ADTRAN Holdings, Inc. (ADTN) Earnings Call Transcript & Summary

Hello, welcome to Needham's 26th Annual Growth Conference. I'm Ryan Koontz. I cover the broadband networking sectors on the sell side here at Needham. Really pleased to be joined by executives today from ADTRAN. We've got Ulrich Dopfer, CFO; and Steven Williams, VP of Treasury and IR there. Unfortunately, Tom Stanton, CEO participation was impacted by the snowstorms in Alabama, if you haven't heard. Sounds like some serious power issues and things like that affecting some folks down there. So really happy to have Uli and Steven here. With this, welcome, gentlemen.

Thank you, Ryan.

Thanks for having us.

Surely. Well, let's just start with kind of recapping how we got here, '23 was a tough year for the entire industry. ADTRAN was not alone in some of that. Can you talk about some of the kind of key drivers?

So first of all, the year was kicked off with the substantially improved lead times for semiconductor prices, which then customers realize the oversupply they had, they realized that they can get new orders very quickly, if needed. So -- and this hit us really hard at the beginning when we saw the first inventory correction predominantly in for the CPE products. And then, the year continued with the macroeconomic environment getting more and more challenging, right? Substantially increased interest rate, the inflation costs and then -- and we saw this impacting predominantly then our -- especially our larger customers, our Tier 1 customers as well as some of the mid-size customers. And then I think on the positive side, we saw -- we added many new customers despite the challenging environment. We were able to add about 70 Fiber-to-the-Premises customers and then also some key customers in Europe and the U.S. So I think overall, disappointing year, obviously, with numbers significantly down, but then some promising signs when it came to new customer wins and opportunities.

Right. That's fair enough. I know you've been chasing some pretty sizable Fiber-to-the-Home deals, some Huawei displacement opportunities have been teeing up some -- a pretty big pipeline of opportunities. You've got a couple of big customers that have ramped up already and a few more in the pipeline. Is that correct on the fiber side?

Sorry, I was -- you were breaking up for me a couple of seconds. So I could not get the full question. Would you mind repeating it?

Sure. Sure, Uli. I was saying on the Chinese displacements, you've seen some progress there. You've got 2, I think, large customers have already ramped up and you've got a few more that are under contract now that are still in the process of ramping up?

So I would say ramp up is probably not the right word. We had some early shipments of some of the replacement opportunities. But as you rightfully said, we also won some new customers where we -- from one specifically, we definitely know that Huawei replacing customers, this one has not ramped yet. We anticipate this will happen late 2024 or early 2025. And the other one, we also anticipate that this is definitely a Huawei replacement, will also ramp rather 2025. But I think we spoke a lot about Huawei replacement in the years past, but it's really becoming a reality now.

That's great. And on the gross margin front, this year, I know that it's been a little bit of a headwind there. Can you kind of walk us through -- is that primarily driven by lower volumes and fixed costs or product mix, maybe unpack the gross margin results that you saw in the first few quarters of '23?

I mean, the gross margins overall, we were able to improve throughout the year sequentially, right? If we started really in the mid-30s essentially, and then we were able to get to 40% already in the third quarter. Obviously, the gross margin is heavily impacted by the increased pricing based on the supply prices, not only the component pricing itself, but also expedite fees and all these type of things that contributed to higher costs. We still have -- some of our inventory still has a high price tag, but it will flush out over time. And as you saw, we were able to improve our gross margin already this year. Obviously, it's also tied to customer mix and product mix. But overall, I think we will see a continued -- or we will see a continuation of the improvement of the gross margin throughout next -- this year and then the year after. And I think it will not only be the pricing, it will be, of course, economies of scale, it will be some of the things you're doing to get more efficient as a company, things that we were planning when we did the merger with ADVA, consolidating EMS, consolidating operations footprint and so on getting some efficiencies there. And then last but not least, obviously, also scaling software and services. So this all will contribute to better gross margins going forward.

Great. That's terrific to hear. And as you look back and think about the impact of the macro on your customers, do you think that, that was one of the drivers? Or was it primarily inventory? How do you balance the impact of macro conservation efforts versus inventory on what you saw in '23?

I think you can simply look at our 3 revenue categories. And I would say Access & Agg and Subscriber Solutions predominantly. Inventory correction, whereas in the optical business, it's predominant to the macroeconomic environment because this is typically a product that you don't put on stock but you have long -- you have rollout plans, you have [indiscernible] plans and so on. And based on the increased cost and all of our -- most of the carriers are BEAD funded so they [indiscernible] CapEx budget and so [indiscernible], right? And I think this is how you -- if you look at our product category, then this is how I would see it.

That's fair. That's very fair and really helpful. And so you announced a business efficiency program to reduce OpEx and limit your cash burn. Can you walk us through that OpEx adjustment and the capital allocation changes you made recently? And what some of your targets are there that you announced?

Yes. So from an OpEx reduction, we announced that we will lower our cost base by about $90 million in 2024 over 2023, I said this in an earlier meeting, and I will repeat it here. If there is one positive of 2023, then it is that we had our -- based on the merger, we had a synergy plan already in place that we were -- that we started executing in 2023, but the original -- originally, we wanted to be completed with the synergy plan in -- by the end of 2024. And by then, we wanted to have our $52 million in synergy to realize. However, the challenging revenue situation kind of forced our hand to accelerate the synergy plan and do it even more, right? So we did -- we followed through on the synergy plan and we did much, much more when it comes to getting more efficient as a company, take out costs, move from high-cost sites, manpower to lower cost sites or high efficiency sites as you like to call it. We just reshaped the company and with a speed, which I think it would be possible, and we're still not done yet. We're consolidating sites. We have the consolidating footprint. We just moved, for example, in North America from the [indiscernible] legacy side, the operations and logistics center that used to be in [ Atlanta ], we just moved -- completed -- just moved it into [indiscernible]. So these are some of the things we're doing. We shut down a site in -- that the ADVA legacy business has in China. And we're just working through it, getting more efficient, getting better, getting faster, being there for our customers. And then also, of course, we just opened up a new factory in Germany. On the -- at the legacy side, where we in-house certain things that we -- let's say, some of the high-end products, highly automated factory, very efficient. And we just try to get better and more efficient. And I think like we said, we are planning to be free cash flow positive at second quarter of this year based on a fairly low revenue level. And as soon as revenues come back to normal levels, then we will be an extremely profitable company. And I think this is a positive kind of that the situation really forced us to get aggressive when it came to the implementation of the synergy plan and some of the additional savings that we did.

Maybe...

Second question -- Steven [indiscernible] this one.

Yes. And maybe in addition, we also have the site consolidation or the capital efficiency plan in place, which is also part of the business efficiency program. One part of it is the suspension of the dividend, which will save us something approximately $30 million a year in cash working to sell some more sites in the Huntsville headquarters, which we were thinking will provide us additional cash in excess of $100 million, which we will use to pay down debt, strengthen our capital structure and save interest expenses going forward.

Got it. Yes. And that's a rapid response and hats off to you guys for reacting quickly to the changing conditions. It's been -- you're not alone in facing those headwinds. And in terms of...

[indiscernible] by the way, Ryan, we had a COVID office plan already that we were working on based on the fact that many of our offices -- or people or employees in our offices are on hybrid schedules. We already had this kind of worked out. It's just one of the things that -- again, let's just do it now quickly. So also something we -- our hands got not a little bit fast, but we were happy that we already had the plan in place, right? So plan was already there.

Yes, just accelerated. That makes sense. So as you think about '24, I know you can't comment quantitatively, but can you maybe highlight some of the different customer and product opportunities you're most excited about in '24 that you can see beginning of a turnaround in?

Well, overall, I would say, I said it very early in the call, we had several wins that really help us to build a foundation of future growth, right? Even in a difficult macroeconomic environment, as soon as those new wins will ramp, we will add revenues to our top line. Then of course, on the product side, we have some really cool products that we -- SDX 6330. We have some new Wi-Fi and mesh products really could [ help ] on the optical side, we will ramp our 100ZR pluggable QSFP28. So there are some really -- it's really cool stuff in our pipeline. And again, the wins of new customers, the tailwinds from the Huawei replacement, and then last but not least, also the BEAD funding, where we expect that we will see an impact later this year. It's definitely promising. Despite the -- it's going to be challenging, I think, for the first half of the year at least. But if you believe all our analysts -- industry analysts and financial analysts, then they -- everybody is talking about second half of the year should be much better. We should definitely see some signs of improvement. And I think we will also see some signs as soon as the market starts to relax a little bit.

Yes. I think both in terms of kind of a return to normal as well as you have these subsidy programs coming in, are you expecting to see the beginnings of some bookings in the late '24 around BEAD? Do you think that's a rough time frame when you can start to see some impact?

I think this is realistic that you will see some bookings. I mean by talking to some of our customers who are applying for BEAD funding, I think that's realistic that there will be some bookings towards the end of the year. Yes.

You probably saw that Louisiana is the first state, right, to get the full approval from the CIA?

That's correct. I think Louisiana is 10 phases now. And I think we have 5 more states which has, I think, completed already 9 out of the 10. So we really see progress here.

That's really great. So it's been a long time waiting for the speed money to show up. So we're all very hopeful. Are there similar programs in Germany as well around subsidy? Or is that not as significant as what you're expecting in the U.S.?

I mean U.S. is always more significant than most other countries in the world. There are some funding pockets available from the European Union and also from some of the local government, I think there's a large fund in [indiscernible] was Italy, if I'm not mistaken, about $7 billion from the European Union. So but by far, of course, not in the size of BEAD funding, but still promising.

That's great. So let's go back to talk about some of your innovations you have and some exciting things happening. A lot of -- some improvements on the software side, I know with Mosaic One. Can you maybe talk about how you're doing with customer traction, with the Mosaic portfolio and what some of the new features are there that are getting some customer interest?

I think that...

Sure. So...