Infinera: Key Items To Watch In Q1 Earnings (NASDAQ:INFN)

Infinera (INFN) is expected to report its Q1 earnings in the coming two weeks. Its management had projected a $15 million revenue impact for the period on their last conference call, so investors would be eager to see if the hit is in line with expectations. But in addition to tracking Infinera’s revenue figure, investors should also closely monitor its margin profile and its management’s guidance for Q2 to get clarity about where the company and its shares may be headed next.

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The Coronavirus Surge

The current coronavirus-related disruptions present a unique situation for Infinera. On one hand, supply chain and logistics-related bottlenecks are making it difficult for hardware manufacturers to get sufficient amount of product out to meet customer demand. On the other hand, internet service providers across the globe are experiencing a surge in network traffic; one such example is Vodafone, wherein it had to upgrade its network capacity by 4Tbps to handle the recent surge in network traffic due to more and more people staying at home.

These dynamics play against, and in favor of, companies such as Infinera. So, investors should listen in on management’s remarks around the same during its upcoming earnings call, and ascertain which of the two factors was predominant for the company – was it able to meet the growing customer demand or was its supply bottlenecked. This would provide clarity on how Infinera stands to benefit going forward, in case lockdowns across major markets are extended further.

I personally expect Infinera to report healthy hardware sales during Q1 as its customers would be scrambling to procure whatever equipment they can, in a bid to quickly meet the surge in network traffic. So, I’m of the opinion that the company’s inventories would have flown off the shelves during the quarter. There isn’t much competition in the high-speed 600G optical transport anyway, with Infinera and Ciena at the helm, so I believe both companies stand to benefit here.

This leads me to believe that Infinera management’s forecasted hit of $15 million, in light of the coronavirus outbreak, will be mitigated or even offset by strong customer demand without the need to discount its platforms. The optical transport equipment provider has actually been a subject of analyst upgrades of late (such as here) on grounds of robust customer demand. So, investors should keep a close eye on the company’s revenue for the period as it’s likely to come in at towards the upper end of the management’s guided revenue range of $315 million to $335 million.

Also, closely listen in on management’s guidance for Q2. It’s possible that Infinera’s customers pull forward their network upgrade plans in a bid to better tackle the surge in network traffic. But this is just a theory at this point in time and we need to look for Infinera management’s confirmation around the same.

Margin Profile Evolution

To understand Infinera’s margin profile evolution, we need to understand its business model first. The company sells optical network transport equipment to its clients so there’s the upfront hardware fee. But in a bid to keep the total cost of ownership low, Infinera charges its customers only for the bandwidth that they consume – the company calls it Instant Bandwidth.

(Source: Business Quant)

So, there are predominantly two factors at play here that would impact its margins – instant bandwidth and equipment fee.

From its last 10K:

We also provide software-enabled programmability that offers differentiated capabilities such as Instant Bandwidth. Combined with our differentiated hardware solutions, Instant Bandwidth enables our customers to purchase and activate bandwidth as needed through our unique software licensing feature set. This, in turn, allows our customers to accomplish two key objectives: (1) limit their initial network startup costs and investments; and (2) instantly activate new bandwidth as their customers’ and their own network needs evolve.

Infinera’s instant bandwidth is subscription based which means the company doesn’t have to incur any hardware cost. Unfortunately, the company doesn’t disclose how big of a revenue stream this is. So, in theory, the surge in network traffic across the globe is bound to push instant bandwidth usage higher across most, if not all, of Infinera’s clients. And since this revenue stream is virtually high-margin in nature, it should result in some form of margin expansion for the company.

At the same time, Infinera’s new hardware sales tend to push its margins lower for the sole reason that these devices aren’t maxed out on bandwidth capacity in their initial few months and because they current include third-party merchant optics. So, I’m expecting Infinera’s margin profile to improve over the course of the year in light of heightened instant bandwidth usage.

For the record, Infinera’s management was already forecasting their gross margins to expand by 200 to 400 basis points during FY20 on a year on year basis. From their Q4 earnings call:

For the full year, we currently expect to generate gross margins 200 to 400 basis points greater than in 2019.

Final Takeaway

Analysts are expecting Infinera’s Q1 revenues to come in at $328.53 million, well within its management’s guidance range. This suggests that the Street and the management’s expectations are largely in sync even during this uncertain macroeconomic environment.

ChartData by YCharts

But having said that, Infinera’s Q1 would be critical for the company’s growth trajectory. We would get clarity on whether the strong demand is a long-lasting trend or if it’s just a short-lived blimp in an overall downtrend. Hence I believe investors should keep a close eye on the company’s revenue, its margin profile and its management’s outlook for the next quarter. These items are likely going to dictate where Infinera’s shares head next. Good Luck!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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