awarded and when they start spending.

So, never say never, but we're hopeful that we will see our typical Q1 versus the industry's typical Q1.

Fair enough.

My last question is on the ATN.

Clearly some good momentum there, I guess some positive kind of momentum.

Six new metro customers, you talked about 20% of the existing customers now deploying kind of ATN.

Obviously it's probably not 20% of the pipeline, but could you just tell us a little bit about are you seeing actually the new customer wins show up in the increasing pipeline and when do you think kind of ATN can be a material kind of growth driver from a revenue standpoint for you?

We haven't broken out revenues yet.

We will have to do that at some point.

We haven't broken them out, but I don't think it materially alters our profile at this point.

Every one of these wins however becomes exceptionally important because it's the embracing of the Infinera end-to-end architecture and value proposition that these customers are seeing.

It provides a huge benefit of locking us into the architecture.

It's a compelling, competitive advantage.

And over time by providing a solution versus point products, we should be able to increase our margin while at the same time we increase the customers' value proposition for our product.

So we will work at -- talking about next year how we break that out.

I am -- it's important that over a period of time, it becomes an important and meaningful portion, the metro, as part of our revenue.

We introduced a product about one year ago and I thought it would take about one year to start creating significant traction.

We just got our second release out kind of as we speak.

So by next year, early next year, we will give you an update and a breakout of how that looks.

(Operator Instructions) Sanjiv Wadhwani, Stifel Nicolaus.

Tom, Level 3, obviously their contribution has been really strong for the first three quarters of the year.

You've said that it will drop in Q4.

Looking ahead in 2011, sort of any indication of are they largely done with their buildouts?

Could Level 3 continue to be an important customer looking into 2011, specifically going to continue to be a 10% customer in multiple quarters in 2011?

The only thing I can tell you is one, we continue to have opportunities to win new routes and each quarter since we announced that they had chosen a new path, we have earned new routes.

Q3 was no different than that.

I'm going to reiterate, we don't give guidance to 2011, but I'm just going to unfortunately reiterate what I said before.

Level 3 has publicly said they're moving in a new direction.

I don't anticipate that that has changed.

We have stated that they continue to be a very good partner with a very good working relationship and we have continued opportunities to earn business.

I don't see that changing either.

But I can only reflect that they've been clear that they're going to migrate toward a new architecture.

Their cheapest capacity expansion opportunity is to continue to fill out the network they have deployed with us.

I think that goes on until it's full.

But we also as I mentioned have opportunities to win new networks.

That's about as much as I can unfortunately clarify for you.

I guess is -- could I ask, when you look at as you mentioned the cheapest opportunity for them is to fill out their chassis, are they halfway there, three quarters there?

Any color that will just help us sort of look at what Level 3 could bring in 2011?

I can't comment on any customer specific network in percentages or fills.

We don't do that in aggregate and I would certainly not want to do that for a specific customer.

Okay and then just on TAMs, I know you have said it will fall in Q4 to 2400 or so as an approximate number.

Is there a risk as you again look out beyond that that that number could actually fall below 2400 as sort of you see maybe a continuation of a pause in spending as your customers digest equipment let's say the first six months of the year?

Could it potentially fall below 2400 or do you feel as if 2400 is sort of the baseline number for you as sort of even a worst-case scenario?

Based on what we see now, that seems like a good baseline number.

Customers will -- they don't buy the TAMs upfront.

So when they put out a network, they create the TAM slots.

So we would expect to see pullthrough on the TAMs as they continue to fill out those networks.

So I think that's kind of the baseline that we set and when we talked about it last quarter, we see in early October bookings, we've seen that we're trekking to that level.

So I think the 2400 is a good baseline number.

And we add new customers too.

We're averaging almost three a quarter this year.

Every time we add new customers, that's a new installed base that will have to have TAM expansion to it.

So I think that as Ita said, there's a base of business that we are anticipating is roughly this level.

Got it, thank you.

Blair King, Avondale Partners.

Yes, thanks.

Just a couple of quick questions.

One is a follow-up on some of the previously asked questions.

There has been a lot of conversation around the sort of consume-and-digest outlook.

Tom, I don't know if you can comment on how much of the mix is consume and digest versus how much would be in inventory build as well at the customer site for common equipment and TAMs.

You kind of touched on that before but if you could put some color around that, that would be great.

We don't have an ability to track internally to our customer base exactly what they are doing.

But I do not believe that there is much inventorying at all going on within our customer base.

We work very hard to have reasonably short leadtimes.

We still do that within our industry.

We kind of set the benchmark in that.

We've to date still never had a customer miss a turn-on date based on lack of our equipment.

I think there is very -- my estimation would be there is very little build of inventory in our customer base.

That doesn't mean there is zero, but if there was any significant amount, I would be very, very surprised.

That's good.

Thanks.

One last question probably for Ita.

Ita, you had mentioned on the R&D run rate that it would be right around $25 million and I assume you meant that that is kind of a go-forward number?

No, 28.

We said R&D would be about 28 which is (multiple speakers) taking the 26 plus the rollover plus the OSMINE stuff that we talked about for Q4.

Okay and how long does the -- how long should that OSMINE period last?

Should we count on $28 million as being a steady run rate through 2011 or should we expect that number to drift off a little?

We're not kind of guiding the R&D numbers for next year at this point.

I will tell you specifically to OSMINE, we will see some OSMINE expenses in Q1 as we complete the work that we are doing there to get ready for Qwest.

OSMINE is a repeating certification that we have by release, by certain releases.

We get OSMINE certified on an as-win basis.

So if a product wins certification within a network but requires OSMINE, we will then go and make that expenditure.

OSMINE is a fairly significant cost.

It can cost anywhere from a couple million to several million dollars to be certified depending on what you're being certified for.

So we do it on an as-win basis.

So that will typically be above what we would normally forecast in our R&D budget.

But it doesn't last every quarter.

It's on a release basis.

I want to thank you for joining us today and thank you for your questions.

Have a great day.

Thank you.

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