Infinera Corporation

Good afternoon. Welcome to InfoNero's second quarter 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, excess inventory held by customers beyond normalized levels, expectations regarding industry-wide supply chain dynamics and the macroeconomic environment, market adoption of coherent optical engines, expectations regarding 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 a future performance, revenue growth, and market expansion, and a financial outlook for the third quarter of 2023. These statements are subject to risks and uncertainties that could cause Infinura'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 an annual report on Form 10-K for the year ended on December 31st 2022, as filed with the SEC on February 27, 2023, and in our quarterly report on Form 10-Q for the quarter ended April 1, 2023, as filed with the SEC on May 4, 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 INFINRR 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 each discussed on a GAAP basis. Pursuant to Reg G, we've provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, earnings release and investor slides for this order, 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, so 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 Hurd.

Yeah, thanks, Amitabh. Good afternoon, and thanks for joining us today. I'll begin with the highlights from our Q2 results and then turn the call over to Nancy to cover the financial details of our second quarter and the outlook for Q3. Overall, the second quarter was another solid quarter for us. We beat the midpoint of our outlook range across all key financial metrics, revenue, gross margin, operating margin, and APS. On a year-over-year basis, we grew revenue by 5%, expanded gross margins by 320 basis points, and increased operating margins by 240 basis points while continuing to invest in our strategic programs. In the first half of the year, we increased our top line by 10%. improved gross margins by approximately 300 basis points to 39%, and grew EBITDA by 137% compared to the first half of 2022. Bookings in Q2 improved sequentially with book-to-bill just below 1, which was in line with our expectations. In our subsystems business, we continue to win new strategic deals in the areas we've been prioritizing. For example, first, consistent with our efforts to expand our metro footprint, we want a new deployment with a major U.S. service provider. This is a turnkey award, which will include our GX Metro platform, next-generation line systems, software suite, and professional services. The footprint we establish with this customer will allow for future margin expansion as we integrate our own 400-gig ZR ZR Plus plugables in 2024, which we just made commercially available. Second, our investments in go-to-market and geographic expansion resulted in new deals in India, a market where we believe we have significant growth opportunity. These wins span both subsea and terrestrial deployments in India for domestic service providers and U.S. hyperscalers who are increasing their presence in the region. Finally, we continued our momentum in the hyperscale segment where we landed a new subsea deal with a major hyperscaler. a customer with whom we historically have less share, positioning us well for future expansion in this account. In the subsystems business, we're seeing the first signs of commercial progress. Our 400-gig ZR ZR Plus pluggable is now commercially available, and we're excited about the margin expansion potential as we vertically integrate into the Metro portfolio. We're on schedule to make the first set of software-enabled 100-gig pluggables commercially available in the second half of 24. We will open a significant market opportunity at the edge of the network with broadband access, 5G, and cable networks. And we're on track to deliver the highest performing lowest power 800 gig pluggable that will leverage three nanometer technology and enable our customers to reach greater distances at unmatched economics. In addition to all of our intelligent pluggables have software that enables seamless integration and router switches which allows simplified management, increased agility, and dramatically lowers operating costs for our customers. These achievements have resulted in a solid pipeline and purchase orders from 15 network equipment manufacturers and service providers to date. The purchase orders are broad-based and include our entire suite of pluggables and components from 100 gig to 800 gig. While these initial wins are relatively small in magnitude, they're encouraging and signs of the return we expect to get from our investment going forward. Finally, as a company, we've been a proponent of open architectures and open networks. We're excited to see the addition to three new members to the OpenXR forum in the quarter, including Arista Networks. Total membership in the OpenXR forum is now up to 34 members and represents a significant portion of the overall network spend. Our results in the first half of 2023 continue to build on our momentum over the last five years that validate our strategy as working. From 2018 to 2022, we've grown company revenue at an average of 14% annually, expanded operating margins by over 1,000 basis points, ramped I6 as one of the fastest technologies in our history to ramp, refreshed our entire hardware and software portfolio, and added a significant number of new customers gain share, especially in the metro segment with our refreshed GX portfolio. We're now in a position to expand our market opportunity further with a newly launched subsystems business, a business which we're investing close to $100 million this year. As this business ramps, we expect to benefit from the higher margins in 2024 as we vertically integrate into our metro portfolio. And from the operating leverage, once we ramp up the sale of external pluggables, Furthermore, we've continued to position ourselves to benefit from the Chips and Sciences Act to augment our existing business plan. As a U.S.-based optical semiconductor manufacturer, Infinera is well situated at a time when significant government funding is on the table to reshore and secure critical supply chain, an issue of increasing importance to our customers. While long-term demands will continue to be healthy with data rates growing from network payloads, they're getting amped from artificial intelligence and machine learning. We believe the second half of the year is going to be lighter than our original expectations as our customers are going through a three to four quarter period of inventory digestion that's industry-wide. and are being cautious about spending in a recessionary environment. We believe we're roughly halfway through this projected four-quarter digestion period and are taking this into account in our outlook for the back half of the year. However, for the full year, we expect we'll grow revenue in the low single-digit percentage range and deliver our sixth consecutive year of top-line growth. We'll expand operating profit and EBITDA by double-digit percentages on a year-over-year basis, Like the near-term and temporary industry-wide digestion mentioned earlier, the longer-term secular drivers of our business and target business model remain intact. We're executing to the six strategic milestones we outlined during our March Investor Day, and we're focused on gaining additional market share, expanding margins, ramping the pluggables business, and delivering at least a dollar in earnings per share in the 2025-2026 timeframe. Overall, our investment thesis remains unchanged. We continue to expand EPS. As I close today, I'd like to reiterate the fact that I'm confident in our strategy and our ability to execute through this adjustment period. Over the past few years, we've delivered consistent commercial and financial progress while navigating a pandemic, supply chain disruptions, a war, rising interest rates. As evidence by our progress over the last few years, our systems portfolio is in the best shape it's ever been, and I'm equally excited about the outlook of the new subsystems business. I would like to take this opportunity to thank the Infonera team for their unwavering commitment to our customers and one another and delivering on innovation that matters. In addition, I'd like to thank our partners, customers, and shareholders for their ongoing support. I'm now going to hand the call over to Nancy to cover the financial details of the quarter and the outlook. Nancy?

Thanks, David. Good afternoon, everyone. I will begin by covering our second quarter results and then provide the outlook for the third quarter. For your reference on our investor relations website, we have posted slides with financial details including our gap to non-gap reconciliation to assist with my commentary. As you heard from David, the second quarter was another strong quarter for us. Revenue was 376 million, up 5% on a year-over-year basis, and just above the midpoint of our outlook range. This performance was primarily driven by strength in the Americas, Asia Pacific, and with ICP customers. Geographically, we derived 58% of our Q2 revenue from domestic customers, a level generally consistent with Q1. There was one customer who accounted for over 10% of our revenue in the quarter, which was an ICP customer. Q2 gross margin of 39.3%. was above the midpoint of our outlook range and increased 320 basis points year over year. Compared to the prior quarter, gross margin in the quarter benefited from higher vertical integration, including I-6, and some relief in supply costs, partially offset by lower services margin as we continue to work through our lower margin professional services backlog. Overall, I'm encouraged by the gross margin trend in the first half of the year, as it supports my confidence in our ability to show continued gross margin improvement in 2024 and beyond as we vertically integrate our Metro portfolio and ramp up our external pluggables revenue. Operating profit in the quarter was $10.7 million, with an operating margin of 2.8%, which was at the higher end of our outlook range. On a year-over-year basis, we expanded our operating margin by 240 basis points. Operating expenses of $137 million in Q2 were below our outlook range of $140 to $144 million as we tightly managed quarterly spending while continuing to make substantial investments in our subsystems business. The resulting diluted EPS was at the high end of our outlook range at breakeven and compared to a loss of $0.05 in the year-ago quarter. Moving on to the balance sheet and cash flow items, we ended the quarter with $167 million in cash and cash equivalents with no amount drawn on the ABL. From a cash flow perspective, we generated $1.4 million in cash flow from operations, while free cash flow was an outflow of $9.4 million. Let me now turn to the outlook for the third quarter of 2023 and our expectations for the rest of the year. As you heard from David, the near-term operating environment has become more challenging than our original expectations, as customers in our industry have slowed the pace of bookings while continuing to work down their inventory. However, even against this backdrop, we achieved our plan in the first half of the year, growing revenue by 10%, expanding operating margin by 350 basis points, and increasing EBITDA by 137% compared to the first half of 2022. We believe we are about halfway through this temporary industry-wide four-quarter customer adjustment period. As a result, we now expect our outlook for the third quarter to be revenue of $376 million plus or minus $15 million, gross margin of 39% plus or minus 150 basis points, operating expenses of $141 million plus or minus $2 million, and operating margin of 1.5% plus or minus 250 basis points. Below the operating income line, we assume $7 million for net interest expense and $4 million for taxes. Finally, we are anticipating a loss of 2 cents plus or minus 4 cents per share, assuming a basic share count of approximately 228 million shares and a fully diluted share count, if profitable, of approximately 260 million shares. We expect to utilize cash from operations in Q3, primarily for working capital, and return to generating cash from operations in Q4. We are continuing to target generating cash from operations for the full year. Despite the near-term considerations, our investment thesis is sound and we are still planning on delivering year-over-year improvement in our financials in 2023. This will include growing revenue in the low single-digit percentage range, driving gross margins to 40%, expanding operating profit in the double-digit percentage range, and delivering at least 25% growth in earnings per share compared to 2022, remaining on the path to delivering a dollar of EPS in 2526. We expect bookings to continue to improve sequentially in Q3, and then again in Q4, and to exit the year with our remaining performance obligations, or RPOs, of approximately $800 million. which should set us up well for 2024 when we believe demand should start to normalize. As I close today, I would like to reiterate that I'm pleased with our second quarter and first half performance, especially considering the industry-wide slowdown that we are experiencing. In the near term, we are tempering our expectations for the back half of the year, but believe our strategic initiatives are on track and we are on pace toward our sixth consecutive year of revenue growth, and fifth consecutive year of operating profit expansion. We expect to improve our earnings per share by at least 25% in 2023, while investing close to $100 million in our subsystems business this year. And we remain on the path to delivering at least a dollar in earnings per share in the 25-26 timeframe. I would like to thank the Infinera team, as well as their continued commitment to innovation and execution excellence. and our partners, customers, and shareholders for your continued cooperation and support. David, we can now open the line for questions.