Infinera Corp. Management presents at Citi Global Technology Conference [Transcript]

| About: Infinera Corporation (INFN)

Infinera Corp. [INFN]

Citi Global Technology Conference

September 4, 2013 08:15 AM ET


Ita Brennan - CFO


Kim Watkins - Citi

Kim Watkins - Citi

Thanks everyone for joining us this morning for the Infinera presentation. My name is Kim Watkins. I am on the communication equipment and data networking team here at Citi. And it's my pleasure to introduce Ita Brennan, the CFO. Ita was appointed CFO of Infinera in July 2010. So she has been in that position for a few years now. She's going to kick off with a brief presentation and then we'll go into Q&A. Ita?

Ita Brennan

Thank you, Kim. The presentation is just to reset everybody on Infinera, where we come from and where we see ourselves at this point in time. I have two disclaimers for you; one standard SEC stuff, forward-looking statements, the other is my voice which may modulate a little bit as I am recovering from a bronchiolar infection. Please don't pay too much attention to that.

Okay. So who is Infinera? Infinera is really a technology leader around intelligent transport networks. We hear a lot these days about intelligent transport and intelligent networks, but truly Infinera was built around that and that's the vision right from the beginning of the founding of the company. The founders came together back in 2000, 2001 and determined that as networks scales, as bandwidth growth increased, there will be need for intelligence transport network. And what that meant was an ability to operate networks from the transport layer using switching capabilities, digital capabilities while they are remaining exclusively in the optical domain.

And they said about building the key building blocks necessary from a technology perspective to enable that to happen, and we have been very methodical and systematic around building those blocks and connecting those building blocks as the company has evolved and we'll talk some more about what those building blocks are, but they are key proprietary research and development projects that we have built and capabilities that we have within the company.

Therefore we've vertically integrated from a development perspective around those key technologies, but also we took the view at the time they needed to be vertically integrated from a manufacturing perspective for certain key elements and what it takes to build those networks. So we have looked at certain key parts of our system and we have chosen to build those ourselves and we believe that that allows us to have a very differentiated leveragable cost model as we grow the company. And we'll talk some more about that as well.

It is an exciting time for the company. We have taken our addressable market with the launch of our DTN-X 500 gig super-channel product from about $2 billion to $4 billion market and we see an expansion of that available market into the future up to about 13 billion between now and 2016 and 2017. So that's initially an expansion of our addressable market inside long haul the WDM transport which is where we play today, and then a further expansion into an adjacent metro market with the introduction of a metro platform later in our development cycle.

We have 121 customers in 71 countries. So a fairly at large scale deployment and service organization at this stage that's capable of supporting large accounts and large customer deployments across the world. We started out being very much focused on North America, Tier 2 adjacent to market type customers and we have expanded that over time and we believe we now have the services footprint and infrastructure that we can support large accounts around the world successfully.

We introduced our DTN-X platform middle of last year. This is our basically 500-gig super-channel converged platform. We believe it's a very differentiated solution for carriers and for large scale carriers in particular and we now have 34 DTN-X customer commitments. That was as of the end of Q2. That's a very significant ramp for a new platform in this space and we added seven of those new in Q2.

So what makes Infinera different and what are these key building blocks that we talked about when we think about our technology portfolio? All right, the first and largest differentiation around the company is the Photonic Integrated Circuit and its FlexCoherent processor. It's what we call the PIC. So the PIC was designed and built to enable this intelligent transport network, to enable the free flow if you like between optical and electrical conversions at a very low cost and large scale.

So the purpose of the PIC originally was to allow the creation of massive amounts of bandwidth, but intelligent bandwidth that could be easily converted back and forth from optical to electrical. That is a key and unique differentiator to Infinera. There are some other efforts around integration, different parts of product sets but nothing that is large scale and nothing that enables the capability that the Infinera 500-gig PIC that we're selling today enables.

We marry that together with a digital switching or ASIX [ph] actually. The capability of PIC allows you to have a pervasive switching capability throughout your platform. Our original DTN platform has capability and now DTN-X has even increased from a capacity perspective and from a granularity perspective. That's very important to play between those two capabilities to allow you to build a converged platform that [indiscernible] the transport and the switching capabilities. We'll talk some more about what Infinera's unique differentiation is around that. And then you pull all of this together with intelligent software.

Right from the beginning we understood the importance of having a software capability that would sit on top of these technologies and allow for ease of use and efficient use of the network. We have the largest installed base at GMPLS around the world and that capability allows peoples to provision networks and transport networks using a point-and-click capability. If you look at our website you’ll see we’ve just been awarded a Guinness Book Of Records Award in Europe for provisioning capacity, one of our customers over there DANTE. That’s just a simple way to look at what that means to our customer. They were able to win again as per the Records award and how quicker they can turn up capacity in their network and then it all builds off of these three capabilities that have from the technology perspective.

So, what we do with that? We take all of those capabilities to build the intelligent transport network and we’ve sold this in three platforms overtime. We have our DTN platform, which is our 100 gig platform and now the DTN-X, which is our 500 gig super-channel platform. What these components allow us to do with those platforms is to really allow for a simplification and an efficient and large scale deployment of transport networks.

I see that system is differentiated from a customer perspective because of the speed at which they can turn up capacity, efficiency which they can use that network capacity and then the large scale capability that’s represented in the 500 gig super-channel. And all those three metrics are critically important and becoming more important as you look at the evolution of network architecture from a transport perspective.

What does the opportunity look like for Infinera? We started out, prior to the launch of DTN-X, selling into about 50% of the long-haul DWDM space. With the DTN-X introduction, we increased that addressable market by about 2x, right, because it gave us an opportunity to go and sell to large Tier 1 carriers. Up until then we have not had the opportunity to line up prior to the technology introduction with the beginning of a cycle from a carrier perspective and are purchasing cycles from a carrier perspective.

What the DTN-X allowed us to do was to bring a platform to market that address not only the capacity needs but also the technology needs that carriers were seeing and looking for in that time frame and we believe we now have a real opportunity to go and address those Tier 1 customers. You saw us announce our first domestic Tier 1, which was Century Link. We’ve had some very strong success with them, putting the DTN-X into their backbone network. We announced another Tier 1 win on our Q2 call in Europe. We haven’t named that account yet but we talked about and having the ability to go sell into that network and we have a number of large engagements with accounts around the world where we’re competing for that additional addressable market.

If you look beyond that, that market is targeted on depending on which analyst and numbers you read but somewhere around 10% to 11% per annum on a category [ph] between now and 2016-2017. So we see there is a real growth driver and growth opportunity off of the DTN-X platform over the next couple of years, as we go and engage these accounts, share with these accounts and grow our footprint within those accounts.

Beyond that, we look at the metro market as the next area for expansion. On our Q2 top call, Tom had referenced the fact that we have begun development of a PIC chip around the metro application and we’re looking at developing a metro platform that will leverage some of the same capabilities, uptick difference and that has come to address those specific needs of the metro market but leveraging all of the infrastructure that we have around the SaaS and around our manufacturing capability. We haven’t pointed to a particular roadmap or timing around that but we see it as coming in as a revenue driver once we’ve exploited the DTN-X and the DTN-X has done its job around growing our market share inside the long-haul space.

So what’s happening from a network architecture perspective, because this is really important in terms of what’s driving the spending that we’re seeing, the spending growth that we’re seeing across the industry and that why do we think Infinera has a unique vision and can take some market share in this cycle. There are really three different metrics that we see the network evolving on at this point in time. There is scalability, which is obviously capacity. We’re very familiar with this one. It's been the age old growth requirement, to add capacity to the fiber, add capacity to the system and to the network. Never been so much pressure around adding capacity and the capability of systems to drive capacity but also with a new emphasis on power, space and other capabilities. So scalability is a very important metric and we believe it will become an even more important metric over time.

You’ve talked to carriers now and much more worried about power, space. Those are big drivers for the operational tasks of their network. So scalability is obviously adding capacity builds, adding that capacity in a manageable footprint from an OpEx perspective. The other aspect [ph] that's become important is around conversions. We talked about conversions for a long time and the need to convert the different layers of the network in order to reduce cost and drive efficiency. I think we are finally seeing deployments of converged system with both transport and optical conversions happening with this product deployment. That's another reason why it’s taken some time to get to this cycle but also as a cycle can have a long and healthy spending pattern to it because it really represents a very different network architecture.

Combining these two together, you need automation, how do we automate the provisioning of the network? How do we automate the provisioning of the network? How do we automate the integration of those layers? We obviously do our own automation within the transport layer, but also there is increasingly opportunities to take additional functionality into that transport layer but also to help through software and other managed tools and how you manage across those layers.

So where are we today? We believe 100 gig is clearly the capacity of choice at this stage and most of the competitors are still looking at a DWDM solution with some convergence towards adding switching capabilities into that, but it's really taking existing platforms and existing solutions and converging those into a combined box, whereas Infinera has designed from the bottom up a system that supports that convergence without compromise. So we can add both transport and switching capability into the same platform within the same size and power footprint.

Our DTN-X has a five terabyte switching capability attached to it, and that's clearly very important in terms of giving the customer the optimal switching and transport experience. On the scalability side the other thing that we bring to the market is 500 gig super-channel. This is important. The PIC enables us a much denser capacity underline module than what the competition can deliver today. So we're able to provision 500-gig super-channels in pretty much the same footprint in cost structure as the competitors who provision 100 gig. That enables things like our instant bandwidth offerings where we're able to put this capacity in place and then have customers provision that with software and give them a more virtual capacity experience as they provision the networks.

And then obviously on the convergence side we believe that the DTN-X represents the most effective convergence of transports and OTN switching, that that capability is without compromise. We are seeing competitors show trials, on the capacity side. We have seen some 200 gig type demonstrations from Ciena. So they are making efforts to move towards a higher capacity super-channel type approach. I believe there are still in trials at the moment and they will still take a lot of time to get that capability in the marketplace.

And then also on the convergence side we're seeing a retro-fit of existing platforms and combining those into a single footprint rather than a complete redesign of the systems architecture, which is what Infinera has done as part of its core technology.

So what happens after this? Obviously the scale continues. We have demonstrated one terabyte super-channel capability already from a technology perspective. So you will continue to see a march on the scale side and there is endless demand for that trajectory to continue. It will be in the right time. It will have to be at the right time when customers are ready to make their next move. We do believe it's important to have the technology ready and be in a position to respond to that when that's needed.

However we believe right now the focus is on getting 100 gig and 500 gig super-channels equipment deployed in peoples networks and then obviously on the convergence side the goal is to continue to add MPLS to the platform so that when customers are ready to make that next convergence step and combine MPLS capability we will have the technology ready to also be able to do that. This is driven by given customer solutions, making solutions available to customers. They are going to determine when and how the organizations can absorb those capabilities.

From an automation perspective, we believe we have done a lot of work around transport network automation with our GMPLS software solution and the next step here can be some sort of SDN, transport SDN solutions. What that would bring to the table is allow some provisioning and optimization across the layers of the networks, whereas today we're able to optimize between the transport and switching layer only.

So is the 100 gig cycle in place? I think that's no longer a debate. We see it across the board, across the industry. Every analyst reports that we see is showing increased revenues from 100 gig. So 100 gig shipments are growing. You are seeing 40 gig begin to decline pretty quickly which is kind of what was expected to see and really anybody who has reasonable capacity in the network is now going to make 100 gig decision. More than 90% of the RFPs that we see now are looking for 100 gig capability.

So for sure the scale access is in play and I think that decision is made, anybody who is deploying networks is now looking at 100 gig. We'd like to believe that we have something to do with and that bringing the product to the market finally allowed customers to have multiple choices around technology and capability in cost structure with the DTN-X and we continue to see that 100 gig cycle grow from there.

In terms of convergence, you know where are we? Again this is a representation of the network from, we all talked about the three layers of the network. I think on the right hand side of the page we're trying to show what does that mean? It means lots of boxes, lots of fiber connects lots of OpEx, lots of overhead. So we are seeing this convergence finally happen.

Again when you look at RFPs right now, the demand for convergence in those RFPs is again, almost above 80% at this stage of RFPs looking for some form of converged solution. So carriers and customers are finally buying into the fact that this is an important part of the network architecture as they go forward, and they’re looking to drive conversions between the switching and the transport layer.

And then finally there is network automation, right. So we have spent a lot of time in energy around automating network provisioning within our domain and that’s now transport plus switching. We have the first industrially instant bandwidth solution. It basically allows customer to provision the network and then add 100 gig wave and services to those networks for the point and click software solution and licensing and system, and we attribute that to capabilities of 500 gig super channels.

And also there is a real opportunity to continue to drive this intelligent transport network and increase the share of router that the transport layer can acquire, right. If you look at how our network is provisioned today, if you’re going from point to point, you can see lots and lots of router ports being used in that network and that is because the routers are determining the intelligence of the network and driving the intelligence of the network. Either through further MPLS capabilities in the transport layer or with some form of SPN solution, we believe that you can remove a significant amount of those router ports from the network and therefore make it optimized for the customer but also increase the intelligence and the value that the customer gets from the transport layer.

We see this is kind of the next evolution from a network perspective and how that plays out between SPN and MPLS, we believe there will be some form of software solution that will enable that either on generic basis or on a specific capabilities basis but it’s obviously a next step from a network evolution perspective.

What does all that mean for Infinera? These are the latest market share data from Delora [ph]. It’s from shipments of DTN-X to date and you can see that we have shipped 26% of all 100 gig long haul ports into the market in that timeframe.

We were just picked at the line by Huawei, which quite honestly we have been expecting to see happen for the last couple of quarters because they do have a lot of band coming out of China and some leeway around how and what gets reported from there. If we pullout the China piece of the market, which we believe is really not available to us, or certainly not available to us from a level playing field perspective, then you can see that we shipped 35% of all 100 gig ports into the market in that yearly period. So clearly gaining market share, driving market share, taking footprint with the DTN-X platform.

So 34 customer commitments in four quarters. This is a very important metric for me as I think about the business model and financials because it’s very important that a certain portion of these new customer adds are actually new customers to Infinera and new footprint to Infinera because that’s where the growth comes from, that’s where the growth in revenue will come from.

So about third of the customers that we have added so far have been new customers to Infinera and can drive incremental revenue growth. On top of that we have had number of customers like CenturyLink where we have increased our presence within those accounts and that can also drive growth. So that’s the revenue expansion strategy around how do we expand revenues and grow revenues leveraging this platform. Always very important to maintain our existing customer base and we have been very successful at doing that and we are delighted to see kind of 2013 existing customers already making that move to DTN-X.

The other thing is interesting about this chart is that you can see the geographic expansion. We have traditionally been North America focused. We had about 30% of our revenues outside of the U.S. and we’d been able to grow that and we’re continuing to grow that and we are delighted to see 14 out of the 34 customers coming out of the EMEA, right. So the DTN-X definitely is giving us access to accounts in EMEA where we previously did not play and were not involved in RFPs and we continued to see that. We have good access to future RFPs and RFIs in Europe off of the back of the DTN-X in accounts where we did not participate prior to this.

What does all that mean from a business model perspective? So clearly over the last couple of years, we had been in investment mode around technology and bringing the DTN-X to market. We then had a roadmap that we laid out in terms of profitability, both of the growth margin and operating margin levels and we have been executing to that pretty successfully through this year. We are seeing revenue expansion on the top side. We had guided for 10% to 20% revenue growth in the year. We have now set 20% as our floor for the year. We guided for margins, that would be in the 38% to 40% range and right now we’re on track to achieve that and exit the year in the low 40% range.

We Q3 guide clearly demonstrates that with revenue scale in this $140 million range and gross margins approaching our midterm target that we can drive profitability and we are very pleased to have that as a demonstration of what business model can do when those two factors will line up? Our target model calls the 45%, 10% operating margin and that’s in environment where we believe we’re still continuing to grow and continue to introduce new capabilities to the market.

And you think about how a network gets deployed, your initial footprint when you deploy a network is always going to have lower gross margin. That is the nature of the industry. That's where the highest competition is around acquiring the footprint. And then as you deploy into that network the margins expand over time.

We are right now in the initial deployment phase on a lot of large networks, the larger network deployments that we've seen historically. So that is going to cause our margins to remain in that 40 -ish percent range for a period of time and then we'll see the expansion as we shift from new deployment to sales, and the sales becomes a larger portion of our revenue. So part of that expansion to 45% or maybe beyond really comes from adding sale to this network footprint and having these networks fill out over time.

Where does that leave us as we stand here today? We believe we're clearly a technology leader, an accepted technology leader in the intelligent transport network space and that space is becoming better understood and more credit goes to carriers every day. So we believe that that's critically important, to have those capabilities and to continue to evolve those capabilities. We own those technologies and we will continue to stay focused evolving those technologies and keep that market leadership position.

We have an addressable market that's going from $4 billion today to $13 billion in 2017. We believe we are vertically integrated, which means as we scale revenues we will see leverage from a profitability perspective and really the technologies and the capabilities that the company has are actually in the right place at the right time, now, as we see the 100 gig cycle truly take place and drive spending in the marketplace.

Thank you for your time. Kim, I think you have some questions.

Question-and-Answer Session

Kim Watkins - Citi

Thank you for that presentation. It was very thorough. Great introduction to Infinera. Couple of questions for you, why don’t we start on just general demand environment. I think one of the things that you mentioned that I found really interesting was that the DTN-X was giving you an opportunity in Europe that you haven't had, previously with the DTN and I think last quarter you saw 21% sequential revenue growth in Europe, if I have that correct. How long do you believe, where are you seeing these opportunities? Are they tier 1, what parts of Europe, because weakness and economic weakness continuing in the region, and number two, how long do you believe this is sustainable in this region?

Ita Brennan

Yes, I think as you look at the Infinetics report last quarter they actually said that Infinera was the fastest growing vendor in Europe and into the EMEA space. So we are seeing traction there from both a revenue perspective but also from an opportunities perspective, more so than in a lot of regions. We've been very successful in what I would say pan European business with the DTN, but because of the timing of the introduction of that technology, we did not really have the opportunity to go after maybe some of the larger accounts, DTTs et cetera who'd already made technology decisions.

So we definitely see you know a greater opportunity to infiltrate more accounts where we haven't played before. We see some of those in Western Europe and also in Eastern Europe, Russia. There is clearly money being planned to be spent and money being spent in those regions and we think we have a greater opportunity to go pursue that this time. Huawei has always had a strong presence there, they still do, but we really believe the technology quality execution is playing a bigger role in some of those decisions and we see Huawei maybe a little less aggressive from a pricing perspective and customers a little bit more willing to look at the other values that other vendors are bringing.

Kim Watkins - Citi

It's very interesting. And then what about Asia, your revenue there has doubled in the first half of the year.

Ita Brennan

Yes, and that doubled off a pretty small base for sure but again we're seeing the same dynamic, whereas before we were knocking on doors that had already made decisions and didn't really have a buying decision in place. Now we are seeing opportunities there where there's real decisions to be made around spending money. So we had some good success, DayCom [ph], KDDI, FX Networks in New Zealand. It's a small initial base but for the first time we see real activity there that can drive revenue expansion.

Kim Watkins - Citi

The tier 1 opportunity, I'm also recovering from that cold or getting one, tier 1 revenue opportunity, you talked a lot about your tier 1 opportunity opening with the DTN-X. How are your conversations going with tier 1 providers? How long is the window open for the 100 gig land grab and where are we at in that process, and is there still an opportunity with the large tier 1 carriers in North America or have those decisions already been made?

Ita Brennan

I think our view is there is a long cycle of decisions here and that means people are going to be making decisions for least through the end of next year if not beyond right. In fact in some cases we'd like them to go faster, right but we see engagements today with people who intend to spend money in the near term right and I think we're seeing that in the announcements that we made both -- of the 34 purchase commitments to the DTN-X, there is two domestic tier 1s in that and there's about seven international tier 1 in that. So you can assume we're actively engaged with all of those in terms of other buying decisions that they may have in play. On top of that everybody talks about the Verizon decision. Clearly there is an RFP in place and we will compete for that. That's likely to be a 2014 decision, and again that would be to their timeline until their specification was [indiscernible], something we are very focused on and engaged in. There are number of other, if you think of all the major tier 1s they all will have if not a first 100 gig decision then it’s definitely a second vendor 100 gig decision to make over the next 12 to 18 months and we will engage as many of those as we can. We won't win them all but clearly we believe we are in a competitive position in those.

Kim Watkins - Citi

So just to boil it down, would do you say there is RFP activity and RFI activity is increasing decreasing at this point?

Ita Brennan

Yes, I think we see it as being pretty consistent, and in our last earning’s call we were clear to point to the fact that the overall sales pipeline and the number of opportunities that were decisions that are still pending is still very strong and we think that remains the case. Again if you look at the number of 100 gig ports that have been deployed, there is still a significant amount of 100 gig deployment up for grabs and to be decided here over the next period of time.

Kim Watkins - Citi

Well, let’s transition a little bit and talk about the metro strategy because you talked about metro provided an opportunity to expand [indiscernible] with a PIC based solution. That was something also that Tom talked about in the second quarter earning’s call. How does Infinera differentiate in this market and secondly, given the prior sensitive nature of the metro market relative to long haul, does that imply the margins might be little bit lower in that market for you once revenue ramps?

Ita Brennan

Yes, we believe that is we enter that market, it has to be in a differentiated way, right, and it has leveraged the capabilities that we have around integration and the assets that we have in the fab and in our manufacturing cycles. So again Tom had talked about spending some initial investment around working on PICs and the fab, around that unless the first step for us in designing a solution that can drive to both performance metrics from a capabilities perspective but also from a financial model perspective that will make sense to enter that space.

So we haven’t laid out a roadmap. Again as I said our first priority is leverage the DTN-X to grow revenue and then this will come in after that but we do believe that there is a capability there from a combination of leveraging the existing assets that could drive to an effective metro solution but it will have to be differentiated and would look somewhat different to the existing platform although leveraging the core technologies involved in that.

Kim Watkins - Citi

Okay. Now on your earning’s call you’ve gave guidance for next quarter but you declined to update your annual guidance and one of the things that you had talked about, you’ve said that you’d be above the high end of your original 10% to 20% revenue growth guidance the year? Now you’ve decided reduce visibility into Q4 is the reason for not updating the annual member. What do you attribute the lower visibility to and typically I think historically we've seen something like 10% to 11% growth in Q4. How do you factor seasonality into this comment?

Ita Brennan

Yes, I mean we have traditionally historically given guidance for one quarter and particularly on a quarter granularity level we’ve only ever guided the next quarter and that’s from the back of where we pride ourselves on the short lead times and our typical lead times of four to six weeks. So we come in to a quarter, we have reasonable visibility to the revenue for that upcoming quarter but not much beyond that in terms of quarter granularity. We have obviously have sales pipeline instead of RFIs and RFPs that we are engaged in, but in terms of determining how much that revenue going to hit and what quarter, we feel like we can do that with reasonable fidelity in the upcoming quarter but much more difficult to do beyond that.

We had come into the year and tried to give direction around our annual guidance expectations but as we get towards the back end of the year, if we were to update that, we'd essentially be guiding a Q4 revenue number as well and what we try to communicate was that we did not have the fidelity to go and do that on the last call and so we weren’t certainly saying that we had seen -- we were concerned about Q4 but we were not in a position to say we’re ready to guide a revenue number for Q4. I think much more important to us to focusing on the sales pipeline and that those opportunities are there. Whether they land in Q4 from a revenue perspective or not was something that we couldn’t provide visibility to at that point in time.

Q4 typically an up quarter. We’d be delighted to see that happen this year. There is a little difference in spending patterns when people are making some of the investment decisions that their making. So we’re little cautious around saying we assume that this year is going to follow the exact same trend as we seen before.

So a little caution on our parts. We’ll provide Q4 guidance on the next call and we really are kind of slipping back into that normal cycle of saying here is our quarterly guidance based on what we can see and then we’ll provide kind of more color around the longer term pipeline as we lookout beyond that.

Kim Watkins - Citi

Okay. I’m going to ask you one more question and then I’m going to open it up to audience. So if you have any questions, you will have an opportunity in a minute. Next on gross margins, guidance you gave was actually very strong up 5 points sequentially for Q3, yet [indiscernible] commentary on your call suggested that you’re going to continue to do chassis deployments of new systems. In the past, you’ve characterized those as little bit low our margin. Are these two statements contradictory?

Ita Brennan

Yes, I mean there is really -- we have talked about common equipment as a big book. There is really two elements to that. One is around chassis deployments which is ongoing at all times. The rest is around the line system or the ampchain that goes with the network.

Normally if you put out a completely new Greenfield network we have to deploy an ampchain and then we'll obviously deploy chassis as we deploy capacity into that network. In Q3 we had a couple of unusual deployments where people are actually going to hard cut all round their networks from DTN to DTN-X and they're going to end up reusing that ampchain. So that's driving a healthier mix on those deployments. So that's giving us more of a prop in Q3 margins than maybe we would have originally expected, although I would say we're still performing nicely on gross margin expansion half of the core cost reduction strategy that we laid out at the beginning of the year. So I think it's great to see the proof points in Q3, but from a gross margin expectation perspective I'd kind of go back to our original road map that calls for gross margins in the low 40s exiting the year but we don't expect to see that deployment strategy be kind of widespread and that works.

Kim Watkins - Citi

Okay, thanks, helpful clarification. Any questions in the audience?

Unidentified analyst

To clarify what you said in for Q4, is it a case where customers aren't giving you enough visibility for Q4, or you're just maintaining your practice where you don't want to comment on Q4?

Ita Brennan

Yes. I'm not trying to update a Q4 view now, I think on the call we had talked about at that point in time we really didn't have the visibility to go outside of our normal practice and provide a Q4 guidance number.

Kim Watkins - Citi

Any others out there? Couple of questions that we've been asking all companies at the conference today; so I wanted to ask very quickly. First off, use of cash, can you rank your intended use of cash between floating [ph] dividends, buyback, M&A, other.

Ita Brennan

I think for us right now the best use of cash that we have is to grow the business and to leverage the opportunity that's in front of us with the DTN-X, so raise some money to support that and support the balance sheet around and that's where our cash will be focused for the foreseeable future.

Kim Watkins - Citi

Secondly, visibility, we touched on this a little bit already but just to distill it, current visibility relative to one quarter ago and one year ago, getting better, worse?

Ita Brennan

Versus a year ago we're in a much better position obviously right. This time last year we're sitting here with a platform that we thought people wanted to buy but we didn't really have any evidence that that was going to be the case. I think we've seen a lot of traction around the platform and we're very pleased with that. Versus a quarter ago, I think the, the pipeline that we talked about is still robust and is probably pretty consistent with where it has been over the last four quarters.

Kim Watkins - Citi

Okay, and the last one is productivity gains. How would you describe your opportunity for operating margin expansion versus a year ago and a quarter ago?

Ita Brennan

I mean there's two key elements of margin expansion for us. One is around the fixed cost nature of our manufacturing model and that will continue to be available to us as we scale revenue. So the incremental costs of making the next pick in our fab right now, it's really pretty small relative to the average cost if you like. So we expand revenue we'll definitely get flow through from a gross margin perspective, just from the cost structure part of the business. Second piece is obviously what we saw on that chart as we're in a high investment, high footprint phase now and will likely be for some time into the future but then after that as you get the sale into those networks, you will also see the opportunity to expand margins from that and from the increased sale to commons ratio that's afforded to us with the DTN-X.

Kim Watkins - Citi

Okay great, well thank you so much for being with us today.

Ita Brennan

Thank you, Kim. It's been a pleasure.

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