Adtran Networks SE

XMUN:ADV

Earnings Call Transcript 2022-Q4

[Steven Williams, executive]

Thank you, Francie, and welcome to ADVA's full year 2022 preliminary 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 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 networking solutions, internal estimates and liquidity. 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 try to limit this conference call to 60 minutes. Christoph will start this call providing a business update and Uli will guide us through our Q4 financials. And finally, we will have sufficient time for your questions, which we'll be happy to answer.

And with that, I turn the call over to Christoph.

[Christoph Glingener, executive]

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

Page 4, Q4 and full year 2022 financial highlights. We're proud to report on a highly successful fourth quarter and fiscal year 2022 where we achieved our highest revenues in the history of our company. Revenues in Q4 2022 reached EUR 195.7 million, up by 24.1% compared to EUR 157.7 million in Q4 2021. For the full year 2022, revenues increased by 18% from EUR 603.3 million in 2021 and reached a record level of EUR 712.1 million in 2022. Our pro forma EBIT for 2022 -- Q4 2022 was EUR 24.4 million or 12.5% of revenues, an increase by 108% compared to EUR 11.7 million or 6.5% of revenues reported in Q3 2022. Compared to Q4 2021, pro forma EBIT improved by 69.9% from EUR 14.4 million or 9.1% of revenues. And we report a Q4 cash balance of EUR 58.4 million.

Despite ongoing challenges caused by the semiconductor crisis, bottlenecks in the supply chain, inflation and fears of recession, we were able to stay on course comprehensively serving and supporting our customers with innovative communication technology, software and services.

Moving to the next slide, Page 5, recent highlights and press releases. I will summarize a few highlights we announced over the recent weeks and try to provide a bit of context. As more and more networking applications need higher precision and assured timing, we brought two new products to market that further solidify our technology leadership in this space.

First, we introduced time-sensitive networking, or TSN capabilities to our FSP 150-XG418 high-speed packet edge device. The upgraded solution actively uses technologies that minimize latency and reduce jitter. With its new capabilities, the product will simplify the rollout of 5G services at scale and enable use cases, including mobile fronthaul, industrial automation and video-audio bridge.

Second, we launched our latest optical cesium atomic clock solution, providing unprecedented protection for critical network infrastructure systems that rely on synchronization from global navigation satellite systems. The new OSA 3350 Super ePRC delivers extended timing holdover with high performance stability and lifetime that significantly outperforms any other solution on the market. The use cases for this product go way beyond the traditional telco space and empower us to further diversify our customer base.

Furthermore, we brought new software capabilities to the market. The new unfounded cloudlet software is direct response to the growing demand from enterprises for on-premise cloud solutions. With our solver cloudlet, enterprises can harness edge computing to meet low latency requirements for applications such as private 5G, augmented reality and smart manufacturing. The software also enables service providers to offer customers an easily scalable edge cloud with localized control.

On the security front, we were proud to announce that our flagship 10-gigabit per second edge solution with ConnectGuard Ethernet encryption has been approved for transmission of classified data by the German Federal Office for Information Security, BSI. The BSI approval will be a major boost for customers with higher security standards.

Speaking of customers with high security standard, Shibuya, a leading Swedish IT service provider and long-term select partner, is deploying our open optical technology to deliver secure managed services to leading banks across the Nordics and Baltics. The network features robust optical encryption cards from our upfront network security team for critical data protection.

And last, but not least, I want to highlight the topics that is very near to my heart. The Layer 123 network transformation award, China's spotlight on the industry's most innovative people and companies by recognizing the most notable achievements in accelerating network transformation over the last 12 months. We won this award in the category sustainability with our coherent 100ZR transceiver. The product is a real [indiscernible] in our industry. It enables network operators to introduce coherent optical technologies at the network edge, thus increasing network capacity while dramatically simplifying the network architecture and reducing the power consumption per bit. We will showcase the product at the end of this month at the Optical Fiber Communications Conference, OFC, in San Diego.

On to my next slide, Slide 6, market environment. We are in a unique investment cycle for communication networks. The digitization of ecosystems has taken a center stage in both politics and business and the need for secure, high-performance communication infrastructure has never been greater. The market environment provides us with several tailwinds, which includes the following topics.

First and foremost, the investment in fiber and bandwidth continues at unprecedented level. Fiber is the basis for all advanced communication infrastructure, including 5G and viewed as long-term value investment. Capacity demands keep growing rapidly, and the world needs more fiber to satisfy the demand.

Secondly, this upgrade and expansion cycle is supported by a strong funding environment. The U.S., the world's leading economy added to the existing program so-called Big project valued at USD 42.5 billion and set to launch in late 2024. Also in Europe, there are tens of millions of public funding for fiber broadband paired with robust private investment.

And finally, we see increasingly strong commitment from network operators in the Western Hemisphere to replace high-risk vendors in the networks and limit exposure to the technology in future builds. According to a report published by industry analysts from Omdia in December 2022, ADVA gained 4% market share in the optical networking market in Europe based on rolling 4 quarters in Q3 2024 versus Q4 2020 more than any other supplier, while Huawei was the same amount of share in the same period. A clear indication that this transition is happening and the U.S. has been expanding the entity list restrictions on Chinese vendors. The proposed Network Act in the U.S. had significant implications for operators continuing to deploy high-risk windows.

While we enjoy these tailwinds, we are also mindful of the headwinds facing us. First and foremost, the macroeconomic outlook uncertainty. Inflation remains high, borrowing rates going up and recession risks remain high. So we carefully watch the buying behavior of our customers and manage our inventories carefully.

These macroeconomic uncertainties come at a time when our supply chain risks have started to improve, but are still very demanding. On the one side, transportation-related costs such as expedite fees and freight decreases in a few cases, but sourcing certain components remains challenging.

In summary, we are seeing early signs of normalization in the semiconductor availability and expect to reduce our backlog and inventory levels somewhat in future quarters. Freight costs remain high and inflationary pressures from energy prices continue to be a concern, but we foresee a gradual return to normal operating modes. Next slide, please.

Page 7, business combination with ADTRAN completed. With the registration of the domination and profit and loss transfer agreement, in short, DPLTA, with the Inner Local Court on January 16, 2023, we can now closely align with ADTRAN. As a result, ADVA's success story, which we have been writing since 1994, will continue in a financially strong group with more than USD 1 billion in annual revenues under the leadership of ADTRAN. Closely aligned with ADTRAN, we can take even better advantage of the current market dynamics and participate even more in this unique investment cycle.

As fiber rollout continues to gain momentum, we can offer network operators a much broader range of products and solutions and a highly differentiated portfolio. Our technology complement ADTRAN's and jointly, we can offer optical networking solutions from the network core to the customer premise. We can deliver end-to-end automation and insights as well as enhance security and assurance.

Together, our customer base is nicely diversified. We have a well-balanced mix of national service providers, regional service providers, enterprises and Internet content providers, as we see continued growth opportunities in each segment. Also, geographically, we are well balanced and diversified. A balanced mix of U.S. and non-U.S. customers with focus on Europe gives us great exposure to strong growth opportunities in our focus regions.

And finally, we are stronger together in our focus markets. By combining our teams and portfolios, we can offer our customers a truly differentiated and compelling set of products and services. Our combined solution offerings will be among the strongest in the world for connecting every home, business and 5G sites with fiber. Furthermore, by augmenting R&D sales and support resources in regions where we see the greatest growth potential, we'll be well positioned to serve an increasingly significant customer base.

We are creating a scaled technology leader with a broad and diverse customer base. This is an exciting time for the communication industry, and we are confident in our ability to compete and gain market share in several relevant segments.

With that, I pass it on to Uli.

[Ulrich Dopfer, executive]

Thank you, Christoph and welcome, everybody. Let's move to Slide #9, Q4 2022 key financials. As Christoph mentioned, revenues in Q4 reached EUR 195.7 million, up by 24.1% from EUR 157.7 million in the year-ago quarter. Q4 2022 marks a new record for revenues in one single quarter, which was, in particular, due to very high demand from telecommunications service providers. Gross profit reached EUR 71.4 million and increased by 27.4% compared to EUR 56.1 million year-over-year. Our gross margin increased year-over-year by 0.9 percentage points, supporting the signs of an improved supply environment.

Pro forma EBIT margin was 12.5% compared to 9.1% we have seen in Q4 2021. The strong 2022 finish is due to significantly higher revenues at more favorable margins and reduced OpEx relative to revenues. Net income was EUR 3.8 million, down from EUR 17.5 million in the year-ago quarter. While Q4 2021 net income benefited from a EUR 5.2 million tax credit, Q4 2022 was negatively impacted by FX by EUR 4.8 million mainly resulting from the weaker U.S. dollar.

Our net cash position of EUR 36.2 million in Q4 2021 turned into a net debt position of EUR 19.2 million in Q4 2022 since we took out additional debt to finance higher inventory levels, allowing us to fulfill customer orders with reasonable time frames despite the long lead times on the supply side.

Next slide, please. Regional revenue development. EMEA was once again the strongest region. Q4 revenues increased by 15.7% year-over-year, now representing 59.5% of revenues. Revenue was driven by a strong demand from our communications service provider customer group.

In the Americas, Q4 revenues performed strongly and increased by 43.6% year-over-year, representing 28.9% of revenues in this quarter. Growth was primarily driven by communication service and Internet content providers, in addition to the positive impact from U.S. dollar appreciation compared to the year-ago quarter.

Asia Pacific revenues grew by 28.1% and now represents 11.6% of Q4 revenues. Growth in Q4 was predominantly driven by a strong demand from customers in Australia.

Moving to the next slide, cash flow and balance sheet. Operating cash flow was once again impacted by the increase in working capital and was EUR 20.4 million, down from EUR 35.7 million in Q4 2021. We invested EUR 20.8 million in CapEx and R&D versus EUR 19.7 million in the year-ago quarter. This results to a slightly negative free cash flow of EUR 0.4 million compared to positive EUR 16 million in Q4 2021. Our debt leverage ratio of 0.7x EBITDA and an equity ratio of 57.0% supports our very solid capital structure and investment-grade credit metrics. Q4 OC on a last 12 months basis was 4.4%, which is below our expectations. However, last 12 months operating income without pro forma adjustments was significantly impacted by extraordinary costs related to the business combination with ADTRAN.

And in summary, despite a very challenging macro environment in 2022, we are very pleased with our operating results. Revenues were the highest we have ever seen in our history, and we were able to deliver solid profitability.

And with that, we are happy to answer any questions you may have.

[Operator]

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

[Robert-Jan van der Horst, analyst]

So I have basically only one question and it's on inventory. So last year, inventories increased, of course, as a response to the shortages. How do you predict the working capital will develop going forward since you mentioned that there is still -- that the supply situation is still challenging? I understand the bottlenecks are really limited to a smaller number of components compared to last year. So do you expect the inventories to come down? How fast will they come down? And are the components in the inventory to, right now, where there maybe -- had a significant markup to now current market prices? And do you expect that to kind of weigh on your gross profit in, let's say, the first half of this year?

[Ulrich Dopfer, executive]

First of all, you were very hard to understand acoustically. I think there's -- you have a very bad connection, but I think we got your question. So overall, yes, the supply situation improved. There were lot critical components. As you could see, we had really good output in Q4. However, I would assume that the inventory levels will remain fairly high, at least for the first half of the year, maybe going into the second half of the year, simply because a, we continue to drive material -- the lead times are still long even though the components are -- or the availability improved. We still need to drive a lot of material because we still have lots of backlog and high demand for many of our products. And so again, I would assume inventory levels remain high with a slight improvement during the second half of the year.

As per the pricing of those components, we do not see any lower prices yet, and we don't really expect this to improve drastically this year. However, this has to be seen. It's a little bit too early to comment on that one. I hope that answered your question.

[Operator]

The next question comes from Thorez Nicolas from ODDO BHF.

[Nicolas Thorez, analyst]

Can you hear me correctly?

[Christoph Glingener, executive]

Yes, we can.

[Ulrich Dopfer, executive]

Yes.

[Nicolas Thorez, analyst]

First, congrats for the strong finish. Three small ones, if I may. The first question, just getting back to the moving parts impacting the net income in Q4. Is there anything else to consider other than the exceptional expenses, let's say, one-off expenses related to the business combination because those expenses amounts to only EUR 3 million in Q4? But the gap between the debt income and the bottom line looks much bigger. So if we could have a bit more color on the elements impacting the profit, it would be great. That was my first one.

[Ulrich Dopfer, executive]

So for whatever reason, the quality was -- it was really good and then it got worse. But again, I try to answer this. I think your question was related to the onetime expenses related to the business combination with ADTRAN. And I would assume -- so we are -- obviously, the deal is now closed, the DPLTA is registered as Christoph mentioned. So I would not expect any major costs related to the business combination going forward. So I think you can scratch this off your financial outlook for the next year.

[Nicolas Thorez, analyst]

Okay. But it was more -- except for the one-off expenses, it was more like -- is there any other elements that could explain the gap between the operating income and the net profit at the bottom line? Because the gap looks like much bigger than the one-off expenses.

[Ulrich Dopfer, executive]

It was related to the FX impact that I mentioned during my part of the presentation. We had a multimillion FX impact due to the stronger U.S. dollar. As you know, we are hedging on our cash flows. And depending on how the dollar moves, we either see a benefit or a credit or a debit on the net income.

[Nicolas Thorez, analyst]

Okay. Okay. Crystal clear. And my second question on the outlook for 2023. Could we have an idea of your backlog at the end of 2022 and maybe more specifically, your degree of visibility going into 2023? And basically, how you see the state of demand this year going forward?

[Ulrich Dopfer, executive]

So first of all, we do not disclose our backlog overall, but I can confirm we continue to see extremely strong order intake throughout the entire quarter -- fourth quarter. So our backlog remains on record levels. So far, it's a little early to say how demand will develop. But as Christoph said, there are so many opportunities, and we're still in this extremely interesting cycle in our industry that we have to believe that we will continue to see strong orders and strong demand from our customers.

[Nicolas Thorez, analyst]

Okay. Okay. Good. And maybe a last one, but you mentioned in the press release that the first synergies with ADTRAN should materialize from 2023. It will be interesting to have, let's say, certain rough quantitative estimate and also what can be expected regarding the cost synergies as well?

[Ulrich Dopfer, executive]

So I believe we will see revenue synergies going forward. I mean we spoke about this in the past, right, revenue as well as cost synergies. We are working on this. We've prepared for this. So as you know, and maybe you need to join the ADTRAN earnings call, I think they will talk about -- potentially about this a little bit more. But we're working on finding the synergies that were disclosed when we announced the deal, we spoke about $52 million within a 24-month time frame after closing. So I think we are on it and realizing those synergies, identifying where we can find those. And again, this will be revenue synergies. You will see those in OpEx, but you will also see those in COGS. And so, yes. I hope that answers your question.

[Operator]

[Operator Instructions] We have a question from Tim Savageaux from Northland Capital Markets.

[Timothy Savageaux, analyst]

I think that's me. A couple of questions about the quarter. You mentioned service provider strength driving the strong results in Europe. I wonder if you had any more color there with regard to particular regions or products, or that was pretty broad-based? And kind of same question, I think you touched on it, but I may have missed it in terms of the sequential declines you saw in the Americas, if there were any particular drivers there?

And then you mentioned strong order flow throughout the quarter and record backlog. Did that broadly conform to that you saw in revenues, strength in Europe primarily? Or was there anything different about the order book versus what you reported in revenues?

[Christoph Glingener, executive]

Okay, Tim. Let me start with your first question. So as we said, it was mostly driven by service providers in Europe. To be a little bit more detailed, classical network build-out in Metro, Metro edge backhaul infrastructure, mostly by big service providers as said in Europe.

The second one, I think you were referring to a slight decline in the Americas, which is really a real slight decline, mostly due to semiconductor shortages driven.

And the third one, I have to ask, I'm sorry, Tim. Can you repeat the third one?

[Timothy Savageaux, analyst]

The third one is about the order commentary and whether there was anything -- whether we should assume that the strength in orders that you noted, including record backlog, had a similar profile in terms of strength in Europe? Or given your commentary about the supply issues impacting America, perhaps Americas could have grown, normalized implying and you saw strong orders there? So I was looking a little color on orders versus revenue.

[Ulrich Dopfer, executive]

Yes. This is a good question, Tim. So actually, almost 50% of our order backlog is North America backlog. So as -- so again, our output in Q4 was simply impacted by the semiconductor shortage. So if you look at the backlog, it's almost 50% is based on U.S. customers. So very strong U.S. share in there.

[Christoph Glingener, executive]

And no significant change in order patterns between the regions, Tim.

[Operator]

The next question comes from Fahad Najam from Loop Capital.

[Fahad Najam, analyst]

I guess a little bit confused on the commentary around component shortages. You are expecting them to improve or normalize. I guess what is normalized means and over what time? If you can help us maybe decipher that. Could normalizing meaning going back to pre-COVID-19 supply chain. Is that what you're implying?

[Christoph Glingener, executive]

Yes. So that is what we're referring to. But as we said, we still see less critical or we do see less critical components being short. So the amount of critical components we are chasing is reducing. We also think that throughout 2023, this will ease. Hopefully, by the second half, or end of 2023 to be back to normalized, i.e., pre-COVID levels.

[Fahad Najam, analyst]

Sorry, is that referring availability as well as pricing coming down? Or is this availability improving?

[Ulrich Dopfer, executive]

I think there's two components, right? It's the availability and it's the pricing, right? And the availability, I think we will continue to see that this will improve. However, now comes my favorite word, that we still see the golden screw issue, right, that we have a bunch of components, but we cannot complete our systems because there's one important piece missing.

And then the second one is the pricing. And the pricing is where we are really careful right now because we don't see any indication that the pricing will decline anytime soon. So I don't -- to be honest with you, and Christoph, you chime in if I say something wrong here, but I don't think we will ever see the pre-COVID-19 levels when it comes to pricing.

[Operator]

That was our last question for today, and I hand back to Steven Williams for closing comments.

[Steven Williams, executive]

All right. Thank you for all your questions. We appreciate it. And in case of any follow-ups, please feel free to contact us at any time. Enjoy your day. Thank you. Bye, bye.