Infinera Management Discusses Q3 2013 Results - Earnings Call Transcript

Oct.23.13 | About: Infinera Corporation (INFN)

Infinera (NASDAQ:INFN)

Q3 2013 Earnings Call

October 23, 2013 5:00 pm ET

Executives

Jenifer Kirtland

Thomas J. Fallon - Chief Executive Officer and Director

Ita M. Brennan - Chief Financial Officer and Principal Accounting Officer

David F. Welch - Co-Founder, President, Director and Member of Technology & Acquisition Committee

Analysts

Simona Jankowski - Goldman Sachs Group Inc., Research Division

George C. Notter - Jefferies LLC, Research Division

Dmitry Netis - William Blair & Company L.L.C., Research Division

Michael Genovese - MKM Partners LLC, Research Division

Alexander B. Henderson - Needham & Company, LLC, Research Division

Mike Lin - Stifel, Nicolaus & Co., Inc., Research Division

Roderick B. Hall - JP Morgan Chase & Co, Research Division

Operator

Welcome, and thank you for standing by. Welcome to the Third Quarter Year 2013 Investment Community Conference Call of Infinera Corporation. [Operator Instructions]

Today's call is being recorded. If anyone has any objections, you may disconnect at this time.

I would now like to turn the call over to Ms. Jenifer Kirtland of Infinera Investor Relations. Jenifer, you may begin.

Jenifer Kirtland

Thank you, Joe. 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 markets and customers, our products and our competitors' products, and prospects for the company in the fourth quarter of fiscal year 2013 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 March 5, 2013, for more information on these risks and uncertainties.

Today's press releases, including results of the third quarter of fiscal year 2013, and associated financial tables and investor information summary will be available today on the Investors section of Infinera's website at infinera.com.

The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.

This afternoon's press release and today's conference call also include certain non-GAAP financial measures. In our earnings release, we announced operating results for the third quarter of fiscal year 2013, which exclude noncash, stock-based compensation expenses and amortization of debt discount on our convertible senior notes. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons.

Please see the exhibit of the earnings press release for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful and how they are used by management, which will be available today in the Investors section of our website.

On this call, we'll also give guidance for the fourth quarter of fiscal year 2013. We have excluded noncash stock-based compensation expenses from this guidance because we cannot readily estimate the impact of our future stock price on future stock-based compensation expenses.

I will now turn the call over to Infinera's Chief Executive Officer, Tom Fallon.

Thomas J. Fallon

Good afternoon, and thank you for joining us on our third quarter 2013 conference call. With me on the call today are Chief Financial Officer, Ita Brennan; and President, Dave Welch.

Our third quarter financial results were strong and demonstrate the continued momentum we have established in the developing 100-gig and converged network transport market.

Revenues were $142 million, an increase of 27% over the prior year's third quarter, and 3% sequentially. We generated positive cash flow from operations with both gross margin and profitability exceeding our expectations.

Our success continues to be driven by strong customer acceptance of Infinera's Intelligent Transport Network and the DTN-X platform, which uniquely offers super-channel scale, converged OTN switching and GMPLS network automation today.

During the third quarter, we generated DTN-X purchase commitments from 5 additional customers, including 2 new to Infinera. These additional DTN-X customers include 2 Tier 1 international carriers, a large Internet content provider, a bandwidth wholesaler and a competitive carrier. This brings our total DTN-X customer count to 39 since its introduction last year. 14 of these customers are new to Infinera, demonstrating that our commitment to expanding market share remains on track.

On the new customer front, we are pleased to publicly announce our second domestic Tier 1, Rostelecom, Russia's largest telecommunications provider with over 500,000 kilometers of fiber.

We also had our first win in Africa, showing that we are gaining traction in new regions in EMEA, while still seeing continued strong momentum in Western and Eastern Europe. In fact, Infonetics named Infinera the fastest-growing optical vendor in Europe for the second consecutive quarter.

Clearly, our technology differentiation and passion around customer success is yielding sustained market share growth.

APAC momentum continues as 2 of these additional DTN-X purchase commitments in the quarter are based in this region. We also recently publicly announced our first customer win in South Korea, with the addition of the Dacom Crossing, a bandwidth wholesaler with both terrestrial and submarine routes.

North America demand remains solid from our existing Tier 1 cable wholesale and Internet content provider customers, along with significant new RFP activity. I am particularly pleased that in Q3, 2 greater than 10% customers were large North America Internet content providers.

In North America, we see more opportunity in the next 12 months than we've seen it a long time, and we believe we are well-positioned to take significant market share. Adoption of 100-gig and converged networks has been faster than industry analysts anticipated.

Dell'Oro now estimates a 275% increase in portship in 2013, with majority in long-haul routes compared with its previous 210% estimate in July.

Infinera's own experience validates this phenomenon. We have shipped and invoiced more 100-gig ports this quarter than any past quarter.

The industry is also aggressively moving toward converged architectures. Infonetics reports that by 2016, in the network core, over 90% of server providers surveyed wants to employ systems with integrated DWDM and OTN switching, up significantly from a survey just 1 year before.

Infinera pioneered this network architecture with our DTN, and we have scaled and enhanced it with the DTN-X and our Intelligent Transport Network. This shift is being driven by the carriers' need to make their networks more efficient and accommodate growing data volume and more dynamic traffic patterns as video, mobile and cloud continue to drive new network architecture direction.

It is also being driven by their need to quickly respond to their customers' requests and leverage time as a weapon for a more competitive posture in the marketplace. Our customers continue to tell us that our solutions are not only more reliable, but easier and faster to deploy than any other solution on the market.

Infinera has now deployed 3 quarters of a petabit per second of super-channel capacity. This is 100x the capacity of the Internet in 2005 in just over 1 year of deployment activity.

Additionally, 12 of our 39 DTN-X customers are using our instant bandwidth solutions that allows them to instantly deploy bandwidth on demand in 100-gig increments with no truck roll, a capability available only with the Infinera Intelligent Transport Network.

On the competitive front, we see the environment is gradually narrowing and driving the market toward a more sustainable business model. We believe the leaders in the evolving market must offer 100-gig and OTN switching capability today to get the majority of the business. And you can see router vendors, longtime advocates of IP over DWDM, now enhancing future plans for OTN switching solutions.

We also believe that to compete effectively, suppliers will need to own the intellectual property for these vertical technologies in order to book, differentiate and earn a reasonable return. Unlike 10-gig technology, there are just a handful of companies in this category.

Finally, as carriers are making strategic decisions on how to build their networks for today and tomorrow, financial stability, the ability for vendors to be here tomorrow, is critical. We anticipate that as the market continues to develop in the next 4 to 6 quarters, business will continue to gravitate toward those supplies that offer 100 gig or super-channels providing higher bandwidth and the capability to support convergence requirements. Competition remains fierce for these critical footprint wins. We are confident that Infinera has the right technologies and business model to bring on new customers and gain market share while executing on our vision.

Turning to technology. On the optical front, we introduced our super-channel, Soft Decision FEC product in Q3 that is now being deployed in multiple networks. We also continue to provide industry leadership around network intelligence and automation. Earlier this month, we've successfully demonstrated multilayer of Carrier SDN control of both the IP and transport layers. This was done in close collaboration with Brocade and our mutual customer ESnet and demonstrated the potential of SDN to leverage an Intelligent Transport Network to simplify operations and reduce traffic at the router layer.

While we are extremely pleased with the result of this trial, we are cognizant that service providers remain in an exploratory mode with SDN, and we are managing our investments in this technology carefully. Although it's important that people deploy SDN-ready Intelligent Transport Networks today, we don't anticipate material carrier demand for SDN for a couple of years. However, when it does materialize, we believe Infinera will be well-positioned to succeed, and the DTN-X will provide an optimal platform to support Carrier SDN.

As we look ahead, we continue to see strong interest in DTN-X and converged solutions across all geographies and market segments. We have visibility in the intermediate term on numerous large opportunities with strong RFP activity. However, predicting the timing of purchase commitments remains challenging because of our short lead times and the strategic nature of many of these customer decisions.

At the macro level, the optical long-haul DWDM market is expected to grow at 8% on average when comparing 2014 to 2013. I continue to believe that Infinera will grow at or faster [ph] in the market over this time period.

We are focused on winning market share based on the RFP activity and the increasing momentum that DTN-X has demonstrated. I am confident that we will significantly expand our penetration of existing customers and add new strategic customers over the next 12 to 18 months. We believe we have the technologies, infrastructure and financial stability to support our growth plans. We'll look forward to attacking this opportunity.

I would again like to thank our Infinera team and our partners for their hard work and dedication that resulted in very strong Q3 results. I also like to express my thanks to our customers for their support and confidence in Infinera.

On a disappointing note and for our press release, Ita has decided to try her hand at a startup. Ita has been with Infinera for 7 years and been my business partner as CFO for over 3 years. While her contributions are too innumerable to go through, I am most appreciative of the world-class team she has built here and the strong financial position she leaves us with. In a classic style, she has agreed to continue full-time as CFO to the end of February. This will allow her to see out our fiscal 2013 and will give us ample time to determine our move-forward strategy.

I'd like to publicly thank Ita for her contributions, her partnership and her friendship.

Now I'll turn the call over to Ita for a more detailed financial review of the quarter and our guidance for Q4.

Ita M. Brennan

Thanks, Tom, and good afternoon. This analysis of our Q3 results and our guidance for Q4 '13 is based on non-GAAP. All references exclude noncash stock-based compensation expenses and the amortization of noncash debt discount amounts when it's drawn [ph] to convertible notes.

Total GAAP revenues in Q3 were $142 million, in line with our guidance of $135 million to $145 million, and representing 27% growth on a year-over-year basis. We recognize DTN-X revenue from 4 additional customers this quarter, 2 of which were new invoice customers to Infinera.

In addition, we also added 2 new DTN customers, taking our total invoice customer roster to 126. We had 3 greater than 10% customers in the quarter, 2 Internet content providers and an MSO. Our top 5 customers included an additional MSO and a bandwidth wholesaler.

International revenues totaled $39 million or 27% of total revenues, reflecting a particularly strong quarter in North America. EMEA accounted for $32 million or 23%, with APAC and the other Americas representing 3% and 1%, respectively. While we expect our geographical revenue mix to fluctuate based on the timing of deployments, overall, we are making good progress in expanding our international footprint.

Service revenues for the quarter were $20.7 million, up from $17.7 million in Q2, reflecting ongoing strength in deployment activity. Services gross margin was 69%, up from 63% in Q2.

Overall gross margin in Q3 was an outstanding 49%, well in excess of the upper end of our guidance and exceeding our 45% midterm target. We had anticipated some of this improvement on the July call related to the deployments of a number of large DTN networks, DTN-X networks, that did not require the shipment of lower-margin amplifiers and other parts for turnup. In addition, our revenue mix in the quarter reflected an increase in revenues from a higher-margin DTN-X network's field sales, somewhat offset by a reduction in field sales for DTN. We also realized higher gross margins on our services revenues in the period, the second completion of a number of large DTN-X service projects.

Our progress on yield improvements and cost reductions remained on track. We saw continued benefits in these improvements in the September quarter, strongly contributing to our Q3 gross margin performance.

Operating expenses for the quarter came in at $55.8 million, slightly above our guidance, which calls for operating expenses of approximately $55 million. This increase included some acceleration in R&D spending.

Overall headcount for the quarter was 1,296 versus 1,238 in Q2. The increase in headcount primarily reflects additions in R&D related to accelerated development activities and in operations. Our operating income for the quarter was $14.1 million. Non-GAAP other income and expense for the quarter was a negative $1 million, which included $0.8 million of interest expense associated with our convertible debt. This amount represents the cash interest payable on the notes and excludes the amortization of the debt discount.

Net income for the quarter was $12.8 million, resulting in earnings per diluted share of $0.10, well above our guidance, which called for an EPS range of $0.01 to $0.07 per share.

Now turning to the balance sheet. Cash, cash equivalents restricted cash and investments ended the quarter at $346 million. Excluding the proceeds of our debt offering of $145 million, this equates to a net cash balance of $201 million, up from $184 million in Q2. We generated $12.8 million of cash from operations in the September quarter. DSOs came in at 56 days, down from 64 days in Q2. This reflected good biddings than [ph] the R&D in the quarter and a continued focus on cash management.

However, our current outlook could result in an increase in DSOs in the fourth quarter, mainly related to the timing of completion and the geographical location of a number of key projects.

Inventory turns were 2.3x, down from 2.8x in Q2. Accounts payable days were 29 days, down from 32 days in Q2. Capital expenditures were $4.2 million, compared to our $4.5 million in Q2, and consistent with our guidance for capital expenditures of approximately $20 million for the year.

Now turning to our outlook for the fourth quarter and beyond. We are pleased with our financial performance in the third quarter and the proof point that it provides for the financial model when the business and revenue mix is balanced. We continue to see strong RFP activity with opportunities to both grow our share within existing customers and to add new strategic accounts. However, the timing of closing these opportunities and their impact on quarterly revenues will remain unpredictable.

As we look at the fourth quarter, we expect our revenue to range from $130 million to $140 million. This outlook reflects a number of significant new wins and deployments, both at existing and new customers. We do not currently expect significant budget flush or year-end money and have not affected this in our guidance.

As we look at performance for the year, industry analysts indicate that growth in the long-haul DWDM markets for 2013 will approximate 11%. Taking the midpoint of our fourth quarter guidance, our revenue growth for the year is expected to be approximately 23%, twice marked growth and above our previous outlook.

As Tom mentioned in his remarks, we remain focused on leveraging the DTN-X and the 100-gig cycle to increase our market share and believe that we can grow revenues at or faster than the market.

Our Q3 gross margin benefited from a revenue mix that we do not regard as typical for this stage of the DTN-X rollout. Rather, we would expect to see higher levels of common equipment as we run 100-gig footprint, and this is expected to constrain gross margins in the end term. This footprint, however, forms the foundation of our future business and allows for an ongoing, processable [ph] business model and long-term, sustainable growth.

As we look to the fourth quarter, we expect gross margins to be approximately 40%, reflecting a very strong mix of low-margin common equipment and the completion of a number of large international service deployments.

In addition, we are beginning to see some reductions in quarterly DTN field sales, and although this has been somewhat offset by a healthy ramp in DTN-X fill, this may have a short-term negative impact on gross margins.

That said, we are very pleased with our progress on yield improvements and cost reductions, which is key to our ability to fulfill this level of network expansion while maintaining gross margins at or above 40%.

Our fourth quarter guidance would result in gross margin for the year of 41%, ahead of our original outlook, which calls for gross margins up 38% to 40%.

As we look to 2014, we would expect gross margin to remain in the low 40s in a period where we are competing for and winning new strategic accounts and expanding our share in existing accounts. We believe that consistent gross margin expansion towards our midterm target of 45% will occur as we add higher margin sales to these networks.

As we look at operating expenses for the year, our previous outlook calls for operating expenses in the range of $210 million to $215 million, depending on revenue and profitability performance. Our guidance for the fourth quarter at $55 million would result in slightly increased spending for the year of approximately $217 million, largely due to increased sales commissions and some customer-driven accelerated R&D activities.

We've not yet completed our operating plan for 2014 but remain committed to increasing operating expenses at a lower rate than revenues in order to support ongoing profitability and achieve our midterm business model.

In summary, our guidance for Q4 is just based on non-GAAP results and excludes any noncash stock-based compensation expenses, and the amortization of our non-debt -- of our noncash debt discount amounts is as follows: revenues of approximately $130 million to $140 million; gross margins of approximately 40%; operating expenses of approximately $55 million; operating income of approximately $1 million income to $3 million loss; net income of breakeven to approximately $4 million loss; and based on estimated average dilutive shares outstanding of $125 million, this would lead to an EPS range of breakeven to $0.04 loss. Please note that the basic share count is expected to be $120 million for the quarter.

Now operator, would you please open the call up for questions? Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Simona Jankowski from Goldman Sachs.

Simona Jankowski - Goldman Sachs Group Inc., Research Division

I just was putting together the slightly lower out-quarter guidance with the lower margins in the quarter, or excuse me, with the higher margins in the quarter, which seem to indicate that perhaps some of the -- kind of the new footprint opportunities are either pushed out or maybe there is just the gap in how those are lattering into the business. So can you just dig into that point a little bit more and just talk a little bit about what are the puts and takes that seem to have impacted the guidance in the out quarter and the mix in the third quarter?

Ita M. Brennan

Yes. So Simona, I think if you look back to our last call, we had talked about margins being higher in Q3 and then kind of coming back down in Q4. And that was because we had a number of pretty significant network deployments where we weren't going to actually be deploying the amplifiers in some of the other lower-margin stuff because they were actually upgrading Samsung DTN footprint, right. So that was definitely part of our expected higher margin performance in Q3, and we didn't expect to see that again in Q4. On top of that, in Q3, we saw some really pretty healthy DTN-X fill that was probably a surprise versus our guidance. And then also, services and services margins actually came in a little bit higher than we would've expected as well. So that's kind of the Q3 story. We fast forward to Q4. We have some very large deployments in Q4. They don't necessarily have the same level of first infill that we saw in some of the deals in Q3. And some of them are also international where there's a lot of services activities. And we think the margins in services may also be a little lower on some of those. That's kind of the bridge between the 2 quarters.

Simona Jankowski - Goldman Sachs Group Inc., Research Division

But as far as just looking towards sequential decline in the quarter that's typically up at least from a seasonality perspective, was there anything that -- was either a competitive situation that you would have hoped to win and you didn't? Or is it purely timing? Or was it just difficult comps -- you had a bunch of big quarters out of the gate when you launched the DTN-X, and perhaps, you can't sustain that same pace? It's just somewhat atypical to have a down quarter in December.

Ita M. Brennan

Yes. I mean, we have been pretty clear on the last call that we weren't sure that Q4 was going to necessarily have the same trend that it would have historically, just given kind of the 100-gig cycle and what's happening, right. But I think it's very much timing, I mean, you heard Tom's remarks about -- in the midterm, we are seeing lots of opportunities, and there are a lot of deployments that we see in the pipeline. It really is a timing of when can you -- it could end up taking revenue on some of those.

Thomas J. Fallon

Yes, Simona. This is Tom. I would reiterate that. I'm very comfortable in the intermediate range time frame. I am more bullish than I have been on what I see. There's a number of deals that we've actually won, but they won't start deploying during kind of a Q4 moratorium on new builts that we'll start seeing next year. I think we've been trying to be pretty consistent that this industry and our company are still going to have some level of volatility quarter-to-quarter. But I am very confident and comfortable with both the market share we're gaining, the customers that we are winning and the RFP activity that I feel -- nothing's done until it's done, but I think we're very well-positioned in the intermediate term to add some very significant customers.

Operator

Our next question comes from George Notter with Jefferies.

George C. Notter - Jefferies LLC, Research Division

Back to the gross margin discussion, I think you guys referenced in the monologue something about some pent-up revenue recognition on the services side, and that having an impact on gross margins. Could you walk through that again?

Ita M. Brennan

Yes. I'm not sure that we said there was pent-up rev-rec, but we did have some large services projects that concluded in the quarter. And a chunk of those were in North America, which is a more established kind of higher-margin service model for us. So that did -- if you look at the margins on services, they're off probably 4 or 5 points on the services piece. So that did help kind of the overall growth margin as well.

George C. Notter - Jefferies LLC, Research Division

Got it. Okay. So just to be clear, the costs associated with those services projects, I believe, are incurred as you -- as time passes, as you work on those projects, and then the service revenue then gets triggered upon completion. Isn't that how the rev-rec works?

Ita M. Brennan

No. So the cost and the revenue are kind of moved together, right? So if you're working on a project and you're accumulating costs, those costs are deferred on the balance sheet, along with any perspective revenue. And then when you complete the project, you recognize the revenue and the costs, right? So this isn't that there were no costs kind of in period or less costs in period. From an accounting perspective, it's more that just these particular projects had a higher profitability.

George C. Notter - Jefferies LLC, Research Division

Got it. Okay. So then if I'm just trying to just still -- I guess as I'm trying to look at service, margins for the products side of the company, I can just eliminate the whole services discussion on margins and get a good look at that. Okay, anything else that was unusual in terms of rev-rec or the margin discussion that we can point to?

Ita M. Brennan

Yes. I mean, it was really -- we knew that we were going to have some deployments that would drive a higher gross margin in the quarter, right. I think, but we were surprised by a little bit as how much DTN-X fill we actually saw in some of the deployments that we completed in Q3. And when you look at Q4, some of these built deployments do not have that same initial field profile, right. So it's really a product mix story more than anything else in the quarter.

Thomas J. Fallon

To me, George, one of the things that's interesting is it's a proof point to me of both our intermediate and longer-range targets. And, typically, as I've been pretty consistent on, at this point, we have the rollout of a new platform, I don't want margins that are too high because it reflects too much fill and not enough footprint. Q3 is an exception to that because we had a couple of customers, who actually had very big new footprint deployments, but they are actually decommissioning their old DTN network using the amplifiers that were in place and putting on 100-gig or 500-gig super-channel networks. That's going to be unusual. Very few customers will do that. And that's why I'm actually delighted with the margin because it's a proof point.

George C. Notter - Jefferies LLC, Research Division

Got it. And then, the other question I have -- I'm sorry, go ahead.

David F. Welch

I have one more point on that. You think about is, is that, we're still a year into the product, right, which means I've got a non-stabilized mixture of commons versus fill, all right? And it takes a couple of years for the margins of any particular distribution of portfolio or customers across that to fully develop. And you'll see a little bit of that ups and downs associated with that.

George C. Notter - Jefferies LLC, Research Division

Got it. Okay. That makes sense. And then just -- another question I have was on visibility. I think you were talking about visibility looking good over the intermediate term in that, I think, product lead times were shorter. Can you just walk us through that again? And how do you view that in light of the comments last quarter? Talking about having 2 months of visibility and less visibility into the third month of the quarter. How does that shape up now as we look into the December quarter?

Thomas J. Fallon

Yes, let me take you back to Q2. In Q2, we said that visibility short-term was probably at an all-time high. And in Q3, I reflected that visibility was probably more normal. It was not as good as it was in Q2 in the short term. I would say this quarter, my view is that the short-term visibility is not distinctly different than it was a quarter ago. But I'm adding to it my view that the intermediate-term visibility is as good or better than I've seen it. And usually, I don't comment on intermediate visibility, but I try to be transparent. Contracts that we're winning today or have won recently, they will start creating revenue opportunity for us early next year. They won't be for Q4. So like the short-term visibility is kind of what it was last quarter, intermediate-term visibility is significantly better.

Operator

Our next question comes from Dmitry Netis with William Blair.

Dmitry Netis - William Blair & Company L.L.C., Research Division

Ita, so just a clarification there. Are you taking -- at a new startup, are you taking the CEO role?

Ita M. Brennan

No. CFO. I'm not sure I'd make a pretty good CEO.

Dmitry Netis - William Blair & Company L.L.C., Research Division

Okay. I'm just wondering. Okay. And then on the Tier 1 customer you announced last quarter, I guess that's Rostelecom?

Thomas J. Fallon

That's correct.

Dmitry Netis - William Blair & Company L.L.C., Research Division

And you mentioned the 500,000 kilometers of fiber. What percentage of that...

Thomas J. Fallon

I'm sorry. You cut out.

Dmitry Netis - William Blair & Company L.L.C., Research Division

Footprint of 500,000 kilometers of fiber is won by Infinera in this case?

Thomas J. Fallon

Yes. We've got our first deployment with them. It's a very small amount of fiber coverage today. And this has to be our opportunity. Anybody like this, it's -- one, how do you compel them to put you in their network? Two, you have to dazzle them with quality, ease of use, reliability, integrated OTN, with switching or with transport and create a new experience for them. And then you have the opportunity to go and hunt within their broader network for those opportunities. So as a percentage of their overall network, it's very, very small today. Our opportunity is we've now opened the door. We have our foot in the door, and we have to go and dazzle and make them a significant customer over time.

Dmitry Netis - William Blair & Company L.L.C., Research Division

Okay, great. That's helpful. And then on the strategic -- I think you made a very clear comment here that you expect new strategic customers to be won over the, I guess, next 12 to 18 months. Any color as to whether those will be U.S. customers, international customers. How should we think about it? Where is traffic going to come from?

Thomas J. Fallon

I think they will be customers, certainly, in North America. They will be customers in Europe. We'll have opportunities in APAC, and none of them will come from China.

Dmitry Netis - William Blair & Company L.L.C., Research Division

Sounds good. All right, very good. And then I guess, my last question would be just -- if you have any comment on the Korean acquisition of Tellabs. I know they have now a long-hauled product. They've got the Metro product, certainly putting the pieces and puzzles together there. And does that affect Infinera? Is that a good or bad thing that's sort of happening in the market? I know there are some large Tier 1 Customers, and how does that sort of affect you or position you in the market? Any color on that would be helpful, Tom.

Thomas J. Fallon

I think, quite frankly, it's healthy for the market. We've long said that the industry has to consolidate. And that this is, I think, the continuation of the beginning of that process. I think having fewer participants, healthy participants, in the market is a good thing for everybody. Second of all, I think it reflects that the size of your company in this industry does matter. We're trying to get there organically by winning large, strategic accounts and market share. They're doing it inorganically, but size is relevant. And I think that we've long believed that, and I think they reflect that. I think that they have a different approach than we do. They're looking at, in my mind, installed base value versus technology differentiation value. We are deep technology innovators. We value the technology disruptions that we think we could bring to market. That is not the path that I view them on. And I think that in my view, anytime these things happen in the industry, I'm going to go and try to work very hard on focusing on their current customers, while they figure out organization structures and who to fire. So I'm doing it as a good opportunity for Infinera.

Dmitry Netis - William Blair & Company L.L.C., Research Division

And your Metro pick, is that still on track, Tom?

Thomas J. Fallon

Yes. We said before that we would deliver prototypes, working prototypes, this calendar year. We are on track to do that this quarter. But I would -- we are, as I've stated before, we have our sights on the Metro. We have every intention of going into the Metro. It will be pick-based, but I wouldn't overread into any specific timing on when you think we're going to get a product to market.

Operator

Our next question comes from Alex Henderson with Needham. Looks like we're going to have Michael Genovese from MKM Partners.

Michael Genovese - MKM Partners LLC, Research Division

Okay, great. I wanted to follow up on the last question. Just about your participation and how we should think about your participation in the coherent Metro 100G-and-above market going forward. So it sounds like what you're saying is you planned something in that market, but it's in product development at this stage? Any more color there?

David F. Welch

Sure. Let me see if I can answer that a little bit. First off, DTN-X is a high-capacity system whether it's Metro or Long Haul. We sell a lot of DTN-X into Metro applications today, and our customers are very happy with that application. The question, really, for us in the Metro is: For the lesser-capacity Metro applications, what complementary boxes do we need to make available to our customers? We've been involved in technology development for the past year, and that technology development is on track, as Tom indicated. In the appropriate time, we'll roll out what we want to say about product launches. But now is not that time. We view it as a market that we will get into, and we believe that we can deliver the customer satisfaction that we have in the long haul into the Metro space. So we think that will bode -- play well for us when we get the right product in there.

Michael Genovese - MKM Partners LLC, Research Division

Okay. When we look at the third quarter and the visibility that you had going into the third quarter, and the third quarter revenues turned out to be strong, and it looked like it was the mix you were looking for, primarily, or even a little bit better in the way it impacted gross margins, but how many kind of customers gave you that particularly -- had that particularly high channel sale? I mean, just roughly, was it in a hand -- a small handful of customers, kind of providing that sense of visibility and that added to the third quarter? And that's just not there -- that's got a different mix in the fourth quarter?

Ita M. Brennan

Yes. I mean, we had a couple of -- so we obviously had the ones that we talked about, specifically, where we had a strong mix of -- because they weren't deploying the amplifiers and stuff, right. And then -- but then we also had a couple of other deployments where -- that they took a higher fill level as part of the initial deployment than we might have anticipated, right. And that's -- that will fluctuate. If you look at Q4, we have some fairly significant deployments where their initial fill level is lower, right. And that's really the dynamic, right, between any large deployment that can be in the $5 million to $10 million range and has that kind of change in mix is going to have an impact on margins, right. Either way, the fill will come. It's just a question of whether you get it kind of initially or it comes out the network, starts to be used, right.

Michael Genovese - MKM Partners LLC, Research Division

But I mean, do you have any sense just roughly speaking that with the customers who took the higher channel sale in 3Q -- kind of any rough sense of how long it will be? How many kind of quarters of demand they started with before they come back with more channel fill demand?

Ita M. Brennan

I mean, obviously, it's going to vary by customer. But nobody is buying fill upfront and paying for it unless they think they're going to use it in a reasonable timeframe, right. I mean, we've seen -- and it's been good news to see people coming back and adding fill to networks kind of inside 12 months. So I would look at the customers that took that extra or additional filler taking it because they think that they're going to use it, certainly, inside 12 months.

Thomas J. Fallon

Our lead times on the fill -- it's 2 to 3 weeks. So this is not "I got to buy a bunch and put it in my warehouse in case I create demand." They can typically win circuits in the market and buy from us and get it deployed without having inventory. So I don't anticipate, as Ita said, that they're stockpiling inventory.

Michael Genovese - MKM Partners LLC, Research Division

And then just last question. I mean, we -- would you just generally expect, I mean, without giving any particular quarter here, guidance like -- but would you predict -- expect to be adding kind of a mid-single-digit number of DTN-X customers on average? Do you feel like that, that's sustainable?

Thomas J. Fallon

I think we've been adding 4 to 5 a quarter, and we're continuing those. What's interesting to me is we continue to, on average, add 3 DTN customers a quarter over the last year. And that product has been out in the market for -- since 2005. So I certainly anticipate we'll be adding some number of like we've been 4 to 6 each quarter. Some quarters might be more. Some quarters might be less. But on average, I would say that's not our unreasonable expectation.

David F. Welch

Just in general, only about a little over a third of our customers buying the DTN-X today. So there's quite a few number of customers to convert. And in general, about 40% of our DTN-X customers are new. So beyond that, I think there's quite a bit of -- and as Tom indicated, we have a strong RFP pipeline. On that, we expect to see a substantive growth and be able to grow faster to market, and that's because of the expansion of that product line.

Operator

Our next question comes from Alex Henderson with Needham.

Alexander B. Henderson - Needham & Company, LLC, Research Division

I got a couple of questions for you. And actually, right on the subject that you were just talking about. So you made a comment that 40% of your DTN-X customers are new. Is that a similar weighting in terms of the amount of backlog that you've got. I would assume that the majority of the newer customers take longer, probably to put in and get acceptance out since your existing customers can accept very quickly. So as I look into what you're looking at into the next several 2, 3 quarters is the mix more towards new customers than old customers in the way you see the revenue pulling?

Ita M. Brennan

Yes. I mean, that's -- I'm not sure on a dollar basis that, that would be true, right. I think we've still got a lot of existing customers that will drive significant dollars, right. In terms of looking at numbers of customers, I think it's fair to say that we will -- we expect to see, and we are seeing, a fair representation of new customers and kind of adding revenues and adding incremental, additional revenues or new revenues to the pipeline. Right? I think if you look -- we've got 4 customers that we haven't invoiced on your DTN-X purchase commitments, and the bulk of those are new, right. So that gives you some idea for kind of where the length of deployment to revenue is on some of the new stuff, right?

Alexander B. Henderson - Needham & Company, LLC, Research Division

Can you give us a sense of how long that typically goes for new customers these days? Is it typically 2 or 3 quarters? Or is it less?

Ita M. Brennan

It very much depends on the customers. It's probably at least a quarter if it's a completely new customer, and mostly 2 and in certain cases, it might be 3. But 3 would be kind of unusual, right.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Similars, if you could help us out a little bit. Similar kind of discussion between domestic and international, are you seeing a shift towards more international? Again, trying to understand the timeline for closing and recognizing revenues, as well as the implications for costs because I would assume that there's a lot more installation internationally and support internationally, which is fairly expensive compared to domestic support.

Ita M. Brennan

Yes. I mean, I think you saw this quarter in the U.S. is very strong, right, because we had a number of large customers in the U.S. that drove significant revenue. So your U.S. mix was actually strong this quarter. But I think as a generic statement, we are seeing a lot more international business and international activities. And we would expect to see that shift continue. And in Q4, if you look at my comments around service projects and stuff that we expect to see a good, healthy international mix in Q4 as well.

Alexander B. Henderson - Needham & Company, LLC, Research Division

So that shift to international is a big piece of the spreading out of the timeline of recognition of revenue then?

Ita M. Brennan

Yes. It will contribute. Some of that will definitely contribute to it taking longer. But if it's a large international customer that we have not done business with before, then the booked revenue cycle is longer than if it was something in the U.S., for sure. Yes.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Another question. There's been a fair number of a announcements out of AWS around the Equinix, and Level 3 talking about cloud-to-cloud. And obviously, I don't want to ask you a direct question on any particular customer here. But can you talk a little bit about how much cloud-to-cloud is a driver of your business? When you say you have 2 10% customers that are in the Internet, are those cloud-to-cloud related? Or are those access-oriented content delivery networks? What should we be thinking about in terms of the cloud footprint as a driver?

David F. Welch

I think what you're seeing is there's growth across-the-board, is the right thing [ph]. Our -- we see -- do a lot of data center-to-data center types of interconnects. We do a lot of distribution networks interconnect, and we are seeing -- we've talked about data center markets, the MSO markets, the carrier markets. All of them are doing well. We see both growth internationally, and in North America from a market share perspective in both -- but I don't think the weighting of one over the other is frankly changing that much. You're just seeing strong growth out of -- across-the-board.

Operator

Our next question comes from Sanjiv Wadhwani from Stifel.

Mike Lin - Stifel, Nicolaus & Co., Inc., Research Division

This is Mike Lin, speaking on behalf of Sanjiv. I just wanted to follow up on the gross margins. Your target for gross margins was 45% in 2014. And I was just trying to get a sense of how much of that improvement is under your control and how much of that was depending on mix.

Ita M. Brennan

Okay. So the -- I mean, the 45% target margin is part of our midterm business model. And we -- if you look at the discussion in my remarks, it's -- we don't see that as being something that we achieve as we work through 2014 in an environment where we're adding some of these strategic customers that we talked about, right. So I think we see it very much as 2014 as the year, where we are continuing to add strategic accounts and strategic footprints. And in that scenario, the margins -- I think what we saw with our Q4 guidance, is we believe we can keep margins in that 40% or above range. But I wouldn't expect to see them expand out towards the 45% on a consistent basis until we're putting fill into these networks that we're deploying now.

Mike Lin - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And regarding visibility, the topline in 2014, you've given indications that in the intermediate term, you feel like you have pretty good visibility. But do you have a sense of what you think growth will be for 2014 overall?

Ita M. Brennan

Yes. I mean, other than saying that we really believe we can take share, right, we haven't really commented on 2014 revenue number beyond that. I mean, we do believe from what we're seeing that we are adding new customers and taking market share. But we'll have to get more granular on that as we move through next year.

Mike Lin - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And how would you characterize the pipeline and your activity as -- would you comment it as accelerating versus the past quarter or 2?

Thomas J. Fallon

Well, I think the RFP activity as in the number of different RFPs that would come into the house as strong and stable over the last couple of quarters. And when it called -- accelerating, I think a lot of networks are making conversions over to 100-gig technologies. When we got into the market and it's called beginning in Q3 of last year, the market started really -- started to turn at that point and really had some acceleration in that process in the first half of the year and I think we continue to see that conversion going on. But it's at a steady clip.

Thomas J. Fallon

I'll add that the pace of the RFP, and I agree with Dave, is roughly the same. I think one of the differences is we're seeing a couple of these deals be more strategic and larger than the average deal.

Operator

[Operator Instructions] Our next question comes from Rod Hall with JPMorgan.

Roderick B. Hall - JP Morgan Chase & Co, Research Division

Tom, I just had a couple. I wanted to see -- I guess, kind of understand what's going on with current business trends. Although [ph] Tom, I don't think I've ever heard of median-term visibility in telecom equipment. So that's a new one.

Thomas J. Fallon

Trying to set a new benchmark to see if anybody'll follow my lead on this. I'll even look smarter than you, but we'll see.

Roderick B. Hall - JP Morgan Chase & Co, Research Division

Exactly. You found a new vein of optimism there. But anyway, I wanted to check and see. Cisco's come out and said that they're going to add long-range optics to their routing platforms, which -- I don't know, it doesn't strike me as that serious of a threat. But I just wondered if you could comment on that strategically. Do you think that as you talk to people -- you think there's any interest in that, you think it could be a new kind of competitive threat in optical? And then I just wondered -- I don't -- you guys may have said this at the beginning of the call so I -- I missed the first part of the call. But can you update us on the CFO search? And are you -- what's your plan there? And when do you think you'll have a new CFO on board? That's all.

Thomas J. Fallon

Sure. I'll start with the CFO. That's more straightforward. We have not started the search yet. I anticipate I will start to launch an official search this week, and I anticipate that the goal, certainly, is to have a CFO on board during Ita's tenure here through the end of February. And I think that's a reasonable target. So that's that one I think. In regard to Cisco putting long-reach optics onto their platform, I'll make a couple of comments and then I'll ask Dave to complete them. One, I think that this is a continuation of the strategy to sell more routers. And anything you can do to sell more routers is a right, what they want to do. And we and the rest of the industry is working very hard to show what the value proposition of an intelligent optical network is. And that means that you need less routers to perform the transport function in the core of the network. I don't certainly felt their strategy for saying that the router can do this. My view is there are technical limitations, particularly around power and space in that. Second of all, I just have a fundamental question is: Why would you put transport technology into the highest cost port platform and the least reliable port platform in the network, when the most reliable port network is at the transport layer and the most value-add pricing proposal is the transport layer? So I understand why they're doing it. I think that -- I personally believe it's going to have a hard time creating much traction and it's a response to, I think, a threat that the transport industry is bringing to the router industry. Dave?

David F. Welch

So I'll add on a couple of thoughts here. It's been our position as always, as architectural position, has always been IT over OTN, which is the Intelligent Transport Network. The concept of IP over DWDM has been a philosophy. It's been talked about for quite a while, half a dozen years or more probably. It never stuck. But sad to say, and we've mentioned this in our call, is that they go out to the surveys, they go out to service providers. 90% of them claim that they will convert their networks to IP over OTN in the coming years. But why is that? The primary cost that they're trying to pull out of network is the burden of the space, power and cost of the IP transit traffic through routers. And IP over OTN or an Intelligent Transport Network reduces that cost. So putting DWDM ports onto a router isn't helping out on the space, power, cost structure of the overall network whereas IP over an OTN or an Intelligent Transport Network satisfies the overall network cost savings. In order to drive a total network cost, layer 0 to layer 3, going down, a good chunk of it is going to come from redistributing how you managed the network from a -- how you manage the packet traffic through these switch structures with inside the network. And it's going to be over OTN in the near term.

Thomas J. Fallon

Thank you for joining us this afternoon, and thanks for your questions. We look forward to updating you on our continuing progress. Have a great day.

Operator

That concludes today's conference call. Thank you for participating. You may disconnect your phone lines at this time.

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