Bob Jones - Thomas J. Fallon - Chief Executive Officer and Director Brad D. Feller - Chief Financial Officer and Senior Vice President of Finance David F. Welch - Co-Founder, President, Director and Member of Technology & Acquisition Committee.

Simona Kiritsov Jankowski - Goldman Sachs Group Inc., Research Division George C. Notter - Jefferies LLC, Research Division Michael Genovese - MKM Partners LLC, Research Division Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division Alexander B. Henderson - Needham & Company, LLC, Research Division Roderick B.

Hall - JP Morgan Chase & Co, Research Division Dmitry Netis - William Blair & Company L.L.C., Research Division Natarajan Subrahmanyan - The Juda Group, Research Division Brian Coyne - National Alliance Capital Markets, Research Division Ted J. Moreau - Barrington Research Associates, Inc., Research Division.

Welcome to the Third Quarter Year 2014 Investment Community Conference call of Infinera Corporation. [Operator Instructions] Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn the call over to Mr. Bob Jones of Infinera, Investor Relations. Bob, you may begin..

Thank you, Sharon. Welcome to Infinera's third quarter 2014 conference call. A copy of today's earnings release is available on the Investor Relations section of Infinera's website. Additionally, this call is being recorded and will be available for replay from the website.

Today's call will include projections and estimates that constitute forward-looking statements.

This may include statements regarding Infinera's overall business strategy, market conditions, market and growth opportunities, Infinera's results of operations, views on Infinera's customers and its products as well as Infinera's financial outlook for the fourth quarter of fiscal year '14.

These statements are subject to risks and uncertainties that could cause Infinera's results to differ materially from management's current expectations.

Please refer to Infinera's current press releases and SEC filings, including Infinera's most recently filed quarterly report on Form 10-Q and subsequent filings for more information on these risks and uncertainties.

Please be reminded that all statements are made as of today, and Infinera 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. Today's earnings release and conference call also include certain non-GAAP financial measures.

These non-GAAP financial measures include noncash, stock-based compensation expenses and amortization of debt discount on our convertible senior notes. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons.

And further, management does not consider these items to be related to Infinera's core operating performance.

Pursuant to Regulation G, Infinera has provided a reconciliation of these GAAP (sic) [non-GAAP ] financial measures to the most directly comparable GAAP financial measures in its third quarter earnings release, which has been furnished to the SEC on Form 8-K and is available on Infinera's website in the Investor Relations section.

With that, I'd now like to turn the call over to Chief Executive Officer, Tom Fallon..

a high-density, lower-power, rack-and-stack solution with server-like ease-of-use and industry-leading scale. While it's too early to give metrics around market success, we have had very positive feedback to date from multiple customer lab trials in multiple markets. Our expectation continues to be that we will begin revenue shipments in December.

At Insight Infinera, we also unveiled an update to our flagship DTN-X product with the introduction of a packet-switching module.

Integrating packet switching into the DTN-X enables service providers to reduce the number of expensive router ports required to operate portfolio of services based on carrier Ethernet and MPLS, enabling customers to operate more efficiently while providing additional revenue opportunities.

We believe that longer term, as cloud networks continue to grow, and NFV and SDN take hold, Intelligent Transport Networks with the right amount of packet will become the packet forwarding solution of choice because they offer the lowest total cost of ownership and the best optical scalability.

Our continued investment in the DTN-X platform demonstrates our confidence in the significant market opportunity we see and shows we remain committed to winning in this space. As we look forward to the end of 2014 and into 2015, our outlook remains very positive.

We grew revenue 24% in 2013, expect to grow revenue greater than 20% through 2014, and believe in our ability to continue to gain share and outgrow the market despite the challenges that many of our peers are experiencing.

I believe this is due to an accelerating architectural shift, leveraging Intelligent Transport Networks, the unique value our products deliver, our competitive advantage with ownership of key technologies like the PIC and strong execution by the Infinera team.

While I will not break down our outlook in terms of time horizons, as I've done in the past couple of calls, I will state that I believe Infinera has never been better positioned as we continue to deliver what we believe are the right products at the right time.

In summary, we are pleased with the performance of the business in the third quarter and year-to-date. Our business outlook is positive as we continue to execute our plan, and our focus will continue to be on winning footprint, increasing our profitability and generating cash while we make smart, strategic and timely R&D investments.

We've strengthened our product portfolio and competitive position with the introduction of the Cloud Xpress while enhancing the market-leading DTN-X.

We believe the market will continue to converge, the optical transport layer will become an increasingly strategic component of network architectures and Infinera will continue to lead as the market evolves. We are excited about the future and believe we are well positioned to deliver on our goals and drive shareholder value.

Finally, I would like to thank our customers, employees and partners for their ongoing commitment to Infinera. Now I'll turn the call over to Brad for a more detailed financial review of the third quarter and our outlook for the fourth quarter..

Thanks, Tom; and good afternoon, everyone. As Tom mentioned, we reported revenue of $173.6 million for the third quarter of 2014, an increase of 22% over the third quarter of last year, a 5% sequential increase and near the high end of our guidance range.

We are very pleased to have grown our revenues sequentially in Q3, on top of the 16% sequential growth we experienced in Q2.

We continue to see broad strength in our business, with our top 5 customers in Q3 spanning multiple customer verticals, including a North American Tier 1, an Internet content provider, 2 bandwidth wholesalers and a Tier 2 carrier. We had 1 greater than 10% customer in the quarter, a North American Tier 1 service provider.

Demonstrating the continued strong demand for the DTN-X, we added 3 additional DTN-X invoiced customers this quarter, including 1 new to Infinera and 2 existing DTN customers who have now deployed the DTN-X. These customers represent a European bandwidth wholesaler, a Tier 1 service provider in APAC and a large enterprise company in North America.

This brings our total DTN-X customer count to 49. We continue to see strong RFQ activity as additional customers are looking to adopt the DTN-X platform, which we expect will lead to an increased DTN-X customer count in the near future.

Although our revenues continue to be strongest in North America, international revenues represented 30% of total revenues in Q3, up from 18% in Q2. After a relatively soft first half of fiscal 2014, the EMEA region showed improvement in the quarter, accounting for $34 million or 20% of total revenue.

In addition, we continued to see growth with partners in Latin America and APAC, as revenue in each region individually accounted for 5% of total revenue. Service revenue for the quarter was $26 million, an increase of 15% sequentially driven by deployment services as we continue to win new routes with existing customers as well as new customers.

Moving next to gross margin and operating expenses. Our overall non-GAAP gross margin for the third quarter was 44.2%, up from 43.3% in the second quarter. This result was better than our guidance of low 40s due to several factors.

These included the benefits of our vertically integrated manufacturing as volumes grow, the continued momentum of fill activity across our customer base and the impact of customers starting to license additional capacity through our Instant Bandwidth program.

Services gross margin were 56% in the quarter, down sequentially as a result of the increased mix of deployment services. Our non-GAAP operating expenses were $62 million in the third quarter, up $5 million sequentially and at the high end of our guidance as we begin to ramp our R&D spending towards our target of 20% of revenues.

We have several key business opportunities that are critical for us to invest in that we believe leverage our core technologies and expertise. Cloud Xpress, which we launched in September to address the rapidly growing data center interconnect market, is a great example of an investment that leverages these capabilities.

SG&A expenses also grew in the quarter as we are making strategic investments in new markets, along with higher sales commissions in connection with the increased revenue levels. Taken altogether, we achieved a non-GAAP operating margin of 8.6% for the third quarter, essentially flat sequentially.

This demonstrates our ability to continue to maintain higher profit levels as we invest in and grow the business. With our recent financial results, we are nearly at our midterm model of 45% gross margin and 8% to 10% operating margin. Interest and other expense for the quarter was $500,000, and tax expense was $200,000.

The shares used to compute diluted non-GAAP EPS during the third quarter were 129 million, up from 127 million in the prior quarter as a result of stock issuances through option exercises and our employee stock purchase plan.

In total, this resulted in non-GAAP net income for the third quarter of $14 million or $0.11 per diluted share, flat sequentially. This exceeds our guidance range driven by the higher gross margin level. Now summarizing Q3 results on a GAAP basis.

We had net income of $5 million or $0.04 per diluted share in the third quarter, driving us to a year-to-date GAAP profit. This represents a significant improvement as our year-to-date results through Q3 of the prior year was a net loss of $22 million.

The difference between our GAAP and non-GAAP results during the third quarter was due to stock-based compensation expense of $7 million and $2 million of amortization of debt discount. Now turning to the balance sheet.

Cash, cash equivalents and investments as of the end of the third quarter were $378 million, an increase of $22 million from the previous quarter. We generated cash from operations of nearly $23 million in Q3 compared to $10 million in Q2.

As we have stated in the past, cash generation is 1 of our top priorities, and we remain confident in our ability to continue to generate cash in our business. Moving next to our outlook for the fourth quarter of fiscal 2014. As Tom mentioned, the underlying trends across our business remain very strong.

As such, I'm pleased to announce that we currently project revenue for the fourth quarter to be in the range of $175 million to $185 million. The midpoint of this range represents year-over-year growth in the fourth quarter of nearly 30%. For the full year, this would represent a second consecutive year of 20-plus percent revenue growth.

This level of growth demonstrates the market's strong acceptance of our differentiated product and the superior customer experience that we provide. We currently project non-GAAP gross margin to be 44%, plus or minus 100 basis points.

While we expect to continue to grow footprint across our customer base, we believe the underlying momentum of fill activity will continue, along with the leverage on our vertically integrated model as volumes continue to grow.

We currently anticipate non-GAAP operating expenses to be $64 million, plus or minus $1 million, with the increase driven by continued investment in R&D to allow us to address new markets and fuel our future growth.

While we will continue to grow in the 100-gig long-haul portion of the market for years to come, it is important that we enter new markets as well.

With regards to our SG&A expense, although we will need to increase the overall spend over time to support our growth, we anticipate this to be slower than revenue growth, driving additional financial leverage. At the midpoint of our projected guidance, this would translate to a non-GAAP operating margin of 9%, plus or minus 100 basis points.

The combination of interest and other expense is expected to net out to approximately $500,000, and tax expense should be approximately $1 million. We currently expect the diluted share count to be approximately 130 million shares and project non-GAAP EPS to be $0.11 per diluted share, plus or minus a couple of pennies.

We currently expect GAAP EPS to be lower than non-GAAP EPS by about $0.07 per share, primarily related to stock-based compensation expense. We anticipate continuing to generate positive free cash flow in the fourth quarter. This year has represented a year of continued strong revenue growth and significantly improved profitability.

As mentioned above, the midpoint of our Q4 guidance would represent growth for the entire year of greater than 20%, significantly faster than the overall market. As we have grown revenues, we have also continued to improve our gross margin, now approaching our midterm target of 45%.

In relation to operating expenses, I believe we have done an excellent job of balancing the need for investment with prudent expense management. This has allowed us to transform our business from roughly breakeven to one that generates growing profits and cash.

We are excited about the opportunities we continue to see with both new and existing customers. We are also excited about the additional technologies we are developing, for both the long haul and Metro markets.

We believe these 2 factors along with the leverage of our vertically integrated manufacturing, which is unique to Infinera, will allow us to continue to deliver differentiated financial results. With that, I'd like to turn the call over to the operator to begin the Q&A portion of the call.

Sharon?.

[Operator Instructions] Our first question comes from Simona Jankowski of Goldman Sachs..

I wanted to ask you first how much you're embedding into your Q4 guidance from the Cloud Xpress launch?.

Yes. So in Q4, Simona, Cloud Xpress should be low to mid-single-digit millions of dollars..

Okay. And then I think you mentioned that you had a new enterprise win in the quarter.

Can you expand on that? Do you mean enterprise or do you mean like a Web 2.0 kind of customer?.

No, we mean an enterprise customer. We can't comment on who it is, but you should assume it's like a large industrial type of company. And it's -- I think some of these large companies are going to start looking at building their own DWDM networks for certain applications. Whether it goes somewhere or not, I don't know.

But they are buying it, and they're evaluating, I think, both the product and their own strategy..

Interesting.

I mean, as far as I know, this is your first enterprise customer, is that right? And if so, is this a one-off or is that some kind of an early trend we should keep our eye on?.

Well, we've sold to enterprises when you consider them like banking industry before through managed services and directly. This is the first type of industrial type of company we've sold to. And here's what I think. I think whether it's next year or the next 10 years more and more people are going to be building more and more data centers.

More and more people are going to be building their own kind of optical infrastructure. It's becoming just too much of a fabric of how you do business. So I do think that it is something that we should pay attention to, though I don't think it's going to be something that accelerates rapidly..

Okay. Then just last question for me. You mentioned the Instant Bandwidth as one of the drivers of the gross margin upside.

Could you just help us quantify that, whether in terms of the actual contribution in the quarter to gross margin or what percent of your revenues utilize that program?.

Yes. So Simona, we don't necessarily break out that level of detail. But we have about 20 customers that are utilizing Instant Bandwidth. Most of those customers have not licensed the additional slices of capacity. We expect that to contribute going forward there. It's a good flexibility piece for our customers for certain routes that they have..

Our next question comes from George Notter of Jefferies..

I wanted to ask about the improvement in expectations for Q4. I think going back a couple of quarters ago, you guys were seeing one particular project really driving top line upside in Q2 and then also in Q3. And I think there was a view that the business would kind of step down in Q4.

And I guess I'm trying to understand where the strength is coming from in Q4.

Is it broad based? Is it driven by a certain customer project or customer win? Can you kind of give us some sense for where the incremental demand is coming from?.

Sure. So if you remember back, George, to the Q2 call, Tom had said we have normal visibility in Q4. And what that means for us is we don't have visibility to exactly which customer and which deal. But we had also said that the underlying momentum across the business was strong. As you noted as well, we had a large order that went across Q2 and Q3.

So we knew we were going to have a hole in Q4. In addition, given how strong the first 3 quarters had been, we were concerned the customers would've used all their budget and not have much to come back in Q4. That was why we were cautious about Q4.

The good news is since then across our business we've seen customers continuing to spend money and wanting to continue to grow both the bandwidth across their existing networks but also grow new networks..

Got it. Okay.

So just to be clear, this is a multitude of customers or opportunities or projects that are driving the strength in Q4, it's not just 1 or 2 customers?.

Correct..

Great. Okay. And then I also wanted to ask about the DSO calculation. I think I got 71 days this quarter. It's up a few days relative to the prior quarter. And then you also -- relative to recent quarters this year.

Is there -- is the business a little bit more back-end loaded this quarter? Is there something different about linearity or the mix of customers? What can you say about that?.

Yes. So George, this is not something you should expect to continue. We had a large customer payment that was actually done on day 1 of Q4. So just at the end of the quarter, it was a little bit higher than we would like, but not a trend that you should expect to continue..

Our next question comes from Michael Genovese of MKM Partners..

Just a couple of things. First on the Cloud Xpress, should we think about -- I guess there's a little bit of concern about that cannibalizing DTN-X opportunity with the Web 2.0s.

Or should we think about with the different kilometer and distance capability that those are distinct applications in distinct markets? What's the risk of cannibalization there?.

This is Dave Welch. The Cloud Xpress, the product's targeted at the Metro cloud interconnect. That doesn't really cannibalize any of our long-haul or high-capacity Metro regional products in the DTN-X. So we don't see that eating away at things. And I want to emphasize, eating away is the wrong term.

It is really that certain parts of our network over time may transition to that type of platform, but that is still a -- that would be a healthy transition for us..

But the -- so does the hyper -- given that the top topologies of the hyperscale guys' networks, which they don't do a lot of public speaking about -- and I don't really want you to reveal their plans, which you can't do.

But will that group of customers remain a big customer base for DTN-X? Do they have enough long-haul and ultra-long-haul applications that you expect to continue them to be a meaningful target for DTN-X?.

What the DTN-X does is a meshed optical network over a long haul. And that application for interconnecting different Metro areas is alive and well and will be for years to come. What the Cloud Xpress is, is adjacencies between data centers that are miles apart as opposed to across larger geographies. It's a whole new business opportunity for us..

Great. And just following up on the last question that George asked. Three months ago, you were looking ahead to now and sort of not knowing what's happened -- what was going to happen. And then obviously there's been an improvement, and it seems very broad based.

But is there any more detail by -- at least talk about cable or telco, wholesale, Tier 1, whatever it is.

Is there any more detail? Is there anything that strengthened more than others or -- international versus U.S., different geographies? Is there any more color or granularity there that would be helpful?.

So Mike, as we've talked about before, cable tends to be -- do most of their ordering in the first half of the year. So not driven by cable. Obviously, the Internet content guys continue to grow capacity and add bandwidth to their networks. Our Tier 1 customers continue to do business with us.

And customers on the bandwidth wholesaler side continue to be strong as well..

And international has picked up a lot..

Yes. And we talked about Europe being strong as well as some of the other international regions in Q3. You should expect that to continue into Q4 as well..

And any surprise that you only had one 10% customer in the quarter? Was that what you expected when you were looking at Q3? Or do you think there might be 2?.

Yes. I mean, it's typical. There's -- we normally have 1 to 2. We had 1 this quarter. It wasn't a surprise to us..

Our next question comes from Sanjiv Wadhwani of Stifel..

My question is also on the results on the outlook. A couple of questions, Tom, also you've done an extremely good job in terms of growth over the last year. And then this year is also going to be 20%-plus.

Any predictions on what the optical market does next year as you look into 2015?.

It's one of those -- all we do at this point is mostly listen to analyst reports, which kind of project, I think, somewhere in the 8% to 10% range. Probably, they say Metro growing a little bit faster than long haul, which they typically forecast. And sometimes that's accurate; sometimes long haul grows a little faster.

I would assume the industry will grow roughly in the 8% to 10% range next year. And we anticipate -- I don't know what we'll do, and we're certainly not going to guide to that, but my commitment to the company is we're going to continue to grow faster than the market. And I have every reason to believe we will do that..

Got it. That's helpful. And then, Brad, on gross margins, one of the elements that you mentioned that led to the upside was just the fills happening faster.

Can you sort of walk us through what's going on there, any more detail or granularity? Is that sort of thing that you're expecting to continue for the foreseeable future? And then for Cloud Xpress, remind me what the gross margins look for -- look like for that product?.

Sure. So the thing you're seeing related to fill activities, Sanjiv, is we're essentially at the 2-year point after the introduction of the DTN-X and just the natural momentum of customers coming back to add capacity to those networks. As we mentioned in Q3, we had several of the Internet content guys come back for additional capacity.

You're now seeing customers across multiple of the verticals start to come back for additional capacity. So we're going to continue to try to grow as much footprint as we can because that will benefit us from years to come. But I do think that the momentum of the fill activity is going to continue and will continue to benefit the gross margins..

I might add on something to Brad's comments there. I want to note that it's not -- our gross margin migration is not strictly a result of fill. It's really an acknowledgment of our differentiation within the product set.

When we're growing at twice market, it's not -- it's because we have something better to offer than our competitors' products, and that will represent itself in margins..

And then, Sanjiv, yes, to address the Cloud Xpress. So what we've talked about is some of the early, large volume orders from some of the ICP guys may be a little bit lower than corporate gross margin, but we believe over time the Cloud Xpress and that family of products will be accretive to our gross margins..

Our next question comes from Alex Henderson of Needham & Company..

A couple of mundane things. Just wanted to make sure I got the metrics right on the customers. So how many -- can you just tell us how many customers you're currently carrying? I just want to make sure that I'm plotting it correctly..

I believe the number is 131..

It's 139..

139..

Yes. I thought it was like 136 last quarter and you added 3.

Is that not right?.

Yes. So 139. Yes, Dave's got it right..

Okay.

And then the DTN-X is at 49, that's correct?.

Yes..

Okay, great. Just want to make sure I had those right. So in terms of a content question, the obvious parameter around 2014 has been this very large customer that you noted in 2Q and 3Q. It looks like they've re-upped again into 4Q.

Does that set up a situation where we should be anticipating tough comparisons in 2Q, 3Q and 4Q next year? Or is that just the natural process of your business? And while it impacted the visibility as you went through it sequentially, it's normal comparisons as we look at it into next year?.

Yes. So Alex, the large order that we talked about in Q2 and Q3 is largely done and built at this point. There is a lot of ports in that network that we think will grow for years to come, but that is largely done.

So the strength you're seeing is across the broad customer base, which would imply that as we get into next year, we should continue to see growth across the customer base..

So I shouldn't be concerned about comparisons?.

No..

No..

Okay, great. And then going back to the cloud product. There's obviously any time you launch a product some startup costs associated with it.

And with December launch, should we be anticipating there's some startup expenses in there that will gradually fall out as the year progresses, allowing a little bit better margin by midyear next year on that product? Or should we assume that it comes out pretty much at margin?.

Yes. So I wouldn't expect any differentiation upfront in Q4 versus into '15..

Great. And the other question is relative to the rate of activity. Have you seen a change in the rate of activity over the course of the last couple of months? It seems like it's been pretty robust all summer. You were thinking it might slow, but it doesn't look like it did.

So is it reasonable to say that business is as robust as it's been all year?.

Yes. So I think business continues to be strong, Alex. I think the pipeline activity continues to be strong. Obviously, there's been good early interest in the Cloud Xpress. So I would say it's strong. It's been strong all year..

That's still early December launch for that right?.

Yes..

It's being launched launch FCS [ph] early December, correct..

Great. I'll cede the floor..

And the one comment I will make, Alex. You asked is it as strong as it's been all year. The year has seen different levels of strength. I think it's been fundamentally strong all year. I would consider currently the outlook and pipeline of activity to be good. Unlike last year, we are seeing signs that there'll be some year-end money.

And while I don't particularly -- we're not baking any plans on year-end money, I think that there's a different level of spending ability in the industry when there is year-end money. And I'm seeing that dynamic much better than last year. I will provide one level of caution. Q1 is in the industry typically a pretty down quarter.

We bucked that trend last year with a strong and up quarter. It is far too early to assume that, that will be a -- not an outlier event. So I'd encourage people to think about Q1 in our industry as being roughly soft, and then building on top of that, even with the backdrop of a good pipeline of activity..

Our next question comes from Rod Hall of JPMorgan..

So I've got a couple of questions and clarifications, I guess. The gross margin it sounds like, Brad, you're saying it's mostly mix related.

But I wonder, Tom, could you comment on the pricing environment what -- if there's any change to it at all and give us any further color on pricing that you might have to add? And then I also wanted to see if you guys could give us any kind of indication on the kind of -- the number of trials that you're running at Cloud Xpress right now, the number of trials you might expect to have by the end of the year? And I might have a follow-up to that..

Let me talk a little bit. You said that a lot of it is mix. And some of the pricing advantage is mix that we're having some fill. Some of it is filling on Internet bandwidth. Some of it is just raw scale.

If you look at our company and the volume that we associate with it, 2 years in a row of growing more than 20%, when you're a vertically integrated manufacturer, the flow-through of the leverage on that is really, really nontrivial.

And as we continue to outgrow the market, I think that -- we've promised that our shareholders are going to have the benefit of an enhanced margin because of the incremental risk they take by being vertically integrated. We're starting to deliver on that promise.

And I think as you see us continuing to scale, as we add new markets using the same infrastructure, the margin will continue to expand and allow us a consistent premium to what the market can bear. I think from a competitive position, pricing is, I would say, relatively normal. And it's one of the funny things I think about.

Funny is, I don't know, odd things I think about. If you look back over the long-haul industry, a decade ago there were, what, a dozen competitors competing in the long-haul space. Today, I'd fundamentally say there's 4 people competing for the bulk of the long-haul business.

That is a much more rational market than we've experienced over the last few years. I look at the Metro market today. There's, what, a dozen or 15 competitors in the Metro market.

And as I see the 100-gig and the technologies moving into that Metro space, making it harder and harder for subscale people to make the required investments, I think you're going to see the same kind of shakeout over the next 5 years. Instead of a dozen Metro competitors, you'll see a half a dozen competitors.

That is going to make it a much more appealing environment for those half dozen people or less that are the new winners, and I firmly believe that is Infinera's opportunity..

Okay. And I just -- I wanted to see if you guys also could comment on the rate of fill that you're seeing in this particular product cycle. Would you say that, that rate is faster than what you've observed in prior cycles? Maybe Tom and/or Dave could weigh in on that..

I think you might be overemphasizing the aspects of fill. The fill rates for the quarter are normal and steady. Those are things that change at a frankly slow clip.

To reemphasize what Tom stated before, really our margin expansion comes from the value we offer, the vertical infrastructure that we've developed, the scale of which we're supplying it and then fill plays a role in it. But it is not a -- our business is not driven by fill or builds. It's driven by the other values..

Our next question comes from Dmitry Netis of William Blair..

I missed the early part of the call, so I apologize. But I wanted to see -- how many customers have lined up to buy that CX platform that you're launching in December? Can you quote a number there? Just give us sort of an overview of the customer base that you're getting here.

And then I assume that the average deal size on CX would be lower, somewhat lower than the DTN-X, is that correct? I mean just walk us through sort of your assumptions there..

Yes. So Dmitry, it's a little too early to say on the Cloud Xpress in terms of how many customers. We haven't even ordered -- opened up formal orderability yet. We have got good feedback from customers that are evaluating the product, but given that we haven't formally opened up orderability yet, there's no metrics we can give at this point..

Okay, great. And then the second question would be, if you could share any color on the last sort of big wins you had, one was with XO, the other is Level 3. What the traction there has been? I mean if you color that out for us would be great..

Sure. So Level 3 was earlier on in the year. I would say overall it's been a little bit slower than we anticipated. I think they're a important customer, and I think they will do well over time. And as they continue to win in the market, that will be good for us. But this year, it's been a little bit slower than we anticipated. XO is a more recent win.

They continue to build new routes with us, and I think will be a good customer going forward as well..

Our next question comes from Subu Subrahmanyan of The Juda Group..

I had 2 questions. First on seasonality. Tom, you mentioned this briefly. This year you also had the benefit of a large cable customer in the first quarter, which sort of altered the seasonality.

Can you talk about what you're seeing in that cable market and how cable M&A could potentially exacerbate seasonality this year, if that's a thing you worry about? My other question is on Cloud Xpress.

If you could just broadly talk about what percentage of revenues you think it could represent in 2015? Could this be a 10% of revenue sort of product?.

So in regard to cable, it's just too early to ask the question, Subu. It's -- cable buys a lot in the first half of the year. We have very specific plans of what we're going to go do with cable in regard to the merger and acquisition.

The last I looked I think that the 180-day review period has been put on hold by the SEC in regard to Comcast and Time Warner. So we don't know what it means yet, and it's too early to speculate. I think that we are not anticipating in Q1 having any impact by whatever happens. But in regard to a longer view of that, yes, it's just too early to tell.

We can game theory it out, but I don't think it really helps a lot. In regard to what percentage of our business could Cloud Xpress be? I think it could be a very significant percentage of our business. I think it's early to break out, whether it's 10% or more. But next year being the first real year of the product, I expect a significant ramp.

I think longer term it could probably be more than 10%..

And if I could follow-up on gross margin. As you mentioned some of the factors, volume, mix, given you're further along into the DTN-X cycle and then fill rate, what are the puts and takes, Brad, in terms of the factors? In the past, large footprint adds have had a depressing effect on margins.

But given higher volumes, you'll get better utilization from Cloud Xpress, and also given just kind of really being later in the stage, in the 100-gig build-out cycle, what are some of the puts and takes in gross margins as you look out into the next year?.

Yes. So as I mentioned earlier, our plan is to go -- continue to build as much footprint as we can. Obviously, the systems we deploy today can take a lot more capacity. So our shareholders should want us to continue to build a lot of footprint. And you characterized it correctly, that those initial builds have a lower margin profile.

What will happen, what we expect to happen in '15 is the level of fill to continue to increase, which will balance off some of that footprint as you go through '15. But, yes, we obviously delivered 44% gross margin this quarter, and we expect to continue to grow margins over time..

[Operator Instructions] Our next question comes from Brian Coyne of National Alliance Capital Markets..

A couple of things. Tom, I got completely lost, unfortunately, in your response to Alex's question, I think, on sort of year-end money or budget flush. I was wondering if you could just help clear that up. I couldn't tell if you were saying that you saw any of that or weren't sort of attributing or saw any potential benefit from that in Q4.

And then, I guess, just sort of how that extends as well into -- I know sort of the cable question came about, but if you can just sort of talk about that with regard to cable as well. And then a second one on Cloud Xpress, I'll try to ask it maybe in a different way.

I know at your Analyst Day you spoke a bit about a more kind of deliberate deployment into the first half of 2015 as it might befit sort of a new product.

But given the momentum you're seeing in DTN-X, is any of that sort of customer activity momentum spilling into the Metro cloud area? Could you possibly see sort of a faster pull in demand that changes that trajectory in the first half of next year?.

So let me hit the first one on the Q4, and I apologize if I was unclear earlier. I said last year we were very specific stating we did not see any year-end budget flush. We did not see year-end opportunities. I think we turned out to be correct on that. And we're given credit for kind of having an insight into that market.

This year, I do see some year-end money being available. We have not baked that necessarily into our plan or commitment because it hasn't materialized yet. But I do see an environment where there is more likely than not some Q4 year-end budget flushing.

And I think that to me what that means is an overall healthier market that we're selling into and other people are selling into. I think that's a positive sign for the industry. That's my only point on a budget flush. In regard to Q1, I'm encouraging people to think about the typical cyclical down quarter that there is there.

And while we are, I think, having incredibly strong momentum right now across a very broad range of customers and geographies, I don't want people to assume at this point that we will be immune this year to a Q1 downturn like we were last year. I'm not saying we will have one. I'm just saying be careful of assuming we won't.

In regard to cloud, I'm very careful about trying to introduce new products into the market to make sure that they meet our customers' expectation around quality, reliability, performance, software quality. We typically do, do a reasonably metered ramp into a market to make sure. Quantities of one don't prove anything.

You have to build a number of units before you fully understand that the market is being satisfied by your product. Having said that, I do anticipate there'll be a fairly steep ramp in Q1 and Q2 for Cloud Xpress. Our overall demand profile of what we anticipate winning is pretty strong. And at the end of the day, we build products to satisfy demand.

So if the demand does materialize, we will work very hard to ramp up that product in such a fashion that it meets not only time to volume, time to quality but also time to market and volume goals..

Our next question comes from Ted Moreau of Barrington Research..

Kind of getting back to this Q4 versus Q1 seasonality question. If I think back to the Q2 earnings call, you guys talked about deals that you saw in the Q4, Q1 time frame.

And given the strength of the guidance that we're seeing for Q4, are a bunch of these deals for Q4, Q1 largely now being pulled into Q4? Is that kind of what's happening? Or can you give some color there, please?.

Maybe I can, and I'll let Tom follow up. As indicated by our guidance, Q4 looks good. And as Tom indicated, that's based on our exposure to what the customer demand is. It's coming from a broad base of customers. Due to the same thing we've described in the past, Q1, I -- we're just not giving guidance around what Q1 is.

I think you guys are trying to reach to far, too far forward. The next quarter, Q4 looks good, and we'll have to make commentary on what Q1 looks like at the end of Q4..

I think it's important to understand we are not trying to ramp up a Q4 by pulling in fundamental demand from Q1. I'm a big believer as a company keeping things as natural as possible allows you to run a healthy, normal business. And we are not trying to accelerate demand from Q1 into Q4.

If anything, if Q4 end of year money becomes available, our challenge might be quite frankly being able to take that because the demand profile of our business right now is robust -- and surprise things at the end of the year, sometimes you can't -- if you're already full, you're already full. So that's a challenge..

And maybe I can add one other comment here. Understand, our customer base is predominantly the customers that carry the traffic of the Internet. We are not highly dictated by wireless bandwidth. This is the bandwidth that drives the high-capacity pipes and the data center types of activities out there.

That background demand and the growth of that background demand is driven by the same processes that are out there that drive whether it's consumer consumption, business consumption, cloud -- moving your IT systems to the cloud. That trend is a strong trend, and that's why we're experiencing this across our set of diversified customer base..

I agree. I think fundamental growth of Internet demand and new sources of network architectures to deal with the cloud, data center, et cetera, just create a great backdrop for us and other people in the industry. And I think that's our last question. Thank you for joining us this afternoon and for your questions.

We look forward to updating you on our continued progress. Have a great day..

This concludes today's conference. Thank you for your participation. You may now disconnect..