Infinera Corp (INFN) 2011 Q1 法說會逐字稿

Welcome to the first-quarter 2011 investment community conference call of Infinera Corporation.

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

(Operator Instructions).

Today's call is being recorded.

If you have any objections, please 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.

Thank you.

Today's coal 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 conditions, results of operations, business initiatives, views on our markets and customers and our products and our competitors' products and prospects of the Company in Q2 2011 and beyond that are subject to risks and uncertainties that could cause actual results to materially differ 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, 2001, for more information on these risks and uncertainties.

Today's press releases, including Q1 2001 results and associated financial tables and an investor information summary will be available today on the Investor's 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 include certain non-GAAP financial measures.

In our earnings release we announced operating results for the first quarter of 2011, which exclude the impact of restructuring and other related costs and non-cash stock-based compensation expenses.

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

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

On this call we will also give guidance, including guidance for the second quarter of 2011.

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.

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

Good afternoon, and thanks for joining us.

With me are Chief Strategy Officer David Welch, and CFO Ita Brennan.

Our first-quarter results reflect stable bandwidth demand from our terrestrial and subsea customers, evidenced by strong TAM purchases in the quarter.

However, we saw slower new footprint activity in Q1 versus a year ago as certain of our customers and prospects await the introduction of our new higher capacity products later this year, and some have opted for competitive 40G solutions in the interim on a tactical basis.

While our reputation for customer care, high quality and rapid turn-up are assuring customer loyalty, our ability to compete for certain capacity sensitive opportunities is impaired by our current lack of a high fiber capacity solution.

In order to address our customers' interim need for 40G transmission in advance of the rollout of our 500G PIC-based system for 100G transmission, we will be introducing our 40G products in the third quarter.

The introduction of this product will enable our DTN System to offer 6.4 terabits of capacity on a fiber, which we believe will up to 2 times the capacity of most competitive offerings in the market.

It is also important to note that we continue to grow the number of network customers, customers who are buying a multiproduct Infinera solution.

This includes customers deploying either a combination of the long-haul and Metro applications from us, or a combination of terrestrial and subsea applications.

At the end of Q1 we had 26 such network customers out of a total of 86 customers worldwide, an important trend as network customers have made a more significant Infinera architectural commitment.

We believe we are earning network customers, because our portfolio delivered important end-to-end benefits such as simplified network management, improved CapEx through efficient interconnect and improved end-user experience by integrating provisioning and performance monitoring.

In the Metro we continue to build additional features and capabilities into our ATM platform.

And in the second quarter we led Ethernet aggregation functionality.

Turning to the optical transport industry.

We are in the early stages of a series of significant and complex transitions.

We believe these changes create a unique opportunity to successfully launch new products and new architectures, because customers are looking for more efficient and cost effective ways to grow and manage their future networks and to compete for new business.

One of the most important of these transitions is the move to higher bit rate transmission, specifically from 10G to 100G.

These higher bit rates are necessitated by the need to increase the carrier's capacity for fiber.

However, this move does raise issues for carriers regarding network economics, both on the cost per bit on transmission and avoiding the inherent inefficiency of stranded bandwidth when service capacity and wavelength capacity are mismatched in conventional transponder-based optical networks.

A second important trend is the move toward converging the layers of the network to collapse optical transport and switching into a single platform.

This shift is consistent with Infinera's founding vision for the Digital Optical Network.

One of the primary drivers for the move to a converged network is the ability to deliver router bypass, and manage more of the carrier's traffic at the optical layer instead of the traditional and more expensive router layer.

Wider use in the network of intelligent optical switching solutions and bandwidth virtualization allow for a significant reduction in the need for router ports in the core.

These innovative architectural transitions have been publicly promoted by many large carriers, as well as a number of content providers, because they significantly improve the cost structure of the core network, while providing a simplified and scalable architecture.

This is an architecture that Infinera customers already have benefit from in our DTN, and an integrated OTN switching and optical transport platform.

Infinera is well-positioned to benefit from both of these industry transitions, and to help accelerate the migration to the next generation of higher capacity, more intelligent networks.

We believe that our Digital Optical Network architecture, based on large-scale PICs, enables us to integrate higher bit rates and advanced digital switching functionality more easily and more cost effectively in any traditional solutions based on discrete components.

With OTN switching integrated into our DTN since 2004, we are already familiar with and well known to customers for pervasive, integrated DWDM switching.

Further, we believe that Infinera offers the lowest cost technology for the interconnection of these switching capabilities.

By offering a 500G PIC-based transceiver technology, Infinera will lead the industry with 5 times the line card capacity of conventional transponder architectures.

We feel confident that we are bringing our new solutions, particular our 500 gig PIC-based system, to the market at just the right time to both benefit from and encourage these trends.

At the same time, we have continued to focus on extending our roadmap and technology leadership by demonstrating (inaudible) PIC with 1 terabit of capacity.

We also announced our intent of bringing this technology to market to support up to 25 terabits per second of fiber capacity as a future product development milestone.

In the more near term we are strong believers in the view that a 500 gig PIC-based solution for 100G transmission will be the industry's next multiyear network standard, and will offer customers the most cost effective, long-term value for their capacity requirements.

We believe that the current strength and demand for 40G networks are driven by the immediate need of certain carriers to address fiber capacity shortages and the lack of availability of a viable 100G-based solution.

As our customers deploy 40G capability we see them doing so on a route-by-route basis rather than for long-term strategic reasons.

As we work with potential customers it is clear they are looking to the economics and capacity of 100G solutions.

Today I am pleased to announce that due to our continued engineering progress we will be launching our 500G PIC-based system for 100G transmission in our fourth quarter of this year as a prelude to volume shipping the product in the first half of 2012.

To avoid any confusion, I want to clarify our product terminology.

In 2004 we introduced our DTN System based on 100G PICs, which delivered 10 channels of 10G transmission.

The system we will launch in Q4 will be based on 500G PICs delivering 5 channels of 100G transmission.

We believe our 100G transmission products will be the most significant new product in the history of the Company.

And it will help us achieve similar market success to our 100G PIC system introduced six years ago, leveraging radical economics and enabling the simplicity of a Digital Optical Network.

We believe the timing of this launch will allow existing customers and prospects to evaluate our 500G PIC-based products for their network plans in 2012.

Customers' response thus far has been very positive to the differentiating capabilities and features that this new platform will deliver.

Looking at the transition from 40G to 100G, the latest industry data released from [internext's] forecast that the largest single segment of the market will be 100G transmission in the 2013 to 2014 timeframe.

Furthermore, 100G is expected to be the dominant transmission rate on a dollar basis throughout the second half of this decade, and most likely well into the decade after.

If this proves accurate, our introduction of our 500G PIC at the very earliest days of this 100G transmission cycle will play perfectly with our expectation of disrupting the transport market once again with the industry's only Digital Optical Network.

We believe that our technology and product roadmaps provide a clear path to achieving our long-term business model, and we have an urgency to execute on these roadmaps.

As we make progress on our product and technology goals, we fully understand that our current financial performance is unacceptable on a sustained basis.

By delivering our technologies and products to the market, we feel confident we will create competitive advantage for our customers and appropriate returns to our shareholders.

Ita Brennan will now provide details on our Q1 financial performance and our outlook for the second quarter.

Thanks, Tom.

I will review our Q1 actual results, and then follow that up with our outlook for Q2.

This analysis of our Q1 results is based on non-GAAP.

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

Total GAAP revenues in Q1 were $92.9 million compared to our guidance of $90 million to $97 million and revenues of $117.1 million in Q4.

Level 3 was our heir only 10% customer in the quarter at 14% of revenues.

We saw stable demand for bandwidth from our existing customers, as they continue to fill out network footprint.

However, as expected, we experienced lower revenues from new deployments.

TAM shipments for the quarter exceeded our target of 2,400 units.

We added four new customers in the quarter for a total roster of 86.

One of the new customers added in Q1 was a new ATN-only customer.

Three of our existing DTN customers completed new ATN deployments in the quarter, bringing the number of customers now benefiting from the combined DTN/ATN network solutions to 22.

Please note we are providing the total number of customer wins for reference this quarter, but as previously indicated, we will be discontinuing this as a regular practice as it is no longer the most meaningful metric for estimating the scale and growth of our business.

Instead, we will provide other metrics around certain customer and new product subsets that we believe will be more meaningful in that timeframe.

International revenues amounted to $24.1 million or 26% of total revenues for the quarter.

EMEA accounted for $20.3 million or 22%, down from 26% in Q4 2010.

The level of international business will fluctuate on a quarter-over-quarter basis depending on individual customer buying patterns.

We expect the ratio of international revenues to increase in Q2.

Our service revenues for the quarter were $9.4 million, down from $13.5 million in Q4.

Services margins increased to approximately 67% from 58% in Q4, reflecting reduced levels of lower-margin deployment services sold in the quarter.

Overall gross margins in Q1 were 48%, down from 51% in Q4, and this compares to our guidance of 45% to 47%.

As outlined in January in our guidance, margins were negatively impacted by approximately 2% related to new product introduction activities and our PIC fab and systems manufacturing areas.

We expect to continue to incur these expenses through the end of the year.

And these costs, depending on revenue levels, will continue to have an approximate 2% to 3% negative gross margin impact each quarter in 2011.

Operating expenses for the quarter were $48.1 million versus our guidance of $50 million, and versus $51.9 million in Q4.

R&D expenses came in at $27.5 million, approximately $0.5 million below our guidance.

The remainder of the (inaudible) expenses resulted from deferred hiring and cost management.

Overall headcount for the quarter was 1,118 versus 1,072 in Q4.

Headcount additions primarily occurred in operations and sales as we prepare for the launch of our 100G platform.

Operating loss for Q1 was $3.6 million.

Other income and expense for Q1 was unfavorable at $0.1 million.

Net loss for the quarter was $4 million, resulting in a loss per diluted share of $0.04 versus our guidance, which called for a loss of $0.04 to $0.09 per share, and versus earnings of $7.6 million in Q4.

Now turning to the balance sheet.

Cash, cash equivalents, restricted cash and investments ended the quarter at $287 million versus $296 million in Q4.

We used $0.9 million of cash from operations in Q1 versus cash generation of $7 million in Q4.

DSOs were 60 days, up from 59 days in Q4.

Inventory turns where 2.5 versus 2.8 in Q4.

Total inventory was $78.3 million, down from $81.9 million in Q4.

Inventory turns declined to 2.5 times, primarily due to lower revenue levels in the quarter.

Accounts Payable days are at 39 days, down from 43 days in Q4 due to lower inventory receipts in the quarter as we continue to utilize inventory on hand.

Capital expenditures were $10.6 million in Q1 versus $5 million in Q4.

As discussed last quarter, we expect capital additions to be approximately $40 million for the year as we add manufacturing capacity in advance of the launch of the 100G product.

Turning to our Q2 outlook.

Customers continue to require higher fiber capacity products on portions of their network.

We are responding to these opportunities by deploying 10G capacity now, with a migration path to our 40G and 100G solutions as they become available.

In the interim we expect that our ability to grow revenues will be restrained until we have volume releases of these new products.

In addition, we are competing aggressively for new footprint opportunities in order to ensure we have access to future buildouts of these networks when our higher capacity products are available.

In the short term, we believe that these investments in future business will continue to put negative pressure our margins.

Level 3 is assumed to remain a significant customer for the June quarter as we continue to meet their needs for fast and flexible response time.

All of these factors combined result in revenue guidance that is consistent with Q1 levels.

Our current outlook is for lower gross margins in Q2 based on the following assumptions.

Changes in product mix are expected to have a negative impact of approximately 3% to 4%.

TAM shipments are expected to again be at or in excess of our target at 2,400 units, which will be offset by a higher mix of lower-margin common new footprint deployments.

We expect the need for increased competitiveness on our new footprint wins to negatively impact gross margins by approximately 2%.

Finally, at current revenue level the impact of our fixed cost, including the impact of the new production -- product introduction costs mentioned above on the overall gross margin percentage is more significant.

Operating expenses are expected to be approximately $50 million for the quarter, with R&D accounting for approximately $29 million of this amount.

We believe that this R&D number represents a high point for the year as the number of key R&D deliverables are the expected to occur in the quarter.

We will continue to make the R&D and sales investments necessary to support a successful ramp of our 100G platform in 2012.

Other costs are being managed carefully until revenue and margin trends improve.

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

Revenues of approximately $92 million to $97 million, gross margins of approximately 40%, operating expenses of approximately $50 million, operating and net loss of approximately $11 million to $14 million.

And based on estimated average weighted diluted shares outstanding of 110 million this would lead to a loss per share of approximately $0.10 to $0.12.

Please note that the basic share count is expected to be 105 million for the quarter.

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

Thank you.

(Operator Instructions).

George Notter, Jefferies.

I guess I wanted to start out by asking some questions on the new product roadmap here.

I guess for starters on the 40G line card.

I guess I had understood that would be available midyear.

You guys are now saying Q3.

Maybe we are parsing words too finely here, but I guess I'm trying to understand if there has been a slip in the timeframe on 40G.

You have got Tom here.

When we talked about it last year (inaudible) midyear we have -- I always operate the Company on two schedules.

One is a stretch and what is a commit, and that is how we typically end up somewhere between those two dates.

Our stretch timeframe was kind of a Q2 and our commit was kind of a Q3 internally, so we are roughly operating within the window that I [have been] anticipating.

Clearly, I was hoping to get it out closer to Q2.

We will -- you'll see us introduce it comtempory to the first part of Q3 -- or still in Q3.

So I don't want to try to negate that the midyear is probably kind of like end of June, but it operated within our window of what we had expected the engineering deliverable frame of control could be.

Got it.

Great.

Is there risk of that timeframe slipping out then?

Do you have a high confidence level on the 40G line card at this point as Q3?

Yes, I think until something is (technical difficulty) there is always some level of risk, but we have a pretty high confidence at this point of our schedules, and what we are anticipating taking to market and when.

We are out clearly talking to customers at this point and setting expectations about when they can expect product, so we have a pretty high confidence at this point.

Great, okay.

Then shifting gears onto the 100G product, I heard what you said in terms of the timing for 100G.

I'm trying to understand where you are in terms of milestones at this point.

I know that after the PIC development was done you guys still had some ASIC development that was in front of you.

You still had a chassis to buildout, line cards, software.

Can you talk about where you are in terms of the progression towards completing that product development?

Yes, sure.

So if I start with kind of an endpoint of a product, actually taking (inaudible) general availability and prior to that is (inaudible), and prior to that is obviously order ability.

And on a platform like this we often don't do that, but for a platform like this we are going to do a launch.

All those things mean that from my perspective when we say we're going to launch it in Q4, we now have enough, I would say, engineering evidence across a broad spectrum of the results, whether it is at a PIC level, a PIC factory level, software development level, a hardware development level that we feel comfortable that we can launch this platform in Q4.

That means -- I'm trying to -- instead of saying there is a particular milestone, that it is trying to give an overall measure that we are comfortable with the aggregate progress of the overall system, that we should set an expectation that we will launch this in Q4.

We continue to make progress in all fronts, whether it is software development.

Our hardware is vastly into the [BDT] phase.

So it is no longer in design, but it is in design validation.

There is still obviously milestones that have to be achieved, but we feel very comfortable that we are progressing across broadly all the fronts that the best aggregate kind of milestone would be telling you when we plan on launching it.

Got it.

Okay, fair enough.

I am sorry -- correct to say that there are some ASICs that go into this system.

I assume those are pretty sizable developments.

Those are [done] in?

Is that fair to say or no?

There is a number of ASICs that are going into this system.

Some of the ASICs are completely done.

The PIC is an ASIC.

It is now in, obviously, rel testing, so it is done from a design perspective, but we are still validating the reliability.

We have other ASICs that are in -- I mentioned last time that we had the switch ASICs that was completely in.

And we have since validated that it is fully functional.

And barring some giant surprise, we believe it is completely done.

Other ASICs are still in the bringing up phase.

And some ASICs will not come out necessarily in the first release, but in follow-on line cards that we will probably launch at the same time, so people can have an understanding of our overall platform.

It is very difficult to answer the question -- are all the ASICs done.

They're not all done, but we believe there is substantive enough progress across the suite of them that we are on track to launch the platform in Q4.

Great.

Then what is your expectation in terms of the timing of the ramp here?

How long will customers test or trial these systems?

Ho will revenue recognition work?

Is that something you can take pretty quickly upon commercial deployment or is there a longer acceptance phase, and kind of map out for us how you see that?

(inaudible) I am going to answer part of it, and then I'm going to ask you to answer the part on revenue recognition.

So various customers are going to operate differently.

I think a range of customers who already are Infinera customers would probably still require a level of lab certification in process, and we will begin that process before we do SDS.

That process can vary by customer from very short to more thorough up to a quarter probably.

For a new customer that would probably be a longer process than that.

And that is going to depend, quite frankly, just on who the customer is.

We see customers -- some customers who basically do nothing more than testing in our lab to certify products.

And we see other customers who will go through a very rigorous process where they have to test it in their lab and then they will do a first office application, and then basically certify the product post that.

So it is not an easy answer to answer in one fashion.

I would expect a range of some that would be early and some that would be much more extended.

Ita, if you could answer on the rev req portion, I would appreciate it.

I think on the rev req it will somewhat follow that pattern.

Existing customers will have established acceptance criteria.

A lot of it will be on shipments and installation at this stage.

For new customers, whether it is a trial and deployment, probably some testing at the end of that, [it will] take longer.

So I think an existing customer revenue stream can come fairly quickly after shipment.

For new customers it may take longer.

Got it.

So then from the time you GA this thing, I guess, to revenue -- and you guys are certainly a lot closer to this than I am, I guess I'm trying to ballpark it.

Do you think it is six months for the earliest customers from GA and then 12 for a new customers or -- any kind of range you can put on this?

My suspicion is once we FCS, we will start to see some revenue within a quarter would be my belief.

Certainly with the existing customers that is doable.

Great, okay.

Fair enough.

Thank you very much for the time.

Simona Jankowski, Goldman Sachs.

This is [Tom Gleason] on behalf of Simona.

Just a couple of quick questions.

So is it fair to assume that in the [42] market we are seeing a little bit of a land grab with vendors, I guess, targeting footprint expansion in hopes of 100G upgrade opportunities?

And just, I guess, to piggyback off that, given the timing of your -- of your 40G product, I am just curious if I might get your confidence level in terms of the 100G past-due, if you feel still feel like that is pretty open for you with the 100G product line coming out next year?.

I heard two questions.

Is there a land grab with 40G currently and how comfortably do we feel with our timing of 100G.

Exactly.

I think clearly there is requirements, good news for (inaudible).

There is requirements for more fiber capacity.

People are willing to spend money and needing to spend money to increase their ability to carry more bandwidth.

We consistently still see the preference -- a strong preference -- a universal preference going to 100G as soon as possible.

But there are customers who have decided that 10G is insufficient today, so they're moving to 40G, because 100G does not provide either the market-proven volume yet or re the economics that are necessary for it to create the mass market.

So I think that -- I don't know if there is a land grab going on.

There is fundamental and continued growth in the need for bandwidth.

There is a continued shortage of certain fiber in certain networks, and 40G is a reasonable solution for that.

I think that if there is a land grab I don't know.

There is opportunity out there.

And if we had 40G today we would be selling it.

If we had 100G today we we selling that also.

In regard to 100G, are we comfortable with our time?

I will make two comments.

One, we are comfortable with the schedules that we laid out.

And I'm very comfortable that we are going to be what I would consider the very early phases of a 100G market that is going to last for a very long time.

The number of 100G [wave] sold today is very, very small.

No matter which reports or analysts you look at.

Most of the deployment of 100Gs really don't begin until 2013 and 2014.

I think by having our customers be aware of our technology today, by our customers being able to see the products in the very near term, and us launching it in Q4, we are going to be positioned at the very early phase of a very long 100G cycle.

(multiple speakers).

I couldn't be more comfortable with the timing that I think the market requirement and our availability are quite frankly perfectly aligned.

Got you.

Then, I guess, with your new product do you feel if you -- as I think about domestic versus international, what do you feel like do you see as the biggest opportunity, or do you feel like it is pretty wide open both here and international markets?

From a domestic perspective, we have been very fortunate to earn a very substantive leadership position in marketshare.

And I think that by introducing both our re 40G to allow our customers to upgrade and earn new customer footprint, and by introducing a new platform with 100G, we are well-positioned to re-create the same type of North America presence that we had for the last several years.

I think last year we had 37% marketshare in long-haul transport in North America.

And I think internationally we are making good progress, but I would say there is more opportunity to grow that marketshare internationally.

Europe, we continued to make, I think, steady progress -- slow and steady progress.

In APAC we have just hired a new leader for our APAC arena that I think will bring very good insight into the industry, good relationships in the industry.

And I believe that we are at a good foundational point of starting to grow the APAC business.

We have some very good relationships there.

We just have to turn that into dollar opportunities.

Got you.

Okay.

Then maybe if I could just shift gears to income statement, more just on OpEx.

I think last quarter you gave guidance, I guess, for total OpEx, if I'm not mistaken, $204 million, $205 million range.

I am just curious if for the full year does that still stand?

Then I think on the R&D side I think you had said like $110 million to $115 million.

I think that is good guardrails for what we set out for the year.

Obviously, with the revenue where it is we are trying to reduce that and put pressure on that.

Outside of key sales and R&D and operations headcount where we really need to do that to support the 100G, we have deferred hiring, etc., and we will continue to do that.

So I think the $50 million for this quarter, we are definitely trying to stay in that window for the year.

And, also, obviously looking for opportunities to take some more cost out.

Got you.

Thank you.

Kevin Dennean, Citi.

Tom, acknowledging your comment that 40G is really seeing kind of route specific deployment as opposed to a broader-based adoption, do you think that the commercial -- just the commercial availability of 40G product is putting pressure on the 10G market?

I think that people are interested in continuing to grow their networks to make sure that they can handle the incremental demand that all of the new video and 4G, etc., bring to the world.

40G is a good interim solution.

I think the challenges that 40G does not yet have the economics that are necessary to make people want to adopt it as broadly.

It does not still have 10G economics.

And the view is 100G will have better economics and achieve better 10G equivalent economics of a [4] 40G does.

Secondarily, 100G is starting to happen, so they don't have to wait very long.

So I do think there is pricing pressure that is being applied in the market.

If somebody is interested in moving to 40G we are certainly responding with commercial opportunities on 10G pricing to have them defer that decision until either we can bring 40G out or our 100G program.

And I suspect that is not unique to us.

Okay.

That is helpful.

Thank you.

As a follow-up, when the 40G product does launch for Infinera, how should we think about the gross margin profile on that product relative to your existing 10G business, putting aside the June quarter guide, which I think has a lot of specific issues around it?

I think when the 40G products comes out for us, obviously, it will be a new line card with new volumes and so on, so I think certainly initially it is not going to have the same margin profile as a 10G module at a [3] level.

I am sorry, at what level?

At a part number level.

SKU level, okay.

Modules module basis.

I think if you -- is it is going into an existing network into an existing footprint, there will be no commons scheduled to be deployed with that, and that will offset some of that margin impact.

If it is going into kind of new footprint and new opportunities then I think it will probably have more -- less favorable margins than what we are seeing on the 10G products today.

And how the fix of that plays out is really not clear yet.

It will depend on where those deployments are.

(multiple speakers).

Our 40G product will have kind of the same kind of margin that the rest of the industry would have based upon discrete technology that we are buying from other people that are available in the market.

It won't have PIC economics, and that is not the intent of our 40G solution.

Our PIC economics are designed to bring radical cost structures to the industry.

And the discrete solution should be roughly on par with what the industry should bear for 40G.

Look, Tom, just to follow up on that comment, it is hard to see what other companies gross margins are given that there is not very many pure plays out there.

So how would you describe the gross margin profile for discrete 40G right now?

I would describe the industry as an industry that typically bears a margin structure of high 30s to low 40 points of margin industry.

We have said our Company's long-term business model is to achieve 50 points of margin.

We do that to offset, obviously, being vertically integrated.

We have had, certainly, a few proof points of being the high 40s to low 50s.

But I think our industry ranges from probably the low 30s, if you are a commodity player, to roughly 40% as an industry would be my estimate.

Dave, you want to make a comment on that?

Yes, I think the gross margins of PIC-based systems in general are going to be inherently several points higher.

We would expect when we look at the modeling that they could be in the range of somewhere between 3 and 5 points better gross margins than discrete-based (inaudible).

Great, thank you very much.

Rod Hall, JPMorgan.

Thanks for taking my question.

Sorry about that.

I just wanted to check in on the order books for the 40G product, and maybe just see if you guys could talk a little bit about what the expressed interest is in the 40G product at this point.

Can you give us any number of customers that have -- I guess, of your existing customers what proportion of them have said they might be interested in it or have it in labs testing it now?

Then I've got a follow-up to that.

I won't be able to just address -- this is David Welch -- and I won't be able to address in maybe the detail you're looking for.

But most of our customers, as we have stated before, are comfortable with the 10G deployments and holding out for the 100G deployment when the PIC-based systems come out because of the overall network cost benefits that will come with that platform.

As we stated before, there are aspects on a route-by-route basis of our current customer base that do need more capacity than 10G can offer, and those are the customers that we would be focusing in on in the second half of this year to deploy our 40G products for.

I think the question is I am not sure we can quantify what fraction of that -- of our customer base is in that, but the majority of our customers are able to and willing to wait for 100G to (inaudible).

I don't know if that answered your question or not.

Yes.

It sounds like the data is not right here, so thanks for giving us some color on that anyway.

The other thing I wanted to ask -- and I'm not sure if anybody has asked this yet, but is the -- can you comment on the expected impact from the Level 3 acquisition of Global Crossing?

What do you guys think the impact to you is there?

Can you quantify it at all for us?

We certainly can't quantify it, because it is -- first of all, the acquisition is certainly not complete yet.

And I don't think it is forecasted to be done until the end of this year.

But if you look at it the way we look at it, Level 3 continues to be a significant customer of ours.

Global Crossing has and continues to be a significant customer of ours.

I think it puts us in a good position that they have two networks with common equipment, and as networks get bigger, the value of having an intelligent network grows.

So I think that the fact that Infinera infrastructure and that our network is an intelligent infrastructure would help them scale their business efficiently.

Having said that, I clearly think this is a capital intensive industry for them, and one of the reasons that they would combine is so that they could lower the amount of CapEx that they would need to spend as two independent companies.

So I think that we are going to be well-positioned to earn business.

I think are installed base relationship with both companies is an advantage.

But I do believe that over a longer period of time they will spend less money than they would have independently.

I do believe, however, that is healthy for the industry.

The industry needs to consolidate so that there are more profitable companies in the industry.

Okay, thanks a lot for that, Tom.

Sanjiv Wadhwani, Stifel Nicolaus.

Thanks so much.

Tom, I was a little bit confused, and I apologize if you -- I know you addressed some of this.

I'm a little confused about the 500 gig PIC release in Q4 versus what is going to happen in the first half of next year.

I don't know if you can go through it again as to what exactly going to happen in Q4.

Sure.

So if you remember our previous guidance was that we would introduce this new platform in volume in 2012.

That was the full gambit of what we said.

And we gave some engineering milestones that gave proof points of our confidence that that was going to happen.

This time we have said that we are going to launch, which is basically announce, describe, to the industry, to our customers very publicly what this product is, what the features of this product are, what the pricing of this product is, and all the availability in Q4.

That is so that we can accelerate when we will bring this product to market, which we have now said will be in volume in the first half of 2012.

So the goal of launching this platform in the end of this year is to allow customers a more comfortable way of making 2012 capital investment decisions around this architecture sooner.

Got it, that is helpful.

So is it fair to say when you launch it in the first half in volume clearly it is going to be available for testing in labs before then.

And I don't know if you can give a timeframe as to when that might happen actually.

We will have that kind of data at the launch.

But I -- you should have a perspective that is sometime maybe up to a quarter before we (inaudible).

Our customers will start having it in their labs for their own internal testing.

Got it.

That is helpful.

I appreciate you giving clarity there.

Then Level 3 obviously grew sequentially.

And then it looks like it is going to continue to be an important customer in Q2.

Any impact that you guys are seeing at all, maybe not, from the decision last year to go with Huawei?

I am just trying to see if you have any clarity on that.

Well, clearly as we have said before, Level 3 has articulated that they have moved now to a two vendor strategy.

We continue to have a very good relationship with Level 3.

We continue to have the opportunity to win new business and new routes.

But Huawei is clearly being deployed in their network.

And it is because they are doing it at a CapEx level that, quite frankly, we don't think anybody can make money at.

I think that Level 3 would agree that we offer much lower operating and total costs, but at a CapEx level they find that solution very compelling for parts of their application.

But we continue to win business.

We continue to have a very good relationship, and we are going to continue to work to be their primary supplier.

I appreciate that.

Thanks so much.

Alex Henderson, Miller Tabak.

So I just wanted to talk a little bit about what you're hearing from your customers as you are discussing these programs with them and to what extent you are seeing an acceleration in activity in the market generally.

In other words, if I were to look at the aggregate number of proposals that are running around in the field, have you seen an acceleration or a change in the pace and tone and scale of the transactions that are in the field, not necessarily for your product, but in general?

So I think that is a general question of are we seeing more and more activity?

Do we expect to see an acceleration in the spend in long-haul DWDM space?

Did I interpret the question?

Clearly there has been 12, 13 years since we did the last cycle, the upgrade from 2.5 to 10.

We are at the point now where finally there are alternative technologies hitting the market.

Is that resulting in an acceleration of activity of companies saying -- okay, now is the time to make this bigger investment, and therefore, seeing proposals that are larger and more numerous than you had seen in prior periods?

I think there is two things we are seeing.

There is some of the large telecom providers have over the course of the next 18 months are going through product upgrade cycles at a total dollars spent within DWDM space, I think, it is on the average over multiple quarters is on a general smooth trend.

So that is seeing bandwidth growth that are on average 30%, 40% per year bandwidth growth.

And that is driving the absolute dollars of preinstalled system versus new systems.

However, there will probably be -- I think less so in 2011, but in 2012 and 2013 there are some major system overhauls that are being contemplated that would make that dollar shipped move from legacy type of gear towards next-generation gear.

The second part of the same question is, to the extent that you're seeing activity in the field now are customers pushing to make decisions quickly, because they want to get involved with this upgrade earlier, or are they basically saying -- we will wait until 2012, and pushing off the decision?

Are you seeing a material impact on your bidding process as a result of people wanting to make decisions faster?

I think the customer base is seeing that the 100G technology is coming in faster.

We have talked about in the past this structure of what we call 40G squeeze, if you will.

As they see the 100G technology as a technology they would prefer to get to.

That is creating some uncertainty on a number of the customers of whether they can hold off their capacity demands until they get to that technology.

And, certainly, we see that from our customers, as we indicated earlier, prefer to wait from the 100G technologies and not go through an interim product cycle in order to get there.

And so to that extent I think that is -- they're taking their systems, they are driving to a higher level of deployed capacity in pre-existing systems before going out and applying new footprint and new systems.

The last question then is on just a repeat of what happened in the prior question.

You talked about the time you're getting the product to your customers, but you didn't talk to how long you think the test cycle from the time it reaches their labs to the time you would actually see revenue recognition.

Are you still talking a couple, two, three quarters in that process?

I think Tom's comment was from the time that we [FCS] it to the time we see some revenue from it is within a quarter.

And it depends very much on the type of customers we supply.

Customers that will have fully certified by the time we FCS it, and there will be other customers that will require a six-month test cycle before they would accept it.

So that transition, they will continue to deploy the current existing product -- 10G and 40G product while they are certifying the 100G.

We expect that transition to be reasonably smooth.

But the revenue will come from when we introduced 100G product relatively quickly.

Thank you.

Subu Subrahmanyan, Sanders Morris.

I have two questions.

First on OTN switching and the whole packet optical layer industry and then the new products we are seeing, can you talk a little bit about -- you supply terabit, and on the 5 terabit OTN switch, with what kind of packet capabilities you might have on your transport platform?

And the other question is on 40G (inaudible).

You probably can talk about -- you talked about the 40G [squeeze] in the past.

But if you look at the market today, what percentage of wavelengths is being shipped at 40G in the long-haul?

What percentage of routers is 40G versus 10G?

Can you give us a snapshot on how you expect next year some combination of 10, 40 and 100, how you would expect your business to look?

Well, there is a couple of questions here.

One is what do we see from the 10G kind of volume and 40G volumes.

I think 10G volumes have been relatively flat in the industry and are forecasted to be done on a port basis relatively flat, with probably 10% to 15% price compression per year in the industry.

I think that is probably what you can expect.

I think from a port perspective on 40G what we are seeing is an increase certainly.

I think the recent numbers I see are about 5,000 may be at the top ports per quarter, but that is a combination of coherent and noncoherent ports, so not all serving the long-haul.

I still consider or see that for long-haul 40G it carries a premium to 10G pricing of probably somewhere in the 4X to 5X range at least.

I think that our industry right now has got an interesting number of changes that are happening -- 40G, 40G coherent, 100G coherent, OTN packet.

With all these changes I think it both creates a lot of opportunity, but it also potentially defers some of the buying decisions, while the strategies are vetted out to make sure the industry knows how -- the customer knows how they're going to spend their money.

This is the first time our industry has experienced this for quite a while.

I think that is quite frankly good news for our industry, and particularly good news for us as our -- we will benefit from the customer base evaluating the value of 40G coherent and the value of 100G coherent and the value of OTN, which we think, as I mentioned before, is really what our product is all about.

So I think that next year we will see probably a predominant amount of our volume still being 10G.

That is what the largest volume in the industry is.

I think that we will get a reasonable share of 40G, but I do think next year 100G will start being a substantive amount of revenue in the industry, though probably not that great on a port basis.

I think on a port basis the 100G market for long-haul is estimated to be in the 1,000 port range for next year.

Our job is to do two things.

One, get a substantial portion of those 1,000 ports, but more importantly is to accelerate the industry to 100G ports and pick up a large portion of that.

So getting things to market early, but also creating PIC economics and OTN economics for the customer base will help accelerate the 100G adoption.

And that to me is most important thing we can do.

Dave, if you could answer the packet question, I would appreciate it.

Yes, I think your question is asking for what is -- how do we think about packaging our products.

We are not at a point where we are going to do our product introduction of our next generation platform, so I don't want to get into specific details of what will be on that system.

However, we introduced the concept of Digital Optical Networks five years ago, which was the concept of having digital bandwidth management integrated with the optical transport layer.

We have been very successful in showing that has a significant added value in a network.

We believe that packet is part of the roadmap of the Digital Optical Network as we go through the evolution and phases of that technology developing.

So we are certainly absolutely going to pay attention to it, but at this time we are not going to make a product announcement about what capabilities or when.

Understood.

Tom, if I could follow up on your point.

If you look at dollar spent today in the long-haul, do you think we are at the crossover point?

The port obviously on 40G are lower than 10G in terms of dollars.

And in the long-haul are we getting close to parity between 40G and 10G in the long-haul?

On gross dollar spent?

Not on price per -- price per 10G equivalent but on gross dollar spent?

On gross dollar spent.

I would say we are probably getting fairly close.

I will have to follow up exactly back with you, but I suspect the industry is probably getting fairly close.

Therefore, (inaudible) your addressable market is only really top of the long-haul market in dollars spent of 40G.

I mean until you get your 40G line card, you're really only addressing half of the market -- of 40Gs becoming half of the market.

Is that a fair way to think about it?

I think the buying cycle of our customers are such that as Tom indicated, we will be bringing our 40G product in Q3, they are in the process of integrating that into their buying plan now -- aspect.

I think when you look at the market numbers you'll get from the research analysts you have to be a little careful also, because the line system, which is identical between 10G, 40G and 100G tends to work the relative dollars in any one particular market for that.

Those dollars are frankly neutral to the 10G or 40G market.

So the total dollar available to the 10G market is certainly more than the ratio of the transponder values.

I also think it is very important to segment out -- and David is right -- every time our customer today buys a line system from us, that is a 40G ready line system or 100G ready, so that is money that we are not losing to market.

But if you pull back and say -- who is buying 40G?

Approximately half of it is going to China.

I don't care if we have 40G for free, we are not going to sell any to China.

So we are not losing half of an available market.

Half of the available market is closed to us.

The other big portion of the 40G is going to AT&T and Verizon.

We haven't won AT&T and Verizon yet.

So it is not a choice of can they buy our 10G or our 40G or our 100G, that market is not available to us today.

So if you were to ask me what percentage of our truly available market are we losing today because it, it is a very small percentage.

Now that doesn't mean that we aren't anxious to recover that.

But I don't want you to walk away saying that either we are losing half the market opportunity today or when we bring out 40G that half the market doubles.

It is not true.

Fair enough.

I was thinking in aggregate market terms, but certainly with your customer mix I understand that percentage is quite different.

And recognize China is nobody but the Chinese's customer mix, right?

That is a big portion of the 40G market.

Thank you.

Michael Genovese, MKM Partners.

In your comments -- in your guidance it sounds like in the second quarter you expect to sell more common equipment than you did in the first quarter.

I was wondering if you could comment on what that is.

Is that 10G -- new 10G chassis going out?

Is that more weighted towards terrestrial or underseas?

I think it is a combination.

We are going to sell common equipment line system, which will be 10G, 40G and 100G ready, so it is not the actual common equipment -- the line systems that we are putting are not linked to a wavelength or a transmission speed.

So we are seeing a number of -- and you'll see this in our customer account next quarter -- of fairly sizable opportunities, some subsea content and terrestrial content.

So I think is a good thing to see some of that common equipment back in the mix, because the last couple of quarters where we have had the 50%, 51% gross margin we haven't had that same level of common equipment.

Okay, and then on those gross margins -- with Kevin's question earlier, that discussion made me wonder, does the long-term business model of the Company change?

At 10G you laid out a certain revenue level you can get to, and 50% gross margins to get to an operating margin target.

It sounded to me, although I may be interpreting -- reading too much into it, you are saying with 100G the gross margin sounded like it wouldn't necessarily reach that 50%.

Am I reading too much into that or is there a different business model for the Company at 100 versus 10?

No, we are not changing the business model at all.

In fact, we think the 100G product, with all of its added switching and greater level of switching and bandwidth management capabilities is actually a driver towards that business model.

I think the discussion with Kevin around margins is very much focused on the 40G product and the discrete 40G.

But once we get back to PIC-based 100G system then we believe that very much contributes toward achieving that business model.

I will make two comments on addition to that.

We are at the most expensive phase right now of bringing to market our 100G platform.

We are having to invest in new manufacturing capacity, both for a system and for the PIC, so we're building capacity today that will be utilized across the next decade.

The second thing is the 100G cycle is probably going to be 15 to 20 years or more.

The 10G cycle started in 1997, so we are, what, 13 years into it.

We didn't bring out our 10G solution until 2005.

So we caught it in the middle of the cycle.

We should have a very good opportunity coming in at the early part of a cycle, making the capital investment at the early part of the cycle that we can actually have a very, very good business model as these volumes take into the industry.

We can accelerate the demand.

And I'm actually -- as Ita pointed out, I think the 100G opportunity is the first time that we actually get to test our business model.

If I could just slip one in before the end.

Thanks, Tom.

On 40G, your early opening comments sounded extremely confident, talking about interim 40G deployments on a tactical basis with competitive solutions.

You sound very confident about your competitive position in your customer base.

I just want to ask you the question, do you think that if they choose somebody else for 40G does that do not change the competitive situation on the account?

What makes you so confident that these guys are all going to come back for 100G with Infinera?

I never confident that if we lose somebody they come back.

I [crawl] a wall of worry around that.

Every day I want to make our customers satisfied.

The reason I feel confidence, and, please, don't take it as arrogance or lackadaisicalness.

Everybody we talk to wants 100G today at 100G economics, with the proven ability to go to market in volume.

That just doesn't exist today.

But everybody wants it, and everybody can see it in the relatively near term.

If two years ago there was big questions of whether it was going to be 40G or 100G.

Even a year ago there was some question.

I don't think there is a question today.

Either when I talk to customers, potential customers or see a universe of industry analysis, there is a fairly consistent story that they want 100G at good 10G type of economics, 6 times 10G economics or even 10 times 10G economically quite frankly.

So I feel pretty comfortable that the consistent story is that the world wants to move to 100G.

At the same time, we are going to deliver a world-class 40G product.

That is for our installed base so that they can upgrade the network absolutely the most cost effective way.

There is no customer we have that can upgrade to a 40G network more efficiently than to upgrade our platform with our line card, because it is already installed.

It is already 100% in use, and all you have to do is buy an upgrade line card.

So we are going to be very sensitive to making sure that is a good long-term decision for them also.

But I think that if somebody makes 100G PIC today, I still think it is an early enough time in the industry that those decisions are going to have an opportunity for second vendoring.

I just think it is very, very early parts of this 100G deployment.

Thanks a lot.

Good luck.

Thank you.

I want to thank you for joining us today and for your questions and continued interest in Infinera.

We look forward to keeping you informed of our progress.

Thank you.

Thank you for joining today's conference.

That does conclude the call at this time.

All participants may disconnect.