ADTRAN Holdings Inc (ADTN) 2002 Q2 法說會逐字稿

Good morning, my name is Holly, and I will be your conference facilitator today. I would like to welcome everyone to the ADTRAN second earning conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, press star and the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

During the course of this conference call, ADTRAN representatives expect to make forward-looking statements which reflect management's best judgement, based on factors currently known. However, the statements involve risks and uncertainties including the successful development of marketing acceptance of new products, the degree of competition in the market for such products, the products and channel mix, components cost, manufacturing efficiencies and other risks detailed in the Annual Report on Form 10-K for other risks detailed in their the year ending December 31, 2001. Such risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements, which may be made during the call.

Speaking on today's call from ADTRAN are Mr. Mark Smith, Chairman and Chief Executive Officer, Mr. Howard Thrailkill, President and Chief Operating Officer and Mr. Jim Matthews, Senior Vice President and Chief Financial Officer. Mr. Smith, you may begin your conference.

Thank you, Holly. Good morning. I'm Mark Smith and I'd also like to welcome everyone to ADTRAN's second quarter conference call. It's a personal pleasure this morning to share with you the second quarter performance of ADTRAN. While operating in this difficult market environment, ADTRAN has again consistently been profitable. During the second quarter ADTRAN both improved our gross margin and we also further reduced our inventories. Also, this past quarter marked the first [inaudible] quarter for revenue that we have seen in over seven quarters. To get into a detailed discussion of the financial performance, I'd like to turn the call at this point over to Jim Matthews, our CFO. Jim, will you give your report on the detailed financials.

Yes, certainly. Good morning, everyone As disclosed in the press release, revenue for the second quarter was [inaudible]. This was the first sequential quarterly increase in revenues since the third quarter of the year 2000. Revenue for the second quarter comprised the following. HDSL T-1 was $45.2 million, down from $46.8 million in Q2 of '01, but slightly up of $45.1 in Q1 of '02. Systems were $29.5 million in Q2, up from $27.6 million in Q2 of '01, and up from $26.6 million in Q1 of '02. And Digital Business Transport [inaudible] was $11.1 million in Q2, down from $22.8 million in Q2 of '01, and down from $11.6 million in Q1 of '02. By market, the revenue breakdown for the quarter was 62% for carrier and 38% for enterprise. The carrier enterprise percentages include their respective share of revenue from the international sector which approximated 5.9% of the total.

Gross margin was 48.5% of revenue during the second quarter quarter '02 compared to 47.2% Q1 of '02, and 46.9% of Q2 of '01. The increasing gross margin is due to continued improvements in manufacturing efficiencies and continued reductions in costs across product lines. Research and development expenses were $14.6 million in Q2 of '02, compared to $13.8 million in Q1 of '02. Selling, general and administrative expenses were $20.3 million for Q2 of '02, compared to $20.8 million for Q1 of '02.

In the second quarter, we recorded an impairment charge related to other than temporary declines in the third value of publicly traded equity investments below their cost basis. This impairment charge reduced earnings per share by 2 cents. Earnings per share for Q2 of '02 were 13 cents compared to 12 cents for the same period last year and 11 cents for the first quarter of '02. From a balance sheet perspective, we continue to build cash reserves and improve our working capital position. Inventories declined from $47 million to $41 million during the quarter. DSOs came in at 52 days down from 60 days at March 31 of '02. Net cash provided by operating activities was $26 million for the three months ended June 30, '02. Cash and marketable securities net of debt totalled $241 million at June 30 of '02. Now, during the second quarter, the Company repurchased 374 thousand shares of common stock as part of the 2 million share repurchase program announced last year. Total shares repurchased under this program amount to 589,000.

Now, I would like to discuss guidance for the third quarter of '02. As you remember, ADTRAN does not carry significant amounts of backlog from quarter to quarter as we remain a book-and-ship business. In our analysis, we see the business continuing to bounce along the bottom as difficult times linger in the markets we serve. During these factors, we are estimating revenue in the range between $83 million and $87 million for Q3 of '02. Our overall gross margin percentage for Q3 '02 should be in range for the gross margin percentage experienced in Q2. Operating expenses should be in range with Q2. Taking these factors into consideration, assuming a tax rate of 28% and average weighted shares outstanding remain the same in the second quarter, and no further other than temporary impairment of investments, we are anticipating a range for earnings of share of 12 cents to 15 cents for the third quarter of '02.

Mark, back to you.

Thank you, Jim. Before we start our question-and-answer session, I would like to address the main question that is on all of our minds, and namely that is, have we seen the start of the recovery in IT spending. Unfortunately, the answer here is still no, not yet. We believe we have seen the bottom. We think that we have been bouncing and in fact along that bottom. But convincing evidence of an overall IT spending upturn has just not arrived yet. There is no question in all our minds that as this condition goes on, that the longer it does, then the stronger the return to normalcy will be. But at this point in time, I think that that it is very prudent for Jim to maintain a guidance of a flat operating performance for our Company and for us to basically assume that we are continuing in the very soft market environment that we have been operating in now for almost two years and that this condition will continue until sometime hopefully in the near future when we will be able to report to you that we have seen a significant return to normalcy in the capital spending patterns for the IT and technology industries. Holly, at this point, I think it would be appropriate to turn the conference call over to the question-and-answer session. If you would pease do that for us.

At this time, I would like to remind everyone, in order to ask a question, press star 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before asking your questions. Your first question comes from the line of Rob Sanderson, Bank of America Securities.

Good morning, thank you. Let's ask a couple of questions on, again, the overview on some of your new product initiatives, if I could. First [inaudible] you rounded out the net data line, could you comment on the response so far from the channel, and from the customers and where would you say we are in wrap of the product family? Do you think it's going to be a larger, a significant wrap in the end of this year, or is this really a 2003?

Rob, I would say that the really significant, portion of that product line as far as affecting the Company's revenue will be a 2003-type of situation. We plan to announce additional products in that line between now and the end of the year. We are seeing a very good acceptance with our channels and with the customers on some selected products that we have been showing to them but we think that 2003 is going to be significant impact of the net [inaudible] line, not in 2002.

And similar, could we also get an update, Mark, on Opti 3 assuming -- We didn't see an announce of an Osmond [ph] certification process. Is that complete and we all know how slowly [inaudible] can be, but are things kind of progressing there as expected or has that slowed somewhat?

No, it's progressing as we expected. I believe that the Osmont [ph] process is complete. There may be a few minor things left, but I don't think so. I think it is totally complete and now it's up to,as you say, it's up to the carrier community to get the product approved and get it going. We have received orders, by the way, from Arbucks [ph] for that product. We're not into a full production shipping environment yet, obviously, but it's proceeding very nicely. We're very pleased with the initial acceptance of the Opti-3.

Would it be fair to say a little bit of revenue in September and then quite a bit more in December?

I think that'd be very fair. We received a very minimal revenue in this past quarter on Opti-3, but we think that that will ramp nicely during the year.

Thanks, guys, good luck.

Our next question comes from the line of Mike Lynch, Morgan Stanley.

Great, thank you. Could you explain the trading program you've announced recently. What's the initial response been, how do you expect margins to be impacted and what do you expect from this program in general?

I didn't catch that, Mike, would you give me that again?

Yeah, you announced, what is it, the IQ 710 trading program, I was just wondering if that's is a big initiative for you, and if so, what's the initial response been, and how will margins be impacted? What do you expect out of it?

Yes, Mike, that is a -- a narrow portion, a narrow program doesn't cover a significant number of products for us. Howard, do you have a better answer to that? Number one, I don't think it's going to affect revenue or margins in any way. Howard do you have any more details on that?

It's just -- Mike, it's early on in the process and I think it's too early to tell what it will do. It's something that is very favorable to us, and as it progresses, we're watching with interest, but I agree with Mark. It's not a significant event one way of the other as far as our financial results are concerned.

Another thing I wanted to ask you, have you held -- I think you were holding salaries, can talk about if you've provided any raises recently, and if you haven't do you expect to [inaudible] you kind of guided to flat expenses. So, I'm just trying to understand if it's sustainable.

Mike, we have not, unfortunately, been in a position to reinstate the salary reductions that we instituted about a year ago now. We will -- we will do that as we see a return to normalcy in our market, but we have not -- we have not done that at this point in time and unless we're surprised, pleasantly surprised, to see a turnaround in the marketplace, we will not do so during this quarter.

One last one on a new product, the Digital Carrier products. Are they -- are you -- is there any extra, the thing you talk about attraction, you mentioned Arbucks [ph] were in trial but I think you mentioned one that was, or two that would buying but you didn't provide details. Can you give us an update on the status of that product?

I think the -- Rob in the prior question, answered that almost by noting the slowness of the Arbuck [ph] community moving, and the situation there is about the same as it was previously. We're proceeding, but especially with the market conditions and the spending environment that exists, progress that has been very, very slow.

Okay, thank you.

Our next question comes from the line of Andrew Showpeg, Nutmeg Securities.

Thank you, good morning, all. A couple of questions, first for Jim. Jim, how would you characterize your current capacity utilization at the company?

Well, first of all, if you look at our manufacturing as it relates to revenue, about 50% of that roughly is outsourced to major manufacturing contractors, who, I think we all know have very significant capacity order to expand in.. We all also have a portion of manufacturing here in-house at ADTRAN, the other 50% and we would view ourselves at about 65% of total capacity there.

Okay, could you comment Jim about any 10% customers in the quarter, quantify them in any manner.

Sure, they continue to be Verizon, SVC and Sprint, no significant changes from what stated in the K.

And the aggregate of those three represented about what percent of the quarter's revenue?

In the aggregate, we're looking at about, roughly, 44 to 45%.

Okay, and Mark, I'm curious to ask you, in which particular areas of your three major product groupings, you would be the most optimistic or where your expectations would be highest for growth and recovery soonest, if I may. Is there any one particular area of the business in which you have an expectation of more rapid recovery?

I think there's two of them. One is the area that we call Systems, and the other would be in the T-1 area, HDSL [ph] T-1. Those are the two areas that I see recovering strong, whenever we IT spendings pick back up again.

Okay, thank you.

Our next question comes from the line of Chris Fisher, Raymond James.

Yes, Chris Fisher from Todd Kaufman. Mark, in the releases it suggested that you were seeing some market share gains. Could you share with us your views on those please.

Yes, Chris. If you take a look at the different businesses that we are in in both the carrier and also in the enterprise area, why it does appear to us, the best of our evaluation on an overall basis, that we are picking on market share pretty well across the board on an individual product area basis, some more and some not as much in the DBT [ph] or our business digital area, which is more legacy equipment, the market share there we have a very high and market share and there really hasn't been that much of a change, or is there a possibility of much of a change from our standpoint in that area in the HGSL T1. We continue to pick up additional business and additional market share in our opinion. However, there has been no truly significant changes there. Once again because of the high market share we have in the systems area, however, there is a number of different product areas that market share gains are very much appropriate -- two of the areas were mentioned earlier by Rob from B of A, namely the Advanta [ph] which is our first OC3 [ph] product for Sonnet [ph], and we are new entering into the optical area, and new entering the silence and lots of market share that we feel could be picked up there . Also, as we enter into additional product areas in our enterprise group, we feel that there is lots of market share that we picked up there, so, on a -- the past quarter, we think that we have performed better than the market has in general, pretty well showing a small improvement overall in our market share, and going forward we think that we can continue that or maybe even improve the rate of market share gain.

Thanks for that rundown, Mark. That was very, very helpful. One other question, if I could, on the inventory, it's come down remarkably for you all. In the past, Mark, you said you don't mind carrying a little extra inventory for the reason that you don't want to lose any business, with the inventory coming down,, are we seeing sort of a shift in your thoughts there is, or is it just a suggestion of the current telecom market that we are operating in?

Well, unfortunately, it's two things. One is that there's been an awful lot of very, very good effort in bringing our inventory down, but not bringing it down in a manner that would jeopardize our ability to ship in a timely manner. The unfortunate part of that was that we're bringing it down from a level that was just absolutely too high. Back two years ago, we were finding it very, very difficult for us to buy in a timely manner components, we were finding it very, very difficult for us to get outside assembly accomplished in a timely manner from our subcontractors, and the net of that was we increased our inventories and looking back at it, of course. one can say that we increased our inventories entirely too much, and right before the bottom fell out of the market. So two years ago, we were sitting with inventory of approximately $100 million, which at that point in time, and obviously today, is entirely too much. We're now down to the low 40s, which is an enormous improvement.

Where we are at these numbers, I think addressing the overall cash and overall inventory situation. cash and overall inventory, the days of our generating large amounts of cash due in part to drastic reduction in inventory, I think are over. We have made that adjustment. We are within the range of inventory to sales that, as you say, fits our mode of operation with our carrier customers who, quite frankly, look to us and their suppliers to carry their inventory and not themselves. They will order only when they absolutely need for installation, hence it's up to us to carry the inventory, which under the circumstances, of course, we gladly do. So I think what we really have done is not changed our ideas or philosophy, we just simply reduced it from an abnormally high level to levels that we think at this point in time, with this revenue base are sustainable.

Thank you very much.

Our next question comes from the line of George Notter, Deutsche Banc Securities.

Hi, guys, thank you very much. I was interested in the Seelec [ph] mix this quarter. I think last quarter it was 12 or13%, what does it look like in this quarter, and what are the business trends on that piece of the business?

Jim, could you take that?

Right, George. George, we, on a monthly and quarterly basis, look at the point of sale information that we can obtain from folks in the channel, in addition to what smaller part we still direct to Seelec [ph] and for the second quarter, it's looking at about 14% of revenue.

Got it, and so it looks like an on absolute terms, that business hasn't really changed very much. How about the Seelec [ph] portion of the business? Do you still feel fairly comfortable relative to the run rate going forward?

Well, I think so, I don't see varying up or down very much from that number at this point.

Got it, great, thanks very much.

Our next question comes from the line of Tim Beckter, Legg Mason.

Good morning, guys. I have a couple of balance sheet questions here. Accounts payable was up considerably. I wanted you to talk about that and I also noticed the other liabilities went down pretty well, and if you could also add a little bit of discussion on long-term investments? I see that that went up considerably, and I am just wondering if that's highly rated bonds in that category?

To answer your question on the liability side, the fluctuation up on accounts payable is really more related to the revenue level, okay, as it's going up from the prior quarter revenue level. As far as investments, yes, you'll see that investments from quarter to quarter increased about $20 million. And, yes, the vast majority of that is going into the highly rated bonds, within three year maturities, so very short maturities on that.

Jim, what about the liabilities line that went down?

I think it went down perhaps only slightly. We, it was resolving around the number of payrolls that we have in a particular month at the end of the quarter versus the first quarter, so it was only in relation to timing of payouts in cash.

Okay, so these are all basically just swings due to the changes in revenues for the most part?

The accounts payable is.

Okay, one last question, I guess, would be the number of employees?

Number of employees is right in the area of about 1600.

So it did go down a bit from first quarter?

Yes, slightly.

Okay, thank you.

Our next question comes from the line of Tim Slevin, Parker Hunter.

Good morning. Any -- just a quick question, most of my questions have been answered, and any update regarding, or outlook with respect to T-1 line growth and basically flattish from your perspective?

Tim, this is Mark Smith. Yes, I think that on an overall basis, you'd say that T1 lines were flat. If not, maybe very, very slightly down.

Okay. Great. Thank you.

All right.

Our next question comes from the line of Michael Parika, Kaufman Brothers.

Thank you, good morning folks, I have a quick question for Mark, following up on the Opti-3 [ph] in your initiative into penetrating the Sonnec [ph] market. What's the primary application you see for this system? Do you see it as a low-cost opportunity for traditional ring functionality, or do you see opportunities for access, perhaps mapping ethernet frames into Sonnec [ph]. Thank you.

Michael, yes. Wonderful question. What it is, is the access, it -- a portion of it -- Our first product is the OC3, with 150 megabit system. That is not really used in the ring configuration any more because higher bit rates are always involved in that. However, it is a very high usage of technology in the terminal mode. If you look at the market, it looks like this around the 750, 800 million worth of OC3 products that -- you then look at the applications involved [inaudible] it's almost primarily all in a terminal mode environment. And so basically, what we have done is to take a look at our entrance into the silent market and say here's an area that has been underserved in the products that were originally designed for ring applications, are now being primarily are now being used in a terminal mode primarily and why not go ahead and let's offer into this underserved marketplace, products that were designed for the use that is there now being put to, namely in the terminal mode. So, yes, it's definitely terminal mode, or product does not offer in a ring mode, and we're very excited, obviously, about its future and plans to expand our interest into the Sonnec [ph] area into higher speeds and much more complex products in the future.

If I could also follow up, thanks for the answer, regarding layer 2 functionality. Is that on the box yet? Is it capable, and if not, is it something you can offer in the future. Thank you.

I think what you need to do there is get in touch offline with Tom Stanton [ph], and h'ed be happy to talk with you about the details of these products and these features.

Will do, thank you. Okay, Mike.

You next question is from the line of Wayne Cooperman, Cobalt Capital.

Hi, guys, a question on the expense ratio. The SG&A was actually down a couple of percent, Q1 to Q2, anything in particular, and you said -- we should just look for flat SG&A from Q2 level and how long would you guide that out look for?

We need to look for flat expenses there, and we just got that out for as long as we see the revenues stay in a flat basis. The one thing, if you really look at those expense items, I think you'll find that most everything is there with the exception of our R&D and engineering expense which is up.

I guess my question is why was it down from Q1 to Q2 and should we not expect continued declines in SG&A?

There was a little bit of shuffling of personnel in the sales area, very small, as you saw the decline wasn't that large in the expense. We do not anticipate that there's going to be a continuing decline, however, in the SG&A area. It should be flat.

Got you. Okay, thanks and good luck.

Our next question comes from the line of David Fondery, Heartland Advisors.

I was wondering if you could give us information on why shareholders' equity went down. I understand you bought back some shares but the sequential decline in shareholders' equity is confusing to me.

Okay, the share buyback and the impairment charge that we discussed in the press release, for two obvious reasons. Jim, is that it, or do you have a more thorough explanation to express?

Sure, the components, moving equity were, of course, income for the quarter, and then as Mark said, a change in the unrealized gain, lost balance from March to June, and that change was a reduction of $6.4 million. Again, to explain that in more detail, in March, we had unrealized gains of $4.8 million in marketable securities and at the end of June, we had under-realized losses in marketable securities of $1.6 million, so you have that swing to account for, and also, we're looking at about $7.3 million in funds that were used to buy treasury shares.

Okay, so was -- it was the unrealized gains which -- I guess, the realized gains, the realized and losses were only about a million something that was included in the income statement.

Well --

And the unrealized gains --

Yes, we actually, , , wroke down $1.3 million, just over $1.3 million in our cost basis on certain marketable equity securities.

Right, okay. I'm with you then.

Okay.

And can you give us a little -- a little information on those equity securities, how much you have left? I think you had about $37 million at the end of the year,, and what risk there is there?

Sure, in total equities that we carry now, we carry about $34 million in total, dollars, in total equities spread over about $29 different individual equities and, the impairments were taken over four those.

Thank you very much.

Our next question comes from the line of Rob S\sanderson, Bank of America Securities.

Yeah, thanks for the follow-up. Just a quick housekeeping, could you give us the average price of the shares that were repurchased this quarter and, maybe shed a little bit of light on what you're thinking on a go-forward basis?

Mark --

Yeah, Jim, that's --

I can answer that. The average price that we repurchased was just under $20 for the 374,000 shares that we repurchased.

I will answer going forward, we still have a million and a half, we looked at our shares at this point in time as being undervalued and we'll -- depending on the marketing conditions, continue our repurchase plan.

Thank you very much.

Our next question comes from the line of Tim Beckter, Legg Mason,

I wanted to follow up on Legg Mason. the R&D issue. Where is that money being spent these days, is that primarily on Optical?

No, Tim, it's right across the board. One of the things that we feel is sort of one of the keys to our success has been that whenever we introduce a product, no matter where it is, that we do so with the intent of continually upgrading and continually working on that product with time. You just about impossible for a three or four-year-old product design in our marketplace to be competitive,, so at least a half of our activities are generating new generations for all of the different product areas that we're involved in, and we think that's the key to our being able to maintain and increase our market share with time In the new product area, yes, of course, you're right. The -- the Optical area, silent area , the [inaudible] area, the DSC [ph]area, the Net Vantive [ph] different products in the enterprise, each of these areas are continuing to receive additional development monies and we are certainly not decreasing and we have not decreased our spending in the R&D area because that's the engine of our future.

Thank you, Mark.

Our next question comes from the line of Tim Slevin, Parker Hunter.

A follow-up again on the R&D question. The uptick from Q1 to Q2, any particular color on the spending and, any particular areas that are new product related or subsequent generations or is it just a timing issue?

The uptick really wasn't that much, Tim, and, I'd be hard pressed to tell you and try to break out exactly where it was. I would say that the [inaudible] area certainly contributed some to that uptick as well as the sum of the development activities so far, international activities and markets that we really haven't discussed so far.

Okay, great. Thank you.

At this time I would like to remind everyone in order to ask a question, please press star 1 on your telephone keypad. Your next question comes from the line of Anton Wallman, Needham & Company..

Good morning, Mark and Howard, regarding [inaudible] HDSL, in particular in the international markets, Europe and to a lesser extent, South America, could you give an update on how that is progressing and also as a follow-up to that, if you also address if you think there is ever any hope or potential for any other flavor of DSL in which you would be interested in supplying given your focus in the market. For example, do you see any meaningful need, whether domestically or internationally at some point, for any asymmetric business class technology that you would be interested in being involved in, or is that going to be outside of your scope of affairs also going forward.

First off, Howard, would you answer the international question on this the SHDSL [ph].

Yes, I will, Mark. Anton, we have gotten increasingly broad acceptance of our HDSL [ph] products and the platforms from which it's deployed, particularly in the Pacific Rim arena and we have routine installations going on as we speak. And we expect that to accelerate in the current quarter. We do see our customers exploiting some of the advantages of SHDSL [ph] as well, the multi-rate capability, and we expect as we enter the next year, the two-pair solutions to be receiving some attention, which is brand new and nobody's really done much of, that yet, so we see a broad rich fabric of new business opportunities for the technology. It's proven to be robust, and well accepted. Mark, I guess the other thing was the asymmetric services.

Right, let me address that one. In the business, asymetric services as it relates to both ADTRAN and as it related to business services, number one, as it relates to business service, we think that going forward, a majority of services are going to be symmetric. However, in the smaller environments, there is going to be, of course, the asymmetric internet access. We are supplying AVSL [ph] which is the technology of choice for asymetric services as part of our Advanta [ph] series, we also have a small dish LAN which is capable, of course, of AVSL [ph], or asymmetric deployment, and that unit is used in a small footprint residential as well as primarily in the business environment also. So, we see ourselves participating more in the participating future in the asymetric world than we have in the past, however, we still don't feel it would be the major service when competing with symmetrical services going into the business environment.

Mark, final question, given the fact that you are one of the exceptionally few, almost one of the only profitable and financially strong telecom suppliers today, do you view yourselves as a potential future or in the near future, consolidator, are you looking at -- are you active in looking at pursuing some form of acquisitions given the state of the market today or are you going to be seeking to do growth predominantly generically?

Well, one of the reasons, at least one of the reasons that I can tribute to our being possible and financially sound is that we did not get overly involved in the acquisition fever that existed for a period of time ending about two years ago. Going forward, the obvious question is, with the design and revenues and the design and equity prices in capitalization of values, aren't there values out there that we would able to consolidate. I can unfortunately say at this point, we have not seen a, a crying of value of play that would fit our particular business areas. We will look but it will have to be a business opportunity that, as we believe, would be financially sound and also culturally sound because it's not going to be to anybody's advantage unless on an operating basis going forward that it would be profitable for all concerned. With that being the case, I think it's obvious that the majority of our long-term growth is going to be internal.

Good, thanks, Mark, and thanks, Howard.

At this time, there are no further questions. Please proceed with any closing remarks.

Okay, thank you, Holly. I appreciate the questions that we've had this morning from everybody. It's a pleasure to have the opportunity to talk with you. Also, it was very nice that we had the significant number of people on the conference call this morning. I appreciate you all for that and look forward to having an opportunity to go over our financial results three months from now when we discuss our third quarter results. Thank you very much for being on the call this morning.

Thank you for participating in today's conference. You may now disconnect.