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INFINERA CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge)
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 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
dates; statements related to capital expenditures; statements related to future
economic conditions, performance, market growth or our sales cycle; statements
related to the liquidity of our auction rate securities; 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 31, 2011 filed on
March 6, 2012. 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
Infinera was founded in December 2000 with a unique vision for optical
networking. Prior to Infinera, service provider optical networks were built from
fairly commoditized products, broadly known as dense wavelength division
multiplexing ("DWDM") 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 only be achieved with photonic integrated circuits ("PICs") and that
only through photonic integration can network operators scale their network
bandwidth without significant increases in space, power or operational workload.
We first introduced our Digital Optical Network architecture to the market in
2004. This architecture is based on our unique PICs and enables high-capacity
low-cost bandwidth in the cloud and distributed switching throughout the
network. Since 2004, our strategy has been to extend the benefits of our Digital
Optical Network throughout the optical networking market. We have made
significant enhancements to our Digital Transport Node System ("DTN platform")
during this time by increasing reach and fiber capacity for the long-haul
market, adding the Infinera MTC, a 19-inch chassis option tailored for the metro
core market, and adding a submarine version of the DTN platform for the
Submarine Line Terminating Equipment market. In addition, we introduced our ATN
metro access platform ("ATN platform"), extending Infinera's digital bandwidth
management and intelligent network benefits to the network edge. Finally, in
order to meet the growing bandwidth demands of our customers, we introduced our
40 Gigabits per second ("Gbps") non-PIC based solution in late 2011 and launched
our DTN-X 100 Gbps PIC-based platform, which we anticipate will be available in
the second quarter of 2012. The DTN, DTN-X and ATN platforms are designed to
operate as a tightly-integrated network with a single management system
providing an end-to-end Digital Optical Network experience.
Traffic patterns in the optical network continue to grow to accommodate
increased bandwidth demand from video, mobility and cloud computing. The market
is seeing growing demand for increased fiber capacity with networks migrating
from the current 10 Gbps wavelength solutions to 40 Gbps solutions in the
short-term and 100 Gbps solutions in the longer-term. Infinera launched the
DTN-X platform, a 100 Gbps PIC-based solution, in September 2011, with expected
volume production in 2012. The DTN-X platform will incorporate our 500 Gbps PICs
and our 5 Terabit OTN switch and will combine competitive fiber capacity with
the unique features of the Digital Optical Network. We continue to position our
DTN platform and associated benefits of the Digital Optical Network into the
smaller backbone and metro core networks needing lower capacity 10 Gbps and 40
Gbps wavelengths. Our ATN platform is a metro access solution that extends
Infinera's digital bandwidth management and intelligent software operating
system benefits to the network edge.
Our goal is to be a 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 revenue and achieve profitability will be directly affected by the
level of acceptance of our products in the long-haul and metro DWDM markets and
by our ability to cost-effectively develop and sell innovative products that
leverage our technology advantages on a time-to-market basis.
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As of March 31, 2012, we have sold our network systems for deployment in the
optical networks of 102 customers worldwide, including Colt, Cox Communications,
Deutsche Telekom, Equinix, Inc., Interoute, KVH, TeliaSonera, Level 3, NTT, OTE,
Pacnet and XO Communications. We currently have 33 ATN customers enjoying the
benefits of an ATN platform and 28 of those have deployed an integrated ATN-DTN
solution. 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. One customer accounted for over 10% of our revenue in each of the three
months ended March 31, 2012 and March 26, 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 to us.
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 96% of our revenue from direct
sales to customers for March 31, 2012 and March 26, 2011, respectively. We
expect to continue generating a substantial majority of our revenue from direct
sales in the future.
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 2012 will range from $255 million
to $265 million, including stock-based compensation expense of approximately $40
million to $45 million.
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 U.S. GAAP. The preparation of these
financial statements requires management to make estimates and assumptions that
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 three months ended March 31, 2012 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 31, 2011.
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Results of Operations
The following sets forth, for the periods presented, certain unaudited condensed
consolidated statements of operations information (in thousands, except %):
Three Months Ended
March 31, % of total March 26, % of total
2012 revenue 2011 revenue
Revenue:
Product $ 92,391 88 % $ 82,528 89 %
Ratable product and related
support and services 531 1 % 922 1 %
Services 11,779 11 % 9,440 10 %
Total revenue $ 104,701 100 % $ 92,890 100 %
Cost of revenue:
Product $ 59,324 57 % $ 46,618 50 %
Ratable product and related
support and services 191 - % 385 1 %
Services 4,759 4 % 3,143 3 %
Total cost of revenue $ 64,274 61 % $ 50,146 54 %
Gross profit $ 40,427 39 % $ 42,744 46 %
The following table summarizes our revenue by geography and sales channel for
the periods presented (in thousands, except %):
Three Months Ended
March 31, March 26,
2012 2011
Total revenue by geography
Domestic $ 70,898 $ 68,826
International 33,803 24,064
$ 104,701 $ 92,890
% Revenue by geography
Domestic 68 % 74 %
International 32 % 26 %
100 % 100 %
Total revenue by sales channel
Direct $ 101,843 $ 88,814
Indirect 2,858 4,076
$ 104,701 $ 92,890
% Revenue by sales channel
Direct 97 % 96 %
Indirect 3 % 4 %
100 % 100 %
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Revenue
Total revenue increased to $104.7 million for the three months ended March 31,
2012 from $92.9 million for the corresponding period in 2011. Revenues in the
first quarter of 2011 were negatively impacted by our inability to offer higher
capacity solutions to satisfy customer demand prior to the release of our 40
Gbps and 100 Gbps products.
International revenue increased to 32% of total revenue for the three months
ended March 31, 2012 from 26% of total revenue in the corresponding period in
2011. This increase was primarily due to increased investment in sales resources
in Europe resulting in higher revenue for the region. 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 to $92.4 million for the three months ended
March 31, 2012 from $82.5 million for the corresponding period in 2011. Product
and related support services revenue that is recognized ratably includes sales
of products and services that were deferred under previous accounting standards,
prior to our adoption of ASU 2009-13 and ASU 2009-14 as further discussed in
Note 2, "Significant Accounting Policies," to the Notes to Consolidated
Financial Statements in our Annual Report on Form 10-K filed on March 6, 2012,
because vendor specific objective evidence of fair value had not been
established for the undelivered elements. Total ratable revenue levels decreased
to $0.5 million for the three months ended March 31, 2012 from $0.9 million for
the corresponding period in 2011. These decreases were due to an overall
reduction in sales of products and services that were deferred following our
adoption of ASU 2009-13 and ASU 2009-14.
Total services revenue increased to $11.8 million for the three months ended
March 31, 2012 from $9.4 million for the corresponding period in 2011 primarily
reflecting the incremental recognition of $1.6 million in deployment services
revenue and $1.2 in hardware warranty and spares management related services,
offset by a decrease of $0.4 million in software subscription revenue. As our
installed customer base grows, we expect to continue to grow our extended
hardware warranty and spares management services revenues in future periods.
We anticipate commencing shipments of our DTN-X platform in the second quarter
of 2012 but we do not expect to recognize revenues on these shipments until the
second half of the year. We believe this may result in lower revenues in the
second quarter of 2012, however, we expect revenues in the second half of the
year to recover as customers deploy the DTN-X in their networks.
Cost of Revenue and Gross Margin
Gross margin decreased to 39% in the three months ended March 31, 2012 from 46%
in the corresponding period in 2011. This decrease was primarily due to
continued price declines in response to competitive pressure and the inclusion
of costs associated with ramping production of the DTN-X product in advance of
shipment.
We do not have the visibility necessary to accurately predict quarterly gross
margins beyond a one-quarter time horizon. However, based on our current
outlook, we expect gross margins for the remainder of 2012 to continue to be
negatively impacted by the inclusion of ongoing costs associated with ramping of
production and the initial sales of our DTN-X product. We believe that our cost
structure beyond 2012 will improve as we achieve increased volume and scale for
the DTN-X platform.
Operating Expenses
The following tables summarize our operating expenses for the periods presented
(in thousands, except %):
Three Months Ended
March 31, % of total March 26, % of total
2012 revenue 2011 revenue
Operating expenses:
Research and development $ 30,986 30 % $ 31,309 34 %
Sales and marketing 18,241 17 % 13,935 15 %
General and administrative 11,084 11 % 13,509 14 %
Total operating expenses $ 60,311 58 % $ 58,753 63 %
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The following table summarizes the stock-based compensation expense included in
our operating expenses (in thousands):
Three Months Ended
March 31, March 26,
2012 2011
Research and development $ 3,320 $ 3,826
Sales and marketing 2,219 2,060
General and administration 2,223 4,783
Total $ 7,762 $ 10,669
Research and Development Expenses
Research and development expenses decreased by $0.3 million in the three months
ended March 31, 2012 compared to the corresponding period in 2011 primarily due
to lower personnel related costs of $1.8 million comprised of $1.3 million of
cash compensation and $0.5 million of stock-based compensation expense. These
decreases were partially offset by increases in depreciation of $0.7 million,
professional and outside services costs of $0.5 million and facilities and other
costs of $0.5 million.
Sales and Marketing Expenses
Sales and marketing expenses increased by $4.3 million in the three months ended
March 31, 2012 compared to the corresponding period in 2011 primarily due to
$3.0 million in compensation and personnel-related expenses, increased expenses
for customer lab trials of $0.7 million, increased travel and related expenses
of $0.4 million, and increase in facilities and other costs of $0.2 million.
General and Administrative Expenses
General and administrative expenses decreased by $2.4 million in the three
months ended March 31, 2012 compared to the corresponding period in 2011
primarily due to decreased stock-based compensation expense of $2.6 million and
lower costs related to facilities and other costs of $0.6 million. These
decreases were partially offset by increased compensation and personnel-related
expenses of $0.5 million and increased professional services costs of $0.3
million.
Other Income (Expense), Net
Three Months Ended
March 31, March 26,
2012 2011
(In thousands)
Interest income $ 275 $ 312
Other gain (loss), net (424 ) (411 )
Total income (expense), net $ (149 ) $ (99 )
Interest income decreased by an insignificant amount in the first quarter of
2012, compared to the corresponding period in 2011. The decrease was mainly due
to lower total investments.
Other gain (loss), net for the first quarter of 2012 included a loss of $0.4
million of realized and unrealized foreign currency transactions. Other gain
(loss), net for the first quarter of 2011 included a loss of $0.5 million of
realized and unrealized foreign currency transactions and a gain of $0.1 million
related to sale of assets.
Income Tax Provision (Benefit)
Provision for income taxes for the three months ended March 31, 2012 was $0.6
million, or negative 2.9% on a pre-tax loss of $20.0 million, compared to a tax
provision of $0.3 million, or negative 1.8%, on a pre-tax loss of $16.1 million
for the three months ended March 31, 2011. The difference between our effective
tax rates and the federal statutory rate of 35% is primarily attributable to
unbenefited U.S. losses, foreign taxes provided on the income of our foreign
subsidiaries, non-deductible stock-based compensation expense, and various
discrete items. The higher effective tax rate in 2012 relates to higher foreign
income and associated taxes, the expiration of the Indian tax holiday on
March 31, 2011, and the release of $0.2 million of tax reserves in 2011 due to
statute of limitations lapses.
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The realization of tax benefits of deferred tax assets is dependent upon future
levels of taxable income, of an appropriate character, in the periods the items
are scheduled to be deductible or taxable. Based on the available objective
evidence, management believes it is more likely than not that the domestic net
deferred tax assets will not be realizable. Accordingly, we have provided a full
valuation allowance against its domestic deferred tax assets, net of deferred
tax liabilities, as of March 31, 2012 and December 31, 2011. In determining
future taxable income, we make assumptions to forecast federal, state and
international operating income, the reversal of temporary differences, and the
implementation of any feasible and prudent tax planning strategies. The
assumptions require significant judgment regarding the forecasts of future
taxable income and are consistent with our forecasts used to manage our
business. We intend to maintain the remaining valuation allowance until
sufficient positive evidence exists to support a reversal of, or decrease, in
the valuation allowance.
Liquidity and Capital Resources
Three Months Ended
March 31, March 26,
2012 2011
(In thousands) Net cash flow provided by (used in):
Operating activities $ (5,757 ) $ (854 )
Investing activities $ 1,529 $ (6,453 )
Financing activities $ 6,173 $ 4,822
March 31, December 31,
2012 2011
(In thousands)
Cash and cash equivalents $ 96,709 $ 94,458
Short-term and long-term investments 139,841 155,611
Short-term and long-term restricted cash 3,254 3,047
$ 239,804 $ 253,116
Cash, cash equivalents, short-term and long-term investments and short-term and
long-term restricted cash consist of highly-liquid investments in certificates
of deposits, money market funds, commercial paper, corporate bonds, U.S. agency
notes and U.S. treasuries. As of March 31, 2012, long-term investments include
$8.1 million (par value) of available-for-sale auction rate securities ("ARS").
The restricted cash balance amounts are pledged as collateral for certain
stand-by and commercial letters of credit.
Operating Activities
Net cash used in operating activities for the first quarter of 2012 was $5.8
million as compared to $0.9 million for the corresponding period in 2011. Cash
flow from operating activities consists of net income (loss), adjusted for
non-cash charges, plus or minus working capital changes. Our working capital
requirements can fluctuate significantly depending on the timing of deployments
and the acceptance, billing and payment terms on those deployments.
Additionally, our ability to manage inventory turns and our ability to negotiate
favorable payment terms with our vendors may also impact our working capital
requirements.
Net loss for the three months ended March 31, 2012 was $20.6 million, which
included non-cash charges of $15.5 million, compared to a net loss of $16.4
million in the corresponding period in 2011, including non-cash charges of $17.4
million.
Net cash used to fund working capital was $0.6 million for the first quarter of
2012. Inventory increased by $12.1 million primarily due to increased levels of
DTN-X inventory in advance of shipments and increased levels of DTN inventory
previously committed to the supply chain. Accounts payable decreased by $7.3
million due to the timing of purchases and payments of purchases during the
period. Accrued liabilities decreased by $1.0 million primarily due to reduced
levels of compensation and commission related accruals. These were partially
offset by decreased receivables of $15.6 million primarily driven by better
linearity of invoicing and collections activities in the period.
Net cash used to fund working capital was $1.8 million for the first quarter of
2011. Accrued liabilities decreased by $15.5 million primarily due to reduced
levels of compensation and commission related accruals. Accounts payable
decreased $8.8 million due to lower inventory receipts during the period. This
was partially offset by a decrease in receivables of $18.9 million primarily
driven by lower level of sales in the quarter and the collection of prior
quarter receivables. Inventory decreased by $4.0 million primarily due to lower
levels of inventory at customer sites awaiting customer acceptance.
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Investing Activities
Net cash provided by investing activities in the first quarter of 2012 was $1.5
million compared to net cash used of $6.5 million in the corresponding period of
2011. Investing activities for the first quarter of 2012 included net proceeds
of $15.3 million from purchases, maturities, calls and sales of investments in
the period partially offset by $13.6 million of capital expenditures. Investing
activities for the first quarter of 2011 included $10.6 million of capital
expenditures and a $1.5 million advance to secure manufacturing capacity
partially offset by net proceeds of $5.4 million from purchases, maturities,
calls and sales of investments in the period.
Financing Activities
Net proceeds from financing activities in the first quarter of 2012 and 2011
were $6.2 million and $4.8 million, respectively, primarily related to proceeds
from the issuance of common stock under our stock-based compensation plans. This
was offset by $0.8 million related to the repurchase of shares from employees to
satisfy minimum tax withholdings in the three months ended March 31, 2012.
Liquidity
As of March 31, 2012, we held $8.1 million (par value) with a fair value of $7.6
million of available-for-sale ARS with two issuers. Of these ARS, $5.0 million
(par value) was AAA rated and $3.1 million (par value) was A3 rated. These ARS
have contractual maturity terms of up to 34 years and it is not clear when we
will be able to liquidate these investments. In 2009, we determined that the
present value of the expected cash flows for these securities was below their
par value, and recorded an initial other-than-temporary impairment ("OTTI") of
$2.7 million, equal to the difference between the fair value and the par value
had occurred. During the three months ended March 2012, $0.2 million of these
ARS were called at par value.
Failed auctions resulted in a lack of liquidity in the ARS but do not affect the
underlying collateral of the securities. We do not anticipate that any potential
lack of liquidity in our ARS, even for an extended period of time, will affect
our ability to finance our operations, including our continued investments in
research and development and planned capital expenditures. We continue to
monitor efforts by the financial markets to find alternative means for restoring
the liquidity of these investments. Our ARS investments are classified as
non-current assets until we have better visibility as to when their liquidity
will be restored.
For 2012, capital expenditures are expected to be in the range of approximately
$35 million to $40 million, primarily for product development. In addition, we
may experience an increase in working capital requirements as we prepare for
volume shipment of our DTN-X platform and manufacturing expansion related to new
products.
We believe that our current cash and cash equivalents and investments will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months. If these sources of cash are
insufficient to satisfy our liquidity requirements beyond 12 months, we may
require additional capital from equity or debt financings to fund our
operations, to respond to competitive pressures or strategic opportunities, or
otherwise. We may not be able to secure timely additional financing on favorable
terms, or at all. The terms of any additional financing may place limits on our
financial and operating flexibility. If we raise additional funds through
further issuances of equity, convertible debt securities or other securities
convertible into equity, our existing stockholders could suffer dilution in
their percentage ownership of us, and any new securities we issue could have
rights, preferences and privileges senior to those of holders of our common
stock.
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Off-Balance Sheet Arrangements
As of March 31, 2012, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which would have been
established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes.
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