Adtran Networks SE

XMUN:ADV

Earnings Call Transcript 2022-Q1

[Operator]

Dear ladies and gentlemen, welcome to the conference call of ADVA Optical Networking for the first quarter 2022 IFRS financial results. This call is being recorded. [Operator Instructions]

I now hand you over to Mr. Steven Williams, ADVA Optical Networking's Director Treasury and Investor Relations. Please go ahead, sir.

[Steven Williams, executive]

Thank you, Lucas, and welcome to ADVA's Q1 2022 Financial Results Conference Call. In addition to this call and the press release, we have posted a presentation, which is available for download from our homepage adva.com, on the conference call page in the Financial Results section of the About Us/Investors section.

Before turning the call over to Brian, please be reminded that this presentation contains forward-looking statements with words such as believes, anticipates and expects to describe expected revenues and earnings, anticipated demand for networking solutions, internal estimates and liquidity. These factors are discussed in greater detail in the Risk and Opportunity Report section of our annual report 2021.

Please also be reminded that we provide consolidated pro forma financial results in this presentation solely as supplemental financial information to help the financial community make meaningful comparisons of our operating results from one financial period to another. This pro forma information is not prepared in accordance with IFRS and should not be considered a substitute for historical information presented in accordance with IFRS. Pro forma operating EBIT is calculated prior to noncash charges related to the stock compensation programs and amortization and impairment of goodwill and acquisition-related intangible assets. Additionally, expenses related to M&A and restructuring measures are not included. Unless stated otherwise, all numbers are presented in euro.

We will target to limit this conference call to 60 minutes. As usual, Brian will start this call providing a business update, then Uli will guide us through our Q1 financials and outlook. And finally, we will have sufficient time for your questions, which we'll be happy to answer.

And with that, I'll turn the call over to Brian. Please go ahead.

[Brian Protiva, executive]

Thank you, Steven. Let's move to Page 4, Q1 2022 financial highlights.

Growth is our main message this quarter. And in general, we started 2022 strong. Despite ongoing challenges due to the COVID-19 pandemic, the semiconductor crisis and supply chain bottlenecks, we delivered more product than expected, and we satisfied much of our customers' demand that is driving our growth. We met most of our targets and even exceeded them in many areas, although I personally would have hoped for less increases in semiconductor costs.

More specifically, thanks to continued strong customer demand and great efforts in purchasing, manufacturing and logistics, we were able to expand our revenues and achieve a successful start to this fiscal year 2022. Q1 revenues were up 18% compared to the year-ago quarter at approximately EUR 170.5 million.

Our pro forma operating income dropped to a respectable 4.6% in Q1 2022, down 39.3%, but still giving us a solid start to maintain our annual guidance range of 6% to 10%. Net cash was up by $11.4 million year-on-year, even though we spent aggressively to secure our supply chain and support our strategic suppliers. A secured supply chain should help us generate cash throughout the rest of the year.

Most excitingly and even with record revenues for Q1, we are starting Q2 2022 with a record order backlog after setting once again record order entry in Q1 2022.

Moving to the next slide, Page 5, innovation supporting our business transformation. We have a positive macroeconomic demand environment and the growth drivers for our industry are fully intact. In addition, as already outlined on the previous quarters, we have defined 3 strategic goals that will lead us to sustainably higher margins.

First, increased growth in software and services. Second, accelerated growth in new markets outside the traditional telco space with a high degree of differentiation. And third, revenue growth and cost reduction through verticalization. Our innovation engine is focused on supporting these business transformation goals.

Since our last earnings call, we announced several interesting new pieces around new products and customer solutions, and I want to highlight a few. Number one, our new GNSS assurance software helps to protect third-party timing receivers from cyberattacks. This is key as synchronization based on satellite signal is vulnerable to failure, interference and cyber threats. And so network operators urgently need to protect their critical timing with continuous monitoring and assurance.

Two, TOYO Corporation in Japan is now using our latest Oscilloquartz atomic clock to enable researchers to achieve highest positioning accuracy. R&D institutions require such new levels of precision timing for field trials and our market first high-precision optical cesium technology meets the needs of verticals from telecom to critical infrastructure.

Our optical cesium clock products will drive continued growth for Oscilloquartz business unit over the coming years. One of northern Germany's largest power grid operators, and point 3, has successfully completed a field trial of quantum secured data transport using the ADVA FSB 3000 platform with ConnectGuard Layer 1 encryption technology.

For the first time, with a full commercial solution, our future-proof key exchange based on quantum key distribution was used to encrypt data across aerial fiber cables, a very important aspect for power utilities.

And point 4, last but not least, in the area of verticalization, we further expanded our MicroMux product family and launched the MicroMux Edge BiDi module, a highly integrated multiplex solution that offers interesting added value in the rollout of 5G mobile networks, essentially allowing for 4x 10 gig BiDi communication within one module built specifically for 5G opportunities, but can be used in various other use cases and application areas.

These are only a few examples on how we are sustainably improving our cost base, expanding software and services revenue and accessing new markets, all in the context of our open edge networking philosophy and with the commitment to be trusted to be a trusted supplier for technologies that builds a trusted network infrastructure.

Page 6, innovation for the converged edge. The innovation news I highlighted on the previous slide to not only support our own business transformation strategy, but are also supporting the joint vision we have with ADTRAN for the converged edge. As you all know, on August 30, 2021, we announced, together with ADTRAN, our intentions to create a global market leader for scalable communications technologies with a focus on the so-called network edge. The business transaction combines ADTRAN's global leadership in residential fiber access, specifically fiber-to-the-home and local loop solutions, which you see in the middle of the slide.

With our global leadership in data center interconnect solutions for large enterprises, business connectivity that is business Ethernet or fiber to the building infrastructure, metro WDM and network synchronization, together, we are well prepared to address new requirements, especially with regard to the convergence of the network solutions at the network edge. The combined portfolio is based on a common philosophy of open, disaggregated and software-centric networking products that create the industry's most comprehensive solution set from the premise to the core.

The merger will create significant long-term value for all stakeholders of both companies by further enhancing our ability to serve as a trusted supplier to customers worldwide with a broader product offering. The majority of the shareholders of both companies have approved the transaction, and we are currently working with the German authorities on open issues regarding foreign trade regulation. We are making progress and confident that we will attain the necessary approvals.

And Page 7, before I hand off to Uli the ADVA Terafactory. I want to share a piece of exciting news regarding our core facility in Meiningen. Earlier this month, we broke grounds for our new Terafactory. On the photo on the upper right, you see the Prime Minister of the State of Taringa [ Boto Ramada ] with an oversight spade with Christoph Glingener in the background, our CTO, helping us to get started with an exciting expansion project on one of our most important sites.

With a total investment scope of around EUR 12.4 million, which is partly government-funded, we are building a new state-of-the-art facility in the heart of Europe, that includes R&D, new product introduction and operations. We will use a high degree of automation, and this includes robotics, smart logistics, smart manufacturing, all supported by our own ADVA campus 5G network and lots of solar power. The combination of highly skilled employees with our planned automation investments will make us cost competitive on a global level.

In times of deglobalization, supply bottlenecks and higher cost of energy and transportation, we sharpened our profile as a trusted supplier with local value creation in the western world. We're excited about the new capabilities we can drive from this facility expected to be fully operational in the second half of 2023.

I think Uli will take us through the next slides, and we'll be back for the Q&A. Thank you very much.

[Ulrich Dopfer, executive]

Thank you, Brian, and welcome, everybody. As Brian mentioned, revenues in Q1 reached EUR 170.5 million, up by excellent 18% from EUR 144.5 million in the year-ago quarter. Similar to recent quarters, our success was limited by supply shortages.

Nevertheless, today, we report the highest quarterly revenue number in our history. Customer demand continues to be very strong. However, growth is becoming more and more a matter of execution. Higher purchasing costs due to the silicon shortages and the appreciation of the U.S. dollar had a significant impact on our gross margins and increased our COGS by a substantial amount in Q1 2022.

Consequently, gross profit decreased by 3.5%. Pro forma EBIT margin was a solid 4.6% compared to 8.9% we have seen in Q1 2021. In the year ago quarter, we had informed the capital markets that profitability was exceptionally high when compared to our historical Q1 results. Given the extremely difficult external circumstances, we are very pleased with our performance. Net income reached EUR 6.2 million, down from EUR 11.2 million in the year ago quarter.

And consequently, diluted earnings per share were $0.12 compared to $0.22 a year ago. We have been using some of our excess cash to secure supply and still managed to improve net cash by EUR 11.4 million year-over-year.

Slide 10, please. As explained in the past, we added a slide for the purpose of transparency and to provide our analysts and investors an enhanced comparison since most of our peers report their numbers in U.S. GAAP. Please note, the U.S. GAAP numbers here has not been audited. The main differences between the 2 standards are due to the capitalization and amortization of R&D under IFRS.

The R&D amortization leads to higher COGS and for Q1, the residing difference in gross margin is 6.6 percentage points. The R&D capitalization on the other hand, leads to lower OpEx, positive EBIT impact from R&D capitalization was 0.7 percentage points and thus, pro forma EBIT margin under IFRS was 4.6% compared to 3.9% under U.S. GAAP.

Slide 11, regional revenue development. EMEA was once again the strongest region. Q1 revenues increased slightly by 0.2% year-over-year, now representing 56.5% of revenues. Demand continues to be strong, especially from communication service providers and enterprise customers.

In the Americas, Q1 revenues increased substantially by 61.3% year-over-year, now representing 34.7% of revenues in Q1 and is now back to former strength. Growth was primarily driven by communication service and Internet content providers. Compared to the year ago quarter, Asia Pacific increased substantially by 29.3% and now represent 8.8% of Q1 revenues. Growth in Q1 was predominantly driven by strong demand for private enterprise networks in the financial services sector.

Moving to the next slide. As mentioned in the beginning, we spent some of our excess cash to secure our supply and thus increase our inventory levels substantially when compared to the year ago quarter. Hence, operating cash flow was negative EUR 12.7 million. CapEx and R&D investments increased substantially mainly due to the expansion of our production site in Meiningen and capitalized development activities, which led to a cash flow from investments of negative EUR 22 million compared to negative EUR 12.3 million in Q1 2021.

As a result, free cash flow was negative EUR 34.7 million compared to positive EUR 15.1 million a year ago. Our debt leverage ratio of 0.5x EBITDA and an equity ratio of 58.9% supports our very solid capital structure and investment-grade credit metrics. Q1 ROCE on an LTM basis was 10% and reflects our commitment to deliver shareholder value.

Slide 13, outlook. Despite ongoing difficulties caused by the external environment, we had a good start into the 2022 financial year and showed strong execution. Demand is driven by the digitization of ecosystems and the expansion of communication networks supported by public funding programs in many regions and countries. Our investments in innovation in recent years has laid the foundation for the differentiated portfolio of solutions, which enables us to grow.

And finally, the transformation of our business towards growth markets with a higher share of software and services as well as more verticalization is developing well and should support our margins. Nevertheless, the entire industry is confronted with challenges arising from the global shortage of semiconductors. It's all about execution, securing supply and the ability to deliver products while managing significantly higher purchasing costs. We currently assume that the semiconductor crisis will continue for the remainder of the year.

With respect to the COVID-19 pandemic, it remains to be seen whether new lockdowns in China or other parts of the world will lead to further tightening of supply chains. We also cannot foresee if new virus variants will appear, leading to further restrictions.

Considering the positive demand environment, but recognizing the supply challenges, we reiterate our full year guidance for 2022 with annual revenues of between EUR 650 million and EUR 700 million and a pro forma EBIT margin of between 6% and 10%.

Now to Slide 14. Just a brief update on the ongoing merger process with ADTRAN. The last outstanding closing condition is the FDI approval from the German government, which we still expect to receive within Q2 or Q3 this year.

And with that, thank you, and I would like now to open the Q&A session.

[Operator]

[Operator Instructions] The first question is coming from Robert-Jan van der Horst at Warburg Research.

[Robert-Jan van der Horst, analyst]

Congratulations on the excellent growth figure there. I do have a question. I read through your report and the wording in terms of your outlook regarding the chip shortage seems to be a little -- has gone a little less optimistic, I suppose. So you don't really expect significant improvements now in the second half of the year also. I would just like a little -- an idea, a little more detail maybe on how you see the situation right now and how it has developed in Q1, how it's continuing in Q2 and when you expect maybe some improvements in this area, that would be great.

[Brian Protiva, executive]

So basically -- definitely, we believe there's going to be challenges into 2023. And I think if you look at the industry as a whole, that's consensus at this point. There are good signs, things like TSMC realizing more than half their revenues on 7 nanometers and above high-performance nodes, which means people are transferring designs into the latest and greatest wafer fab infrastructure, which means that reduces the stress on, let's say, the older nodes like 16, 20-nanometer nodes, et cetera that are needed for a lot of the designs that the comms community uses.

And therefore, we believe things are getting better. We do believe that it's going to be a slow tail though. We hope that we were peaking Q1, Q2 as far as costs and because you see it in our margins as brutal impact clearly. But like I said, we hope things slowly get better into the second half and then no longer our major challenges is in 2023. That's kind of how we view it at this point.

[Robert-Jan van der Horst, analyst]

Maybe a short follow-up on the top line. Because in Q1, you actually reached a number significantly above an estimate. So I was just wondering if this is something you think you can keep up or are you expecting that maybe those shortages will also impede on your top line development more in the coming quarters or in the coming quarter than it did in Q1. So did you just get lucky or is it just good, good procurement and we can expect that to continue?

[Brian Protiva, executive]

I think -- I believe that we are driving revenues. Margins are lower. Revenues are higher in that model where I reiterated our 6% to 10% guidance means that we're making comments that the chip shortages through 2023, therefore, that will have impact on gross margins. And yet we're keeping our guidance where it is, would mean, yes, more strength in revenues than originally planned because of a combination of demand and our ability as an organization to actually access what's necessary to drive revenues.

Part of that is also we've used a lot of our cash, as you see in our balance sheet in order to secure, as I mentioned, both components as well as our supplier, let's say, infrastructure to be able to respond to our increased revenue demand. And even though we had very good revenues in Q1, I also made the clear statement. I think for those listening to my presentation was that our backlog increased once again, and we had record order entry in Q1, which indicating very strong book-to-bill. So the environment is such that we are now planning higher revenues with lower margins, but the same framework on performing EBIT.

[Operator]

The next question is coming from Hugo Paternoster at Kepler Cheuvreux.

[Hugo Paternoster, analyst]

Yes. My first question is related to your top line development. As you have had a strong growth in Americas, I just wonder if you could shed some more light on that apart from the FX impact, to what extent this performance can be replicated? And maybe could you give us some comments from where it comes in terms of demand or customer types?

[Brian Protiva, executive]

Some of you recall, we were a little bit defensive when people said, oh, Americas volumes are down, and we said for a couple of quarters, you guys, no problems. We haven't lost customers. We're strategically in a very similar position. Sometimes it's customer mix and product mix and just even ability to ship certain line cards that are needed. And I think it's -- what it's doing is rebalancing. So the Americas, the statement is not that Americas is outgrowing the rest of the business. I think we're doing well in Europe, we're doing well in the Americas.

We've continued to expand our opportunities there. We're looking at expanding our customer base aggressively with our really our transformation strategy, and we are winning accounts there step by step, small, even some medium-sized business opportunities. And so in the big context of things, I would view this as I told you so that Americas isn't weaker. We haven't lost customers. We're moving it along. We're still a strong player. We continue to win accounts in America, but I'm also not making the statement that America is going to radically outgrow our other regions. I think it's going to be -- continue to evolve going forward. And it is our goal to ramp it faster with new customer wins, but we have that goal for Europe and Asia Pac as well.

[Hugo Paternoster, analyst]

And my second question is a follow-up in terms of profitability. So you maintain your pro forma EBIT margin guidance. So it implies some improvement in subsequent quarter. I just wonder if you could drive us through your assumption in terms of margin expansion? And maybe more on the OpEx side, development going in the subsequent quarter. As you already mentioned that you still expect some easing pressure on the semi soft stage and which could play maybe positively from H2 on your gross margin?

[Brian Protiva, executive]

Uli, do you want to grab that or do you want me to?

[Ulrich Dopfer, executive]

I can certainly start, and then you can chime in if you have additional information. So overall, I don't think that the cost structure will change significantly in the second quarter. As you can see, we are up in certain areas, for example, in sales. We are up in R&D, maybe across the board based on the inflation tendencies. We see everywhere. Gross margin, I guess, at the end, there will not be a significant change.

Freight costs will be up, supply costs will be up, expedited fees will be up similar to what we have seen in Q1. And at the end, it comes down to the customer and product mix, what will we be able to ship, and this could have an impact on the margin profile for the second quarter. But as Brian mentioned, we have remained in our 6% to 10% yearly guidance, which should imply that we should see probably a higher EBIT margin in the second quarter already to get into that corridor that we are guiding. Brian, you want to talk about the price increases?

[Brian Protiva, executive]

I was just waiting as to increasing revenues, margins. Yes, as I had indicated some kind of crisis, we hope we've seen the peak now, and it's going to stay really tough in the second half as well in Q2 and the second half, but don't believe it's getting worse. And therefore, slow recovery there. I don't think we want to name exactly percentage numbers there, but I think you'll have hopefully a step-by-step incrementally, linear development on that layer.

And then we are doing things to also counter lower margins, and that is we have selectively had to increase pricings where our costs have increased dramatically for the longer time. So we've been looking at all these costs and some of them are long-term effects. Some of them are freight, some of them are short term, PPV, some of them sourcing new sourcing channels in order just to get product at all.

And we've kind of managed through that and say what are the long-term impacts, and we're already starting to adjust pricing and to counter those mid- to long-term effects, as Uli just mentioned. But in general, the shift -- I've already said this once, but I'm just going to say shifting to maybe you could look at higher end of framework and revenues, margins coming down, but staying right in the same corridor on the 6% to 10% pro forma EBIT.

[Operator]

The next questions are coming from Hana Maalej at ODDO BHF.

[Hana Maalej, analyst]

From my part, I have 3 questions, if I may. The first one is a follow-up on growth in Americas. I had in mind that the backlog in there was very strong, but it was more focused on products that you couldn't really deliver or you have difficulties to deliver. So the strong growth apart from the ForEx effect, is it more coming from the new clients that you mentioned, market share here or is the easing pressure on shortages regarding the backlog in the Americas. Should I give you all the questions or one by one?

[Brian Protiva, executive]

One by one. So the first one, again 2 of us in Americas. When our numbers were lower, we were saying we were booking better than what our numbers are showing. We had indicated that a few times. So that's one aspect. As the shift back is that was relevant to supply chain, product mix, et cetera. That's one issue.

Second one is, yes, our customers are expanding clearly demand in the U.S. It's a good market environment. But it's just -- our customers, our main big customers that we're growing with that demand. Third is, yes. There is some ForEx advantages that we get as the dollar is in the 105, 106, 107 range right now versus that 118 119, 120 range, it means we are getting higher contribution out of the United States as well.

So there's a number of reasons that I'm going to report -- restate what I said. And that as I feel there has not been a shift, fundamental shift in our regional strengths. In the U.S. is my guess it's in that 30% to 38% range, kind of thing, 28% to 38% range and depending on a lot of different factors, could that shift to 33% to 40% yes, based on a very strong dollar and continued new wins and we are winning stuff, especially with some of our business transformation products.

Some of the things even are self-limited. We can't ship enough products. So we'd have more volume and more margins in the United States. So there's -- the framework is solid, but there isn't a fundamental shift here you guys. And I think that's what you guys are getting at. Is there something in the bush or ADVA is going to grow fundamentally much faster in the United States than in Europe or in APAC. And I don't get the sense. I think both U.S. is strong, solid, good opportunity. Second question?

[Hana Maalej, analyst]

Okay. Second one is about the cost structure. Just to have an idea about your natural hedging. Can we have an idea about the percentage of sales labeled in dollar and the percentage in costs? Just to have an idea about the hedging.

[Brian Protiva, executive]

So this is our cost structure. You want actually revenue contribution, dollar revenue contribution and how much is being converted into euros essentially, that's what you'd like.

[Hana Maalej, analyst]

Yes. And I mean, even in terms of costs in top line and in bottom line, I would say.

[Brian Protiva, executive]

So you're asking for -- that's fair to see on revenues as well as OpEx. Uli, I don't know what you want to give there?

[Hana Maalej, analyst]

Yes, both.

[Ulrich Dopfer, executive]

I can give a little bit of light to that one. So maybe, first of all, there is a negative impact to our pro forma based on the current exchange rate environment. Since we purchased more in U.S. dollars referring not only to the U.S. dollar, we purchased about 80% to 90% of our COGS is based on U.S. dollar, whereas only as you can see in the slide, revenues is only 35% or maybe 40 at some point of time. So there's definitely a clear disadvantage.

We also have, of course, some OpEx in U.S. dollar, so there is a negative impact to our profitability based on the current exchange rate environment, a few million, I would say, negative impact. However, you mentioned the word hedging referred to natural hedging. But of course, you do some real hedging as well to offset this, which you will see then in our financial results to mitigate that impact for the net income.

[Hana Maalej, analyst]

Okay. And my last question is about the Terafactory. How is it going to contribute in adverse figures? I mean you said that it was going to be operational in H2 2023. But when do you expect first revenues and how we did the ramp-up for this activity?

[Brian Protiva, executive]

Well, first of all, if we get it done in Q3, you'll see first revenues in Q3 2023. That gets done in Q4. It will be first revenues in Q4 of 2023. This doesn't fundamentally change our model. What we're doing is rebalancing from a, let's say, Asia Pacific Euros Ops strategy to a Europe led Op strategy more global in nature. And this has to do with the rebalancing after the trade wars and not only the political frameworks that we were facing, but also customers' demands. And what we were -- didn't want to do clearly is we don't want to increase costs. So we looked at various different models, and we brought in or bringing back, let's say, a lot of operational capabilities back into Europe. We've done a lot of that work already.

But then we realized you guys -- some of our high-end stuff, we can drive equivalent cost like in APAC or in other regions by fully automating certain things. So we've selectively picked certain products that are now being manufactured with much more manual labor, and we are automating things. So again, robotics, software capabilities, the whole -- the way you build the logistics facility as a whole, all of that's being done so that we can build product, but we're building that product today already. It's not a new product that we're launching into the Terafactory will be existing products and there'll be 2 sources of those types of products and ultimately, maybe even 100% of certain things would be done in the Terafactory.

So the answer is revenues, hopefully, in Q3 of next year, if not, then in Q4 of next year. They will be with products that we already drive lots of revenues with today. It will be able to address low volume, a very complex products, but also some of the things that we can attack will be higher volume, lower cost because of, like I said, the automation capabilities of our end-to-end planning.

[Operator]

The next question is coming from Tim Savageaux at Northland Capital Markets.

[Timothy Savageaux, analyst]

I have a question about the overall demand environment and your guidance -- revenue guidance in particular. Given the commentary around bookings and backlog, which are both very strong, I would expect that you might expect some growth in the second quarter. And I just want to try and reconcile that with your unchanged guidance for the year, just given the degree of upside in Q1. You're kind of suggesting in the middle of the range, you're going to stay around this $170 million run rate throughout the year. Again, that seems conservative relative to the bookings and backlog commentary. I imagine there are concerns around supply and that being the variability there in forming that.

But I wonder -- I mean it seems like we should be biased toward the high end of the range here at the very least. I'd love your commentary on that. And then overall, well, I hear you on the Americas side, it seems like you're catching up to demand. There does seem to have been some degree of uptick in overall demand. And I wonder if you can describe -- are we reading that properly and maybe what's behind that? And if you could talk a little bit more about the overall kind of pipeline environment on the optical side or in particular among carrier customers.

[Brian Protiva, executive]

So Uli, do you want to do the first part or...

[Ulrich Dopfer, executive]

Why don't you just start and...

[Brian Protiva, executive]

Okay. So I'll start with the U.S. again. So we've already covered that quite a few times, and that is I guess, demand is solid. I think it's hard to really understand the order run rate and long-term demand picture because Tim, I think you're looking at a big picture here. I guess the sense that you get out of the industries, yes, demand is at a higher rate than the forecast in our product area, let's say, the optical area, which is the forecast are fairly conservative, depending on who you listen to, 2%, 3%, 4%, 5%.

But I think the sense is that, yes, the demand environment is better than that, and it's not better than that for the next quarter, but it seems to be a midterm at least environment. So demand environment is good, but that's not just the U.S. you guys, that's generally an year throughout Europe as well. And we see that as a good environment to be doing business in. Still have to track all of this very closely because remember, the massive backlogs and those massive orderings were coming off of a shift of securing product into the future, trying to avoid things like price increases, et cetera, like that. But even with that, by side, we see a very good demand environment.

Second part of the question frameworks was, yes, shifting to the upper end. Right now, coming off of Q1, that's what we're saying is that revenue is shifting. You're right at 170 times 4 you're already in the upper closing in, I think, what we say, $650 million to $700 million. So you could -- what you could do a $5 million increase each quarter from where we're at and we're still in that range kind of area, the upper guidance.

And yes, we -- right now, as we look at our business, we're looking at our business upper range. We're not ready to change guidance because we feel that in general, we're still in tune with where we guided beginning of the year and feel comfortable at that 6% to 10%, which I think is the key metric anyway, but we're shifting revenue up, gross margins down, profitability solid.

[Operator]

The next question is coming from Johannes Ries at Apus Capital GmbH.

[Johannes Ries, analyst]

Okay. It's not worked because I have been canceled separate times as I try to ask a question. I don't know why. If you only want to have sell-side analysts, I don't know, but maybe only because some questions I want to ask. What of your revenue increase is price increase and how much is volume? Because you increase your prices, I think, or is it not the case?

[Brian Protiva, executive]

I think in general the industry has increased pricing. Different people went earlier, different people later over the last 12 months. Some people even did 2 price rounds. I think at this point, you're seeing no increase in our numbers, no price increase is influencing any our numbers up to date. It is more -- the impact will start to happen in the second half of the year and fully be realized into next year from our price increases. So none of the revenue or the dollar demand, it's 100% real demand.

But there's an underlying theme throughout the next 12 months that you'll slowly get a little bit more of these price increases because as people reacted to price increases, ADVA was very fair to our customers and said, listen, these are the reasons very transparent of what's happening in semiconductor costs and supply issues, and these are long-term costs that we just can't avoid and then work with our customer bases. And then some of them said, well, I don't want to accept that and order long term into the future and various strategies out there. So you only see some of those over a long period of time, some advantages off of those price increases. So like I said, it's a step by step process over the next 12 months, also probably been a kind of a linear fashion, and that should support both revenues and compensating some of these extra costs mid-term.

[Johannes Ries, analyst]

Okay. I see. So for, it's not so easy to change the mind of your customers because they have been familiar with permanent decrease in prices, not increase as well?

[Brian Protiva, executive]

Correct. It's been a lot of work on the -- because this was an ADVA, the lead. It was more ADVA as a follower to an industry that just walk up one day and realize, wow, we're between a very difficult situation of service providers that are very optimized and outstanding professional purchasing organizations, pushing, pushing, pushing, pushing and semiconductor suppliers that just didn't seem to be listening to our environment and just increasing, increasing, increasing because they could.

And I think the industry has responded and said, well, we have to, at some point, recoup some of those costs. And so different people -- different companies have different strategies. But in general, the industry has moved to solidifying the pricing structure. And it seems to be in general accepted by the industry and the customer base. For most suppliers, not just ADVA specifically, but for the industry as a whole.

[Johannes Ries, analyst]

I see because we are in inflationary environment, so for also hit your business in some regard. And therefore, that's one reason. Maybe you said it before, maybe I missed it, that the margin in the full year can get better because you have this effect in the second half now.

[Brian Protiva, executive]

That's one of the -- we hope we both have lower costs into the second half of the year, and we hope that, yes, price increases will slightly -- will help us into that second half of the year. And then we're working our business transformation strategy. I want to see more software and services. I want to see more non-telco business to balance our margin profiles. And then the verticalization is -- we're doing really well. We have some outstanding interesting products. Our biggest issue there is scaling the product volumes. And so there's more time to scale some of these things. And those are kind of the topics that we're pursuing in order to recoup margins, drive ever greater profitability, et cetera. So kind of those 3 initiatives, business transformation. Yes, pricing solidifies and three, costs, hopefully, slightly decline literally over the next 12, 15 months. And hopefully, you don't see much of it left actually in 2023.

[Johannes Ries, analyst]

Okay. Super. Do you see already the bond which is coming from all this? Can you indirectly see if your customers are seeing it from all these infrastructure programs, especially in the U.S., you mentioned during the ADVA road shows that this is a big driver or is it something which comes in the year '23 and later?

[Brian Protiva, executive]

No, I think it's already helping. Clearly, it's helping. It's part of demand creation in various regions. That's definitely part of it. I do believe, in general, digitization of society, bandwidth is continuing to grow nicely. And then you've got some of these 5 to 7 year kind of wave of extra government funding on top of those 2 initiatives so that you're in this kind of period where all of that is helping drive hopefully a consistent demand development environment for our industry as a whole.

[Johannes Ries, analyst]

Okay. And again, as ADTRAN deal was not the reason that you maybe have thought more open doors in your assets. You mentioned it already before, there are other reasons for that service.

[Brian Protiva, executive]

Yes, there's no -- as you -- most of you know, in an environment where you have a potential merger ahead of us, really one big hurdle left, but you don't work together in any way or form. So we have not been helping each other because you just can't. There's competitive landscape. There's legal frameworks and ADVA has always done everything by the book. We are not a company to play around and ADTRAN the same way. So we've been doing everything very professionally. But that means we haven't been able to help each other yet. And I think if we can close the deal, there will be further very positive effects. And then most of the effects clearly come with the synergies and the combined organization, whether it's still 2 organizations or it's 1 organization, but you start to have then more aligned and positive effects coming off of the transaction.

[Operator]

The next question is coming from Simon Scholes at First Berlin.

[Simon Scholes, analyst]

Yes. I've just got one, and that's on inventory. I mean you were talking about investing in inventories to secure your ability to deliver. I mean just looking at the last quarter, I mean, you've gone from EUR 129 million at the end of December to EUR 130 million at the end of March. I mean, the big jump it looks as if it happened in Q4, where you went from EUR 100 million to EUR 130 million. I mean I was just wondering whether we should expect any further sort of larger increases in inventories during subsequent quarters this year? Well, I mean, just in general, how you see the inventory situation. I mean if you have to...

[Brian Protiva, executive]

Well, lets us answer the question because it's a little bit more complicated than that. Uli, do you want to grab it?

[Ulrich Dopfer, executive]

I can start. Yes, you saw the big jump in Q4 already if you compare to Q1 of last year, it's significant, right? It's all about the ability to deliver, right? I mean if we will continue, and I guess we indicated that we should be in the same magnitude that Q1 may be higher if we continue to be able to deliver that our inventory should be rather flattish on that high level that we are right now. Will there be some volatility for sure, right?

Because, again, we are investing a lot in buying components, securing components. And -- but I would not believe that there's a significant further uptick unless we are really short on certain pieces where we have finished systems to the very end, and then there's only a little piece missing and we cannot shift the system. But overall, I think this level is something you should expect throughout the year.

[Brian Protiva, executive]

So I'd like to add something there. So from a cash perspective, because that's -- I mean, you're looking at inventories in the cash issue. So inventories grew year-over-year. They grew steady throughout over the last 12 months, up only slightly now in Q1, but we are doing things like prepayments. And as the exposure, remember, we're growing in exposure of our contract manufacturers and things we are having to pay to secure infrastructure. That's why I said it very clearly in my presentation, we're paying to secure supply chain from both components and infrastructure. So some of that is coming from prepayments is another one that we are dealing with, and those are prepayments that have been rising quarter-for-quarter as our business is growing, we've been -- we need to take cash in order to secure driving those higher business volumes.

[Operator]

There are no further questions at the moment. For closing remarks, I go back to Brian Protiva.

[Brian Protiva, executive]

Thank you very much. I mean, being an innovation company, #1 on our list is to grow, grow, grow. Environment is not bad for that. We clearly have an opportunity to manage the business even better, and that is control costs, drive up margins, execute on our business transformation. We're working hard on those things step by step. And we will hear from each other in 3 months. Thank you very much.

[Operator]

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.

[Ulrich Dopfer, executive]

Thank you.