Infinera Corp (INFN) 2012 Q3 法說會逐字稿

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

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

(Operator Instructions).

Today's call is being recorded.

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

And I would now like to turn the call over to Jenifer Kirtland of Infinera Investor Relations.

You may begin.

Thank you, operator.

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

These statements address the financial condition; results of operations; business initiative; views on our market and customers, our products and our competitors products; and prospects for the Company in the fourth 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 release and the 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 release including the results of the third quarter of fiscal year 2012 and associated financial tables and investor information summary will be available today on the investor 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 third quarter of fiscal year 2012 which exclude 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 Infinera's website.

On this call, we will also give guidance for the fourth 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 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 on our third-quarter 2012 conference call.

With me are Chief Financial Officer Ita Brennan and Chief Strategy Officer Dave Welch.

I will start by stating that we continue to make excellent progress as a consequence of the introduction of the DTN-X.

Sales activity remains strong with the addition of six customers who have made purchase commitments for the DTN-X since our call in July for a total of 16.

Furthermore, we began generating revenue from our DTN-X shipments this quarter as evidenced by our solid third-quarter results.

Before turning it over to Ita for a full review of our Q3 financial results and Q4 outlook, I will talk about trends in the global transport market and provide a more detailed update on the market acceptance of our new DTN-X.

In regard to the market, Dell'Oro forecasts that the total optical transport market will grow at a five-year compounded annual growth rate of 7%.

However, not all markets are created equal.

And when Dell'Oro further segments its market, they identify significant spending shifts.

They show declining legacy technology segments such as Sonet and SDH offset by a rapidly growing next-generation technology segments.

Dell'Oro predicts the 100G market will grow at an 80% annual rate and the converged optical packet transport market will grow at 25% annually over the next five years.

The DTN-X platform is in the sweet spot of both of these fast-growing segments.

This is consistent with our customer interactions where we are seeing a fundamental shift away from legacy technologies and a rapid transition to next-generation transport solutions.

The majority of our customer request for proposals are now asking for both 100G and OTN switching.

We believe this validates the market projections that there is a significant opportunity emerging for both 100G long-haul systems and a converged 100G WDM/OTN solution.

I believe Infinera is uniquely qualified and well positioned to meet this need versus competitors who have exposure to both legacy technology and dated architectures.

Infinera foresaw the need for this converged 100G solution well in advance when we designed the DTN-X and now we are delivering on that vision.

We believe that customers would need to do an optical reboot to a cost-effective 100G network built for the next decade.

We believe that the most effective solution was not to incrementally upgrade a platform optimized for 10G or 40G, with a 100G line card, but rather to deliver a platform optimized with forward scale to 100G, 500G and 1 terabit super channel capabilities.

We also believe that in addition to delivering greater scale, we need to focus on reducing the operational costs of running a next-generation network while improving our customers' speed to market for new services.

The DTN-X delivers on this vision with a converged WDM and OTN switching solution where both functions are integrated yet operate at full capacity without compromise.

To achieve this, we combined our unique 500G Photonic Integrated Circuit with our FlexCoherent processor to deliver the industry's highest density and lowest power WDM capability supporting the industry's first 500G long-haul FlexCoherent super-channels.

We combined this with WDM capability with a world-class 5 terabit nonblocking OTN switch and a GMPLS control plane to deliver the industry's most scalable, efficient, simple, and reliable converged platform.

This integrated approach produces better results at a lower cost by more efficiently utilizing optical capacities on a network.

Customers use fewer wavelengths, less space and less power to deliver the same set of services.

The integrated approach also enables customers to more quickly and efficiently scale their network by eliminating thousands of fiber interconnects, manual configurations and truck rolls.

Furthermore, through leveraging our automated control plane and operational innovation, the DTN-X helps our customers deploy services faster and compete more effectively in their markets.

Infinera's teams' execution of the DTN-X has been excellent.

We launched the product in September 2011, began shipping to customers for deployment in June and now have live traffic running on networks across the globe.

The DTN-X reception continues to be incredibly positive, reinforcing the value proposition that a combined super channel and OTN platform can offer.

On our last earnings call I indicated that we had secured 10 purchase commitments and today I am pleased to announce that this number has climbed to 16.

Of these 16 customers, five are new to Infinera and 11 are existing customers.

These new customers validate that DTN-X is allowing us to address larger bandwidth opportunity in new markets.

The support from existing customers is based on our earned reputation for quality and performance and showcases the value of a combined DTN and DTN-X network running common software.

These customers span North America, EMEA and APAC and across each of our vertical markets including a Tier 1 domestic win and four Tier 1 international wins.

We have also seen strong traction in the cable segment along with wins at bandwidth wholesalers, Internet content providers, research and education, and in the submarine market.

We recently announced two of these additional DTN-X customers.

Telephonica International and PIPE Networks.

These wins are complemented by strong trial activity and further significant opportunities in North America, Europe, India, and Russia.

Unlike competitor 100G upgrades, it is important to remember that the operators deploying the DTN-X are generally not upgrading a single route with a pair of 100G cards.

Rather, they are building new networks for the next decade.

As a result, Infinera is shipping a significant number of 100G ports.

I am pleased to announce that we have shipped over 1,000 100G ports for revenue through the end of the quarter.

This compares to approximately 800 long-haul 100G WDM ports shipped by the rest of the industry in all of Q2 according to Dell'Oro.

We believe that this rapid market impact reaffirms the unique value proposition that the DTN-X offers our customers.

We continue to see strong interest in the DTN platform and this quarter we added three new DTN customers for a total customer count of 106.

Our ATN, DTN, and DTN-X now provide a broad portfolio that allows us to address multiple applications in markets with varying requirements.

We are also seeing DTN-X customers take advantage of some of the newer DTN capabilities, including 100GigE service interfaces.

Both Eurofiber and Interoute recently announced their 100GigE offering on their DTN networks in Europe.

The ability for our customers to adapt their existing Infinera DTN network to deliver these next-generation services demonstrates the inherent value of the Infinera Digital Optical Network architecture.

While we have seen a steep decline in 100G pricing over the past year, we believe that has started to flatten out.

We believe that 100G is now a better economic solution than 40G for customers and we expect that this will drive significant volume in the high-capacity market.

We continue to compete aggressively to secure new DTN-X footprint and as volume increases, we will leverage the scale and cost advantages of our unique PIC-based vertically integrated model versus our competitors who are using less cost-effective off-the-shelf optical technology.

Finally, we now expect OSMINE certification to be complete at the end of Q4.

This is an important milestone and is required to open up the North America Tier 1 market.

We are executing well on our growth objectives and remain confident about our ability to continue to drive adoption of the Digital Optical Network.

This activity is strong and we believe we are well positioned for a solid finish to 2012 and an opportunity to build on our strong momentum into 2013.

Now before turning the call over to Ita, I want to thank the Infinera team and supply partners for meeting our commitments and deploying the DTN-X in multiple networks across the globe.

I would also like to thank our customers for their continued business and partnership as we move forward into the terabit age together.

Ita will now provide a detailed financial review.

Thanks, Tom, and good afternoon.

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

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

Total GAAP revenues in Q3 were $112 million compared to our guidance of $106 million to $116 million.

Our solid revenue performance in the third quarter was led by our DTN-X platform which contributed significant revenue from deployments with eight customers across multiple customer segments.

We added a total of five new customers in the quarter, two of whom deployed the DTN-X.

The remaining three new customers purchased and deployed Digital Optical Network based on the DTN platform.

We had one greater than 10% customer in the quarter which was a cable operator.

The top five customers also included two other cable operators, a Tier 1, and a bandwidth wholesaler.

International revenues totaled $33 million or 30% of total revenues for the quarter.

EMEA accounted for $28 million or 25% with APAC and the other Americas representing two and 3% respectively.

Service revenues for the quarter were $12.9 million down from $15.1 million in Q2 as a number of service projects straddled the end of the quarter.

We expect to recognize a healthy deployment services revenue in the December quarter as these and other deployments are completed.

Services gross margin for the quarter was strong at 69%.

We expect services margins to decline in the fourth quarter as the mix of deployment-related services increases.

Overall gross margin in Q3 was 39% at the higher end of our guidance of 37% to 39% and up from 37% in Q2.

Third-quarter gross margin reflected the recognition of our first DTN-X revenues.

As expected, these systems represented early production units and at a higher cost.

Product mix for the quarter was healthy with TAM and TAM units at levels consistent with prior periods.

Our new footprint, common equipment deployments increased as we began to ramp DTN-X deployments.

Operating expenses for the quarter were significantly lower than expected at $51 million compared with our guidance of approximately $55 million.

Operating expenses were $53 million in Q2.

The primary drivers for the reduction in operating expenses in Q3 as compared to our guidance included a reduction in compensation accruals, a decline in payroll taxes as employees reached favorable tax caps combined with careful cost control across all areas of the Company.

Looking forward to the December quarter, we expect operating expenses to be approximately $52 million reflecting lower compensation expense through the end of the year and a continued focus on cost control.

Overall headcount for the quarter was 1,235 versus 1,228 in Q2.

Headcount additions were primarily related to direct labor for manufacturing.

Our operating loss for the quarter was $6.9 million.

Other income and expense for the quarter was unfavorable at $0.4 million.

Net loss for the quarter was $7.8 million resulting in a loss per diluted share of $0.07, better than our previous guidance which called for a loss of $0.09 to $0.14 per diluted share and a significant improvement over a reported loss of $18.6 million or $0.16 per diluted share in Q2.

Now turning to the balance sheet.

Cash, cash equivalents, restricted cash and investments ended the quarter at $183 million versus $210 million in Q2.

We used $29.3 million of cash from operations in Q3 versus $22.7 million in Q2.

DSOs came in at 74 days, up from 55 days in Q2.

This increase is in line with our outlook on the July call as we expected DSOs to increase given the impact from the DTN-X ramp.

As we look forward to Q4, we believe DSOs will improve significantly as we experience better billing linearity and collect on the higher receivables balance outstanding at the beginning of the quarter.

Inventory turns were 2.3 times versus 2.1 in Q2.

We experienced some improvement in inventory turns in the quarter, while overall inventory levels increase to $118.5 million.

This near-term increase in inventory is in line with our expectations for the initial DTN-X sales period.

Our goal is to return to more competitive inventory metrics once our go-forward sales mix of DTN and DTN-X is better understood.

Accounts payable days were 48 days up from 44 days in Q2.

Capital expenditures declined to $2.5 million compared to $6.1 million in Q2.

We intend to continue to manage capital expenditures to a run rate at or below $20 million per annum.

We believe that these forecasted reductions in working capital and capital expenditures combined with our income statement guidance for the fourth quarter will result in an improved cash position for the end of the year.

Turning to our outlook for the fourth quarter and beyond.

We continue to see strong interest in the DTN-X platform with a healthy pipeline of RFIs and lab trials.

We received purchase commitments from 16 customers for DTN-X network deployments.

Although we are seeing some decline in DTN revenues as some of our larger bandwidth customers migrate their deployments to DTN-X, we continue to win new customers and new deployments with the DTN platform.

Based on our current visibility, we believe that revenues for the fourth quarter will range from $122 million to $132 million which when combined with our Q3 revenue performance is consistent with our prior guidance for revenues of $230 million to $245 million for the second half of 2012.

Looking beyond 2012, we believe that with the DTN-X platform, we are well-positioned to grow market share and add new customers.

Industry analysts have various views of forecasted market growth for 2013 and the state of which 100G footprint will be deployed.

Expected overall market growth rates for the year range from 7% to 10% with, as Tom mentioned, some technology segments growing rapidly and others in decline.

We believe depending on the level of the realized market growth that Infinera can achieve revenue growth in the 10 to 20% range for 2013.

In looking at the next couple of quarters, we believe that gross margin will be volatile as we ramp deployments and production of the DTN-X platform.

We are seeing a faster than expected uptake of DTN-X which will ultimately help our volume ramp and 100G cost structure but will likely negatively impact margins in the near term.

Our gross margin guidance for the fourth quarter affects solid footprint and DTN-X wins with significant common equipment deployments, combined with a higher mix of deployment services revenue, a lot of which carry a lower gross margin.

However, this footprint is the foundation required to achieve an ongoing healthy business model and longer-term sustainable growth.

We believe that with solid revenue growth our vertically integrated model can deliver significant leverage and allow for a healthy gross margin expansion in excess of that earned by the industry.

In addition, over time, we would expect to see a more balanced mix of new footprints in network still.

We will elaborate further on the margin profile of various network architectures over time and how this impacts our overall gross margin entitlement at our analyst day in December.

As we think about operating expenses and CAPEX for 2013 and beyond, management is committed to spending at levels that are supported by the business.

We believe that we can tailor spending to levels to support a consistent cash flow breakeven point by the second half of 2013.

This must be done in a manner that supports the competitive roadmap and continued growth and new footprint wins.

In the longer term, we would expect that expense increases would be at a lower rate than revenue growth, allowing for improved profitability.

Now let's turn to guidance for Q4, which is based on non-GAAP results and excludes any non-cash stock-based compensation expenses.

Revenues of approximately $122 million to $132 million, gross margins of approximately 35% to 36%, operating expenses of approximately $52 million, operating and net loss of $4 million to $9 million and based on an estimated average weighted diluted shares outstanding of 115 million, this will lead to a loss per share of approximately $0.04 to $0.08.

Please note that the basic share count is expected to be at $112 million for the quarter.

Finally, before we open the call up for questions I wanted to remind you that we will be holding an analyst day in New York City on December 6 and we look forward to updating you then.

Now, operator, would you please open the call up for questions?

Thank you.

(Operator Instructions).

Simona Jankowski, Goldman Sachs.

Just wanted to follow up a little bit on the commentary around the customer wins with the DTN-X.

I noticed you mentioned a North America Tier 1 customer and obviously you have been undergoing OSMINE and I believe a couple months ago you had mentioned that you would announce this customer later this year.

Can we still expect you to announce who that customer is?

And is this something that at this point has been awarded to you as a design win?

And if you can maybe just expand on what parts of the network or what applications it will be used for?

This is the same one we have referenced for a period of time.

Since the last call, two things.

One we had said that OSMINE certification would begin in Q4 and complete some time in Q1.

We have now pulled in the certification, to our expectation, is OSMINE certification will be complete by the end of Q4.

We have been awarded a -- this project.

It is a long-haul application in a Tier 1 and we do intend to announce it this year with their permission.

Terrific.

And then following up on Ita's comments on the profile of growth margins which are being impacted here in near-term buy of faster ramp of the common equipment for DTN-X.

You know, to the best to have visibility at this point, when would we expect gross margins to come back maybe to the mid-40s which I would assume would reflect a more normalized mix?

I think certainly through the next couple of quarters we are going to have production ramps, impacts, plus a healthy common equipment mix.

Once we get through that then we should start to seep margins improve.

And you're right, I think probably a mid-40% range is a good steady state with growth target.

We haven't exactly pegged when that would be, but we should start seeing progress towards that through next year.

Following a comment as I mentioned in my script, right now we have the opportunity not to upgrade an existing network on a single wave of 100G, but our customers are deploying, upgrading their entire network with new platforms, new chassis, new line infrastructure.

And that is going to allow us to be an Infinera 100G, 500G super-channel network.

The best thing we can do for now and for the near term is to win as much footprint as we possibly can.

We have been pretty clear that we are going to drive the Company to have market share leadership so that we have the opportunity to fill those chassis over a very, very long period of time.

While our absolute commitment is to create a company that has a margin premium to the industry based on our technology, over the next period of time, my absolute commitment is to grow our market share as fast as possible while maintaining a good conservative view of cash use.

Sure.

Lastly, I was a little bit surprised by the guidance for next year, 10% to 20%, which is a bit below where consensus is right now especially given the comments around the Tier 1 win and the stronger traction in DTN-X, and also some of the Dell'Oro forecast you're citing.

So can you just help bridge those numbers for us?

Yes, I think if you look at industry growth rates right now they are somewhere in that 7% to 10%.

So that range of 10% to 20% is really saying we will grow roughly 2X to the market.

I don't think there's any doubt that we are winning opportunities and gaining new customers.

It is really a matter of timing and how those opportunities ramp and how the revenue ramps with those opportunities.

So that is kind of our current visibility to that range.

We will obviously continue to update that as we move forward.

Terrific.

Thanks very much.

George Notter, Jefferies.

I guess I wanted to ask about the pipeline of DTN-X opportunities.

I think you said you had 16 purchase commitments now, total.

Can you talk about what you see beyond that in the pipeline?

Is there a larger number of customers presumably you are engaged with?

Any way you could quantify that or give us a sense for it?

And if you have been turned down with particular customer opportunities, were there particular reasons why customers maybe are looking elsewhere relative to the DTN-X on 100G?

Thanks.

Maybe I can answer.

This is Dave Welch.

We are seeing a very robust marketplace for DTN-X right now.

We have a large number of engagements at various stages within the process from early demonstrations to trials to field trial deployments that are going on.

There isn't a really an appropriate quantification of that to give any guidance in general to the market other than to say that it is being received very well.

We are going to win our fair share of the business out there.

We are seeing a lot of robust activity around it.

I would just add that and we said, George, that we are not going to comment on the number of trials that we are doing because we think it is a bit of a misleading indicator.

I will comment that our pipeline of trials and demos is as big or bigger than it has ever been.

So my view is the fact that we have already won 16 customers after basically shipping product for a little over a quarter in this industry is fairly remarkable.

And the pipeline of activity is as big or bigger than it has ever been.

We are extremely satisfied with the reception of the DTN-X into the market.

Are you limited in terms of the number of trials or account relationships you can maintain right now on the DTN-X?

Is there a sales and marketing challenge here?

Not really.

We are pretty much full, but we are finding the appropriate hours and appropriate scheduling opportunities to make sure we do the right management for the expenses associated with the trials and making sure to qualify that customers are appropriate.

I would say we are not turning anyone away, but we are definitely operating at a highly efficient operation right now for getting that out.

And the last one I had (multiple speakers).

The last question I had was on OTN switching.

Is that commercially available right now?

Has it been deployed by customers?

Can you talk about where you are with that?

And then also would that provide you with some gross margin lift to the extent that you can deliver that to customers?

Thanks.

Sure.

The DTN-X has a -- comes with it is both the DWDM system based on the super-channel, 500G super-channels as well as some integrated OTN switch.

So all of our systems were deployed have integrated OTN capability.

The feature set of that OTN capability is strong right now.

And over a series of the next few releases over the coming quarters it will continue to fill out.

So to -- precision to your statement is, yes, that what is shipping out right now has an OTN capability to it and that is used to make the networks as efficient as possible.

The OTN covers a wide range of the specification and you are going to see continue to add on to specifications over the course of time.

Thanks.

Jeremy David, Morgan Stanley.

Good afternoon.

I wanted to ask first about the mix that you saw this quarter in terms of 100G revenue versus 10G.

And I have a couple of questions on 100G pricing.

Yes, we are not really going to break out the 10G versus 100G revenue streams.

It was significant though.

You can see with a customers that would drive a significant piece of the revenue.

So it did contribute well to the quarter, but we are not going to try to break those out as separate pieces of business.

Okay.

In terms of the pricing environment, how many of those wins have been based on price meaning the DTN-X was more competitive than other platforms that were being evaluated?

And can you give us a flavor for what pricing is for your solution today versus [trending] solutions in the marketplace?

Yes, I think the -- it's kind of an impossible question to answer quite honestly.

We sell networks.

We don't sell transponders.

We don't sell commoditized items.

We sell a fairly -- highly sophisticated network.

Everybody's network is different.

Everybody's network utilizes a different degree of point-to-point network or different degree of mesh network and there is no singular pricing around what a network costs in that.

So I don't think there is an adequate answer.

If I was a component company, which we are not, maybe I could go and I made a commoditized product maybe I could answer what that is.

But as a network company that doesn't really fit our model.

One comment I will make, certainly in the market 100G pricing has come down quite significantly over the past year.

We have seen that level off a great deal.

I think that that was necessary.

This market, this technology has experienced a price curve that I think is fairly unprecedented in this industry, as people are trying to capture market share.

I do think that it is leveling off.

The second comment I will make is we have not been the lowest price offering in each of the wons.

We have lost some that we are not the lowest price and we have won some that we have not lowest price.

So it is a very competitive market out there.

But I think as Dave said, the value opposition of the network, the reputation that we bring, or rather our quality and reliability, has value to our customer set.

Thank you and just the last one if possible.

It looks like you have more of a focus on cash, other things that you have decided not to pursue in order to get breakeven faster and if so, what are those things?

I think it has always been our intention to come back and focus on cash once we got the DTN-X product to market.

For the last number of quarters we have been very focused on the need to do that and maybe relax some of our normal operational controls around some things in order to make sure that that happens.

So you'll definitely see us shift back to just normal operational focus around various things.

First it was CAPEX, now it is going to be around inventory, receivables and driving the working capital metrics.

And ultimately on the P&L as well.

Let me add just one flavor to that.

I think we have been very clear over the last two years that our goal line of success was bringing a world-class product, the DTN-X, to market as soon as humanly possible.

And we did that.

I think we spent the necessary money.

We brought the necessary people on board.

We created the appropriate technologies to do that.

Our next goal line as Ita mentioned is consistent cash flow generation.

We are going to move the energy of our Company toward focusing on that while not foregoing a continuation of delivering great products to customers or customer care.

Alex Henderson, Needham.

Thanks.

A couple of questions.

First can you digress a little bit and talk about what is going on in the 10G segment of the market in terms of pricing?

I think you had talked about it being extremely competitive and sharply discounting over prior periods.

Is that also starting to level out as the market starts to solidify around 40G, 100G coherent?

Well, I think in 10G, 10G is experiencing electively normal price curves.

Sometimes in a long technology cycle, the technology cost will flatten out, the price will flatten out.

10G continues to have reasonable price erosion partly driven by the fact that our customers are experiencing price erosion in the 10G services they offer.

So we are seeing I would say normal price erosion.

I think that, talk about 40G, I really do believe 40G has been, we call it the 40G squeeze.

We are going to see that.

100G is more cost-effective -- I'm sorry 100G is more cost-effective than 40G.

10G is more cost-effective than 40G.

And the market has been waiting for an opportunity to go to a next-generation technology that will afford both the capacity and the dollar per bit that the market needs.

It is not 40, it is not going to be 40, it is 100.

10G is still going to have a long life.

It is still going to serve a lot of purposes.

It is still a good economic answer if you are out of capacity.

I think that that 10G is going to last a long time and I think 100G is going to scale magnificently.

Just so we're clear, normal pricing curves, that sounds less pressured than what you had been describing in the past, I believe.

Am I correct in reading that that may have started to stabilize, the rate of decline may have stabilize a little bit as people actually got their 100G products out, coherent products out, so they are no longer is rambling, trying to stem the incursion to the market by dropping 10G?

Is that the right way to read it?

Yes.

I think -- we have been -- I think I have tried to be clear on two things.

One, 100G has gone through a rapid price reduction and we are seeing that stabilize.

The other thing I commented on historically is that until we had a 100G solution, we were making economic trade-offs around our 10G solution to allow customers a fair economic solution until we had 100G.

So there is a difference between market price of 10G and some of the commercial arrangements we made to make our 10G compelling while people waited for the 100G.

So it has stabilized, though?

For us, yes.

But what about in the broader industry that you are competing, the backdrop that you are competing in?

Do you think the pricing of 10G is still coming down hard or do you think it has stabilized?

I believe it has stabilized into normal technology curves.

I believe that a couple of things are necessary to make a market.

One is economics and two is enough viable competitors selling a technology.

This year is the first year that there has been a number -- an appropriate number of viable competitors selling 100G solutions.

Super.

Thank you very much on that.

Let me ask a second question, if I could.

As you are looking at the mix of chassis to line cards, any thought on, given the 16 customers that you have now seen commitments from, how long it will take to start to see a mix shift back to getting some blades into the mix to get the margins up?

Is that going to take 12 to 18 months from the time the chassis ship or do you think it might be longer than that?

I would say that there are two dynamics going on.

One is there is a relatively short-term transition in order to ramp our manufacturing capabilities and, Ita, you can comment more on that if you -- appropriate.

There is a -- what we have typically experienced with the customer when they deploy a network is we get a bump and sometimes about six months into that, then they start going into more of a full distribution of fill after the initial deployment of assuming it is a reasonably large network or so.

So I would it is certainly inside of the 12-month period you see a reasonable distribution of line to fill.

Now these systems have 8 terabits of capacity versus our prior systems which had 1.6 terabits of capacity.

So we should see the life of that fill last longer.

And certainly from a bandwidth perspective it lasts subsequently longer so that those ratios will be more dominant over time going forward.

If I could follow up on that, so when you are shipping your initial box out at this point, it is going out with what percent loaded?

Varies again by customer base, but on a relative basis it is lightly loaded or certainly there's a fair amount of growth to go in that system.

So multiple hundred gigabits going out.

It has got to -- in that.

Does it also go out with a similar amount of trib cards in it?

It depends on the customer, it depends on the application that you are looking at.

The fill of the tribs in general are less than the fill of the line modules.

However in an OTN enabled network the line capacity is more fully utilized.

It is not a point-to-point network that you are dealing with.

Thank you very much.

Michael Genovese, MKM Partners.

In the next quarter's guidance how do you expect the 10G DTN business to trends in the fourth quarter?

I think although we are not going to break it out just directionally, we are seeing more of our existing larger bandwidth customers transition to the DTN-X.

We will see some fallout on the DTN as the DTN-X ramps and the DTN-X will ramp for two reasons, right.

Obviously there's existing customers moving and there's new customers adding to the overall revenue number.

But we will -- you know, for a period of time here, we will see the DTN new footprint with these larger bandwidth customers start to decline.

We did add three DTN customers this quarter.

We added two new DTN customers last quarter.

And customers who break up their markets by region, within those customers we continue to win new regions within the DTN.

We have a very large installed base of DTNs and a lot of those are not at capacity.

So I certainly agree with Ita's commentary that as far as new business goes, there will be more guided towards the DTN-X.

We anticipate that the DTN-X is going to have a good lifecycle for a long time.

What I am trying to get at is the guidance is up $15 million sequentially at the midpoint.

So I am basically trying to ask, do we think that the new product, the DTN-X is going to be up more than $15 million sequentially in revenues?

Yes.

We are not really going to break that out, but we will tell you that the DTN-X is ramping strongly in Q4.

And one other question.

Going back to the statement, I think I -- correct me if I am wrong, but I think you said that in the third quarter you shipped 1,000 100G line cards and the whole industry shipped 800 in the second quarter.

Can you flesh that out a little bit more?

And I know in the 10G you became number 1 overnight in terms of line cards, but if you had asked your competitors they would say there's a difference in the system in how they were counted and you guys are getting a 10 to 1 advantage on that counting.

What's your view on that?

We didn't say it was 1,000 line cards.

We said 1,00 100G ports.

Each one of our line cards has 500G on it.

And so I know our competitors like to say that that is not an apples to apples.

I can tell you that the next 100G port that is going to be bought by that customer or filled by that customer is an Infinera port because they preprovisioned it.

It is in place.

And all they have to do is insert a TIM.

So whether it is an accurate measure of a point in time, I can't tell you.

There are different points of view.

I can tell you it is an accurate reflection of market share of 100G capacity over time.

I will add one of the things in there.

You need to keep in mind that their 100G port is a muxponder.

They are deploying 100G of bandwidth on a line side and they are deploying some amount of 10G interfaces into that line card.

So that the only fair metric and fair comparison is how much line side bandwidth are you shipping for revenue.

And then you will figure out what the fill capability of that is over time.

We ship the equivalent of 1,000 100G line side bandwidth for revenue.

Great.

Thanks a lot.

(Operator Instructions).

Rod Hall, [JPMC].

Just a couple of quick questions for me.

So you mentioned this Tier 1 supply or Tier 1 customer that you are going to announce in Q4.

I wonder if you could talk about whether you are going to be the first or second supplier on that customer.

I mean are you going to have the primary position or would you be following someone that is already there?

So that is my first question.

The second one is just on pricing again.

Gross margin guidance obviously pretty weak but yet you are talking about 100G pricing declines leveling off.

And I just wonder if you can put those two things together for us, help us understand.

Are we talking about declines leveling off post this quarter we are in now?

Or are they already leveled off and other things are driving that gross margin?

If you could just talk a little bit about what is going on with the pricing environment, it would be helpful.

It's with regard to the customer.

Until we officially announce it I am not going to give any more clarity on it.

I am going to respect their desire to not talk about it until we can officially talk about it.

In regard to cost, Ita, I am going to ask you to start and I will finish.

Yes.

I think if you look at the Q4 margin guidance, what we are really seeing is we have some production ramp issues that are still happening.

And we clearly have a very strong mix towards new common equipment deployments in that quarter.

So I don't know that it is necessarily that pricing has gotten any worse from what were seeing before.

It is more just the dynamic of us moving through ramping production on our new product set.

We have got that replacing some DTN margin product at the same time.

So a lot of dynamics there from a gross margin perspective.

On top of that, we also have -- will have kind of our highest deployment services number in Q4 that we've ever had.

And that also carries a slightly lower margin.

So when you look at all of those things combined they are really more operational ramp issues than they are anything that is necessarily related to the change in pricing on a quarter-over-quarter basis.

Okay, could I -- just following up on that then, if it is mostly mix that is impacting the guidance, could you still -- you have the benefit of seeing more detailed data than we do.

So could you still talk a little bit about what is going on with like-for-like pricing?

Is it -- when you say it is leveling off, do you mean it is still coming down a little bit more or do you mean it actually is looking pretty flat now quarter on quarter?

I think what we saw was, if you look back over the last year on 100G, we saw some very aggressive price declines and very competitive as new vendors moved into the market.

And now I think it has really reached a point where it can't continue that way.

And we really are starting to see it level off.

I don't think it levels off forever and that there will be further technology driven declines out into the future.

But I think in this time period people have reached the point where it really does have to level off so that we can catch up from a cost structure perspective to support the pricing that has been in the market already.

Okay.

I have seen it level loft over the last quarter.

So we are pretty much seeing the same type of pricing from a quarter ago.

So I do believe, as Ita said, the industry is coming to the point where the value proposition of 100G is sufficiently better than 40G.

It provides the capacity required for next-generation networks and people are comfortable with the pricing that is in the market.

I will go back and talk about commons again.

The most important thing we can do right now is when new footprint and new customers.

Commons bear approximately 0% margin.

The best thing we can do is assure that our commons are everywhere so as people fill out, as Dave said, 8 terabits of capacity is within Infinera capacity.

Yes.

Great.

Thanks a lot.

I will now turn the meeting back over to Tom Fallon for closing remarks.

Thank you very much 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.

This concludes today's conference.

You may disconnect at this time.