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Dear, ladies and gentlemen, welcome to the conference call of ADVA Optical Networking for the first quarter 2018 IFRS financial results. This call is being recorded. [Operator Instructions]I now hand you over to Mr. Stephan Rettenberger, ADVA Optical Networking's Senior Vice President, Marketing and Investor Relations. Please go ahead, sir.
Yes, thank you, and welcome from my side. This earnings call builds on a presentation, which is available for download in PDF format from our homepage at www.advaoptical.com, in the About Us/Investors section. Should you not have the presentation in front of you, you may want to access it on the conference call's page in the Financial Results section of the Investors part of our website. Before we will lead you through the presentation, as always, please be informed that this presentation contains forward-looking statements with words such as believes, anticipates and expects to describe expected revenues and earnings, anticipated demand for optical networking solutions, internal estimates and liquidity. These factors are discussed in greater detail in the Risk Report section of our annual report 2017. Please also be reminded that we provide consolidated pro forma financial results in this presentation solely as supplemental financial information to help the financial community make meaningful comparisons of our operating results from one financial period to another. This pro forma information is not prepared in accordance with IFRS and should not be considered a substitute for historical information presented in accordance with IFRS. Pro forma operating income or loss is calculated prior to noncash charges related to the stock compensation programs and amortization and impairment of goodwill and acquisition-related intangible assets. Additionally, from Q3 2017 onwards, nonrecurring expenses related to restructuring measures are not included. Unless stated otherwise, all numbers are presented in euro. We will target to limit this conference call to 60 minutes. As usual, Brian will start and provide a business update and outlook. Then Uli will talk us through our Q1 2018 financials. And finally, we will have sufficient time for your questions, which we will be happy to answer. So Brian, please go ahead with the business update.
Thank you, Stephan. We will start on Page 4 with the business update, Q1 2018 in review. Q1 revenues reached EUR 120.5 million, up from EUR 117.2 million in Q4 2017, but down from EUR 141.8 million in Q1 2017, where North America and the ICP space contributed higher revenues. This was within our guidance corridor provided on February 22, 2018, of between EUR 115 million and EUR 130 million. Our Q1 pro forma operating income was at EUR 2.2 million or 1.9% of revenues, above the midpoint of guidance of between minus 1% and 4% revenue. On a positive note, although we lost quite a bit of revenue from one strategic customer from last year, our total gross profit only decreased by 4% from Q1 2017 to Q1 2018. In addition, we achieved a similar operating cash flow to last year. We're slowly turning the ship with both slight growth and stronger gross margins, which will have a positive impact on our 2018 results. We were able to demonstrate good execution when it comes to our strategic investments, which are beginning to deliver returns. Specifically, the MRV integration is completed and delivering additional revenues, which is revenue and starting to positively influence our profitability. The Oscilloquartz EBIT contribution continues to increase, paying back investment and giving us a number of new strategic wins in the carrier, enterprise and ICP space. In general, the carrier service provider customers and enterprise business has stabilized in all regions. Moving on to Page #5, prospects for Q2 2018. We will continue to strengthen our balance sheet by tightly managing our costs and generating cash. We're leveraging our technology in the sync and timing space as well as with our Carrier Ethernet and edge NFV product portfolio to win new footprint. In reflection, Q2 2017 had significant ICP revenue contribution. We've partly refilled this loss, or we will partly refill this loss with new business from other areas while aggressively pursuing further ICP opportunities. We now service 3 of the big i5 ICPs, and we're working diligently on the next generation of DCI technology to upsell our existing customer base. Most likely, more importantly, if we're in the upper half of our forecast for Q2 2018, we'll be able to demonstrate a gross profit increase from our Q2 2017 numbers. Every euro of revenue means more to us in 2018 than in 2017 due to our increasing gross margins. Furthermore, positive contributions from the packet edge and synchronization space are allowing us to build out both our regional footprint, but also our Tier 1 customer base. It is important to have relationships and contracts in place in order to have an opportunity to cross-sell our optical Carrier Ethernet NFV or our sync and timing product solutions. On the next 3 slides, I will outline my view on our position in these 3 technology segments. Page 6, open optical networking in 2018. Our focus will be to leverage the metro core upgrade cycle at our carrier customers to drive additional optical revenues by expanding the use cases at our existing customers. We're also aggressively pursuing DCI opportunities with open line systems, and we're introducing a number of new products for this market segment later this year. In addition, decisions are now being made for the infrastructure investments for the upcoming upgrade to the 5G mobile network. We're going to win new footprint for flexible and programmable 5G infrastructure, where we can leverage all 3 core technologies and our software expertise. We believe for the first time there will be opportunity for networking equipment manufacturers other from the big 3 mobile network providers to win real share due to the virtualization of certain parts of the network and the differentiated technology needed for 5G. The investments are too big and the lock-in too great for carriers to solely rely on the big mobile network equipment vendors. In addition, ADVA Networking -- Optical Networking has been investing in a software-defined strategy in order to support our customers looking at flexible capacity in the network in order to support cloud-like operations in carrier networks. Page #7, physical and virtual packet edge in 2018. With respect to our second technology segment, we have a number of opportunities to grow our ADVA packet edge market share in 2018. The first and primary goal is to protect our MRV customer base and drive cross-selling initiatives with our NFV solution or other ADVA products. Next, we plan on extending the customer base for cloud access solutions by offering both physical and virtual packet edge solutions for a complete flexibility and secure access. They can choose to use our all-in-one hardware solutions, which will lead with price performance; or to use our software solutions over their cloud infrastructure, usually blade servers, to build secular, high-bandwidth and software-defined on-ramps to data centers or cloud infrastructure. Furthermore, we plan on accelerating revenue contribution from our Ensemble software solutions, as we see a lot of activity from the carrier landscape and our win rate is increasing. This is based on our comprehensive product strategy, ease-of-use, secure platform and some of our latest technology features such as zero-touch service delivery for both carriers and enterprises. We are the global leader in Carrier Ethernet, and we have the most competitive technology for the universal CPE application, which is often the first use case to be ruled out by carriers as they start on the path of virtualizing their networks. One virtualizes to make the hardware layer independent from the software layer in order to standardize frameworks and interfaces and avoid proprietary solutions. It yields greater simplicity, lower cost and scalability, which is not supported with those proprietary solutions. ADVA is the global technology leader in virtualizing the edge of the network. And from my final slide, synchronization in 2018, Page 8, we are winning multiple footprints and growing rapidly with our synchronization strategy. So far, we are leveraging our large footprint in the carrier space, but there are a number of other customer segments, which we will be successfully expanding into over the next 2 to 3 years. We are utilizing our technology leadership in synchronization to further improve overall corporate gross margins and win new footprint where we can cross-sell our other technologies. With the decision for 5G infrastructure builds being made now, we have all the pieces in order to offer a comprehensive portfolio with core, access and software timing assurance solutions, which far exceed our competitors' offering. Accurate and scalable time and frequency synchronization will continue to give a strong third leg to stand on and the ability to leverage optical packet and timing technologies for next-gen networks. I would now like to introduce Uli as the next speaker.
Thank you, Brian, and hello, everybody. If we move to Slide 10, IFRS quarterly revenue and pro forma profitability. As already stated, we ended Q1 2018 with revenues of EUR 120.5 million. This result is within our revenue guidance range of EUR 115 million and EUR 130 million and represents an increase of 2.8% compared to the EUR 117.2 million in Q4 2017. Year-over-year, our revenues decreased by 15%, with nearly halves of our revenues in U.S. dollar. The much weaker U.S. dollar exchange rate had a major impact as well. The change in customer and product mix combined with successful cost-reduction efforts led to a strong gross margin of 36.7% compared to 32.5% in the year-ago quarter. These effects are also reflected in the strong pro forma operating income, which was in Q1 2018 with EUR 2.2 million or 1.9% of revenues, above midpoint of our guidance of between minus 1% and 4% of revenues. This compares to 3.8% in Q4 2017 and confirms our return to profitability. Let's move on to the next slide, quarterly IFRS profitability. In Q1 2018, IFRS operating income was slightly negative, EUR 0.4 million or minus 0.4% of revenues, down from EUR 2.3 million or 2% in Q4 2017. This result was impacted by about EUR 1 million restructuring expenses. The integration of the recently acquired MRV Communications group is progressing well, and we expect some further minor financial restructuring expenses as we move along.Due to the weak U.S. dollar, the revaluation of our balance sheet resulted in expenses of EUR 1.9 million, leading to a negative net income in Q1 2018 of EUR 2.4 million or minus 2% of revenues. Of course, the strengthening U.S. dollar will reverse this effect again. As the number of weighted average shares outstanding has not changed significantly, diluted EPS developed in proportion with IFRS net income to minus $0.05 per share. Next slide, please, quarterly revenues per region. EMEA saw strong growth of EUR 6.7 million compared to Q4 2017 and represents 54% of our total revenues. After a strong Q4 2017, order entry at the beginning of Q1 2018 was slow, but improved nicely in the second half of the quarter in the Americas. As a result, revenues in the Americas were at EUR 41.3 million or 34% of revenues. As already seen in Q4 2017, the strong MRV presence in Asia-Pacific results in continued growth in this region, 27% quarter-over-quarter or 87% year-over-year. Next slide, please, IFRS consolidated balance sheet. Overall net working capital of EUR 122.5 million decreased slightly compared to the EUR 123.8 million reported at the end of Q4. Tight inventory management resulted in a significant decrease for inventories to EUR 73 million from EUR 82 million at the end of 2017. Accounts receivables increased, caused by higher revenues. Payables were slightly lower than at the end of 2017. As always, the cash balance in our first quarter is impacted by the cash outflow from variable personnel expenses. This is reflected by the lower net liquidity of negative EUR 44.2 million compared to negative EUR 38.2 million at the end of Q4 2017. Growth cash remained stable at EUR 57.7 million compared to EUR 58.4 million at the end of Q4 due to the new financing of EUR 10 million, which was partly offset by regular debt repayments of EUR 4.7 million. Year-over-year, net liquidity decreased, mainly due to the cash-based acquisition of MRV Communications, which was financed with a short-term loan. We're currently in the process of converting this loan into long-term obligations. Our equity ratio is at 49% with a total stockholders' equity of EUR 223.5 million. Next slide, please, our guidance for Q2 2018. We confirm that for 2018, we expect a moderate single-digit percentage revenue growth and a mid-single-digit pro forma EBIT. We project Q2 2018 revenues of between EUR 120 million and EUR 135 million, with pro forma operating income to range between 1% and 6% of revenues. We remain committed to a flexible cost and operating model that allows us to quickly adapt to changing market conditions. We will continue to perform detailed reviews of our expected business development in respect of all intangible assets, including capitalized development projects. In case of highly adverse business prospects, such a review may result in noncash impairment charges in Q2 2018 and beyond. The pro forma operating income guidance we have provided today excludes any such potential impairment charges. With that, I'd like to summarize today's call. Last slide. We had a successful turnaround in Q4 2017 and a solid start in the new fiscal year. We optimized our cost structure, which is aligned with our revenue profile, and this will be -- enable us to grow our profitability in 2018 and beyond. Thanks to the MRV acquisition, we have more customers, better revenue diversification and a broader solutions portfolio than ever before. The global growth drivers, cloud and mobility, and the preparation of the network infrastructure for 5G create new opportunities for us with multiple ways to win. With our cloud interconnect portfolio, we are supplying the industry with a new architecture for programmable, open optical networks. Furthermore, with our physical and virtual network edge portfolio, we are rapidly extending our customer base for cloud access solutions. And last, but not least, we're leveraging our technology leadership in network synchronization to increase our presence among large network operators and tap into new verticals. We have a solid foundation for future growth and increased profitability. Thank you for your participation in today's call. With that, I'd like to turn the call over to the operator to begin the Q&A portion of the call.
[Operator Instructions] We received the first question from Robin Brass, Hauck & Aufhäuser.
I have 2 questions. First of all, the DCI or ICP segment here, is it fair to assume that now with lower sales around maybe 10% of revenues in Q1. Is there indication you could give us? And the second question would be, how does the ban on ZTE affect your business in any positive or negative way?
So the first one is high single digits in Q1, still believe in around 10% for the year, annual number. And I think it's a healthy percentage of our business. From a ZTE perspective, ZTE was mostly focused on China. I think 75% of their revenues was China, another big chunk in Asia and very little outside of those regions. Therefore, there might be some upside, but I think that it's going to be relatively small pickings for most Western providers of the technology base. Again, there might be some small opportunities in Southeast Asia and maybe through Africa.
And do you assume any, like, consolidation push now in the market from this development?
I mean, the consolidation has been taking just far too long, 18 years, to get down to 1/10 of the vendors we once had, but it's still too many vendors. I believe the consolidation is going forward, but it's not necessarily driven by the -- this issue with ZTE or the U.S.-China stress that's occurring right now. But I think it's happening, because fewer companies can keep up from a technology perspective. And therefore, there are some weak companies that are bleeding cash, losing customers and revenues rapidly and are no longer truly competitive. So I do believe the consolidation continues, and it will -- remains in our optical one of our 3 legs to stand on very competitive markets out there to make sure that you continue servicing your existing customer base, but also winning new footprint. So yes, the answer is yes, consolidation continues.
The next question is from Tim Savageaux, Northland Capital Markets.
Uli, I think you mentioned briefly some of the drivers for the strong gross margin. I wonder if you can kind of go over that again or provide any more additional color, so there's sort of mix MRV, what have you, and maybe any comments on the sustainability of gross margins in that range? Brian, I think you talked to the potential for increased gross profit year-over-year at the high end of the range on an absolute dollar basis. I want to make sure I got that right as well.
So gross margin, yes. We just discussed the ICP portion in the revenues, just below 10%. There's -- definitely, there's an impact on stronger gross margins. We have, in general, a different product mix. We have a stronger business with synchronization and timing. But also, of course, MRV has a good positive impact on our gross margins.
The U.S. dollar, could you repeat -- the U.S. dollar clearly is now stabilizing. It was far too strong relative to other currencies. Software sales increasing. So there's a number of drivers to support further strengthening. And that's why we mentioned in both my section and Uli's section, we feel comfortable with the expanding gross margin. My statement was, yes, also gross margin on one part and gross profit absolute, we -- if we're in the upper half of our guidance, we'll actually increase our gross profit, absolute increase from Q2 of last year. Still be down if you look in the upper half, off of the revenue number, but we're contributing more dollars to our business for investments and profitability already. And you have now 3 quarters of looks like growth. If we meet our range of guidance, you see us recovering on a top line, but already having recovered nicely from a gross profit perspective.
Got it. And wonder if you could comment on kind of the sort of core European carrier market for transport. You were kind of down year-over-year. In Europe, you've been sort of commenting on the relative health and stability of that market for a few quarters now. I wonder if you can update your views on kind of the carrier metro market amongst your European customers?
So I think there are always waves. I mean, there was -- beginning of last year, there was some good momentum on certain customers that helped us. But in general, I feel positive. Maybe slightly down, but could be up shortly here. There is "steady as you go" type of thinking, no explosion in investment dollars. There's been no major, let's say, a change in the consolidation wave of any major customer of ours. So we feel comfortable with our business in Europe.
Okay. And last question from me for now. You had mentioned during the call -- made some reference to kind of next-generation DCI technology. I wonder if you could kind of dig into that a little bit further? We continue to see pretty strong, if not dizzying, levels of investments as these cloud providers report. And I wonder if that's a reference to sort of new platform development on your front or higher line rates. Or if you can update us on kind of your efforts to sort of reestablish yourself, reconnect with some of that strong COGS spending?
So yes, we've mentioned the short reach for metro use case was the one we had lost in one of our big customers. We're bringing next-generation technologies to market under our brand named TeraFlex. But it's -- at this time, it's using all of our standard software architecture. We've introduced that new platform. So there's very little risk around the software architecture perspective. The development cycle is going very well. We said, second half of this year will be driving our wins and scaling that, then after those wins, always a quarter or 2 later. Feel comfortable with higher line rates on the network side so that you're getting a dramatic cost benefit at a 100-gig and ultimately, 480-GigE line rates. I feel that our technology that we're introducing is as good as it gets. There's no indication that anybody has a better bandwidth scalability, ease-of-use. I think you married out with some of our differentiated features that we like, including the encryption piece. I believe that we are very competitive.
Okay. And really final question now, just a quick along those lines, heading into OFC this year. You announced and after having announced a partnership with Ranovus last year for kind of direct oriented DCI solutions. You now have a general availability there. Heading into OFC, any expectations for material revenues under that partnership this year?
We're hoping for that for sure. We've always been good at positioning different 100-gig solutions into different market segments. We sell effectively into carriers, managed service providers, enterprises, ICPs. There are different use cases for the different technologies and the price points. So we feel that we wouldn't be introducing it unless we think that we can use it to differentiate and to focus on market segments that need different technology or specs in their network architecture. The answer is yes.
There are currently no further questions. [Operator Instructions]
Then, I guess, we'd like to wrap up...
We actually received 2 more questions. The first one is from Rob Sanders, Deutsche Bank.
So yes, my first question is just on the capitalized R&D that you have on your balance sheet. As I understand, a lot of the synergies from MRV were basically realized by discontinuing some of the ADVA comparable initiatives. So I would have -- I understand that the OpEx has come down partly as a result of that. But I would've expected some of the capitalized R&D to be sort of written down if that was the case. So I'm just trying to understand that. And then the second thing is just -- the question is just around the -- I think it's called in Germany the Schuldschein, the refinancing that you mentioned in the annual report. I understand you're not going -- you're not necessarily going with the Schuldschein now. But I just only -- I'm trying to understand, do you have enough credit lines to support your liquidity, are there any covenants, et cetera?
All right. First question, the capitalized R&D, no, we have not written off. We actually -- in Q3 of last year, we wrote a small portion of the R&D off as part of the restructuring. But so far, we -- of course, we've not capitalized any of the MRV R&D expenses. And I would also not expect that we have extraordinary depreciation of existing capitalized R&D expense based on the combination of the platforms with the MRV product and the ADVA product. Then the next question, the Schuldschein, yes, we -- the plan was to go Schuldschein, but Q1 turned out to be not a really good quarter for the Schuldschein. So in general, the market was down. And after consulting our banks, we decided to pull back our offer, shortened the offer period. And then we're now in discussions to refinance with rather traditional syndicated loan. But there are no -- I mean, we don't expect any major issues. And of course, the liquidity is secure. We are currently in a bridge loan scenario, which will last till the end of the year. So we have plenty of time to refinance the bridge loan.
Got it. And the bridge line carries what interest rate?
I don't know if I'm allowed, to be honest, to disclose it. I cannot disclose it, but it's very low.
It's lower than the Schuldschein, right?
Yes.
And the next question is from Mirko Maier, LBBW.
A couple of questions from me. First on Asia, you've mentioned that MRV was strong in Asia. So in the past, the Asian revenue was somewhat lumpy. So in the last 3 quarters, there was no steady development. So it's just a new trend? Or is revenue based in Asia still too small to be on a stable base. And then I'll follow-up on also on the activation of the R&D expenses. I've learned about most based on the MRV integration. And so was that the reason for the very low activation and the lower revenue with this special customer in the United States? And you've mentioned that the MRV integration is completed. And so it's been -- there are very low integration costs to be expected in Q2 and nothing more in Q3. And then I have a question on your -- of your good shares. Positive news when it comes to cross-selling effects is those MRV customers in the United States? And then I have one to Oscilloquartz. You've mentioned that the revenue contribution was 5%. I guess, it was for 2017. And you've mentioned that timing will grow much faster than the whole market you're addressing. So what will be the share from Oscilloquartz to your top line in 2018?
So let's try to get this right. The first one was Asia. And 2 pieces positives is the sync and timing business grew fastest in Asia, and we've won many customers. And we have, therefore, better stability. Point two, MRV. MRV is, as indicated during our presentation, has stabilized Asia further. So we have 2 very positive effects. We are hoping to continue to grow Asia over the coming years, and we have a better team than ever before. Activation of R&D, you want to take that one?
To be honest, the second question, Mirko, if you could repeat the second question, because I did not really...
It was follow-up on the integration. Activation was really low. And you've mentioned that it was -- belongs not to MRV. So I assume it belongs to the lower revenue with this special customer in the United States. Is that the reason behind those very low activation of R&D?
Well, we don't activate on a customer basis. We activate development project. So we -- while we do customer-specific developments here and there, but what we develop is in general new product, new features, new technology. So you cannot tie it to an individual customer.
And maybe a follow-on to that. So our -- the quality of our pro forma EBIT is stronger this year than last year, because we -- there was greater activation. So I think that's the theme that we talked about. And as you see in Q1, there's less activation. And then that will follow through in Q2, Q3 in our forecast. So that's an upside positive for our -- ultimately, our cash flow generation off of our pro forma EBIT.
So then I could assume that the level we've reached on the positive effect from the activation will be stable on the level we had seen in Q1?
Yes, I would assume that.
So the next one was the completed MRV integration. We integrated as an SAP. We've shutdown other ERP systems, other -- I don't think there is a company out there that can go acquire a company 15% of its size and do what we did over the last 7 months. Process fees, IT lands -- tool landscapes, full synergy realization on the cost basis. Of course, there is somewhat of a tail, because not everything happens. And you'll see, in general, we said OpEx management throughout the year. So you'll still see some effects of decisions that we've made throughout the year, but very small. And I'll pass to Uli, are there any restructuring below line type of pieces in Q3 or Q4.
Minor.
Or Q2 and Q3 minor.
Minor.
Minor means less EUR 1 million, no?
Yes, definitely.
Definitely. Okay. So cross-selling opportunities and in the MRV customers. And yes, we have, I think, 2 cases of cross-selling so far. It's never easy to cross-sell, especially in the carrier community. It takes them a long time to make decisions. They have integration into their OSS, BSS, their software frameworks. But I think we're making gains, and you'll see a lot of leverage, especially on MRV's Carrier Ethernet products and their customers and our NFV strategy. So you'll see us already coming with very nice strategies. And essentially what ADVA has today is we're a global leader in Carrier Ethernet. But we're the actual global technology leader when it comes to the NFV edge solution set. And that maps very well into that customer base. So it's a good combination to have. There's a lot of big nice customers that trust ADVA and leading technology for a kind of next-gen architectures, the virtualization of the edge of the network. So that's definitely a big cross-selling. And then clearly, there's -- we're trying to cross-sell features that we have in the ADVA architecture into the MRV optical customer base. And the final one is also -- and revenue contribution is 5% was the question. And I think that statement is, it's about 5% this year, but it should go up to 6%, 7%, up to -- it can get to 10% of our revenues over the coming years, because we have really differentiated technology and we are winning most of the things we've focused on, including major Tier 1s in Asia and in Europe so far and very big momentum there. It's not a huge market, but a very nice market. We leverage the business, and we can even sell into enterprises, ICPs and other market segments. So we continue to believe that as a strategic product solution set for us that can be leveraged in revenues, gross margins as well as cross-selling.
There are currently no further questions. I hand back to the speakers.
Thank you very much. Thank you for joining step-by-step. We're running a tight ship. And you'll see progress going forward in 2018. Talk to you soon.
Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.