Infinera Corp (INFN) 2011 Q4 法說會逐字稿

Welcome to the fourth-quarter year 2011 investment community conference call with 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 call over to Mister Bob Blair of Infinera Investor Relations.

Sir, you may begin.

Thank you.

Today's call will include projections and estimates that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements address the financial conditions, results of operations, business initiatives, views on our market and customers, our products and our competitors' products and prospects of the Company in the first quarter of fiscal year 2012 and beyond, and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

Please refer to the Company's current press releases and SEC filings including the Company's Annual Report on Form 10-K filed on March 1, 2011 for more information on these risks and uncertainties.

Today's press release is including fourth-quarter and fiscal year 2011 results and associated financial tables and investor 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 release we announced operating results for the fourth quarter and fiscal year 2011, which exclude the impact of restructuring 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 press release for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful and how they are used by management, which will be available today on the investor section of our website.

On this call we will also give guidance for the first quarter of fiscal year 2012.

We have excluded non-cash stock-based compensation expenses from this guidance because we cannot readily estimate the impact of our future stock price and 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 Dave Welch and CFO Ita Brennan.

I will spend a few minutes today commenting on the market, touch on our Q4 results and then provide an update on the reception to our new products before turning it over to Ita for a full review of our Q4 performance and Q1 outlook.

Internet bandwidth continues to expand with unabated growth driven by video, mobile, and cloud computing applications.

Simultaneously, we are observing the transformation of the Internet into the primary and mission-critical telecommunications network of the future.

We believe these trends are causing service providers to take a hard look at how they build and manage their next-generation transport infrastructure.

This transformed transport infrastructure will need to scale smoothly to multi-terabits of optical transmission starting with 100G and quickly moving to terabit capacities, efficiently accommodate more fluid cloud-based traffic demands, and support mesh networking while maintaining the predictability and reliability of transport networks, and become simpler and more cost-effective requiring significantly less human resource, power, cooling, and space per bit of traffic carry.

We believe our recently launched DTN-X is optimized to accelerate this important transformation.

Our competitors are starting to ship 100G and present concepts and demos of 200G on a line card.

Customers are testing our DTN-X today with 500G super channel line cards and we have already demonstrated technology to go to one terabit super channel capacity on a single card.

The DTN-X is the step function that service providers and, in paricular, Tier One carriers need to properly prepare their networks for the high-capacity future.

We believe that our new DTN-X in conjunction with our enhanced DTN and existing ATMs all with control plane unification software enable us to better address our traditional customer as well as a new set of Tier One customers across verticals and geographies.

In Q4, we saw an active market in the cable, Tier One and bandwidth wholesale segments.

While much of the industry conversation and our own go to market strategy centers around 100G and greater than 100G super channel speeds, the 10G market remained strong.

It is a consensus view among analysts that 10G will continue to grow in volume throughout the next several years and we believe will remain robust for another decade.

In fact, we believe the strength of the 10G market was a key factor enabling Infinera to achieve the number one share position in the North America terrestrial long-haul WDM transport and roto market and advance to number 3 worldwide, based on Infinera's data for the third quarter of 2011.

Our view continues to be that 40G will flatten out and serve as an interim solution as carriers continue to deploy more cost-effective 10G for lower capacity links and move to 100G and 500G super channels for high-capacity links.

Our opportunity is clearly defined -- maintain leadership in a 10G market and repeat that success with 100G.

We also continue to see an increasingly competitive pricing environment which we expect to remain so as multiple vendors now compete with three DWDM transmission speeds -- 10, 40, and 100G.

We are also seeing market consolidation among our carrier customers, reducing the universe of customers and increasing the leverage of each customer as they become larger.

Our better-than-expected revenue performance in Q4 reflects continued solid demand for the DWDM equipment along with the benefit of some unanticipated year-end budget spending by a number of our customers.

We recovered well from the disruption caused to the optical supply-chain by the historic flooding in Thailand, muting the negative impact to our performance that we had originally signaled in November.

Our operations team at supply partners worked tirelessly to deliver on our disaster recovery plan and ensure that our customers were not hurt as a result of this catastrophe.

Although the vast majority of our Q4 revenue was 10G related we did achieve our first 40G revenue, addressing pent-up demand from key customers.

We saw broad balance across our customer base in the fourth quarter with the top five customers accounting for approximately 40% of revenue.

Two cable companies were among our top five customers including one in excess of 10%.

I am also happy to report that one of our Tier One customers win as our top five for the second consecutive quarter.

As a reminder our strategy has been to demonstrate our value in the international and regional networks of Tier One carriers with a DTN and then to leverage the multi-terabits scalability, efficiency, and simplicity of the DTN-X to earn an assertion opportunity in their core backbone networks.

On the customer win front we added five new customers in the fourth quarter.

This gives us 16 customer additions in 2011 for a total roster of 98.

Given that we were primarily shipping our 10G DTN for most of the year, the growth and stability of our customer base is a testimony to the importance placed on the Infinera value proposition, anchored of course by our differentiated digital optical approach to the network.

In another validation we now have 36 network customers, customers who have purchased multiple products from us across multiple applications.

On the new product front customer interest in our new DTN-X since its launch has been very strong, which we believe is in recognition of the unique advantage Infinera's integrated platform brings to market, the only platform operating integrated DWDM and OTN switching functionality without compromise.

As a reminder, this platform is fundamentally three products in one.

A DWDM transmission system that will support the world's first 500G super channels based upon 100G flexible coherent channels upgradable in the future to 1 Tb super channels unleashing highly efficient DWDM transmission capacity at the lowest operational cost, an integrated OTN switching system that will scale from 5Tb in its first release, 100Tb in the future and will enable operators to efficiently tame these large pipes through grooming of traffic down to 1G granularity.

And third, a system that is designed to be upgradable to MPLS switching in the future which will further enable convergence of the network for improved efficiency, reducing the number of interconnections between layers while preserving network investment.

Infinera pioneered the integration of OTN switching and DWDM with the DTN in 2005.

Leveraging this unique learning for more than a decade of development and seven years of field operation, the DTN-X integrates three technology building blocks to deliver value and differentiate itself from the competition.

500G photonic integrated circuits with flex-coherent DSPs, custom switching ASICs, and a multi-terabit nonblocking switch fabric, an intelligent GMPLS control plane software that scales to thousands of nodes.

The DTN-X design has been optimized to meet the needs of Tier One carriers and addresses their need to prepare for extremely high capacity and dynamic networks, opening up a large and new market for Infinera.

Competitors are following Infinera's architectural lead, announcing integrated solutions.

However unlike the DTN-X, design for this integration from day one, competitors are taking existing systems and adding DWDM or switching after the fact.

This approach results in a compromise between the switching and transmission capacity of these systems.

This does not occur with the DTN-X.

We believe the DTN-X will be the only platform on the market that will allow all components including the optical functions based on our PIC technology to be consistent with Moore's Law, delivering best-of-breed switching integrated with best-of-breed DWDM without compromise.

The DTN-X is on track with lab trials in Q1 and volume production starting in Q2.

We have begun to scale the production capability and the 500G PICs have been released to manufacturing.

On the trial front we have scheduled four DTN-X lab trials in our current quarter.

All four of these trials are with Tier One carriers reflecting a mix of both new prospects and current customers with two located in North America and two located in Europe.

In addition to these trials we have had numerous demonstrations of the full DTN-X system.

While we are pleased with the early interest by the carriers in our DTN-X by form it is important to note that Tier Ones often have extensive qualification testing and that a lab trial is only one of several steps toward revenue.

In the quarters ahead we will report to you on additional trials and DTN-X wins.

Infinera's mission is to transform the way telecommunications transport networks are built.

Our first step on this journey was the DTN introduced in 2005.

This platform delivered the world's only commercially available 100G photonic integrated circuit, the world's first optical transport platform that integrated DWDM OTN switching and a GMPLS control plane into one platform and the world's first digital optical network.

Our customers have validated this architectural approach of integrating photonic elements, platforms and network players, delivered network scale, efficiency, simplicity and reliability.

We are now taking this [decutive] experience and are scaling and improving upon this architecture for the DTN-X.

Infinera is delivering on the promise of the terabit age in 2012 and preparing our current and future customers to transform their networks to scale efficiently across the next decade.

This is what the network will be.

Before turning it over to Ita for a detailed review of our Q4 performance and our outlook for Q1, I want to thank the Infinera team for their continued commitment to innovation and their focus on execution, allowing us to make sure we deliver on the promise of helping our customers be successful in their markets.

I want to say a special thanks to our supply partners that helped us navigate a uniquely challenging Q4 and I will close by thanking our customers for their continued business and partnership as we move forward into the terabit age together.

Ita will now provide you her review of Q4 and outlook for Q1.

Ita?

Thanks, Tom.

I will review our Q4 actual results and then follow that up with our outlook for Q1 2012.

This analysis of our Q4 results and our guidance for Q1 2012 is based on non-GAAP.

All references exclude non-cash stock-based compensation expenses.

As outlined on the September call, our revenue guidance for the quarter had a wider range than normal due to uncertainty around the timing of revenue recognition on a number of large deals.

The flooding in Thailand which occurred just after our call triggered notification from the supplier that they would not be able to achieve their previous supply commitments.

This increased the uncertainty around our revenue guidance and required us to expand the range of potential outcomes in a subsequent press release.

As Tom mentioned in his remarks, we were successful in securing supply of impacted components and met most customer requirements.

In addition, we completed and recognized revenue on all three large deployments that were targeted for completion at or around the end of the quarter.

This included recognizing the first revenue from our 40G solution.

As often happens in the industry, we also had a number of customers approach us with some year end budget money and we were pleased to be in a position to accept and satisfy that demand in the quarter.

All of these factors resulted in total GAAP revenues in Q4 of $112 million compared to our original guidance of $100 million to $110 million and our revised guidance after the Thailand flood of $85 million to $105 million.

Our revenues were broadly diversified across our customer base with one greater than 10% customer in the quarter which, as Tom mentioned, was a cable provider.

We saw a healthy mix of new footprint deployments combined with continued strong TAM shipments.

International revenues amounted to $34 million or 30% of total revenue for the quarter.

EMEA accounted for $24 million or 21% with APAC and the other Americas representing 5 and 4%, respectively.

Our service revenues for the quarter were $18.4 million, up from $13.6 million in Q3, reflecting the completion of a number of large deployments and renewal of some significant [entitlement] contracts.

Services margins were favorable at 68%.

Overall gross margin in Q4 were 42%, up from 41% in Q3, reflecting continued strong TAM shipments, improved volumes and a healthy services mix.

Operating expenses for the quarter were $53 million in line with our guidance and compared to $52 million in Q3.

Looking forward to the March quarter we expect operating expenses to be approximately $54 million, reflecting increased R&D testing and verification activities as the DTN-X product moves closer to final release.

Overall headcount for the quarter was 1,181 versus 1,151 in Q3.

Headcount additions primarily related to direct labor from manufacturing and from software verification adds for R&D.

Our operating loss for Q4 was $6.3 million, other income and expense for Q4 was favorable at $0.1 million.

Net loss for the quarter was $6.7 million, resulting in a loss per diluted share of $0.06 compared with our original guidance which called for a loss of $0.08 to $0.12 per diluted share, and compared to a loss of $9.2 million or $0.08 per diluted share in Q3.

Now turning to the balance sheet.

Cash, cash equivalents, restricted cash and investments ended the quarter at $253 million versus $276 million in Q3.

We used $5.1 million of cash from operations in Q4 versus generating $4.1 million in Q3.

DSOs were 65 days, up from 60 days in Q3, mainly due to shipments occurring later in the quarter as we work through supply issues.

Inventory turns were 2.9 times versus 3.5 in Q3.

As a result of executing on our disaster recovery process, some double sourcing occurred and we exited the quarter with higher DTN inventory levels.

We expect to consume these inventories in the first and second quarters.

We also began production of components for the new DTN-X product and plan to ramp this production in the March quarter.

As a result, we expect to drive increased inventory levels over the coming two quarters in advance of recognizing revenue on the DTN-X in the second half of the year.

Accounts payable days were 53 days up from 43 days in Q3, again reflecting delayed receipts from suppliers in the quarter.

Capital expenditures were $16.1 million in Q4 versus $5.9 million in Q3 for a total of $39 million for the year.

As we look to 2012, we expect CapEx to average approximately $10 million per quarter for the first half of the year and then return to lower levels in the second how.

Now turning to our guidance for Q1 2012 and beyond.

We may experience some seasonality in the first quarter as service providers typically take time to plan their annual budgets and deployments.

As a result we have been somewhat cautious with our assumptions around TAM shipment volumes for the March quarter.

In addition, expecting recent success in new footprint wins, we plan to take revenue on a number of significant deployments for both new and existing customers driving a stronger common equipment mix.

As mentioned above we will ramp DTN-X related production in both our fab and module factories this quarter and, depending on volume and yields, this may drive some growth margins volatility.

As we look beyond Q1 2012 we see good overall demand for our products and strong interest in the DTN-X platform.

Revenues in the second quarter may be tempered by some existing customers choosing the DTN-X for their new footprint deployments.

We expect that the shipment and acceptance criteria for these initial DTN-X deployments may push revenue recognition for this business into the September quarter.

With these factors in mind, the following guidance for Q1 is based on non-GAAP results and excludes any non-cash stock-based compensation expenses.

Revenues of approximately $102 million to $108 million, gross margins of approximately 38% to 40%, operating expenses of approximately $54 million, operating and net loss of approximately $11 million to $15 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 $0.14.

Please note the basic share count is expected to be at $108 million for the quarter.

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

Thank you.

(Operator Instructions).

George Notter of Jefferies.

I guess I wanted to just get updated on, again, the delivery of the DTN-X.

Can you just lay out for us which milestones are still in front of us in terms of I don't know if it is software verification or just walk us through what is left in terms of development to get that shipping commercially?

Sure.

We are in two phases right now.

As we mentioned we are in the process of doing customer lab trials.

That is always a good way to validate the performance that you are expecting matches the market requirement.

So that process has started and I anticipate that we will both do well and discover things that we need to work on.

The vast majority of the work is, as you point out, in the back end testing process and system validation testing.

It is a product of magnificent scale and with that scale comes complexity, and we are going to make sure that we introduce this platform, it comes with the reputational quality that Infinera delivers.

So the bulk of the remaining time is in system validation testing, making sure that the switching functionality works as planned.

All the alarms on the system that are [quite substantive] all work as designed and I suspect we will stumble across some bugs that need software fixes.

So that is really the next major milestones.

The development work is vastly done.

Okay.

So I guess just to I guess more finely tune the delivery -- I assume the delivery then for trials is late Q1.

Is that fair to say?

What we said is that we scheduled have scheduled four for Q1 and that volume production will occur in Q2.

We -- I am reaffirming that that is our current plan.

Of the four trials we have scheduled we have actually completed one and so we are marching down the path.

Great.

And then you mentioned earlier that there was some pent-up demand associated with the 40G line card delivery and then, certainly, some budget flush also here in the quarter.

Can you tell us how much that was, relative to the $112 million you printed here?

Yes, I think the year-end budget are just probably low single digits, millions of dollars it wasn't more than that.

I mean we executed on those large opportunities that we talked about in the original guidance and then we saw some upside in that range.

And then, I'm sorry the piece attached to the 40G delivery was that I guess that was also budget flush or --?

Didn't put a number on that but the 40G piece was planned.

We had talked about that on the last call that we had some subsea 40G business that was kind of on the bubble from a rev rec perspective and that happened.

So, I don't think we put a specific number on that but it is a large subsea deal so you can imagine that it is multiple millions of dollars.

And then just as I look out over the balance of the year and I think about you guys ramping the DTN-X, how should I think about that in terms of the margin profile?

Safe to say it will come initially at lower margins, you are working through the yield issues and then, over time, the margins ramp and how that compared to the current margin profile of the existing DTN?

Yes, it is tough to kind of plot it out on a quarter-by-quarter basis.

We did, we looked at the plan for the last call and we guided kind of to that 40% -- approximately 40% range for the year.

I think with the first quarter we put out a range of 38% to 40%.

That is kind of just some -- we haven't got a ton of visibility for the TAMs yet for this quarter.

Hopefully they come but as of right now we wanted to be somewhat careful about what we included in that guidance.

We did see a healthy mix of [commons] as well in Q1 which is probably maybe more than we might have expected initially.

So we are winning new footprint and we are seeing customers putting in new line systems even in Q1.

Whether that gets filled out completely with DTN or DTN-X will depend on what the customer needs but we are seeing kind of a heavy commons snacks.

So that is impacting the margins in Q1.

I think depending on where revenues actually turn out for Q2, we could see some kind of lower margin impact there maybe.

And then on the back end of the year then we sort of ramp some volume and start to utilize some of the overhead that is already in the cogs number.

We should start to see margins improve but averaging out to that 40% is kind of what our current plan would say.

Got it.

Great.

Thank you very much.

Blair King from Avondale Partners.

Ita, couple of quick questions.

One for you and maybe one for Tom.

When you mention in your preferred remarks about the revenue in the second quarter potentially being tempered by the DTN-X, does that imply or should we read into that that the second-quarter revenue should be down from the first quarter?

Yes.

I mean it is hard to tell at this point.

We are seeing a dynamic where really just on the new footprint deployment.

So I think that the existing DTN business is continuing to transact as normal but when customers are looking at new deployments depending on when exactly they are going to need that capacity, they will either deploy DTN in or they may want to start to deploy the DTN-X.

If it is DTN-X in Q2 that may push out to Q3 from a rev rec perspective, because there will be acceptance in some other criteria.

Blair, this is Tom.

The DTN and DTN-X are guided toward different markets.

They are guided toward some different customers, some customer overlap, some customer and market overlap.

But they are really specified to be two product lines or two products within one family.

The issue that Ita brings to rise is as we introduce a new platform, and my goal is that the customer base picks Infinera and I don't have a preference but quite frankly if the DTN does that better for them that's great.

If the DTN-X does that better for them that's great.

And now we have that DTN-X tool in their toolbox.

Some customers who might have bought a DTN might decide to go to the DTN-X because it has obviously more head room.

If that were to occur then, end of the day, we are winning the footprint and we are going to enjoy that business for a long time.

But it causes some volatility that we don't control right now and what we want to do is win footprint and help customers make the best choice for their long-term success.

So she is just letting you know that there is an unusual dynamic afoot in Q2 that is new for our customer base.

Right.

I understand that perfectly clear.

Thanks for the clarity.

The second question I had was, Tom, maybe you could just -- there's been questions in the past over the acceptance rate of not just Tier One but just broadly the customer base in general over the 100G market as well as the 500 channel, super channel product that you have coming to market and that that acceptance rate is ultimately what determines the ramp within that product.

So if there's -- you may not have a lot more clarity this quarter than you did a quarter ago, but to the extent that you do maybe you could talk a little bit about how you see that market unfolding for you this year.

A little bit more than just what you have done in terms of explaining the back half should be able to ramp and then if you'd take a (multiple speakers).

I am very optimistic that this platform, the DTN-X, is going to be well-received by the Tier One markets.

We've designed it for the scale of their networks.

We design for the complexity of their networks.

I think that they want to converge network layers because they see that the way to reduce network costs over time is much less a discussion around transponder costs, it is much more a discussion around network costs.

And I think the DTN-X is uniquely ready in the platform case to do that.

I think that the DTN and DTN-X, it is important that people don't confuse the DTN-X -- the DTN wasn't accepted into the core of Tier Ones.

The DTN actually had fairly good receptivity into Tier One just not into the core of their networks typically.

And that is because I firmly believe we introduced the DTN which was a 10G wavelength platform seven to eight years after 10G was brought to the market.

I think carriers need to make sure that as they are certifying new platforms they are doing it on a relatively early end of the technology lifecycle to make sure they get full advantage of the investment they make.

I think that our DTN-X platform with 100G is at the very earliest part of the 100G market and we are quite frankly creating the 500G super channel market.

I was very clear to point out that the four customer trials, lab trials, we have scheduled for Q1 they are all Tier Ones.

Two in Europe and two in North America.

That is pretty darn good for a brand-new platform that is still not released to market.

So at the end of the day, Blair, as you know all of this is interesting.

PO's will matter and wins will matter and we will be clear to you on what those are when they occur.

But I am pretty optimistic with the progress we are making to date.

Thank you very much.

Appreciate it.

Ehud Gelblum.

Morgan Stanley.

Couple of questions.

The four trial customers you have right now for the DTN-X, are they existing customers of your DTN or are any of them new people, new carrier customers?

It is a mix of existing and potential new.

So in that four is at least one possibly two new customers that are not currently Infinera customers?

At least one.

Excellent.

When you look at your Q2, you were talking about against this concept of potentially stalling some of your DTN customers with the concept of the DTN-X coming out momentarily.

I'm still a little unclear as to whether the concept is that we should be looking at Q2 as being a potentially down quarter or not because then you additionally were talking about how they are marketed to different customer bases.

So I am just trying to correlate those two and how we should look at Q2 and kind of the pacing for out there for the rest of the year.

Is it two scenarios and one scenario Q2 ends up being down and the other scenario gets you into being up?

If you can walk us through how you are looking at that.

And then what is the gross margin profile in both scenarios?

If people hold out for DTN-X in Q2, what does that mean for gross margin if they don't -- what does it mean for gross margin?

Yes, it's not that clear at this point exactly how it is going to play out.

What we're trying to do is to kind of at least paint some of the boundaries around what we see could happen.

I think on the DTN-X the key is the product is really -- and a lot of the opportunities that we are seeing with the product are with new customers.

That is back to Tom's comment.

But obviously there will be existing customers as well who have the capacity and will want to adopt the DTN-X.

I think what we're seeing in Q2 is we have customers who are deploying new footprint and they are putting in DTN to satisfy capacity and as soon as they can shift to the DTN-X if they require that capacity, then they will look to do that.

How that plays out specifically in the quarter is tough.

I don't think we see the existing run rate DTN business being impacted.

It is more on the choice on new footprint deployments and the timing of those.

That is tough to call.

I think from a gross margin perspective if there's a -- volumes are higher we will have better margins.

If they are lower if you take your revenues down then you will see some impact to margin.

But it doesn't matter though the types of revenue that we're seeing in Q2 in different scenarios?

I think either way, I don't think we will recognize revenue from DTN-X in Q2.

So it is really going to be a DTN revenue base in Q2 either way.

The question is do we impact any growth that we would have expected to see in Q2 because we see people waiting to transition to the DTN-X or not.

But I think the DTN base is there and we are not looking to -- there won't be a DTN-X impact in Q2 from a margin perspective.

I am going to add two comments.

One, the backdrop to me is what is happening in the macro market for transport and we are seeing relatively steady demand across all of our markets.

I think that that's a very healthy thing for our business, regardless of whether people (technical difficulty) DTN or DTN-X.

We are seeing a lot of activity.

We are seeing a lot of activity in various markets and I believe even the industry group is now saying that the long-haul market should experience some relatively good growth this year.

I think there is a question certainly in North America about AT&T and Verizon but I don't have anything to add to that.

But I can tell you across our customer base we are seeing people making investment decisions.

So the backdrop is, I believe that the environment for this year should be reasonably healthy.

Q2 adds a new dynamic that is new because we are introducing a new platform, and we believe that on the DTN-X, assuming we are fortunate enough to have the opportunity to sell to people, we will have a longer acceptance cycle.

A lot of our customers will allow us to accept upon shipment.

These are people that have large installed base with us.

We ship the product.

We ship add-ons and they allow us to recognize revenue because they have pre-certified it.

The DTN-X probably has a longer certification system or process than recognize revenue on shipment.

At least for the first bit it will be through certification.

That creates a revenue recognition dynamic that Ita is trying to in full disclosure share with you.

So for once actually it is a good thing that you don't have the Tier One exposure.

You know, you guys are seeing positive trends whereas a lot of your competitors are not.

So as we look finally at Q3, how confident are you that you can actually recognize DTN-X revenue in Q3?

Or do you think the cause of this revenue recognition issue on the new platform, it could push out in Q4 possibly Q1 of 2013 in terms of when you can actually start recognizing DTN-X revenue?

I think we are sticking to kind of the guidance that we have out there which is revenue in the second half.

We ramped production in Q2 and then we'll just have to let it play out.

We will update you obviously on the next call as to where we are.

We'll be closer at that point and have more visibility.

Very helpful.

I appreciate it.

Rod Hall of JPMC, your line is open.

I just had a couple of things to ask.

Tom, I just wonder on the trial if you guys could clarify what the pipeline for trial looks like?

I mean you have got these four people that are trialing.

Is that -- have you had to cut it off?

Do you have other people in line that want to trial it but you are just trying to limit it to those four Tier Ones?

Or do you expect by next quarter when you guys report to us to be talking about a considerably larger number of trials?

And can you give us any idea how many we might be looking at?

And then I also just wanted to ask about the DTN-X.

Let's say it all goes well, say the Tier Ones want to buy it.

How are you fixed for production?

I mean are you feeling pretty good about your ability to serve demand and what are you doing about distribution?

Let's say if you get those headline customers, I guess you will definitely get a longer line of people that want to come in and look at the product and potentially purchase it.

Do you feel like you have got the distribution in place to handle that kind of demand if it comes through?

Yes, on the first one, the trials -- we very specifically had decided to just talk about current quarter trials and I think that that is just a prudent thing to do.

So we are only talking about the ones that we have scheduled from Q1.

There is a pipeline of requests beyond our Q1 committed trials but I am not going to give you any more clarity on that.

My goal at every quarter will be to give you an update on previous trials, current trials for the current quarter and any activity of sales we might have achieved.

So that doesn't completely answer your question but hopefully it gives you a flavor for our thinking.

In regard to the DTN-X fulfillment capability, I will just so I guess talk philosophically for a minute.

If you remember last year we said we were going to raise our sales headcount because we had spent a significant amount of money bringing what we think is a very significant platform and technology to market.

Our view was that it would be inappropriate not to have invested in enough salespeople to sell the product.

That is in place.

The sales guys are out I think being productive.

Certainly, the trials make me think that.

And their actions have -- make me know that.

We are going to take the same philosophy to manufacturing.

In our business, being a vertically integrated manufacturer, as you look back on the 100G market last year it was forecast that it is somewhere between $100 million and $200 million somewhere in the area of 1,000 wavelengths or so.

If we are as successful at doing 1,000 wavelengths even if that is 100% of the market, that is insufficient for us to build the business model that we need.

Our job is twofold.

One, to deliver a compelling solution to the market based upon our 500G technology and cause the industry to adopt 100G as a primary vehicle and we are going to put the manufacturing capability and are putting the manufacturing capability to affect that.

Okay and I just want to clarify one thing too.

Maybe Ita is the right person to ask or maybe Tom, but these 5% and 10% customers would you expect the same ones in Q1 again or do you think that mix of top customers is going to change materially as we head into Q1?

Yes.

Typically if you look at that top five lists they do rotate in and out of there depending on whether we are doing new deployments et cetera with them.

So there's always a good mix across the segments but it tends to be a different player on a quarter-over-quarter basis.

Thanks a lot.

Michael Genovese of [MKM Partners].

Just two quick questions.

One, can you just comment on what you're seeing in the pricing environment?

And then, number two, I am going to ask using coded language but, since you mentioned the names of AT&T and Verizon I will just come straight out and ask if either one of those are in these four trial customers that you have for the DTN-X?

Thanks.

I will answer the first one first on pricing.

Pricing is a fairly interesting dynamic because there is now 10G, 40G, and 100G to all vying for footprint.

We continue to see 10G come down at fairly significant pricing kind of historic run rates of 10+ percent a year and typically this long in the cycle of a technology that starts tempering itself it doesn't seem to be tempering.

I don't think it is accelerating but is not tempering.

So I think the 10G pricing is going to continue to be downward.

40G is, I think, trying to keep up with that downward trend.

To the best of my view on 40G Coherent there really isn't a crossover yet.

I think it is close to it.

Some people will say it has crossed over.

Some people say it hasn't.

My view is it is roughly at parity and as long as it is at parity, unless you have fiber constraints or you want to make sure your network has more capacity in the future, 10G continues to be a fairly good economic answer.

I believe that 100G is still early on in this technology cycle.

I think that my view is that 100G will achieve crossover with 10G at the same time or approximately the same time as 40G.

I think that is why we continue to believe there is a 40G squeeze that will occur.

I think a number of people who have 40 and 100 today are selling a large installed base of 40G with the ability to upgrade to 100 because I think for them allows them more margin and an upgrade path to 100.

I think that is not an unreasonable approach.

Infinera's approach is going to be install with 100 at good competitive price and be ready to upgrade to 100 to a Tb and I think that if you look at the demand growth I think going from 40 to 100G is an interesting step.

I think going from 100 to a Tb or 500 to Tb is really the problem set that needs to be solved.

So I am pretty compelled to believe the value proposition that we bring to the market we can do that competitively for a fair return and bring our customers great value.

In regard to the second question which was are AT&T and Verizon within that fold of people on trials we are not making any comment on who any of those four are.

If I could get a quick follow-up here on the margins, really, is the pricing environment with the outlook this year for 40% gross margins and it is obviously a transition year and the product portfolio but is it still reasonable to assume a long-term target of 50% gross margins?

I believe that is probably still the guidance that is out there for the long-term margin.

That is the long-term business model.

I think as we look out we guide to kind of 40% through 2012 and then into 2013 you have started to see that margin expand as we start to get more volumes around the DTN-X and more balanced kind of commons versus sale in the network.

I think that will expand out into 2013 and then beyond you start to approach that higher kind of 50% range.

So it is kind of an expansion over time as you grow the top line.

Thanks.

Simona Jankowski of Goldman Sachs.

Just to clarify first of the four trials, are those customers who are committed to buying the product at this point or are they still more evaluating so they could still not convert to customers?

Any time that somebody is doing a trial I think the intention is to evaluate whether it solves a problem for them in their network.

As I tried to explain on the call, trials are a first step of a many step process toward a customer deciding that it is something they want to put in their network.

I think that companies are far too busy to send people to our labs for several days of testing just to be entertained in the California sun.

So I think that it's an indication to me that what we are bringing to market represents a solution to a problem set they either have or have in the future.

But it is just a first step in a many step process toward a purchase decision.

Based on your historical experience, what percent of trials typically convert into customers?

We don't give out that type of statistic.

The best way to look at it the people that are trialing their gear have a serious need for DWDM bandwidth.

They are in a purchasing cycle.

They are evaluating our product seriously for those considerations.

And you mentioned that some of your competitors have a 40G system that is upgradable to 100G.

Among carriers who have adopted such a 40G system do you feel like they have actively committed to that competitor's 100G roadmap or are any of them trialing your product and do you still feel like you have an opportunity to convert them to the DTN-X?

So I think anytime you have a current customer you have a certain level of incumbency.

There isn't a -- in this space, there isn't a hard lock in that inhibits that business to go into another competitor as well.

Great, and then just lastly can you just clarify what you meant about the segmentation of the DTN-X in the DTN-X?

Cause clearly they both can and -- can sell into the Tier One customer base.

So did you just mean more that within a single customer they can target different parts of the network or if you can just expand on kinds of the tiering that you are referring to.

As we have talked about before, our DTN products for national Tier One markets really hasn't been fully appropriate for the large Tier Ones.

The DTN-X is, does the their maximum fiber capacity, their density and now the integrated OTN switching that satisfies a lot of key tech sectors.

So by bringing the DTN-X to market we substantively improved our accessible market from that.

So there will be a new market addition on the DTN-X as well as some overlap with our current DTN customers, as well as a bunch of our significant amount of our DTN customers are perfectly happy at the capacities and positions we have been at.

As we have talked about North American share in the past, we have developed a number one position within North America without the existence of the largest Tier One customers in North America.

We think by bringing a DTN-X on board to complement that market position that will broaden out our accessible market.

If you also look at the DTN versus the DTN-X, a single card on the DTN-X comes as 500G of capacity.

That is more capacity than the entire DTN chassis handles.

So it is a -- they can certainly work on the same application but if you need significant scale you are going to go with the DTN-X.

If you don't need something that goes up to that capacity, the DTN is an exceptionally affordable and proven platform to achieve simplicity, efficiency and scale.

Great.

Thank you.

(Operator Instructions).

Nathan Johnsen of Pacific Crest Securities.

You talked some about crossover points between the various speeds.

I was wondering as you guys look at the, I guess, yield roadmap for DTN-X and what you are assuming for price reduction on the DTN, just wondering where you actually see a potential crossover point for DTN-X versus the DTN?

I mean, is that a 2013 event or is that maybe not the right way to think about it?

I'm sorry a crossover point from a --

From a cost per bit.

I -- we think that the DTN, you know, you have got to look at it from a network point of view as opposed to people try to take systems companies and push them down into a transponder market.

It is not.

It is a network market.

From a cost per bit, if I have a large mesh network with integrated OTN, the DTN-X is a better performer out there just because of the integration of the OTN switch.

You know, you have absorbed a lot of gear that would have otherwise sat in another chassis next to your DWDM platform.

That poor guy that has a non-large mesh network but is really looking at a singular point to point type of network then -- and is happy with capacities in the Tb or less range, you know, DTN is going to be a preferred economic solution for it.

And so, at a network level if you measure these things at a network level you are going to come up with a different answer.

If you try to push both of these products into a transponder equivalent pricing, you are not going to come up with the right answer because it is not a component.

It is a system.

And then looking at yields of I guess the key DTN-X components, particularly the PIC.

I was wondering how current yields for that product compared to previous tech generation, just whether those are on track at this point.

Yes, so specific on numbers we don't put out numbers on either.

When we define production we define our ability to meet entitlement yields which would mean I can get to the proper economic solution for the DTN and DTN-X; and I would say they are comparable in that range.

And last one for me.

You guys have talked about the feature integration of MPLS capabilities.

Just wondering if you could provide an update on when you expect that to be added as a capability and whether you see that future capability being important for purchasing decisions now?

So we've talked about that the DTN-X is a system that is compatible with upgrades to include MPLS technologies in it.

We are absolutely marching down that path and we think the complement of all bandwidth management technologies which are at the optical level at the OTN level and up at the MPLS level on a common platform is what is required in the marketplace and the DTN-X offers that -- or offers the migration to include that.

We haven't put a date on the integration of the MPLS and I don't think we are at the stage where we want to do that just yet.

But we have got a fair amount of expertise announced that understands that problem and I would say it's safe to say we are working down that path.

I apologize I have forgot your second question.

Just curious whether that's being thought about in purchasing decisions now or if that is something that you will start pushing to customers later?

Yes, I would put it in the area of an interesting topic for architecture teams but not in a decision-making topic.

They like to hear on where my -- where their network is going to go several years out.

They like that they need to have a vision that says that my network level that might cost per bit and that my power per bit et cetera are all decreasing and they understand that layer convergence is part of that solution for them.

But their decisions now are not being dictated by the need for an MPLS today.

Very helpful.

Thank you.

Kevin Dennean of Citi.

Just a few random questions.

I guess, Ita, for you -- should we think about the investment in salesforce ahead of the DTN-X, should we think about that as being largely complete?

Or do we need to think about bringing more headcount onboard midyear?

Yes, no, I think we deliberately ramped it ahead of the revenues last year and we feel like we are pretty well positioned from a headcount number and expense right now.

Thank you.

And I know you are not giving the mix of 40G but within the gross margins this quarter, specifically product gross margins, was there any noticeable impact from 40G, given that it is a non-PIC merchant-based solution?

There is a little bit of a difference but not enough to impact the corporate margins, and the mix of it was not significant enough that it would drive corporate margin impact.

Is that a faction of it not being a substantial difference or it not being a big enough part of the mix?

Probably a little bit of both.

I mean the impact is not that significant and it didn't drive enough revenue to move the needle on that basis.

And last one from a comment, Dave Welch was just talking about eventual development of MPLS capability.

Do we need to think about at some point in 2012 or 2013 and a step up in R&D expense to support that effort or is that process underway now and it is already in the numbers?

It is baked into the numbers.

We are not -- we are staying within consistency within our R&D burns that we have communicated to you.

We have been working on the problem and we think we have some good things that we can add in that space, and you'll start to see maybe we'll start talking about that maybe towards the end of the year or whatever with our product plans are.

Terrific.

Thank you.

Sanjiv Wadhwani from Stifel Nicolaus.

Just two quick questions on the DTN-X.

First question is, I know you have highlighted trials with four Tier Ones.

Any color at least in North America whether they are just regular telcos or MSOs or Internet companies, any color over there would be helpful.

We are not going to comment on any more clarification of that.

Okay.

And with the trials starting this quarter what's sort of the -- is it the next step is probably first office application, is that sort of something that happens in Q2?

Is that a Q1 event?

Any timing on that or any clarity on whether that is the next step indeed?

It is all consistent with what we have said repeatedly is and we are going to trial and engage customers this quarter.

We are going to ship volume products in 2 or have manufacturing capable of shipping volume products and we are going to realize revenue in Q3.

And so, different customers have different processes.

Some are faster than others, some are slower than others.

And I'm not sure what else, what other details you want to get into.

That's helpful.

Thanks.

Thank you for joining us this afternoon and for your questions.

We look forward to staying in touch in the months and quarters ahead with reports on our continued progress.

Have a great day.

Thank you.

That does conclude today's conference.

Thank you for your participation.

You may now disconnect from the audio portion.