ADTRAN (ADTN) - 2023 Q2 - Quarterly Report

GLOSSARY OF SELECTED TERMS This section defines key acronyms, concepts, and terms used in this Quarterly Report on Form 10-Q | Acronym/Concept/ Defined Term | Meaning | | :------------------------------ | :-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------| | BEAD | Broadband Equity, Access and Deployment Program | | CPE | Customer-Premises Equipment | | DPLTA | Domination and Profit and Loss Transfer Agreement | | DSO | Days Sales Outstanding | | E.U. | European Union | | EURIBOR | Euro Interbank Offered Rate | | IPCEI ME/CT | Important Project of Common European Interest - Microelectronics and Communication Technologies | | MSO | Multiple System Operator | | ODM | Original Design Manufacturing | | OLT | Optical Line Terminal | | RNCI | Redeemable Non-Controlling Interest | | SaaS | Software as a Service | | SEC | Securities and Exchange Commission | | Service Provider | Entity that provides voice, data or video services to consumers and businesses | | SI | Person or company that specializes in bringing together component subsystems into a whole and ensuring that those subsystems function together | | SLA | Service Level Agreement | | SMB | Small and Mid-Sized Business | | SOFR | Secured Overnight Financing Rate | | U.S. | United States of America | | VAR | Value-Added Reseller | GENERAL This section clarifies company references and notes a subsidiary's official name change - References to 'ADTRAN,' 'Company,' 'we,' 'us,' and 'our' in this report refer to ADTRAN, Inc. and its consolidated subsidiaries prior to the Merger on July 8, 2022, and to ADTRAN Holdings, Inc. and its consolidated subsidiaries following the Merger[10] - ADVA Optical Networking SE, a subsidiary of the Company, officially changed its name to Adtran Networks SE on June 8, 2023[10] CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This section warns about uncertainties and risks associated with forward-looking statements and disclaims future updates - Forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from the views, beliefs, and projections expressed[11] - Key risk categories include those related to the Business Combination and DPLTA, financial results and Company success, control environment, the telecommunications industry, the Company's stock price, and regulatory environments[12][16][17][18][21][22] - The Company cautions investors not to place undue reliance on forward-looking statements and undertakes no obligation to publicly update or revise them, except as required by law[24] PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS This section presents the unaudited condensed consolidated financial statements of ADTRAN Holdings, Inc. for the periods ended June 30, 2023, and December 31, 2022, including balance sheets, statements of (loss) income, comprehensive loss, changes in equity, and cash flows, along with detailed notes explaining significant accounting policies, business combinations, revenue recognition, and other financial disclosures Condensed Consolidated Balance Sheets | ASSETS (in thousands) | June 30, 2023 | December 31, 2022 | | :-------------------- | :------------ | :---------------- | | Cash and cash equivalents | $124,294 | $108,644 | | Accounts receivable, net | $239,565 | $279,435 | | Inventory, net | $416,802 | $427,531 | | Total Current Assets | $850,024 | $882,358 | | Property, plant and equipment, net | $115,719 | $110,699 | | Goodwill | $388,163 | $381,724 | | Intangibles, net | $355,084 | $401,211 | | Total Assets | $1,882,938 | $1,943,494 | | LIABILITIES, REDEEMABLE NON-CONTROLLING INTEREST AND EQUITY (in thousands) | June 30, 2023 | December 31, 2022 | | :----------------------------------------------------------------------- | :------------ | :---------------- | | Accounts payable | $171,735 | $237,699 | | Total Current Liabilities | $309,641 | $428,575 | | Total Liabilities | $655,006 | $639,881 | | Redeemable Non-Controlling Interest | $445,462 | $— | | Total Equity | $782,470 | $1,303,613 | | Total Liabilities, Redeemable Non-Controlling Interest and Equity | $1,882,938 | $1,943,494 | Condensed Consolidated Statements of (Loss) Income | (In thousands, except per share amounts) | Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Total Revenue | $327,378 | $172,038 | $651,290 | $326,556 | | Gross Profit | $92,553 | $62,506 | $180,361 | $116,822 | | Operating (Loss) Income | $(44,628) | $8,133 | $(94,360) | $8,065 | | Net (Loss) Income | $(36,215) | $2,143 | $(76,668) | $1,016 | | Net (Loss) Income attributable to ADTRAN Holdings, Inc. | $(33,334) | $2,143 | $(67,798) | $1,016 | | (Loss) earnings per common share – basic | $(0.43) | $0.04 | $(0.87) | $0.02 | | (Loss) earnings per common share – diluted | $(0.43) | $0.04 | $(0.87) | $0.02 | Condensed Consolidated Statements of Comprehensive Loss | (In thousands) | Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Net (Loss) Income | $(36,215) | $2,143 | $(76,668) | $1,016 | | Other Comprehensive Income (Loss), net of tax | $6,957 | $(3,140) | $15,739 | $(4,782) | | Comprehensive Loss attributable to ADTRAN Holdings, Inc., net of tax | $(29,258) | $(997) | $(61,173) | $(3,766) | Condensed Consolidated Statements of Changes in Equity - Total Equity decreased from $1,303,613 thousand as of December 31, 2022, to $782,470 thousand as of June 30, 2023[37] - The reclassification and remeasurement from equity to mezzanine equity for noncontrolling interests in Adtran Networks resulted in a decrease of $(443,757) thousand for the six months ended June 30, 2023[37] - Net loss attributable to ADTRAN Holdings, Inc. for the six months ended June 30, 2023, was $(67,798) thousand[37] Condensed Consolidated Statements of Cash Flows | (In thousands) | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :------------- | :----------------------------- | :----------------------------- | | Net (loss) income | $(76,668) | $1,016 | | Net cash used in operating activities | $(36,160) | $(5,918) | | Net cash (used in) provided by investing activities | $(17,468) | $4,784 | | Net cash provided by (used in) financing activities | $68,179 | $(8,574) | | Net increase (decrease) in cash and cash equivalents | $14,551 | $(9,708) | | Cash and cash equivalents, end of period | $124,294 | $43,368 | Notes to Condensed Consolidated Financial Statements GENERAL - ADTRAN Holdings, Inc. is a leading global provider of networking and communications platforms, software, systems, and services focused on the broadband access market[46] - The Domination and Profit and Loss Transfer Agreement (DPLTA) with Adtran Networks SE became effective on January 16, 2023, granting ADTRAN Holdings, Inc. control and the right to Adtran Networks' annual profit, while obligating it to absorb annual net losses[46] - Minority shareholders of Adtran Networks can elect to receive either an Annual Recurring Compensation of €0.59 per share or Exit Compensation of €17.21 per share plus guaranteed interest, with appraisal proceedings ongoing that could increase these amounts[48] 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - The unaudited Condensed Consolidated Financial Statements are prepared in conformity with U.S. GAAP, requiring management to make significant estimates and assumptions[50][52] - Due to the DPLTA's effectiveness on January 16, 2023, the non-controlling interest in Adtran Networks was reclassified to redeemable non-controlling interest (RNCI) and remeasured to fair value[53] - The Company early adopted ASU 2021-08 on July 1, 2022, for business combinations, affecting the accounting for contract assets and liabilities[55] 2. BUSINESS COMBINATION - ADTRAN, Inc. acquired 65.43% of Adtran Networks' outstanding shares on July 15, 2022, for a total purchase price of $578.3 million, with ADTRAN, Inc. identified as the accounting acquirer[57][58] - The Business Combination resulted in the recognition of $350.5 million of goodwill, allocated to the Network Solutions segment ($272.8 million) and the Services & Support segment ($77.7 million)[63] - Adtran Networks contributed $379.0 million in net revenue and a net loss of $67.5 million to the Company's consolidated financial statements for the six months ended June 30, 2023[63] 3. REVENUE | (In thousands) | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :--------------------------------- | :----------------------------- | :----------------------------- | | Optical Networking Solutions | $290,752 | $— | | Access & Aggregation Solutions | $199,537 | $190,084 | | Subscriber Solutions | $161,001 | $136,472 | | Total Revenue | $651,290 | $326,556 | | Network Solutions Revenue | $565,420 | $294,366 | | Services & Support Revenue | $85,870 | $32,190 | - The aggregate amount of transaction price allocated to remaining performance obligations not yet satisfied was $369.3 million as of June 30, 2023, with approximately 46.5% expected to be recognized over the next 12 months[68] | (In thousands) | As of June 30, 2023 | As of December 31, 2022 | | :----------------------------- | :------------------ | :---------------------- | | Accounts receivable, net | $239,565 | $279,435 | | Contract assets | $1,153 | $1,852 | | Unearned revenue | $48,030 | $41,193 | | Non-current unearned revenue | $24,111 | $19,239 | 4. INCOME TAXES - The Company's effective tax rate changed from an expense of 50.1% (Q2 2022) to a benefit of 18.8% (Q2 2023) of pre-tax loss, and from a benefit of 34.3% (H1 2022) to a benefit of 20.4% (H1 2023) of pre-tax loss[78] - This change was primarily driven by the Business Combination with Adtran Networks and the release of the domestic valuation allowance during the fourth quarter of 2022[78] - As of June 30, 2023, the Company had net deferred tax assets totaling $42.5 million, with a valuation allowance of $5.0 million[78] 5. STOCK-BASED COMPENSATION - Stock-based compensation expense was $8.0 million for the six months ended June 30, 2023, compared to $3.8 million for the same period in 2022[81] - As of June 30, 2023, total unrecognized compensation expense related to non-vested market-based RSUs and restricted stock was approximately $21.8 million, to be recognized over a weighted-average period of 2.4 years[82] - Unrecognized compensation expense related to ADTRAN Holdings, Inc. stock options was $6.3 million, to be recognized over a weighted-average period of 2.0 years[84] 6. INVESTMENTS | (In thousands) | As of June 30, 2023 | As of December 31, 2022 | | :-------------------------------------------- | :------------------ | :---------------------- | | Available-for-sale debt securities held at fair value | $8,074 | $9,253 | | Marketable equity securities | $858 | $810 | | Deferred compensation plan assets | $25,395 | $22,942 | | Total short-term and long-term investments | $34,327 | $33,005 | - Net investment gain for the six months ended June 30, 2023, was $2,549 thousand, compared to a net investment loss of $7,948 thousand for the same period in 2022[95] - The Company's cash equivalents and investments held at fair value are primarily categorized as Level 1 or Level 2 in the fair value hierarchy[96][97] 7. INVENTORY | (In thousands) | As of June 30, 2023 | As of December 31, 2022 | | :--------------- | :------------------ | :---------------------- | | Raw materials | $186,262 | $186,346 | | Work in process | $13,576 | $12,087 | | Finished goods | $216,964 | $229,098 | | Total inventory, net | $416,802 | $427,531 | - Inventory reserves for estimated excess and obsolete inventory increased from $57.0 million as of December 31, 2022, to $79.6 million as of June 30, 2023[99] 8. PROPERTY, PLANT AND EQUIPMENT | (In thousands) | As of June 30, 2023 | As of December 31, 2022 | | :------------------------------------- | :------------------ | :---------------------- | | Total property, plant and equipment | $431,787 | $409,800 | | Less: accumulated depreciation | $(316,068) | $(299,101) | | Total property, plant and equipment, net | $115,719 | $110,699 | - Depreciation expense was $13.8 million for the six months ended June 30, 2023, compared to $5.5 million for the same period in 2022[101] - No impairment charges on long-lived assets were recognized during the three and six months ended June 30, 2023, and 2022[101] 9. GOODWILL | (In thousands) | Network Solutions | Services & Support | Total | | :----------------------------------- | :---------------- | :----------------- | :-------- | | As of December 31, 2022 | $298,280 | $83,444 | $381,724 | | Foreign currency translation adjustments | $5,013 | $1,426 | $6,439 | | As of June 30, 2023 | $303,293 | $84,870 | $388,163 | - Goodwill of $350.5 million was recognized upon the closing of the Business Combination with Adtran Networks on July 15, 2022[103] - No impairment of goodwill was recorded during the three and six months ended June 30, 2023, and 2022[103] 10. INTANGIBLE ASSETS | (In thousands) | Weighted Average Useful Life (in years) | Net Book Value (June 30, 2023) | Net Book Value (December 31, 2022) | | :--------------------- | :-------------------------------------- | :----------------------------- | :--------------------------------- | | Customer relationships | 10.9 | $40,935 | $42,745 | | Backlog | 1.6 | $8,571 | $33,057 | | Developed technology | 8.5 | $284,229 | $298,508 | | Trade names | 3.0 | $18,659 | $23,811 | | Total | | $355,084 | $401,211 | - Amortization expense was $52.3 million for the six months ended June 30, 2023, significantly higher than $1.8 million in the prior year, primarily due to the Business Combination[104] | (In thousands) | Estimated Future Amortization Expense | | :------------- | :------------------------------------ | | 2023 | $30,683 | | 2024 | $58,478 | | 2025 | $46,835 | | 2026 | $43,554 | | 2027 | $42,180 | | Thereafter | $133,354 | | Total | $355,084 | 11. HEDGING - The Company uses forward rate agreements to hedge foreign currency exposure of expected future cash flows, not for trading or speculative purposes[106] | (In thousands) | Balance Sheet Location | June 30, 2023 | December 31, 2022 | | :-------------------------------------------- | :--------------------- | :------------ | :---------------- | | Foreign exchange contracts – derivative assets | Other receivables | $10,467 | $11,992 | | Foreign exchange contracts – derivative liabilities | Accounts payable | $(2,378) | $(633) | | Total derivatives | | $8,089 | $11,359 | - The Company entered into Euro/U.S. dollar forward contracts to convert Euro-denominated DPLTA payment obligations into U.S. Dollars, with an aggregate notional amount of $160.0 million[108] 12. REVOLVING CREDIT AGREEMENTS | (In thousands) | As of June 30, 2023 | As of December 31, 2022 | | :-------------------------------------------- | :------------------ | :---------------------- | | New Nord/LB revolving line of credit | $10,912 | $— | | Total current revolving credit agreements | $10,912 | $35,936 | | Wells Fargo credit agreement (non-current) | $200,000 | $60,000 | - The Wells Fargo Credit Agreement allows for borrowings up to $400.0 million, maturing in July 2027, and the Company was in compliance with all material covenants as of June 30, 2023[114] - As of June 30, 2023, the weighted average interest rate on the Company's revolving credit agreements was 6.4%[114] 13. NOTES PAYABLE | (In thousands) | As of June 30, 2023 | As of December 31, 2022 | | :----------------------------------- | :------------------ | :---------------------- | | Syndicated credit agreement notes payable | $— | $24,598 | | Total Notes Payable | $— | $24,598 | - The outstanding borrowings under the syndicated credit agreement note payable were fully repaid on January 31, 2023[119] 14. EMPLOYEE BENEFIT PLANS - The Company maintains defined benefit pension plans covering employees in certain foreign countries, with a net pension liability of $10.9 million as of June 30, 2023[120][122] - In connection with the Business Combination, the Company acquired $29.6 million of additional obligations and $22.3 million of assets related to post-employment benefit plans[121] | (In thousands) | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :------------------------- | :----------------------------- | :----------------------------- | | Service cost | $802 | $502 | | Interest cost | $(66) | $434 | | Expected return on plan assets | $118 | $(919) | | Amortization of actuarial losses | $13 | $174 | | Net periodic pension cost | $867 | $191 | 15. EQUITY - Accumulated other comprehensive income increased from $46,713 thousand as of December 31, 2022, to $62,208 thousand as of June 30, 2023[127] - Foreign currency translation adjustments contributed $15,618 thousand to other comprehensive income for the six months ended June 30, 2023[127] | (In thousands) | Six Months Ended June 30, 2023 | | :--------------------------------------------------------------------------- | :----------------------------- | | Unrealized gain (loss) on available-for-sale securities | $98 | | Reclassification adjustment for amounts related to available-for-sale investments included in net (loss) gain | $(35) | | Reclassification adjustment for amounts related to defined benefit plan adjustments included in net gain (loss) | $58 | | Foreign currency translation adjustments | $15,618 | | Total Other Comprehensive Gain (Loss) | $15,739 | 16. REDEEMABLE NON-CONTROLLING INTEREST | (In thousands) | Six Months Ended June 30, 2023 | | :------------------------------------------------------ | :----------------------------- | | Balance at beginning of period | $— | | Reclassification of non-controlling interests | $443,757 | | Redemption of redeemable non-controlling interest | $(1,552) | | Net income attributable to redeemable non-controlling interests | $5,691 | | Annual recurring compensation earned | $(5,691) | | Translation adjustment | $3,244 | | Adtran Networks stock option exercises | $13 | | Balance as of June 30, 2023 | $445,462 | - The redeemable non-controlling interest balance was $445.5 million as of June 30, 2023, following its reclassification from permanent equity due to the DPLTA becoming effective[139] - For the six months ended June 30, 2023, $5.7 million in Annual Recurring Compensation was recognized as accrued for non-controlling shareholders[139] 17. (LOSS) EARNINGS PER SHARE | (In thousands, except per share amounts) | Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Net (loss) income attributable to ADTRAN Holdings, Inc. | $(33,334) | $2,143 | $(67,798) | $1,016 | | Weighted average shares outstanding – basic | 78,366 | 49,123 | 78,364 | 49,110 | | Weighted average shares outstanding – diluted | 78,366 | 49,809 | 78,364 | 49,813 | | (Loss) earnings per common share attributable to ADTRAN Holdings, Inc. – basic | $(0.43) | $0.04 | $(0.87) | $0.02 | | (Loss) earnings per common share attributable to ADTRAN Holdings, Inc. – diluted | $(0.43) | $0.04 | $(0.87) | $0.02 | - For the six months ended June 30, 2023, 0.3 million shares of unvested PSUs, RSUs, and restricted stock were excluded from diluted EPS calculation due to their anti-dilutive effect[141] - For the six months ended June 30, 2023, 1.0 million stock options were excluded from diluted EPS computation because their exercise prices were greater than the average market price[141] 18. SEGMENT INFORMATION | (In thousands) | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :------------------- | :----------------------------- | :----------------------------- | | Network Solutions Revenue | $565,420 | $294,366 | | Network Solutions Gross Profit | $129,330 | $103,791 | | Services & Support Revenue | $85,870 | $32,190 | | Services & Support Gross Profit | $51,031 | $13,031 | | Total Revenue | $651,290 | $326,556 | | Total Gross Profit | $180,361 | $116,822 | | (In thousands) | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :--------------------------------- | :----------------------------- | :----------------------------- | | Optical Networking Solutions | $290,752 | $— | | Access & Aggregation Solutions | $199,537 | $190,084 | | Subscriber Solutions | $161,001 | $136,472 | | Total | $651,290 | $326,556 | | (In thousands) | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :------------------ | :----------------------------- | :----------------------------- | | United States | $263,760 | $204,801 | | Germany | $151,824 | $25,376 | | United Kingdom | $109,468 | $59,243 | | Other international | $126,238 | $37,136 | | Total | $651,290 | $326,556 | 19. LIABILITY FOR WARRANTY RETURNS - The liability for warranty obligations totaled $6.8 million as of June 30, 2023, a decrease from $7.2 million as of December 31, 2022[153] | (In thousands) | Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | | :-------------------------------------- | :----------------------------- | :----------------------------- | | Balance at beginning of period | $7,196 | $5,403 | | Plus: Amounts charged to cost and expenses | $1,539 | $1,111 | | Plus: Foreign currency translation adjustments | $40 | $— | | Less: Deductions | $(1,944) | $(1,672) | | Balance at end of period | $6,831 | $4,842 | 20. COMMITMENTS AND CONTINGENCIES - ADTRAN Networks and its subsidiary filed a lawsuit against Huawei Technologies Co. Ltd in May 2023 regarding standard essential patents (SEPs) and alleged infringement[156] - Assuming all minority shareholders elect Exit Compensation under the DPLTA, the Company would be obligated to make aggregate payments of approximately $348.1 million[158] - Purchase commitments totaled $377.4 million as of June 30, 2023, related to open purchase orders with contract manufacturers, ODMs, and suppliers[160] 21. RESTRUCTURING - The Company initiated a restructuring program in Q4 2022 to optimize assets, business processes, and IT systems following the Business Combination, expected to be completed in late 2024[162] | (In thousands) | Six Months Ended June 30, 2023 | | :-------------------------------------- | :----------------------------- | | Balance at beginning of period | $159 | | Plus: Amounts charged to cost and expense | $8,305 | | Less: Amounts paid | $(2,012) | | Balance as of June 30, 2023 | $6,452 | | (In thousands) | Six Months Ended June 30, 2023 | | :------------------------------------- | :----------------------------- | | Cost of revenue | $76 | | Selling, general and administrative expenses | $3,573 | | Research and development expenses | $4,656 | | Total restructuring expenses | $8,305 | 22. SUBSEQUENT EVENTS - On August 6, 2023, the Board of Directors declared a quarterly cash dividend of $0.09 per common share, totaling approximately $7.1 million, payable on September 5, 2023[168] - The Wells Fargo Credit Agreement was amended on August 9, 2023, to include a new $50 million delayed draw term loan (DDTL) for repurchasing minority shares of Adtran Networks[168] - The amendment also revised financial covenants, including an automatic step-up in the consolidated total net leverage ratio to 5.00:1.00 upon a 'Springing Covenant Event,' and permitted up to $172.5 million in convertible indebtedness[168] ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section provides management's perspective on the company's financial condition and results of operations for the three and six months ended June 30, 2023, compared to the prior year. It covers an overview of the business, the impact of the Adtran Networks Business Combination and DPLTA, financial performance trends, and liquidity and capital resources OVERVIEW - ADTRAN is a leading global provider of networking and communications platforms, software, systems, and services focused on the broadband access market, serving diverse domestic and international customers[171] - The Company's strategy relies on increasing unit volume and market share through continuous product development and enhanced functionality[171] - Financial performance is reviewed based on two reportable segments (Network Solutions and Services & Support) and three revenue categories (Subscriber Solutions, Access & Aggregation Solutions, and Optical Networking Solutions)[171] ADTRAN NETWORKS DOMINATION AND PROFIT AND LOSS TRANSFER AGREEMENT - The DPLTA with Adtran Networks became effective on January 16, 2023, granting ADTRAN Holdings, Inc. control, the right to Adtran Networks' annual profit, and the obligation to absorb annual net losses for fiscal year 2023 onwards[175] - Minority shareholders can elect Exit Compensation (€17.21 per share plus interest) or Annual Recurring Compensation (€0.59 per share), with ongoing appraisal proceedings potentially increasing these amounts[175] - As of June 30, 2023, ADTRAN Holdings, Inc. incurred $26.2 million in transaction costs related to the Business Combination[175] MULTI-YEAR INTEGRATION PROGRAM - A multi-year integration program was initiated in Q4 2022 to optimize assets, business processes, and IT systems post-Business Combination, aiming to realize cost synergies[176] - Identified cost synergies include operational scale, combined sales channels, streamlined corporate functions, and combined sourcing and production costs[176] - For the six months ended June 30, 2023, $1.4 million in integration costs and $8.3 million in restructuring costs related to the Business Combination were recognized[177][178] FINANCIAL PERFORMANCE AND TRENDS - Revenue increased 90.3% year-over-year for Q2 2023, primarily driven by the Business Combination with Adtran Networks and increased sales to Service Provider customers[179] - Domestic revenue increased 25.1% year-over-year, while international revenue increased 194.3%, largely due to the Business Combination and increased shipments in Europe[179] - Challenges include growing customer concerns over inventory stocking levels for Subscriber Solutions, supply constraints limiting backlog clearance, and inflationary pressures on input and distribution costs[179] EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS - Refer to Note 1 of the Notes to Condensed Consolidated Financial Statements for a full description of recent accounting pronouncements, including adoption dates and estimated effects[181] RESULTS OF OPERATIONS – THREE AND SIX MONTHS ENDED JUNE 30, 2023 COMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 REVENUE - Total revenue increased 90.3% to $327.4 million for the three months ended June 30, 2023, and 99.4% to $651.3 million for the six months ended June 30, 2023, primarily due to the Business Combination with Adtran Networks[186] - International revenue increased 194.3% for the three months and 218.3% for the six months ended June 30, 2023, representing 59.6% and 59.5% of total revenue, respectively[187] - Subscriber Solutions category was affected by growing customer concerns over inventory stocking levels, which is expected to continue into Q3 2023[186] COST OF REVENUE - Cost of revenue as a percentage of total revenue increased from 63.7% (Q2 2022) to 71.7% (Q2 2023) and from 64.2% (H1 2022) to 72.3% (H1 2023)[188] - The increase was primarily attributable to $33.4 million (Q2 2023) and $66.0 million (H1 2023) in adjustments from intangible amortization of backlog, developed technology, and fair value adjustments to inventory costs due to the Business Combination[188] - Services & Support cost of revenue as a percentage of segment revenue decreased from 59.9% (Q2 2022) to 40.3% (Q2 2023), driven by customer mix and changes in service mix[189] GROSS PROFIT - Gross profit as a percentage of revenue decreased from 36.3% (Q2 2022) to 28.3% (Q2 2023) and from 35.8% (H1 2022) to 27.7% (H1 2023)[190] - The decrease was primarily due to $33.4 million (Q2 2023) and $66.0 million (H1 2023) in adjustments from intangible amortization and fair value adjustments to inventory costs from the Business Combination[190] - Services & Support gross profit as a percentage of segment revenue increased from 40.1% (Q2 2022) to 59.7% (Q2 2023), driven by increased sales volume and favorable changes in service mix[190] SELLING, GENERAL AND ADMINISTRATIVE EXPENSES - Selling, general and administrative (SG&A) expenses increased 138.9% to $66.6 million for Q2 2023 and 140.3% to $134.0 million for H1 2023[192] - As a percentage of revenue, SG&A increased from 16.2% (Q2 2022) to 20.3% (Q2 2023) and from 17.1% (H1 2022) to 20.6% (H1 2023)[192] - The increase was primarily due to higher employee-related costs, restructuring program costs, amortization of intangible assets, and transaction costs related to the Business Combination[192] RESEARCH AND DEVELOPMENT EXPENSES - Research and development (R&D) expenses increased 166.4% to $70.6 million for Q2 2023 and 165.6% to $140.7 million for H1 2023[193] - As a percentage of revenue, R&D increased from 15.4% (Q2 2022) to 21.6% (Q2 2023) and from 16.2% (H1 2022) to 21.6% (H1 2023)[193] - The increase was primarily due to higher employee-related costs and expenses related to the multi-year integration program and restructuring from the Business Combination[193] INTEREST AND DIVIDEND INCOME - Interest and dividend income increased from $0.2 million (Q2 2022) to $0.4 million (Q2 2023) and from $0.4 million (H1 2022) to $0.7 million (H1 2023)[194] - The increase was due to higher income related to the Business Combination with Adtran Networks[194] INTEREST EXPENSE - Interest expense increased from $0.1 million (Q2 2022) to $4.1 million (Q2 2023) and from $0.1 million (H1 2022) to $7.4 million (H1 2023)[196] - The increase was primarily related to the Wells Fargo Credit Agreement and assumed debt associated with the Business Combination[196] NET INVESTMENT (LOSS) GAIN - The Company recognized a net investment gain of $1.3 million for Q2 2023 (compared to a loss of $4.6 million in Q2 2022) and a gain of $2.5 million for H1 2023 (compared to a loss of $8.1 million in H1 2022)[197] - Fluctuations in net investments were primarily attributable to changes in the fair value of securities[197] OTHER INCOME, NET - Other income, net, increased from $0.7 million (Q2 2022) to $2.5 million (Q2 2023) and from $0.5 million (H1 2022) to $2.2 million (H1 2023)[198] INCOME TAX BENEFIT (EXPENSE) - The effective tax rate changed from an expense of 50.1% (Q2 2022) to a benefit of 18.8% (Q2 2023) of pre-tax income, and from a benefit of 34.3% (H1 2022) to a benefit of 20.4% (H1 2023) of pre-tax income[199] - This change was primarily driven by the Business Combination with Adtran Networks and the release of the domestic valuation allowance in Q4 2022[199] NET (LOSS) INCOME ATTRIBUTABLE TO ADTRAN HOLDINGS, INC. - Net (loss) income attributable to ADTRAN Holdings, Inc. decreased from net income of $2.1 million (Q2 2022) to a net loss of $33.3 million (Q2 2023) and from net income of $1.0 million (H1 2022) to a net loss of $67.8 million (H1 2023)[200] - The Company began absorbing all Adtran Networks losses after the DPLTA became effective on January 16, 2023[200] LIQUIDITY AND CAPITAL RESOURCES - The Company historically finances operations with existing cash, investments, and cash flow from operations, and expects to continue using these sources for working capital, acquisitions, dividends, and general corporate purposes[201] - As of June 30, 2023, available short-term liquidity was $127.4 million, with $86.3 million held by foreign subsidiaries[207] - Net cash used in operating activities increased by $30.2 million to $36.2 million for the six months ended June 30, 2023, primarily due to net loss and working capital changes[208] - Capital expenditures totaled $20.1 million for the six months ended June 30, 2023, primarily for manufacturing and test equipment, software, and building improvements[211] - Dividends paid totaled $14.2 million for the six months ended June 30, 2023[213] | (In thousands) | Total | 2023 | 2024 | 2025 | 2026 | 2027 | After 2027 | | :------------------------------- | :-------- | :-------- | :------- | :------ | :------ | :---------- | :--------- | | Wells Fargo credit agreement | $200,000 | $— | $— | $— | $— | $200,000 | $— | | Nord/LB revolving line of credit | $10,912 | $10,912 | $— | $— | $— | $— | $— | | Purchase obligations | $377,427 | $308,708 | $62,976 | $5,736 | $7 | $— | $— | | Operating lease obligations | $32,499 | $4,662 | $8,658 | $7,159 | $4,506 | $2,950 | $4,564 | | Totals | $620,838 | $324,282 | $71,634 | $12,895 | $4,513 | $202,950 | $4,564 | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This section outlines the company's exposure to financial market risks, including interest rate risk and foreign currency exchange rate risk, and describes the strategies employed to manage these exposures - The Company is exposed to interest rate risk; a hypothetical 50 basis point increase in interest rates would increase interest expense by $1.1 million[229] - Primary foreign currency exposures are with the Euro and British pound sterling, which can affect revenue, gross margins, operating expenses, and operating income[230] - The Company uses foreign currency forward contracts to reduce the impact of currency exchange rate movements, with 51 contracts outstanding and a fair value of $8.1 million as of June 30, 2023[230] ITEM 4. CONTROLS AND PROCEDURES This section reports on the evaluation of the company's disclosure controls and procedures, identifies a material weakness in internal control over financial reporting, and details management's remediation efforts, while noting the exclusion of Adtran Networks from the initial internal control evaluation - Disclosure controls and procedures were not effective as of June 30, 2023, due to a material weakness in internal control over financial reporting[234] - The identified material weakness relates to the design and maintenance of effective controls over the presentation and disclosure of debt agreements, which led to a restatement of prior financial statements[234] - Management plans to remediate the material weakness by implementing a new control for reviewing new or amended debt agreements for terms and conditions impacting presentation or disclosure[235] - Adtran Networks operations are currently excluded from the internal control over financial reporting evaluation for the first year after the Business Combination, but oversight processes are being extended[236] PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS This section discloses the company's involvement in various lawsuits, claims, and legal proceedings, including patent disputes, and notes the inability to predict outcomes or estimate potential losses - The Company is subject to various lawsuits, claims, investigations, and legal proceedings, including those related to employment matters, patent rights, and commercial disputes[238] - An unfavorable outcome in a legal matter could result in damages, royalties, or restrictions on product sales, potentially requiring significant financial and managerial resources[238] - The Company is currently unable to predict the outcome or estimate the possible loss or range of loss associated with these legal matters[238] ITEM 1A. RISK FACTORS This section updates and elaborates on factors that could materially affect the company's business, financial condition, or operating results, with a focus on risks related to the Business Combination and DPLTA, financial performance, control environment, and regulatory changes - The Company expects to incur significant non-recurring integration and restructuring costs related to the Business Combination, with $26.2 million in transaction costs incurred as of June 30, 2023[239] - Increased indebtedness from the Wells Fargo Credit Agreement ($200.0 million) and Nord/LB revolving line of credit ($10.9 million) could adversely affect operations and liquidity, potentially limiting the ability to meet debt service obligations[240] - The DPLTA terms, including potential Exit Compensation of approximately $348.1 million, could have a material adverse effect on financial results and condition, especially if ongoing appraisal proceedings result in higher payment obligations[244] - A material weakness in internal control over financial reporting has been identified, leading to a restatement of previously issued financial statements and potential litigation risks, which could adversely affect investor confidence and financial results[253] - Rising interest rates due to central bank monetary policy actions could increase borrowing costs under variable interest rate debt facilities, negatively impacting financial condition and future operations[257] ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS This section confirms that the company did not repurchase any shares of its common stock during the six months ended June 30, 2023, and currently has no authorized stock repurchase program - No shares of common stock were repurchased during the six months ended June 30, 2023[258] - There is no current authorized stock repurchase program[258] ITEM 5. OTHER INFORMATION This section provides updates on insider trading arrangements and details the First Amendment to the Wells Fargo Credit Agreement, which enhances financial flexibility for potential share repurchases and modifies financial covenants - No directors or executive officers adopted or terminated Rule 10b5-1 trading arrangements during the fiscal quarter ended June 30, 2023[259] - The Wells Fargo Credit Agreement was amended on August 9, 2023, to include a new $50 million delayed draw term loan (DDTL) specifically for repurchasing minority shares of Adtran Networks[259] - The First Amendment also revised financial covenants and permitted the incurrence of up to $172.5 million in convertible indebtedness, subject to certain conditions, for share repurchases or revolver repayments[260] ITEM 6. EXHIBITS This section lists all exhibits filed with the Quarterly Report on Form 10-Q, including corporate governance documents, employment agreements, and the First Amendment to the Credit Agreement - The exhibits include the Amended and Restated Certificate of Incorporation and Bylaws of ADTRAN Holdings, Inc[262] - Several employment agreements and their amendments are listed as exhibits, including those for Christoph Glingener and Ulrich Dopfer[262] - The First Amendment to Credit Agreement, dated August 9, 2023, is filed as Exhibit 10.7[262] SIGNATURE This section contains the signature of the Chief Financial Officer, Ulrich Dopfer, certifying the filing of the Quarterly Report on Form 10-Q - The report was signed by Ulrich Dopfer, Chief Financial Officer of ADTRAN Holdings, Inc., on August 14, 2023[265]