Preliminary 3Q20 Results and View into FY21

9 November 2020

Key Points

  • Infinera is positioning itself to take advantage of bandwidth demand growth driven by COVID-related remote access, 5G wireless rollouts, and overall global growth. The high-end optical market (600G+) is expected to grow 25% a year through 2024 to over $2bn annually (according to Ovum).
  • Infinera’s 5th gen optical engine (ICE6) has been showing well in trials (especially with Verizon this summer). With Huawei security concerns, there are now only two vendors at 800G (Infinera and Ciena) – down from 8+ for 3rd gen and 4th gen.
  • ICE6 reportedly beats the 800G competition with 4x longer reach and a 25% cost advantage. At 600G, the reach advantage is 2.5x and cost advantage is 35%. These advantages could be why Ciena’s outlook is for a broad decline, while Infinera is looking for growth. The 3Q is seasonally down but the company guided for sequential growth in 3Q20 and 4Q20.
  • The world is in the early stages of a 600G ramp with its lower price/bit and lower power consumption. The company added six new 600G customers in 2Q20 to a total of 16, including one major ICP.
  • After 11 years as CEO, Tom Fallon is planning on be stepping down and David Heard, the Company’s Chief Operating Officer, is expected to be taking the helm by the end of 2020.
  • The company is expecting step-function margin expansion in 2H21. This will likely be driven by 600G rollouts first, then by 800G. Some COVID-driven supply issues continue but have lessened recently. Marketing and sales costs are lower as an ERP upgrade and the Coriant integration are completed.
  • Read our initiation report HERE.

What Happened?

For the September quarter (3Q20) the consensus non-GAAP EPS estimate was for a ($0.06) loss, which the company beat by $0.08, achieving a $0.02/share profit. Revenue was $340mn, above consensus expectations of $336mn. Revenue growth was 4.2% YoY and 2.6% sequentially. Non-GAAP gross margin expanded +140bps QoQ and +210bps YoY to 35.2%. Guidance for 4Q20 is for revenue of $355mn, below prior consensus of $357mn, but with a wide range of +/- $15mn. The company said the key ICE6 800G technology is on track for the first customer shipment in 4Q20, it has a “strong pipeline”, and it sees few competitors. This was the last earnings call for the long-time CEO Tom Fallon who is being replaced by ex-COO David Heard. The company plans to hold an Analyst Day in March 2021.

Our Insight on What Happened

The Opportunities

4Q20 guide below consensus, but…

The 4Q20 revenue guidance of $355mn +/- $15mn would have revenue down 8% YoY at the mid-point. Gross margin, however, is expected to increase 30bps YoY to 35.5%. While the 4Q might be down YoY, and the 1Q21 comp will likely be tough, the company is focused on 2H21, at which point it expects ICE6 (800G) revenue to ramp.

…FY21 is expected to see first material ICE6 (800G) revenue and design wins

The company cited four areas for future growth and operating improvements.

  1. Company Moves to More Vertical Integration. With more vertical integration the customer should see higher performance at a lower cost per bit, particularly at 400G and faster. This is expected to help Infinera take share and expand margins. Infinera indicated that less than 50% of its products were deeply vertically integrated today and that could grow to 70% (partially driven by ICE6).
  2. Market Shift to Open Optical. Open optical generally allows for faster adoption and insertion of new technologies. This allows existing fiber to be more cost effective and deliver higher performance. The company sees these insertion points creating more opportunities for share gain in its fastest growing market (+18% CAGR according to Cignal AI).
  3. Access and Metro Networks Evolving. This should create new revenue streams from things like 5G and the cloud. The company believes it should be able to disrupt these markets with innovations like point-to-multipoint. These could provide both revenue growth and margin expansion opportunities.
  4. Changes to Competitive Landscape. Customers are shying away from some Chinese optical suppliers. Infinera expects to capture international market share as customers mitigate the risk by changing their approved supplier lists.

The Obstacles

While likely obvious, external economic factors, elections, geopolitical issues, pandemics, etc., can all negatively impact demand for any product or service; Infinera is no different. Despite the variety of factors helping to sell bandwidth, customers are still sensitive to the global economic conditions, though its customers tend to be better insulated as they have significant resources.

ICE6, both 600G and 800G, is predicted to be the future of Infinera. Any material issues with performance or manufacturing of ICE6 would be a significant obstacle for Infinera. This will be Infinera’s fifth-generation optical product.