ADTRAN Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to ADTRAN's fourth 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 during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further 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 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, and our quarterly report on Form 10-Q for the quarter ended September 30, 2020. 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, Chris. Good morning, everyone. We appreciate you joining us for our fourth quarter 2020 conference call. With me today is AdTrans CFO Mike Foliano. Following my opening remarks, Mike will review the quarterly financial performance in detail, and then we will take any questions that you may have. COVID-19 continues to impact our day-to-day lives and the way that we do business. It has highlighted the importance of the work we do, enabling operators to provide high-speed broadband connectivity for consumers and businesses. I am proud of our employees' perseverance throughout these difficult times and want to start by saying thank you to all of our team. Moving to the quarterly performance. The results for the fourth quarter demonstrated solid execution against our plan. This included broad-based demand across our customer segments, with a strong contribution from regional and emerging service providers. We continue to make great progress with the Tier 1 fiber access projects that we announced earlier last year, while still growing and diversifying our customer base across a variety of market segments. From a top-line perspective, revenue for the quarter was $130.1 million with 41.1% gross margin. Network Solutions accounted for 88% of that total revenue at $114.1, while global services contributed 16 million. During the quarter, we had four 10% customers, one of the highest numbers we have ever reported. Each of these customers' percentage of total revenue was in the low double digits, pointing to the success of our diversification efforts. Of these, there was one service provider customer and three distribution partners. These distribution partners serve hundreds of regional service providers in the U.S. market with a mix of broadband access and connected home and enterprise solutions, further reinforcing our success that we are having with both customer and portfolio diversification. New customer acquisition remains strong. We added 35 new service provider customers during the quarter, bringing the total to 134 for the year. Our fiber access portfolio has led the way in terms of both new customer acquisition and revenue growth. We expect this to continue as our fiber access solutions and software platforms are adopted by customers around the world who are upgrading their networks due to favorable government, regulatory, technology, and competitive factors. Similar to Q3, the growth that we saw during the quarter was led by our continued success in the Tier 2 and regional broadband operator market in the U.S., which was up 85% year over year. We are seeing increasing demand for our fiber access, connected home, and cloud services offerings. Our fiber access and aggregation business grew 98% year over year. In-home service delivery platforms were up 68% year over year. And cloud services increased 46% year over year. We are seeing similar trends in Europe, where favorable regulatory and funding environments are driving the build of fiber access networks. We posted revenue growth of 54% year-over-year in the EMEA market segment. This increase was driven by investment in 10-gig fiber access networks with European AltNet providers. In the Tier 1 customer segment, as mentioned earlier, we are making great progress with all three announced wins, including two European and one U.S.-based customer. Two of the three have already achieved a significant milestone of first customer connections. and we expect lab exit for all three around the middle of the year. In addition, we are actively involved in several other Tier 1 decision processes around the world, some of which we expect to reach decision points around the middle of this year. COVID-19-related logistics issues and global chip shortages continue to impact lead times and inventory levels, and our operations team continues to take proactive steps to mitigate logistics and component availability challenges to meet our customer needs. However, lead times do remain extended on some key components, and as a result of our efforts to address these needs, we have maintained elevated inventory levels and incurred increased freight costs due to decreased capacity associated with higher transportation rates and expedite fees. From an organizational perspective, we continue to maintain a disciplined approach to operational expenses. The structural changes that we have implemented over the last year continue to improve our operational efficiency. In the past 18 months, we have reduced our non-GAAP quarterly operating expenses by almost 12 million, or 19%, through disciplined expense management. These changes have allowed us to reach investment levels that aligns with our target operating model moving forward. On the product side, we continue to invest in end-to-end broadband solutions that make it easy for broadband operators to deploy and operate fiber-based broadband access networks. In the customer connectivity segment, we expanded our in-home service delivery platforms with our new SDG series of cloud-managed mesh Wi-Fi 6 gateways. These platforms deliver gigabit speeds wirelessly throughout the home or business. They are complemented by an intuitive mobile app and cloud-based software suite that simplifies deployment and management of Wi-Fi mesh IoT advanced security and parental control services. These platforms will enhance our ability to capitalize on the increased investment we are seeing in the connect-and-home segment. In fiber access, we have established ourselves as one of the fastest-growing vendors through the widespread adoption of our 10-gig fiber access platforms. Whether you're a regional operator looking for an easy-to-deploy system with integrated access and transport, or a large Tier 1 broadband operator seeking the leading open disaggregated fiber access platform available, AdTrend has solutions that are an ideal match for these customers' needs. On the software side, we enhanced our cloud software suite with the launch of Mosaic One, a SaaS offering that combines network and subscriber analytics with AI-driven algorithms to optimize end-to-end network performance while providing actionable insight for operations and marketing teams. Highlighting our growth in cloud service, we secured our largest SaaS contract to date with an award that covers hundreds of thousands of customers over a multi-year period. The consumer demand and government support for fiber-based broadband services are at an all-time high. One notable program, of course, is the FCC's Rural Digital Opportunity Fund, or RDOF, and in December, the FCC announced 180 winning bids in the RDOF Phase I auction. These winning bidders are expected to receive a total of $9.2 billion in funding over a 10-year period to build out broadband services to over 5 million homes. Over 85% of these homes will be served with gigabit broadband speeds. AdTrans Portfolio is a great match to these service tier and customer segments. In Europe and around the globe, many global operators are significantly increasing their fiber investment while also looking to diversify the vendors in their supply chains. As an established global vendor with a leading fiber access portfolio and global R&D presence, including Europe, ADTRAN continues to stand out as a reliable option for future broadband deployments. The shift to gigabit-enabled fiber access networks will also drive further demand for gigabit-capable cloud-managed wireless mesh connectivity in the home or business, providing material additional growth opportunities for ADTRAN as end-to-end broadband solution provider. I mentioned earlier in 2020 that Abtrans fiber business had eclipsed our copper business for the first time in our history. In Q4 of 2020, fiber-related solutions represented over 70% of our business. Overall, we achieved some key milestones in 2020, and we have a lot of positive momentum in the growth segments of our portfolio, driving a diversified customer base in our target markets. The progress that we had in 2020 has us well-positioned for additional success in 2021. Mike will now provide a review of our financials. Following those remarks, I will be happy to answer any questions you may have. Mike?

Thanks, Tom, and good morning to all. I will review our fourth quarter 2020 results and also provide our view on the first quarter of 2021. During my report, I will be referencing both GAAP and non-GAAP results with reconciliations presented in our press release and supplemental financial schedules on our investor relations webpage at www.adtran.com slash investor. The supplemental financial schedules on our webpage also present certain revenue information by segment and category, which I will be discussing today. As Tom stated, our fourth quarter revenue came in at $130.1 million dollars. compared to $133.1 million in the prior quarter and $115.8 million for the fourth quarter of 2019. Breaking this down across our operating segments, our network solutions revenue for the fourth quarter was $114.1 million versus $115.2 million reported for Q3 of 2020 and $96.2 million in Q4 of 2019. Our services and support revenue in Q4 was $16 million compared to $17.9 million reported for the third quarter of 2020 and $19.6 million for the fourth quarter of 2019. Across our revenue categories, access and aggregation revenue for the fourth quarter of 2020 was $79 million compared to $85.4 million in the prior quarter and $74.6 million in quarter four of 2019. Revenue for our subscriber solutions and experience category was $45.4 million for the quarter versus $43.1 million for quarter three of 2020 and $33.2 million for quarter four of 2019. Traditional and other products revenue for the quarter was $5.8 million compared to $4.6 million in Q3 of 2020 and $8 million for quarter four of 2019. Looking at our revenue geographically, Domestic U.S. revenue for Q4 2020 was $95.8 million versus $92.8 million reported in quarter three of 2020 and $69.9 million in quarter four of 2019. Our international revenue for the quarter was $34.3 million compared to $40.3 million for quarter three of 2020 and $45.9 million in quarter four of 2019. In the fourth quarter, we had four 10% of revenue customers. Our gap gross margin for the fourth quarter was 41.1% as compared to 44.3% in the prior quarter and 40.8% in the fourth quarter of 2019. Non-GAAP gross margin for the quarter was 41.3% as compared to 44.5% in the prior quarter and 41.2% in the fourth quarter of 2019. The quarter-over-quarter decrease in both GAAP and non-GAAP gross margins were driven by product, services, and customer mix and lower volume and lower manufacturing absorption. The increases in both GAAP and non-GAAP gross margin on a year-over-year basis were driven by increases in volume as well as product, services, customer, and geographical mix changes. During the quarter, we did experience extended component lead times, which we expect to continue into 2021, potentially affecting component availability and component and logistics costs. Total operating expenses on a GAAP basis were $56.8 million for quarter four of 2020 compared to $54.4 million reported in the prior quarter and $61.3 million for Q4 of 2019. The quarter-over-quarter increase was primarily related to market-driven increases in our deferred compensation expense, restructuring related costs in both R&D and SG&A, and contract services partially offset by a decrease in labor expense as a result of our restructuring program, which was initiated in 2019. The year-over-year decreases in operating expenses were a result of lower labor expenses in both R&D and SG&A as a result of our restructuring program, and lower travel-related expenses partially offset by increases in contract services costs, restructuring expenses, and market-driven increases in our deferred comp expense. On a non-GAAP basis, our fourth quarter operating expenses were $49.5 million compared to $49.4 million in the prior quarter and $56.8 million in the fourth quarter of 2019. The slight increase quarter-over-quarter in non-GAAP operating expenses was primarily due to increases in contract services offset by a decrease in labor expenses. The non-GAAP year-over-year decrease in operating expenses was primarily the result of our expense reduction efforts and lower travel expenses year-over-year partially offset by an increase in contract services. Operating loss on a GAAP basis for the fourth quarter of 2020 was $3.3 million compared to an operating income of $4.5 million in the prior quarter and an operating loss of $14.1 million reported in Q4 of 2019. Non-GAAP operating income for quarter four of 2020 was $4.3 million. compared to $9.9 million in the prior quarter and an operating loss of $9 million in quarter four of 2019. The quarter-over-quarter gap decrease in profitability was attributable to lower sales volume, less favorable gross margin mix, and higher operating expenses driven by restructuring and market-driven deferred compensation expenses. The year-over-year decrease in GAAP operating loss was driven by higher sales with favorable gross margin mix and reduced operating expenses. The non-GAAP quarter over quarter decrease in profitability was mainly driven by lower sales volume and less favorable gross margin mix. The non-GAAP year-over-year operating income improvement was related to higher sales volume, higher gross margin mix, and reduced operating expenses. Other income on a GAAP basis for the fourth quarter of 2020 was $3 million compared to other income of $1.5 million in the prior quarter and other income of $3.2 million for quarter four of 2019. Our non-GAAP other income for the quarter was $1.7 million compared to a non-GAAP other income of $876,000 in Q3 of 2020 and $2.9 million for quarter four of 2019. The increases in both the GAAP and non-GAAP other income as compared to the prior quarter were primarily market driven, caused by increases in the fair value of our investment portfolio and lower realized foreign currency exchange losses. The decrease in GAAP and non-GAAP other income on a year-over-year basis was primarily driven by higher realized foreign currency exchange losses and lower gains in our investment portfolio. The company's tax provision for the fourth quarter of 2020 was a benefit of $6.5 million as compared to a $562,000 expense in the prior quarter and a $768,000 expense in the fourth quarter of 2019. The current quarter benefit was primarily the result of finalizing our 2019 net operating loss carryback claims related to the 2020 CARES Act and a shift in profitability across tax jurisdictions. The tax expense for the fourth quarter of 2019 was a result of our international operations as the deferred tax benefits generated in that quarter by our domestic operations were offset by additional changes in the valuation allowance that was previously established in the third quarter of 2019. GAAP net income for quarter four of 2020 was $6.1 million compared to $5.5 million in the prior quarter and a net loss of $11.6 million in the fourth quarter of 2019. Non-GAAP net income for the fourth quarter of 2020 was $5.2 million as compared to $7.9 million in the prior quarter and a net loss of $2.5 million in quarter four of 2019. Earnings per share assuming dilution on a GAAP basis was 13 cents as compared to 11 cents per share in the prior quarter and a loss of 24 cents per share in the fourth quarter of 2019. Non-GAAP earnings per share, assuming dilution for the fourth quarter of 2020, was 11 cents per share compared to 16 cents per share in the prior quarter and a loss of 5 cents per share in the fourth quarter of 2019. Turning to the balance sheet, unrestricted cash and marketable securities totaled $118 million at quarter end after paying $4.3 million in dividends during the quarter. For the quarter, we used $11.2 million of cash from operations. Net trade accounts receivable was $98.8 million at the end of the quarter, resulting in a DSO of 70 days compared to 69 days in the prior quarter and 72 days at the end of the fourth quarter of 2019. The variability in DSOs quarter over quarter and year over year is mainly attributable to the timing of shipments. Net inventories were 118.7 million at the end of the fourth quarter compared to 120.3 million in Q3 of 2020 and 98.3 million at the end of Q4 of 2019. While our inventories were down slightly quarter over quarter, we continued to carry higher inventory levels in preparation for new product ramp-ups and strategic inventory buffer purchases, which have been made to ensure supply continuity throughout 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 pandemic the availability of component supplies to align with our customer demand, the book and ship nature of our business, potential supply chain expediting costs, and other component and logistics cost variations, the timing of revenue associated with large products, the variability of order patterns into the customer base in which we sell, as well as fluctuations in currency exchange rates, in our international markets may cause material differences between our expectations and actual results. Having said all that, we expect that our first quarter 2021 revenue will be in the range of $122 to $130 million. After considering the projected sales mix, we expect that our first quarter gross margin on a non-GAAP basis will be in the range of 40% to 42%. We also expect that non-GAAP operating expenses for the first quarter of 2021 will be about $50 million. And finally, we anticipate the consolidated tax rate for the first quarter on a non-GAAP basis will be in the low 20s percentage rate. We believe that the significant factors impacting revenue and earnings realized in 2021 will be component availability and costs, macro spending environment for carriers and enterprises, the ongoing effects of the COVID-19 pandemic, the variability of mix and revenue associated with our project rollouts, the proportion of international revenue relative to our total, professional services activity levels, both domestic and internationally, the adoption rate of our broadband access platforms, potential changes in corporate tax laws, currency exchange rate movements, and inventory fluctuations in our distribution channels. Once again, the financial information is available at ADTRAN's Investor Relations webpage, at www.adtran.com slash investor. Now I'll turn the call back over to Tom for questions.