Infinera Corp (INFN) 2014 Q1 法說會逐字稿

Welcome to the first-quarter year 2014 investment community conference call of Infinera Corporation.

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

(Operator Instructions)

Today's call is being recorded.

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

I would now like to turn the call over to Ms. Leigh Salvo of Infinera Investor Relations.

Leigh, you may begin.

Thank you, Gabrielle, and welcome to Infinera's first-quarter 2014 conference call.

A copy of today's earnings release is available on the investor relations section of Infinera's website.

Additionally, this call is being recorded and will be available for replay from the website.

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

This includes statements regarding Infinera's overall business; market conditions; Infinera's results of operations, business strategy, and initiatives; views on Infinera's customers, products, and competitors' products; as well as Infinera's financial outlook for the second quarter of FY14.

These statements are subject to risks and uncertainties that could cause Infinera's results to differ materially from Management's current expectations.

Please refer to the Company's current press releases and SEC filings, including Infinera's annual report on Form 10-K filed on February 21, 2014 and subsequent filings for more information on these risks and uncertainties.

Please be reminded that all statements are made as of today, and Infinera 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.

Today's earnings release and today's conference call also include certain non-GAAP financial measures.

These non-GAAP financial measures include 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, and further, Management does not consider these items to be related to Infinera's core operating performance.

Pursuant to Regulation G, Infinera has provided reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in its first-quarter earnings release, which has been furnished to the SEC on Form 8-K and is available on Infinera's website in the investor relations section.

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 first-quarter 2014 conference call.

With me on the call are Chief Financial Officer, Brad Feller, and President, Dave Welch.

I will touch briefly on the financial highlights for Q1 and then provide an update on the market, our business, and an overview of some technology developments.

I will then turn the call over to Brad, who will provide a more detailed review of our first-quarter results and our outlook for the second quarter of 2014.

In what is typically a soft quarter for our industry, Infinera's first-quarter performance and financial results were strong.

We are benefiting from the continued investment cycle in 100 gig and network convergence.

The favorable economics of our PIC-based architecture and the operational benefits of super channels positions us as the industry-recognized leader in the optical market.

Consequently, our financial results were at the high end of our guidance, as revenue grew to $143 million, representing a 15% year-over-year increase and 3% growth on a sequential basis.

Gross margin was 41.8%, above our guidance of approximately 40%, as we were able to hold our margins steady while continuing to build new network footprint in the growing 100-gig market.

Operating expenses were slightly lower than anticipated due to the timing of certain R&D investments.

However, we are excited about the new capabilities we are developing, not only for the long-haul optimal transport market, but adjacent markets as well.

I therefore anticipate continued engineering spending at approximately 20% of revenue for the foreseeable future.

The higher revenue levels and lower operating expenses yielded earnings that exceeded our guidance range.

From a market perspective, it is clear that 100 gig is the standard in long-haul optical transport, and we expect the market to continue to grow steadily for many years to come.

The [low row] recently reported that it expects the 100 gig market to trend up through at least 2018.

This is consistent with our view that the 100-gig cycle will be significant and extended.

Our opportunity to increase revenue is therefore, twofold: new network builds today, as companies make strategic, architectural decisions, and a long cycle of capacity fill, as traffic continues to grow unabated.

We see excellent DTN-X deployment momentum across a broad base of customer verticals in Q1, with particular strength in cable and tier-one service provider.

This momentum includes the deployment of new footprint and bandwidth fill, as customers build out their DTN-X networks.

As a result, I am pleased to announce the we achieved another record quarter of 100-gig ports invoice.

In Q1, we invoiced one new DTN-X customer, and now have 42 invoiced DTN-X customers.

We continue to have a strong pipeline of activity from customers that are new to Infinera, and with existing customers that desire to expand with the DTN-X.

In addition, we continue to see customers choosing our DTN platform for certain new, lower-capacity builds.

From a geographic perspective, North America drove the growth in the quarter, with strength across cable operators, as well as continuing strong business with a tier-one account and internet content providers.

We also began to see the initial revenue from a new Level 3 opportunity, the large North America bandwidth wholesaler we rerun, as noted in our last earnings call.

During the quarter, we announced that Windstream, an advanced network communications provider to much of the DTN-X for its 100-gig, long-haul express network.

This is a significant and growing deployment across the central and Eastern United States, again, in Q1.

In the EMEA region, we saw a solid range of bookings across a number of tier-one customers, as they continue to expand our networks utilizing the DTN-X.

In Q1, Internet Solutions in South Africa, a division of Dimension Data, deployed our DTN-X across their network and were the first company to deploy 500-gig super channels in Africa, a new market for Infinera.

In the APAC region, we continue to see good RFQ activity during the quarter, but revenues were softer, coming off an exceptionally strong Q4.

The focus on APAC was the deployment of networks sold in Q4 and setting up new opportunities for 2014 and beyond.

We did see continued demand from our install base, which included winning new routes, as well as adding capacity within these customers' existing footprint.

From an overall market perspective, we were recently acknowledged by Infonetics at the top optical vendor in 2013.

This distinction is based on an independent analysis of seven metrics and direct customer feedback on innovation, reliability, and customer service.

I believe this is a tremendous proof point of our business, as we were recognized as the number-one Company in the world based on the attributes that customers care about and that we have always made a priority.

We remain committed to providing our customers with the best optical technology, the best optical transport networks, and the best optical solution experience.

We continue to be optimistic about our short, intermediate, and long-term opportunity.

Our positive outlook for the short term is being driven by the pipeline of activity that is quickly turning into purchase orders and backlog.

We have consistently described our business as lumpy, and we see some exceptional near-term opportunity that will likely create growth that is in excess of what we see as sustainable, even with our continued commitment to gain market share in an expanding market.

Brad will describe this during his financial review.

We are also confident about our intermediate-term opportunities, which are driven by our strong pipeline of activity, improving economic conditions, and our continued traction in establishing new channels, and have the opportunity to significantly expand our geographic footprint.

We remain confident that we are on track to grow faster than our view of the long-haul market's 8% growth expectation in 2014.

For the long-term, our optimism stems from three dynamics.

First, the continued consolidation of the industry around technology leaders that have fiscal discipline.

Second, from architectural transformation, which is shifting CapEx spending away from routing and towards intelligent transport solutions.

And third, the continued momentum of video, cloud, and mobility driving the requirement for additional capacity and new architectures to support efficient growth.

Turning to technology highlights.

We are continuing to support architectural transformation for our customers by delivering on our vision of providing an infinite pool of intelligent bandwidth, and by driving more capabilities into the transport layer.

At OSC this year, we announced the next phase of our Intelligent Transport Network with the introduction of our multi-layer automation solution.

This includes the industry's first super-channel FlexROADM, first 500-gig flexible-grid super-channels, and the first unified control plane.

These new capabilities allow full automation of both the OTN and flexible-grid optical layer through a single-user interface, improving a service provider's ability to deploy services faster, to increase network efficiency to save CapEx, and to lower operational cost.

These new products and features will be available to our customers this summer.

This completely automated transport layer is designed to provide the necessary foundation to support a powerful Carrier SDN implementation.

In February, Telefonica demonstrated how they were able to use their own SDN controller to quickly integrate and deliver new services on top of the Infinera SDN-enabled solution.

We, along with forward-thinking customers, believe that the network can be improved in multiple dimensions of scale, convergence, and automation via an intelligent transport network, including reducing the amount of router resources required.

In addition to our recently announced products, we are excited about our product pipeline and plan to continue to build momentum with powerful capabilities that include packet, metro, data center WAN and SDN, as we continue to help service providers transform their networks.

You will hear more details on these new product development later this year.

In summary, we are pleased with performance of the business in Q1, the outlook for Q2, and the prospects for the full year.

We continue to have a high level of confidence in our ability to meet our financial objectives based on our short-, intermediate-, and long-term view.

Our focus in 2014 remains on winning footprint, gaining market share, and servicing customers.

We are pursuing these efforts with a commitment to drive increased profitability, while generating cash over the life of every project.

We believe that the continued growth of our business in long-haul, combined with our product investments in adjacent markets is the best way for us to provide long-term shareholder value.

I would like to thank our customers, employees, and partners for their ongoing commitment to Infinera.

Now I will turn the call over to Brad for a more detailed financial review of the quarter and our guidance for Q2.

Thank you, Tom, and good afternoon, everyone.

As Tom mentioned, we reported revenue of $143 million for the first quarter of 2014, an increase of nearly 15%, as compared to the first quarter of 2013 and at the high end of our guidance range.

Our revenue increased by 3% on a sequential basis, a strong result in the quarter where the industry has historically been down 10% to 15% based on seasonality.

The main driver of our stronger results in Q1 2014 was solid demand within North America.

In fact, our top five customers came from a variety of customer verticals in North America, including cable MSO, Internet content provider, tier-one, and bandwidth wholesaler.

We had two greater-than-10% customers in the quarter, a cable MSO and a North American tier-one service provider.

We recognized DTN-X revenue from one additional customer this quarter, bringing our total DTN-X customers to 42.

We continue to see strong RFQ activity, with additional customers migrating to the DTN-X solution, which we expect to add to our DTN-X customer count in the near future.

International revenue totaled $32 million, or 22% of total revenue.

EMEA accounted for $26 million, or 18%, with APAC and the other Americas each representing 2%.

While we expect our revenue mix to fluctuate based on the timing of deployments, overall, we are making good progress in expanding both our North American and international footprint.

Over time, we expect our international business to grow at least as fast as our North American business.

Service revenue for the quarter was $19 million, an increase of 14% year-over-year and a 23% sequential decline.

Services gross margins were 68% in the quarter, up from 59% in Q4, and in line with our historical levels.

Our Q4 results included a large amount of international deployments, which drove higher revenues but carry a lower margin profile.

Moving next to margins and operating expenses.

Our non-GAAP gross margin for the first quarter was 41.8%, which is slightly above our guidance of approximately 40%, due to a better mix of revenue in the quarter.

We are pleased that we have been able to maintain gross margins in the 40% range as we continue to build footprint in the 100-gig market.

Our non-GAAP operating expenses came in at $54 million, which is below our guidance of approximately $56 million, as some R&D spending pushed in to Q2.

Although there may be minor fluctuations in our operating expense levels from quarter-to-quarter, we remain committed to our target of R&D equal to approximately 20% of revenue on an on-going basis.

Taken altogether, this resulted in a non-GAAP operating margin of just under 4% for the quarter.

As we continue to achieve revenue growth, we expect our gross margin levels to expand, both from capacity being added to existing footprint, and over time, also by the improved utilization of our manufacturing infrastructure.

This, along with continued diligence on operating expense management, should lead to continued improvements to our operating margin levels.

In Q1, our interest and other expense was $1.2 million, and tax expense was $250,000.

The shares used to compute non-GAAP EPS during the first quarter were 125 million, roughly flat from the prior quarter.

In total, this resulted in non-GAAP net income for the first quarter of $4 million, or $0.03 per diluted share.

This is about $0.04 higher than the midpoint of our guidance, driven by higher revenue and gross margin levels and lower operating expenses.

Now summarizing Q1 results on a GAAP basis.

We had a net loss of $4 million, or $0.04 per diluted share, compared to a net loss of $15 million, or $0.13 per diluted share in the year-ago period.

The difference between our GAAP and non-GAAP results during the first quarter was due to stock-based compensation expense of $7 million and $2 million of amortization of debt discount.

Now turning to the balance sheet.

Cash, cash equivalents, and investments as of the end of the first quarter were $349 million, a decrease of $16 million from the prior quarter, due to the annual bonus payout during the quarter, growth in accounts receivable of $7 million driven by a backend-loaded quarter, and growth in inventory of $3 million due to our anticipation of a strong Q2.

This result was in line with our expectations, and we remain confident in our ability to generate cash over the course of the year.

Moving next to our outlook for the second quarter of fiscal 2014.

We currently project revenue to be in the range of $160 million to $170 million.

The midpoint of this range represents a sequential increase of 16% and a 19% increase on a year-over-year basis.

We continued to see strong demand across our customer base, including both new customers, as well as growth with existing customers.

As we have mentioned before, there may be certain quarters where we win large deals that are deployed over a short time period.

And our ability to maintain revenue at these levels over future quarters may prove to be challenging.

We currently project non-GAAP gross margin of 40% plus or minus 100 basis points.

We have consistently stated that this year is about footprint win in the growing 100-gig market.

In periods of large footprint deployments, which are higher than our historic levels, such as this quarter, there may be some short-term pressure on our gross margin levels.

However, we remain confident in our ability to maintain our gross margin in the low 40%s over the full year.

This same footprint will allow us to improve our gross margin, as we add capacity to these networks in the future.

The 40% gross margin level during these footprint-growth quarters is much higher than we have historically earned during previous cycles of significant footprint growth.

We currently anticipate non-GAAP operating expenses to be in the range of $59 million, plus or minus $1 million, as we continue to invest in technology for the long-haul market as well as adjacent markets.

At the midpoint of our projected guidance, this should translate to a non-GAAP operating margin of 4% plus or minus 100 basis points.

The combination of interest and other expense is expected to net out to approximately $600,000, and tax expense should be approximately $700,000.

We currently expect the diluted share count to be approximately 128 million shares and project non-GAAP EPS to be $0.04 per diluted share, plus or minus $0.02.

On the balance sheet, we currently expect to generate positive cash flow from operations in the quarter and remain confident that we will grow our levels of cash over the course of the full year.

We currently expect our GAAP EPS to be lower than our non-GAAP EPS by about $0.08 per share, primarily related to stock-based compensation expense.

The first quarter was a solid start to 2014, reinforcing our view that the 100-gig market is growing and that we will be able to grow our business faster than the market during 2014.

We are excited about the opportunities we continue to see with both new and existing customers.

We are also excited about the additional technologies we're developing for both the long-haul and adjacent markets.

With that, I would like to turn the call over to the operator to begin the Q&A portion of the call.

Gabrielle?

Thank you, now we will begin the question-and-answer session.

(Operator Instructions)

Sanjiv Wadhwani with Stifel.

Thank you so much.

Sorry, I joined the call a little bit late, so this question might have been already answered.

If you look at the wholesaler that you talked about in the last earnings call, and I think in the last upgrade cycle, they went through an investment of I think $450 million or so.

Now the cost per bit has come down.

I'm just curious to see in this current 100-gig upgrade cycle what are your expectations from them going forward?

And then, second question I had was a lot of investments being made by Web 2.0 guys like Google.

If you could talk about your exposure to that market and what you're seeing in that market in terms of growth, that would be helpful too.

Thank you so much.

Sure, first, in regard to the bandwidth wholesaler, you missed today that I did say that it was Level 3. We have permission --

There you go.

I don't think it was a big surprise to anybody.

No, but I didn't want to say the name in case you didn't want to talk about in terms of names.

They have been a very substantive part of our business in the past; they've been a long-term partner of ours, and they have now reselected us to go to market with 100-gig.

That revenue started in Q1, and we anticipate it ramping over the next several years.

I'm not going to quantify the size of the deal; I think they wouldn't appreciate that, but if you look at Level 3's business model, they drive to be the largest provider of [waves] in the world and provide them at the lowest dollar per bit.

They put in substantive amounts of capacity, and they make very large investment decisions.

And I think we're in a very good position to take advantage of a lot of that capital expenditure.

In regard to Web 2.0, we are in three of the top four; it's been a market that we have long been in.

We have a very good relationship with most of the major providers, and they are generally all making fairly substantive investments currently.

We are participating in a good part of that, and I do think, as I commented here for any number of quarters now, I still believe that the industry focuses too much on the top two tier 1s in the country, because of where CapEx was historically.

And doesn't focus enough on the Internet content, or ICP, or Web 2.0 people, which is where I think most of CapEx is going to be in the future.

And I think we are extraordinarily well placed in that market.

Got it.

Thank you so much, and great quarter, guys.

Thank you.

Simona Jankowski, Goldman Sachs

Hi, thank you.

I wanted to ask you about your 21% customer, if I heard that correctly.

I don't think you have had a customer over 20% for quite a few quarters, or even years.

Could you comment a little bit -- and your two big ones were, as you mentioned, the tier 1 in the US and then a cable operator.

Could you give a little more color on the lumpiness of that?

Is that a big one-time lump for some reason, or what is the sustainability of that revenue with that one customer?

Simona, I don't think we said 21%.

We said we had two customers that represented over 10% of our revenues for the quarter.

One of those being a cable operator and the other being a North American tier 1 service provider.

We have strong business with them, historically; we expect to continue to have strong business with them.

It's not a one-time phenomenon.

So just to be clear, so in the press release where it says that the largest customer percent is 21%, did that -- was that supposed to say largest customers combined?

(Inaudible)

So the 21% is combined for the two together?

He's going to look at the press release and see what we did.

Okay.

Thank you very much.

George Notter, Jefferies

Thank you very much.

I wanted to ask about the guidance for Q2, the $160 million to $170 million in sales.

That's a fair amount higher than, certainly, we were expecting.

Can you talk about what's driving that?

It sounds like it's one single customer opportunity.

Can you tell us any more about that deployment?

Is it indeed a one-quarter build?

Is it multiple quarters?

It puts us in a tough spot in terms of modeling out the Company beyond Q2.

I would love to get anymore sense for how that builds out, that would be great.

And then also on Q2, why wouldn't the gross margin be lower in Q2, just given what seems to be a really big footprint build here?

Thanks a lot.

Two questions, comments, George.

One, it is not driven by one order.

We are seeing really good demand in general.

A lot is skewed toward North America, but we're seeing strong demand from cable; we're seeing strong demand from Internet content or Web 2.0 people, and we're seeing strong demand from tier 1s around the world.

On top of that we did have a large opportunity that came in, but the base fundamental business is very strong.

On top of that, we have this very large opportunity.

That opportunity, one of the things that we talk about all the time, we believe time is a weapon.

That means customers can deploy with us.

I think uniquely in the world, very large networks, very, very rapidly.

They value that.

They want to deploy this one order across the next two quarters.

So you'll see that not all hit in Q1, but when you have that order partially shipping in Q1 on top of our base business being very strong, we're seeing good solid demand and growth that, one, is clearly above Wall Street expectations, but as we highlighted, that kind of growth rate, there is risk that it is not sustainable.

George, to touch on your question about margin, we've talked about it in the past, any time we have periods of large footprint deployment, that's going to put some downward pressure on our margins.

You take the large opportunity we won at the end of the quarter, as well as certain other customers ramping a lot of new footprint; that's going to put some downward pressure on our margins in Q2.

But as you know, laying out that tremendous amount of footprint will benefit us significantly in the future.

As I've always said, George, any quarters that our margin is too high, we run the risk that we are not expanding our footprint and our market share fast enough during this phase right now.

I'm not uncomfortable at all with the guidance of our margin, because we are putting out so much footprint, and that will allow us to monetize that for a long time.

Got it.

As a quick follow-up, so if I look at the delta above where expectations were, let's say for Q2, up to $160 million to $170 million, is that delta alone just this one particular project that came in and will deploy over two quarters?

Or are you also seeing above-expectation strength from your customer base at large?

Yes, George, it's a combination of things.

The large deal we talked about is driving part of it, but it's broad strength across several different customers.

Got it.

Thank you very much.

Scott Thompson, FBR

Hello, guys.

I wanted to go back to the question Simona started with.

I think what we're looking at is invoice shipping composition of the largest customer rather than revenues.

Does that make a difference?

On top of that, maybe we talked a little bit about DTN-X customers; we've showed 42 in the quarter, and I think we're talking around somewhere around 45 last quarter, if I'm not mistaken.

I just wanted to get what you think there.

Then, maybe if you could comment on the metro opportunities out there.

We're hearing a lot from others in the optical space that metro is heating up.

Can you give us a update on that?

I will take the first couple parts, and I'll let Tom comment on the metro piece.

The 21% we said is the largest.

We mentioned that there's two that are over 10%.

We can't really say which one is 21% and which one is the smaller one, greater than 10%.

They are existing customers we have had that we have very strong relationships with.

Your question on the 42 versus 45, you'll remember historically, we've commented on new customer commitments, so this is activity that we had with customers that was early on, where we hadn't actually shipped or invoiced or recognized revenue with those customers.

Given now that the DTN-X is more mature, we actually shifted that metric to actual invoice revenues, invoice customers that we have actually recognized revenue with.

That's the difference between the two.

We did actually have one new invoice customer for DTN-X this quarter.

We did not have a 45 number before.

Last time we said 42 customer commitments.

This time it's 42 invoiced customers, and we're no longer talking about customer commitments.

Got it.

Thank you.

Dave, can you talk about metro?

Sure.

As we've indicated before, some portion of what we ship today gets sent to high-capacity metro.

We have a number of -- we see that as a great opportunity to continue to expand our presence in 100-gig technologies.

And we will continue to compete in high-capacity aspects of the metro market over the coming quarters.

We see this as a growth area for ourselves; however, it will be primarily centered around -- initially centered around high-capacity types of metro applications.

As we said last year or last quarter, we did deliver a PIC that was designed for a metro platform that would complement what we're currently doing in the metro.

We have not put a timeline on that system, and I encourage people not to over speculate on that.

We anticipate we will be bringing out a metro based for lower capacity, as the market -- the economics of the 100 gig for that market make it the primary capacity vehicle, and we don't believe that is the case today.

If you think back to the long-haul market, the 100-gig long-haul market started basically in very late 2009 or early 2010.

We delivered our first platform in the middle of 2012 when we felt that the economics and the volume for market receptivity was there.

We have done extraordinarily well in taking significant market share.

I would expect to have the same type of model for the metro.

Got it.

Thank you.

Rod Hall, JPMorgan

This is [Rodrigo] calling on behalf of Rod Hall.

Thank you for taking my question.

I have got one question and one follow-up.

So you mentioned that you were strong on tier 2. What's the status of tier 2 and tier 3?

Are you seeing any weakness on that?

We mentioned good business with tier 1, and you are asking if the tier 2 and tier 3 business has been relatively healthy, I believe.

Is that correct?

Yes.

I am seeing relatively good demand in that market, nothing exceptional, certainly no weakness.

We continue -- that has been one of our primary markets.

It's not certainly a huge portion of our business, but it is a solid part of our business, and I continue to see it doing relatively well.

Okay.

Can you also tell us about the status on the metro optical compatible gear?

Will it be in a position to bid for Verizon's metro project when that RFP comes out?

As I indicated earlier, our focus in early entry into metro is going to be on high capacity metro applications.

We already, some of our product makes its way in there today.

And we have got a number of enhancements that will allow it to create greater market share in the metro area coming out of the coming quarters.

You should look for us to play over time in high-capacity metros.

Okay.

Thank you.

Michael Genovese, MKM Partners

Thank you very much and congratulations on a good set of numbers.

I may have missed this, so excuse me if I did, but on this large opportunity that you're talking about that's driving some of this very good second-quarter revenue guidance, can you talk about what vertical that customer is in and talk more about the specifics of that to the extent possible?

It sounds like these orders came in at the end of 1Q, and the revenue is going to be recognized in 2Q and 3Q.

Is that the right way to think about this?

Yes.

So, it's -- we won the business the end of Q1, we were awarded the business.

The actual POs will come in, they've started to come in now, will come in throughout Q2, and the customers' expectation is that it will be deployed over the course of Q2 and Q3.

And can you identify the vertical that this Company is in?

No.

Unfortunately, we can't.

Okay, but it is a US customer?

Yes.

And can we say that it's not the Level 3?

Can we say who it isn't?

Yes, it's a different opportunity than the Level 3 win we have talked about.

Great.

And then last question for me is on the international.

In a recognized-revenue basis, international was down pretty big quarter over quarter.

Were the order trends any different than that?

And what's the confidence level, and where is the visibility in the pipeline on international business coming back in 2Q and 3Q?

We continue to have a strong pipeline of activity in the international region, and in APAC specifically, as well as EMEA Sometimes with new customers, it takes time for those new, initial deployments to come out.

We did have an exceptionally strong 2013, in specifically Q4 in APAC, so it's just a timing thing, Mike.

Nothing else to read into it.

We've ramped up our activity with channel partners, which we think will continue to help the international revenues.

Those are relatively early relationships as well.

We are still very confident about our ability to grow internationally.

It's really just a timing thing in Q1.

Congratulations again.

Alex Henderson, Needham

I got behind Mike this time instead of one in front of him.

We are dueling for position here.

A couple of questions.

One, could you talk a little bit about any exposure you might have to what's going on in Russia and Ukraine, and if that might impact any revenues or receivables over time?

Second, can you talk a little bit about if you're seeing any change in pricing environment.

It seems like the industry is accelerating, and pricing might be getting a little less pressured as a result of the acceleration.

So, can you give us a little bit of feedback on those two points?

One, in regard to Russia, we are watching it probably like everybody else is.

We are continuing to extend sales efforts there.

We are continuing to make progress with our customers there.

It has not disrupted anything to date, but it's a pretty small number as part of our base to begin with.

I don't think there's risk for payment problems at this point, and we are watching it guardedly.

We're not going to, certainly, give up on selling into Russia, and we're not going to count on anything until it happens.

We will see.

So you can match that with the hedging so that you're protected against any exchange-rate swings?

Yes, Alex, it's not really a big enough number to really move the needle.

So, we are watching it, but it hasn't become a problem yet.

I think with Russia, I see over a longer period of time and a lot of opportunity.

We've made some traction with customers there already.

We have other opportunities that are coming.

My suspicion is the anxiety that everybody is feeling today will abate itself over some period of time, and I still see a lot of investment happening there, and assuming that our countries allow free trade to occur, we anticipate participating in that.

I don't think there's a real risk of capital there right now.

In regard to pricing, I'm going to say what we've said for the last period of time, pricing has gone to a relatively normal model in the industry.

Don't confuse yourself, there's always pricing pressure in this industry, because the industry continues to be over-served.

The pricing pressure today is distinctly different than it was a couple of years ago.

The dollar per bit I see reducing, much more long classical, historic terms.

Two last, really quick questions, I didn't catch a book to bill.

And then second, relative to the metro, are you seeing metro deployments coming in sooner than you would have expected the activity around that, or do you still think it's the same longer time line?

Some people have talked about it coming in earlier; some people are saying no, no, no, that's not happening.

It's really 2015 and 2016.

What is your view on that?

Thank you.

The book to bill is fairly flat quarter to quarter.

Yes, and then I will let Tom address the other piece of the question.

Alex, on the book to bill, we don't comment on book to bill.

So, you didn't miss it.

In regard to metro, we have been pretty clear, it's an area we are investing in.

We think it's an area that's important to us.

We believe, as I keep abreast of everything that's happening, there's always going to be some early adopters in certain verticals that adopt a certain technology, regardless of the economics of that technology.

I think that in the metro 100-gig right now is not the most cost-effective solution.

If you have fiber exhaust, you might have to do it.

If you want to investigate and explore technologies, you might want to do that.

I think the mass market, everything I see still says the 2015, 2016 timeframe, and that's what I continue to believe.

I think I'd add a little bit onto that, is that if you go back and look at the 10-gig market, and you look at 10-gig first-penetrated long-haul, then there is a delayed time between 10 gig -- between the metro transition from 2.5 to 10 gig.

It's the same process here.

Understand the vast majority of the wavelengths that are in the metro today are 10 gig.

They will start converting over time.

It will be at least a couple, maybe even a few years, before you have reached that peak transition in the wavelengths in the complete metro network.

Dmitry Netis, William Blair

Thank you very much.

Nice quarter, guys.

A couple of questions.

On the large PO, I hate to beat the dead horse to death here, but can you say that's not from Century Link?

I think you mentioned that is a customer last quarter.

Dmitry, unfortunately, we can't get into who specifically the customer is.

We would love to, but unfortunately, we can't.

Okay.

Good.

And on the gross margin and operating expense lines, I think George had asked the question on gross margin, but I wanted to follow up on the OpEx.

That's holding up by about $5 million next quarter -- or this quarter.

If that just purely a function of high revenues that you expect?

And how do you expect that to return to a mid-50s levels since it's been tracking?

And I'm certainly mindful of that 20% R&D target that you put out.

Just give some color around that, that would be great.

I mentioned there was a little bit of spend that pushed out from Q1, so that's a little bit of it.

But he reality is we have talked about several other adjacent markets that we want to go address, and we have talked about maintaining inside the 20% of R&D.

So we will continue to balance inside those parameters.

But you should expect the R&D and overall OpEx to be at similar levels for the next several quarters.

Our commitment is to grow operating expenses less rapidly than we're growing revenue.

We're going to go do that.

The good news, in my mind, we have a whole deck of things that we know we want to go off and build.

We think that there is a massive opportunity for us, and right now, if I were to unleash the R&D budget, we could go and attack these much more rapidly.

But I have committed to the shareholders that I'm willing to be mindful that we are here to make money, and we're going to go do it at a reasonable rate.

But as revenues go, I plan on spending R&D dollars at 20%, and if we have revenue opportunities to increase that, we're going to go do that because we see the opportunities ahead of us over the next few years as being pretty magnificent.

Okay, so if I understood what you said, it is 59 over the next couple of quarters is basically the run rate that we should be expecting.

Is that correct?

Yes.

I would model at 20% of revenues, but 59 type of number is -- 59, 60 is a good number to model longer term.

Great, thank you.

I appreciate that color.

And then the last question would be on the submarine market, one of the key stakeholders reported this morning, and I think they cited diminished demand in the submarine segment.

They also lowered the 2014 target by about $100 million.

My question is, have you seen any slowdown and weakness in this market, given that you have a fair amount of success there?

And how does factored into your guidance?

Thank you.

Submarine is a smaller but an important sector for us.

We have focused on identifying and working with customers that we think are strong players in that space.

We do not see our customers as becoming weak in that perspective.

As a matter fact, our technologies over the last six months have increased or approved our differentiated position within that, even to the extent we talked about a variety of technologies, be they Soft Decision FEC or we've talked about recently or fast shared-mesh protection, which is also applicable within some of the submarine networks.

So, we see that as being a good market for us going forward.

Great.

Thank you.

Keep up the good work, gentlemen.

(Operator Instructions)

Subu Subrahmanyan with Juda Group.

Thank you.

I have two questions.

First, Tom, you mentioned a couple of times that there could be some lumpiness [within certain] revenue levels with some large contracts coming in and out.

If you look at 2014 from a bigger-picture level, how are you thinking about year-over-year growth in the market and the opportunity for Infinera to exceed it?

Is it fair to say that given this large opportunity is working out over the next couple of quarters, any lumpiness is likely in the fourth quarter?

And then the second question is on adjacent opportunities.

Clearly, metro is one that you talked about integrating more packet-switching capability.

And another one, can you talk about when you talk about increased investments in adjacent opportunities, what some of those are and what the timeline of some of those could be?

Sure.

So the lumpiness, we have said for a long time, this is a lumpy business.

Sometimes we say that because it's a down quarter; this time, we're saying it because it's an exceptionally strong quarter and we do see it spanning the next couple of quarters.

So if there's any risk, it probably would be around in a Q4 timeframe.

Part of that is we anticipate shipping this one big opportunity in the next two quarters.

Candidly, because of our rapid lead times, Q4 is a long way away.

We don't see what we don't see.

I have no belief that demand falls off.

But I can't see it yet, so I just want to be fully disclosing of what we see and what we don't see.

Hopefully that answers your question.

In regard to new opportunities, certainly the metro is an opportunity.

Certainly, you mentioned packet is an opportunity.

We have shown and demonstrated the packet capability.

You can anticipate we will be launching a product before too, too long.

We see and you have seen a lot of demonstrations around SDN.

We continue to make reasonable investments in SDN.

We think that's an important technology for us, because quite frankly, our Infinera architecture is perfect for an SDN environment; an infinite pool of intelligent capacity.

What we have done from day one leverages what SDN is trying to do perfectly.

You will see us make investments there, and you will see us invest more in products focused on WAN -- data center WAN interconnect.

That's going to be an important market for us too, partly a metro application, but we do see some specific requirements for the Web 2.0 people that we think, with our PIC capability, we are uniquely capable to address.

Lots and lots of opportunities, more than we can afford to do if time was the measurement stick.

But we think we can do it successfully, and build good market acceptance for our technologies and architectures.

Tom, when you think some of these will start contributing from a revenue perspective?

We see today the basis long-haul focus, when did they start to become important adjacent revenue opportunities as well?

This is Dave again.

The new technologies come out on a regular basis.

You have to understand, especially in the long-haul market, that the people need to deploy networks in the ground that are anticipating future capabilities, such as SDN, such as MPLS or multilayered intelligence structure in the transport capability.

I think we are benefiting from it now.

The reason why we are taking a -- winning large opportunities on a regular basis is because they appreciate that our platform is differentiated in the ability to offer a multi-layered management, to be able to manage, whether it is an OTN service or a packet service across the network more efficiently than alternative systems.

As we bring out the capabilities and we have talked about things like fast-shared mesh protection, which takes some of the protection mechanisms out of the Layer 3 structure and moves it into an intelligent transport structure, it makes our networks more efficient.

It helps us to deliver better packet serve and packet services across the network.

We are benefiting now, and as we continue to roll out, the market is definitely motivated to move from a mid-network Layer 3 infrastructure to an intelligent transport network and an OTN-centric network in the long haul.

Perfect.

Thank you.

Brian Coyne, National Alliance.

Hello, guys.

Long-time listener, first-time caller, so thank you for taking my questions.

Nice to meet you, Brian.

Thank you, thank you.

Real quick, I want to go back to gross margin for just a moment.

I think putting a longer-term perspective on it, in at least recent historically, you've talked about that roughly 40% level being as, I think Tom, as you said, at the level you want to target if -- in the land grab or the footprint acquisition mode that you're in.

I think if you take the commentary qualitatively, as you said on the call, I probably would have backed out and said, you're looking at probably 36%, 38% gross margin.

I'm wondering, if you look, you had a crystal ball, look a little bit farther ahead, if you wanted to come out or exit out of this big lump of demand that's coming up here in Q2 and looks to extend in Q3, would you reset that expectation for a baseline gross margin as you continue to deploy common equipment and gain footprint?

I think we've talked about being low 40%s for the year; I don't think that has changed.

We talked about getting into 2015 and starting to see more fill from some of the DTN-X deployments, which obviously has the phenomenon of pushing up our overall gross margins.

As Tom mentioned earlier, when you see us having lower gross margins in periods where we have significant growth, that is a great thing for us over the long term, because we do see this as a great opportunity to go build that footprint and to be able to leverage that for many years to come in the future.

One thing Brad teased at in his commentary was if you look back over time and look back to when we were doing a similar thing with 10 gig with the DTN, our current margin is many points higher than it was during our last land grab in 10 gig.

That's a good sign that the cost structure of the Company has improved, and we can more effectively earn this footprint at a higher margin.

Typically, when we were going through that phase on the DTN with the 10 gig, about six quarters later, we started seeing substantive fill to those chassis we deployed, enhancing our margin structure of the Company.

I would anticipate the same type of cycle here.

That was actually going to be my follow-up, to try to figure out -- you talked about timing being a weapon for you guys and if that also extends to the fill aspect.

If you see customers making decisions based on how rapidly they can deploy with you versus a competitor, does that also extend into how quickly they want to fill those line cards?

A lot of it depends, quite frankly, on what demand they see they can create in their markets.

Once they have the infrastructure in place, what services are they bringing to market?

What price point are they bringing to market?

What customers are they attracting that are going to be able to bring users to their network?

Typically, what we've seen is people with an Infinera infrastructure are able to respond much more rapidly to those opportunities than other people.

If a large Web 2.0 company comes to wholesaler or somebody, a tier 2, and they have an Infinera infrastructure, these guys, our customers can respond.

We commit 10 days or less, you can have that fill from us in your network.

That is a, I think, a competitive weapon for our customers.

They value that, and quite frankly, that enhances our ability to fill our chassis faster.

That's great.

Very helpful.

It all comes down to Internet demand, right?

As long as there's Internet demand, there is going to growth opportunities.

If that were to abate, there would be a problem.

Okay.

Not just for us, but for the Internet suppliers.

That make sense.

And then a couple quick housekeeping ones.

Did you give a headcount number anywhere?

And then secondly, maybe I misheard, I don't know if you have confirmed that neither of your two 10% customers in Q1 were new customers, or if they were both existing customers?

Yes.

The headcount is in the press release, so we added 28 people over the course of the quarter.

And then in terms of your question on the new customer, we added one new customer on DTN-X, an existing customer.

The top two are both existing customers.

Got it.

Great, thank you.

Alex Henderson, Needham

Thank you, a couple of quick housekeeping questions.

The R&D swing from 1Q to 2Q, it sounds like that is pushing R&D up a little faster than it would go on a normal glide path.

Should we anticipate that that flattens it out or even edges it down as we go into the 3Q?

Is that the right way to think about that Q to Q?

Take the average of the two, or is it more the base rate?

No.

You should probably model the rest of the year at that similar rate, and your parameters for the year is that 20% of R&D.

Okay, I see.

And then, the second question I wanted to ask you is, on the tax rate and the interest line, any guidance of how we should be seeing that going over the course of the year?

It's obviously got a lot of NOLs, but I would think that some local taxes would increase if it goes back to the international mix.

Is that the right way to think about it?

Yes.

Alex, I would model at similar levels the rest of the year.

Things move around in there, but no big drivers in those numbers.

And then finally, the last question I have for you, the service line dipped somewhat sequentially; that's a little unusual for service.

I assume that was driven by installation services, predominantly in the prior quarter, falling off a little bit, hence the margin improvement.

First of all, is that right?

And then second, should we anticipate that the service mix trends back towards more installation mix as a result of this large installation program around this large order over the next couple of quarters?

Yes, so it's a couple of things on why Q4 was stronger: there was -- it was a very strong deployment quarter; it tends to be the renewal quarter for a lot of the ongoing software and warranty-type of items.

Those are the things that move it.

Like I said, Q4 was exceptionally strong.

Going forward from quarter to quarter, the level of install can vary.

It's a little bit of a tough one to predict going forward, but you should see the deployment, obviously, with this large opportunity, we expect services to be with that.

So over time, it should drift up.

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

We look forward to updating you on our continued progress.

Have a great day.

With that, we conclude today's conference.

Thank you for your participation.

You may disconnect at this time.