Infinera Corp (INFN) 2014 Q3 法說會逐字稿

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

All lines will be 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 Mr. Bob Jones of Infinera Investor Relations.

Bob, you may begin.

Thank you, Sharon.

Welcome to Infinera's third 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.

This may include statements regarding Infinera's overall business strategy, market conditions, market and growth opportunities, Infinera's results of operations, views on Infinera's customers and its products, as well as Infinera's financial outlook for the fourth quarter of FY14.

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

Please refer to Infinera's current press releases and SEC filings, including Infinera's most recently filed quarterly report on Form 10Q and subsequent filings, for more information on these risk 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 statement to reflect events or circumstances that may arise after the date of this call.

Today's earnings release and conference call also includes 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 a reconciliation of these GAAP financial measures to the most directly comparable GAAP financial measures in its third 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.

With that, I'd now like to turn the call over to Chief Executive Officer Tom Fallon.

Good afternoon, and thank you for joining us on our third quarter FY14 conference call.

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

I will touch briefly on the financial highlights for our third quarter, provide an update on the market, as well as discuss recent product developments, including the introduction of Infinera's new Cloud Xpress platform.

I will then turn the call over to Brad, who will provide a detailed review of our third quarter results and our outlook for the fourth quarter of FY14.

Following our solid performance in the first half of this year, our business strength continued in the third quarter, allowing us to deliver another quarter of strong financial results.

We reported record quarterly revenue, achieved another record for 100-gig port shipments and continued to drive strong profitability and free cash flow.

Our quarterly revenues were $173.6 million, representing a 22% year-over-year increase and 5% growth on a sequential basis.

I'm pleased that we achieved this revenue growth while continuing to expand our gross margin levels to 44.2% in the third quarter, demonstrating significant progress toward our midterm target of 45 points.

Operating expenses were $62 million; this yielded non-GAAP earnings of $0.11 per share as we continue to successfully execute on our plan of building footprint in the expanding 100-gig cycle while continuing to improve our financial performance.

New DTN-X deployment continued across multiple geographies and customer verticals as we built upon our recognized leadership position.

We added three new invoiced DTN-X customers in the third quarter with server provider wins in both Europe and APAC, as well as a large enterprise customer win in North America.

Infinera now has 49 DTN-X customers and a total customer count of 136 with deployments in 72 countries.

According to industry analyst Ovum, we achieved number one revenue market share in the North America long haul market in Q2 as we continued to see very robust demand from our North America customers across multiple verticals.

In addition, our international business strengthened in Q3, representing 30% of total revenues and was led by strength in the EMEA region.

Our partnership strategy in APAC and Latin America continues to deliver in these emerging regions.

Partner wins in Q3 included a tier 1 customer in APAC with Nissho, as well as a service provider in Latin America with NEC.

Moving on to our market outlook, we believe there is still a significant opportunity for the 100-gig long haul business to grow as bandwidth demand continues to increase and as the optical transport layer continues to become more important to evolving network architectures.

Infinera has executed extremely well in terms of building a diverse customer base across tier 1, internet content providers, cable operators, bandwidth wholesale providers and government customers.

While these customers come from diverse markets, they tend to all value scalability, ease of use and the ability to rapidly deploy larger amounts of bandwidth.

With this customer mix, we are seeing good growth prospects.

As opposed to some of our peers, we're seeing a slowdown in their outlook due to legacy technology exposure and an overly concentrated positions on select tier 1s.

We see our opportunity in long haul continuing for a number of years as the majority of DTN networks deployed today are lightly populated and are just beginning to see fill.

We have a pipeline of DTN customers who we believe will convert to the DTN-X family, and we believe we will continue to win market share with new DTN-X customers.

As most of you are aware, we recently hosted Insight Infinera 2014 and introduced a major new product, the Cloud Xpress, as well as packet upgrades to our existing DTN-X platform.

For those who did not attend or view the webcast, I'm going to take a moment and provide a brief summary of these new product offerings.

The Cloud Xpress platform was designed for the metro cloud market, a brand new market defined by high capacity data center to data center interconnect, driven by rapidly increasing amounts of server to server traffic.

We believe this is the market that will drive the first volume adoption of 100-gig into the metro starting this year and accelerating into 2015.

Industry analyst firm ACG expects the metro cloud market to grow to over 3 billion by 2019, which significantly expands Infinera's addressable market and further enhances our operating leverage by driving more volume through our vertically integrated manufacturing capability.

In the distinct but complementary metro aggregation market, we expect 100 -- to see 100-gig growth starting in late 2015 or early 2016.

And as we said at the event, we will address that market with a new product in that time frame.

I would like to take pause and restate why we are so excited about this opportunity.

Metro cloud interconnect is fundamentally a brand new market that is expected to grow at an estimated compound annual rate of 78% over the next five years, reaching 3 billion by 2019.

We believe our PIC technology provides a truly differentiated solution that will enable this market to accelerate the adoption of 100-gig into the metro and position us as the cloud transport leader.

We believe this increased metro volume will continue to drive real leverage across the entire Company.

We have seen the impact of volume on our cost structure as we have grown over the past couple of years.

We are currently the only supplier in the industry that has true manufacturing scale leverage.

As we add new volume by diversifying into other markets, our margin should continue to expand.

I believe that our photonic integrated circuit technology and intelligent software capabilities allow Cloud Xpress to deliver exactly what cloud operators want.

A high density, lower power, rack-and-stack solution with server-like ease of use and industry leading scale.

While it is too early to give metrics around market success, we have had very positive feedback to date from multiple customer lab trials in multiple markets.

Our expectations continues to be that we will begin revenue shipments in December.

At Inside Infinera, we also unveiled an update to flagship DTN-X product with the introduction of a packet switching module.

Integrating packet switching into the DTN-X enables service providers to reduce the number of expensive router ports often required to offer a portfolio of services based on carrier ethernet and MPLS, enabling customers to operate more efficiently while providing additional revenue opportunities.

We believe that longer term, as cloud networks continue to grow and NFV and SDN take hold, intelligent transport networks with the right amount of packet will become the packet forwarding solution of choice because they offer the lowest total cost of ownership and the best optical scalability.

Our continued investment in the DTN-X platform demonstrates our confidence in the significant market opportunity we see and shows we remain committed to winning in this space.

As we look forward to the end of 2014 and into 2015, our outlook remains very positive.

We grew revenue 24% in 2013, expect to grow revenue greater than 20% through 2014 and believe in our ability to continue to gain share and outgrow the market despite the challenges that many of our peers are experiencing.

I believe this is due to an accelerating architectural shift, leveraging intelligent transport networks, the unique value our products deliver, our competitive advantage with ownership of key technologies like the PIC and strong execution by the Infinera team.

While I will not break down our outlook in terms of time horizons, as I have done in the past couple of calls, I will state that I believe Infinera has never been better positioned as we continue to deliver what we believe are the right products at the right time.

In summary, we are pleased with the performance of the business in the third quarter and year to date.

Our business outlook is positive as we continue to execute our plan, and our focus will continue to be on winning footprint, increasing our profitability and generating cash while we make smart, strategic and timely R&D investments.

We have strengthened our product portfolio and competitive position with the introduction of the Cloud Xpress while enhancing the market leading DTN-X.

We believe the market will continue to converge, the optical transport layer will become an increasingly strategic component of network architectures, and Infinera will continue to lead as the market evolves.

We are excited about the future and believe we are well positioned to deliver on our goals and drive shareholder value.

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

Now, I'll turn the call over to Brad for a more detailed financial review of the third quarter and our outlook for the fourth quarter.

Thanks, Tom, and good afternoon, everyone.

As Tom mentioned, we reported revenue of $173.6 million for the third quarter of 2014, an increase of 22% over the third quarter of last year, a 5% sequential increase and near the high end of our guidance range.

We are very pleased to have grown our revenue sequentially in Q3 on top of the 16% sequential growth we experienced in Q2.

We continue to see broad strength in our business with our top five customers in Q3 spanning multiple customer verticals including a North American tier 1, an internet content provider, two bandwidth wholesalers and a tier 2 carrier.

We had one greater than 10% customer in the quarter, a North American tier 1 service provider.

Demonstrating the continued strong demand for the DTN-X, we added three additional DTN-X invoice customers this quarter, including one new to Infinera and two existing DTN customers who have now deployed the DTN-X.

These customers represent a European bandwidth wholesaler, a tier 1 service provider in APAC and a large enterprise company in North America.

This brings our DTN-X customer count to 49.

We continue to see strong RFQ activity as additional customers are looking to adopt the DTN-X platform, which we expect will lead to an increased DTN-X customer account in the near future.

Although our revenues continue to be strongest in North America, international revenues represented 30% of total revenues in Q3, up from 18% in Q2.

After a relatively soft first half of FY14, the EMEA region showed improvement in the quarter, accounting for $34 million, or 20% of total revenue.

In addition, we continue to see growth with partners in Latin America and APAC as revenue in each region individually accounted for 5% of total revenue.

Service revenue for the quarter was $26 million, an increase of 15% sequentially, driven by deployment services, as we continue to win new routes with existing customers as well as new customers.

Moving next to gross margin and operating expenses, our overall non-GAAP gross margin for the third quarter was 44.2%, up from 43.3% in the second quarter.

This result was better than our guidance of low 40s due to several factors.

These included the benefits of our vertically integrated manufacturing as volumes grow, the continued momentum of fill activity across our customer base, and the impact of customers starting to license additional capacity through our instant bandwidth program.

Services gross margin were 56% in the quarter, down sequentially as a result of the increased mix of deployment services.

Our non-GAAP operating expenses were $62 million in the third quarter, up $5 million sequentially and at the high end of our guidance as we begin to ramp our R&D spending toward our target of 20% of revenues.

We have several key business opportunities that are critical for us to invest in that we believe leverage our core technologies and expertise.

Cloud Xpress, which we launched in September, to address the rapidly growing data center interconnect market is a great example of an investment that leverages these capabilities.

SG&A expenses also grew in the quarter as we are making strategic investments in new markets, along with higher sales commissions in connection with the increased revenue levels.

Taken all together, we achieved a non-GAAP operating margin of 8.6% for the third quarter, essentially flat sequentially.

This demonstrates our ability to continue to maintain higher profit levels as we invest in and grow the business.

With our recent financial results, we are nearly at our midterm model of 45% gross margin and 8% to 10% operating margin.

Interest and other expense for the quarter was $500,000 and tax expense was $200,000.

The shares used to compute diluted non-GAAP EPS during the third quarter were $129 million, up from $127 million in the prior quarter, as a result of stock issuances through option exercises and our employee stock purchase plan.

In total, this resulted in non-GAAP net income for the third quarter of $14 million, or $0.11 per diluted share, flat sequentially.

This exceeds our guidance range, driven by the higher gross margin level.

Now, summarizing Q3 results on a GAAP basis, we had net income of $5 million, or $0.04 per diluted share in the third quarter, driving us to a year to date GAAP profit.

This represents a significant improvement as our year to date results through Q3 of the prior year was a net loss of $22 million.

The difference between our GAAP and non-GAAP results during the third 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 third quarter, were $378 million, an increase of $22 million from the previous quarter.

We generated cash from operations of nearly $23 million in Q3 compared to $10 million in Q2.

As we have stated if the past, cash generation is one of our top priorities, and we remain confident in our ability to continue to generate cash in our business.

Moving next to our outlook for the fourth quarter of FY14, as Tom mentioned, the underlying trends across our business remain very strong.

As such, I'm pleased to announce that we currently project revenue for the fourth quarter to be in the range of $175 million to $185 million.

The midpoint of this range represents year-over-year growth in the fourth quarter of nearly 30%.

For the full year, this would represent a second consecutive year of 20%-plus revenue growth.

This level of growth demonstrates the market's strong acceptance of our differentiated product and the superior customer experience that we provide.

We currently project non-GAAP gross margin to be 44%, plus or minus 100 basis points.

While we expect to continue to grow footprint across our customer base, we believe the underlying momentum of fill activity will continue, along with the leverage on our vertically integrated model as volumes continue to grow.

We currently anticipate non-GAAP operating expenses to be $64 million, plus or minus $1 million, with the increase driven by continued investment in R&D to allow us to address new markets and fuel our future growth.

While we will continue to grow in the 100-gig long haul portion of the market for years to come, it is important that we enter new markets as well.

With regard to our SG&A expense, although we will need to increase the overall spend over time to support our growth, we anticipate this to be slower than revenue growth, driving additional financial leverage.

At the midpoint of our projected guidance, this would translate to a non-GAAP operating margin of 9%, plus or minus 100 basis points.

The combination of interest and other expenses is expected to net out to approximately $500,000, and tax expense should be approximately $1 million.

We currently expect the diluted share count to be approximately 130 million shares and project non-GAAP EPS to be $0.11 per diluted share, plus or minus $0.02.

We currently expect GAAP EPS to be lower than non-GAAP EPS by about $0.07 per share, primarily related to stock-based compensation expense.

We anticipate continuing to generate positive free cash flow in the fourth quarter.

This year has represented a year of continued strong revenue growth and significantly improved profitability.

As mentioned above, the midpoint of our Q4 guidance would represent growth for the entire year of greater than 20%, significantly faster than the overall market.

As we have grown revenues, we have also continued to improve our gross margin, now approaching our midterm target of 45%.

In relation to operating expenses, I believe we have done an excellent job of balancing the need for investment with prudent expense management.

This has allowed us to transform our business from roughly breakeven to one that generates growing profits and cash.

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 are developing for both the long haul and metro markets.

We believe these two factors, along with the leverage of our vertically integrated manufacturing which is unique to Infinera, will allow us to continue to deliver differentiated financial results.

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

Sharon?

Thank you.

(Operator Instructions)

Simona Jankowski, Goldman Sachs.

Hi, thanks very much.

I wanted to ask you first, how much you are embedding into your Q4 guidance from the Cloud Xpress launch?

In Q4, Simona, Cloud Xpress should be low to mid single-digit millions of dollars.

Okay, thanks.

And then I think you mentioned that you had a new enterprise win in the quarter.

Can you expand on that?

Do you mean enterprise or do you mean like a web 2.0 kind of customer?

No, we mean an enterprise customer.

We can't comment on who it is, but you should assume it's like a large industrial type of company.

It's -- I think some of these large companies are going to start looking at building their own DWDM networks for certain applications.

Whether it goes somewhere or not, I don't know.

But they are buying it and they are evaluating, I think, both the product and their own strategy.

Interesting.

As far as I know, this is your first enterprise customer.

Is that right?

And if so, is this a one-off, or is that some kind of an early trend we should keep our eye on?

We've sold to enterprises when you consider them like banking industry before -- through managed services and directly.

This is the first type of industrial type of industrial type of company we've sold to.

Here's what I think.

I think whether it's next year or over the next ten years, more and more people are going to be building more and more data centers, more and more people are going to be building their own optical infrastructure.

It's becoming just too much of a fabric of how you do business.

So, I do think that it is something that we should pay attention to, though I don't think it is going to be something that accelerates rapidly.

Okay.

Then just last question for me.

You mentioned instant bandwidth is one of the drivers of the growth margin of upside.

Could you just help us quantify that, whether in terms of the actual contribution in the quarter to gross margin or what percent of your revenues utilize that program?

Yes, Simona, we don't necessarily break out that level of detail, but we have about 20 customers that are utilizing instant bandwidth.

Most of those customers have not licensed the additional slices of capacity.

We expect that to contribute going forward there.

It is a good flexibility piece for our customers for certain routes that they have.

Great.

Thank you very much.

Our next question comes from George Notter of Jefferies.

Go ahead, your line is open.

Hi, thanks very much, guys, and congratulations on the quarter and the strength of the business going forward.

I wanted to ask about the improvement in expectations for Q4.

I think going back a couple of quarters ago, you guys were seeing one particular project really driving top line upside in Q2, and then also in Q3, and I think there was a view that the business would step down in Q4.

I guess I'm trying to understand where the strength is coming from in Q4.

Is it broad-based, is it driven by a certain customer project or customer win?

Can you give us some sense for where the incremental demand is coming from?

Sure.

If you remember back, George, to the Q2 call, Tom had said we have normal visibility in Q4.

And what that means for us is we don't have visibility to exactly which customer and which deal.

But we had also said that the underlying momentum across the business was strong.

As you noted as well, we had a large order that went across Q2 and Q3, so we knew we were going to have a hole in Q4.

In addition, given how strong the first three quarters had been, we were concerned that customers would have used all their budget and not had much to come back in Q4.

That was why we were cautious about Q4.

The good news is since then, across our business we have seen customers continuing to spend money and wanting to go continue to grow both the bandwidth across their existing networks, but also grow new networks.

Got it, okay.

So, just to be clear, this is a multitude of customers or opportunities or projects that are driving the strength in Q4?

It is not just one or two customers?

Correct.

Great, okay.

And then I also wanted to ask about the DSO calculation.

I think I got 71 days this quarter.

It is up a few days relative to the prior quarter then you also -- relative to recent quarters this year, is there -- is the business a little bit more back-end loaded this quarter?

Is there something different about linearity or the mix of customers?

What can you say about that?

George, it is not something you should expect to continue.

We had a large customer payment that was actually done on day one of Q4.

At the end of the quarter, it was a little bit higher than we would like, but not a trend that you should expect to continue.

Got it.

Great.

Okay, thank you guys very much.

Thanks, George.

Michael Genovese of MKM Partners.

Great, thanks very much.

Just a couple things.

First on the Cloud Xpress, should we think about -- I guess there is a little bit of concern about that cannibalizing DTN-X opportunity with the web 2.0s?

Or should we think about the different kilometer and distance capabilities, that those are distinct applications in distinct markets?

What is the risk of cannibalization there?

This is Dave Welsh.

The Cloud Xpress had products targeted at the metro cloud interconnect.

That is -- doesn't really cannibalize any of our long haul or high capacity metro regional product of the DTN-X.

So, we don't see that eating away at things.

And I want to emphasize, eating away is the wrong term.

It is really that certain parts of our network, over time, may transition to that type of platform, but that is still a -- that would be a healthy transition for us.

But so the hyper -- given that the topologies of the hyperscale guys' networks, which they don't do a lot of public speaking about, don't really want you to reveal their plans, which you can't do, but will that group of customers remain a big customer base for DTN-X?

Do they have enough long haul and ultra long haul applications that you expect to continue them to be a meaningful target for DTN-X?

What the DTN-X does is a meshed optical network over a long haul, and that application for interconnecting different metro areas is alive and well, and will be for years to come.

What the Cloud Xpress is, adjacencies between data centers that are miles apart, as opposed to across larger geographies.

It is a whole new business opportunity for us.

Great.

Just following up on the last question that George asked, three months ago you were looking ahead to now and not knowing what's happened -- what was going to happen.

Obviously, there has been an improvement, and it seems very broad-based.

But is there any more detail by -- I think you talked about cable or telco, wholesale tier 2, whatever it is, is there any more detail?

Is there anything that strengthened more than others or international versus US?

Different geographies?

Is there any more color or granularity there that would be helpful?

Mike, as we've talked about before, cable tends to be -- do most of their ordering in the first half of the year, not driven by cable.

Obviously, the internet content guys continue to grow capacity and add bandwidth to their networks.

Our tier 1 customers continue to do business with us, and customers on the bandwidth wholesaler side continue to be strong as well.

And international has picked up a lot.

Yes.

And we talked about Europe being strong, as well as some of the other international regions in Q3.

You should expect that to continue into Q4 as well.

Any surprise that you only had one 10% customer in the quarter?

Was that what you expected when you were looking at Q3, or did you think there might be two, is that --

Yes, it's typical.

There's -- we normally have one to two.

We had one this quarter, it wasn't a surprise to us.

Keep up the great work.

Congratulations on the numbers.

Next question from Sanjiv Wadhwani of Stifel Nicolaus.

Thanks, my congratulations also on the results on the outlook.

A couple of questions.

Tom, also you have done an extremely good job in terms of growth over last year, and then this year is also going to be 20%-plus.

Any predictions on what the optical market does next year, as you look into 2015?

All we can do at this point is mostly listen to analyst reports which kind of project, I think somewhere in the 8% to 10% range.

Probably -- they say metro growing a little bit faster than hang long haul, which they typically forecast and sometimes that is accurate, sometimes long haul grows a little faster.

I would assume the industry will grow roughly in the 8% to 10% range next year.

And we anticipate -- I don't know what we'll do, we are certainly not going to guide to that.

But my commitment to the Company is we are going to continue to grow faster than the market, and I have every reason to believe we will do that.

Got it, that is helpful.

And then Brad, on gross margins, one of the elements that you mentioned that led to the upside was just the fills happening faster.

Can you walk us there through what is going on there, any more detail or granularity?

Is that sort of thing you are expecting to continue for the foreseeable future?

And then for Cloud Xpress, remind me what the gross margins look like for that product?

Thanks.

Sure.

The thing you're seeing related to fill activity, Sanjiv, is we are essentially at the two year point after the introduction of the DTN-X, and just the natural momentum of customers coming back to add capacity to those networks.

As we mentioned in Q3, we had several of the internet content guys come back for additional capacity.

You are now seeing customers across multiple of the verticals start to come back for additional capacity.

We are going to continue to try to grow as much footprint as we can because that will benefit us from years to come.

But I do think that the momentum of the fill activity is going to continue and will continue to benefit the gross margins.

I might add on something to Brad's comments there.

I want to note that it's not -- our gross margin migration is not strictly a result of fill; it is an acknowledgement of our differentiation within the product set.

When we are growing at twice market, it's not -- it's because we have something better to offer than our competitive products, and that will represent itself in margins.

Got it (multiple speakers).

To address the Cloud Xpress, so what we've talked about is some of the early large volume orders from some of the ICP guys may be a little bit lower than corporate gross margin, but we believe over time the Cloud Xpress, and that family of products, will be accretive to our gross margins.

Got it.

All right.

That is helpful.

Thanks so much.

Alex Henderson of Needham & Company.

Thanks.

A couple of mundane things.

Just wanted to make sure I got the metrics right on the customers.

How many -- can you just tell us how many customers you are currently carrying?

I just want to make sure I'm putting it correctly.

I believe the number is 131 -- 139.

I thought it was 136 last quarter and you added three, is that not right?

Yes, 139.

Dave's got it right.

Okay, and then the DTN-X, is it 49, that's correct?

Yes.

Okay, great.

Just wanted to make sure I had those right.

In terms of a content question, the obvious parameter around 2014 has been this very large customer that you noted in 2Q and 3Q.

It looks like they have re-upped again into 4Q.

Does that set up a situation where we should be anticipating tough comparisons in 2Q, 3Q and 4Q next year, or is that just a natural process of your business?

And while it impacted visibility as you went through it sequentially, it is normal comparisons as we look at it into next year?

Yes, Alex.

The large order we talked about in Q2 and Q3 is largely done and built at this point.

There is a lot of ports in that network that we think will grow for years to come, but that is largely done.

The strength you are seeing is across the broad customer base, which would imply that as we get into next year, we should continue to see growth across the customer base.

So, I shouldn't be concerned about comparisons?

No.

Okay, great.

And then going back to the cloud product.

There is obviously, anytime you launch a product, some start up costs associated with it.

And with December launch, should we be anticipating there is some start up expenses in there that will gradually fall out as the year progresses, allowing a little bit better margin by mid year next year on that product?

Or should we assume that it comes out pretty much at margin?

Yes.

So, I wouldn't expect any differentiation up front in Q4, versus into 2015.

Great, and the other question is relative to the rate of activity, have you seen a change in the rate of activity over the course of the last couple of months?

It seems like it's been pretty robust all summer.

You were thinking it might slow, but it doesn't look like it did.

So, is it reasonable to say that business is as robust as it's been all year?

Yes, so I think business continues to be strong, Alex.

I think the pipeline activity continues to be strong.

Obviously, there's been good early interest in the Cloud Xpress.

I would say it's strong, it's been strong all year.

It is still early December launch for that, right?

Yes.

It's been launched, FCS, early December, correct.

Great, I'll cede the floor, thanks.

The -- one comment I will make, Alex, you asked, is it as strong as it's been all year?

The year has seen different levels of the strength.

I think it's been fundamentally strong all year.

I would consider currently the outlook and pipeline of activity to be good.

Unlike last year, we are seeing signs that there will be some year end money.

And while I don't particularly -- we are not making any plans on year end money, I think that there is a different level of spending ability in the industry when there is year end money, and I'm seeing that dynamic much better than last year.

I will provide one level of caution, Q1 is, in the industry, typically a pretty down quarter.

We bucked that trend last year with a strong and up quarter.

It is far too early to assume that will be a -- not an outlier event.

So, I encourage people to think about Q1 in our industry as being roughly soft and then building on top of that, even at the backdrop of a good pipeline of activity.

Great, thank you very much.

Rod Hall of JPMorgan.

Hi, guys, thanks, good job on the numbers.

I've got a couple of questions and clarifications, I guess.

The gross margins, it sounds like, Brad, you are saying it is mostly mix-related.

But I wonder, Tom, could you comment on the pricing environment?

What -- if there is any change to it at all, and give us any further color on pricing that you might have to add?

And then I also wanted to see if you guys could give us any kind of indication on the number of trials that you are running at Cloud Xpress right now, the number of trials you might expect to have by the end of the year?

And I might have a follow-up to that.

Thanks.

Let me talk a little bit.

You said that a lot of it is mix, and some of the pricing advantage is mix that we are having some fill.

Some of it is filling on internet bandwidth, some of it is just raw scale.

If you look at our Company and the volume that we associated with it, two years in a row growing more than 20%, when you are a vertically integrated manufacturer, the flow through of the leverage on that is really, really non-trivial.

And as we continue to outgrow the market, I think that we've promised that our shareholders are going to have the benefit of an enhanced margin because of the incremental risk they take by being vertically integrated.

We are starting to deliver on that promise.

And I think as you see us continuing to scale as we add new markets using the same infrastructure, the margin will continue to expand and allow us a consistent premium to what the market can bear.

I think from a competitive position, pricing is, I would say, relatively normal.

And it is one of the funny things I think about -- funny, odd things I think about.

If you look back over the long haul industry, a decade ago there were, what, a dozen competitors competing in the long haul space.

Today, I fundamentally say there is four people competing for the bulk of the long haul business.

That is a much more rational market than we have experienced over the last few years.

Look at the metro market today, there's what, 12 or 15 competitors in the metro market.

And as I see the 100-gig and the technologies moving into that metro space, making it harder and harder for sub scale people to make the required investments, I think you are going to see the same kind of shakeouts over the next five years.

Instead of 12 metro competitors, you'll see 6 competitors.

That is going to make it a much more appealing environment for those half dozen people or less that are the new winners, and I firmly believe that is Infinera's opportunity.

Thanks, Tom.

I wanted to see if you guys also could comment on the rate of fill that you are seeing in this particular product cycle.

Would you say that rate is faster than what you have observed in prior cycles?

Maybe Tom and/or Dave could weigh in on that?

I think we might be overemphasising the aspects.

Fill rates for the quarter are normal and steady.

Those are things that change at a, frankly, slow clip.

To reemphasize what Tom stated before, our -- really, our margin expansion comes from the value we offer, the vertical infrastructure that we've developed, the scale at which we are supplying at.

And then fill plays a role in it, but it is not a --our business is not driven by fill, our business is driven by the other values.

Great.

All right.

Thanks a lot, guys.

Appreciate it.

Dmitry Netis, WIlliam Blair.

Thank you, guys.

I missed the early part of the call, so I apologize.

But I wanted to see, how many customers have lined up to buy that CX platform that you are launching in December?

Can you quote a number there and just give us an overview of the customer base that you are getting here?

And then, I assume that the average deal size on CX would be lower, somewhat lower than the DTN-X?

Is that correct?

Just walk us through your assumptions there.

Yes, so Dmitry, it is a little too early to say on the Cloud Xpress in terms of how many customers.

We haven't even ordered -- opened up formal orderability yet.

We have got good feedback from customers that are evaluating the product.

But given that we haven't formally opened up orderability yet, there is no metrics we can give at this point.

Okay, great.

And then the second question would be, if you could share any color on the least big wins you had.

One with XO, the other is Level 3, what the traction there has been?

If you could color that out if us, it would be great, thank you.

Sure.

Level 3 was earlier on in the year.

I would say overall, it's been a little bit slower than we anticipated.

I think they are an important customer, and I think they will do well over time.

And as they continue to win in the market, that will be good for us.

But this year, it's been a little bit slower than we anticipated.

XO was a more recent win.

They continue to guild new routes with us and I think will be a good customer going forward as well.

Okay, thank you.

Subu Subrahmanyan at the Juda Group.

Thank you, I had two questions, first on seasonality, Tom, you mentioned this briefly.

Last -- this year you also had the benefit of a large cable customer in the first quarter, which offset the seasonality.

Can you talk about what you are seeing in that cable market and how cable M&A could potentially exacerbate seasonality this year?

If that is a thing you worry about?

My other question is on Cloud Xpress, if you could just broadly talk about what percentage of revenues you think it could represent in 2015.

Could this be a 10% of revenue sort of product?

In regard to cable, it is just too early to ask the question, Subu.

It's -- cable buys a lot in the first half of the year.

We have very specific plans of what we are going to go do with cable in regard to the merger and acquisition.

The last I looked, I think that the 180-day review period has been put on hold by the FCC in regard to Comcast and Time Warner.

We don't know what it means yet, and it is too early to speculate.

I think that we are not anticipating in Q1 having any impact by whatever happens.

But in regard to a longer view of that, it is just too early to tell.

We can game theory it out, but I don't think it really helps a lot.

In regard to what percentage of our business could Cloud Xpress be, I think it could be a very significant percentage of our business.

I think it is too early to break out whether it's 10% or more.

But next year the first real year of the product, I expect a significant ramp.

I think longer term, it could probably be more than 10%.

If I could follow-up on gross margin, as you mentioned some of the factors, volume, mix, given you are farther along into the DTN-X cycle and then fill rate.

What are the puts and takes, Brad, in terms of the factors?

In the past, large footprint ads have had a depressing effect on margins.

But given higher volumes, you will get better utilization from Cloud Xpress.

And also, given just being later in the stage in the 100-gig build out cycle, what are some of the puts and takes in gross margins as you look at into the next year?

Yes, so as I mentioned earlier, our plan is to go continue to build as much footprint as we can.

Obviously, the systems we deploy today can take a lot more capacity.

Our shareholders should want us to continue to build a lot of footprint, and you characterize it correctly, that those initial builds have a lower margin profile.

What will happen -- what we expect to happen in 2015 is the level of fill to continue to increase, which will balance off some of that footprint as you go through 2015.

But we obviously delivered 44% gross margin this quarter, and we expect to continue to grow margins over time.

Got it, thank you very much.

Thanks.

(Operator instructions)

Brian Coyne of National Alliance Capital Markets.

Hi guys, thanks again, and congratulations on the nice quarter.

A couple of things.

Tom, I got completely lost, unfortunately, in your response to Alex's question, I think on year end money or budget flush.

I was wondering if you could just help clear that up?

I couldn't tell if you were saying that you saw any of that or weren't attributing, or saw any potential benefit from that in Q4.

And how that extends as well into -- I know the cable question came about.

But if you could just talk about that with regard to cable as well.

And then a second one on Cloud Xpress, I'll try to ask maybe in a different way.

I know your analyst day, you spoke a bit more about a more deliberate deployment into the first half of 2015 as it might befit a new product.

But given the momentum you are seeing in DTN-X, is any that have customer activity momentum spilling into the metro cloud area?

Could you possibly see a faster pulling demand that changes that trajectory in the first half of next year?

Let me hit the first one on the Q4, and I apologize if I was unclear earlier.

I said last year we were very specific, stating we did not see any year end budget flush.

We did not see year end opportunities.

I think we turned out to be correct on that and were I think given credit for having an insight into that market.

This year I do see some year end money being available.

We have not baked that necessarily into our plan or commitment because it hasn't materialized yet, but I do see an environment where there is more likely than not some Q4 year end budget flushing.

And I think that to me what that means is, an overall healthier market we are selling into and other people are selling into.

I think that is a positive sign for the industry, that's my only point on budget flush.

In regard to Q1, I'm encouraging people to think about the typical cyclical down quarter that there is there.

And while we are, I think, having incredibly strong momentum right now across a very broad range of customers and geographies, I don't want people to assume at this point that we will be immune this year to a Q1 downturn like we were last year.

I'm not saying we will have one, I'm just saying be careful of assuming we won't.

In regard to cloud, I'm very careful about trying to introduce new products into the market to make sure that they meet our customer's expectation around quality, reliability, performance, software quality.

We typically do a reasonably metered ramp into a market to make sure.

Quantities of one don't prove anything.

You have to build a number of units before you fully understand that the market is being satisfied by your product.

Having said that, I do anticipate there will be a fairly steep ramp in Q1 and Q2 for Cloud Xpress.

Our overall demand profile of what we anticipate winning is pretty strong; and at the end of the day, we build products to satisfy demand so that if the demand does materialize, we will work very hard to ramp up that product in such a fashion that it meets not only time to volume, time to quality, but also time to marketing and volume goals.

That's great, very helpful.

Thanks again.

I was afraid I'd further lost you when you were silent.

I hope I'm not more confusing.

Sorry, a little slow on [mutual guys], but thank you.

Ted Moreau, Barrington Research.

Thank you, and congrats guys, on a great quarter.

Getting back to this Q4 versus Q1 seasonality question, if I think back to the Q2 earnings call, you guys talked about deals that you saw in the Q4, Q1 timeframe.

And given the strength of the guidance that we're seeing for Q4, are a bunch of these deals for Q4, Q1 largely now being pulled into Q4?

Is that what's happening?

Or can you give some color there, please?

Maybe I can, and I'll let Tom follow up.

As indicated by our guidance, Q4 looks good.

And as Tom indicated, that's based on our exposure to what the customer demand is.

It's coming from a broad base of customers.

I -- due to the same thing we've described in the past, Q1, we're just not giving guidance around what Q1 is.

I think you guys are trying to reach too far forward to next quarter.

Q4 looks good, and we'll have to make commentary on what Q1 looks like at the end of Q4.

I think it's important to understand, we are not trying to ramp up a Q4 by pulling in fundamental demand from Q1.

I'm a big believer; we're, as a Company, keeping things as natural as possible allows you to run a healthy, normal business.

And we are not trying to accelerate demand from Q1 into Q4.

If anything, if Q4 -- end of year money becomes available, our challenge might be, quite frankly, being able to take that because the demand profile of our business right not is robust.

And surprise things at the end of the year, sometimes you can't -- if you're already full, you're already full.

So, that's a challenge.

Maybe I can add one comment here.

Understand, our customer base is predominantly the customers that carry the traffic of the internet.

We are not highly dictated by wireless bandwidth; this is the bandwidth that drives the high capacity pipes in the data center types of activities out there.

That background demand and the growth of that background demand is driven by the same processes that are out there that drive, whether it's consumer consumption, business consumption, cloud -- moving their IT systems to the cloud.

That trend is a strong trend, and that's why we're experiencing this across our set of diversified customer base.

I agree.

I think fundamental growth of internet demand and new sources of network architectures to deal with the cloud, data center, et cetera, just create a great backdrop for us and other people in the industry.

And I think that's our last question.

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.

This concludes today's conference.

Thank you for your participation.

You may now disconnect.