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. [Operator Instructions] 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. Following my opening remarks, Uli will review the quarterly financial performance in detail and then we will take any questions that you may have. I'll start off by looking at the performance this last quarter and then we will discuss our current market positioning, both near and long-term. The results in Q2 were within the guidance range that we said on the last call and closely follow what we expected from both the product mix and regional split. Like Q1, the revenues in the quarter were led by our Optical Network Solutions and our Access and Aggregation Solutions. From a regional revenue split, the US was 40% and non-US came in at 60%. The split is consistent with the past couple of quarters. Looking across our various market segments, the US regional service provider for one of the strongest customer groups in the quarter particularly with fiber access platforms as these customers continue to build-out fiber footprint in underserved markets. Due to German capital requirements, we did issue a pre-announcement on lower revenue projections for the second half of this year. This lower forecast is primarily attributable to inventory optimization and optical networking solutions, as customers adjust their inventory and corresponding bookings. Our Access and Aggregation solutions along with our subscriber solutions are not expected to see any further forecasts adjustments this year due to ongoing inventory scrutiny. The investment thesis has not changed and we remain upbeat on our industry in 2024 and thereafter. We made great progress this past quarter in executing on the strategic initiatives of maximizing the broadband funding opportunity being the leading option for Huawei replacement in…

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 web page 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…

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

Thank you. [Operator's Instructions] 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 phrase it a different way, if you don't mind. So it looks like if you think of a classic ADTRAN, legacy ADTRAN business, access and ag is doing well, and we expect growth through the second half of the year. We expect subscribers. Subscribers, we talked about the inventory situation with subscribers. That's kind of flattish. And then -- so, yes, the majority, if not all, the decline is in the optical piece. And really, the way that I'd characterize it in the way that we think about it is going through this downturn, the ADTRAN side of the business kind of hit the downturn first and that may be because we're in access, and that's where it's just kind of a different buying cycle. And then the [indiscernible] piece kind of followed after that. And that was both in the uptick and in the downturn. And I think that's the same thing that's happening right now. So ADTRAN is kind of the legacy ADTRAN pieces kind of flattening out and we expect that to turn quicker and then ADTRAN will follow that. So the premise of your question is correct.

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.

And then I guess just any color you can help us sort of understanding how on the optical piece on the ADVA piece, that this sort of inventory correction sort of hits all at once. So just any color on, I mean, it's such a big magnitude, just more color there. And is this across US, Europe, enterprise service provider. It seems like the whole business is being affected. So I'd just love some more color there. And then my real final last question, which I'll leave you with here, and pass it on is, any early thoughts on '24, do you think that you'll -- should be a strong growth year in '24? Or that these issues will kind of make the visibility of '24 hard to say. Thank you.

Well, yes, I mean -- and that last question is a really good question. The first on the timing, that's not dissimilar to what we saw in the ADTRAN, if you can remember. I mean, it -- the impact on the subscriber piece came very quickly. If I look back and if I look at the aggregation, the aggregation product line went through a very similar phenomenon. The difference was the magnitude of the new customer wins offset the decline, let's say, to some extent, offset and, to a large extent, offset the decline that we were seeing in -- because of inventory corrections from existing customers. So I think the phenomena was similar. So on the optical piece, we're adding customers right. I mean I have no doubt, if I take a look at the new customer wins over the last six months, it's probably the biggest and I'm looking at Uli here, but it's probably the biggest we've ever seen in such a short period of time. We're adding new customers. As you know, those customers take a long time to turn on. And so it just doesn't have -- and it doesn't have the same runway that we did on the access and ag, which kind of grew market size wise at a different pace earlier. So I don't think there's a change in kind of the way that the impact is being felt. So I think that answered that. And then as far as next year. So yes, for next year, look, I mean, I mentioned that the majority of the customers that we have out there are either very slowly online or just coming online, and that's just on the access piece. There's still a significant number of opportunities that are out there that haven't…

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'll give you some color. So basically, if you're in Europe, maybe we should do a heat map on kind of where Huawei is still in because I think we could do that with just public data, which would give you a better feel for it. But the way to think about it, if you're in Western Europe, and you're still using Huawei, then you're still yet to be -- then you still have work to do. And my sense is we're probably in process right now. So that's either awarded RFP or contract, my sense is we're probably -- it's -- I mean it's got to be less than 30%. So because in each of these countries, you have multiple carriers. And usually, in those cases, you have no carrier that's made a move, potentially, but not the entire carrier base within that customer. And I would say that's kind of the way I would see access. And then you have the optical piece, which is later. It has just absolutely started later. And some of that may be inherent capacity that they had into their network. But we really saw a big movement in, let's say, activity and awards six months ago. And where we saw that a year -- at least a year ago on the access fee. So I would say they're not as far into that. So I hope that answered 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 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. Okay.

Thank you.

All right.

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' -- 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 aggregate, probably not, because some of the you know you're aware, George, some of these optical components just take a while to build. So I think a comfortable -- if you give me the latitude of three to four months, that's kind of historic. So we're kind of in that range right now.

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

Yes, that's fair. Yes. Okay. It doesn't help me if they have a bunch of inventory. It may help me near term, it does help me long term. Right. So, yes, customers are rescheduled.

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.

Sure. So we're not in a hurry to actually retire that investment base. We initially -- depending on interest rates and things, we were looking at doing that earlier, and that's what kind of earlier in the overall process with where things sit right now, I think we're comfortable letting that sit out there and looking at it again, it is something that comes up in our Board meetings, but it's something that we're just comfortable where the current situation is right now.

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've 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, kind of easy math is kind of rule of thumb, think about 5%, 5%. 5% next quarter, 5% again next quarter -- and then our exit out of the year will be at that level.

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. I mean it's a good point. It is still a bar. It is still -- and it's not that we can't ship them. It is -- so somebody talked about the European business Well, that European business is predominantly our new products, 6330, and so the magnitude of the RAF that we're doing in the second half on that 6330 is pretty organic. It's probably the biggest ramp the company has ever gone through. I mean we're literally going to be shipping tens of millions of that this quarter. So and some of that is gated by product availability. But I wouldn't call it a supply chain issue. I would call that just a significant ramp.

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

US we're doing -- US I think , yes, U.S. we're doing okay. I mean there is some tightness in -- the US customer base is kind of traditionally TA5000 based in eight port combo cards are -- I am gated by supply there. But here again, I wouldn't call that a supply issue. I am just gated by just the sheer number that we're actually shipping there. Access and Ag general is just doing really good. All right. 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. And we touched on the last call. So the real drop in the ADTRAN business, the significant drop in the ADTRAN business was subscriber solution. So it was really RGs, ONTs. And we saw that also on the [indiscernible] business, but it was on here again kind of the subscriber of the last point, which was at the IP Ethernet nets. We didn't see that big of a drop on access and ag and looking at access and ag, we were adding new customers -- have been adding new customers. And some of that is new customers coming online. Some of that is just different pieces. So I would say the surprise was the number of push-outs in the quarter and then just a substantially slower order rate from quarter-to-quarter. It was maybe not as bad, but it was kind of felt a little bit like subscriber. So it was kind of in between that. So it was a -- it was the kind of halting of -- and when we go and talk to customers, I mean so the slide out is not just existing orders. The slide out is also customers that were saying, hey, I want to start this quarter. And now all of a sudden, they're saying, hey, we've gone back and we want to start next year. We want to start Q1 and that was it wasn't so much the number of customers. It was just that it was fairly significant customers that were doing that.

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?

No, no. I do think that, that is different. I do think that in that particular case. So first of all, there's weight on both, right? So there's wait on inventory and then waiting on project starts. And if you -- the other thing that's different about the optical business is there's a significant amount of that optical business that is project related. And those projects don't necessarily last multiple years. They sometimes last a year, they sometimes last six months. So they go in, upgrade their footprint and they're done, right? So it's not subscriber ad base like it is with fiber the pro. So what we saw is explicit, I can think of like two right now that literally we're going to start in Q3 and now are starting in Q1. And they didn't have inventory. So, yes, that was literally kind of a rethinking of their capital for this year.

Okay. Thank you. Appreciate the additional color.

Okay. I think that handles our question queue. So I appreciate all of you guys joining us on the call today and I look forward to -- let me just make sure because I think last time I left some people hanging out there, -- that's all I see. Julian, do you see anybody else in the question the question queue?

No, we have no further questions in queue.

All right. With that, thank you, everybody, for joining us today. We're really not happy about the news that we had to deliver, but we do think this is a -- and we'll answer any question anybody has. This is a near-term issue that I think is a broader issue than just ADTRAN. We'll get through this issue and then all of the thesis that we've been talking about will come together. So thanks very much.

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