Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN Holdings, Inc. Second Quarter 2023 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. 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 cost, 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 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, Julian. Good morning, everyone. We appreciate you joining us for our second-quarter 2023 earnings conference call. With me today is ADTRAN Holdings' CFO, Uli Dopfer. After my opening remarks, Uli will review the quarterly financial performance in detail, and then we will take any questions you may have. I'll begin by discussing our performance this past quarter and then we will cover our current market positioning, both short-term and long-term. The results in Q2 were within our guidance range provided during the last call and in line with our expectations regarding product mix and regional distribution. As in Q1, revenues this quarter were primarily driven by our Optical Network Solutions and our Access and Aggregation Solutions. The revenue split was 40% from the US and 60% from non-US markets, which is consistent with recent quarters. Looking at various market segments, US regional service providers were among our strongest customer groups, especially for fiber access platforms, as these customers continue to expand their fiber presence in underserved areas. Due to capital requirements in Germany, we issued a pre-announcement regarding lower revenue projections for the second half of this year. This adjustment is mainly due to inventory optimization and changes in optical networking solutions as customers reassess their inventory and bookings. Our Access and Aggregation solutions, as well as our subscriber solutions, are not expected to experience further forecast changes this year due to ongoing inventory management. Our investment thesis remains unchanged and we are optimistic about our industry in 2024 and beyond. We made significant progress this past quarter in executing strategic initiatives to maximize broadband funding opportunities, become the preferred alternative for Huawei replacements in fiber networking, and promote cross-selling synergies within our comprehensive portfolio. I want to emphasize that this success is occurring during a time of unprecedented funding for fiber-based broadband networks and a shifting away from high-risk vendors, particularly in Europe, where we have secured more Huawei replacement business than anyone else in our sector. To put it simply, we are witnessing a transformation of the vendor landscape across Europe, and we are positioned to benefit significantly from this market shift. Regarding customer acquisitions, we achieved our second-highest quarter ever for new fiber-to-the-home operators by adding 26 new customers in Q2, primarily in the US with regional service providers that are benefiting most from broadband stimulus funding. This growth in customers aligns with our strength in the US regional service provider market and the anticipated growth in fiber access platforms for the second half of the year. Additionally, in Europe, we secured another large multinational operator for access, continuing our success in the EMEA region and raising the total number of large fiber access customers there to seven. Many of these customers have not yet achieved scale deployments, and even without their contributions, ADTRAN has moved to the number two position, surpassing Huawei in market share for fiber access platforms across North America and EMEA. This progress underscores that the work we are doing today will lead to substantial revenue opportunities as we move out of the current environment. Similarly, our vendor replacement strategy for Europe has been successful in the optical transport space. During the quarter, we achieved a significant win in Metro WDM with a large multinational operator in Europe, building on our ongoing achievements in that region. We are also enhancing our cross-selling capabilities as we integrate our teams and processes. Recently, two large service providers expanded their business with us—one being an existing optical networking customer now selecting our fiber access platforms and another an existing fiber access customer opting for our optical network solutions. As we enhance our optical portfolio catered to regional operators, further integrate our solutions under a unified management system, and present our complete portfolio to customers, we expect to boost these cross-selling synergies. On the software front, we added a record number of new customers to our latest Mosaic One SaaS offering. We now have over 275 service operators adopting Mosaic One, up from 200 just at the end of last quarter. This increase in SaaS customers has significantly contributed to our recurring software revenue growth over the past year, and we anticipate accelerating this growth in the coming year. To summarize our strategic approach, we plan to capture new fiber footprint with our optical transport and fiber access platforms in markets with the highest growth potential, particularly in the US and Europe. Next, we aim to cross-sell our entire portfolio, including our software and subscriber platforms. This past quarter was very successful in building momentum behind this strategy. While we remain confident in our long-term outlook, we recognize that we are still navigating a period of uncertainty as customers adjust their inventory and near-term capital plans. Consequently, we have reduced our non-GAAP operating expense levels during the quarter and will continue to manage our expenses throughout the remainder of the year. Overall, our focus on fiber networking, customer growth, and improved inventory management and operational cost synergies position us as the largest beneficiary in this historic global investment in fiber networks. While short-term headwinds exist, they are just that—short-term—and our outlook remains strong. With that, I will hand it over to Uli for a review of the financials, and after Uli's remarks, we will open the floor to any questions you may have.

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 ADTRAN Networks 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 investor.adtran.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. Q2 2023 revenue came in at $327.4 million, within our guidance range of between $325 million 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 & 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, SSME 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% compared to the previous quarter. Our Optical Networking Solutions category contributed 43.7% of revenues and was down 3.2% from a record quarter in Q1 2023. On a regional basis for year-over-year, second-quarter domestic revenue grew by 24.8% and international revenue increased by 194.7%. Similar to Q1, international revenue made up 59.7% and domestic revenue contributed 40.3% to total Q2 revenues. We had one customer with 10% or more of revenue 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 offset by high legal costs. Non-GAAP operating expenses were 37.5% of revenue compared to 31.5% of revenue in Q2 2022 and 38.9% of revenue in Q1 2023. Non-GAAP operating income was $3.6 million, which translates into a non-GAAP operating margin of 1.1%, 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. For the third quarter, we anticipate a quarter-over-quarter improvement in profitability 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 expenses 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 ADTRAN Networks SE. This resulted in diluted earnings per share attributable to the company of $0.00 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 receivables 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 flows. All of this is negatively impacting our revenue expectations for Q3. We don't expect any changes to our midterm 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 is only of a temporary nature. Our comprehensive product offerings, architectures, 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 million and $305 million, and we expect a non-GAAP operating margin of between -5% and 0% of revenues. Once again, additional financial information is available at ADTRAN's Investor Relations webpage at investor.adtran.com. Now I will turn it back over to Tom, and we will take your questions.

All right. Thanks, Uli. Julian, we're ready to open it up for any questions people may have.

Thank you. Our first question comes from Michael Genovese from Rosenblatt Securities. Please go ahead. Your line is open.

Okay. Thanks a lot. 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 Networks released 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?

Yes, let me express it differently. It appears that the traditional ADTRAN business, particularly the access and agriculture segments, is performing well, and we anticipate growth in the latter half of the year. Regarding subscribers, we mentioned the inventory situation, which seems to be relatively stable. The primary decline is in the optical segment. I would describe the situation as such: the ADTRAN side of the business experienced the downturn first, possibly due to our focus on access, which tends to follow a different buying cycle. The subscriber segment then followed, both during the upswing and the downturn. I believe we are seeing a similar pattern now. The legacy ADTRAN aspects are stabilizing, and we expect that to improve soon, with ADTRAN adapting afterwards. Your interpretation of the situation is accurate.

Okay. Great. I just want to follow up then quickly like I think there's three pieces here in the business and I want to follow up on each of them. So for access and aggregation, can you just sort of characterize how the European Tier 1s who have already started to deploy. So like 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, how the European Tier 1s are?

Very strong in the second half. Europe in general will be strong in the second half.

And then could you characterize for us just in the CPE subscriber in Solutions. I mean, how far are we towards this inventory correction being done? So a quarter later, sort of where are we with inventory in CPE?

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 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 as being offset by just new wins.

Could you provide some insight into the inventory correction related to the optical segment and the ADVA piece? It appears that this correction is impacting the entire business all at once. I'm interested in understanding whether this is affecting operations across the US, Europe, and enterprise service providers. I’d appreciate more details on that. Additionally, do you have any preliminary thoughts on the outlook for 2024? Will it be a year of strong growth, or do you anticipate that these issues will complicate visibility for that year? Thank you.

Yes, that last question is very relevant. Regarding the timing, it's somewhat similar to what we experienced with ADTRAN. The impact on subscribers occurred quite rapidly. If I reflect on the aggregation product line, it went through a similar situation. However, the substantial new customer acquisitions more than balanced out the decline we were seeing due to inventory corrections from existing customers. Therefore, the phenomena were similar. For the optical segment, we are indeed adding new customers. In fact, over the past six months, we've likely seen the largest influx of new customers in such a short time frame. These new customers take time to activate, so they won't ramp up as quickly as what we experienced in access and aggregation, which grew at a different pace earlier on. I don't see a change in how the impact is being felt. As for next year, most of our customers are either slowly coming online or just starting to do so, particularly in the access segment. There remain many significant opportunities that have yet to be awarded. We are onboarding around 26 customers this quarter, which will eventually surpass the existing slowdowns. I anticipate that the existing slowdowns in access will recover the quickest, leading to a strong year next year for access and aggregation. I do have concerns about the magnitude of the inventory situation because it involves not just our inventory but that of all players, since customers frequently swap routers and optical network terminals. This situation is challenging to navigate. I believe this inventory issue will not extend into the second half of next year, although there may still be some residual impact in the first half. Overall, if we are indeed at the bottom, things should stabilize. For the optical segment, I expect to see a rebound in the second half of next year, though I don’t foresee a lengthy recovery process. Considering everything in aggregate, we have two segments that should perform well by the second half, alongside strong growth in access and aggregation. Therefore, I do expect next year to be a year of solid growth overall.

Okay. Thanks for all the color, Tom.

Okay.

Our next question comes from Greg Mesniaeff from WestPark Capital. Please go ahead. Your line is open.

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 US. Can you give us some sort of color on what inning we're in that process? I mean how much of a tail do we have left for that? Thanks.

Sure, I can provide some insight. In Europe, it might be helpful to create a heat map showing where Huawei is still present, based on public data, to give you a clearer picture. In Western Europe, if companies are still using Huawei, they have some work to do. I believe we are currently in the process of addressing this situation, which includes awarded RFPs or contracts. My estimation is that it's likely below 30%. Each country typically has multiple carriers, and often no single carrier has made significant moves yet, although that might not apply to all carriers in the area. This is how I perceive the access situation. As for the optical aspect, it has just started gaining momentum and seems to be behind. Some of that may be due to inherent capacity already in their networks. We observed significant activity and awards about six months ago, compared to where we were over a year ago with the access issue. So, I would say they haven’t progressed as much in that area. I hope this addresses your question.

Sure. So we're talking at least several quarters out.

Yes. Yes, definitely. Without a doubt, absolutely. Just even on the excess piece, it's still several quarters out. And that's for the win, right, that's for the wins, and then you still have to operationalize them. So, yes.

Our next question comes from George Notter from Jefferies. Please go ahead. Your line is now.

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.

Yes. Maybe a good rule of thumb is think about it as 12 months, 4 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.

Got it. And then do you expect those lead times to shorten from the performance level going forward? Does that make sense?

In general, probably not, since some of these optical components take time to manufacture. If you allow me three to four months as a typical timeframe, we are currently in that range.

And then are you letting customers reschedule deliveries, I assume so. Is that fair?

Yes, that's fair.

Got it. Okay. And then the other question, I was just curious about your thought process on the minority interest. Obviously, there's a piece of the ADVA 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.

We are not rushing to divest from that investment base. Initially, we considered doing it sooner depending on interest rates, but given the current circumstances, we're comfortable with it as it stands. This topic is discussed in our Board meetings, but for now, we are satisfied with the situation.

Great. Okay. Thanks very much, guys.

All right. Thanks.

Next question comes from Ryan Koontz from Needham & Company. Please go ahead. Your line is open.

I wanted to touch on the OpEx. You talked about cost cuts. I assume these are primarily synergy-related cost cuts you talked about historically and looking to pull those in. Can you give us any color there on kind of the slope of the curve down here and what you might expect to say exit '24 on OpEx run rate? Thank you.

Yes, it’s a simple way to look at it. Consider 5% for the next quarter, another 5% for the following quarter, and we’ll finish the year at that rate.

Got it. Really helpful. And on the US side, it sounds like some kind of ongoing strength in access and aggregation as you look across your kind of Tier 1s, 2s, and 3s. It sounds like that you saw some strength in some Tier 2s executing? Is that what I read heard in the RSB, the regionals?

Yes. Yes. That business. Actually, just on a sequential basis, it was up kind of high teens. So definitely, and then they buy a lot of subscribers' stuff. Subscriber was still down, but just the access and ag, right, the OLTs and stuff has actually had a really good quarter.

And how are lead times there on the kind of OLT type products you're rolling out? I know you've got there some product transitions there. So any comment on the transition?

Yes, that's a valid point. It is still a barrier. It's not that we can't deliver them. Regarding the European business, it's mainly focused on our new products, particularly the 6330, and the scale of the ramp-up we're executing for that product in the second half is quite substantial. This is likely the largest ramp the company has ever experienced. We are set to ship tens of millions of units this quarter. Some of this is limited by product availability, but I wouldn't categorize it as a supply chain issue; rather, it's simply a significant ramp-up.

Got it. And how about the US, how the SDX product is kind of very impressive?

In the U.S., we're doing okay. There is some tightness in the customer base, which is traditionally based on TA5000 and eight port combo cards. I'm limited by the number we are actually shipping there. However, I wouldn't categorize that as a supply issue. Access and Ag general is performing really well. Thank you.

Thanks for that.

Our last question comes from Bill Dezellem from Tieton Capital Management. Please go ahead. Your line is open.

Thank you. I want to circle back to the guidance. And what changed that you didn't anticipate? I guess that's what I'm really trying to get my head wrapped around is how did this end up surprising you given that you had the inventory correction on the historic ADTRAN business. Why wasn't it more obvious that this was the next shoe to drop?

Yes, we discussed this in the last call. The notable decline in the ADTRAN business was primarily due to subscriber solutions, specifically RGs and ONTs. We also noticed this on the business side, particularly related to IP Ethernet nets, but there wasn't a significant decrease in access and ag. When we examine access and ag, we've been gaining new customers, which includes both new clients coming onboard and various other factors. The unexpected element was the number of delays we experienced this quarter, along with a markedly slower order rate from one quarter to the next. While it wasn't as severe, it felt reminiscent of the subscriber situation. There was a notable stall, and when we spoke with customers, the delays were not just regarding existing orders; they also included clients who initially wanted to begin this quarter but then decided to postpone until next year, specifically Q1. It wasn't necessarily a large number of customers, but the impact came from a few significant clients making this change.

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?

I believe this situation is different. There's pressure on both inventory and project starts. A key point about the optical business is that a large portion is project-related, and these projects typically don’t span multiple years. They can take a year or sometimes only six months. Companies come in, upgrade their facilities, and then they're done. Currently, I can think of two specific projects that were originally set to start in Q3 but are now pushed to Q1 due to inventory issues. This reflects a realignment of their capital plans for this year.

Okay. Thank you. Appreciate the additional color.

I believe we have addressed all the questions. Thank you all for participating in the call today. I look forward to ensuring everyone has had their opportunity to ask questions. Julian, do you see any additional questions in the queue?

No, we have no further questions in queue.

Thank you, everyone, for being with us today. We're not pleased about the news we had to share, but we believe this is a temporary situation that extends beyond just ADTRAN. We will resolve this issue, and then all the concepts we've discussed will align. Thank you very much.

This concludes today's conference call. Thank you for your participation. You may now disconnect.