Infinera Corporation (NASDAQ:INFN) Q3 2023 Earnings Call Transcript
Infinera Corporation (NASDAQ:INFN) Q3 2023 Earnings Call Transcript November 8, 2023
Operator: Hello, my name is Chris, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Infinera Corp’s Q3 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there’ll be a question-and-answer session. [Operator Instructions] Thank you. Amitabh Passi, Head of Investor Relations, you may begin.
Amitabh Passi: Thank you, Chris and good afternoon, everyone. Welcome to Infinera’s third quarter of fiscal 2023 conference call. The copy of the press release issued by Infinera today is 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 the accounting and financial matters referenced in the press release, current Form 8-K and notification of late filing that we’ll file today. Our business plans, product development and growth opportunities, including progress against strategic priorities, including with respect to vertical integrations, and its anticipated benefits, trends, competition and customers.
Furthermore, expectations regarding the macroeconomic environment, expectations regarding our inventory levels and industry-wide CapEx dynamics, expectations regarding our subsystems group and its impact on our financial results, expectations regarding potential governmental funding, projected year-over-year drivers of our key financial performance metrics, expectations regarding the future performance, revenue growth, margin expansion, generation of cash flow from operations and EPS expansion, and preliminary financial outlook for the fourth quarter of 2023. The 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 31st, 2022, as filed with the SEC on February 27th, 2023 and in our quarterly report on Form 10-Q for the quarter ended July 1st, 2023 as filed with the SEC on August 9th, 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. Pursuant to Regulation G, we’ve provided a recon of these non-GAAP financial measures to the most directly comparable GAAP financial measures in our earnings press release for this quarter, 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, so 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 Heard: Hey. Thanks, Amitabh. Good afternoon and thanks for joining us today. I’ll begin with the highlights from our preliminary third quarter results and then turn the call over to Nancy to cover the preliminary financial details of our third quarter performance and the outlook for the fourth quarter, and the items referenced in the press release in Form 8-K we filed earlier this afternoon. Before I jump into the details of the quarter, I want to pause, take a step back and focus on our quarterly accomplishments at a high level. Overall, the third quarter was another solid quarter for us, in which, all financial – preliminary financial metrics, revenue gross margin, operating margin and EPS are expected to exceed the midpoint of our outlook range.
We delivered strong bookings with the book-to-bill ratio above 1. We continue to land new tier 1 design wins for our Systems business. We won additional orders for our Subsystems business and are shipping our first vertically integrated Metro Systems this quarter, all while we expanded profitability on a year-over-year basis. Furthermore, as we look ahead to Q4, we’re forecasting growth to be generally in line with the consensus view. While capital markets and macroeconomic conditions have been challenging, we’ve been keeping our heads down and remaining focused on executing our plan. For the full year of 2023, we currently project that we’re still on track to grow revenue and deliver our sixth consecutive year of revenue growth. Expand the operating profit and EBITDA and drive greater than a 25% improvement in earnings per share, which would represent our fourth consecutive year of significant EPS expansion.
These accomplishments directly reflect the strong execution against the strategy we laid out in our past two Analysts Days, and add to our track record of doing what we say we’re going to do. Getting into some of the specifics of the quarter, Q3 marked the 14th quarter out of the last 15, which we believe we have met or exceeded our outlook range. Bookings in the quarter were up sequentially and on a year-over-year basis, with most of the sequential growth driven by customers in EMEA, and the Americas. On a year-to-date basis, through Q3 and compared to the same period last year, we expect to report growth and revenue, expanded gross margin, increased operating margin and improved EBITDA. Traction across our portfolio remained strong in the quarter, and I’d like to touch on some of the highlights, starting with our Systems Group.
First, we won new strategic deals globally, including wins with two tier 1 service providers in Europe, several subsea consortiums, an award to modernize and expand the nationwide network for a tier one operator in Asia Pacific. The wins in Europe in Subsea are especially noteworthy as these are new customer logos, where we have no incumbency. Second, we continued our momentum with US hyperscalers with year-over-year growth in both revenue and bookings. The strength in this customer segment was broad-based spanning multiple customers’ applications, and Infinera products. And finally, we booked our first set of orders and recognized revenue from the Metro win we referenced during last quarter’s earnings call. As a reminder, this is a turnkey award with a major US service provider, which includes our GX Metro platform along with our software suite and support services.
In our Subsystems Group, a few noticeable accomplishments were: first, both the CFP2 and QSFP-DD versions of our 400 gig ICE-X pluggables are now commercially available. These two form factors give us flexibility of integrating our pluggables in our own Metro platforms, as well as in third-party hosts like routers and switches. In Q3, we received our first set of vertically integrated orders for our ICE-X pluggables and are in the process of shipping our first Metro systems with our own pluggables this quarter. This is a significant milestone and accomplishment for us and is consistent with the expectations we laid out in our Investor Day. We expect margin benefits from our own vertically integrated Metro platform to begin in 2024. Second, we remain on track to deliver the highest performing and lowest powered 800 gig pluggable that will leverage 3-nanometer technology and enable our customers to reach greater distances and unmatched performance in economics, which also has landed us our first set of 800 gig component orders.
And lastly, we’re excited to see four new members of the Open XR Forum in the quarter. We built the solid pipeline for both pluggables and components and received additional purchase orders spanning the entire portfolio. As our Subsystems business expands, we expect to benefit from higher margins from both the vertical integration of our Metro portfolios as I described earlier and from the incremental operating leverage as we ramp the sales of external pluggables. In addition, we are continuing to pursue government funding available, both the state and federal levels via programs like The CHIPS Act to continue to supply the US made optical semiconductors to secure critical supply chains. These issues are increasing importance to our customers, and as a company with US-based optical semiconductor fabrication and advanced test and packaging, we believe we are well positioned for this opportunity.
In closing, my confidence in our strategy portfolio on execution remains high as evidenced by our market share gains and financial progress over the past few years. In the short-term, our customers are still going through a period of inventory digestion and remain cautious about spending in a recessionary environment. Our job in this environment is to focus on the highest priority spend areas, which are broad fiber deployment, datacenter build outs and new applications inside the data center, while taking more than our fair share of orders and managing spending tightly. In the long-term, demand for bandwidth continues to grow as hyperscalers accelerate the rollout of artificial intelligence and machine learning workloads and service providers drive fiber deeper into networks, pushing 100 gig to the edge, 400 gig in the Metro and 800 gig in the core.
It’s apparent that the growth inside the data center over the next few years is creating new opportunities for our business. Clearly, coherent optical technologies and vertical integration are becoming more important than ever. Our guiding principles for the company remain unchanged and centered on continuing to expand market share in our Systems business across long haul Subsea and Metro, vertically integrating our Metro portfolio with our own pluggables which will expand margins, ramping up external sales of our pluggables, driving operating leverage in our business model, and meaningfully expanding earnings per share. I’d like to thank the Infinera team and their dedication and unwavering commitment to our customers and one another, and for continuing to deliver on innovation that matters.
I’d also like to extend my thanks to our partners, customers and shareholders for their ongoing support. Finally, my thoughts and prayers go out to the people of the Ukraine and Middle East who are suffering through these very unthinkable times. I’d now like to hand the call over to Nancy to cover the preliminary financial details of the quarter and our outlook. Nancy?
Nancy Erba: Thanks, David. Good afternoon, everyone. I will begin by covering our preliminary third quarter results and then provide the preliminary outlook for the fourth quarter. For your reference, we have included the GAAP to non-GAAP reconciliation of our preliminary financials in our press release. As a reminder, any financial commentary or metrics provided today are based on our preliminary non-GAAP results. Before beginning our third quarter results, I’d like to provide some contexts on why we are providing ranges today, and why the filing of our 10-Q is delayed as noted in the two SEC filings we made this afternoon. During Q3, our external auditors informed us of a routine PCAOB inspection of their work papers that randomly included their audit of Infinera’s 2022 financial statements.
Late in the third quarter, our auditors asked about our method of revenue allocation between products and services, and our documentation related to our closed cash and inventory cycle. As a result, in connection with the quarter end closed process, we reexamined the revenue recognition methodology we have been using historically, as well as our internal control documentation processes. Subsequently, we identified two material weaknesses in our internal control of our financial reporting and have concluded that they were present as of December 31st, 2022, and through the first three quarters of 2023. Based on our initial evaluation, we expect any adjustments to revenue will be shift in allocation between revenue that is deferred and revenue that is recognized upon delivery, and expect that there will be no lost revenue, only shifts in revenue between accounting periods.
In addition to providing preliminary ranges for Q3 on our call today, we will also be providing our preliminary outlook for the fourth quarter. The information we are providing reflects our expectations regarding the allocation of revenue under our updated methodology. The scope of this review is limited to the matters I described. Based on the progress we have made in addressing them in a compressed period of time, we would hope to file the 10-Q reasonably promptly. Turning to the performance in the quarter, I am pleased with the continued momentum in our business. Preliminary revenue of $378 million to $392 million is expected to come in above the midpoint of our outlook range. This performance was primarily driven by strength in the Americas and EMEA with both ICP and service provider customers.
Geographically, we derived approximately 60% of our Q3 revenue from domestic customers, a level generally consistent throughout the year. There was one ICP customer that accounted for over 10% of our revenue in the quarter. Q3 preliminary gross margin of approximately 40% to 42% is expected to be above the midpoint of our outlook range and up on a year-over-year basis. Compared to the prior year, gross margin in the quarter benefited from higher vertical integration, continued release in supply cost, product mix and ongoing cost improvements and quality initiatives. Overall, I’m encouraged by the gross margin trend in 2023, with gross margin progressing toward our goal of 40% for the year. This margin expansion supports my confidence in our ability to deliver continued improvement in 2024 and beyond, as we vertically integrate our Metro portfolio and ramp up our external pluggables’ revenue.
Preliminary operating margin in the quarter was 4.6% to 8% and above our outlook range. On a year-to-date basis, we expect to deliver higher operating margin compared to the same period last year, benefiting primarily from higher revenue and gross margin. Operating expenses in the quarter of $134 million were below our outlook range of $139 million to $143 million as we tightly managed quarterly spending, while continuing to make substantial investments in our Subsystems business. The resulting preliminary diluted EPS is expected to be $0.03 to $0.08, also above our outlook range. Moving on to the balance sheet and cash flow items. We ended the quarter with $127 million in cash and cash equivalents, with no amount drawn on the ABL. From a cash flow perspective, the primary use of cash in the quarter was inventory, as we prepare for client deliveries in Q4 and Q1 of ‘24, while reducing our overall purchase commitments.
We believe Q3 marked a peak for our inventory in this cycle and we plan to generate cash from operations in Q4. Let me now turn to the outlook for the fourth quarter of 2023. Despite the near-term challenging macro and industry environment, we are planning for sequential revenue growth in Q4, in line with consensus expectations. Our preliminary outlook range for the fourth quarter is revenue of $421 million to $451 million. Gross margin of 38% to 41%. Operating expenses of $138 million to $142 million, and operating margin of 5.5% to 9.5%. Below the operating income line, we assume approximately $7 million for net interest expense, and approximately $3 million for taxes. Finally, we’re anticipating EPS of $0.05 to $0.13 per share, assuming a basic share count of approximately 230 million shares, and a fully diluted share count, if profitable, of approximately 260 million shares.
Furthermore, at approximately the midpoint of our outlook range for Q4, the implied expectations for the full year are generally consistent to slightly better than our commentary on last quarter’s earning call. Specifically for the full year and compared to 2022, we expect to deliver revenue growth, expand gross margin, operating margin and EBITDA and expand non-GAAP EPS by at least 25%. As I close today, I would like to reiterate that I am pleased with our performance year-to-date, especially considering the industry-wide slowdown that we have been experiencing for the past few quarters. Our strategic initiatives are on track and we should be on pace to deliver our sixth consecutive year of revenue growth and expand gross margins toward 40% for the year, and drive a greater than 1,000 basis points of operating margin expansion since 2019.
Furthermore, we have proactively strengthened our balance sheet by refinancing the majority of our 2024 notes ahead of the continued increase in interest rates. We currently have approximately $19 million of the 2024 convertible notes due upon maturity in September of 2024. We remain laser-focused on continuing to drive meaningful EPS expansion and generating free cash flow in the quarters and years ahead. I would like to thank the Infinera team as well for their continued commitment to innovation and execution, and our partners, customers and shareholders for your continued cooperation and support. I’d now like to open up the line for questions.
Operator: Thank you. [Operator Instructions] Our first question is from Ruben Roy with Stifel. Your line is open.
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