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INFN > SEC Filings for INFN > Form 10-K on 21-Feb-2014All Recent SEC Filings

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Form 10-K for INFINERA CORP


21-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS
This Annual Report on Form 10-K contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include any expectation of earnings, revenues, gross margins, expenses or other financial items; any statements of the plans, strategies and objectives of management for future operations and personnel; factors that may affect our operating results; statements concerning new products or services, including future PIC capacity and new product delivery and revenue dates; statements related to capital expenditures; statements related to the sufficiency of our current cash, cash equivalents and investments to meet our liquidity requirements; statements related to future economic conditions, performance, market growth or our sales cycle; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," or "will," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included in Item 1A of this Annual Report on Form 10-K. You should review these risk factors for a more complete understanding of the risks associated with an investment in our securities. Such forward-looking statements speak only as of the date of this report. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The following discussion and analysis should be read in conjunction with our "Selected Consolidated Financial Data" and consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. Background
Infinera was founded in December 2000 with a unique vision for optical networking. Prior to Infinera, communications service provider optical networks were built from fairly commoditized products, broadly known as wavelength division multiplexing ("WDM") systems. Recent growth in bandwidth demand has increased the need for the delivery of high-capacity low-cost bandwidth throughout the network. We believe that traditional point-to-point network architectures do not provide the required flexibility to meet this demand. It takes large amounts of low-cost bandwidth, pervasive Optical Transport Network ("OTN") switching, and the intelligence of bandwidth management to manage these larger networks and deliver high-capacity services quickly and cost-effectively. Infinera believes this can best be achieved with photonic integrated circuits ("PICs") and that only through photonic integration can network operators efficiently scale their network bandwidth without significant increases in space, power or operational workload.

We call our solution for Service Providers the Infinera Intelligent Transport Network. The Intelligent Transport Network is an architecture for Service Providers to address the increasing demand for cloud-based services and data center connectivity. The Intelligent Transport network helps Service Providers use time as a weapon to increase revenues with reliable, differentiated services while reducing operating costs through scale, multi-layer convergence and automation. The Intelligent Transport Network is based on platforms built with Infinera's unique PICs.

Traffic patterns in the optical network continue to grow to accommodate increased demands for transmission capacity prompted by increased use of high-speed Internet access, mobile broadband, streaming high-definition video services, business Ethernet services, cloud-based services and wholesale bandwidth services. We believe that Infinera's Intelligent Transport Network architecture is uniquely enabled to deliver improvements in these areas compared to competitive WDM systems that still rely on discrete optical components rather than PICs. We believe that our Intelligent Transport Network architecture enables Service Providers to deploy reliable, high-capacity, efficient optical network solutions that are easy to use and improve the integration between the layers of Service Provider networks with the lowest total cost of ownership.

Infinera's DTN platform currently supports 10 Gigabits per second ("Gbps") and 40 Gbps WDM transmission


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capacity combined with integrated switching capabilities. Infinera's DTN-X platform supports 100 Gbps WDM transmission capacity with 500 Gbps super-channels and also integrates 5 Terabits per second ("Tbps") of OTN switching capacity in a single bay. The DTN-X platform leverages the unique capabilities of our 500 Gbps PICs to deliver high-capacity Intelligent Transport Networks that reduce power, cooling, and space while simplifying transport network operations. The ATN platform supports direct wavelength connectivity to DTN and DTN-X nodes, reducing equipment costs and providing unique network management capabilities across our Intelligent Transport Network.

2013 Financial and Business Performance
Our financial results for 2013 demonstrate strong market acceptance of Infinera's Intelligent Transport Network and the DTN-X platform. Revenues grew 24% compared to 2012, significantly faster than the overall DWDM market. We also experienced improved gross margins in 2013 and generated positive operating cash flow resulting in much improved financial performance on a year-over-year basis.

Since its introduction in mid-2012, we have received purchase commitments for the DTN-X platform from 42 customers, representing a cross section of markets including Tier 1 carriers, cable operators, Internet content providers and bandwidth wholesalers. We also continued to sell the ATN and DTN platforms as customers leveraged the full Infinera product portfolio to best meet their needs.

DTN-X market traction and the resulting growth in revenue contributed to an improvement in our financial performance in 2013. Our overall gross margin for 2013 was 40%, an increase from 36% in 2012. This increase reflected significant improvements in manufacturing yields and product costs as DTN-X volumes increased and we ramped production in our manufacturing facilities. Our product mix remained heavily weighted towards lower margin common equipment deployments in the year as we continued to win new customers and expanded market share with existing customers.

In 2014, we intend to continue to leverage the DTN-X platform to increase revenues and expand our market share as customers extend deployments of 100 Gbps transport solutions in their networks. This focus on revenue growth will be balanced with overall prudent financial management and continued efforts to drive cost improvements across all of our products and services. We believe that with sustained revenue growth, we can leverage our vertically-integrated manufacturing model, which combined with selling bandwidth capacity into deployed networks, can result in improved future profitability and cash flow. Future Business and Industry Trends
Our goal is to be the leading provider of optical networking systems to communications service providers, internet content providers, cable operators, subsea network operators, and others. Our revenue growth will depend on the continued acceptance of our products, growth of communications traffic and the proliferation of next-generation bandwidth-intensive services, which are expected to drive the need for increased levels of bandwidth. Our ability to increase our revenue and achieve profitability will be directly affected by the level of acceptance of our products in the long-haul and metro WDM markets and by our ability to cost-effectively develop and sell innovative products that leverage our technology advantages on a time-to-market basis.
As of December 28, 2013, we have sold our products for deployment in the optical networks of 131 customers worldwide, including CenturyLink, Colt, Cox Communications, DANTE, Deutsche Telekom, Equinix, Interoute, KDDI, Level 3, NTT, OTE, Pacnet, Rostelecom, Telefonica, TeliaSonera International and Vodafone. We do not have long-term sales commitments from our customers. Although key customers account for a significant portion of our revenue, no individual customer accounted for over 10% of our revenue in 2013, 2012 or 2011. Our business will be harmed if any of our key customers do not generate as much revenue as we forecast, stop purchasing from us, or substantially reduce their orders for our products.
We are headquartered in Sunnyvale, California, with employees located throughout the Americas, Europe, and the Asia Pacific region. We expect to continue to add some personnel in the United States and internationally to develop our products and provide additional geographic sales and technical support coverage. We primarily sell our products through our direct sales force, with a small portion sold indirectly through resellers. We derived 92%, 98%, and 97% of our revenue from direct sales to customers for 2013, 2012 and 2011, respectively. We expect to continue generating a substantial majority of our revenue from direct sales in the future.


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Our near-term year-over-year and quarter-over-quarter revenue will likely be volatile and may be impacted by several factors including general economic and market conditions, time-to-market development of new products, acquisitions of new customers and the timing of large product deployments.

We will continue to make significant investments in the business, and management currently believes that operating expenses for 2014 will range from $260 million to $265 million, including stock-based compensation expense of approximately $30 million to $35 million.

Results of Operations

Revenue
The following table sets forth, for periods presented, certain consolidated
statements of operations information (in thousands, except %):

                                                 Years Ended
                        December 28,      % of total      December 29,      % of total
                            2013           revenue            2012           revenue         Change        % Change
Revenue:
Product               $      465,424           86 %     $      380,035           87 %     $   85,389           22 %
Services                      78,698           14 %             58,402           13 %         20,296           35 %
Total revenue         $      544,122          100 %     $      438,437          100 %     $  105,685           24 %
Cost of revenue:
Product               $      295,715           54 %     $      259,437           59 %     $   36,278           14 %
Services                      29,768            6 %             21,431            5 %          8,337           39 %
Total cost of revenue $      325,483           60 %     $      280,868           64 %     $   44,615           16 %
Gross profit          $      218,639           40 %     $      157,569           36 %     $   61,070           39 %



                                                 Years Ended
                        December 29,      % of total      December 31,      % of total
                            2012           revenue            2011           revenue         Change        % Change
Revenue:
Product               $      380,035           87 %     $      352,644           87 %     $   27,391            8  %
Services                      58,402           13 %             52,233           13 %          6,169           12  %
Total revenue         $      438,437          100 %     $      404,877          100 %     $   33,560            8  %
Cost of revenue:
Product               $      259,437           59 %     $      220,806           54 %     $   38,631           17  %
Services                      21,431            5 %             18,580            5 %          2,851           15  %
Total cost of revenue $      280,868           64 %     $      239,386           59 %     $   41,482           17  %

Gross profit $ 157,569 36 % $ 165,491 41 % $ (7,922 ) (5 )%


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The following table summarizes our revenue by geography and sales channel for the periods presented (in thousands, except %):

                                                  Years Ended
                       December 28,       % of total       December 29,       % of total
                           2013            revenue             2012            revenue         Change       % Change
Total revenue by
geography
Domestic             $      345,734           64 %       $      296,849           68 %       $  48,885           16 %
International               198,388           36 %              141,588           32 %          56,800           40 %
                     $      544,122          100 %       $      438,437          100 %       $ 105,685           24 %
Total revenue by
sales channel
Direct               $      501,375           92 %       $      428,734           98 %       $  72,641           17 %
Indirect                     42,747            8 %                9,703            2 %          33,044          341 %
                     $      544,122          100 %       $      438,437          100 %       $ 105,685           24 %



                                                  Years Ended
                       December 29,       % of total       December 31,       % of total
                           2012            revenue             2011            revenue         Change        % Change
Total revenue by
geography
Domestic             $      296,849           68 %       $      283,443           70 %       $  13,406            5  %
International               141,588           32 %              121,434           30 %          20,154           17  %
                     $      438,437          100 %       $      404,877          100 %       $  33,560            8  %
Total revenue by
sales channel
Direct               $      428,734           98 %       $      391,811           97 %       $  36,923            9  %
Indirect                      9,703            2 %               13,066            3 %          (3,363 )        (26 )%
                     $      438,437          100 %       $      404,877          100 %       $  33,560            8  %

2013 Compared to 2012. Total revenue increased $105.7 million, or 24% in 2013 from 2012. Revenues continued to be positively impacted by increased revenues from sales of our DTN-X platform. These revenues included sales to existing customers transitioning their higher-capacity network deployments to the DTN-X and new customers purchasing our Intelligent Transport Network solutions for the first time. This increase in DTN-X revenue was somewhat offset by a reduction in sales of our DTN platform as demand for 100 Gbps network deployments continued to increase. In 2013, we added 20 new customers.

International revenue increased to 36% of total revenue in 2013 from 32% of total revenue in 2012. The increases were primarily due to an increased proportion of our sales occurring in Asia Pacific which increased to 7% in 2013 compared to 3% in 2012. While we expect international revenues to continue to grow in absolute dollars on a long-term basis as we increase our sales activities in Europe, Asia Pacific and other regions, this metric may fluctuate as a percentage of total revenue depending on the size and timing of deployments both internationally and in the United States.

Total product revenue increased $85.4 million, or 22% in 2013 from 2012 reflecting increased sales of our DTN-X platform. Total services revenue increased $20.3 million, or 35% in 2013 from 2012 primarily reflecting the incremental recognition of $12.6 million related to deployment services revenue, $4.1 million related to our software subscription service revenue, $1.6 million related to our spares management service revenue, $1.4 million related to extended warranty service revenue, $0.7 million from training services revenue and $0.3 million of first line management services revenue, primarily offset by a decrease of $0.3 million related to network management services revenue. The increase in deployment services in 2013 was primarily due to the introduction and deployment of new networks based on our DTN-X platform. In addition, we expect to continue to grow our extended


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hardware warranty and spares management service revenues in future periods as our installed base continues to grow.

2012 Compared to 2011. Total revenue increased $33.6 million, or 8% in 2012 from 2011. Revenues were positively impacted by the recognition of revenues from sales of our DTN-X platform during the second half of 2012. These revenues included sales to existing customers transitioning their higher-capacity network deployments to the DTN-X and new customers purchasing our Digital Optical Network solutions for the first time. While this increase in DTN-X revenues was somewhat offset by a reduction in sales of our DTN platform, we continued to deploy the DTN platform in lower capacity applications with nine new customers in 2012. Revenues for 2011 were negatively impacted when customers who required higher-capacity network solutions in advance of the availability of our 40 Gbps and 100 Gbps systems purchased competitor products for portions of their networks.
International revenue increased to 32% of total revenue in 2012 from 30% of total revenue in 2011. The increases were primarily due to an increased proportion of our sales occurring in Europe. While we expect international revenues to continue to grow in absolute dollars on a long-term basis as we increase our sales activities in Europe, Asia Pacific and other regions, this metric may fluctuate as a percentage of total revenue depending on the size and timing of deployments both internationally and in the United States. Total product revenue increased $27.4 million, or 8% in 2012 from 2011 reflecting increased sales of our DTN-X platform in the second half of 2012. Total services revenue increased $6.2 million, or 12% in 2012 from 2011 primarily reflecting the incremental recognition of $3.2 million related to deployment services revenue, $1.5 million related to our spares management service revenue, $1.4 million related to extended warranty service revenue, $0.4 million of first line management services revenue, $0.3 million of network management services revenue, and $0.3 million from training services revenue, offset by a decrease of $0.9 million related to our software subscription service revenue. The increase in deployment services in 2012 was primarily due to the introduction and deployment of new networks based on our DTN-X platform. In addition, we expect to continue to grow our extended hardware warranty and spares management services revenues in future periods as our installed base continues to grow.
Cost of Revenue and Gross Margin
2013 Compared to 2012. Gross margin increased to 40% in 2013 from 36% in 2012. This increase reflected improvements in manufacturing yields and product costs as DTN-X platform volumes increased and we ramped production in our manufacturing facilities. These improvements were somewhat offset by a greater mix of lower margin network footprint sales in 2013 as we added new customers and expanded market share with existing customers.
2012 Compared to 2011. Gross margin decreased to 36% in 2012 from 41% in 2011. Gross margin in 2012 reflected the recognition of revenues from the initial sales of our DTN-X platform. These sales represented early production units and as such, had a higher product cost. The transition of a portion of our revenues from the DTN platform to these lower-margin initial DTN-X units contributed to a decline in gross margins in the second half of the year. In addition, costs for the first half of 2012 included pre-production costs associated with the DTN-X platform production ramp. We also experienced a higher level of lower margin network footprint sales in the second half of 2012, as we began DTN-X platform deployments. Competition for initial 100 Gbps network deployments has been strong, which resulted in a highly-competitive pricing environment for new deployments during 2012.
Based on our current outlook, we expect that gross margins in 2014 will remain constrained in a period when we expect to deploy significant amounts of new network footprint while winning strategic accounts and expanding our share in existing accounts. We do not have the visibility necessary to accurately predict quarterly gross margins beyond a one-quarter time horizon.


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Operating Expenses
The following table summarizes our operating expenses for the periods presented
(in thousands, except %):
                                               Years Ended
                     December 28,      % of total       December 29,      % of total
                         2013            revenue            2012            revenue         Change        % Change
Research and
development        $      124,794           23 %      $      117,233           27 %      $    7,561            6  %
Sales and
marketing                  72,778           14 %              75,862           17 %          (3,084 )         (4 )%
General and
administrative             45,253            8 %              47,475           11 %          (2,222 )         (5 )%
Total operating
expenses           $      242,825           45 %      $      240,570           55 %      $    2,255            1  %



                                              Years Ended
                     December 29,      % of total      December 31,      % of total
                         2012            revenue           2011            revenue         Change       % Change
Research and
development        $      117,233           27 %      $     127,120           31 %      $   (9,887 )         (8 )%
Sales and
marketing                  75,862           17 %             64,773           16 %          11,089           17  %
General and
administrative             47,475           11 %             54,375           14 %          (6,900 )        (13 )%
Restructuring and
other costs
(credit)                        -            - %               (129 )          - %             129         (100 )%
Total operating
expenses           $      240,570           55 %      $     246,139           61 %      $   (5,569 )         (2 )%

The following table summarizes the stock-based compensation expense included in our operating expenses (in thousands):

                                               Years Ended
                            December 28,      December 29,      December 31,
                                2013              2012              2011
Research and development   $       10,900    $       13,306    $       14,990
Sales and marketing                 7,624            10,450             8,818
General and administration          5,956             9,529            18,502
Total                      $       24,480    $       33,285    $       42,310

Research and Development Expenses
2013 Compared to 2012. Research and development expenses increased $7.6 million, or 6% in 2013 from 2012. This increase was primarily due to increases in cash compensation and personnel related costs of $8.7 million and professional outside services and other costs of $1.3 million as we continued to add software engineering resources to support the development of our future products. These increases were offset by decreased stock-based compensation expenses of $2.4 million.
2012 Compared to 2011. Research and development expenses decreased $9.9 million, or 8% in 2012 from 2011. This reduction was primarily due to $8.6 million of research and development resources redeployed to manufacturing in support of initial DTN-X production builds. In addition, prototype and other equipment spending decreased by $5.7 million in 2012, following the release of the DTN-X platform. These decreases were partially offset by $2.6 million of increased depreciation, $0.6 million increase in professional and outside services and $0.6 million increase in facilities and other costs, as compared to 2011. Total other personnel-related costs increased by $0.6 million. This increase was comprised of $2.3 million increase of cash compensation offset by $1.7 million decrease of stock-based compensation expense.


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Sales and Marketing Expenses
2013 Compared to 2012. Sales and marketing expenses decreased $3.1 million, or 4% in 2013 from 2012 primarily due to decreased DTN-X related customer lab trial expenses of $4.9 million, stock-based compensation of $2.8 million, and outside services and related expenses of $2.1 million These reductions were offset by increased compensation and personnel-related expenses of $6.7 million related to increased sales commissions and incremental sales headcount.
2012 Compared to 2011. Sales and marketing expenses increased $11.1 million, or 17% in 2012 from 2011 primarily due to $4.7 million related to increased expenses for customer lab trials, $3.7 million in compensation and personnel-related expenses due to increased headcount, $1.6 million of increased stock-based compensation expense, $0.7 million of increased travel and related expenses and $0.4 million of increased facilities and other costs. This increase in spending primarily reflects the ongoing impact of incremental sales resources to support the expansion of our addressable markets with the introduction of the DTN-X platform.
General and Administrative Expenses
2013 Compared to 2012. General and administrative expenses decreased $2.2 million, or 5% in 2013 from 2012 primarily due to decreased stock-based compensation expense of $3.6 million, and lower consulting services and other costs of $1.0 million, offset by increased compensation and personnel-related costs of $2.4 million.
2012 Compared to 2011. General and administrative expenses decreased $6.9 million, or 13% in 2012 from 2011 primarily due to $9.0 million of decreased stock-based compensation expense, which included the impact of reduced management bonuses and other changes in equity grant activity, and $0.2 million decrease in facilities and other costs. These decreases were partially offset by increased professional services costs of $1.6 million primarily related to implementation of our new enterprise resource planning system and related increased depreciation costs of $0.7 million.

Restructuring and Other Costs
In 2011, we recorded a credit of $0.1 million due to a change in estimates
. . .
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