ADTRAN Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the AdTran Holdings Incorporated Third Quarter 2023 Earnings Release Conference Call. At this time, 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 the star followed by the number one on your telephone keypad. If you'd like to withdraw your question, please press the star followed by the one once again. 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, component costs, freight and logistics costs, manufacturing efficiencies, ability to effectively integrate mergers and acquisitions, and other risks detailed in our annual report on Form 10-K for the year ended December 31st, 2022, and our quarterly report on Form 10-Q for the quarter ending June 30th, 2023. These risks and uncertainties could cause actual results to differ materially from those in forward-looking statements, which may be made during the call. The investor presentation found on ADTRAN Investor Services 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 Atran Holdings. Sir, please go ahead.

Thank you very much. Good morning, everyone. We appreciate you joining us for our third quarter 2023 earnings conference call. With me today is Atran Holdings CFO Uli Dopfer. Following my opening remarks, Uli will review the quarterly financial performance in detail, and then we'll take any questions that you may have. Before reflecting on the quarter, I'll start out by addressing the announcements that we made yesterday. We have taken decisive steps to transform our business to a leaner, more efficient, and more profitable company. We have already implemented and have recently expanded a business efficiency program focused in two key areas, cost efficiency and capital efficiency. On the cost efficiency side, the program includes the discontinuation of legacy non-core products, the streamlining of operations to align with the current market environment, and operational savings from site consolidation. These operational cost savings are expected to generate a 15% reduction in non-GAAP operating expenses from Q3 to Q4 of this year, while preserving our substantial investment in our core product and growth regions. The capital efficiency portion of the program includes suspension of the AdTran Holdings quarterly dividend and cash proceeds from site consolidation. regarding the decision to suspend the quarterly AdTrend Holdings dividend, this decision did not come lightly. Although we believe the dividend can be an appropriate value delivery mechanism, we believe that shareholders will benefit both in the near term and long term by redirecting the cash dividend to reduce our debt and interest expense. This assessment aligns with the input we received from our investors as we reached out with a recent survey where we requested input from investors that in total held more than 70% of our shares outstanding. The majority of those that responded to the survey indicated that the dividend is not their preferred use of capital at this time. Overall, we expect that the result of the capital efficiency program, including site consolidation, will produce up to $180 million in cash in 2024, which will be applied towards paying down debt and improving our capital structure. Coming out of this program, we expect to be a leaner, more efficient, and more profitable company and one that can easily navigate market uncertainty and, of course, drive higher returns once we get past these near-term market headwinds. Moving to the results in the third quarter, the product mix and regional split of revenues were consistent with the first half of this year, pointing out that there are no fundamental changes in demand for the product categories or regions that we're serving. However, we did see slower spending with our midsize and larger service provider customers as they continue to reduce inventory levels, and took a more cautious approach given the uncertain macroeconomic conditions. This cautiousness did lead to a general slowdown in revenue for the quarter. Looking across our customer base, our large enterprise customers and regional broadband service provider customers showed the most stability relative to previous quarters. The large enterprise customer segment primarily consists of governments, universities, financial institutions, and web-scale companies purchasing optical network solutions for public and private data center, interconnect applications. The regional service providers continue to be driven by the buildup of fiber networks across the U.S. and the U.K. Taking a long-term view, we are still making good progress on key initiatives around fiber footprint capture, high-risk vendor replacement, fiber network cross-selling synergies, and adoption of our software platforms. These are the initiatives that will drive long-term, sustainable growth after the market recovers from the near-term headwinds. Starting with customer acquisition, we added 13 more fiber to the home operators during the quarter. As we bring on these fiber to the home operators, we are having increasing success in selling them our complete portfolio, including our in-home Wi-Fi solutions and SAS applications, while also driving interest in our packet optical portfolio. This growth in the U.S. is well aligned with the broadband funding still ahead of us, with large programs like BEAD expected to make impact in late 2024 through 2026. Looking outside the U.S., we continue to be one of the biggest beneficiaries of high-risk vendor replacement initiatives. In this past quarter, we were awarded two key Tier 1 Metro WDM projects, which would have likely been awarded to high-risk vendors in the past. On the fiber-to-the-home side, we have multiple large service provider opportunities in the funnel in Europe, where we are well-positioned for success, considering that we shipped over 75,000 ports of our new flagship OLT platform, the SDX 6330, this past quarter. and this platform is an ideal fit for these customers. While some of these vendor replacement initiatives won't produce market material revenue in this year, we are on pace to become the market share leader in both Metro WDM and fiber to the home OLT solutions in Europe within the next two years. We continue to build momentum in our packet optical portfolio in the U.S. regional service provider space, and we are, of course, expanding our footprint of fiber access across Europe. The timing of these opportunities is a good match to enhancements in our optical transport folio that are targeted to the needs of regional service providers, including our new coherent pluggable modules, our open line system optimized for regional networks, and a new generation of cost, space, and power optimized optical terminals that are 800 gig ready. For the 100 ZR coherent pluggable module, which is highly anticipated across a broad range of customers, We are launching trials this quarter, and we have already received orders for future deployments. On the software side, we added 68 new Mosaic 1 customers in the quarter, the second highest number in additions in any quarter, driving adoption of Mosaic 1 to more than 300 customers in total. This growth in SaaS has been aided by the recent launch of Intellify, our cloud-managed Wi-Fi solution, paired with the launch of our next-generation Wi-Fi 6, Wi-Fi 6e, and Wi-Fi 7 platforms, that deliver high performance multi gig speeds and a compact form factor. We expect continued growth in both SAS and our in-home platforms in the quarters ahead, given the enhancement to this portfolio and the broader adoption of our software platforms. In addition to our SAS offerings, we continue to grow our base of recurring revenue associated with hardware and software maintenance and our leading network infrastructure and network management platforms. This portion of our revenue streams offers high margins more predictability, and steady growth opportunities while contributing towards our software-related revenue that generates more than 10% of the total company revenue at this point in time. In summary, we continue to focus on capturing fiber footprint with our optical transport and fiber access platforms, led by the US and Europe, and then drive adoption of our complete portfolio, including subscriber platforms, software applications, and services. Despite broader market challenges, we still made progress against these goals. While we remain very confident in our long-term outlook, we are in a period of market uncertainty due to ongoing inventory reductions and more restrained capital spending across our service provider customer base, particularly in the large service customer segment. This uncertainty led to more order push-outs in Q3 and Q4 this year, driving us to take a more cautious approach with our forecast and operating model. We are now planning for a scenario in which the current headwinds could persist through 2024. As a result, we decreased our non-GAAP operating expense levels during the past quarter, consistent with previously stated targets, and we have set additional expense reduction targets for early next year. Non-GAAP operating expenses were reduced 6% this past quarter relative to Q2, and as stated earlier, we expect to see an additional 15% reduction in non-GAAP operating expenses this quarter as part of our expanded efficiency program. As noted earlier, we are still focused on investing in products and regions that are core to our growth in the future and are still achieving our planned cost optimizations with those in mind. Our continued focus on customer capture in high growth regions, new product innovation, improving margins, and operational cost savings has us well positioned for long-term growth after we navigate the headwinds that are in our market. With that, I will turn things over to Uli to provide a review of our financial results, and then following Uli's remarks, we'll open it up to any questions that you may have. Uli.

Thank you, Tom, and hello, everybody. I will cover our third quarter 2023 results and provide our expectations for the fourth quarter. Please note that Q3 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. Q3 2023 revenue came in at $272.3 million and was down 20% year over year and down 17% quarter over quarter. Our network solutions segment accounted for 83.9% of revenues in Q3 compared to 89.5% in Q3 2022 and 86.4% in Q2 2023. Our services and support segment contributed 16.1% of revenues in Q3 2023 compared to 10.5% in the year-ago quarter and 13.6% in the previous quarter. Access and aggregation contributed 34.8% of revenue and grew 7.3% compared to the year-ago quarter, but was down 7.9% compared to the previous quarter. Our optical networking solution category contributed 42.7% revenues and was down 2.2% year-over-year and down 18.7% quarter-over-quarter. Subscriber solutions continued to struggle and was down 54% year-over-year and 24.7% quarter-over-quarter and contributed 22.6% of Q3 revenues. As Tom mentioned earlier, all three revenue categories were impacted by constrained customer spending. Regionally, year over year, third quarter domestic revenue was down 34.3% and international revenue declined 6%. International revenue made up 59.1% and domestic revenue contributed 40.9% of total Q3 revenues. We had one 10% or more of revenue customer in Q3. Q3 non-GAAP gross margin was 40.3% and increased by 220 basis points year-over-year and 170 basis points sequentially. The year-over-year and quarter-over-quarter increase is due to low purchasing and transportation costs and a more favorable customer and product mix. Our cost synergies are starting to show the expected effects. Compared to Q3 2024, which was a quarter with only a partial adverse contribution, our non-GAAP operating expenses were $114.9 million, increasing by 5% year-over-year. However, compared to Q2 2023, non-GAAP operating expenses decreased by 6%. We reduced non-GAAP R&D spend by 4% and SG&A expenses by 8% quarter-over-quarter. Non-GAAP operating expenses were 42.2% of revenue compared to 32% of revenue in Q3 2022 and 37.5% of revenue in Q2 2023. Non-GAAP operating loss was 5.1 million, which translates into a non-GAAP operating margin of negative 1.9%. The quarter-over-quarter and year-over-year decrease in our operating profitability is due to lower revenues, partially offset by increased gross margins and operating expense improvements. The company's non-GAAP tax provision for the third quarter of 2023 was $6.8 million. The company's GAAP tax was a benefit of $16.6 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 the income statement results, total non-GAAP net loss was $13.7 million and a net loss of $10.8 million after adjusting for minority shareholder interest in Adren Networks SE. This resulted in diluted loss per share attributable to the company of $0.14 per share. Turning to the balance sheet and cash flow statement. Cash and cash equivalents totaled $116.1 million at quarter end. Cash flow generated from operations was 6.8 million and improved by 23 million compared to the previous quarter. Trade accounts receivable were 229.3 million at quarter end, resulting in DSO of 77 days compared to 67 days in the prior quarter. Inventories were 374 million at the end of the third quarter, resulting in terms of 2.0 compared to 2.3 in Q2 2023. Inventory includes a write-off of 21 million as we accelerated the end of life of certain products to streamline our product offerings. Accounts payable were 148.9 million, resulting in DPO of 60 compared to 59 in the previous quarter. As Tom mentioned earlier, We have taken decisive steps towards a much leaner and more efficient company. Furthermore, we have taken measures to deliver our balance sheet and strengthen our capital structure. For this reason, we implemented and expanded a business efficiency program which consists of a cost efficiency program and a capital efficiency program. With the cost efficiency program, we are expecting annual savings of 90 million by the end of 2024. The key initiatives of the program are global workforce reduction, site consolidation, including partial sale of owned real estate, which will reduce operating cost and increase efficiency, and then accelerated end of life of certain products. First three sides of the cost efficiency program will already be effective in Q4 2023. We estimate to reduce our non-GAAP operating expenses sequentially by 15%. With our enhanced operating model, we are expecting to return to non-GAAP profitability latest by Q2 of next year and to generate positive free cash flow. As part of the capital efficiency program, The company yesterday decided to suspend the quarterly dividend, generating annual cash savings of 28 million, which we will use to contribute on the execution of our business efficiency program and to repay debt. In addition, we are executing our site consolidation program, which will include divestiture of certain company-owned real estate. In total, we expect to generate cash of up to 180 million, which will be used to repay our existing debt borrowings and improve our capital structure. Ultimately, we believe that this business efficiency program will benefit all our stakeholders and will increase shareholder return. Consistent with our industry, we expect for Q4 similar trends compared to Q3 and anticipate that the ongoing macroeconomic challenges and higher inventory levels at our customers will continue into 2024, affecting our customers' ability to invest. We expect our industry being challenged through the first half of 2024. To address these challenges, we are concentrating on aspects we can influence, specifically managing cost and enhancing operational efficiency. We are actively working to reshape our business at its core, and we remain committed to implementing our strategy aimed at bolstering our strong position in fiber access and optical networking. For the fourth quarter of 2023, we expect revenue to range between $210 and $240 million, and we expect a non-GAF operating margin between negative 7 and 0% of revenues. Looking beyond 2024, I would like to discuss with you our midterm financial target model, which builds on our enhanced operating model. We expect to be ideally positioned based on our existing customer base and continuous success of new customer wins. Our comprehensive product and software portfolio. The future tailwinds arising from government funding and high risk vendor replacement initiatives. and most importantly, the strength of the global Atron team. We are targeting to achieve a sustainable, non-gap operating margin in the low teens for the year 2025. This comprehensive and forward-looking financial model is designed to guide the company's growth, enhance the financial stability, and ensure a prosperous future for all our stakeholders. Once again, additional financial information is available at Attrend's Investor Relations webpage at investors.attrend.com. Thank you for attending our call. I will now turn it back over to the operator and we will take your questions.