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INFN > SEC Filings for INFN > Form 10-Q on 1-Aug-2014All Recent SEC Filings

Show all filings for INFINERA CORP

Form 10-Q for INFINERA CORP


1-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q 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 our expectations regarding earnings, revenue, gross margin, expenses, cash flows and 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 costs, delivery dates and revenue; statements related to capital expenditures; statements related to future economic conditions, performance, market growth or our sales cycle; statements related to our convertible senior notes issued in May 2013; statements related to the effects of litigation on our financial position, results of operations or cash flows; 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 elsewhere in this Form 10-Q and in our other SEC filings, including our Annual Report on Form 10-K for the fiscal year ended December 28, 2013 filed on February 21, 2014. 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 condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.
Overview
We were founded in December 2000 with a unique vision for optical networking. Prior to this, 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 in many cases, 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. We believe 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 provide optical transport networking equipment, software and services to telecommunications service providers, internet content providers, cable operators, and wholesale network operators, including subsea network operators (collectively, "Service Providers") across the globe. Optical transport networks are deployed by Service Providers facing significant demands for transmission capacity prompted by increased use of high-speed Internet access, mobile broadband, high-definition video streaming services, business Ethernet services, cloud-based services and wholesale bandwidth services.
The Infinera Intelligent Transport Network is an architecture for Service Providers to address the increasing demand for cloud-based services and data center connectivity. This architectural approach 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 Infinera Intelligent Transport Network is based on platforms built with our 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 the Infinera 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 also believe that this enables Service Providers to deploy reliable, high-capacity, efficient optical network solutions


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that are easy to use and to improve the integration between the layers of Service Provider networks with the lowest total cost of ownership.
Our DTN platform currently supports 10 Gigabits per second ("Gbps") and 40 Gbps WDM transmission capacity combined with integrated switching capabilities. Our DTN-X platform supports 100 Gbps WDM transmission capacity with 500 Gbps super-channels and also integrates 5 Terabits per second 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. Our 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.
As of June 28, 2014, we have sold our network systems for deployment in the optical networks of 133 customers worldwide, including CenturyLink, Colt, Cox Communications, DANTE, Deutsche Telekom, Equinix, Interoute, KDDI, Level 3, NTT, OTE, Pacnet, Rostelecom, Telefonica, TeliaSonera International Carrier, Vodafone and XO Communications. Since the commencement of shipping our DTN-X platform in the second quarter of 2012, we have 46 customers who have purchased our DTN-X platform.
We do not have long-term sales commitments from our customers. To date, a few of our customers have accounted for a significant portion of our revenue. Two customers each accounted for over 10% of our revenue in the second quarter of 2014, and no customer accounted for over 10% of our revenue in the corresponding period in 2013. Two customers each accounted for over 10% of our revenue in the six months ended June 28, 2014, and one customer accounted for over 10% of our revenue in the corresponding period in 2013.
We are headquartered in Sunnyvale, California, with employees located throughout the Americas, Europe and the Asia Pacific region. We expect to continue to add 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 97% and 98% of our revenue from direct sales to customers in the three and six months ended June 28, 2014, respectively, and 88% and 92% of our revenue for the three and six months ended June 28, 2013, respectively. Our strategy is to leverage channel partners where appropriate to expand our presence in certain geographies; however, we expect to continue generating a substantial majority of our revenue from direct sales. In the remainder of 2014, our goal is to continue our growth in the 100 Gbps technology cycle with additional network builds to both new and existing customers. We also anticipate customers who deployed the DTN-X platform over the past two years to buy additional capacity for their networks, which if they do, will drive both additional revenue and also improve gross margin levels. Given the lower than expected research and development expenses incurred during the first half of fiscal 2014, we currently expect to ramp up our research and development spending levels in the second half of the fiscal year to allow us to execute on our future product roadmap, including additional features for our long-haul offerings and new products for adjacent markets. We anticipate generating positive cash flows over the remainder of the fiscal year. Our 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. Critical Accounting Policies and Estimates Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our condensed consolidated financial statements, which we have prepared in accordance with the U.S. generally accepted accounting principles ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates, assumptions and judgments that can affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes that there have been no significant changes during the six


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months ended June 28, 2014 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013.

Results of Operations
The following sets forth, for the periods presented, certain unaudited condensed
consolidated statements of operations information (in thousands, except
percentages):

                                                Three Months Ended
                                    June 28, 2014                 June 29, 2013
                                            % of total                    % of total
                              Amount          revenue       Amount          revenue       Change        % Change
Revenue:
Product                      $ 142,364            86 %     $ 120,647            87 %     $  21,717          18 %
Services                        23,035            14 %        17,738            13 %         5,297          30 %
Total revenue                $ 165,399           100 %     $ 138,385           100 %     $  27,014          20 %
Cost of revenue:
Product                      $  85,906            52 %     $  80,198            58 %     $   5,708           7 %
Services                         9,240             6 %         6,533             5 %         2,707          41 %
Total cost of revenue        $  95,146            58 %     $  86,731            63 %     $   8,415          10 %
Gross profit                 $  70,253            42 %     $  51,654            37 %     $  18,599          36 %




                                                 Six Months Ended
                                    June 28, 2014                 June 29, 2013
                                            % of total                    % of total
                              Amount          revenue       Amount          revenue       Change        % Change
Revenue:
Product                      $ 266,606            87 %     $ 228,990            87 %     $  37,616          16 %
Services                        41,608            13 %        34,020            13 %         7,588          22 %
Total revenue                $ 308,214           100 %     $ 263,010           100 %     $  45,204          17 %
Cost of revenue:
Product                      $ 164,344            53 %     $ 155,645            59 %     $   8,699           6 %
Services                        15,211             5 %        13,009             5 %         2,202          17 %
Total cost of revenue        $ 179,555            58 %     $ 168,654            64 %     $  10,901           6 %
Gross profit                 $ 128,659            42 %     $  94,356            36 %     $  34,303          36 %

Revenue
Total revenue increased by $27.0 million, or 20%, during the three months ended June 28, 2014 compared to the corresponding period in 2013 and increased by $45.2 million, or 17%, during the six months ended June 28, 2014 compared to the corresponding period in 2013.
Total product revenue increased by $21.7 million, or 18%, during the three months ended June 28, 2014 compared to the corresponding period in 2013 as a result of growth across multiple customer verticals. We continue to see customers adding new routes and additional capacity to their existing networks. In addition, we continue to win opportunities with new customers wanting to adopt our platforms.
Total product revenue increased by $37.6 million, or 16%, during the six months ended June 28, 2014 compared to the corresponding period in 2013. This increase was driven by relatively stronger demand across our customer base as they continue to deploy our products to meet the growing bandwidth needs of their networks.
Total services revenue increased by $5.3 million, or 30%, during the three months ended June 28, 2014 compared to the corresponding period in 2013. Total services revenue increased by $7.6 million, or 22%, during the six months ended June 28, 2014 compared to the corresponding period in 2013. The increase in both the quarter


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and year-to-date periods of fiscal 2014 was due to higher levels of deployment services as customers build out new networks utilizing our teams' expertise as well as higher on-going support services as we continue to grow our installed base.

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

                                                  Three Months Ended
                                      June 28, 2014                 June 29, 2013
                                              % of total                    % of total
                                 Amount         revenue        Amount         revenue        Change       % Change
Total revenue by geography
Domestic                       $ 136,342          82 %       $  88,251          64 %       $ 48,091          54  %
International                     29,057          18 %          50,134          36 %        (21,077 )       (42 )%
                               $ 165,399         100 %       $ 138,385         100 %       $ 27,014          20  %
Total revenue by sales channel
Direct                         $ 160,310          97 %       $ 122,234          88 %       $ 38,076          31  %
Indirect                           5,089           3 %          16,151          12 %        (11,062 )       (68 )%
                               $ 165,399         100 %       $ 138,385         100 %       $ 27,014          20  %


                                                   Six Months Ended
                                      June 28, 2014                 June 29, 2013
                                              % of total                    % of total
                                 Amount         revenue        Amount         revenue        Change       % Change
Total revenue by geography
Domestic                       $ 247,033          80 %       $ 167,324          64 %       $ 79,709          48  %
International                     61,181          20 %          95,686          36 %        (34,505 )       (36 )%
                               $ 308,214         100 %       $ 263,010         100 %       $ 45,204          17  %
Total revenue by sales channel
Direct                         $ 300,784          98 %       $ 243,082          92 %       $ 57,702          24  %
Indirect                           7,430           2 %          19,928           8 %        (12,498 )       (63 )%
                               $ 308,214         100 %       $ 263,010         100 %       $ 45,204          17  %

International revenue decreased by $21.1 million to 18% of total revenue for the three months ended June 28, 2014 from 36% of total revenue in the corresponding period in 2013. International revenue decreased by $34.5 million to 20% of total revenue for the six months ended June 28, 2014 from 36% of total revenue in the corresponding period in 2013. In absolute dollars, international revenue declined as we experienced strong demand led by Europe in the first half of 2013, which we have not been able to duplicate in the first half of 2014. In addition, as a percentage of total revenue, international revenue decreased during the three and six months ended June 28, 2014 due to strong demand within North America.
We believe that our DTN-X platform is well positioned as existing customers continue to build out their networks and as we gain new opportunities to deploy our networks with new customers. We continue to see strong demand across our customer base including both new customers as well as growth with existing customers. As a result, we currently expect that these dynamics will drive our revenue slightly higher in the third quarter of 2014 on a sequential basis and represent significant year-over-year growth. Cost of Revenue and Gross Margin
Gross margin increased to 42% in the three months ended June 28, 2014 from 37% in the corresponding period of 2013. The increase was primarily driven by customers adding an increased volume of capacity to the DTN-X networks they have built over the last few years.
Gross margin increased to 42% in the six months ended June 28, 2014 from 36% in the corresponding period of 2013. This increase was primarily due to improvements in revenue mix, including both the mix of customers as well as the ratio of new network builds to capacity adds to existing networks.


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Based on our current outlook, we expect that gross margin in the third quarter of 2014 will decline slightly as compared to the prior quarter as we anticipate a significant number of new network builds. Operating Expenses
The following tables summarize our operating expenses for the periods presented (in thousands, except percentages):

                                                Three Months Ended
                                   June 28, 2014                   June 29, 2013
                                            % of total                      % of total
                             Amount           revenue        Amount           revenue        Change        % Change
Operating expenses:
Research and development   $    31,738           19 %      $    31,681           23 %      $       57         0.2 %
Sales and marketing             18,082           11 %           17,155           13 %             927           5 %
General and administrative      12,381            7 %           11,426            8 %             955           8 %
Total operating expenses   $    62,201           37 %      $    60,262           44 %      $    1,939           3 %



                                                Six Months Ended
                                  June 28, 2014                  June 29, 2013
                                           % of total                     % of total
                             Amount          revenue        Amount          revenue        Change        % Change
Operating expenses:
Research and development   $   61,084           20 %      $   61,407           23 %      $     (323 )      (1)  %
Sales and marketing            35,944           12 %          35,201           14 %             743          2  %
General and administrative     24,635            8 %          21,298            8 %           3,337         16  %
Total operating expenses   $  121,663           40 %      $  117,906           45 %      $    3,757          3  %

Research and Development Expenses
Research and development expenses increased by $0.1 million, or 0.2%, during the three months ended June 28, 2014 compared to the corresponding period in 2013 primarily due to increased facilities and depreciation costs of $0.8 million and costs of professional outside services of $0.2 million. These increases were primarily offset by $0.9 million of decreased prototype and non-recurring engineering expenses due to the timing of certain projects.
Research and development expenses decreased by $0.3 million, or 1%, during the six months ended June 28, 2014 compared to the corresponding period in 2013 primarily due to a decrease in prototype and non-recurring engineering expense due to timing of certain projects of $1.6 million and decreased stock-based compensation expense of $1.5 million due to lower equity activity as compared to the prior year. These decreases were partially offset by increased facilities and depreciation costs of $1.1 million, increased costs of professional outside services of $0.8 million, increased compensation costs of $0.6 million due to higher headcount and other discretionary spending of $0.2 million.


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Sales and Marketing Expenses
Sales and marketing expenses increased by $0.9 million, or 5%, during the three months ended June 28, 2014 compared to the corresponding period in 2013 primarily due to increased compensation costs of $0.9 million due to higher headcount to support the continued expansion of our business, as well as increased travel and trade show related expenses of $0.5 million. These increases were partially offset by $0.6 million in lower costs related to customer lab trials.
Sales and marketing expenses increased by $0.7 million, or 2%, during the six months ended June 28, 2014 compared to the corresponding period in 2013 primarily due to increased travel, trade show and other marketing related expenses of $0.9 million, increased compensation costs due to increased headcount of $0.5 million and $0.2 million in lower costs of professional outside services. These increases were partially offset by $0.9 million in lower costs related to customer lab trials.
General and Administrative Expenses
General and administrative expenses increased by $1.0 million, or 8%, during the three months ended June 28, 2014 compared to the corresponding period in 2013 primarily due to higher compensation and personnel-related costs of $0.6 million due to an increase in headcount along with increased costs of professional outside services of $0.3 million.
General and administrative expenses increased by $3.3 million, or 16%, during the six months ended June 28, 2014 compared to the corresponding period in 2013 primarily due to higher compensation and personnel-related costs of $2.1 million and increased costs of professional outside services of $1.1 million. Other Income (Expense), Net

                           Three Months Ended                                    Six Months Ended
            June 28,     June 29,                                June 28,     June 29,
              2014         2013         Change      % Change       2014         2013         Change      % Change
                                                       (In thousands)
Interest
income     $    337     $     207     $    130          63 %    $    673     $     404     $    269          67 %
Interest
expense      (2,728 )        (849 )     (1,879 )       221 %      (5,405 )        (849 )     (4,556 )       537 %
Other gain
(loss),
net            (264 )        (158 )       (106 )        67 %        (993 )        (361 )       (632 )       175 %
Total
other
income
(expense),
net        $ (2,655 )   $    (800 )   $ (1,855 )       232 %    $ (5,725 )   $    (806 )   $ (4,919 )       610 %

Interest income increased by $0.1 million and $0.3 million during the three and six months ended June 28, 2014, respectively, compared to the corresponding periods in 2013. These increases were primarily driven by a higher investment balance as a result of both our cash generated from operations over the past year and the proceeds from the issuance in May 2013 of $150.0 million aggregate principal amount of 1.75% convertible senior notes due June 1, 2018 (the "Notes"), partially offset by lower investment returns.
Interest expense for the three and six months ended June 28, 2014 consisted of cash interest payments and amortization of discount and issuance costs related to the Notes.
The change in other gain (loss), net for the three months ended June 28, 2014 as compared to the same period of 2013 was primarily due to an increase in realized and unrealized foreign currency transaction loss. The change in other gain
(loss), net for the six months ended June 28, 2014 as compared to the same period of 2013 was primarily due to a $0.8 million increase in realized and unrealized foreign currency transaction loss, partially offset by $0.2 million gain from the disposal of our remaining auction rate securities. Income Tax Provision
Provision for income taxes for the three and six months ended June 28, 2014 was $0.6 million and $0.9 million, respectively, on pre-tax income of $5.4 million and $1.3 million, respectively. This compared to a tax provision of $0.6 million and $0.9 million, respectively, on a pre-tax loss of $9.4 million and $24.4 million, respectively, for the three and six months ended June 28, 2013. In all periods, the tax expense primarily represents foreign taxes of our overseas subsidiaries compensated on a cost plus basis and remains relatively similar in all periods, regardless of the level of consolidated earnings. We do not provide for tax on U.S. income, nor benefit U.S.


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losses, because of our significant loss carryforward position and a corresponding full valuation allowance. The release of transfer pricing reserves in the future will have a beneficial impact to tax expense, but the timing of the impact depends on factors such as expiration of the statute of limitations or settlements with tax authorities. No significant releases are expected in the near future based on information available at this time.

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