Infinera CEO Discusses Q4 2010 - Earnings Call Transcript

Jan.28.11 | About: Infinera Corporation (INFN)

Infinera Corporation (NASDAQ:INFN)

Q4 2010 Earnings Call

January 27, 2011 06:00 pm ET

Executives

Tom Fallon – President and Chief Executive Officer

Ita Brennan – Chief Financial Officer

Dave Welch – Executive Vice President and Chief Strategy Officer

Bob Blair – Investor Relations

Analysts

Alex Henderson - Miller Tabak

Kevin Dennean - Citi

George Notter - Jefferies & Co.

Brent Bracelin – Pacific Crest

Rod Hall – JP Morgan & Chase

Ehud Gelblum – Morgan Stanley

Samona Jankowski – Goldman Sachs

Blair King - Avondale Partners

Operator

Welcome to the Q4 and fiscal year 2010 Investment Community Conference Call of Infinera Corporation. (Operator instructions.) I will turn the call over to Mr. Bob Blair of Infinera Investor Relations. Sir you may begin.

Bob Blair

Thank you. 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 and results of operations, business initiatives, views on our market and customers, our products and our competitors products and prospects of the company in Q1 2011 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 companies current press releases and FCC filings including the company’s annual report on form 10-K filed on March 1, 2010 for more information on these risks and uncertainties.

Today’s press releases include fiscal year in Q4 2010 results and associated financial tables and investments, investor information summary which will be available today on the investors section of Infinera’s website. 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 fiscal year in Q4 of 2010 which exclude the impact of restructuring and other related costs of non cash stock based compensation expenses. These non-GAAP financial measures are provided to facilitate meaningful year over year comparisons. Please see the exhibit of the earnings release for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful and how they are used by management.

On this call we’ll also give guidance including guidance for the Q1 of 2011. We have excluded non-cash stock base compensation expenses from this guidance because we can not readily estimate the impact of our future stock price on future stock based compensation expenses.

I will not turn the call over to Infinera President and Chief Executive Officer, Tom Fallon.

Tom Fallon

Good afternoon and thanks for joining us. With me are Chief Strategy Officer and Co-Founder Dave Welsh and CFO Ita Brennan.

We are pleased to have concluded a year of significant achievements for Infinera both operationally and within our market. We also made important strategic investments and decisions that align our future with a significant opportunity and we have to help build out and fully utilize the optical infrastructure of the internet.

At the beginning of 2010 we said that our four primary areas of focus would be making progress towards our long term business model, growing share and customers, expanding into new markets and investing in key technologies to extend our competitive advantage. We believe that we have made significant progress of all those (inaudible) over the past 12 months.

During fiscal 2010 we significantly improved the company’s profitability, showing a net profit on a non-GAAP basis in three of the last four quarters and posting $22 million in operating income for the year compared with a non-GAAP loss of $48 million in fiscal 2009.

We believe that we have also achieved proof points of our long-term business model with non-GAAP gross margins of 51% in the last two quarters of the year. In addition we generated $30.5 million in cash from operations and grew our cash balance to $296 million while carrying zero debt.

We also grew our revenue 47% year over year from $309 million to $454 million on expanding our number one market share position in the US WDM market to 30% up from 29% one year ago and growing our share worldwide to 16% up from 12%. We believe this reflects continued customer preference for Infinera’s differentiated digital optical network and the economic and operational benefits that it provides.

We had an especially strong year with customers in the cable and internet content providers basis with revenues up 82% year over year and several of these customers completed large build-outs.

While I remind you that in the US cable industry, six of the top seven providers utilize Infinera gear on their networks. This business is increasingly important as it reflects where so much of today’s internet traffic is moving and demonstrates that the Infinera value proposition resonates clearly with this class of customer for rapid response to market demand and flexible demand with our paramount.

On the new customer front we added five customers in Q4 bringing our roster to 82 versus 69 one year ago. We also made some important strides in penetrating new markets in 2010. After introducing our ATN metro product we signed up and shipped the ATN to 22 customers last year including three ATN only customers.

With 19 existing DTN customers taking the ETN we now have 23% of our customers buying end-to-end Infinera networks. The metro market remains one of our most promising long-term growth opportunities and to the degree our top line growth allows a growing portion of our future investments will reflect an increase in focus on this opportunity.

We also established Infinera as a significant participant in the submarine market where we now have five customers carrying traffic over 8500 kilometers of submarine networks. The success with our sub sea landing station platform has resulted in additional terrestrial business with some of our submarine customers who have recognized the cost effectiveness of not only the Infinera platform but also the Infinera network solution. And we continue to grow our worldwide presence with live traffic on Infinera networks now in 43 countries having expanded our product and equipment deployment into the Middle East, Brazil and additional Eastern European countries.

During the year we also made a set of investment decision relative to our product roadmap that we believe over time will provide a significant strategic advantage to our company, our customers and our shareholders.

In May 2010 we accelerated the development of our 100G coherent network based on our 500G PIC and decided to address the 40G with a solution based on discreet components. We remain on schedule to introduce our 40G solution in the middle of this year providing twice the fiber capacity of competitive offerings. We are also on target for volume production of our 100G solution in 2012. We believe our PIC based economics and early entry into the 100G coherent transmission adoption cycle positioned us well for significant market share gains with those customers that are looking for high capacity systems and radical economics.

Today I’m happy to report additional advancements that demonstrate our new programs are progressing on schedule. Our first flex coherent (inaudible) is in fab. Flex coherent technology is important because it enables software configurable selection of different modulation schemes for varying customer applications. In addition, we now have working in our labs the five terabit OTM switch that will be a key part of our integrated 100G platform uniquely integrating full bandwidth management intelligence and world class optics. In addition we have finished the first phase of our PIC manufacturing expansion preparing for the 500G PIC production and volume ramp.

When we first entered the market in 2004 Infinera brought to the industry the digital optical network architecture which consists of high capacity low cost bandwidth based on PICs, an integrated OTM switching. Our continuous expansion in market share over the last five years and our reputation with customers for high quality, high service velocity and low OPEX costs are due to the unique features of the digital optical network and the value it enables our customers to achieve.

Today the traffic patterns in the optical network continue to grow to accommodate increased bandwidth demand from video, mobility and cloud computing. The market is seeing growing demand for increased fiber capacity, which is being met in the short term with solutions based on 40-gigabit wavelengths and with 100-gigabit systems following soon after.

Competitor 40G solutions typically provide 3.2 terabits of capacity on a fiber. Our 40G solution which will be introduced in the middle of this year will provide up to 6.4 terabits of capacity on a fiber which we expect to be the highest capacity 40G solution in the market.

In this environment our customer base remains energized about our product and technology road map. We see this in the quality of our trial activity for our 40G and 100G solutions and in the customer feedback from these trials.

In the near term however there are some opportunities we are missing out on when customers who have an immediate need to increase the fiber capacity in their networks are forced into a short-term 40G decision. We’ll be able to address these opportunities later in the year when we bring our differentiated 40G solution to market and over the longer term with our PIC based 100G solution.

The addition of our 100G technology to our optical platforms will combine increased fiber capacity with unique features of the digital optical network. Further we believe that Infinera and its customers will experience the same competitive advantages that we began delivering to customers with the BTN system in 2004 that resulted in our rapid market share gains.

At the network architecture level the collapse of layers zero, one and increasingly layer two, also known as optical, transport and switching into a single layer of the network is an important transition which Infinera has led and one that we believe we will benefit from even more as the network continues to evolve.

Back in 2001 our founders recognized that a digital optical network based on PICs would enable a new kind of transport network, one with massive low cost bandwidth in the cloud and a pervasive distributed switching capability throughout the network. We began delivering our BTN to customers in 2004 and achieved a market share leadership position in North America in just 18 months. In the last couple of years we have seen competitors in both the optical and the routing world embrace this approach and talk about future architectures that combine these layers. We believe that with our PIC based digital optical network we are uniquely positioned to capitalize on this trend as networks take advantage of 100G based wavelengths.

Rapidly growing and unpredictable, bandwidth demand will place even more of a value on the ability to deliver and manage high capacity bandwidth rapidly anywhere in the network. In this world point-to-point pipes don’t meet the needs of the network. We believe that it will take a massive pool of low-cost bandwidth in the cloud, pervasive OT and switching and the intelligence to manage the networks of the future to deliver high capacity services quickly and cost effectively. That can only be achieved with PICs. That was our vision in 2001 for today’s networks when we introduced the digital optical network and we believe it is even more true for tomorrow’s high capacity 100G based networks.

We believe that as we introduce our 40G and 100G systems we will see more and more service providers recognize these unique advantages and adopt a digital optical network architecture. While we will continue to focus on expense management in fiscal 2011 our top priority is to ensure that we set the stage for a successful launch of our new products later this year and in 2012. Along those lines you will see us increase our investments to enable our PIC (inaudible) to handle the expected volumes of our new 500G PIC and to expand our sales force around the world as we begin the process of selling our broader portfolio of products.

Ita Brennan will now provide a review on our Q4 financial performance and our outlook for Q1 of 2011.

Ita Brennan

Thanks, Tom. I’ll review our Q4 actual results and then follow that up with our outlook for Q1.

The following analysis of our Q4 results is based on non-GAAP. All references exclude non cash stock based compensation and any restructuring costs. Total GAAP revenues in Q4 were $117.1 million compared to our guidance of $115 million to $120 million and revenues of $130.1 million in Q3.

Level three was our only 10% customer in the quarter at 10.2% of revenue. We saw a good demand from bandwidth from our existing customers. As many of them filled out networks footprint they had purchased earlier in 2010.

TAM shipments for the quarter exceeded our 2400 unit target with level three TAM purchases as expected below historical level. We added five new customers in the quarter for a total customer roster of 82. One of the new customers added in Q4 was an ATN only customer. In addition we completed six new ATN deployments with existing customers bringing our total ATN customer count to 22.

International revenue amounts to $34.7 million or 30% of total revenue for the quarter. (inaudible) accounted for $30.6 million or 20% up from $20.3 million and 16% in Q3. The balance of our international revenues came from the other Americas and APAC.

Our service revenues for the quarter were flat to Q3 of $13.5 million. Services margins were approximately 58% reflecting the improved mix of higher margin services in the quarter.

Overall gross margins in Q4 were 51%, same as in Q3. This compares to our guidance of 45% to 47%. As mentioned above we experienced strong bandwidth demand from existing customers in the quarter that resulted in higher shipments of TAMs and DLNs which drove a favorable margin mix. In addition, although we added five new customers, it did not drive significant lower margin footprint in the quarter. As we continue to diversify into new markets and technology we believe the customer adds metric becomes less useful as an indicator of footprint expansion and mix of business. Going forward we believe there will be more meaningful measures of our progress such as penetration of current customers markets and new technology and we will be sharing these metrics as we launch our newer products.

Operating expenses for the quarter were $51.9 million compared to our guidance of $50 million to $51 million and versus $48.1 million in Q3. Our R&D expenses came in at $27.5 million up slightly from our expected $27 million with the remaining overage in operating expenses coming from costs associated with incremental customer lab trial activities.

We began the year indicating that all things being equal we would exit the year with operating expenses in the mid $40 million dollar range. This guidance incorporated an expectation of R&D expenses of approximately $26 million compared to the $27.5 million reported in the December quarter.

Approximately $1 million of this overage in spending related to our success at Quest and the need for further (inaudible) certifications. We will complete our final quest related Telcordia payment of $1 million in Q1 of 2011. Sales commissions, expansions and some limited sales headcount additions accounted for the balance of the higher operating expenses. Overall headcount for the quarter was 1072 versus 1040 in Q3. Most of the headcount additions occurred in operations as we began preparation for the manufacture of our 100G platform.

Operating income for Q4 was $7.6 million. Other income expense for Q4 was a favorable $0.3 million. Net income for the quarter was $7.6 million resulting in earnings per diluted share of $.07 versus our guidance which called for earnings of $.02 to $.05 per share versus earnings of $18.7 million in Q3.

Now turning to the balance sheet. Cash, cash equivalents, restricted cash and investments ended the quarter $296 million versus $288 million in Q3. We generated $7 million of cash from operations in Q4 versus $10 million in Q3. DSO’s were 59 days up from 45 days in Q3. Inventory turns were 2.8 versus 2.9 in Q3. We saw a reduction in overall inventory levels of $6.8 million down from $88.7 million at the end of last quarter. We will continue to focus on inventory management as we rebound the supply chain having buffered supply constraints earlier in the year.

Accounts payable days were 43 days down from 52 days in Q3 primarily due to linearity of inventory receipts which were weighted to the beginning of the quarter. CAP and expenditures were $5 million in Q4 compared to $5.9 million in Q3.

And now turning to our Q1 outlook. We exited the December quarter with backlog of approximately $35.5 million as compared to $52 million at the end of 2009. At this stage in Q1 we have limited visibility to additional new footprint that will be deployed within the quarter. However (inaudible) purchases for TAMs and DLNs from existing customers have remained strong as they continue to build out capacity. It is important to note that we do not believe that we have lost any existing customers but rather that many of our customers are still digesting the expanded 1.6-terabit footprint that they installed 2010.

We are seeing some increase in opportunities where a higher fiber capacity is becoming a more important criterion for success. We continue to compete for this business using the other benefits of our digital optical network deploying 10 Gig capacity now with a migration to our differentiated 40G line card when it is introduced mid-year. However there are some opportunities in the short term that we are missing out on with customers who would require higher fiber capacity today. The combination of these factors calls for revenue guidance that is based primarily on continued bandwidth consumption with lower levels of new footprint additions in the quarter.

Our gross margin outlook for the quarter assumes continued strong gross margins and products makes with TAM shipments in excess of our target of 2400 units and common equipment remaining at lower levels.

As Tom mentioned in his remarks, we completed phase one of our Fab reorganization which will support early production volume of 500G PIC. We are now beginning phase two of this work which will exam production of the 500G PIC and module increasing manufacturing capabilities and adding capacity in anticipation of volume shipments of the platform in 2012. These phase two activities will involve increased facility space and the installation and qualification of additional equipment.

In addition to planning our PIC (inaudible) capabilities we are also beginning the expansion of our systems manufacturing new product introduction or NPI capabilities for our new platform. This will also involved additional space and equipment build out, incremental headcount and materials similar to those described for PIC and modules above.

We expect to incur additional capital expenditure of approximately $20 million for the year as part of these efforts. In addition we expect to see an unfavorable impact to gross margin of approximately 2% for the year to cover headcount and material expenses needed to complete the lengthy qualifications steps required to qualify the equipment and production line.

As a management team we have given much consideration to our approached operating expenses for 2011. We believe that it is imperative that we make the investments necessary today that will allow the company to leverage the launch of the 100G platform in 2012. These key investments include marinating R&D expenses for the year in the $110 million to $115 million range with some volatility on a quarter-by-quarter basis depending on timing of activities.

Continuing targeted investments in sales and marketing related to the expansion of geographical footprint focus on key market segments and presales activities important to the success of the 100G platform and limited investments in G&A to ensure that we have the right people and information systems in place to support future international expansion and company growth. On this basis all things being equal, we expect total operating expenses to be in the $204 million to $208 million range for the year.

The following guidance for Q1 is based on non-GAAP results and excludes any non-cash stock based compensation expenses. Revenues of approximately $90 million to $97 million, gross margins of approximately 45% to 47%, operating expenses of approximately $50 million, operating and net loss of approximately $4 million to $10 million. Based on estimated average rate of diluted shares outstanding of 109 million, this would lead to a loss per share of approximately $.04 to $.09. Please note the basic share account is expected to be 104 million for the quarter.

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

Question-and-Answer Session

Operator

At this time we will now begin our question and answer session. (Operator Instructions.) Our first question is from Alex Henderson. Your line is now open.

Alex Henderson - Miller Tabak

Hey guys. So a lot of stuff there. You’ve got weaker then expected backlog, lower than expected revenues, higher than expected OPEX and down GM some. So as we look out past Q1 guidance which is obviously pretty rough, does this persistent to Q2 and into the early second half before we get that 40G PIC out or how should we be thinking about the trajectory over time? I know you don’t want to give more than one quarter guidance but I think this kind of guidance calls for a little bit more clarity on trajectory.

Tom Fallon

Hi Alex. This is Tom. A couple things; I don’t give more than one quarter outlook of guidance but I will make some comments across the larger horizon. First of all it’s important, I think, that we do not believe that Q1 represents a new baseline aerate for the company. We methodically tried to bring down our backlog because we’ve always viewed time as a weapon. At parts of last year our backlog was large which gave us great visibility but it doesn’t reflect the part of the value proposition we bring to our customer base so we’ve been working to bring that backlog down and represent more reasonable lead times to our customers in the two to four weeks.

Second of all you know our bookings for the quarter have started out somewhat slow certainly compared to normal. But if we compare them to how they started both in 2009 and 2010 we’re running slightly ahead of what we ran in both those periods and what we typically see then is some pick ups later in the quarter in to the year. Having said that, it is a slow start to a quarter and our visibility is less than we normally see.

When I look across the horizon, you know I can see lots of different scenarios that I’m conflicted with, what I look at, and I’ll give you my perspective on some of the positives and some of the neutrals and some of the challenges.

On the positive side I think we all agree that the fundamental demand drivers in the industry remain very strong whether it’s video or 4G or cloud, the fundamental demand when I talk to customers continues to be there and that is good for the industry and it’s good for us.

I think secondarily the economy seems to be from a macro-economic perspective in a reasonable position to make reasonable investments. I don’t witness people going back to very bold investment strategies of taking significant risks, if we build it they will come, but I do think that there is a fundamentally reasonable environment for people willing to make reasonable investment decisions and once again, that’s good for the industry and it’s good for us.

I also see and agree with the overall market forecasts where both the industry is projected to grown at a dollar level and it’s projected to grow at a wavelength level this year. You know, in the neighborhood of 20% or so. And I don’t have any reason to suspect that not being true. So from all those perspectives I think that that’s good news.

I also think that the 10G solution is still the best economic answer in the industry. I think 40G at now as the data I get from customers is that 40G with coherent is probably roughly on par with the cost of 10G and that is relatively new and it’s important to keep in mind that 40G has been up for a long time and it’s just now at parody. So that to me is both a positive and a negative. Typically a new technology wont be adopted at any large scale until it has better economics then a repeated replacement technology and I still think that’s going to be the case. We believe that 40G will be short-lived but clearly for the negative side there is traction in the 40G market where in certain places there is fiber exhaust and while we sell an optical transport system that is 10G, 40G and 100G ready at an optical layer, if you have fiber exhaust today, you are going to make decision to alleviate that problem with 40G and today we don’t have that. As we said, we will have that answer and we think a world class answer later this year. But in the short term that creates some downward tension.

I also think that a positive sign or signal is that from everybody we talked to, we believe that 40G is being used tactically to bridge short-term gaps until 100G is economic and the view from all the customers I’ve talked to is that they don’t view 100G as being economically ready for the market until 2012 or more than likely 2013. I think from a longer-term horizon, that is very, very positive for us that it creates an opportunity for us to introduce our 100G platform in 2012 and enable the market. We believe that the radical economics, as only enabled by (inaudible) integrated circuit will allow us to enable that 100G market and we have every intention of creating the market share gains that we did for the DTA when we introduced the 10-gig.

So if I paint all of that out and it doesn’t maybe help you a lot but I believe that this current low rate in Q1 is not reflective of the opportunity of the market and it is not reflective of our opportunity in the year. From a longer-term guidance I see scenarios based upon fundamental demand and our leadership in 10G that we could have a year that grows certainly off of last year. I see an opportunity based upon the success of short term 40G quite frankly that we could have a flat or down year even. Though I think that that’s less likely.

So in the longer term I think the 100G sets us up very well. I think our 40G solution that comes out in the middle of the year with it’s twice the fiber capacity of the competitive offering positions us very well. And I think in the short term our customer base will continue to expand their networks but they are getting off to a slow start giving us very limited visibility right now.

Alex Henderson - Miller Tabak

Just to clarify, did you say 2400 PICs for Q1 and if the road is down and the PICs are flat to up, wouldn’t that imply improvement of gross margins. So could you talk a little bit about the timing and filtering in that 2% hit to gross margins due to the hiring for the production facilities. And similarly on the Telcordia payments, a million in Q1 on the final on the old one, when do the other ones kick in for the Telcordia testing for the next set of products?

Tom Fallon

So you said 2400 PICs and I think you must have meant TAMs. So that’s fine. But I’ll answer the Telcordia question and then I’ll have Ita talk about the TAMs and the margin, the two points that you referenced.

Telcordia is a fee that we have to pay when we get certified for a RBOC when we won Qwest, part of winning their Qwest in region areas was that we get our release 6 certified by Telcordia. So we do that on an as-demand basis. It typically takes about six months to go through the complete certification process. About half the costs were experienced in Q4 of last year and about half the costs will be experienced in Q1 of this year that Ita talked about. And then we will be done with the Telcordia fees until we decertify a new release.

Ita Brennan

Yeah. And (inaudible) on the margins. In Q4 we saw TAM units that were in excess of that 2400 unit number. We’re guiding kind of a 2400 or a little above that for Q1. The mix of TAMs to total revenue is pretty consistent over those two quarters but we are anticipating that we will have that two point impact in the first quarter as we start to kind of hire and it’s really materials and other consumables that will get used as we kind of continue to bring up equipment etcetera in the fab. So that’s going to be kind of an ongoing somewhat linear 2% of margin across the year. So if you start with kind of a 50.5% that we had in Q4, take off those two points and then we’re, you know we are losing some scale on fixed costs because the revenues are down so much, that will get you in the 45% to 47% range.

Alex Henderson - Miller Tabak

Okay. Thanks.

Operator

Our next question is from Kevin Dennean from Citi. Your line is now open.

Kevin Dennean - Citi

Great, thanks very much. Tom, question for you. I guess could you give a sense for how you expect a 10G market to grow this year within your key markets and your key customer base.

So, I heard your comment, it was a fairly general comment about the overall market but to my mind, you know, Infinera doesn’t play a significant role in China obviously, not much in Japan, you’re primarily a domestic story for I would say bandwidth wholesalers. What do you think, what sort of demand are you expecting from your key customer base or your typical customer base this year?

Tom Fallon

Yeah, thanks Kevin. You know I think we’re going to experience with our typical customer base roughly what the growth of the overall market is in North America. You commented, and I agree, we are not a participant in the Chinese market; quite frankly no North America or European suppliers are; you have to be a Chinese supplier to do that. But you’re referencing a lot of our businesses with the wholesalers and a lot of it is. But if you look at also what I commented on the cable and internet content provider market for us last year, it grew very, very significantly, I think somewhere in the, I think 80%.

We talk about last quarter, they’ve been consistently about 35% of our overall revenue and if you look at where the internet traffic is moving to, it’s moving to the wholesalers, it’s moving to the cable providers, it’s moving to the internet content providers, it’s moving to our customer base. So I believe that as the market which is forecasted to grow approximately the 10 Gig market probably about somewhere between 15% and 20% on a waves basis, a 4% or 5% on a revenue basis. And I think our customer base, quite frankly, should be most of that. And I think that we should have the opportunity to participate in a lot of that. We continue to have extremely good relationships with our customers. We are consistently told we are the best provider from an overall quality and overall operating cost and ease of use perspective and I believe that we’re going to continue to have opportunities to expand as they would expand in their markets. And that’s the content providers, the cable providers, it’s the wholesalers.

Kevin Dennean - Citi

Thanks for that Tom. And then Tom, a follow up for you. I think previously you’ve made comments that you’ve expected some of your key customers, some of the bandwidth wholesalers to see budgets get released earlier in the year then fade to tier one. Has that played out to script so far? What are the early indications here?

Tom Fallon

Yeah, that’s part of the challenge of why we are approaching this quarter in Q1. We are not seeing yet the level of visibility that I would have anticipated at this time of the year and it is because the best I can tell that the budgets are not being released to our teams, our sales teams, and understand what the build plans are. I don’t think it’s, I don’t get the feeling it’s because, I don’t certainly get a sense when I talk to the customers it’s because they don’t plan to invest this year. It is just a slow roll out of their budgets and the execution of their plans. When we look at our pipeline of activity, I talked about a good pipeline last year. You know the pipeline activity we went about this Q4. In Q4 we went about 40% of the deals that we saw and that’s a pretty good continued win rate. If we looked at the larger deals over the last half of last year, our win rate is less on the larger deals but those are the more, the deals that we have a less opportunity. It includes tier ones that are not necessarily North America but it shows that we are continuing to participate with them and sell to them for our future architectures.

So I do think that it is a slower release of budgets than we are used to. But when I compared it, like I said, to our start in 2010 and in 2009, we are tracking slightly ahead of them. We are tracking slightly behind how we started 2008.

Kevin Dennean - Citi

And if I may one quick one for Ita. I think Ita, I heard you say that going forward you won’t release the customer base number but there will be some other metrics that you’ll reference. Can you give us some insights on when we’ll start hearing about those metrics and some color on what they may be?

Ita Brennan

Yeah, I mean we’re still going to work through that here over the next couple of quarters but the thoughts that we have as stuff that will be interesting is like penetration of the 40G at existing customers, new deployments that new customers and focus more on that rather than kind of an arbitrary number of customers which doesn’t really weight by size of customers. That was a meaningful metric back when we were a smaller company and we requiring were somewhat similar in nature and size. So it’s become less useful I think for what it was intended which was kind of helping you guys understand footprint deployments etcetera. So we’ll look to talk more around the product between metro and also kind of around our success at rolling out new technology.

Kevin Dennean - Citi

And will you be offering that type of color with Q1 numbers or are we going to go dark for a while in terms of some additional metrics to think about the business?

Ita Brennan

We certainly wont go dark. We will attempt at east to come up with metrics that are meaningful and explain what’s happening. I mean we’ll definitely provide you with as much color as we can. I mean if the customer ad numbers is useful and meaningful, we’ll provide that but then we’ll also find some other metrics that will help you understand what’s happening.

Kevin Dennean - Citi

Okay, great. Thanks very much.

Ita Brennan

Thanks Kevin.

Operator

Our next question is from George Notter of Jefferies. Your line is now open.

George Notter - Jefferies & Co.

Hi guys, can you hear me? Great, thanks very much. Hey I wanted to ask about just the competitive environment. There are other companies out there now developing photonic integrated circuits, one of them is actually on the road to do an IPO in the photonics. I guess I wanted to get your perspective on what that means for the industry, the availability of PICs for others and how do you differentiate yourself visa vie these guys and others who are coming up on the PIC side as well. Any thoughts there would be great.

Dave Welch

George, maybe I can take this. This is Dave Welch.

There’s two things I’d like to say about that. One is it’s clear that PICs that the concept of photonic integration is a key concept for the advancement of the networks going forward and that’s what you’re seeing from discussions that’s been around from the component set as well as some of our system level competitors understanding the value that it brings. But just like in the silicon industry, there’s a wide variety and delineation between what integration means. There’s a key difference in what we do in both the ability to integrate what I would call a true system on a chip which means I’ve got an electronic interface and I’ve got a fully digital optical output as opposed to having an optical layer as an interface between technologies. The ability to integrate active components, the ability to integrate a highly complex system which is compatible with the long haul or off the long haul marketplace is truly unique if we look at what we integrate offered, started offering to the market in 2005, over five years ago, five and a half years ago, the level of complexity and the level of complete system on a chip integration for what’s being offered out there is a just would be a different metric. It just doesn’t compare into the added value of the system.

George Notter - Jefferies & Co.

Okay, maybe I’ll take that one offline as well. I’d love to ask you some follow-ups there. But, okay, the other question I have was just on the ATN business. I mean it sounds like that is better, you added customers there, I guess 22 customers now this quarter. If memory serves, flow through provisioning came available through a new release I think in the fall time frame. Is that the catalyst that’s really driving the growth on the ATN and then also I’d love to know where that is now as a percentage of sales or at least when you might start breaking that out in terms of being significant for your overall revenue stream.

Tom Fallon

Sure George, I think it’s a couple things. One, they happen to be integrated under our overall digital optical architecture having flow through provisioning but not have back to back transponders. Having Infinera as quite frankly a quality, Infinera service and support, Infinera end-to-end being responsible for the network and overall network management, the efficiency of being able to provision. Our customer base is becoming more and more compelled by the operational efficiencies and the ability to use time as a weapon for their customers in their markets with our overall architecture. So I think ATN is going to continue as we continue to add more features. We have another release coming out in this year. The plan is for Q2 of this year to add some more functionality that will make it even more attractive in the metro. So we’re going to continue to invest in that space.

You ask about what kind of run rate it is. We haven’t broken it out historically. I can tell you that it’s running about 5% of our overall business so it’s an area we still have a lot of opportunity to grow. It continues to be primarily today for our DTN customers who are extending the value proposition of our digital optical architecture more end to end. But we also have now three customers who are ATN only and that tells me that our platform has enough compelling advantages on its own and will continue to grow that we should be able to grow our base and at some point have ATN customers that then choose the DTN. And we’ll probably, at 5% revenue, quite frankly I don’t think it’s significant to break out on an ongoing basis but we will start as we bring out new platforms, break out more of our businesses so that you can see it.

George Notter - Jefferies & Co.

Great. Fair enough. Thank you very much.

Operator

Our next question is from Brent Bracelin with Pacific Crest. Your line is now open.

Brent Bracelin – Pacific Crest

Thank you Tom. Obviously a lot of moving parts here. several questions from me but what I really wanted to start with, you know, the change in the demand environment. Over the last six months and basically your guidance here looks like the business on a quarterly basis will be down about 25% from where it was trending in September. I think last quarter you talked about kind of customers digesting capacity 2010, 47% growth. Clearly customers added capacity last year. The new wrinkly I guess today is the 40G coherent and price imparity with 10 Gig. As you think about the change in demand environment, how much would you attribute to your customers digesting the capacity that they bought and that’s what you’d attribute this slowdown here to versus a change in preference relative to a 10 Gig versus 40G.

Tom Fallon

My belief is that it is vastly related to our customer base putting in a substantial amount of build in the early and middle parts of last year. I would say that we did not understand well enough that it was probably over building for a period of time as I think certain dynamics in the industry caused a very, very significant peak of demand in a short period of time. And I think some of that quite frankly can be attributed to Netflix build outs. That forced some people to go and buy a lot of capacity and put it in place.

Now the good news is that dynamic as a structural dynamic in the industry is not going away, that’s going to continue to drive more and more demand. But I think that our very significant Q3 was a bigger than, a bigger bubble than we had anticipated from a fundamental demand. I think that that is being consumed and I think, like I said, I do not believe Q1 represents a new run rate for our business. Having said that, I do think there is some impact to 40G. I don’t think it is subsidize. If I look at where 40G is being sold today, it is vastly not into our customer base. But I don’t think that our customer base, it doesn’t raise questions. So there’s an amount of how much business is it taking away versus how much uncertainty does it create that delays some purchasing. I do think (inaudible) my Q1 that we (inaudible) to is based upon the fact that we have taken down backlogs so that we can continue to service our customers and help them win in their markets. And it is our customers having a slower s tart than we would have liked to the quarter versus they have structurally made new decisions moving forward.

Brent Bracelin – Pacific Crest

Fair enough. And then as we kind of look forward here, Verizon’s buying Terremark that was announced after the close. Is Terremark a customer? If so, does that give you a new foothold into Verizon and how should we kind of think about that relationship?

Unidentified Company Representative

Terremark is not a current customer of ours.

Brent Bracelin – Pacific Crest

Okay. Relative to the 5-terabit OTN switch, you talked about that being in the lab. You have not indicated when that product will ship and is that only in your lab or is it in other customer labs as well?

Tom Fallon

Yeah we have indicated when the component will ship. We have said it will be introduced in 2012, right. So it’s going to be integrated with our 100G photonics so we’re talking about we’ve historically given milestones typically on how we’re progressing around more of a component level. We are now giving a big of a look into how we are progressing at a larger system level although the intention is to say that we now have our, it’s not a product announcement but you can understand now that we have a 5-terabit switch that goes into the integrated platform.

Brent Bracelin – Pacific Crest

Fair enough. My last question is really around the more color than you’re giving here on 100G and phase two of ramping up capacity and (inaudible) much more granularity around 100G and then trying to volume ship 100G. How much of that is tied to the response to 40G kind of coherent at parody versus customer interest in 100G and you really wanted to hit that sweet spot of the market in 2012.

Tom Fallon

Yeah it really doesn’t have, in my mind, nothing to do with 40G other than I continue to believe, we’ve said there’s a 40G squeeze. We continue to believe that. 40G is filling a tactical spot in the market where there’s fiber exhaust in certain places but being at price parody with 10G, nine years after it’s introduced to the market, that is not a successful technology launch. We are bringing the, we made a decision to accelerate our 100G to market but I’ve always been clear with our vertically integrated capability, we might not be first to market but we have every intention to structurally enable markets through radical economics and we’re going to bring online capacity, this year, that prepares us not to bring a few waves to market in 2012 but to be the market leader in 100G in 2012. And we’re going to do what’s necessary this year to make that investment.

Brent Bracelin – Pacific Crest

Very clear. Thank you.

Operator

Our next question is from Rod Hall with JPMC. Your line is now open.

Rod Hall – JP Morgan & Chase

Yeah, thanks for taking my question. I’ve just got two. One is with regards, and again I know you’ve given a lot of color of what’s going on with the revenues but I just want to revisit the topic a little bit just to get a better feel for how you think the market is developing. It feels, I mean to me it feels like 10 Gig spending is probably tapering off and that may be why you’re seeing this weakness in revenue. You can correct me if that’s wrong.

What I’m wondering is I guess you’ve got two options if you’re a carrier and your tapering off at 10 Gig spending either you’re going ahead and planning for 40G spend or you’re going to wait until 100G comes along and I wonder if which one of those do you think people are doing? Are they just, they have enough capacity, they’re just going to utilize capacity this year, run networks a little hot if they have to and then 100G next year when it becomes available. Or do you think 40G is gaining some meaningful traction at this point and will continue to gain some traction through the year until 100G becomes available.

Sorry for the long-winded question but that’s number one. And number two is for Ita. OPEX is expanding this year. I know you’re preparing for 100G but given the revenue hit that you’re taking; does it really still make sense to continue to expand OPEX like this? Wouldn’t it be better to wait until maybe a little bit further towards the back end of the year before you go ahead and induce the revenues or is that what’s actually going to happen? Are we going to see a dip in OPEX and then a recovery?

So those are my two questions. Thanks guys.

Tom Fallon

Yeah, so in regard to the market on 10 Gig waves versus 40G. You know 40G is creating some traction. If you look at the breakout, the last ones I’ve seen, it’s still, there’s a substantial amount going into China, mostly by the Chinese suppliers. There is a substantial amount going into tier ones. There is a growing amount going into what we would classically consider our customer base.

Do I think that it is taking away much of our business? We have lost some deals. So far I don’t think that they have been material to revenue that we would have recognized yet but each quarter it is becoming more impactful and I take it very seriously, I don’t care if it’s one dollar or a million , I take every loss very, very seriously. Having said that, the 10 Gig wave market is forecasted to grow about 20% this year and that will translate to about a 4% or 5% growth in revenue in the industry. I think there is no reason to believe that the heritage of the telecom industry will change that they are willing to be driven by dollar per bit per mile. And 10 Gig continues to be the best economic answer if you are going to move to a 100G as the long-term answer.

If you’re making the strategy or decision to move to 40G as the long-term answer, the economics now say it’s a neutral to 10 Gig. But there’s no belief, certainly that I’ve seen, that it provides an economic advantage over 10 Gig. Everybody I talk to, even the people who are deploying 40G say we are deploying 40G when we have to. We are waiting for 100G because we believe the 100G is going to provide the normal economics evaluation that will allow us to deploy 100Gs at six times or ten times the capacity at six times the cost of 10 Gig and we don’t think that’s going to happen until probably 2013.

So people are deploying 40G, they’re doing it when they have to for the most part. And if they don’t see themselves going to 40G, they’re going to continue to deploy 10 Gig until 100G becomes available economically. Our job is to make 100G available economically.

Does that answer your question, Rod?

Rod Hall – JP Morgan & Chase

Yeah, yeah, thanks Tom. That’s good color. Thank you.

Ita Brennan

Yeah. And then on the OPEX, I mean the two areas really that we’re investing in, one is around R&D and the other is in sales and marketing and particularly in sales headcount. The R&D piece, I think the worst thing we could do at this point in time would be to interfere with the momentum that we have in getting both the 40G and the 100G products launched as quickly as possible. And what we’ve done is we’ve looked at that as closely as we can and come up with a budget that we believe is the best and most efficient way that we can do that and now we want those engineers to go do their job and get this product to market as quickly as possible. I think interfering with that or trying to hold that back or push it towards the back end of the year would be penny-wise and pound-foolish honestly. So you will see the R&D probably move around quarter over quarter. We’re not going to try and enforce some kind of linear model on that just because we really want them to move as quickly as possible. If they can pull something in, we’re probably going to let them pull it in but we believe we’ll stay within that envelope of spending for R&D.

On the sales and marketing side it will be a ramp over time. We do have particular accounts or particular segments where we believe we need to put some headcount in now because it takes from six to nine months for them to get to a revenue generating point. But that will be a ramp and obviously we’ll watch that carefully versus kind of what happens with the top line from an affordability perspective. The G&A stuff is really noise relative to the overall OPEX number but that’s kind of our thinking right now. It’s really to allow the company to progress as quickly as possible.

Unidentified Company Representative

(inaudible) I want to make one comment. You know last year I talked a lot about progress for a long-term business model and I think we made such good progress last year. And I don’t want you to think that I’m walking away from an absolute commitment to achieving our long-term business model. But it’s important to look at it is long term and if we thought that this investment was not going to accelerate our structural ability to move our long term business model forward, we wouldn’t make that investment. We believe it is mandatory for us to make these investments to accelerate our success towards achieving our long-term business model on a repeatable basis.

Rod Hall – JP Morgan & Chase

Okay, thanks guys.

Operator

Our next question is from Ehud Gelblum with Morgan Stanley. Your line is now open.

Ehud Gelblum – Morgan Stanley

Hi guys. I appreciate it, thank you very much. A couple quick kind of just housekeeping questions and then some more bigger picture questions.

In the inventory I saw inventory was down a little bit but kind of the pieces were moving all over the place. So Ita, if you could just comment on what does it mean to us when raw materials were up as much as they were and working process was down. Is there anything we can read into that leading into kind of what the back level looks like on your Q1?

But another question, when you look at your revenue in Q1 of last year, it was very comparable to what your guide is right now. I think you did $96 million in Q1 of last year and you had a gross margin of 41%. So from that perspective your gross margin guide now of 45% etcetera is better on the same revenue run rate then it was last year. Is that the mix of the extra TAMs you’ve now had for a couple quarters in a row? And if that’s the case, as we start looking out into the rest of the year, should we start assuming that the number of TAMs that you’re selling now naturally comes down because it’s an unnaturally high rate and if your revenue stays at the mid-90s level, we’re looking at gross margins back at (inaudible) level that you are in the beginning of the year.

Ita Brennan

Okay, maybe let’s start with the gross margin question. I think our view at this point is that the mix of the business that we’re seeing and kind of the shift in the mix between TAMs and common equipment is probably a long-term effect. I mean it’s a factor of increased capacity per line site equipment so that you don’t have as much common equipment actually being deployed and to the TAM numbers to begin with. We actually have that shift in ratio. And if we look at kind of the trends and what we see both from customers, etcetera, that looks like that’s an ongoing trend. So we would hope and believe that that 2400 number is a new baseline from a TAM mix perspective. So I think that’s the other 45% kind of gross margin numbers that we had in the past (inaudible) anything else, are probably lower than what we would expect in the same circumstances now.

Ehud Gelblum – Morgan Stanley

Can you minus what the mix was like, how many TAMs you sold in Q1 of last year?

Ita Brennan

Oh I think, like, it was down at like 2000 or maybe even below that.

Ehud Gelblum – Morgan Stanley

Okay, so as long as we say 2400 you think that’s a function of the number of customers you have. We should be permanently at 45% or higher in terms of-

Ita Brennan

Yeah, and just the amount of footprint that’s out there now to be consumed and the bandwidth that’s deployed to be used.

Unidentified Company Representative

All things being equal, the word permanent always worries me because nothing’s permanent. But all things being equal.

Ehud Gelblum – Morgan Stanley

But it sounds like we’re not, it sounds like if added 5 new customers that’s a decent number and that the low gross margins of the common equipment did not seem to impact you in Q4 so it would seem to be that we’re not going to experience another 35% to 40% gross margin (inaudible).

Ita Brennan

Yeah, unless you have a major new deployment. I mean something like a really significant large win obviously with a tier one or something, then you are definitely going to see that impact margins. But I think the model now has enough kind of (inaudible) from a diversity perspective to be able to absorb normal kind of new deployments without driving the margins down like that.

Unidentified Company Representative

(inaudible) large macro economic like a 2009 (inaudible).

Ehud Gelblum – Morgan Stanley

Or a 2001. The inventory and then also could you comment on DSOs?

Ita Brennan

Yeah, so back to the, I mean the inventory is just a factor of some of the stuff that we have going on with the factories etcetera moving stuff around. I wouldn’t read anything else into that. It’s just our own internal kind of manufacturing and where stuff is at in the pipe. We had kind of stopped building with, we actually pulled some stuff into finished goods and it kind of just got out of balance and that will kind of return to normal this quarter.

And then on DSOs, I think if you look at Q4 of last year as well, this quarter was somewhat (inaudible) and so it’s just in more of a linearity position than anything else that drove that.

Ehud Gelblum – Morgan Stanley

Okay, level three fell 50% from 19% of your $130 million last quarter to just 10% this quarter of 117. Is that a function of them starting to buy more from (inaudible) or as you kind of have knowledge as to what they’re doing in the network or is that them just digesting and you expect them to come back up again into the 15% to 20% of revenue as you get into Q2 and beyond?

Ita Brennan

Yeah I mean I think we’ve acknowledge that our Q3 level was higher and probably them doing some very particular builds etcetera and higher than we would expect it to be. Because of that, they were definitely digesting in Q4 and they were abnormally low in Q4. I think based on what we see now we’ll expect to see them come back to a more normal level in Q1. So probably not back up to where they were in Q3 but back to something more run rate to what they have been in the past.

Ehud Gelblum – Morgan Stanley

So around 15% or so in Q1?

Ita Brennan

Yeah, I mean that would seem to be somewhat-

Ehud Gelblum – Morgan Stanley

Which would indicate if they go from 10% of your 117 to 15% of a 95 call it, then the rest of your customers are going down an abnormally high amount. Are you contributing that to digestion or how should we look at what physically is going on there?

Ita Brennan

Yeah I mean I think the issues is when you look at the revenue numbers, if you have just bandwidth, I say just bandwidth because we have customers consuming bandwidth and buying TAMs and DLNs but not doing any large like common equipment new deployments, you’re going to be missing a $10 million or $15 million of common equipment spikes that you would have in a quarter where they will be doing something. So I think this whole digestion period where people are not doing new deployments is driving a lot of that revenue number.

Ehud Gelblum – Morgan Stanley

And do you think that’s happening around the entire industry or just in the customers that you’re seeing that there are not, that there are fewer new deployments and that there’s this pause?

Unidentified Company Representative

That’s a really hard question for us to answer because you know we have a very small presence in APAC, we have a very small presence in tier ones, so it would be a dangerous question for me to answer because I think it can only give you our slice of the world and I don’t want to do that.

I think one of the things that it’s important to remember too both from our just in TAM program but also as we brought our leap time back down, there’s less tension within the customer base to lay out plans as they make plans. Now we try to be very intimate with them and understand what they’re building but short lead times creates lack of visibility both because there’s not as much backlog but there’s less incentive in the customer base to include you. We think that’s a competitive advantage for us because they can make decisions and quite frankly we’re the only people that can respond quickly. But it does bring a visibility challenge to us.

Ehud Gelblum – Morgan Stanley

Right. And finally you had a (inaudible) and terabit product. You said 2012, will you be actually selling it in early 2012, so you’re actually in labs in 2011? Or does it only go into RFPs and labs in mid-2012 and you start really selling it possibly in 2013? And then when you look at your customer base aside from level three and XO, how many of your other customers do you think really will be moving to 100G anytime soon. I mean we usually think of the tier ones as the big 100G movers.

Unidentified Company Representative

So a couple things. We’ve said that the new platform will be available in volume in 2012. We have not provided further clarity on when it will be in labs and those types of things but you can anticipate at our quarterly call that we will continue to give you milestones towards that progress. But it’s very clearly we are preparing to ship in volume in 2012. From a perspective of who will buy 100G, I think it’s raw economics. Certainly today there’s a number of people who are carrying traffic certainly as large as the Tier 1’s, and I think that there’s a- I’ve been in the telecomm business for a long time. Invariably market demand fills up systems faster than people think they will, and we’re going to come out with a very high capacity capability both from a switching capability and also from a transport capability. I am very comfortable that we’ll be glad we’re coming in with a system that has this much capacity. And when we deliver the economics that make it more compelling than 10 gig I don’t know any groups who would not want it, quite frankly.

Ehud Gelblum – Morgan Stanley

Okay, I’ll take two. Thank you very much.

Unidentified Company Representative

I’m going to remind you of that.

Unidentified Company Representative

Thank you.

Operator

Our next question is from Simona Jankowski with Goldman Sachs. Your line is now open.

Simona Jankowski – Goldman Sachs

Hi, thanks so much. Just wanted to ask you a question first on your 40G product that I think you said is going to come out about the middle of this year. Given the timing of sales cycles and lead times do you think it will be meaningful to revenues for you this year or is that more at the beginning of next year?

Tom Fallon

Yes, Simona. So I certainly anticipate it’s going to be meaningful this year. The great thing about the 40G that we’re introducing the middle of this year is it’s going into our current [DTN’s], it’s going into our installed base. It’s going into people that have grown to trust our release process and our product and our quality. It is going into an optical line infrastructure that is already in place and ready. So it’s a fairly easy upgrade for us to sell.

Now from a green field perspective, that goes into a more natural, longer-term sales cycle; but from an upgrade cycle, when we introduce a new capability there’s pretty quick adoption of it. So I’ll be disappointed if it doesn’t impact this year.

Simona Jankowski – Goldman Sachs

Okay. And then among your existing base of customers, are you aware of any that have chosen 40G solutions from your competitors because of fiber exhaust or whatever their factor?

Unidentified Company Representative

Yeah. In my commentary I said that we lost a couple of opportunities, and I certainly am aware of the customers – maybe not all of them – but I certainly am aware of the customers that have made a decision for 40G. Some of those decisions have been made and executed; some of those are just decisions that have made and not executed yet. But I’m certainly aware.

Simona Jankowski – Goldman Sachs

Okay. And then of the customers who are making decisions for 40G today, whether they’re among your existing customers or others, what confidence do you have that the 100G path will still be open to you when you come out with that product in 2012? In other words, since they are committing presumably to a competitor’s 40G roadmap and the network management solutions that come along with that, and the optical line network and all of that – how high do their switching costs become once they’ve sold them 40G?

Unidentified Company Representative

Yeah. I think maybe I could answer or add some different color to this. Our customers - and the reason we’ve taken substantive market share in our markets - have bought digital optical networks. That’s why they buy it, that’s why they’ve stayed with it. It is because the experience of working and deploying high-capacity distributed switching and the rapid servers turn-on. There is an issue on a route-by-route basis of when they run out of capacity of a fiber, at which point then they have to make an individual choice of what’s the lowest cost technology that they can achieve to extend the capacity and the lifetime of that fiber?

If at the presence of 100G it’s $1 per gigabit - we believe we’ll be substantively less then at a 40G. And at that point in time when they’re looking at upgrading and preserving the lifetime of that fiber they will do that, and then they’ll do it in a digital optical network which is why we expanded our market share substantially last year. The features that they really want in a network are wrapped in a digital optical network. What they get out of the 40G or 100G is the ability to expand the lifetime of their fiber.

Tom Fallon

I want to make one other comment. People have gone to 40G and classically they move because there’s an economic advantage to do that, and 40G has not delivered that economic advantage. And I think that when we or somebody else delivers 100G at an economic advantage, and typically it needs to be 25% or 30% better economics, that will be adopted by the industry because it will be forced to be.

The first time somebody makes that decision they will take that new cost point and price point of a cost to the market and they will price their services around that. That will force everybody else to price their services at that level. Our industry has enough competition that the minute somebody in the provider space price’s waves that are based upon a lower price point, it forces that same discussion around lowering your architectural costs to be cascaded through the industry.

Simona Jankowski – Goldman Sachs

Great, and just my last question, more near-term. Your guidance for revenues this quarter seem to be similar to those of a year ago March quarter, and I think last year you entered with $62 million in backlog and this year it’s with $35 million in backlog. So what gives you that incremental visibility? The higher pace of bookings or is this just a quarter with less visibility so it might actually turn out quite a bit differently than you expect right now?

Ita Brennan

Yeah, I think the mix of products is a little different. Coming in last year the backlog was higher because you’ve got new deployment stuff. Here we’re turning bookings much quicker in the quarter, with the TAMs deal and the (inaudible) much faster turn on booking. So based on the run rate and what we can see now that’s our expectation of where we’ll come out.

Simona Jankowski – Goldman Sachs

Okay, thanks very much.

Operator

Our next question is from Blair King of Avondale Partners. Your line is now open.

Blair King - Avondale Partners

Yeah, hi. Thanks for taking the question. I just wanted to kind of go back to an earlier question on this notion of 40G and sorry to beat the dead horse here, but if you could help kind of figure- Maybe Tom, explain to us what the strategy is when you’re faced with a customer trying to move to 40G. We’ve seen where Global Crossing came in and you’ve got the 4x10 lanes there in supporting their 40G network, and perhaps that’s started off a competitive threat. But obviously there will be more as you move through the course of 2011 and I’m just wondering how you combat that, and should we expect that that becomes more and more of an issue up until summertime of this year?

Tom Fallon

Yeah, Blair. 40G, this is not a new discussion with the customer base. You know, 40G was introduced a number of years ago into the market, and clearly the coherent architecture changed the receptivity from a performance basis two years ago or more. And we’ve been working with our customers through that period of time and we’ve been very successful at helping them build, as Dave points out, a digital optical architecture that is ready for 10, 40, and 100. It’s only if you have fiber exhaust in a very short period of time do you have to make a decision.

We are working with all of our customers who have that situation and we try to work through that. There’s a number of ways that we can do that commercially and we work on those. Sometimes, however, it doesn’t work commercially. But my perspective is every day that we extend ourselves into this year the problem becomes less dramatic because we are closer to us delivering our solution. So I think we have clearly a couple of quarters that we have to be willing to continue to work commercially with our customers. We have to continue to earn the business and we run the risk of losing some opportunities. But as we move closer and closer to executing our 40G and then our 100G strategy, that risk becomes less. We’re going to lose some opportunities.

Blair King - Avondale Partners

I hear you, okay. The last question is just trying to figure out, and this is also a follow-up, but just moving back to the top line here and trying to look forward into 2011. It sounds like you’ve said that the first quarter is going to be obviously down, but it would seem as though you’d get more demand from your product – it sounds like listening to you – as you move through 2011 and into the Q2 potentially. So when you think about, and you might have touched on this earlier, but when you think about 2011 are you thinking about a year that’s significantly down from 2010, flat from 2010 or up from 2010?

Tom Fallon

Yeah, I kind of paint out the scenarios that we’re kind of a macro in the environment, and in each one of those answers I can paint scenarios based upon dynamics in the industry that I can plausibly paint a down story, I can plausibly paint a flat story and I can plausibly paint an up story. And I think I choose to spend my time here because I believe in our ability to change the network and our ability to be successful in the market. So I’m an advocate and I’m biased toward that advocacy both in the short- and long-term.

I think it’s important and that’s why we don’t give guidance, quite frankly, longer than a quarter. It’s because the fidelity of that guidance is influenced by too many competing trends. All I can say is I’m very optimistic on the trend of the industry, I’m very optimistic on the trend of our progress installing digital optical networks end to end; I’m very optimistic on our progress in 40G and 100G, and I think that- A year from now I think we’ll look back and say “This was an interesting year and we’re very excited about where we’re at from a roadmap perspective.”

Blair King - Avondale Partners

Just one last follow-up, Tom, on the common equipment side. Is it fair to say that we’ll probably see a lot less common equipment in 2011 and the TAM growth will do what it does; and if we assume that common equipment is that 10% to 15% per quarter or $10 million to $15 million per quarter spike should that come out of the numbers on a higher gross margin? Would you imagine that’s a fair way to look at it?

Tom Fallon

Yeah, I’m not willing to extend out that we’ll see a lot less common equipment this year. I mean I can give you insight into this quarter that we’re in, next quarter; Pete has given you kind of a flavor on why TAM ratios are probably up because of increased fiber capacity capabilities and extended reach and that we believe that there’s a fundamentally different ratio moving forward. But I won’t say that this year we don’t expect to see or hope to see substantive amounts of common equipment. Like I said, any one of the three scenarios I painted is plausible and I’m not going to say that there’s not going to be a lot of common equipment sold.

Blair King - Avondale Partners

Okay. Thanks, Tom, I appreciate it.

Tom Fallon

Thanks. Thank you for your time, thank you for joining us today and for your questions about our business. We look forward to visiting with many of you in the months ahead and to keeping all of you posted on our progress. Have a great day.

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