In making its first earnings release as a public company, Infinera trotted out the expected negative numbers yesterday. (See Infinera Revenues, Losses Widen.) But the company also explained that it's going to be reporting sales differently from other optical hardware firms -- in fact, it's using methods more familiar to the software industry.
The result, Infinera says, is that the earnings and gross margins in any given quarter are better than they look under generally accepted accounting principles (GAAP).
"We're not afraid of the financials," as one source with ties to Infinera told Light Reading. Given that the single-product company, with no Tier 1 wins, is still valued at about $1.9 billion, investors aren't, either.
What's happening is that Infinera doesn't report a sale all at once; rather, it spreads the money out over multiple quarters or even years.
It all comes down to a bit of magic known as Vendor Specific Objective Evidence (VSOE) -- an agreed-upon value for goods and services. Infinera claims that it doesn't have VSOE established for its software, support, and training, all of which are included in its contracts when its hardware is sold.
In such cases -- again, you usually only see this with software companies -- the accepted practice is to amortize each sale across the contract's lifetime. Because it's trying to be conservative with its accounting, Infinera is choosing to do that for everything it sells, applying the lifetime of the longest-lived item (a warranty, for instance) to everything else that was in the sale (such as hardware).
So the revenues from an Infinera DTN system get spread out across many quarters -- in fact, 3.7 years was the average amortization span for sales made in the fourth quarter of 2006, according to Infinera's SEC filings. One contributing factor: At least one customer got a five-year software warranty, the filings say.
By tweaking some of its biggest contracts, Infinera whittled that average down to 1.3 years in the first quarter. That's much less eye-popping, but still highly unusual for a DWDM hardware comapny.
Here's where GAAP complicates things: The accounting rules for dealing with VSOE state that losses get recognized immediately, even if the corresponding revenues are deferred into the future. That "makes our profit margins look lower than they really are, in our view, based on invoiced shipments," an Infinera spokesman says.
Running the numbers
The key is that phrase, "invoiced shipments," which Infinera thinks is a better measure of the money it's received in any given quarter. With yesterday's earnings, the company spelled out invoiced shipments as well as GAAP revenues, and all its forecasts -- as well as Wall Street analysts' estimates -- will be based on invoiced shipments, the spokesman says.
For the past few quarters, invoiced shipments did paint a rosier picture than GAAP revenues.
Table 1: Infinera's New View
|Q4 2006||Q1 2007||Q2 2007|
|Gross Margin (GAAP)||6%||24%||28%|
based on Invoiced Shipments
Here's how it works, taking an example from the prospectus.
Look at the first quarter of 2007. GAAP revenues were $49.2 million, but the invoiced shipments were $66.7 million. The difference, $17.5 million, is the amount by which Infinera's deferred revenues rose during the quarter -- to $128.4 million from $110 million (rounded off).
Using the $66.7 million figure, it turns out Infinera's first-quarter gross margins were 35 percent, rather than the 24 percent tallied under GAAP.
There's nothing wrong with Infinera doing things this way, but it does look funny considering hardware peers like Ciena Corp. (NYSE: CIEN) don't go through the same kind of accounting calisthenics.
"I think it almost has something to do with the way Infinera structured their contracts," says one financial source requesting anonymity. "They sell deals that have future provisions that are an integral part of the deal. That's when it gets extremely convoluted, even for shipping plain hardware."
Does Infinera get any extra benefits from doing its revenues this way? Possibly. The company's revenues could be prone to the occasional lull, since it sells big boxes at high prices -- the kind of business where a customer's delay can ruin a quarter. Amortization of revenues can keep things more predictable -- less lumpy, as Wall Streeters say.
At any rate, Infinera won't do this forever. As VSOE gets established for its products, the company expects to phase out this practice and eventually report everything under normal GAAP rules, Infinera's spokesman says.
But for now, enjoy the intrigue!
— Craig Matsumoto, West Coast Editor, Light Reading