Ladies and gentlemen, thank you for standing by, and welcome to the ADTRAN Holdings, Inc. Second Quarter 2024 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. [Operator Instructions] As a reminder, today's call is being recorded. 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 the risks the risks detailed in our earnings release, our annual report on Form 10-K and our filings with the SEC. 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. We undertake no obligation to update any statements to reflect the events that occur after this call. During the course of today's call, we will refer to certain non-GAAP financial measures. Reconciliations of non-GAAP to GAAP measures and certain additional information are also included in our investor presentation and our earnings release. 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, John. Good morning, everyone. We appreciate you joining us for our second quarter 2024 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 you may have. While the quarter came in largely as expected. Financially, we realized the non-GAAP operating profit driven by gross margin improvements and substantially lower operating expenses. Working capital was significantly reduced as we continue to decrease our inventory levels, our non-GAAP free cash flow was positive for the second straight quarter, and we grew our customer base across the U.S. and Europe, as customers continue to adopt our latest fiber networking solutions. We achieved all of these despite the headwinds that we are all feeling. Taking a closer look at the results in the second quarter. We had a strong quarter in the U.S. with revenue up across all three categories in this region. On the product mix, we were well balanced in revenue across our three categories with 36% of our revenues coming from Subscriber Solutions; 31% of revenues coming from Access and Aggregation solutions; and 33% of our revenues coming from Optical networking solutions. Our Subscriber Solutions category was up 18% quarter-over-quarter with a growth led by our residential solutions that were up 47% quarter-over-quarter. In our Access and Aggregation solutions category, growth in the U.S., broadband revenue was offset by declines in shipments to our large European customers. Following a strong first quarter of shipments of these customers. Optical networking solutions was essentially flat relative to the prior quarter. Taking a closer look at the regional mix, we saw sequential growth in the U.S. across all major customer segments. With these customers purchasing a diverse set of…

Thank you, Tom, and hello everybody. I will walk you through our financials of our last quarter and provide our expectations for the third quarter of 2024. I will be referencing non-GAAP information with reconciliations to the most directly comparable GAAP financial measures presented in our press release. Additionally, I will discuss certain revenue information by segment and category, which is available on our Investor Relations webpage at investors.adtran.com. We've also updated the investor presentation to this site, which is available for download. Unless stated otherwise, all financials are presented in US dollars. With that, let's dive into our financial performance for Q2 2024. Q2 2024 revenues of $226 million were similar to Q1 2024 revenues and slightly above midpoint of our guidance, but we're down 31% year over year. Our network solutions segment accounted for 79.3% of revenues in Q2 2024 compared to 86.4% in Q2 2023, and 80.1% in Q1 2024. Our services and support segment contributed 20.7% of revenues in Q2 2024 compared to 13.6% in the year ago quarter and 19.9% in the previous quarter. Access & Aggregation contributed 30.9% of revenues and was down 31.9% compared to the year ago quarter, also down 14% sequentially. Our Optical networking solutions category contributed 32.6% of revenues and was down 48.5% year-over-year, and down slightly by 1.9% quarter-over-quarter. Subscriber Solutions contributed 36.5% and was up 0.9% year-over-year, and up 18.1% quarter-over-quarter. International revenues made up 52.4% of total revenues and domestic revenues contributed 47.6%. Domestic revenues were sequentially up in all three product categories. Q2 non-GAAP gross margin was 41.9%, an increased by 334 basis points year-over-year and 37 basis points sequentially. The improved growth margin is reflective of our ongoing efforts to optimize our supply chain and supply related processes. Q2 non-GAAP operating expenses were $93.2 million,…

Hi John. At this point, we'd like to open up for any questions people may have.

[Operator Instruction] Your first question comes from the line of Ryan Koontz from Needham & Company.

On the access weakness here, sounds like a lot of that's coming from Europe, but maybe you can unpack a little bit what's going on there in terms of the domestic transition to the SDX, kind of where we are in that transition. Then in Europe, you talked about a very strong Q1, probably some inventory remaining to be deployed there, but any other color you can give on the European side of things and what might be behind the macro caution in Europe? Thank you.

Yes, sure. I would say that's exactly it. In the U.S. we had access actually grew. In the U.S. also, all three product segments grew, which is the first time we've seen that in a while, that was good to see. In Europe is specifically two customers. We had two customers that bought and they tend to buy in chunks. So it's not uncommon for them to come in a quarter and then come in either the next not by the next quarter and then by the quarter after or the quarter after that. That's just, that's typical. And it was specifically, we actually had two actually that hit in Q1, and that, so those were sequentially down, but that's not indicative of anything other than the fact that, that's just the way that they bought it. All the other business, the alt business and all of that was very solid in Europe for access and ag.

You said the two that hit in Q1, those were not your big ones. These are newer customers that maybe placed first orders or --

No. Those were existing customers...

And on the in terms of your outlook there in terms of kind of getting Europe back on track and you've had a number of contract wins we've talked about for a long time. How are those new wins kind of progressing through lab approvals and moving forward with deployments kind of broadly?

So, let me talk just a little bit about Europe. Europe on Fiber-to-the-Prem and from and Subscriber, RGs, ONTs is actually fairly solid. We did have the shift, but that's not indicative of anything other than they bought and then they don't buy and then they buy. So I would say that market is actually doing fairly well and on Subscribers, it was actually up. I mean it's. So if they didn't buy infrastructure, then they bought something to connect up customers. So that was actually very good to see. Optical is where the biggest concern is in Europe and we really didn't see a whole lot of change there. I fully expect Subscribers and access to have a good quarter in Q3. I think the question mark that we have is Optical and right now expectations are for it to be kind of flattish, but that's where the biggest concern is. And then, -- so you also asked about SDX, and SDX is relatively new. We just kind of launched that. We launched a big suite of software for both Optical and for the SDX a little earlier this year that's just now getting out there. I think I wouldn't call it conversions for some customers, if you're a Greenfield customer, you typically go with SDX or if you're you hurt certain metrics. So people still buy the 5,000 and they buy the SDX. So I wouldn't call it a conversion, I would say it's either or -- just this quarter we just seem like everybody that bought the system this quarter was --- that was new, was an SDX customer.

And just a quick housekeeping question for Uli, on the tax swing. Any color you can share there in terms of how we should think about that going forward? Seemed like it had a pretty big effect on your non-GAAP income.

That's the usual you see throughout the quarter I would on a non-GAAP basis expect a tax rate of about 15 to 20%. If you do your modeling on a GAAP basis, then I would expect a tax rate of about 3% to 5% for the year.

Your next question comes from the line of George Notter from Jefferies.

I guess I just wanted to kind of get level set on the inventory. Can you just kind of go through the different pieces of the business and kind of give us a sense for where there's still excess inventory how long you think it'll take to kind of work that off. And then off -- and then conversely where are we done with the inventory?

Let me do it from a broad segment then. Any specific questions I'll let you come back and ask. So, on Subscriber, it feels like there is very little inventory out there at this point. The we saw a sequential 47% increase in shipments into that customer base, and we expect a strong Q3 as well. So it feels like that inventory piece has worked itself out. Now maybe not coincidently, that was the first piece to fall, right? That was the first. So it's not that crazy that it would be the first one to be coming out. On Fiber-to-the-Prem, I would say it's similar. There are still pieces where there is some inventory, but there's not a lot. And so the inventory situations that we'd see coming going forward, I would think, would be largely what we just saw, right, where we have some customers that just buy 6 months out of time and then deploy it and then buy again, right? So I don't think that there's going to be -- I would say that's the majority of the fluctuations, but that's just normal business. That's just normal how people buy. And then on Optical, there's still some inventory buildup here in the U.S., and there's still some inventory buildup in Europe. We expect all of those -- our expectation is for those to be depleted by the end of this year.

That's great. I'm sorry. So you said by the end of this year?

Right. That's correct.

And then just shifting gears a bit. Anything on the real estate side of things? I know you guys were looking at rationalizing a portion of the headquarters. Could you give us an update there?

Yes. We still have interested buyers. I think there’s 3 or 4 depending on level of interest, but still moving forward that processes. Some of them have hired architects to come in, so that’s still on the plate. It’s a difficult thing to forecast when something like that will close, but there’s still a lot of interest. We’re moving forward in the process, the real estate selling process. There are some other assets that we’ve talked about in the past that are kind of nonstrategic assets that we are also looking at selling, and those are moving forward as well.

Your next question comes from the line of Bill Dezellem from Teiton Capital.

I actually have a couple of questions. Relative to the inventory adjustments that are taking place, what do you believe that, that has hurt your revenue this quarter? So if you were to normalize in-customer consumption to our reported revenue what was the delta?

That's a really hard thing. I'll take a stab at it, but it will probably kick me. So I think the best way to look at it -- what you're looking at is what is normalized revenue net any market share losses or gains, and normalized for customer changes over time depending on their particular situation. I'm trying to figure out a way to get you a number. Let me just put it this way. It's tens of millions of dollars, and it's predominantly in Optical is the way to think about it. So that's the biggest impact. Subscriber, like I said, has pretty much worked its way through, and there's little on Fiber-to-the-Prem I don't know if that helps you a Bill, but...

No, Tom, I think it does. So go ahead.

No, no. That was it. That was it. Just in the 2 customers, the 2 large customers that we have that still have inventories on Opticals, they typically buy in the tens of million dollars a quarter, and those are substantially down right now because they're depleting inventory.

So basically, tens of millions, essentially times 2, because each of those customers would be buying tens of millions more per quarter, would be the way to think --

I would be a little careful with that because it's not like they're not buying anything. But I think in combination, it would be tens of millions, yes. And it depends quarter-to-quarter, but yes.

All right. That is the --

They're not the only inventory, yes. And they're not the only inventory situation out there, they're just the most notable.

Right. And then, do you see any correlation between what's happening in the U.S. where we now have all 3 segments showing growth as a leading indicator for Europe? Or is Europe really a dynamic of these 2 large customers and they're very specific excess inventory in the Optical arena?

Well, so the Optical space, and this is something that may be notable, the Optical space -- we have one large customer in Europe, we have one large customer in the U.S. that are actually hurting our Optical business. Having said that, Optical was up sequentially, but it was not the best quarter in the world sequentially, too, in the Optical space. But the U.S. Optical business itself was able to overcome that customer not really buying. So I think it is more -- I wouldn't call it a precursor. Well, maybe. I mean if you look at the U.S. from a Fiber-to-the-Prem and Subscriber perspective, the U.S. and Europe were very similar, except that we had in -- we had 2 customers that happened to buy a lot in Q1, and the rest of those customers picked up in Q2. But those 2 customers are depleting. So Subscriber and Fiber-to-the-Prem, I think, are -- they're very similar in Europe and in the U.S. I hope I didn't confuse everybody with that answer, but --

I found that helpful. It did. I'm going to switch to one additional question on the -- and this is really coming from a point of ignorance. Your SaaS business is showing some signs of strength in the U.S. Is that an opportunity that you have in Europe? Or is the SaaS business really more going to be centric on U.S.?

It's predominantly -- our focus right now is U.S. And the reason for that is making sure that it is a strong kind of strategic weapon that we have in winning market share for big customers. So the majority of the development right now is very much centered on U.S. customers. So it could be, yes. And we do have some interest in Europe, but our feature set development and everything is very much focused on the U.S. right now.

And are there development challenges besides language to taking that offering to the European continent?

No, it has more to do with interfaces to back office, existing back-office systems, right? So there’s -- and some of those actually are kind of cross-border, but we’re very much taking the priorities based off of what the majority of U.S. Tier 2s and Tier 3s mainly.

Your next question comes from the line of Tim Savageaux from Northland Capital Markets.

A couple of questions here. First, you had mentioned kind of the buying patterns among your big European guys, 1 big quarter and then maybe 1 or 2 off. But as you look into your Q3 guide, what are your expectations there? What are you modeling with regard to what you're going to see out of your big European guys?

We're not expecting a huge uptick. I think we'll see that later in the year. Now there's 2 different ones, and they don't necessarily buy it the same cycle. So it wouldn't be that surprising to see one of them come in stronger in Q3. But at this point in time, that's not in our expectation. Needless to say, based off of the environment, we're trying to continue to make our guidance numbers. So there's a little bit of conservatism in that.

Well, got it. And that's kind of where I was heading next, which is you're looking for 3 flat quarters here around the $225 million level. Composed quite differently, I think, from a geographic and product standpoint. My question was going to be, is there any reason to think there could be an uplift here into year-end as you stand here now? And you kind of spoke to that there, and I think I may have said maybe, but please go ahead and expand upon that if you could.

Well, I think what we're trying to do, and maybe it's a nuance that's too nuanced. You see us continuing to try to tighten the range of the numbers. We had a very broad range coming into the year because it was so difficult to see how the customers were reacting on kind of a monthly basis, right? That has gotten better. Visibility has gotten better. The surety within our forecast has gotten better. The biggest unknown for us right now is really kind of the Optical space and has that bottomed out? Or where is the bottom of that and when does that actually start adding on the Subscriber Fiber-to-the-Prem space, we feel very good right now. So the direct answer to your question is, we're hopeful that we'll see an uptick this quarter, and we're probably even more confident about fourth quarter than third quarter. That's where we sit today.

Got it. And you keep setting me up here with your answers. So on the Optical side, I was very intrigued by your commentary, your aspiration for top 2 in Europe. And I had a couple of questions around that, which -- and also the cross-selling that you mentioned in the U.S., obviously, a lot going on with Lumen these days. Historically a big customer of yours on the Access side. And this kind of segues into another one of your comments around strategic changes in the landscape. I think the broader question there is what kind of opportunities – are you seeing anything anecdotally in real time coming out of the planned merger of Nokia and Infinera? Obviously, big Lumen shop there at Infinera. So I wonder if you might see any opportunities there as they go about building this giant data center network. But more broadly, is it really the merger that drives you to target that top 2 position in Europe, which is -- which would be pretty meaningful thing? So kind of all over the map here question wise, but I think you know where I’m going.

Well, I think the way we look at it, when we were -- when we’ve been bidding in Europe right now for Optical gear, there were really -- there was always Nokia, there was always [Siena], there was always -- there was us. And there’ll be one less. And I think our technology is very competitive in the metro and regional space that we play in. I think we win our fair share. I think our fair share just on a percentage basis goes up. And I think we have very deep relationships with a lot of those large customers in Europe. So yes, I feel good about Europe. U.S., I don’t know if that’s going to be any new inroads or not necessarily. Our – there’s – any time that you have a merger like that, there’s potential disruption. So we’ll have to see how that plays out. At this time, it looks like, I think we’re out of questions. So I appreciate everybody joining for our conference call, and we look forward to talking to you next quarter at this time.

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