Infinera Corp (INFN) 2012 Q1 法說會逐字稿

Welcome to the first-quarter year 2012 investment community conference call of Infinera Corporation.

(Operator Instructions).

Today's call is being recorded.

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

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

Bob Blair of Infinera Investor Relations.

Sir, you may begin.

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 condition, results of operation, business initiatives, views on our market and customers, our products and our competitors' products, and prospects for the Company in the second quarter of fiscal-year 2012 and beyond, and are subject to risks and uncertainties that could cause the 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 6, 2012, for more information on these risks and uncertainties.

Today's press releases, including results of the first quarter of fiscal-year 2012 and associated financial tables and investor information summary, will be available today on the investors section of Infinera's website at Infinera.com.

The Company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.

This afternoon's press release and today's conference call also include certain non-GAAP financial measures.

In our earnings release, we announced operating results for the first quarter of fiscal-year 2012 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 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 investors section of Infinera's website.

On this call, we will also give guidance for the second quarter of fiscal 2012.

We've 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 Dave Welch and Chief Financial Officer Ita Brennan.

I will start with some commentary on market trends and how we believe they will impact architecture and technology choices by service providers moving forward.

Then I will provide an update on the reception to our new products and highlight some results from our first quarter before turning it over to Ita for a full review of our Q1 performance.

We continue to see three fundamental trends that are driving significant network traffic growth -- cloud, mobile, and video.

First, cloud continues to grow in importance for our service provider customers across both enterprise and consumer applications.

Forrester Research predicts that the cloud service market will approach $240 billion by 2020.

Many analysts predict that most applications in the future will be cloud-based, increasing the role of the network.

We see cloud growth driving a need for large amounts of optical bandwidth that can be provisioned quickly to absorb unpredictable spikes, in the case of disaster recovery or for large workload shifts.

In order to satisfy this without wastefully overprovisioning these networks, carriers will require an optical layer that delivers large pools of virtualized bandwidth that can be deployed quickly, in minutes instead of days or weeks.

Second, mobile traffic is growing rapidly, driven by increasing access rates, combined with an explosion of smartphones, tablets, and wirelessly-connected laptops.

Industry analysts estimate mobile data usage will grow approximately 18-fold by 2016.

There has been tremendous investment in 3G, 4G, and Wi-Fi infrastructure, but these are simply access methods into the wired backbone, and we anticipate this dramatic increase in mobile traffic will require additional optical investments.

Finally, we believe that streaming video will continue to be a huge driver for added optical capacity.

Video is streaming from multiple sources, including user-generated content from YouTube, from aggregators like Netflix and Amazon, from content creators like HBO via service providers delivering managed IPTV services.

We are also seeing improved quality in each stream from standard definition to high definition and on to 3-D.

This growth in video traffic is being further amplified by cloud-based service delivery, mobile access, and significantly increased wired broadband access capacity.

Overall, we see these trends underpinning the requirement for a significantly increased investment in optical transport spending.

We believe this optical reboot is a cyclical transition that happens about once every decade.

It has just begun, evidenced by some 19 million miles of optical fiber that were installed in the U.S.

last year, the most since the boom year of 2000, according to research firm CRU Group.

All of this fiber will need to be lit.

Dell'Oro sees that DWE and transport market growing at a five-year compound annual growth rate of 10% to $11.7 billion in 2016.

We believe that the traffic growth and patterns for cloud, mobile, and video data will require investment in a next-generation optical network that can scale smoothly to multi-terabits, while simultaneously delivering increased intelligence and functionality.

We believe that this increased intelligence and functionality will require OTN and MPLS switching integrated with DWDM into a single platform.

Dell'Oro calls this segment optical package transport where they include Infinera's new DTN-X and forecast it to grow at a five-year compound annual growth rate of 22%, attaining $7 billion by 2016.

Now, the challenge.

Operators continue to see a decline in basic connectivity [use] in the face of this tremendous growth.

For example, according to telecom market research firm TeleGeography, 10 GB prices linking London to Frankfurt are forecasted to decline 19% compounded annually from 2011 to 2018.

Historically, operators solve this problem by deploying increased optical transmission rates.

That would lower the overall cost per bit.

This faster pipe approach is no longer sufficient to meet the new demands of scale, increased optical network functionality, and a lower total cost of ownership.

Carriers need a new architecture to solve these problems, and we believe this, when paired with the commercial possibility of scalable DWDM and integrated OTN switching, will drive a major secular transition.

They need to move from a world of dedicated waves to flexible pools of nearly infinite capacity.

From [rig hitted] overprovisioned transport layers to an efficiently-converged transport infrastructure, and from manual operations to intelligent automation.

This architecture needs to not only scale with lower operational costs, but it needs to free up time and provide the tools to deliver new value-added services that drive profitable revenue.

We see this secular transition intersecting with the optical reboot cycle, providing an unprecedented opportunity that Infinera is uniquely well positioned to address with our DTN-X platform.

The DTN-X is ushering in a new era of next-generation network architecture, moving from the traditional world of multiple network layers, discrete analog optical implementations, and manually-provisioned all-optical networks to a converged, high-performance, automated digital optical network.

This is not a vision; it is a capability that we are shipping this quarter and only Infinera can deliver this now with DTN-X.

Infinera is an innovator, not a commoditizer, and we have built a vertically-integrated technology and supply model that allows us to develop and build leadership with all of the key technology elements required to deliver on this new architecture.

We believe vertical integration and the associated R&D investments are mandatory to win in the next phase of this market.

As proof points, here is a sampling of leadership technology differentiators that we bring to the table with the DTN-X.

First to architect and deliver a large-scale photonic-integrated circuit, now delivering our third-generation 500 GB PIC and already demonstrating results from our 1 Tb PIC.

First to architect and deliver FlexCoherent, software, programmable, coherent transmission that optimizes reach and capacity while reducing costs.

First to architect and deliver 500 GB long-haul super channels, scaling capacity without scaling operations and upgradable to 1 Tb superchannels in the future.

First to architect and deliver a platform that integrates 5 Tb of best-of-breed nonblocking OTN switching with best-of-breed DWDM transmission without compromise.

First to architect and deliver a platform that is upgradable from OTN switching to MPLS switching and that is also upgradable from 5 Tb to 100 Tb of switching capacity in the future.

I cite these achievements to highlight our innovation and technology leadership, and to point out that only now are we seeing our competitors follow in our path with their roadmaps.

We are confident that photonic integration brings higher densities with reduced power and space, lowering cost in multiple dimensions while delivering tremendous scale on a single line card.

In the March quarter, two of our competitors purchased companies engaged in the research of integrated photonic technology, solidifying our long-held view that photonic integration is mandatory.

We believe that we are years ahead of these competitors in terms of execution, investment, and learning curve, and in our IP portfolio.

Based on our experience, we have also come to believe that truly understanding how to commercially manufacture PICs is an imperative for delivering on next-generation architectures and long-term success in this market.

While the industry is moving to 100 GB technology, we are leading the industry by envisioning and delivering commercially-available 500 GB FlexCoherent long-haul superchannels.

The OFC/NFOEC tradeshow this year, a number of competitors followed us with announcements and slideware around flexible modulation and metro superchannels.

While we appreciate our competitors' validation of the superchannel approach and the value it brings to customers, what is missing in these announcements is that their superchannel strategy doesn't meet the requirements of a long-haul network.

In long-haul networks, capacity dictates the operational and architectural benefits of superchannels.

They must operate over thousands of kilometers, and therefore must operate in a QPSK modulation format.

So, if our competitors deliver these metro superchannels in the future, they will be limited to applications of less than 700 kilometers of reach and are not applicable to long-haul networks.

Only Infinera is delivering commercially-available, 500 GB, long-haul superchannels today, well ahead of any competition.

We also believe the new architecture requires the convergence of DWDM and switching, married with GMPLS automated control.

Convergence is important to reduce OpEx and increase CapEx efficiency, while distributed switching delivers network flexibility or more add drop points and rapid deployment of bandwidth, all automated via GMPLS.

Only Infinera brings over 10 years of experience in developing and seven years deploying this converged architecture with a pioneering DTN and digital optical network.

Recently, we have seen a number of competitors announce their intent to retrofit switching to their DWDM platforms and retrofit DWDM to their switching platforms.

We continue to believe the new DTN-X, which has been purpose-built from day one for this integration, will be the only platform on the market that allows all components, including the optical functions based on our PIC technology, to deliver best-of-breed switching integrated with best-of-breed DWDM, without compromise.

DTN-X is being recognized by carriers around the world for its leadership design and innovation, and we strongly believe it is uniquely positioned to capture the opportunity being created by the intersection of the cyclical optical reboot and secular optical rearchitecture beginning this year.

At OFC/NFOEC this year, we announced our first DTN-X customer, Cable & Wireless Worldwide.

A new Infinera customer, Cable & Wireless looked at DTN-X as the sole platform for the Europe to Persia Express Gateway, known as EPEG.

To date, we received DTN-X purchase orders from four customers, one from Cable & Wireless Worldwide and three from existing customers, and we are in active contract negotiations with additional service providers.

We believe this early traction is a tremendous sign of confidence in the DTN-X platform and affirms our view that this is an industry-changing event.

Of the four Tier 1 trials planned in Q1, two resulted in purchase orders, one was split into phases and is ongoing, and one moved to an in-country trial now scheduled in Q2 at the customer's request.

Looking ahead, we have six new trials planned for Q2 for a total of eight planned trials in total.

These trials are a combination of Tier 1 global providers, cable operators, and bandwidth wholesalers, and they are also a mix of existing and potential customers.

I also want to note that we have started the OSMINE certification process to satisfy a North America Tier 1 associated with one of the purchase orders I mentioned already.

As a point of clarification, by Tier 1 I mean a traditional, large incumbent carrier, typically with in-region and out-of-region regulated and unregulated business.

This definition does not include cable operators, Internet content providers, or bandwidth wholesalers.

As we stated on our last call, we're expecting to begin shipping DTN-X in volume to customers this quarter and we expect revenue recognition in the second half of 2012.

As we signaled on our February conference call, we are seeing some existing customers choose DTN-X for a new footprint.

Implementing a new platform often includes a process of trialing, qualifying, and running first office applications, which can take one or more quarters.

This transition will result in reduced revenues in Q2 until revenue recognition kicks in for the DTN-X in the second half of the year.

As the capabilities and early success of the DTN-X challenge the more traditional approaches, we see competitors aggressively pricing their 100 GB offering as they compete for the same footprint during the optical reboot.

Gaining footprint now will advantage Infinera's gross margin opportunity over time more than others who are using less cost-effective commercially-available optical technology.

This footprint will allow us to leverage the scale advantages of a PIC-based vertically-integrated model as our customers fill these initial installs with up to 8 Tb of capacity.

As a result, we are competing aggressively for these new footprint opportunities.

Ita will describe how these factors are playing out in the near term when she provides our guidance, which will include some color on the expected revenue flow in the second half of the year when the revenues related to our early DTN-X success begins to materialize.

From our inception, Infinera's mission has been to transform the way telecommunications networks are built and to help our customers succeed.

It is clear that our customers are entering a time of great challenge and great opportunity.

We believe DTN-X provides a new architectural approach that moves the industry from a world of status quo and incumbency to a world of innovation, scale, efficiency, and simplicity.

We believe that this platform is squarely located at the intersection of two events, the secular inflection point requiring a new architectural approach and the cyclical optical reboot portending a renewed optical investment cycle.

Infinera is uniquely positioned with the DTN-X and we are committed to winning.

Before turning it over to Ita, I want to thank the Infinera team for meeting our commitments to customers and allowing us to deliver on the promise of helping them succeed in their markets.

And I will close by thanking our customers for their continued business and partnerships as we move forward into the terabyte age together.

Ita will now provide a detailed financial review.

Thank you.

Thanks, Tom.

This analysis of our Q1 results and our guidance for Q2 2012 is based on non-GAAP.

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

Total GAAP revenues in Q1 were $104.7 million, compared to our guidance of $102 million to $108 million.

We added four new customers in the quarter for a total roster of 102.

The imminent completion of three previously-announced mergers will reduce this number according next quarter.

We added one ATM customer in the quarter for a total of 33 ATM customers.

We had one greater than 10% customer in the quarter, which was an Internet content provider, with one cable operator and three bandwidth wholesalers completing the top five.

International revenues amounted to $31 million, or 29% of total revenues, for the quarter.

EMEA accounted for $26 million, or 25%, with APAC and the other Americas representing 3% and 1%, respectively.

Our service revenues for the quarter were $11.8 million, down from $18.4 million in Q4.

Service revenues in Q4 were higher than normal and included some catch-up amounts related to the renewal of a number of significant entitlement contracts.

Services margins for the first quarter were at 60%.

Overall gross margins in Q1 were 40%, down from 42% in Q4, reflecting a lower services contribution, somewhat lower TAM shipments, and a healthy common equipment mix.

Operating expenses for the quarter were $52.5 million and below our guidance of approximately $54 million.

This reduced spending versus guidance reflected some changes in the timing of some nonrecurring engineering expenses and the effect of some R&D cost savings in the quarter.

Looking forward to the June quarter, we expect operating expenses to be approximately $54 million, including OSMINE certification costs associated with the Tier 1 agreement and the rollover of some NRE costs from the first quarter.

Overall headcount for the quarter was 1,210 versus 1,181 in Q4.

Headcount additions primarily related to direct labor for manufacturing and some sales adds.

Our operating loss for Q1 was $10.4 million.

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

Net loss for the quarter was $11.2 million, resulting in a loss per diluted share of $0.10, compared with our previous guidance which called for a loss of $0.10 to $0.14 per diluted share and compared to a loss of $6.7 million, or $0.06 per diluted share, in Q4.

Turning to the balance sheet.

Cash, cash equivalents, restricted cash, and investments ended the quarter at $240 million versus $253 million in Q4.

We used $5.8 million of cash from operations in Q1 versus $5.1 million in Q4.

DSOs were 57 days, down from 65 days in Q4.

Inventory turns were 2.5 times versus 2.9 times in Q4.

Overall inventory levels increased to $102 million in Q1.

DTN inventories remained higher than normal due to some excess supply put in place to mitigate the impact of the Thailand floods.

Actions have now been taken to return DTN inventories to normal levels by the end of the June quarter.

We continued production of components for the new DTN-X product and we'll move the complete system to production in the June quarter.

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

Accounts Payable were 44 days, down from 53 days in Q4, reflecting lower inventory receipts at the end of the quarter.

Capital expenditures were $13.6 million in Q1 versus $16.1 million in Q4.

Q1 CapEx included final payments on some of the fab-related projects undertaken last year.

Capital expenditures are expected to return to lower levels in the second half of the year as all DTN-X investment activities are completed.

Now turning to our outlook for future quarters.

As Tom mentioned earlier, adoption of the DTN-X has been strong, and we are seeing some existing customers shift their new footprint demand to that platform.

As a consequence, we experienced lower-than-expected bookings on our DTN platform in the first quarter and exited the period with lower-than-normal DTN backlog.

We believe this is in part due to planned DTN-X transitions and may also be reflective of normal seasonality as our first-quarter bookings have historically been lower than other quarters.

Based on our current visibility, we expect overall bookings levels to recover in Q2, with the DTN-X expected to account for a meaningful portion of those bookings.

Since we do not expect to recognize revenue for the DTN-X in Q2, this will likely result in reduced revenue for the quarter.

However, this should allow us to enter Q2 with a healthy backlog and good prospects for topline growth in the second half.

At this point, we believe revenues for the second half of 2012 will range from approximately $230 million to $260 million.

Now turning to gross margins.

As Tom mentioned, we have seen more aggressive pricing from competitors and a number of new 100 GB footprint opportunities.

In most cases, we are responding with increased levels of upfront discounts in order to secure the initial footprint and have access to the future network fill.

Each fiber and line system deployment will now support up to 8 Tb of capacity, providing the opportunity to sell additional high-margin network fill in the future.

On the cost side, we are executing well, and our [add from fab] is in plan from an operations execution perspective.

We are experiencing good cost reductions in the fab and expect, based on current trends, that the DTN-X line module cost will decline satisfactorily over time.

We expect to recognize our first DTN-X revenues in the third quarter.

While these shipments should help topline growth, it may have a negative impact to gross margins in that quarter as we sell the first and highest-cost PICs produced in our fab.

All other things being equal, the initial footprint pricing dynamics described above, when coupled with a higher level of common equipment and the DTN-X ramp-up costs we'd already factored into our 2012 model, may result in gross margins for the year somewhat below our previous guidance of approximately 40%.

Importantly, we believe executing on winning this new footprint now will allow us to capture the volume needed to leverage our 500 GB PIC base line module cost advantage and drive to expanded margins in the future.

Looking beyond 2012, we believe that, with solid revenue growth, our vertically-integrated model can deliver significant leverage and allow some good margin expansion.

In addition, over time, we'd expect to see a more balanced mix of new footprint acquisition and network fill that should also improve our gross margin structure.

Now returning specifically to Q2 guidance.

While we expect Q2 bookings to recover, a meaningful proportion are expected to relate to the DTN-X platform and will not drive revenues for Q2.

In addition, the overall lower volume for the quarter, combined with a higher mix of lower-margin new deployments, is expected to pressure gross margins.

TAM shipments are expected to be in a range similar to Q1 levels.

With these factors in mind, 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 $100 million, gross margins of approximately 36% to 38%, operating expenses of approximately $54 million, operating and net loss of approximately $16 million to $21 million, and based on estimated average weighted diluted shares outstanding of 114 million, this would lead to a loss per share of approximately $0.14 to $0.18.

Please note that the basic share count is expected to be 110 million for the quarter.

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

Thank you.

(Operator Instructions).

Ehud Gelblum, Morgan Stanley.

Couple of questions, Ita, and Tom, if we can kind of go through the guidance and the pieces of that.

So we're looking at mid to high 90s for Q2.

How do you sure -- and then it picks up in the $230 million to $260 million for the -- so it picks up significantly in the back half of the year.

How are you sure that the deposit in DTN -- I know you had part of it seasonality, but how do you know the deposit in DTN is going to be picked up by DTN-X?

You are trialing it at eight people right now.

When you say you're going to recognize DTN-X revenue in Q3, is that with all eight or is that only with one and two of them?

I'm assuming Cable & Wireless is probably the first one you will recognize with, but when you saw the order book come down now for DTN, was that -- did it only come down for those eight that are trialing DTN-X or did it come down with other guys as well?

So, first of all, we have orders from four customers that we have already taken, and typically if we've taken orders from a customer at this point in the cycle, we would ship and revenue that in that current quarter.

In this case, we plan on shipping, but we won't be able to revenue that until the second half of the year.

Two of the customers -- two of the opportunities would be for opportunities that would be incremental for what the DTN would service, so without the DTN-X, we would likely not have one of those deals.

Two of the DTN-X POs that we have received to date are from customers that had we not had the DTN-X, I believe they would have deployed the DTN because they are investing in the DTN-X as a scalable future versus the DTN wouldn't be able to satisfy it now.

So I think that if I look at both the POs we've received and the eight trials, in addition to the four POs, we are seeing a mix of new opportunities that, without the DTN-X, we would not have an opportunity for and we're seeing an opportunity for our current customers to continue an Infinera path by the next-generation architecture.

So I feel pretty comfortable that the DTN-X will have an opportunity to sell to both types of customers, new and potential, but also current, and the fact that we are taking orders today, have four to date for different customers and normally would recognize that revenue, that revenue goes into the back half, which should be incremental assuming that there is some level of continued Internet demand for -- in general.

So all things being equal, we feel pretty comfortable that the DTN revenue will have a continued, ongoing, healthy revenue stream, and the DTN-X represents a new opportunity for new customers and opportunities that will be incremental to the Company where the DTN would not have satisfied it.

That's a long-winded way of answering your question, Ehud.

Does that answer your question?

It sort of does, although it does seem as though from the two -- the second of those two customers, second two of those pairs for which they would have bought the DTN but are now buying the DTN-X, it's somewhat of a pushout from Q2 into Q3, Q4, but it's the same demand they would have had anyway.

It sounds like you only have two customers that are actually adding DTN-X in that market expansion from the DTN-X.

And so, it seems pretty heady to see $115 million or, let's say, $120 million, $125 million revenue quarters in the back half of the year, just based on two customers that will have incremental.

What else gives you confidence?

Well, it's two customers to date and six additional new trials scheduled for Q2, and these customers that we are trialing are pretty big opportunity type customers that typically the DTN would not have allowed us to win.

So these are large-scale type customers that could buy a substantive amount of product.

I don't anticipate certainly all six will give us POs in Q2.

I'm hopeful that over a period of time, all six will give us POs.

And not all of that revenue would recognize or happen in this year, but some of it will.

And DTN-X is opening a new class of customer and a caliber of customer that is trialing with us, we are pretty satisfied with.

So it sounds as though we're counting on those customers, whatever portion of those six that trial in Q2, to come through and push through that $230 million to $260 million.

So my guess is if they're trialing in Q2, that revenue doesn't get recognized until Q4.

So it sounds like we're probably hugging $100 million in Q3 end up a much, much bigger number in Q4.

Is that right?

I'm not going to give you a Q3 number.

We gave you -- we spent a lot of time looking at what the opportunities are in the back half of the year, and as you know, the fidelity between quarters is challenging, but we feel comfortable with the $230 million to $260 million range in the back half.

I did mention that we are in contract negotiation with a couple of other people.

So it's not just that we have four orders and we have got to start to work on some others.

We are in the midst of contract negotiations with some other customers that I am highly confident will close this quarter.

Great.

One last thing, if I could.

The competition, this environment that you talked about, that you both talked about.

Is this -- it sounds like it's worse than it was six months ago.

What kind of -- what areas do you see it in?

Do you see in 10 GB as well or is it only in 100 GB?

Where do you see it, and is it from one customer -- or one competitor in particular or has the entire environment gotten worse, and what do you think predicated it?

Yes, I see -- as we have said, that for a period of time we have been competing aggressively with the DTN and have had to make commercial terms that would allow us to compete where we didn't have 100 GB.

So that has been fairly challenging and that is not new.

What is -- I'm surprising a little bit is that there is a lot of pricing competition for a 100 GB footprint, and it seems to be becoming more intense in certain areas.

Certain markets, like submarine, it's, I would say, the most intense, and I think that people view, like we do, that the opportunity to fill fiber capacity for a longer period of time with more bandwidth, you have to win that footprint.

So I think that there is a level of competition to make sure that there is an opportunity to create the fill based upon harder commercial terms up front.

Wouldn't that competitor feel the same way you do, and therefore aren't we stuck in a situation with no natural equilibrium?

I assume the competitor feels the same way I do.

You know, I think that the opportunity for this industry always is the fill is where you are allowed to make a reasonable return, and footprint right now during an expansion of market, I think, is viewed as critical by the participants in that market.

So I think it's going to be a fairly competitive environment.

George Notter, Jefferies.

I guess just back on that prior question, so you're talking about revenues in Q2 in the high $90 millions.

How many customers do you think you'll really experience an overhang and DTN demand from because of the DTN-X?

And I guess I'm wondering as we go out, you've got certainly many, many other customers in the fold for the DTN.

Is it logical that as those folks potentially start looking at the DTN-X, you'd have additional overhang and demand on your hands as we go out through the balance of the year?

I think, the way I view it, is it's not -- most of our customers who are interested in the DTN-X, it's not like they flip a switch and they moved from DTN to DTN-X.

There is a different class of product.

The DTN has 400 Gb capacity.

A line card on the DTN-X has 500 Gb.

It is a different class of product.

Have people been buying the DTN awaiting for the DTN-X?

Some range of customers have been because they see the ability to utilize the DTN.

It continues to be the market leader in 10 Gb and provide a very good economic solution.

I think that I don't view it as much as they're making a decision to not buy the DTN.

I see it as a decision that they're making an infrastructure -- a network structure that can scale to multi-terabyte, and in certain parts of their network, that's going to be mandatory.

In other parts of their network, the DTN is going to continue to provide an exceptionally compelling value proposition.

I don't know any customer that I have today for the DTN that is not going to buy more DTNs because of the DTN-X.

But if somebody's putting in a new core to their backbone or if somebody's putting in a massive new region, the DTN-X is a great way to do that, and DTNs are still going to be extraordinarily useful in regional, metro, and in certain core applications where the bandwidth and the fiber is just not required.

Got it.

Okay, so then if I were able to split out -- if I just step back and I look at the two classifications of customer opportunities, I mean, how would you parse that?

Do you think that 50% of your current revenue today on the DTN would be ongoing over time and have a long tail to it, and you grow the DTN-X on top of that, or is it a higher percentage or lower percentage?

How should I parse the two opportunities?

George, maybe if -- this is Dave Welch.

Maybe if I can contribute to the answer here.

The majority of DTN-X revenue in business that we have is going to continue forward.

As we've had in any of our products customers go through in cycles of looking at either adding new routes, lighting up a new rail or a new fiber on top of a current network that is growing, it is in those opportunities that are evaluating to put DTN-X in, as opposed to DTN.

So all of the fill associated with everything that we've deployed before, the lowest-cost addition of bandwidth is to continue to do that, and we expect that to go on, and that's going to -- that takes years to fully fill their deployed networks.

So if you were a -- it is a -- you know, I'd put it in the 15%, 20% of our DTN revenue are evaluating DTN-X for a portion of that.

And the rest of it is perfectly happy with the product that they have, and they're going to continue on.

And the majority of the DTN-X is, frankly, bringing in new markets, new customers, new applications of a product of a scale that we haven't had before, and that's what most of the customers that we have bringing in, they're looking at their existing customers, but they're looking at DTN-X for applications that we have never competed with before.

(Multiple speakers)

Got it.

Thank you very much.

That's very helpful.

Kevin Dennean, Citigroup.

Just a couple of quick housekeeping questions, to begin with.

On services, Ita, I heard you mention that services were down off of a tough sequential comp because of some catch-up revenues.

There's a lot of volatility in services over time.

Should we think about that -- about the service revenues snapping back in two quarter -- in the second quarter, or do we stay around these levels?

Yes, I think if you look at Q4, that was particularly high, right?

We had a good level of deployments happening in the quarter and we also had some catch-up stuff on some large annuity contracts, right?

So I think Q4 was actually higher than our typical run rate, if you look back over time.

I think the Q1 range, we probably, with some more deployments, probably a little bit higher than that, but that's probably more of a typical run rate for us on a normal quarter.

And then, on services gross margins, how should we think about that going forward?

What is kind of the normalized range there because I would imagine that the gross margin level this quarter was a little depressed just on kind of revenue scale?

Yes, I mean, those margins do move around a bit, depending on the deployment levels, mix in there, right?

I mean, I think if you look back historically, there's been anywhere from about, say, 58 up to as high as 65, 66, right, so that's been kind of the typical range.

So the 60 is -- you know, it's not completely out of bounds, right, but it does have that range to it, depending on how much deployment stuff we are actually doing in the quarter because the deployments will have lower margin than, say, the annuity services, which have almost 100% margin, right?

Okay, and then, a quick question from me is on gross margins and the impact of ramping your 100 Gb PIC.

So it sounds like a little bit of a drag current quarter, maybe it persists for a while.

You mentioned that you expect to drive costs down on a -- I think you used the word satisfactorily.

How should we think about the progression of gross margins through the year?

Yes, I mean, I think (multiple speakers)

And how big -- I'm sorry to interrupt, but how big a drag are we seeing right now?

I mean, if you think about our gross margin through the end of the year, we've always talked about this two to three points of kind of ramping DTN-X overhead rate, if you like, that's in there.

I think that's fair probably through the end of the year, maybe it starts to get better in Q4, right, get a little bit better in Q4 and then kind of burns off as we start to kind of be truly in full production and looking into the new year, right?

So I think about the impact of DTN-X through kind of the end of the year is we've got some impact in Q2 when we actually ship those initial units.

We'll have a little bit more impact in Q3, and then in Q4 we should be starting to get back to something that approaches a more normal production, but still not fully ramped and not fully optimized, right?

Okay (technical difficulty) and for me in your OpEx guidance, that includes OSMINE costs?

Yes, what you'll see with OSMINE is it's going to be in every quarter probably between now and through the end of the year at least, right?

So it's for smaller amounts, but it's spread out over a period of time.

We had already kind of included that in our guidance, that there would be some OSMINE activity, so really we're just kind of fine-tuning that, but it has always been kind of built into the OpEx guidance.

Rod Hall, JPMorgan.

I just wanted to drill into the pipeline a little bit more, just to make sure I understand it.

I understand that you got these eight trials running.

I wonder if you could say whether those are limited by the availability of equipment, or is that the total number of people that are interested in trialing the DTN-X right now?

Just some kind of indication of where we are in the process of spinning trials up.

And if you could elaborate on the -- maybe how many people you have got active in the DTN-X sales pipeline, that would also be useful.

Just kind of figure out what the potential for additional trials is and how the wholesale cycle might progress.

Thanks.

Yes, so let me -- this is Dave Welch again.

Let me see if I can answer that for you, and I probably will not be able to answer it satisfactorily.

But the interest -- I'm going to back off and talk at a high level.

The interest in the DTN-X is great.

There is a significant -- across our customer base, they see various values of that.

We have a -- at the beginning of the quarter, where we are today, we have a number of committed trials to come in, either in our lab or their lab, to be able to execute on what I would call present as a qualification process trial, as opposed to a early evaluation trial.

So in that discussion, there's many early evaluation trials that we engage into varying degrees with our customers.

If we look at our 100-plus customers that we have engaged with over the years, we're not going to have 100 guys walk in here and value the product.

We're going to have -- typically, it's the larger capacity networks that are going to come here and evaluate our product, and they're going to try and time that for when they see new applications and new capacity builds and their cycle to come on out.

So, it's not just the availability of the product that dictates when they buy it, it's the availability of product times as they need it, when they need to make that technology transition.

So the interest is high.

I don't want to go through and quantify that, but we have, I think, the general mixture of what we see of new customers, new applications, and current customers, and old applications with current customers.

That mixture that we're presenting to you is fairly consistent as we look forward.

(Multiple speakers)

Dave, could I -- just to clarify what you're saying there, so the eight trials you guys had talked about, those you would classify as qualification trials, and then you're saying that there's a bunch of other customers that are in early evaluation stages on the product.

Is that the right way to think about it?

This is Tom.

The trials that we're doing, the eight we're talking about, is a level of rigorous test that typically takes a couple of their engineers, customer engineers, three to five days, and it's typically linked to a deployment opportunity that they are truly evaluating a product against.

That is what we consider a trial here.

So there's one finite capacity, but more importantly, there's a customer desire to make a final decision on a product to go through this level of testing.

In addition to that, as Dave pointed out, there are a lot of demonstrations.

There are a lot of customers coming in.

Well, they'll get a couple-hour lab tour and be able to see the gear working, play with it for a couple hours.

That's for them to get a sense that -- of what's available, and as they're going into some type of RFI or some RFQ point, whether they want to include Infinera on that.

And then, above that, we would have just pipeline quoting.

So we have a lot of pipeline activity where our sales guys are bringing us opportunities, responding to bids.

Depending on our success with that bid, that could either lead to a demo where they could test and say, do we want to make Infinera have a short list, and then that would lead to a trial.

So the trials we are doing are fairly late stage in a cycle and they're fairly intense from a customer perspective on amount of time commitment they have to spend, both here and in preparation for it because they will typically have to generate a test plan of what they want to do when they are here.

Okay, and you're saying, Tom, that it is capacity limited, so that if you had unlimited capacity in your labs, you'd probably -- you might have more than eight trials.

I don't know.

It's hard to say.

I mean, you can only do so many.

It's not infinite.

A trial takes -- a successful trial takes about a week, so we're doing about eight this quarter.

A quarter is 13 weeks.

Now if somebody came in and said, listen, I really want to trial this, we have an opportunity, we're going to go take that trial.

If they say we have an opportunity for Q4, they'll probably say we want to trial it in Q3.

Okay, all right.

Thank you.

We're not trying to cram as many in as possible.

I'd rather be horribly successful with the ones we're doing.

Yes, it makes sense.

Alright, thanks a lot.

Alex Henderson, Miller Tabak.

I just wanted to talk a little bit about the trajectory of margins and the pricing commentary.

It is quite obvious when you look at the results out of Ciena over the last 18 to 24 months that part of their problem is that they've been shipping at very low cost a lot of chassis, and not shipping a lot of blades in them because they go out 40% loaded.

And it takes at least a year to a year and a half from the time they get shipped to -- those chassis out to absorb that initial slug of capacity.

So what you end up with is chassis versus TAM mix being quite negative.

Is it not reasonable to think that if you have success with the DTN-X that you would see a similar window to absorb the initial capacity that goes out loaded on the DTN-X boxes, and therefore have to price down to get that valuable footprint in order to have the opportunity to sell TAM into the future periods?

Let me see if I can give some insight in that.

There is absolutely a variation in gross margin between first-in cost and fill costs.

Our product architecture and our product cost structure is different than our competitors', and that allows a different profile and a different recovery period from first-in cost.

What Tom tried to infer in his commentary is that the upside margin for Infinera, based on our advanced technology and our photonic integration and that we're vertically integrated on our Coherent technologies, etc., allows us to have a gross margin recovery that we believe is much faster than some of our competitors out there.

I wasn't trying to imply that it would be the same margin structure, but the structure that I just detected where you're talking about shipping primarily chassis in a new product launch for a better part of a year before you start to see the absorption of the initial capacity that shipped along with the chassis on the first install to get the TAM sales in that (technical difficulty) after the fact.

And if it's 12 months, that would imply that you're not going to get the high-margin TAM revenue in until well into 2013.

Yes, as I said, keep in mind our system is made up of three pieces.

There's common chassis; there's long-haul bandwidth, which is what our photonic integrated circuits deliver; and then there's tributary access.

Our tributary access is a smaller granularity than our 500 Gb, and our initial deployments will go out with a small capacity of tributary bandwidth, but they will quickly deplete that tributary bandwidth and then start adding on, and so our margin profile, it won't be 12 months for margin recovery.

We also -- it's important to remember that the optical layer that Dave referred to, the DTN-X completely compatible with the optical layer we have selling for a long time, and that invariably carries a very low margin.

So customers who already have our optical infrastructure, we will have the opportunity to upgrade them and achieve margin recovery much faster than if you're deploying the overall optical layer in addition.

Second question, could you talk to the -- you've got a very large installed base of customers.

By my count, it's a little over 100 now.

Can you tell me what portion of those would actually have a network that could handle a DTN-X sized platform because obviously the bandwidth is substantial compared to some of the smaller competitors -- smaller service providers?

That's a little bit hard question to answer, and frankly, the pertinent question is to answer it more on a dollar basis as opposed to a number of customer basis.

I think that being that anyone who is truly in the long-haul business will at some point in their cycle have an interest in the DTN-X, our customers that are in the metro, more of a metro or metro/regional network, their interest is going to -- it will take longer for those capacity demands in areas that are more fiber rich to take advantage of it.

Our business is not -- it's not a supermajority, but it's certainly a majority of our business is true long-haul carriers and subsea carriers.

They have an interest in that immediately.

(Multiple speakers)

(Multiple speakers) over half your customer base still metro or regional, and therefore would not be likely candidates for even moving to a DTN-X, so when we look at the customer base of 102 and say, okay, half of that is 50.

We're doing eight.

It gives us a better handle on what portion of the customer base is a viable candidate for a trial.

I don't think -- I'm not sure I could give you what the accurate number is on the quantity of customers at this point, so I'll have to defer that question to another time.

You also need to be careful of assuming that every customer is going to trial it.

If it's a DTN customer today, there's a reasonable percentage of them that will not do a trial.

They will do a first office application.

Two of the first POs we have were not based upon them coming in and doing trialing.

They know our gear.

They know the software release is based on a previous release.

They're very comfortable saying, we are going to roll this out based upon our history with the Company.

One last question, then I'll cede the floor on it because it's on the same basic concept, which is, can you talk a little bit about what portion of your customer base that are looking at the DTN-X product would have an acceptance criteria that would cause an extended delay in the timing of the recognition of the revenues?

I know you're saying you're going to have revenues in this back half of the year, but are some of the installations in the back half also going to be deferred into 2013 for revenue recognition purposes?

Yes, I mean, I think -- we've talked about it before, Alex, be very much existing customers with existing contracts.

What we're seeing is those customers are not really trying to go change the terms of their contract.

So if we have customers in that bucket who are taking revenue and allowing us to take revenue on shipments and on receipt, we're not seeing people come and say, well, I want to change that for the DTN-X, right?

I think for new customers who haven't used the product before, then you will see a longer acceptance period.

And on submarine, invariably whether it's new product or old product, they want to see the submarine link up and running for a period of time before they will sign off on it.

And that's, to me, less to do with the DTN-X and more to do with the submarine market.

Sanjiv Wadhwani, Stifel Nicolaus.

Tom, I just wanted to take a crack at the second-half trajectory.

If you look at your revenue run rate over the last six quarters or so, and let's just round it up to about $100 million a quarter, if you're guiding to $230 million to $260 million for the second half and if you assume that $100 million comes from the DTN in every quarter, does that mean that the DTN-X is going to be between $30 million and $60 million for the second half?

Well, the way you did it, it would.

(Multiple speakers)

We just spent a full day with all of our sales team, rolling up and looking at very specific DTN-X opportunities.

We are typically hesitant to give out guidance beyond the quarter.

We have not done that, and we're doing that this time because, quite frankly, we think Q2 is an anomaly.

Its revenue is down, but we have the opportunity.

We've won four new DTN-X customers.

We have a pipeline full of trials that are coming and we are in a negotiation with a number of other DTN-X opportunities.

We either believe that we are going to win those and what we are going to start shipping -- taking orders for in Q1 and Q2 and start shipping in Q2 translates into new opportunities, or it doesn't.

We believe it does, so we wanted to share with you our observation, and it's based upon a roll-up of what we've done with all of our various regions on the opportunities that they see both for the DTN and the DTN-X.

And the reason we are creating a kind of out-of-process guidance for that is because I don't believe that a revenue reflection of Q2 is representative of the opportunity that we see with DTN-X.

We started taking orders for DTN-X in Q1.

We never have a quarter and a half until we recognize revenue.

This is an anomaly on there.

And quite frankly, any forecast can be wrong.

We would not give that forecast unless we had done the work and the diligence of being able to say, this is what we can touch and see.

Got it, fair enough.

I guess the other question on the OSMINE certification and it going through.

You've already done some prior certification with Qwest, and I'm trying to figure out if this is DTN-X with the same customer, a brand-new customer, or any color there?

Well, I'm not going to give any color there.

We've done two OSMINE releases.

We did our release three with OSMINE.

We did our release six at OSMINE, and that was at a customer request.

You know, OSMINE is a nontrivial expenditure, and the DTN, we did it based upon a specific request from a customer.

We are also doing, as Ita had said, we had baked OSMINE into our planning, but we're also doing it at a specific customer request, and that's all I'm going to say about it.

(Operator Instructions).

Simona Jankowski, Goldman Sachs.

I just wanted to ask one more follow-up there on the second-half trajectory.

So, can you just give us a sense for when you think DTN-X revenues will cross over the halfway point in terms of percent of the total?

I mean, it sounds like that might even happen exiting this year, but do you think that will be exiting this year or more first half of next year?

Yes, we're not in a position to do that yet, Simona.

We'll provide more color kind of on the product split as we can report the actuals, but we're not going to try to project that at this time.

Okay, and then a couple of follow-ups on the margins in the next few quarters as well.

I think there was some helpful discussion there on how long you think it will take for the proportion of common equipment to TAMs to normalize, and it sounds like you thought that would be less than a year before that aspect of pressure on margins is relieved.

And please correct me if I misunderstood that, but the follow-up is, there's also kind of the yield aspect in terms of your PICs, which are obviously new technology and much larger, so how long do you think before kind of the yield in the manufacturing aspect of your new PICs normalizes back up to what your historical 10 Gb or 100 Gb PICs have been?

Yes, I think, as we commented in the remarks, we are seeing good traction in the fab around the comps, and it is trending kind of as we expected, right?

So I think we have -- if we'd originally guided 40% gross margin for the year, with kind of some of the volatility that we're seeing, I think we'll be somewhat below that, but not -- if we get the top line and the revenue growth that we are projecting, then not significantly off of that, right?

If you look beyond that, I think what starts to happen is we take out some of the DTN-X overhead type margin impacts that we've had, you start to ramp some volume, and then you really do start to see kind of the flowthrough on the model, right, where you start to truly ramp the fab and have leverage, the fixed costs that are in the fab, and then you can start to see margins expand again through kind of next year.

Right, but that's more of an overhead comment.

What about just the yields themselves?

So more the variable costs, as opposed to the fixed-cost drag?

I mean, the yields are ramping along kind of a similar relative curve as they did with the gen-one and gen-two products, right, so we'll expect to hit entitlement yields some time next year, right?

I'll ask Dave to kind of maybe comment a little more on that.

Our yields on our PICs, I caution you to -- it's not -- the question you're trying to get at is what the cost structure is of our business.

The yields of our PICs are ahead of schedule.

They're fine.

The PICs work.

It is the usual capability of technologies there, and we can make as much as we need of it.

And we sell systems.

We sell networks.

These are highly complex things of which the PIC is an enabler for cost structure elsewhere in the system, but it is not the dominant cost structure.

We're not a component company.

Fair enough, and then, just last quick one, and I realize this might have been too recent to kind of have all the details, but in terms of the proposed acquisition of Cable & Wireless by Vodafone, is there any change there that you think might happen relative to your involvement, either in terms of incremental opportunities at Vodafone or maybe a change in how Vodafone wants to run that piece of the Cable & Wireless business?

Yes, I think there's two parts to the question, in my mind.

One, does it affect what our current plans are in the short term with rolling out the DTN-X with Cable & Wireless?

I don't believe that there's any impact to the current plan we have of rolling out the DTN-X against the current contract with Cable & Wireless.

For longer term, it's a much bigger question.

I don't think that the acquisition will close -- earliest, it will be August; I think latest is October.

And I think that more than likely, new decisions will probably have a period of reluctance to make big commitments to anything.

I feel very comfortable that the current PO and plan of expansion with their EPEG network is on track.

Beyond that, Simona, I think it's too early for anybody to say what will happen.

Okay, terrific.

Thank you very much.

Michael Genovese, MKM Partners.

Tom, you spoke earlier in the prepared remarks pretty enthusiastically about the optical reboot cycle and the expansion for optical, and then -- meanwhile over on this side, you were pretty angsty about [carriage FX] this year, and is it strong, is it weak, is it front-end loaded, is it back-end loaded?

Is there an optical cycle, is there not?

So when you talk about all these decisions being made and this capacity going into the network and capital dollars being spent, is this something that is happening this year, in your view, or is it more of a 2013-2014 event?

Well, I think it's mixed.

I mean, a lot of discussion happens around AT&T and Verizon CapEx.

And for good and bad, we are not exposed to that right now.

My commentary on kind of optical reboot is based upon two things.

I just see, quite frankly, the investment happening the wireless, the investment that has to at some point translate into core networks.

I see what's happening with data center distribution.

I see what's happening with all of those types of activities, and at some point there has to be a resurgence of CapEx.

That's part of it.

The second part is I see the amount of quoting and activity that we have, and it is quite substantial right now.

Certain areas of the market are making decisions without question for this year, and those include cable, those include submarine, those include a number of activities that are happening in Europe.

There are some very substantive builds being planned.

That is outside of, quite frankly, the market of what does AT&T and Verizon plan on spending in CapEx.

Those are very big numbers.

I certainly anticipate, hopefully, the DTN-X will help us move the progress of having -- not to be more germane to our conversation, but I see the opportunities.

A lot of people are saying Europe is soft.

Our Europe in Q1 was actually pretty darn good and we see lots of activity there.

So I think people are making investments where their networks are needing to expand for new services, whether they're latency commercial services or cloud services or just video content.

I see substantive investments being made.

Great, that's a great answer.

And then, just a follow up, or separate question.

Earlier -- in the response to an earlier question, you talked about OSMINE -- I'm sorry, you talked about evaluations of DTN-X, early stage to late stage.

And typically, where in that process would a request from the customer (technical difficulty) come in?

Would it be earlier and later in the evaluation process?

It is socialized early in it and it is finalized in a contract phase where you will do it or I am not buying from you.

But along with that, I mean, just generally speaking, so they say you do know that I'm not buying from you.

Do they promise you anything (multiple speakers) that investment?

(Multiple speakers).

Quite frankly, they're very reasonable business people.

They use OSMINE certification to help run the backend of their businesses.

They have no desire for us to indiscriminately spend money on OSMINE if they don't have a business need that they think that DTN-X can help solve.

We're doing it based upon the strong belief that they have every intention to roll out the DTN-X.

OSMINE is a gate to that.

Obviously, the product has to go into their network and it will go into their network, but it has to be successful when it goes into their network.

That's up to us to make it happen.

And I have every confidence that we will make that happen.

So I believe OSMINE, to me, isn't a threat.

It is an opportunity that basically says, we are going to go roll out your stuff on the network, but for us to mass-deploy your stuff, you've got to do it within a context that makes our business successful and you have to do OSMINE for that.

And that's why we're doing it.

So far when we've rolled out OSMINE historically, on both release three and release six, it's been an extremely good investment for us.

Thank you all for joining us today on the call.

We appreciate your interest and questions.

We look forward to keeping you informed of our progress in the months ahead as we execute our significant opportunities with the DTN-X and on our strategy to win in the marketplace.

Have a great day.

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