ADTRAN Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to ADTRAN's third 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 answers period. In order to ask a question during this period, you will need to press star then 1 on your telephone keypad. To withdraw yourself from the queue, please press the pound key. If you require further operator assistance, please press star 0. During the course of the conference call, ADTRAN representatives expect to make forward-looking statements which reflect management's best judgment based on factors currently known. However, these statements involve risks and insurgencies, including the continued spread and extent of the impact of 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 nits, component costs, manufacturing efficiencies, and other risks detailed in our annual report form, 10-K, for the year ended December 31, 2019. These risks and uncertainties could cause 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 ATRA. Sir, please go ahead.

Thank you, Ian. Good morning, everyone. We appreciate you joining us for our third quarter 2020 conference call. With me today is ADTRAN CFO Mike Fogliano. Following my opening remarks, Mike will review the quarterly financial performance in detail, and then we'll take any questions that you may have. I'd like to begin by expressing our concern and sympathy for those affected by the ongoing global pandemic that has touched our employees, customers, partners, and suppliers. The current times have changed the way we communicate, work, and learn, and I remain encouraged by our perseverance in the face of such adversity. With these challenges, it is more critical than ever to connect people, communities, and businesses with each other. The results for our third quarter demonstrated solid execution against our plan. This included broad-based demand across our customer segments, with regional and emergency service providers leading the way. We were also making great progress with Tier 1 fiber access projects that we announced earlier this year and continue to have very strong momentum on new customer acquisition across a broad base of market segments. From a top-line perspective, revenue for the quarter was $133.1 million with 44.3% gross margins. Network solutions accounted for 87% of the revenue at $115.2 while global services contributed $17.9 million. During the quarter we had one 10% service provider customer and one 10% distribution partner, along with strong contributions from both our direct and distribution channel partners that serve the regional broadband service provider market. We added 38 new service provider customers during the quarter, bringing the total to 99 for the first three quarters of 2020. These new customers range from global Tier 1 operators to electric co-ops, cooperatives, municipalities, cable MSO, and regional broadband providers. The new customer traction remains positive, reinforcing our belief that we are in the early stages of a generational communications infrastructure network upgrade cycle driven by a confluence of favorable government, regulatory, technology, and competitive factors. The strength we saw during the quarter was fueled by our continued momentum with regional broadband operators who were up 60% year-over-year and 33% quarter-over-quarter. We were also helped with a solid performance for our U.S. Tier 2 customers who were up 18% year-over-year as they started to emerge from restructuring and are again investing in their network expansions. In Europe, our revenue from emerging alt-net providers was up 76% year-over-year and 20% quarter-over-quarter and highlighting our growth in that region. For the third quarter, our fiber access and aggregation business grew 34% over the previous period and increased 66% on a year-over-year basis. This continues to be our top sales category. Within fiber access, our pond OLT revenue grew 31% quarter-over-quarter and a strong 77% year-over-year. which we believe is significantly outpacing the growth in the general market and will continue to step up our market share position in this key segment. We also saw strong revenue contribution from our U.S. regional broadband service providers, growing 37% over the previous period and 58% over the previous year, with broad-based growth across both direct and distribution channels. From a supply chain perspective, lead times remained extended on some key components and vendors, but our operations team took several proactive steps to mitigate logistics and component availability challenges to meet our customers' needs. In our efforts to address these needs, we have increased our inventory levels and incurred increased freight costs due to decreased capacity associated with higher transportation rates and expedited fees. From an organizational perspective, the structural changes that we have implemented over the last 12 months continue to improve our operational efficiency. The company has achieved material reductions in operating expenses through control and expense management, and we are ahead of our plan for the target operating model moving forward. On the product side, we are focusing on growing our wallet share with our service provider customers. In addition to selling fiber-active OLTs, we are growing our residential gateway business. A residential gateway revenue grew 22% quarter-over-quarter and a strong 64% year-over-year as we increased the number of OLT customers also buying our RGs by 17% year-to-date. In addition to RG attach rates, we have also focused on increasing attach rates for our Mosaic software subscription services as we migrate customers to our Mosaic suite in our upcoming Mosaic One Virtual Control Center. On October 29th, the FTC began its 904 auctions for $16 billion of RDOF broadband subsidies. There are 386 qualified bidders that represent over 700 operators. Whereas the Connect America Fund was targeted to the large price cap carriers providing a first right of refusal, the RDOF subsidies provide an opportunity for rural, local exchange carriers and community broadband providers, such as rural electric fill-ups, to receive 10 years of funding. We expect to see RDOT funding to begin to positively impact our revenue beginning in the mid-2021 timeframe. In Europe and around the world, the strategic importance of 5G and fiber broadband infrastructure is causing governments to carefully reconsider the security risks of their networks and implementation policies and are implementing policies to ban high-risk vendors from participating in these network builds. As a result, AdTrans stands out as a safe, technically advanced alternative to those high-risk vendors as national operators look to limit, cap, or replace high-risk vendors in their network. 2020 has brought forth a number of challenges that none of us could have envisioned. However, we have risen to these challenges and are emerging as an even stronger and more resilient company. We have achieved much thus far in 2020 with the material benefits just beginning to bear fruit and as they start to begin to be more fully recognized next year. We have much to be excited about, including the growing number of new customers selecting our products and services to build out or upgrade their networks with rapid adoption of our Mosaic platform and Subscription Services and our SDX Solutions as Tier 1 operators begin their transition to the network of the future and the promise of RDOF awards and being able to help regional service providers, utilities and municipalities provide gigabit services to the communities that they serve. I am proud of our company and our employees for the success we have seen thus far this year. We look forward to a strong finish to 2020 and have a bright outlook as we look ahead into 2021. Mike will now provide an overview of our financials, and following his remarks, I will load up any questions that you may have.

Thank you, Tom, and good morning to all. I will review our third quarter results and provide our view for the fourth 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 but are not presented in our earnings release, reconciliations to their comparable GAAP measures are published in a 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 revenue information by segment and category and other non-GAAP reconciliations, which I will be discussing today. As Tom said, ADTRAN's third quarter revenue came in at $133.1 million compared to $128.7 million in the prior quarter and $114.1 million for the third quarter of 2019. Breaking this down across our operating segments, our network solutions revenue for the third quarter was $115.2 million versus $111.3 million reported for Q2 of 2020 and $94 million in Q3 of 2019. Our services and support revenue in Q3 of this year was $17.9 million compared to $17.4 million reported in the second quarter of 2020 and $20.1 million for the third quarter of 2019. Across our revenue categories, access and aggregation revenue for quarter three of 2020 was $85.4 million compared to $82.8 million in the prior quarter and $65.1 million in quarter three of 2019. Revenue for our subscriber solutions and experience category was $43.1 million for the quarter versus $40.4 million in quarter two of 2020 and $42.5 million in quarter three of 2019. Traditional and other products revenue for the quarter was $4.6 million compared to $5.5 million for quarter two of 2020 and $6.5 million for quarter three of 2019. Looking at our revenues geographically, domestic revenue for Q3 2020 was $92.8 million versus $84.5 million reported in quarter two of 2020 and $83.1 million in Q3 of 2019. Our international revenue for the quarter was $40.3 million compared to $44.3 million for Q2 of 2020 and $30.9 million in Q3 of 2019. For the third quarter, we had two 10% of revenue customers. Both of these were domestic customers. Our gap gross margin for the third quarter of this year was 44.3% as compared to 41.5% last quarter and 40.6% in the third quarter of 2019. Non-gap gross margin for quarter three was 44.5%, as compared to 41.6% in the prior quarter and 41% in the third quarter of 2019. The quarter-over-quarter increase in both GAAP and non-GAAP gross margins were driven by increases in volume as well as favorable product and services mixed and lower freight-related charges in the current quarter. The increases in both GAAP and non-GAAP gross margins on a year-over-year basis were driven by increases in volume as well as product myths, which were partially offset by higher freight-related charges and expedite premiums. Total operating expenses on a GAAP basis were $54.4 million for Q3 of 2020, compared to $59.2 and the Board of Directors of the Board of Directors of the Board of Directors and reduced travel expenses, offset by increases in some restructuring-related costs. The year-over-year decreases in operating expenses were a result of lower expenses in both R&D and SG&A and lower travel-related expenses, partially offset by market-driven increases in our deferred compensation expense and an increase in contract services costs. On a non-GAAP basis, our third quarter operating expenses were $49.4 million compared to $52.3 million in the prior quarter and $59.4 million in quarter three of 2019. Both the non-GAAP quarter-over-quarter and year-over-year decreases in operating expense were primarily driven as a result of our expense reduction efforts and lower travel-related expenses. Operating income on a GAAP basis for the third quarter of 2020 was $4.5 million compared to an operating loss of $6 million in the prior quarter and an operating loss of $20.3 million reported in Q3 of 2019. Non-GAAP operating income for quarter three of 2020 was $9.9 million compared to an operating income of $1.3 million in Q2 of 2020 and an operating loss of $12.6 million in Q3 of 2019. The quarter-over-quarter and year-over-year gap and non-gap profitability was driven by higher sales with favorable gross margin mix and reduced operating expenses. Other income on a GAAP basis for the third quarter of 2020 was $1.5 million compared to other income of $8.4 million in the prior quarter and other income of $1.9 million in quarter three of 2019. Our non-GAAP other income for the quarter was $900,000 compared to other income of $5.7 million in Q2 2020 and other income of $2.7 million for quarter three of 2019. The decreases in both GAAP and non-GAAP other income as compared to quarter over quarter were primarily market-driven caused by changes in the valuation of our investment portfolio The decrease in GAAP and non-GAAP other income on a year-over-year basis was primarily driven by realized foreign exchange losses offset by market-driven upsides in the valuation of our investment portfolio. The company's tax provision for the third quarter of 2020 was $600,000 as compared to an expense of $1.6 million in the prior quarter and an expense of $27.7 million in the third 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 continued to be offset by changes in our valuation allowance. The tax expense in the third quarter of last year was the result of a valuation allowance against our domestic deferred tax assets. GAAP net income for quarter three of 2020 was $5.5 million compared to a net income of $800,000 in the prior quarter and a net loss of $46.1 million in the third quarter of 2019. Non-GAAP net income for the third quarter of 2020 was $7.9 million as compared to an income of $1.6 million in the prior quarter and a loss of $2.8 million in quarter three of 2019. Earnings per share assuming dilution on a GAAP basis was 11 cents per share as compared to 2 cents per share last quarter and a loss of 96 cents per share in the third quarter of 2019. Non-GAAP earnings per share, assuming dilution for the third quarter, was 16 cents compared to an income of 4 cents per share in the prior quarter and a loss of 6 cents per share in quarter three of 2019. Turning to the balance sheets, Unrestricted cash and marketable securities totaled $132.2 million at quarter end after paying $4.3 million in dividends during the quarter. For the quarter, we used $7 million of cash from operations. Net trade accounts receivable was $100.2 million at quarter end, resulting in a DSO of 69 days. compared to 67 days in the prior quarter and 73 days at the end of the third quarter of 2019. The variability in DSOs quarter over quarter and year over year is mainly attributable to the timing of shipments during the quarter and customer mix. Net inventories ended the quarter at $120.3 million. compared to $106.1 million in Q2 of 2020 and $104.9 million at the end of Q3 2019. The increase in our inventories for the quarter that just ended was in preparation for new product ramp-ups and strategic inventory buffer purchases made to ensure supply continuity during the pandemic. We 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 our customer demand, the book and ship nature of our business, the timing of revenue associated with large projects, the variability of order patterns, into the customer base in which we sell, as well as the fluctuation in currency exchange rates in our international markets may cause material differences between our expectations and the actual results. We expect that our fourth quarter 2020 revenue will be in the range of $122 million to $132 million. After considering the projected sales mix, We expect that our fourth quarter gross margin on a non-GAAP basis will be in the range of 41% to 42%. We also expect non-GAAP operating expenses for the fourth quarter of 2020 will be between $50 and $51 million. And finally, we anticipate the consolidated tax rate for the fourth quarter of 2020 on a non-GAAP basis will be a benefit at a mid-single-digit percentage rate, resulting from the expected mix of domestic and international income in the quarter. We believe that the significant factors impacting revenue and earnings realized in 2020 will be component availability, a macro spending environment for carriers and enterprises, 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 in both domestic and international markets, the adoption rate of our broadband access platforms, potential changes in tax laws, currency exchange rate movements, and inventory fluctuations in our distribution channels. Once again, additional financial information is available at ADTRAN's investor relations webpage at www.ADTRAN.com. Now I'll turn the call back over to Tom.