Good afternoon. Welcome to Needham's 27th Annual Growth Conference. I'm Ryan Koontz. I cover the communications and networking sectors here at Needham. Really thrilled to be joined today by ADTRAN management. We've got Welcome, gentlemen. How are you guys doing?
Good. Good. Thank you.
Excellent. Well, maybe start first by kind of cheering everyone up on kind of messaging to investors. Tom, you're going into your quiet period in December, and we've seen some improving visibility, I think, in the industry, kind of industry-wide for telecom, CapEx, a little more optimism. We saw Ciena lay out a pretty strong guide based on their kind of carrier drivers. Can you share what you've seen in terms of order trends into the December time period and what you've been relaying to investors about your view of the coming time period, the next few quarters?
Yeah, sure. First of all, I'm glad to be here, and thank you, everybody, for showing up. As we came into the quarter, and I'll speak a little more freely about that, our view had been that a lot of the inventory overhang that we had been suffering for the last, you know, the previous year and a half or so had started to clear up, and we had seen that clearing already starting to happen. First, let me step back and say, you know, we break our businesses into three fundamental areas. We hav e the subscriber piece, which is kind of in-home Wi-Fi and business connectivity. We have the optical piece, which is mid-mile metro optical equipment infrastructure, so the carriers, and then we have our access and aggregation, which is fundamentally fiber-to-the-premises infrastructure.
Of those three businesses, the subscriber business had started to rebound back in the second quarter, and that had continued on. Fiber-to-the-premises had been fairly consistent, hadn't been impacted to the same level as the other two businesses, and then optical was the one that we had not yet worked itself through its inventory situation. And what we signaled at the end of the third quarter was we had felt the bottom of that. It had kind of come to a trough in its revenue, and that we expected things to get better from that point on, and that was based off of a few things. One is activity level had picked up. Our main markets, our Europe and US, had picked up. General environment across all the businesses had picked up or had what was becoming active.
And we had seen an increase in bookings pretty much across the businesses, but kind of more fundamentally in the optical business, which we had not seen in a while. So that was kind of what was driving the optimism.
Yeah, fantastic, and you know, as we look at 2025 here, you know, some easier comps with the inventory overhead, I mean, overhang kind of dissipating. How are you feeling at a high level about 2025? I know you're not providing guidance right now, but kind of optimism do you have around 2025?
It definitely feels better than a year ago. I mean, it was, I would say, activity level is interest level and activity level. Interest level is just people discussing. Activity level is either purchase orders, which are the best, or RFPs and people going out and actively searching for things. I would say that's definitely picked up pretty much across the board.
On all three business sectors?
On all three businesses, yeah.
That's fantastic. Great. Maybe touching on the balance sheet real quick, Ulrich. Any update you can provide on what we've talked about in terms of real estate rationalization?
Yeah. So, as you know, one of our big targets for this year is to deliver our balance sheet and repay the majority or all of our debt. Part of this program is to sell some of the real estate that we own. As we announced during the last earnings call, our goal is to, let's put it this way, we hope that we can communicate something during our next earnings call that is upcoming at the end of February. And so we're progressing in those areas.
Got it. Great. And, Tom, with regards to channel inventories, is that any different from traditional customer-located inventories that you've seen out there? Or is it a similar situation?
It's a similar situation. I mean, we do track our channel, being predominantly distribution partners. We do track that inventory fairly closely after the last, you know, two years ago, and yeah, I would say it's probably at the lowest level it's been historically, at least in recent years.
Great.
Yeah, channel inventory is fairly low. Everybody is still kind of mindful of inventory, you know, because everybody in our vertical got hurt. But yeah, they're at low levels at this point.
Ulrich, how do you feel about your own internal inventories with regards to ADTRAN raw materials?
We had some good improvement this past year. But as you know, we are not where we want to be. We want to get back to, you know, inventory turns of north of three over the next few quarters. So there's still a lot of work to do, but we have come a long way over the last few quarters.
Great. And in turn, you know, how do you think that will impact free cash flow and any free cash flow kind of bogeys you have?
I mean, we had some really good free cash flow generation through the third quarter of last year. We anticipate to, as we continue to deplete some of our inventory, that we will continue to add to free cash flow .
Great. And, Tom, can you remind us kind of what your normal seasonality looks like going from Q4 to Q1? And is that even still relevant in this new kind of time period we're in coming out of the inventory overhang?
I think it's still relevant because at the end of the, you know, what drives that seasonal pattern is typically budget finalization within our customer base. And to some extent, weather, although I don't know if it really matters that much, but weather is always blamed on it. So it does impact things, but.
You're not seeing changes in your customer base that would change that necessarily?
No, no. I mean, we haven't, you know, we'll talk about the first quarter on our conference call in February, but yeah, let me leave it at that.
Great. Let's shift topics here to BEAD and the kind of subsidy programs and, you know, what's your latest perspective on when some of these programs start to impact your demand?
There's multiple ways that it impacts, that BEAD has impacted our customer base and will impact our customer base. One is, you know, the most direct is flow of dollars from the BEAD stimulus program into our customers and then from those customers to us. That has not started happening yet in any material way. In fact, I think even in a non-material way, I don't think it's really happened. Our expectation is that that funding will start. There are three states that have gotten through the process. Somebody told me this morning that one of them had actually gotten approved through NTIA, so that's very far down the path. We expect some dollars this year, but not material.
We don't have a whole lot in the plan because we think it'll take a while for it to normalize and get all the way through the different building, you know, milestones before they start purchasing equipment. But we expect some, and I think, so that's kind of from a direct basis. On an indirect basis, I think any flow of those dollars is positive because I think you have a lot of carriers right now that are literally sitting on the fence. They're not spending, they're not freeing up their capital. They don't know, is this program going to work or not? What's going to be the hurdles to get it done, right? And how long does that take?
So, I think once those dollars start flowing, it frees up not just direct, but indirect dollars where people are sitting on the fence to see do they want to start pulling the trigger on their own internal capital or not. So, I think it's a positive movement whenever it happens.
Yeah. To some degree, they have to save that capital for the matching, right?
Exactly.
The matching because they're sitting there waiting.
Yeah. And what are the rules ultimately? How hard is this going to be? Do I do it or not do it? So I think just certainty is a good thing.
Yeah. Quick look at the Louisiana and Nevada awardees. There's a lot of small in-state providers.
That's right. Yeah. There's quite a few more of our customers.
You're thinking about that?
Yeah, yeah, yeah.
ADTRAN exposure?
Yeah. I think we've got a good customer base that's going after this. But like I said, just getting the dollars moving and taking that uncertainty out of the market, I think it'll be positive.
In terms of timing, so you're not expecting revenue, but maybe some bookings later in 2025?
Yeah, we'll get some revenue in 2025. It just wouldn't have really moved the needle. We'd like to get it done. We're not planning on it, right? I mean, if it comes, that's great.
Great. There's been a lot of fear about Elon and Starlink and, you know, canceling BEAD and all this sort of thing. What's your personal opinion on what you think is going to happen here? I know you don't have a crystal ball, but.
I definitely don't have a crystal ball. The money's going to flow. I mean, it's going to be predominantly fiber. It's a good thing. Those areas need to be built out. Even without BEAD, it was going to be built out. It's just the time frame by which it gets built out. I mean, if you look at what's happening, it's not just the U.S., it's in Europe as well. I mean, fundamentally, what's happening is people are, since, you know, it used to just all be copper, and 80 years or 100 years ago, there was this big wholesale spread of copper to everybody's home. That's now being completely displaced by fiber. And it is happening, right? I mean, there are many countries that have whole country initiatives, including the U.S., to convert to fiber and for the first time rebuild that infrastructure. So it's going to happen.
I think BEAD is a stimulus towards that.
You're not too worried about LEOs. Maybe that would be a niche.
No, no. I can't tell you how many times over the years that, no, I'm not. I mean, there'll be some areas where, for whatever reason, if you live high up on a mountain and you're the only person, you know, fiber's going to be tough. But I think that's the minority by far.
Yeah. And you mentioned a couple of other countries. I know you guys have been very active in the U.K. and Germany. Maybe can you update the audience on some of those programs?
Yeah. So those are two countries that have very specific initiatives similar to what ultimately the U.S. is falling into, albeit through different means. And in the U.K., they announced about three or three and a half years ago that they were going to go build out fiber in the U.K. And at that point in time, they had two million homes passed out of 30 million. And they set a target to build out 24 million homes by the end of 2026. And they're on track to do that. And right now, we are the biggest provider into that account for fiber optic equipment.
That's BT.
That's BT. DT has a very similar initiative. They're not quite as far progressed, but they have a goal of 22 million homes, and they're coming from the same base of around 2 million homes. This is happening all through Europe. It's going to be fundamentally a fiber network, and it comes on, so it's a great market if you're in the fiber-to-the-premises business. And all the fundamentals are there. But what's happening on top of that is at the same time this is happening, the market leader, which was Huawei, who had 55% market share in the fiber-to-the-premises business, has also exited that market, so timing-wise, it just really could not be better.
Yeah. Competitively, I think you see Nokia over there.
Nokia, it's pretty much, yeah, Nokia is the by far.
Looks like there's an open seat at the table.
That's right. Because most of these people have two sources, right? So.
Absolutely. Ulrich, can you remind us where you are in your manufacturing kind of realignment and where you've been, where you're going to?
Yeah. So a few things to the manufacturing alignment or streamlining of our manufacturing landscape. With the acquisition of ADVA, right, we already back then we identified that we need to streamline our landscape. And this came in line with also the move out of China. So we are pretty far ahead with this one. We will have completed the, you know, vacated China essentially by mid of this year entirely when it comes to manufacturing. And then, you know, we moved a lot into other parts of Asia, Eastern Europe. As some of you may know, we have our own production in Huntsville in the U.S. And we also do some of our own production in Germany.
Great. And where are you on exiting China at this point?
We are almost completed, right? So like I said, mid of this year, we should be completely out from a manufacturing perspective.
That's great. Tom, remind us kind of where you were this last quarter in terms of momentum across your different customer segments, kind of small, medium, and large, you know, as it relates to kind of second half demand drivers.
I'm going to try to interpret that in a way I can answer it. So, you know, there are many ways to break up the market. One is geographically, and that's for us, 85% of the revenue is U.S. and Europe. So in that vein, Europe has been fairly consistent, fairly strong. It has grown as a higher percentage of revenue within the company, mainly because of the activity that I just talked about with fiber-to-the-premises build-outs in Europe. That's going to continue on. We've added several new customers that will be coming on this year, several large customers. Many of you may know their names as they continue to try to displace Huawei out of that network and bring in a Western vendor or at least a strategically safe vendor. Our optical business is fundamentally in Europe, so that's been depressed.
And it was depressed again in the third quarter where we kind of hit that bottom and we expect we'll be coming back up. Those are mainly large carriers. So there are people like British Telecom, Deutsche Telekom, Telefónica, Liberty Global, we just recently won, but they're larger carriers in Europe. So that's where the biggest piece of our business is. We also have a segment called alternative carriers in Europe. And those are centered in some of the larger kind of more, I don't want to offend anybody here. So those are just centered in different countries. And so the biggest area of that is in the U.K. And in the U.K., we have 60-some-odd% market share in those alternate carriers. There's also a lot of those in Germany. And so that business is smaller businesses and they have been going through some consolidation.
As you can imagine, capital costs got up. These people's whole business in life was to beat the incumbent carrier to market. That's an expensive proposition. And so there's been some restructuring going on there, which has slowed that business down. That seems to be settling down at this point. And we expect positive momentum into this year, but it's kind of just on hold. In the U.S., you can divide it up the same way. We have larger carriers, which are carriers like for us, Lumen, Windstream is a big carrier, Charter is a carrier that sells us. And, you know, a lot of them have announced big plans. AT&T, for instance, announced a big plan, not one of our customers, but big plan in fiber. There have been different announcements around that.
That market is also being fueled now by, so you have these BEAD, go build out my incumbent network providers, but you also have this new entry of providers, which a lot of them are private equity backed that are going out to try to build fiber. The same thing the alt carriers were doing in Europe. Let me build fiber quicker than the incumbent. And there's a whole group of those that are right now building as fast as they can. That is a very active segment right now. Some of these are our customers and some of them aren't, but people like Ziply, Brightspeed, I'm sure you guys have heard about, Metronet, who T-Mobile just took a 50% position in. That whole group of carriers, their mission in life is to go build their fiber as quickly as possible and monetize it.
You have the tier three space, which is predominantly what people think about being the biggest recipient of BEAD funding, who have been building, but they've really slowed down over the last year. The general thought is it's predominantly because they're waiting to figure out what's BEAD going to do. That piece, although for us, it really hasn't shrank. You know, it used to be a 30%-40% year grower, and now it's just kind of flat. We expect that to pick up coming into next year.
I think the one area you've seen some strength in has been subscriber side. That's a lot.
Oh, yeah, yeah, yeah. Yeah, right, and now, subscriber side, multiple, one is, there was a huge inventory correction that had to happen.
A year ago.
Yeah, a year ago, and that really started getting better, and what you had happen over the last year and a half is when capital got to be more expensive, you had a real focus by these carriers to add subscribers to their existing footprint, let's just try to monetize our footprint, and you're really seeing a benefit from that right now on our subscriber business.
Yeah. That's great. And you had pretty good 3Q.
Yeah, yeah, we did. Yeah, yeah, we had very strong.
Nice recovery there. That's great. On the optical side, are you seeing much of an impact from Nokia and Infinera merger? I mean, do you mainly focus on that, I imagine?
Yeah, we do. Less so Infinera.
More long haul.
Yeah, they're more long haul and we're kind of mid-mile. We've picked up a few customers. You know, when you bring two companies together like that, if you happen to be caught in the middle of an RFP, one of them gets thrown out. If you happen to buy the product that's going to be discontinued, you're not happy. Yeah. So, you know, so sometimes that creates opportunity. We've seen a little bit of that, but it's not a watershed.
Gotcha. How about in general, the competitive environment there against mainly Calix and Nokia, I imagine. Can you maybe comment a little on each of those two, how they're behaving?
Yeah. So you can think of our competitive space as fundamentally three players. And I'm going to talk about optical and fiber-to-the-premises. So in optical, the three players are us, Nokia, and Ciena. On fiber-to-the-premises, it's us, Nokia, and Calix. Now, Calix is almost exclusively in the U.S. for the smaller carriers. So that's where we compete with them. For the larger carriers, it's usually us and Nokia. And I'm talking fiber-to-the-premises. And then in Europe, it's us and Nokia. That's pretty much it. On the optical side, it's us, Nokia, and Ciena, both in Europe and in the U.S. And yeah, I'm going to say competitively, everybody's still trying to pick up as much market share as possible. I think the big change competitively is the exit of Huawei, which I don't know if you guys know this, but they used to be quite a drag on margins.
Very difficult to compete with. And that has gotten more rational.
Ulrich, on the margin front, you think are you going to start to see that translate into the income statement?
I mean, we have seen some margin improvements over the last few quarters already, coming from the high 38% now to last few quarters, we were around 42%. Our long-term target is to get to 43%. So we made quite some progress, but still not there yet.
Great. Tom, you've mentioned a couple of wins here that, you know, I think you secured in times past in Europe. Can you maybe walk us through a couple of those? You don't have to name names, but, you know, kind of scope, size, timing, where you are in onboarding with some of these new wins, moving into deployment mode?
Yeah.
Even over the past 12 months.
Yeah. So I'm trying to think of which ones are public and which ones aren't. So that makes it difficult. So let me just say this. We've operationalized less than 50% of the customers that we have secured. And if you're a large carrier in Europe right now and you haven't driven an RFP, you're going to because there's a very good chance that your country is not going to allow you to continue to deploy that equipment.
Just even from a supply chain risk.
Yeah, just exactly.
Modifying and stuff like that.
Exactly.
Supply chain risk.
Any dollars you're putting into that network right now, you know, are dollars that are going to have to be pulled out. Now, we're in different phases. I would say we're in a very early phase of this right now. We have some countries that are leading the way. The UK is leading the way. Not only have they capped it and put a very strict percentage of what they can be in the network, but they're working on how to remove it. We have another country in Sweden where they're actively going to remove equipment. That's very expensive. Nobody at this point in time is writing up a check to do that, although governments may end up doing that. Although a lot of the large carriers have already made moves, most of the carriers in Europe have not.
So this is still an ongoing thing that will be playing itself out over the next few years. So we'll continue to operationalize. We have a carrier that will be coming online. In fact, just recently came online in Sweden for our fiber-to-the-premises. The Huawei replacement will happen later on this year. We have another coming online in Spain middle of the year. We just recently won an award, which will, and I don't know if we announced it or not, but that will be coming online at the very tail end of this year. And these are all kind of large multinational carriers.
Super exciting.
Yeah, it was a really good time.
Great. Excellent. Ulrich, you've talked about your 43% gross margin target. Can you kind of walk us through the overall operating model you guys want to get to?
Sure. Operating.
Long term?
Yeah, sure. Like no problem. So like I said, from a gross margin perspective, we target 43%. And then from an operating expense perspective, about 30%. So leading to a long-term operating margin of low double-digit %.
Yeah. Outstanding. Let's see here. Let's see. Ulrich, can you walk us through maybe for folks that don't know the story all that well, the change you've made in the OpEx line as part of the merger? We've been through a lot here, I think, with ADVA and the downturn and inventory. It's been a real challenge.
Yeah. It has been a lot going on over the last few years, I have to say. Yeah. So when the companies came together and the deal closed in 2022 in July, we communicated a target that our plan was to lower our OpEx or find synergies of $52 million by the end of 2024. So if you do the math, if you look at our numbers, and if I just use the consensus that is out there, we will have lowered our cost base by about $80 million, north of $80 million during that timeframe, which exceeded obviously the plans that we had. Obviously, we didn't count on the overall macroeconomic dynamic that happened through the years. So we were keen on exceeding our target. But we have come a long way, right? We did a lot of things that you probably wouldn't do under normal circumstances, right?
But we discontinued a lot of the product lines that we probably would have held on to a little bit longer, discontinued early end-of-life certain products, cleaned the house as good as we could, moved out of China, shut down R&D sites, shut down a large R&D site over in Germany earlier last year. So a lot going on, but essentially making the company more efficient and making the company ready for the growth to come.
Yeah. Excellent. I'd be remiss if I didn't ask you about the DPLTA with regard to ADVA. It's probably the most common question I get from new investors to the story. Can you spend maybe just a minute?
It's very simple.
Yeah, go ahead. It's very simple. Maybe you can explain to everybody just clearly.
So the DPLTA is, if you want to write a book by a German company, it'll have volumes. And the DPLTA is an agreement that we have. So we ended up with 65% of, when we started this, 65% of the ownership of ADVA, which was a German company. So 35% was held by minority investors. Those minority investors have rights in Germany. And Josh, you're not going to want to listen to this.
Well.
Ultimately, so there's a ticker in Frankfurt, which is the ADTRAN SE Networks Company. That is the minority shares that are traded out there. At that point, we made an offer to acquire those shares. That offer is in court because it's typically put in court. And I mean, that's typically just what happens. And then we pay those shareholders a dividend and an interest rate on their ownership. We have control post-DPLTA. We have control of the corporation. And we can do whatever we need to do to operate the combined company. But that minority share ownership is still out there. And we continue to pay them somewhere around 8% a year. And we will do that until we take what's a dividend plus interest. And the majority of that is interest.
Gotcha.
So you can think of the dividend as being a prepayment on the interest. The interest does not come due until we ultimately come to an agreement with them on that 35%, which is now, I think, 33% ownership.
But you accrue for it.
We accrue for it. Yeah. So it just sits there, and sometimes these things go on years and years and years. We made the statement and continue to say that we want to retire that ownership. That's not something we're going to do in the near term right now. Our focus this year is getting our debt retired, and at that point in time, we will then tackle that 35% ownership.
Perfect. That's great. And you did file a shelf offering.
Yeah, that's typical.
It's just standard housekeeping.
We had it before that, and we will continue to do that.
Got it, and Ulrich, in terms of capital allocation here at this point, how should investors think about that relative to what we talked about, debt retirement?
Keith, one of our biggest goals is to retire the debt this year. This is where the focus is on retiring the debt, improving working capital, you know, put the money to work where it should work.
Excellent. You know, we're wrapping up here. Any questions from the audience? Anyone want to lob in at all?
No DPLTA questions?
Sure.
Okay.
All right. Tom, any last minute comments here in wrapping up?
No. I will tell you, it feels better this year than last year. So, you know, the market's the market. It's going to have ups and downs. But fundamentally, I think that the markets that we're in right now are in a good and long-term trajectory in what's going on. There's been more movement and more excitement in the fiber-to-the-premises market than I think I've ever seen.
Yeah. Thanks for your time. Well, thanks, Gentlemen for joining. We appreciate it.
Thank you.
Thank you.
Thank you, everybody.