ADTRAN Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to ADTRAN Holdings Inc. first quarter 2023 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. If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. During the course of the conference call, ADTRAN representatives expect to make forward-looking statements that reflect management's best judgment based on factors currently known. However, these statements involve risks and uncertainties, including 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, components costs, freight and logistics costs, manufacturing efficiencies, or ability to effectively integrate mergers and acquisitions, and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2022, and our quarterly report on Form 10-Q for the quarter ending March 31, 2023. 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. The investor presentation found on ADTRAN Investor Relations website has been updated and is available for download. It is now my pleasure to turn the call over to Tom Stanton, Chief Executive Officer of ADTRAN Holdings. Sir, please go ahead.

Thank you, Rob. Good morning, everyone. We appreciate you joining us for our first quarter 2023 earnings conference call. With me today is ADTRAN Holdings CFO Uli Dopfer. And also joining us today is Christian Glingener, AdTrans CTO. Following my opening remarks, Uli will review the quarterly financial performance in detail, and then we'll take any questions that you may have. I'll start by offering a high-level summary of what happened in the quarter and our views of the market going forward. As I mentioned in our pre-release, the results of the quarter were impacted by slowing revenue, predominantly in our subscriber solutions category. While we did have more than enough backlog to cover this gap, supply chain constraints hindered our ability to overcome these challenges during the quarter. We believe the slowdown in subscriber solutions was the result of increased scrutiny of inventory levels with our customers, driven by a combination of reduced lead times in the market and uncertainty in the broader economic environment. Looking ahead, while we do expect tighter inventory management to continue to impact us in the near term, Our longer-term growth outlook remains unchanged, given the historically high demand for fiber networks, our diversified customer base, and the progress we have made with fiber footprint capture. With that background, let me provide some additional context. Adren has built a comprehensive fiber network portfolio built upon three key pillars, optical network solutions, access and aggregation solutions, and subscriber solutions. Each of these categories are ultimately tied to the build-out of fiber networks, which continue to have a positive outlook given the investments planned in fiber networks in the years ahead. In addition to market growth trends, we are also benefiting from cross-portfolio synergies as we integrate our teams and processes and are better positioned to cross-sell our larger fiber portfolio. In the optical networking solutions, we have had back-to-back record quarters, and we experienced growth across all regions in this past quarter. Our strongest region for this portfolio has been Europe. With the strength of the combined company, we have been the biggest beneficiary of ShareShift away from high-risk vendors. Vendor selection activities in the metro optical space remain at their highest levels in many years, highlighted by our involvement in eight large carrier opportunities right now. And our access and aggregation solutions, we continue to see good progress in wrapping our large carrier customers in Europe, while also being well-positioned in six new large carrier investments selections in that area. Like the optical transport segment, this elevated vendor selection activity is accelerated by the shift away from high-risk vendors, and ADTRAN continues to be a key beneficiary in this market shift. Within our existing fiber large fiber access customers in Europe, there has been some notable, there has been one notable customer that was publicized to have CapEx reductions in their current plans. With continued collaboration with his customers and others in this region, we are assured that their long-term fiber deployment plans remain in place, and in some cases, we've actually seen acceleration in these plans into this year, reinforcing this long-term strength in fiber network investments that we see going on in Europe. In the U.S. market, we had 47% quarter-over-quarter growth with our fiber access platforms, driven by success in the regional service provider market, reinforcing our continued growth and capturing new fiber footprint. We now have over 600 operators globally deploying our fiber access platforms, including 11 new operators that we added this quarter. On the subscriber solutions category, we did experience high volatility during the past quarter. However, as we capture new fiber footprint and more customers upgrade to 10-gig fiber access networks and multi-gig Wi-Fi networks, we expect to see this category return to higher growth. The same is true for business and wholesale services that continue to shift to higher speed fiber services. This fiber networking portfolio spanning the metro core to the customer premises is complemented by a comprehensive software and services offering that simplifies engineering, deployment, and ongoing operations associated with these fiber networks. On the software side, we see continued demand for SaaS applications with over 200 service providers already adopting our Mosaic One offering, up from 150 customers at the end of last quarter. In summary, the long-term demand for fiber networks has not changed despite near-term inventory adjustments and economic uncertainties. Our progress in capturing new for our optical infrastructure platforms, including both optical transport and fiber access, as well as has us well positioned to benefit from the long-term investment in infrastructure, software, and services to support these fiber networks. Our ability to grow our customer base and cross-sell our combined portfolio will continue to improve as we further integrate our sales teams and processes. While we remain confident in the long-term outlook, we will be cautious in our spending as we traverse this period of uncertainty in the market. We are on track with our previously stated synergy goals And we expect to see meaningful improvements in our operational expenses this quarter as compared to last. Before I hand things over to Uli, I'd like to thank Mike Foliano. Mike, as all of you, many of you on the call know, has been our CFO for several years and has been with the company for 17 years with AdTrend. Mike has been a very, very dedicated, very professional, just a fantastic teammate. And I'm really extremely grateful for Mike for all the years of service that he contributed, and I wish him all the best as we move forward into his new life. We have, of course, transitioned that role. We are transitioning that role from Mike to Uli. And with that, I'm going to turn things over to Uli to go over the financials. After that, we'll open it for any calls you may have.

Thank you, Tom. And hello, everybody. I will cover our first quarter 2023 final results and provide our expectations for the second quarter of 2023. Please note that Q1 2023 results include a full quarter consolidation of the ERPA financials, which affects year-over-year comparisons. Since this is the case, I will refrain from repeating the consolidation effects when discussing the year-over-year comparisons of our results. I will be referencing non-GAAP information with reconciliations to the most directly comparable GAAP financial measures presented in our press release, and also certain revenue information by segment and category, which is available on our investor relations webpage at investors.adtrend.com. In addition, we have updated the investor presentation to the site, which is available for download. unless stated otherwise, all financials are presented in US dollars. Let's move to the revenues. Q1 2023 revenue came in at 323.9 million, up 109.6% year-over-year, and down 9.6% quarter-over-quarter. As already presented in our pre-announcement, we missed the lower end of our guidance range of 355 to 375 million by 8.8%. Our network solutions segment accounted for 87.2% of revenues in Q1 2023 compared to 89.6% in Q1 2022 and 89.4% in Q4 2022. Our services and support segment contributed 12.8% of revenues in Q1 2023 compared to 10.4% in the year-ago quarter and 10.6% in the previous quarter. Year-over-year and quarter-over-quarter revenue decline was primarily driven by inventory management in our customer inventory for ONTs and Ethernet NITs in the subscriber solutions category. While this category was up 39.9% year-over-year, it was down 34.1% quarter-over-quarter. Supply constraints also limited our flexibility to clear path to backlog across all product categories. However, optical networking and access and aggregation performed as expected. Optical networking solutions category contributed 45.6% of revenue and was up 3.9% quarter over quarter. Access and aggregation revenue share was 29.9% and was slightly down 1% year over year and increased by 1.1% compared to Q4 2022. On a regional basis, for year over year, first quarter domestic revenue grew by 32.7% international revenue increased by 246.9 percent international revenue made up 59.4 percent of our revenue and domestic revenue contributed 40.6 percent of q1 2023 revenues similar to q4 2022 we had two 10 or more revenue customers in q1 q1 non-gap growth margin was 37.3% and increased by 200 basis points year-over-year and decreased 180 basis points sequentially. The year-over-year increase is due to improved purchasing and transportation costs. The quarter-over-quarter decline in gross margin was primarily attributable to an increase of our inventory reserve as well as lower absorption credit compared to the previous quarter. In addition, an unfavorable customer and product mix contributed negatively to our growth margins. Our non-GAAP operating expenses were 125.9 million, increasing by 137% year-over-year and 6% quarter-over-quarter, which were primarily driven by increased labor costs and high R&D expenses. Non-GAAP operating expenses were 39% of revenues compared to 34% of revenue in Q1 2022 and 33% of revenue in Q4 2022. Non-GAAP operating loss was 5.2 million, which translates into a non-GAAP operating margin of negative 1.6% compared to positive 1% in Q1 2022 and 6% in the previous quarter. The decrease in profitability was driven by the low revenue volume at lower margins and an increased cost base. Let me emphasize that we are striving to significantly lower our cost base in the near term to adjust for the lower than expected revenues by accelerating our synergy efforts and optimizing discretionary spending. Non-GAAP other expenses was negative 3.3 million and mainly driven by higher interest expense. The company's non-GAAP tax provision for the first quarter of 2023 was $1 million or 12%. The company's GAAP tax was a benefit of $11.3 million or 22%. The difference between the GAAP and non-GAAP rates was primarily driven by the jurisdictional mix of the non-GAAP adjustments during the quarter. Closing out our income statement results, total non-GAAP net loss was $9.5 million and a net loss of $5 million after adjusting for minority shareholder interest in Adva. This results in diluted loss per share attributable to the company of $0.06 per share. I will discuss the details of the EPS calculation later in this call. Let's move to the balance sheet. Turning to the balance sheet and cash flow statement, cash and cash equivalents totaled 0.5 million at quarter end. For the quarter, operating cash flow was negative 19.9 million due to low earnings and increased working capital. Trade accounts receivables were 262 million at quarter end, resulting in DSO of 73 days compared to 72 days in the prior quarter. Inventories were $416.3 million at the end of the first quarter, resulting in terms of 2.2 compared to 2.4 in Q4 2022. Accounts payables were $198.6 million, resulting in DPO of 69 compared to 80 in the previous quarter. Q4 2022 was an unusual back-end loaded quarter, which resided in higher trade accounts payables and explains the drop in DPO in Q1. Working capital management and free cash flow generation is one of our focus areas during 2023. We expect that we will continue to carry a high amount of inventory in 2023, which should improve during the second half of the year. Paired with improvements in operating results and strict cost controls, we expect free cash flow to turn around in 2023. Following the DPLTA registration in January 2023, ATRAN and ADWA can now fully integrate and work on utilization of revenue and cost synergies. As of today, ATRAN owns 65.4% of ADWA shares which resides into outstanding Adva minority shares of 18 million. Adva minority shareholders still have the option to tender their shares for a cash compensation of 17.21 euro or to receive 59 euro cents fixed annually recurring compensation payment from Adren for the duration of the DPLTA. As of today, 62,435 shares were tendered. On April 18, ADWA applied for a segment change from prime to general standard to reduce complexity and cost. Our focus is on successful integration of both companies combined with achieving our cost targets on the increase of operational efficiency and as a result, free cash flow generation. A potential D-list offer is not a priority for 2023. Since the DPLTA was registered on January 16, the accounting treatment of minority shareholder for Q1 is a combination of the previously applied method, a percentage of adverse loss or profit for the time prior to the DPLTA, plus the recurring cash compensation of 2.8 million. In Q2 2023 and beyond, only the recurring cash compensation of approximately $2.8 million will be applied. Quick update on synergies. We remain committed to realize cost synergies of $52 million as already communicated previously, of which we expect to materialize approximately 40% in 2023 and 60% in 2024. 30% of cost synergies can be allocated to cost of revenue sold and refer to synergies in purchasing and logistics. 2023 cost synergies were already identified and we are on track to achieve them during the year. Further, 31.2 million cost synergies are expected to be achieved in 2023. Now to the guidance. Looking ahead to the second quarter of this year, the ability of component supplies to align with customer demand, the book-ship nature of a large portion of our business, the timing of revenue associated with large projects, the variability of ordering patterns from our customer base, as well as the fluctuation in currency exchange rates, and any additional required purchase accounting adjustments related to the business combination may cause material differences between our expectations and the actual results. We continue to focus on the supply side, optimize our cost base, and our merchant integration. We anticipate further improvements in the semiconductor supply chain and expect our backlog to moderate and to decrease inventories over the next few quarters. We will continue to focus on cost management and operational efficiencies while investing in key areas to drive growth. As Tom already stated, we believe that the inventory reductions that we experience with our customers and across the industry is transitory, and we expect to see some improvements to both the oversupply of CPE products and the backlog of products across all categories in the coming quarters. The fundamental growth catalysts remain intact, and we remain confident to be ideally positioned for sustainable growth due to the ongoing demand to upgrade and deploy new fiber networks. While we are confident in regards to our long-term outlook, we remain cautious in the near term due to tighter inventory management of our customers. Consequently, we guide for our second quarter, 2023, revenues to range between $325 and $335 million, and we expect a non-GAAP operating margin of between 1% and 2% of revenues. Once again, additional financial information is available at Atron's investor relations webpage at investors.atron.com. And with that, thank you. And now we'll turn over back to Tom, and we will take your questions.