Infinera Corporation Q1 2009 Earnings Call Transcript

Apr.21.09 | About: Infinera Corporation (INFN)

Infinera Corp. (NASDAQ:INFN)

Q1 2009 Earnings Call

April 21, 2009; 5:00 pm ET

Executives

Jagdeep Singh - President & Chief Executive Officer

Duston Williams - Chief Financial Officer & Principal Accounting Officer

Bob Blair - Investor Relations

Analysts

Ehud Gelblum - J.P. Morgan

Sanjiv Wadhwani - Stifel Nicolaus

George Notter - Jefferies & Co.

Jeff Schreiner - Capstone Investments

Ajay Diwan - J. & W. Seligman

Todd Brady - Wells Fargo

George Notter - Jefferies & Co.

Operator

Welcome to the first quarter fiscal 2009 investment community conference call of Infinera Corporation. At this time all participants are in listen-only mode. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn today’s conference over to Mr. Bob Blair of Infinera Investor Relations. You may begin, sir.

Bob Blair

Thank you and good afternoon and welcome to Infinera’s Q1 2009 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 condition, results of operations and our products and our competitors’ products and prospects of the company in Q2 ‘09 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 17, 2009, for more information on these risks and uncertainties.

Today’s press releases, including Q1 2009 results and associated financial tables and investor information 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 press release, we announced operating results for the first quarter of ‘09, which exclude the impact of non-cash stock-based compensation. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons.

Please see the exhibit to the earnings press release for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, and for an explanation of why these non-GAAP financial measures are useful and how they are used by management.

On this call, we will also give guidance, including guidance for the second and third quarters of 2009. We have excluded non-GAAP, non-cash stock-based compensation expenses from this guidance, 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 excluding the impact of these items as we discuss our first quarter 2009 results and our second and third quarter 2009 guidance and we’ll refer to these results.

I will now turn the call over to Infinera President and CEO, Jagdeep Singh.

Jagdeep Singh

Good afternoon and thank you for joining us. With me is Chief Financial Officer, Duston Williams, who will provide a report on our Q1 results and our outlook.

Turning to our first quarter results, we posted revenue of $66.6 million within the guidance which we provided and we reported an operating loss of $16.5 million and lower than forecasted gross margins of 31%.

As we advised on our January call, Q1 revenue and gross margins were impacted by the timing of the large new customer deployment and an unfavorable mix of lower gross margin, common equipment associated with our recent high level of new customer wins. The Q1 gross margin performance was influenced by some additional factors that Duston would cover in his remarks.

I’d like to take a moment to discuss our top line performance. The strength of our business top line can be analyzed in terms of two different components; revenue from existing customers and new customer wins. The first obviously indicates how much current customers are spending on our equipment in any given period and the second relates to new network build activity, which will drive future revenue.

As indicated in our Q1 results, current customers clearly bought less equipment in Q1, reflecting the macro economic conditions prevalent in the quarter. However, offsetting this effect was a fact that new customer build activity continues at a robust pace, with several important new customers selecting Infinera as their platform for their next generation WDM networks.

While more revenue from these wins was recognized in the quarter, these new wins include two new Tier 1 European PTTs that we believe represent important new account, both in terms of future revenue potential and in terms of their competitive significance, given we beat out several of our top competitors to win.

In addition to these new Tier 1, we had another important European customer win in the quarter. Two of these three wins represent $1 figure in the double-digit millions on initial deployment and we expect this revenue to be realized later this year. Of course those of all the things we know, new customer wins are associated with lower gross margins because of the common equipment required for a new customer deployment. This factor resulted in margin pressure during the quarter.

We believe the continued strength in new customer build activity is a key reason to be encouraged by the prospects of recovery from the slowdown reflected in our Q1 results. A related reason to be optimistic about the long term health of our business is our progress with Tier 1 carriers.

A year ago, we said that we were pleased with our fashion with Tier 1 carriers and that we saw no reason why the benefits of the Infinera PIC-based solutions would not be as good a fit for this class of carrier as we are seeing with customers. We have delivered on that promise, with the stream of Tier 1 success that began with Deutsche Telecom less than a year ago and was followed up last quarter with our win at OTE, the $10 billion Greek telecommunications carrier.

Today we are happy to report the two new additional wins at the European-based Tier 1 customers that I referred to earlier, bring our total Tier 1 customer count to six, including three of the world’s top five carriers. The fact that these Tier 1 customers are choosing to go with us over their established suppliers, provides strong evidence of the compelling nature of the Infinera value proposition and this gives us the confidence that we will be able to add to our Tier 1 count over time.

A third and closing development that I want to note is our recent success in winning deals that include some re-networks, a more demanding DWDM application from a performance standpoint, and typically one that comprises larger size deals. Our ability to compete with these opportunities is based on the ultra long-haul line system that we added to our portfolio last year.

We had another important development as is successfully seen in advancing our technology. Throughout the economic downturn, we have remained committed to extending our technology leadership position through enhanced functionality of future generation of Infinera based networks. You will recall that a year ago we announced the industry’s first PIC-based roadmap, indicating our belief that it is possible to double capacity per chip every three years and we promised to have our next generation PIC in the hands of our developers in 2009.

Last month, we demonstrated our 40gig solution at the OFC tradeshow, an important step towards achieving that goal. We showed working Photonic Integrated Circuit, delivering 400 giga bits per second of optical capacity in a single pair of chips, using complex modulation format. The key here is that unlike our competitors’ discrete 40 gig solutions, the Infinera 40 gig solution is integrated, which allows us to offer carriers substantially superior economic scaling and efficiencies.

For example, this platform will enable our next generation optics to deliver up to 80% power savings, over our competitors’ 40 giga bit optic and it integrates more than 300 optical functions into a single package. This is a tangible result of the investment that we continue to make to extend our competitive advantage of providing the market’s only large scale PIC-based solution.

Finally, we feel good about our relationships with and the diversity of our current customer base. Although in Q1 we saw lower spending by certain customers, we continue to see customers building out their networks as we discussed earlier and we believe that there is no inventory build-up at customer sites. What this means is that once activity does take up, we are in a good position to immediately benefit from the upturn.

We also continue to make good progress with existing builds. With DT for example, we continue to further penetrate other parts of their network and have already shift gear for their North American rounds. So, even as we manage through the current macro economic environment, we are encouraged that we continue to win new customer footprint worldwide. This provides further evidence that our photonic integrated base solution remains the only effective path, with which customers can scale their networks to address their bandwidth growth needs.

We also believe that our unique, vertically integrated business model continues to put us in a very strong position to protect our competitive lead, and to respond more quickly than our competitors to a potential up tick in customer demand. Moving forward, we remain focused on our strategic growth initiatives which are; first, to continue to invest in and dominate the course base that has bought us to where we are, long-haul DWDM, where we currently lead the market in North America with a 24% share and have a 10% share worldwide.

Second, we remain focused on expanding into the metro markets, which we think will roughly double the size of the market that we currently address. Third, we remain focused on leveraging our successes in North America and Europe, to win market share in other parts of the world, including the Asia-Pacific region.

We’ve expanded our investment in the region as evidenced by the recently announced opening of our Beijing development center in China, as well as the naming of Satoshi Fujita as President for our operations in Japan. Fujita will play a key role for Infinera in Japan, with this relationship and experience that includes 30 years of NTT, as well as his role as President of Alcatel-Lucent, Japan.

Finally, we remain focused on winning additional Tier 1 carriers, the area which I’ve mentioned earlier we’re seeing great success in, and we continue to focus on. So in conclusion, we remain confident in the long-term growth opportunities for Infinera in optical transport and believe that our technology advantage will allow us to continue to gain share in the transport market, especially as several other players in this space retreat.

It’s important to keep in mind that the increased footprint we are winning today, while that we have some near term negative impact on margin, has great potential to translate and to continue the market share growth and revenue and margin expansion for Infinera in the future. Our goal remains to build a strong and sustainable business for the long run, and we believe that when the economy turns, we will be well positioned to achieve better top and bottom line performance.

I will now turn the call over to Duston, who will cover our Q1 performance and outlook.

Duston Williams

Thank you, Jagdeep. I’ll review our Q1 actual results and then follow that up with our outlook for Q2. The following analysis of our Q1 results is based on non-GAAP and the results from other quarters are based on adjusted GAAP in invoice shipments. All references exclude non-cash stock-based compensation.

Looking at the specifics for the quarter, GAAP revenues in Q1 totaled $66.6 million, basically at the mid-point of our guidance of $65 million to $70 million, versus $86.2 million in Q4. In Q1, level 3 was our only 10% customer, representing 30% of our GAAP revenues versus 18% in Q4 of 2008 and 31% in Q1 of 2008.

Gross margins in Q1, which were below our expectations, were 31% versus 36% in Q4. The lower gross margins were in part caused by higher than expected lower cost of market inventory adjustments.

Additionally in Q1, one of our customers utilized a greater than anticipated portion of a significant fixed dollar product discount. Previously, we had expected this discount would be used by the customer throughout 2009, but it now appears that this discount will be fully utilized by the customer in the first half of 2009, spread across Q1 and Q2.

During the quarter, we also have discovered a supplier quality issue which was detected by our in-house test processes. Although it did not result in any defective parts being deployed in any customer networks, this issue did impact margins during the quarter.

Summarizing the effect of these factors, the additional LCM adjustment had approximate 3% margin impact. The supplier quality issue had a 3% margin impact and a higher than expected utilization of the customer discount in Q1, accounted for another 3% impact.

Operating expenses for the quarter were $37.5 million versus our guidance of $41 million and versus $40 million in Q4. The $3.5 million favorable variance to forecast was a direct result of conscious cost management, including delaying some headcount additions and pushing significant project expenses into Q2.

The operating loss for Q1 was $16.6 million versus an operating loss of $9.3 million in Q4. Other income expense for Q1 was an unfavorable $0.9 million versus an unfavorable $0.4 million in Q4, and net loss for the quarter was $17.6 million or a loss of $0.19 per basic share or $0.18 per diluted share, versus the loss of $9 million in Q4.

Quickly turning to the balance sheet, cash, cash equivalents, restricted cash and investments, ended the quarter at $306.5 million versus $312.6 million in Q4. We used $2.9 million of cash from operations in Q1 versus a negative 5.4. DSOs were 61 days versus 74 days; inventory turns were 2.8 versus 3.8; accounts payable days came in at 44 days versus 45 days and capital expenditures were $6 million in Q1 versus $7.8 million.

Our Q2 performance will be influenced by factors similar to those that occurred in Q1; a few large new customer deployments and some deployments of new foot print with existing customers resulting in upfront LCM adjustments in very low initial gross margins upon revenue recognition; as well as the greater utilization of one time customer discount, in the lower than historical average term volumes.

On our January call, we said that we anticipated three significant new European customer wins, for which all the revenue will be recognized outside of Q1. We also indicated that these new additions will have a greater portion of lower margin common equipment associated with them, which would significantly impact margins both prior to shipment through lower cost to market inventory adjustments and upon customer invoices.

We expect the initial revenue recognition will occur in Q2 for one of the three new customers, with revenue of upwards of $10 million, but with very low gross margins. We anticipate revenue recognition for another one of the three new customers in Q3 at slightly more than $10 million; however the negative LCM impact will occur in Q2.

The third new customer which is the smallest initial deployment is anticipated to be invoiced in Q3, with revenue recognition occurring at some future period based on various revenue recognition complexities. Two of these new customers are European PTTs.

In addition to these new customers, we also expect some initial revenue in Q2 from two existing customers for significant new U.S. deployments. One of these deployments is for an internet content provider and is a continuation of the new nation wide build out and the other is in the initial phase of a new nation wide over bill. As you might expect, the initial deployments for both of these customers will be having on common equipment, and will initially have significant downward pressure in gross margins in Q2.

While we had previously assumed that one time customer discounts would be spread evenly throughout 2009, it now looks like they will be fully utilized in the first half of 2009. In total for Q2, we expect that these discounts will negatively impact gross margins by approximately 7%.

In the long run, the cumulative effect of all these new deployments and new customers is of course very positive and should position us well for additional product sales, including higher gross margins tributary adapter modules. With these near term hits to our gross margin performance, it is important to keep this key long term consequence in mind.

Regarding TAM volumes in the near term, we continue to experience lower than historical average volumes in Q1 and from what we see now, we anticipate this trend will continue into Q2. Because of the importance of TAM to our overall business model, we thought it would be appropriate to provide some additional detail on our historical TAM shipments.

For the period of Q4 2006 through Q3 2007, we shipped an average of 1300 TAMs per quarter for this fourth quarter period. During this period we averaged 29 customers and gross margins of 35%. For the period of Q4 2007 through Q3 2008, we shipped more than 2000 TAMs in each quarter and averaged 2100 per quarter.

During this period we average 44 customers and gross margins of 45%. We now have an excess of 58 customers and we have experienced TAM shipments in Q4 of 2008 and Q1 of 2009 that we are a good deal less than 2000 and also anticipate TAM shipments in Q2, 2009 of at least 25% below the Q4 ‘07 through Q3 ‘08 average of 2100 TAMs.

The only explanation we have for this drop off in TAM shipments even in the faith of significant customer growth is to correlate it to the general economic conditions that have prevailed in the time frame.

It is not surprising that the Infinera business model suffers significantly in any given quarter that has this confluence of factor. Very low gross margins in LCM adjustments related to large new deployments, combined with accelerated one time special discounts, below average TAM shipments and lower overall revenue levels.

Although we remain very pleased with the overall acceptance of the Infinera product solution as evidenced by our Tier 1 traction and new customer wins in general, our Q2 guidance is reflective of this confluence of factors and of our continued investments for future to ensure that we build a strong and viable business for the long term.

Based on the factors above the following guidance for Q2 is based on GAAP results and excludes any non-cash stock based compensation expenses. Revenue of approximately $70 million, gross margins of 25% to 30%, operating expenses of $40 million, and then operating a net loss of approximately $19 million to $23 million, which based on an average diluted weighted shares outstanding of $98 million, this would lead to an EPS loss of $0.19 to $0.23.

Looking ahead to Q3, we believe there is reason to expect that both revenues and gross margins will increase from Q2 levels. This is based on the fact that we believe revenue recognition from a portion of these larger deployments with new and existing customers will occur in Q3, along with our expectations at this time that the current customer base spending remains stable, no additional new large deployments occur and that TAM shipments will not decline from the levels we are currently seeing.

With that operator, if you could please open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have Ehud Gelblum; your line is open sir.

Ehud Gelblum - J.P. Morgan

Hello, can you hear me?

Jagdeep Singh

We can.

Ehud Gelblum - J.P. Morgan

Great, thank you. Duston, for a quick moment I thought you were about to give us Q3 guidance here?

Duston Williams

No, no, we just thought it was appropriate to share with you at least the generic feel for what we potentially see happening in Q3.

Ehud Gelblum - J.P. Morgan

All right. I’ll try and get a little bit more than just generic in a second, but just to clarify a couple of things that you and Jagdeep said earlier, when you are talking about having now three of the world’s top five carriers as customers, DT is clearly one of them. Does level 3 count is really top five?

Jagdeep Singh

We haven’t said any specifics about who they are; all we said on the call was that there are three of the top five. So if you look at who are top five carriers are worldwide, I think that will you give a sense for the kind of feel we’re talking about.

Ehud Gelblum - J.P. Morgan

But how do you judge? I mean, do you consider level 3 as top five? How do you measure that revenue traffic?

Jagdeep Singh

Yes, if you look at it by revenue for example that way, surely the top carriers in the world are all going to be Tier 1 kind of incumbent players’ right.

Ehud Gelblum - J.P. Morgan

Okay. So in that case Level 2 will not be one and it’s the carriers we’re talking about; we’re not talking about an internet service provider that would be in that category?

Jagdeep Singh

Yes, that’s right, and just to be more specific, Level 3 is not one of the world’s top five carriers; and internet content guys aren’t really carriers. This is really top carriers in worldwide right.

Ehud Gelblum - J.P. Morgan

Okay. I wouldn’t have thought they were either; I just wanted to make sure. The LCM that cost you 300 basis points of gross margin this quarter, what happened with that; was that a surprise to you versus your guidance before, that 300 basis points of your gross margin hit or was that something that was in the guidance normally.

I mean, it sounded like that extra lower cost inventory that was more than you expect to be. Why was that; was there more discounting than anticipated or were the costs of the goods higher than expected. Just why was that adjustment more than you thought to the tune of 300 basis points of gross margin?

Jagdeep Singh

Yes, so it’s obviously not a perfect sign to go and try to do all the stuff, and the LCM has various factors that play in there and they start with the amount of PEOs that we have on suppliers; not even in our inventory, but just PEO commitments on suppliers. The amount of inventory levels we have in-house, the customer mix of that product that anticipates the shift, in this case in Q2. So there’s a lot of different factors and there’s just no way that we could nail that specifically.

When those factors change, we had a little bit more inventory, so in that case for these additional new builds that were in shipments that we’re planning had build up a little bit of inventory. Some customer mix has changed within there and it’s hard to predict exactly how many dollars of PEOs you’re going to have on suppliers at any point in time in the quarter. So it’s a bunch of three or four different factors that added up to about 3%. Your question is clearly over and above what we had anticipated.

Ehud Gelblum - J.P. Morgan

And the other 300 basis points that came from the discount that was taken; I’m assuming this is one customer was given a discount to apply to all of his purchases for the entire year or was it specific types of purchases. They did more of that specific type of purchases in Q1 than you expected?

Jagdeep Singh

It was one customer and it was product discounts that we had structured a while ago related to common equipment, which we had anticipated based on what we thought the purchasing patterns of the customer might be; would be pretty much evenly spread throughout 2009. What we’ve seen now in Q1 and what we anticipate to happen in Q2, we believe that that customer would have lost all those discounts in the first two quarter, based on their increased demand effectively for those products.

So the discount was in common equipments; so that should be read as that customer is building out the initial coverage of the network faster than you expected. They are buying more of that common equipment that we offer the discounts on faster than we expected.

Ehud Gelblum – J.P. Morgan

Okay, so it’s more coverage. So they couldn’t have applied to TAM’s or anything else or DLM was just the common equipment.

Jagdeep Singh

Correct.

Ehud Gelblum – J.P. Morgan

Okay, and then finally I’ll give up my side of things. You said the discounts impact Q2 gross margin by 700 basis points?

Jagdeep Singh

Yes.

Ehud Gelblum – J.P. Morgan

Is that the continuation of this one discount?

Jagdeep Singh

Yes, it was the exactly same discount. It’s just, what’s happened now is the amounts that we expected to happen in three and four are basically pulled in. So as we see the forecast now anyway, they all get flushed.

Ehud Gelblum – J.P. Morgan

So, there’s one customer.

Jagdeep Singh

Correct.

Ehud Gelblum – J.P. Morgan

Were the three new customers you had, the Europeans and the others, did they get discounts as well?

Jagdeep Singh

Every customer is structured differentially, so every contract is different.

Ehud Gelblum – J.P. Morgan

Then finally, how do you know or what prevents this customer who got the discounts and used them early from asking for more discounts later. Is it that they no longer will be making core equipment purchases and the DLM and TAM’s, there are no discounts at all or is there a possibility that their discounts could keep going?

Jagdeep Singh

We don’t see that, no.

Ehud Gelblum – J.P. Morgan

Okay, I appreciate it. Thank you.

Operator

Sanjiv Wadhwani your line is open. Please state your company

Sanjiv Wadhwani - Stifel Nicolaus

Thanks. Jagdeep, just a quick question on spending patterns from your customers; I know obviously it’s difficult to gauge, but just Jan, Feb, March how things progressed, and maybe first 15 days of April of the activity levels have gone up; they’re still pretty glow; just sort of generically if you could talk about that?

Jagdeep Singh

I don’t think that I can give you the level of fidelity that you are looking for by week for example, or even by month. I think only the key point that I referenced in my talk was that while current customer purchasing of our equipment was down in Q1, just based on what the numbers were for top line, the new network build activity continues at a fairly robust level.

In other words, the big deals that are in our pipeline, that were in the pipeline for example in Q4, for that matter Q1, have not been cancelled and not even been pushed out, and that’s a key sign for us, for the fact that there is no activity which is important.

Another key point of course is that, we are winning a lot of that activity, right, as evidenced by the fact that we now have fixed Tier 1 to customers. I mentioned earlier that three of the top five carriers as measured by revenue. So the activity exists and we continue to win many of those build outs.

Sanjiv Wadhwani - Stifel Nicolaus

When you compare the two recent European Tier 1 PTT events to DT, would you classify the opportunities as bigger, similar or sort of less than DT?

Jagdeep Singh

Well, I think in my talk I actually said that two of those three are actually going to be double digit million initial builds. So they’re fairly sizable builds and I don’t think we are able to quantify the DT, but independent of that, it’s closer (Inaudible).

Sanjiv Wadhwani - Stifel Nicolaus

Got it, alright. I appreciate it. Thanks so much.

Operator

George Notter, please state your affiliation or company.

George Notter – Jefferies & Co.

I guess I was just trying to step back a little bit, looking at the margin issue. Can you talk a little bit about what the competitive dynamics are right now? If we go back and look at your business and your business model; a year ago I understand obviously at a bigger mix of TAMs, backed in, a lot less of the revenue stream was coming from incumbent Telcos and now you’ve got more of it coming from incumbent Telcos.

You’ve got new wins in the pipeline; you are seeing margins really come in. I guess I’m trying to understand the dynamic there; what’s different about that the business and the new customer opportunities now versus a year or two years ago when you had much better margins?

Duston M. Williams

Yes, this is Duston. I think as you mentioned one of the factors that exposes us a little bit is the downturn in TAMs, where normally we could have a reasonable level of TAMs to offset some new customer wins and some bigger customer wins. Right now, we don’t have that TAM volume now.

If you look back again in my comments there, we had roughly 2000 TAMs a quarter with 35 customers or so. I think we could get back to those levels with 58 customers, but we’ll have to see. But I think we’ve seen a little bit on these larger deals, I guess maybe a little bit more pressure on the common equipment from a pricing perspective, but a good chunk of that will get behind us here in Q1 and Q2.

We still got a lot of revenue coming from other sources; whether it’s internet content, through the MSOs, the different revenue sources. So clearly at this point in our business model we’re not going to have a large majority of our revenue from Tier 1 of PTTs.

George Notter – Jefferies & Co.

Got it, okay. Is there any discounting going on, on DLMs or TAMs at all?

Duston Williams

On the TAMs, due to our vertical integration we’re already, we believe very competitive from that perspective. So we’ve seen as I say, some additional common pressure, but the TAMs we think were pretty well set there from a competitive perspective.

George Notter – Jefferies & Co.

Okay. So is it fair to say that you’re not discounting terms more aggressively than you have been in the past or there’s nothing new pricing wise going on there.

Duston Williams

Correct.

George Notter – Jefferies & Co.

Great thanks.

Operator

Hasan Imam, state your company please.

Hasan Imam - Thomas Weisel Partners

Yes hi, it’s Thomas Weisel Partners. I just had a couple of questions. First of all on the OpEx front, could you maybe comment on how you are thinking about that given gross margin compression and reduce revenue run rates. Are you planning to pull in spending a bit or is the view that it’s really at temporary down take and we’re going to have recovery shortly, so strategies to spend your way through and then I have a follow up?

Jagdeep Singh

Yes, we’ve been pretty consistent as far as the strategy goes with the spending. I think the only difference in our view is we’ve gotten a little bit tighter on the SG&A side of the equations, where we’ve pretty much although we are selectively hiring some resources here and there, we pretty much closed down most of that hiring.

On the flip side, on the R&D piece; now we’ve got charges and things that flopp quarter-to-quarter, but we’re still clearly hiring for key positions within the R&D rank. From there as you know, these projects sometimes go two plus years out, so for us to take focus of those now, we don’t believe that’s a prudent thing and we feel pretty good about the new customer activity and the existing customers; some of the new activity we’re seeing there.

So we are looking at it really close, but we continue to hire key resources in R&D and we’ll continue to do that.

Hasan Imam - Thomas Weisel Partners

Great, thank you. Then on the gross margin front, I have more of like a longer term question, which is, one of the most exciting parts of Infinera story has been this; huge cost advantage you are going to have in terms of COGS versus the traditional optical equipment. So at one point, shouldn’t we assume that that should start showing up in gross margins, given that maybe you would have one-tenth of the cost of your competitors where price discounts are not going to be as significant. When is that point you think?

Jagdeep Singh

So, obviously to the question, I think the key point to note there is that boys and girls obviously are higher on the TAMs and the common equipment; and all of the value we create relative to the pick and the integration is the one that really applies to those line cards, the DLMs and TAMs as apposed to the common equipment; the sheet metal and basic amplifiers and so on. There is not much that the pick does for those parts of the broad line.

So given that disparity in margins, the overall blended margin is going to be a function of the mix that the new common equipment sales and TAM sales. So, firstly pouring out, in Q4 and Q1 we saw a drop off in TAM shipments and at the same time we also saw a number of big wins, which meant more common equipment.

So, because we continue to win new customer footprint at a rate that we believe is higher than many of our competitors, there is obviously that downward pressure from the common equipment sales, “But the point in general as we start showing out those empty slots, you clearly would expect the margin to go up. We can’t tell you when or the time of when that happens, but if you look at the numbers, the history Duston point out clearly, the four quarter period that Duston referred to had obviously a lot higher margins that we are seeing today and also happened to have much higher level of TAM shipments that we are seeing today.

So, clearly TAM shipments and gross margins are hardly correlated as we all know, and unless we believe there’s some systemic reason why new customer foot point wins are not going to turn into new TAMs, then, over time we would expect those TAMs to ship and the margins to go up.

Just one last point, to keep your mind off the customer, even though there’s a lot of pressure on us because of the common equipment margins. The customer doesn’t get anything out of the common equipment and they really only get value when they plug a TAM in and light up a circuit viable wave length. So obviously customers are going to deploy TAMs, but the mix will be a function of new range versus writing up of current TAMs.

Hasan Imam - Thomas Weisel Partners

Great, okay, and I have just one last question; thanks for that answer. In terms of your comment Jagdeep, that incumbent customer deployments have weakened, but at the same time new builds are progressing to plan, isn’t that kind of a disconnect here? With operators facing the same macro picture, why aren’t we seeing slowdown in the green fields or push ups in the green fields as well? What do you think is the real disconnect there between the two groups?

Jagdeep Singh

Well, one possible difference is that the guys that are doing new build are doing the build outs for a reason and the reason is there is lot of other capacity, and so they might need to deploy new capacity just to be able to grow revenue at all, and may be the guys would have existing gear or trying more efficient about what they use.

Again we don’t have any illegal sites into what our customers are thinking from an insight perspective obviously, but we’re kind of affording what we see and we’re clearly the fact that the TAM shipments in Q1 were lower than what they’ve been historically; the facts are that the network build-out activity continues. So that’s just the fact that we are reporting.

Hasan Imam - Thomas Weisel Partners

Okay. Thank you.

Operator

Simona Jankowski, state your affiliation please.

Simona Jankowski - Goldman Sachs

Hi, thank you with Goldman Sachs. Thank you guys for providing that incremental detail on the historical TAM shipments and that’s certainly very helpful. One thing I just wanted to clarify on that is that when we compare the situation now to the one you are highlighting back in the late’06, and through the fourth quarter of ’07, when you were shipping about 1300 TAMs on average, if I got that number right.

Right now you said you’re shipping about 25% less than a year ago. So that will put you right now at about 1500. That’s so higher than what you guys were shipping back then and revenues are at above the same level, but yet margins are actually lower. So can you just clarify what’s kind of the main driver of the discrepancy of why despite the higher TAMs margin, they’re still lower.

Then kind of related to that, back in that period, while clearly TAMs were low, you were in a period of hyper growth, with revenue growth of over 100% each quarter year-on-year. Right now we’re in a negative growth trajectory, so we’re seeing that if you’re kind of getting hit on one side, we’d get some benefit on the other?

Duston Williams

Yes, let me answer a couple of things that Jagdeep chimed in to. You got to look at it and obviously we didn’t provide detail on the mix of common equipment and all that stuff, but the issue that we are facing now is why are margins higher, even though revenues are lower and you’ve got 1500 TAMs or whatever you are say there.

We still got, facing a lot of these LCM adjustments with these new build which puts a lot of pressure on the gross margins; and if you look at the percentage of common equipment between probably now and historically, I guess you went back and looked at that as a percentage of the total revenue, is probably a greater mix of common equipment also.

Also those back in the 1300 TAM range per quarter, we had roughly 35 customers driving those. As of today we’ve got upwards of almost 60 customers and we certainly expect that those levels get back to the 2000 level here sometime in the future.

Simona Jankowski - Goldman Sachs

So, is the LCM phenomenon something that you were not experiencing back then?

Duston Williams

No, not to that extent.

Simona Jankowski - Goldman Sachs

Okay, and then one of the other follow-ups I had is, you mentioned that you are expecting a couple of your European carriers to have double-digit million of sales this year. Was that primarily in common equipment or does that include a reasonably large proportion of TAMs within that double digit million figure?

Duston Williams

It will be dominated by common equipment, but obviously it will include DLMs and TAMs.

Simona Jankowski - Goldman Sachs

Okay. Thank you very much.

Operator

(Operator Instructions) Jeff Schreiner, your line is open. State your affiliation please.

Jeff Schreiner - Capstone Investments

Yes, Capstone Investments. Good afternoon gentlemen. I was wondering if we can talk a little bit about may be a historical time line from what we’ve seen in terms of previously signed contractors and customer, to much larger scale deployments and when we look at historical, how is that in comparison with what we’re seeing here in early 2009?

Jagdeep Singh

Jeff, I’m not sure. Could you repeat that please?

Jeff Schreiner - Capstone Investments

Yes, what I’m trying to understand, it seems that some of the push outs that Jagdeep has referenced in terms of some of the large customers, I’m wondering if we are seeing a change in terms of not only the time of when I signed the contract with Infinera, I deployed the common equipment and then I started uploading TAMs and get to maybe a more normalized deployment figure; if that has changed dramatically from what the historical patterns used to be?

Jagdeep Singh

Yes, I understand the question. I don’t know that we are seeing any dramatic change in the time lines of new roll outs. Typically we get awarded. They first tell us where they want us to be and then we negotiate the contracts and then we shift gears against the contracts, against POs and stuff that gets installed and accepted, and then over time they’ll start adding either more and more of TAMs as they add more bandwidth.

I think the time line on which all that occurs has been largely consistent. It obviously varies by customer size and network bandwidth growth and so on, but in general, you don’t know if there’s been a dramatic change in the time line for how new customer deployments occur.

Jeff Schreiner - Capstone Investments

Okay. What visibility would you guys say you have currently? I mean, we heard you’re almost ready. It seemed that as one card stated; possibly make some statements about Q3. Could you give us some idea of where visibility is today and maybe where it was just even just two months ago?

Jagdeep Singh

Yes. It hasn’t changed dramatically from what we always say, that “As we go under our current quarter we’ve got reasonable visibility.” The only difference I guess with Q3 in this case is that as we see it today there’s a few chunks of revenue if you will that will get invoiced in Q3 from some of these larger deployments.

So from a visibility perspective we have insight into, obviously in advance of which we normally would. So I think that’s probably the only change from a visibility perspective as to say in the current quarter. I think nothing’s changed from all of our recent quarters that we thought reasonable visibility, not perfect but reasonable visibility into the current quarter.

Jeff Schreiner - Capstone Investments

Okay, one final question gentlemen, thank you for your time. Just kind of following off that Duston; if you have some reasonable visibility, then does management now think that first quarter ’09 is quite possibly the likely low for the operating model in fiscal year ’09, and do things start to move higher from here as we move to the transition from common to TAM and the company should start to see incremental benefits from that?

Jagdeep Singh

Yes, I mean the only thing we additionally commented on was the Q3 comment that all other things being equal, with a few of these larger guys getting invoiced that we could see, and revenues going up in Q3, but we haven’t really quantified it beyond that, whether it’s below or how the rest of year looks or anything like that.

Jeff Schreiner - Capstone Investments

Okay. Thank you, gentleman.

Jagdeep Singh

Okay.

Operator

Ajay Diwan, state your affiliation please.

Ajay Diwan - J. & W. Seligman

Yes, it’s J. & W. Seligman. I just have like few questions; in the past you’ve talked about the cable MSO’s as a group, as a meaningful customer base. Can you just give an update on what you’re seeing from those guys in terms of deployment?

Jagdeep Singh

Yes. They continue to be customers. I think one of the key points is that we have a fairly diversified customer base from a market segment stand point, the MSO’s, internet content guys and these Tier-1, and I guess the nice thing about handling that diversity is that they don’t all move in exact lock steps.

So at any given quarter when your top customer list moves around in terms of the different segments and so yes, there’s absolute flows in each of those segments relative to their own industry sort of development, but overall those guys are the main customers and we continue to work with them as we do with the other segments and generally pleased with their activity.

Ajay Diwan - J. & W. Seligman

But in general I mean they are kind of seeing the same macro effects that you are generally referring to. So their purchases maybe kind of lower than what they are on a normalized basis?

Jagdeep Singh

They actually increased a little bit in Q4 from the Q3 levels actually.

Ajay Diwan - J. & W. Seligman

And then in Q1?

Jagdeep Singh

I haven’t commented on that.

Ajay Diwan - J. & W. Seligman

Okay. Got it.

Jagdeep Singh

Then of course we also referred to new activity, new build out activity that we are seeing in the customer base. That spans all the different segments, so that would include the AMSO’s as well.

Ajay Diwan - J. & W. Seligman

Got it, then you said you have a new application on the submarine side. I was wondering, given that the distances tend to be so long and my general understanding of one of your key value propositions was these low cost, optical to electrical conversions. You would think that you don’t need to do that in the submarine vessel, but why are you winning in that environment and just can you tell me what your….?

Jagdeep Singh

Yes. It’s a good question. So if you recall last year, last summer we announced our ultra long-haul systems that did on the order of 2000 kilometers of reach between electrical sites and the reason we did that is because there was an emerging market for longer reach WDM platforms driven by a number of different applications and submarines, happy to be one of them and because of that system in the cure vertical, we had a rough point in time.

Our system does in fact compete quite effectively in that environment, effectively not to win against the incumbent competitors. So clearly the submarine is a great example where you obviously don’t have the ability to access the signal in the middle of the ocean, so you have to drive thousands of kilometers between (inaudible) and the key is to have a system that has the optical reach to be able to cover that and our system has that as of last summer, and still there is a much more complete offering overall.

The other thing that I would point out is that whole segment is actually seeing a reasonable level of activity. It seems to go in cycles and I guess last six cycles was on the order of a decade ago or so and a lot of those systems are running low on capacity and so there seems to be a high level activity across multiple customers in that space.

One final point if I can just add, just a little bit different note that I want to just, she asked the question and this is relevant; the other thing we’ll be doing with our systems, we’ve been increasing the capacity of the systems, so our first generation system four years ago had 40 channels worth of 10 gig capacity. It had on the order of 500 kilometers of reach.

So what I meant was every 500 kilometers you are buying more DLMs and then you’re every 40 channels; buy a new life system with more capacity. We then added longer reach and doubled the capacity to 80 in the last summer we added even long-reach ultra long-haul and doubled the capacity to 160.

So the side effect is that, switching to Simona’s question, you actually benefit as you lowered the customer’s pushed in cost, because there’s not as many DLM sites that you need. You also have lower upfront DLM requirements; one of the factors that would lower the first end margins of these deals, but then the offsetting effect is you have a longer stretch out time in which you are just adding TAMs with no other common equipment required in that link. So you go for a 160 rate links worth of TAMs. So the longer terms margin actually gets better.

Ajay Diwan - J. & W. Seligman

Got it. So, just let me follow-up on a couple of things; is it fair to infer that one of these Tier 1 wins then you are talking about, is it submarine application; and then the second thing is, given that the margins are so low, are these kind of field deployment, lab trials or actually RFP wins.

Can you classify where they are, because it feels like the initial sale, as if you’re kind of giving away the product. I don’t know how else to put it, but if you could may be clarify, are these actual RFPs that you responded to and won, or are they trials or what kind of wins are they?

Jagdeep Singh

Yes, in most cases the Tier 1 will in fact RFP. So I think it’s the same question that most of the Tier 1 wins that we are talking about in fact came as the order of winning an RFP and they are definitely not lab trials. I don’t know any labs that would buy on the order of double digit million types of gear.

So these are real deployments, real networks. We haven’t commented on any more about where the submarine networks are; which carriers they belong to? So we’ve said that there’s three of the top five Tier 1, we have six Tier 1 world wide now. We have submarine networks, but we haven’t said anything more than that.

But I think to your point about the margins, by giving away comments. I mean in effect that to some extent is the business model of this industry right. The common equipment as always been low margin equipment and the vendors make their money effectively on the line cards, and the only question is how attractive are your line cards, your transponder or tributary optics margins and if they are really attractive, then there’s a very good business model over time as they feel. If they are not, then you have a problem.

We obviously believe that our TAM margins are better than people that are building the suite based optics, so that’s good for us, but in the end were the margins going to be at any point of time is really going to be a function of the mix between the TAM fill rate of a given network and then new customer footprint that’s being won.

Ajay Diwan - J. & W. Seligman

Got it. Thanks a lot.

Operator

Todd Brady, state your affiliation please.

Todd Brady - Wells Fargo

Wells Fargo. I think you guys already answered my question. I wanted a clarification; first, you said level3 was 30% of your revenues. Can you quantify or actually breakup the top five customers and what percent they’re representative of revenues, and once again I think you answered my question, but are any of your customers running into financing issues in building out their previously planned networks because of the capital markets. Thanks?

Jagdeep Singh

Sure, yes historically we’ve only broken up the 10% or greater customers, so we’ve never given the layer below the 10% and we obviously won’t start now on that. On the financing part of the equation, I don’t know if anybody’s delayed their rollouts and stuff like that for the financing. I don’t know if anybody like that has delayed any significant rollouts or build outs because of financing issues.

Now we had one customer last quarter, we provided a bad debt reserve for in Russia; that’s was kind of one off thing. Occasionally customers ask us for some help here and there and whatever, but there’s been nothing, no significant changes or delays because of financing method; that’s been obvious to us anyway.

Todd Brady - Wells Fargo

Okay. Thanks.

Operator

George Notter, state your affiliation please.

George Notter - Jefferies & Co.

Just as a follow up, I guess I was trying to figure out what your headcount was here at Q1 end?

Jagdeep Singh

962 I believe George.

George Notter - Jefferies & Co.

Okay, so then you were still hiring additional people here. That leads into a question about operating expenses. So, where do you think operating expenses go in absolute terms over the longer term or intermediate term and obviously you’re investing aggressively here and a multitude of projects Symetra; you have a 40 gig PIC development and so on.

Does it stand a reason that once those projects start to roll off, your operating expenses would roll off with them or do you think you can kind of continue to spend at these rates or even higher going forward. What’s the longer term picture?

Jagdeep Singh

Yes, it’s hard to tell whether things would significantly roll off. I mean the big chunks of things, the NREs are more one-time project related and there are obviously several million here and there that can come and go easily. We will continue, I think potentially to add modestly to R&D expenses.

SG&A might vary a little bit with commissions on revenues and things like that, but I wouldn’t expect any substantial upward change in the expenses or on the downside I wouldn’t expect at this point a substantial downward change in stock.

Duston Williams

Just if I can just add a more qualitative point to this as well, the obvious, sort of the real challenge obviously on this fund is how do you balance the need to have competitive product lines, say a couple of years out with the need to have an OpEx line that’s consistent with the top line, and if there’s never an easy answer to that, you just got judgment calls related to what functionality you believe is going to be required to be competitive in the couple of year time frame; balanced against what the outlook is with top line growth.

So in the end if we didn’t see a fundamental top line that was capable of sustaining a certain level of warning, then we would obviously take action of that scenario, but if we do believe there is a real business and there is a real top line here to be had, then in order to own that top line we need to have a functionality that’s competitive. So that’s kind of a generic answer to the question and then obviously there is a judgment call that you keep making on a regular basis.

Jagdeep Singh

So in fact, on that note let’s go ahead and close the call. I want to thank you all for joining us today. I think we clearly continue to see evidence that our value proposition is resonating with customers based on our recent wins and combined with the continued advancement of our PIC based technology, we believe that we are well positioned to resume top line growth and improve our bottom line performance as the macro economic environment improves. We look forward reporting our progress in the next earnings call. Thank you.

Operator

This concludes today’s conference. You may disconnect at this time.

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