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FWIW, here's a write-up that I posted on the TMF subscriber boards. Hope it's helpful...


I spent about 90 minutes listening to the call tonight. 4Q was good, but the outlook is not pretty. I'll be working on a deep dive soon, but here are some quick thoughts...

1. I won't get into all the numbers, but by any metric, 4Q10 was really pretty good (beat on earnings, met on revenue, excellent GMs, 5 new customers, etc...). In my mind, this was better than what they had projected in 3Q.

2. Their product roadmap is on track for 40G in mid-2011 (providing 6.4TB on a fiber - the highest in the industry) and 100G in 2012.

3. They continue to have limited visibility into customer orders and have lost some deals to 40G. Thus, they guided much lower for 1Q11:

Revenue: 90M - 97M
GM: 45-47%
Net loss: 4M - 10M
Earnings: ($0.04) - ($0.09)

Thump. What the heck just happened?

I believe that there are two issues that they are fighting against:

(1) The industry went wild in 1H10 with network builds and they are still consuming that bandwidth. It turns out that a large portion of this build-out was due to Level 3 getting ready for Netflix's strong move to online streaming. I believe that also signaled to the entire industry that it was time to upgrade. But now, they are consuming that additional bandwidth. They do not believe this is a long term trend and expect that orders to pick up again. They mentioned that 1Q11 is slow, but actually ahead of 1Q10 and 1Q09, but behind 1Q08.

(2) They have lost "a few deals" to 40G. This is the most concerning issue and in the Q&A, this was the focus. The concern is that INFN starts to lose their 10G customers to 40G before their 40G solution is ready. I thought Tom did a nice job answering the questions. The net is the following:

A. The 10G market is expected to grow 4-5% on a revenue basis and INFN should play strongly.

B. 40G does not provide an economic advantage over 10G, even after being out there for 10 years. Today, it is basically on par with 10G. But to get the industry to move, it needs to provide a 25% - 35% advantage. Thus, 40G is being treated as stop-gap to provide bandwidth until 100G platforms are ready.

D. When INFN comes out with their 100G solution, it will drop the price of 100G significantly, much like they did to 10G. They will enable industry adoption through the "radical economics" of their PIC-based solutions. Their 40G will also be a stop-gap to get to 100G.

E. Until their 40G and 100G systems are ready, they project that they will continue to sell 10G systems. At the same time, they recognize that they will lose the business of companies with fiber exhaustion until they are ready with 40G.

Now it's a guessing game. And I think the relevant questions are:

1. Will they execute their roadmap?
I think they will. They are under tremendous pressure to do so. They mentioned that they are ramping up manufacturing capability for 100G and already have a 5TB switch working in the lab. Also, their software-controlled 40G FlexCoherent ASIC is in fab now.

2. Are they under-estimating the impact of 40G?
This is a tough one. Tom seemed to have very convincing arguments, but they would have been more convincing if they were projecting a good 1Q. I'm sure that in the next few days, we'll see some analyst downgrade the stock on worries that 40G may eat more into their revenues through mid-2011. INFN seems pretty conservative in their guidance, so I do take some comfort there.

3. Will their 40G product be competitive enough to stop the bleeding?
Yeah, I think it will. They mentioned that 6.4GB/Fiber will be the best in the industry. And they also mentioned that because of the way the digital optical network works, if their customers are forced to use someone else's 40G solution, they will have not trouble getting back in the game with them on their own 40G or 100G solution. .

4. Will their 100G solution really take off?
Yes, I believe it will. When they introduced their 10G solution, it changed the industry. I think 100G will do the same. The litmus test will be to see if any Tier 1's make the jump to INFN when it goes into production.

Well, that's about it for now. Once they publish the 10-Q and the transcript, I'll start working on my next deep dive. But my net for tomorrow is that INFN is likely to take a beating. Given all that I can tell right now, that might be (yet another) excellent buying opportunity as the company hits the accelerator in 2011/12.

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