Infinera Corp (INFN) 2023 Q1 法說會逐字稿

Good day. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Infinera First Quarter 2023 Earnings Conference Call. (Operator Instructions)

Amitabh Passi, Head of Investor Relations, you may begin your conference.

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 future 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 drivers 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've 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'll allow for plenty of time for Q&A today that we ask that you limit yourselves to one question and one follow-up, please.

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

Thanks, Amitabh. Hey, good afternoon, and thanks for joining us today. I'll begin with a 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 6 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 road map and time line that we laid out for you during our Investor Day. Fifth, we're continuing to position ourselves for the CHIPS and Sciences 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 reshore 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 at least $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 hotter. Despite this macroeconomic 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 remains centered on fiber builds, higher speeds and feeds, lower cost and power efficiency.

These are areas that firmly hit our sweet spot. Our overall sales funnel is solid and RFP activity is quite healthy. As we stated during our Investor Day and like the prior 2 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 staying focused on our growth strategy, prioritizing investments in 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 midpoint 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 are executing to the 6 strategic milestones we outlined during our Analyst Day, and 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 time frame.

I'd like to thank the Infinera team for their continued commitment to building a culture centered on caring 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 second quarter. Nancy?

Thanks, David. Good afternoon, everyone. I will begin by covering our first quarter results and then provide the outlook 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 ICP customers and was 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 relief in 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 of 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 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 in free cash flow.

Let me turn now to the outlook for the second quarter of 2023. While we remain encouraged by the long-term drivers of our business, our design wins, our 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 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 2 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 up 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 road map. 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 road map are clearly resonating with our customers, and we believe the investment thesis is compelling. We are focused on executing our strategy, delivering on the 6 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.

(Operator Instructions) And your first question comes from the line of Mike Genovese from Rosenblatt Securities.

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 could 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?

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 3 or 4 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 Analyst 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 they'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 of billion dollars, and it's really the priority of the spend. So I think that's what they're going through as 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?

Yes, that was great. I guess just looking at last year, there was a pretty steep ramp 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. Is that -- where does that confidence come from in the second half, like where are you getting that confidence?

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 front half slower start. I think what you saw is, our Q1 performance was quite a bit stronger than our last 2 years. And that front half being 10% and being above the 8%, 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 rate, which is again below the 10% in the front half. We'd be crazy in this market, Mike, to get more frothy than that.

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 at 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 mess, like we did through the pandemic. We're keeping our same forecast methodology and our same executional focus.

Your next question comes from the line of Alex Henderson from Needham & Company.

Great. I think the Street believes that you guys have a pretty good-sized backlog of product that you will 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 Ciena, 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 transceivers 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?

Yes. I'll start and David you can jump in.

Sure.

But the backlog, we're not going to get into the specifics of what's in our backlog. But one of the comments that I did make is we are seeing, I'll say, some of the supply loosen up and you're seeing more line systems getting deployed, one of the statements that I made about the Q2 margin and keeping that range where we did. It really depends on the customer and the deployment. Certain customers are going to buy lines, going to buy the transponders, at the same time, they're deploying the line systems and fill at different rates. Others, it will be a more staged and take multiple quarters. But it really is going to depend on the customer, the deployment, and the timing of what they need in order to get their network up and running.

But to your point, Alex, I think there's a good portion of line systems in our backlog.

Yes.

And that there is still -- that's the one area that there is still a fair bit of supply constraint in the industry. As those come out, let's say, you have a 5x opportunity in terms of fill on value to go from the first order to completely filling, like typically unless it's a true subsea where they're going to fill the whole -- the whole spectrum right away. You are absolutely right. Typically, people aren't going to buy line systems and then not fill them right, and deploy them. And we certainly don't want that to happen.

So we kind of track where we've got line systems out and where that gives us forward visibility in our funnel, that loads our sales force funnel, which is what we manage in this -- in these micros. And yes, when we're selling those transponders, they tend to be at higher margins than that nasty line system.

Just to be clear, the line system orders generally do not include at the same time as the order was put in, the transceivers to meaningfully light them up, there is always 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?

Partially. I mean, there are people that when they're 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.

Great. And just to be clear, have you -- did you work down your backlog during the period or is it -- I mean normally this is seasonally weak quarter for orders, I'd assume [if that's] the case?

Yes, yes. We have mentioned at the Analyst Day, we thought that in the first half that would definitely be the case.

Yes. RPOs went from 983 to 903.

Your next question comes from the line of Simon Leopold from Raymond James.

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 that. I do 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 5G radios being absorbed or you are specifically talking about your own products. And if it's your own products, I'm puzzled how they got that inventory?

Simon, I would like to make a very clear statement here. So thank you for the clarifying question. Yes, 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 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.

And then as a follow-up, just what are you thinking in terms of the ebbs and flows in your customer mix in that second quarter guidance? So it implies that at least one of your verticals is not following seasonality. And 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?

Yes. I think 2 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 governments typically run at their own productivity time lines, 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 ICPs lumpy in terms of shipments to revenue from us. I think you're continuing to see -- we had a very strong Americas for the quarter. Europe continued to be a little bit weaker. I think that's overall a more of a cautious environment, although, we see a very large number of RFPs out there, that one is 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.

Appreciate the clarification. And just as a quick verification, I'm assuming that government shows up with your other service provider segment?

That's correct, Simon.

Your next question comes from the line of Meta Marshall from Morgan Stanley.

Great. Maybe on your commentary about kind of the 10 customers kind of looking at the external pluggables. Just wanted to get a sense of kind of what early feedback you are 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 were seeing in general, are you seeing any kind of slowdown in their activity and in valuations or is this really just kind of slowdown of orders?

Yes. Meta, good question. I want to -- I do want to clarify this one as well to be very specific. Yes, the 10 customers 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 OFC, you did see a large degree of interest as 400 gig goes into the metro for CSPs, as well as our 400 gig ZR+ and ZR module, 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 ZR ICE-X pluggable is filling that need. So we -- 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 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 U.S.A, especially given the performance and reach that they're looking for and the economics have been a hit.

And just...

Yes, go ahead.

I will quickly 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 into '24 to vertically integrate our own metro platform, and that's the margin expansion that we shared with you at Investor Day that, that really starts to kick in, in '24.

Now that's a 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.

And your next question comes from the line of George Notter from Jefferies.

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. I'm kind of wondering what the update is on that mix of product sales?

Yes. Amitabh, why don't you hit the ICE6 and vertical integration, and then Nancy can hit the other piece?

Yes. So George, ICE6, we said -- well, we didn't say it, it's just north of 30% in the quarter of product revenue and VI was north of 50%, 5-0.

Yes. 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're 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 38.5% and continue on our track to get to 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.

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.

No, 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 6 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 happened 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 points of operating margin expansion, nice job to the team.

Our Q2 guidance implies 10% 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 listen 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 it. 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 are encouraged by what we see in the subsystems business, that's quite exciting. We know it takes time. But again, those 6 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.

Thank you.

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