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Executives

Bob Blair - Investor Relations

Jagdeep Singh - President and CEO

Duston Williams - CFO

Analysts

Simona Jankowski - Goldman Sachs

Ehud Gelblum - JP Morgan

George Notter - Jefferies

Subu Subramanian - Standard & Poor's

Jeffery Schreiner from Capstone Investments

Jack Monti - Lehman Brothers

Infinera Corporation. (INFN) Q2 2008 Earnings Call July 22, 2008 5:00 PM ET

Operator

Good afternoon and welcome to the second quarter fiscal 2008 investment community conference call of Infinera Corporation. All lines will be in listen-only until the question-and-answer portion of the call (Operator Instructions) Today's call is being recorded. If you have any objections you may disconnect at this time. Your first speaker is Mr. Bob Blair of Infinera Investor Relations. Sir, you may begin.

Bob Blair

Thank you. Good afternoon and welcome to Infinera's Q2 2008 earnings call. Today's call will include projections and estimates that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements address the financial condition, results of operations, business initiatives, views on our market and customer, market condition results of operations, our products and our competitors' products and prospects of the company in 2008 and beyond and are subject to risks and uncertainties that could cause actual results to differ materially from such forward looking statements.

Please refer to the company's current press releases and SEC filings including the company's Annual Report on Form 10-K filed on February 19, 2008 for more information on these risks and uncertainties. Today's press releases including Q2 2008 financial tables and investor information summary and a guidance reconciliation summary will be available today on the Investor Section of Infinera's website at www.infinera.com.

The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. This afternoon's press release and today's conference call also include certain non-GAAP financial measures.

In our earnings press release, we announced the operating results for the second quarter 2008 which will exclude the impact of the roll off of certain ratable GAAP revenue and costs from the balance sheet as well as the impact of non-cash, stock-based compensation and warrant revaluation expenses.

These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons. Please see the exhibit to the earnings press release for a reconciliation of these non-GAAP financial measures for 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 also give guidance including guidance for the third quarter of 2008 and for the full year of 2008. In this guidance, we'll include adjusted GAAP results, which exclude the impact of the roll off of certain ratable GAAP revenue and costs from the balance sheet as well as the impact of non-GAAP, non-cash stock-based compensation expenses form our results. Again, we have reconciled these adjusted GAAP projections to our GAAP results on the Investor section of our website in the document entitled Q3 guidance reconciliation summary.

We have excluded non-GAAP, non-cash stock-based compensation expenses because we cannot readily estimate the impact of our future stock price on our future stock-based compensation expenses. For the remainder of today's call; we'll be discussing our second quarter 2008 results and our third quarter 2008 and full year 2008 guidance excluding the impact of these items and we'll refer to these results as adjusted GAAP.

I'll now turn the call over to Infinera President and Chief Executive Officer Jagdeep Singh.

Jagdeep Singh

Good afternoon everyone. Joining me today is CFO Duston Williams, who will provide a second quarter financial report and an outlook for Q3 after my remarks. Turning to the second quarter highlights; we reported adjusted GAAP revenue of $91 million in Q2 versus $69 million of invoiced shipments in the year ago period representing 32% year-over-year growth.

We posted adjusted GAAP net income of $11 million or $0.11 per share verses $0.04 per share in the year ago quarter and we generated $5.6 million from operations. We also added two new customers in the quarter not including Deutsche Telekom bringing our new customer roster to 44. In terms of geographic diversity, our international revenue included 22% of revenue in Q2 versus 16% in the year ago quarter.

Last month, we were clearly disappointed in having to revise our near term outlook. This was primarily an outgrowth factors associated with our customer concentration, a challenge that we continue to diligently address. We remain steadfast in our belief in Infinera's long-term growth potential based on our compelling valve proposition; our highly differentiated technology advantage, a substantial and growing optical market and the effectiveness of our business model.

The vectors for our long-term business model remain encouraging. We believe that we have built a substantial business based on differentiated technology as evidenced by the results from our first five quarters as a public company. Revenue of $429 million, net income of $53 million and a global customer roster with a growing installed base of Infinera equipments.

We intend to leverage these long-term fundamentals and return to higher levels of growth. We have identified markets that we believe will be the most critical for us to focus on and we are implementing initiatives across these including further expansion into international markets by leveraging the resources we have invested overseas and continuing to harvest the momentum of our initial successes in the EMEA region including our recent win with Deutsche Telekom.

Second, we remain focused on penetrating additional tier 1 carriers worldwide. We continue to be pleased with our traction with this important group of potential customers. Third, we have begun to focus our energies on competition in new adjacent markets including ultra long haul and metro access. And fourth, in North America, where we are not fully penetrated, we'll focus on maintaining our share with the existing customers, while also growing new footprint in market segments such as ILEC, Federal Government, cable MSOs, and Internet content providers.

We remain committed to funding R&D and product development in order to extend our competitive advantage. We believe that this investment is critical to maintain and grow our technology lead and also to open up doors to compete for business in new markets like ultra long haul and metro.

In the last six months, we converted our ongoing investments into several significant technology advances to enhance our PIC based optical networking offering. We provide our customers, with what we believe is the industry's first PIC based Roadmap indicating our belief that it is possible to double capacity per chip every three years. We offer what we believe is the only effective path with which customers can scale their networks to meet their bandwidth growth needs into the next decade.

With the recent introduction of our new ILS2 line system, we improved the capacity and reach of our PIC based system, while also strengthening our ability to compete on more long haul opportunities. We hear this from our customers and believe that their selection of Infinera, as their WDM provider over their incumbent vendor is a validation of our digital optical networks architecture and of the innovative photonic integration, which is at the heart of all our systems.

One of our most recent and significant new customers, Deutsche Telekom reaffirmed its value proposition, when it selected our systems for its next generation of international network. We believe we won the deal because of the significantly improved scalability, flexibility and speed of service delivery that our architectures will provide.

In every other segment that we have focused on including bandwidth wholesalers, cable MSOs and Internet content providers establishing a strong relationship with an industry leader has translated into strong industry word of mouth, an additional business with others in those segments. We believe we'll enjoy similar success with DT and other tier 1 incumbent player's overtime. Industry analysts now estimate the total optical market at about $15 billion.

Infinera is now addressing the DWDM or dense wave division multiplexing segment of that market, which we estimate is $6 billion in size. The optical market remains a large opportunity and we are addressing it with differentiated technology and with a significant competitive advantage. Our strategy in the years ahead is to integrate more and more components into our PICs in line with the PIC Roadmap we announced earlier this year and deliver more services through systems enabled with these more powerful PICs, thus creating even greater value for our customers and placing more distance between us and the competition. This strategy is resonating with customers and prospects and we are seeing many new opportunities in the market beyond Q3, but it's too early to translate these into forecasted revenues.

Duston will now provide a financial report and our Q3 outlook. Duston?

Duston Williams

Thank you, Jagdeep. I'll review our Q2 actual results and then follow that up with outlook for Q3. The following analysis of our Q2 results is based on adjusted GAAP and the results from other quarters in fiscal years are based on invoiced shipment and exclude non-GAAP stock-based compensation.

Please see the GAAP to non-GAAP invoiced shipment and adjusted GAAP reconciliation, which is attached as an exhibit to today's earnings press release for a reconciliation of these results to our GAAP results. Q2 was a quarter in which we slightly exceeded our revenue expectations and significantly outperformed on an earnings basis. Looking at the specifics for the quarter, adjusted GAAP revenues in Q2 totaled $90.8 million versus $95.5 million in Q1.

In Q2, we had three 10% or greater customers on an adjusted GAAP basis, level 3, Cox and Global Crossing. As expected Level 3 revenue decreased from Q1 and accounted for 21% of our Q2 adjusted GAAP revenue versus 31% of invoiced shipments in Q1. Looking at gross margins, they were 47% in Q2 versus 45% in Q1.

Once again, strong TAM shipments combined with modest cost reductions or improvements accounted for the better than expected gross margins. It's also worth noting that while TAM shipments in the quarter were strong; we also invoiced a record-tying amount of chassis in Q2.

Operating expenses for the quarter were $32.3 million versus $33.4 million in Q1. Although, expenses were down slightly quarter-over-quarter, they were less than our previous expectations of $36 to $37 million. This variance was attributed to lower prototype spending a somewhat slower than expected headcount ramp long with the reversal of previously accrued bonus dollars as our current operating plan does not project a bonus payout for 2008. We expect the majority of this variance to roll into spending during the second half of 2008.

Operating income for Q2 was $10.4 million versus $9.6 million in Q1. Other income expense for Q2 was a favorable $2.6 million driven primarily by interest income versus $4.2 million in Q1, which also included asset sales and FX gains. We booked a tax provision for Q2 of $2.3 million. Net income for the quarter was $10.7 million or $0.11 per diluted share based on $97.3 million shares outstanding versus $12.6 million or $0.13 per diluted share in Q1.

Looking at the balance sheet, cash, cash equivalents, restricted cash, and investments ended the quarter at $318.2 million versus $316.4 million in Q1. We generated $5.6 million of cash from operations in Q2 versus $9.8 million in cash from operations in Q1.

DSOs were 57 days versus 42 days in Q1. The DSOs were higher than historical trends, as we had one specific deal totaling $9 million that was shipped earlier in the quarter but the timing of the customer acceptance cause the payment to be pushed into Q3. This accounted for an additional 10 days. Inventory turns were 3.3 versus 3.5 in Q1. Accounts payable days came in at 37 days versus 42 days in Q1 and capital expenditures were $4.8 million in Q2 versus $2.5 million in Q1.

During our Investor Call on June 16th, we provided preliminary adjusted GAAP revenue guidance for Q3 of $75 to $80 million and our guidance today for Q3 remains the same. As previously discussed this guidance was based on the timing of new network build at existing customers and the sales cycle with potential new customer wins along with the timing impact associated with the transition of our recently announced new products. Additionally on our June 16th call, we provided growth guidance for 2008 of approximately 10% and our guidance today for 2008 remains unchanged.

The complete guidance for Q3, which follows below is based on adjusted GAAP results and excludes any non-GAAP stock-based compensation expenses. Revenue of approximately $75 million to $80 million, this assumes total GAAP revenues of $113 million to $118 million reduced by approximately $38 million for the amortization of the deferred revenue recorded on the balance sheet at the end of Q2, 2008, which reflects sales included invoiced shipments in prior periods.

Gross margins of 39% to 40%. This gross margin estimate includes an approximate 4% negative impact from the previously disclosed $3 million onetime charge associated with the initial shipments to Deutsche Telekom. Operating expenses of $36 million and a net loss of $3 million to $5.5 million once again this loss assumes an approximate $3 million negative impact from the initial shipments of Deutsche Telekom. Based on an average estimated diluted weighted shares outstanding of $97.5 million, this would lead to an EPS of loss of between $0.03 and $0.06.

Operator, if you would now open it up for questions, please.

Question-and-Answer Session

Operator

At this time all lines are in listen only (Operator Instructions) Simona Jankowski from Goldman Sachs. You may ask your question.

Simona Jankowski - Goldman Sachs

Yes. Hi, thank you for taking my question, I just wanted to ask you as far as the upside this quarter from both gross margin and an OpEx perspective, can you just help us sort of disentangle a little bit how much of that is sustainable and should carry forward into the forward quarters verses how much of that was more of a one quarter kind of benefit?

Duston Williams

Simona this is Duston. As far as Q2 goes once again we did get a little bit of a pop from TAMs cost reductions continue to come in nicely there. Going forward the $39 to $40 is really on equivalent basis, if you add the 4% back for the DT impact you had 43% to 44%. So, we have trimmed it back a little bit assuming that the TAM shipments aren't quite as strong in Q3. So, majority of that continues to roll forward and we have always said in the next foreseeable future that the margins going to hover probably in the low to mid 40% range plus or minus.

Simona Jankowski - Goldman Sachs

Thank you for that. And then just secondly from revenue prospective, you commented on looking to address more completely the metro access and the ultra long haul spaces and certainly with your ILS2 line system that is making some progress towards the ultra long haul space. But can you also just comment what other products if any do you need to rollout or do you have in the pipeline for the metro access segment? And also similarly what other investments if any do you need to make from a sales or distribution or headcount prospective for those new segments.

Jagdeep Singh

Relative to the second question all of the segments we are addressing are in the same general customer base that we sell through today. So, we believe that the current sales forces and the footprint that we have worldwide allows us to sell through all those applications.

Relative to the ultra long haul part, you are correct. We announced a couple of important new developments last month that were pretty key in allowing us to compete in that space, extended reach of our systems, higher capacity systems and so on.

On the metro front, we haven't specifically talked about any products there. But what we are saying, is we believe that is an important segment there for us and we have got number of initiatives underway to address that space.

Simona Jankowski - Goldman Sachs

But in terms of the products that you would need to address this space that’s not something that you've really introduced as of today for the metro access portion?

Jagdeep Singh

That's right. What we probably talked about today has been our current product, which competes well in the metro core segment. We haven't talked about metro access. But we believe that's an important segment for us to play in and so we have got some initiatives underway in that area.

Simona Jankowski - Goldman Sachs

And then just lastly on that point for the ILS 2 system, at what point do you think that should be starting to get reflected in your revenues?

Duston Williams

We have started to see some initial orders here and so Q3 and then additional in Q4.

Simona Jankowski - Goldman Sachs

Thank you very much.

Operator

Ehud Gelblum from JP Morgan. You may ask your question.

Ehud Gelblum - JP Morgan

Hi, thanks. A couple of things, if I could. First of all, it's a minor thing, but I'm wondering what was the mix in the revenue versus what you expected? There are a couple of telltale signs that kind of look as though the mix ended up slightly different than you anticipated. One is it seems like, you got more TAMs and you expected even a month ago when you pre-announced, if you can comment if that was correct? And how do that happened, was the quarter very, very backend loaded to give you those TAMs? And I'll stop with that and then a follow-up?

Duston Williams

Yeah. I wouldn't call it the quarter backend loaded. We shipped actually reasonably linear on a shipment basis throughout the quarter. On the TAM we have talked about this before again, but where we guarantee delivery of TAMs in ten days, once again, it's not surprising that we do get surprised occasionally with TAM orders at the end of the quarter, because our customers know that we have TAMs and we'll deliver promptly. So, yeah you are right that was a little bit different then we had thought.

Ehud Gelblum - JP Morgan

But I mean, even after I think three or fourth quarters straight have been getting your gross margin consistently low in the guidance versus what you end up with. And that's why I'm assuming that the TAMs ended up being a more significant part of the revenue base than you expected. Why is it that you keep getting the gross margins low and underestimating the TAMs and…

Duston Williams

Yes.

Ehud Gelblum - JP Morgan

I just want to know because that you only beat by $1 million. So, as you underestimated the TAMs whether you overestimate it. You said chassis were at a record. So, what was

Duston Williams

All good questions.

Ehud Gelblum - JP Morgan

Something is missing here.

Duston Williams

Yeah. The only….

Ehud Gelblum - JP Morgan

Outperforming….

Duston Williams

The only correction I would make there is your comment that TAMs were significantly incremental to revenue. Again few TAMs here or there can augment the gross margin percentage pretty heavily. So

Ehud Gelblum - JP Morgan

Like 500 or 600 basis points?

Duston Williams

Well, no, not obviously that much. But, from what changed in the mix, we did ship a fewer DLMs. So, chassis were strong. TAMs were strong. DLMs came down roughly 20% or so from last quarter.

Ehud Gelblum - JP Morgan

But aren't chassis lower margins than DLMs. I'm just trying to understand is what changed, I mean, you even reported numbers, you even pre-announced in mid June and some how you blow up the gross margin, which is terrific. But I'm just wondering what went up so much it must have been TAMs and what came down it was just DLMs. I just can't seem unless you were very, very conservative on your gross margins guidance in which case, you might be doing it again this quarter trying to gauge that?

Duston Williams

Yeah. I mean respectively, when we have the call on June 16th, we confirmed guidance in total for Q2 and once again it doesn't take a whole lot of TAM movement to augment the gross margins. And then clearly at that point we hadn't closed the books on the manufacturing side of the equations, some cost reductions, warranty continues to please us with the product quality continues to get better just when we think it can't get much better because its really good. It continues to get little better. So not having all that information on June 16th obviously we wouldn't be comfortable and tweaking anything at that point.

Ehud Gelblum - JP Morgan

Okay. And finally, if you were to keep your revenue in the invoiced revenue perspective and sort of switching to this adjusted GAAP revenue, would DT become a 10% customer and/or be one of your larger customers anytime over the next year? Would it be that larger enough to do that?

Duston Williams

Yeah, probably obviously I won't comment on potential shipment to DT on that front.

Ehud Gelblum - JP Morgan

Okay, thanks.

Duston Williams

Okay. We don't predict pretty much any new customer's revenue growth over the next several quarters.

Ehud Gelblum - JP Morgan

Okay.

Operator

George Notter from Jefferies. You may ask your question.

George Notter - Jefferies

Hi, thanks a lot. I wanted to ask about your initiatives in Europe in trying to penetrate incumbent telcos above and beyond DT. What you are seeing competitively from some of the big traditional OEMs. What you are seeing from Huawei, VTE some of the Chinese vendors anything new from a pricing perspective out there? Thanks.

Jagdeep Singh

Usually what we see in most of these accounts is typically there is the incumbent vendor, whoever that is, there is Huawei is pretty commonly seen over there and then it's us. So, that's typically the three that tend to make most of the final shortlist. And our basic approach as I think you might know George is to really focus on the value proposition and the things that you get with your Infinera approach like the speed of service turn up and the scalability of the system with the PIC Road map and the ease of use and so on which you don't get with the commercial WDM solution. So, we are trying to really focus on the value proposition and obviously, you can't be a way out of line with pricing but again we find that we don't need to be the absolute lowest bidder on those deals. So, the pricing environment, we try to stay away from turning into a pure commodity sale that seems to be working for us.

George Notter - Jefferies

Got it. Have you lost any deals on pricing in the last several months?

Jagdeep Singh

I think generically, we win a lot of the deals we compete on. But we certainly don't win every single deal. And so, there are deals that we haven't won. But we don't always know why we don't win those deals that we don't win. So, unnecessary that we win every deal that we compete on.

George Notter - Jefferies

Got it, okay. And then just separately, I know there was a manufacturing off shoring initiative going on I think, I have asked about this in prior quarters, I guess, I'm just trying to get a sense for where that is in the process have you moved more of your manufacturing offshore. How much of a cost benefit, could you capture from that? Is that starting to run through gross margins now, any flavor there would be great? Thanks.

Duston Williams

What we have previously said there George, again, that it would be a second half initiative. Actually we have done a lot of work in the first half and things are going quite well there and we should start to see some benefit in the second half. Now, where that benefit pops up and does some go into pricing to offset some pricing and other things we'll have to see how it plays out. But we should definitely get some impact going forward.

George Notter - Jefferies

Great, thanks.

Operator

[Subu Subramanian] from Standard & Poor's. You may ask your question.

Subu Subramanian - Standard & Poor's

Thank you I wanted to ask about December quarter, I know it's a little early to talk about that. But given the lot of the issues in September are timing related issues. I just wanted to see, what's your subsequent conversations with customers have been and will some of those opportunities get pushed out into December creating more opportunity for growth than you have guided for?

Also on the metro access side and which if you mentioned this briefly. But is there a new set of products that you need to develop to beat these areas., can they still be PIC based and what kind of tweaks to the existing product or new products would you need to develop to address that market effectively?

Duston Williams

Subu, this is Duston. I'll take the first half and let Jagdeep take the second piece their. Regarding Q4 although we are I guess, four or so weeks subsequent to our June 16th call, 5 weeks I guess. We have got another month under our belt there. We are encouraged by potential opportunities out there like Jagdeep mentioned but nothing that we feel comfortable at this point that would change our view of Q4 and approximate 10% growth rate for the year.

Subu Subramanian - Standard & Poor's

Yeah. And so from yours customers that they were delays on either existing customer build outs or new customer acquisition, no real change in status from your conversations a few weeks ago?

Duston Williams

Nothing substantial.

Subu Subramanian - Standard & Poor's

Okay.

Jagdeep Singh

Yeah. I think, it's just we see activities just too early to roll that into the forecast. And then the second part of your question about metro and I think the things that we want to do there is, the value proposition resonates very well in environments, where there is high amount of bandwidth density. So, clearly long haul core regional networks ultra long haul metro core all those markets works very, very well.

The focus of our metro initiatives is really are to extend that value proposition to a lower bandwidth environment if you will. So, in networks sort of range where you have fewer wavelength and fewer drops and so on, what can we do to make the product more compelling in that environment. And that's what we are focused on. We think getting into those networks is helpful for a couple of reasons one is it provides a more complete solution for our customers, who already use us as the backbone of their networks. And secondly it provides a good entry point into many networks that we don't clearly play in. So, those are the key things we want to focus on the metro side.

Subu Subramanian - Standard & Poor's

Got it. Thank you.

Operator

(Operator Instructions) Jeffery Schreiner from Capstone Investments. You may ask your question.

Jeffery Schreiner - Capstone Investments

Good afternoon gentlemen. Thanks for taking my question. One question I want to ask is, the Chinese market it's been something that you guys have talked to recently about looking into. And I was wondering have you seen any initial reception with any of the Chinese carriers within the Chinese market and could this be the type of market that could help offset any prolonged U.S. spending slowdown?

Jagdeep Singh

I think relative to Asia in general we have been expanding our footprint there over the last quarters. We certainly see activity there. I think that what we have seen is when we enter a new market it typically takes some period of time before the sales footprint translates into meaningful revenue traction. And so, we are a little bit cautious about expecting anything big in the near term there. But what's clear is that Asia-Pac in general is on the order of one third of the world market for WDM equipment. So, we absolutely want to and intent to be players there, but it's just the history it generally takes time to ramp up momentum in a given market. So, that's really what I would say about Asia.

Jeffery Schreiner - Capstone Investments

Just trying to understand, I think a lot of questions are focused just on the June conference call and what we saw in terms of maybe customer delays. But besides customer delays or in lieu of customer delays, what are the pushback are you guys receiving right now, when you are talking to customers and trying to craft new deals?

Jagdeep Singh

I think the kind of things that we have been hearing from customers is actually kind of things in some ways have addressed and our addressing in the pipeline. So, for example, the introduction of the ILS2 system last month addressed a number of things that we are hearing from certain customers.

So, system now has much longer reach. We announced that we can get to [2100] kilometers worth of reach on the system with the 160 channels in the C-band so that's the twice as many wavelengths in the C-band as most competitive systems get using a 25 gigahertz space. So, that the capacity of reach were important aspects of certain applications, which we have addressed. We continue to hear from lot of interesting customers in taking our products downstream towards the metro access, I referred to that earlier in the call, so those are things we are looking at addressing. Those are the main things.

People, I think are very pleased with the whole PIC Roadmap. I mean, if you are a carrier that believes that bandwidth is growing exponentially, whatever rate you believe, but that's 50% or 75% per year, there is really nothing else on the horizon that let's you deal with that kind of capacity, outside of photonic integration. So, the whole PIC Road map that we have with the notion of bandwidth per chip doubling every three years is a very powerful concept to resonate and that's the core of the value proposition and then what we'll be doing is filling in the key pieces around that with the reach and the capacity of the overall fiber and the metro access and so on.

Jeffery Schreiner - Capstone Investments

One final question, I appreciate your time gentlemen. As we look out in terms of how the business may shift in transition and do you see the current products be more developed and matured and possibly see a higher level of TAM shipments there. How should we expect the business then to trend as the ISL2 product line as you just discussed is brought in and perhaps less common equipment sales, we are going to be needed to be associated with that product? Should we see a little bit higher margins initially from an ISL2 type of product sale versus then what we might see from today's current product line?

Jagdeep Singh

It's a good question. I think it's hard to say what difference you'll see in the actual financial results because the financial roughly reflect a blended average of both the regular reach system and the extended reach system with the ILS2, so it will be blended. But within the ILS2 family given the high capacity long reach family, your points are valid which is for example with a 160 channel system that same initial common equipment deployment now supports twice as many TAM deployments overtime. So, hypothetically if you had a network in which you had a nine month window to max out from zero TAMs to the full capacity. But now you would be doubling that window assuming the growth rate were consistent.

So, you would go longer with TAM additions without having to add another layer of common equipment which at some point obviously should have help margin obviously at a product line level, but the impact at the financial statement level was going to be somewhat muted because it's going to blended with other products that we are selling there.

Jeffery Schreiner - Capstone Investments

Thank you.

Operator

Jack Monti from Lehman Brothers. You may ask your question.

Jack Monti - Lehman Brothers

Hi. Thanks for taking my question. I'm just trying to get a better grasp of how we should think about the operating model going forward and I think that OpEx is roughly 46% of revenues in our guidance for the third quarter and I think the target model is more or like 35% of revenues for operating expenses and 15% operating margins. How should we think about that going forward and how was the company thinking about that in its long range plan? Can we think about 15% operating margins sometime in 2009 or is that further back in 2010?

Duston Williams

Yeah. Sure, Jack. When we talked about the operating model in its totality, again we have been talking 2010 in some cases a little bit beyond there. So, 2009 I think is aggressive on the expenses it's a little hard on pushing with the revenue downturn to correlate that to a percent of revenue because again what we are investing in we believe very heavily in and we'll continue to invest and we are saying that expenses are going to come up about $4 million quarter-over-quarter from Q2 to Q3. So, we'll continue to invest, majority of that investment is in R&D. But we are going to continue that type of investment going forward. So, I think in the short term it gets a little disconnected because of the revenues. But ultimately yeah, there is 35% and 15% there is no change to that thought.

Jack Monti - Lehman Brothers

And it's fair to think about R&D continuing to trend up through 2009 quarter-to-quarter?

Duston Williams

Certainly it will poke up a little bit in Q4 and we'll have to see how it trends in '09.

Jack Monti - Lehman Brothers

And also just quickly, I guess, on the tax rate, it seems like the provision is picking up 8% in the first quarter, roughly 17.5% in the June quarter. Should, we start thinking 15% to 20% for that provision?

Duston Williams

No, unfortunately with our adjusted GAAP and GAAP results that tax provision is based on GAAP profit. And if you look at the cumulative six-month provision, I think it's around 4.6% of GAAP profits. And I think on the last call, we mentioned it would be roughly equal as we see it today anywhere about four percentage of GAAP profits. So, you really got to flip back on this case, look at what we are generating for GAAP profits. Now, because of the roll off in the deferred revenues and margin starts to decline in Q3 and Q4 that actual tax provision will also decline in Q3.

Jack Monti - Lehman Brothers

Thanks a lot.

Duston Williams

Okay.

Jagdeep Singh

Okay. In closing, I want to say that we are excited about the opportunities for growth in the digital optical network space for Infinera. Despite our near term outlook we set, we believe that the fundamentals remained strong and our long-term business model remains intact. We continue to have confidence in our technology advantage with our PIC based solution and the compelling nature of the value proposition.

And our team is focused on delivering strong financial performance in the years ahead, as we continue to establish ourselves, as the leading systems company through our differentiated product offering. I thank all of you for joining us today and we look forward to reporting on progress in our next call.

Operator

This is the operator. This call has concluded. You may now disconnect. Thank you.

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Source: Infinera Corporation. Q2 2008 Earnings Call Transcript
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