Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN’s Fourth Quarter 2020 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. [Operator Instructions] Please be advised today’s conference is being recorded. [Operator Instructions] During the course of the conference call, ADTRAN representatives expect to make forward-looking statements, which reflect management’s best judgment based on factors currently known. However, these statements involve risks and uncertainties, including the continued spread and extent of the impact of COVID-19 global pandemic, the 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, manufacturing efficiencies and other risks detailed in our Annual Report on Form 10-K for the year ended December 31, 2019, and our quarterly report on Form 10-Q for the quarter ended September 30, 2020. 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, Chris. Good morning, everyone. We appreciate you joining us for our fourth quarter 2020 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’ll take any questions that you may have. COVID-19 continues to impact our day-to-day lives and the way that we do business. It is highlighted the importance of the work we do enabling operators to provide high speed broadband connectivity for consumers and businesses. I am proud of our employees perseverance throughout these difficult times and want to start by saying thank you to all of our team. Moving to the quarterly performance, the results for the fourth quarter demonstrated solid execution against our plan. This included broad-based demand across our customer segments with a strong contribution from regional and emerging service providers. We continue to make great progress with the Tier 1 fiber access projects that we announced earlier last year, while still growing and diversifying our customer base across a variety of market segments. From a top line perspective, revenue for the quarter was $130.1 million with 41.1% gross margin. Network solutions accounted for 88% of that total revenue at $114.1 million, while Global Services contributed to $16 million. During the quarter, we had four 10% customers, one of the highest numbers we have ever reported. Each of these customers percentage of total revenue was in the low-double digits, pointing to the success of our diversification efforts. Of these, there was one service provider customer, and three distribution partners. These distribution partners serve hundreds of regional service providers in the U.S. market with a mix of broadband access and connected home and enterprise solutions further reinforcing our success that we are having with both customer and portfolio…

Thanks, Tom, and good morning to all. I will review our fourth quarter 2020 results and also provide our view on the first quarter of 2021. During my report, I will be referencing both GAAP and non-GAAP results with reconciliations presented in our press release and supplemental financial schedules on our investor relations webpage at www.adtran.com/investor. The supplemental financial schedules on our webpage also present certain revenue information by segment and category, which I will be discussing today. As Tom stated, our fourth quarter revenue came in at $130.1 million, compared to $133.1 million in the prior quarter and $115.8 million for the fourth quarter of 2019. Breaking this down across our operating segments, our network solutions revenue for the fourth quarter was $114.1 million versus $115.2 million reported for Q3 of 2020 and $96.2 million in Q4 of 2019. Our services and support revenue in Q4 was $16 million, compared to $17.9 million reported for the third quarter of 2020 and $19.6 million for the fourth quarter of 2019. Across our revenue categories, access and aggregation revenue for the fourth quarter of 2020 was $79 million, compared to $85.4 million in the prior quarter and $74.6 million in quarter four of 2019. Revenue for our Subscriber Solutions & Experience category was $45.4 million for the quarter versus $43.1 million for quarter three of 2020 and $33.2 million for quarter four of 2019. Traditional & Other Products revenue for the quarter was $5.8 million, compared to $4.6 million in Q3 of 2020 and $8 million for quarter four of 2019. Looking at our revenue geographically, domestic U.S. revenue for Q4 2020 was $95.8 million versus $92.8 million reported in quarter three of 2020 and $69.9 million in quarter four of 2019. Our international revenue for the quarter was $34.3 million,…

Okay. Thanks, Mike. Chris, at this point, we’re ready to open up to any questions people may have.

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

Thank you for taking my question. This is Bala Reddy on for Rod. [Indiscernible] you mentioned different factors, like growing space like supply constraints, macroenvironment or what have you making in any further color would be helpful. And I have a follow-up. Thanks.

Can you repeat that? You were cutting out a little bit there.

I was talking about that, could you talk a little supply constraint situation that you are passing [indiscernible]

The supply chain situation. Yes. So, I mean we’ve seen tightness throughout the year, but it’s definitely at least on the silicon side continue to increase. I think everybody where a lot of people are aware of the lead time extensions by some of the silicon vendors. And there have been – when you’re having to go and buy chips from pretty much any outlets you can get and use sometimes the expedite charges on those. We have factored that into our guidance for the next quarter. The reality is that we don’t know exactly what that will be until we actually get those chips, whatever chip it may be in-house but we have tried to factor that into our guidance. Does that answer your question?

Could you help us maybe quantify it into this, if it does by task – could you help us quantify it? How much are you putting on the table off the table, because supply chain situation..

That level of detail to be honest with you is not at hand right here, but it’s not everything. It is predominantly on the chip side by far. And certain chips are worse than others. So I don’t have an exact number. I can just tell you that when we rolled up our margin forecast that we did want to try to take into account, and we can look at that. We look at that and Mike had mentioned gross margin forecast is fairly detailed and that we look at it on a SKU level. So certain SKUs are impacted by it and certain ones aren’t, but I don’t think we have a total number on that.

Okay. Fair enough. I got one more question. Could you expand on this audit off opportunity? I believe last quarter, you talked about how some of the providers, we’re still figuring out what the past going to be. Maybe you had a few more conversations with them, and then could you expand on the opportunity? I believe you mentioned second half, like, it’s going to be gradual.

I do think it’ll – some carriers will kick off as quickly as possible. Others will wait, because there was some time period that you don’t have to build everything right off of the bat. The quiet period is now over. And so we’re able to have dialogue with a lot of the customers. I think we are happy as of now with kind of how things turned out. A lot of those customers are long-standing customers with ADTRAN and some of the bigger ones are definitely longstanding customers with ADTRAN. We also – although there are wisps involved that have one significant amount of that award, some of those whips, if you actually get into the details are actually going to be building out fiber, which is good for us. And then even where they are doing something different, unless they like fixed wireless, which is typically at lower rates, right. So there’s still connectivity opportunities for us with those wisps. So I would say, we’re feeling pretty good about how the option itself turned out at this point.

Okay. Thanks.

Okay. Right. Thank you very much.

Your next question comes from George Notter of Jefferies. Your line is open.

Hi, guys. Thanks very much. I guess, as I look into the quarter, my impression is that your largest North American customer was slow again, is they have been, I think, in prior Q4. And it sounded like you were really able to backfill for that softness with Tier 2 and Tier 3 operators in the U.S. And is that the right picture that we should be thinking about here? And then I’d also like to know what the mix of your Tier 2 and Tier 3 operators is at this point, I think in the past you said it was about a third of the business, but it seems like that must quite a bit bigger now. Any sense of that would be great. Thanks.

Yes, I think we said last time, Mike, what did we say last time on the call?

Well, first of all, it’s the fastest growing segment we have, but I think it was – do you remember, what percentage we got?

I think we have said in the past that in general, it’s been roughly a third of each, but if we’ve had so much growth in the Tier 3 segment than it is at least twice the thirds, right. So that’s growing fast.

So it’s over 50%. And like I said, may actually from quarter to – it’s been growing fast. So at this point in time, closer to 60 than 50. And as far as the Tier 1 customer and there you asked you’re exactly right. That customer did fall off in the Q4, the U.S. business was still up, which tells you that even we typically see seasonal decline in Q4. So the rest of the U.S. business was pretty strong. There’s also another piece that’s kind of hidden a little bit. I shouldn’t say hidden, but not readily apparent, which is – we do have another large customer in Australia that was down. And for the most part, the Avnet carriers in Europe were able to make up for that. So we had two areas of strength that we were glad to see happening.

Got it. And then CenturyLink, I think, has been the biggest customer historically. Any sense for what CenturyLink accounted for in the year as a percentage of sales? Or should we just wait for the 10-K filing?

Yes. I literally don’t have that in front of me, but they were stronger in the first half and kind of dwindled down a little in the second half and then fourth quarter was not a great quarter. So I really don’t know. I don’t know that George, if you – I guess you’d have to wait.

Okay. Okay. Super. Hey, thanks very much guys.

Okay.

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

Thank you. Wanted to follow-up on the component tightness you’re seeing. At this point, do you think that would impede your ability to ramp in the second half? I mean, you noted making good progress with the number of Tier 1. So presumably some ramp there. What’s your confidence. You’ll be able to get the components to enact that ramp.

Where we have some predictability and believe it or not, there’s actually more predictability and infrastructure builds like that. I think we’ll – I think we’re good. We have been placing orders out for a long period of time. This newest change in lead time is relatively new, but the orders that we’d already placed on the old late time regimen is still in place. So I don’t have a lot of worry about that, where we’re kind of hurts you the most honestly is the more unpredictable piece is like take rates on ONTs and RGs and things like that, where you could – that business has just been going fantastic for us, and we’ve been able to keep up – being able to buy those pieces, those parts, because the variability can be 30%, 40% quarter-to-quarter and you have different SKUs and everything. So that’s probably a little bit more problematic. So far we’re doing okay, but it’s just – it’s going to get tougher.

Yes, understood. And relatedly, I know you guys don’t give multi quarter guidance, but with these ongoing component issues, should we think of gross margins as sort of being relatively flattish over the next few quarters at sort of the level you’ve guided for Q1? Just wondering if there’s any kind of broad color you could give on your thoughts on gross margin.

Yes. That’s probably the safest bet right now. We were expecting gross margin is actually to expand this year. And at this point, because we just don’t know how bad third quarter, fourth quarter will be as far as trying to find parts. So that’s probably a safe way to look at it.

Got it. And then Tom, could you expand on the RFP – the outstanding RFPs that you’re bidding on? You mentioned that you might see some of them actually be awarded as early as mid-year. Can you give us a little color on what that pipeline looks like?

Yes. The number of RFP that there is probably material RFPs is, somewhere between six and eight, two of them we expect to close. And I will tell you, we don’t control that. But current expectations for two of them to close before the half both of those are European – both of those are global carriers was headquarters based in Europe.

Got it. That’s helpful. And then finally, just on international, I mean you noted that Australia was weak, but overall that business international was down pretty meaningfully year-over-year and quarter-over-quarter. Anything else in international that was going on?

Well, our German carrier is typically a little bit of a wildcard. They came in about where we expected. So I mean the biggest decline it was – its material decline in Australia. Having said that, that is a lumpy customer. There are times where they come in and we sell a lot and there are times where we don’t. We have just started shipping actually this quarter a new award for them, which will continue to ramp through this year. Having – but it will still be lumpy. It’ll still be lumpy. I mean the toll key to us is to grow that Tier 3, Tier 2, Avnet carrier segment, which is hundreds of customers to a point to where any of those materials those larger Tier 1s won’t have such a material impact.

Right, understood. Okay. Thanks for taking my questions.

Thank you.

[Operator Instructions] The next question comes from Paul Silverstein of Cowen. Your line is open.

Thanks, guys. Appreciate taking the questions. Tom, as the Tier 2s and 3s, assuming that their growth continues to outstrip the growth of your Tier 1, so that they become a larger percentage of grabbing around they did this quarter. Does that change all the things bagel? Does that have an impact on your margin structure one way or the other?

Yes, yes.

I assume for the better.

That’s a good assumption, yes. Yes, it would – that is a I mean that that’s a good market for us.

Based on your current visibility, looking at your order book, your pipeline, I assume you expect that class of customers to continue to outstrip in terms of growth, relative to overall growth relative to your Tier 1s.

I think this year in totality, yes. I think next year, because we’ll be in full bore with three Tier 1s buying fiber access equipment. I think next year will be more difficult or to keep up, but I don’t know, hard off may have an impact on that as well.

That makes the question, given that that shift should have a positive impact and you’re pointing out this year, what’s the offset that keeps – I recognize you all have been very transparent and saying that gross margin for the foreseeable future. And I think you all quantified over the next two years, feel free to correct me if I’m wrong, that we should expect a meaning change from the low 40s where it’s been for quite some time. But given that shift, that should have a positive impact and it sounds like you’re not expecting any uplifts or any meaningful uplifting gross margin this year. What’s the offset that’s counteracting the benefit you should get from that customer mixture?

Well, there are two things. We don’t expect the supply chain to get better. And I will tell you where you’re paying expedite fees now, we pay them in Q4. And we paid at least from a historic perspective, very high logistics charges versus our typical. We don’t expect that to get materially better this year. So in fact, we expect pressure to increase. So that’s point number one. Point number two, where we have tried to forecast in is some additional wins, so although, what you’re talking about is gross margin better in a smaller carrier segment, yes. Do I expect that growth to eclipse the growth in the, let’s say larger carrier segment this year, yes. But having said that, we also still have some Tier 1 projects that are just going to be getting kicked off that will have a margin impact as we get them up and running. So that will also be a negative.

Got it. I appreciate that. Tom, I trust you’re indicating that this would accuse, which have been around for a while for you and for others for the better part of the past year, you’re telling us that they’re actually a higher this past quarter, you’re expected to stay at that elevated level relative to previous quarters. Was that not the case?

Yes. Let me be a little more granular on that. So if I look at expedite fees for last quarter versus previous quarters on logistics and chip supply, it was a little higher. I expect it to get tighter this year.

All right. But so it sounds like perhaps the bigger issue is you’re hoping, expecting rollouts from the new Tier 1 awards. And as you pointed out in the initial stage of those rollouts, the margins are especially relative to over time.

Yes, right. Once we get up and running and you got some scale and volume and things, yes.

All right. And I apologize, because I’m asking you to repeat yourself, but relative to your previous comments, you said there’s six to eight RFPs in terms of pipeline of additional opportunities. And so I hear you that two those are Tier 1s that you expect to be awarded in the first half of this year.

No, no, no. So yes, so two of those are Tier 1s, but I probably – if I look at the number of RFPs that are out there or opportunities, it’s way bigger than six or eight. So if I look at material like large customers, it’s in the realm of six to eight that we’re working on right now. But I will tell you there’s probably 100 smaller carriers that we’re working on. I mean we captured what 34, I think carriers just last quarter. So at any point in time, there are hundreds that we’re working on.

Understood. I appreciate the clarification. The six to eight, you referenced are all of those non-U.S.

Most of them.

It is – do you think that’s tied specifically to why we’re getting cut back or is it more than that?

I think it’s three things. I think it’s – well, I think it’s really four things, so I think its Huawei, I think its 10-gig, I think its disaggregation, and I think its COVID.

I appreciate the response. I’ll pass it along. Thanks, Tom.

Okay. All right.

Your next question comes from Bill Dezellem of Tieton Capital. Your line is open.

Thank you, Tom. I’d actually like to follow-up on your last comment. Why do you believe that COVID is playing a role there?

I think broadband became more important and some countries, like I’ve said a conversation late last night with the customer. Some countries found themselves a little flat-footed and for whatever reason around the same time fiber was gaining an importance. And I think people that have kind of okay, broadband plans have been – having to relook at those plans and refresh those plans and make sure that they’re going to keep up in a future pandemic for wherever the world may turn. So I think the highlight that the visibility that it put on carriers, but just if not more importantly on governments and relooking at their infrastructure has absolutely added fuel to this.

Makes a lot of sense. Thank you for the clarification. And then you referenced this substantial growth in your Tier 2 and Tier 3. And yet you had four, 10% customers, can you tell us how that can happen? It almost seems like mathematically that’s a really a small needle to thread.

Yes. I try to highlight this in my notes, but I don’t think it came out clear. So we have four 10% customers. We typically have two or three. Those are typically Tier 1 carriers. Very rarely are they not Tier 1 carriers, sometimes a Tier 2 may come in, but they’re typically direct sales the carriers. Three of our four this quarter, we’re actually distribution partners that sold to Tier 3. So those customers are actually – those three are actually selling to hundreds of carriers and they’re typically in this Tier 3 segment. Does that make sense, Bill?

It makes the perfect sense. Thank you for the clarification. And I didn’t even think of that as a possibility. Thank you.

Yes, okay. All right. At this point, I see no more questions in the queue. So I appreciate you for joining us and we look forward to talking to you this time next quarter.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.