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Infinera Corporation (NASDAQ:INFN)

Q3 2008 Earnings Call

October 21, 2008 5:00 pm ET

Executives

Bob Blair - Investor Relations

Jagdeep Singh - President and Chief Executive Officer

Duston M. Williams - Chief Financial Officer and Principal Accounting Officer

Analysts

George Notter - Jefferies & Co.

Ehud Gelblum - J.P. Morgan

Jason Ader - William Blair

Jeff Schreiner - Capstone Investments

Subu Subrahmanyan - Sanders Morris-Harris Group

[Ashken] Marsh - Private Investor

Mark Sue - RBC Capital Market

[Unidentified Analyst]

Operator

Welcome to the third quarter fiscal 2008 investment community conference call of Infinera Corporation. (Operator Instructions). I would like to introduce your speaker for today’s call, Mr. Bob Blair of Infinera’s Investor Relations.

Bob Blair

Good afternoon and welcome to Infinera’s Q3 2008 earnings call. Today’s call will include projections and estimates that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements address the financial condition, results of operations, business initiatives, views on our market and customers, our products and our competitors’ products and prospects of the company in 2008 and beyond and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

Please refer to the company’s current press releases and SEC filings including the company's annual report on Form 10-K filed on February 19, 2008, for more information on these risks and uncertainties.

Today's press releases including Q3 2008 financial tables and investor information summary and a guidance reconciliation summary will be available today on the Investor Section of Infinera’s website at www.infinera.com.

The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. This afternoon's press release and today's conference call also include certain non-GAAP financial measures. In our earnings release, we announced the operating results for the third quarter of 2008 which will exclude the impact of the roll-off of certain ratable GAAP revenue and costs from the balance sheet as well as the impact of non-cash stock-based compensation and warrant revaluation expenses. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons. Please see the exhibit to the earnings release for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful and how they are used by management.

On this call, we also give guidance including guidance for the fourth quarter of 2008 and the full year of 2008. In this guidance, we'll include adjusted GAAP results, which exclude the impact of the roll-off of certain ratable GAAP revenue and costs from the balance sheet as well as the impact of non-GAAP, non-cash stock-based compensation expenses from our results. Again, we have reconciled these adjusted GAAP projections to our GAAP results on the investor section of our website in the document entitled Q3 guidance reconciliation summary. We have excluded non-GAAP, non-cash stock-based compensation expenses because we cannot readily estimate the impact of our future stock price on our future stock-based compensation expenses.

For the remainder of today's call, we'll be discussing our third quarter 2008 results and our fourth quarter 2008 guidance excluding the impact of these items and we'll refer to these results as adjusted GAAP.

I'll now turn the call over to Infinera’s President and CEO, Jagdeep Singh.

Jagdeep Singh

Good afternoon everyone. Joining me today is CFO, Duston Williams, who will provide the third quarter financial report and an outlook for Q4 after my remarks.

Turning to the third quarter, we reported results that were slightly better than the guidance we provided in July. We recorded adjusted GAAP revenue of $80.9 million in Q3 versus $80.4 million of invoiced shipments in the year ago period. We broke-even on an adjusted GAAP net income basis versus invoiced shipments based income of $0.12 per share in the year ago quarter, and we generated approximately $10 million of cash from operations. Gross margins on an adjusted GAAP basis were 42%.

We’ve always said that new customer footprint is one of the leading indicators of future business growth in Infinera, though we’re very pleased to report that we added 5 new customers in the quarter not including Deutsche Telekom, bringing our total customer roster to 49. This includes a new top five North American cable MSO, so we now count all 5 of the top 5 North American cable MSOs as customers. This also includes two new European customers continuing our momentum in Europe. We’re pleased with the resumption in new customer win momentum and we believe this will continue into Q4 with the addition of at least another 4 new customers including DT.

Also during the third quarter, we completed our initial migration on the DT pan-European network to Infinera equipment in a 5-week timeline highlighting the speed of service advantage that our architecture provides. We were able to migrate traffic from the previous incumbent DWDM platform on to our equipment using only the existing single pair of fibers without requiring additional fiber as would have been the case with the conventional WDM solution. DT now serves as a strong reference account for our new business efforts worldwide.

This quarter, we saw a strong reception to the new Infinera Line System 2 from both our installed base and new customers. The ILS2 which we began shipping in August provides extended reach and increased capacity for our existing DTN system and is designed to seamlessly allow our DNT to scale to 8 Terabits/second in the future. Much of our pipeline of large network build-outs now contains ILS2 as an element of this version.

We also achieved two key milestones this quarter. First, Infinera’s photonic integrated circuits surpass the cumulative total of 100 million hours of operation in live networks worldwide without any PIC failures. Evidence of the high reliability of Infinera’s photonic integration technology and a tangible demonstration of our outstanding field quality is something that really matters to our customers. Secondly, we’ve now shipped over 10,000 Infinera DLM line cards since the company began commercial shipments in late 2004. We estimate this accounts for approximately 40% of all of the 10-gig long-haul ports shipped by the industry in this timeframe, and equate to a total DWDM network capacity of 1 Terabit/second representing a significant potential future revenue opportunity for Infinera.

Now, I want to briefly address Infinera’s business in the context of current economic conditions.

This is clearly an uncertain time at a macroeconomic level. On the other hand, we have not seen any significant changes in spending plans to date on the part of our customers that we can attribute directly to the macro-economy. However, this will change and we continue to closely monitor the potential of such an impact on our business.

Our plan to grow the business over the long-term lies on two things; the first is continued growth in the demand for band width and the second is our ability to be the WDM vendor of choice to address this band width growth. We believe that demand for WDM equipment is tied directly to growth in band width demand and that band width demand continues to exhibit robust growth because of consumer video and other such drivers. We believe WDM equipment is more like a cost of goods sold for our customers than a discretionary expense, and as long as band width continues to grow, carriers will need to deploy WDM equipment.

Second consideration is our belief that we can continue to be the WDM vendor of choice to address this growth in band width demand. In particular, we believe that first the Internet cannot scale without disruptive technology like photonic integration. Second, we have a superior product portfolio and also a compelling value proposition and a highly differentiated technology advantage that allows carriers to compete more efficiently and effectively in an increasingly competitive marketplace. Third, in order to continue to be a significant player in the long run and maintain our leadership position, we must continue to fund our R&D spending even in this uncertain time.

Relative to growth going forward, we’ve been executing on the 4 major initiatives that we outlined on previous calls. First, we said we wanted to further expand into international markets. We’ve seen good progress in this front as evidenced by our two new EMEA customer wins and the successful DT deployment. Second, we said we wanted to penetrate additional tier 1 carriers worldwide. We continue to be pleased with our traction with this important group of potential customers and expect to expand our customer base in this segment. Third, we wanted to continue to grow under-penetrated segments in North America including non-telecommunication carriers such as cable MSOs, Internet content providers, and the R&D community. Our recent cable MSO win is evidence of our continued traction here. In addition, we see significant activity in the North American pipeline of large long-haul build-outs.

Fourth, we are committed to focusing our energies on developing new products that will allow us to continue to differentiate our DTN system and compete in a new adjacent market including ultra long-haul and metro access. We’ve already seen great success with the recently introduced ILS2 which has allowed us to break into the ultra long-haul market.

In summary, we see continued DWDM build-out activity and believe we have the opportunity to win a meaningful share of this business. This gives us comfort that we can grow the business over the long-term. Our strategy in the years ahead is to continue to develop our products to maintain their relevant and highly differentiated offerings. We will focus R&D on integrating more and more components into our PICs in line with the PIC roadmap we announced earlier this year and delivering more services through systems enabled with those more powerful PICs, thus creating even greater value for our customers and placing more distance between us and the competition. This strategy continues to resonate with customers and prospects and we continue to see new opportunities in the market.

Duston will now provide the financial report and our Q4 outlook.

Duston M. Williams

I will review our Q3 actual results and then follow that up with the outlook for Q4.

The following analysis of our Q3 and Q2 results is based on adjusted GAAP and the results from other quarters in the fiscal year are based on invoiced shipments and all exclude non-GAAP stock-based compensation.

Please see the GAAP to non-GAAP invoiced shipment and adjusted GAAP reconciliation which is attached as an exhibit to today’s earnings press release for a reconciliation of these results to our GAAP results.

For Q3, we outperformed our guidance on all metrics including revenue, gross margin percentage in both operating and net income. Looking at the specifics for the quarter, adjusted GAAP revenues in Q3 totaled $80.9 million including $4.9 million of services revenue versus $90.8 million in Q2. In Q3 we had two 10% or greater customers on an adjusted GAAP basis, Level 3 and FDN Communications or South Dakota Networks. Our largest customer, Level 3, accounted for 27% of our Q3 adjusted GAAP revenue versus 21% in Q2.

Gross margins were 42% in Q3 versus 47% in Q2. As we previewed in July, the Q3 gross margins were negatively impacted by approximately 4 percentage points by the one-time impact related to the initial Deutsche Telekom shipments. Our overall shipments during the quarter were well balanced among chassis, TAMs, and DLMs.

Operating expenses for the quarter were $35.9 million versus $32.3 million in Q2, right in line with our expectations. The increase in spending from Q2 to Q3 was attributable to R&D headcount increases as well as additional project and prototype expenses as we continue to fund next generation programs to extend our technology advantage.

The operating loss for Q3 was $1.7 million versus an operating profit of $10.4 million in Q2. Other income and expense for Q3 was a favorable $1.7 million versus $2.6 million in Q2. The quarter-over-quarter decrease is primarily attributable to lower interest income. We broke-even for the quarter on a net income and the EPS basis versus a net profit of $10.7 million or $0.11 per diluted share in Q2.

Turning to the balance sheet, one of our clear strengths in today’s uncertain macro-environment, cash, cash equivalent, restricted cash and investments ended the quarter at $324.6 million versus $318.2 million in Q2. We generated $9.9 million of cash from operations in Q3 versus $5.6 million. DSOs were 55 days versus 57 days. Inventory turns were 3.2 versus 3.3. Accounts payable days came in at 38 days versus 37 days and capital expenditures were $5.9 million in Q3 versus $4.8 million.

I would like now just to spend a brief minute on another VSOE update. As previously discussed, in Q2 2008, Infinera recently introduced a number of new service offerings including spares management and first-line maintenance support as part of our new relationship with Deutsche Telekom. Because of our limited experience with these services, we had expected that they would initially be non-VSOE compliant and that any product revenue associated with these services would be recognized ratably over the longer service period. However, we are now pleased to inform you that starting in Q4 2008, we will become VSOE compliant on these new services and revenue recognition for these deals will near that of our other transactions, i.e., product revenue will be recognized upon billing and service revenues will be deferred and recognized over the service period. On a separate note, we remain on track to convert to full GAAP recording beginning in Q1 2009.

Now onto our Q4 outlook. Since June of this year, we have been guiding for annual revenue growth of approximately 10% for 2008. Today, based on the uncertain economic conditions that exist, we see no reasons to lean into the wind from a guidance perspective. However, we remain comfortable with the previous guidance of 10% annual growth for 2008.

The following guidance for Q4 is based on adjusted GAAP results and excludes any non-GAAP stock-based compensation expenses, and revenue of approximately $75 million, which is based off the underlying revenue growth assumption, for 2008 of 10%. This assumes total GAAP revenues of $90 million reduced by approximately $15 million for the amortization of the deferred revenue recorded on the balance sheet at the end of Q3 2008 which reflects sales included as invoiced shipments in prior periods, gross margins of 42% to 43%, operating expenses of $38 to $39 million, and operating loss of approximately $6.5 million, and a net loss of approximately $7 million.

It is important to note that this loss projection has a one-time negative tax provision impact of approximately $2 million related to the elimination of the use of state NOLs in California effective January 2008 for a period of 2 years. The elimination of NOL usage was signed into law on September 30, 2008, and therefore will result in a $2 million retroactive tax provision catch-up to be booked in Q4 of 2008. Based on the estimated average diluted weighted shares outstanding of $97.5 million, this would lead to an EPS loss of $0.07.

As Jagdeep indicated, we remain confident in the Infinera business model and we are pleased that our value propositions continue to resonate with our installed base and that we have resumed momentum in the addition of new customers.

Operator, if you would now open the call up for questions please.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from George Notter of Jefferies & Co.

George Notter - Jefferies & Co.

I wanted to ask about the guidance for Q4 first of all, $75 million I think, some of those were a little bit higher previously. Is it fair to say that you just took the 10% guidance for the year and did nothing else but net out the first three quarters of the year or was there more of a bottoms-up analysis that you took? I would assume the revenue could be a little bit higher given all the new customers you added here in Q3 and the new ones coming online in Q4.

Duston M. Williams

It’s always a bottoms-up detailed forecast obviously. In this case, it came relatively close to equate to the 10% guidance that we had given back in June. We did outperform the consensus number a little bit in Q3 by $4 million. In this environment to assume that we’re going to continue to outpace anything is probably not a prudent assumption and that’s why we think that the 10% still makes sense for the year in total.

George Notter - Jefferies & Co.

And then just a followup, I wanted to ask you about the competitive environment. Nortel obviously has announced that they are interested in selling their optical network business. Are you guys seeing any disruption in the marketplace associated with that and is that something you’re able to take advantage of competitively?

Jagdeep Singh

Anytime a vendor announces a divestiture of a business unit, clearly customers are going to be concerned about what the future of that business unit is and who is going to end up owning it and what the support is going to be and so on. So, you clearly expect some level of impact in the customer base. With or without a Nortel announcement obviously to get customers to go without solutions instead of other competitive solutions and we think that this doesn’t in any way hurt our momentum. If anything, it clearly helps our ability to convert those customers over to an Infinera equipment.

George Notter - Jefferies & Co.

Fair enough.

Jagdeep Singh

On your customer, I don’t think I answered the question, the second part of your question on the new customers, and you are expecting to see potentially more revenue because of new customers, you’re absolutely right. Sooner or later new customers lead to additional revenue growth. As you know our customers pretty much order quarter after quarter once we get them as a customer. So, whether that happens in this quarter or next quarter or quarter after, the more customers we add, obviously the more potential revenue base that we have also. Now in Q4, historically over the last 2 years, Level 3 has come down as a percentage of our total revenues and we clearly expect that same pattern to happen this quarter. That’s not a new assumption, but there’s a lot of moving parts as we bring on new customers and some existing customers based on historical buying patterns will come down and then hopefully go back up at the beginning of the year.

Operator

The next question is from Ehud Gelblum of J.P. Morgan.

Ehud Gelblum - J.P. Morgan

When you look at the fourth quarter and the guidance you’ve given, normally there’s some sort of seasonality to the business that has been in the last couple years and clearly your customers are cutting back, are they communicating to you directly that seasonality is no longer there or are you just taking hints from these macro-environment as opposed to direct hints from your customers that next quarter could be a little more dicey?

Jagdeep Singh

We haven’t heard from anybody directly that the seasonal patterns would not exist this quarter. I think it would be somewhat irresponsible for us to assume that everybody has a bunch of extra budget here and we’ll adjust because it’s the end of the year, spend that budget money. So, nobody said anything directly. I just don’t think that’s a prudent assumption in today’s environment. And again, we’ve kept the total for the year, the revenue, the 10%, we’ve kept the same. We outperformed a little bit in Q3, we’ve taken a little bit out of Q4, but the total against the year remains at that 10% we’ve said back in June.

Ehud Gelblum - J.P. Morgan

The ratio of TAMs to DLMs and chassis you said was well balanced in the quarter, as you look to the next quarter, do you expect that to remain roughly the same and is that why the gross margin is somewhat flattish at 42% to 43%?

Jagdeep Singh

Yes, at this point we don’t see any substantial changes there.

Ehud Gelblum - J.P. Morgan

Okay. As you look into 2009, the last thing I think you had standing before the spring pre-announcement was about the 20% revenue growth and the 25% revenue growth, and the street is still somewhere in the 20% give or take a range. Given what you see now, how should we be looking at the progression going into 2009 based on your main customer base you have today and what they sort of have to do to keep their COGs, as you call them, going?

Jagdeep Singh

At this point it’s just too early to talk about ’09. We’ll certainly address how we feel about it on our Q4 call which will happen at the end of January. We will look at what we have for visibility at that point and whether we feel comfortable enough given what’s going on in the macro-environment, whether we feel comfortable to provide some guidance at that time, but right now, it’s too early quite honestly to comment on ’09. The good news is that we did sign up five new customers this quarter. Two of those were from Europe. We’ve committed to do at least four new customers in Q4. So, nine in two quarters here, it’s certainly a good sign going forward, but we’ll have to see how 2009 progresses.

Ehud Gelblum - J.P. Morgan

Did you get revenue from those five customers or just signed them up?

Jagdeep Singh

That’s our definition of a new customer. We have a contract signed, we shipped, and we recognized at least $100,000 of revenue, so it’s a pretty definitive measure.

Duston M. Williams

Yes, we don’t count them as customers until we’ve actually shipped and invoiced.

Ehud Gelblum - J.P. Morgan

Okay, and then finally on the Nortel sale of their MEN business including most of their optical, is there any part of that that would interest you to perhaps…

Jagdeep Singh

Yes, we’ve been pretty consistent on this that the M&A stuff is just not something that we comment about or speculate about and obviously you will get the same answer on the Nortel business there.

Operator

The next question is from Jason Ader of William Blair.

Jason Ader - William Blair

Just a clarification on the gross margin guidance, did you say it was 42% to 43%?

Duston M. Williams

Correct.

Jason Ader - William Blair

Okay, but I thought you had a 4-point impact from the initial DT shipments, so I guess I’m confused why it wouldn’t be higher.

Duston M. Williams

Yes, you’ve got again customer mix, and again, don’t forget we’ve always said all along that as we sign up new customers we ship reasonable amounts of comp, and we fill those chassis over time, so there’s always a mix in there, and again, we’ve been pretty consistent for the immediate future, a low 40% to mid 40% margin range, and so that 42% to 43% kind of falls in that generic guidance window.

Jason Ader - William Blair

Okay, in the last answer you said that you expect a similar balance between chassis, DLMs, and TAMs from Q3, but it sounds like may be in Q4 there’ll be a little bit higher mix of chassis, is that fair to say?

Duston M. Williams

You’ve got some customer mix that happens at the same time, so you can’t directly correlate product mix, but you’ve got other things going on in there. They are generically close but they always move around a little bit but they’re pretty close.

Jason Ader - William Blair

Of the customers that you expect to add in Q4, can you comment on whether any of those are what you would consider tier 1 customers?

Duston M. Williams

I won’t comment on that, I’ll tell you though that the five did not include, we should clarify this, the five did not include DT. DT was accepted on 09/30 out of our quarter, so DT will roll into Q4, and including DT probably at least two of those four will be Europe based.

Jason Ader - William Blair

Okay, so in Q4 there will be at least one tier 1 which is DT, but you’re not commenting on whether any of the other 3 would be tier 1, is that correct?

Duston M. Williams

Correct.

Jason Ader - William Blair

And you made a comment, I think it was Jagdeep, you said you saw significant activity in the pipeline of North American long-haul build-outs and it was sort of vague, could you may be comment on that or give us a little more granularity on that, Jagdeep?

Jagdeep Singh

Yes, I’d be happy to do that. I think the comment specifically was that we see activity in the North American long-haul market, and if you look at the pipeline overall, there are definitely carriers that are looking at building out nation-wide networks, and for that matter, pan-European networks, and so, the key task for us is to see if we can win that business, but the main point I was making was that there was activity out there and that’s relevant because we get a lot of questions about the macro-economy and the effect on bandwidth and build-outs and so on, and I think based on what we’re seeing, we’re not aware of carriers stopping their build-out based on network and other concerns at this point, which is one part of the solution. The other part is we got to go out and win that business, but yes, we definitely see carriers and service providers of all types looking at building out networks in response to bandwidth growth.

Jason Ader - William Blair

And then last question on the Deutsche Telekom ramp, is it fair to say that in Q4 there will be a significant contribution from Deutsche Telekom, I guess may be Duston if you could provide some color on how quickly this ramps.

Duston M. Williams

Yes, I would not make that assumption, no. I mean we shipped equipment in Q3, got accepted in the beginning of Q4, as you know some one-time discounts come off the top. We’ve got other carve-outs for software subscription and spares management services and things like that. So, you will not see a significant impact to Q4.

Jason Ader - William Blair

When do you think we might see a significant impact?

Duston M. Williams

We’ll see how it progresses in ’09 and how they build up the network and their capacity requirements, how that plays out in ’09.

Jason Ader - William Blair

So, it would be a function of their next big purchase, not just recognizing what they’ve already purchased, is that what you’re saying?

Duston M. Williams

That’s true.

Operator

The next question is from Jeff Schreiner of Capstone Investments.

Jeff Schreiner - Capstone Investments

I was wondering how you felt customer demands have been, I know you commented a little bit in the prepared remarks, do you guys feel at this point that with the release just happened in August that it has exceeded your estimated demand?

Jagdeep Singh

Let me answer the question this way, basically, I think I said this in the prepared remarks as well, but effectively in most of the large-scale build-outs that we’re seeing around the world have actually some element of ILS2 in them which means that it’s really been a very critical release. You could argue that had we not had that product mix in the timeframe, we might not have been able to serve all the applications that we currently see out there for us. So, the way I’d answer your question is, yes, we believe the ILS2 has been a very significant offering for us and will obviously play a huge role in helping us continue our momentum in the airspace here.

Jeff Schreiner - Capstone Investments

Should we be looking at with the release of the ILS2 and per your answer Jagdeep that it’s already in a lot of your major network deployment, but could we look at customers who may not be using a lot of the ILS2 product coming and looking at may be price discounts on what could be considered a legacy product for you now?

Jagdeep Singh

I think the way to think about it is that the ILS2, the fundamental feature that enables it really is ultra long-haul and higher capacity, and so for networks that needs longer reach and more capacity, the ILS2 has been a key part of the solution. There are still other networks out there that are regional in nature or don’t have the kind of capacity the ILS2 provides, and for them, the current system is, in fact the DTN system, is the right solution, it is economically the best solution. So, we’re going to keep both offerings in the product line. It’s really a question of what fits the customer application best.

Jeff Schreiner - Capstone Investments

And you’re not seeing any issues relating to pricing just based on the fact that you feel it’s really just whether or not you can use one solution or the other and you’re going to have to pay the price based on your selection?

Jagdeep Singh

That’s the way we’re thinking about it.

Operator

The next question is from Subu Subrahmanyan of Sanders Morris-Harris Group.

Subu Subrahmanyan - Sanders Morris-Harris Group

I had two questions, first on visibility, just given from the commentary you made, both about bottoms-up forecast and to the macro-environment, can you just talk about visibility qualitatively versus the last few quarters, have you factored in a weaker environment due to the probabilities you have assigned to some of the deals closing, and then on getting VSOE for the services, does it accelerate the timeframe for recognition of revenues from DT versus what you had expected earlier?

Duston M. Williams

On the DT stuff, the initial revenues again because of the discounts and things like that is not substantial, but the future product we ship to them without VSO we would have deferred over many years, so the situation now is that if we ship more equipment that will be recognized upfront, so effectively in the quarter that we ship rather than deferring over an extended period of time as does anybody else that might have those services prior that we didn’t have VSOE also would have been deferred now to get upfront revenue.

Jagdeep Singh

On the previous question, I’ll go ahead and take that one regarding the macroeconomic effect, I think what I would say is it’s not clear that we’ve seen any changes in carrier spending that we can attribute directly to macroeconomic head wins if you will. They are too caveats, one of course is that things can change and that could change on short notice basically, but secondly, inherently a company like ours with the high level of customer concentration and sort of big customers, the impact of a given customer win or loss could well dwarf the impact of larger-scale macro level trends. It’s not the best proxy for macroeconomic trends. Having said that, we’re not trying to argue that we’re immune in any way to macroeconomic effect, but we haven’t seen customers come to us and say we’re putting so and so spending on hold because we are concerned about the macroeconomic situation, and part of that as I mentioned earlier in the prepared remarks is because where we have this cost of goods sold like nature where they need the bandwidth, they kind of have not choice, they can’t defer the WDM given the need to turn up that bandwidth.

Subu Subrahmanyan - Sanders Morris-Harris Group

Another question was on your tax probabilities to wins and so on, in this environment are you being more conservative with the probabilities you attach and visibility, you usually talk about one quarter visibility being quite good, is that pretty much the same in this environment also?

Jagdeep Singh

Yes, I think that’s a good question, and nothing has changed about our forecasting methodology and the probabilities that we assign are intended to reflect all of the information that is available about any given account, so the answer to the question would be absolutely. Those probably, as we estimate them, should reflect the deal specific factors as well as kind of macro factors. Having said that, forecast or forecast rate, it’s not a mathematical sign and in the end there’s some level of judgment involved right now.

Subu Subrahmanyan - Sanders Morris-Harris Group

I have a final customer related question. Duston, did I understand you right to say Level 3 will decline as a percentage of revenue into December given the lower revenue base and there’s obviously an absolute dollar decline also and I’m just wondering if there’s a level at which it just flattens out and what you expect, and also, on internet content providers and ultra long-haul opportunities, the ILS2, could you talk about that?

Duston M. Williams

I’ll let Jagdeep take the second part. On Level 3, we do expect them to come down as a percent and in dollars, much like as I said they did in Q4 of ’07 and I believe Q4 of ’06. So, obviously we’ve got the input for the quarter and that input mirrors those trends. So, we do expect to see that come down, but not a surprise.

Jagdeep Singh

The other question, we can’t comment on any specific customer obviously, but we absolutely believe that our product line in general and the ILS2 in particular are well suited for some of the applications we’re seeing coming out of the internet content provider space, and we’ve seen pretty good confirmation of that from the players that we’re currently working with.

Operator

The next question is from [Ashken] Marsh, Private Investor.

[Ashken] Marsh - Private Investor

Just wanted to check how that VSOE treatment is going to affect the revenue guidance that you gave, the $75 million?

Jagdeep Singh

It’s included and assumed in the $75 million. The DT revenues aren’t that meaningful to alter our assumptions for Q4. I think more importantly as we sell these services to other potential customers, it eliminates us from having to ratably recognize that revenue associated with the service. So, it’s really the future business, in Q4, even if we signed up somebody for Q4, with that service we could recognize it upfront and then more importantly throughout ’09 we won’t have that ratable revenue issue with these services.

Operator

The next question is from Mark Sue of RBC Capital Markets.

Mark Sue - RBC Capital Markets

This is [Joe], calling in for Mark. Just wanted to firstly touch on the competitive landscape a little bit more, was wondering as an update from your second quarter call, what are you seeing out there competitively especially from some of the Chinese vendors, we’re hearing some pretty aggressive pricing, wondering if you are seeing that accelerate at all.

Jagdeep Singh

I don’t think that we’re seeing anything fundamentally differently from what we’ve seen in the past and this is a pretty competitive business. In any given deal, certain competitors maybe more or less aggressive depending on what they are trying to accomplish with the customer, but I would say in general it’s nothing that we’ve seen or we’re seeing any dramatic shift in what the Chinese or anybody else has been doing in the customer base.

Mark Sue - RBC Capital Markets

If I look at your customer base, I was wondering if you guys are seeing any impact in terms of payments, and if I look at DSOs, I know they were down against 55 days from 57 last quarter, but if I remember correctly you said second quarter was impacted by 10 days. So if you back that out, it looks like they may have been off and I was wondering if you could comment on that.

Jagdeep Singh

No. It just depends when we shift stuff and how it flows within the quarter, but if you looked at the detailed accounts receivable aging, which we do all the time, it’s extremely current and up to date, but you raised a good point in this environment. So at this point, we intend to scrutinize a little bit more, but we’ve been pretty happy with not much change there at all. But again, we’re scrutinizing things a little bit more and asking a lot more questions, but so far so good and hopefully we won’t have any issues there.

Mark Sue - RBC Capital Market

There is not residual gross margin impact from DT in the fourth quarter?

Jagdeep Singh

Correct.

Operator

The next question is from George Notter of Jefferies & Co.

George Notter - Jefferies & Co.

Any commentary on the availability of the metro platform, is it sometime next year we could expect to see a product in that market segment?

Jagdeep Singh

I think what we’ve said is that it’s a phase of interest to us, but we’ve not really said about any specific products or timeframes and we think we’ll just stick with that for now.

Operator

The next question is from [Unidentified Analyst].

[Unidentified Analyst]

When you mentioned restricted cash, I am assuming that’s referring to the adjustable rates and at what level is that?

Duston M. Williams

No, it isn’t actually. I believe it’s a fairly immaterial amount of a couple of million dollars that, I don’t know if it’s LC based or something along those lines, but it’s a very small amount. We just collect all the terminology classifications and just pile them all in there just to add up the total cash.

[Unidentified Analyst]

To your cash? It is liquid then?

Duston M. Williams

Well, we’ve disclosed several times in the Qs and the K the auction rate securities, and we’ve got $75 million of those, $65 million of those reside with UBS and they’ve reached an agreement with the SEC to purchase those back from us at par between now and latest of June 2010.

[Unidentified Analyst]

And then two qualitative questions. One, you are looking for very highly qualified employees and quite a lot of them, are you having any difficulty getting the right people in place despite today’s environment. I am talking about the qualitative aspect of the people that you are hiring.

Jagdeep Singh

You are right that we try to look for the top of the industry. We actually have had generally speaking pretty good success attracting people in this environment. It’s never easy to attract the best people, but we actually have been having pretty good luck so far and hopefully we can continue that going forward.

[Unidentified Analyst]

Okay. By the way, congratulations; it seems like you guys are really focused on and delivered on what you initially stated in your roadshow meetings well back then. One of the issues that you mentioned way back then and not just specifically, it seems like every sales presentation you go for, you come away with a win. Have you lost anybody and if so whom?

Jagdeep Singh

We don’t win everything that we compete on, but we do win a very large fraction of them that we’re actually very pleased, and thank you for the feedback there. We can’t comment on specific customers, but I think what I would say in general is that we tend to win where the application is adjusted for our solution and that tends to be where there is a high amount of bandwidth density. So we intend not to play today frankly within the very low end of the market where you only have a handful of wavelengths being added or dropped, but in this space, the metro core on and off, the space that we have a sales footprint, we do end up being quite competitive, and that’s worked into our advantage.

Bob Blair

Okay. I think on that note we will close out the call. I want to say in closing that we remain confident in the ability of our business model. We’re pleased that our value proposition continues to resonate with the installed base as well as new customers as evidenced by the resumption in new customer win momentum. Our team remains focused on advancing our technology deep and specifically to go into business on the long term. And I want to thank all of you for joining us today, and we look forward to reporting our progress in our next call.

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Source: Infinera Corporation Q3 2008 Earnings Call Transcript
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