Infinera (INFN +0.00%) announced a strong first quarter to 2014, right on the heels of a strong prior quarter. Revenue came in at the high end of management's guidance, and margins held strong, despite emphasis on the lower-margin expansion of what the company calls "footprint," which is the sale and installation of chassis into which its high-margin photonic integrated circuit modules, or PICs, can later be installed en masse.
Each chassis sold is like a footprint on the customer's floor -- and a foot in the door to future sales of PICs. As customers gradually builds out bandwidth to keep pace with demand, they buy PICs to fill into the unused chassis they previously bought.
Customers spending with confidence
The strong quarter was due both to a large contract win, which will continue into next quarter, as well as strength across all of their product lines including its legacy 10G business. Of particular note was management's comment that the gross margins during this current epoch's 100G "landgrab" are superior to those during the prior 10G effort several years back.
"Landgrab" is the industry's euphemism for the first two years or so in each roughly 10-year technology upgrade cycle during which the big Internet cable companies select which equipment providers will build out their future network capacity over the coming years. Suppliers try to win as much of that future capacity at the outset by installing as many chassis as they can.
It is very encouraging to long-term shareholders that Infinera's margins are strong during this low-margin phase of the technology upgrade cycle, as it indicates a systematic strengthening of the company's business model and cost structure. This is a milestone Infinera shareholders have long been waiting for.
Management also noted during the conference call a normalization of pricing, as customers in all of their sub-markets are spending on capital equipment with more confidence. This bodes well for Ciena (CIEN +10.98%) as well. Though it has diversified into many product lines, Ciena remains a direct competitor to Infinera's PIC business.
Infinera is recognized as having the superior technology, but Ciena has broader and older customer relationships. It sells a wider variety of products and services. And the telecom customers which both companies serve will always want multiple suppliers, both to maintain competitive pricing and to ensure equipment and service availability.
Strong R&D pipeline
Infinera's management continued to emphasize that the business is endemically lumpy, limiting their visibility to about two quarters ahead. But as revenue grows, they intend to continue spending 20% of sales on research and development. Infinera CEO Tom Fallon said "there are more opportunities out there than we can afford to pursue." Long-term shareholders will welcome this commitment to capturing as many of those opportunities as they can with copious R&D.
Challenging Cisco's router business
One of the most exciting points made during the conference call was how Infinera is challenging the very need for complex routers, or for the deployment of so many. This was first explicitly mentioned during 2013's third-quarter conference call, and reiterated here. In the prior call, Fallon gleefully indicated that Cisco's (CSCO +2.15%) product response was woefully inadequate to Infinera's challenge.
Cisco has much invested in its router product line, and it is fighting to move the transport layer capabilities -- where competitors are strong -- into the router layer where Cisco dominates. Infinera is challenging that with products that are increasingly merging the functionality of the expensive router layer -- in terms of cost, physical space, and power -- into the transport layer that Infinera serves. We cannot understate how big this challenge is and how handsomely it will pay off to Infinera -- at Cisco's loss -- if it succeeds.
Future opportunities abound
In a similar vein, management noted that the protection functionality is also moving into the transport layer, which plays right into Infinera's hands. Furthermore, the market is shifting from Tier-1 customers to Web 2.0 and Internet content providers, for whom Infinera is well-positioned to serve. Packet and SDN are strong market opportunities, the latter for which Infinera is a "perfect fit."
Lastly, Infinera is still "pushing" on the high -capacity piece of the Metro market in which Ciena has a strong position, but it's going to be a while before meaningful progress is made there.
It was a good quarter for Infinera; but the long-term future will be even more exciting, as it once again disrupts the industry.
