ADTRAN Holdings, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023. Figures are in U.S. dollars; financial amounts are in millions unless otherwise stated. The prior-year comparison predates ADTRAN’s acquisition of control of ADVA and excludes ADVA’s results, so year-over-year growth is not directly comparable.
Business context and results
ADTRAN provides broadband access, networking and communications products and services. It reports two segments: Network Solutions and Services & Support. ADTRAN acquired a controlling 65.43% stake in ADVA in July 2022; the DPLTA became effective January 16, 2023. Q1 2023 results include ADVA for the full quarter.
| Metric | Q1 2023 | Q1 2022 |
|---|---|---|
| Revenue | $323.9 | $154.5 |
| Gross profit / gross margin | $87.8 / 27.1% | $54.3 / 35.2% |
| Operating loss | $(49.7) | $(0.1) |
| Net loss | $(40.5) | $(1.1) |
| Net loss attributable to ADTRAN Holdings | $(34.5); $(0.44) per diluted share | $(1.1); $(0.02) per diluted share |
| Cash from operating activities | $(19.9) | $4.9 |
| Capital expenditures | $8.4 | $1.5 |
Revenue increased 109.6%, largely reflecting ADVA’s contribution, including $192.3 million of ADVA revenue. By category, Subscriber Solutions revenue was $79.3 million, Access & Aggregation $96.8 million, and Optical Networking $147.8 million. Network Solutions generated $282.4 million of revenue at a 22.4% gross margin; Services & Support generated $41.5 million at a 59.1% gross margin.
Financial position and material changes
- Cash and cash equivalents were $136.5 million; short-term investments were $1.1 million. Management reported $137.5 million of available short-term liquidity. The company also had $216.6 million of availability under its $400 million Wells Fargo facility, net of letters of credit.
- Revolving borrowings totaled $190.8 million at March 31, 2023, at a weighted average interest rate of 6.2%; notes payable were zero. Interest expense was $3.3 million, versus less than $0.1 million a year earlier.
- Total current assets were $883.8 million and current liabilities $522.2 million. Inventory was $416.3 million, down from $427.5 million at year-end, while inventory reserves rose to $73.3 million from $57.0 million.
- Operating cash flow was negative $19.9 million, with cash generation affected by the net loss and working-capital outflows, including lower accounts payable. Cash increased by $28.9 million during the quarter, primarily reflecting net financing inflows, including revolving-credit draws.
- Gross margin fell to 27.1% from 35.2%, primarily due to acquisition-related purchase-accounting effects, including intangible amortization and acquired-inventory fair-value adjustments, as well as mix and lower ADTRAN, Inc. sales volume. These acquisition-related cost-of-revenue adjustments were $32.6 million.
- Operating expenses increased with the combined business: selling, general and administrative expense was $67.4 million and research and development expense $70.1 million. The company recorded $2.4 million of restructuring costs and $0.8 million of integration costs in Q1.
- The balance sheet reports $442.7 million of redeemable non-controlling interest following the DPLTA’s effective date. A prior-period balance-sheet presentation error was revised: deferred tax assets and liabilities, and total assets and liabilities, each increased by $61.6 million at December 31, 2022. The company said the error was not material to previously issued statements.
Outlook, risks and contingencies
- No quantified revenue or earnings guidance is provided. Management said near-term revenue growth and profitability remain pressured by supply-chain constraints and customer inventory corrections. It expected excess CPE inventory to continue into Q2 2023 and anticipated some improvement in inventory conditions and backlogs over coming quarters; it also said supply-chain challenges could persist through fiscal 2023.
- Management cited continuing demand for fiber-network upgrades and said it saw no material change to near-term opportunities or long-term growth catalysts. It planned to adjust near-term operating expenditures to market conditions. Integration and DPLTA implementation costs expected during 2023 were described as material; anticipated synergies include operational scale, combined sales channels and streamlined functions.
- Under the DPLTA, ADTRAN generally absorbs ADVA’s annual losses and receives its annual profits, subject to terms and limitations. Minority shareholders may elect cash exit compensation of EUR 17.21 per share or recurring compensation of EUR 0.59 per share per full fiscal year. If all minority holders tendered, estimated exit payments were approximately EUR 309.5 million, or $335.6 million; recurring payments would be approximately EUR 10.5 million, or $11.3 million annually, if none elected exit. German appraisal proceedings could increase either amount, and the tender period is extended pending a final decision.
- Other significant commitments include $459.3 million of purchase obligations and $11.7 million of performance-bond commitments. The company reported compliance with material credit covenants. It said cash, investments, operating cash generation and facility access should meet operating and capital needs and obligations for at least the next 12 months.
- Risks include supply and component availability, customer concentration and inventory corrections, gross-margin volatility, integration execution, debt service and variable interest rates, foreign exchange, and potential impairment of goodwill or intangibles. The five largest customers accounted for 40% of Q1 revenue; two international service-provider customers each exceeded 10%.
- ADVA and its U.S. subsidiary filed a patent and FRAND-related lawsuit against Huawei in May 2023; the company said the outcome and any potential loss could not be estimated. The company also disclosed that its evaluation of internal controls excluded ADVA under the permitted first-year acquisition relief while integration of oversight and monitoring processes was underway.
Key facts for investors to verify
- Separate acquisition-driven growth from underlying organic performance; the prior-year comparison excludes ADVA.
- Track whether CPE inventory corrections and supply constraints ease, and whether gross margins recover as acquired inventory and purchase-accounting effects run off.
- Monitor operating cash flow, inventory reserves, supplier-payment trends, revolving borrowings and interest costs.
- Assess the timing and possible amount of DPLTA exit and recurring payments, including the outcome of German appraisal proceedings.
- Follow integration costs, expected synergies, ADVA control implementation and the progress and potential exposure of the Huawei litigation.