Adtran Networks SE

XMUN:ADV

Earnings Call Transcript 2022-Q3

[Steven Williams, executive]

Thank you, Princi, and welcome to ADVA's Q3 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/Investor section.

Before turning the call over to Christoph, please be reminded that this presentation contains forward-looking statements with words such as beliefs, anticipates and expects to describe expected revenues and earnings, anticipated demand for our 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. Christoph will start this call providing a business update, and Ulrich will guide us through our Q3 financial outlook and the latest progress on the ongoing business combination with ADTRAN. And finally, we will have sufficient time for the questions, which we'll be happy to answer.

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

[Christoph Glingener, executive]

Thank you, Steven. Starting with our standard format and our business update and outlook.

Page 4, Q3 2022 highlights. It has been an extremely eventful third quarter, and we're very proud of what we've been able to achieve. Never in our company's history have we delivered more products or generated higher revenue in a single quarter. This record quarter comes at a time when our business environment is becoming increasingly chaotic and less predictable, supply shortages, the pandemic inflation, the energy crisis, currency fluctuations, political tensions, et cetera. The list of challenges is getting longer and the speed with which we have to respond to changes is increasing.

Despite this, we are proud to have delivered very strong results. Q3 revenues reached EUR 179.6 million, up 18.3% compared to the year ago quarter at EUR 151.8 million. 9 months revenues reached a record level of EUR 516.4 million.

Our pro forma EBIT margin for Q3 was at a solid 6.5% of revenues, and we report a Q3 cash balance of EUR 61.4 million. We continued our aggressive approach to procuring important components and carrying higher inventory. And once again, we started the fourth quarter with a record level backlog and further signs of solid demand.

Moving to the next slide, Page 5, Business Transformation update. In several quarters, we've been updating you about the strategic transformation of our business model, which is based on 3 pillars. First, we are determined to further diversify our customer base and accelerate growth in private and security relevant networks. This last quarter, we published a customer use case for the transport of uncompressed native video signals using our timing expertise. We continue to innovate for these specialized applications that bring us new opportunities beyond the standard carrier infrastructure.

Secondly, we are committed to increase revenue contributions from software and services. Our momentum with network function virtualization solutions continues to build. Bottleneck with specific hardware components accelerates the acceptance of disaggregated models, separating the software from the underlying hardware allowing the flexibility to deliver the identical service from a variety of hardware variants.

Our universal CPE software is built to run on a wide range of servers from different manufacturers and find more and more implementations with operators around the globe. This last quarter, we announced our success with Etisalat, a joint win with our partner NEC. And last but not least, the third pillar of our business transformation strategy is all about verticalization. The development of new markets and cost optimization of our own systems through stronger in-house capabilities in the field of optoelectronics is progressing well.

We launched two new solutions in the field of ultracompact pluggable transceivers that enable new approaches of implementing higher data rates around the edge of the network.

Next slide, Page 6, ADVA Network Security. Another big announcement was the launch of ADVA Network Security on October 1. The new company was specifically created to serve the increasing requirements for secure network infrastructure. The new legal entities specializes in secure transmission technology to protect highly sensitive communication networks from cyber attacks.

The stand-alone company will complement ADVA's market-leading portfolio with proven and proved security mechanisms to protect wide area networks and critical infrastructure. ADVA Network Security will develop, manufacture and integrate encryption technologies into networks that can withstand increasingly sophisticated attack scenarios.

The company has its own IT infrastructure with a secure data center in Germany and will cooperate with national security authorities to ensure a comprehensive protection of networks. This will also meet the most stringent requirements of organizations with highly secure needs as sensitive data is protected even against the attacks of future quantum computers. We expect this to be particularly relevant in government projects.

And on to my next and final slide, Page 7, our Meiningen Terafactory extension. Before I close, I want to provide a brief update on our Terafactory. During our last Capital Markets Day, we announced our plans to expand our production capabilities in Germany. Deglobalization, trade conflict and supply bottlenecks drives the necessity to bring more elements of our value chain back in-house and closer to home.

The new Terafactory is a 4,000 square meter expansion of our main manufacturing site in Meiningen. This double-digit million euro project is partially funded by the state of Thuringia and will allow us to bring the production of optical subsystems back into the heart of Europe.

Higher levels of differentiation, faster response times to customer requests and greater independence of global supply chains are some of key benefits we will gain. Earlier this year, in May, we broke ground. The picture in the middle of the bottom row shows the ceremony with Thuringia's Prime Minister, Bodo Ramelow, and construction since then has been progressing very well. We are excited about our future in-house capabilities and expect to move into this highly automated factory environment as early as Q1 2023.

And with that, I hand over to Uli.

[Ulrich Dopfer, executive]

Thank you, Christoph, and welcome, everybody. As Christoph mentioned, revenues in Q3 reached EUR 179.6 million, up by 18.3% from EUR 151.8 million in the year ago quarter. Q3 2022 marks a new record for revenues in the quarter and is the result of a fantastic job of our operations teams despite the still challenging supply environment.

Gross profit reached EUR 60.9 million and increased by 16.7% compared to EUR 52.2 million year-over-year. Despite the ongoing supply challenges and the strengthening U.S. dollar, we maintained a gross margin of 33.9%, which is on a similar level as reported in the year ago quarter.

Pro forma EBIT margin was 6.5% compared to the 8.6% in Q3 2021. However, compared to the previous quarter, pro forma EBIT margin improved significantly by 82.3%. Net income was EUR 0.9 million, down from EUR 18.5 million in the year ago quarter, and this was heavily impacted by extraordinary expenses in connection with the business combination with ADTRAN.

Consequently, diluted earnings per share were EUR 0.02 compared to EUR 0.36 in Q3 2021. We continued to invest our cash in inventory and are using our credit lines to fund additional working capital. Thus, our net cash position of EUR 20.6 million in Q3 2021 now turned into a net debt position of EUR 17.4 million.

Next slide, please. Regional revenue development Q3 2022. EMEA was once again the strongest region. Q3 revenues increased by 11.1% year-over-year, now representing 54.5% of revenues. Demand continued to be strong across all customer groups. In the Americas, Q3 revenues performed strongly and increased by 21.5% year-over-year, now representing 32.7% of revenues in this quarter.

Growth was primarily driven by communication service providers, intent content providers in addition to the positive impact from the U.S. dollar appreciation. Compared to the year ago quarter, Asia Pacific grew significantly by 50% and now represents 12.8% of Q3 revenues. Growth in Q3 was predominantly driven by strong demand from Australia.

Moving to the next slide, cash flow and balance sheet. Operating cash flow was again impacted by working capital increase and was EUR 0.6 million, down from EUR 28.4 million in Q3 2021. We invested EUR 17.6 million in CapEx and R&D versus EUR 15.1 million in the year ago quarter. This results to a negative free cash flow of EUR 17 million compared to positive EUR 13.3 million in Q3 2021.

Our debt leverage ratio of 0.7x EBITDA and an equity ratio of 56% supports our solid capital structure and investment-grade credit metrics. Q3 ROCE on the last 12-month basis was 3.5%, which is below our expectations. However, last 12 months operating income without proforma adjustments was impacted by extraordinary costs related to the business combination with ADTRAN.

Next slide, please, outlook. Our revenues in the first 9 months of 2022 were at a record level, and our order books are very strong. Despite many external factors impacting our margins, operating results have been solid so far. The progress of digitization in all ecosystems as well as security concerns in numerous industries and network operators of the Western industrialized nations are driving the demand for our technology.

On the other hand, there is still a high level of complexity with additional costs in the areas of procurement, production and logistics. This environment will continue for the foreseeable future. Our teams work tirelessly on solutions to meet market demand, and we work closely with our customers every day to provide the best possible support for their network expansion.

Nevertheless, the industry continues to solve the challenges arising from the global shortage of semiconductors. In particular, this includes ensuring the ability to deliver as well as significantly higher purchasing costs. These challenges had a substantial impact on margins in the first 9 months of the financial year. We continue to expect that the price level for components will remain high and that the uncertainties in the supply chain remain due to the ongoing zero COVID policy in China.

On the demand side, the macroeconomic challenges due to the rising prices and interest rates are leading to greater complexity and uncertainty. However, we currently do not see any additional demand risks for the last quarter of the financial year.

For the full year 2022, we expect revenues of between EUR 680 million and EUR 730 million and a pro forma EBIT margin of between 5% and 9%.

And now to my final slide, road to business combination with ADTRAN. We communicated on July 6 that ADVA entered into negotiations regarding a DPLTA with ADTRAN Holdings, formerly Acorn HoldCo. The Management Board of ADVA and ADTRAN agreed on the final draft of a DPLTA on October 18. This DPLTA requires both the approval of the extraordinary general meeting of ADVA, which is to result on the approval of the agreement on November 30, 2022 as well as the registration in the commercial register. We have taken another step forward in creating a company with revenues in excess of EUR 1 million, thus becoming one of the major players in our industry. There is a great need for innovation around the network edge and combined with ADTRAN, we will create a leader in this space.

And with that, I would like to open the Q&A.

[Operator]

[Operator Instructions] We have the first question from Robert-Jan van der Horst from Warburg Research.

[Robert-Jan van der Horst, analyst]

Two, actually. So the first question is on the component shortages, offered from other market participants that while the number of components in limited supply has reduced significantly, while some critical components remain scarce and also that the scarcity has somehow shown first signs of improvement in the third quarter. And I was just interested in kind of a more detailed picture how you see the shortages right now compared to the first or second quarter? Is there any significant developments that you could share?

The second question is on the extraordinary expenses relating to the merger. They were quite high of expects in the third quarter. I was just interested, is that the bulk that we should expect this year? Or do you foresee any significant extraordinary expenses in association with the merger in the fourth quarter?

[Christoph Glingener, executive]

Okay. Christoph speaking here, I think I'll take the first part of your first question, and then Uli will handle the second one. On the semiconductor shortage, yes, I would echo to what you just said. So we have less -- the amount of components we are chasing is getting smaller. But some of them, so to say, you just can't get. So it's getting a little bit more severe on a smaller amount of components. Nevertheless, as Uli rightly said, we do believe that we will be okay overall in Q4. And we also -- I would also echo what you said regarding it's easing overall. It's hard to say. There are still some buckets, but I think it's getting better overall step by step. So less components, but harder to get and then overall easing.

[Ulrich Dopfer, executive]

I'll take the second one related to the extraordinary costs. Yes, the Q3 definitely was the bulk of the cost. You should see in Q4, maybe costs related to the business combination and the magnitude of not more than EUR 1 million.

[Operator]

[Operator Instructions] There seems to be no further questions at the moment, and I hand back to Mr. Steven Williams.

[Steven Williams, executive]

Okay. There are no other questions. Maybe we wait few seconds. So maybe give them...

[Operator]

Yes. One question just came in, and that will be from Hugo Paternoster from Kepler Cheuvreux.

[Hugo Paternoster, analyst]

Just to rebound or to follow up on the component scarcity. You mentioned that for a few components, you have to redesign them. Just wonder what is the cost associated with this redesigning? Is it also waiting on your margin? This is for the first question.

The second question is more a broad question market-wise. Just to try to further your view on still strong demand on the market. Because at the moment, we are seeing like some CapEx easing from the worldwide telecom operator. I just want to assess what could be the propensity for those operators to continue to spend going forward most likely in 2023.

[Christoph Glingener, executive]

Okay. So on the semiconductor shortage, it's mostly opportunity cost, obviously, when we're doing redesigns and getting other components. And it's not necessarily a direct impact on the margin. That is more driven by component costs increasing overhaul, as Uli rightly said. So this is mostly about not developing something nice and new and differentiated -- you could do, but spending time on doing the same product again with some other components, so can keep shipping them.

So I think the margins are mostly influenced in the short term by component increases and expedite fees and all those costs around there, not necessarily by R&D redesign. That's something which might hurt us, if you want to say so, in the long term because we could have done some really nice new products.

So on the second part of your question, the overall demand in the market. Broadly saying, we don't see that yet. But obviously, we are also carefully looking out for what is happening in the market. But so far, we see a steady demand. And as we said earlier, our backlog was even increasing.

[Ulrich Dopfer, executive]

If I can add to this one. I guess we still are in a situation where the demand is higher than what we are able to deliver, right? And this might change going forward. But on the positive side, we are sitting on large record order backlog and which should help us. I just read this morning that there are some expectations regarding the potential recession in Germany and the specialists predict a little bit more positive outlook than they did some weeks ago. So I think, hopefully, we get through this on a good note.

[Operator]

[Operator Instructions] Seems to be no further questions. and I hand back to Mr. Williams.

[Steven Williams, executive]

Okay. Thanks, everyone, for your questions. We appreciate. Thank you for connecting today with us. And if you have any further questions, feel free to contact us at any time. Have a good day. Thank you.

[Ulrich Dopfer, executive]

Thanks.

[Christoph Glingener, executive]

Thank you. Bye-bye.