Infinera Muddles Through a Difficult Period and Predicts More Challenges Ahead

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We already knew that it was going to be a rough quarter for Infinera (INFN 1.04%). During its second-quarter earnings report, the optical-equipment maker warned that demand for its products was softening. In response, management forecast that revenue would decline by roughly 20% during the third quarter, which would cause the company to post breakeven results on the bottom line.

Let's take a closer look at Infinera's actual performance to see how it is holding up during this challenging period.

Infinera Q3: The raw numbers

Data source: Infinera.

Infinera's top line was right in line with projections. Non-GAAP gross margin held up well during the difficult period, coming in at 49.2%. That was up 170 basis points over the year-ago quarter, which is a solid result given the large revenue decline. Management credited the strong margin boost to product mix, delays in lower-margin deals, and a handful of one-time benefits. When combined with its previously announced hiring freeze and other cost-saving measures, management was able to exceed its guidance on the bottom line.

During the conference call with analysts, CEO Thomas Fallon said that the revenue drop was caused by a number of factors. Long-haul customers paused on their spending, and there was a general lack of demand for the company's subsea products. Fallon also admitted that the Metro business isn't growing as quickly as he had originally expected. DC Interconnect revenue also fell sequentially, but that was mostly owing to record sales that were posted in the first and second quarters. 

More challenges ahead

While management offered up a lot of positive commentary about longer-term prospects, it believes that the fourth quarter is also going to be quite rough. Here's a look at what it is projecting for the period:

As you can see, the lower-than-expected demand is predicted to persist into the fourth quarter. CFO Brad Feller believes that this is mostly owing to customers delaying their purchases until 2017. 

Margins are also forecast to decline considerably during the quarter. Feller stated that the drop is being caused by loss of sales leverage combined with the company's commitment to investment in its new product offerings. Even with the continuation of its hiring freeze and a general halt to discretionary spending, the bottom line is expected to dip into the red.

While Feller isn't happy with the near-term outlook, he remained steadfast in his belief that this is the right move for the business in the long term, saying:

Maximizing our long-term opportunities requires us to make substantial investments that could result in an operating loss for a period of time. Given the massive opportunity we have ahead of us, particularly as our next generation of products hit the market, as much as I don't like to have an unprofitable quarter, my belief is that the investments we are making will prove worthwhile, enabling significant market share expansion and profitability growth over time.

Thankfully, management believes that the weak demand it is seeing today will start to abate in 2017. Long-haul recovery is expected to begin next year and should eventually return to mid-single-digit growth. It also predicts that it will succeed at cross-selling its Metro products next year.

The company also expressed enthusiasm for the upcoming launch of its Cloud XPress 2 product. This new product will be the first to be enabled by its new Infinite Capacity Engine. The market that this product competes in is forecast to grow by roughly 60% annually through the end of the decade, which suggests that this is a multibillion-dollar opportunity.

In closing, Fallon did his best to remind investors that he believes that the company's future remains bright:

While the revenue environment is likely to remain challenging in the near term, we are making continued progress toward delivering our next generation of products and increasing the cadence in which we will introduce step function technology improvements. I firmly believe that we have the team and the core technologies that will enable us to recover from our current challenges and ultimately return to delivering differentiated financial results.