ADTRAN Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to ADTRAN's second quarter 2020 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. To ask a question, you will need to press star 1 on your telephone. During the course of the conference call, ATTRAN representatives expect to make forward-looking statements which reflect management best judgment based on factors currently known. However, these statements involve risks and uncertainties, including the continued spread and extent of the impact of the COVID-19 global pandemic, the ability of component supplies to align with customer demand, the successful development and market acceptance of our products, Competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies, and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2019. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which may be made during the call. It is now my pleasure to turn the call over to Tom Stanton, Chief Executive Officer of AdTran. Sir, please go ahead.

Thank you, Tamiya. Good morning, everyone. We appreciate you joining us for our second quarter 2020 conference call. With me today is AdTran CFO Mike Foliano. Following my opening remarks, Mike will review the quarterly financial performance in detail and then we'll take your questions. To begin, I'd like to address the ongoing COVID-19 pandemic. Given our global operations, we have been carefully monitoring the COVID environment in all regions where our employees and customers reside. We continue to strive to deliver the right solutions to help people stay connected through these difficult times. ADTRAN has been extremely proactive in taking significant measures to protect our employees, partners, and customers, and I want to thank our employees for the diligence they are using to keep themselves and others safe. One thing that is abundantly clear thus far through the pandemic is the vital importance of high-speed broadband connectivity. And AdTrend is committed to providing an exceptional broadband experience to help drive the global economic recovery. Whether it's work from home, school from home, enabling virtual healthcare, keeping businesses running, or keeping families connected, we are doing what we can to make that experience exceptional. 2020 continues to be a pivotal year for the company. The fiber investment cycles continue to accelerate globally, aided by government actions to encourage broadband service providers to limit and or ban the threat of high-risk vendors in their critical infrastructure. This timing aligns well with these operators' plans to transition to next-generation software-defined architectures creating tremendous new opportunities for AdTran in our SDX and Mosaic cloud platforms. Furthermore, the need for network and home virtualization to provide better connectivity, enable remote customer connections and changes, and provide a better integrated experience is fueling our momentum with our Mosaic software subscription services. During the quarter, we made tremendous progress in capturing new customer opportunities with next-generation platforms, subscription software, and services. We entered the first half of 2020 with very strong momentum in our fiber business with a good mix of awards in both the GPON and XGS PON. As a result, we have been gaining market share and have jumped to the number two position to become the leading U.S.-based supplier in North America for all PON OLTs and the most recent market share reports from industry analyst firm Del Oro. Gaining seven share points in the 10-gig XGS PON OLT category, AdTran gained eight share points against our competitors in the strategic growth market. Our market share gains not only include service riders that are moving from legacy fiber access solutions to next-generation platforms, but we are also continuing to see a surge of new entrants in the market, including utilities, municipalities, developers, and electric co-ops in the U.S., and alternative broadband providers in Europe and Australia who have stepped up to deliver gigabit services to unserved and underserved communities. We are very pleased that we added 33 new service provider customers during the quarter, bringing our new customer count for the year to 61. These operators are now counting on Adtern to help them accelerate the delivery of exciting new services in the communities that they serve. We are making excellent progress at each of our Tier 1 operators in the UK, the EU, and North America, in which we have won major awards with our software-defined SDX fiber access platform, and we are on track to start seeing material revenue from these programs in 2021. In fact, we will soon be announcing live customers on some of these awards this quarter. These market share gains, new customers, and scale Tier 1 awards position the company for solid growth for many years to come. Given that backdrop, the financial results for the second quarter demonstrated solid execution, against our plan with strong demand in most of our segments with the domestic, regional, and emerging service provider market segment leading the way. From a top-line perspective, revenue for the quarter was $128.7 million with 41.5% gross margins. Network solutions accounted for 86% of the revenue at $111.3. Global services revenue contributed $17.4. To provide some context, Our 2019 revenue included a major LATAM project. Excluding this project, revenue was up 12% in 2Q on a year-over-year basis. We continue to build a strong, diversified customer base from a geographic product and market segment perspective. For the quarter, our fiber access business grew 21% over the previous period and increased 16% on a year-over-year basis and continues to be our top sales growth category. In addition to growth of our PON OLP revenue, the fiber CPE and ONT revenue grew 27% quarter-over-quarter and 37% on a year-over-year basis. Our supply chain team continued to work hard in helping us deliver in Q2, managing through logistics and component availability challenges, During the quarter, we were affected by higher freight costs as available capacity has decreased and the rates continued to rise. From an organizational perspective, we continue to execute and accelerate structural changes to improve our operational cost basis to achieve the target operating model in our plan. We have achieved material reductions in operating expenses through operational control and expense management over the past five quarters, and we are on track to achieve our target expense profile on plan. Overall, it was a solid quarter. Let me now provide a little more detail around some of the products and segments. Our continuing investments in the highly successful and widely deployed Total Access 5000 platform continue to pay great dividends. During the quarter we deployed our XGS GPON combo card for the TA5000 that enables service providers to cost-effectively accelerate 10-gig service delivery in new and existing markets. We have also expanded our SDX portfolio to deliver a greater capability to operators that are migrating to software-defined networks. ATTRAN continues to lead the industry in the development of an open-disk aggregated software-defined fiber access solution centered around our SDX product family and the Mosaic cloud platform. By offering our customers the flexibility to evolve their networks by adding 10-gig delivery in existing chassis or in new virtual solutions, leveraging a common management platform, it enables them to accelerate service delivery while significantly lowering their costs. We are also providing service providers greater visibility, network intelligence, analytics, and capabilities to deliver a more immersive, connected home experience as we continue to build out our Mosaic Cloud Services portfolio of software applications. During the quarter, we introduced new software services that are gaining strong adoption by both new and existing customers. In fact, 28 of the 33 new customers this quarter also purchased software subscription services enabling us to surpass over 2.4 million devices under management. These software applications will work together in concert providing an operator with an end-to-end visibility, network intelligence and automation, and a unified view. And the upcoming Mosaic One Virtual Control Center enables operators to efficiently deliver a seamless customer experience to accelerate new subscription revenue streams while reducing costs through automation. In addition to the exceptional progress in our fiber access business, our next-generation fiber extension portfolio, coupled with our Mosaic Cloud platform, remains strong. A new Tier 1 customer in Central Europe selected Aturan's second-generation G-Fast fiber extension solution to further accelerate its delivery of high-quality, high-capacity broadband services for business and residential customers. Additionally, we announced GFAST awards from Mnet in Germany and from Wellcome, Mnet, and Finland during the quarter. Outside of Europe, our international revenue performance was driven by our continued progress in Australia with fiber-to-the-curve deployments for the national broadband network. While the pandemic has hit small and medium enterprises the hardest, our enterprise CPE business remained resilient given our long heritage in the diversified sales channel. Revenue for the enterprise CPE business for the first half of 2020 was in line with the same period of the prior year. Despite the COVID-19 headwinds in this sector, we remain encouraged on our enterprise business, and we have continued to invest in refreshing our highly successful router and switch portfolio business, which we will be announcing later this fall. In the residential broadband market, the current work-from-home and online school environment provided some tailwinds. We had a strong quarter for our residential CPE portfolio, with revenue growing 29% quarter-over-quarter and 40% on a year-over-year basis. We are seeing strong demand from our residential gateways by regional service providers in North America, the Alt-Meds in Europe, and in the town. From a market segment perspective, our revenue from regional service providers grew 29% in the quarter on a year-over-year basis, and revenue in this segment grew 37% for the first half of 2020 over the same period of 2019. We expect to see further uplift in our domestic, regional, and emerging service provider segments going through 2021 as the $16 billion FCC RDOF auction plays out this fall and into the first half of next year. During the quarter, ADTRAN announced the most comprehensive RDOF portfolio, which is ideally tailored to support the build out of rural broadband across a wide range of network topologies. ADTRAN was heavily cited in the FCC RDOF order as we influenced the selection criteria to ensure the program provides maximum funding for low latency gigabit solutions to help ensure that we close the digital divide for rural America. We continue to be extremely active as we assist operators with network planning and their applications, and we are well positioned to help our operators to participate in this program and expect to see awards and revenues in mid-2021. With the possibility of the program accelerating earlier in the year. Several years ago, we embarked on a mission to invest heavily in R&D to put the company in position to lead the industry paradigm shift to the next generation of software-defined fiber access platforms. Our success rate during this narrow window of next-generation platform selection puts the company in a strong position in the next decade and beyond. In addition to addressing the connectivity bottleneck, our vision includes redefining the subscriber experience and the investment is paying off as we are beginning to see stronger adoption of subscription software across our customer base. These technology advancements along with the flexibility we're building in our organization really puts us on a strong trajectory for growth. The share gains we've made and many more. And while this global pandemic has created many challenges, I continue to be extremely proud of our company's progress and strong execution. We have performed exceptionally well across all areas of the company with a strong focus on mitigating supply chain risks and helping our customers meet today's demands while enabling them to quickly transition to the network of the future. Our team remains safe and healthy as a result of our early actions, and we continue to ensure that health and well-being of our employees, customers, and partners are a top priority. Our vision to enable a fully connected world where the power to communicate is available to everyone everywhere could not be more relevant or more important than in our current environment. Mike will now provide an overview of the financials, and then we'll open it up for questions. Mike?

Thank you, Tom, and good morning to all. I will review our second quarter results and provide our view for the third quarter of 2020. During my report, I will be referencing both GAAP and non-GAAP results. With respect to non-GAAP financial measures that are discussed on this call that are not presented in our earnings release, reconciliations to their comparable GAAP measures are published in the supplemental financial schedule. that appears on our investor relations webpage at www.adtran.com. For non-GAAP measures discussed on this call that are presented in the earnings release, reconciliations are contained within the release. The supplemental financial schedules on our webpage also present certain relevant information by segment and category and other non-GAAP reconciliations which I will be discussing today. With that, now let's get to the numbers. ADTRAN's second quarter revenue came in at $128.7 million compared to $114.5 million in the prior quarter and $156.4 million in the second quarter of 2019. Breaking this down across our operating segments, our network solutions revenue for the second quarter was $111.3 million versus $97.4 million reported in Q1 of 2020 and $139.2 million in Q2 of 2019. Our services and support revenue in Q2 of this year was $17.4 million compared to $17.2 million reported for the first quarter of 2020 and also for the second quarter of 2019. Across our revenue categories, access and aggregation revenue for quarter two of 2020 was $82.8 million compared to $66 million in the prior quarter and $109.4 million in quarter two of 2019. Revenue for our subscriber solutions and experience category was $40.4 million for the quarter versus $42.2 million for quarter two of 2020 and $40.5 million for quarter two of 2019. Traditional and other products revenue for the quarter was $5.5 million compared to $6.4 million for quarter one of 2020 and $6.5 million for quarter two of 2019. Looking at our revenues geographically, Domestic revenue for Q2 2020 was $84.5 million versus $79 million reported in Q1 and $75.3 million in Q2 of 2019. Our international revenue for the quarter was $44.3 million compared to $35.5 million for Q1 of 2020 and $81.1 million in quarter two of 2019. For the second quarter, we had two 10% of revenue customers, one domestic and one international. Our GAAP gross margin for the second quarter of this year was at 41.5% as compared to 45.1% last quarter and 41.6% in the second quarter of 2019. Non-GAAP gross margin for quarter two was 41.6% as compared to 45.4% in the prior quarter and 41.4% in the second quarter of 2019. The quarter-over-quarter decrease in both GAAP and non-GAAP gross margin were driven by product and geographical mix, increases in freight-related expenses, and these were The change in gross margins in both GAAP and non-GAAP on a year-over-year basis were minimal, resulting from favorable product and geographical mix and lower manufacturing expenses, which were offset by lower volume and increased freight-related expense. Total operating expenses on a GAAP basis were $59.5 million for Q2 of 2020 compared to $56.5 million reported for the prior quarter and $65.7 million for Q2 of 2019. The quarter-over-quarter increase was primarily related to market-driven increases in our deferred compensation expense, contract services, and restructuring expenses partially offset by expense reductions in both R&D and SG&A as a result of our restructuring program initiated in 2019 and also reduced travel expenses. The year-over-year decreases in operating expense were a result of lower expenses in both R&D and SG&A and lower travel expenses. partially offset by market-driven increases in our deferred compensation expenses and an increase in R&D contract services. On a non-GAAP basis, our second quarter operating expenses were $52.3 million compared to $56.7 million in the prior quarter and $61.2 million in quarter two of 2019. Both the non-GAAP quarter over quarter and year over year decreases in operating expenses were primarily the result of expense reductions and lower travel expenses. These reductions were partially offset by an increase in R&D contract services. Our operating loss on a GAAP basis for the second quarter of 2020 was $6 million compared to an operating loss of $4.5 million in the prior quarter and an operating income of $562,000 reported in Q2 of 2019. Non-GAAP operating income for the quarter two of 2020 was $1.3 million compared to a loss of $4.6 million in Q1 of 2020 and an operating income of $3.6 million in quarter two of 2019. The higher quarter-over-quarter operating loss was driven primarily by the higher deferred comp expense, contract services and restructuring costs and partially offset by higher gross profit on increased revenue. The quarter-over-quarter non-GAAP profitability was driven by higher sales and reduced operating expenses. On a year-over-year basis, the lower operating income on both GAAP and non-GAAP basis was the result of reduced sales volumes. Other income on a GAAP basis for the second quarter of 2020 was $8.4 million compared to a loss of $9.4 million in the prior quarter and other income of $2.8 million for quarter two of 2019. Our non-GAAP other income for the quarter just ending was $5.7 million compared to a loss of $7.5 million in Q1 of 2020 and an income of $2.4 million for Q2 of 2019. The increases in both the GAAP and non-GAAP other income as compared to quarter-over-quarter and year-over-year comps are primarily market-driven caused by changes in the valuation of our investment portfolio. The company's tax provision for the second quarter of 2020 was $1.6 million expense as compared to a benefit of $4.4 million in the prior quarter and a benefit of $588,000 in the second quarter of 2019. The current quarter tax expense was primarily due to profitability in our international operations as the deferred tax benefits generated by our domestic operations continue to be offset by changes in our valuation allowance. As a reminder, the significant tax benefit realized last quarter was primarily related to the passage of the CARES Act in the U.S., partially offset with tax expense in our foreign operations as the deferred tax benefits generated by our domestic operations were offset by additional changes in the valuation allowance. The tax benefit in the second quarter of last year was the result of a provision to return adjustment that was related to the completion of a transfer pricing study which was partially offset by tax expense related to pre-tax profitability. GAAP net income for quarter two of 2020 was $752,000 compared to a net loss of $10 million in the prior quarter and a net income of $4 million for the second quarter of 2019. Non-GAAP earnings for the second quarter of 2020 were $1.6 million as compared to a loss of $2.2 million in the prior quarter and net income of $5.9 million in the second quarter of 2019. Earnings per share assuming dilution on a GAAP basis was 2 cents per share as compared to a loss of 21 cents per share last quarter and an earnings of 8 cents per share in the second quarter of 2019. Non-GAAP earnings per share assuming dilution for the second quarter of 2020 was 4 cents compared to a loss of 5 cents per share in the prior quarter and earnings of 12 cents per share in the second quarter of 2019. Turning to the balance sheet, unrestricted cash and marketable securities at the end of the quarter totaled $136.7 million after paying $4.3 million in dividends during the quarter. For the quarter, we generated $1.7 million of cash from operations. Net trade accounts receivable was $95.3 million at quarter end, resulting in a DSO of 67 days compared to 69 days in the prior quarter and 68 days at the end of the second quarter of 2019. The variability in DSOs quarter over quarter and year over year mainly attributable to the timing of shipments during the quarter and the customer mix. Net inventories were $106.1 million at the end of the second quarter compared to $99.5 million in Q1 of 2020 and $95.1 million at the end of Q2 in 2019. The increase in our inventories for the quarter was related to strategic inventory buffer purchases that were designed to ensure supply continuity during the pandemic. We do believe that we are positioned to maintain adequate liquidity in the current environment. Looking ahead to the next quarter, the possible effects of the ongoing COVID-19 pandemic, the ability of component supplies to align with customer demand, The book and ship nature of our business, the timing of revenue associated with large projects, the variability of order patterns and the customer base into which we sell, as well as fluctuations in currency exchange rates may cause material differences between our expectations and the actual results. Having said that, we do expect that our third quarter 2020 revenue will be in the range of $127 million to $137 million. After considering the projected sales mix, we expect that our third quarter gross margin on a non-GAAP basis will be about 41%. We also expect non-GAAP operating expenses for the third quarter of 2020 will be in the range of $51 to $52 million. Finally, we anticipate the consolidated tax rate for the third quarter on a non-GAAP basis will be in the high 20s percentage rate. We believe the significant factors impacting revenue and earnings realized in 2020 will be the following. Continued component availability, the macro spending environment for carriers and enterprises, The ongoing effects of the COVID-19 pandemic The variability of mix and revenue associated with project rollouts The proportion of international revenue relative to our total revenue Professional services activity levels both domestically and internationally The adoption rate of our broadband access platforms Any potential changes in tax laws Currency Exchange Rate Movements, and Inventory Fluctuations in Our Distribution Channels. Once again, additional information is available at ADTRAN's Investor Relations webpage at www.ADTRAN.com. Now I'll turn the call back over to Tom.