Infinera Corp (INFN) 2015 Q2 法說會逐字稿

Welcome to the second-quarter year 2015 investment community conference call of Infinera Corporation.

(Operator Instructions)

Today's call is being recorded.

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

I would now like to turn the call over to Mr. Jeff Hustis of Infinera Investor Relations.

Jeff, you may begin.

Thanks, Richard.

Welcome to Infinera's second quarter of FY15 conference call.

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

Additionally, this call is being recorded 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 third quarter of FY15 and intent to acquire Transmode.

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 Infinera's current press releases and SEC filings, including Infinera's most recently filed quarterly report on Form 10-Q 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 conference call include certain non-GAAP financial measures.

Pursuant to Regulation G, Infinera has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in its second 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 would now like to turn the call over to Chief Executive Officer, Tom Fallon.

Good afternoon, and thank you for joining us on our second quarter 2015 conference call.

Joining me today are Chief Financial Officer, Brad Feller and President, Dave Welch.

Today, I will go over our financial highlights for Q2 and then provide an update on our business, the market environment, and some of our key initiatives including the current status of our announced offer to acquire Transmode.

I will then turn the call over to Brad who will provide a more detailed review of our second quarter results and our outlook for the third quarter of 2015.

I am very pleased with our second quarter financial performance.

Revenue in the quarter was $207 million, above our guidance range of 25% higher than last year's second quarter revenue.

Non-GAAP gross margin was 47.4%, also above our guidance range.

Our strong revenue and gross margin resulted in non-GAAP earnings of $0.18 per share, at the high end of our guidance.

Finally, we achieved exceptionally strong cash generation as we increased our cash balance by more than $50 million in the second quarter.

The combination of the value that Infinera delivers to customers with the levers that we are deriving from our business model is enabling Infinera to grow our top line rapidly and to grow our bottom line even faster.

In the second quarter, we experienced robust demand across multiple verticals as customers continued to turn to Infinera to build and fill their networks.

In particular in Q2, we enjoyed some sizable new footprint wins with existing customers.

For the quarter, we had three customers that were greater than 10% of revenue.

One each from cable, tier one and wholesale and enterprise carrier verticals.

We also enjoyed broad strength from ICPs, which remains one of our fastest growing opportunities.

The core of our business remains extremely strong.

As we expanded the new growth markets, long-haul today still represents greater than 90% of Infinera's revenue.

I was encouraged that both HIS, formerly Infonetics, and Ovum ranked Infinera number one in North America long-haul market share in the first quarter of 2015.

In long-haul, we continued to win footprint and are increasingly benefiting from past builds as we fulfill capacity expansion opportunities.

Considering the meaningful footprint we have built in recent years, I am often asked, where are we on the 100 gig long-haul technology cycle?

Based on our recent results and potential opportunities in the horizon, I remain confident that 100 gig long-haul demand will continue to grow to the end of the decade.

Moving to metro cloud, our cloud expressed platform continued to progress in the second quarter as we had both our 10 and 40 gigE versions available for the full quarter and in June, announced our 100 gigE cloud expressed solution.

To date, we have invoiced 12 customers for Cloud Xpress and see a growing pipeline of new opportunities as well.

A good example of which is our recent announcement that Equinix has implementing Cloud Xpress to interconnect its datacenters in Hong Kong.

In line with our comments over the past two quarters, through the halfway point in the year, the 10 and 40 gigE versions of Cloud Xpress have ramped more slowly than we had originally anticipated as customers have taken longer than expected to define and deploy their new transport cloud architectures.

While this makes it less likely that our CX revenues will be near the top end of analysts' estimates for this platform this year, it also signals that Cloud Xpress has emerged as a strategic element in our customer's datacenter architectures, a longer-term positive for Infinera.

Of note, 4 of our 12 CX customers have already placed follow on POs for new opportunities.

As we move into the second half of the year, we are very encouraged that Cloud Xpress order volumes are trending significantly upward and we also anticipate a positive inflection point attributable to availability of our 100 gigE datacenter solution.

Even as our 10 and 40 gigE Cloud Xpress platforms are ramping, we have a few large customers that have limited or held off purchasing in anticipation of implementing our 100 gig platform when it starts shipping this quarter.

Recently, several of our competitors have announced metro cloud solutions.

We view these announcements as validation for the magnitude of the overall metro cloud opportunity.

In this market, Infinera has a significant technology and first mover advantage.

Our product is in the market today with a picked base approach that offers tremendous capacity, carrier class reliability, appliance-like ease of use and minimal power and space requirements.

Importantly, our vertically integrated model enables us to innovate quickly while others must rely on third parties to innovate on their behalf.

We believe this is a sustainable advantage as this new market rapidly evolves and grows into a multi-billion dollar opportunity.

Now moving onto metro aggregation.

We remain on target to introduce our metro product by the end of 2015, in line with industry demand materializing for 100 gig.

Based on customer feedback during lab demonstrations, we believe that our new product will be well received in the market.

Regarding Transmode, we remain excited about the prospect of this acquisition, which will provide us with an immediate portfolio of metro access and aggregation products, accelerating our end-to-end solutions offering across multiple metro applications.

Since we announced our intention to make this acquisition, customer feedback has been positive.

It is clear that Transmode has a terrific reputation and the market believes that Transmode's products are highly complementary to Infinera's current offering.

Closing the transaction requires 90% of Transmode shareholders to vote in favor of the deal.

Having listened to feedback from Transmode's largest investors, a few weeks ago, we enhanced our offer to provide shareholders the option to elect a larger portion of cash versus stock.

While 90% approval rate is a high hurdle, we are optimistic that Transmode shareholders will see the value of this deal for both companies and the opportunity this unlocks as the transport market simultaneously grows and consolidates.

The metro DWDM market today is already a $5 billion market, expected to grow to $8 billion range by 2019, driven by a once in a decade technology shift.

We are very excited about Infinera's opportunity to intersect this market as the transition to 100 gig occurs, as virtually all customers will eventually transition to 100 gig.

Infinera is extremely well-positioned to take share in metro by leveraging our core technology and selling to our existing customers who already value the Infinera experience.

Furthermore, unlike our competitors, the metro market is incremental to Infinera as we have very limited legacy gear to cannibalize.

Finally, the number of market participants should decline over time as analysts expect industry consolidation in the metro to continue.

We believe Infinera has a terrific opportunity in the metro when it is only enhanced should we complete the Transmode acquisition.

Turning now to some noteworthy achievements announced in the second quarter.

I am very proud that IHS recognized Infinera with its highest distinction naming Infinera as a leader on its optical network hardware vendor score card, which is based on customer ratings and categories such as product reliability, service and support, and technology innovation.

I was particularly tickled by their classification of Infinera as the NE plus ultra, or the ultimate, of the ICP and datacenter interconnect market.

Additionally, Light Reading recognized Infinera on some important fronts.

First, they designated Infinera as Public Company of the Year for the second consecutive year.

Secondly, they recognized Telstra for introducing the industry's first commercial deployment of an SD and transport service, a solution that was enabled by Infinera's open transport switch software and DTN-X platform.

Finally, we are already beginning to see opportunities from the partnership we've announced with Arista to provide joint datacenter interconnect solutions to cloud service providers and to support Arista's cloud vision initiative which gives customer choice in their SDN strategy.

Over time, we believe this partnership will enhance the abilities of both companies to compete, giving the risk of the opportunity to offer best in class optical and Infinera best in class switching.

I would like to close by stepping back and taking a broader view.

We're seeing the transformation for the communications infrastructure moving to on-demand cloud-based application delivery and migration of network functions from layer three to layer seven into the cloud.

We refer to this suite of capabilities as Layer C of the network.

These clouds need to connect to end users as well as to each other, and they will be served by highly scalable packet optical networks, an intelligent transport network which we refer to as Layer T.

This transition is driving an unrelenting growth in bandwidth demand across subsea, long-haul and metro with one of its key drivers being east-west datacenter-datacenter traffic running over private optical networks.

We are seeing this growth firsthand from our customers as 100 gigE clients have rapidly overtaken 10 gigE clients over the last year.

There's no indication that continued bandwidth growth will subside in the near-term, at trend that bodes well for Infinera.

In summary, I'm pleased with our continued progress and remain optimistic about the opportunity in front of us.

As network architectures evolved to Layer C and Layer T, the strategic importance of optical has never been higher.

And while this is a positive for the broader industry, it is especially good news for an innovator like Infinera.

I strongly believe that you will see further consolidation in this industry as new winners emerge and new losers exit.

Armed with best in class technology, a differentiated customer experience and a vertically integrated business model, Infinera is one of the new winners.

In closing, I would like to thank our customers, our 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 second quarter and our outlook for the third quarter.

Thanks, Tom, and good afternoon, everyone.

As Tom mentioned, we had another strong quarter in Q2 with excellent growth on both the top and bottom lines.

Q2 revenue was $207 million, a 25% increase over the second quarter of last year, up 11% sequentially and above our guidance range.

Of note, the halfway point of the year marks the three year anniversary of bringing the DTN-X to market.

Demonstrating DTN-X's amazing success and widespread adoption, overall Company revenue in Q2 2015 was 122% higher than the period before we launched the DTN-X.

Having enjoyed considerable success over the past three years, we're excited about the continued momentum of our DTN-X platform, as well as the acceleration we are starting to see on Cloud Xpress.

In Q2, we enjoyed broad-based demand with our top five customers all coming from different customer verticals.

We had three greater than 10% customers in the quarter, a cable operator, a tier one and a wholesale and enterprise carrier.

Over the past two plus years, we have had eight different customers account for greater than 10% of revenue in a given quarter, but only one of them has been greater than 10% over the course of an entire year.

This demonstrates that we have several customers that can drive significant revenue in a given quarter and we are not overly reliant on any one of them to drive our continued success.

We truly believe that we are aligned with those customers building the biggest networks the fastest due to tremendous bandwidth requirements created by their business models.

Our growth in the quarter was driven by our existing customer base as they continued to aggressively build new routes and add capacity to existing routes.

Although we did not add any new customers in the quarter, we continued to see broad interest in our solutions and remain confident that we will continue to add new customers in the coming quarters.

From a geographic perspective, North America was extremely strong in Q2, accounting for 75% of total revenue.

This strength was fueled by our greater than 10% customers in the quarter, our major ITT customers, as well as other top 10 customers which are all based in North America.

Internationally, EMEA declined in the quarter after a strong Q1, representing 13% of total revenue in Q2.

Within APAC, we saw strength in the quarter through multiple subsea opportunities as the region grew to 6% of total revenue.

In LatAm, we are having continued success through both direct and channel sales initiatives as the region increased to 6% of total revenue.

Services revenue for the quarter was $28 million, up 9% sequentially, primarily to increases in deployment services.

On a year-over-year basis, services revenue grew more than $5 million, or 23%, as customers continued to utilize our services as they deploy new footprint and our growing install base increasingly sees value in our support offerings.

Moving now to gross margin and operating expenses.

Our overall non-GAAP gross margin for the second quarter was 47.4%, again above our guidance range as we continue to demonstrate our ability to drive strong margin results due to our unique business model.

We benefited from a combination of factors including cost reductions from leveraging our vertically integrated model, capacity additions to existing networks including instant bandwidth licenses, as well as a favorable customer mix in the quarter.

One trend we continue to be excited about is the increasing adoption rates of our instant bandwidth offerings.

We see customers adding capacity through follow on licenses and we also continue to ship additional instant bandwidth modules which further enables us to build a sizable annuity of very high-margin revenue for the future.

Services gross margin was 61% in the quarter, down from 65% in Q1, largely as a result of increased deployment services.

Our non-GAAP operating expenses were $71 million in the second quarter, up about $5 million sequentially and slightly above our guidance as we took the opportunity to accelerate certain R&D spend when we saw signs of our financial results tracking well ahead of plan.

We continue to invest in our expanding product road map while still maintaining alignment with our R&D target of 20% of revenue.

It is critical that we spend the required R&D to ensure we deliver the right products at the right time for both current markets and adjacent market opportunities, such as our future metro aggregation product, innovations in our Cloud Xpress platform, as well as our STN solutions.

Overall, we were able to drive operating leverage as SG&A expenses grew only 3%, even as we continued to invest in key personnel to address new markets and verticals.

Pulling it all together, we achieved a non-GAAP operating margin of 13%, up from 12.2% in Q1 and above our guidance range.

We continue to demonstrate our ability to drive profitability that is amongst the highest in the industry due to our differentiated business model and financial discipline.

Interest and other expense for the quarter was $300,000 and tax expense was $1 million.

The shares used to compute non-GAAP EPS during the second quarter were 141 million, up from 137 million in the prior quarter as our increased stock price continues to drive additional dilution.

In summary, non-GAAP net income for the second quarter was $26 million, or $0.18 per diluted share, up from $0.16 per diluted share in the prior quarter and at the high end of our guidance range.

On a GAAP basis, we had net income of $18 million, or $0.13 per diluted share in the second quarter.

The difference between our GAAP and non-GAAP results was due to approximately $8 million in stock-based compensation, $2 million in amortization of debt discount and $2 million in acquisition related costs.

Additionally, we recorded a gain of nearly $5 million in Q2 from a currency hedge on the Swedish krona in anticipation of the Transmode acquisition.

Now turning to the balance sheet.

Cash, cash equivalents and investments as of the end of the second quarter, grew to $460 million, an increase of $51 million from the previous quarter.

We generated cash from operations of $55 million in Q2, compared to $20 million in the first quarter.

This remarkable Q2 cash generation was driven by excellent operating results and positive working capital trends such as lower AR due to a favorable shipment SKU, as well as the timing of certain liability accruals.

In Q2, CapEx was $9 million, or about 4% of revenue, and we generated $6 million in net proceeds from employee stock activities.

While it is unrealistic to expect the same level of quarterly cash generation in the near term, these results clearly demonstrated our ability to generate significant cash from the business.

Over the last four quarters, we've generated $116 million of cash from operations and $87 million of free cash flow, which we define as cash from ops less CapEx.

This represents a free cash flow margin of over 11%.

Now for our outlook for the third quarter of FY15.

I'm pleased to announce that we currently project revenue for the third quarter to be $215 million, plus or minus $5 million.

The midpoint of this range represents year-over-year growth in the third quarter of 24%.

We currently project non-GAAP gross margin to be 46%, plus or minus 100 basis points as we anticipate a continued balance of new footprint builds and incremental capacity on existing networks.

We currently anticipate non-GAAP operating expenses to be $73 million, plus or minus $1 million.

This represents growth in operating expenses at a slower rate than revenue growth in the quarter, consistent with our long-term operating model.

The midpoint of our projected guidance translates to a non-GAAP operating margin of 12%, plus or minus 100 basis points.

The combination of interest and other expense 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 142 million shares and project non-GAAP EPS to be $0.17 per diluted share, plus or minus a couple of pennies.

As for GAAP EPS, we project it to be lower than non-GAAP EPS by about $0.08 per share primarily related to stock-based compensation expense.

Regarding cash, in the third quarter we anticipate another positive quarter of cash flow generation.

Finally in Q3, we look forward to driving closure of the Transmode deal.

With 54% of investors signed up in favor of the deal and Transmode's Board's unanimous recommendation of our offer, we are optimistic about closing this deal and having Transmode officially join the Infinera family.

With the offer period now in progress through August 7, we will keep you updated on key developments around Transmode.

In summary, I'm pleased that our financial results continue to be strong on both the top and bottom lines as we increasingly take advantage of the cost benefits of vertical integration, invest in the business prudently and generate cash.

Our strong Q2 results reflects excellent execution as we are capitalizing on broad demand from across our customer base as bandwidth growth continues at a tremendous pace.

We look forward to continuing to deliver differentiated financial results by addressing our core and long-haul, taking advantage of growing momentum in metro cloud and seizing the impending opportunity in metro aggregation.

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

(Operator Instructions)

George Notter, Jefferies.

Thank you, guys, very much and congrats on a terrific quarter and guide.

I guess I wanted to ask about Cloud Xpress.

If I remember correctly, you said last quarter you had seven customers that you had taken revenue from; and this quarter, I guess 12.

I think the way you phrased it this quarter, was 12 that are invoiced.

Are we comparing apples and oranges here?

Is this [rev rac] or is this invoicing?

Or what are we talking about?

And I also wanted to ask about the customer adds on Cloud Xpress.

Can you just talk about what kind of customers you brought into the fold here?

Are these Internet content providers?

Are they Equinix-type players?

Or walk us through the nature of those new customers.

And then also, I think last quarter, you said you had three of the four top ICPs, and I was wondering if you could update that?

Have you been able to penetrate some of the other ICPs, that fourth one, five, six, seven?

Give us an update of where you are with customers there.

(Multiple speakers).

George, I will try to address all of that.

The seven to 12 is an apples to apples.

It's the invoice customer count for Cloud Xpress.

The customers we added during the quarter is a mixture of different folks.

There's cloud service providers, there's folks through the channel, we obviously announced Equinix yesterday, so it is a broad mix of customers.

The big ICPs continue to drive the biggest volumes in that space, but we continue to get more and more interest from a broad base of customers.

You said 90% of the business is long-haul this quarter.

Can I infer from that, that 10% of the business was Cloud Xpress?

No.

We do sell into some metros.

It is with either the DTN or the DTN-X.

We said 90%-plus was long-hauls.

So it's the other pieces in combination of other solutions.

Got it.

And then, do you know that mixture from the March quarter?

The 90% long-haul versus other?

I don't think -- our mixture hasn't changed systemically in any -- the Cloud Xpress is growing.

We've always had various levels of subsea, long-haul, metro, datacenter, interconnect activities; and as we've pointed out before, a lot of our datacenter connections have been via DTN-X as a platform as well.

I'd say the mixture between markets remains strong and healthy.

Probably the best metric is noting the top five customers are across five different market sectors.

And then the slower revenue recognition on Cloud Xpress this year -- you said it was just more about adoption cycles or eval cycles.

Any more flavor you can give us there?

Do you still feel the same in terms of your overall confidence in the revenue outlook for that business?

Is this just a timing issue?

Walk us through the bigger picture.

I think, George, I'm surprised that -- I've said it before and I'll say it -- when we came out with this, I assumed people would buy it somewhat like an appliance; and they are not.

It's much to my great surprise being certified much more classically like a telecom service provider.

And the contract cycles are long.

The qualification cycles are long.

And it's a surprise to me.

The volumes of the units are going up nicely every quarter.

I'm happy with the progress that we are making from an adoption perspective.

I'm happy with the fact that we are growing the number of customers and I feel very good about the pipeline of what I would consider probable customers across Q3 and Q4.

I think that we probably underestimated the pent-up demand for 100 gig.

We're getting it out as fast as possible, but some of the customers have said, I'm just not going to deploy this now when I can get 100 gig in Q3.

So, I'm going to wait for the 100 gig.

I'm very optimistic that we're going to sell a lot of that.

And I'm also extremely optimistic now that I said that we have of the 12, four have already come back for repeat purchase with new opportunities.

They're deploying them, they're happy with them, and they're seeing more and more opportunities for this -- and I've called it an architectural piece -- into their new network and I believe that's being played out.

If nobody comes back and buys it, it's not an architectural piece, and I think that we are being, our customers are liking what they are seeing.

Dave?

I want to add on one point on the -- the customer cycle is, they will pick a particular location and particular application.

They'll buy a small number of units and they'll operationalize those units within their network.

If they liked what they saw, they come back and they buy one and that's what we're seeing in the cycle.

So we are engaging with and we're getting an early buy-in from the large customers that we want, but they need to first go through the operationalization at a small level.

And now we are starting to see them come back and looking at things in a bigger level.

The optimism for market penetration is as strong as ever.

If there is any delay -- I'm not sure there is a delay -- but if there is any missed expectations on timing, it has to do with that two-step process of operationalizing a small number and then moving on to larger quantities.

Thank you.

Thanks, George.

Sanjiv Wadhwani, Stifel.

Tom, just to follow-up on the Cloud Xpress -- you mentioned about the 100 gig.

You are surprised with the pent-up demand there.

Walk us through what type of customers are looking at 100 gig; because I think it varies between ICPs and service providers and traditional enterprises.

Walk us through what type of customers are looking at 100 gig solutions on the Cloud Xpress.

And then, you mentioned competition.

They're have been a couple of announcements in the last quarter or so, and you walked us through some differentiation.

But on a more granular level, is it power?

Is it the bandwidth?

Is it the size that helps skew the customer buying decision towards you versus the competition?

The biggest skew right now that causes the customer to buy from us versus the competition is that ours is the only product shipping.

And there's a ton of great slideware out there that talks about all kinds of features and I look forward to our competition starting to ship something and then we will go do the analytics.

We have a very good feeling about where we stack up.

But I think that the biggest differentiator today: we've been shipping.

We've been shipping for three quarters and nobody else is shipping.

The advantages that we are going to have are going to continue to be around our technology.

The PIC -- nobody else has a PIC -- and these kind of applications uniquely favor PIC-type of technology.

Where you integrate and make things smaller, everything gets better simultaneously: space, power, quality and cost -- all of it gets better simultaneously, and there's no recipe other than integration that provides that.

In regard to 100 gig, it's mostly people that have giant bandwidth.

It's mostly the cloud guys, the datacenter guys.

That's who's driving the biggest, earliest demand for 100 gig.

And that's from my view.

Brad, just a quick follow-up on the numbers.

I think the range that was out that was 30 to 60.

I think Tom mentioned in the prepared remarks that high end might be a little bit on the top side.

Are we looking at somewhere in the midpoint?

Are we looking somewhat closer to the low end when it's all said and done for the year?

Sanjiv, it's hard to say at this point.

It's just that, given the slower ramp in the first half, getting to the high end is going to be more difficult.

But we still got two quarters to go.

And as Tom mentioned, we see more and more customers coming in, asking for demos, asking for product, actually starting to order.

Just practicality though, to get to the high of the range will be tough.

Where we end up, I am not going to speculate on.

We are just trying to be as transparent as possible, Sanjiv.

I appreciate that.

Thank you.

That's helpful.

Thanks.

Michael Genovese, MKM Partners.

My first question is -- investors who, some of them have recently become concerned about the near-term outlook for spending in the ICP market.

But your results, your guidance doesn't really show any need for concern.

But what is your take on that?

Do see any change in spending trends in the ICP market near-term?

It's interesting when people talk about CapEx cuts at either a Tier 1 or an ICP, and it creates a lot of churn and turmoil and fear.

My fundamental outlook is that there is nothing but fundamental demand continuing to drive from the ICPs, and I don't see that anything on the horizon changes.

They spend CapEx in a lot of ways.

But at the end of the day, what they have to be able to do is get data from one datacenter to other datacenters, and they have to get data or information or video from datacenters to consumers.

As long as that demand keeps growing, I don't see any way that they cannot continue to invest, particularly with the advent of 100 gig technology moving in, which provides a lower cost infrastructure from them -- from a CapEx perspective, on a dollar per bit basis, on a power basis, on a space basis.

There's too many either fundamental demand drivers, and then also fundamental cost drivers, that say 100 gig is going to help them solve a lot of their problems.

So I just don't see it.

Now maybe their CapEx elsewhere is going to be cut, but in fundamental transport, I do not see it.

Great.

And then moving on, when I look at the guidance for the next quarter -- 4% sequential revenue growth, about $8 million incremental revenues -- how should we think about that $8 million split between DTN-X and Cloud Xpress?

Mike, I'm not going to break that down into too much detail, but obviously, we expect DTN-X to continue to do well.

We expect CX, Cloud Xpress, to continue to ramp; but we're not going to get into exact granularity of it.

The reality to it is, the underlying business is very strong.

We see strong demand for CX.

Okay then, I will try to sneak one more in and I'll take the answer off the air.

Could you just Transmode confidence that you're going to get the 90%.

Can you quantify the confidence?

Is there any other kind of measure of that confidence you can give us?

Mike, there's no magic to it.

We have to get to 90%.

As we mentioned in the prepared remarks, 54% of their holders signed up before the offering period even started.

That gets us a good pace along the way.

We've obviously talked to other holders that are favorable to it.

And we are consistently going and talking to more and more investors to go get above that 90%.

I can't really handicap it at this point.

We will know better on the seventh in terms of where we are ending up.

We are very committed to making this happen.

We do think it's a strategic piece to our go-forward plans.

Doug Clark, Goldman Sachs.

I want to focus a little bit on gross margins, which continue to be really strong.

I think the comments for this quarter were a little bit more heavily skewed towards the favorable mix shift, especially when you consider no new DTN-X customers.

Is that true?

And how much was capacity still a contributor to margins this quarter?

Yes, Doug, it continues to be a combination of things.

We continue to get good leverage out of the fab.

Obviously, we are ramping new products, which helps as well.

But we are seeing people starting to order more and more capacity adds as well.

It is a combination of different things that continues to drive the margin and will continue to drive the margin going forward

And maybe as a followup to that -- instant bandwidth was also cited.

And certainly, if you look at deferred revenues, they continue to grow a little bit each quarter.

Is that primarily what is driving that deferred revenue growth?

And is that becoming a more meaningful contributor to gross margins?

One clarification, Doug.

The instant bandwidth licenses don't sit in deferred revenue.

They're nowhere on the balance sheet.

It's really, we've deployed a lot of instant bandwidth modules and there's still a lot of ports to still be filled with licenses in the future.

We continue to see both customers adding new licenses, but also customers buying more and more modules.

We are able to deliver those first modules, still deliver strong margin profile, and build up an annuity as they license these 100 gig licenses going forward.

It's a nice margin uplift in the future as well.

Okay, great.

If I can sneak one more in as well on the gross margin front from the CX.

How are those margins, can you remind us, relative to corporate average?

I would say it's similar to what we've said since the launch, which is, some of the initial bigger customers will have lower than corporate average gross margin.

As we get more and more customers, I feel good about the margin profile of it.

We're seeing customers adopt instant bandwidth for CX as well.

The initial margin on that will be a little bit muted, but over the long-term will be higher than corporate average gross margin.

I still feel good about the margin profile of CX being at or above corporate average gross margin over time.

Great.

Thanks a lot and congratulations.

Thank you.

Vijay Bhagavath, Deutsche Bank.

Congratulations, Tom and team.

Solid results and [solid out].

Thank you, Vijay.

A two-part question, if I may?

The first part is, give us an understanding of the waterfall for the 100 gig Cloud Xpress.

And where I'm coming from is, from the fourth quarter of this year, we do anticipate new merchants silica and 100 gig leaf and spine datacenter switches.

Do you see that as a tailwind for the 100 gig Cloud Xpress product?

Thanks.

I think that the 100 gig -- we see large datacenters today deploying with 100 gig in both the routers and switches inside the datacenter where they want to hand off to transport.

That's moving from 10 to 40 to 100.

And a lot of people are moving to that 100 now as router and switch ports have become much more cost-competitive around 100 gig.

We could sell 100 gig right now if we had it available.

We'd be shipping it right now.

Instead, we'll be doing it this quarter.

And there is pretty significant pent-up demand, but it's still not the mass part of the market.

It's where people are making the investments now and haven't been making them recently that they want to move all of their spend -- these are the large guys -- to 100 gig as soon as possible.

I think that the new 100 gig for routers, ports, switch ports becoming cost-effective, and us then delivering 100 gig on transport's going to create a nice combination to accelerate the 100 gig growth a lot.

And I don't think we have to wait for the inside of the datacenter to change at all.

This is all the handoff of intra to outside.

There is a secondary effect that's going on intra-datacenter, where the transition of net cards to 25 gig which is going to continue to -- which is 2.5 times increase over current cards.

The aggregation of that as it exits the datacenter is where that is transitioning rapidly to 100 gig interfaces as opposed to 10 gig.

Especially at the volume applications.

Excellent.

And then the second part is that on the 100 gig metro opportunity.

We are a little fuzzy, honestly, on that.

Give us an understanding.

You're still working on the Transmode deal.

You have a metro version of your DTN-X product looking to ship any time now.

So would it be the second half of next year, Tom?

And realistically, we could start seeing 100 gig metro dollars flowing into the top line?

How should we view and model the 100 gig metro opportunity?

Thanks.

We are definitely bringing our metro product to market this year, this calendar year.

We are showing it to customers now, and I would anticipate you could start having some reasonable amount of ramp starting in Q1 of next year.

The good news is, like I said on the call, we are going to sell this mostly at first to our current customers.

It's going to have the same fundamental ease of use, look and feel, network management experiences to DTN-X.

So I think that there is not going to have to be a long ramp up.

Clearly, we are not going to sell out of the chute a lot, but I think that you can start seeing revenue that is nontrivial in the first half of the year, ramping up in the second half of the year.

And if Transmode closes to our desire in the August/September timeframe, we will clearly get 100 gig volumes from that this year.

Excellent.

Thanks again.

Dmitry Netis, William Blair.

Thank you very much.

Nice quarter, guys.

Thank you, Dmitry.

I have a question for each one of you, and pardon my poking around the customer base once again.

As you called out -- I think, Brad, this is for you -- the cable, the Tier 1 and the wholesale -- are these ordered from the largest contributor to the lowest contributor?

No.

It's just those are the three top guys.

We do not break out who is exactly who.

And was the Tier 1 the US Tier 1, the same one we saw recurring over the past year?

Yes

Okay.

Do you expect these cable and Tier 1 guys to come back in Q3?

When we talk about cable, Dmitry, if you remember, cable tends to be strong in the first half of the year.

They don't order as much in the second half of the year.

I don't expect cable to be as strong in Q3.

The Tier 1 customer has been a -- Tier 1 and the enterprise and bandwidth wholesaler have been great customers throughout and continue to spend aggressively with us.

Okay, awesome, thank you.

And Tom, just back to this cable discussion.

As we see this cable market consolidating, we have the Comcast Time Warner in the past, and we clearly heard your message there.

I was wondering if you could update us on what your thoughts might be on this Time Warner cable charter Bright House acquisition strategy there, and how are you positioned for the good or for worse as this thing occurs?

Well I think, if it occurs, I personally view that we're going to be in a good spot with this.

One of those companies has a backbone, one doesn't.

The backbone's ours today, and I can't imagine building a new backbone just because you buy somebody.

Why would you want to build out your own new backbone when you can leverage the one that you already would have?

So I think that this is a -- for the same reason it makes maybe sense for those guys to get together, I think they will have an opportunity to really leverage some of the infrastructure in place; and a lot of that infrastructure is ours.

I think it would be not a bad thing.

Now, in any type of acquisition, there's always the period where things are going to slow down until the deal is done.

As Brad had mentioned, however, that cable historically is not that strong in the second half of the year.

We are in that period now, and assuming that it doesn't take an unreasonable period of time to get done, we should be in time for an early next year buying cycle.

I'm optimistic on what it means to Infinera.

I have no idea whether it will happen in the industry or not.

I don't track it within any trade competitiveness, et cetera.

My suspicion is, it will go through.

Okay.

That's helpful.

And then last one for Dave -- as we track this highly hyper growth DCI market, I suppose, and all the competitors that are jumping in the fray there, Ciena came out with a wave server.

They also announcing their acquisition or have announced their acquisition of Cyan, which provides this multi-vendor orchestrator.

Just kind of an interesting idea, because they can come into datacenter and start managing multiple environments that aren't Ciena's based environments.

And so my question is, how are you positioned in this multi-vendor orchestration, ESDM orchestration environment?

I know you've been working on ESDM controller.

I don't know if it's multi-vendor or not.

Can you give us a sense of where you are and how competitive you might be to this Blue Planet piece of software that Ciena's buying?

Yes, I am not sure I'm going to be able to shed as much light as you would like on that question.

The market is, at this point in time, is such that they can see value of being able to operationally establish services through a common control plane.

That is what is motivating the development of SDN.

I think it is clear that SDN as it develops is not going to be a controller, but it's going to be a series of controllers, and controllers of controllers, and depending on the application that people want on that.

And what is critically important for our business, where we view our business as in the equipment necessary to establish services in the WAN, is that we can integrate into our customer's control system, which is how we integrate today.

And to whatever control system that customer wants to buy.

Maybe Blue Planet, maybe any of a number of other controllers in our marketplace.

And then finally, to make sure that we can put together the right management structure that allows for our industry-leading ease of use of establishing services.

So there's going to be a number of places at which we integrate into, and that transition from the current control plane structure exists with the customers to an SDN ramp is a multi-year event and it's going to depend very much on the different customer bases.

Do you foresee opening your APIs to this Blue Planet software?

We integrate into our customers' infrastructure today.

They sit there and operate our network with adjacent router networks, with adjacent switch networks and managed services across that.

And today, our customer has their own management software that does that.

In the telco extreme it's Oz Mine.

In the Internet content providers' stream, it's a very simplified network controller that they built to do that.

And for us to play across the multi-markets, we will integrate in with a controller that our customers ask us to integrate in with.

Our Pacnet demonstration was integrating in with the first deployment of a true SDN service was with a third party controller that Pacnet elected to choose.

And so the point of integration is going to be varied.

What is clear from the customer base is, there isn't going to be -- an equipment provider isn't going to dictate a controller across all of the networks.

It's just not going to happen.

The customer base will not allow it to happen.

What we do best, is we put bandwidth on the network better, faster than anyone out there, and we allow the ease of use and control of that and the customer experience to be better than anyone else out there.

We will work with our customers to make sure that they can turn on services faster than anyone else and that they can monetize their investments faster than anyone else.

Okay.

That's very helpful.

Thank you.

Keep up the good work.

Alex Henderson, Needham.

Hello, Alex.

Hey, how are you doing?

I've got a simple question for you but it entails unfortunately more than one quarter of thought.

So if I look back over the last 18 to 24 months, we've seen a beautiful acceleration and superb execution as you've gone up into the 30s and growth in the fourth quarter last year and first quarter this year.

You are on track to do 25%-plus-type growth this year.

Should we be thinking about the out period as having enough acceleration in demand associated with the DCI market, cloud to cloud market, combining with continued strength in long-haul and subsea, that we should think about you as able to sustain higher than that 10%-plus market growth that people have talked to?

How should we think about the longer-term periods as we start to run up against these extraordinarily difficult comps we will have in 4Q and 1Q coming forward?

This is how I'm going to look at it, and how I've had to explain it to people.

The long-haul market, where we have primarily grown, is growing at about 8% a year.

We've obviously been very successful at growing with that market, but also taking significant market share from other people.

And to your point, that becomes challenging as you become a significant participant of market share.

The very unique position we find ourselves in is that, with our same fundamental technology and a lot of the same customers, we have the opportunity to go from the long-haul market to the long-haul-plus metro market.

That metro market is a $5 billion or $6 billion market, also growing 8% to 10%.

And then, you take the DCI market, which is fairly small today, a few hundred million dollars growing to a few billion dollars.

I find it remarkably unique position as a company that does not have to change its DNA, doesn't have to change its way of going to market, doesn't have to change its technology and can go from a $4 billion market today to a $15 billion-plus market over the next few years.

That's a shocking opportunity.

We won't be able to serve all pieces of that market.

The point that you are making about can we outgrow the 10% range in the long-haul market?

I don't think we could in the long term.

But over the next several years, we are not going to be in the long-haul market alone.

It's long haul, metro, cloud, subsea -- and it's a $15 billion market opportunity.

If you look at our market share in long haul, I can tell you, I am not going to over a period of time accept anything less than that kind of market share in the larger market that we are going to go pursue.

That's going to take some time and some work.

And I don't want everybody to believe that this is going to be a linear up-and-to-the-right kind of progression.

But our strategy over the next several years is to recreate our success in the long haul by leveraging our core technologies and optimizing them and going into adjacent spaces that will allow us to fundamentally triple the market we are serving.

It psyches me up.

Great answer.

Second question, I think I also know the answer to this.

I keep getting asked the question about people coming out with quote-unquote white label pizza box going after this DCI market, cloud to cloud market, based on the idea that there is an increasing availability of off-the-shelf transceivers capable of doing 100 gig that are sold as straight-out modules.

Can you address that?

I keep getting asked the question.

I think I know the answer, but I just want to hear your response.

There has always been off-the-shelf technology.

Always.

And people have always been able to take things and piece them together for niche solutions.

But you, in the history, people who invest in technology have captured the largest market share, and I don't think that's going to change.

Just because you can buy 100 gig off the shelf from somebody, that doesn't mean it is differentiated.

It doesn't mean it means optimized for space, power, capacity, reach -- any of those things.

And I think you're going to see that, just like in the long haul, coherent matters, ticks matter.

You're going to see that even more so in the metro.

And I think this is an area where I do agree with Ciena, who had this same comment I think this week, when they were asked about this.

They just don't fundamentally believe that off the shelf technology is going to solve the bulk of the problem.

Will some people go out and maybe try to save a few pennies by building something themselves?

They might.

But I think at the end of the day, the cost curve of the technology that we are providing, the dollar per bit we provide on a transport level, they'll be able to scale that to magnificent size scales -- I really don't think most of our customers today enhance their bottom line by trying to save a few pennies off a transponder from off the shelf and making stuff themselves.

I just don't see it.

It's not that big of a savings.

So not even in the big sky market where they've historically had a tendency to try that?

No.

I think on servers -- do you know how many billions of dollars of servers did they even buy -- and switches?

Those markets -- they spend enough money that it might actually make a difference.

They are not buying, in my mind, enough transport -- I hope they do some day -- to fundamentally move the needle on their bottom line by building it themselves.

And I don't know why they would ever go about trying to do that when in our market, in the market the optical industry bears about a 40% industry margin.

In the switching business, they're trying to cannibalize the 70% margin business of those guys.

It's not the same thing.

And if you've been reading, a lot of these ICP guys are all talking about trying to make sure they are only investing where they can have significant -- it's more mature -- only investing where they can have significant payoff.

Building white box optical switches, or transport boxes -- to me, it's not in the first thousand items of waste for them to be more efficient.

It's just not.

Perfect.

That's what I would have expected you to say.

One last question and then I'll --

Dave just wants to add one thing.

One second.

The industry is forgetting a key thing.

When the integrated circuit expanded, you could buy off-the-shelf discrete components.

Right?

And its off the shelf.

But you know, when you have a high-capacity demand, and I got to buy a bunch of off discrete components at a low bandwidth requirement, you are not doing it in the lowest cost structure rate possible.

Intel, integrated circuits -- all that came out is a proven thesis.

You put this stuff on an integrated platform.

You go for something that is, in our case, more bandwidth, and their case, more computing power, you can make things that are more sophisticated, less expensive than you can in a discrete fashion.

And that's what drives this.

That's where we are the only provider, the only capability of high capacity in photonic integrated circuits.

If your application requires bandwidth, we will be able to supply that, and a much more reliable, productive, higher density capability.

Great stuff.

One last question, if I could?

The metro core product -- you've been surprised at the rate of adoption timeline through the amount of testing for the Cloud Xpress taking longer than you'd expected.

It seems to me that the adoption rate for a metro core product, which is going into a much more complex multi-mesh environment, would be much harder to get into the install base without significant testing and a significant amount of potential revenue recognition criteria on those contracts.

Isn't it reasonable to think that, that would take considerably longer for that product to reach revenues at ramp than the shove-it-in type approach of some of the Web 2.0 players?

You know that's what I -- we were surprised at how long it's taken for the Web 2.0.

The metro aggregation product we're coming out is going to a customer base that we know well, who has a large install base of our product.

And I think we have a pretty good understanding of how they will get certified there.

It won't happen overnight, I agree with you.

But this one is not going to be a surprise to us.

Great.

Thank you.

Rod Hall, JPMorgan.

Thanks for taking my question.

A couple of things.

First of all, I wanted to see if you have any idea how far through the conversion of datacenter interconnect we are?

The movement from leased line to owned facilities.

And then, secondly, you guys talked about new risked opportunities with the partnership there.

Can you just expand a little bit on what's going on there?

Do you think you're gaining new customer access?

Customers you did not have access to before?

And it's mostly filtering expansion in customers you're already in?

Can you talk a little bit more about what opportunities that affords you?

Sure.

I will answer the second one.

I will let Dave handle the question on datacenter technology conversion.

Arista and us approach this with the same kind of model.

We want our customers to be able to provide them with best-in-class transport and best-in-class switching.

They want the same thing.

Versus the model of a large competitor providing an end to end, where they are prisoner of having maybe inferior choices of one or both.

And we are going to do this in a fashion that does it such the customer wins around best-of-class technology.

And we're going to go and integrate with Arista around ease of use in SDN.

We are training our sales forces mutually and the opportunity for Infinera -- I think for both companies -- is good, but for Infinera, candidly, is probably better.

We have a couple hundred customers at most that we can help introduce them to.

They have several thousand customers that they can help us being introduced to.

That doesn't mean that all of them would necessarily want transport or need transport, but we see a very large potential opportunity to expand into markets that we aren't going to have a direct sales force.

Financial markets would be a good example.

Large enterprises, another example.

And we have had some joint sales calls now and so far, early days, I am optimistic that this could be meaningfully positive to both companies.

I don't have enough data to say it's going to move the needle.

But at least early interactions are, both companies are excited about the potential of providing a world class end-to-end solution to these customers.

I think your second question was, where are we in the datacenter interconnect cycle.

And I would have to say extremely early in that process.

The world is rapidly converting to more and more content moving into the cloud.

These transitions are very early.

And they last for a long time.

Have you guys quantified that at all?

Where in the cycle?

Yes.

Do you guys have a number of datacenters and the proportion of them that have connectivity in your estimation?

Or is it just an unknown quantity out there?

The datacenter and interconnect projections have a growth rate of somewhere in the excess of 60% type of growth, which is well above that of long haul.

I think we've just recently transitioned where machine-to-machine traffic is equated to person-to-person traffic.

Since machine-to-machine traffic is technically a multiplier of 100 to 1,000 times the amount of bandwidth required to handle that, I fully expect that in the coming years, that the machine-to-machine traffic is going to dwarf the person-to-person traffic as it goes along.

And that is datacenter interconnect traffic.

There's something like 500,000 datacenters today in the world.

But it becomes more interesting is when you look at who has five or more of them, from our perspective.

And we are actually in the process of vetting that right now.

So maybe I'll give you an update when I see you next.

Great.

Okay.

Thanks, guys.

(Operator Instructions)

Subu Subrahmanyan, The Juda Group.

Thank you.

I wanted to take a shot at the metro question once again.

Tom, if you think about the 8% growth in the long-haul market continues into next year, and some of the factors between CX Transmode products and your metro aggregation product starting to impact that, do you think for 2016, Infinera will be able to see a full-year benefit of having the metro products?

Does it start to get more meaningful around midyear?

I'm just trying to understand when you feel like the metro opportunity can fully realize with your product portfolio.

That's a hard question, Subu, because a lot of it depends, quite frankly, on Transmode, on both the timing of that and the success of that.

And if this closes in August/September, I would certainly anticipate getting the full benefit of next year, and hopefully accelerating it because we are going to apply our sales force to this product offering that's a lot bigger than the Transmode's sales team has.

I think there should be an acceleration.

But until that is done, it is very hard to say, and it depends on when it closes.

I think for our own metro aggregation product, I think we will start seeing sales certainly in revenue in Q1.

But I would say the meaningful revenue would be in the second half of the year, candidly, but we will get revenue in the first half.

And cloud -- I have actually pretty significant expectations for cloud for next year.

I think we're going to have our whole portfolio out there.

We're going to have gone through the digestive period of learning about all of the certification issues and contracting issues and operationalizing issues.

And we're going to have, I think, set a very nice table to enjoy Cloud Xpress volumes next year.

I think an interesting way of looking at it -- in the long-haul space, we've spent a number of years, and I think our best metric is 40%.

We maintained our 40% North American market share for a number of years there.

We are entering into a metro market space that is, we have single-digit, small single-digit market share in that.

We think our technologies play equally well across high-capacity metro as they do in long haul.

So I think it will be a number of years as we grow into a major supplier across North America and the world.

Right.

Thank you.

You bet, Subu.

Ted Moreau, Barrington Research.

Thanks very much for taking my questions.

I was wondering, how do you see the Cloud Xpress mix shaking out in the second half of this year between 10 gig, 40 gig, and 100 gig?

And I assume that the 40 gig really starts to fall off now that you have the 100 gig version available?

The market is going to migrate into 2, into 10, and 100.

So you are correct that over time, the transition will happen from 40 will convert to 100.

And I would say that's probably will be the faster product lifecycle.

10 gig is going to last for a long time because datacenters come in all shapes and sizes for that, and services come in shapes and sizes.

But I think the 40 gig is probably good 12 months, 18 months, something like that.

But over that course of time, it will transition to 100 gig.

Okay; and then I hear you about the delay in Cloud Xpress revenue because of waiting for 100 gig.

I was just wondering, do think any influence came from all the competing solutions that are out there hitting the market?

I know there are more slideware, as you were saying, but do you think that's had an influence at all?

I don't think it is had any influence whatsoever.

I think we were the first mover, we saw the opportunity, we listened to customers, we created a differentiated approach with our differentiated technology.

I think the industry is trying to scramble to catch up.

I'm really enjoying, quite frankly, the number of people who are introducing products and I'm really enjoying the amount of time some of our competition is talking about how their products are going to be a lot better than ours.

Right now, if you want it, and a lot of these guys want it right now, you can only get it in one place.

And we are enjoying that and we are not having, to date, a problem with selling against somebody who is going to have something.

It's going to be an explosive market, and when they do come out with things, I think they will have opportunities too.

And that's when there will be a more competitive challenge.

Sounds good.

And then, one final question.

Given the number of guys that are coming out with these types of boxes, what -- I mean I hear you about the technology prowess of Infinera.

What prevents this market from facing tougher gross margins similar to maybe what we saw at 10 gig with so many players out there?

What prevents that from becoming a little more challenging on the gross margin side?

I'm going to answer it in two steps.

First, you've got to understand, the guys that run datacenters -- their lifeblood is that data that exits that building.

And so they will be very cautious about who they entrust with their lifeblood.

It is very simplistic to view the market that I'm going to go trust my life on a white box.

I entrust my life on companies, and on people behind the companies, and people that are back their products on those companies.

That's why, quite honestly, we get recognized as the industry leader as far as customer support, and we get recognized that our margins are better than our competitors.

One, because we have a great cost structure; and two, because our customers value that added capability to it.

I'm not worried about our ability to satisfy our customers' needs and the presence of a discrete-based technology compared to a PIC-based technology.

I'm not worried about it, because we meet what the customer values from us.

In closing, we look forward to seeing you at Inside Infinera 2015 on October 6. Thank you for joining us this afternoon and for your questions.

Have a great rest of day.

Thank you.

That concludes today's conference.

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