ADTRAN Holdings, Inc. Q3 FY2025 Earnings Call

Good morning. My name is Carly, and I will be your conference operator today. I would like to welcome everyone to the ADTRAN Holdings Third Quarter 2025 Financial Results Conference Call. I would now like to turn the call over to Mr. Peter Schuman, Vice President, Investor Relations. Please go ahead.

Thank you, Carly. Welcome, and thank you for joining us today, and welcome to all those joining by webcast. During the conference call, ADTRAN representatives will make forward-looking statements that reflect management's best judgment based on factors currently known. However, these statements involve risks and uncertainties, including those detailed in our earnings release, our annual report on Form 10-K as amended and other filings with the SEC. These risks and uncertainties could cause actual results to differ materially from those in our forward-looking statements, which may be made during the call. We undertake no obligation to update any statements to reflect events that occur after this call. During today's call, we will refer to certain non-GAAP financial measures. Reconciliations of GAAP to non-GAAP measures and certain additional information are included in our investor presentation and our earnings release. We have not provided reconciliations of our fourth quarter 2025 outlook with regard to non-GAAP operating margin because we cannot predict and quantify without unreasonable effort, all of the adjustments that may occur during the period. The investor presentation has been updated and is available for download on the ADTRAN Investor Relations website. Turning to the agenda. Tom Stanton, ADTRAN Holdings' CEO and Chairman of the Board, will provide key highlights of the third quarter of 2025. Tim Santo, our Senior Vice President and CFO, will review the quarterly financial performance in detail and provide our fourth quarter 2025 outlook, and then we will take any questions you may have. I'd like to now turn the call over to Tom Stanton.

Thank you, Peter. Good morning, everyone. ADTRAN delivered solid third quarter results with revenue near the upper end of our guidance and higher operating margins. All three business categories achieved double-digit year-over-year growth, reflecting disciplined execution, new customer wins and healthy demand for fiber networking solutions. Operating profit exceeded the midpoint of our outlook, underscoring the solid execution and our focus on leveraging financial performance as a driver of longer-term value creation. The quarter was led by strong results in Optical Networking and Subscriber Solutions, while Access & Aggregation reflected anticipated buying patterns of two large European customers. We expect those customers to come back online either late in the fourth quarter or early next year. We remain confident about the overall market for the remainder of this year, however. During the quarter, we closed on a $201 million financing transaction that lowered our borrowing cost and increased financial flexibility, important steps that strengthen our capital structure and position us to execute confidently on longer-term strategic objectives. Turning to the quarterly results. ADTRAN reported $279.4 million, reflecting strong year-over-year growth across all three revenue categories. This marks the fifth consecutive quarter of sequential growth and fourth consecutive quarter of year-over-year improvement, proof points that our portfolio strategy and market positioning are driving sustainable momentum. This consistency underscores the health of our business, continued improvement in market conditions and the progress we are making in strengthening our foundation for longer-term growth. From our customers' perspective, engagement across our portfolio continues to strengthen as we broaden our technology reach. We're making it easier to choose ADTRAN, not just because of what we build, but because of how seamlessly our solutions work together. Our integrated portfolio means fewer handoffs, faster time to value and one accountable partner across optical, access, subscriber and software. Our technology is the enabler, but the outcome is what matters; simpler operations, greater efficiency and a trusted relationship that continues to open new opportunities for collaboration. Our Optical Networking solutions grew 47% year-over-year and 15% sequentially, driven by strong momentum in Europe, including deployments with a new large service provider. We added 15 new optical customers in the quarter, reflecting continued share gains and the expanding reach of our portfolio. Demand remains robust and geographically diverse, supporting a wide range of applications. These include national networks throughout Europe, secure connectivity for major enterprises and government clients worldwide with high-capacity interconnects for large-scale content providers. Access & Aggregation revenue grew 12% year-over-year, supported by ongoing fiber access investments among regional operators in the U.S. and Europe. While revenues from our small and medium service providers in the U.S. were substantially up, this increase was offset by the seasonal buying pattern of two major European customers. We added 14 new customers for our fiber access and Ethernet aggregation platforms, demonstrating continued traction across both new and existing markets. In Subscriber Solutions, revenue grew 12% year-over-year and 21% sequentially, driven by demand for both residential and wholesale applications. We added 18 new customers during the quarter as service providers continued expanding fiber reach and upgrading Wi-Fi capabilities. This quarter, we introduced Mosaic One Clarity, a new application built on our carrier-grade Agentic AI platform that enables predictive maintenance, guided issue resolution and proactive network optimization. Early results from customer pilots are promising, demonstrating a reduction of up to 75% in network-related trouble tickets. This is a strong validation of our AI-driven approach to network intelligence and a clear example of how innovation within Mosaic One is helping operators improve performance and efficiency. Structural shifts across our industry from core to edge computing and the advent of intelligent networks are reshaping connectivity worldwide. AI isn't just transforming data centers; it's redefining the entire network. The rise of distributed computing and edge processing is driving new requirements for bandwidth, latency and reliability, fueling demand for high-capacity optical solutions, next-generation access platforms and intelligent software to automate operations. ADTRAN is uniquely positioned at the intersection with our differentiated portfolio and our Mosaic One operating platform. As investment accelerates in AI and cloud computing, upgrades will follow across the network through metro transport, access and aggregation, and ultimately, the subscriber edge. Our Optical Networking, Access & Aggregation, Subscriber Solutions and Mosaic One software are built for that cascade, delivering higher throughput, lower latency and smarter, more efficient operations at scale. In summary, Q3 was another quarter of solid execution and strategic progress, marking a clear step forward in both performance and positioning. We delivered top line momentum and profitability improvements while enhancing our ability to invest and operate with greater financial flexibility, all of which reflects the disciplined way our teams are executing across the business. More importantly, we are setting the foundation for sustained value creation. The actions we've taken to enhance efficiency, strengthen our balance sheet and sharpen our focus are enabling us to operate from a position of greater agility and confidence. As Tim will discuss in more detail during the financial review, our scale efficiencies are creating meaningful operating leverage across the business. With disciplined cost control and a strengthened balance sheet, we see a line of sight to continued margin expansion and earnings growth as we move through 2026, all while maintaining the same financial discipline that has guided our progress. With that, I will turn the call over to Tim to review the financial results in more detail. Tim?

Thank you, Tom, and thank you all for joining us this morning. We delivered solid results in the third quarter, reflecting strong discipline and consistent execution across the business. As Tom shared, we achieved broad-based revenue growth, higher margins and improved operational efficiency as benefits from increased scale began to take hold. Demand was strong in optical networking and subscriber solutions, supported by healthy customer activity and continued broadband investment globally. Over the past quarter, we've reinforced the operational fundamentals of the business and enhanced our financial controls and processes to support growth. These actions strengthen reliability and transparency of our published results and position us to deploy capital effectively, aligning operational execution with long-term value creation. As Tom shared, the third quarter also marked a significant step in strengthening our capital structure. The $201 million transaction that we completed has lowered borrowing costs, improved liquidity and substantially reduced risk. While it also unlocks significant availability under our revolving credit facility, it does not change the strategic priorities we've outlined to monetize our non-core assets. As many of you know, we recently engaged new partners to represent the sale of our Huntsville campus. Together, we have relaunched a targeted marketing process and are actively speaking with interested parties. We will remain disciplined on terms and timing, and we'll provide updates as appropriate. Simply put, we are moving forward with the process with focus and intent. Maintaining a healthy balance sheet remains a top priority. We've made tangible progress this year, and our balance sheet today is more resilient, flexible and better aligned to support long-term growth. Turning to the financial results for the third quarter of 2025. Revenue was $279.4 million, up 23% year-over-year and 5% sequentially, finishing at the high end of our guidance. Growth was broad-based, led by Optical Networking, which increased 47% year-over-year. Geographically, non-U.S. revenue accounted for 57% of total revenue, while the U.S. represented 43%. One customer contributed more than 10% of total revenue during the third quarter. Non-GAAP gross margin improved to 42.1%, up both sequentially and year-over-year, driven by scale efficiencies, product mix and component cost reductions. We remain focused on sustaining gross margin in the 42% to 43% range over the long term. Non-GAAP operating profit rose to $15.1 million or 5.4% of revenue, exceeding the midpoint of our outlook. On a sequential basis, operating profit increased by $7.1 million or 89% compared to $14.6 million from approximately 0 in the prior year. Operating income during the same period has increased to 5.4% in Q3 2025 from 3% in Q2 2025 and 0.2% in Q3 2024. Currency had a minimal impact on our earnings this quarter. While volatility persists across both revenue and expenses, our natural hedging framework continues to mitigate risk. Building on the stronger forecasting, reporting and treasury processes established this year, we are now expanding our FX strategies to further protect our balance sheet and working capital. Non-GAAP tax expense in Q3 2025 was $3.5 million or an effective rate of 38.3%. Non-GAAP EPS was $0.05 compared to breakeven in Q2 2025 and compared to a loss of $0.07 one year ago. We continue to strengthen our financial position with working capital improving by $13.2 million. Accounts receivable increased by $13.9 million, resulting from increased sales with DSO remaining relatively flat at 59 days. Inventory declined by $16.3 million sequentially, reducing days inventory outstanding by 11 days to 124. Accounts payable totaled $188.9 million with days payable outstanding remaining flat at 70 days. We remain focused on maintaining a healthy balance sheet with our objective of achieving a net positive cash position. Operating cash flow was $12.2 million, and year-to-date, we've generated $38 million in free cash flow. We ended Q3 2025 with $101.2 million in cash, cash equivalents and restricted cash and importantly, a stronger liquidity position. In summary, Q3 reflects disciplined execution, profitability improvement and continued financial progress. We entered the fourth quarter with confidence, despite typical seasonal factors, fewer shipping days, holiday-related customer acceptances and budget timing. While those dynamics remain, we expect solid demand and our execution to offset the usual headwinds. We expect revenue between $275 million and $285 million and anticipate a non-GAAP operating margin of 3.5% to 7.5%. We expect OpEx to remain relatively flat compared to Q3. We look forward to a strong finish to the year and remain focused on driving sustainable growth and maximizing long-term stockholder value. I now turn the call back to Tom for some concluding remarks.

Thanks, Tim. I think we'll open up to some questions first. Carly, at this point, we can open up the question queue for any questions people may have.

Your first question comes from Michael Genovese with Rosenblatt Securities.

I guess my first question is, looking at the Access & Aggregation and the comments on the European customers there as well as the information put out by ADTRAN Networks in Europe talking about a little bit of a timing change. So my question is, was there like a pushout of some things? I know the first half of the year tends to be seasonally stronger than the second half in that Access & Aggregation European business. But versus prior expectations, was there some kind of push out in the timing of some of those shipments?

There has been some changes in the timing. We have two major customers that typically lead the way. In fact, they are among our largest customers for the year. One of the customers has a calendar that does not align with the norm, which means their budget cycles are also different. However, there are always some ups and downs. So, the answer is yes.

Okay. I'm sorry, but I couldn't quite follow your update on the real estate. Could you please explain it again?

Sure. What Tim mentioned is that we have placed both buildings back on the market. We are actually receiving multiple offers, right Tim? I'll let you elaborate on that.

We've been working through an exclusivity agreement this past quarter, during which we took the buildings off the market. As we mentioned previously, they are now back available and actively being marketed. We have received interest from multiple parties for both parts of the campus and are engaging in regular discussions.

Okay. I have a broader question. Traditionally, the telecom market has not experienced rapid growth; it's generally a single-digit growth market. So, if ADTRAN aims to exceed that growth rate and become a high single or double-digit growth company, is this due to fundamental acceleration in your fiber and access initiatives, or are you capturing market share? Alternatively, is there a shift towards higher growth markets, such as increased data center involvement? How should we view 2026 and identify the key drivers for the business at a high level?

I kind of agree with everything you're saying. I mean you typically see the telecom market in the single digits, kind of mid-to-high single digits, and it varies year-to-year. Our premise has been, there is that typical growth. We believe markets in general are focused right now on data center speeds and data center capacity is starting to affect the overall market, although I don't think that's reflected in numbers today. But the premise is, there's a significant market share disruption happening in Europe right now, and we are the number one winner in that market share grab happening in Europe. The largest player in Europe is being displaced.

Is there anything new happening in Germany regarding Huawei? I understand that Germany had already decided to limit Huawei's presence, but I'm unsure if they have actually started replacing it yet. Could this lead to an actual replacement of Huawei?

Yes, they could. I think over time, rip and replace is going to have to happen everywhere just because you have to maintain the network and you can't be getting new drops of code all the time. There has been a lot of talk over the last few weeks about trying to accelerate that process in Germany. I don't think there's been any material rip and replace at this point in time. I think what they've been trying to do is effectively cap utilization on an ongoing basis.

Your next question comes from Ryan Koontz with Needham & Company.

I want to ask about Optical. It looks like the best quarter you've had there in a couple of years. Tom, any color you can give us in terms of trends in terms of product mix, geo mix within the Optical domain would be helpful because Optical is obviously gaining a lot of momentum regarding cloud and AI spend really starting to ramp up.

Yes. I would agree with you on what the outcome of the quarter was, and I would tell you that the momentum there is strong. It's both in the U.S. and in Europe. The quarter was definitely helped by us picking up a larger Tier 1 in Europe, and we started initial shipments into that carrier. But we've seen a thaw across the market, most notably in Europe. So, we're expecting a good year next year as well.

Great. And as Mike mentioned about the Huawei displacement opportunities, how would you broadly characterize those today with regards to deals you've won as well as prospective deals you hope to win in the next 12 months, relative to revenue opportunity?

Yes, it has had a significant positive impact despite the downturn with what we've achieved. However, looking at the number of carriers that have successfully converted, particularly in Germany, the progress has been slow. This momentum is steadily increasing each quarter and is currently influencing our results, with that effect expected to grow over the next two to three years. Therefore, it is certainly a positive factor. I should also mention that there are different dynamics between the access and optical spaces. There’s a strong possibility that optical will gain momentum sooner than access. While access has been consistently progressing, it involves millions of customers due to its widespread infrastructure, whereas optical projects advance on a case-by-case basis.

Got it. Great. And maybe one on margins, if I could sneak it in. Are you guys happy with where you're at here at 42% non-GAAP? Do you think this is where you have it pegged or is there further upside we can aim for?

No, our longer-term goal is 43%, and I think we're within line of sight to that. I think we'll be bumping up against that next year.

Your next question comes from Christian Schwab with Craig-Hallum.

Great. Some other players in the space have started mentioning that they've got their first BEAD orders. Would you anticipate an improved BEAD spending environment possibly impacting you in calendar '26?

Yes, that's an easy bar to reach. It has been stagnant for a while, but there is definitely going to be much more activity happening. So the answer is yes.

Is that something that you guys would anticipate seeing orders in the first half of calendar '26? Or is that yet to be determined?

I think we'll see orders in the first half of '26.

Great. And then, you guys talked about operating margin expansion in 2026. I know you've outlined the goal of getting to double digits eventually. But what should we think about the potential for operating margin expansion in calendar '26?

We anticipate growth in 2026. The key factor for us is that gross margins have remained fairly stable and are trending upwards over time. The crucial area for us is the operating expense line, which is influenced by foreign exchange. However, on a constant currency basis, we are currently in the high 90s, where we have maintained. The real question is how long we can sustain this. We believe we have sufficient research and development resources and the right product lineup to avoid a significant increase in R&D expenditures. Our sales expenses fluctuate somewhat with revenue, but structurally, we do not foresee major changes needed to reach that $300 million-plus target. Therefore, I expect growth to continue through next year. Tim, feel free to add any thoughts on that.

I think as we continue the expansion, you'll see $300 million in second half of next year or early 2027. And I think on a constant currency basis, you get to the double-digits once you get somewhere around $315 million in revenue.

Your next question comes from George Notter with Wolfe Research.

I'm curious about the minority interest related to the previous ADVA shareholders. Do you have any updates on that? Did you redeem any shares during the quarter? Any insights on how you plan to manage that obligation moving forward would be appreciated.

Well, we're happy if they redeem at this point. So, we would like to see some. I think there was one redemption in the quarter, right, Tim?

It's in the subsequent events. It happened early this quarter. But yes, we continue to see nominal activity and expect there to be some level of run rate.

Yes. But nothing worth sharing. And like I said, redemptions are a good thing at this point.

Would you look to do anything proactive? I mean, obviously, you did the financing this quarter. Would you look to get more proactive with those shareholders? Is that something that's in the cards at this point or does it hinge on selling the buildings in Huntsville? How do you think about that?

Selling that building definitely gives us much more flexibility. I believe we will start to be more active in that area toward the end of next year, although we are probably still a few quarters away from that. Nevertheless, redemptions are a positive development.

Your next question comes from Tim Savageaux with Northland Capital Markets.

A non-core asset question to start with, and that centers on the old ADVA kind of sync and timing business. I assume you capture that in Optical, although I really don't know. That's one question. And I wonder if you can give us a sense of the dynamics around the business, kind of overall size, growth rate, profitability? Anything you can share along those lines? And I have a follow-up.

Yes, it falls under the Access & Aggregation business. We do not provide a separate breakdown for it, but it is included in that category and is experiencing growth. We are currently reevaluating that segment to better understand its operations. It has a distinct business model and requires a different approach to sales, as well as targeting various contacts within our customer base. Therefore, we are actively working on adjusting the way this business functions.

Okay. And can you hear me?

Yes. Yes, go ahead.

Okay. Sorry. The second question was going to be on any impact from memory prices, especially on the subscriber side of the business and what you're seeing there?

There has been some fluctuation over time, but I would say the gross margin in that business has remained fairly stable over the last few quarters, and I believe we can maintain that moving forward. A lot of this is due to the churn in different areas of the business, as we have a new generation of subscriber products. In fact, we have more new products for subscribers than any other category in our portfolio.

Got it. Maybe one more for me. You mentioned starting to ramp with one of the Tier 1 European wins, I guess, on the Optical side. And I think that win included Access as well. So, do you expect that to start ramping soon? And anything else to call out in terms of upcoming Tier 1 ramps here in the next quarter or two?

Yes. I think that will take longer. The optical aspect was incredibly quick, and a lot of work was done in advance to enable that speed. I believe the access portion will require more time, but we anticipate seeing progress next year. Overall, everything is advancing, albeit not at the pace we would prefer, but developments in Europe are moving ahead. We haven't lost any components. The other projects we've mentioned before, which involve some changes in various parts of Europe, are also progressing. So, I believe all of this will provide a positive boost next year.

There are no further questions at this time. I'll now turn the call back over to Tom Stanton for closing remarks.

Okay. Thanks very much for joining us on our conference call. And I really would like to extend my appreciation to our teams around the world. Thank you for everything that you do. I also want to thank our stockholders and our customers and partners for the confidence and the collaboration that you've shown us over the last year. So thanks very much, everyone.

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.