Thomas Stanton - Chief Executive Officer and Chairman of the Board Roger Shannon - Senior Vice President of Finance, CFO, Secretary and Treasurer.

Paul Silverstein - Cowen & Company Michael Genovese - MKM Partners Rich Valera - Needham & Company.

Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN’s Third Quarter 2018 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. [Operator Instructions] Please note today’s call may be recorded.

In addition, ADTRAN will webcast this conference call live through the Q4 Inc. webcasting service. During the course of this conference call, ADTRAN representatives expect to make forward-looking statements, which reflect management’s best judgment based on factors currently known.

However, these statements involve risks and uncertainties, including the successful development and market acceptance of core products, the degree of competition in the markets for such products, the product and channel mix, component cost, manufacturing efficiencies and other risks detailed in our Annual Report on Form 10-K for the year ended December 31st, 2017.

These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements, which may be made during the call. It is now my pleasure to turn the call over to Tom Stanton, Chief Executive Officer of ADTRAN. Sir, please go ahead..

Thank you, Savannah. Good morning. Thank you for joining us on our third quarter 2018 conference call. With me this morning is Roger Shannon, Senior Vice President and Chief Financial Officer.

As usual, I’d like to begin this morning by discussing the details behind our third quarter results and then I will end with some comments on what we see for the future. Then we will open up the call for any questions that you may have. As we stated in our early press release, revenues for the quarter were up 10% sequentially at $140 million.

Network Solutions accounted for a bulk at $121 million or 86% of the total revenue, while Global Services and Support contributed $19.3 million or 14% of the total company quarterly revenues. The 19.3% represents a significant 49% increase over the previous quarter.

Looking at domestic and international revenue, domestic markets came in at $83.7 million or 60% of the total and international revenues were $56.6 million or 40% of the total. Domestic revenue was up 23% from the previous quarter, and international revenue was up 52% on a year-over-year basis.

Moving down a little deeper, our access and aggregation business was up 8% and $91.9 million from the previous quarter and customer devices were at $38.6 million, 12% over the same period or over the last quarter.

Overall, we are seeing good level of engagement across domestic and international operations in strategic areas, a software-defined access, next-generation 10-Gig-PON solutions like EPON and GPON-2 and XGS-PON and of course G.fast.

As I have mentioned on previous calls, we are also continuing to see growth in the cable MSO broadband access market as we continue to grow shipments of 10-Gig EPON solutions to multiple cable MSOs.

Also notably this quarter, a major North America Tier-1 cable operator has selected ADTRAN to provide our next-generation SDN capable 10-Gig remote EPON solution for a large deployment beginning later next year.

In the near term, we continue to expand our EPON market leadership with solid growth seeing a 40% increase in the cable MSO market, sequentially. This progress is important and a direct result of our acquisitions and organic development throughout the year to extend our leadership as the top fiber access provider in the cable market.

Within the larger telecommunication service provider market, our next-gen – our next-gen PONs activity remains very high with continued progression and the addition of new customers in Europe, Australia, and the U.S. Also notable this quarter is the beginning of super vectoring shipments to a new Tier-2 company here in the U.S.

With the latest round of Federal Connect America Funds announced, we are pleased with the activity that we are seeing in the buildout of broadband access infrastructure in the U.S. rural markets with our CAT business up nicely both on a quarter-over-quarter and year-over-year basis.

As expected, in the G.fast area, we saw a pickup in Q3 for G.fast shipments with total shipments now averaging or excuse me, Q3 shipments actually reaching nearly 70,000 ports worldwide just for the quarter.

Finally, although we expect Q4 to be affected by typical seasonality, we remain encouraged by the core progress that we saw during the quarter and look forward to 2019. With that, I’ll turn the call over to Roger and be happy to answer any questions people may have. .

The macro spending environment for the carriers and enterprises; currency exchange rate movements; the variability of mix and revenue associated with project rollouts; professional services activity levels, both domestic and international; the timing of revenue related to the Connect America Fund projects; the adoption rate of our broadband access platforms and inventory fluctuations in our distribution channels.

You can see this information at ADTRAN’s Investor Relations website by going to www.adtran.com, and following the Investor Relations link. With that, I’ll now turn the call back over to Tom..

Great, thank you, Roger. Savannah, at this point, we’re ready to open it up for any questions people may have..

[Operator Instructions] Rod, your line is open. Please check your mute function. .

Yes. Go ahead.

Go ahead. .

Thank you for taking my question. This is Ashwin on behalf of Rod. My first question is on components really.

Just wondering if you guys are seeing any impact from emergency [ph] component shortages? And sort of related to that, I also wanted to check if you are seeing any higher component cost into equipment because of tariffs? And then I have a follow-up. .

Sure. So, component shortages, there are, we have seen some component shortages, but to be honest, we’ve seen those component shortages pretty much throughout the entire year and probably a little bit into last year. But it’s been a tightening of the market really as we’ve seen economies recover.

I would say there is – the way that that manifests itself to us is just longer lead times. So I would say there is nothing materially different now than let’s say six months ago. From a tariff perspective, one of the positive things that we have going for us of course is that we do not manufacture a material amount of goods in China.

So the direct tariff to us for finished products is relatively small. There are some components that are affected depending on where we manufacture, but I would say that they’re at this point in time, it’s manageable. There is an impact and it’s over a year’s period of time.

The way we are calculating it, and it maybe a couple million dollars or so, but at this point in time, it seems very manageable. .

Got it. And I wanted to check on this large Tier-1 customer that slowed this year.

Can you update us on your expectations there and what you are thinking in terms of timing? And at what point do you think there is – or if at all, do you think there is any share risk at this customer now?.

I think you are talking about the big year-over-year decline that we saw because of that customer, is it that customer, right?.

Yes..

Yes. So, as far as share risk, I don’t believe so, so the impact that we had was really the – effectively the cancellation for a period of time of a major project, which was the vectoring project. We have seen that customer actually regain some interest in – let’s say activity in that area.

I won’t say that the project is as large, but we are working with them on some specific things that I think are very cost-effective for them to do. Right now, our revenue is kind of at a steady state with that customer, and that’s kind of the expectations we have that we had kind of set around Q2 of this year.

So, it’s been fairly predictable, let’s say. And of course, the business we have with them is not only we do some vectoring, we do some PON business and of course we do Connect America Fund business as well. As far as next year is concerned, we really haven’t set that. It really depends on some of these kind of project trials that we have.

We have projects or trials going on both on the vectoring side as well as on some meaningful services potential business for us that we’ll just have to see as they evolve next year. .

Okay. .

Does that answer your question?.

Thank you. Yes, that’s good. .

Thank you. .

And we’ll go next to Paul Silverstein with Cowen. Please go ahead. Your line is open. .

I appreciate it. Tom, Roger, I was hoping you could walk us back through the steps I know timing is always difficult to predict, especially with these big projects, but I was hoping you could walk us back through the larger projects like NBN, the AT&T G.fast.

I know you mentioned the cable opportunity, but if you could revisit the cable opportunities and anything else I maybe forgetting, that’d be greatly appreciated. .

Yes, sure. So, first on the Australia G.fast shipments, we did actually start shipping in a material manner in Q3. We didn’t ship everything that was scheduled for Q3, so there is a little bit of that that got pushed into Q4.

And it just so happened that math is fairly easy as to kind of what our initial expectations in Q3 versus where they ended up, and that had to do with the fact that we ran into some kind of last minute lab issues early into Q3, and we had to remedy those lab issues, which means we didn’t really start shipping that customer until the second half of the quarter.

I think, honestly our operations team did a very good job of trying to recover and they recovered materially, but we still left some product on the shelf that has probably since shipped in this quarter. So, all of that is actually albeit when we saw a delay, it is understandable.

As far as the cable opportunities, I think probably the big news is, you may be aware that there was effectively a process going on for selection of some new EPON equipment, 10-Gig remote EPON equipment with a very, very large MSO here in the U.S., and we’ve selected for that deployment actually during the quarter towards tail end of Q3, and we still have lab activity and things to do there, but probably that is the biggest single EPON award that we’ve been given.

Having said that, we still ship EPON which is kind of more central – let’s call it central office, but it’s more centralized solution EPON to a few customers here in the U.S. including some of the largest MSOs. Both of those actually did very well in the quarter. I kind of highlighted the growth that we saw in that business.

We expect, it’s a fairly new base for us that we expect more typical seasonal decline in Q4 although, as you know it felt like I said that’s a fairly new business for us. .

And AT&T?.

AT&T did not or actually, I am not going to talk about a specific customer. So, in Tier-1 G.fast shipments here in the U.S. I would say that they were sluggish.

So, I think there are still that the product itself is not been ready to go and it’s fully integrated and at this point it’s a matter of them going out and selling the product and I would say that it’s not to a level that we had expected and we are encouraged by the discussions we have that we haven’t seen it really happen here. .

And so, I am going back to NBN and the cable MSOs, you previously kind of cite those opportunities. Has there been any change in your thinking? Has there been any change in the timing, in NBN in particular now that you’ve received that actually shipped on - off the first orders.

Is that any sense for the rhythm of that business? Have you already gotten in more orders and so it will be a seasonal aspect like now it’s ongoing or it’s going to be deploy, digest, deploy digest. .

I would – I don’t – the answer as far as future purchase orders, the answer to that is directly yes. We do have future purchase orders. As far as how quickly they consume the inventory that they have, it’s – there are lot of variables in that today. I feel comfortable that they have a very solid operating plan.

But, that we really just started shipping last quarter. So, I would say, it’s a little early to – I understand what the plan is, but it’s a little early to understand what the reality is going to be..

One last question from me, just to clarify, you mentioned specifically G.fast for NBN.

Is this specifically G.fast, were there also other technologies that they are using from you for their broadband access delivery?.

The product that we are shipping can actually operate in BESR mode or G.fast mode. So it covers those two spaces. It does not cover the fiber space which maybe what you are talking about. .

I’ll pass it on. Thank you. .

Okay, thank you. .

And our next question comes from Michael Genovese with MKM Partners. Please go ahead. Your line is open. .

Well, thanks. So the fourth quarter guidance is better than normal seasonality in terms of the sequential change, but at the street it was actually I think a little bit ahead in terms of sequential change than where you guided to.

So, my question is, just in terms of total second half 2018 revenue, when we put 3Q and 4Q together, I am hearing it sounds like maybe there is just a sort of slight downtick in the timing of G.fast across two continents, not just one, but two. And then, I am wondering, that’s right.

And then secondly, what else sort of changed in your expectations for the second half, which sort of customers, which verticals, which got better, which got worse, which are the same from the beginning of the third quarter to the end of the third quarter?.

Yes, sure. So let me see if I capture that that or if I don’t capture a piece of that and just iterate it to me. So, in general, I think G.fast shipments, let’s say G.fast purchase orders in the second half are effectively where we had expected them to be.

We did see what you are talking about from seasonal versus where we ended up in that being up is reflective of the fact that we did not ship some of the product in Q3.

So the Q3 order flow we are expecting to be more seasonal, but actual shipments will be up because of the shipments that we did not ship in Q3 and that was literally just us getting them out the door. Right, so that kind of explains that number.

If we look at the second half, let’s say earlier in the year versus now, probably the biggest – maybe not the biggest, but one of the pieces and but probably is the biggest is the fact that G.fast shipments here in the U.S. still haven’t materialized.

So, we have been going back and forth and honestly we’ve seen a lot of variations in forecasts and that we are so – that product just has not yet – that product just not yet being up took by that customer and that product is dependent upon that customer being successful with their sales initiatives. So, that’s probably the biggest thing.

The variability that we expect is, we have a fairly wide range in Q4,but we expect it to be seasonal, plus the uptick that we still gave a fairly wide range. That range is – there is – it’s really going to be dependent upon our European customer and just what they end up doing with their inventory situation.

We really don’t know more than that, but that range is a little wider in Q3 than – excuse me, Q4than it typically is. .

Great. That’s super helpful. Thank you.

And just very quickly, on the G.fast product, if you are selling in Asia-Pacific or you are selling in the U.S., are the gross margins very different on that product?.

No, not, not materially. .

Okay. And then, finally, inventory, just it seems very low this quarter. If you are going to do $135 million in revenue, but you are only going in with $100 million in inventory.

Can you just explain that to us?.

Yes, that’s still too high. So, our inventory situation was dramatically impacted. So, we’ve seen an uptick. Some of that had to do with us prepositioning some of the material for the tariff to make sure that we weren’t hurt, not a lot of that with that, but there was some explicit buys.

We also picked up some material because of the shortages that were previously mentioned. So there is certain areas where we did some spot buys, probably even like towards into the tail-end of last year that actually kind of increased our inventory.

But then it was materially increased because of what happened with the G.fast or vectoring customer here in the U.S. And we have been working on bringing those inventories down. 100 is not a low number and that does not at all scare me for doing north of $150 million actually. So, I understand there is a mix problem.

Our inventory level even at a 100 is not, but we are happy with it. .

Thank you, Tom. .

I was glad to see the decrease actually, because we have been working on that effort since the beginning of the year once we start to pick up. .

Appreciated. .

Okay. .

Thank you. And our last question comes from Rich Valera with Needham & Company. Please go ahead. Your line is open. .

Thank you. Tom, I was hoping if you could give a little more color on the new Tier-1 EPON win with that North American MSO. Do you expect that to generate revenue in the fourth quarter or is that just a 2019 revenue generating event? There is any other color you can give in terms of the potential magnitude with that, that’d be helpful. Thanks. .

Sure. So, it is a project that we have been working on over a year from an R&D perspective and from a sales perspective. Of course, longer than that. So, this customer does currently buy our EPON solution and uses it for deployment of the majority if not all of their EPON deployments today. But they are relatively to the size of this customer small.

They actually still are material to us, but it’s a very, very large customer. The new product solution that the reason people have been anxious to get their different products approved in this space, us being one of them is that, it materially changes the method by which they deploy EPON and it materially lowers the cost.

So the intention is for them to be able to start deploying this product and change the entire – the market size that they are actually deploying into. From a timing – and so, it was a very significant win for us.

The timing of that was, and I mentioned this in my note that we are expecting it right now towards the tail end of next year, because we have to get different lab cycles and things. So it will not affect this year.

The only positive to that being so long is, they are right now effectively single sourcing to current EPON solution from us to the extent that this extent we are seeing revenue and we would expect to see increased revenue next year as they continue to focus more on EPON. .

Got it. And then, not sure if you gave an update on the Verizon GPON situation.

If not if you could give any additional color on that?.

Sure. We are continuing to progress with them. We did reach a couple of fairly big milestones in the quarter. I don’t want to overstate what we are – I would say, that our confidence continues to grow with that customer.

And I would probably don’t want to say any more than that, but other than the fact that I think we are in a – from a R&D perspective, and kind of entire deal perspective, we are feeling – we continue to feel better. .

Got it. Okay. That’s it for me. Thank you. .

All right. Well, I appreciate everybody joining us on our call today and I look forward to talking to you next quarter. .

And this does conclude today’s call. Thank you everyone for your participation. You may disconnect at any time and have a great day..