Infinera Corp (INFN) 2013 Q1 法說會逐字稿

Welcome to the first quarter year 2013 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 also being recorded.

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

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

Jennifer, you may begin.

Thank you.

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

These statements address the financial conditions, results of operations, business initiatives, views on our market and customers, our products and our competitors' products, and prospects of the Company in the second quarter of fiscal year 2013 and beyond, and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

Please refer to the Company's current press releases and SEC filings, including the Company's annual report on Form 10-K filed on March 5, 2013, for more information on these risks and uncertainties.

Today's press release, including results from the first quarter of fiscal year 2013 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 includes certain non-GAAP financial measures.

In our earnings release we announced operating results for the first quarter of fiscal year 2013, which exclude noncash 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 reconciliation of these non-GAAP financial measures to 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 year 2013.

We have excluded noncash 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.

And with that, I will turn the call over to Infinera's President and Chief Executive Officer, Tom Fallon.

Good afternoon, and thank you for joining us on our first quarter 2013 conference call.

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

As we ended 2012, we had created significant traction with our DTN-X, gaining substantial share in the fast growing 100 gig market.

In our first two quarters of shipping the DTN-X we had secured over 20 customer commitments, achieving not only number one market share for 100 gig ports recognized for revenue in those two quarters, but also achieved 26% of all 100 gig long haul ports ever sold.

In Q1 of 2013 we saw these positive trends continue.

Revenue growth on a year-over-year basis was 20%, reflecting the strength of our current DTN-X market momentum.

During the first quarter we received DTN-X purchase commitments from six additional customers, two that were new to Infinera, for a total of 27 DTN-X purchase commitments to date.

We exited the first quarter with increased backlog and strong bookings momentum.

In addition, our pipeline remains robust, with more RFP activity than we have seen for many years.

As we continue to win new footprints and gain market share, we also started to see customers begin to add 500 gig super channels and TIMs to their existing DTN-X network deployments.

Continued growth in higher margin network fill sales, balanced with ongoing new footprint wins, is critical to achieving our margins and business model objectives over time.

On the DTN front we announced wins with Akado, a leading cable operator in Moscow, and CyrusOne, a cloud provider in the US.

Further, we are seeing increased customer interest in 100 gig services on the DTN, a proof point of the investment protection that is provided by the DTN eight years after its first deployment.

Architecting platforms that are ready to deliver services that may not be envisioned yet is a cornerstone of our approach.

DTN customers are taking advantage of this today.

We anticipate that DTN-X customers will take advantage of this tomorrow.

It is clear that 100 gig offers customers a compelling economic value proposition and is proving to be the currency of choice for new builds in the market today.

After the recent unprecedented price compression on this new technology, we are seeing 100 gig prices flattening to more traditional industry norms.

Today 100 gig offers the optimal solution for long haul and high capacity DWDN applications for customers that are seeking to optimize their CapEx and minimize their operating expense.

Our shipments of 100 gig ports remains strong.

According to Dell'Oro data, Infinera was number one in 100 gig ports shipped in the second half of 2013, the first two quarters since shipments of DTN-X had commenced.

And in the first quarter we achieved another quarterly record for 100 gig ports shipped for revenue.

While the industry likes the debate whether the future preference for transmission will be 400 gig or terabit, we are convinced that the standard today is 500 gig super channels, as they are being widely and rapidly deployed in production networks.

And as the 100 gig market continues to ramp, we believe Infinera is well positioned to take share with our leading architectural approach and differentiated customer experience.

Infinera's commercialization of photonic integration has positively changed the cost structure of the optical transport industry.

Today that benefit is being realized by large scale adoption of 500 gig super channels.

We are now beginning to see the market explore the next cost function in network design, convergence.

Convergence is becoming a reality, as carriers seek additional improvements for the integration of switching and DWDN transmission to reduce the complexity of operating networks as they scale.

Infinera, with our photonic integration advantage, is uniquely able to deliver convergence without compromise, ensuring the full capabilities of DWDN and OTN switching, even when integrated into its platform.

Leveraging this position, we are combining our architectural advantage with software intelligence to deliver more capabilities at the transport layers and [to deliver] functionalities previously reserved for higher and more expensive layers in the network.

In March at OFC/NFOEC we unveiled FastSMP, the industry's first hardware based shared mesh protection solution, offering customers protection against multiple failures while lowering the total cost of ownership.

This is one of many features we have lined up to leverage our convergence advantage, helping [serve providers replace] their current layered infrastructure.

Moving now to our first quarter operating performance.

As I mentioned, we added six DTN-X customer purchases commitments in the quarter.

Our 27 customer commitments was a diverse cross section of almost every significant vertical and geographic market that requires a high bandwidth transport.

Recent public announcements of several DTN-X customers include Pacnet, [Data DI], TI Sparkle MedNautilus, [Otay] and Interoute.

We also continue to see our customers turn up new routes and networks built upon DTN-X very quickly.

With our unique architecture and digital deployment model delivery of use and simplicity, time becomes a weapon.

This is part of what we like to call the Infinera experience.

We have over 335 terabits of DTN-X capacity on live networks, up from 180 terabits in the fourth quarter, spanning 24 countries.

We do not believe any of our competitors offer this type of differentiation, and believe that we have in fact won opportunities because of this capability and commitment.

In summary, Q1 was a very good start to the year for Infinera.

The DTN-X continues to demonstrate strong traction in the marketplace, and industry recognition is growing as more customers see the benefit that our 500 gig platform brings in terms of flexibility and total cost of ownership.

We have a very active pipeline, with large customers across multiple segments and geographies.

The DTN-X was built for large networks and designed to meet the needs of tier one customers.

It is opening up opportunities for us around the world and expanding the markets we can address.

In Eastern and Western Europe we are winning new business, contrary to what many would expect given the economic concerns in the regions.

In North America our business with tier one, cable and internet content provider customers is robust.

We are seeing strong interest in Asia, which historically has not been a significant market for us.

Fundamentally, we believe that our strategy of [rolling] the DTN-X product to address tier ones and other high capacity providers, combined with Infinera's scalable business processes, manufacturing and global support services, is allowing us to achieve our objectives.

With our first quarter financial performance and positive momentum, we believe we are well positioned to achieve the priorities that we established for 2013.

We remain focused on winning footprint and gaining market share while balancing this with prudent financial management.

Once again I would like to thank the Infinera team and our partners for their commitment and hard work in delivering a great start to 2013.

I would also like to express my sincere appreciation to our customers, for their support, and confidence in Infinera.

Now I will turn the call over to Ita to provide a more detailed financial review.

Thank you.

Thanks, Tom, and good afternoon.

This analysis of our Q1 results and our guidance for Q2 2013 is based on non-GAAP.

All references exclude noncash stock-based compensation expenses.

Total GAAP revenues in Q1 were $125 million, at the upper end of our guidance of $115 million to $125 million.

We are pleased with our top line performance in the first quarter, with revenue growth on a year-over-year basis at the upper end of our 10% to 20% growth outlook for the year.

While we experienced the typical first quarter slow start to bookings, momentum built as we moved through the quarter.

We exit the quarter with increased backlog versus the end of Q4, reflecting robust sales of our DTN-X platform, combined with continued deployments of the DTN.

We recognized DTN-X revenue from eight additional customers this quarter, two of which were new invoice customers to Infinera.

In addition, we added two new DTN customers, taking our total invoice customer roster to 115.

We had one greater than 10% customer in the quarter, which was an MSO.

The top five customers also included an additional MSO, two competitive carriers and a tier one customer.

International revenues totaled $46 million or 37% of total revenues for the quarter.

EMEA accounted for $39 million or 31%, with APAC and the other Americas representing 5% and 1% respectively.

Service revenues for the quarter were $16.3 million, down from $18.6 million in Q4, reflecting unusually high levels of service activity in the December quarter.

Services gross margin was consistent with Q4 levels at 60%, reflecting ongoing deployments in various regions.

Overall gross margin in Q1 was 36%, at the higher end of our guidance of 35% to 36%.

Product mix for the quarter remained healthy, with bandwidth [builds] consistent with recent periods.

We continue to see higher levels of new footprints common equipment sales was we ramp DTN-X.

This is due to the large number of new deployments completed in the quarter and is reflective of a significant amount of 100 gig footprints that we are winning.

While we are seeing some [initial] network build sales on [air] DTN-X deployments, our product mix has a strong weighting to common equipment, which will constrain our gross margin in the interim.

This footprint, however, forms the foundation of our future business and allows for an ongoing profitable business model and long-term sustainable growth.

Our progress on yield improvements and cost reductions on the DTN-X platform remains on track.

We expect to see initial benefits from these improvements in the June quarter, contributing to our improved Q2 gross margin outlook of 37% to 39%.

All things being equal, we'd expect cost reduction activities to continue to contribute to the financials on an incremental basis through the end of the year.

These improvements are a key element of achieving our gross margin targets for the year of 38% to 40%.

Operating expenses for the quarter came in at $52 million, slightly above our Q1 guidance and Q4 spending of $51 million, reflecting some increased sales expenses in the period.

Looking forward to the June quarter, we expect operating expenses of approximately $53 million to $54 million, reflecting increased R&D costs related to some prototypes to be delivered in the quarter and some increases in sales compensation expenses.

Overall head count for the quarter was 1,219, versus 1,242 in Q4.

The reduction in head count primarily reflects changes in operations and R&D resources as the DTN-X product matures.

Our operating loss for the quarter was $7 million.

Other income and expense netted to zero.

Net loss for the quarter was $7 million, resulting in a loss per diluted share of $0.06, at the better end of our guidance, which calls for the loss of $0.05 to $0.09 per diluted share.

Now turning to the balance sheet.

Cash, cash equivalents, restricted cash and investments ended the quarter with $164.9 million, down from $187.6 million in Q4.

We used $21.3 million of cash from operations in the quarter, a significant swing from generating $8.3 million in Q4.

While we approached EBITDA breakeven on the income statement, working capital management this quarter was a challenge.

There were a number of larger deals that booked later than expected in the quarter.

This was resulted in cash payments for inventory purchases that were not matched with collections in the period.

DSOs came in at 82 days, up from 76 days in Q4.

Our aging remains current; however, the late timing of bookings resulted in delayed billings and therefore lower collections in the period.

A strong opening backlog and good early bookings momentum should result in improvement [minority] and DSOs in the June quarter.

Inventory turns were 2.4 times, versus 2.6 in Q4.

Inventory turns reduced to 2.4 times in Q1, as we positioned increased levels of finished goods inventory to support bookings received at the end of the quarter requiring shipment in early 2/2.

Our increased inventory reflects our outlook for near term demand and the value customers place on time as a weapon.

Having said that, we do not anticipate the fundamental goal inventory.

Accounts payable days were 48 days, down from 56 days in Q4.

Capital expenditures were $4.9 million, compared to $3.2 million in Q4 and in line with our guidance for capital expenditures of approximately $20 million per annum.

Although we invested more cash into working capital in the first quarter than anticipated, we believe we are making the right decisions about the timing of inventory purchases to support this key growth phase for the business.

We expect to see some incremental improvement in cash metrics in Q2 and believe that we will exit 2013 having increased our cash balance on a year-over-year basis.

Now turning to our outlook for the second quarter and beyond.

We continue to see strong interest in the DTN-X platform, with good bookings momentum and a healthy pipeline of RFPs and lab trials.

We are pleased with the level of purchase commitments driven by the platform to date and especially with the number of new customers the DTN-X platform has generated.

Although most of the new network builds are DTN-X based, we continue to see new customers and new deployments with the DTN platform.

As outlined in our February call, we were concerned about the seasonality associated with Q1 and its impact on the timing of bookings and revenue in the first quarter and for the year.

Q1 revenues came in at $125 million, at the higher end of our guidance for the quarter and in line with the higher end of our revenue growth outlook for the year.

Based on our current view, we believe that revenues for the second quarter will range from $130 million to $140 million, and we are becoming increasingly comfortable with the high end of our revenue growth outlook of 20% for 2013.

We expect some improvement in gross margins in Q2, as we benefit from DTN-X related cost reduction activities.

Our guidance for Q2 2013 calls for gross levels of 37% to 39%.

This assumed continued footprints and DTN-X wins in the quarter, with higher levels of common equipment driving lower initial gross margins.

We remain committed to our 2013 gross margin outlook of 38% to 40%, with expected incremental benefits from cost reductions and product mix improvements later in the year.

We believe that with solid revenue growth, our vertically integrated models can deliver significant leverage and allow for a healthy gross margin expansion.

In addition, over time we expect to see a more balanced mix of new footprints and network [fill].

These factors allow for gross margin expansion towards our midterm target of 45%.

As we look at operating expenses, our outlook on analyst day in December called for operating expenses in 2013 of approximately $201 million to $205 million, depending on our projected revenue attainment.

We now believe that with revenues at the upper end of our outlook, operating expenses could range from $205 million to $210 million.

This increase in spending for the year includes some assumptions around accelerated R&D costs related to customer specific features and a refinement of our sales commission estimates as customer mix and requirements become clearer.

This increase would only be executed on as our confidence increases around the improved revenue outlook.

As we go forward, we intend to grow operating expense expenses at a lower rate than revenues in order to support profitability and achieve our midterm business model.

In summary, our guidance for Q2, which is based on non-GAAP results and excludes any noncash stock based compensation expenses, is as follows.

Revenues of approximately $130 million to $140 million, gross margins of approximately 37% to 39%, operating expenses of $53 million to $54 million, operating and net income loss of approximately $1 million income to a $5 million loss.

Based on estimated average weight of diluted shares outstanding of 120 million, this would lead to an EPS range of [$0.001] income per share or $0.04 loss per share.

Please note that the basic share count is expected to be 117 million for the quarter.

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

Thank you.

And with that we will now begin the question-and-answer session.

(Operator instructions.) One moment, please for our first question.

Our first will come from George Notter with Jefferies.

Your line is now open.

Hi, guys, thanks very much.

Congratulations on a very strong quarter and guide.

I guess I wanted to ask about the DTN-X, and it feels like the pace at which you guys are adding customers and seeing revenue growth maybe is a bit ahead of where you guys had previously expected, and I guess I'm just trying to understand what's new here.

Is this the addition of certain particular customers that could be sizable?

Is it more broad based?

I mean, is there any kind of root cause analysis that you can point us towards to talk about the inflection into this DTN-X business?

Hi, George, this is Tom.

First of all, thanks for the congratulations.

Second of all, certainly the DTN-X progress is at the upper end of what we are driving for.

We are a pretty aggressive group of people, so we are trying to, quite frankly, win as many opportunities as possible.

But from a more balanced perspective, I would say we are winning customers at a clip to me that is very impressive, and the size of the deals is also impressive, both from the initial footprint and opportunity over time.

I think that were I am looking at where are we being pleasantly, not surprised, but on the upside, Europe has really been a great place for us.

While most of the world talks still about the challenges of Europe, and there are many, there are clearly a significant number of networks being built in Eastern and Western Europe.

And I think that we are benefiting a great deal from that.

Our outlook for the future, I think, has been enhanced with more comfort towards the top end of the range, because the DTN-X is being very well received by potential Asia customers.

We won't win all of them, but the interest is very significant, and I'm confident that we are going to win at least some of them.

And in our home base, where we kind of always had an established leadership role, cable, Internet content providers, wholesalers, they are putting in networks.

Capacity is certainly -- requirements are certainly growing.

It is clear to me that anybody building a new network today is going to build with 100 gig.

I feel very comfortable that we have the best 100 gig solution on the market.

Our reputation for quality, time as a weapon and customer support is unparalleled.

SoI just think that we are seeing an investment period after a dearth of investment.

I'm seeing 100 gig as being standardized as the right answer for today and tomorrow, and Infinera is just executing well.

Do you think -- just expanding on that, do you think there's anything that's more germane to the marketplace itself that's going on?

Would it be just the pure economics of 100 gig as they improve?

Do you think people start to come off the sidelines and launch more RFPs and more deals and deployments?

Do you think it's maybe the presence of more vendors in the marketplace that's getting people off the sidelines?

Could it be the presence of Infinera certainly that was previously in overhang in the 100 gig space, and now the overhang has come off as you issue product?

It seems like there's just more activity out this right now, and I guess I'm trying to understand why that is, above and beyond just you guys now having a product.

I think it's all of those things, George.

I think that even as recently as a year ago this was a grand debate on whether it was going to be 40 gig for how long and then 100, or is it going to go to 100.

The 100 gig supply base was too narrow to be standardized upon.

100 gig pricing did not offer a compelling economic choice to 10 gig.

I do believe, just like we did with 10 gig, Infinera entered the market and catalyzed rapid growth.

Other people have also entered the market.

I think that the customer base today uses 100 gig as the best economic choice and broad enough product base that there's not a great deal of risk.

I also think that, just like we've said for a long time, a 40 gig squeeze is happening, and nobody is going to be wrestling with is it going to be 40 or is it going to be 100.

It's 100.

It's today.

It's 500, it's today, and we have a great platform, a great install base, and there is a pent up demand for transmission capacity around the world.

Got it.

Great.

And then one just last qualification.

You guys threw out a couple of numbers 335 terabits, and then I think you compared that with 180 terabits in the prior quarter?

Was that the amount of 500 gig super channel adds in aggregate each quarter, Q1 versus Q4?

No, that's the cumulative amount -- let me go look at the numbers real quick.

It's the cumulative amount of basically AOLM.

It has -- if people buy the whole thing, it's got 500 gig on it.

If people buy it by bandwidth, by channel, we have one channel that accounts for that, and we are collectively adding up all the capacity that is cumulative deployed in the world.

And there's a slight difference between bandwidth product purchased and product deployed.

So this represents the amount that's gone through the acceptance and deployment cycles.

It's 335 versus 180, George.

Got it.

Great.

Thank you.

And obviously that number should grow every quarter.

Don't view it as an incremental -- that 335 is incremental.

It's the cumulative amount of capacity.

Got it.

Thank you.

And our next question comes from Rod Hall with JPMC.

Your line is now open.

Hi, this is Ashwin on behalf of Rod.

Tom, could you elaborate on 100 gig pricing comment you made?

I think you said your 100 gig prices, it's probably flattening versus the industry.

Does that mean that you are seeing less pricing pressure?

And is it specific to Infinera or is it a marketwide phenomenon?

Can you elaborate on that?

I specifically said it's no longer falling at the rate it has fallen at the last two years, and it is approaching more traditional industry norms.

Usually when you introduce a new technology, it takes a number of years -- typically greater than five -- before that technology will offer price per bit parity.

And with 100 gig it's been about two years, and it's already much more cost effective than 40 gig at a price per bit, and it'sactually quite, frankly, at this point, less than 10 on a price per bit basis.

That's a very rapid degradation of pricing.

That's good in one way.

It helps the market adopt that technology as a standard and ramps that volume in the industry much more rapidly.

As a vertically integrated manufacturer we have more benefit from that ramp than the traditional competitors do, because the more volume we create, the lower price or cost of each device.

We are not trying to drive that price curve.

The market drives the price curve as people enter the market andare interested in establishing footprint.

There's several of us in the market now, and any -- on any given day some customer might be viewed as strategically important to one of the competitors, and for that it drives a market price down.

And the market will typically respond, and the competitors will typically respond.

We have seen that behavior over the last year, and what we are seeing now is less of that behavior.

There's a market price that's been set, and there's a small range around that.

That doesn't mean that for some strategic customer, somebody wouldn't do something that I would consider out of common sense practice.

That's part of the business world, but I do see that the natural degradation of pricing is going to be slower.

I think that's very important, because our industry needed to have the opportunity to recoup our R&D through fair margins and that's a challenge in our industry.

As you can see, as Ita pointed out, we believe that our margins are starting to uptick.

So we believe that we are taking advantage of the volume that we are creating in the market, and that should help us over the next both several quarters and several years.

Fair enough.

Thanks.

Shifting gears to the general business environment, I mean, obviously we saw a lot of negative news around CapEx in the last few weeks.

How do you characterize the business environment out there in the market now?

So I'm going to put some fidelity on what I'm hearing you say.

Negative news on CapEx over the last few weeks.

What it specifically is is negative news on CapEx from a couple of tier ones.

Not negative news in general in the market, is that a correct assertion or incorrect assertion?

Yes, maybe we can start there.

Okay.

So I continue to be somewhat befuddled by what I consider a fairly narrow view of the world of CapEx as being defined by a couple of tier ones in North America.

We are growing business.

Obviously not with the people who are publicly saying their CapEx is going down.

We are picking up market share.

We see incredible opportunities with cable, with wholesalers, with international tier ones, with contend providers.

And as long as the industry views one or two people as defining the market, I think there's going to be a disjoint of reality of who is going to do well and would is not going to do well.

Our job as a company is to get into those markets, because they are important markets, but I don't believe they define the market.

All right, great.

Thanks.

Our next question comes from Ehud Gelblum with Morgan Stanley.

Your line is now open.

Thank you.

This is Kate Watkins in for Ehud today.

I just wanted to first ask you about your large tier one in North America, or actually the US.

It looked like, just looking at the revenue trends for domestic versus international, that they are relatively similar.

So just wanted to get a sense of when you are expected to see a ramp from CenturyLink specifically?

How you expect that deployment to occur?

Does it happen in one quarter suddenly?

Are we going to be surprised to see the domestic number tick up pretty significantly?

Just your expectations there would be helpful.

Yes, I mean, I think it's hard to derive that from looking at the split -- the geographical split.

We are seeing a lot of strength internationally, and a lot of kind of the new customers that we have added have actually been international customers.

So that will mask what you will see as shifting revenues in North America.

I would point you to our top five customers and the fact that there's a tier one customer in there.

And that's a major tier one customer and an important customer to us.

I'm not sure that we can say very much else about CenturyLink at this point, but that is -- we are seeing that growth and that tier one customer being in the top five.

Got it.

Okay.

That's helpful.

And then the comment about -- Tom, you made a comment about some opportunities in Asia.

Could you just comment on the number of 100 gig RFPs right now in China specifically?

Are you involved in any of those, and if so, would that result in any additional margin pressure, i.e.

this flat pricing that you are seeing on a global basis, is there any differences on a regional basis?

Yes, you are going to put me on a little bit of a soap box for a second, andI apologize.

I see all of the news about the big builds and 100 gig coming in China, and you will notice that they are all Huawei and ZTE oriented.

I want -- my view, and the biased view, the China market is not an open market to non-Chinese suppliers for long haul transmission.

We are involved with zero RFPs.

We have I have zero opportunities to win any RFPs.

It is a closed market.

Where we are seeing opportunities around the world, we are seeing them in Japan.

We are seeing them in Hong Kong.

We are seeing them in the New Zealand, Australia area.

We are seeing them in India.

We are seeing them in Korea.

We are seeing broad based ranges of opportunity, Vietnam.

Whether we win those or not, I don't know, but DTN-X is viewed as cutting edge technology, with a history of large scale deployments around the world, with other carriers, and we are being invited, very aggressively, to both RFPs and are earning opportunities for short listing.

I think that the tale will still be told later this year, but we have not seen this amount of broad activity in Asia ever.

And I'm expectant of success in that area, though it's starting off on a pretty small base.

Got it.

Just to my question specifically about pricing, the comment about pricing relative to -- turning back to industry norms, which I think is somewhere around 10% to 15% declines per year.

Is it -- are there any differences on a regional basis that you are seeing?

I would say it's fairly the same around the world.

There are some areas in the world that have historically seen -- shocking areas -- better pricing.

Some of it sometimes is due what I would consider to nationalistic pride.

If there is a supplier in that region, they typically will make sure that they are the supplier of choice for the telecom company in that region, and they will get an unusual price.

But in general, the pricing and the pricing expectations are relatively the same.

The biggest difference in pricing will come from how big is the opportunity?

Obviously the guy buying $10 millions or $50 million a year is probably going to get a better price than the guy buying $1 million a year.

Yes, got it.

One last question.

JustI wanted explore the service gross margin line.

I realize it's been a little bit weaker because of the deployment mix in the services line.

How are you thinking about the service margin specifically shaking out throughout the year, and I guess really we need to talk about revenues, because it seems like you've got quite a lot of activity.

So I would expect deployment revenues to be -- continue to be strong but I wanted to hear your thoughts this.

Yes, I think we expect to see the deployment revenues stay strong, and that kind of high 50s, 60% gross margin is probably a good place to think about services margins being for the rest of the year.

Because we will -- we are doing a lot of deployments, and we are doing deployments in new regions, et cetera, so we will see increased activity and some of the new activity, which we will need to optimize over time.

I think high 50s, 60% is a good place to be.

Great.

Thank you very much.

Our next question comes from Mike Genovese with MKM Partners.

Your line is now open.

Great, thanks a lot.

Congratulations again, guys, on a great quarter and great guide.

But speaking of the guide, did you think about not necessarily tightening the range, but lowering the bottom end or even just raising the entire guide?

It seems like the second half would have to be pretty terrible for you to come in the lower end of this 10% to 20% for this year?

Yes, I think based on my comments, we are saying we are pretty comfortable with the upper end of the range at this point, right?

If you think about the back end of the year, I mean, our visibility has improved, but we still don't have visibility at a bottoms up basis to the second half, even though we think there's good momentum there and there's a lot of RFP activity there.

I think our message is more that we are comfortable with the upper end of that range at this point, and then as we get more visibility on the next call, we will provide some more fidelity through the end of the year.

One of the things we want to avoid, Mike, is getting in the habit of kind of giving a year outlook on every quarterly call.

We gave the original year outlook, if you will remember, at investor day, and what we are trying to do is update our view of that guidance at that time versus reset guidance on a quarterly calls that extend beyond a quarter.

Great.

So along those lines, with the order strength, could you just give us a sense of the backlog expansion?

I mean, is there any just goal posts you can put around how much bigger the backlog is now than it was at the end of 2012?

We are not going to give kind of quarterly backlog numbers.

We put it in the K once a year, and we are probably going to stick with that.

But it's up a significant amount, right?

It certainly helps us have comfort around the guide for Q2.

Great.

And just your advantage on kind of order to time to build the network to time to taking revenue, could you just give us -- again -- I mean, versus the competition -- the typical competitors you have out there, how much faster do you think you are turning orders into revenues than they are?

Yes, I think from a pure rev rec perspective it's going to vary significantly customer by customer.

From a network turn up perspective I think we believe we do that significantly faster than the competition.

I know for a fact in Q1, we won a deal when one of our competitors could not the execute the requested timeline.

I have think that quite frankly we were going to be number two on the deal, and we ended up winning.

That network was taken in the quarter, it was delivered in the quarter, it was turned up in the quarter, and it was turned over in the quarter.

I think our culture, our [DNA] says time is a weapon.

Our architecture is a digital architecture.

You can deploy services and equipment very quickly, and that's -- I think it's a big advantage to some customers some of the time.

What other competitors do, I don't really know.

Our customers say I know, if I need it fast, I know I need to get it from Infinera.

Just hopefully a couple more quick ones.

The seasonality, Tom, now that your customer base is broadening out more, do you think that seasonality is a factor, and that now that we are past 1Q, which is -- should be the seasonally weakest of the year, do you have any view on seasonality?

And I realize that we are not talking about just AT&T and Verizon.

We are not really talking about them.

We are talking about everybody else.

But do you have kind of an updated view on seasonality now that the customer count is up to well over 20, approaching 30 for DTN-X?

Yes, there's still an impact of seasonality, and depending on what industry there is, certain industries buy more in the first half of the year, certain industries buy more in the second half of the year.

I think as we expand our customer base beyond 27, into more and more both geographies and industries, it will become more moderated, but I would not assume at this point that we're going to escape seasonality.

Clearly in Q1, which is a typically a tough quarter for both the industry and us, we came through pretty well, but I think that the industry was still say that Q1 had some seasonality.

And I think Q1 will continue to be a slower quarter for our industry in general, and I don't think that we're going to be immune from that moving forward.

Finally, Ita, you mentioned a midterm margin target.

I think you said on the gross margin 45%, but I think there's a long-term target out there at 50%, unless I'm wrong about that?

Yes, we pretty much reset to the midterm view at the analyst day, and we haven't really updated a long-term model beyond that.

I think we are more focused on achieving that 45% and then providing some further color after that.

Does the 45%, is that with the 10% operating margin?

Am I remembering that directly?

Correct, yes.

Okay, great.

Thanks again and congratulations again.

Thank you.

(Operator Instructions).

Our next question will come from Alex Henderson with Needham.

Your line is now open.

Thank you very much.

I was hoping you could talk a little bit about the mix between existing customers and the new customers in terms of not just simply the number of orders, but rather what degree the existing customers are already showing up -- excuse me, the new customers are showing up as revenue?

Or are the larger new customers still longer time to deploy and revenue recognition?

Looking at the orders that you have had announced on your website and tracking them against existing customers, with the exception of KDDI and two small customers, virtually all the announced contracts on the website for the last two quarters were existing customers.

And I'm assuming that there are a couple of larger orders underneath the surface from new customers that are going to take a little longer to come through.

So can you give us in terms of magnitude of what you are seeing in terms of new customers in the current quarter and what we should expect that to go towards as the year progresses?

Yes, I think if you look at the number of new customers that are customers that we have invoiced, there's a good percentage of those that are new customers, and new customers are all driving significant revenue amounts, right?

Because you can't -- you are not going to turn up a DTN-X network with an acceptance, et cetera, without driving meaningful dollars, right?

So I think every new DTN-X customer that we have talked about or those that we can't talk about are driving meaningful revenue and have the potential to driver further revenue.

But a DTN-X is still multimillion dollars of revenue at any point in time.

What I was --

I also think it's important not to focus just on the names we announce.

As Ita said, there are a number of very significant wins we both had and recognize revenue on from very significant market segments that are -- they just don't allow you to talk about it.

And that's the Internet content space.

It's the tier one space.

It's the cable space.

So be cautious of assuming that if we announce somebody that you think doesn't drive a lot of revenue, that that's representative of the entire sweep of customers that we are winning and delivering for revenue DTN-X.

Yes, I'm just trying to get a handle on the pig in the python problem with a lot of your first half 2012 customers deferring into the back half, and it looks like it looks like it continued into the first quarter, the substantial amount of delay to wait for the DTN-X to be available, and then you ship into them, and then you can recognize revenue very quickly.

Versus if you were bring if you were to bring in, say, a tier one service provider, it could take four or five quarters for that customer to show up as revenue.

What I'm trying to get a handle on is the mix that we are seeing first half mainly existing customers that are coming on and that mix starts to shift towards newer customers in the back half?

Can you just qualitatively talk about that mix shift?

Yes, I mean, it's tough, right?

We are -- we certainly see a good, strong representation of our own customers in the Q1 and Q2 revenue numbers, right?

But at the same time, there's a very meaningful number of new customers would will ramp a little more slowly than an existing customer, right?

So for sure, our existing customers are more likely to take larger dollars and have shorter rev recs, right?

But the -- there's a fair representation of new customers there, and they are ramping meaningful dollars pretty quickly.

We haven't had customers that have taken four or five or six quarters to come to revenue.

We just don't have that phenomena.

A long turn up time for with us a customer to get to a multiple million dollars is two quarters or there abouts.

So we don't see the long tail that you are describing.

One last question, one last crack at it and then I will cede the floor.

So ifI were to look at your lead book, if you look back at the customers that you had over the years versus the customers that are new, is there a higher percentage of new customers in your lead book than there has been in prior periods?

Yes, absolutely.

I mean, we are getting access to customers that we didn't have access to before for sure, and those customers have a different profile.

They are definitely larger customers, tier one type customers that we can -- that we didn't have access to before.

I want just add on very quickly.

What we have talked about before is the DTN-X brings out a variety of new features, and I want to emphasize we are winning because of those added features, the integration of the OTN, the value 500 super channel's the capability to network.

And it's those features that allow us to expand the market space out to a greater set of new customers.

And we are seeing the benefits of that market expansion in the new customers.

Thank you.

And our next question comes from Subu Subrahmanyan with The Juda Group.

Your line is now open.

Thank you.

My question is on market growth versus share gain.

I know you talked about it, Tom, but areyou thinking that the market growth is also toward the higher end of the range then you had earlier expected?

Is there a broader inflection point in 100 gig that we're seeing over a lot of this upside [from] share gain?

So let me define market growth.

If I define market growth as the 100 gig or, in our case, the 500 gig market sector, I have think that's growing at a good -- very strong clip.

It's coming at the negative consequence to 40 gig markets that have existed out there, and that's clearly made a transition.

So there's quite a ride range of predictions on what the growth rate was for the 100 gig market sector, but I would say from our experience, we are seeing that market sector doing very well.

I thinking more in terms of long haul DWDM market, not necessarily the 100 gig.

Yes, so if I expand to look at 10 gig, 40 gig and 100 gig as an aggregate, I would say that it's probably on target for what the growth is.

I'm not sure that the market growth is -- it's a little hotter, not a lot hotter from that.

What we are seeing is a -- we think there's a substantive market share gain that's coming about.

One, we didn't really participate in the 40 gig market sector, and so now our 100 gig -- now that has moved towards 100 gig, we are seeing market share gains for ourselves on that.

It's a mixture of both, we think the -- again, the market expansion for us, new customers we haven't gotten to before.

The 100 gig market is doing very well.

The total long haul market sector is doing reasonably well.

There seems to be good business out there.

But kind inform that order is what's driving that growth.

And if you could talk about margin, I mean, the last time you were $130 million in revenue, a couple of years ago, obviously margin [CPS] were much higher.

Can you talk about kind of what kind of targets from a revenue perspective should need to be in to think about your long term operating margin?

Obviously part of that is gross margin improvement from a revenue direction.

If you could speak about that.

Yes, I mean, I think the margin phenomena that we are seeing right now and through the end of 2013 is pretty unique in that it's really -- it's going to be largely driven by two factors, right?

One is product mix and getting to a balanced mix level on the DTN-X.

And the second piece of it is that we have -- we just have a cost curve that we need to work through, right?

So that's why if you look at the guidance even for 2013, by the time you get to Q4, you do start to see margin expansion to hit that 38% to 40%, right?

So I think the two biggest drivers in the near term are going to be get down that cost curve, which we see and we are seeing ongoing progress towards that, and then have some product mix and fill on the DTN-X, which we are also starting to see, which is a positive sign, right?

Beyond that, obviously, as revenues grow we will get some gross margin flow through, et cetera, as well.

What the revenue number is to hit 45%, it's somewhat more than where we are in 2013, but it's really more driven by those two factors than it is necessarily going to be the top line in the near term.

And I meant on operating margin, to get to your target operating margin ranges, what kind of revenue number --

I mean, it's going to be dependent on the gross.

If you get the gross margin up to 45% and thereabouts, then you get -- you start to drive towards that 10% bottom line, right?

The key is the gross margin.

Thank you.

Our next question comes from Simona Jankowski with Goldman Sachs.

Your line is now open.

Hi, thank you very much, andI joined the call a bit late, so I apologize if you've already addressed this.

But as far as where you are on the yield curve in terms of your pick for the DTN-X, could you comment on that?

And perhaps if you are able to quantify, if we were to magically be at the ultimate goal of your yields, how much would that contribute to gross margin in terms of points or dollar amount?

Yes, so I don't know that we are going to talk specifically about the yield in the fab, but I think if you look at our gross margin guidance for the year and kind of the expansion that has to happen in that margin to get to that annual number, it gives you some idea for how we see those cost reduction efforts impacting and helping gross margins through the end of the year.

Maybe just to try to ask it another way.

If you look at the upside to margins from the kind of the blade versus chassis shift and compare that to the potential upside from improving yields, which one is the larger factor for us to look for in terms of driving upside?

Yes, I think through the end of the year we are relying more heavily on the cost optimization and cost reductions, because we think we will still be shipping a heavier mix of commons.

And then as we move into next year and expand beyond that, it will come mainly from mix as we start to see the fill on the existing networks.

Okay.

That's helpful.

And then the second question is, what percent of your sales roughly at this point are coming from customers who are using that new revenue model that introduced a quarter or two ago where you can sell chunks of capacity kind of decoupled from the actual TAMs?

The percentage of revenue at this point is still pretty low, and I know we have talked about this a little bit, but it's a model that will be used by a particular customer set as opposed to being broad based, right?

So we are seeing it in some key accounts where it fits the customer needs, but it's not driving a significant proportion of revenue.

To me, the importance isn't whether or not it's a big part of the revenue.

Infinera is passionate around being on the same side of the negotiating table as our customer.

Some people want 500 gig at a time, some people want 100 or think they want 100.

We offer that.

They have the choice of what makes the best economic sense to them.

Sometimes they end up buying the 100 at a time, and sometimes they come back and say, no, I just want the 500.

Our job is to help them build a successful business.

We are creating tools that allow them to do that in their markets and allows us flexibility of [holding] a good business model and fair return for our shareholders.

Is it a larger percent of the backlog for you versus what's in the run rate revenues?

No, I mean, I think it's still -- it's a tool to be used in the sales process, but it is not driving a significant portion of our existing Q1 and Q2 revenues.

It may do in the future, depending on the customer, but right now it's not driving a major portion of that revenue.

Got it.

Thank you very much.

And we do have time for one more question.

That question comes from Sanjiv Wadhwani with Stifel.

Your line is now open.

Thanks.

Congrats on a great quarter, guys.

Tom, I had a question on gross margins.

Wanted to get your thoughts around strategy going forward.

I mean, it does seem that you guys are starting to take some share, and I'm just fast forwarding let's say two to three quarters from now, and lets say your share gains accelerate.

Trying to figure out if some of the larger competitors then decide to use pricing as one of the mechanisms to stem those gains.

Are you going to be participating in that?

And just curious to see whether you would sacrifice gross margins in the short term just to gain those footprints with pricing as an element?

Yes, first of all, thank you for the congrats for the quarter.

Your observation is if we are winning market share from now, a few quarters from now people might want to truncate that by having a pricing war.

My view is that the market cannot become more competitive than it's been over the last year, as this new technology is absorbed into the market, and the market share winners for the long term are going to be defined over the next few quarters and years.

There's intense competition today for that market share.

I think that once we or somebody else is into a customer, to dislodge that competitor as a primary supplier is very difficult to do just around pricing.

It has to be more of a value of network, value of service, quality experience.

So I think that and my view is that the vast majority of the competitiveness we are already in the midst of.

It is rationalizing itself.

I think that candidly, as I watch Huawei begin to have challenges on the world stage and extract themselves -- I guess, at least what I'm reading is they have stated that they are not interested in the US market anymore -- that helps the market.

I think that Huawei, they weren't winning in the market anyway and certainly in the United States.

They didn't have a differentiated solution.

Their customer service and support, I think was inferior.

I think their business practices were inferior.

They did not receive acceptance.

Having said that, a number of people have used them as a pricing lever to bring down competitive pricing.

I think that there's a more rational view on now, and as people -- companies exit from certain markets, there's less abnormal behavior to drive irrational pricing.

So I'm more comfortable that the future will have more rational pricing, not less rational pricing.

Yes, if I can add a couple of points here also.

You need to understand that the -- this transition that is going on right now is not just a transition to 100 gig.

It's a transition to an intelligent transport network.

And when you have features such as Fast Shared Mesh Protection, as [Peter Bole] indicated in one of his talks, that was almost a factor -- could be as much of a factor of two benefit in the cost structure of his networks, it's far more valuable than the price pressure on the transponded basis.

It is the added intelligence that goes into a transponder network with the integrated OTN switching, with big super channels on there, that creates a better total cost of ownership when looking at the network in entirety and not looking at the historical point-to-point transponder market.

It's no longer a 10 gig market per se.

It is an intelligent transport market that takes big pipes in there to make it efficient.

Got it.

That's helpful, thanks.

Thanks, Sanjiv.

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

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

Have a great day.

And with that we will conclude today's conference.

Thank you very much for your participation.

You may disconnect at this time.