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Infinera (NASDAQ:INFN)

Q1 2011 Earnings Call

April 28, 2011 5:00 pm ET

Executives

Ita Brennan - Chief Financial Officer

Thomas Fallon - Chief Executive Officer, President and Director

Bob Blair - Investor Relations

David Welch - Co-Founder, Chief Marketing & Strategy Officer, Executive Vice President and Director

Analysts

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

Kevin Dennean - Citigroup Inc

Alex Henderson - Miller Tabak + Co., LLC

Rod Hall - JP Morgan Chase & Co

Michael Genovese - MKM Partners LLC

George Notter - Jefferies & Company, Inc.

Unknown Analyst -

Operator

Welcome to the First Quarter 2011 Investment Community Conference Call of Infinera Corporation. [Operator Instructions] Today's call is being recorded. If you have any objections, please disconnect at this time. I would now like to 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, results of operations, business initiatives, views on our market and customers in our products and our competitors' products, and prospects of the company in Q2 2011 and beyond that are subject to risks and uncertainties that could cause actual results to materially differ 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 1, 2011, for more information on these risks and uncertainties. Today's press releases' including Q1 2011 results and associated financial tables and investor information summary, 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 first quarter of 2011, which exclude the impact of restructuring and other related costs and 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 press table, 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.

On this call, we'll also give guidance, including guidance for the second quarter of 2011. We have excluded non-cash 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 President and Chief Executive Officer, Tom Fallon.

Thomas Fallon

Good afternoon, and thanks for joining us. With me are Chief Strategy Officer, Dave Welch; and CFO, Ita Brennan.

Our first quarter results reflects stable bandwidth demand from our terrestrial and subsea customers, evidenced by strong comp purchases at the quarter. However, we saw slower new put productivity in Q1, versus a year ago as certain of our customers and prospects await the introduction of our new higher capacity products later this year and some have opted for competitive 40G solutions in the interim on a tactical basis.

While our reputation for customer care, high-quality and rapid turn up are assuring customer loyalty, our ability to compete for certain capacity sensitive opportunities is impaired by our current lack of a high-fiber capacity solution.

In order to address our customers interim need for 40G transmission and advance of the rollout of our 500 gig PIC-based system for 100G transmission, we will be introducing our 40G products in the third quarter. The introduction of this product will enable our DTN systems over 64 terabits of capacity on a fiber, which we believe will be up to 2x the capacity of most competitive offerings in the market.

It is also important to note that we continue to grow the number of network customers. Customers who are buying a multi-product Infinera solution. This includes customers employing either a combination of long-haul and metro-applications from us, or a combination of terrestrial and subsea applications.

At the end of Q1, we had 26 such network customers out of a total of 86 customers worldwide. An important trend as network customers have made a more significant Infinera architectural commitment. We believe we are earning network customers because our portfolio delivers important end-to-end benefits such as; simplified network management, improved CapEx through efficient interconnect and improved end user experience by integrating provisioning and performance monitoring.

In the metro, we continue to build additional features and capabilities into our ATN (Application Transport Network) platform. And in the second quarter, we will add ethernet aggregation functionality.

Turning to the Optical Transport industry. We are in early stages of a series of significant and complex transitions. We believe these changes create a unique opportunity to successfully launch new products and new architectures because customers are looking for more efficient and cost-effective ways to grow and manage our future networks and to compete for new business.

One of the most important of these transitions is the to move to higher bit rate transmissions, specifically from to 10 to 100G. These higher bit rates are necessitated by the need to increase the carriers capacity for fiber. However, this move does raise issues for carrier regarding network economics, both on the cost of transmission and in avoiding the inherent inefficiency of stranded bandwidth when service capacity and wavelength capacity are mismatched in conventional transponder base optical networks.

Our second important trend is to move toward converging the layers of the network. To collapse optical transport and switching into a single platform. This shift is consistent with Infinera's founding vision for the digital optical network. One of the primary drivers for the move to a conversion network, is the ability to deliver, router bypass, to manage more of the carrier's traffic at the optical layer instead of the traditional and more expensive router layer.

Either used in the network of intelligent optical switching solutions and bandwidth virtualization allow for a significant reduction in the need for router ports in the core. These innovative architectural transitions have been publicly promoted by many large carriers, as well as a number of content providers, because they significantly improve the cost structure of the core network, while providing a simplified and scalable architecture.

This is an architecture that Infinera customers already have benefited from, in our DTN (Delay/disruption Tolerant Network) and integrated OTN switching and optical transport platform.

Infinera is well positioned to benefit from both of these industry transitions and to help accelerate the migration to the next generation of higher capacity, more intelligent networks. We believe that our digital optical network architecture based on large-scale PICs (Photonic Integrated Circuit) Enables us to integrate higher bit rates and advanced digital switching functionality more easily and more cost-effectively than any traditional solutions based on discreet components.

With OTN switching integrated into hour DTN since 2004, we are already familiar with and well known to customers for pervasive, integrated DWDM (Dense Wavelength Division Multiplexing) switching.

Further, we believe that Infinera offers the lowest-cost technology for interconnection of these switching capabilities. By offering a 500 gig PIC-based transceiver technology, Infinera will lead the industry with 5x the line card capacity of conventional transponder architectures.

We feel confident that we are bringing our new solutions, particularly our 500 gig PIC-based system to the market at just the right time to both benefit from, and encourage these trends. At the same time, we have continued to focus on extending our roadmap and technology leadership by demonstrating a PIC with one terabit of capacity. We also announced our intent of bringing this technology to market to support up to 25 terabits per second of fiber capacity at a future product development milestone.

In the more near-term, we are strong believers in the view that a 500 gig PIC based solution for a 100 G transmission will be the industry's next multi-year network standard and will offer customers the most cost-effective long-term value for their capacity requirements.

We believe that the current strength and demand for 40G networks is driven by the immediate need of certain carriers to address fiber capacity shortages and a lack of availability of a viable 100G-based solution.

As our customers deploy 40G capability, we see them doing so on a route-by-route basis rather than for long-term strategic reasons. As we work with potential customers, it is clear, they are looking to the economics and capacity of 100 Gig solutions.

Today, I am pleased to announce that, due to our continued engineering progress, we will be launching our 500G PIC-based system for 100G transmission in our fourth quarter of this year, as a prelude to volume shippings of the product in the first half of 2012.

To avoid any confusion, I want to clarify our product terminology. In 2004, we introduced our DTN system based on 100 gig PICs, with delivered 10 channels of 10G transmission. The system we will launch in Q4 will be based on 500 gig PICs delivering 5 channels of 100G transmission.

We believe our 100G transmission products will be the most significant new product in the history of the company, and that will help us achieve similar market success to our 100 Gig PICs system introduced 6 years ago, leveraging radical economics and enabling the simplicity of a digital optical network.

We believe the timing of this launch will allow existing customers and prospects to evaluate our 500 Gig PIC-based product with our network plans in 2012. Customer response thus far, has been very positive to the differentiating capabilities and features of this new platform we'll deliver.

Looking at the transition from 40G to 100G, the latest industry data released from Infenex [ph] forecast that the largest single segment of the market will be 100G transmission in the 2013 to 2014 timeframe. Furthermore, 100G is expected to be the dominant transmission rate on a dollar basis throughout the second half of this decade, and most likely, well into the decade after.

If this proves accurate, our introduction of our 500 Gig PIC at the very early phase of this 100G transmission cycle, will play perfectly with our expectation of disrupting the transport market once again with the industry's only digital optical network.

We believe that our technology and product roadmaps provide a clear path to achieving our long-term business model and we had an urgency to execute on these roadmaps. As we make progress on our product and technology goals, we fully understand that our current financial performance is unacceptable on a sustained basis.

By delivering our technologies and products to market, we feel confident we will create competitive advantage for our customers and appropriate returns to our shareholders.

Ita Brennan we'll now provide details on our Q1 financial performance and our outlook for the second quarter.

Ita Brennan

Thanks, Tom. I'll review our Q1 actual results and then follow that up with our outlook for Q2. This analysis of our Q1 results is based on non-GAAP. All records exclude non-cash stock-based compensation in any restructuring costs.

Total GAAP revenues in Q1 were $92.9 million, compared to our guidance of $90 million to $97 million and revenues of $117.1 million in Q4.

Level three was only 10% customer in the quarter at 14% of revenues. We saw stable demand for bandwidth from our existing customers as they continue to fill out network footprint. However, as expected, we experienced lower revenues from new deployments. Time shipments for the quarter exceeded our target of 2,400 units.

we added 4 new customers in the quarter for a total roster of 86. One of the new customers added in Q1 was a new ATN only customer. Three of our existing DTN customers completed new ATN deployments in the quarter, bringing the number of customers now benefiting from the combined DTN/ATN network solution to 22.

Please note, we are providing the total number of customer wins for reference this quarter. But as previously indicated, we will be discontinuing this as a regular practice as it is no longer the most meaningful metric for estimating the scale and growth of our business.

Instead, we will provide other metrics around certain customer and new product subsets that we believe will be more meaningful in that time frame.

International revenue's amounted to $24.1 million or 26% of total revenues for the quarter. EMEA accounted for $20.3 million or 22%, down from 26% in Q4 '10. The level of international business will fluctuate on a quarter-over-quarter basis depending on individual customer buying pattern. We expect the ratio of international revenue to increase in Q2.

Our service revenues for the quarter were $9.4 million, down from $13.5 million in Q4. Services margins increased to approximately 67% from 58% in Q4, reflecting reduced levels of lower margin deployment services sold in the quarter. Overall, gross margins in Q1 were 48%, down from 51% in Q4, and this compares to our guidance of 45% to 47%.

As outlined in January in our guidance, margins were negatively impacted by approximately 2% rated to new product introduction activities in our PIC fab and systems manufacturing areas. We expect to continue to incur these expenses through the end of the year and this cost, depending on revenue level, will continue to have an approximate 2% to 3% negative gross margin impact each quarter in 2011.

Operating expenses for the quarter were $48.1 million versus our guidance of $50 million and versus $51.9 million in Q4. R&D expenses came in at $27.5 million, approximately $0.5 million below our guidance. The remainder of the underrun on expenses resulted from deferred hiring and cost management. Overall headcount for the quarter was 1,118 versus 1,072 in Q4.

Headcount additions, primarily occurred in operations and sales as we prepare for the launch of our 100 Gig platform.

Operating loss for Q1 was $3.6 million. Other income and expense for Q1 was unfavorable at $0.1 million. Net loss for the quarter was $4 million, resulting in a loss per diluted share of $0.04 versus our guidance which caused for the loss of $0.49 per share and versus earnings of $7.6 million in Q4.

Now, turning to the balance sheet. Cash, cash equivalents, restricted cash and investments ended the quarter at $287 million versus $296 million in Q4. We used $0.9 million of cash from operations in Q1 versus cash generation of $7 million in Q4.

DSOs were 60 days up from 59 days in Q4. Inventory turns were 2.5 versus 2.8 in Q4. Total inventory was $78.3 million, down from $81.9 million in Q4. Inventory turns declined to 2.5x, primarily due to lower revenue level in the quarter.

Accounts payable days are 39 days, down from 43 days in Q4 due to lower inventory receipts in the quarter as we continue to utilize inventory on hand.

Capital expenditures were $10.6 million in Q1 versus $5 million in Q4. As discussed last quarter, we expect cap and additions to be approximately $40 million for the year as we add manufacturing capacity in advance of the launch of the 100 Gig products.

Turning to our Q2 outlook. Customers continue to require higher fiber capacity products on portions of their network. We respond to these opportunities by deploying 10 Gig capacity now, with migration paths to our 40 and 100 Gig solutions as they become available. In the interim, we expect their ability to grow revenues will be restrained until we have volume releases of these new products.

In addition, we are competing aggressively for new footprint opportunities. In order to ensure we have access to future build outs on this networks when our higher capacity products are available. In the short-term, we believe that these investments in future business will continue to put negative pressure on our margins.

Level 3 is assumed to remain a significant customer for the June quarter as we continue to meet their needs from fast and flexible response time. All of these factors combined, results in revenue guidance, that is consistent with Q1 levels.

Our current outlook is for lower gross margins in Q2 based on the following assumptions: changes in product mix are expected to have a negative impact of approximately 3% to 4%. TAM (Tributary Adapter Module) shipments are expected to again, be at an or in excess of our target of 2,400 units. This will be offset by a higher mix of lower margin common new footprint deployment. We expect to meet the increased competitiveness are on new footprint wins to negatively impact gross margins by approximately 2%.

Finally, our current revenue levels, the impact of our fixed cost, including the impact of the new production and to product introduction cost mentioned above on the overall gross margin percentage is more significant.

Operating expenses are expected to be approximately $50 million for the quarter, with R&D accounting for approximately $29 million of this amount. We believe that this R&D number represents the high point for the year as a number of key R&D deliverables are expected to occur in the quarter. We will continue to make the R&D and sales investments necessary to support successful ramp of our 100 Gig platform in 2012. Other cost are being managed carefully until revenue and margin trends improve.

The following guidance for Q2 is based on non-GAAP results and excludes any non-cash stock-based compensation expenses. Revenues of approximately $92 million to $97 million; gross margins of approximately 40%; operating expenses of approximately $50 million; operating and net loss and approximately $11 million to $14 million; and based on estimated average weighted diluted shares outstanding of $110 million, this would lead to a loss per share of approximately $0.10 to $0.12. Please note that the basic share account is expected to be $105 million for the quarter.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from George Notter with Jefferies.

George Notter - Jefferies & Company, Inc.

I guess I wanted to start out by asking some questions on the new product roadmap here. I guess for starters, on the 40 Gig line card, I guess, I had understood that, that would be available mid-year. You guys are now saying Q3. Maybe we're parsing words too finely here. But, I guess I'm trying to understand if there's been a slip in the time frame on 40 Gig?

Thomas Fallon

Yes, George. It's Tom here. We've talked about it last year saying 40 Gig mid-year. I always operate the company on two schedules. One is a stretch and one is a commit. And that's how we typically end up somewhere between those two dates. Our stretch timeline frame is Q2 and our commitment was Q3, internally. So we are roughly operating within the window that I had anticipated. Clearly, I was hoping to get it out closer to Q2. You will see us introduce it intently at the first part of Q3 or still in Q3. So I don't want to negate that mid-year is probably like end of June, but we operate within our window of what we'd expect it, the engineering deliverable frame of control could be.

George Notter - Jefferies & Company, Inc.

Is there a risk of that time frame slipping out then? I mean, do you have a high confidence level on a 40 Gig line card at this point, this Q3?

Thomas Fallon

Yes, I think. You know, George, until something is done, there is always some level of risk. But we have a pretty high confidence at this point of our schedules. And what we are anticipating, taking to market and when. We are only talking to customers at this point in setting expectations about when they can expect products. So we have a pretty high confidence at this point.

George Notter - Jefferies & Company, Inc.

And then shifting gears on to the 100 Gig product. I mean, I heard that you said in terms of the timing for 100 Gig. I'm trying to understand where you are in terms of milestones? At this point I know that after the PIC development was done, you guys still had some ASIC development that was in front of you. You still had a chassis to build out, line card, software making, can you talk about where you are in terms of the progression towards completing that part of development?

Thomas Fallon

Yes, sure. So, if I start to look at the end point of a product, they are actually taking it prior to shipping and general availability, and prior to that is ASICs, and prior to that is obviously orderability. And on the platform like this, we often don't do that but if our platform's like this, we are going to do a launch. And all those things mean that from my perspective, when you say we're going to launch it in Q4, we now have enough, I would say, engineering evidence across a broad spectrum of the results, whether it's at a PIC level, a PIC-factory level, software development level, hardware development level that we feel comfortable that we can launch this platform in Q4. And that means that I'm trying to, instead of saying as a particular milestone that it's trying to give an overall measure that we are comfortable with the aggregate progress of the overall system that we should expect, set an expectation that, that we'll launch this in Q4. We continue to make progress in all fronts, whether it's our software development, our hardware is vastly in the DVT[ph] phase, so it's no longer in design but it's in design validation. There's still obviously in milestone that have to be achieved, but we feel very comfortable that we are progressing across broadly all the fronts, that the best aggregate milestone would be telling you when we plan on launching it.

George Notter - Jefferies & Company, Inc.

Correct to say that there are some ASICs go into the system. I assume those are pretty sizable developments, those are done then or is that, fair to say or no?

Thomas Fallon

There's a number of ASICs that are running into the system. Some of the ASICs are completely done. The PIC isn't ASIC, it is now in, obviously, Rail[ph] testing. So it's done from a design perspective, but we're still validating the reliability. We have other ASICs that are in, I mentioned last time that we had the switch ASICs that was completely in. And we have since validated, it's fully functional in some -- and barring giant surprise we believe it is completely done. Other ASICs are still in the bring up phase. And some ASICs will not come out unnecessarily in the first release, but in follow online cards that we will probably launch at the same time. So people can have an understanding of our overall platform. So, it's very difficult to answer your question. All the ASICs done, they're not all done but we believe there is substantive enough progress across the suite of them that were on track to launch the platform in Q4.

George Notter - Jefferies & Company, Inc.

And then what's your expectation in terms of the timing of the ramp here? How long will customers test or trial these systems? How will revenue-recognition work? Is that something you can take pretty quickly upon commercial deployment or is there a longer acceptance phase, and can you map out for us how you see that?

Thomas Fallon

So, various customers are going to operate differently. I think a range of customers who already Infinera customers would probably still require a level of lab certification in process. We'll begin that process before we do FCS[ph]. That process can vary by customer from very short to a more thorough up to a quarter probably. For a new customer, that would probably be a longer process than that. And that's going to depend quite frankly just on who the customer is. We see customers, some customer who basically do nothing more than testing and all that to certify product and we see other customers who will go to a very rigorous process where they have to test it in their lab and then they'll do a first-office application. And then basically certify the product post that. So it's not an easy answer to answer in one fashion. I would expect a range of some that will be early and some will be much more extended. Ita, if you can answer all the rev-rep[ph] portion, I'd appreciate it.

Ita Brennan

I think on the rev-rep[ph], it'll somewhat follow that pattern. Our existing customers will have kind of established acceptance criteria, a lot of them would be on shipments and inflation at this stage. For new customers, whether it's a trial and deployments, probably some testing at the end of that, it'll take longer. So I think, our existing customer revenue stream can come fairly quickly after shipment for new customers it'll take longer.

George Notter - Jefferies & Company, Inc.

So then from the time you GA this thing, I guess took to revenue, I mean you guys are certainly a lot closer to this than I am. I guess I'm trying to just ballpark it, if you think it's 6 months for the earliest customers from G&A and then 12 for new customers or any kind of range can you put on this?

Thomas Fallon

My suspicion is once we FCS, we will probably hit revenue within a quarter. That would be my belief.

Ita Brennan

It's with the existing customers.

Operator

Our next question comes from Simona Jankowski with Goldman Sachs.

Unknown Analyst -

This is Tom, on behalf of Simona. Just a couple of quick questions. Is it fair to assume that on the 40G market we're seeing a little bit of land grab with vendors targeting footprint expansion in hopes of 100G upgrade opportunities? I just kind of, to piggy back off that, given kind of the timing of your 40G product, just curious t to kind of your confidence level in terms of the 100G fasting and if you still feel like that's pretty for you, with the 100G product coming on next year?

Thomas Fallon

Is there kind of a land grab with 40G currently and how confident we feel with our timing of the 100G?

Unknown Analyst -

Exactly.

Thomas Fallon

Certainly, there is requirements, good news for more fiber capacity. People are willing to spend money and needing to spend money to increase their ability to carry more bandwidth. We consistently still see, the preference, a strong preference, universal preference going to a 100G as soon as possible. There are customers who have decided that 10G is insufficient today's with their moving to 40G because 100 G does not provide either the market proven volume yet or the economics that are necessary for it to create a mass market. So I think that, I don't know if there's a land grab going on. There's fundamental and continued growth and the need for bandwidth, the continued shortage of certain fiber in certain networks and 40G is a reasonable solution for that. I think that, if there's a land grab, I don't know. There's opportunity out there and if we had 40G today, we'd be selling it. If we have a 100G today, we'll be selling that also. A 100G, you know are comfortable with our time. I'll make two comments. One, we're comfortable with the schedules that we've laid out and I'm very comfortable that we are going to be, what I would consider the very early phases of a 100G market that is going to last for a very long time. The number of 100G waves sold today is very, very small no matter, which reports or analyst you look at. Most of the deployment of 100G really don't begin until 2013 and 2014. I think by having our customers be aware of our technology today, by our customers being able to see the products in very near term and is launching in Q4, we are going to be positioned at the very early phase of a very long 100G cycle. I couldn't be more comfortable with the timing that I think the market requirement and our availability are quite frankly perfectly aligned.

Unknown Analyst -

And then I guess within your product, do you feel, as I think about, kind of domestic versus international, what do you feel like it? Do you see kind of a biggest opportunity? Or do you feel like it's pretty wide-open in both here and international markets?

Thomas Fallon

From a domestic perspective, we've been very fortunate to earn a very substantive leadership position in market share. And I think that by introducing both our 40 Gig to allow our customers to upgrade and earn new customer footprint and by introducing a new platform with 100 Gig, we are well-positioned to recreate the same type of North America presence that we've had for the last several years. I think last year, we had 37% market share in long-haul transport in North America. And I think internationally, we are making good progress, but I would say there's more opportunity to grow that market share internationally. Europe, we continue to make steady progress, slow and steady progress. In APAC, we have just hired a new leader for our APAC arena. And that I think we'll bring very good insight into the industry, good relationships in the industry and I believe that we are at a good foundational point of starting to grow the APAC business. We have some very good relationships there. We just have to turn that into dollar opportunities.

Unknown Analyst -

And then maybe I could just shift gears to the income statement, more just on OpEx, I think last quarter you gave guidance, I guess for the total OpEx. If I'm not mistaken 204, 205 range. Just curious if for full year, if that's still stand and then I think on the R&D side I think you'd said like 110 or 115.

Ita Brennan

Yes, I think there is still good guard rails for what we have set out for the year. I mean, obviously with the revenue where it is, we are trying to kind of reduce that and put pressure on that outside of key sales and R&D and operations headcount where we really need to do that. To support the 100 Gig we have deferred hiring et cetera and we'll continue to do that. I think the $50 million for this quarter, we're definitely trying to stay in that window for the year and also obviously looking for opportunities to kind of take some more cost out.

Operator

Our next question comes from Kevin Dennean with Citi.

Kevin Dennean - Citigroup Inc

Tom, acknowledging your comment that 40G is really seeing kind of route specific deployment as opposed to a broader base adoption. Do you think that, that the commercial, just the commercial availability of 40G product is putting pressure on the 10G market?

Thomas Fallon

I think that people are interested in continuing to grow their network to make sure that they can handle the incremental demands that all of the new video and 4G, et cetera bringing to the world. And 40 Gig is a good interim solution. I think the challenge is that 40G does not yet have the economics that are necessary to make people want to adopt it as broadly. It does not still have 10G economics and the view is 100G will have better economics and achieve better 10G equivalent economics of 4 40G does. And secondarily, I mean, 100G is starting to happen and so they don't have to wait very long. So I do think that there's some pricing pressure that's being applied in the market. If somebody is interested in moving to 40G, we are certainly responding with commercial opportunities on 10G pricing to have them defer that decision until we can bring 40G out or our 100G program. And I suspect that it's not unique to us.

Kevin Dennean - Citigroup Inc

And as a follow-up, when 40G product does launch for Infinera, how should we think about the gross margin profile on that product relative to your existing 10G business? Putting aside the June quarter guide, which I think has a lot of specific issues around it?

Ita Brennan

Yes, I think when a 40 Gig product comes out first, obviously it will be a new line card with new volumes and so on. I think it's certainly initially, it's not going to have the same margin profile as a 10 Gig module at a FRU-level. Module to module basis. I think if you -- if it's going into an existing network, into existing footprint, there will be no common it's better to be deployed with that and that will offset some of that margin impact. If it's going to get into a new footprint and new opportunities, then I think it will probably have more, less favorable margins than what we're seeing on the 10 Gig products today. And how the fix of that plays out is really not clear yet. It will depend on where those deployments are.

Thomas Fallon

Yes, our 40G products will have the same kind of margin that the rest of the industry would have, based upon discrete technology that we're buying from other people that are available in the market. It won't have PIC economics and that's not the intent of our 40G solution. Our PIC economics are designed to bring radical cost structures to the industry and the discrete solutions should be in roughly on par with the industry should bear for 40G.

Kevin Dennean - Citigroup Inc

Tom, just a follow-up on that comment. I mean, it's kind of hard to see what other companies gross margins are given that does not very many pure players out there. So how would the gross margin profile for discrete 40G right now?

Thomas Fallon

I would describe the industry as an industry that typically bears a margin structure of high 30s to low 40 point of margin industry. I say we have set our company's long term business model is to achieve 50 points of margin. And we need to do that to offset obviously being vertically integrated. We've had certainly a few proof points of being in the high 40s to low 50s, but I think our industry ranges from probably the low 30s, if you're a commodity player to roughly 40% as an industry would be my estimate. Dave, do you want to make a comment on that?

David Welch

I think the gross margins of PIC-based systems in general are going to be inherently several points higher. We would expect when we look at the modeling that they could be in the range of somewhere between three to five points better gross margins.

Operator

Our next question comes from Rod Hall with JPMorgan.

Rod Hall - JP Morgan Chase & Co

I just wanted to check in on the order book for the 40 Gig product. And maybe just see if you guys could talk a little bit about what the expressed interest is in the 40 Gig product at this point? Can you give us any number of customers that is, I guess of your existing customers, what proportion that they said they might be interested in it? Or have it in labs testing it now. And then I got a follow-up to that?

David Welch

I won't be able to address. This is Dave Welch. We won't be able to address in the -- maybe the detail you're looking for. But most of our customers, as we've stated before, are comfortable with the 10 Gig deployments and holding out for the 100 Gig deployments when the PIC-based come down because of the overall network cost benefits that will come with that platform. As we stated before, there are aspects in route-by-route basis, there were current customer based do need more capacity than 10 Gig can offer. And those are the customers that we will be focusing in on in the second half of this year to deploy our 40 Gig products for. And I think the question is, I'm not sure we can quantify fraction of that our customer basis, majority of our customers are able to and willing to wait for 100 Gig solutions.

Rod Hall - JP Morgan Chase & Co

Yes, it sounds like you just the data is not right there, so you know, thanks for giving us some color on that anyway. The other thing I wanted to ask and I'm not sure if anybody is, has some , can you comment on the expected impact from the Level 3 acquisition of Global Crossing. Would you guys think the impact to you is there? Can you quantify it all for us?

Thomas Fallon

Yes, we certainly can't quantify it because it's -- first of all, the acquisition is certainly not complete yet. I don't think it's forecast's to be done by until the end of this year. But if you look at it, the way we look at it a Level 3 continues to be a significant customer of ours. Global Crossing has and continues to be a significant customer of ours. I think it puts us in a good position that they have two networks with common equipment. And as networks get bigger, the value of having an intelligent network grows. So I think that the fact Infinera infrastructure, and that our network is an intelligent infrastructure would help them scale their business efficiently. Having said that I, clearly, think this is a capital intensive industry for them and one of the reasons that they would combine is so that they could lower the amount of CapEx that they would need to spend as two independent companies. So I think that we are going to be well-positioned to earn business. I think our installed base and relationship with both companies is an advantage. But I do believe that over a longer period of time, they will spend less money than they would have independently. I do believe, however, that's healthy for the industry. The industry needs to consolidate so that there are more profitable companies in the industry.

Operator

Our next question comes from Sanjiv Wadhwani with Stifel, Nicolaus.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

Tom, I was a little bit confused and I apologize if you -- I know you addressed some of those. I'm a little confused about the 500 Gig PIC release in Q4 versus what's going to happen in the first half of next year. I don't know if you can just sort of go through it again, as what's exactly is going to happen in Q4.

Thomas Fallon

Sure. If you remember our previous guidance was that we would introduce this new platform in volume in 2012. That was kind of the full gain[ph]. This time we have said that we are going to launch, which is basically announce, describe to the industry, to our customers very publicly what this product is, what the features of this products are, what the pricing of this product is and all the availability in Q4. And that's so that we can accelerate when we'll bring this product to market, which we have now said will be in volume in the first half of 2012. So the goal of launching this platform in the end of this year is to allow customers a more comfortable way of making 2012 capital investment decisions around these architecture sooner.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

So is it fair to say when you launch it in the first half in volume, clearly it is going to be available for testing in labs before then? And I don't know if you can give a time frame as to when that might happen actually.

Thomas Fallon

We will have that done at data at the launch. But my perspective, you should have perspective that is sometime, maybe up to a quarter before we FCS[ph] it. Our customers will start having it in their labs for their own internal testing.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

And then Level 3, obviously, grew sequentially and it looks like it's going to continue to be an important customer in Q2, any impact that you guys are seeing at all? Maybe not from the decision last here to go Huawei? I'm just trying to -- do you have any clarity on that.

Thomas Fallon

Well, we clearly, as we said before, Level 3 has articulated that they have moved that it's not too kind of a two-vendor strategy. We continue to have a very good relationship with Level 3. We continue to have the opportunity to win a new business and new routes. But Huawei is clearly being deployed in their network and it's because they are doing it at a CapEx level. That quite frankly we don't think anybody can make money at. I think that Level 3 would agree that we offer much lower operating in total cost, but at a CapEx level, they find that solution very compelling for parts of their application. But we continue to win business. We continue to have a very good relationship and we're going to continue to work to be their primary supplier.

Operator

Our next question comes from Alex Henderson with Miller Tabak.

Alex Henderson - Miller Tabak + Co., LLC

I just wanted to talk a little about what your hearing from your customers as you're discussing these programs with them. And to what extent you're seeing in acceleration in activity in the market generally? In other words, if I were to look at the aggregate number of proposals that are running around in the field, have you seen an acceleration or a change in the pace and tone and scale of the transactions that are in the field? Not necessarily for your product, but in general.

David Welch

The general question of are we seeing more and more activity? Do we expect to see an acceleration to spend in the long-haul DWDM space?

Alex Henderson - Miller Tabak + Co., LLC

Clearly there's been 12, 13 years since we did the cycle to upgrade 2.5 to 10. We are at the point now, we're finally, there are alternative technologies here in the market. Is that resulting in an acceleration of activity of companies saying, okay, now is the time to make this bigger investment and therefore seeing proposals that are larger and more numerous than you had seen in prior periods?

David Welch

I think, there's two things you're seeing. There is a -- some of the large telecom providers over the course of the next 18 months are going through product upgrade cycles at a total dollars spent within DWDM space, I think it's on, averaged over multiple quarters, is on its general smooth trend. So that is a -- I've seen bandwidth growth on average, 30%, 40% per year bandwidth growth. And that's driving the absolute dollars of pre-installed system versus new systems. There will probably be -- I think less so in 2011 but in '12 and '13, there are some major system overhauls that are being contemplated that would make that dollar shift move from Legacy type of gear towards the next-generation gear.

Alex Henderson - Miller Tabak + Co., LLC

And the second part of the same question is to the extent that your seeing an activity in the field now, our customers pushing to make decisions quickly because they want to get involved with this upgrade earlier? Or are they basically saying, we'll wait until 2012 and pushing of the decision? Are you seeing a material impact on your bidding process as a result of people wanting to make decisions faster?

David Welch

I think the customer base is seeing that 100 Gig technology is coming in faster. We've talked about in the past as structural of what we call 40 Gig squeeze if you will. They see the 100 Gig technology they would prefer to get to. That is creating some uncertainty on a number of the customers of whether they can hold off the capacity demands until they get to that technology. And certainly, we see that from our customers have indicated earlier, preferred to wait for the 100 Gig technologies and not go through an interim product cycle in order to get there. And so to that extent, I think that is -- they're taking their systems or driving to a higher level of deployed capacity in pre-existing systems before going out and deploying new footprints in new systems.

Alex Henderson - Miller Tabak + Co., LLC

The last question is just to repeat of what will happen in the prior question. You talked about the time your getting the product to your customers but you didn't talk to how long you think the test cycle from the time it reaches their labs to the time you'd actually see revenue recognition. Are you still talking a couple of two, three quarters in that process?

David Welch

I think Tom's comment was from the time that we FCS[ph] since this time we see some revenue from it is within a quarter. And it depends very much on the type of customers we supply. Customers that will have fully certified by the time we FCS [ph] it. And there'll be other customers that will require 6 months test cycle before they would accept that. So that transition, they will continue to deploy the current existing product tenant 40 Gig product while they're certifying the 100 gig. We expect that transition to be reasonably smooth, but revenue will come from our own entries, the 100 Gig product relatively quickly.

Operator

Our next question comes from [indiscernible] with Sanders Morris.

Unknown Analyst -

I have two questions. First on, Fookien[ph] switching and the whole Packet optical there [indiscernible] and then the new products received. Can you talk a little bit about -- your supply target and [indiscernible] OTN switch, what kind of packet capabilities you might have on your transport platform? And the other questions on 40G, probably talk about the 40G's use in the past. If you look at the market today, what percentage of wavelengths is being shipped out 40G in the long-haul and what percentage of dollars does 40G versus 10G. And can you give us a snapshot and how you expect next year, some combination of 10G, 40G and 100G, how would you expect your business to look?

Thomas Fallon

Well, there's a couple of questions there. What is -- what do we see from the 10G volume and the 40G volumes. I think that in 10G volumes have been relatively flat in the industry and are forecasted to be at port basis are relatively flat. But probably you know, 10% to 15% price compression per year in the industry, and I think that's probably what you can expect. I think, from a port perspective on 40G, what we're seeing is an increase certainly. I think you had a recent number that I see here about 5,000, maybe at the top ports per quarter. But that's a combination of coherent and non-coherent ports and not all serving the long-haul. I still consider our sea[ph] that for long-haul 40G, it carries a premium to 10G pricing of probably somewhere in the 4x to 5x range at least. I think that our industry right now is, got an interesting of changes that are happening. 40G, 40G coherent, 100G coherent, OTN packet. And with all these changes, I think it both creates a lot of opportunity, but it also potentially, defers some of the buying decisions, while the strategies are redded[ph] out to make sure of the industry knows how the customer knows they're going to spend their money. This is the first time our industry has experiences for quite awhile. And I think that, that's quite frankly good news for our industry and particularly good news for us as our -- we will benefit from the customer base evaluating the value of 40G coherent and the value of 100G coherent and the value of OTN, which we think, as I mentioned before, is really what our product is all about. So I think that next year, we will see probably a predominant amount of our volumes still being 10G. That's what the largest volume in the industry is. I think that we will get a reasonable share of 40G, but I do think next year, 100G will start being a substantive amount of revenue in the industry. They will probably not that great on a port basis. I think on a port basis, the 100G market for long-haul is estimated to be in a thousand port-range for next year. Our job is to do two things. One, get a substantial portion of those thousand ports, but more importantly is to accelerate the industry to 100G ports and pick-up a large portion of that. So getting things to market early, but also creating PIC economics and OTN economics for the customer-base, will help accelerate the 100G adoption. And that to me is the most important thing that we can do. David, you could answer the packet question. I'd appreciate it.

David Welch

I think your question's asking for what is, how do we think about packets in our products. We're not at a point where we are going to do our product introduction of our next generation platforms. So I don't want to get to the specific details of what's -- will be on that system. However, we introduced though the concept of digital optical networks five years ago, which was the concept of having digital bandwidth management integrated with the optical transport layer. We've been very successful in showing that, that has a significant added value on the network. We believe that packet; is part of the roadmap of the digital optical network as we go through the evolution and phases of that technology developing. So we're certainly absolute you're going to pay attention to it, but at this time, we are not going to make a product announcement about what capabilities or when.

Unknown Analyst -

Tom, if I could follow up on your point. So if you look at dollars spent today in the long-haul, do you think we are at the crossover point though ports obviously on 40G are lower than 10G in terms of dollars and in the long-haul, are we getting close to [indiscernible] Between 40G and a 10G in the long-haul?

Thomas Fallon

On gross dollar spent? not on price per 10G

Unknown Analyst -

On gross dollars spent.

Thomas Fallon

I would say, we're probably getting fairly close. I'll have to follow-up exactly back with you, but we expect the industry's probably getting very close.

Unknown Analyst -

And therefore, your addressable market is only really half of the of the long-haul in market, in dollars spent if 40G? I mean until you get your 40G land guards. They're really on the addressing half of the market of 40G is becoming half of the market is rather a fair way to think about it?

David Welch

I think the buying cycle of our customers are such that as Tom indicated, we will be bringing out our 40G product in Q3. They are in the process of integrating that into the buying plan now. I think when you look at the market numbers you'll get from the research analysts, you have to be a little careful also because the line system, which is identical between 10 gig, 40 gig, and 100 gig tends to work the relative dollars in any one particular market for that. Those dollars are frankly neutral to the 10 gig or 40 gig market. So the total dollar available to the 10 gig market is certainly more than the ratio of the transponder values.

Thomas Fallon

And I also think it's a very important to segment out. And David is right, every time our customers today buys a line system from us, that is a 40G ready line system, or 100G ready. So that is money that we're not losing to the market. But if you pull back and say, "Who's buying 40G?" Approximately half of it is going to China, and I don't care if we have 40G for free, we're not going to sell any to China. So we're not losing half of an available market, half of the available market is close to us. The other big portion of the 40G is going to AT&T and Verizon. We haven't won AT&T and Verizon yet. So it's not a choice of can they buy our 10 gig, or our 40G, or our 100G. That market is not available to us today. So if you're to ask me, what percentage of our truly available market are we losing today because of it, it's a very small percentage. Now that doesn't mean that we are anxious to recover that, but I don't want you to walk away saying that either we're loosing half the market opportunity today, or when we bring out 40G that half the market doubles. It's not true.

Unknown Analyst -

Fair enough. I was thinking aggregate market terms. Certainly, with your customer -- I understand that percentage is quite different.

Thomas Fallon

And recognize, China is nobody but the Chinese's customer mix, right? It's a big portion of the 40 gig market.

Operator

Our next question comes from Michael Genovese with MKM Partners.

Michael Genovese - MKM Partners LLC

Ita, in your comments -- in your guidance, it sounds like in the second quarter, you expect to sell more common equipment than you did in the first quarter. And I was wondering if you could comment on what that is? Is that 10G, new 10G chassis going out? Is that more weighted towards terrestrial or underseas?

Ita Brennan

I think its a combination. We're going to sell common equipment line systems, which will be 10 gig, 40 Gig, and 100 gig ready, right? So it's not the actual common equipment, the line systems that we're putting in and are not linked to a wavelength or transmission speed, right? So we are seeing a number of, and you will see this in our customer account next quarter, a fairly sizable opportunities and somewhat subsea content and terrestrial content. And I think its a good thing to see kind of some of that common equipment back in the mix because the last couple of quarters, where we've had the 50%, 51% gross margin. We haven't had that same level of common equipment.

Michael Genovese - MKM Partners LLC

And then on those gross margins, with Kevin's question earlier, that discussion made me wonder, does the long-term business model of the company changed? At 10G, you had laid out a certain revenue level you get to in 50% gross margins to get to an operating margin target. And it sounded to me, although I maybe interpreting -- although I may be reading too much into it, you were saying with 100G, the gross margin sounded like it wouldn't necessarily reach that 50%? Am I reading too much into that, or is there a different business model for the company at 100 versus 10?

Ita Brennan

No, we're not changing the business model at all. In fact, we think the 100 gig product with all of its kind of added switching and greater level of switching in bandwidth management capabilities is actually a driver towards that business model. I think the discussion with Kevin around margins is very much focused on the 40 Gig products and the discrete 40 Gig. But once we get back to PIC-based 100 Gig system, then we believe that very much contributes towards achieving that business model.

Thomas Fallon

Two comments in addition to that. We are at the most expensive phase right now of bringing to market our 100G platform. We're having to invest in new manufacturing capacity, both for our system and for the PIC. So we're building capacity today that will be utilized across the next decade. The second thing is, the 100G cycle is probably going to be 15 to 20 years or more. The 10G cycle started in 1997. So we're 13 years into it. We didn't bring out our 10 gig solution till 2005. So we caught it in the middle of the cycle. We should have a very good opportunity coming in at the early part of the cycle, making the capital investment at the early part of the cycle, that we can actually have a very, very good business model as these volumes take into the industry, we can accelerate the demand. And I'm actually -- as Ita pointed out, I think the 100 gig opportunity is the first time that we actually get to test our business model.

Michael Genovese - MKM Partners LLC

And if I could just slip one in before the end. On 40G -- you're early opening comments sounded extremely confident, talking about interim 40G deployments on a tactical basis, with competitive solutions. And you sound very confident about your competitive position in your customer base. And I just want to ask you the question, if you think that if they choose somebody else or 40G, does that not change the competitive situation in the account? How do you -- what makes you so confident that these guys are all going to come back for 100G with Infinera?

Thomas Fallon

I'm never confident that if we lose somebody they come back. And I crawl the wall to worry around that. Now, everyday I want to make our customers satisfied. The reason I feel confident, and please don't take it as arrogance or lackadaisicalness. Everybody we talked to wants 100G today. At 100G economics, with the proven ability to go to market in volume. That just doesn't exist today, but everybody wants it, and everybody can see it in the relatively near term. Two years ago, there was big questions of whether it's going to be 40G or 100G. Even a year ago, there was some question. I don't think that there's a question today. Either when I talk to customers, potential customers, or see the universe of industry analysis. There's a fairly consistent story that they want 100G at good 10 gig type of economics. 6x 10 gig economics, or even 10x 10gig economics quite frankly. So I feel pretty comfortable that the consistent story is that the world wants to move to 100G. At the same time, we're going to deliver a world-class 40G product. That's for our installed base, so that you can upgrade their network. Absolutely the most cost-effective way. There's no customer we have that can upgrade to a 40G network more efficiently than to upgrade our platform with our line card, because it is already installed. It is already 100% in use, and all you have to do is buy an upgrade line card. So we're going to be very sensitive to making sure that's a good long-term decision for them also. But I think that if somebody makes a 100G PIC today, I still think its an early enough time in the industry that those decisions are going to have an opportunity for second vendoring. I just think its a very, very early part of this 100G deployment.

I want to thank you for joining us today, and for your questions and continued interest in Infinera. We look forward to keeping you informed of our progress. Thank you.

Operator

Thank you for joining today's conference. That does conclude the call at this time. All participants may disconnect.

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