Infinera Corp (INFN) 2013 Q3 法說會逐字稿

Welcome and thank you for standing by.

Welcome to the third quarter year 2013 investment community conference call of Infinera Corporation.

(Operator Instructions.) Today's call is being recorded.

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

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

Jenifer, you may begin.

Thank you, Joe.

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 initiatives, views on our market and customers, our products and our competitors' products, and prospects for the Company in the fourth 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 releases, including results of the third quarter of fiscal year 2013 and associated financial tables and investor information summary, will be available today on the Investors section of Infinera's website at Infinera.com.

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

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

In our earnings release we announced operating results for the third quarter of fiscal year 2013, which exclude non-cash stock-based compensation expenses and amortization of debt discount on our convertible senior notes.

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 the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful and how they are used by management, which will be available today on the Investors section of our website.

On this call, we will also give guidance for the fourth quarter of fiscal year 2013.

We have excluded non-cash stock-based compensation expense 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 Chief Executive Officer, Tom Fallon.

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

With me on the call today are Chief Financial Officer, Ita Brennan, and President Dave Welch.

Our third quarter financial results were strong and demonstrate the continued momentum we have established in the developing 100-gig and converged network transport market.

Revenues were $142 million, an increase of 27% over the prior year's third quarter and 3% sequentially.

We generated positive cash flow from operations, with both gross margin and profitability exceeding our expectations.

Our success continues to be driven by strong customer acceptance of Infinera's Intelligent Transport Network and the DTN-X platform, which uniquely offers super-channel scale, converged OT and switching, and GMPLS network automation today.

During the third quarter, we generated DTN-X purchase commitments from five additional customers, including two new to Infinera.

These additional DTN-X customers include two Tier 1 international carriers, a large Internet content provider, a bandwidth wholesaler, and a competitive carrier.

This brings our total DTN-X customer count to 39 since its introduction last year.

Fourteen of these customers are new to Infinera, demonstrating that our commitment to expanding market share remains on track.

On the new customer front, we are pleased to publicly announce our second domestic Tier 1, Ross Telecom, Russia's largest telecommunications provider, with over 500,000 kilometers of fiber.

We also had our first win in Africa, showing that we are gaining traction in new regions in EMEA while still seeing continued strong momentum in Western and Eastern Europe.

In fact, Infonetics named Infinera the fastest-growing optical vendor in Europe for the second consecutive quarter.

Clearly, our technology differentiation and passion around customer success is yielding sustained market share growth.

APAC momentum continues, as two of these additional DTN-X purchase commitments in the quarter are based in this region.

We also recently publicly announced our first customer win in South Korea with the addition of Dacom Crossing, a bandwidth wholesaler with both terrestrial and submarine routes.

North America demand remains solid from our existing Tier 1, cable, wholesale, and Internet content provider customers, along with significant new RFP activity.

I am particularly pleased that in Q3, two greater-than-10% customers were large North America Internet content providers.

In North America, we see more opportunity in the next 12 months than we've seen in a long time, and we believe we are well positioned to take significant market share.

Adoption of 100-gig and convert networks has been faster than industry analysts anticipated.

Dell'Oro now estimates a 275% increase in ports shipped in 2013, with the majority in long-haul routes compared with its previous 210% estimate in July.

Infinera's own experience validates this phenomenon.

We have shipped and invoiced more 100-gig ports in this quarter than any past quarter.

The industry is also aggressively moving toward converged architectures.

Infonetics reports that by 2016 in the network core, over 90% of service providers surveyed want to deploy systems with integrated DWDN and OTN switching, up significantly from the survey just one year before.

Infinera pioneered this network architecture with our DTN, and we have scaled and enhanced it with the DTN-X and our Intelligent Transport Network.

This shift is being driven by the carriers' need to make their networks more efficient and accommodate the growing data volume and more dynamic traffic patterns as video, mobile, and cloud continue to drive new network architecture direction.

It is also being driven by their need to quickly respond to their customers' requests and leverage time as a weapon for a more competitive posture in the marketplace.

Our customers continue to tell us that our solutions are not only more reliable, but easier and faster to deploy than any other solution on the market.

Infinera has now deployed three quarters of a petabit per second of super-channel capacity.

This is 100 times the capacity of the Internet in 2005 in just over one year of deployment activity.

Additionally, 12 of our 39 DTX customers are using our Instant Bandwidth Solution that allows them to instantly deploy bandwidth on demand in 100-gig increments with no truck roll, a capability available only with the Infinera Intelligent Transport Network.

On the competitive front, you see the environment is gradually narrowing and driving the market toward a more sustainable business model.

We believe the leaders in the evolving market must offer 100-gig and OTN switching capability today to the majority of the business.

You've even seen router vendors, long-time advocates of IP over DWDM, now announcing future plans for OTN switching solutions.

We also believe that to compete effectively, suppliers will need to own the intellectual property for these vertical technologies in order to both differentiate and earn a reasonable return.

Unlike 10-gig technology, there are just a handful of companies in this category.

Finally, as carriers are making strategic decisions on how to build their networks for today and tomorrow, financial stability -- the ability for vendors to be here tomorrow -- is critical.

We anticipate that as the market continues to develop in the next four to six quarters, business will continue to gravitate toward those suppliers that offer 100-gig or super-channels providing higher bandwidth and a capability to support convergence requirements.

Competition will remain fierce for these critical footprint wins.

We are confident that Infinera has the right technologies and business model to bring on new customers and gain market share while executing our vision.

Turning to technology, on the optical front, we introduced our super-channel Soft Decision FEC product in Q3 that is now being deployed in multiple networks.

We also continue to provide industry leadership around network intelligence and automation.

Earlier this month, we successfully demonstrated multi-layer carrier SDN control of both the IP and transport layers.

This was done in close collaboration with Brocade and our mutual customer, ESnet, and demonstrated the potential of SDN to leverage an Intelligent Transport Network to simplify operations and reduce traffic at the router layer.

While we are extremely pleased with the results of this trial, we are cognizant that service providers remain in an exploratory mode with SDN, and we are managing our investments in this technology carefully.

Although it is important that people deploy SDN-ready Intelligent Transport Networks today, we don't anticipate material carrier demand for SDN for a couple of years.

However, when it does materialize, we believe Infinera will be well positioned to succeed and that DTN-X will provide an optimal platform to support carrier SDN.

As we look ahead, we continue to see strong interest in DTN-X and converged solutions across all geographies and market segments.

We have visibility in the intermediate term on numerous large opportunities, with strong RFP activity.

However, predicting the timing of purchase commitments remains challenging because of our short lead times and the strategic nature of many of these customer decisions.

At the macro level, the optical long-haul DWDN market is expected to grow at 8% on average when comparing 2014 to 2013.

I continue to believe that Infinera will (inaudible) in the market over this time period.

We are focused on winning market share.

Based on the RFP activity and the increasing momentum that DTN-X has demonstrated, I am confident that we will significantly expand our penetration of existing customers and add new strategic customers over the next 12 to 18 months.

We believe we have the technologies, infrastructure, and financial stability to support our growth plans and look forward to attacking this opportunity.

I would again like to thank our Infinera team and our partners for their hard work and dedication that resulted in very strong Q3 results.

I'd also like to express my thanks to our customers for their support and confidence in Infinera.

On a disappointing note and for our press release, Ita has decided to try her hand at a startup.

Ita's been with Infinera for seven years and has been my business partner and CFO for over three years.

While her contributions are too innumerable to go through, I am most appreciative of the world-class team she has built here and the strong financial position she leaves us with.

In a classic style, she has agreed to continue full-time as CFO until the end of February.

This will allow her to see out our fiscal 2013 and will give us ample time to determine our move-forward strategy.

I'd like to publicly thank Ita for her contributions, her partnership, and her friendship.

Now I'll turn the call over to Ita for a more detailed financial review of the quarter and our guidance for Q4.

Thanks, Tom, and good afternoon.

This analysis of our Q3 results and our guidance for Q4 2013 is based on non-GAAP.

All references exclude non-cash stock-based compensation expenses and the amortization of non-cash debt discount amounts related to our convertible notes.

Total GAAP revenues in Q3 were $142 million, in line with our guidance of $135 million to $145 million, and representing 27% growth on a year-over-year basis.

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

In addition, we also added two new DTN customers, taking our total invoiced customer roster to 126.

We had three greater-than-10% customers in the quarter, two Internet content providers and an MSO.

Our top five customers included an additional MSO and a bandwidth wholesaler.

International revenues totaled $39 million, or 27% of total revenues, reflecting a particularly strong quarter in North America.

EMEA accounted for $32 million, or 23%, with APAC and the other Americas representing 3% and 1%, respectively.

While we expect our geographic revenue mix to fluctuate based on the timing of deployments, overall, we're making good progress in expanding our international footprint.

Service revenues for the quarter were $20.7 million, up from $17.7 million in Q2, reflecting ongoing strength and deployment activity.

Services gross margin was 69%, up from 63% in Q2.

Overall gross margin in Q3 was an outstanding 49%, well in excess of the upper end of our guidance and exceeding our 45% midterm target.

We had anticipated some of this improvement on the July call.

Later, the deployments of a number of large DTN-X networks that did not require the shipment of lower-margin amplifiers and others parts for turn-out.

In addition, our revenue mix in the quarter reflected an increase in revenues from higher-margin DTN-X networks fill sales, somewhat offset by a reduction in fill sales for DTN.

We also realized higher gross margins on our services revenues in the period, reflecting the completion of a number of large DTN-X service projects.

Our progress on yield improvements and cost reductions remained on track.

We saw continued benefits of these improvements in the September quarter, strongly contributing to our Q3 gross margin performance.

Operating expenses for the quarter came in at $55.8 million, slightly above our guidance, which called for operating expenses of approximately $55 million.

This increase included some acceleration in R&D spending.

Overall headcount for the quarter was 1,296 versus 1,238 in Q2.

The increase in headcount primarily reflects additions in R&D related to accelerated development activities and in operations.

Our operating income for the quarter was $14.1 million.

Non-GAAP other income and expense for the quarter was a negative $1 million, which included $0.8 million of interest expense associated with our convertible debt.

This amount represents the cash interest payable on the notes and excludes the amortization of public debt discount.

Net income for the quarter was $12.8 million, resulting in earnings per diluted share of $0.10, well above our guidance, which called for an EPS range of $0.01 to $0.07 per share.

Now, turning to the balance sheet.

Cash, cash equivalents, restricted cash, and investments ended the quarter at $346 million.

Including the proceeds of our debt offering of $145 million, this equates to a net cash balance of $201 million, up from $184 million in Q2.

We generated $12.8 million of cash from operations in the September quarter.

DSOs came in at 56 days, down from 64 days in Q2.

This reflected good billings linearity in the quarter and a continued focus on cash management.

However, our current outlook could result in an increase in DSOs in the fourth quarter, mainly related to the timing of completion and the geographical location of a number of key projects.

Inventory turns were 2.3 times, down from 2.8 in Q2.

Accounts payable days were 29 days, down from 32 days in Q2.

Capital expenditures were $4.2 million compared to our $4.5 million in Q2 and consistent with our guidance for capital expenditures of approximately $20 million for the year.

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

We are pleased with our financial performance in the third quarter and the proof point that it provides for the financial model when the business and revenue mix is balanced.

We continue to see strong RFP activity, with opportunities to both grow our share within existing customers and to add new strategic accounts.

However, the timing of closing these opportunities and their impact on quarterly revenues will remain unpredictable.

As we look at the fourth quarter, we expect our revenues to range from $130 million to $140 million.

This outlook reflects a number of significant new wins and deployments, both at existing and new customers.

We do not currently expect significant budget flush or year-end money and have not reflected this in our guidance.

As we look at performance for the year, industry analysts indicate that growth in the long-haul DWDN market for 2013 was approximately 11%.

Taking the midpoint of our fourth quarter guidance, our revenue growth for the year is expected to be approximately 23%, twice market growth and above our previous outlook.

As Tom mentioned in his remarks, we remain focused on leveraging the DTN-X and the 100-gig cycle to increase our market share.

I believe that we can grow revenues at or faster than the market.

Our Q3 gross margin benefited from a revenue mix that we do not regard as typical for this stage of the DTN-X rollout.

Rather, we would expect to see higher levels of common equipment as we win 100-gig footprint, and this is expected to constrain gross margins in the interim.

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

As we look to the fourth quarter, we expect gross margins to be approximately 40%, reflecting a very strong mix of low-margin common equipment and the completion of a number of large international service deployments.

In addition, we are beginning to see some reduction in quarterly DTN fill sales.

And although this has been somewhat offset by a healthy ramp in DTN-X fill, this may have a short-term negative impact on gross margins.

That said, we are very pleased with our progress on yield improvements and cost reductions, which is key to our ability to fulfill this level of network expansion while maintaining gross margins at or above 40%.

Our fourth quarter guidance would result in gross margin for the year of 41%, ahead of our original outlook, which calls for gross margins of 38% to 40%.

As we look to 2014, we would expect gross margin to remain in the low 40s.

In a period where we are competing for and winning new strategic accounts and expanding our share in existing accounts, we believe that consistent gross margin expansion towards our midterm target of 45% will occur as we add higher-margin fill to these networks.

As we look at operating expenses for the year, our previous outlook called for operating expenses in the range of $210 million to $215 million, depending on revenue and profitability performance.

Our guidance for the fourth quarter, at $55 million, would result in slightly increased spending for the year of approximately $217 million, largely due to increased sales commissions and from customer-driven accelerated R&D activities.

We've not yet completed our operating plan for 2014, but remain committed to increasing operating expenses at a lower rate than revenues in order to support ongoing profitability and achieve our midterm business model.

In summary, our guidance for Q4, which is based on non-GAAP results and excludes any non-cash stock-based compensation expenses and the amortization of our non-cash debt discount amounts, is as follows.

Revenues of approximately $130 million to $140 million, gross margins of approximately 40%, operating expenses of approximately $55 million, operating income of approximately $1 million income to $3 million loss, net income of breakeven to approximately $4 million loss.

And based on estimated average diluted shares outstanding of 125 million, this would lead to an EPS range of breakeven to $0.04 loss.

Please note that the basic share count is expected to be 120 million for the quarter.

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

Thank you.

(Operator Instructions.) Simona Jankowski, Goldman Sachs.

I just was putting together the slightly lower out-quarter guidance with the lower margins in the quarter -- or sorry, with the high margins in the quarter -- which seems to indicate that perhaps some of the new footprint opportunities are either pushed out, or maybe there's just a gap in how those are laddering into the business.

So can you just dig into that point a little bit more and just talk a little bit about what are the puts and takes that seem to have impacted the guidance in the out-quarter and the mix in the third quarter?

Simona, I think if you look back to our last call, we had talked about margins being higher in Q3 and then coming back down in Q4.

And that was because we had a number of pretty significant network deployments, where we weren't going to actually be deploying the amplifiers and some of the other lower-margin stuff because they were actually upgrading from some DTN footprint.

So that was definitely part of our expected higher margin performance in Q3.

And we didn't expect to see that again in Q4.

On top of that, in Q3 we saw some really pretty healthy DTN-X fill that was probably a surprise versus our guidance.

And then also, services and services margins actually came in a little bit higher than we would have expected as well.

So that's the Q3 story.

If you fast-forward to Q4, we have some very large deployments in Q4.

They don't necessarily have the same level of first infill that we saw in the some of the deals in Q3.

And some of them are also international, where there's a lot of services activities, and we think the margins in services may also be a little lower in some of those.

So that's the bridge between the two quarters.

But as far as just looking for sequential decline in a quarter that's typically up, at least from a seasonality perspective, was there anything that was either a competitive situation that you would have hoped to win and you didn't, or was it purely timing, or was it just difficult comps?

You had a bunch of big quarters out of the gate when you launched the DTN-X, and perhaps you can't sustain that same pace.

It's just somewhat atypical to have a down quarter in December.

We've been pretty clear on the last call that we weren't sure that Q4 was going to necessarily have the same trend that it would have historically, just given the 100-gig cycle and what's happening.

So I think it's very much timing.

You heard Tom's remarks about in the midterm, we are seeing lots of opportunities, and there are lots of deployments that we see in the pipeline.

It really is a timing of when do you end up taking revenue on some of those.

Yes, Simona, this is Tom.

I would reiterate that.

I'm very comfortable in the intermediate-range timeframe.

I'm more bullish than I have been on what I see.

There's a number of deals that we've actually won, but they won't start deploying during kind of a Q4 moratorium on new builds that we'll start seeing next year.

I think we try to be pretty consistent that this industry and our Company are still going to have some level of volatility quarter to quarter, but I am very confident and comfortable with both the market share we're gaining, the customers that we are winning, and the RFP activity.

And I feel nothing's done until it's done, but I think we're very well positioned in the intermediate term to add some very significant customers.

Okay, thank you for that color.

Appreciate it.

George Notter, Jefferies.

Back to the gross margin discussion, I think you guys referenced in the monologue something about some pent-up revenue recognition on the services side, and that having an impact on gross margins.

Could you walk through that again?

Yes.

I'm not sure that we said there was pent-up rev rec, but we did have some large services projects that concluded in the quarter, and a chunk of those were in North America, which is a more established, higher-margin service model for us.

So that did, if you look at the margins on the services, they're up probably four or five points on the services piece, so that did help the overall gross margin as well.

Got it, okay.

So just to be clear, the costs associated with those services projects, I believe, are incurred as time passes as you work on those projects.

And then the service revenue then gets triggered upon completion.

Is that how the rev rec works?

No, so the costs and the revenue are kind of moved together.

So if you're working on a project and you're accumulating costs, those costs are deferred on the balance sheet, along with any prospective revenue.

And then, when you complete the project, you recognize the revenue and the costs.

So this isn't that there were no costs in period or less costs in period from an accounting perspective; it's more that just these particular projects had a higher profitability.

Got it, okay.

So then if I'm just trying to distill -- I guess, as I'm trying to look at service margins for the product side of the Company, I can just eliminate the whole services discussion on margins and get a good look at that.

Anything else that was unusual in terms of rev rec or the margin discussion that we can point to?

Yes, it was really -- we knew that we were going to have some deployments that would drive a higher gross margin in the quarter, I think.

But what we were surprised about a little bit is how much DTN-X fill we actually saw in some of the deployments that we completed in Q3.

And when you look at Q4, some of those deployments do not have that same initial fill profile.

So it's really a product mix story more than anything else in the quarter.

To me, George, one of the things that's interesting is it's a proof point to me of both our intermediate and longer range target.

And typically, as I've been pretty consistent on, at this point in the rollout of a new platform, I don't want margins that are too high, because it reflects too much fill and not enough footprint.

Q3 is an exception to that, because we had a couple of customers who actually had very big new footprint deployments, but they are actually decommissioning their old DTN network, using the amplifiers that were in place and putting them on 100-gig or 500-gig super-channel networks.

That's going to be unusual.

Very few customers will do that, and that's why I'm actually delighted with the margin, because it's a proof point.

Got it, okay.

And then the other question I had -- I'm sorry, go ahead.

I have one more point on that.

What you need to think about is for -- we're still a year into the product, which means I've got a non-stabilized mixture of commons versus fill that takes a couple of years for the margins of any particular distribution of portfolio customers across that to fully develop.

And you'll see a little bit of that ups and downs associated with that.

Got it, okay.

That makes sense.

And then just the only other question I had was on visibility.

I think you were talking about visibility looking good over the intermediate term and that, I think, product lead times were shorter.

Can you just walk us through that again?

And how do you view that in light of the comments last quarter, talking about having two months of visibility and less visibility into the third month of the quarter.

How does that shape up now as we look into the December quarter?

I'm going to take you back to Q2.

In Q2, we said that visibility, short term, was probably at an all-time high.

In Q3, I reflected that visibility was probably more normal, was not as good as it was in Q2 in the short term.

I would say this quarter, my view is that the short-term visibility is not distinctly different than it was a quarter ago.

But I'm adding to it my view that the intermediate-term visibility is as good or better than I have seen it.

And usually I don't comment on intermediate visibility, but I'm trying to be transparent.

Contracts that we're winning today, or have won recently, they will start creating revenue opportunity for us early next year.

They won't be for Q4.

So I think the short-term visibility is kind of what it was last quarter; intermediate-term visibility is significantly better.

Got it.

Thank you very much.

Dmitry Netis, William Blair.

Ita, so just as a clarification there, are you taking -- at a new startup, are you taking the CEO role?

No, CFO.

Okay.

I'm not sure I'd make a pretty good CEO.

Okay.

Okay, just wondering.

Okay, and then on the Tier 1 customer you announced last quarter, I guess that's Ross Telecom?

That's correct.

And you mentioned the 500,000 kilometers of fiber.

What percentage of that --

I'm sorry, you cut out.

Footprint, the 500,000 kilometers of fiber, is won by Infinera in this case?

Yes, we've got our first deployment with them.

It's a very small amount of fiber coverage today.

And this has to be our opportunity.

Anybody like this is, one, how do you compel them to put you in their network?

Two, you have to dazzle them with quality, ease of use, reliability, integrated OTN with switching, or with transport, and creating a new experience for them.

And then you have the opportunity to go and hunt within their broader network for those opportunities.

So as a percentage of their overall network, it's very, very small today.

Our opportunity is we've now opened the door, we have our foot in the door, and we have to go and dazzle and make them a significant customer over time.

Okay, great.

That's helpful.

And then on the strategic, I think you made a very clear comment here that you expect more strategic customers to be won over the next 12 to 18 months.

Any color as to whether those will be US customers, international customers?

How should we think about where the strength is going to come from?

I think there will be customers, certainly, in North America.

There will be customers in Europe.

We'll have opportunities in APAC.

And none of them will come from China.

Sounds good.

All right, very good.

And then, I guess my last question would be just if you have any comment on the Coriant acquisition of Tellabs.

I know they have now a long-haul product.

They've got the Metro product.

Certainly putting the pieces and puzzles together there.

Does that affect Infinera?

Is that a good or bad thing that's happening in the market?

I know they're in some large Tier 1 customers.

And how does that affect you or position you in the market?

Any color on that would be helpful, Tom.

I think, quite frankly, it's healthy for the market.

We've long said that the industry has to consolidate, and this is, I think, the continuation of the beginning of that process.

I think having fewer participants, healthy participants in the market, is a good thing for everybody.

Second of all, I think it reflects that the size of your company in this industry does matter.

We're trying to get there organically by winning large strategic accounts and market share.

They're doing it inorganically.

But size is relevant, and I think that we've long believed that, and I think they reflect that.

I think that they have a different approach than we do.

Now, they're looking at, in my mind, installed base value versus technology differentiation value.

We are deep technology innovators.

We value the technology disruptions that we think we can bring to market.

That is not the path that I view them on.

And I think that my view, any time these things happen in the industry, I'm going to go and try to work very hard on focusing on their current customers while they figure out organization structures and who to fire.

So I'm viewing it as a good opportunity for Infinera.

And your Metro PIC, is that still on track, Tom?

Yes.

We've said before that we would deliver working prototypes this calendar year.

We are on track to do that this quarter.

But we are, as I stated before, we have our sights on the Metro.

We have every intention of going into the Metro.

It will be PIC based.

But I wouldn't over-read into any specific timing on when you think we're going to get a product to market.

Okay, very good.

Thank you so much.

Alex Henderson, Needham.

Alex, if you're talking, we can't hear you.

Michael Genovese, MKM Partners.

I want to follow up on the last question, just about your participation and how we should think about your participation in the coherent Metro 100-gig and above market going forward.

So it sounds like you're saying you plan something in that market, but it's in product development at this stage.

Any more color there?

Here, let me see if I can answer that a little bit.

First off, the DTN-X is a high-capacity system, whether it's Metro or Long O. We sell a lot of DTN-X into Metro applications today, and our customers are very happy with that application.

The question, really, for us in the Metro is for the lesser capacity Metro applications, what complementary boxes do we need to make available to our customers?

We've been involved in the technology development for the past year, and that technology development is on track, as Tom indicated.

And at the appropriate time, we'll roll out and what we want to say about product launches.

But now's not that time.

We view it as a market that we will get into, and we believe that we can deliver the customer satisfaction that we have in the long haul into the Metro space, and we think that will play well for us when we get the right product in there.

Okay.

When we look at the third quarter and the visibility that you had going into the third quarter and the third quarter revenues turned out to be strong, and it looked like it was the mix you were looking for, primarily, or even a little bit better in the way it impacted gross margins, but how many customers had that particularly high channel sale?

I mean, just roughly?

Was it a small handful of customers providing that sense of visibility that added to the third quarter, and that's just got a different mix in the fourth quarter?

Yes, we had a couple of -- so we obviously had the ones that we talked about specifically, where we had a strong mix just because they weren't deploying the amplifiers and stuff.

Then we also had a couple of other deployments where they took a higher fill level as part of the initial deployment than we might have anticipated.

And that will fluctuate.

If you look at Q4, we have some fairly significant deployments where their initial fill level is lower, and that's really the dynamic between any large deployment that can be in the $5 million to $10 million range and has that kind of change in mix is going to have an impact on margins.

But either way, the fill will come.

It's just a question of whether you get it initially or it comes as the network starts to be used.

I mean, do you have any sense, just roughly speaking, that with the customers who took the higher channel sale in 3Q, any rough sense of how long it will be, how many quarters of demand they started with, before they come back with more channel sale demand?

Obviously, it's going to vary by customer.

But nobody is buying fill upfront and paying for it unless they think they're going to use it in a reasonable timeframe.

We've seen, and it's been good news to see people coming back and adding fill to networks inside 12 months.

So I would look at the customers that took that extra or additional fill are taking it because they think that they're going to use it, certainly, inside 12 months.

Yes, our lead times on the fill, it's two to three weeks.

So this is not, "I've got to buy a bunch and put it in my warehouse in case I create demand." They can typically win circuits in the market and buy from us and get it deployed without having inventory.

So I don't anticipate, as Ita said, that they're stockpiling inventory.

And then just last question, would you just generally expect, without giving any particular quarter here guidance, like, but would you expect to be adding kind of a mid-single-digit number of DTN-X customers on average?

Do you feel like that's sustainable?

I think we've been adding four to five a quarter, and we're continuing.

What's interesting to me is we continue to, on average, add three DTN customers a quarter over the last year.

And that product's been out in the market since 2005.

So I certainly anticipate we'll be adding some number of, like we've been, four to six each quarter.

Some quarters might be more; some quarters might be less.

But on average, I would say that's not an unreasonable expectation.

Yes.

I would, just in general, only about a little over one-third of our customers buy in the DTN-X today.

Right.

So there's quite a few number of customers to convert.

And in general, about 40% of our DTN-X customers are new.

Right.

So beyond that, I think there's quite a bit of -- and as Tom indicated, we have a strong RFP pipeline.

On that, we expect to see substantive growth and be able to grow faster to market in this because of the expansion of that product line.

Okay, thanks very much.

Alex Henderson, Needham.

Oh, my God, can you hear me?

Welcome back, Alex.

I've got a couple of questions for you, and actually, right on the subject, too, we're just talking about.

So you made the comment that 40% of your DTN-X customers are new.

Is that a similar weighting in terms of the amount of backlog that you've got?

I would assume that the majority of the newer customers take longer, probably, to put in and get acceptance out of, since your existing customers can accept very quickly.

So as I look into what you're looking out into the next several, two or three quarters, is the mix more towards the new customers than old customers in the way you see the revenue unfolding?

I'm not sure on a dollar basis that that would be true.

I think we've still got a lot of existing customers that will drive significant dollars.

In terms of looking at numbers of customers, I think it's fair to say that we expect to see, and we are seeing, a fair representation of new customers in adding revenues and adding incremental additional revenues or new revenues to the pipeline.

I think if you look, we've got four customers that we haven't invoiced on their DTN-X purchase commitments, and the bulk of those are new.

So that gives you some idea for where the length of deployment to revenue is on some of the new stuff.

Can you give us a sense of how long that typically goes for new customers these days?

Is it typically two or three quarters, or is it less?

It very much depends on the customer.

It's probably at least a quarter if it's a completely new customer, and mostly two.

In certain cases, it might be three.

But three would be kind of unusual.

Similar, if you could help us out a little bit, a similar kind of discussion between domestic and international.

Are you seeing a shift towards more international?

Again, trying to understand the timeline for closing and recognizing revenues, as well as the implications for cost, because I would assume that there's a lot more installation internationally and support internationally, which is fairly expensive compared to domestic support.

Yes, and I think you saw this quarter, the US was very strong, because we had a number of large customers in the US that drove significant revenue.

So your US mix was actually strong this quarter.

But I think as a generic statement, we are seeing a lot more international business and international activities, and we would expect to see that shift continue.

And in Q4, if you look at my comments around service projects and stuff, we expect to see a good, healthy international mix in Q4 as well.

So that shift to international is a big piece of the spreading out of the timeline of recognition of revenue, then?

It will contribute.

Some of that will definitely contribute to it taking longer.

But the large international customer that we have not done business with before, then they booked, the revenue cycle is longer than if it was somebody in the US, for sure, yes.

Another question.

There's been a fair number of announcements out of AWS around the Equinix and Level 3, talking about cloud-to-cloud.

And obviously, I don't want to ask you a direct question on any particular customer here, but can you talk a little bit about how much cloud-to-cloud is a driver of your business?

When you say you have two 10% customers that are in the Internet, are those cloud-to-cloud related, or are those access-oriented, content delivery networks?

What should we be thinking about in terms of the cloud footprint as a driver?

I think what you're seeing is there is growth across the board, is the right thing.

We see, do a lot of data center to data center type interconnects, we do a lot of distribution networks interconnect, and we are seeing, we've talked about data center markets, the MSO markets, the carrier markets.

All of them are doing well.

We see both growth internationally and in North America from a market share perspective in both.

I don't think the weighting of one over the other is, frankly, changing that much.

You're just seeing strong growth across the board.

Okay, I'll cede the floor.

Thank you.

Sanjiv Wadhwani, Stifel.

This is Mike Lin speaking on behalf of Sanjiv.

I just wanted to follow up on the gross margins.

Your target for gross margins was 45% in 2014, and I was just trying to get a sense of how much of that improvement is under your control, and how much of that was depending on mix.

The 45% target margin is part of our midterm business model, and if you look at the discussion in my remarks, we don't see that as being something that we achieve as we work through 2014 in an environment where we're adding some of these strategic customers that we talked about.

So I think we see it very much as 2014 is a year where we are continuing to add strategic accounts and strategic footprints.

And in that scenario, the margins, I think what we saw in our Q4 guide, is we believe we can keep margins in that 40% or above range.

But I wouldn't expect to see them expand out towards the 45% on a consistent basis until we're putting fill into these networks that we're deploying now.

Okay.

And regarding visibility on the top line in 2014, you've given indications that in the immediate term, you feel like you have pretty good visibility.

But do you have a sense of what you think growth will be for 2014 overall?

Other than saying that we really believe we can take share, and we haven't really commented on a 2014 revenue number beyond that.

We do believe, from what we're seeing, that we are adding new customers and taking market share, but we'll have to get more granular on that as we move through next year.

And how would you characterize the pipeline and deal activity?

Would you comment it as accelerating versus the past quarter or two?

Well, I think the RFP activity, as in the number of different RFPs that would come into the house, is strong and stable over the last couple of quarters.

I wouldn't call it accelerating.

I think a lot of networks are making conversions over to 100-gig technologies.

When we got into the market in, let's call it the beginning of Q3 of last year, the market started to turn at that point, and it really had some acceleration in that process in the first half of the year.

And we continue to see that conversion going on, but it's at a steady clip.

I would add that the pace of the RFPs, I agree with Dave, is roughly the same.

One of the differences is we're seeing a couple of these deals be more strategic and larger than the average deal.

Okay, great.

Thank you.

(Operator Instructions.) Rod Hall, JPMorgan.

I just had a couple.

I wanted to see, kind of understand what's going on in (inaudible) trends.

Although, Tom, I don't think I've ever heard of medium-term visibility in telecom equipment, so that's a new one.

I'm trying to set a new budget mark and see if anybody will follow my lead on this.

I'll even look smarter, but we'll see.

Exactly.

Found a new vein of optimism there.

But I wanted to check and see.

Cisco's come out and said that they're going to add long-range optics to their routing platforms, which I don't know, it doesn't strike me as that serious of a threat.

But I just wondered if you could comment on that strategically.

Do you think that, as you talk to people, is there any interest in that?

Do you think it could be a new kind of competitive threat in optical?

And then I just wondered -- you guys may have said this at the beginning of the call, so I missed the first part of the call -- but can you update us on the CFO search?

What's your plan there?

When do you think you'll have a new CFO onboard, and so on?

Sure.

I'll start with the CFO.

That's more straightforward.

We have not started the search yet.

I anticipate I will launch an official search this week, and I anticipate that the goal certainly is to have a CFO onboard during Ita's tenure here through the end of February.

And I think that's a reasonable target.

So that's that one, I think.

In regard to Cisco putting long-reach optics onto their platform, I'll make a couple of comments, and then I'll ask Dave to complete them.

One, I think that this is a continuation of the strategy of sell more routers.

Anything you can do to sell more routers is right what they want to do.

And we and the rest of the industry is working very hard to show what the value proposition of an intelligent optical network is.

And that means that you need less routers to perform the transport function in the core of the network.

I don't, certainly, fault their strategy for saying that the router can do this.

My view is there are technical limitations, particularly around power and space in that.

Second of all, I just have a fundamental question is, why would you put transport technology into the highest-cost port platform and the least reliable port platform in the network, when the most reliable port network is at the transport layer, and the most value-add pricing proposal is the transport layer.

So I understand why they're doing it.

I personally believe it's going to have a hard time creating much traction and response to, I think, a threat that the transport industry is bringing to the router industry.

Dave?

And so I'll add on a couple of thoughts here.

It's been our position, as always, architectural position has always been IP over OTN, which is the Intelligent Transport Network.

The concept of IP over DWDM has been a philosophy that's been talked about for quite a while, half a dozen years or more, probably.

It never stuck.

What's fascinating, and we've mentioned this in our call, is that if you go out to the surveys that go out to service providers, 90% of them claim that they will convert their networks to IP over OTN in the coming years.

So why is that?

The primary costs that they are trying to pull out of network is the burden of the space, power, and cost of the IP transit traffic through routers.

And IP over OTN, or an Intelligent Transport Network, reduces that cost.

So putting DWDM ports onto a router isn't helping out on the space-power-cost structure of the overall network, whereas IP over an OTN, or an Intelligent Transport Network, satisfies the overall network cost savings.

In order to drive the total network cost, layer zero to layer three, going down, a good chunk of it is going to come from redistributing how you manage the network from how you manage the packet traffic through these switch structures with inside the network, and it's going to be over OTN in the near term.

Great.

Thanks a lot, guys.

That's all I've got.

Thank you.

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

We look forward to updating you on our continued progress.

Have a great day.

That concludes today's conference call.

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