Ladies and gentlemen, thank you for standing by and welcome to ADTRAN's Second Quarter 2019 Earnings Release Conference Call. [Operator Instructions] During the course of the conference call, ADTRAN representatives expect to make forward-looking statements which reflects management's best judgment based on factors currently known. However, these statements involve risk and uncertainty, including the impact of the company's assessment and of its success and ultimately inventory reserve, the successful development and market acceptance of core products, the degree of competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2018. 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. It is now my pleasure to turn the call over to Tom Stanton, Chief Executive Officer of ADTRAN. Sir, please go ahead.

Thank you, Julianne. Good morning, everyone. We appreciate you joining us for our second quarter 2019 conference call. With me today is ADTRAN's CFO, Mike Foliano. Following my opening remarks, Mike will review the quarterly financial performance in detail, and then we will take your questions. During the quarter, we were pleased with our continued progress and solid performance for the second quarter of 2019. During the quarter, we achieved strong execution towards our goals to meet our financial objectives, strengthen our customer, product and geographic diversification and accelerate customer traction with our fiber broadband and subscriber experience solutions. From a top line perspective, revenue for the quarter was $156.4 million, up 22% on a year-over-year basis. Network Solutions accounted for the majority at $139.2 million, a 21% increase over the same quarter in 2018. Global Services & Support revenue contributed $17.2 million or 11% of total company revenue for the quarter and a 33% year-over-year increase. During the quarter, 52% of our revenue came from international markets due to the timing of key customer infrastructure products. Similar to last quarter, we finished the second quarter with three 10% revenue customers located in three different regions, LATAM, Europe and U.S., underscoring the impact ADTRAN is having as we help our customers around the world build their best networks. Expanding our customer base internationally has been a strategic focus for ADTRAN over the past several years. We believe that our market-leading 10-gig fiber access platforms will play a fundamental role in how next-generation networks are built for the next decade. Our open and flexible 10-gig platforms offer scalable services offerings which is one of the key considerations that operators are looking for as they move to enhance their customer's broadband experience. The portfolio investments we have made over the last few…

Thank you, Tom and good morning to all. I'll review our second quarter result and also our view for the third quarter. During my report, I will be referencing both GAAP and non-GAAP results. The differences between reported GAAP and non-GAAP include stock-based compensation, acquisition-related amortizations and other expenses, restructuring expenses, gain on a bargain purchase of a business and other contingencies, amortization of pension, actuarial losses, noncash changes in fair value of equity investments for our deferred compensation plan and a reimbursement from a claim settlement. Before I get into the numbers, I'd like to discuss the preliminary nature of the information. As was announced in our press release, we are assessing the reasonableness of our reserves for excess and obsolete inventory. We're working to finalize this assessment and determine if corrections are necessary to our reported results. Please note that any potential changes would not affect revenue, operating expenses or other income but could affect gross profit, gross margin, operating income, tax rates, net income and earnings per share on the income statement and net inventory, total current assets, total assets and shareholders' equity on the balance sheet. If changes are required, an updated release will be issued. With that let's move on to the numbers. As Tom stated, ADTRAN's second quarter revenue came in at $156.4 million compared to $143.8 million last quarter and $128 million for the second quarter of last year. Breaking this down across our divisions, our Network Solutions revenue for the second quarter was $139.2 million versus $125.8 million reported for Q1 of 2019 and $115.1 million in Q2 of last year. Our global Services & Support revenue in Q2 of this year was $17.2 million compared to $18 million reported for the first quarter of 2019 and $13 million in the second…

Thanks, Mike. Julianne, we’re ready to open up for any questions that people may have.

[Operator Instructions] Your first question comes from Rod Hall from Goldman Sachs. Your line is open.

Hi. Thank you for taking my question. This is Ashwin on behalf of Rod. I was wondering if you could comment further on the internal control deficiencies you’re currently assessing? Any sort of comments on what triggered the process, and your worst-case expectations. I guess what I’m trying to understand is whether or not this could result in just like onetime impact or are we talking about some potential structural cost increases. And then I have a follow up.

Okay. Ashwin, this is Michael. Let me start with just a little bit of background. For quite a while here we’ve used a fairly detailed method and a tool to develop our excess and obsolete inventory reserves. It looks at more than 20,000 SKUs that we use throughout the business, everything from raw materials through all of our finished goods. And on a realtime basis, it calculates what we believe that the reserve for that inventory to be that would bring it back to net realizable value. What that tool actually requires because it is fairly complicated is a significant number of inputs. When we went back and looked at the inputs, we did not have on all of those inputs the validation level that may have been necessary to make sure that all of those were exactly right. Now the output of the tool is a reserve at a high level for all of our inventories. And we believe by looking at what we’ve seen out in the market for other companies in our space that, that reserve is reasonable. But we are not certain at this time as we simplify the tool and move to a process that is much more like what other companies do, that there won’t be some fluctuations in the inventory value. So that’s kind of the background on it. And I think your other question was around whether or not it would be a long-term issue versus just a one-time? I don’t see the amount that would be reserved in any period changing significantly from what we’ve seen in the past.

Let me say, having said that, we still have to go through the completion of the audit to make sure that everything – once the audit is done, we will know. But if you look at everything that we’ve looked at from external companies and from really kind of what our historical place has been, I would agree with Mike.

Got it. So those are…

Does that answer your question?

Yes. It does. And my follow-up is really on this Tier 1 European slowdown. I guess it’s not completely surprising given the amount of money they spend on spectrum. But I was wondering if you could comment more on what gives you confidence that some of the spending could come back? Are there other projects in pipeline that you see or opportunities you think that they have to deploy to?

Yes. Sure. So with that carrier, the thing that gives us confidence is this carrier has typically been very forthright with us. And there – the timing of the resumption at the beginning of next year is the feedback that we’ve gotten directly from the carriers. So – and we also know that the requirement for the product itself continues. So they still have things that they have to get done and – so that’s not going to go away. As far as incremental pieces, I did mention the G.fast, the larger G.fast award in – with a Tier 1 European carrier and without getting into names, that’s the same carrier.

Understood. Thank you.

Your next question comes from Paul Silverstein from Cowen. Your line is open.

Thanks, guys. A couple of questions, if I may. First off, I know there’s sensitivity about individual carrier disclosure. But on the 10% customers, can you tell us what the three collectively constitute as a percentage of revenue?

We don’t – that’ll come – I don’t know when that comes out, but we typically don’t give that, Paul.

I know you don’t but, Tom, there’s a – I mean it ties into the second question, which is it strikes me that you all quarter-after-quarter and year-after-year you have – you typically have a lot of opportunities. You get a nice number of awards, release awards that represent big potential opportunities, whether telMAX, the AT&T G.fast opportunity and a slew of others that we’ve all been talking about for a while. And so I guess my question to you is twofold. One, the new awards that you’ve now referenced today, are there any – I get it that it’s really hard to predict, to forecast revenue flow in terms of timing and magnitude of these awards given the nature of your customers. But do you have any insight as to the timing and magnitude of these opportunities? And how does that relate to the current revenue concentration of the company? I mean you always have been a very fine competitive broadband access leader. You’ve always had prominent projects but there’s also been a healthy degree of revenue concentration to one degree or another. Historically, that has plagued the company. And I’m trying to decipher, to what extent is the revenue diversifying with these new awards, to what extent is it highly concentrated among three, four opportunities?

Without a doubt the diversification, the revenue stream, because in any one quarter as we’ve just, any one quarter can impact you materially. And one of the problems we have is typically the larger the opportunity, it’s typically with a larger carrier and that doesn’t really necessarily help. So the example is the one that we’re facing right now, right? So we have a slowdown because of a capital issue at that company, I shouldn’t call it an issue but a capital shift at that company, and that same company is one of the largest G.fast opportunities that we have globally. So that’s not been a help when the diversification come a year from now. Our big push has been and continues to be to look at markets outside of the traditional carrier market, more specifically the MSO market, and I did reference one of those opportunities there as you know we’re right now working with the top three MSOs in the U.S. to try to broaden that. We have, in Europe, since the beginning of the year, landed approximately 10 new 10-0gig PON customers and those customers will start shipping, let’s say, towards the tail end of this year and into next year. The problem is, is most of them, which is the makeup of the market itself, are Tier 2 or alt carriers. So it takes four those to make a Tier 1. We’re continuing to work on that and that is, the focus is diversification outside of our traditional carrier base. But it’s not something that’s going to go away near term. And to the extent that you have a Tier 1 come in and place some material order with you, it’s hard to get upset about it but that does lead to the lumpiness that you’re talking about.

One last question. One quick one if I may. I’ve heard you talk more about fiber-based solutions on this call, I think, than I’ve ever heard you talk about before, maybe that just reflects the ongoing shift in the market, albeit the market has been shifting to fiber and optic space for a while now. Can you give us any sense for what portion of your revenue is now fiber-PON based as opposed to your traditional various DSL flavored solutions?

I don’t have that break out in front of me. I will speak to that on an ongoing basis. But I don’t want to just come off the cuff. But it is a material portion and it is as you know, and we’ve talked about – and I talked about in my notes, the fastest growing portion that we have. The opportunity and the reason we talked about fiber last time, the reason I think that we’re highlighting it more than we have historically is the 10-gig opportunity, really – it’s really the penetration into Europe that is more definitive and more broadened than it had been historically with what we were trying to do with our vectoring in copper-based solutions. So that really has opened the door to us, which has led to some diversification, albeit not enough, but has led to some diversification, so we see the opening in Europe. In the U.S. there’s always been kind of this – kind of slow push towards fiber and that continues on, and we’ve got 10-gig opportunities in the traditional carrier base here in the U.S. But our biggest opportunity near term in that space is going to be with 10-gig EPON fiber going to the MSOs, which will here, again, help our diversification.

Got it. I’ll pass it on. Thank you.

Okay. Thank you.

Your next question comes from Rich Valera from Needham & Company. Your line is open.

Thank you. Tom, a follow-up on the European Tier 1 that has kind of paused spending. My understanding was that they were going to do kind of a nationwide super-vectoring upgrade to the kind of the vectoring that they had done initially. Can you say if that’s still the case? And if so, have they completed that? And – or does the – and just talk about the scope of the G.fast win with that carrier. Is that a nationwide? Is that going to be as broad as the prior vectoring and super-vectoring rollouts? Or is that for like selected business customers? Just wondering how they’re targeting that?

Yes, sure. So, as far as the super-vectoring, yes, that continues on, albeit now a little delayed. But it continues on and the plans are for that to continue on into next year and in fact, we’re very hopeful that will not only continue on with the rollout but actually broaden our footprint next year within that customer base. The G.fast rollout is nationwide. It is – our view of it right now is multiple tens of millions a year, and it is not just for business, it’s for – it’s basically to lower the cost of gigabit service to residential as the biggest piece. But it would include MDUs and businesses as well. So it’s not a specific small project, it is a – their migration has been stated to be and continues to be a move from VDSL, Vectored VDSL, super-vectoring, G.fast and then ultimately fiber.

Got it. And I know this will be a tough one to answer but when you think of your annualized revenue run rate with that customer, when things resume, now that you’ve actually got another program, the G.fast program, would you expect that run rate to be similar, higher, lower than it’s been kind of in the last few years?

I hate to speculate into the next year. I mean, they’re very good about giving us forecast as we get towards the end of the year. And if I tried to overlay G.fast, and I have to think about the timing of IP integration of G.fast, which you know is a no-win game. So I’d like – let me – I don’t see a major trajectory change, but I will tell you that we don’t have a solid forecast yet. That won’t happen until the – towards the middle to end of fourth quarter.

Okay, fair enough. I was hoping to also delve into a couple of other historically – recently large customers. So your Latin American customer, it looks like they’ve been strong now for a couple of quarters in a row. And it didn’t sound like there was anything in your comments to suggest they’re slowing. But can you give us any sense of how things look in Latin America for the second half of this year? And any sense at all you have of the continuity of that since they kind of turned on recently, but have been historically kind of an on and off customer?

Well, our history with that customer would tell you that they are different in the way that they plan their demand, but they have a goal of – a specific goal of VDSL Vectored footprint expansion. I would tell you they are not to that goal, they have to buy significantly more amount of material in order to meet that, which is their first phase goal. So we’re just continuing to operate with them and try to meet their demand and their time lines and things like that.

Got it. And then just on NBN, which I don’t think – you didn’t mention them by name, but I think you may have referred to them indirectly. It sounds like maybe you’ve got another win with them that includes CPE. Is that accurate?

Yes. Without naming the customer, it is true that in Australia we picked up a fairly significant CPE award as well as an expansion of our current G.fast business

Got it. And when would those be expected to start shipping?

The CPE won’t, there’s some dependencies on that. But I would – my guess would be sometime in the first half, maybe as early as the first quarter.

Got it. And then putting aside the – we understand that your European Tier 1 is going to be softer in the entire second half, it sounds like, how about the rest of your business from a seasonality perspective in 4Q? Is there anything going on in the non-EU Tier 1 customer that would make us think that seasonality in the fourth quarter would be otherwise different than it’s been historically?

No. If I look at – the problem is that European customers are a material portion and if I looked at the rest of the customer base and what our forecasts are at this point in time, no, I would say everything else looks in line with what we would expect.

Okay. Fair enough. Thanks for taking my question, gentlemen.

[Operator Instructions] Your next question comes from Michael Genovese from MKM Partners. Your line is open.

Great, thanks. Tom, I wanted to ask, first of all, about the risk of this issue with this one customer leading to lower guidance, if there’s broader implications and if it could spread. So if the narrative is that, that carrier had to spend a lot on spectrum and is pausing infrastructure spend this year, what do you see happening with other, sort of, Tier 1 carriers in Europe along those lines? I think you don’t have any other customers that big, but you have some other customers and you’re pursuing opportunities. So can you just talk about whether we need to worry about this spreading beyond just one carrier?

You can take a look at where the – let me just directly answer your question, the answer is no. So the carriers where we’re seeing – in the European base right now, today, notwithstanding any awards that we have is very concentrated. So the impact of any potential slowdown would be relatively immaterial at this point in time, unfortunately. Then other piece of that is there has been no talk of any material changes in their deployment plans with us for the awards that we’ve had based off of any recent activity.

Okay. But I guess just as you analyze the market, do you worry about European CapEx weakness on infrastructure maybe going – it sounds like not but just if there’s any, sort of, analysis that even though you don’t quite have exposure that this could impact the market or is that something you think we should be worried about?

Any billion dollar check everybody should be worried about, and so I don’t want to underplay that. I can just tell you what the direct conversations that we’re having with right now and – so the direct answer is we don’t see that. And I don’t see the auctions have pretty much played themselves out at this point in time to what's available so we don't see an impact.

Great. Great. And then I just wanted to ask you just for updates – touched a little bit on this but I just want to, sort of, directly updates on three things. Number one, the cable MSO space. Is it 10% of revenues combined yet? How close are we to having your 10% customer in that area? And then just the two Tier 1s in the U.S. who are not your 10% customers, if you could just sort of specifically update us where we are with those two carriers, please?

One, we…

So cables and then the two Tier ones.

Yes. Cable is – Mike, I don't know if I have that in front of me. I don't believe it's at 10% yet. In fact if I just kind of do the math in my head, I don't think we're quite at 10% yet, but I don't – we're not far off. And the big uptick there, we're still going through the lab with the largest one of those customers with our new remote OLT solution, so that's still progressing through and we would still expect deployment and my guess would be, at this point in time with where we are in the lab it would be sometime in the first half of next year where that will actually start kicking in, in a more material way. And that's really true with the top two customers, the top two MSOs. So they're kind of buying existing products – existing EPON products and the real trigger to a movement in that is going to be the new remote product coming up for both of those customers. We now have a third customer that we're in the trial stage with, which is the third largest here and that's just still early. We do, do some business for that customer but it's relatively small. As far as the other two carriers, they are – actually we're in negotiations with both of those carriers right now. One for a project that has been – well, both of these projects have been ongoing for quite some time. So they're not 10% today. I would expect to the extent that there is a material change in that it would be towards the tail end of the first half.

Is it still GPON at one and NG-PON2 at the other that – where the focus is?

I hate to say this but NG-PON at one and G.fast at another.

Yes. G.fast right. Okay. Perfect. I appreciate the update. Thank you, Tom.

All right. Okay. All right. With that, we'll end our session today. I look forward to talking to you all next time during the end of the quarter. Thanks.

This concludes today's conference call. You may now disconnect.