ADTRAN Holdings, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Amounts below are in U.S. dollars. ADTRAN completed its combination with Adtran Networks in July 2022, so 2022 comparative results do not include Adtran Networks; reported growth is therefore not a like-for-like measure of organic growth.
Business context and financial performance
The company provides broadband networking and communications products, software and services. It reports Network Solutions and Services & Support segments. Q2 revenue growth chiefly reflects consolidation of Adtran Networks, while management also cited customer inventory adjustments and constrained supply.
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $327.4 million | $172.0 million | $651.3 million | $326.6 million |
| Gross profit / margin | $92.6 million / 28.3% | $62.5 million / 36.3% | $180.4 million / 27.7% | $116.8 million / 35.8% |
| Operating income (loss) | $(44.6) million | $8.1 million | $(94.4) million | $8.1 million |
| Net income (loss) | $(36.2) million | $2.1 million | $(76.7) million | $1.0 million |
| Net income (loss) attributable to ADTRAN Holdings | $(33.3) million | $2.1 million | $(67.8) million | $1.0 million |
| Basic and diluted EPS | $(0.43) | $0.04 | $(0.87) | $0.02 |
- Q2 revenue rose 90.3%; first-half revenue rose 99.4%. Adtran Networks contributed $186.7 million of Q2 revenue and $379.0 million for the first half. Management said legacy ADTRAN operations’ sales activity declined by $31.4 million in Q2 and $54.3 million in the first half year over year.
- Q2 Network Solutions revenue was $283.0 million, with gross profit of $66.0 million; Services & Support revenue was $44.4 million, with gross profit of $26.5 million. Optical Networking Solutions contributed $143.0 million of Q2 revenue; this category was added following the combination.
- Lower overall gross margin primarily reflected acquisition-related amortization and inventory fair-value adjustments, as well as product/customer mix and lower sales in legacy ADTRAN operations. Q2 included $33.4 million of these acquisition-related cost-of-revenue adjustments; first-half expense was $66.0 million.
Cash flow, debt and liquidity
- Cash from operating activities was negative $36.2 million in the first half, versus negative $5.9 million in the prior-year period. Capital expenditures were $20.1 million, compared with $3.3 million. Financing activities provided $68.2 million, including net revolving-credit borrowings.
- At June 30, cash and cash equivalents were $124.3 million and short-term investments were $3.1 million; the company reported $127.4 million of available short-term liquidity, including $86.3 million held by foreign subsidiaries. Cash was $108.6 million and short-term investments $0.3 million at December 31, 2022.
- Revolving credit borrowings totaled $210.9 million: $200.0 million under the Wells Fargo facility and $10.9 million under Adtran Networks’ Nord/LB facility. Notes payable were nil, after repayment during the first half. The weighted-average interest rate on revolving credit agreements was 6.4%. The company reported compliance with material Wells Fargo covenants at June 30.
- Current assets were $850.0 million and current liabilities $309.6 million. Inventory was $416.8 million; its reserve increased to $79.6 million from $57.0 million at year-end. Accounts receivable was $239.6 million, down from $279.4 million; days sales outstanding fell to 67 from 72.
Material changes, outlook, risks and unusual items
- Demand and operations: Customer concern about excess customer-premises equipment inventory affected Subscriber Solutions, and management expected the oversupply to continue into Q3 2023. Supply constraints limited the ability to clear past-due backlog. Management expected some improvement in inventory and backlog over coming quarters and said it saw no material change to near-term opportunities or long-term fiber-upgrade growth drivers. No quantified revenue or earnings guidance is provided in the supplied filing text.
- Integration and costs: The multi-year integration and restructuring program is expected to run through late 2024. Q2 restructuring expense was $5.9 million; first-half expense was $8.3 million. Management expected additional integration and DPLTA implementation costs during the rest of 2023, and said these costs would be material. BEAD funding was expected to commence in late 2024 to early 2025; IPCEI ME/CT funding supports research and development.
- DPLTA obligations: Under the agreement with Adtran Networks, ADTRAN generally absorbs its annual net losses and owes minority shareholders either recurring compensation or cash exit compensation. If all eligible minority holders chose exit compensation, estimated payments, including interest, were approximately €319.0 million ($348.1 million). The company said it lacked liquidity to meet that amount if a substantial majority elected exit in the current period, but considered such elections in the next 12 months remote and believed available resources adequate for at least 12 months. It warned it might need to suspend dividends, reduce capital spending or take other working-capital measures. Appraisal proceedings could increase the payment amounts; the tender period is extended pending a final decision. Annual recurring compensation would be about $11.6 million if no minority holders chose exit compensation.
- Financing subsequent event: An August 9, 2023 Wells Fargo amendment added a $50 million delayed-draw term loan available only upon a specified purchase of at least 60% of the Adtran Networks shares not already owned. The amendment also revised pricing and covenants and permits, subject to conditions, up to $172.5 million of convertible debt. Proceeds from such debt must be used for minority-share repurchases or to repay revolver borrowings.
- Accounting and control: The company reported restatements of prior financial statements and an unresolved material weakness in controls over presentation and disclosure of debt agreements. Management concluded disclosure controls were not effective at June 30, 2023. Adtran Networks was excluded from the company’s internal-control evaluation under the SEC’s first-year acquisition accommodation. Subsequent stock-price volatility prompted management to monitor whether a goodwill impairment assessment would be required.
- Tax and legal items: After an unfavorable IRS response, the company abandoned claims relating to amended 2018 tax returns and removed a previously recorded $15.2 million receivable and related $1.8 million research credit carryforward, along with offsetting uncertain-tax-position reserves. Adtran Networks pursued a U.S. patent/FRAND action against Huawei; Huawei separately sued in Germany alleging patent infringement. The company said outcomes and potential losses could not be estimated.
- Other obligations: Purchase commitments were $377.4 million at June 30. The company paid $14.2 million in dividends in the first half; the board subsequently declared a further $0.09-per-share dividend payable September 5, 2023. The filing says dividends may be suspended if needed to preserve liquidity.
Important facts for investors to verify
- How much of reported revenue and growth reflects the acquisition versus comparable organic demand, particularly in legacy Subscriber Solutions and optical networking.
- Whether gross margins recover as purchase-accounting inventory adjustments and acquired intangible amortization decline, and how inventory reserves and customer oversupply develop.
- Cash generation, borrowing availability and covenant headroom relative to working-capital needs, purchase commitments, dividends and potential DPLTA payments.
- Progress and final outcomes of the German DPLTA appraisal proceedings, including any higher exit or recurring compensation obligations.
- Remediation and independent testing of the debt-disclosure control weakness, and any further restatements or related proceedings.
- Developments in the Huawei litigation, goodwill impairment indicators, and execution and costs of the integration program.