Preliminary Q3 2021 ADTRAN Inc Earnings and Business Outlook Call

During Q3, we recorded the highest order bookings for any quarter in our history.

<unk> were up 43% year over year with a book to Bill ratio of 143 for the quarter.

This increased demand has been consistent throughout the year with a book to Bill ratio of 134 for the first three quarters of this year.

The order growth rate was well balanced across our growth areas of fiber access platforms and home service delivery platforms and SaaS applications.

These bookings included the first large order of our new tier one fiber customer in Europe, and our first order for art off related fiber access deployments with our tier one MSL customer here in the U S.

In addition to the strong bookings during the quarter, we secured two new tier one fiber operator awards in Europe.

Both tier one customers are new.

Customers to add trend.

In addition to these awards we have several additional large fiber access opportunities that we expect to close out soon.

The demand we see in the U S and Europe continues to be aided by the unprecedented funding for fiber based broadband in these markets along with technology upgrade cycles and high risk vendor swap outs.

In the U S. A portion of the $11.0 billion in broadband funding from phase one of the rural digital opportunity Fund has started to get distributed to the winners of this auction.

In addition to art off much larger investments in fiber based broadband are expected over the next five years due to funding from the American Rescue Plan Act and the proposed infrastructure Bill.

These funds are preliminary are primarily targeted towards regional service providers, we're seeing tremendous growth.

In Europe over $35 billion in public funding has been pledged for expanding high speed broadband along with a rapidly growing base of private investments, including in the UK and Germany, where <unk> has a strong presence.

In addition to increased funding, we continue to see a shift away from high risk vendors across Europe.

With AD trends industry, leading 10 gig fiber access portfolio, we are well positioned to serve these customers.

Looking at the preliminary Q3 financials revenues for the quarter is expected to be $138 million up 4% year over year.

This revenue.

<unk> level was held back due to supply chain disruptions across our industry <unk>.

Non-GAAP gross margins is expected to be 34, 6% and non-GAAP operating loss is expected to be $8.0 million.

Our revenue for the quarter fell on the lower end of the guidance range that we provided during the Q2 earnings call, while the gross margins and profitability were lower than we expected.

We provided a broader guidance range for Q3 than typical due to the strength in product demand and uncertainty and component supply.

As noted earlier the demand side exceeded our expectations, while our component supply and supply chain expenses worsened as we progressed through the quarter.

Excluding additional supply chain constraint related expenses in the quarter gross margins were within our third quarter guidance range.

The supply chain challenges facing our industry, our multifaceted, including rising cost for semiconductors.

Increased expedite fees to pull into components due to extended lead times or <unk>.

Sourcing of components from higher third party sources and increased freight expenses.

We do expect the supply shortages and freight expenses to improve in the first half of next year.

On the inventory side, we decreased our finished goods inventory from the previous quarter, while increasing our raw materials inventory as we built up supply to minimize further disruptions to our supply chain.

Looking ahead, we believe these challenges are peaking during the second half of this year will begin to normalize by mid 2022, we expect.

The impact on AD trends of results to be temporary given the future supply outlet coupled with strong demand for our products.

In summary, the demand for our solutions is at an all time high and we expect that demand to continue given the broadband investments tailwind our competitive position the ramping of our existing customer demand and new customer awards.

As you would expect we are working closely with our customers for fulfill to fulfill required demand and we remain in good standing with all of them.

In short our long term strategy remains unchanged and the outlook for our business continues to grow.

Looking at the fourth quarter, we expect a similar supply environment as to that that we saw in the third quarter and although we expect bookings to remain robust revenue as expected at this point to be similar to the Q3 levels.

We will provide additional details and an update on our on our earnings call November 2nd.

With that background would now like to open up for any questions that you may have.

Thank you Sir at this time, if you would like to ask a question simply press Star then the number one on your telephone keypad, we will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Michael Genovese of West Park capital.

Alright, great. Thanks.

Thanks, So much can you hear me.

Yes, okay.

Great. So first question I mean.

The book to Bill is impressive I guess, we're used to you being more of a book and ship.

Company first feels like Theres, a transition going to being more of a backlog driven company.

You talk about the duration of those orders like how many are in the next six months 12 months or beyond that roughly.

Yes, we do have orders that are placed out as long as 12 months. The majority of the orders are much closer than that.

I'm going to give you kind of some color for that.

I had mentioned last quarter on the call that we had enough in orders requested in the quarter as we had the phone call.

To actually meet consensus for the quarter.

And being as we didn't meet consensus for the quarter, you can imagine that group, but the booking rate actually grew substantially to so I am at the same point today I entered the fourth quarter with more than enough to meet.

What our expectations had been and where consensus has been for the fourth quarter at the very beginning of the court.

It is actually exceeds that so we have a lot of near term demand that we're working with customers to make sure we understand what's required and kind of what's what's I would like to have to make sure that they're not building inventory positions, but.

The majority of that demand is within the first six months.

Does that answer your question, yes very helpful. Thank you.

Okay, I guess I wanted to if we could get any more detail on the tier ones.

I think you said they were in Europe are these.

Pizza pleased with.

Your country names sort of associated with them in western Europe type of customers or are they different type of tier one.

Western Europe customers.

Both of them are multinational.

Which means that they are they cover.

Multiple countries.

That answer your question.

Okay. So so so they wouldnt exactly be in a similar like the same category as BT and <unk> are there a little bit slightly different I guess, if I tried it.

If you can follow.

The market there is different right because there is more kind of.

You have PTT tier ones that are within our country and our leading the country and you also have carriers that may be in France, and in Germany, and overbuilding in Germany and.

There are carriers that for instance cover all the Nordics.

And so there are multi they are multinational.

<unk>.

And size and scope.

The spend that they have I think they are they're very much consistent with what we would see with the <unk> got it okay, great very helpful.

I think one of them is one of them is that kind of scope one of them is probably a little smaller than that.

Okay last question for me I, just wanted to dig in more on the supply constraints and sort of ask.

Two ways.

If this question makes sense, but.

Are you seeing that.

Constraints, you mentioned semiconductors, so it sounds like maybe it's more high end, but.

Is it more on high end.

Parts or more cheap low end parts that are hard to get a hold of and then asked another way do you think that these are common.

Fly chain parts with with you and your competitors or do you feel like these are company specific parts were there.

These issues are happening.

So everybody has their own different inventory situations I don't want to speak too much for competitive I'll tell you.

From our perspective, we entered the quarter with the majority of the issues being kind of those high end semiconductors that everybody knows about.

As we kind of got into the quarter, what youre talking about absolutely happened where some of the.

Lower end kind of glue logic.

Chips.

It came very scarce and.

And ultimately I think that was probably.

The piece that hurt us the most.

And definitely you know everybody is trying to get those expedite fees and.

Surcharges are were definitely higher than wed ever seen before.

So its actually both but I would say that the.

The second portion of that is glue logic stuff.

Is really the first quarter, where it had gotten to be so pronounced.

Fantastic. Thanks, Tom Thanks for answering the questions. So so detail I appreciate it alright.

Your next question.

Comes from the line of Bill <unk> of Tia Tim capital.

Thank you.

Relative to the bookings increase.

Bear with me as I try to get this question out but.

Does that actually improve your opportunity for revenues, meaning that you can plan out better than you previously could because you have orders in hand, exactly what parts need to be ordered and therefore you can.

You can just deal with your own internal issues better that way.

Absolutely I mean, it's.

That's a bad problem to have and in light of visibility. It's a very good problem to have because.

Like I said I can literally look through my backlog today, and if I could shift just a portion of my backlog.

I mean.

Just not all my backlog.

A portion of the backlog then.

I would be set from a financial perspective for Q4 fairly easily.

And I would say that that backlog is as you can imagine well you know what the book to Bill. So you kind of know what the backlog is.

Tom.

And with the order rate is which is substantially higher than anybody would have thought coming into this year.

So the answer to your question is yes, but it's not so I mean, even with that visibility.

Talking about.

Semiconductors, having.

On average I think I think its something as high as 70% or something like that of the semiconductors, having 52 week lead times.

So even though you have that visibility and we did jump on it early in the year. We've actually started in the fourth quarter of last year. One of the problems. We had is definitely demand outstripped our supply than even what our forecast were from a bookings perspective and being able to adjust like you normally do in almost any other time has just been very difficult to do and then you have the.

Of this <unk> logic coming in which you typically.

In normal times would not even think about as being a constraint and then.

You can have a lot of your inventory in place, but if you're missing one.

40, <unk> do you have a problem so.

So.

The.

Things that we're going through right now and bill on the supply side really compounds. The problem is you've got suppliers now that although your orders that have been out there for months and months theyre not willing to commit to an exact delivery date until they get within within the same month that they plan to deliver.

So although we've got visibility in orders are lined up the hard part is just making sure all the commitments coincide so we can actually make.

Yes.

It's really kind of unprecedented what we're seeing here.

We literally will have orders that had been placed within the lead times of the manufacturer and they will have been committed even when we will have gotten a receipt of the order and saying, yes, we're going be able to ship. It and then within a month of when Theyre supposed to ship to us they will decommit.

Never seen that before.

So it's very tough.

<unk>.

To plan when wind, what you're betting on coming in.

Really no longer assured.

That's still the minority of the products that we have but it's definitely a.

Problem and it's typically your higher end product our chipset that those decommit has happened on.

And so those deaconess.

Is it your sense that.

Someone else.

It is coming in and just frankly.

Creating an auction.

We'll pay more than anybody else. So we'll take those chips.

Or I don't.

Actually happening on the supply front.

The semiconductor manufacturer, where they don't have the parts are available.

So I.

I think.

Think of it wasn't an auction then I think that it would be crazy for us not to participate in that auction.

And we just don't see that that much there are people that are charging expedite fees and.

Surcharges that.

Or just <unk>.

Just making just.

I mean, there is a supply and demand problem and.

And people are going to make money off of that.

And there are third party sources that are definitely.

Trying to make money off of that but when you really get to the real supply of the product itself.

What's supposed to be coming in you don't see that bidding.

End of <unk>.

Action happening. So my sense is is that.

Their ability to forecast, which come in what's coming from the fab has been substantially constrained so theyre kind of in a position of committing to things that they may not themselves have.

Direct control over and Youll see deep commenced because of that or you may see higher follow ups on a particular chip or something and they're having to make choices, but I really don't see them at the last minute, saying, Hey, if you paid 30% more and we'll ship it to you.

I just haven't seen that happen.

I'm going to expose my ignorance here, but relative to the SaaS, what would make their ability to predict the.

The output from the SaaS any any worse today than in the past.

I think that the fabs are substantially constrained in supply.

And.

Now as to why why they can't nail that down on a wafer basis I really don't know how they actually make those decisions but.

I mean at the end of the day. This constraint problem is driven by fab supplies, it's not any particular chip.

Vendors problem.

So it's higher up the chain.

Great. Thanks for taking my questions.

Okay.

Again, if you would like to ask a question simply press Star then the number one on your telephone keypad, we will pause for just a moment to compile the Q&A roster.

No.

With that I don't see any additional questions I appreciate everybody joining us on this call today are sorry about the.

I guess, we do have one more question from.

So go ahead please.

Your next question comes from the line of Rod Hall of Goldman Sachs.

Hi, Thanks for taking my question. This is <unk> on for Rob.

And yes, I know I hate to ask a question on would be.

Okay.

You might be thinking about in terms of crossing Hyatt cough, the customers, especially at yield.

Yes.

Okay.

Hello.

I think we lost rod.

Although I think you cut out.

Rod Please press star one again to ask your question.

Hello can you hear me.

Okay.

Ross Your line is open.

Go ahead Roger.

Hi, This is Paul onslaught, Roger can you guys hear me.

Yes, we got you, yes, sorry about that.

Go ahead.

Question on the price increases Sofia products incomes passing on this highest cost to customers I know that youre planning customers from new projects and I'd like to follow up.

Yeah, right you still there.

I think we lost you again.

Rod please respond to the question.

Hi, I'm still here.

So you said in terms of passing on price increases to the customer I think that was your question.

Yes.

So.

Our customers understand the supply.

Situation and.

I think there is the ability to move that pricing too.

Customers, depending on the competitive situation of course are.

Or.

Kind of.

What that customer may be buying and how impacted they are by the expedite fee. So.

We will we will utilize that capability where it exists.

Got it that makes it maybe along the same.

That's helpful.

Maybe one on the phone lines.

How do you thinking about.

Prioritizing.

This limited glad that you got.

The customers I know you got lots of big customers. So.

Of course.

All of this having this conversation with the customer comes off.

Have you prioritize.

Customers.

Yes, I think first of all I think they all understand situations, which helps I think especially the larger customers are involved in discussions with some of the semiconductor manufacturers themselves, which hopes and we will get them involved where we think that that may be beneficial but.

In general.

We're looking at what requirements are and if we look at like near term requirements.

What they have if they're launching a service or.

If there is demand in a particular area.

To date, we've been able to manage that very successfully and like I said, we havent really we havent lost any customers because of the supply issue.

The sooner it gets over the better and there is no doubt that there had been constraints and we've had to have backup plans. There are some products that we have gone through and continuing to go through redesign them to make sure that those constraints are minimized.

But.

So far it's just been open dialogue directly with the customers and understanding what they need and what they what they can live with.

Got it Tom if I may squeeze in one more.

Q4 revenue guidance.

Flattish sources carefully.

Heading into the seasonally weaker.

Deployment.

Maybe in Tijuana.

But given.

Yes, that's not longer apropos, I got plenty of orders.

Gotcha.

That makes sense I suppose what I'm wondering is given that locks off <unk> comments are happening.

I suppose what gives you confidence that you'll be able to make at least flattish on Mr. <unk> CFO.

I mean, it's a.

The things that happened in Q3, I mean, when we went into Q3.

We felt good about the plan and really there was some kind of.

Some supply in freight stuff that happened towards the very end of the quarter, which kind of.

May does not come in where we wanted to but going through the quarter. We felt good about where we were with both supply and demand and freight and then really in that last week some.

Somebody commits hit us.

We had some power issues with one of our manufacturers in China, and we had some.

Some freight problems in the UK. So theyre, just a myriad of things that kind of happen, but other than that the plan would have been right, where we expected it to be so.

I feel better that the.

Actually in Shanghai, some of the supply constraints or some of the freight constraints are getting better.

Pricing is actually getting better coming out of that line.

We do have more and more raw material coming into the quarter that doesn't mean that we still won't be missing a chip here or there but.

Just in general I think we feel better where we are and being able to make that solid.

Like I said, and we definitely have a broad backlog to pick from and products that we could ship so.

We could still be surprised we'll give you more color when we have our November call.

The farther we get into the quarter of course, the better visibility we have.

That's very helpful. I appreciate your patients excellent okay. Thank you.

Your next question comes from the line of Paul Cohen.

Paul.

Have a spine of Cowen.

I appreciate I appreciate you all taking the questions Tom just some clarifications.

Relative to your last response, if I heard you correctly, you said the repower issues with one of your manufacturers in China.

You referenced some freight issues in the UK.

Or am I.

There are some freight issues in the UK. They are afraid issue at the end of last quarter freight was kind of a very hectic, but yes. There are some fragrances.

As I said, there are a myriad of different things that kind of happen at the end of quarter or at least last quarter.

And I appreciate or maybe I don't appreciate the dramatic expansion.

The complexity of managing the supply chain, but also heard you say.

That you've seen some of those freight constraints improve in particular with respect to China and some pricing improvement.

If that's the case and again I understand that there are many many variables here, but given that there's been some improvement.

And given the strength of your order book.

And I recognize you're still going through the numbers.

That why is your outlook for the fourth quarter.

<unk> were flat with the third there's been some improvement.

At least a appreciable extent in terms of both pricing and supply constraints given the strength of your order books and that translates to a better outlook.

It should it should but I will tell you the.

The variability.

Of.

Both supply and.

Freight.

On time.

Variability on supply thing is a weekly if not daily thing.

The variability on freight is kind of more of a weekly thing.

And although it's better right now I can't tell you as we move into November that it will necessarily be better. There are a lot of just different dynamics that are happening when they start claiming the port outs reports out in California, We don't know exactly what that will do to the lanes, where people where people have been actually holding up shipping into.

Until our long beach and some other areas because there was no port for NIM to Landon and once that loosens up what will that do to that actual lanes. So theres just a lot of different.

Things that could happen and what we're trying to do is make sure that we give you a solid number that you can understand in Bangkok.

If it continues to improve into our November call and then we'll revise the numbers at that point.

Got it just through additional clarifications, if I may.

Sure.

The numbers clearly indicate if I did the math right you had a $10 million sequential increase in Cogs on a 5 million sequential decline in revenue.

And I understand that.

<unk> chain constraints are not improvement it sounds like from your commentary that.

Worse in but that would suggest either a dramatic worsening.

In supply chain or alternatively that you elected to pay up significantly.

In order to secure enough.

And just ship enough in order to hit the bottom end of your range.

I'm not trying to be already meeting or I'm, just trying to understand to what extent did you.

You all the luck.

To pay up significantly in order to obtain the bottom in that range, which dramatically adversely impacting profitability as measured by margins. So what extent was this just a function of a dramatic step up in pricing.

Okay.

Yes, I can tell you we did not buy material just to hit the bottom end of the range.

And you can imagine that those material purchases happened kind of through the quarter. They weren't they didn't just happen in the last week and we said, let's try to hit the bottom and so that's not what happened without a doubt expedite fees and third party purchases and the cost of those third party purchases went up dramatically in the quarter as well.

As freight by the way Henry freight was a fairly.

It was the highest we've ever pay for freight.

That was not trying to hit a particular number to a large extent to the largest extent that was trying to make sure that we actually kept all of our customers in good standing.

And that's the way we're thinking about it I mean, we've got unprecedented demand.

<unk> customer reputation.

Great momentum within all of our customers and we want to make sure that we hold that during this down period. So that we can actually see all of the benefits of it during the <unk>.

During normal times.

Got it one last clarification.

Tom It quite a number of companies in networking, including yourself.

Focused on the carrier sector or customer.

Customer segments had spoken about customers providing.

Well beyond the normal 90 day booking ship many of you all talking about four to six quarters of visibility with an increasing number of customers trying to help you better manage.

<unk> supply chain in order to be able to deliver against the requirements.

From your commentary it sounds like that's.

It's a minority of your business is not a meaningful portion of at least in.

In it.

At the risk of asking them sort of question in terms of asking you to speak for others wont.

What could account for the difference between what Youre seeing what others are saying or am I mistaken in what you do.

Describe your overall order book.

And Jim.

No I would say that that's true I would say what's happening though is what we're seeing happen is they will give us in place and not all of them but.

A material percentage of larger material percentage of our bookings are that way. So they will give us bookings that will go out.

12 months.

What is consistently happened through this year and definitely since the second quarter, but even in the in the first quarter and the first quarter. There are a lot of orders that were really place kind of trying to extend their lead times and trying to reach out farther from from that point on I would say, it's been a mix and probably more of a pull ins where people are trying to actually.

Increase within lead times, even though they have placed these 12 month PFS.

And one of the problems as they don't understand the demand necessarily that will either and that's where they've always been bad at forecasting.

So they'll lay in orders for projects that they know, but what is consistently happened pretty much across the board.

Near term demand has grown substantially and the bookings between their stated lead orders and now have gone up substantially and Thats happened every single quarter.

So what that does is it gives you a large chunk that's out there for 12 months, but then you have even a large chunk thats coming in every month for basically ship. It to me as soon as you can.

So it's filled in that front and even more so than what those long term orders are.

Got it.

One final clarification.

New wins were those also Huawei displacement opportunities.

Yes, one of them is.

Yes, well in both cases is Huawei.

Displacing as an ongoing lumen.

Be careful how I say this.

And so those opportunities I think that there'll be two vendors.

And my sense would be that there will not be eastern vendors, but I don't want to speak for the customer.

And in one case my sense would be that there would be replacement as well for existing infrastructure.

Thanks algorithm, while we wanted to.

At least has been to date, one or two vendors that Egypt for broadband access that each of those two companies.

Yes.

Okay.

You've commented in the past the pricing through these non USD yields or actually better because huawei has been eliminated from <unk>.

Consideration was that true here as well.

Yes.

It remains a consistent theme.

I appreciate the response thanks Tom.

Okay.

Alright with that.

We are out of all of it I.

<unk> everybody for joining us today and look forward to talking to you in November.

Yes.

Thank you. This concludes today's conference call you may now disconnect.