ADTRAN, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. The filing registrant is ADTRAN, Inc.
Business context and financial results
ADTRAN supplies networking and communications equipment and related services to service providers and businesses. Revenue fell 20.4% year over year, principally reflecting lower shipments to two Tier-1 customers, including reduced international demand.
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Revenue | $114.5 | $143.8 |
| Gross profit / margin | $51.6 / 45.1% | $60.6 / 42.2% |
| Operating loss | $(4.9) | $(6.2) |
| Net income (loss) | $(10.0) | $0.8 |
| Diluted EPS | $(0.21) | $0.02 |
| Cash from operating activities | $(0.02) | $9.7 |
Network Solutions revenue declined 22.6% to $97.4 million; Services & Support revenue declined 4.6% to $17.2 million. By category, Access & Aggregation revenue decreased to $66.0 million from $99.8 million, while Subscriber Solutions & Experience increased to $42.2 million from $36.8 million. U.S. revenue rose 8.9% to $79.0 million; international revenue fell 50.1% to $35.5 million.
Gross margin improved year over year, which management attributed to customer and product mix, regional mix, services mix, and lower fixed personnel costs following restructuring. SG&A declined 24.2% to $26.6 million and R&D declined 5.6% to $29.9 million. R&D nevertheless increased as a share of revenue, to 26.1% from 22.0%.
Cash, debt and liquidity
- At March 31, 2020, cash and cash equivalents were $71.3 million, short-term investments $6.0 million, and total current assets $293.8 million. Short-term liquidity was $77.3 million, including $47.5 million held by foreign subsidiaries.
- Working capital was $204.4 million; the current ratio was 3.29 and the quick ratio 1.83. Management said available cash, investments and expected operating cash flows were adequate for operating and capital needs for at least 12 months.
- The $24.6 million Alabama revenue-bond balance matured and was repaid in January 2020. No bonds payable remained at quarter-end. Cash and short-term investments declined from $107.0 million at year-end, primarily because the related $25.6 million certificate of deposit matured and the bond was repaid.
- Cash decreased by $2.5 million during the quarter to $71.3 million. Investing activities provided $27.6 million, largely reflecting investment maturities and sales; financing activities used $28.9 million, including bond repayment and $4.3 million in dividends.
- Inventory was $99.5 million, up from $98.3 million at year-end, and inventory turnover declined to 2.54 from 2.70. The inventory reserve was $35.0 million.
Period changes, unusual items and outlook
- The $10.9 million net investment loss, compared with a $5.9 million gain in Q1 2019, was primarily associated with market declines during the COVID-19 downturn. It was the principal reason the company reported a net loss despite improved gross margin and a smaller operating loss. The quarter’s investment loss included a $1.6 million impairment of a private-company equity investment and a $1.5 million gain recorded in correcting a prior-period investment classification and valuation error; management considered that correction immaterial.
- The CARES Act generated a $7.4 million tax benefit, partly offset by a $6.1 million increase in the valuation allowance against domestic deferred tax assets. At quarter-end, deferred tax assets totaled $62.2 million, with a $54.7 million valuation allowance.
- Management reported COVID-19-related supply-delivery slowdowns and higher raw-material and freight costs, alongside early increased network demand. It said the pandemic’s overall effect was not then expected to materially affect operations, results or cash flows, but emphasized that the duration and severity were uncertain and future periods could be materially affected.
- Management cited potential fiber-deployment investment and demand for next-generation SD-Access solutions, and expected government broadband-program payments to service providers to begin later in 2020. The filing provides no quantified earnings or revenue guidance.
- Two shareholder lawsuits remain pending: a securities class action and a derivative action. The company disputes the claims; it could not estimate a potential loss or range of loss.
- Disclosure controls were deemed ineffective because of a continuing material weakness in controls over inventory valuation, especially excess and obsolete inventory reserves and the supporting reports and assumptions. Remediation was underway but not complete at March 31, 2020.
Most important facts for investors to verify
- Whether inventory-reserve controls are remediated and whether reserve estimates or inventory levels change materially.
- How customer demand and shipments recover, particularly for international markets and the two Tier-1 customers cited as drivers of the decline.
- COVID-19’s ongoing effects on supply, costs, customer orders, collections and cash generation, compared with management’s then-current assessment.
- Further changes in investment values and the resulting effect on earnings, alongside the valuation and recoverability of deferred tax assets.
- Developments in the shareholder litigation and any eventual estimate or disclosure of potential exposure.