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spk01: Ladies and gentlemen, thank you for standing by and welcome to ADTRAN Holdings' second 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. To ask a question at that time, please press star followed by the number one on your telephone keypad. To withdraw your question, please press star one again. During the course of the conference call, ADDRAN 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, our ability to efficiently 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 June 30, 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 AdTrend 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 AdTrend Holdings. Sir, please go ahead.
spk07: Thank you, Julian. Good morning, everyone. We appreciate you joining us for our second quarter 2023 earnings conference call. With me today is AdTrend Holdings CFO, Uli Doppler. Following my opening remarks, Uli, We'll review the quarterly financial performance in detail, and then we'll take any questions that you may have. I'll start out by looking at the performance this last quarter, and then we will discuss our current market positioning, both near and long term. The results in Q2 were within the guidance range that we set on the last call and closely followed what we expected from both a product mix and regional split. Like Q1, the revenues in the quarter were led by our optical network solutions, and our access and aggregation solutions. From a regional revenue split, the U.S. was 40% and non-U.S. came in at 60%. This split is consistent with the past couple of quarters. Looking across our various market segments, the U.S. regional service provider for one of the strongest customer groups in the quarter, particularly with fiber access platforms, as these customers continue to build out fiber footprint in underserved markets. Due to German capital requirements, we did issue a pre-announcement on lower revenue projections for the second half of this year. This lower forecast is primarily attributable to inventory optimization and optical networking solutions as customers adjust their inventory and corresponding bookings. Our access and aggregation solutions along with our subscriber solutions are not expected to see any further forecast adjustments this year due to ongoing inventory scrutiny. The investment thesis has not changed, and we remain upbeat on our industry in 2024 and thereafter. We made great progress this past quarter in executing on the strategic initiatives of maximizing the broadband funding opportunity, being the leading option for Huawei replacement and fiber networking, and driving cross-selling synergies with our comprehensive fiber networking portfolio. I want to remind our listeners that this success is coming at a time of unprecedented funding for fiber-based broadband networks and an ongoing shift away from high-risk vendors led by Europe. And we have one more Huawei replacement business than any other in our segment. To put it bluntly, we are seeing a reshaping of the vendor landscape across Europe, and we are well-positioned to be the largest beneficiary of this market shift. Starting with customer acquisitions, we had our second highest quarter ever for new fiber to the home operators, adding 26 new customers in the second quarter. In this past quarter, the growth came primarily in the U.S. with regional service providers. This customer group is benefiting the most from broadband stimulus funding in the U.S. This customer group also aligns with our strength in the U.S. regional service provider market and the growth in fiber access platforms that we expect to continue in the second half of this year. Highlighting our continued momentum in Europe, we added another large multinational operator for access, continuing our run of success in the EMEA region and bringing the total large fiber access customers in that region to seven. Most of these customers have not yet reached scale deployments, and even without these contributions, Adren has moved to the number two position, surpassing Huawei in market share for fiber access platforms in North America and EMEA combined. This underpins our belief that the work we are doing today will lead to significant revenue opportunities as we exit the current environment. Similarly, our vendor replacement strategy for Europe is seeing similar success in the optical transport space. During the quarter, we secured a key metro WDM win with a large multinational operator in Europe, building on the ongoing success we have had in that region. We are also improving our cross-selling capabilities as we integrate our teams and processes. Just this last quarter, we had two large service providers expand their business with us. One customer was an existing optical networking customer selecting our fiber access platforms, and another was an existing fiber access customer that has now selected our optical network solutions. As we enhance our optical portfolio focused on regional operators, further integrate our solutions under a common management system, and introduce our complete portfolio to our customers we expect to accelerate these cross-selling synergies. On the software side, we added a record number of new customers to our latest Mosaic One SaaS offering. We now have more than 275 service operators that have adopted Mosaic One, up from 200 just the end of last quarter. This growth in SaaS customers helped us significantly grow our recurring software revenues over the past year, and we expect to accelerate this growth in the year ahead. To recap our strategic approach to the market, our plan is to capture new fiber footprint with our optical transport and fiber access platforms in the markets where we see the highest growth potential, led by the US and Europe. We then want to cross-sell our entire portfolio, including attaching our software and subscriber platforms. This past quarter was very successful in helping us continue to build momentum in this strategy. While we remain very confident in our long-term outlook, we understand that we are still in a period of uncertainty as customers rationalize their inventory and near-term capital plans. As a result, you saw AdTorrent decrease its non-GAAP operating expense levels during the quarter, and we will continue to reduce our expenses throughout the rest of this year. Overall, the focus on fiber networking, our customer growth, and improving inventory situation and operational cost synergies have us positioned to be the largest beneficiary in this historic investment in fiber networks globally. Although near-term headwinds are a reality, they are just that. They are near-term, and the outlook remains as strong as ever. With that, I will turn things over to Uli to provide a review of the financials, and following Uli's remarks, we'll open it up to any questions you may have. Uli?
spk02: Thank you, Tom, and hello, everybody. I will cover our second quarter 2023 results and provide our expectations for the third quarter. Please note that Q2 2023 results include a full quarter consolidation of the AdTrend Network's 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 U.S. dollars. Q2 2023 revenue came in at 327.4 million within our guidance range of between 325 and 335 million. Revenue was up 90.3% year-over-year and up 1.1% quarter-over-quarter. Our network solutions segment accounted for 86.4% of revenues in Q2 2023, compared to 90.7% in Q2 2022 and 87.2% in Q1 2023. Our services and support segment contributed 13.6% of revenues in Q2 compared to 9.3% in the year-ago quarter and 12.8% in the previous quarter. Temporary softness in order behavior in the subscriber solutions and experience category, especially with ONTs and Ethernet needs, continued in Q2. However, SSNE grew 2.4% year-over-year and 2.9% quarter-over-quarter and contributed 24.9% of Q2 revenues. Access and aggregation contributed 31.4% of revenue and grew 11.3% compared to the year-ago quarter and 6.1 percent compared to the previous quarter. Our optical networking solutions category contributed 43.7 percent of revenues and was down 3.2 percent from our record quarter in Q1 2023. On a regional basis for year-over-year, second quarter domestic revenue grew by 24.8 percent and international revenue increased by 194.7 percent. Similar to Q1, international revenue made up 59.7% and domestic revenue contributed 40.3% to total Q2 revenue. We had one 10% or more of revenue customers in Q2. Q2 non-GAAP gross margin was 38.6% and increased by 216 basis points year over year and 132 basis points sequentially. The year-over-year and quarter-over-quarter increase is due to improved purchasing and transportation costs and a more favorable product mix. Our non-GAAP operating expenses were $122.7 million, increasing by 126% year-over-year, but decreased by 3% quarter-over-quarter. The quarter-over-quarter decrease was mainly due to savings in the R&D area, partially upset by high legal costs. Non-GAAP operating expenses were 37.5 percent of revenue compared to 31.5 percent of revenue in Q2 2022, 38.9 percent of revenue in Q1 2023. Non-GAAP operating expense was three, excuse me, non-GAAP operating income was 3.6 million, which translates into a non-GAAP operating margin of 1.1 percent which was within our guidance range of between 1% and 2% of revenues. Non-GAAP operating margin decreased by 377 basis points year-over-year, but improved by 272 basis points compared to a negative 1.6% sequentially. The quarter-over-quarter improvement in profitability is attributable to higher gross margins and lower operating expenses. We're making great progress with the execution of our synergy plan and expect now to realize the majority of our run rate synergies already in 2023. As a result, we expect Q3 non-GAAP operating expense to further decrease. The company's non-GAAP tax provision for the second quarter of 2023 was 4.7 million. The company's GAAP tax was a benefit of 8.4 million. The difference between the GAAP and non-GAAP rates was mainly 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 5.2 million and net income of 77,000 after adjusting for minority shareholders' interest in Adren Networks SE. This resulted in diluted earnings per share attributable to the company of zero cents per share. Turning to the balance sheet and cash flow statement. Cash and cash equivalents totaled 124.3 million at quarter end. Cash flow used for operations was 16.2 million and improved by 3.7 million compared to Q1 2023. Trade accounts receivable were 239.6 million at quarter end, resulting in DSOs of 67 days compared to 73 days in the prior quarter. Inventories were $416.8 million at the end of the second quarter, resulting in terms of 2.3 compared to 2.2 in the first quarter. Accounts payable were $171.7 million, resulting in DPO of 59 compared to 69 in the previous quarter. Tom explained earlier how customers adjusted their order behavior to the now shorter lead times. Additionally, inflation and the increase in interest rates are leading to more emphasis among our customers on short-term cash flow. All of this is negatively impacting our revenue expectations for Q3. We don't expect any changes to our mid-term opportunities and long-term growth catalysts. as carriers worldwide proceed with network upgrades to fiber. Due to the tremendous amount of customer activities related to future projects and opportunities, the tailwinds arising from high-risk vendor replacement initiatives, as well as government funding, we anticipate that the current softness in orders are only of temporary nature. Our comprehensive product offerings, architectures, and solutions, as well as our rich feature roadmap positions us well in all of our target markets. We will continue our prudent management of non-GAAP operating expenses, anticipating a further sequential decline in the third quarter. For the third quarter of 2023, we expect revenues to range between $275 and $305 million, and we expect a non-GAAP operating margin of between minus 5 and 0 percent of revenues. Once again, additional financial information is available at AdTrans Investor Relations webpage at investors.adtrans.com. Now I will turn it back over to Tom, and we will take your questions.
spk07: All right. Thanks, Julian. Julian, we're ready to open it up for any questions people may have.
spk01: Thank you. As a reminder, to ask a question, please press star followed by the number one on your telephone keypad. Our first question comes from Michael Genovese from Rosenblatt Securities. Please go ahead. Your line is open.
spk05: Okay, thanks a lot. Our first question, Tom and Uli, when I look at the guidance for the third quarter and maybe what's implied in the back half of the year, given the AdTran Network's release in Germany, am I right in assuming that the core, or I'd say the organic, not organic, the classic AdTran business, the broadband piece of AdTran and the subscriber solutions related to that, that the guidance is actually better for the third quarter than consensus, and that more than 100% of the lower guide versus consensus is coming out of the optical business. Am I reading that right?
spk07: Yeah, let me phrase that a different way, if you don't mind. So it looks like, if you think a classic ad trend, legacy ad trend business, access in ag is doing well, and we expect growth through the... second half of the of the year we expect subscribers you know subscribers you know we talked about the inventory situation with subscribers um that's kind of flattish um and then so uh so yeah the majority if not all of the decline is in the optical piece and really the way that i characterize it in the way that we think about it is going through this downturn um you know The AdTran side of the business kind of hit the downturn first, and that may be because we're in access, and that's where, you know, it's just kind of a different buying cycle. And then the Adva piece kind of followed after that, and that was both in the uptick and in the downturn, and I think that's the same thing that's happening right now. So AdTran is kind of the legacy AdTran piece is kind of flattening out and, you know, We expect that to turn quicker, and then Advil will follow that. So the premise of your question is correct.
spk05: Okay, great. I just want to follow up then quickly. There's three pieces here in the business, and I want to follow up on each of them. So for assets and aggregation, can you just sort of characterize how the European tier ones who have already started to deploy, so we're thinking about the UK in particular, maybe Germany, I'm not sure, but how those are looking in the second half of the year, you know, how the European tier ones are.
spk07: Very strong in the second half. Europe in general will be strong in the second half.
spk05: Okay. And then can you characterize for us just in the CPE, you know, subscriber and solutions, you know, I mean, how far are we towards this inventory correction being done? You know, so a quarter later, Sort of where are we with inventory and CPE?
spk07: Not great visibility there, so tough to put a real number on it. It feels like we're just kind of bouncing around the bottom. I mean, it feels like there's still a lot of inventory in the field, but there are specific projects that we're winning. And actually, there's some incremental market share that we are picking up and we'll start shipping in the fourth quarter. That's kind of still offsetting what the original flow was. So I would say we're kind of just flattish. And I don't expect a real change in that through this year. So I would expect that to carry forward all the way through the end of this year. Really any growth you see in that and to some extent even offset of slowness is being offset by just new wins.
spk05: Okay. And then I guess just any color you can help us in sort of understanding how you know, on the optical piece, on the Adva piece, that this sort of, you know, inventory correction sort of hits all at once. So, you know, just any color on, I mean, it's such a big magnitude, just more color there. And, you know, is this across, U.S., Europe, enterprise, service provider. It seems like the whole business is being affected. So I just love some more color there. And then my real final last question, which I'll leave you with here and pass it on, is any early thoughts on 24? Do you think that there should be a strong growth here in 24 or that these issues will kind of make the visibility of 24 hard to say? Thank you.
spk07: That last question is a really good question. First on the timing, that's not dissimilar to what we saw on the ad trend, if you remember. The impact on the subscriber piece came very quickly. If I look back and if I look at the aggregation, the aggregation product line went through a very similar process. phenomena, the difference was the magnitude of the new customer wins offset the declines, you know, let's say to some extent offset and to a large extent offset the declines that we were seeing because of inventory corrections from existing customers. So I think the phenomena was similar. So on the optical piece, we're adding customers, right? I mean, I have no doubt. If I take a look at the the new customer wins over the last six months, it's probably the biggest, and I'm looking at Uli here, but it's probably the biggest we've ever seen in such a short period of time. We're adding new customers. As you know, those customers take a long time to turn on. And so it just doesn't have, and it doesn't have the same runway that we did on the Access and Ag, which kind of grew market size-wise at a different pace earlier. So I don't think there's a change in kind of the way that the impact is being felt. So I think that answered that. And then as far as next year, so yeah, for next year, look, I mean, you know, I mentioned that, you know, the majority of the customers that we have out there are either very slowly online or just coming online, and that's just on the access piece. They're still... significant number of opportunities that are out there that haven't been awarded yet. We're picking up over 26 customers or something like that this quarter. So sooner or later, that eclipses the slowness in the existing base. And I think that the slowness in the existing base on the access, I would expect that to recover the quickest. So on ag, we should have a fantastic year next year. Subscriber, you know, I'm worried about the magnitude of the inventory and kind of, because that inventory is not just AdTrend inventory. That inventory is everybody's inventory because, you know, customers do swap RGs and ONTs routinely. So that one's just more difficult to guess. I'm willing to say expect it through this year. It's very difficult to call an end to it. You know, I'm going to, you know, I don't think it lasts into the second half of next year. Could be still some hangover in the first half. In aggregate, though, that's a relatively, you know, if we're at the bottom, which we believe, then it'll just be kind of hanging out there. And then on the optical piece, look, it could actually, you know, I could see that. I could see the bottom. The bottom I would expect in the second half when we actually see a rebound. I would expect it. Here again, I don't expect it to be as long as the second half of next year. So if you look at that in aggregate, you've got two pieces of business that come online at latest in the second half and kind of a different trajectory than the bottom that we're starting to feel right now. And then you've got Access and Ag that's going gangbusters. So I expect next year to be a solid growth year in aggregate.
spk05: Okay. Thanks for all the call, Tom.
spk07: Okay.
spk01: Our next question comes from Greg Mesnia from West Park Capital. Please go ahead. Your line is open.
spk08: Yes. Thank you for taking my question. Tom, you referenced several times the Huawei replacement situation that's playing out both in Europe and I guess to some extent here in the U.S. Can you give us some sort of color on what inning we're in and In that process, I mean, how much of a tail do we have left for that? Thanks.
spk07: Sure, I'll give you some. So basically, if you're in Europe, maybe we should do a heat map on kind of where Huawei is still in, because I think we could do that with just public data, which would give you a better feel for it. But the way to think about it, if you're in Western Europe, and you're still using Huawei, then you're still yet to be, then you still have work to do. And my sense is we're probably in process right now, so that's either awarded RFP or contract. My sense is we're probably, I mean, it's got to be less than 30%. So because in each of these countries, you have multiple carriers. And Usually in those cases, you've got one carrier that's made a move, you know, potentially, but not the entire carrier base within that customer. And I would say that's kind of the way I would see access. And then you have the optical piece, which is later. It has just absolutely started later. And some of that may be inherent capacity that they had into their network. But we really saw a big movement in, let's say, activity and awards six months ago. And where we saw that a year, at least a year ago on the access fee. So I would say they're not as far into that. So I hope that answers your question.
spk08: Sure. So we're talking at least several quarters out.
spk07: Yes. Yes, definitely. Without a doubt, absolutely. Even on the excess space, it's still several quarters up. Thank you. And that's for the wind, right? That's for the winds, and then you still have to operationalize them. So, yes. Okay. Thank you. All right.
spk01: This question comes from George Nodder from Jefferies. Please go ahead. Your line is open.
spk04: Hi, guys. Thanks very much. I wanted to ask about lead times in the optical business. Can you just give us a sense for where lead times are now and maybe where they were at the peak of the supply chain crunch, and I'm just curious how those are changing.
spk07: Yeah, maybe a good rule of thumb is think about it as 12 months, four months in general. I mean, there are some that are longer, there are some that are shorter, but I think in general that's a good rule of thumb. Okay.
spk04: Got it. And then do you expect those lead times to shorten from the four-month level going forward? Does that make sense?
spk07: In aggregate, probably not because some of the, you know, as you're aware, George, some of these optical components just take a while to build. So I think a comfortable, if you give me the latitude of three to four months, that's kind of historic. So we're kind of in that range right now.
spk04: Got it. And then are you letting customers reschedule deliveries? I assume so. Is that fair?
spk07: Yep, that's fair. Yeah. Okay. Got it. It doesn't help me if they have a bunch of inventory. It may help me near-term. It does help me long-term, right? So, yeah, customers are rescheduling.
spk04: Got it. Okay. So, and then the other questions, I was just curious about your – thought process on the minority interest. Obviously, there's a piece of the admin business that I guess directionally you're looking to take out over time. Any new thoughts on how you handle that, how you finance it, what the pacing would be? Thanks. Sure.
spk07: So we're not in a hurry to actually retire that investment base. We initially, depending on interest rates and things, we were Looking at doing that earlier, and that's what's kind of earlier in the overall process, with where things sit right now, I think we're comfortable letting that sit out there and looking at it again. It is something that comes up in our board meetings, but it's something that we're just comfortable with the current situation is right now. Great. Okay.
spk04: Thanks very much, guys. All right.
spk07: Thanks.
spk01: Next question comes from Brian Kuntz from Needham and Company. Please go ahead. Your line is open.
spk03: I wanted to touch on the OpEx. You talked about cost cuts. I assume these are primarily synergy-related cost cuts you've talked about historically and looking to pull those in. Can you give us any color there on the slope of the curve down here? what you might expect to say exit 24 on OPEX front rate. Thank you.
spk07: Yeah, kind of easy math. There's a kind of rule of thumb. Think about 5%, 5%. 5% next quarter, 5% again next quarter. And then our exit out of the year will be at that level.
spk03: Got it. Really helpful. And on the U.S. side, sounds like some kind of ongoing strength in access and aggregation. As you look across, you're kind of, Tier 1s, 2s, and 3s, it sounds like you saw some strength in some Tier 2s executing. Is that what I heard in the RSP, the regionals?
spk07: Yes. Yeah, that business actually just on a sequential basis was up kind of high teams-ish. So, yeah, definitely. And then they bought a lot of subscriber stuff. Now, subscriber was still down, but just the access and ag, right, the OLTs and stuff was actually at a really good quarter.
spk03: And how are – lead times there on the kind of OLT-type products that you're rolling out. I know you've gone through some product transitions there, so any comment you have on the transition?
spk07: Yeah, I mean, it's a good point. It is still a bear. It is still – and it's not that we can't ship them. It is – so, you know, somebody talked about the European business. Well, that European business is predominantly our new product, 6330s. And so the magnitude of the ramp that we're doing in the second half on that 6330s is pretty gargantuan. It's probably the biggest ramp the company has ever gone through. I mean, we're literally going to be shipping tens of millions of that this quarter. And some of that is gated by product availability. But I wouldn't call it a supply chain issue. I would call that just a significant ramp.
spk03: Got it. And how about in the U.S.? How are the SDX products?
spk07: The U.S. we're doing okay. I mean, there is some tightness in it. The U.S. customer base is kind of traditionally TA5000 based, and eight-port combo cards are – I am gated by supply there. But here again, I wouldn't call that a – supply issue. I am just gated by just the sheer number that we're actually shipping there. Access and Ag in general is just doing really good.
spk03: Sounds like it. Thanks for that.
spk01: Our last question comes from Bill Dieselman from Titan Capital Management. Please go ahead. Your line is open.
spk06: Thank you. I'm going to circle back to the the the guidance and um what changed that you didn't anticipate i guess that's what i'm really trying to get my head wrapped around is is how did this end up surprising you given that you had the uh the inventory correction on the um on a historic ad tran business um why wasn't it more more obvious that this was the the next shooter drop yeah so so um and we touched on on the last call so
spk07: the real drop in the AdTran business, the significant drop in the AdTran business was subscriber solutions. So it was really RGs, ONTs. And we saw that also on the Adva business, but it was on here again, kind of the subscriber, the last point, which was IP nids, Ethernet nids. We didn't see that big of a drop on access in ag and, you know, in looking, at Access and Ag, we were adding new customers, had been adding new customers, and some of that is new customers coming online, some of that is just different pieces. So I would say the surprise was the number of pushouts in the quarter, and then just a substantially slower order rate from quarter to quarter. It was maybe not as bad, but it was kind of, it felt a little bit like subscriber. So it was kind of in between there. So it was that, it was the kind of halting of, and when we go and talk to customers, I mean, so the slide out is not just existing orders. The slide out is also, you know, customers that were saying, hey, I want to start this quarter. And now all of a sudden they're saying, hey, we've gone back and we want to start next year. We want to start Q1. And that was, you know, it wasn't so much the number of customers. It was just that it was fairly significant customers that were doing that.
spk06: And, Tom, using that last comment, customers that were just starting their program and choose to move it to Q1 from Q2, Do you think that's specific to lead times being shorter and therefore they didn't have to plan ahead as far or something totally different?
spk07: No, no. I do think that that is different. I do think that in that particular case. So first of all, there's weight on both, right? So there's weight on inventory and there's weight on project starts. And the other thing that's different about the optical business is there's a significant amount of that optical business that is project related. And those projects don't necessarily last multiple years. They sometimes last a year. They sometimes last six months. So they go in, upgrade a footprint, and they're done, right? So it's not subscriber ad-based like it is with Fiverr, Fiverr to the prem. So what we saw is explicitly, I can think of like two right now that literally were going to start in Q3 and now are starting in Q1. And that they didn't have inventory. So, yeah, that was literally kind of a rethinking of their capital for this year.
spk06: Great. Thank you. Appreciate the additional color.
spk07: Okay. I think that handles our question queue. So I appreciate all of you guys joining us on the call today. And I look forward to, let me just make sure, because I think last time I left some people hanging out there. That's all I see. Julian, do you see anybody else in the question queue?
spk01: No, we have no further questions in queue.
spk07: All right. With that, thank you, everybody, for joining us today. Really, you know, not happy about the news that we had to deliver, but we do think this is a – and we'll answer any question anybody has. You know, this is a near-term issue that I think is a, you know, broader issue than just ADTRAN. We'll get through this issue, and then all of the theses that we've been talking about will come together. So thanks very much, everyone.
spk01: This concludes today's conference call. Thank you for your participation.
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