Infinera Corporation (NASDAQ:INFN) Q1 2023 Earnings Call Transcript

Infinera Corporation (NASDAQ:INFN) Q1 2023 Earnings Call Transcript May 3, 2023

Operator: Good day! My name is Rob and I will be your conference operator today. At this time I would like to welcome to the Infinera First Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. . Thank you. Amitabh Passi, Head of Investor Relations, you may begin your conference.

Amitabh Passi: Thank you, Rob and good afternoon. Welcome to Infinera’s first quarter of fiscal 2023 conference call. A copy of today’s earnings and investor slides are available on the Investor Relations section of the website. Additionally, this call is being recorded and will be available for replay from our website. Today’s call will include projections and estimates that constitute forward-looking statements, including but not limited to statements related to our further business plans, product development and growth opportunities, including progress against strategic priorities and milestones, trends, competition and customers; capacity growth; expectations regarding industry wide supply chain challenges, and the macroeconomic environment, market adoption of coherent optical engines; expectations regarding the launch of our subsystems business and its impact on our financial results.

Expectations regarding obtaining government funding, projected year-over-year drives of demand, revenue, gross margin, operating expenses and operating margin, expectations regarding our future performance, revenue growth and margin expansion and our financial outlook for the second quarter of 2023. These statements are subject to risks and uncertainties that could cause Infinera’s results to differ materially from management’s current expectations. Actual results may differ materially as a result of various risk factors, including those set forth in our Annual Report on Form 10-K for the year ended on December 31, 2022, as filed with the SEC on February 27, 2023, as well as subsequent reports filed with or furnished to the SEC from time-to-time.

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 conference call includes references to non-GAAP financial measures, except for revenue, balance sheet items and cash flow from operations, which are discussed on a GAAP basis. Pursuant to Regulation G, we have provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in our earnings release and investor slides for this quarter, each of which is available on the Investor Relations section of our website. And finally, as a reminder, we will allow for plenty of time for Q&A today, but we ask that you limit yourself to one question and one follow-up please.

I’ll now turn the call over to our Chief Executive Officer, David Heard. David

David Heard: Thanks Amitabh. Hey, good afternoon and thanks for joining us today. I’ll begin with the review of our results and then I’m going to turn the call over to Nancy to cover the details of our financial performance for the first quarter. We had a very solid start to 2023 with first quarter revenue, gross margin, operating margin and EPS, all beating the midpoint of our outlook range. Revenue in the quarter was $392 million and grew 16% year-over-year and we expanded gross margins by 260 basis points and operating margins by 450 basis points compared to the first quarter of 2023. During the quarter we continued to make progress towards the six strategic milestones that we laid out at our Investor Day in March. Specifically, first we had another good quarter of shipping ICE6 and currently are on track to drive ICE6 to greater than 35% of product revenue in 2023.

Second, our 400 gig ZR, ZR+ software defined ICE-X pluggables are performing well and are being integrated into our own Metro platforms. We are expanding our Metro footprint with new design wins and expect to see initial margin benefit from the vertical integration of these Metro platforms as we exit the year. Third, the pipeline for our external pluggables business is expanding quite nicely and we’re on track to capture tens of millions of dollars of orders during 2023. To-date we’ve received orders for qualification, sampling and initial deployment from over 10 customers spanning network equipment manufacturers, ICPs and service providers. Fourth, the development of our next generation embedded engines, including ICE6 and ICE7 is progressing well and we’re focused on delivering to the technology roadmap and timeline that we laid out for you during our Investor Day.

Fifth, we’re continuing to position ourselves for the CHIPS and Science funding Act to augment our existing business plan. As a U.S. based optical semiconductor manufacturer, Infinera is well situated at a time with significant government funding is on the table to reassure and secure critical supply chains. And finally, we’re driving towards our full-year plan for revenue growth and margin expansion. As you’ve just heard, Q1 revenue was 16% and above our 8% annual target and we expect the first half of 2023 to be generally in line with our expectations coming into the year. All of these milestones are aligned towards delivering our target business model of atleast $1 of EPS in the ’25, ’26 time period. From a macro perspective, there’s no doubt that the current environment is a little more dynamic, with customers taking more time to balance the need to work down their backlog, prioritize projects and establish the right strategic budgets for the year.

Within the ICP segment, which represents 25% to 30% of our revenue and less than 15% of the overall optical systems market, we’ve seen a bifurcation in customer behavior. While some of our ICP customers are digesting inventory and working down backlogs, we’re winning and shipping to others who are gearing up for artificial intelligence and machine learning workloads, while continuing to drive significant incremental traffic growth. Within the communication service provider or CSP customer segment, we are also seeing a push out of some projects as customers work down inventory and run their networks a bit harder. Despite the smacker economic backdrop, we’re continuing to land new design wins with our strong portfolio as customers look to diversify their vendor base.

Furthermore, spending priorities across our customer base remain centered on fiber bills, higher speeds, and feeds, lower costs and power efficiency. These are areas that firmly hit our sweet spot. Our overall sales funnel was solid and RFP activity is quite healthy. As we stated during our Investor Day, and like the prior two years, we expect to grow ahead of the market in 2023 with bookings weighted towards the second half of the year. In the meantime, we’re saying focused on our growth strategy, prioritizing investments and expanding our market reach, and building our pluggables business, while being judicious about all other expenses. At this point, our bottoms-up view supports our annual plan for 2023. As you’ve seen from our press release today, at the mid-point of our outlook range for Q2, 2023, we would deliver 10% year-over-year revenue growth in the first half of 2023, which is above our annual target of 8%, while continuing to expand margins.

In closing, while there is some near-term uncertainty in the market, it’s our expectation that much of what we’re seeing today is short-term and timing related and not a reflection of any long-term underlying demand. We’re executing to the six strategic milestones we outlined during our Analyst Day and in our primary objectives remain unchanged; to grow faster than the market, expand our margins, launch our pluggables business and deliver at least $1 of EPS in that ’25. ‘26 timeframe. I’d like to thank the Infinera team for their continued commitment to building a culture centered on carrying for our customers and one another, and delivering on innovation that matters. I would also like to thank our partners, customers and shareholders for their ongoing support.

I will now turn the call over to Nancy to cover the financial details of the quarter and our outlook for the second quarter, Nancy.

Nancy Erba: Thanks, David. Good afternoon, everyone. I will begin by covering our first quarter results and then provide the outlet for the second quarter. For your reference, on our Investor Relations website, we have posted slides with financial details, including our GAAP to non-GAAP reconciliation to assist with my commentary. As you heard from David, the first quarter was a solid quarter for us, in which we delivered double digit year-over-year revenue growth with key financial metrics; revenue, margins and EPS, all coming in above the midpoint of our outlook range. Revenue in the quarter was $392 million, up 16% on a year-over-year basis, with product revenue up 18% year-over-year. This performance was driven primarily by strength in the Americas and with ICT customers, and with across both our GX portfolio and line systems.

Geographically we derived 60% of our Q1 revenue from domestic customers, a level consistent with Q4 as we saw continued strength across our customer base in the U.S. Q1 gross margin of 38.8% was above the midpoint of our outlook range and increased 260 basis points year-over-year. Compared to the year ago quarter, gross margin benefited from higher ICE6 revenue and some release and supply costs, partially offset by higher line systems revenue and services mix as we continue to work through our lower margin professional services backlog. As we have discussed in prior calls, line systems revenue comes at a lower gross margin, but the expanded customer footprint bodes well for the future attachment of higher margin transponder sales. Operating profit in the quarter was $13.6 million, with an operating margin of 3.5%, compared to an operating loss of $3.5 million in Q1, 2022.

On a year-over-year basis we expanded our operating margin by 450 basis points, benefiting from higher revenue, higher gross margin and improved operating leverage. Operating expenses of $138.6 million in Q1 were slightly below our outlook range of $139 million to $143 million as we tightly managed quarterly spending. The resulting diluted EPS was $0.02 per share at the high end of our outlook range, which compared to a loss of $0.07 cents in the year ago quarter. Moving on to the balance sheet and cash flow items, we ended the quarter with $170 million in cash and restricted cash, with no amount drawn on our ABL. The primary use of cash in the quarter was working capital as we continue to strategically build inventory while reducing our payables.

Consequently, cash flow from operations reflected a modest use of $1.8 million in cash in the quarter and $18.6 million in outflow and free cash flow. Let me turn now to the outlet for the second quarter of 2023. While we were indeed encouraged by the long term drivers of our business, our design wins are above industry growth and healthy backlog. We are cognizant of the environment we are operating in as our customers take a little bit more time to determine their spending priorities for the year. However, we don’t expect this transitory effect to reflect the material shift in the longer term drivers of our business. Based on our current visibility, we expect Q2 revenue to be in the range of $375 million, plus or minus $20 million, representing 5% growth on a year-over-year basis at the midpoint of the range, and implying 10% growth in the first half of 2023 over the first half of 2022.

Partially impacting our Q2 outlook is the push out of our approximately $20 million dollar government project that we now expect to materialize in the second half of the year. Overall, we believe our revenue trajectory in 2023 will mirror the trend of the last two years with sequential growth in both Q3 and Q4 and a stronger second half compared to the first half. We expect Q2 margins to be in the range of 38.5% plus or minus 150 basis points, up 240 basis points year-over-year at the midpoint of the range. The primary driver of the year-over-year increase in gross margin is the projected greater contribution of ICE6 in our revenue mix and the continued abatement of supply costs, partially offset by a more acute impact from lower margin line systems and metro products that are currently non-vertically integrated.

We are forecasting Q2 operating expenses to be in the range of $140 million to $144 million, modestly and sequentially as we continue to prioritize investments in global sales and business development, to take advantage of the growing market opportunity, and as we continue to invest in our product roadmap. The resulting operating margin in Q2 is expected to be approximately 0.6% plus or minus 300 basis points, up 20 basis points on a year-over-year basis at the midpoint. Below the operating income line, we assume $7 million for net interest expense and $4 million for taxes. Finally, we anticipate a loss of $0.03 per share, plus or minus $0.05, assuming a basic share count of approximately 226 million shares and a fully diluted share count of approximately 267 million shares.

The midpoint of this Q2 outlook range would represent year-over-year improvement across all outlook metrics; revenue, gross margin, operating income, and EPS. As we look ahead, at this point we are leaving our full year 2023 outlook unchanged. Consistent with the messaging during our Investor Day in March, we expect our revenue growth to be approximately 8% for the year and our annual EPS to be above $0.20 for 2023. As I wrap up today, I want to thank those of you who attended our Investor Day in March, and I enjoyed seeing you in person. We had record attendance at our OFC booth, our portfolio and technology roadmap are clearly resonating with our customers, and we believe the investment thesis is compelling. We are focused on executing our strategy, delivering on the six milestones and driving at least $1 of EPS by ‘25, ‘26.

I would like to thank the Infinera team for their continued commitment to innovation and execution excellence, and our partners, customers and shareholders for their continued cooperation and support. Operator, I’d like to open it now for questions.

Q&A Session

Operator: . And your first question comes from a line of Mike Genovese from Rosenblatt Securities. Your line is open.

David Heard: Hey, Mike.

Mike Genovese: Hi David, thanks for the question. I guess David, when you’re talking about cloud or ICP versus service provider, I didn’t get a clear message, but I guess that’s kind of what you were saying, is that some of the cloud guys are speeding up, some are slowing down. But if you can just compare cloud to service provider in terms of your – whether you think the markets – which one feels relatively stronger or relatively weaker in the second quarter? And do you think that that same kind of trend will continue in the second half or do you have different expectations?

David Heard: No, it’s a good question. What I was actually saying is exactly what you repeated back, which is it’s bifurcated. There’s some – and they publicly announced their numbers, right. So some of their web services slowed down from some really fantastic growth rates, I mean some above 40%, right. There’s still some high double-digit growth rates. So I think we’ve all expected them to digest some inventory and burn down some backlog and so I think that’s a couple of quarter issue. Well, there’s a second set of them. When you look at their CapEx, I think there were three or four that are driving these machine learning and AI workloads, which are, everybody told us they were going to be 10x and you don’t believe it until you see it in the forecast and then ultimately in the order book.

So I think as I said at Analysts Day, they’re going to continue to be lumpy, but I think the demand will be there. I think even the ones that have slowed down to burn off the backlog, workloads are still – when you’re growing double-digit, you still need to build out data center and server infrastructure and connect it via optics. On the service provider front, I think what we’re seeing is honestly a huge number of RFPs out globally going on right now. But what happens in times like this, when you hear the R word, recession, a lot of them are sweating their assets and running a little hotter and burning down backlog. That being said, service providers typically when they cut their budgets, some of them that are spending $18 billion, they don’t cut them to $9 billion, right, they cut them by a couple billion dollars, and it’s really the priority of the spend.

So I think that’s what they’re going through, is their priority of spend, and where orders are going to be. I think the good news for the long term and the medium term is actually that fiber is a big priority. We’ve got some design wins in many of those big CSPs. I’ll remind you, I would like more customer concentration in those Tier 1 top 50 CSPs. So the slowdown in terms of their order deployment versus their backlog drawdown isn’t quite as painful when you’re not as concentrated, but we are going to continue to drive to be more concentrated on those CSPs. Mike, did I answer your question?

Mike Genovese: Yes, that was great, thanks. I guess just looking to last year, there was a pretty steep branch in the second half of the year compared to the first half of the year. And by saying 8% is achievable this year, it seems like it could be even slightly steeper this year. Where does that confidence come in the second half? Where are you getting that confidence?

David Heard: Well, so a couple of things. I think you’re right. Actually for the last couple of years we’ve had a much more dramatic back half than a front half slower start. I think what you saw is our Q1 performance was quite a bit stronger than our last two years and that front half being 10% and being above the 8%. But we came at Analyst Day in March and talked about that, right? Meaning we said, we thought that the back half certainly would be in magnitude stronger, but that certainly overall we believe we’d be at that 8% market, right, which is again below the 10% in the front half. We’d be crazy in this market Mike to get more frothy than that and we think we’re being really mindful and we’re managing with the micro. We’re looking at our sales funnel; we’re looking at our deployments; we’re looking – having conversations with the people making these deployments and could it get hotter?

Hey look, I think that would be speculation. We’re kind of – at this point we stick with what we said in March and continue to use our micro tools quarter-to-quarter like we did through the supply chain, much like we did through the pandemic. We’re keeping our same forecast methodology and our same executional focus.

Mike Genovese: All right, great. Thanks a lot for the questions.

David Heard: Thanks Mike.

Operator: You are next question come from the line of Alex Henderson from Needham and Company. Your line is open.

Alex Henderson: Great, thanks so much. I think the street believes that you guys have a pretty good sized backlog of product that you’ll be shipping in 2023, and that should give you some pretty good visibility as supply chain improves. The bait on a lot of these companies that are in the systems market with large backlog seems to be focused more on what happens after the backlog comes down. And I was hoping you could talk a little bit about the mix of the backlog and what it might imply. Specifically, it’s my understanding in talking to Sienna and I think you guys have a similar situation, that the optical line systems are a pretty significant piece of your backlog. But it’s also my understanding that the transceiver that is needed to light those optical line systems are not.

And so I guess the question is, if it’s 40% of the backlog is OLS and you ship that out, how long before the orders come in to light those line systems up, and is that a second round of orders that should give visibility to a longer term trajectory of growth.

Alex Henderson: Just to be clear, the line system orders generally do not include at the same time that the order was put in the transceivers to meaningfully light them up, because there is a lag from the OLS going out to when the transceiver order comes in. And therefore that does suggest another round of ordering front. That thesis is correct, yes.

David Heard: Partially, as there are people that when they are doing their initial order might order the line systems and a portion of the initial deployment. But a majority of the dollar value of that potential deal is future versus current.

Alex Henderson: And just to be clear, have you – did you work down the backlog during the period or is it – I mean normally this is a seasonally week quarter for orders. I assume that’s the case.

David Heard: We did, yes. Yes, yes, we had mentioned that in the Analyst Day. We thought that in the first half that would definitely be the case.

Nancy Erba: Yeah. RPOs went from 983 to 903.

Alex Henderson: Thank you so much.

David Heard: Thanks Alex.

Operator: Your next question comes from a line of Simon Leopold from Raymond James. Your line is open.

Simon Leopold: Thanks for taking the question. In the prepared remarks David, you mentioned this comment about inventory absorption and I want to make sure I understand, because I guess I’m a little bit confused in it. I imagine that the – your customers had inventory of your gear now. I didn’t know whether you were sort of referring to the broad sense of things like 5D radios being absorbed or you’re specifically talking about your own products. If it’s your own products, I’m puzzled how they got that inventory.

David Heard: Hey Simon, I would like to make a very clear statement here, so thank you for the clarifying question. Yeah, in the prepared comments, it was industry wide and not just specific to optical and not our gear, right. I think that during the supply chain a lot of CSPs and customers loaded up, and in many cases loaded up to be given where the lead times are. As those are coming down, they have the ability to burn down and economic pressures, you know necessity drives that innovative spirit to drive what’s in the warehouse and try to get that out and what’s deployed. So what I meant is, they’re burning down backlog and they’re burning down the inventory that they have, rather than ordering lots of new gear in the front half of the year. And we mentioned that in the Analyst Day, that we thought that that would happen and then people would kind of reload and recharge as we go out throughout the year.

Simon Leopold: And then as a follow-up, just what are you thinking in terms of the ebbs and flows in your customer mix and that second quarter guidance. So if it implies that at least one of your verticals is not following seasonality, your comments on the call make me think it’s the ICPs and not the traditional telcos. But I just want to make sure that I’m thinking about this correctly.

David Heard: I think two things. One, we did have a government deal of a reasonable size that Nancy mentioned, a $20 million deal that was supposed to be in the first half. And in these times, and the governments typically run at their own productivity timelines, that’s going to move from the first half into the second half of the year and you’ve seen that happen before with other big projects with us. This one is a government project. As I mentioned in the Analyst Day, I think you’re going to continue to see the ICP lumpy in terms of shipments to revenue from us. I think you’re continuing to see we had a very strong America’s for the quarter. Europe continued to be a little bit weaker. I think that’s overall more of a cautious environment, although we see a very large number of RFPs out there.

That one’s just going to be timing. So I think it is a little bit of ICP lumpiness. A government project that has spit out and then just the ramp rate of CSPs that are traditionally pretty darn strong in Q2, that are just taking a lot longer, again, as they try to burn down their backlog.

Simon Leopold: I appreciate the clarification and just as a quick verification. I’m assuming the government shows up with your other service provider segments.

Nancy Erba: That’s correct.

Simon Leopold: Great. Thank you very much.

David Heard: Thanks Simon.

Operator: Your next question comes from the line of Meta Marshall of Morgan Stanley. Your line is open.

Meta Marshall: Great, thanks. Maybe on your commentary about kind of the 10 customers, kind of looking at the external pluggables, I just wanted to get a sense of kind of what early feedback you’re getting. What kind of scale of projects these could be as we head to ‘24 and ‘25. And then maybe a second comment or a second question is just on lab trials that you are seeing in general. Are you seeing any kind of slowdown in their activity, in the valuations or is this really just kind of slowdown of orders? Thanks.

David Heard: Thanks Meta. Good question. I do want to clarify this one as well to be very specific. The 10 aren’t looking. What I mentioned is they are ordering. So we actually have firm hard orders in for either qualification, initial deployment or sampling, so that’s really good news. I’m encouraged by that. I think for those of you who were at you did see a large degree of interest as 400 gig goes into the Metro for CSTs, as well as our 400 gig ZR+ and ZR module, a couple of things are happening. The performance of it has been quite strong and as people go look to deploy the 400 gig ZR spec, in some cases they would like a little bit more reach. And our 400 gig ICE-X pluggable is filling that need. So our sales funnel is building with lots of nice opportunities there.

But look, we won’t – we’ll count those when big orders are able to come in-house, we’ve got some work to do. The second thing is the software definition on them. Meaning, the fact that these are manageable via software has been a big hit. Networks are complicated, even in ICP networks. People are looking to segment alarm, track and be secure and I’d say the third point is, let’s not forget, our pluggables are manufactured in the United States, with our own fab here in Sunnyvale, California and our advanced semiconductor packaging facility in Pennsylvania. And so that value proposition of performance software and Made in the USA, especially given the performance and reach that they’re looking for and the economics have been a hit.

Nancy Erba: And just…

David Heard: Yeah, go ahead.

Nancy Erba: I was to say, just add on that and don’t forget right, that these pluggables are what’s going to allow us, as we exit this year and go on to ‘24 to vertically integrate our own Metro platform, and that’s the margin expansion that we shared with you at Investor Day that really starts to kick-in in ‘24.

David Heard: Now, that’s the new business Meta and that’s 10 orders for, again sampling initially and some initial deployments. That takes a while to scale and that’s why at Analyst Day we talked about our goal being tens of millions of orders by the time we exit the year, and then the scale happening there. But I’m quite encouraged by so far what we see. We need to translate that to the almighty income statement and balance sheet.

Meta Marshall: Great, thanks so much.

Operator: And your next question comes from the line of George Notter from Jefferies. Your line is open.

George Notter: Hey you guys, thanks very much. I’ve got a few questions here. I guess maybe to start, I thought I’d ask about pricing. I know you guys raised price about 5% back in May of last year. I’m kind of guessing that that will start flowing through the model here in Q1. Can you give us a sense of how much of the growth you’re getting is coming from pricing or maybe that benefit is still in front of us. I’d love to get a sense for that. And then secondly, I’m just curious about the mix of ICE6 and mix of vertically integrated products in the quarter and kind of wondering what the update is on that mix of product sales. Thanks.

David Heard: Yeah Amitabh, why don’t you hit the ICE6 and vertical integration and Nancy can hit the other piece?

Amitabh Passi: Yeah, so George ICE6 we said, well, we did say it’s addition 30% in the quarter of product revenue and VI was another 50%.

Nancy Erba: Yeah, and I think we first of all never announced a price increase. So we have as we’ve said, look at our pricing, look at our customer mix, look at the products that they are buying and make assessments on a quarter-by-quarter basis. But the mix of the margin that you’re seeing now, as we go above the 385 and continue on our track to get 40% for the year, is going to be made up of a compilation of a number of things, right. But primarily the mix of ICE6 helps us as we grow our margin there and we’re going to continue to look at our own pricing relative to the market, relative to where we see opportunity, and also where we want to grow, right, and where we want to expand the market in front of us. So I won’t comment further about any other increases or any decreases.

George Notter: Got it. Okay, thanks very much guys. I appreciate it.

David Heard: Thanks George.

Operator: And there are no further questions at this time. Mr. David Heard, I turn the call back over to you for some final closing remarks.

David Heard: I appreciate it. Like Nancy said, it was great to see everybody at Investor Day, so I know we’re short today, because hopefully we reviewed kind of the plans of where we go. As we mentioned there, we have those six milestones that we went through, that we laid out at Investor Day. I think the good news is in times like this, concentrating on ensuring we are closing off on those with credible measures I think happens in Q1. We had quite a strong Q1 and I’m proud of what the team did. 16% year-over-year growth, 260 points of gross margin and 450 of operating margin expansion, a nice job to the team. Our Q2 guidance supplies 10% of revenue growth for the first half, which is again ahead of what we see. We’re certainly mindful of the macro.

We read the news. We’ve listened to other earnings calls. We understand what’s going on. However, we’re operating our business off the micro tools and processes in close discussions with our clients that have proved to be effective as we manage through the pandemic, supply chain crisis, wars, you name us. So that’s what we’re going to continue to do. Our job with you is to always give you a great view of what we see. We’re encouraged by what we see in the subsystems business, that’s quite exciting. We know it takes time. But again, those six key milestones are what we are focused on. So we really appreciate everybody’s continued interest, the thoughtful questions today and we look forward to speaking to you at our next earnings call, if not sooner.

Everybody have a great day!

Operator: This concludes today’s conference call. Thank you for your participation. You may now disconnect.